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.

I have enjoyed many reviews of CORPOCRACY but none pleases me as much as the following from a teacher in Maine:

“Monks, internationally known governance guru, of the stature of Peter Drucker, author of Corpocracy is right now being quoted on NPR/MPBN (Wednesday last) on Exxon’s promotion of false science.

Please show me that you are aware of him. (I don’t know him well, but I just sent him a copy of this and you can reach him at that email.) I suggest you use it.

NOTE his sub title:

Corpocracy: How CEOs and the Business Roundtable Hijacked the World’s Greatest Wealth Machine — And How to Get It Back by Robert A. G. Monks

His book includes a sensational expose of Lewis Powell, Justice of the Supreme Court, whom he labels the “consiglieri” of the corpocracy and its “godfather”, as author of the “Powell Memo.” And he knew Powell as a lawyer whom he hired in one corporate business matter because he knew he was the best!

When are you going to get him interviewed for three hours as he deserves? HE IS SPEAKING DIRCTLY TO THE CURRENT FINANCIALIZED ECONOMIC DISASTER!
John C Bogle and he agree. As you will see, he, like Bogle, knows his business. MONKS is even more of a heavyweight and has better more far seeing recommendations.
Worth your attention. VERY MUCH SO!

Maybe Bogle would interview him for you. Or Lawrence Mitchell of GWU right down there in DC, my old haunts in your neighborhood, when I was a speechwriter for the head of SBA, Howard J Samuels.

I am teaching MONKS in my new course at Senior College in Rockland on The Corporation and the New Capitalisms. The registrants love it! “

(Editor’s note: This post by Praveen Kumar and K. Sivaramakrishnan at the University of Houston is part of the series of posts on corporate governance articles accepted for publication in prominent Finance Journals)

Our forthcoming article in the Review of Financial Studies entitled “Who Monitors the Monitor? The Effect of Board Independence on Executive Compensation and Firm Value” evaluates the efficacy of recent corporate governance reforms that focus on board independence and encourage equity ownership by directors. For instance, both the NYSE and the NASDAQ now require that a majority of directors on corporate boards should be independent, and that the audit and compensation sub-committees should be made up entirely of independent directors. These reforms appear to reflect a widely held belief among regulatory bodies and the corporate world that board independence and equity-based director incentives unambiguously improve board performance and, therefore, enhance shareholder value.

In this paper, however, we show that this belief may sometimes be misplaced. We analyze the efficacy of such reforms in a model where both adverse selection and moral hazard are present at the level of the firm’s management. Delegating governance to the board improves monitoring but creates another agency problem because directors themselves avoid effort and are dependent on the CEO.

We show that as the board’s dependence on the CEO increases, its monitoring efficiency may increase even as incentive efficiency deteriorates with respect to compensation contracts awarded to the managers. The reason is that a more dependent director benefits less from superior information about the firm’s economic prospects generated by monitoring. This endogenous tension implies - contrary to the assumptions underlying recent reforms - that outside shareholders’ value can indeed decrease as board independence increases. Moreover, and again contrary to the general presumption in the literature, higher equity incentives for the board sometimes may increase (equity-based) compensation awards to management.

The full paper is available for download here.

(Editor’s note: this post was written by David Kessler, HLS ‘09, in the course of his taking Corporations with Professor Robert C. Clark)

(With the rhyme scheme and meter mostly intact and with many apologies to T.S. Eliot)

Let us rule then, you and I,
When there’s theft of corp’rate opportunity
Like a patient over-billed by doctors able;
Let us read through certain less well-researched briefs,
The nimbly wrought conceits
Of high-paid lawyers in nearby hotels
Who work so hard all day for corporate shells;
Days that follow, full of insipid argument
Of questionable intent
That lead some to such aggravating questions . . .
Oh, do not ask, “Why is it?”
Let us rule, and don’t inquisit!

In the court attorneys come and go
Talking of prices high and low.

. . .

And indeed there will be time
To wonder, “Why due care?” and, “Why due care?”
Time to cite Disney in Delaware,
With a weak spot for process seeming fair—
[They will say: “How his rules help business win!”]
My rules are right, laws see disloyalty as greater sin,
Not corp’rate course I most protest, with business judgments I begin—
[They will say: “But how can Michael Eisner win?”]
Why due care?
Surely bad faith is worst?
In opinions there is room
For decisions and omissions which the higher courts reverse.

. . .

