The Staff of the Securities and Exchange Commission has certified to the Delaware Supreme Court two questions of law regarding the permissibility of a bylaw amendment submitted as a shareholder proposal to a Delaware corporation, CA, Inc. The amendment would require the company to reimburse reasonable stockholder expenses incurred in running a short slate of director nominees for election. This is the first time that the SEC has used this certification procedure.

CA asserts that the shareholder proposal may be excluded from its 2008 proxy materials under Exchange Act Rule 14a-8 on the grounds that the proposal is an improper subject for shareholder action under Delaware law and that the proposal, if adopted, would cause CA to violate Delaware law. The Court has agreed to an immediate determination of the questions certified and ordered briefs to be filed on or before Monday, July 7. Oral argument is to be held on Wednesday, July 9.

The Supreme Court’s order accepting the questions certified by the SEC is available here. The SEC’s certification of questions of law, with the SEC General Counsel’s covering letter, are available here and here. The competing legal opinions are available here and here.

Together with my colleagues Adam Emmerich and Sabastian V. Niles, I have issued a memorandum entitled “Sovereign Wealth Fund Investment in the U.S. - Six Months Later,” which discusses the surprising slowdown in SWF Activity in the U.S. since the end of 2007 and into the opening weeks of 2008 when investment activity by these funds reached new heights. Our memorandum discusses some of the reasons for the slowdown, highlighting the possibility that the uncertain political receptivity to SWF investments and heightened regulatory activity has chilled SWF interest in the U.S. by increasing the costs and risks of investment. The memorandum concludes by calling for continued SWF activity in order to develop a track record of successful investments that will help cause political concerns to recede and by identifying the critical issues for those SWF transactions that get to the negotiation phase.

The memorandum is available here.

It is well known that firms contribute money to politicians. It is also widely held that such money, in the form of campaign contributions and lobbying expenditures, is used to buy access to and/or favors from politicians. Firms and politicians establish relationships with one another and the value to firms of such relationships likely increases over time. When a politician with a well-established relationship to a firm faces a tough election prospect, it is in the firm’s interest to secure that politician’s future. One obvious way to do so is to make further monetary contributions directly to the politician’s campaign. A priori, direct monetary contributions are not the only channel through which firms can deliver benefits to candidates during political campaigns. In a recent working paper, Sugata Roychowdhury of MIT and I investigate whether political contributions can take a non-cash form, specifically (accounting) information. In other words, we investigate whether (accounting) information can be used as political currency?

Our setting is the US congressional election of 2004, where outsourcing of US jobs was a campaign issue. Firms engaged in outsourcing activities had incentives to ensure that political candidates they were affiliated with did not suffer from negative media due to the outsourcing. These incentives were likely to be strongest when the candidates were in competitive races. We test whether outsourcing firms understated profits in the period leading up to the 2004 election, in circumstances where the firms’ affiliated candidates were in competitive races. Understating profits can help deflect attention away from the firms’ outsourcing activities, and thus spare the candidates considerable embarrassment. We find that outsourcing firms donating to congressional candidates in closely watched races managed their earnings downwards in the two quarters immediately preceding the 2004 election. We find no evidence of downward earnings management among outsourcing corporations donating to congressional candidates not in closely watched races.

Ceteris paribus, if donors’ downward earnings management is effective in deflecting attention away from outsourcing, thus sparing candidates from negative media, we expect such candidates to do better in the election (than the average candidate). In regression tests that control for likely determinants of election outcomes, we find vote shares for candidates are increasing in the extent of their corporate donors’ downward earnings management. Overall, our findings are consistent with firms managing accounting information in circumstances where this is likely to benefit allied politicians. The evidence is consistent the hypothesis that accounting information can be used as political currency.

You can read the entire paper here and an interview with me over the paper here.

As regulators increasingly embrace cooperative approaches to governance, voluntary public-private partnerships and self-regulation programs have proliferated. However, because few of these partnerships and programs have been subjected to robust evaluation, little is known about their effects. In my paper with Mike Toffel, “Coming Clean and Cleaning Up: Is Voluntary Disclosure a Signal of Effective Self-Policing?” we ask whether and in what ways self-regulatory practices at a subset of regulated facilities enhance the effectiveness of the regulatory scheme.

In the context of a program sponsored by the U.S. Environmental Protection Agency that encourages regulated entities to voluntarily self-police and self-disclose regulatory violations, we analyze whether such voluntary disclosures are a good signal of a facility’s effective self-policing practices. There are two components to this question. First, do facilities that send the self-regulation signal outperform those that do not? Second, what is the agency’s response to the signal? Are regulators effectively sorting the good facilities from the bad, and are they leveraging this information in a way that enhances the effectiveness of their enforcement efforts?

We find that, on average, self-policing facilities improved their environmental performance, as measured by a decline in the number and probability of abnormal events resulting in toxic pollution. However, upon closer examination, we find this effect to be significant only among “good apples,” or facilities with clean past compliance records. We find no evidence of improvement among facilities with more problematic compliance histories. In other words, it appears that voluntary disclosure is an effective signal for distinguishing the “great” apples from the merely “good” apples, but not for determining whether a “bad” apple has turned good.

With respect to the behavior of the regulatory agency, we find that regulators are interpreting these signals with a high degree of accuracy and responding accordingly. Our analysis shows that regulators significantly reduced their scrutiny of self-disclosers that were “good apples” (or those that improved their environmental performance) but continued to keep a watchful eye on the “bad apples” (who did not improve).

Taken together, these findings support the theoretical promise of meaningful self-policing practices and suggest that voluntary disclosure can serve as a reliable signal of future compliance under certain circumstances. But, at the same time, they highlight the way in which self-regulation outcomes are contingent on the organizational contexts into which self-regulatory practices are adopted. Our analysis also highlights the possibilities for gaming that self-regulation introduces into the regulatory system, but we demonstrate that, at least in this context, regulators do not appear to be fooled.

The full paper is available for download here.

My paper entitled “Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors”, which I co-wrote with Emanuel Zur and which was recently accepted for publication in the Journal of Finance, examines recent aggressive campaigns by entrepreneurial shareholder activists, which we define as an investor who buys a large stake in a publicly held corporation with the intention to bring about change and thereby realize a profit on the investment.

We conduct our analyses on two samples of entrepreneurial activists. The first sample consists of 151 hedge fund activist campaigns conducted primarily between 2003 and 2005. The second sample contains 154 other entrepreneurial confrontational activist campaigns over the same time period. These activists are composed primarily of individuals, private equity funds, venture capital firms, and asset management groups for wealthy investors. The common feature of each group is that the investor is relatively free from the regulatory controls of the Securities Act of 1933, the Securities Exchange Act of 1934, and most notably the Investment Company Act of 1940.

We find similarities and disparities between our samples of hedge fund and other entrepreneurial activists.

