Archive | August, 2011

Governance is More than Skin Deep!

In a recent Forbes article entitled Warren Buffett, And His Board, May be Too Old to Run Berkshire Hathaway, Francine McKenna makes the case for both greater vigilance by Berkshire investors (including the author) and a different concept of corporate governance.

Ms. McKenna may well be right as to her ultimate conclusion, although Berkshire’s performance over time should give us pause as to whether directors have ‘lost it’. However, her argument that regulators should be involved in this determination illustrates what is wrong with current governance theory. She invokes Prof. Larcker’s treatise on governance as a point of reference as to whether board members are ‘too busy’, discusses the process by which key decisions are made – e.g. the recent $5 billion investment in Bank of America supposedly made by Mr. Buffett while bathing – and discusses at length the ages of board members. Yet none of this has anything to do with the quality of the decision-making or any external exposure which should concern regulators.

One can justifiably argue against (as well as for) the BofA transaction, but the ages of decision-makers and the venue for the decision have nothing to do with its quality. Essentially the same decision-makers were involved in the decision to acquire all of Burlington Northern Railroad, which has thus far been a huge success for Berkshire. Ditto for the 2008 investments in Goldman Sachs preferred stock, which not only paid off handsomely for Berkshire, but also played a role in stabilizing the economy. Are we to believe that 2-3 years have taken a major toll on the competence of the board?

Even assuming that there is some reason for such a belief, is there any reason Continue Reading →

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CEOs: Not the Best Directors

The new 2011 Corporate Board of Directors Survey from Stanford University’s Rock Center for Corporate Governance and Heidrick & Struggles has uncovered surprises about who makes the best board directors: it’s not necessarily the current CEOs that most companies seek out.

“The popular consensus is that active CEOs make the best board members because of their current strategic and leadership experience,” says David Larcker, professor at the Stanford Graduate School of Business. However, when asked about Continue Reading →

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The Mind of an Institutional Investor

Great to see Jon Lukomnik, managing partner of Sinclair Capital, now blogging at The Mind of an Institutional Investor, and now added to our blogroll. Lukomnik’s first two topics are Debunking Myths About ISS and Irrational Short-Termism in Investing.

One of Lukomnik’s arguments with regard to ISS is that they are as much a follower as a leader because of their annual survey, which they use to set their proxy policies. Don’t Miss Chance to Shape ISS Policy. Jon also discusses the failure of ISS to strongly influence say-on-pay votes.

For those interested in Lukomnik’s Irrational Short-Termism in Investing, I would also recommend Can Investors Behave Long Term? and What is Short Term? A Conversation Retesting Assumptions. Although we’ve discussed some of the same issues, Lukomnik brings fresh insights from his years of experience in the field of corporate governance.

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India Against Corruption

Employees replaced their jackets with white tees imprinted with “India Against Corruption” slogan. On 24 August 2011, Bangroleans formed a 17-kilometer human chain on outer ring road to protest against corruption. Finally, the middle class Indians have discarded their cloak of apathy. Passion, enthusiasm and commitment to change the system is replacing cynicism, skepticism and disillusionment.

Indian public supports Anna Hazare’s fight for a strong Lokpal Bill. The bill when implemented will hopefully reduce demand side of corruption. In the din, we are forgetting that demand and Continue Reading →

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Make Auditors Work for ShareOwners: Take Action

The Public Company Accounting Oversight Board (PCAOB) published a concept release that asks for public input on how to get auditors to become more independent, more objective, and more skeptical – and especially whether a mandatory rotation system for audit firms would achieve that objective. While mandatory rotation has been considered and dismissed in the past, PCAOB Chairman James Doty wants to take a fresh look at the idea to see if it might reduce the pressure on auditors to put concerns about the Continue Reading →

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When the CEO Really Must Go

It is often said that “the most important function of a board is to hire and fire the CEO.” Yet the experience of many is that boards do a pretty good job on the hiring front and a not-so-good job on the “exit.”

The Silicon Valley Chapter of the National Association of Corporate Directors will hold a session on September 15, 2011 focusing on the pitfalls of CEO changes and how to avoid them. There will be a candid discussion between an experienced CEO and an experienced chairman of a board, facilitated and led by Rich Moran, a member of our board of directors.

Location: Wilson Sonsini Goodrich & Rosati, 650 Page Mill Road, Palo Alto, CA 94304. This program, like all SVNACD programs, is subject to the Chatham House RuleRegister Now!

