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Saturday
Jun232012

The Director Compensation Project: International Business Machines Corporation

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation.  We are for the most part including companies from 2011’s Fortune 500 and using information found in their 2011 proxy statements.

Nasdaq and the NYSE have similar rules with respect to director independence.  NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors.  A director does not qualify as “independent” if he or she has a “material relationship with the company.”  NYSE Rule 303A.02(a).  In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.  NYSE Rule 303A.06 imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3).

Independent directors are compensated for their service on the board.  The amount of compensation can be seen from examining the director compensation table from the International Business Machines (NYSE: IBM) 2011 proxy statement.  According to the proxy statement, the company paid the directors the following amounts:

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards
($)

All Other Compensation
($)

Total
($)

Alain Belda

250,000

0

0

17,078

267,078

William Brody

250,000

0

0

22,418

272,418

Kenneth Chenault

250,000

0

0

47,884

297,884

Michael Eskew

275,000

0

0

34,681

309,681

Shirley Jackson

250,000

0

0

30,734

280,374

Andrew Liveris

250,000

0

0

5,456

256,456

W. James McNerny, Jr.

250,000

0

0

28,357

278,357

James Owens

250,000

0

0

48,404

298,404

Joan Spero

250,000

0

0

43,596

293,596

Sidney Taurel

270,000

0

0

55,081

325,081

Lorenzo Zambrano

270,000

0

0

37,533

307,533

Director Compensation.  In 2011, non-management directors received a retainer of $250,000 to attend ten meetings of the board of directors.  Attendance at those meetings was greater than 75%.  Under the company’s Deferred Compensation and Equity Award Plan, at least 60% of the annual retainer was required to be paid in Promised Fee Shares (“PFS”), which are the equivalent of one unit of common stock.  When the company issued a dividend, the amount of the dividend was credited to the directors’ PFS accounts and disclosed under the “All Other Compensation” column above.  Mr. Eskew received an additional $25,000 in cash for chairing the Audit Committee.  Messrs. Zambrano and Taurel each received an additional $20,000 in cash for chairing the Directors and Corporate Governance Committee and the Executive Compensation and Management Resources Committee, respectively.  

Director Tenure.  Mr. Chenault is the longest tenured director, holding his position since 1998. Due to IBM’s commercial relationship with American Express, Mr. Chenault does not qualify as an independent director.  Virginia Rometty and David Farr both are the newest members of the board after joining in 2012; hence, they are not listed on the compensation chart above.  Many of the directors sit on other boards.  For instance, Samuel Palmisano, the former Chief Executive Officer and current Chairman of the Board, also sits on the board of Exxon Mobil.  Mr. Owens sits on the boards of Alcoa, Inc. and Morgan Stanley.

Executive Compensation.  Mr. Palmisano was paid $31,798,918 for his roles as Chairman, President, and CEO.  Company aircraft usage of $489,327 is included in this figure.  After departing from his role as CEO on January 1, 2012, Mr. Palmisano also became entitled to an exit package valued at roughly $113,697,548 in stock options, deferred compensation, performance share units, and 401K contributions.  Michael Daniels, the Senior VP and Group Executive of Services, was paid $8,686,835 in 2011.  Ms. Rometty, the newly appointed CEO, will be compensated $1,500,000 in base salary with a target bonus of $3,500,000 in 2012.  Additionally, she will receive $10,000,000 worth of Performance Share Units as a long-term incentive.  In 2011, Ms. Rometty received $8,342,270 in total compensation as Senior Vice President & Group Executive of Sales, Marketing, and Strategy. 

Friday
Jun222012

The Director Compensation Project: American International Group, Inc.

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation.  We are for the most part including companies from 2011’s Fortune 500 and using information found in their 2011 proxy statements.

Nasdaq and the NYSE have similar rules with respect to director independence.  NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors.  A director does not qualify as “independent” if he or she has a “material relationship with the company.”  NYSE Rule 303A.02(a).  In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.  NYSE Rule 303A.06 imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3). 

Independent directors are compensated for their service on the board.  The amount of compensation can be seen from examining the director compensation table from the American International Group, Inc. (NYSE: AIG) 2011 proxy statement.  According to the proxy statement, the company paid the directors the following amounts:

 

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards

All Other Compensation
($)

Total
($)

W. Don Cornwell

101,538

49,990

0

0

151,528

John H. Fitzpatrick

101,538

49,990

0

0

151,528

Laurette T. Koellner

179,000

49,990

0

0

219,990

Donald H. Layton

160,000

49,990

0

0

209,990

Christopher S. Lynch

180,000

49,990

0

0

229,990

Arthur C. Martinez

170,577

49,990

0

0

220,567

George L. Miles, Jr.

170,577

49,990

250

0

220,567

Henry S. Miller

160,000

49,990

0

0

209,990

Robert S. Miller

650,000

49,990

0

0

699,990

Suzanne Nora Johnson

160,000

49,990

0

0

209,990

Morris W. Offit

170,000

49,990

250

0

219,990

Ronald A. Rittenmeyer

161,731

49,990

0

0

211,721

Douglas M. Steenland

360,000

49,990

0

0

409,990

Director Compensation. Non-management directors were compensated with an annual retainer of $150,000 plus $50,000 in deferred stock units (“DSUs”).  Each DSU entitled directors to one share of common stock upon departure from the board.  Directors also received dividend payments in the form of DSUs.  Directors were granted an extra $5,000 for sitting on a committee and an extra $15,000 for chairing a committee, except for the chair of the Audit Committee, who received an extra $25,000.  Robert Miller received an additional $500,000 as Chairman of the Board and ex officio member of all standing committees.  Robert Benmosche, AIG’s Chief Executive Officer, did not receive any compensation for his position on the board.  AIG held fifteen board meetings during 2011.  All directors attended at least 75% of the meetings of the board and of the committees for which they served.  All directors attended the 2011 annual shareholders’ meeting. 

Director Tenure. Mr. Miles is the longest tenured director, having held his position since 2005.  Messrs. Cornwell and Fitzpatrick are the newest members, having just been elected in 2011.  Many of the directors hold positions on other boards, including Ms. Koellner, who sits on the board of Sara Lee Corporation.  Mr. Martinez sits on the boards of PepsiCo; Liz Claiborne, Inc.; IAC/InterActiveCorp; International Flavors and Fragrances, Inc.; and HSN, Inc. 

Executive Compensation. AIG’s CEO, Mr. Benmosche, received $13,984,181 in total compensation for 2011.  Due to limitations placed on AIG for accepting federal TARP money in 2008, Mr. Benmosche received only $3,000,000 in cash and did not receive a bonus.  TARP standards require compensation plans that discourage excessive risk taking and promote long-term value instead of short-term results.  Nearly $11,000,000 of the CEO’s compensation was in restricted stock units (“RSU”) that will not vest for at least two years.  Furthermore, after the RSUs vest, they are only payable in 25% increments up to the level AIG has repaid its TARP obligations.  Jay Wintrob, the Executive Vice President of Domestic Life and Retirement Services, made $7,336,879, which included a cash payment of $495,000.  Messrs. Benmosche and Wintrob each received $22,318 and $10,985 worth of company car services, respectively. 

 

Friday
Jun222012

The Director Compensation Project: Wells Fargo & Company

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation.  We are for the most part including companies from 2011’s Fortune 500 and using information found in their 2011 proxy statements.

Nasdaq and the NYSE have similar rules with respect to director independence.  NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors.  A director does not qualify as “independent” if he or she has a “material relationship with the company.”  NYSE Rule 303A.02(a).  In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.  NYSE Rule 303A.06 imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3).

Independent directors are compensated for their service on the board.  The amount of compensation can be seen from examining the director compensation table from the Wells Fargo & Company (NYSE: WFC) 2011 proxy statement.  According to the proxy statement, the company paid the directors the following amounts:  

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards
($)

All Other Compensation
($)

Total
($)

John D. Baker II

151,000

140,025

0

0

291,025

Elaine L. Chao

49,500

116,675

0

0

166,175

John S. Chen

111,000

140,025

0

0

251,025

Lloyd H. Dean

166,000

140,025

0

0

306,025

Susan E. Engel

143,000

140,025

18,117

0

301,142

Enrique Hernandez, Jr.

166,000

140,025

0

0

306,025

Donald M. James

119,000

140,025

0

0

259,025

Richard D. McCormick

55,250

0

0

0

55,250

Mackey J. McDonald

115,000

140,025

0

0

255,025

Cynthia H. Milligan

199,000

140,025

18,303

0

357,328

Nicholas G. Moore

163,000

140,025

0

0

303,025

Federico F. Peña

18,500

70,000

0

0

88,500

Phillip J. Quigley

188,000

140,025

18,117

0

346,142

Judith M. Runstad

143,000

140,025

18,303

0

301,328

Stephen W. Sanger

148,000

140,025

0

0

288,025

Susan G. Swenson

125,000

140,025

0

0

265,025

John G. Stumpf

0

0

0

0

0

*As an employee director, Mr. Stumpf does not receive additional compensation for his board service.

 Director Compensation.  During 2011, the board held thirteen meetings.  Director attendance averaged 98% for meetings of the board and its committees.  Each director attended at least 75% of the total number of meetings for the board and committees on which he or she served.  Effective on January 1, 2011, the company ceased granting stock options to non-employee directors.  Effective January 1, 2012, the value of the annual stock award for directors increased from $140,00 to $150,000.  Upon Ms. Chao’s election to the board, she received 4,071 shares of common stock.  Upon Mr. Peña’s election to the board, he received 2,826 shares of common stock.

Director Tenure.  Effective at the 2011 annual meeting of stockholders, Mr. McCormick retired as a director. Ms. Chao was elected to the board on July 1, 2011.  Mr. Peña was elected to the board on November 1, 2011.  Several directors also sit on other boards.  For instance, Mr. Baker is a director for Patriot Transportation Holding, Inc.; Progress Energy Inc.; and Texas Industries, Inc.  Mr. Hernandez serves on the board for Chevron Corporation; McDonald’s Corporation; and is Chairman of the Board for Nordstrom, Inc.  Ms. Milligan has been a director since 1992 and has the longest tenure on the board.

Executive Compensation. Mr. Stumpf, President and CEO, earned the highest compensation in 2011 of $19,843,021.  Mark C. Oman, former Senior Executive Vice President of Home and Consumer Finance, retired on December 1, 2011.  He received a total compensation of $16,427,890, $7,957,453 of which was categorized as a “Change in Pension Value and Nonqualified Deferred Compensation Earnings.”  Mr. Oman’s 2011 retirement benefits were calculated pursuant to Securities and Exchange Commission rules and were based on his thirty years of employment with Wells Fargo, his age at retirement of 56 years, and the immediate payment of his retirement benefit in 2012.  Overall, Mr. Oman received a supplemental retirement arrangement in a lump sum of $12,159,452.

Thursday
Jun212012

The Director Compensation Project: Cardinal Health, Inc.

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation.  We are for the most part including companies from 2011’s Fortune 500 and using information found in their 2011 proxy statements.

Nasdaq and the NYSE have similar rules with respect to director independence.  NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors.  A director does not qualify as “independent” if he or she has a “material relationship with the company.”  NYSE Rule 303A.02(a).  In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.  NYSE Rule 303A.06 imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3).

Independent directors are compensated for their service on the board.  The amount of compensation can be seen from examining the director compensation table from the Cardinal Health, Inc. (NYSE: CAH) 2011 proxy statement.  According to the proxy statement, the company paid the directors the following amounts:

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards
($)

All Other Compensation
($)

Total
($)

Colleen F. Arnold

75,000

120,015

0

0

195,015

Glenn A. Britt

88,837

120,105

0

4,330**

218,182

Carrie S. Cox

77,750

120,105

0

0

197,765

Calvin Darden

77,750

120,105

0

0

195,765

Bruce L. Downey

77,750

120,105

0

1,000

198,765

John F. Finn

106,163

140,017

0

0

246,180

Gregory B. Kenny

88,000

120,015

0

0

208,015

James J. Mongan*

61,558

183,720

0

0

245,278

Richard V. Notebaert

77,250

120,015

0

0

197,265

David w. Raisbeck

88,000

120,015

0

0

208,015

Jean G. Spaulding

75,000

120,015

0

0

195,015

*Dr. Mongan retired on April 18, 2011 due to health-related concerns.

** At the request of Mr. Britt’s employer, Time Warner Cable, Mr. Britt uses his employer’s corporate aircraft for travel.  This figure represents reimbursement for the use of that aircraft for travel to Cardinal board meetings. 

Director Compensation. Director compensation was comprised of an annual retainer recently increased from $75,000 to $90,000 on November 2, 2011, restricted stock units recently increased from $120,000 to $140,000, and varying amounts for chairing committees.  The chairs of the Audit Committee, Compensation Committee, and Nominating and Governance Committee received an additional $20,000, $15,000, and $10,000, respectively.  The board of directors held seven meetings during the 2011 fiscal year, which ended June 30, 2011. The directors attended 75% of the board of directors and committee meetings.  All of the directors but Dr. Mongan attended the annual shareholders’ meeting. 

Director Tenure.  Mr. Finn is the longest tenured director, having held his position since 1994.  Mr. King holds the shortest tenure after being elected in September of 2011.  All of the directors except Ms. Arnold and Ms. Spaulding are directors for at least one other company.  For instance, Mr. Britt also sits on the board and is the Chief Executive Officer of Time Warner Cable.  Although Ms. Arnold is an executive at IBM, she was still classified as independent by the Nominating and Governance Committee because payments from Cardinal represented less than 1% of IBM’s gross revenues over the past 3 years. 

Executive Compensation. George S. Barrett, Cardinal’s CEO and Chairman of the Board, received $10,214,206 in compensation last year.  Included in that figure was Mr. Barrett’s personal use of the company’s aircraft, relocation expenses, and monitoring expenses for a security system at his residence.  If Mr. Barrett is terminated before the earlier of December 31, 2012 or the June 30, 2012 annual shareholders’ meeting, he is entitled to $1,200,000 in salary, a bonus of at least 130% of his base salary, long-term incentive awards equal to at least 600% of his annual base salary, and personal use of the corporate aircraft not to exceed $100,000.  Jeffrey W. Henderson, Cardinal’s Chief Financial Officer, was compensated $3,777,410 for his services in 2011. 

Thursday
Jun212012

The Director Compensation Project: The Walt Disney Company

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation.  We are for the most part including companies from 2011’s Fortune 500 and using information found in their 2011 proxy statements.

Nasdaq and the NYSE have similar rules with respect to director independence.  NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors.  A director does not qualify as “independent” if he or she has a “material relationship with the company.”  NYSE Rule 303A.02(a).  In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.  NYSE Rule 303A.06 imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3).

Independent directors are compensated for their service on the board.  The amount of compensation can be seen from examining the director compensation table from The Walt Disney Company (NYSE: DIS) 2011 proxy statement.  According to the proxy statement, the company paid the directors the following amounts:

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards
($)

All Other Compensation
($)

Total
($)

Susan E. Arnold

90,000

140,319

0

7,528

237,847

John E. Bryson

53,407

94,158

0

0

147,565

John S. Chen

90,000

140,319

0

4,044

234,363

Judith L Estrin

90,000

140,319

0

7,365

237,684

Steven P. Jobs*

0

0

0

0

0

Fred H. Langhammer

105,000

140,319

0

16,936

262,255

Aylwin B. Lewis

115,000

140,319

0

5,477

260,796

Monica C. Lozano

90,000

140,319

0

18,396

248,715

Robert W. Matschullat

100,000

140,319

0

20,535

260,854

John E. Pepper, Jr.

0

557,265

0

4,911

562,176

Sheryl K. Sandberg

90,000

140,319

0

13,544

243,863

Orin C. Smith

105,000

140,319

0

7,356

252,675

*At Mr. Jobs’s request, he received no compensation for his services as a director. Mr. Jobs passed away on October 5, 2011.

Director Compensation. Effective October 1, 2011, the board increased the annual board retainer from $80,000 to $100,000, increased the annual deferred stock unit grant from $140,000 to $150,000, and increased the annual committee retainer for the Audit Committee chair from $15,000 to $20,000. The annual retainer for committee membership remained at an additional $10,000 paid to each director. The retainer for committee chairs remained at an additional $15,000. The annual retainer for the Chairman of the Board, Mr. Pepper, was $500,000 for the 2011 fiscal year. The board met five times during the 2011 fiscal year. Every current director attended at least 75% of the board meetings, the committee meetings on which he or she served, and the company’s 2011 annual shareholders’ meeting. To encourage the directors to personally experience the company’s products, services, and entertainment, Walt Disney allowed each non-employee director up to $15,000 per year at the company’s resorts, cruises, and stores. The company also allowed family members, including spouses, children, and grandchildren, to participate and reimbursed their travel expenses.

Director Tenure.  On January 1, 2007, Mr. Pepper became the Non-Executive Chairman of the Board. Mr. Pepper has notified the board that he plans to retire at the 2012 annual shareholder meeting. The board concluded that it will extend Mr. Robert Iger’s CEO employment contract and name him Chairman of the Board upon Mr. Pepper’s retirement. Mr. Jobs passed away on October 5, 2011, and Mr. Bryson resigned from the board on October 21, 2011.

Executive Compensation.  In 2011, Mr. Iger, CEO, received fixed compensation of $2,962,932, a performance-based bonus of $15,500,000, and an annual equity award of $12,900,081. Mr. Iger’s total compensation was $31,363,013. Mr. Iger also received $371,439 in personal air travel and $561,303 for security. James A. Rasulo, CFO, received fixed compensation of $1,457,743, a performance-based bonus of $3,750,000, and an equity award of $4,676,340. Mr. Rasulo’s total compensation was $9,884,083. All executives were entitled to the option of a company-supplied automobile or a monthly payment; health club membership; free access to company theme parks, some resort facilities, and discounts on merchandise; and personal use of tickets that were acquired for business entertainment when no business use had been arranged.

Tuesday
Jun192012

The Director Compensation Project: Apple Inc.

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation.  We are for the most part including companies from 2011’s Fortune 500 and using information found in their 2011 proxy statements.

 Nasdaq and the NYSE have similar rules with respect to director independence.  NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors.  A director does not qualify as “independent” if he or she has a “material relationship with the company.”  NYSE Rule 303A.02(a).  In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.  NYSE Rule 303A.06 imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3).

 Independent directors are compensated for their service on the board.  The amount of compensation can be seen from examining the director compensation table from the Apple Inc. (NYSE: AAPL) 2011 proxy statement.  According to the proxy statement, the company paid the directors the following amounts: 

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards
($)

All Other Compensation*
($)

Total
($)

William V. Campbell

50,000

200,090

0

5,230

255,320

Millard S. Drexler

50,000

200,090

0

13,675

263,765

Al Gore

50,000

200,090

0

10,639

260,729

Robert A. Iger **

0

0

0

0

0

Andrea Jung

50,000

200,090

248,148

3,787

502,025

Arthur D. Levinson

50,000

200,090

0

6,706

256, 796

Ronald D. Sugar

75,000

255,884

0

2,615

333, 499

Steve Jobs***

-

-

-

-

-

Timothy D. Cook****

-

-

-

-

-

*These amounts include one or more products that are made available through the company’s board of directors equipment program. 

**Mr. Iger was appointed to the board on November 15, 2011 after the end of the fiscal year. As a result, Mr. Iger did not receive any compensation from the company in the 2011 fiscal year.  

***Mr. Jobs passed away on October 5, 2011 and, at his request, received no compensation for his services as a member of the board.  

****Mr. Cook received no compensation for his services as a member of the board.

 Director Compensation. During 2011, Apple Inc. held five board of directors meetings.  Each member of the board attended 75% or more of the total number of board meetings and the total number of meetings held by all committees of the board on which that person served.  The Director Plan, amended in 2009, provided for the non-employee directors to receive a one-time prorated stock option grant.  This was done in order to provide compensation for periods of service that would not otherwise be covered due to conflicting timing in the distribution of the annual grants with the director’s anniversary of joining the board and the date of the shareholders annual meeting. 

 Director Tenure and Leadership.  During 2011, there were many changes on the board.  After Mr. Jobs’s resignation as Chief Executive Officer on August 24, 2011, the board appointed him Chairman of the Board, a position he held until he passed away on October 5, 2011.  Mr. Cook was appointed to the board and to CEO on August 24, 2011.  Mr. Cook has been with the company since March 1998.  Dr. Levinson, who has served on the board since 2000, was appointed as Chairman of the Board on November 15, 2011.  Mr. Iger was appointed to the board on November 15, 2011.  Since October 2005, Mr. Iger has been the President and CEO of The Walt Disney Corporation.  Mr. Campbell, Chairman of Intuit Inc. since August 1998, had the longest tenure on Apple’s board, having served since 1997.

 Executive Compensation.  Apple believed that Mr. Jobs’s level of stock ownership, which totaled approximately 5.5 million shares at the end of 2011, significantly aligned his interest with that of the shareholders.  Therefore, his total compensation consisted of a salary of $1 per year.  Mr. Cook, the newly appointed CEO, earned a total of $377,996,537 during the 2011 fiscal year.  This included 1,000,000 restricted stock units (RSUs) at a current stock price of $376.18, totaling $376,180,000 in stock awards.  In determining Mr. Cook’s compensation, the board considered his promotion to CEO, the importance of retaining him, the ten-year vesting period of the RSUs, and the company’s belief that a CEO’s large equity investment aligns with shareholder interests.  In 2011, the board promoted Eduardo H. Cue to Senior Vice President of Internet Software and Services.  This promotion included a stock award of $51,852,000.  Mr. Cue’s total compensation for 2011 was $52,952,975, which included a $607,704 salary, $444,615 from Incentive Plan Compensation, and $48,656 of other compensation.  Mr. Cue’s other compensation consisted of 401(k) contributions of $12,798, life insurance premiums of $1,242, and a cash-out on accrued and unused vacations worth $34,616.

Saturday
Jun162012

Law and Society (Part 2): Teaching Happiness

On Wednesday, June 6, I attended a roundtable discussion entitled, “Engagement, Happiness, and Meaning in Legal Education and Practice.”  What I took away from the discussion was that there is significant evidence to suggest that law students are unnecessarily and excessively suffering from anxiety, depression, substance abuse, and other unhealthy responses to the stress of law school, and that law schools should do a better job of educating students about these risks and providing them with tools to help them better cope with stress.  What follows is a brief overview of the roundtable discussion, which I hope will provide some useful contacts for those wishing to learn more about what we can do as educators to help our students thrive.  I apologize in advance for the brief coverage (particularly of the last three speakers), which in no way does justice to the tremendous work each of these individuals is doing.  I hope you will take the time to follow-up on the links I provide.

The roundtable began with Rhonda Magee guiding us all through a mindfulness exercise.  I have some experience with mindfulness meditation (I’ve edited a book of dharma talks given by my sensei Ji Sui Craig Horton of the Cleveland Buddhist Temple during the year that I studied zazen with him, which is available at cost here--accompanying photobook available at cost here), and Prof. Magee struck me as someone who is highly skilled at conveying the essence of good practice in this area.  She is also President of the Board of Directors of the Center for Contemplative Mind in Society, which seeks to transform higher education "by supporting and encouraging the use of contemplative/introspective practices and perspectives to create active learning and research environments that look deeply into experience and meaning for all in service of a more just and compassionate society."

Peter Huang then spoke about his work with the Telos Project at the University of Colorado School of Law.  I pulled the following from a news story that you can find here:

In order to broaden student's perception of the legal profession, the university has implemented the Telos Project. The project organizes 25 students to reflect on their chosen path in a non-credit, reading intensive course. “The Telos Project is a small group seminar designed to engage law students in conversation about the behavioral and ethical dimensions of their legal training and prepare them for the legal profession,” University of Colorado Law School Vice Dean Dayna Matthew said.

Todd Peterson then discussed some of the empirical evidence that supports the conclusion that law schools have a problem in this area.  You can find his article, “Stemming the Tide of Law Student Depression: What Law Schools Need to Learn from the Science of Positive Psychology,” on SSRN here.

To round out the discussion, Marjorie Silver spoke about her work on therapeutic jurisprudence, Daniel Bowling noted that if you purposely wanted to design a course of study that would induce learned helplessness and depression you likely couldn’t come up with something better than the typical 1L experience (and he has designed a course to try and deal with this problem), and Lorenn Walker talked about her work with restorative justice for healing.

Finally, I couldn't help but think about the work my wife, Dr. Maria Pagano, has been doing in the area of substance abuse, where she has empirically validated the helper principle.  Certainly there is no shortage of techniques, from meditation to reflective writing to reframining to service work, that we can leverage to help our students avoid the pitfalls of excessive stress.

Sunday
Jun102012

Law and Society (Part I)

I just returned from the Law and Society Association's 2012 International Conference in Honolulu.  There were a number of excellent presentations, and I plan on blogging about a few of them over the course of my next few posts.  I want to start with a presentation by Lloyd Drury entitled "The New Governance Model of Publicly-Held Private Equity Firms," wherein Prof. Drury reviewed all the ways in which certain publicy-held private equity firms have effectively rejected traditional corporate governance tools like fiduciary duties and shareholder oversight without sending investors running for the hills.  Obviously, this may be primarily an issue of pricing, but the reason I find the project particularly interesting is because I think it can serve as a great introduction and/or closing to my Corporations class--encouraging my students to question everything corporate law suggests is necessary to facilitate capital formation.  Keep your eyes on Prof. Drury's SSRN page for a draft of the paper. 

Sunday
Jun032012

Director-Primacy and Team-Production as Real Entity Theories

I have previously debated the appropriateness of viewing director-primacy as a type of real entity theory of the corporation with director-primacy’s most renowned spokesperson, Stephen Bainbridge.  (You can find the last post in the series, with links to the preceding posts, here.) 

I now want to take that discussion a step further by suggesting that team-production theory may also be aligned with real entity theory.

For those of you not familiar with team production theory, you can go here to view the abstract for (and download the text of): Margaret Blair & Lynn Stout, “A Team Production Theory of Corporate Law.”  A relevant portion of the abstract provides that:

[W]e argue that the essential economic function of the public corporation is not to address principal-agent problems, but to provide a vehicle through which shareholders, creditors, executives, rank-and-file employees, and other potential corporate "stakeholders" who may invest firm-specific resources can, for their own benefit, jointly relinquish control over those resources to a board of directors…. The team production model … suggests that maximizing shareholder wealth should not be the principal goal of corporate law. Rather, directors of public corporations should seek to maximize the joint welfare of all the firm's stakeholders …

Thus, it appears clear that director primacy and team production theory differ in terms of what they view as the goal of corporate governance.  For director primacy, it is shareholder wealth maximization.  For team production theory, it is the maximization of “the joint welfare of all the firm's stakeholders.”  However, both theories locate the ultimate decision-making power in the board of directors, and I believe this fact makes them both candidates for alignment with real entity theory as follows.

To begin with, I believe it is important to understand that I come to this issue largely as a result of wanting to coordinate traditional corporate law theories of the corporation with traditional constitutional law theories of the corporation as part of my latest project, “The Silent Role of Corporate Theory in the Supreme Court’s Campaign Finance Cases” (forthcoming in the Penn. Journal of Const. Law—latest draft available for download here).  To that end, it seems relatively non-controversial to align artificial entity theory with concession theory, and nexus-of-contracts theory with the aggregate theory of the corporation.  However, deciding which traditional corporate law theory of the corporation (if any) to match up with real entity theory—the third traditional constitutional theory of the corporation—is a bit more complicated.

At the risk of over-simplification, I think one valid way of approaching the problem is as follows.  First, concession theory and artificial entity theory are aligned because both view the corporation as a creature of the state and tend to presume the state has great discretion in regulating its creation.  Aggregate theory and contractarianism, on the other hand, focus on the “association of citizens” that contract with one another for private gain via the corporate form, and view the state’s role as essentially limited to providing default rules to further private ordering.  While the typical economic analysis of contractarianism can be used to explain the corporate norm of director primacy as a function of efficient private ordering, one assumes it does not require power to be centralized in a board of directors as a normative matter.  The theories of director primacy and team production, however, go much further in establishing the board of directors as the “mediating hierarchy” of choice (though certainly not to the point of mandating such a structure), and therefore could be said to come closer to identifying a specific locus of corporate control that can be said to constitute the “real entity” that represents the corporation.  As Reuven Avi-Yonah has written (here): “The [emergence of the business judgment] rule reflected the real entity view, which equates the corporation with its management, and rejected the aggregate view of the corporation as an aggregate of its shareholders.”

Admittedly, there is some smashing of square pegs into round holes going on here.  Furthermore, given that my project ultimately seeks to distinguish theories of the corporation on the basis of how great a role they assign the state in terms of regulating corporations, distinctions between real entity theory and aggregate theory may be of limited relevance since both currently tend to justify limiting state regulation more than concession theory.  As Atiba Ellis has written (here): "The important implication of this real entity theory is that the corporation has a life completely separate and apart from the state; the state merely records the combination of the private parties and plays only observer of the corporation's formation."  However, I continue to believe there is value to be derived from trying to align the corporate and constitutional theories of the corporation, and to that end view director primacy and team production as good candidates for alignment with real entity theory due to their combination of situating the locus of the corporation in the board of directors and justifying this on the basis of contract rather than regulation.  As Lynn LoPucki has written (here):

The Team Production Theory has striking implications for bankruptcy theory. Applied to bankruptcy reorganization, the Team Production Theory turns existing contractarian bankruptcy theory virtually upside down. Bankruptcy reorganization ceases to be a regulation imposed by government and instead becomes a contract term by which creditors and shareholders agree to subordinate their legal rights to the preservation of the going concern.

Saturday
May262012

How JP Morgan’s $2 Billion Trading Loss May Impact Citizens United II

The United States Supreme Court is currently reviewing a petition for a writ of certiorari in the case of American Tradition Partnership, Inc. v. Attorney General of Montana.  The case has been dubbed “Citizens United II” by some because, as I blogged back in February (here), the “Montana Supreme Court ruling that upheld a state ban on corporate political independent expenditures…. appears to be in direct conflict with Citizens United.”  I was reminded of this case when I read the following in the Wall Street Journal (here) this past Tuesday:

 J.P. Morgan Chase & Co. is finding few friends on Capitol Hill…. Republicans haven't forgotten that J.P. Morgan gave a majority of its campaign donations to President Barack Obama and Democrats in the 2008 campaign. Even though the company has since reversed course and donated most of its political dollars to Republicans ... senior GOP officials say they still perceive the firm as cozy with the Democratic establishment…. And Republicans say their displeasure extends to contribution patterns by other banks including Goldman Sachs Group Inc., Bank of America Corp., and Citigroup Inc. …. But frustrations with J.P. Morgan are also a reason the GOP defense of the bank's misstep has been muted, according to senior Republican officials…. In January 2010, Mr. Boehner, now the House speaker, made a pitch to Mr. Dimon over drinks on Capitol Hill to make more donations to Republicans, who were opposing Mr. Obama's plans to impose tough new regulations on the industry. Since then, J.P. Morgan has worked hard to curry favor with important Republicans in Congress.

This strikes me as precisely the sort of thing that implicates both the anti-corruption and shareholder-protection rationales for regulating corporate political expenditures that a majority of the Supreme Court rejected in Citizens United.  In “A Contractarian Critique of Citizens United,” Joseph Morrissey recounts the following from Citizens United:

Justice Stevens cited to the district court opinion, written by Judge Kollar Kotelly.  That opinion discussed the subtleties of corruption and the evidence that electioneering involves indirect forms of influence peddling.   Judge Kollar Kotelly had found that politicians routinely request corporations to make electioneering communications so that the politicians themselves do not have to engage in disseminating certain messages.   She also discovered that politicians routinely communicate with corporations to thank them for distributing those messages.   In addition, she found that a vast portion of the American public – 80% -- believe that corporations get pay backs for engaging in political electioneering.   One lobbyist had even testified that indirect expenditures in fact generate more influence with politicians than direct contributions.   That testimony went uncontroverted.

Furthermore, in “Rational Coercion: Citizens United and a Modern Day Prisoner's Dilemma,” Anne Tucker argues that:

The prisoner's dilemma demonstrates the pressure on corporations to participate in politics via their checkbooks. That pressure existed before Citizens United (i.e., political action committees and affiliated non-profit foundations, and charitable contributions), but was exacerbated with the expansion of corporate political speech through independent expenditures. Increased corporate political spending impacts both the participatory rights and the economic interests of citizen shareholders. The individually rational choice of corporations to make political expenditures creates irrational results, which will impact the price and efficiency of political messages as well as promote the inefficient allocation of corporate resources.

It will be interesting to see whether the evolving JP Morgan story becomes a part of the Citizens United story.

Wednesday
May232012

The NYT, the SEC and Insider Trading (Part 3)

We are discussing the piece in the NYT about alleged "insider" trading at Lehman Brothers.   See Is Insider Trading Part of the Fabric?

The article contained allegations suggesting that pressure had been placed on analysts at Lehman to write more favorable opinions in order to garner additional investment banking business.  This raised possible concerns under NYSE Rule 472 and the global settlement with brokers designed to separate their investment banking and analyst functions.  Lehman was one of the firms subject to the global settlement.    

What ever concerns exist over the relationship between investment banking and analysts, the JOBS Act just put in place a provision designed to make the separation far more difficult to maintain.   According to Section 105 of the On Ramp provision, Section 2(a)(3) of the Securities Act was amended to provide that, in connection with a public offering for equity securities (and not just the IPO) for an "emerging growth company," the publication of an analyst report will: 

not to constitute an offer for sale or offer to sell a security, even if the broker or dealer is participating or will participate in the registered offering of the securities of the issuer.

This presumably means that the SEC cannot restrict the distribution of analyst reports (even those issued by the underwriter) during the offering process.  It probably sets aside the restriction in NYSE Rule 472 that prohibited analysts at firms involved in the underwriting from circulating reports until 40 days after the offering.  See Id.  ("A member organization may not publish or otherwise distribute research reports regarding an issuer and a research analyst may not recommend or offer an opinion on an issuer's securities in a public appearance, for which the member organization acted as manager or co-manager of an initial public offering within forty (40) calendar days following the offering date."). 

Moreover, Section 15D of the Exchange Act has been amended to provide that with respect to an emerging growth company engaging in an IPO, neither the SEC nor the exchanges can adopt rules that restrict: 

based on functional role, which associated persons of a broker, dealer, or member of a national securities association, may arrange for communications between a securities analyst and a potential investor;

The provision presumably overturns the prohibition in NYSE Rule 472 on analysts participating in road shows and may overturn the prohibition on communcations with prospective customers "in the presence of investment banking department personnel or company management about an investment banking services transaction." 