The three main parallels are market reaction to the activism, a further significant increase in share price for the subsequent year, and the activist’s success in gaining its original objective. These findings suggest that the market, on average, believes activism creates shareholder value. Moreover, ex ante, the market is able to differentiate between overall successful and non-successful campaigns. For both groups of activists, the abnormal return surrounding the initial Schedule 13D filing is significantly higher for firms in which the activist gains its objective within one year, when compared to those firms in which the activist is unsuccessful.

The two main differences between the two categories of entrepreneurial shareholder activists are the types of companies each group targets and the activists’ post-13D filing strategies. Hedge fund activists target more profitable and financially healthy firms than other entrepreneurial activists. Hedge funds appear to address the free cash flow problem, since hedge fund activists frequently demand the target firm to buy back its own shares, cut the CEO’s salary, or initiate dividends, whereas other activists do not make these demands. In contrast, other entrepreneurial activists appear to redirect the investment strategies of their targeted firms.

The full paper is available for download here.

On June 25, I presented a paper entitled “Shareholder Activism and the “Eclipse of the Public Corporation”: Is the Current Wave of Activism Causing Another Tectonic Shift in the American Corporate World?” at the 2008 Directors Forum of The University of Minnesota Law School. The paper discusses the pressures that have been pervasively eroding the centrality of the board of directors and transforming its role in the governance structure of public companies, with the end game being a new conception of the corporate organization. Against the backdrop of the subprime and leveraged loan financial crisis and other recent events, the paper addresses what I regard as the crux of the issue affecting public companies today: whether the institution of the corporate board can cope with these pressures and survive as the vital governing organ of public companies. Or, will a forced migration from director-centric governance to shareholder-centric governance, along with a concomitant transformation of the role of the board from guiding and advising management to ensuring compliance and performing due diligence, simply overwhelm American business corporations?

The paper is available here.

My new book, Corporate Governance of Non-listed Companies (Oxford University Press, 2008), which I co-wrote with Erik Vermeulen, examines the set of legal rules and measures needed to improve the governance of non-listed companies. Studies of corporate governance traditionally focus on the governance problems of large publicly held firms, and policymakers’ recommendations often focus on such firms. However most small firms, and in many countries, even many large companies, are non-listed. We provide a comprehensive account of non-listed firms and their particular governance problems.

The book explores current discussions and reforms in Europe, the United States, and Asia providing a state of the art account of the law and the economics. Non-listed firms encompass a vast range, from corporations with the potential to go public through family-owned firms, group-owned firms, private equity and hedge funds, to joint ventures and unlisted mass-privatized corporations with a relatively high number of shareholders. The governance of non-listed companies has traditionally been concerned with protecting investors and creditors from managerial opportunism. However, the virtual elimination of the distinction between partnerships and corporations means that an effective legal governance framework must also offer mechanisms to protect shareholders from the misconduct of other shareholders. Our book examines policy and economic measurements to develop a framework for understanding what constitutes good governance in non-listed companies. We examine how control is gained in the various types of closely held firms and explore the techniques that contribute to the development of a modern and efficient governance framework for these companies. The book concludes with an exploration of how the non-listed firm is likely to stimulate growth and extend innovation and development.

(Editor’s note: A post on April 30 by Brian Cadman also analyzed the role of compensation consultants in setting pay, and is available here.)

My paper, Executive Pay and “Independent” Compensation Consultants, which I co-wrote with Kevin J. Murphy, analyzes two primary sources of conflicts of interest between consultants and their client firms. First, consultants have a conflict of interest whenever they design the pay packages of the same executives that have the power to reappoint them. Consultants who are hired by, or who work for, top management (rather than the board) have clear incentives to please the firm’s top executives by recommending generous pay packages. Second, while some consultants are “boutique” firms focused exclusively on executive compensation, many are large integrated corporations offering a full-range of compensation, benefits, and actuarial services, and therefore there is an incentive to cross-sell additional services. Consultants recommending a lower-than-expected level of CEO pay can jeopardize the opportunities to cross-sell other more lucrative services to the firm.

We use newly disclosed SEC data for 938 firms to investigate whether these conflicts of interest between consultants and their client firms lead to higher pay for CEOs, other top executives, and outside directors. We test the “repeat business” effect (i.e., the consultants’ concern with being reappointed) by examining whether pay is related to proxies for managerial influence over the decision to appoint (or reappoint) consultants, including whether the consultant is retained by the compensation committee or by management, whether the consultant works exclusively for the committee or also works for management, and whether the consult is described as “independent” in the company proxy statement. We test the “other services” effect by examining voluntary disclosures related to such services in the proxy statements, and by merging our data with 5500 filings with the IRS and Department of Labor that identify which of the consultants used by each of our sample companies also provide actuarial services to those firms.

We find that executive and director pay is higher in companies retaining consultants for pay advice than in companies not seeking advice, even after controlling for size, industry, and the mix of pay. However, we find no evidence that the higher pay is related to conflicts of interest: CEO pay is higher (and not lower) in companies where the consultant works exclusively for the compensation committee rather than management, and CEO pay does not increase when the consultant provides actuarial or other services to their client firms. Interestingly, we do find that pay is higher when the companies retain more than two consultants, suggesting perhaps that companies “shop around” until they get the answer they like!

The full paper is available for download here.

For many years, there was a diversity of opinion — including judicial opinion — with respect to various issues connected to the duties of directors and officers in the troubled company situation. Can they be sued directly by creditors? Does the business judgment rule apply to protect them? Is there a tort called “deepening insolvency?” To whom are duties owed? Can directors and officers continue to take (prudent) risks to maximize the value of the enterprise?

I have recently published an article entitled “The Fiduciary Duties of Directors of Troubled U.S. Companies: Emerging Clarity,” which addresses two recent Delaware Supreme Court decisions that have shed needed light on these and related topics, and should provide much comfort to officers and directors. It opines that many ensconced buzzwords and doctrines — like “zone of insolvency” and “deepening insolvency” now have little to no meaning, and that the developing theme of these important decisions is the continuity (not any changes) in fiduciary duties, notwithstanding financial distress. It also provides some practical guidance for directors, suggesting that traditional questions like “are we in the zone yet” and “to whom are our duties owed” may be of much less value than a simplified “are we attempting to maximize the value of the enterprise.”

The article is available here.

(Editor’s note: This post comes to us from Glenn Curtis, Director, Strategic Research of Thomson Reuters)

As part of an effort to provide insight into what types of companies activist hedge funds and private equity firms are targeting, Thomson Reuters tracks proxy battles on a quarterly basis. To that end, we recently released a report, entitled 2007 Shareholder Activism, for the fourth quarter of 2007. The purpose of our research is to shed some light on the types of companies activists are targeting in terms of sector, and market cap. Our goal is to also provide some color on the success rates of activists and the most common demands they are making of boards. Our reported findings include the following:

• Throughout 2007 activists attempted to exert their influence at 61 public companies. That is, they either sought to make changes to the target’s board of directors, or to effectuate some other sort of value enhancing action or transaction.

• Between October and December 2007 (Q4) activists attempted to exert their influence at eight public companies. While it is impossible to definitively determine which party (the activist or the target) will prevail in each of these instances, there are two instances where it appears as though the activist will secure a victory.

• The most common demand made by activist firms was for board seats. This is consistent with two studies that we have completed in the past.

• The average target size in terms of market capitalization during Q4 was about $1.22 billion - well below the roughly $8.49 billion average for the first three quarters of 2007.

• Consumer Discretionary companies were the most frequent targets in the fourth quarter. This too is consistent with studies that we have completed in the past.

• Companies within the financial industry were not targeted in the fourth quarter. This is somewhat surprising given the large decline in equity prices in this group and given that many of these firms continue to maintain valuable and tangible assets on their balance sheets.

• While Carl Icahn and entities controlled by Icahn appeared to be the most active for all of 2007, Ramius Capital was a close second, recording three cases of activism in Q4 and five for the full year.

• Private equity firms and hedge funds remained the most common activists. Q4 did not see major mutual funds or individual investors lead any charges for corporate change as they did in the Q1 to Q3 time frame.

• Perhaps not surprisingly, cash-strapped construction companies and builders were targeted the least by activist shareholders throughout 2007. There was no change from the first three quarters of the year.

To obtain a full copy of the report, please contact its author, Glenn Curtis, at glenn.curtis[at]thomsonreuters.com.

(Editor’s note: This post comes to us from Vidhi Chhaochharia of the University of Miami and Yaniv Grinstein of Cornell University. Their article was recently accepted for publication in the Journal of Finance.)

The purpose of this article is to examine how the new board requirements that were enacted in response to corporate scandals in 2001 and 2002 affected compensation decisions. We use the difference-in-difference approach to compare changes in compensation between firms that were already complying with these requirements and firms that were not complying with them. Our sample consists of 865 firms that belong to the S&P 1500 index for the period 2000 to 2005. To measure level of compliance, we focus on three board structure variables that were required by the rules: the requirement for a majority of independent directors on a single board, the requirement for an independent nominating committee, and the requirement for an independent compensation committee.

We find that firms that did not comply with these requirements significantly decreased CEO compensation in the period after the rules went into effect, compared to the complying firms. The decrease is on the order of 17%, after taking into account performance, size, time varying shocks to different industries during that period, firm fixed effects, and other variables affecting compensation that changed during that time. We also find that the one requirement that is strongly associated with a drop in compensation is the requirement that the majority of board members be independent, and that the significant relative drop in compensation comes from the decrease in the bonus and the stock based compensation. We also find that the decrease in compensation is particularly pronounced in the subset of affected firms with no outside block holder on the board and in affected firms with low concentration of institutional investors. In short, our results suggest that the new board requirements affected CEO compensation decisions.

The full paper is available for download here.

(Editor’s note: For a contrasting analysis of the UN proposal by Guest Contributor Martin Lipton of Wachtell, Lipton, Rosen & Katz, please see here.)

On behalf of our pro bono client Oxfam America, my colleagues, Ira M. Millstein, E. Norman Veasey, Harvey Goldschmid, Steven Alan Reiss, Ashley R. Altschuler, and I have prepared a memorandum that discusses the report, Protect, Respect and Remedy: A Framework for Business and Human Rights, prepared by Harvard Professor John G. Ruggie, the Secretary-General’s Special Representative on Human Rights. Our memorandum is available on the UN Special Representative’s website here.

The Ruggie Report posits three “core principles”: (1) the State duty to protect human rights, (2) the corporate social responsibility to respect human rights, and (3) the need for access to appropriate remedies for human rights abuses.We believe the basic concepts embodied in the Report are sound and should be supported by the business community in the United States. In summary, our reasons are:

• In the first instance, the US and foreign governments have the primary responsibility for defining what human rights obligations are binding legal duties and how those duties are enforced;

• If the Report is taken seriously by foreign government and foreign companies, it will benefit US corporations by leveling the playing field in placing on foreign boards and management the responsibilities to adhere to many of the same fiduciary and binding legal obligations presently applicable to US companies;

• Given the interplay of fiduciary, disclosure, internal control and risk mangement obligations facing US boards and managers today, the Report does not implicate new legal obligations for US companies;

• Violations of human rights may constitute material risks for many US corporations, not only in the US, but also in foreign jurisdictions where they conduct business;

• While the report does not limit the scope of internationally-recognized human rights, each US company must presently determine for itself, what human rights risks may be material to its business;

• Additionally, and beyond the obligation to manage risks, and comply with law, there is a substantial business case in favor of safeguarding human rights wherever the company does business.

The Report is available here, and our memorandum is available here.

While the bulk of the commentary about last week’s CSX/TCI opinion has focused on the requirement for disclosure of derivatives under the Williams Act, the hedge fund defendants missed a great opportunity to attack the odious practice of management using shareholder money to sue a dissident on any pretext in order to entrench itself.

Generally, courts have been getting tougher on implied rights of action and especially so in securities lawsuits. In meVC Draper Fischer Jurvetson Fund,Inc., v. Millennium Partners, 260 F. Supp. 2d 616 (S.D.N.Y., 2003), Judge Sand, citing Alexander v. Sandoval, 532 U.S. 275 (2001) and Olmsted v. Pruco Life Ins. Co. of New Jersey, 283 F.3d 429 (2002) ruled that there is no right of private action section under section 12d(1)(A) of the 1940 Investment Company Act. It dismissed prior cases finding a right of private action as belonging to an “ancien regime.” A similar finding was made by the Third Circuit in a lawsuit brought under the Postal Reorganization Act, Wisniewski v. Rodale, Inc., 510 F.3d 294 (3rd Cir., 2007). The Wisniewski court ruled that after Sandoval a private right of action under a federal statute may be implied only if the court determines that Congress intended to create (1) a private right and (2) a private remedy.

I see no way that a court can find a principled distinction with respect to a private right of action between section 12d(1)(A) of the 1940 ICA and section 13(d) of the 1934 Act. At a minimum, after Sandoval in 2001 the issue of standing for 13(d) claims is certainly fair game. There is no “rights creating” language in either law that would support a right of private action by a supposedly aggrieved company.

Of course, unless a defendant raises the issue, I wouldn’t expect any judge to do it on his own. In the CSX case, the hedge fund defendants blew it and Judge Kaplan perfunctorily noted in passing that there is an implied right of private action under section 13(d) based on pre-Sandoval precedents based on the premise that the “congressional purpose was furthered by providing issuers with the right to sue ‘to enforce [the] duties created by [the] statute’ “�. However, in dismissing one counterclaim for proxy fraud, Judge Kaplan indicated he was well aware of CSX’s real motive:

CSX’s Purposes in Bringing this Lawsuit

CSX’s March 17, 2008, press release quotes Mr. Ward as saying that “[CSX] filed this suit . . . to ensure that all of our shareholders receive complete and accurate information.”� Defendants argue that this statement is materially false and misleading.

Speaking bluntly, this contention does not warrant a serious response. If the American people do not know that not every protestation of high motive, made in a contested election, can be taken literally, there is not much hope for any of us.

