pomtalk

SEC Considering New Rules and Examiners for Credit Rating Agencies

Jim Hodgson — 2009-07-16T19:41:15-04:00

SEC Chairwoman Mary Shapiro recently told the U.S. House of Representatives Financial Services Committee that the Commission is hard at work revising its oversight role with respect to credit rating agencies. Specifically, the Commission is considering implementing new rules for the industry and has established a branch of examiners to oversee the conduct of credit rating agencies.

One of the goals of any new regulatory scheme, Shapiro said, would be to limit a company’s ability to “rate shop.” That is, the new rules will prevent a company in the process of issuing new debt securities from secretly approaching multiple credit rating agencies until it finds one willing to assign the new issue an acceptable rating. Instead, an issuer will be required to disclose every agency that “pre-rates” its securities – and the rating that each would have assigned. Such a regime will prevent an issuer’s ability to play one rating agency off of another – and should thus serve to make the entire ratings process much more transparent.

Although credit rating agencies have long resisted increased scrutiny of their operations, we feel that the time for requiring more fulsome ratings disclosure has come. These agencies have been widely criticized as significant contributors to the current economic crisis – doing little to nothing to signal to the market the risk inherent in mortgage-backed securities, for instance. New SEC regulations and a branch of the Commission tasked with enforcing them appear to be a major step in the right direction toward getting information on investment risk into the hands of the people who most need it – investors.

SEC Votes to Eliminate Broker Discretionary Voting

Tamar Weinrib — 2009-07-13T16:27:13-04:00

As reported on June 29, 2009, the SEC met to discuss the issue of discretionary broker voting. On July 1, 2009, The SEC voted 3-2 to eliminate broker discretionary voting in director elections for meetings held on or after January 1, 2010. Until now, the New York Stock Exchange (“NYSE”) had classified uncontested director elections under Rule 452 as a “routine matter,” giving brokers the discretion to vote shares held in investors’ accounts when they do not receive voting instructions from the beneficial owner within ten days of a company’s meeting. The new rule, which will affect most U.S. public companies, will make it more difficult for directors to be elected under a majority voting standard. As a result, companies may need to increase their solicitation efforts to reach non-responding shareholders, which is likely to increase the costs of uncontested elections. To review the order adopting the amendment click here.

From the Pages of The Pomerantz Monitor: The Value of Private Enforcement of Securities Laws

Carolyn Moskowitz — 2009-07-08T16:49:57-04:00

According to an article in the May/June issue of The Pomerantz Monitor, it has long been recognized that private enforcement is a necessary supplement to the enforcement capabilities of the Securities and Exchange Commission (“SEC”). This proposition is embodied in the idea of a “private attorney general” to police violations of the securities laws, and was endorsed explicitly by the United States Supreme Court since the mid-1960s.

Private litigation often focuses on retroactive payments to damaged investors and corporate governance, while SEC enforcement actions result in injunctive relief, including “cease and desist” orders or the barring of individuals from serving as officers or directors of public companies. More recently, the SEC has itself obtained monetary awards as restitution and sought to disseminate such awards to injured investors directly under the Fair Funds Act. Some commentators now question the need for private securities litigation at all, suggesting that the SEC should be the sole enforcement mechanism for violations of our securities laws.

In light of this, it is legitimate to review the value of past private securities litigation in order to determine whether it should continue. An article by James D. Cox and Randall S. Thomas, “Mapping the American Shareholder Litigation Experience: A Survey of Empirical Studies of the Enforcement of U.S. Securities Law,” Download Mapping the American Shareholder Experiencedoes just this. Professors Cox and Thomas are the authors of a number of papers on securities enforcement, including the influential “Does the Plaintiff Matter? An Empirical Analysis of Lead Plaintiffs in Securities Class Actions,” Download Does the Plaintiff Matterpublished in the Columbia Law Review, noting that courts have overwhelmingly favored institutional investors as lead plaintiffs under the PSLRA, and the now-classic “Leaving Money on the Table: Do Institutional Investors Fail to File Claims in Securities Class Actions?” Download Leaving Money on the Tablein which the answer, unfortunately, was “yes.”

In their newest study, Cox and Thomas offer an overview of recent empirical research on SEC and private actions, precisely in order to determine “if private securities fraud class actions are a necessary supplement to SEC enforcement actions.” Their findings are significant. A sample of private class actions filed from 1990 to 2001 reveals that only 15% overlapped with SEC enforcement actions. A subsequent sample of post-2001 private class actions showed that in less than 23% had the SEC filed a parallel enforcement action. Critically, the SEC has tended to focus its enforcement efforts on smaller targets, “suggesting that the big fish get away,” and the authors suggest – following the Madoff scandal – that “the SEC may be under-enforcing the securities laws.”

The impact on the stock price of companies when an SEC enforcement action is disclosed is also greater. Combined with the fact that the monetary penalties extracted by the SEC tend to be smaller than those resulting from private litigation, companies facing an SEC enforcement action typically occur higher “reputational costs” but lower monetary exposure.