Oh the securities exchanges and the SEC!
Fearful of false traders,
Awake . . . watchful . . . such castigators,
They ask for more, wise use of Rule 10b.
Should I, finding fraudulent devices,
Have the strength to force the moment to its crisis?
And though I don’t see full disclosure ‘fore the trade,
Though I have seen losses [heaped highly] pile up as on a platter,
I cannot stop it—I see no bad actor;
But I too have seen omissions with scienter,
I have seen manipulations by a corporation slicker.
Long or short, a trade was made.

And would it have been worth it, after all,
Before the suits, demands refused by SLCs,
Directors independent, Section one-forty-one (c)s,
Would it have made sense to file,
To have argued that demand was just futile,
To have tried so hard to heed Zapata’s call
To argue interests false or domination
To say: “I am plaintiff pure, for class unsaid,
Come here to sue for all, I shall sue for all”—
If one, junking a lawsuit never read,
Should say: “There is no one to sue at all.
There is no one, at all.”

. . .

I grow bold . . .I grow bold . . .
I shall write some rulings that help law unfold.

Shall I part with precedent? Do I dare to find a breach?
I shall don my robe in chambers, and hear attorneys screech.
I have heard Justices talking, each to each.

I do not think they will overrule me.

I have read their tortured case law now for days
On Revlon and on Unocal attack
Of mergers sound and mega-deals off track.

We have day-dreamed in the Court of Chancery
Of lawyers’ claims, both righteous and unsound
Till our clerks’ voices wake us, and we frown.

One of the major findings of the law and finance literature comparing corporate governance across countries is that large-percentage shareholders in public corporations are a response to weak legal protections for investors. Thus, it is reported that common law countries have less concentrated ownership than civil law countries because they afford stronger legal protections for investors. Similarly, it is reported that ownership is less concentrated in countries with strong investor protection laws.

The papers that reach these conclusions analyze country averages of ownership concentration instead of firm-level data. I just released a paper in which I show that this creates omitted-variable and aggregation biases. Aggregation, in particular, eliminates all within-group (country) variation, leading to artificial clustering. Most papers also use small samples of large firms. This makes inferences to country populations problematic because ownership concentration is inversely related to firm size and firm size varies across countries.

I correct for these limitations by analyzing firm-level observations; control for firm-level determinants of ownership concentration, including size; and use a broad sample of firms from 32 countries. When I take these steps there is no support for the widely held theory that large shareholders are a response to weak legal protections for investors. In particular, there is no relation between ownership concentration and whether a firm comes from a common law country. Similarly, there is no systematic relation between ownership concentration and 14 broad indices of investor protection laws. An index is as likely to be positively associated with ownership concentration as it is to be negatively associated with ownership concentration.

Given these findings, I re-examine the theoretical literature that predicts a negative relation between investors’ legal protections and ownership concentration. There are two branches to this literature, and they have diametrically opposed views on the role of large shareholders in public corporations. One branch models external blockholders who monitor management to stop the appropriation of corporate resources. The problem is that around the world blockholders typically are managers. The other branch, in contrast, models internal blockholders who appropriate corporate resources. Although this comports with the reality that most blockholders are insiders, it is inconsistent with evidence showing that in most countries firm value increases with ownership concentration. Both branches of the literature ignore the effects of large shareholders on management decisions. Given how broadly large shareholders can impact management and given that management decisions are not subject to judicial review, even in countries with strong legal systems, there is no reason to expect ownership concentration to vary with investors’ legal protections.

The full paper is available here.

One of the off-balance sheet structures that has caused substantial losses for a European bank is the so-called “Rhineland Funding”. This structure has resulted in substantial losses for the German bank IKB Deutsche Industriebank. The Rhineland Funding conduit had substantial exposure to U.S. subprime mortgages and was unable to issue asset-backed commercial paper (ABCP) against the conduit and, moreover, was unable to obtain lines of credit from Deutsche Bank and other financial institutions to raise financing. As a result, IKB had to step in and provide liquidity to the Rhineland Funding conduit as a result of various liquidity standby facilities it had earlier provided the Rhineland Funding conduit.

It has been difficult to obtain details on the structures of these off-balance sheet conduits and the various entities affiliated with them. An organizational chart describing the Rhineland Funding structure and affiliated parties is available here.

(Editor’s note: This column by Stephen Davis and Jon Lukomnik was originally published in the May 13, 2008 edition of Compliance Week.)

