May 6, 2008
Say on Pay Votes Are Down This Year
Is the "say on pay" shareholder proposal campaign losing its momentum? While Aflac yesterday became the first major U.S. corporation to give its shareholders an advisory vote on executive compensation, so far this proxy season these proposals have received a majority of votes cast only at Apple and Lexmark International. At many corporations the say on pay proposal received less support than last year, in part because of aggressive campaigning by the corporation, who argue that it is not necessary. WPost, 'Say-on-Pay' Movement Loses Steam; NYTimes, Aflac Investors Get a Say on Executive Pay, a First for a U.S. Company.
May 5, 2008
Donohue on Mutual Fund Reform
Andrew J. Donohue, SEC Director, Division of Investment Management, presented the Keynote Address at the Practicing Law Institute Investment Management Institute 2008, on April 24, 2008 in New York City. He addressed three "hot" topics: mutual fund disclosure, specifically the summary prospectus and tagged data; (2) reform of Rule 12b-1 fees, and (3) the RAND report on the increasingly blurred distinctions between broker-dealers and investment advisers. As to Rule 12b-1 fees, Donohue said that the staff will propose that they be broken into two parts: a sales charge and a fee for services and administrative services. In this way, it is hoped that investors would be less confused about what these fees represent. As to the RAND report, he said that he and the Director of Trading and Markets would be presenting a "range of options" to Chair Cox on May 5.
SEC Issues Order in False Rumors Proceeding
The SEC issued an Order Instituting Administrative Proceedings Pursuant to Section 15(b) of the Securities Exchange Act of 1934, Making Findings, and Imposing Remedial Sanctions (Order) against Paul S. Berliner. The Order finds that Berliner was enjoined from future violations of Section 17(a) of the Securities Act of 1933, Sections 9(a)(4) and 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder pursuant to a final judgment that was entered by consent on April 29, 2008, in a Commission civil injunctive action.
According to the Commission's complaint in that action, on May 17, 2007, Alliance Data Systems Corp. (ADS) announced that it entered into a definitive agreement to be acquired by The Blackstone Group (Blackstone) at a price of $81.75 per share. The Commission alleged in its complaint that, on Nov. 29, 2007, Berliner drafted and disseminated a false rumor that ADS's board of directors was meeting to consider a revised proposal from Blackstone to acquire ADS at a significantly lower price of $70 per share. According to the complaint, Berliner disseminated this false rumor through instant messages to numerous individuals, including traders at brokerage firms and hedge funds. The complaint alleged that this false rumor spread rapidly across Wall Street, and various news services quickly picked up the "story." The complaint further alleged that heavy trading in ADS stock ensued, and within thirty minutes the false rumor had caused the price of ADS stock, which had been trading at approximately $77 per share, to plummet to an intraday low of $63.65 per share -- a 17% decline in the share price. The complaint alleged that Berliner profited from spreading this false rumor by short selling ADS stock at the same time he was disseminating the false rumor. The complaint further alleged that Berliner covered these short sales when the price of ADS stock began to decline. According to the complaint, Berliner made approximately $25,000 in illicit trading profits before the price of ADS stock recovered later in the day.
Based on the above, the Order bars Berliner from association with any broker or dealer. Berliner consented to the issuance of the Order without admitting or denying the Commission's findings, except as to entry of the injunction.
SEC Gets Temporary Freeze of Plus Money and Advisor
The SEC filed an emergency action to halt an ongoing $30 million hedge fund fraud by an investment adviser located in San Diego. Named in the complaint are Plus Money, Inc. ("Plus Money") and Matthew La Madrid ("La Madrid"). The United States District Court for the Southern District of California issued an order on April 30 temporarily freezing the assets of the defendants and the relief defendants.
The Commission's complaint alleges that since at least May 2004, the defendants have managed hedge funds (the "Premium Return Funds") that raised more than $30 million from over 300 investors by telling them they would engage in a covered call options trading strategy. The complaint further alleges that, unbeknownst to investors, in the fall 2007 Plus Money and La Madrid abandoned the covered call trading strategy, emptied out the monies in the Premium Return Funds' brokerage accounts, and dissipated the money through a series of illicit transfers.
