The editors at the Corporate Governance & Social Responsibility blog brought our attention to a recent academic paper from The Ohio State University Moritz College of Law titled “Shareholder Activism as a Corrective Mechanism in Corporate Governance.” In the paper’s abstract, authors Paul Rose and Bernard Sharfman write:
Under an Arrowian framework, centralized authority and management provides for optimal decision making in large organizations. However, Arrow also recognized that other elements within the organization, outside the central authority, occasionally may have superior information or decision making skills. In such cases, such elements may act as a corrective mechanism within the organization. In the context of public companies, this article finds that such a corrective mechanism comes in the form of hedge fund activism, or more accurately, offensive shareholder activism.
Offensive shareholder activism exists in the market for corporate influence, not control. Consistent with a theoretical framework where the value of centralized authority must be protected and a legal framework in which fiduciary responsibility rests with the board, authority is not shifted to influential but unaccountable shareholders. Governance entrepreneurs in the market for corporate influence must first identify those instances in which authority-sharing may result in value-enhancing policy decisions, and then persuade the board and/or other shareholders of the wisdom of their policies so that they will be permitted to share the authority necessary for the policies to be implemented. Thus, boards often reward offensive shareholder activists that prove to have superior information and/or strategies by at least temporarily sharing authority with the activists by either providing them seats in the board or simply allowing them to directly influence corporate policy. This article thus reframes the ongoing debate on shareholder activism by showing how offensive shareholder activism can co-exist with — and indeed, is supported by — Arrow’s theory of management centralization which undergirds the traditional authority model of corporate law and governance.
Empirical studies have repeatedly shown that certain types of offensive shareholder activism lead to an increase in shareholder wealth. However, the results of empirical studies must be interpreted carefully so as not to overstate their informational value. Empirical research supports the argument that certain types of offensive shareholder activism have value, but it does not provide conclusive proof that they have value at any specific company at any specific time. Instead, the use of empirical evidence supporting offensive shareholder activism should be understood as providing proof that offensive shareholder activists may on occasion successfully rebut the presumption of the superiority of existing managerial strategies.
This article provides a much needed bridge between the traditional authority model of corporate law and governance as utilized by Professors Steven Bainbridge and Michael Dooley and those who have done empirical studies on hedge fund activism, including Lucian Bebchuk. The bridge helps to identify when shareholder activism may be a positive versus negative influence on corporate governance.
The full paper is available for download through the Social Science Research Network.
Most equity incentive plans have a number of different shareholder-approved business criteria for setting performance goals and allow the compensation committee to select the criteria each year. This practice generally requires re-approval of the goals by the shareholders under Internal Revenue Code Section 162(m) whenever the committee makes a material change to the criteria. If the committee has not made any material changes to the performance criteria but retains discretion to select the performance targets from year-to-year, shareholders generally will need to reapprove the criteria every five years under Code Section 162(m).
If shareholder approval last occurred in 2009, then it is time to prepare for re-approval in 2014. This is also a good time to consider if an amendment is needed to increase the authorized share pool.
Our colleague and member of the firm’s Litigation Department, Brodie Butland, recently wrote an interesting article for the The Business Suit, published by DRI. Because the article concerns the international arbitration case BG Group PLC v. Republic of Argentina as well as its implications for anyone facing or considering arbitration (regardless of venue), I wanted to take a moment to share it with you. Certainly, the decision will have an impact on many industries.
Ostensibly, BG Group PLC v. Republic of Argentina is an international arbitration case based on a bilateral investment treaty between the United Kingdom and Argentina. But there is a significant chance that the U.S. Supreme Court will use the case to clarify several decades of precedents dealing with whether the issue of arbitrability is decided by a court or an arbitrator. Regardless, the court’s decision is likely to affect the practice of arbitration, international investment and the standing of the United States as a premier international forum for arbitration. Read the full article — “BG Group PLC v. Republic of Argentina: One of the Most Significant Business Cases that You Have Never Heard of”
A “deferred prosecution agreement” (or DPA) is not a new concept to government prosecutors or to SEC Chairman Mary Jo White, but it is new to the SEC. Under a DPA, the government agrees to withhold prosecution in exchange for enforcement assistance — providing information, implementing internal compliance policies, or other cooperation with SEC investigations.
