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.