7:30-8:00 a.m. Continental Breakfast; 8:00-9:30 a.m. Program

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Don't Miss Chance to Shape ISS Policy

Many press reports attribute 20% of voting power at some companies to recommendations made by ISS. That makes them sound like one of the most powerful entities in the world. However, much of their “power” is based on their annual survey, which helps ISS shape its recommendations to meet the voting preferences of its customers. Are they a leader or a follower?

I doubt many investors follow ISS recommendations blindly. However, their positions are certainly used as a guide in helping shareowners identify voting decisions that are consistent with the existing preferences of ISS Continue Reading →

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HP's Loss Offers Lessons

When I put on my law teaching hat for the first time all summer, in preparation for my fall term class at DePaul University College of Law,  it became apparent that the unfolding situation at Hewlett Packard is going to be a case study for many law and business school courses.  A fortiori, this means that it is fertile ground for today’s corporate governance devotees.

Regular visitors to this space will recall that about a year ago, yours truly noted that the ouster of HP’s CEO, Mark Hurd, was a poor reflection upon both our existing corporate governance legal regimen and the performance of the HP board, Mark Hurd’s Termination from HP: Case Study.  The ultimate issue for both was the lack of emphasis on CEO performance vis a vis business strategy and market performance, and overemphasis on personal behavior. Yours truly elaborated on Continue Reading →

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Leave it to Delaware: Why Congress Should Stay out of Corporate Governance

The Delaware Journal of Corporate Law recently announced their hosting of the 27th Annual Francis G. Pileggi Distinguished Lecture in Law with the above topic by Professor Jill E. Fisch. The lecturer is a leading voice in the field of corporation law, and the lecture provides the Delaware Bar, particularly the members of the bench on both the Court of Chancery and the Supreme Court, an opportunity to challenge academia with practical concerns. The notice is available here. Registration information is available here. September 23, 2011 in Wilmington.

Jill E. Fisch is a nationally known scholar, whose work focuses on the intersection of business and law, including the role of regulation and litigation in addressing limitations in the disciplinary power of the capital markets. Her 1997 paper, Retroactivity and Legal Change: An Equilibrium Approach (Harvard Law Review), introduced a new framework for retroactivity analysis that could apply to both adjudication and legislation. Her 2003 paper (with Stephen Choi), How to Fix Wall Street: A Voucher Financing Proposal for Securities Intermediaries (Yale Law Journal), proposed a voucher financing mechanism to increase accountability for securities intermediaries such as research analysts, proxy advisors and credit rating agencies.

The Destructive Ambiguity of Federal Proxy Access posits that private ordering, within the framework of existing state regulation, offers a more flexible mechanism for maintaining equilibrium in the allocation of power between shareholder and managers. The article concludes by outlining the federal regulatory changes necessary to enable effective private ordering.

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Bad Rule Adopted on IR

The US Securities and Exchange Commission (SEC) has approved a New York Stock Exchange (NYSE) rule opposed by investor relations service providers who fear the measure will harm their ability to compete.

The SEC’s Division of Trading and Markets approved (PDF 95KB) new Section 907.00 of the Listed Company Manual, which will result in the NYSE including information about a suite of “complementary” investor relations services available to listed issuers, including investor relations website and news distribution services from giant Thomson Reuters and shareholder identification services from Ipreo.

The rule was opposed in public comments by a variety of investor relations service providers. They branded it anti-competitive and said it would lead to a lack of innovation in the IR services industry.

via SEC approves NYSE IR services rule | IR Web Report, Dominic Jones, 8/16/2011.

Flying in the face of protest, the SEC has approved a controversial new NYSE rule giving issuers free IR services. Service providers outside of the exchange’s coterie of partners bitterly opposed the change, saying it would squash competition and stifle innovation.

via Free IR services from the NYSE get go-ahead, 8/17/2011.

Mistakes were made. I’d love to see them reversed. We need less monopolies, more competition and more information.

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India: Independence of Boards at Risk

Boards have become larger but controlling for other things, less independent (have fewer independent directors) after the crisis. Much of this seems to be the result of a “supply shock” in which independent directors have become more aware of the risks associated with board positions. In the three weeks of January 2009 after the Satyam fraud came to light, independent director exits soared to 109 from a monthly average of about 30 before the crisis. Over a longer horizon, independent director exits per year have risen by 20% in the post-Satyam period as compared to the three years before the crisis…

Executive director appointments have more than doubled in the post-Satyam period than before. Their proportion on boards has risen by 16%.  (The drop in the number of independent directors in boardrooms bodes ill for corporate governance, FT, 8/20/2011)

Indian Boards should consider expanding their horizons, seeking directors from a much more diverse pool of creative professionals from outside their normal circles, including experts in social media, women and international candidates.