One of the major complaints among commentators against private securities litigation is that institutional investors who continue to hold shares in a defendant after a settlement do not benefit, since settlement amounts, when paid by a defendant, weigh down its stock price. It appears, however, that these even larger reputational costs – which may depress stock prices even more – have not been considered in their entirety. And while commentators have long emphasized the effect of attorneys’ fee awards on the amount available to investors – now addressed by the PSLRA – they have ignored the effect of defense litigation costs that are often paid directly by the companies, and which the PSLRA did nothing to resolve.

Perhaps most significant are the findings that the SEC appears not to be the most important entity in detecting corporate fraud, and that class actions may lead to improvements in corporate governance. As the authors conclude: “Good corporate governance practices should lead to better quality disclosures, better monitoring of management, a reduced incidence of fraudulent misconduct by corporate managers and an improved alignment of corporate managers’ incentives with those of shareholders.”

From the Pages of The Pomerantz Monitor: LAMPERS Takes on Excessive Compensation

Carolyn Moskowitz — 2009-07-07T16:35:00-04:00

As reported by Fei-Lu Qian in an April PomTalk post, the Louisiana Municipal Police Employees’ Retirement System (“LAMPERS”) took the responsible step in demanding answers and accountability from directors of Chesapeake Energy by filing a “books and records” demand in a state court of Oklahoma. If the demand is granted, shareholders of Chesapeake will be able to examine the company’s corporate documents to see if the board’s approval of a $75 million bonus to its chief executive officer was proper. In the May/June issue of The Pomerantz Monitor, Marc Gross more fully explains the background of the lawsuit commenced by Pomerantz on behalf of LAMPERS to recoup the $75 million bonus.

The extraordinary bonus was awarded to Chesapeake’s CEO and co-founder, Aubrey McClendon. McClendon’s total compensation for 2008 was $105 million, making him the highest paid executive in the country at a time when the company’s earnings plummeted 50% and stock price tumbled 60%. The company claims that it granted the bonus – five times McClendon’s average annual compensation, including both salary and bonus – to reward him for his role in selling off certain oil and gas properties during 2008.

The real purpose of the bonus, we submit, was to bail out McClendon from his personal financial problems precipitated by the fall in the company’s share price. In other words, Chesapeake used corporate funds to insulate its CEO from the consequences of the corporate meltdown, while shareholders got stuck with their losses

The bail out was even larger than at first appeared. After the lawsuit was filed, Chesapeake issued a Proxy Statement indicating that it also agreed to pay McClendon over $12 million for his personal art collection.

In its opposition to our lawsuit, Chesapeake argues that if it weren’t for the bonus, McClendon might have jumped ship in favor of other opportunities. This seems far fetched, given that McClendon founded the company and still has a sizable stake in its wells. Moreover, the Board had other ways to insure his retention, like lowering the share ownership requirement – which it did – and providing loans to help him meet his obligations.

A similar books and records strategy was used successfully at the start of the Disney/Ovitz excess compensation case, and is favored by Delaware courts. Although Chesapeake is an Oklahoma corporation, that state follows Delaware corporate law.

We believe that the Chesapeake case warrants support by other public pension funds concerned with corporate governance reforms, either by direct intervention or a letter to the court. If ever there was a time to draw the line on excess compensation, it is now.

In pursuing this claim, Pomerantz harkens back to its roots. The firm’s first major case was Gallant v. Mitchell, where Abe Pomerantz sought to recoup interest-free loans that officers of National City Bank awarded themselves to tide them through the Great Depression (loans which they ultimately forgave). After trial, Abe recovered $1.8 million, a small fortune in the 1930’s.

Wall Street Back to Its Old Ways

Fei-Lu Qian — 2009-07-02T12:21:29-04:00

As there are some small signs of recovery in the financial crisis, the large Wall Street financial firms are beginning to get back to their normal practice of dishing out huge pay packages. According to an article in the Wall Street Journal, analysts estimate for this year, Goldman Sachs will pay out as much as $20 billion, or about $700,000 per employee. This would be almost double the firm’s $363,000 average last year. Similarly, Morgan Stanley is estimated to pay out between $11 billion and $14 billion in compensation and benefits this year. This range will be about $340,000 per employee, similar to the paid out in Morgan Stanley’s fiscal 2007. One recruiter that fills jobs for Wall Street firms believes that the current “euphoria about bonuses is based on the expectation that the business is returning to normal and that we will be in a robust environment again.”