This realistic observation shows why courts should reject a private right of action in 13(d) cases. They are invariably brought by a management that is under siege for the purpose of fending off a dissident and retaining control of the company. Just look at the relief sought. It is always draconian — to sterilize the votes of the dissident and/or to prevent the dissident from soliciting or voting proxies. This effort to frustrate a shareholder vote is an abuse of the law’s intent as well as a breach of fiduciary duty.

One can always justify private lawsuits to enforce any law as furthering that law’s legislative purpose. But, imagine the abuses that policy would allow without considering the costs. If I have a dispute with my neighbor about leaving his junk on his lawn, should I be able to pressure him to remove it by suing him because he does not have a valid safety inspection sticker on his car? I have no problem with issuers complaining to the SEC about alleged violations of securities laws (or a neighbor complaining to the DMV that my car inspection has expired). But, unless the law specifically allows for private lawsuits, the decision as to whether the public good is served by bringing an enforcement action (or perhaps simply asking the alleged violator for corrective action) should be determined only by the SEC, not by the management of a company faced with a proxy fight which invariably has an ulterior objective.

Thus, with respect to 13(d) lawsuits, limiting enforcement authority to the SEC is both good law and good policy. We just need some defendant to raise the issue.

My paper, co-authored with Julian Atanassov of the University of Oregon, was recently accepted for publication in the Journal of Finance. This paper investigates how labor and investors’ relative influence and firm level variables interact to affect corporate governance. A key conclusion is that weak investor protection combined with strong union laws are conducive to worker-management collusion harmful to investors.

Specifically, we analyze restructuring decisions when firms suffer a sudden, sharp deterioration in operating performance. We proxy for stakeholders’ relative influence at the country level by the strength of legal protection of investors and labor. We consider three types of restructuring measures: large scale employee layoffs, top management turnover, and major asset sales. Our sample consists of 9,923 firms (10,947 firm-years) at the onset of sharply declining operating performance in 41 developed and emerging economies over the period 1993 to 2004.

We find that poorly performing firms in stronger investor protection countries are more likely to undertake large-scale worker layoffs and replace top management than those in weaker investor protection countries. These restructuring actions are followed by superior operating performance in all legal environments. Major asset sales are different, however. We observe more asset sales when investor protection is either very strong or very weak. Asset sales in strong investor protection countries are followed by superior operating performance, whereas asset sales in weak investor protection countries are followed by inferior subsequent operating performance.

The likelihood of value-reducing asset sales increases as collective bargaining and labor relations laws grant more power to labor unions, suggesting that these asset sales are countenanced by workers. In addition, underperforming top managers in low investor protection countries are more likely to retain their jobs as union power increases. These results point toward management-worker alliances motivated by a mutual desire to retain jobs. For such an alliance to work, management needs funds to minimize layoffs and wage cuts. Lacking other means to raise the necessary funds, poorly performing firms sell assets to forestall layoffs even when doing so hurts subsequent operating performance. Indeed, asset sales in weak investor protection countries do not lead to layoffs, whereas in strong investor protection countries asset sales predict layoffs.

We also find that strong union laws are less effective in preventing layoffs when financial leverage is high, indicating that financial leverage is an effective instrument with which investors counter the power of workers.

Overall, our results highlight the importance of interaction among management, labor, and investors in shaping corporate governance.

The full paper is available for download here.

(Editor’s note: We also learned from our Guest Contributor John F. Olson that his firm, Gibson, Dunn & Crutcher LLP, has also just issued a memo on this important decision.)

“The securities markets operate in the real world, not in a law school contracts classroom. Any determination of beneficial ownership that failed to take account of the practical realities of that world would be open to the gravest abuse.” That is just a teaser of an opinion in which every page is a gem. Judge Kaplan’s opinion in the CSX/TCI case is long but well worth reading wholly apart from those with interest in the particular facts of that particular case. It treats with great insight and expertise the activist stockholder tactic of using swaps to gain increased leverage and potential advantage while staying below (they think, or better, thought) the 5% public reporting threshold of Section 13(d) of the Williams Act.

The decision comes to the brink of holding that the long side of a cash-settled total return swap conveys old-fashioned “beneficial ownership” (voting or investment power) of the shares held in the counterparty’s hedge position in the typical case where the long knows and intends that the financial institution on the other side will perfectly hedge by buying the shares and holding them until the unwind (whether that is effected ultimately in cash or in kind). While making a persuasive case for that conclusion, Judge Kaplan rests the beneficial ownership conclusion on the oft-ignored-but-nevermore “anti-evasion” SEC Rule 13d-3(b) which is an effective tool to prevent devices to prevent beneficial ownership from doing so. As to relief, the Court deemed itself constrained by prior precedent not to sterilize the shares bought under cover of 13(d) violation (it did enjoin future violations), but virtually invited the Second Circuit to revisit the question by declaring that the Court would have granted that relief had it discretion to do so. While there will likely be an appellate ruling in the case (an expedited appeal is being taken), Judge Kaplan’s opinion will undoubtedly stand as must reading.

Our short memo on the decision is here, and the Court’s opinion is available here.

The beat goes on — in the on-going CSX/TCI litigation before Judge Kaplan of SDNY which is expected to yield an important ruling on the application of the old school reporting requirements of Section 13(d) to the brave new world of hedge funds/derivatives/synthetics. In a recent letter responding to the Court’s inquiry, the Staff of the SEC’s Corp Fin Div took the view that the typical total return swap did not confer the voting or disposition power sufficient to trigger the beneficial ownership reporting requirement under 13D, and that the (so-called) anti-evasion Rule 13d-3(b) reaches only swaps or the like if the intent was to create a “false” appearance. Our memo on the Staff letter, and on the continuing need for reform, is here. The Court, of course, will have the last word, and there remains ample running room.

Although this blog uses the name Harvard Law School Corporate Governance Blog, I want to introduce a new but closely related topic – uncorporate governance.

By uncorporate I mean partnership-type business associations (i.e., general partnerships, limited liability companies and limited partnerships) and the default rules and norms that are associated with these business forms.

One might say that looking at uncorporations moves away from this blog’s focus on publicly held firms. But as I show in my Uncorporating the Large Firm, uncorporations are increasingly important in governing large, publicly held firms. Examples include not only publicly traded partnerships, limited liability companies and real estate investment trusts, but also private equity, venture capital and hedge funds that exercise critical control powers in firms that are large, publicly traded, or both.

All of these firms are characterized by their substitution of discipline and incentives for corporate-type monitoring as ways to control managerial agency costs. Specifically, uncorporations (1) loosen managers’ grip on the firm’s cash through distributions and liquidation rights; and (2) give managers high-powered owner-like incentives. The trade-off is that uncorporations rely much less on high-cost but often ineffective monitoring devices such as fiduciary duties, owner voting and the market for control.

