Executive Summary

Recently issued rules by the Governmental Accounting Standards Board (GASB) will notably change the way state and local governments account for and report the results of their defined benefit pension plans. Some plans may see their reported funded percentages fall under the new requirements. A plan’s funded status will now be reflected on the balance sheet, increasing transparency as well as the focus on measures that plan sponsors are taking to address these shortfalls. Funded status and pension expense measures are also likely to be more volatile under the revised reporting standards.

While the new GASB rules change some important aspects of public DB plan reporting, they do not change others. In particular, they neither mandate use of a lower discount rate for calculating liabilities nor higher contribution requirements. These are changes to accounting and financial reporting, not economics. Nonetheless, they do represent a notable change to the calculation and reporting of various pension-related metrics.

Some public DB plan sponsors are already facing significant challenges, such as relatively low funded levels. In addition, given budgetary challenges, some state and local governments do not have the flexibility to increase contributions at this time. All of this is occurring in an environment where long-term expected returns across a wide variety of asset classes have been falling. The GASB changes may add yet another layer of stress, if not complexity, for some public plan sponsors.

This paper reviews the following aspects of the GASB changes:

…continue reading: A “Sea Change” in Public Pension Reporting on the Horizon

In our paper, Are Mutual Funds Active Voters?, which was recently made publicly available on SSRN, we document that mutual funds vary significantly in how they fulfill their fiduciary duty to vote their shares in shareholders’ interests. Approximately 25% of mutual funds vote with ISS on nearly all company agenda items throughout our five-year sample period. However, many other mutual funds disagree frequently with ISS, particularly on contentious votes. We find that certain types of funds are more likely to find it optimal to incur the costs of evaluating the necessary information to independently assess the items up for vote. For example, large funds and funds from top 5 families can spread the costs over a wider asset base, and low turnover funds are more likely to own the stocks long enough to realize the valuation effects of the vote outcome and any consequent changes in company governance. We would thus expect such funds to be more likely to actively vote. A summary measure of fund activism, which is based on six fund characteristics, highlights the extent to which variation in funds’ costs and benefits of actively voting translates into dramatically different voting patterns. Across a sample of contentious compensation and governance votes, we find that passive funds follow ISS in 86% of the compensation and 77% of the governance votes, compared to analogous rates of only 15% and 19% among actively voting funds. Similarly, across a sample of contentious director votes, passive funds are approximately three times more likely than active funds to follow ISS.

…continue reading: Are Mutual Funds Active Voters?

The apparition of 2008 returns once more. Two recently released JP Morgan Chase (JPM) reports on the causes of the “London Whale” trading losses raise important questions about whether financial service firms can exorcise the spectral issues which were so central to the financial crisis. They read as if JPM and a key headquarters unit — the Chief Investment Office — had not learned a single lesson from the meltdown four years ago. And unfortunately, they suggest that, in our huge, complex financial institutions, major failures of organizational discipline and major losses are likely to recur, despite greater attention to risk management.

These reports — one from a company task force and a second from a review committee of the board — were overshadowed by two items announced the same day: the related news that the bank board had slashed CEO Jamie Dimon’s annual compensation in half — from $23 million in 2011 to $11.5 million in 2012 — because of his “Whale-related” failures, and that JPM had posted a record 2012 net income of $21.3 billion.

…continue reading: The JP Morgan “Whale” Report and the Ghosts of the Financial Crisis

Summary

On December 17, 2012, the staff of the Federal Reserve issued a Supervision and Regulation (“SR”) letter describing the Federal Reserve’s new framework for consolidated supervision of large financial institutions. SR letters address significant policy and procedural matters related to the Federal Reserve’s supervisory responsibilities.