The 2008 proxy season in the United States is revealing hazardous gaps among the responsibilities expected of corporate directors, the way directors are elected, and the way investors treat decisions about how they vote.

Directors stand at the fulcrum of modern American corporate governance. They weigh the perspectives of management against the interests of shareowners. Getting that balance right is what many of the corporate governance battles of recent years have been about. As a result, demands on directors have skyrocketed. They now spend about 200 hours a year, on average, overseeing a corporation. Delaware courts give huge deference to director judgment while ruling repeatedly that the greatest power shareowners have to protect themselves is the ability to elect the board.

Only recently, however, has the process for electing directors begun to catch up to the centrality of the role. Consider that only in the last two years have most S&P 500 companies embraced a majority-vote system where directors who fail to gain a majority of ‘yes’ votes must resign their seats. That sounds like garden-variety common sense. But it represents a swift and profound revolution in Corporate America.

For decades until 2006, virtually every board director gained office in a Soviet-style election where only ‘yes’ votes counted. Investors’ only other choice was to “withhold”—the procedural equivalent of staying home. Plus, boards generally faced ballots in a single resolution that bundled all candidates together; an entire slate could be installed to pilot a public corporation even if only a single share voted yes and every other vote was withheld. A shrinking (but still significant) minority of companies still feature such rules, even now.

…continue reading: How to Hire a Director

President Bush recently announced the appointment of law professor Troy A. Paredes as a Commissioner of the Securities and Exchange Commission. Pending confirmation by the Senate, Paredes will commence a five-year term on 6 June 2008, filling the seat Paul Atkins will vacate after almost six years in office.

Professor Paredes’ CV outlines his broad experience teaching, writing and practicing in the areas of corporate and securities law. After five years with major law firms in San Francisco and Los Angeles, in 2001 Paredes joined the Washington University School of Law. His scholarship has spanned a broad and varied mix of topics in law and related disciplines. The topics include: securities regulation; corporate governance; corporate control transactions; corporate finance; the theory of the firm; law and economics; behavioralism; and intellectual property transactions. Paredes joins Harvey J. Goldschmid as one of the few Commissioners who have been appointed from the legal academy.

In his writing, Paredes’ supports the use of market discipline - rather than mandatory rules - to protect investor interests, and has recommended that SEC Commissioners attempt to shape market practices through speeches, op-ed pieces, and other public statements. His recent papers, entitled Hedge Funds and the SEC: Observations on the How and Why of Securities Regulation (2007) and On the Decision to Regulate Hedge Funds: The SEC’s Regulatory Philosophy, Style, and Mission (2006), deserve attention since, in many respects, they reflect his approach to securities regulation more broadly. He says that concerns about “empty voting” and other “abuses” by hedge funds should be “kept in proper perspective”. Rather than engaging in illicit behavior, “the vast majority of hedge fund managers are disciplined traders who make informed, although risky, trades.” He takes issue with the SEC’s 2004 decision to regulate hedge funds and expresses concern that the SEC “will at some point regulate venture capital and private equity funds”. Instead, he recommends that the SEC facilitate market discipline of hedge funds by adopting default rules or expressing its view on best practices, leaving the final decision to hedge funds themselves on which practices to adopt. As to the role played by SEC Commissioners, Paredes explains:

“Imagine the potential impact on the industry if the SEC chairman, particularly if joined by other commissioners and the directors of the Divisions of Investment Management and Corporate Finance, pushed a set of hedge fund best practices in a series of speeches, interviews, and op-eds in publications such as the Wall Street Journal and the Financial Times.”

Paredes also explains that when making rules the SEC - like other regulators - may exhibit unconscious biases that can frustrate good decision making. To guard against this and to avoid over-regulation, he recommends more rigorous use of cost-benefit analysis and “new organizational structures that might be mined from the experiences of companies,” among other tools.

In another relevant paper, The Firm and the Nature of Control: Toward a Theory of Takeover Law (2003), Paredes outlines his views on Delaware corporate law and his respect for greater shareholder choice in some contexts. He advocates greater respect for shareholder control in change of control transactions and limits on defensive tactics by target boards. More specifically, he advocates that Revlon duties be stiffened; that in considering Unocal’s “threat prong” Delaware courts should “take a hard look at a target board’s determination that a hostile bid poses a threat to the company” and thereby limit the “just say no” defense; and that “a change of board control should trigger Revlon, even without a change of ownership or voting control at the shareholder level.” These changes, Paredes argues, would result in a more robust takeover market, making directors and officers “more accountable for their actions” and “curb any future outbreaks of greed, disloyalty, and mismanagement on the scale of the [Enron, WorldCom, etc] abuses.”

His current research includes an empirical and theoretical assessment of what causes CEO overconfidence.

Many of Paredes’ other papers may be accessed here.

On May 5, 2008, The Millstein Center for Corporate Governance and Performance at the Yale School of Management and the Mutual Fund Directors Forum partnered with independent leaders of mutual fund boards of trustees to found the Conference of Fund Leaders (CFL), a permanent new body composed of independent board chairs and lead independent directors of mutual funds in the United States. The CFL will provide a unique opportunity for the independent leaders of fund boards to come together with their peers to discuss governance issues that board leaders and their funds face; proactively present their views on policy matters important to fund investors and independent directors, regulators and lawmakers; and promote research into the value and impact of effective, independent leadership at mutual funds.

Mutual funds account for about one-third of equity ownership in North America and hold over $10 trillion in assets on behalf of American investors and savers. Fund boards negotiate the contracts that establish the price fund investors pay to have their assets managed, oversee critical aspects of their funds’ operations and work to protect fund investors from any conflicts of interest that may arise in the management of funds. The success of fund boards is thus crucial to fund shareholders’ ultimate success and their work is increasingly drawing public scrutiny. The CFL, which plans to convene two meetings a year, intends to serve as a unique peer network for sharing ideas and prompting independent collective action where appropriate.

The members of the CFL’s Steering Committee are: John Hill, independent chair of the Putnam Funds and founding chair of the CFL; Peter Clapman, independent chair of the AARP funds and vice-chair of the CFL; Ira Millstein, senior associate dean for corporate governance at the Yale School of Management; David Ruder, chairman of the Mutual Fund Directors Forum Board; Dwight Crane, independent lead director for Legg Mason Partners Equity Funds; William Foulk, independent chair of AllianceBernstein funds; Virginia Stringer, independent chair of First American Funds; and Roger Vincent, independent chair of ING Mutual Funds.

The CFL will be jointly administered by the Millstein Center for Corporate Governance and Performance at the Yale School of Management, which originated the project, and the Mutual Fund Directors Forum, the independent professional body representing U.S. independent fund directors.

The launch event is scheduled for late October in New York City. The agenda will focus on shareholder rights, board leadership and other current topics.

The founding of the CFL comes against the backdrop of recently adopted regulations by the U.S. Securities and Exchange Commission requiring mutual fund boards to be chaired by an independent. Until this SEC initiative, few such boards featured leadership separate from that of the fund family. The regulation itself remains in limbo after court rejection. The SEC has promised to restore it. Meanwhile, an estimated 65% of U.S. mutual funds have already acted to install independent chairs in anticipation of the rule becoming formalized. Most other funds have named independent lead directors.

Contact:
John Hill, chairman of the Conference of Fund Leaders and chairman of the Putnam Funds,
+1 203 625 2503,  JohnHill at firstreserve.com

Stephen Davis, project director, Millstein Center for Corporate Governance and Performance,
+1 203 432 9689,  Stephen.m.davis at yale.edu

Susan Wyderko, executive director, Mutual Fund Director Forum,
+1 202 521 6754,  susan.wyderko at mfdf.com.

I have recently distributed a memorandum entitled “A United Nations Proposal Defining Corporate Social Responsibility For Human Rights,” which discusses a report by a Special Representative to the U.N. Secretary-General. The report has broad implications for global business and particularly for companies operating on a global basis, in emerging markets, in underdeveloped countries, or in countries that lack a democratic system. The report, which will be considered in a June session of the U.N. Human Rights Council, proposes that corporations bear the “responsibility to respect human rights,” that the State has a “duty to protect” against human rights abuses by companies, and that both the State and businesses must provide more effective access to remedies for human rights violations. In the memorandum, we explain that the framework recommended to the U.N. could impose on businesses an array of expansive obligations requiring close attention by corporate management and boards. The memorandum sets forth the core principles which the U.N. Human Rights Council may endorse to guide corporate responsibilities for human rights and additionally considers their implications for directors.

The memorandum is available here.

In Miller v. McDonald, et al., ( D. Del., Bankr., April 9, 2008), the Bankruptcy Court for the District of Delaware decided an issue of great importance to those who follow corporate governance issues related to the fiduciary duties of officers and directors. In this opinion on a motion to dismiss claims against an officer of a company, the Bankruptcy Court relied on decisions of the Delaware Chancery Court and the Delaware Supreme Court to deny a motion to dismiss in the course of ruling that Caremark duties would be imposed on an officer (who was not a director), that was on the management team when the President of the company committed fraud and other actions and omissions that ultimately led to the bankruptcy filing of the company. This is notable in part because there are not as many decisions that address the fiduciary duties of officers, as opposed to directors of a corporation.

Here is a summary of a Delaware Chancery Court decision of a few weeks ago that also imposed fiduciary duties on a corporate officer, (with a link to other similar cases and to a recent article on the topic by Professor Lyman Johnson).

…continue reading: Court Imposes Caremark Fiduciary Duty on Corporate Officer

We have recently distributed a memorandum entitled Delaware Court Rejects Per Se Rules for Financial Advisor Proxy Disclosures, which discusses the ruling of the Delaware Court of Chancery in In re BEA Systems Inc. Shareholders Litigation, a lawsuit arising out Oracle’s $8.5 billion acquisition of BEA Systems. The court denied plaintiffs’ motion to enjoin a special stockholders’ meeting to vote on the merger on the basis of allegedly insufficient disclosure in the merger proxy. The ruling, issued from the bench, provides helpful further guidance regarding the application of Delaware’s materiality standards, especially as the relate to claims challenging the disclosure of investment banker analyses. The ruling also noted the importance of transactional and market context in evaluating claims that seek to interfere with shareholder decision-making or the timing of a proposed transaction.

The memorandum is available here.

The transcript of oral argument and rulings of the court is available here.

The Financial Times recently published the following op-ed piece of mine, entitled Judgment Too Important to be Left to the Accountants.

Two serious asset bubbles–the dotcom explosion of the late 1990s and the recent dizzying ascension in housing prices–have developed in the US economy within the past decade.

Given their damaging consequences, it is time to look for causes. One area that merits attention is fair value accounting, which was adopted as policy by the accounting profession in the 1990s.

This accounting convention requires financial intermediaries to carry their assets at market values, even if those assets are not being held for trading purposes.

When the dotcoms were in vogue, the assets of securities firms and other equity intermediaries were inflated, just as, more recently, rising housing values made banks and other mortgage lenders look flush. Inflated balance sheets and income statements supported more borrowing and more leverage; suddenly, the markets were awash in liquidity and risk premiums fell to unprecedented levels. It could be argued, then, that fair value accounting was the hothouse in which these bubbles bloomed; when prices are rising this system seems both to stimulate and ride the wave of irrational exuberance.

But matters look much less agreeable when the same asset values are falling. Then, the process works in reverse, and the spiral points downwards.

As assets fall in value, leverage rises, creditors and counterparties demand more collateral coverage, and companies must sell assets that they can no longer finance. Forced asset sales drive down prices, causing further write downs of assets under fair value principles–even for those who are not selling. And so it goes on. The downward spiral is continuing as this is written, and where it stops nobody knows.

Fair value accounting also has a one-size-fits-all quality that mimics the inflexibility of over-regulation. Valuing assets with reference to the market seems reasonable for firms that earn their profits from, say, buying and selling securities. In that case, what the market will pay for the firm’s assets and liabilities at any given time may be a good way to assess its overall value. But what about intermediaries such as commercial banks, which are generally in the business of profiting from cash flows? Does it make any difference to an investor in a bank–an investor who is looking to the bank’s success in corralling cash flows–that the market value of the assets that produce these flows may vary?

Many banks point out that the cash flows on portfolios they have substantially written down are doing just fine. A wooden application of fair value accounting to banks–while it may simplify the work of accountants–seems to do a disservice to bank investors, and even more so bank depositors.

If, as banks claim, fair value accounting is causing commercial banks to appear much weaker than they are in fact, it is creating a financial crisis where a mere slowdown might have been warranted.

Fair value accounting is clearly the reigning orthodoxy among accountants, but is that the right test? Accounting is simply a measurement system. What we want to know determines what and how we measure. Which is more important, the balance sheet or the income statement? Do we want to measure financial strength or earnings per share or cash flows? Is the purpose to inform equity investors or creditors and counterparties? Does one measurement system meet all of these objectives?

