The U.S. proxy system is set to undergo a comprehensive review for the first time in nearly 30 years. The Securities and Exchange Commission (SEC) recently voted unanimously to issue a concept release “seeking public comment on the U.S. proxy system and asking whether rule revisions should be considered to promote greater efficiency and transparency.”  This so-called “proxy plumbing” concept release marks the beginning of what will certainly be a years-long process with an emphasis on fact-finding to examine the effects of shifts in “shareholder demographics, the structure of share holdings, technology, and the potential economic significance of each proxy vote.” 
Archive for August, 2010
Thirty years late, the new Dodd-Frank Act hands shareholders power to influence the composition of boards and shape CEO pay. But will these institutional investors, on whom Americans depend for their financial security, use their authority responsibly? Will corporate boards welcome and accept good faith dialogue with their shareholders? Will both sides forego short term financial engineering and align for the long term performance the country badly needs?
For decades, investors, anxious about a company gone awry, have had little choice but to complain from the sidelines, petitioning finger-wagging resolutions directors could easily ignore. Shareholders tried that to no avail at AIG before its epic collapse. Defenses fortified under-performing boards from pressure they should have faced to better control risks and tie CEO pay to measurable actual performance over time. But resolutions and defenses did not stop short-term funds that piled disabling debt on companies. Aggressive investors could cherry-pick firms for proxy fights or use stock techniques to harass. Long term institutional investors were shackled; the short term prevailed. One result: Too many boards tolerated management excesses and failures that ushered in the financial crisis.
In the paper, Corporate Tax Avoidance and Stock Price Crash Risk: Firm-Level Analysis, which is forthcoming in the Journal of Financial Economics, we examine the association between the extent of a firm’s tax avoidance and its future stock price crash risk. Recently, Desai, Dyck, and Zingales (2007) and Desai and Dharmapala (2006) put forth a “theft and taxes” idea: Complex tax avoidance arrangements can provide management with the tools, masks, and justifications for rent-diverting activities, such as earnings manipulation, unauthorized compensation, and insider trading. The purpose of our paper is to test this “theft and taxes” idea in the context of stock price crash risk.
On 29 July 2010, the UK’s Financial Services Authority (the “FSA”) published a consultation paper which sets out proposals to make significant amendments to its existing Remuneration Code (the “Code”).  If implemented in the proposed form, these revisions will have a significant impact on how remuneration policies and practices at UK financial institutions (and some foreign financial institutions operating in the UK) are operated. In particular, the revisions will mean that the Code will now be significantly expanded in its scope of application and will introduce relatively prescriptive rules on bonus deferrals, proportions of bonuses that must be paid in shares and guaranteed bonuses.
In light of the liquidation strategy for failing financial firms set forth in Dodd-Frank, I have now posted a revised version of a forthcoming article calling for a “Systemic Emergency Insurance Fund” to augment the FDIC’s resolution authority. This version, co-authored with Chris Muller, is entitled Confronting Financial Crisis: Dodd-Frank’s Dangers and the Case for a Systemic Emergency Insurance Fund; the paper has been accepted for publication in the Yale Journal on Regulation in Winter 2011.
The paper frames its case for a “Systemic Emergency Insurance Fund” in contrast to the seriously flawed, even dangerously flawed, approach of Dodd-Frank. In the next financial crisis the likely outcome will be serial receiverships imposed on many of the largest financial firms, a nationalization of much of the US financial sector. Apart from disruption to the real economy, this strategy is likely to increase the incidence of financial crises and will dangerously destabilize world financial markets. These are strong claims, but argument flows directly from the decision in Dodd-Frank to make an FDIC receivership the exclusive mechanism of providing support to troubled financial firms, stripping away much of the Fed’s and FDIC’s prior authority to provide systemic support in a financial crisis. Having entrusted the regulators with enormous discretion in the implementation of Dodd-Frank, the legislation withdraws that trust at the moment of systemic emergency, in the name of eliminating bailouts and stamping out moral hazard.
Let me start with an observation and a prediction. The observation is that it appears that a primary, if unstated, objective of this rule is to put the issue of proxy access behind the Commission once and for all. My prediction is that, paradoxically, the rule that the Commission adopts today virtually guarantees that the Commission will be forced to deal with this issue for years to come. I say this for two reasons. First, I believe that the rule is so fundamentally and fatally flawed that it will have great difficulty surviving judicial scrutiny. Second, an inevitable consequence of this rule, if it survives, is that the staff will be tasked with the unenviable responsibility of brokering disputes and addressing a broad array of issues arising from the operation of this new federal right every proxy season.