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"Video" Friday: Dave Lynn and Marty Dunn on Proxy Access

No video today but borrowing a recent installment from Oops, you’ve got to be a member to listen to the Dave & Marty radio show discussing the DC Court of Appeals decision in the proxy access case and the implications for the SEC. Another good reason to signup for their great service.

Here’s CNBC’s coverage. PwC’s perspective.

What would the ideal proposal look like under Rule 14a-8(i)(8) if the SEC lifts their current stay? If you have ideas, e-mail me.

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The Potentially Binding Nature of Say on Pay

Say-on-pay, somewhat hollow on its own, could be used as a gatekeeper of sorts for corporate waste claims, argues Steven C. Caywood in Wasting the Corporate Waste Doctrine: How the Doctrine Can Provide a Viable Solution in Controlling Excessive Executive Compensation, 12/2010. A revitalized corporate waste doctrine would allow shareowners to have some meaningful power as a safeguard against a board of directors that excessively compensates executives. Using these two tools in tandem would allow shareowners to address executive compensation concerns while not overburdening corporations with regulation and litigation.

A waste claim is a relatively simple one. It is brought by shareholders against a company’s board of directors alleging that the board wasted company assets. Waste can include any distribution of company assets, but the doctrine, when Continue Reading →

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CSX Decision May Encourage Use of Social Media by Shareowners

In a guest post on Active Investing, Phil Goldstein notes the importance of the Second Circuit’s CSX opinion is not about swap contracts.  See Blog Post on CSX Decision
More important is that it reduces the fear that mere communication between like-minded shareowners generates the need to form a 13d group. Merely alleging “concerted action” is not enough.  Instead, applying the statute literally requires that coordinated  purchases must be alleged (and proven). According to the decision:
As we have noted, the statute and the implementing rule are both concerned with groups formed for the purpose of acquiring shares of an issuer. See 15 U.S.C. § 78m(d)(3); 17 C.F.R. § 240.13d-5(b)(1).
Whether a group exists under section 13(d)(3) “turns on ‘whether there is sufficient direct or circumstantial evidence to support the inference of a formal or informal understanding between [members] for the purpose of acquiring, holding, or disposing of securities.’” CSX I, 562 F. Supp. Continue Reading →
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Monitoring the Supreme Court

I don’t know if the SEC will appeal the proxy access decision to the U.S.Supreme Court but if they do, or if you are following other issues that go before that body, you might want to load up a couple of free apps for iOS and Android OS devices:

OyezToday tracks the current business of the U.S. Supreme Court in the form of abstracts in all cases granted review.

We share SCOTUS audio in a searchable format linked to transcripts. With a simple flip and tap, It is possible to identify and create clips of segments or turns to share and repurpose. We also make written opinions available shortly after release. This Continue Reading →

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Review: Business Ethics and Corporate Sustainability

Business Ethics and Corporate Sustainability contains fourteen essays examining mainstream business models with the aim of designing more sustainable systems with regard to corporate responsibility issues, such as the environment and human rights, while reducing overall risk profiles and increasing legitimacy.

Christopher J. Cowton, for example, examines the moral status of corporations, their collective responsibility and systems of blame distribution. While it makes sense to blame a corporate entity as a first approximation, that should be only the first step in determining blameworthiness. Leaving blame as resting with BP for the Gulf oil spill, risks failing to identify and blame culpable individuals. Cowton moves us away from reified notions of corporate moral agency, to focus on methods of tracing responsibility in detail to specific individuals according to governance and responsibility frameworks. People are moral agents; corporations are not.  Johan Wempe advances this notion further, examining notions of role responsibility.

Kevin T. Jackson retraces Aristotelian notions of generosity as a moral virtue and ends with a promising direction in his discussion of venture philanthropy, which in some respects, harkens back to businesses during the Middle Ages. Wouldn’t it be great if entrepreneurs started measuring themselves not by how much money Continue Reading →

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Review: Your Billable Life

This isn’t a book about corporate governance but since a large number of attorneys read this blog I thought I’d post a quick review of Your Billable Life: A Law Firm Survival Guide for New Attorneys by Bruce F. Dravis since I recently reviewed his excellent book The Role of Independent Directors in Corporate Governance.

Your Billable Life is written for first year lawyers but it may be even more helpful to those seeking their first job as an associate, since it contains a good discussion that may help you in deciding what type of firm you want to practice with.