This tool has been around for a long time (Mary Jo White used it back in her days as a federal prosecutor) but the SEC did not use it until 2011 when it agreed to a DPA with the steel pipe products company Tenaris S.A. In agreeing to the Tenaris DPA, the SEC announced “its first-ever use of the approach to facilitate and reward cooperation in SEC investigations.” The SEC promised to refrain from civil prosecution of anti-bribery charges against Tenaris in exchange for the company’s strengthening and enforcing stricter internal compliance policies.
Now, the Commission announced that it has, for the first time, agreed to a DPA with an individual, Scott Herckis of Heppelwhite Fund LP. Heppelwhite, a Connecticut-based hedge fund, was charged in 2012 with misleading investors and misappropriating fund assets. Herckis was the fund’s administrator from 2010 to 2012. The Commission credits Herckis’ “voluntary and significant cooperation” in its decision to file an enforcement action against Hepplewhite. Last month, a federal judge in New York ordered the distribution of $6 million of the assets of Heppelwhite’s founder, Berton Hochfeld, to defrauded investors.
Under the DPA, Herckis still faces penalties for his involvement in Hepplewhite’s activities. Herckis is essentially banned from working in financial services for five years, and pays a $50,000 disgorgement fine. But as reward for Herckis’ cooperation, the SEC agreed to refrain from pursuing its civil charges against him.
In its press release, the SEC stated: “We’re committed to rewarding proactive cooperation that helps us protect investors, however the most useful cooperators often aren’t innocent bystanders… [t]o balance these competing considerations, the DPA holds Herckis accountable for his misconduct but gives him significant credit for reporting the fraud and providing full cooperation without any assurances of leniency.”
In our previous posts about In re Trados available here and here, we provided some background about the facts, outcome and usefulness of the Trados case, as well as a discussion of the conflicting interests of the preferred stockholders and common stockholders. In this installment, we will discuss the issue of director independence and conflicts of interest of the Trados directors, and the related analysis conducted by the Delaware Court of Chancery.
In determining whether directors have met their fiduciary duties, the standard of review used by the court is critical to the inquiry. The entire fairness standard, Delaware’s most onerous standard, applies when the directors have actual conflicts of interest.1 To obtain review under the entire fairness standard, a plaintiff must prove that a majority of the directors making the challenged decision were not independent and disinterested.2 In Trados, the plaintiff successfully proved that six of the seven Trados directors were not disinterested and independent, making entire fairness the operative standard of review.3
A thorough discussion of the court’s director by director analysis in Trados illustrates the Delaware courts’ willingness to find that directors of venture capital and private equity portfolio companies are conflicted, thereby triggering an entire fairness review. Continue Reading
In March, an affiliate of SAC Capital agreed to a record high settlement of $616 million for charges of insider trading. As it turned out, the SEC was only getting started with the company and its owner, Steve Cohen. In July, both Cohen and SAC Capital were themselves indicted on insider trading.
Based on reports, SAC Capital agreed earlier this week to settle its charges for $1.2 billion, shattering the record again. In addition, the company agreed to plead guilty to each count in the indictment and close its investment advisory business. The indictment accused the company, among other things, of fostering a culture of insider trading, citing “institutional failure.”
As if setting a new record-high settlement wasn’t enough, the settlement terms give no shelter to Cohen, personally. The settlement states outright that it provides “no immunity from prosecution for any individual and does not restrict the government from charging any individual for any criminal offense.” By refusing to grant immunity to Cohen in this deal, the SEC confirmed that it will continue its civil investigation of the billionaire hedge fund manager and is even considering criminal charges in the future.
The settlement still needs to be approved by the federal court in New York. The hearing is scheduled for Friday. For more, Dealbook has a good analysis of the settlement.
This post appeared originally on the Corporate Governance & Social Responsibility blog. The Federal Securities Law Blog thanks the author for allowing us to share it with you.