This result is unfortunate, because it was so clearly avoidable — it was not a necessary consequence of adopting a rule that would truly facilitate shareholders’ state law rights to nominate directors.
While a great many things in our financial markets have changed since the day I first joined the Securities and Exchange Commission in 1977 as a baby lawyer in our Office of General Counsel, one thing has remained the same — shareholders still do not have a real say in determining who will oversee management of the companies they own. A shareholder today exercising her franchise right has no choice among candidates. Yet, voting necessarily assumes a choice.
For far too long, shareholders have been effectively shut out of the director nomination and election process. And, since 1934 when Congress extended proxy authority to the Commission, our proxy rules have failed to facilitate — in fact, have frustrated — shareholders’ efforts to carry out their franchise rights to nominate and elect directors that they select.
Update: The ruling of the Superior Court was subsequently affirmed on appeal; that decision can be found here.
A Canadian case decided this month is destined to become a landmark decision on the difficult issue of comparative fairness in change-of-control transactions involving collapse of two classes of stock into a single class.
In Magna International, Ontario Superior Court No. CV-10-8738-00CL, major institutional shareholders attacked the restructure of Magna from a dual-class to a single-class stock capitalization. The investment bank retained by the special committee of directors did not give a fairness opinion. (Major investment banks generally do not give “comparative” fairness opinions.) The special committee did not make a recommendation to the shareholders. The high-vote shares received a date-of-announcement premium of 1,800% and the low-vote shares suffered an 11.7% dilution; each far larger than any Canadian or U.S. precedent transaction. Announcement of the proposal for the dual-class collapse was well received by the market with a material increase in the low-vote share price, despite the dilution. A proxy statement for the shareholder meeting called to consider the transaction was approved by the Ontario Securities Commission as satisfying requirements for full disclosure of the facts relevant to the shareholder decision. At the meeting, 75% of the low-vote stock voted to approve the transaction.
The Magna transaction and the Court’s decision provide a clear road map for a company’s directors, and the investment bankers and lawyers advising them, in a dual-class restructure to create a single class of stock. They also provide interesting facts and analysis that may be of use in other types of change-of-control dual-class transactions.
Public companies in the United States can raise capital around the world. As a result, shareholders of public companies are dispersed throughout the 50 states, and across the globe. The idea that shareholder decisions are made in-person at a company’s annual meeting is anachronistic. Shareholders are no longer able to meet in person to discuss who should sit on the board of directors, make nominations, and vote. Instead, these deliberations and determinations are made primarily through the written process that makes up the corporate proxy solicitation.
Recognizing this reality, for the better part of a decade, the SEC and its staff have been considering how to restore to shareholders the traditional ability to nominate directors.
Today, the staff is recommending rules that will enable owners of a significant, long-term, stake in the company to include in the company’s proxy materials a limited number of nominations — no more than 25% of the board. The staff has described these rules in detail, and I will not repeat what has been said.
Today, the Commission is adopting rule changes to provide shareholders with “proxy access.” New Exchange Act Rule 14a-11 creates for shareholders a minimum federal right of access to a company’s proxy materials to nominate directors. As amended, Exchange Act Rule 14a-8 will allow shareholders to include in a company’s proxy materials a proposal to amend the company’s bylaws to provide for proxy access, subject to a major exception. That is, shareholders are unable to opt out of the Rule 14a-11 access regime, even if they want to. The proxy access right the Commission is establishing under Rule 14a-11 is mandatory.
The Rule 14a-8 amendment facilitates shareholders in crafting what the shareholders believe to be an appropriate access regime for a particular company. I welcome the Rule 14a-8 amendment as a sensible step that empowers shareholders, respects the traditional role of states in regulating internal corporate affairs, and allows for efficient private ordering.
Unfortunately, the Commission has chosen to do more than amend Rule 14a-8. The Commission also is adopting Rule 14a-11, the mandates of which displace private ordering and state law and negate the import and effect of shareholder choice when it comes to determining the contours of proxy access. Neither theory nor data adequately substantiate the Commission’s imposition of the mandatory Rule 14a-11 proxy access right. Accordingly, I am not able to support the final rule before us and respectfully dissent.