It is a very quick read. Much of the information may seem obvious but almost everyone will get some insights on getting the most from mentor, how to communicate with them, senior partners and clients. How to be stupid; how to be smart and balancing work and life are among the many brief chapters. Dravis has twenty years of experience. If he can save you from one blunder that could make a huge difference in you career path, shouldn’t you take the plunge and spend an hour or two reading his wise counsel?

Read the first chapter for free and you’ll be hooked.

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The Role of Independent Directors in Corporate Governance: A "Must Have" Reference for Every Corporate Director

When I reviewed the first edition of The Role of Independent Directors after Sarbanes-Oxley by Bruce F. Dravis I called it an entire reference library in a thin volume. For the second edition, entitled The Role of Independent Directors in Corporate Governance, the number of pages has gone up from about 170 to 250 and the typefont is slightly smaller but the guidance remains the most readable I have encountered for providing directors, their advisors, and shareowners with a solid understanding of the primary legal and governance issues faced by independent directors.

The accompanying CD links to legal source material underlying the text, so those interested in drilling deeper are certainly given the resources. Upload the CD to your iCloud account so that you don’t have to go looking for it. Of course one thin volume and a CD can’t cover the entire universe of materials and the field is ever evolving, so minor sections, such as that on proxy access, are already slightly out-of-date. However, Dravis’ succinct coverage of a broad range of topics is unparalleled.

Here’s one I never noticed before: NYSE rules use the term immediate family member to include, as a disqualifying relationship for independence, “a person’s spouse, parents, children, siblings, mother and fathers-in-law, sons and daughters-in-law, brothers and sisters-in-law, and anyone (other than domestic employees) who shares such person’s home.” Thank god you can still appoint your live-in maid to the board and have them be considered independent. Something Rupert Murdoch might want to consider? However, maybe such a person would be Continue Reading →

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Google Book Bibliography Updated

Digital Scholarship has released version 7 of the Google Books Bibliography, which presents over 325 selected English-language articles and other works that are useful in understanding Google Books. It primarily focuses on the evolution of Google Books and the legal, library, and social issues associated with it, especially the Google Book Settlement. To better show the development Google Books, it is now organized by year of publication. It primarily includes journal articles, e-prints, magazine articles, and newspaper articles. This version expands coverage of law review articles and legal e-prints. Where possible, links are provided to works that are freely available on the Internet.

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Governance Roadshows Prepare for Proxy Season

Francis Byrd, Laurel Hill Advisory Group, Jeffrey Morgan, National Investor Relations Institute and Kenneth Wagner, Peabody Energy Corporation, discussed the governance roadshow idea at the Society of Corporate Secretaries and Governance Professionals conference in June.

Now might be the time to begin preparing to engage shareholders with such an effort – especially since the recent stock market slide is likely to make the largest investors even more edgy. Such an effort can alert directors to areas where policy adjustments can head off problem areas, allowing companies to retain the trust and confidence of shareowners.

Morgan suggests traveling to visit key investors during the off-season to keep communications open and to develop relationships that may come in handy later.  Byrd says, ‘This will help you prepare the board to deal with the governance issues most important to the shareholders.’ Wagner suggests that directors sit down with the largest investors and answer their questions on compensation and other governance topics.

Read more: Is it time for a governance road show? Corporate Secretary, 8/12/2011.

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Risk Managers Needed on Audit Committees

Overall, the number of U.S. Foreign Corrupt Practices Act (FCPA) enforcement actions increased by 85% in 2010. Over the course of the year the U.S. Department of Justice brought 48 criminal cases and the SEC filed 26 new actions. The trend has continued in 2011. In February, 2011, Tyson agreed to a $5.2M settlement. A number of other high-profile companies are currently facing FCPA investigations. The SEC has updated its enforcement approach, but most companies have been slow to improve their internal risk management and risk oversight mechanisms. According to GMI, only 6% of the U.S.’s largest publicly traded companies have appointed Audit Committee members who have professional experience in risk management.

Obviously, FCPA investigations and other types of lawsuits represent a significant threat to shareholder value. Publicly traded companies should work to implement strong board-level risk management oversight mechanisms. Otherwise, if liabilities from lawsuits start to pile up, they run the risk that investors will take their money elsewhere.

via How the Battle Against Corporate Bribery Represents a New Risk for Investors – Forbes, 8/12/2011.