Under the new framework, the Federal Reserve’s primary supervisory objectives for large financial institutions will be (1) to enhance resiliency of an institution to lower the probability of its failure or its becoming unable to serve as a financial intermediary, and (2) to reduce the impact on the financial system and the broader economy of an institution’s failure or material weakness. These objectives are meant to conform to key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, such as enhanced prudential standards for large financial institutions. Although the Federal Reserve has not previously stated these objectives as its primary supervisory objectives, and the new framework formally integrates areas such as corporate governance and compensation that Federal Reserve staff has been focused on since the financial crisis, changes in specific supervisory expectations are limited. Changes include greater emphasis on recovery planning in the case of financial or operational weakness, and on orderly resolution planning, as required by the Dodd-Frank Act. The Federal Reserve will also engage in greater “macroprudential” supervision to detect systemic risks.

The new framework applies to the largest and most complex financial institutions subject to consolidated Federal Reserve supervision, including nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve; other domestic bank and savings and loan holding companies with consolidated assets of $50 billion or more; and other foreign banking organizations with combined assets of U.S. operations of $50 billion or more.

…continue reading: Federal Reserve Updates Consolidated Supervision Framework for Large Financial Institutions

More than 40% of global M&A in 2012 involved acquirors and targets in different countries, including $170 billion of acquisitions in the U.S. by non-U.S. acquirors. Given the continuing accumulation of U.S. Dollars in emerging economies, many expect the trend to continue as Dollars are re-invested in the U.S. Natural resources will continue to be an important part of this story, including in the U.S., where substantial non-U.S. investment has been an important trend, as well as in resource-rich developed nations such as Canada and Australia, where non-domestic investment has lately been highly controversial.

Despite the empty election-year protectionist rhetoric in the U.S. last year, and continuing global concern over access to resources and technology by non-domestic actors, U.S. deal markets continue to be some of the most hospitable markets to off-shore acquirors and investors. With careful advance preparation, strategically thoughtful implementation and sophisticated deal structures that anticipate likely concerns, most acquisitions in the U.S. can be successfully achieved. Cross-border deals involving investment into the U.S. are more likely to fail because of poor planning and execution rather than fundamental legal or political restrictions.

Following is our updated checklist of issues that should be carefully considered in advance of an acquisition or strategic investment in the United States. Because each cross-border deal is different, the relative significance of the issues discussed below will depend upon the specific facts, circumstances and dynamics of each particular situation:

…continue reading: Checklist for Successful Acquisitions in the U.S.

In many respects, 2012 was another year of aggressive SEC enforcement. The SEC’s Division of Enforcement again logged a near record number of enforcement actions. More important, the cases reflected a marked increase in the number and proportion of actions against registered investment advisers and broker-dealers, and their associated persons. This increased focus derives from a culmination of factors, including Enforcement’s creation of specialized units for the asset management industry and for structured products, the hiring of industry experts, and the close collaboration between staff from Enforcement and the SEC’s Office of Compliance Inspections and Examinations (“OCIE”). With the expansion of the registered private fund adviser population under financial reform legislation, and the launch of an initiative to conduct focused, risk-based examinations of these new registrants, this trend will likely continue for the foreseeable future.

At the same time, in the latter half of 2012 the SEC confronted significant challenges in litigating previously filed enforcement actions against individuals in cases related to the financial crisis. Whether these cases will cause the SEC to reevaluate its approach with respect to charging decisions in the future is unknown. However, in the short term, Enforcement seems undeterred by individual litigation results in its pursuit of continued enforcement actions.

The last six months of 2012 mark the beginning of another transition for the SEC generally, and for Enforcement in particular. As the year drew to a close, Mary Schapiro announced her departure as Chairman, followed by several division directors. Most notably, on January 9, 2013, the SEC announced that Robert Khuzami would step down as Director of Enforcement. As we look ahead to 2013, a new leadership team at the SEC and in Enforcement will seek to make their own imprint on the SEC’s priorities and processes. In addition, as more time has passed since the depth of the financial crisis, Enforcement’s priorities will shift to more recent conduct and emerging industry risks.