Corporate scholars and practitioners have been complaining for generations about the inadequacy of corporate monitoring devices in controlling agency costs. Tweaks of conventional corporate governance, such as majority voting for directors, are more band-aids than solutions. Defenders of the corporate status quo argue that the benefits of strong managerial power are worth the costs. But whether that is true depends on whether there are cheaper and more effective alternatives. My paper shows that there are, and that market forces have been substituting these alternatives for traditional corporate governance.

So research on corporate governance needs to start paying more attention to uncorporate governance. This means, among other things, more focus on the distinct role of uncorporate structures in producing value. For example, many articles discuss activist hedge funds’ role in unlocking corporate value, but not why they produce these results. My work suggests that hedge funds’ uncorporate structure – that is, use of typical limited partnership and LLC governance devices – is a big part of the answer. Similarly, many attribute the success of private equity to factors such as the escape from securities regulation and the use of debt. Again, I suggest that private equity’s uncorporate structure plays a critical role. The public policy implication is that disabling critical private equity features through tax or regulation may have significant costs.

The role of uncorporations in large firms may increase as new uses are found for these devices. For example, I’ve tried to make the case for publicly traded law firms (which, of course, would involve changes in current ethical rules). See MacEwen, Regan & Ribstein, Law Firms, Ethics and Equity Capital: A Conversation. I show in my “Uncorporating” paper that uncorporate structures are the likely vehicles for such firms.

The future of the uncorporation in large firms depends critically on the courts and Congress. The courts need to enforce contracts in uncorporations, particularly including fiduciary duty waivers, in order to effectuate the uncorporate substitution of discipline and incentives for monitoring. I show in The Uncorporation and Corporate Indeterminacy that the Delaware courts are, indeed, doing that. Francis Pileggi wrote about one recent such case on this Blog, Chancery Gives Victory to Freedom of Contract, May 23, 2008.

As for Congress, we can expect calls by interest groups to stunt the expansion of private equity and other uncorporate governance devices. These devices increase managers’ incentives to respond to owners’ interests and eliminate the shareholder meeting as a mechanism for non-owner interest groups to be heard. As I’ve discussed on my blog (The SEIU and Private Equity, June 4, 2008) the unions are aware of this and fighting back. The political question boils down to the appropriate balance between managerial accountability and managers’ power to allocate some of the corporate pie to non-owner groups. Congress could try to stunt the growth of the uncorporation through tax and regulation. On the other hand, such moves as eliminating the corporate tax or relaxing publicly traded firms’ ability to be taxed as partnerships could pave the way to really significant changes in the way corporations are governed.

In short, managers’ agency costs in large corporations has for a long time been a lot like the weather. Politicians and interest groups talk about it a lot, but the results, like umbrellas and galoshes, don’t change the basic scenery. The uncorporation could make a basic change if we’re willing to unleash its potential.

The UK has, similarly to the US, deep and liquid securities markets and widely-dispersed ownership of publicly-traded firms. The central problem of corporate governance for publicly-traded firms in the UK is rendering managers accountable to shareholders. My recent paper, entitled Enforcement Strategies in UK Corporate Governance: A Roadmap and Empirical Assessment, provides a roadmap of the enforcement strategies employed in UK corporate governance, and a first approximation of their empirical significance.

Enforcement strategies affect agents’ incentives to comply with substantive rules, and so the effectiveness of a regulatory regime is a function of both substantive rules and the strategies by which they are enforced. While recent scholarship has begun to address enforcement-related issues, no clear consensus has yet emerged, as the results seem sensitive to the way in which ‘enforcement’ is measured. Moreover, those studies that have been done have focused on formal (court-based) mechanisms of enforcement. There are, of course, a variety of other ways in which the agency problems at the centre of corporate governance can be kept in check—from quiet intervention by a regulator to the threat of a shareholder revolt. The impact in practice of a corporate governance regime on agents’ incentives is therefore the sum of all institutions—formal and informal—that may impose a sanction on agents for inappropriate performance. Such institutions vary across countries, and so studies that focus solely on court-based enforcement risk misleading comparisons. Of course, this point isn’t new. The challenge is how to identify these modalities and measure their intensity in a meaningful way. This paper offers a first cut at the problem in the context of the UK.

The results suggest three stylised facts about the UK corporate governance system. First, shareholder lawsuits are conspicuous by their absence. Formal private enforcement appears to play little or no role in controlling managers. Secondly, it is public, rather than private, enforcement which dominates in relation to listed companies. However, the lion’s share of the interventions by the relevant agencies—the Takeover Panel, the Financial Reporting Review Panel, and the Financial Services Authority—is of an informal character, not resulting in any legal action. Suasion, rather than sanction, is the order of the day. Thirdly, a simple divide between public and private enforcement fails fully to take account of the role played by institutional investors in the UK, who have engaged systematically in informal private enforcement activity. Strong informal private enforcement has historically therefore been the flipside, in the UK, of weak formal private enforcement.

The paper is available here.

(Editor’s note: This post comes to us from Jonathan Rogers and Andrew Van Buskirk at the University of Chicago Graduate School of Business. Their paper was recently accepted for publication in the Journal of Accounting and Economics)

While the deterrent function of private litigation has been studied in some detail, we investigate the existence of another potential benefit of securities litigation: a change in the conduct of the firms involved in private litigation. Specifically, we examine changes in the disclosure behavior of firms involved in 827 disclosure-related class-action securities litigation cases filed between 1996 and 2005. Prior studies have investigated how proxies for the threat of private securities litigation affect corporate disclosure behavior, but little is known about the behavioral changes of companies that are actually sued.

We find no evidence that the firms in our sample respond to the litigation event by increasing or improving their disclosures to investors. Rather, we find consistent evidence that firms reduce the level of information provided post-litigation. This reduction takes many forms. The probability of a firm hosting an earnings-related conference call or issuing an earnings forecast is lower following litigation. When firms choose to issue earnings forecasts, those forecasts are issued for shorter horizons and are less likely to be quantitative. When quantitative forecasts are issued, these forecasts are less specific (i.e., wider range estimates). We also find an increase in the magnitude of future earnings surprises and an increase in the absolute value of earnings announcement excess returns. We find no evidence that this reduction in disclosure is driven by a decrease in the firm’s forecasting ability; management forecast accuracy is indistinguishable post-litigation compared to a twelve-month window prior to the damage period. Our results hold after controlling for other potential determinants of disclosure choices such as CEO turnover, demand for disclosure, and economy-wide trends in disclosure.

Our evidence suggests that the litigation process encourages firms to decrease the provision of disclosures for which they may later be held accountable, despite the increased protections afforded by the Private Securities Litigation Reform Act of 1995. Our results seem inconsistent with the intentions of regulators and private litigants who seek enhanced corporate transparency.

The full paper is available for download here.

My colleague Laura A.McIntosh and I have written an article recently published in the New York Law Journal on May 22, 2008 entitled Corporate Governance Update: Advance Notice Bylaws: Lessons from Recent Cases. Until recently, advance notice bylaws have been unremarkable and fairly uncomplicated provisions, generally easily complied with and largely uncontroversial. In two recent cases, Jana Master Fund, Ltd. v. CNet Networks, Inc. and Levitt Corp. v. Office Depot, Inc., the Delaware courts allowed activist stockholders to exploit potential drafting ambiguities to circumvent the well-intended rationale of the advance notice bylaw. As a result, advance notice bylaws have emerged as an important battleground in the conflict between companies and activist stockholders. Our article describes the purpose, operation and functions of an advance notice bylaw and considers the CNet and Office Depot decisions. Against the backdrop of these cases and in light of the increasingly complicated mechanisms through which investors hold stock, the article also discusses important points that companies should consider when reviewing their advance notice bylaws and bringing them up to date.

The article is available here.

ICR, the financial communications consulting firm, recently released a discussion paper Shareholder Activism: Proactive Defense and Informed Response. The paper explores the current environment of shareholder activism driven by “Sharks,” “Wolves” and “Jaguars,” as well as these activists’ goals, motives and tactics. The paper also presents a well documented strategy for issuers outlining potential vulnerabilities to attack, defenses against attack, as well as how to best respond to attack

Since the first company went public, activists have been utilizing creative and often confrontational strategies to engage with issuers to achieve their sometimes self-serving goals as well as positive returns from their investment portfolios. Such shareholder activism, traditionally the purview of institutional investors such as labor unions, public pension funds, and religious organizations, has become increasingly contentious and problematic for issuers as the rapidly growing hedge fund asset class has moved toward direct activism.

While “activism” among shareholders is not necessarily new, the credit crunch of last summer has fueled hostility in the current activist environment as more hedge funds chase fewer investment opportunities and face a depressed capital market. This environment has created a scenario whereby activist investing increasingly becomes the norm as hedge funds try to differentiate themselves and continue to deliver the outsized returns that they have promised to their investors. As a result, public companies need to reconsider their preparedness and carefully address how best to protect their position in the public markets.

The paper is available here.

Ernst & Young recently released its 10th Global Fraud Survey “Corruption or Compliance – Weighing the Costs“.

As the US Foreign Corrupt Practices Act (FCPA) becomes the de facto anti-corruption standard worldwide, over 50% of US executives — and 84% globally — still know little to nothing of its key provisions, according to the survey. Another survey finding with governance implications suggests that companies increasingly rely on internal audit to find and address fraud and compliance risk—but internal audit departments may not have the tools, techniques, or resources to do so. Only 28% of US respondents say their internal audit departments are highly successful at detecting bribery and other corrupt practices.

The results show a marked lack of knowledge and preparedness on the part of C-suite executives and other risk management personnel, including internal auditors, about FCPA, which prohibits bribery of government officials by US companies and US-traded foreign companies. More than two-fifths of survey respondents (43%) say their companies do not have specific provisions in place for dealing with government officials—presenting an enormous risk of FCPA non-compliance.

Another key finding is that companies engaged in M&A may not be conducting necessary due diligence on target companies. Nearly half of FCPA prosecutions in 2007 arose during mergers or acquisitions. But fewer than half of survey respondents report that their companies routinely review the risk of bribery in advance of an acquisition—presenting significant risk of so-called “successor liabilities” that expose the buyer to unnecessary risk.

In sum, Ernst & Young’s 10th Global Fraud Survey demonstrates that corruption and bribery remain a significant exposure for US companies, especially as they conduct business across borders. The survey included senior in-house counsel and chief risk officers, along with other corporate executives from the C-suite to internal audit, and surveyed 1,186 respondents in 33 countries from November 2007 to February 2008.

The survey is available here.

(Editor’s note: This post is by Angela Priest and Eric Wilensky of Morris, Nichols, Arsht & Tunnell LLP.)

Over the past year, the areas of corporation law impacting how transaction attorneys guide their clients developed at a significant pace. This trend emerged with Vice Chancellor Strine’s Netsmart, Topps, and Lear opinions, issued during the height of the private equity-led LBO boom and continued through Chancellor Chandler’s United Rentals opinion, in which the Court addressed issues associated with the break up of a transaction entered into during that boom. In between the Court addressed a number of issues, including permissible board actions in the context of seeking stockholder approval; when a company must include management projections in its proxy solicitation materials; and how to value a company in an appraisal proceeding.

In this article, we discuss these developments in the order that a transaction attorney would likely need to consider them-starting with the exploration of strategic alternatives and ending with litigating a busted deal. We do not intend to conduct an exhaustive analysis on any particular topic or any particular case. Instead, we intend to raise awareness of certain guidelines that these cases suggest.

What our experience has taught us over the past year, and what we hope becomes clear, is that although each opinion issued by the Delaware courts provide guidelines to transaction planners, each opinion is decided based on a particular set of facts. Thus, the opinions issued by the Delaware courts should be taken for what they are–guidelines for shaping a transaction–and not bright-line rules to be followed in all instances.

The article is available here.

It’s the height of proxy season, and with the high-profile shareholder meetings taking place at Exxon last week and Yahoo later this summer, a new website ProxyDemocracy.org offers tools to help individual investors take part in the process.

Although individuals own over 25% of US equity, institutional investors run the show when it comes to proxy voting. Driven by a mix of corporate governance zeal and fiduciary duty, mutual funds, pension funds, and other institutions invest in proxy voting research and vote their shares almost 100% of the time. By contrast, only about 20% of individual investors bother to vote; it’s safe to assume that even fewer read the proxy statement and know what they’re voting on.

Given the difficulty of researching the issues on the ballot and the ease of free riding, it’s not surprising that individual investors generally pass up their voting rights as owners. But it has a cost. Though many retail investors don’t realize it, their brokers vote on their behalf when they fail to send in a ballot. The standard approach brokers have taken is to cast all of these “uninstructed” shares for management, which tends to stack the deck against governance reform. Some brokers have recently enacted a “proportional voting” policy, which means that the votes for all of a broker’s clients are cast to reflect the votes of the minority who submitted a vote. But this only increases the importance of informed investor participation: if 20% of retail investors do the voting for the rest, it’s important that they know what they’re doing.

ProxyDemocracy.org, which I developed part-time over the past few years with help from a few other programmers, helps individual investors piggy-back on the research and judgment of respected institutional investors. We collect the intended votes of a handful of institutions (CalPERS, CBIS, Domini, and Calvert) that currently disclose their votes in advance of meetings. Users can sign up for free email alerts on our site to find out how those institutions plan to vote on stocks they own. Just as citizen voters take account of endorsements from respected groups like the Sierra Club or the NRA (depending on one’s political persuasion), individual investors can use these cues from known institutional investors to arrive at a principled vote more cheaply.

The site also provides tools for mutual fund owners. Around half of US households own mutual funds, and mutual funds own about a quarter of US equity. We have processed hundreds of SEC filings to help investors compare the voting records of leading mutual funds and determine whether their fund represents their interests at shareholder meetings. Not surprisingly, SRI funds tend to be much more activist than mainstream funds, but the differences among mainstream funds are significant as well: our fund profiles indicate that Schwab’s S&P 500 fund has a much more activist record than Vanguard’s, for example.