SEC to Decide on Broker Discretionary Voting

Tamar Weinrib — 2009-06-29T15:49:16-04:00

On July 1, 2009, the SEC will hold a Sunshine Act Meeting at which it will consider the issue of instructed broker voting. The New York Stock Exchange (“NYSE”) has long classified uncontested director elections under Rule 452 as a “routine matter,” giving brokers the discretion to vote shares held in investors’ accounts when they do not receive voting instructions from the beneficial owner within ten days of a company’s meeting. The NYSE first proposed an amendment to NYSE Rule 452 in October 2006. The NYSE proposal would re-classify director elections as a non-routine matter on which NYSE member organizations are not permitted to vote—regardless of which exchange the company is listed on—without instructions from the beneficial owner. Brokers would no longer be able to vote uninstructed shares, effectively reducing the number of votes in favor of board-nominated directors. If adopted, this amendment is expected to make it more difficult for companies with “majority voting” provisions to achieve successful elections. Companies may need to increase their solicitation efforts to reach non-responding shareholders, which is likely to increase the costs of uncontested elections. At least three of the five SEC commissioners have stated publicly that they support the change. Click here to review a copy of the proposed rule.

Regulation of OTC Derivatives is on the Horizon

Tamar Weinrib — 2009-06-22T17:32:58-04:00

Following the Obama Administration's proposals last week to bring tighter regulation to financial markets, SEC Chairwoman Mary Schapiro testified before a Senate Banking subcommittee today that it would be relatively simple to change the law to allow for the regulation of over-the-counter (OTC) derivatives and emphasized that this step is needed to help the SEC ensure the proper regulation of securities markets. Companies use OTC derivatives as a risk management tool to manage their exposure to interest rate, currency exchange rate, commodity price, and other risks inherent in their businesses. In her testimony, Schapiro said that regulating the OTC market is necessary because positions in securities-related OTC derivatives can be used to simulate positions in securities markets. Legislation to enhance regulation of OTC derivatives has already been introduced in the House of Representatives and the U.S. Senate and is a direct reaction to the herculean growth of the $680 trillion OTC derivatives market, highly publicized issues surrounding the use of credit derivatives and crises involving major derivative counterparties such as Bear Stearns, Lehman Brothers and AIG that resulted in systemic risk to global financial markets. Passage of any such legislation would bring OTC derivatives under a comprehensive regulatory regime for the first time.

Proponents of regulating the OTC market say that it would mean a more sound securities market in part because it would help the SEC look for fraud. As Schapiro testified, currently it is hard to examine OTC trades for fraud because it is hard to find trade information in the unregulated market and the exclusion of certain securities-related OTC derivatives from most of the securities regulatory regime has undermined the SEC's ability to adequately protect investors. She testified that making the necessary changes is as simple as changing the definition of "security" in current law to cover securities-related OTC derivatives as well as eliminating the “swaps” exclusion from the laws. Non-securities related OTC derivatives would be under the purview of the Commodity Futures Trading Commission. With influential proponents like President Obama, Timothy Geithner, the SEC and various Congressmen behind increased oversight in the financial markets, bringing securities related OTC derivatives under regulatory control seems imminent.

Empowering Shareholders Through Legislation

Fei-Lu Qian — 2009-06-19T15:21:22-04:00

There are at least two bills in the current Congress that are worth noting, the Shareholder Empowerment Act of 2009 and the Shareholder Bill of Rights Act of 2009. According to the Council of Institutional Investors, the bills will "strengthen investors' oversight of management and boards" and "improve corporate governance."

Supreme Court Expansion Of Twombly

Michael Buchman — 2009-06-17T16:56:02-04:00

The Supreme Court decision in Bell Atlantic v. Twombly, 550 U.S. 544 (2007) created some debate whether the decision applied to non-antitrust cases. The Supreme Court’s recent decision in Ashcroft v. Iqbal, No. 07-1015 (U.S. May 18, 2009) applying Twombly to a non-antitrust case makes clear that Twombly has broad reach. A copy of the decision is here.

New Rule FAS 165

Tamar Weinrib — 2009-06-15T12:30:00-04:00

Last month, the Financial Accounting Standards Board (FASB) issued a new rule, which will be applied to the accounting for, and disclosure of, subsequent events not addressed in other applicable Generally Accepted Accounting Principles (GAAP). FAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The rule explains that corporate financial statements are considered issued when they are widely distributed to shareholders and other financial statement users for "general use and reliance" in a form and format that complies with GAAP. Further, financial statements are considered available to be issued when they are complete, which again means that they are in a form and format that complies with GAAP, and all approvals necessary for issuance have been obtained. FAS 165 provides that companies should recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. The settlement of litigation after the balance sheet date, but before the date the financial statements are issued or available to be issued, falls within this category of subsequent events in cases where the events which "gave rise to" the litigation had taken place before the balance sheet date. When a company is required to issue a restatement, FAS 165 provides that it should not recognize events occurring between the time the financial statements were issued or available to be issued, and the time the financial statements were re-issued, unless the adjustment is required by GAAP or by regulatory requirements. FAS 165 will apply with respect to interim or annual reporting periods ending after June 15, 2009. Click here to see the rule.