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Federal "Agency Judgement" Rule Needed

Roger Coffin, associate director of the Weinberg Center for Corporate Governance, argues the D.C. Circuit Court’s recent decision to vacate SEC Rule 14a-11

requires a rethinking of the APA and its intersection with the requirements of the law adopted by Congress in 1995 requiring enhanced cost/benefit analyses. A better approach, and one the SEC should argue on appeal, is for courts to adopt a standard of review similar to that undertaken in business cases, when the actions of a board of directors has been challenged. In such circumstances, many courts determine whether there was a process in place for decision-making, and whether such process was followed in good faith, without conflict of interest and in accordance with law. If met, the court defers to the actions of the board, careful not to disturb the business judgment of American corporations. Under the business judgment rule, courts will not second-guess corporate decisions, awards of compensation, or other actions taken in lawful due course and corporate purpose.

Independent agencies should be afforded a similar level of “agency judgment” protection. If, for the purposes of an APA review, an agency can demonstrate a process whereby costs and benefits are considered, and a good faith adherence to that process is free of conflicts or illegalities, the court should defer to the expertise of the agency. This is a preferred approach whether one believes the SEC should adopt a uniform rule on proxy access or not. The stakes are bigger than the right of large shareholders to access the corporate proxy. They implicate the ability of agencies to do what they have been tasked to do, within the parameters of their jurisdiction and expertise. If we are going to have bodies like the SEC, they should be allowed to function as intended. That the SEC was not given appropriate deference in the proxy access case is bad news for them, and for all agencies.

via SEC’s Missteps on Proxy Access Implicate Larger Interests | Directorship | Boardroom Intelligence, 8/3/2011.

In California all regulations are reviewed by the Office of Administrative Law for compliance with our version of the APA. OAL reviews the rulemaking record to determine whether the rulemaking agency satisfied the procedural requirements of the APA and to review the proposed regulations for compliance with the six legal standards set forth in the APA: Authority, Reference, Consistency, Clarity, Nonduplication and Necessity. OAL may not substitute its judgment for that of the rulemaking agency with regard to the substantive content of the regulations. See Government Code section 11349.1.

Though not binding on the courts, OAL findings are entitled to deference. (Grier v. Kizer (1990) 219 Cal.App.3d 422, 435, disapproved on another ground by Tidewater Marine Western, Inc. v. Bradshaw (1996) 14 Cal.4th 557, 577.) Too bad the SEC isn’t under California’s jurisdiction.

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Trading on Emotions

Investors’ previous experiences with a stock affect their willingness to repurchase the stock. Using detailed trades data from two brokers, Michal Strahilevitz, Terrance Odean, and Brad M. Barber document that investors are reluctant

  1. to repurchase stocks previously sold for a loss and
  2. to repurchase stocks that have risen in price subsequent to a prior sale.

They propose this behavior is driven by investors’ emotional reactions to trading and their attempts to distance themselves from negative emotions (e.g., disappointment and regret). Investors are disappointed when they sell a stock for a loss and regret having ever purchased the stock; these negative emotions deter investors from later repurchasing stocks sold for a loss. Since many investors view their portfolios regularly, they also desire to avoid painful reminders of prior losses.

Having sold a stock, investors are disappointed if the stock continues to rise and regret having sold the stock in the first place; these negative emotions deter investors from repurchasing stocks that go up after being sold. Thus investors engage in reinforcement learning, by repurchasing stocks whose previous purchase resulted in positive emotions and avoiding stocks whose previous purchase resulted in negative emotions.

Stock trading, like many other economic behaviors, is affected by emotions. It makes emotional sense that investors repurchase stocks that have decreased in value since being sold. Investors who do so feel the pleasure of making a choice that results in a better outcome than what might have been had they not previously sold the stock, while investors who repurchase at higher prices feel regret from knowing that they could have easily done better. Similarly, avoiding what has been a source of pain in the past is one of the most basic instincts that humans possess. Investors are unlikely to wish to repeat or to be reminded of actions linked to their previous failures. Thus, it is not surprising that investors are attracted to stocks that have treated them well in the past but shy away from stocks by which they were once burned.

Once Burned, Twice Shy: How Naïve Learning, Counterfactuals, and Regret Affect the Repurchase of Stocks Previously Sold, forthcoming Journal of Marketing Research, May 2011.

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Support Women on Boards: 20% by 2020

Three college degrees for every two earned by a man. 85% of purchasing decisions. Nearly 50% of the workforce. And yet, the tiniest of chips in the glass ceilings of boardrooms across corporate America with women holding just 18% of corporate board posts at S&P 100 companies. What’s wrong with this math?

Aditi Mohapatra, Senior Sustainability Analyst with Calvert Investments, McKinsey’s Women Matter study, which found companies with the highest share of women on executive committees outperformed those with all-male executive committees by 41% in terms of return on equity and 56% in operating results.

She goes on to note that Calvert has filed diversity proposals at 55 companies; 46 agreed to change Continue Reading →

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