In the coming months, we plan to add more mutual fund profiles and collect intended votes from additional institutions. I encourage you to have a look at the site and pass along your thoughts and suggestions, either in the comments here or by email to andy [at] proxydemocracy.org.

At EXXON’S Shareholders Meeting on Wednesday, Resolution #5 received 39.5% of the vote, marginally shy of last year’s 40%. I was relieved as we early learned that the company was seriously soliciting investors to vote against our resolution. The realities of the proxy process are that an issuer has vast advantage. There are many large holders who want to provide 401(k) or other services or who have analysts who want continued favorable access. It is difficult under existing conditions for such holders to consider seriously their fiduciary obligations. Under those conditions, it is gratifying that we can – in a year in which EXXON’s recorded financial performance may be the best ever recorded – hold steady at 40%. If this is a base, we can work on expanding it.

A letter in support of the proposal by myself and members of the Rockefeller family, filed with the SEC on May 13, 2008, is availabe here. A CNBC video featuring my discussing the proposal is available here. The text of the proposal was as follows:

“RESOLVED, that the shareholders urge the Board of Directors to take the necessary steps to amend the by-laws to require that, whenever possible and subject to any presently existing contractual obligations of the Company, an independent director shall serve as Chairman of the Board of Directors, and that the Chairman of the Board of Directors shall not concurrently serve as the Chief Executive Officer.”

A summary of the 2008 proxy proposal votes is available here.

I recently co-authored an article with Chief Justice Myron T. Steele of the Supreme Court of Delaware, “Delaware’s Guidance: Ensuring Equity for the Modern Witenagemot,” 2 Virginia Law & Business Review 189 (2007), previously explored here, and a subject of the Chief Justice’s keynote luncheon address to the
Business Law Section at the ABA’s 2007 annual meeting. This article was the subject of recent criticism from Jay Brown of racetothebottom.org. Brown opposes the phenomenon we explored in which Delaware’s judges write articles, dicta, and give speeches on emerging issues in corporate governance, as well as participate as advisors to ABA Business Law Section committees. We called it Delaware’s “Guidance Function” and noted some of the more insightful examples from articles and dicta over the last twenty years. That someone of his stature would work on this important topic with a law clerk eager to get published is a testament to his 20 years of dedication mentoring law clerks and spent in tireless service to Delaware’s bench and bar. I should note that this post represents only my own personal response to Brown’s criticism and my understanding of Delaware’s Guidance Function.

Brown’s principle objection is that it represents an impermissible method for a judge to influence the law. He has, unfortunately, missed the point. Delaware’s Guidance Function is about informing Boards of Directors, and the attorneys of the Negotiated Acquisitions bar who advise them, of trends in corporate governance requiring special focus. Advice from neutral and informed jurists at the center of the maelstrom is valuable for Boards and corporate lawyers faced with inevitable uncertainty in the law that previously litigated fact patterns have yet to fully illuminate. Views of Delaware Judges in this medium are, as we were sure to note, clearly non-binding. Whether it is Justice Holmes’s The Common Law, former Chief Justice Rehnquist’s predictive insights into detention jurisprudence in All The Laws but One, or Judge Posner’s voluminous work on a variety of subjects, judges sharing insights outside the four corners of opinion writing has long been a respected pursuit central to American legal history.

Brown also begins from the assumption, central to his sensationalist “race to the bottom” blog, that Delaware’s law and judges favor management at the expense of shareholder value. Yet he noticeably avoids comment on the substance of the article. For instance, three of the more compelling examples of the Guidance Function, which we chose from among literally thousands of Westlaw citations to Delaware dicta and speeches, offer a general sense of our argument. Consider, for instance, former Chancellor Allen’s delphic observation in 1990 that “[I]n a sale context, counsel for a special committee must accept from the outset that as a practical matter she will have to demonstrate that the special committee’s process had integrity; that the committee was informed, energetic and committed in this transaction to the single goal of maximizing the shareholders’ interest….This is not a call to pay even greater attention to appearances; it is advice to abandon the theatrical and to accept and to implement the substance of an arm’s-length process.” William T. Allen, Independent Directors in MBO Transactions: Are They Fact or Fantasy?, 45 BUS. LAW. 2055, 2056 (1990). Kahn v. Lynch, decided in 1994, rewarded advisers who heeded the Chancellor’s call and spawned a line of cases representing one of the more litigated questions today. We also highlighted roughly a dozen other examples, including Chancellor Chandler’s admonitions about termination fees in Louisiana Mun. Police Employees’ Ret. Sys. v. Crawford and the compensation committee best practices offered by Justice Jacobs in the Disney case.

The Guidance Function has been embraced by Delaware’s judges, who travel around the world to remain engaged in the corporate governance debate. Indeed, the Chief Justice joined various experts on May 16, including former Senator Paul Sarbanes, to address the Institutional Investor Education Foundation’s Annual European Conference on vital issues of shareholder rights. The Delaware Guidance Function is a useful service working to the equal benefit of Boards of Directors, corporate counsel, and shareholders in Delaware corporations.

As noted in an article by Floyd Norris of the New York Times, a panel of the Seventh Circuit Court of Appeals unanimously ruled in Jones v. Harris Associates that courts should play a limited role in reviewing fees charged by mutual fund advisors. In an opinion by Judge Frank Easterbrook, the court relied on what it called a “careful study” by Harvard Law School Professor John C. Coates IV and Columbia Business School Dean R. Glenn Hubbard that found that market forces and existing regulations provide powerful constrains on mutual fund fees, as well as an article by Ohio State Finance Professor René M. Stulz showing that hedge fund compensation regularly exceeds mutual fund fees.

The following summary and memorandum concerning the decision is by John Baumgardner of Sullivan & Cromwell LLP.

In Harris Assocs. v. Jones, No. 07-1624 (7th Cir. May 19, 2008), the United States Court of Appeals for the Seventh Circuit ruled that as long as a mutual fund investment adviser does not breach the fiduciary duty owed to shareholders by failing to disclose all of the pertinent facts or otherwise hindering the fund’s directors from negotiating a favorable price, no judicial review of the reasonableness of the adviser’s fee is required to dismiss a claim under Section 36(b) of the Investment Company Act of 1940. This decision rejects the long-followed Second Circuit decision in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982), which, while respecting the deliberations of independent directors, required courts to consider those deliberations in light of multiple factors in determining whether investment adviser fees were excessive. The Seventh Circuit examined the definition of fiduciary duty, rather than the amount of the fee itself, to evaluate whether the adviser complied with the duty created under Section 36(b), and held that a court should not substitute its judgment of what is “reasonable” for a fee determined by marketplace competition, absent lack of disclosure, deceit or some other breach of a fiduciary duty. (c) Sullivan & Cromwell LLP

A memorandum summarizing the decision is available here.

(Editor’s note: This post is by Carol Bowie of the RiskMetrics Group Governance Institute.)