It was a pretty normal day until Marc Smith called me for a chat on Skype. Marc is a sociologist of computer-mediated collective action at Connected Action and director at Social Media Research Foundation, Belmont, CA, and in 90 minutes he just confirmed everything I thought about the development and future of the Internet and social networks. We discussed Twitter networks predominantly, but the model transfers to any networked entity where one named thing interacts with (talks to) another. Stay with me on this…
Social networks are, after all and as I figured, extrapolated scaled models of our intrinsic human social permutations and permeations, perhaps even our psyche (doffing my hat to Freud and Jung). They even start from archetypes (Jung, again), they develop organically, and they form structures that reflect our ‘collective’ [Jung would have said 'collective unconscious', probably]. Bizarrely, that thin veneer of perceived protection from recourse for our actions afforded by thinking “well, its only a tweet” might even strip away some of the social airs and graces we might have in our fleshy lives, leaving a more immediate expression of our underlying thoughts, maybe, in some cases, perhaps. Continue Reading
The SEC voted unanimously to propose rules regulating the offering and selling of securities through “crowdfunding”. Crowdfunding – a method of raising money through small sums contributed by many individuals – has become an internet mainstay. But so far, crowdfunding websites (such as Kickstarter or Indiegogo) constructed their platforms so as to avoid falling under SEC regulation. In particular, the traditional crowdfunding method does not offer financial returns on an investment or a share in a company’s profits.
The proposed rules (read them in their entirety) would allow companies to raise up to $1 million through crowdfunding platforms within a 12-month period. Other features of the proposed rules include:
- Investors will be subject to income-based limits on the total amount of securities they can purchase through crowdfunding within a 12-month period. No investor will be able to invest more than $100,000 in crowdfunding-based securities within a 12-month period.
- Certain companies will be ineligible to raise funds through crowdfunding, including: companies that are already SEC-reporting companies, non-U.S. companies, companies with no specific business plan, and certain investment companies.
- Companies will be required to file certain information with the SEC.
- Companies are required to disclose certain information to the crowdfunding platform and prospective investors, such as financial statements, related-party transactions, the company’s business plan, and description of the offering.
- Crowdfunding platforms will have to become registered with the SEC, either as broker-dealers or funding portals.
The rules were proposed as directed by the Jumpstart Our Business Startups Act (JOBS Act), which was passed in part to assist small-business fundraising and directs the SEC to draft an exemption for crowdfunding platforms from the securities laws. The rules will be subject to comment for 90 days. The SEC includes prompts in the proposed rules for comments, which can be submitted electronically.
After “refusing to be bullied” into settlement, Mark Cuban, the billionaire owner of the Dallas Mavericks, won over a Texas jury and was cleared of insider trading charges brought by the SEC. The nine-person jury in the federal court in Dallas determined that Cuban did not violate federal securities laws in selling his stake in Mamma.com in 2004. Cuban was accused of using material, non-public information in deciding to sell his Mamma.com shares, avoiding a $750,000 loss.
The trial centered around a conversation between Cuban and then-CEO of Mamma, Guy Faure, in which Faure informed Cuban of an upcoming equity transaction that would dilute Cuban’s ownership stake in the company. Testimony at the trial boiled down to comparing Faure’s and Cuban’s accounts of their conversation. In the end, the SEC failed to convince the jury, among other elements of insider trading, that Cuban promised to keep the information confidential or that the information was not already in the public domain.
It is a big win for Cuban, who chose to take the SEC to trial over negotiating a settlement. Cuban was pleased with the outcome, but said “it’s not like winning a [Mavericks] championship.” A spokesman for the SEC, John Nester, said the agency will “respect the jury’s decision,” but it “will not deter us from bringing and trying cases where we believe defendants have violated the federal securities laws.”
At the beginning of the federal shutdown, the SEC announced that it would continue to operate as normal “for a few weeks” because of its ability to access a pool of funds not available to other federal agencies. But as we continue into the third week of the federal shutdown, that ambiguous timeline of a “few weeks” may be nearing an end. In the event the SEC runs out of its backup funding, it has a contingency plan, which it released in late September.
Following is a summary of what functions will, and won’t, continue in the event of an SEC shutdown.
These SEC activities will continue: