(Editor’s note: We have received other memoranda on the proposed amendments to Statement of Financial Accounting Standards No. 5 by Eric Roth of Wachtell, Lipton, Rosen & Katz and our guest contributor Holly Gregory of Weil, Gotshal & Manges LLP. The memoranda are available here and here.)

My colleagues and I have prepared a memorandum summarizing the serious concerns raised for public companies by proposed amendments to the Financial Accounting Standards Board’s Statement of Financial Accounting Standards Number 5, dealing with loss contingencies. Boards of directors, particularly audit committee members, and those who advise boards should become familiar with the proposed amendments and the potential consequences, which include earlier, more detailed public disclosure and, including liability estimates, for litigation and other claims, even in cases where the company expects to prevail or does not believe there will be a material cost to settle the matter. Comments in writing are due on this proposed amendment by August 8, 2008 and FASB will thereafter host an open forum on the issue at which those who have submitted comments may testify. We welcome reactions to the concerns we have expressed.

The memorandum is available here.

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.

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.

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: 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.

(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.

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.

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.

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! “

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.

(Editor’s note: This post is by John Savarese of Wachtell, Lipton, Rosen & Katz.)

My colleague David B. Anders and I have written a memorandum commenting on the guidance recently provided by the Acting Deputy Attorney General Craig S. Mortford concerning principles that DOJ will now consider when negotiating and finalizing monitor provisions for deferred prosecution arrangements. The DOJ guidance addresses, among other matters, possible criteria for monitor selection, the independent nature of the monitor, procedures for resolving disputes over the monitor’s suggestions, and ways to determine the appropriate terms of any monitorship.

The memorandum is available here.

It is not often that the Southern District of New York (aka The Mother Court) rules on a stockholder derivative case. Here is a recent ruling in which Judge Swain of the SDNY forcefully applied Delaware law in dismissing a stockholder attack on the Morgan Stanley board arising out of management changes in 2005. The opinion also treats important issues that intersect federal disclosure obligations and corporate governance responsibilities. Our memorandum is available here.

On March 28, the Delaware Court of Chancery issued a decision in Schoon v. Troy Corporation, upholding a board-approved bylaw amendment that cut-off advancement rights to a former director. I previously posted here on related litigation between the parties where the court held that directors do not have standing to bring derivative suits.

At issue this time was an amendment to the company’s advancement bylaw, which originally provided that “the Corporation shall pay the expenses incurred by any present or former director.” After a director left the board but shortly before he became involved in litigation with the company, the existing board amended the bylaw to delete the reference to “former” directors.

Once litigation began, the director claimed a vested right to mandatory advancement because the lawsuit related to his official capacity as a former director when the original bylaw was in place. As a result, the bylaw amendment arguably had no affect on his advancement rights. He relied on a prior Delaware decision, Salaman v. National Media Corp., 1992 WL 808095 (Del. Super. Oct. 8, 1992), holding that a board of directors cannot unilaterally terminate a former director’s right to advancement through a bylaw amendment while litigation is pending.

The Court of Chancery rejected the former director’s argument and upheld the bylaw amendment that denied him mandatory advancements. It reasoned that a director’s right to advancement becomes “vested” when litigation is filed, not when the underlying conduct allegedly occurred. This holding may surprise some practitioners, given that the purpose of indemnification and advancement is to encourage board service and assure directors that their expenses relating to their official actions will be paid—even if litigation arises after they resign from the board. In addition, this holding was in spite of another bylaw provision providing that “[t]he rights conferred by this Article shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of such person.” The court explained that this provision “is better understood as providing that a director, whose right to advancement is triggered while in office, does not lose that right by ceasing to serve as a director” (emphasis added).

Decisions affecting directors’ rights to advancement and indemnification are always significant. This decision, in particular, may have important implications for dissident directors and directors who are ousted in proxy contests. Both litigators and drafters should take note.

The opinion is available here.

Chancellor Chandler in litigation captioned TravelCenters of America LLC v. Brog, et al., C.A. No. 3516-CC decided, among other issues, two significant legal questions worthy of broader publication. Since both rulings are contained in memorandum opinions, they will not be reported officially. The first ruling was contained in a pre-trial memorandum opinion and dealt with the admissibility of a law professor’s expert testimony on matters of state and federal law. The second, contained in a bench memorandum delivered at the end of the trial, decided whether provisions contained in an LLC Agreement were required to comport with concepts of “good corporate governance.”

I. Law Professor Testimony
In the pre-trial ruling, the Chancellor held that expert testimony from a law professor (a) could not be presented on the question as to whether, under Delaware law, the LLC’s provisions regarding advance notice were consistent with good corporate governance practices but (b) could be presented as to whether the Notice complied with the Agreement’s incorporation of federal securities law disclosure. The first holding was based on an unreported opinion in the Court’s earlier Disney litigation which had held that “‘in this Court, witnesses do not opine on Delaware corporate law.” The pre-trial ruling foreshadowed the result of the case in chief by stating that: “Delaware does not impose a legal requirement on LLCs to draft their bylaws to be consistent with some abstract notice of good corporate governance. LLCs are creatures of contract designed to afford the maximum amount of freedom of contract, private ordering and flexibility to the parties involved.”

The Court did allow expert testimony (a) on the requirements of federal securities law and, (b) citing an unreported opinion in the Court’s Wells Fargo v. First Interstate Banking litigation, as to the materiality of omissions as measured by the standards of federal securities law. Wells Fargo, relying on TSC v. Northway, had held that “issues of materiality are generally held to be mixed questions of law and fact but predominantly questions of fact.”

The pre-trial ruling is available here.

II. LLC Agreement Provisions
In the case in chief, the Chancellor granted TravelCenters’ declaratory judgment that the activist stockholder plaintiff’s notice of intended nomination of board members at the annual meeting (the “Notice”) was contrary to the LLC Agreement and “of no force or effect.”

The Court found that the Notice violated a requirement in the Agreement that such notices disclose all the information that the Exchange Act would require to be disclosed in a proxy solicitation. The decision was based on the legal proposition that LLC’s are “creatures of contract” and are not limited by general rules applicable to corporate governance. Since valid notice was required for the nominations to be accepted at the meeting, the management slate would be expected to be unopposed.

The bench memorandum is available here.

My colleague Laura A. McIntosh and I have written an article entitled Corporate Governance Update: Advice for Directors in Complicated Times: The Fundamentals Still Apply. The article considers directors’ oversight responsibility in a volatile business environment, including directors’ obligations as a company approaches the zone of insolvency and the extent to which directors are entitled to rely on management’s and experts reports, advice and decisions. The article also discusses directors’ exposure to potential liability, including the degree of vigilance required to discharge fiduciary obligations and how active directors should be in seeking information from management.