CVS Caremark and I have reached an agreement under which the company adopted a by-law provision limiting the adoption of poison pills. The adopted by-law is based on a shareholder proposal to amend the company’s by-laws that I submitted for the company’s upcoming annual meeting. Following the agreement that the company and I reached, the company’s board adopted the new by-law earlier this week, and I withdrew my shareholder proposal. The amended by-laws of CVS, including the new section 8 of Article VI, were filed yesterday and are available here.

Under the new by-law provision, any extension of a poison pill plan not ratified by the shareholders must be approved by at least 75% of the members of the board of directors, and a pill not so extended will expire one year after its adoption or last such extension.

My shareholder proposal and the by-law adopted by CVS are based on a model by-law that was the subject of litigation and a court decision in the CA case, which led CA to abandon its attempt to exclude my proposal from the corporate ballot. An article about the litigation and my model by-law is available here.

CVS is the third company to adopt a by-law provision based on this model by-law. The adoption by CVS was preceded by an adoption by Disney, which adopted a version of my proposal after the proposal won 57% of the votes in Disney’s annual meeting, as well as an adoption by Bristol-Myers-Squid.

I commend the board of CVS for its adoption of the pill-limiting by-law. I hope that boards of other public companies will follow the example set by the boards of CVS, Disney, and Bristol-Myers and adopt similar by-law provisions.

I would like to thank the law firm of Grant & Eisenhofer for its valuable legal advice and legal representation in connection with my shareholder proposals in general and the pill by-law proposals in particular. I also wish to thank Spotlight Capital Management for advising me on engagement with companies.

I posted previously here on Vice Chancellor Strine’s decision in Mercier v. Inter-Tel (Delaware), Inc., and I continue to believe that it was probably the most important decision issued by the Delaware Court of Chancery in 2007. I recently wrote an article for the Securities Litigation Report discussing Inter-Tel and explaining its potential significance. In particular, Vice Chancellor Strine’s reasonableness standard in reviewing a decision to move a stockholders meeting date — if endorsed by the Delaware Supreme Court — would provide much clarity to practitioners and boards of directors. The decision is also notable for, among other things, its discussion of the roles of ISS and arbitrageurs in influencing merger votes.

The article, which originally appeared in the November 2007 issue of the Securities Litigation Report, is available here and is being reproduced with the permission of Thomson West.

Our firm has recently released a Corporate Governance Commentary providing an overview of the recent proxy rule amendments designed to encourage the use of electronic shareholder forums (for convenience, referred to as “e-forums”). The amendments were hastily adopted at a time when most of the attention was on proxy access. While the amendments were intended to benefit both companies and shareholders, it is activist investors who may be the most significant beneficiaries.

The Commentary, entitled “A Practitioner’s Guide to Electronic Shareholder Forums“, explains how the amendments facilitate the use of e-forums, and what the potential risks and benefits to companies are. It explains that for a lot of companies, e-forums may serve as an additional channel of communication with shareholders for which the companies do not have a pressing need. For companies that do decide to construct or participate in e-forums, the companies will have to be careful that the e-forums are functionally useful and are not used for launching tirades against management. Perhaps more troubling for companies, e-forums will improve the ability of hedge funds and other activist investors to mobilize.

The full Commentary is available online here.

I have just posted a forthcoming Vanderbilt Law Review article on issuer proxy access, Proxy Access in an Era of Increasing Shareholder Power: Forget Issuer Proxy Access and Focus on E-Proxy. The current draft is posted on SSRN here.

The abstract is as follows:

The current debate over shareholder access to the issuer’s proxy for the purpose of making director nomination is both overstated in its importance and misses the serious issue in question. The Securities and Exchange Commission’s new e-proxy rules, which permit reliance on proxy materials posted on a website, should substantially reduce the production and distribution cost differences between a meaningful contest waged via issuer proxy access and a freestanding proxy solicitation. The serious question relates to the appropriate disclosure required of a shareholder nominator no matter which avenue is used. Institutional investors and other shareholder activists should focus their energies on working through the mechanics of waging short-slate proxy contests using e-proxy solicitations.

Activist institutions need to work out the disclosure package required under the existing proxy rules. Such disclosure may be tested (and refined) through litigation, but a standardized package should emerge relatively quickly that the institution could use in proxy contests without a control motive. Institutional investors need to become facile with the e-proxy model (including coordinating a practice for opting-in to web-access) and should appreciate the extent to which proxy advisory services will do much of the actual solicitation work. If institutions are unwilling to make the relatively modest investment to master the mechanics of e-proxy contest, both in their initiation as well as voting in support of them, then their role in corporate governance will necessarily be limited.

With my co-authors Reena Aggarwal (Georgetown), Isil Erel (Ohio State) and Rohan Williamson (Georgetown), I have recently completed a revision of the paper “Differences in Governance Practices between U.S. and Foreign Firms: Measurement, Causes, and Consequences.” The paper is available at SSRN. The paper is now forthcoming at The Review of Financial Studies. The paper shows that foreign firms invest less in firm-level governance and that this lower investment is associated with lower valuations.

Using the well-known definition of Shleifer and Vishny (1997), governance consists of the mechanisms which insure that minority shareholders receive an appropriate return on their investment. Governance depends both on country-level as well as firm-level mechanisms. The country-level governance mechanisms include a country’s laws, its culture and norms, and the institutions which enforce the laws. Firm-level or internal governance mechanisms are those that operate within the firm. Firm-level governance mechanisms that increase the power of minority shareholders to receive a return on their investment are costly, so that the adoption of such mechanisms by a firm is an investment. The payoffs from that investment differ across countries and across firms.