Atkins Announces That He Will Leave SEC
SEC Commissioner Paul Atkins announced today that he intends to leave the SEC following the end of his term in June. Appointed by President Bush in August 2002 for the first of two terms, he plans to stay until his successor is appointed and takes office.
FINRA Issues Investor Alert on ARS
FINRA issued an Investor Alert on Auction Rate Securities: What Happens When Auctions Fail, so that, it says, investors can know about some of the options available to them in the event their ARS investment becomes illiquid and what can happen when an issuer makes a call for a partial redemption.
Brooklyn Federal Prosecutor Leads Subprime Task Force
The U.S. Attorney for the Eastern District of New York (Brooklyn) has set up a special taskforce of federal, state and local agencies to investigate possible crimes relating to the subprime mortgage crisis. Investigations already underway include USB( alleged improper valuation of mortgage holdings), Bear Stearns (collapse of two hedge funds) and American Home Mortgage Investment (possible accounting fraud). WSJ, Wall Street, Lenders Face Subprime Scrutiny.
May 4, 2008
Johnsen on Directed Brokerage
Directed Brokerage, Conflicts of Interest, and Transaction Cost Economics, by D. BRUCE JOHNSEN, George Mason University School of Law, was recently posted on SSRN. Here is the abstract:
This paper relies on the economics of transaction costs to assess the likely effect on investor welfare of the U.S. Securities and Exchange Commission's (SEC's) prohibition on an innovative business practice known as directed brokerage. Its key insight is that the quality of a broker's execution of portfolio trades is difficult for a mutual fund adviser to assess until it is too late - that is, execution quality is an experience good. In the meantime, low-quality brokerage can substantially reduce investor returns. To have the incentive to provide high-quality execution, a broker must expect to receive a stream of premium portfolio commissions in excess of his execution costs, much along the lines of a Klein-Leffler quality-assuring price premium. Competition between brokers for premium commissions leads them to post a performance bond with advisers equal to the present value of the expected premium stream. With directed brokerage, the bond takes the form of up-front broker effort devoted to marketing the fund's retail shares. Once having posted the bond, any broker that provides low-quality execution will eventually be terminated by the adviser and lose the premium stream that provides a normal return on the up-front bond. Low-quality brokerage is thus screened out. Contrary to its intended effect, the SEC's prohibition on directed brokerage likely reduces investor welfare by failing to recognize the problems inherent in transacting experience goods.
Johnsen on SEC's Soft Dollar Guidance
The SEC's 2006 Soft Dollar Guidance: Law and Economics, by D. BRUCE JOHNSEN, George Mason University School of Law, was recently posted on SSRN. Here is the abstract:
After some two years of deliberations, in July 2006 the SEC released its long-awaited Guidance on the scope of the soft dollar safe harbor. Passed as part of the Securities Acts Amendments in May, 1975, the safe harbor has protected fund advisers and other money managers for over 30 years from criminal actions and civil suits for breach of fiduciary duty when they use client assets to pay more than the lowest available brokerage commissions in exchange for brokerage and research services. During this time the SEC has interpreted and re-interpreted the safe harbor's scope, largely owing to the public controversy soft dollars engender as a form of illicit kickback designed to subvert advisers' loyalty. The SEC's 2006 Guidance attempts to dramatically narrow the permissible use of soft dollars by prescribing a laundry list of protected and unprotected services. Yet the SEC is now considering further interpretation, and its chairman has petitioned Congress for an outright repeal of the soft dollar safe harbor. This paper shows that soft dollars are an innovative and efficient form of economic organization that benefits fund investors. According to economic theory now well-established in antitrust law, the SEC's Guidance is hopelessly misguided. Were the Guidance to come under the scrutiny of a federal court, the SEC would very likely experience another in its recent string of embarrassing legal defeats.
Leahy on Underwriters' Due Diligence
What Due Diligence Dilemma? Re-Envisioning Underwriters' Continuous Due Diligence after Worldcom, by JOSEPH KIERAN LEAHY, Brooklyn Law School , was recently posted on SSRN. Here is the abstract:
The recent WorldCom decision is widely believed to pose a due diligence dilemma. This dilemma supposedly forces underwriters for large, established corporations to choose between their clients' desire to issue securities quickly in shelf-registered offering and the obligation to exercise reasonable care in due diligence. According to most commentators, the bar for due diligence set by WorldCom is simply too high to surmount during a shelf takedown. As a result, underwriters will either lose lucrative business or lose their defense to liability for misstatements or omissions in the offering document. And the stakes are high: in WorldCom, the underwriters settled for $6.1 billion rather than test their due diligence defense at trial.
Underwriters could avoid this purported quandary if they investigated clients on a continuous basis, and thus, largely completed due diligence before each offering. Yet, scholars generally agree that underwriters perform little such continuous due diligence.
This article casts doubt on that scholarly consensus. This article urges that underwriters for giant corporations may perform more far continuous due diligence than most writers suppose.
This article sheds light on a source of continuous due diligence that has, to date, entirely escaped scholarly attention: investigation outside of the context of securities offerings. The bulge bracket investment banks that underwrite securities for giant corporations typically are organized into client relationship teams. These teams serve all of the bank's clients' financing needs, not just securities underwriting. As such, the team has reason to investigate its clients in many contexts other than securities offerings. This investigation is continuous due diligence by another name - and it may well provide an escape from the underwriter conundrum.
Choi, Fisch, & Kahan on Proxy Advisors
Director Elections and the Influence of Proxy Advisors, by STEPHEN J. CHOI, New York University - School of Law, JILL E. FISCH, Fordham University - School of Law, and MARCEL KAHAN, New York University - School of Law, was recently posted on SSRN. Here is the abstract:
Using a dataset of proxy recommendations and voting results for uncontested director elections from 2005 and 2006 at S&P 1500 companies, we examine how advisors make their recommendations and how these recommendations and other factors affect the shareholder vote. Of the four firms we study, Institutional Shareholder Services (ISS), Proxy Governance, Glass Lewis, and Egan Jones, ISS is widely regarded as the most influential and its recommendation is claimed to sway 20-30% of the vote. We find that the four proxy advisory firms differ systematically from each other both in their willingness to issue a withhold recommendation and in the factors that affect their recommendation.
We further find that all the proxy advisors, but particularly ISS, base their recommendations largely on factors that shareholders take into account (independent of the recommendation) in casting their vote. Once these factors are controlled for, overall voting outcomes are substantially similar whether or not a proxy advisor has issued a recommendation. Our analysis demonstrates that the reported influence of ISS is substantially overstated. Our evidence is consistent with the view that proxy advisors act primarily as agents or intermediaries which aggregate information that investors find important in determining how to vote in director elections rather than as independent power centers.
Microsoft Withdraws Bid for Yahoo!
Microsoft announced that it would not pursue its bid to acquire Yahoo! In a letter to Yahoo!'s CEO Jerry Yang, Microsoft CEO Steve Ballmer stated:
In our conversations this week, we conveyed our willingness to raise our offer to $33.00 per share, reflecting again our belief in this collective opportunity. This increase would have added approximately another $5 billion of value to your shareholders, compared to the current value of our initial offer. It also would have reflected a premium of over 70 percent compared to the price at which your stock closed on January 31. Yet it has proven insufficient, as your final position insisted on Microsoft paying yet another $5 billion or more, or at least another $4 per share above our $33.00 offer.
Also, after giving this week’s conversations further thought, it is clear to me that it is not sensible for Microsoft to take our offer directly to your shareholders. This approach would necessarily involve a protracted proxy contest and eventually an exchange offer. Our discussions with you have led us to conclude that, in the interim, you would take steps that would make Yahoo! undesirable as an acquisition for Microsoft.
We regard with particular concern your apparent planning to respond to a “hostile” bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo! today. In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo! undesirable to us for a number of reasons....
In response, Yahoo!'s Chairman Roy Bostock stated:
We remain focused on maximizing shareholder value and pursuing strategic opportunities that position Yahoo! for success and leadership in its markets. From the beginning of this process, our independent board and our management have been steadfast in our belief that Microsoft's offer undervalued the company and we are pleased that so many of our shareholders joined us in expressing that view. Yahoo! is profitable, growing, and executing well on its strategic plan to capture the large opportunities in the relatively young online advertising market. Our solid results for the first quarter of 2008 and increased full year 2008 operating cash flow outlook reflect the progress the company is making.