Given its impact on institutions and whole economies, common sense suggests that we consider whether one means of measurement is the only one we should be looking at. The world view of accountants at a particular time should not determine the answers to these questions.

It is important to recall the famous remark of Clemenceau that war is too important to be left to the generals.

Electronic Arts, Inc. recently submitted to the SEC a no-action request seeking concurrence of the SEC Staff that a shareholder proposal I submitted may be excluded from the company’s proxy materials for the 2008 annual meeting. In response to the company’s no-action request, I filed a complaint, through my counsel, in the United States District Court for the Southern District of New York. The complaint seeks, among other things, a declaratory judgment that Electronic Arts may not exclude my proposal from the company’s proxy materials and an injunction requiring the company to include the proposal.

My proposal is precatory and recommends that the board of directors submit to a shareholder vote an amendment to the company’s charter or by-laws. The suggested amendment, if adopted, could facilitate by-law amendments initiated by shareholders. In particular, the suggested amendment could require the company to submit to a shareholder vote shareholder-initiated proposals for changing the by-laws that meet certain procedural and substantive requirements. The suggested amendment could also require the company to include such proposals in the company’s proxy materials for the annual meeting.

I view my precatory proposal as rather moderate and believe that its passage and implementation could well benefit the company’s shareholders. Many shareholders, I believe, would vote for the proposal if given the opportunity to do so. I also believe that, for the reasons indicated in the complaint, the company’s attempt to exclude the proposal from the company’s proxy materials is entirely without merit. I hope that the company will change its position and allow shareholders to vote on my precatory proposal. The text of my proposal is available here, the company’s no-action request is available here, and my complaint is available here.

I would like to express my appreciation to the law firm of Grant & Eisenhofer for its invaluable legal advice and representation in this matter. I also wish to thank Greg Taxin and Julie Gresham of Spotlight Capital, and my Harvard Law School colleagues Victor Brudney, Allen Ferrell, Howell Jackson, Reinier Kraakman, and Mark Roe, for helpful comments and conversations on my shareholder proposal.

My colleagues, Amy Goodman, Gillian McPhee and I have recently published our thoughts on issues to be considered by boards of directors in setting their own compensation. We outline recent trends in compensation practices, particularly since the passage of the Sarbanes-Oxley Act, and discuss issues confronting boards of directors as they review their compensation programs; the issues include: the appropriate forms of cash compensation and equity compensation; the mix between equity and cash components of compensation; the adoption of stock ownership and retention policies; the use of perquisites; and the process for evaluating director compensation. We find that boards of public companies increasingly seek external guidance on these issues, recognizing that, when the board sets its own pay, it is in an unavoidable conflict of interest situation as are the corporate managers overseen by the board.

The memorandum is available here.

Recently, I blogged about a case brought in the US District Court, Southern District of Texas, by Apache Corporation, who sought a declaratory judgment supporting its exclusion of a shareholder proposal submitted by the New York City Employees’ Retirement System. The case sought to enjoin a lawsuit brought by NYCERS in the Southern District of New York over the exclusion of a employment-related proposal by the Corp Fin Staff under the “ordinary business” basis of the SEC’s shareholder proposal rule (ie. 14a-8(i)(7)).

A few days ago, Judge Miller of the US District Court, Southern District of Texas ruled from the bench for Apache, granting Apache’s declaratory judgment. I have posted the Order and related Memo - even the trial transcript - from the court in the “Shareholder Proposals” Practice Area on TheCorporateCounsel.net.

Interestingly, Judge Miller’s opinion appears to stake out new territory from a judicial point of view. For the first time, a court has endorsed Corp Fin’s view that a proposal that involves some significant policy matters can nonetheless be excluded under Rule 14a-8(i)(7) to the extent that the proposal also deals with core ordinary business matters; here for example, advertising, marketing, sales and charitable giving. We’ll see if the Second Circuit ultimately follows suit (I believe the Texas case isn’t binding on the SDNY one, but under a res judicata theory, it’s likely the Second Circuit would recognize the SDTX’s decision and rule in favor of Apache).

Also interestingly, the Texas court didn’t take the bait offered by Apache with respect to the appropriate standard of review for SEC Staff no-action: Apache asked the court to find that a company that excludes a shareholder proposal in reliance on a no-action letter is entitled to a rebuttable presumption that such exclusion was proper. The court declined to adopt such an approach, however, concluding that Staff no-action letters are only persuasive - but not binding - authority.

The opinion is available here.