The U.S. is recognized to have extremely high financial and economic development, to have strong investor protection, and to protect property rights well. Consequently, we would expect the internal governance of firms in the U.S. to come as close as possible to what the optimal internal governance of a firm would be in a foreign country if it were not constrained by weaker institutions and lower development than in the U.S. The internal governance of firms in the U.S. therefore provides a benchmark that can be used to evaluate the impact of different institutions and different development from the U.S. on governance choices and, through these choices, on firm value.

On theoretical grounds, it is not clear whether the characteristics of the U.S. make firm-level investment in governance mechanisms that increase the power of minority shareholders more or less advantageous for U.S. firms relative to firms from countries which do not have the same high level of development and investor protection. One possibility is that foreign firms would invest less in firm-level governance if they were in the U.S. because firm-level governance and country-level investor protection are substitutes. An alternative possibility is that investment in firm-level governance is less productive in countries with poor economic development and weak investor protection than it is in the U.S., implying that firm-level governance and investor protection are complements.

We find strong evidence that foreign firms invest less in internal governance mechanisms that increase the power of minority shareholders than comparable U.S. firms do. In other words, investment in firm-level governance is higher when a country becomes more economically and financially developed and better protects investor rights. Further, to the extent that institutional and development weaknesses reduce a foreign firm’s investment in corporate governance compared to a U.S. firm, we would expect the value of the foreign firm to be lower. As expected, we find that the value of foreign firms is negatively related to the magnitude of their governance investment shortfall relative to U.S. firms.

To conduct our investigation, we need information about firm-level corporate governance attributes that increase the power of minority shareholders for a large number of firms across a large number of countries and we would like individual governance attributes to be assessed similarly across all these firms. We use the corporate governance attributes recorded by Institutional Shareholder Services (ISS). By doing so, we can analyze 44 common governance attributes for 2,234 non-U.S. firms and 5,296 U.S. firms covering 23 developed countries. We create a governance index making sure that the governance attributes included are relevant both for U.S. firms and foreign firms. We call it the GOV Index.

To evaluate the governance a foreign firm would have if it were in the U.S., we use a propensity score matching method in order to match each foreign firm with a comparable U.S. firm. We then show that foreign firms generally have a lower GOV index, so that they give less power to minority shareholders, than if they were U.S. firms. We define the governance gap to be the difference between the governance index of a foreign firm and the governance index of a comparable U.S. firm. A firm with a positive governance gap has a higher value of the GOV index than its matching U.S. firm. Only 12.7% of foreign firms have a positive governance gap. Strikingly, 86.1% of these firms come from Canada and the U.K., so that firms from countries with similar investor protection as in the U.S. are the ones that are the most likely to invest more in governance than comparable U.S. firms. Such a result is inconsistent with the hypothesis that investor protection and internal governance mechanisms are substitutes.

Having compared the governance of foreign and U.S. firms, we turn to the question of whether the governance gap helps explain a firm’s valuation. We find that the value of foreign firms is increasing in their GOV index. More importantly, perhaps, the lower the GOV index of a foreign firm compared to its matching U.S. firm, the lower the value of that foreign firm. We find that this result holds controlling for firm characteristics known to affect q and controlling for the endogeneity of the choice of governance mechanisms.

If firm-level governance is more costly for foreign firms than for U.S. firms, we expect that the foreign firms comparable to the U.S. firms that benefit the most from investing in internal governance will find it optimal to invest less in governance than matching U.S. firms do and will suffer a loss of value as a result. We can therefore use regression analysis to investigate whether a foreign firm’s q is negatively related to the governance index value it would have in the U.S. We find that this is the case. Such a coefficient is not subject to an endogeneity bias because we are measuring the governance of a U.S. firm and the valuation of a foreign firm.

In addition to investigating the value relevance of differences in the aggregate governance index between foreign firms and comparable U.S. firms, we also consider the value relevance of specific governance provisions. We focus on provisions that have attracted considerable attention in the literature and among policymakers. We find that firms that have an independent board, auditors that are ratified annually, and an audit committee comprised solely of outsiders, have a higher value when their U.S. matching firm has these governance attributes. In contrast, neither board size nor separation of the chairman and CEO functions are value relevant.

As indicated in a recent Harvard Law School announcement, statistics released by the Social Science Research Network (SSRN) indicate that, as of the end of 2007, the works of Harvard Law School’s corporate governance scholar Lucian Bebchuk have been downloaded more than the work of any other law professor. His papers have attracted a total of more than 80,000 downloads.

SSRN is the leading electronic service for social science research, and its electronic library contains over 171,000 full-text documents by more than 85,000 authors.

The five works by Bebchuk that have attracted the largest number of total downloads were: What Matters in Corporate Governance? (8093 downloads), The Case for Increasing Shareholder Power (3827 downloads), A Theory of Path Dependence in Corporate Ownership and Governance (3517 downloads), Executive Compensation as an Agency Problem (3336 downloads), and Managerial Power and Rent Extraction in the Design of Executive Compensation (2980 downloads).

The group of the top 100 law professors, based on the total number of downloads of their work, includes three additional HLS faculty working in the corporate area: Reinier Kraakman (13), Mark Roe (32), and Allen Ferrell (41). The Top 100 group also includes senior research fellow Alma Cohen (40) and visiting professor Jesse Fried (23).

For the subset of the 350 companies that were both reviewed by the SEC’s Division of Corporate Finance as part of the executive compensation review project and have received one of these “all clear” letters from the Staff, you will soon find the SEC comment letter and the company response posted on the SEC’s EDGAR system. It looks like the Staff hung pretty close to the timeline of “45 days since the Staff started informing companies that they were clear,” which is earliest that the Staff can post letters/responses pursuant to its own policy (which was confirmed in the Staff Observations in the Review of Executive Compensation Disclosure). I just took a cursory swing through the SEC’s database over the weekend and found these:

- Allstate - comment letter and response

- Bristol Myers - comment letter and response

- Berkshire Hathaway - comment letter and response

- Travelers Companies - comment letter and response

There’s about 50 more out there and we’ve posted a more comprehensive list on CompensationStandards.com in a new “SEC Comments” Practice Area. Hopefully, somebody can prove me wrong - but it’s quite challenging to run searches on the SEC’s comment letter database - as well as the third-party providers’ databases - to find these letters. The good ole boolean-type searches don’t seem to work for these particular batch of letters…

(Editor’s Note I: As the hit counter on the right hand side of this blog indicates, our Harvard Law School Corporate Governance Blog crossed the 1-million-hits mark this past weekend. We express our appreciation to all contributors and to our readers.)

(Editor’s Note II: The post below comes to us from Byron Georgiou and Joseph D. Daley at Coughlin Stoia Geller Rudman & Robbins LLP.)

On Thursday, January 17, a Seventh Circuit Court of Appeals panel led by Judge Richard A. Posner handed down the Circuit’s second crack at the “strong inference” standard in the Tellabs matter. Makor Issues & Rights, Ltd. v. Tellabs, Inc., __ F.3d __, No. 04-1687, 2008 U.S. App. LEXIS 975 (7th Cir. Jan. 17, 2008). This latest Tellabs opinion (“Tellabs II”) arose out of a “comeback” case for the Seventh Circuit, following the United States Supreme Court’s June 2007 rejection of the Circuit’s initial attempt to divine the Securities Exchange Act of 1934’s “strong inference” of scienter requirement, as amended by the Private Securities Litigation Reform Act of 1995 (“PSLRA”). See Tellabs, Inc. v. Makor Issues & Rights, Ltd., ___ U.S. ___, 127 S. Ct. 2499 (2007) (vacating and remanding Makor Issues & Rights, Ltd. v. Tellabs, Inc. (“Tellabs I”), 437 F.3d 588 (7th Cir. 2006)).

By way of background, the Tellabs saga involved a manufacturer of specialized fiber-optic equipment which, along with several of its top officers, was accused of securities fraud by investors. After repeatedly providing optimistic reassurances in late 2000/early 2001 about the company’s financials, projected revenues/earnings, and demand for its main products, the bombshell, contradictory truth burst in mid-2001: the fiber-optics bubble had already burst in the prior year, purported demand for Tellabs’s core products was actually a sham, and the company’s revenues and profits were plummeting. Not surprisingly, Tellabs stock fell from its class-period peak of $67 to just under $16, and outraged investors filed suit.

Following the district court’s dismissal of the investors’ securities-fraud complaint, the Seventh Circuit reversed in part and held that the investors had met the “strong inference” of scienter standard by alleging facts “from which, if true, a reasonable person could infer that the defendant acted with the requisite intent.” (While stating that holding, the Seventh Circuit explicitly rejected a more-stringent standard that had been adopted by the Sixth Circuit – i.e., that plaintiffs’ inferences had to be more plausible than any competing inferences. Cf. Fidel v. Farley, 392 F.3d 220, 227 (6th Cir. 2004) (PSLRA’s heightened pleading requirements mean that “‘plaintiffs are entitled only to the most plausible of competing inferences’”)).

Granting certiorari, the Supreme Court rejected both views: While the scienter inferences in plaintiffs’ favor need not be irrefutable, or even the most plausible of competing inferences, nor will they suffice if merely “‘reasonable’ or ‘permissible.’” Plaintiffs satisfied the PSLRA’s strong-inference requirement “only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.”

On remand to the Seventh Circuit, the Tellabs II panel applied the Supreme Court’s newly enunciated standard. Judge Posner’s opinion is wide-ranging, to be sure, but within its wide expanse there are several gems that are sure to provoke a flurry of supplemental briefing in securities-fraud cases around the country. (Oddly, on the case’s remand the Tellabs II panel was composed of just two of three Circuit judges from Tellabs I; Judge Posner replaced Judge Ripple.) In no particular order, here are several – albeit not all – of the conclusions that Tellabs II reaches concerning strong-inference factors:

…continue reading: Tellabs redux

(Editor’s Note: This post comes to us from Lesley Rosenthal of Lincoln Center.)

The recent governance crisis at the Smithsonian Institution came about through a toxic combination of unchecked arrogance by the CEO, a relatively disengaged Board, and a dysfunctional system of checks and balances. The Smithsonian appointed an independent review committee to take an unflinching look at corporate governance practices there. “How Not to Govern,” which was published in the New York State Bar Journal (Nov/Dec 2007) by Lincoln Center’s General Counsel Lesley Friedman Rosenthal (HLS ‘89), discusses the independent committee’s findings and explores the lessons that may be learned by others in the sector, including chief executives, General Counsel, Corporate Secretaries, board members, outside attorneys, and scholars.

(Editor’s Note: This post comes to us from J.W. Verret.)

(The text of this post summarizes the author’s analysis from an article titled Dr. Jones and the Raiders of Lost Capital: Hedge Fund Regulation Part II, A Self-Regulation Proposal, which will be published in volume 3 (2007) of the Delaware Journal of Corporate Law.)

In 2003, The Securities Exchange Commission instituted a regulation requiring certain hedge funds, previously unregulated, to register as Investment Advisers. That regulation would have meant that funds would have become subject to an intense compliance inspection program. The SEC’s stated goals in instituting this proposal were to minimize instances of fraud perpetrated by hedge funds. Critics of hedge fund registration, such as former Fed Chairman Greenspan, urged that over-regulating hedge funds could mean stifling the liquidity that these funds bring to the securities markets. Other critics argued that hedge funds may have simply moved offshore to avoid the regulation. In the summer of 2006, the District of Columbia Court of Appeals invalidated the 2004 registration provision in Goldstein v. SEC. Since that time, the House Committee on Financial Services, chaired by Rep. Barney Frank, has held hearings into hedge fund regulation. The Administration has announced its intention not to support a further regulatory effort. Though the branches of government are currently at odds, this issue is not likely to go away, especially if Congress and the Executive branch are controlled by the Democratic Party after the ‘08 elections.

In the last ten years, nearly 2 trillion investment dollars have flowed into an industry that found itself at the center of a mutual fund fraud investigation in 2004 and now has a starring role in the subprime lending crisis. Anticipating future regulatory efforts, this article intends to design a regulatory scheme that is more effective and less costly than the SEC’s invalidated registration requirement to provide regulators with an alternative to satiate the desire to “do something” in response to eventual interest group pressure. Self-Regulation is a prominent theme in our capital markets. The NASD and NYSE, now merged to form the FINRA, have long regulated member firms and broker dealers. The Federal Reserve is effectively a quasi Self-Regulatory Organization (”SRO”), with member banks nominating the Regional Presidents. One wonders why the idea of self-regulation in the hedge fund industry has not been previously explored as a viable compromise between the existing extreme views on this topic. Bureaucratic regulators are notoriously slow to innovate their approach, especially when compared to the pace of change in the financial markets, but self-regulators are closer to the front lines. In addition, self-regulatory entities are more sensitive to compliance costs. Even in choosing between equally effective regimes, bureaucratic regulators may, however, have incentives other than cost in mind due to heuristic bias that overemphasizes the risk of scandal or the budgetary allocations that come with enhanced regulatory power.

Economic competition theory also supports self-regulation, as a properly structured SRO creates internal competition among market players which results in decision outcomes that are preferential to direct government oversight. A prisoner’s dilemma can result from the regulation game facing the SRO rulemaking body, in which funds would seek to take capital investments from competitors by voting within the SRO for regulations that enhance transparency of a fund’s fiduciary compliance, out of an interest in taking capital flows from competitors who may not. The result is an equilibrium of compliance that could exceed the level of transparency that would exist without the collective action, thus giving more sharpness and binding effect to any best practices that may exist in the industry and providing a more cost effective enforcement avenue for those best practices. The beauty of this approach is that, unlike the SEC, the SRO internalizes the cost of the regulation. The payoffs to decisions on voting for disclosure regulation are based on revealing things of value to hedge fund investors, so the SRO only increases regulatory cost up to the point at which the new regulation is of such a large marginal value to hedge fund investors that they are likely to decide to switch funds if their fund is revealed as being non-compliant.

…continue reading: A Self Regulation Proposal for the Hedge Fund Industry

(Editor’s Note: This post comes to us from Holly J. Gregory and Ira M. Millstein of Weil, Gotshal & Manges LLP.)

We have just released our annual memo identifying areas for focus by corporate governance participants in the coming year: “Rethinking Board and Shareholder Engagement in 2008″ (co-authored with our colleague Rebecca C. Grapsas). In the memo, we predict — and encourage — increased efforts by boards of directors to engage shareholders in less contentious, more cooperative interaction and communication. While we salute shareholder activism’s stimulus for rebalancing corporate power in the past twenty years, we caution that the forces for change should abate once an appropriate balance is achieved, or a new imbalance will result. Boards are well-advised to be open to shareholder communications on topics that bear on board quality and attention to shareholder value, communications that are likely to improve mutual understanding and avoid needless confrontation.

At the same time, shareholders have the responsibility to act as concerned and rational owners who make decisions based on knowledge of the nuances; who avoid rigid, box-ticking methods of judging good governance; who don’t abdicate to proxy advisors their responsibility to use judgment; and who avoid activism for activism’s sake. In this spirit, we lay out good practices of board-shareholder engagement in the areas of (1) board composition and independent leadership, (2) corporate performance disclosures, (3) executive performance, compensation and succession, (4) strategic direction, and (5) societal concerns, including climate change and other issues. Finally, we suggest that it may be time for a dialogue on the limits of shareholder power. The full text of the memo is available here.

a) The Supreme Court’s Stoneridge decision has received a lot of attention. On this blog, it was summarized here and commented on here. For those who know this Court and who heard the oral argument, the decision is unsurprising. Justice Kennedy’s opinion, however, is broader than necessary to reach the result. He is telling the lower courts, ‘Don’t mess with my Central Bank decision. Most of us up here don’t like implied private rights of action and we’re not going to let the lower courts find ways to expand them.’

Kennedy’s opinion does give plaintiffs some hope. Following the Solicitor General’s brief, the Court does say that non-verbal conduct can be fraud and thus “a wink and a nod” can still get secondary actors in trouble. What is clear is that this Court, like many thoughtful academics, has become highly skeptical of the honesty, cost effectiveness and real value to investors of our class action litigation system. The greed and sleazy ethics of some of the “private attorneys general” of the plaintiffs bar have put the whole class action system in disrepute. A majority of living former SEC Chairmen and a number of other former Commissioners and former academics had filed an amicus curiae brief in the case supporting the decision reached by the Supreme Court on Tuesday. The brief was prepared by colleagues of mine, whose summary of the case can be found here.

b) I’m also posting another too little noticed speech by Cox, delivered a month ago in Washington, in which he discusses the growing concerns with the role of sovereign wealth funds and government-affiliated public companies in global securities markets and the impact of such government-related concentrations of capital, and related market influence, on corporate ethics and policy, transparency and the integrity of financial reporting. What about the values of corporate governance, and shareholder power, when the controlling interest or “golden share” is held by a government, particularly a government that itself does not practice transparency or tolerate democracy as we know it?

This post is a call for papers for the annual meeting of the American Law and Economics Association. The meeting, which is expected to include at least 8 sessions on subjects in the corporate field, will take place this spring at Columbia Law School on May 16-17, 2008. The meeting will bring together researchers from law schools, economics departments, business schools, and elsewhere to present and discuss current projects on a wide range of topics in the field of law and economics. The conference is expected to have two or more sessions in each of the following areas of the corporate field: Corporate Law and Corporate Governance: Policy and Theory; Corporate Law and Corporate Governance: Empirical; Corporate and Securities Law: Comparative and International; and Securities Regulation, Financial Institutions, and Capital Markets Regulation.

Authors are invited to submit their papers electronically at the Association’s website. This website also includes further information about the submission process and the meeting, as well as about prior meetings of the Association. The deadline for submission of papers is Monday, January 28, 2008. For readers interested in attending the meeting, we will post the program in several weeks.

(Editor’s note: We have already posted a summary of the decision here.)

By now the holding in Stoneridge has become well known and widely discussed, including on my site, The Race to the Bottom.    The five justices concluded that Section 10(b) and Rule 10b-5 did not extend to vendors.  In reading the opinion, the analysis is reminiscent of Bush v. Gore, a decision that is better understood as a political rather than a legal statement.  

The majority was mostly influenced by its view of the appropriate method of enforcing the securities laws.  In the majority’s view, there is no real room for private enforcement, at least under Section 10(b) and Rule 10b-5.  Lacking the temerity (and the votes, no doubt) to eliminate the cause of action altogether, the Court simply announced that the guiding principle for interpreting the antifraud provisions would be no “expansion.”

As a practical matter, that means that common law principles will not control.  See Stoneridge, at 11 (“Section 10(b) does not incorporate common-law fraud into federal law.”).  Similarly, the intent of Congress doesn’t matter.  As Justice Scalia is often quick to point out, the best way to discern congressional intent is through textual analysis of the statute.  But other than quoting the statute at the beginning of the legal analysis, the Court engaged in no meaningful effort to make the opinion turn on the language of Section 10(b). 

Then what was the basis for the decision?  “Concerns with judicial creation of a private cause of action caution against its expansion.”  Note the passive nature of the sentence.  Who is concerned?  For purposes of statutory construction, the only one whose concern matters is Congress.  But in fact the authority cited by the majority for the proposition is an isolated sentence from Virginia Bancshares that makes the unremarkable point that “as a general matter” an action under the antifraud provision shouldn’t “grow beyond the scope congressionally intended”.  In other words, the Court cited no authority for the proposition and certainly didn’t demonstrate that the “concerns” emanated from Congress. 

This is because the “concerns” are those not of Congress but of the majority on the Supreme Court.  Legislation by the Court, in other words.  The Court’s legislative efforts to restrict private law suits will have consequences, most likely pushing enforcement away from the civil arena to the criminal authorities.  See Stoneridge, at 15 (”Secondary actors are subject to criminal penalties”.)  But that is a topic for another day. 

On Tuesday, the U.S. Supreme Court handed down its long awaited decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. __ (2008). The decision affirms the Supreme Court’s tendency to limit implied rights of action under the securities laws. Specifically, the Supreme Court rejected the concept of “scheme liability” and refused to grant a private right of action against third parties for entering into transactions with the issuer even if they knew that the issuer’s accounting treatment of these transactions would be fraudulent. Some of my partners have prepared a short summary of the decision, which is available here.

“Constituency director” is a somewhat unfamiliar term in the corporate lexicon for public companies. Perhaps even less familiar, in terms of corporate law and corporate governance, is the status of a “constituency director” vis-à-vis the duty of loyalty and traditional fiduciary duty; specifically, is it different than time-honored expectations imposed upon a typical director serving on the board of a public company?

What is a “constituency director”? We deal here with public company directors whose board membership is attributable to one or more particular constituencies, such as a director whose board election is (or would seem to be) otherwise traceable to a recognizable voting constituency or “sponsor”. [nota bene: this commentary is focused upon – and limited to – the public company environment, for private company situations will often present understandably different considerations (e.g., the family corporation).] Classic examples would include parent company executives serving on the board of a majority-owned subsidiary that is still a public company and union representatives serving on the board pursuant to a collective bargaining agreement. Other examples would typically be (i) private equity or venture capital representatives continuing on the board of the enterprise, after it has again become a public company, until their firm’s investment has been completely liquidated, (ii) directors elected by a separate class of securities (such as a preferred) entitled to board representation so long as that class of securities is outstanding, and (iii) family board members (with significant equity ownership – directly or in family hands) continuing their directorships after their privately-held family enterprise becomes a public company.

…continue reading: The Constituency Director

Our Blog, which was founded just 13 months ago, has experienced tremendous growth over this period. Traffic increased more than tenfold during 2007, reaching 144,431 hits in December. Altogether, the Blog received 874,622 hits during 2007. We featured some 191 posts during the year, covering a wide range of subjects.

A chart of the traffic to our Blog, depicting our exponential growth during 2007, is displayed below:

We are grateful to the many readers who have visited, commented, and published on our Blog. We also thought this would be a good opportunity to remind readers that you can easily sign up to receive email announcements on our new posts. To sign up, just follow these steps:

1) Go to http://blogs.law.harvard.edu/corpgov/announcements/.

2) Look for “To have email updates sent to you each time a new post is added to the Corporate Governance Blog”, and click the “here” link.

3) You will be redirected to our signup page, located here: http://www.feedblitz.com/f/?Sub=186216.

4) To start your free subscription, just provide your email address and click “Subscribe”.

5) You are now signed up, and will receive an email update when we add a new post to the Blog.

We would also like to thank the Corporation Service Company for its support of the Blog’s activities.

Recently, the New England Chapter of the National Association of Corporate Directors hosted a breakfast panel featuring Vice Chancellor Leo E. Strine, Jr. and Martin Lipton of Wachtell Lipton Rosen & Katz. (John L. Reed of Edwards Angell Palmer & Dodge previously posted on the talk here.)

The NACD has released highlights of the talk, entitled The Delaware Courts, the Corporate Bar, and Being a Director. The summary describes the panelists’ insights on the upcoming proxy season, executive compensation, the committee structure in today’s boards, and the role of independent directors.

The highlights of the panel discussion are available online here.

Professor J. Robert Brown of the University of Denver College of Law (and a Guest Contributor on this Blog) recently provided a “Top Five” list of Delaware cases that–in his view–show why Delaware is “anti-shareholder and anti-plaintiff.” I realize that there are many experts who can rebut the professor’s arguments far more persuasively than I, and I am well aware that the Delaware bench certainly does not need my help to defend it.

Nonetheless, having just completed my review of key 2007 Delaware corporate decisions, I offer my own “counter-list” of the Top Five Cases of 2007 that show that the Delaware courts take shareholder rights and director duties very seriously. I could easily provide a longer list–but, for starters, here is an alternative list of the Top Five Delaware Cases of 2007.

Recently, in Reinier Kraakman’s Corporations course here at Harvard Law, Justice Jack B. Jacobs of the Delaware Supreme Court treated students to a highly insightful talk on Delaware’s Takeover Law. Justice Jacobs’s talk provided a rare insider’s perspective on the evolving standards of international takeover law–and the Delaware cases that govern most American acquisitions.

Justice Jacobs gave a detailed analysis of the institutions that regulate takeovers in the United Kingdom, continental Europe, and elsewhere, providing fascinating context for the relative dominance of the common law in Delaware. In the course of his talk, Justice Jacobs noted that the choice among regulatory institutions has had critical, and often overlooked, implications for the substantive approach to takeovers in each jurisdiction: the importance of defenses, the role of directors, and the rights of shareholders. The discussion also provides a striking perspective on Delaware’s leading takeover cases and their relevance to contemporary merger practice.

An audio recording of Justice Jacobs’s talk is available online here.

On December 21, 2007, Chancellor William B. Chandler issued his post-trial opinion in United Rentals, Inc. v. RAM Holdings Corp. The suit, which has been closely monitored by members of the M&A bar and the business press, sought specific performance of a merger agreement whereby Cerberus (through wholly-owned subsidiaries known as “RAM”) would have acquired United Rentals (”URI”) for $34.50 per share in cash. As described by the court, “the dispute between URI and Cerberus [was] a good, old fashioned contract case prompted by buyer’s remorse.”

Nearly four months after agreeing to acquire URI on July 22, 2007, RAM sent URI a letter advising that it was not prepared to proceed with the acquisition on the original terms, but was willing to re-negotiate the price or simply pay URI a $100 million “reverse” termination fee to walk away from the deal. The central issue in the case was whether two terms of the merger agreement– section 9.10 (entitled “Specific Performance”) and section 8.2(e) (entitled “Termination, Amendment and Waiver”)–provided URI with the right to seek specific enforcement of the deal, or whether RAM had the ability to walk away from the deal upon payment of the $100 million termination fee.

Section 9.10 expressly invested URI with a right to seek specific performance. However, section 9.10 explicitly states that it is “subject in all respects to section 8.2(e) hereof, which Section shall govern the rights and obligations of the parties . . . under the circumstances provided therein.” Section 8.2(e) describes the $100 million termination fee payable to URI as the “sole and exclusive” remedy against RAM under the merger agreement in the event of a termination; and, critically, further stated that:

In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall [RAM or Cerberus] . . . be subjected to any liability in excess of the [termination fee] for any or all losses or damages relating to or arising out of this Agreement or the transactions contemplated by this Agreement, . . . and in no event shall [URI] seek equitable relief or seek to recover any money damages in excess of such amount from [RAM or Cerberus].

URI contended that specific performance under section 9.10 remained a viable remedy despite the language of section 8.2(e), in part because the $100 million termination fee was the “sole and exclusive” remedy only in the event of a “Termination” (as defined in the merger agreement) and not a breach of the agreement. In contrast, RAM argued that because section 9.10 is “subject in all respects to section 8.2(e)”, the terms of section 8.2 control, and effectively nullify any right to specific performance that may have been authorized by section 9.10.

The Court held that the meaning of the provisions was ambiguous, and thus denied a motion for summary judgment filed by URI (calling it a “close call”). The parties proceeded to a two-day trial where extrinsic evidence (including the negotiating history between the parties and their respective advisors) was extensively scrutinized by the Court.

…continue reading: Chancery Declines to Require Specific Performance in a Case of Buyer’s Remorse

Cross-border M&A nearly doubled from 2006 to 2007 as a percentage of total activity, and some observers see it as the savior of 2008. Here is a quick checklist of critical issues for US/non-US deals.

And sometimes less really is more: here is a one-pager on M&A in 2008.