…continue reading: 2012 Year-End Securities Enforcement Update

In a second Chancery transcript ruling on the subject in recent weeks, Chancellor Leo E. Strine, Jr. has made clear that Delaware has no per se rule against “Don’t Ask, Don’t Waive” standstill provisions (which prohibit a party subject to a standstill, including a losing bidder in an auction, from requesting a waiver from its standstill obligations). The Chancellor also provided guidance for using such a provision as an “auction gavel” to secure the best price reasonably available to a target company involved in a sales process. The ruling in In Re Ancestry.com is a welcome clarification that will help maintain the vitality of auctions where a target wants to incentivize bidders to come forth with their highest bid.

…continue reading: “Don’t Ask, Don’t Waive Standstills” Revisited (Rapidly)

In the paper, Corporate Governance and Value Creation: Evidence from Private Equity, forthcoming in the Review of Financial Studies, my co-authors (Oliver Gottschalg, Moritz Hahn, and Conor Kehoe) and I attempt to bridge two strands of literature concerning PE, the first of which analyzes the operating performance of acquired companies, and the second that analyzes fund IRRs. In addition, we investigate how human capital factors are associated with value creation in PE deals. We focus on the following questions: (i) Are the returns to equity investments by large, mature PE houses simply due to financial leverage and luck or market timing from investing in well-performing sectors, or do these returns represent the value created at the enterprise level in the so-called portfolio companies, over and above the value created by the quoted sector peers? (ii) What is the effect of ownership by large, mature PE houses on the operating performance of portfolio companies relative to that of quoted peers, and how does this operating performance relate to the financial value created (if any) by these houses? (iii) Are there any distinguishing characteristics based on the background and experience of PE houses or partners involved in a deal that are best associated with value creation?

…continue reading: Corporate Governance and Value Creation

The Rise of Engagement in the 2012 Proxy Season

For many years Georgeson’s Annual Corporate Governance Review has promoted the concept of engagement between public companies and their institutional investors. While Georgeson has noticed increased engagement, the nature of the engagement has generally been incremental and devoted to specific governance and compensation issues from year to year. After years of this slow, incremental growth, the 2012 proxy season became the Year of Engagement and witnessed a marked increase in company/shareholder interaction — engagement that was not limited to a few days out of the five- or six-week period between the mailing of the corporate proxy statement and the last days of a proxy solicitation campaign prior to the annual meeting. The types of issues discussed leading up to and during the 2012 proxy season ranged from executive compensation and board structure to negotiations with proponents over the potential withdrawal of shareholder-sponsored ballot resolutions to just open-ended discussions to understand each other better. The voting statistics contained between these covers cannot fully measure that activity — although they do make it clear that the level of communication was more frequent and intense than in the past.

…continue reading: 2012 Annual Corporate Governance Review

The prevalence of settlements in class and derivative litigation challenging mergers and acquisitions in which the only payment is to plaintiffs’ attorneys suggests potential systemic dysfunction arising from the increased frequency of parallel litigation in multiple state courts. After examining possible explanations for that dysfunction, and the historical development of doctrines limiting parallel state court litigation — the doctrine of forum non conveniens and the “first-filed” doctrine — this paper suggests that those doctrines should be revised to better address shareholder class and derivative litigation. Revisions to the doctrine of forum non conveniens should continue the historical trend, deemphasizing fortuitous and increasingly irrelevant geographic considerations, and should place greater emphasis on voluntary choice of law and the development of precedential guidance by the courts of the state responsible for supplying the chosen law. The “first-filed” rule should be replaced in shareholder representative litigation by meaningful consideration of affected parties’ interests and judicial efficiency.

Putting Stockholders First responds to the observation that in 2011, only 5% of settlements of shareholder litigation challenging mergers and acquisitions involved an additional payout to stockholders, 84% of such settlements were based on additional disclosure only, but all of such settlements involved payment of fees for plaintiffs’ attorneys. These figures reflect a significant change from 1999 to 2000, when 52% of suits filed on behalf of shareholders produced a financial benefit for the class, and only 10% of settlements were “disclosure-only.”

…continue reading: Putting Stockholders First, Not the First-Filed Complaint