Enhanced proxy pay disclosures, which the SEC believed would assist shareholders trying to assess the efficacy of executive compensation at their portfolio companies, have mainly underscored the elaborate and opaque nature of most pay programs. A new paper from RiskMetrics Group entitled Explorations in Executive Compensation aims to guide shareholders through the maze of terminology and complex processes being detailed in proxy statements and -– importantly -– proposes two innovative techniques that may help both investors and directors clarify disconnects between executives’ pay and shareowners’ interests.

You can view the paper, along with interactive tools that illustrate these techniques, at www.riskmetrics.com/compensation. RMG is seeking a range of feedback to help refine the paper and the potential tools.

The first proposed technique focuses on peer group benchmarking -– long suspected of contributing to spiraling pay levels that cannot be linked to consistently superior returns. Academic literature has demonstrated the importance of benchmarking in the pay process (e.g., see Faulkender and Yang’s, “Inside the Black Box: The Role and Composition of Compensation Peer Groups.” Working Paper). But RMG may be the first to create a model to consistently measure the quality of a company’s peer group in terms of its homogeneity (relative to size and industry factors) as well as the company’s rank within the peer group relative to the benchmarks it targets – identifying where a company that is the smallest in the group targets pay at the seemingly innocuous median level, for example. Do such distortions contribute to pay inflation? The data are revealing.

The second technique brings a financial markets perspective to evaluating how a CEO’s pay package is or isn’t aligned, in terms of risk, with that of shareholders. Understanding that alignment -– or misalignment -– can identify companies where incentives may be motivating a top executive to pursue strategies (e.g., high- or low-risk) that don’t fit with a shareowner’s investment goals or even the board’s declared business strategy.

RMG’s project is ambitious in scope and intent — to help bring clarity to the often thorny and always complex issue of executive pay. But it epitomizes our objective of producing thought provoking research that creates constructive dialogue on the important corporate governance issues facing investors and corporations. The goal is to create a shared language and measures that market participants can use to create, evaluate, and communicate about executive pay systems. The project is offered in the spirit of RMG’s commitment to bringing transparency, expertise and access to all financial market participants, and a vital part of the project is the feedback we get from all market participants. We invite your comments at www.riskmetrics.com/compensation.

Together with Adam O. Emmerich, David A. Katz, James Cole, Jr. and Sabastian V. Niles, I have recently distributed a memorandum entitled Cross-Border M&A - SEC Proposes Revisions to Cross-Border Transaction Exemptions, which discusses proposed revisions by the SEC to the current regulatory regime for cross-border transactions. The revisions represent a modest advance toward clarifying existing exemptions and, if implemented, would provide US and non-US bidders with somewhat greater certainty and flexibility in structuring deals for non-US targets. The release also requests comments on a number of additional possible changes that could further broaden the exemptions. The proposed revisions do not address a key concern that under existing regulations foreign issuers are subject to potential exposure under the anti-fraud, anti-manipulation and civil liability provisions of the US federal securities laws for transactions with relatively modest US entanglements. The risk of such exposure has persuaded many international issuers to avoid US markets and US investors altogether, to the detriment of global capital markets in general and US investors in particular. The present amendments may thus be a way-station to a more comprehensive future revision of the cross-border rules.

The memorandum is available here.

The Delaware Chancery Court recently issued its opinion in Fisk Ventures, LLC v. Segal, which I predict will be cited often by scholars and practitioners alike as part of the ongoing discussion about the difference between applying fiduciary duty concepts to LLCs–or not–as compared with the conventional application of those duties in the corporate context.

This case began as an action to dissolve an LLC pursuant to 6 Del. C. Sections 18-801 and 802 but this decision does not address those issues. Rather, the court grants motions to dismiss filed by the Third-party Respondents based on a personal jurisdiction argument and failure to state a claim. (Thus, the court was not called upon yet to address the dissolution issues.)

The third-party claims that the court addressed alleged that the third-party defendants: (i) breached the LLC Agreement; (ii) breached the implied covenant of good faith and fair dealing; and (iii) breached fiduciary duties, among other allegations.

[Although the court granted a motion to dismiss based on lack of personal jurisdiction pursuant to 10 Del. C. Section 3104 and 6 Del C. Section 18-109, because the other issues decided have much more far-reaching importance, I won’t spend any time on the personal jurisdiction discussion, which otherwise is noteworthy in its own right.]

Though clearly separated in the structure of the opinion, the court’s discussion of the breach of contract claim and the breach of fiduciary duty and implied duty claims was somewhat, of necessity, interwoven. The court began its analysis with basic contract principles and the truism that LLCs are creatures of contract, and that a prerequisite to any breach of contract analysis, is to determine if there is a duty in the document that has been breached.

In this regard, the court cites in footnote 34 to Delaware Supreme Court Chief Justice Myron Steele’s article entitled: Judicial Scrutiny of Fiduciary Duties in Delaware Limited Partnerships and Limited Liability Companies, 32 Del. J. Corp. L. 1, 4 (2007)(”Courts should recognize the parties’ freedom of choice exercised by contract and should not superimpose an overlay of common law fiduciary duties…”)

Importantly, the court found no provision in the LLC Agreement at issue that: “create[d] a code of conduct for all members; on the contrary, most of those sections expressly claim to limit or waive liability.”

Here is the money quote:

“There is no basis in the language of the LLC Agreement for Segal’s contention that all members were bound by a code of conduct, but, even if there were, this Court could not enforce such a code because there is no limit whatsoever to its applicability”.

The “implied covenant of good faith and fair dealing” claim was carefully examined and dispatched with one of the more lucid and cogent treatments I can recall of this amorphous cause of action.

Finally, the breach of fiduciary duty claim was confronted by first reciting the provisions of the Delaware LLC Act at Section 18-1101(c) that allow for complete elimination of all fiduciary duties as part of an LLC Agreement. The court read the parties’ LLC Agreement in this case to eliminate fiduciary duties because it flatly stated that:

“…members have no duties other than those expressly articulated in the Agreement. Because the Agreement does not expressly articulate fiduciary obligations, they are eliminated.”

The case is available here.

(Editor’s note: This post is by Professor Lynn Stout of UCLA School of Law and Professor Jonathan Macey of Yale Law School.)

In the latest issue of the Virginia Law & Business Review, we debate whether the classic case of Dodge v. Ford, and its claim that maximizing shareholder wealth is the proper purpose of a business corporation, deserves a place in the modern legal canon. Lynn argues that Dodge v. Ford is bad law, at least when cited for the principle that corporate directors should maximize shareholder wealth. As a positive matter, Lynn suggests, no modern jurisdiction follows this rule, and as a normative matter, advances in economic theory suggest that the goal of shareholder wealth maximization is at best inefficient and at worst incoherent. Jon argues that shareholder wealth maximization is both conceptually coherent and consistent with economic theory, and that Dodge v. Ford can be used to illustrate the fact that shareholder wealth maximization is both a valid goal for corporate law and an ethical requirement, even in contexts in which enforceability is practically impossible.

The debate can be found here.