Recently, in the Mergers, Acquisitions, and Split-Ups course here at Harvard Law, co-taught by Professor Robert Clark and Vice Chancellor Leo Strine, Jr., practitioners from three major hedge funds gave a fascinating talk on the complex legal matters facing funds that take activist positions in publicly traded companies. The panel discussion, entitled Hedge Fund Activism, provided considerable practical insight on the range of regulatory, competitive, and political issues a fund manager must consider before participating actively in a contested election.

The panelists, including William Ackman and Roy Katzovicz of Pershing Square Capital, Sy Lorne of Millennium Partners, and Robert Knapp of Ironsides Partners, emphasized the regulatory risks hedge fund activists face–especially the antitrust and securities issues raised when a fund enters a proxy fight. The talk also addressed the effects of public perception of hedge funds and increased use of derivatives on fund activism. In addition, the panelists shared their insights on the complex voting issues that inevitably arise in a closely contested election–including which shareholders should have been entitled to vote, and which party should have prevailed.

A video of the discussion can be accessed online here.

Our firm has recently released a new M&A Commentary providing strategic analysis of the increasingly common phenomenon of shareholder resistance to the terms of proposed acquisitions. The Commentary, entitled Shareholder Pushback on M&A Deals, explains how several high-profile mergers were rebuffed by shareholders in 2007–including Carl Icahn’s attempted purchase of Lear.

The Commentary emphasizes the importance in this environment of obtaining a positive recommendation from ISS, and of the board’s flexibility in the timing of the shareholder merger vote under Mercier v. Inter-Tel. Where those strategies fail, however, the Commentary points out that acquirers may wish to reconsider the once-dominant two-step tender approach. The Commentary concludes:

“Although the risk of shareholder pushback against announced M&A deals may be receding as the M&A market softens, it is not going away. In light of this added execution risk, parties negotiating a merger should structure the transaction to minimize it to the extent feasible. One readily available way to do this is to use a two-step transaction structure consisting of a tender offer followed by a merger, instead of a traditional one-step merger. The two-step transaction was at one time the prevailing deal structure, and it should become so again.”

The full Commentary is available online here.

Recently, in the Mergers, Acquisitions, and Split-Ups course here at Harvard Law, co-taught by Professor Robert Clark and Vice Chancellor Leo Strine, Jr., two expert practitioners shared their insights on the complex cross-border transactions that increasingly define the M&A landscape. While the panelists provided guidance on the economic reasoning underlying cross-border deals, the discussion also featured fascinating perspectives on the social and political considerations that accompany most major international mergers.

The panelists included Richard Hall of Cravath, Swaine & Moore along with Scott V. Simpson of Skadden, Arps, Slate, Meagher & Flom, each of whom have served as counsel on some of the largest cross-border deals ever to close. The panelists took students through case studies of two recent cross-border deals that illustrate the sensitive issues that corporate counselors face in a major international merger: Mittal Steel’s acquisition of Arcelor, and Basell’s acquisition of Huntsman. The panelists offered an insider’s view of the negotiations in both transactions–and the social and political matters that inevitably arise when a foreign acquirer pursues a large target.

A video of the discussion can be accessed online here.

(Editor’s Note: This post comes to us from Jie Cai and Ralph A. Walkling of Drexel University.)

We have recently released a new paper entitled Shareholders’ Say on Pay: Does it Create Value? The paper examines stock returns around the time of the passage of the Say on Pay Bill in the House of Representatives in search of evidence whether the market views the legislation as creating value. The Abstract of the piece follows:

The post Sarbanes-Oxley Act period is associated with several initiatives designed to give shareholders a greater voice in the boardroom. The latest of these initiatives is the Say-on-Pay Bill (H.R. 1257) which passed the House of Representatives on April 20, 2007 by a 2 to 1 margin. This bill does not limit CEO pay but requires an advisory shareholder vote on executive compensation packages. Using the abnormal return of 1,245 firms surrounding the House passage of this bill, we examine whether the market interprets shareholders’ say on executive pay as adding or subtracting firm value. Stocks of firms with positive abnormal CEO compensation react in a significant, positive manner to the Say-on-Pay Bill. The positive market reaction is stronger among the firms with weaker, but not the weakest governance. In addition, abnormal returns are higher in the subset of firms more likely to receive higher disapproval votes from shareholders and firms more likely to implement changes under the pressure of shareholder votes. Thus, the bill has the greatest impact among the subset of firms most likely to benefit and implement changes. Given the uncertainty surrounding passage, implementation and efficacy of this proposed advisory vote, the results are likely to understate the actual impact of Say on Pay legislation. Our findings suggest that the market views this legislation as value-creating for the companies where it is likely to have the most impact. These results provide important evidence for the current debate regarding the Say-on-Pay legislation in Congress and shareholder access to proxy. Our results also shed light on the role of activist investors.

The full Article is available for download here.

Recently, the Mergers, Acquisitions, and Split-Ups course here at Harvard Law School, co-taught by Professor Robert Clark and Vice Chancellor Leo Strine, Jr., hosted a fascinating talk by Martin Lipton of Wachtell, Lipton, Rosen & Katz, entitled The Future of M&A. The audience was treated to a rare glimpse of the events that have shaped mergers for a generation through the eyes of one of the principal architects of modern corporate law.

The talk began with an intimate history of the developments that led to the conception of modern merger defenses. The students were treated to the definitive account of the development of the shareholder rights plan–more widely known as the “poison pill”–as well as the strategy that led to the successful defense of those measures before the Delaware courts. Questions from the audience led to an insightful discussion of changes in modern corporate governance–including shareholder activism, the increased presence of independent directors, and the prominence of private equity–and their effects on merger practice. The talk closed with an insider’s view on recent developments likely to shape merger practice in 2008 and beyond.

A video of the discussion can be accessed on the Program on Corporate Governance website here. The materials used in the presentation can be downloaded here.

Unfortunately, my friend Lynn Turner prefers invective to analysis. From his comments, I see no evidence that he has in fact read the Second Circuit’s AFSCME v. AIG decision, Chairman Cox’s statement, or the interpretive rule actually adopted by the Commission on November 28.

Lynn states that Chairman Cox should have “voted with” departing Commissioner Nazareth on November 28. That would have produced a deadlock and resulted in no Commission position at all in response to the Second Circuit panel opinion. While those who love the playground of press releases and posturing, and have no current responsibility to administer the laws, might think such an abdication was just the right thing, Chairman Cox and the Commission majority chose to take their responsibilities seriously.

Lynn and the other constantly carping critics will be eating crow next Spring when Cox, with two new Democratic Commissioners in place, puts proxy access back on the agenda and again seeks consensus. If Lynn and other vocal activists really wanted proxy access, they would begin working with Chairman Cox and Corporation Finance Director White now to develop a proposal that could garner majority Commission support.

It appears that instead the critics and their academic enablers prefer to glorify those who have left the field and aim demagogic attacks at the Chairman. Great press . . . but no proxy access for another two proxy seasons. That’s nothing to brag about.

The Program on Corporate Governance has recently issued as a discussion paper my piece, co-authored with Zvika Neeman, entitled Investor Protection and Interest Group Politics. We develop in this paper a framework for analyzing how interest group politics influence investor protection levels. Our analysis identifies factors that impede desirable corporate governance reforms, and can help explain the ways in which investor protection levels vary around the world and over time. The abstract of the paper is as follows:

We model how lobbying by interest groups affects the level of investor protection. In our model, insiders in existing public companies, institutional investors (financial intermediaries), and entrepreneurs who plan to take companies public in the future, compete for influence over the politicians setting the level of investor protection. We identify conditions under which this lobbying game has an inefficiently low equilibrium level of investor protection. Factors that operate to reduce investor protection below its efficient level include the ability of corporate insiders to use the corporate assets they control to influence politicians, as well as the inability of institutional investors to capture the full value that efficient investor protection would produce for outside investors. The interest that entrepreneurs (and existing public firms) have in raising equity capital in the future reduces but does not eliminate the distortions arising from insiders’ interest in extracting rents from the capital public firms already have. Our analysis generates testable predictions, and can explain existing empirical evidence, regarding the way in which investor protection varies over time and around the world.

The full paper is available for download here.

It appears Mr. Olson is sadly uninformed when–in my opinion–he inappropriately labels former Securities and Exchange Commissioner Roel Campos as a “villain” for his role in the SEC rulemaking on proxy access.

Indeed, after the Second Circuit’s decision in AIG, it was Commissioner Campos who brought various parties together in an attempt to bridge the gap that existed between investors and management. Unfortunately, this issue had taken on an emotional, almost fundamentalist tone driven more by political ideals than by common sense. When battle lines were drawn and after the SEC proposed two different rules last summer, I attended a conference at which Commissioner Campos publicly spoke out against both proposals, a stance most investors agreed with. It was a view expressed constantly in thousands of comment letters investors sent to the SEC, only to find their voices falling on deaf ears and their views ignored. Campos also urged the SEC to leave things as they stood after the Second Circuit’s decision, as that was truly best for both sides in this heated debate.

By passing the non-access rule, three of the four current Commissioners have only served to increase the likelihood of open warfare, and perhaps litigation, between shareholders and management. As Chairman, Christopher Cox had the simple choice whether to bring proxy access to a vote or not, and then he alone had the choice as to how he would vote. Indeed he was very decisive when he chose to bring the issue to a vote, and then voted for non-access. He unequivocally made his views on shareholder access very clear. While he speaks of favoring access for investors, his actions speak much louder than any spoken words, and show that he truly opposes shareholders receiving equal rights and access with management to the proxy. Even if Roel Campos had continued as Commissioner, the end result under the current Commission would not have changed. Cox had the chance to vote with Commissioner Nazareth and made his own decision not to. That is a fact beyond argument.

…continue reading: Heroes and Villains

(Editor’s Note: A version of this article appears in the current issue of Directorship.)

We deal here with one of the more challenging provisions of the Sarbanes-Oxley Act of 2002, referred to by some as “SarbOx.” Specifically, section 407 of that Act requires public companies to disclose in their annual reports to the Securities and Exchange Commission, pursuant to an implementing SEC regulation, whether their audit committees include a financial expert–and if not, why not.

SarbOx spells out a complex schema for a financial expert’s qualifications. According to the statute, an expert is expected to have (1) an understanding of (i) generally accepted accounting principles (GAAP), (ii) financial statements, and (iii) audit committee functions, and (2) experience with (i) internal accounting controls, (ii) the preparation or auditing of “generally comparable” issuers’ financial statements, and (iii) applying GAAP to accounting for estimates, accruals and reserves.

A draft SEC regulation implementing this SarbOx provision was put out for comment in October of 2002, while the final rule was adopted in January and became effective in July of 2003. In response to a flood tide of comments on the rule proposal, some ameliorating adjustments were made in the final rule. For example, the “financial expert” term was repositioned as “audit committee financial expert”–ACFE, or “ack-fee”–to distinguish it from the long-familiar expertise concepts embedded in securities regulation.

…continue reading: ACFE Designations Under Sarbanes-Oxley: Directors Beware!