Likewise, the SEC and exchanges cannot adopt a rule that restricts:

a securities analyst from participating in any communications with the management of an emerging growth company that is also attended by any other associated person of a broker, dealer, or member of a national securities association whose functional role is other than as a securities analyst.

Analysts can, therefore, attend meetings in which management of an emerging growth company is "pitched" for investment banking business, overturning yet another requirement of NYSE Rule 472.  See NYSE Rule 472  ("A research analyst is prohibited from participating in efforts to solicit investment banking business. This prohibition includes, but is not limited to, participating in meetings to solicit investment banking business (e.g., "pitch" meetings) of prospective investment banking clients, or having other communications with companies for the purpose of soliciting investment banking business.").

All of this suggests that analysts can, with respect to emerging growth companies, have a much greater connection to the efforts to sell shares and to pitch management.  It will likely be difficult to ensure that this involvement is limited to emerging growth companies.  Moreover, it will likely be difficult to ensure, given this involvement, that analyst reports are uninfluenced by the needs of the investment banking arm of the firm. 

Thus, for example, it is hard to imagine an analyst for a managing underwriter issuing an unfavorable report during the offering.  This will be true even where the analyst is not subject to direct pressure from the investment banking side of the firm.  Investors, therefore, will always get a positive spin on the company, at least from the analysts connected to the underwriter. 

As the tumbling Facebook shares illustrate, investors benefit not from a rosy forecast but from the truth.  It is not at all clear that the provisions of the JOBS Act governing analyst reports have advanced that possibility. 

Tuesday
May222012

The Trial of Rajat Gupta (Opening Arguments)

There is some good coverage of the trial of Rajat Gupta who is accused of engaging in insider trading.  The Deal Book in particular looks like it will provide some detailed coverage.  An early example is here.   We will comment on the case from time to time from afar, relying on the strength of this commentary.  Had the case been in Denver, there is no doubt that the staff of the Race to the Bottom would have blogged the trial as we have for other important cases (the trial of Joe Nacchio and the trial of Ward Churchill). 

This is a case where the government wants it to be simple (and indeed, the prosecution described the matter as a "straightforward case of insider trading.").  Mr. Gupta gave information to others (out of friendship or in return for some benefit) and they traded on it.

Gupta's side will to some degree simply deny the charges.  Suggestive evidence (the taped phone calls that do not refer to Mr. Gupta by name) will be disputed.  But in addition, his side appears to be raising a more complicated defense:  As the Deal Book reported:

Mr. Naftalis also hinted at another defense strategy: portraying Goldman Sachs as a sieve of information. He noted that Galleon was a top customer of Goldman and hinted that Mr. Gupta was not the only Goldman insider with valuable information. Three executives from the company are under investigation by the federal authorities for possibly leaking illicit information.

This is a high risk defense.  A defense that others do it does not absolve Mr. Gupta.  To the extent the defense is that others provided the information, this is premised around the acknowledgment that, in fact, material inside information was conveyed but that someone other than Mr. Gupta conveyed it.  In other words, a crime was committed but not by Mr. Gupta.  Any hint that in fact the law was violated may make it easier for the jury to lean toward a conviction. 

Whatever happens with the defense, one thing seems clear.  Goldman will not come out of this looking particularly good.  The firm already appears to have a credibility problem with clients after some of the behavior, alleged by regulators, occurred during the financial crisis.  To the extent that the trial of Mr. Gupta suggests that there was widespread favoritism (including tips that provided trading advantages) to favored clients, this may not be well received by the less favored clients. 

Tuesday
May222012

The NYT, the SEC and Insider Trading (Part 2)

We are discussing the piece in the NYT about alleged "insider" trading at Lehman Brothers.  See Is Insider Trading Part of the Fabric?.  The implication of the piece was that the alleged facts sustained a case for insider trading but that the SEC somehow dropped the ball.  In fact, as we discussed in the last post, most of the alleged misbehavior (tipping analyst reports in advance of public disclosure to the Lehman trading test and to select clients) may not even be insider trading.  

The article spends a great deal of time on the purported insider trading.  Far less attention was given, however, to the separation of the investment banking and analyst functions at the firm.  As the article describes:   

Lehman bosses, he contends, told him to write research that would support investment banking business — a violation of the Spitzer settlement. He says he was warned not to make negative comments about companies, even when he thought they were merited, lest he antagonize corporate executives. In 2003, he says, he was chastised for downgrading a company that was a corporate finance client of Lehman’s.

The alleged facts suggest the lack of separation between the research arm of the firm and the investment banking arm.  This raises a number of concerns. 

First, NYSE Rule 472 specifies that brokers are to keep separate the analyst and investment banking function.  Under the Rule, analysts may not be "subject to the supervision, or control, of any employee of the member organization's investment banking department."  In addition, the analyst reports must not be "subject to review or approval prior to publication by Investment Banking personnel."  In other words, the analyst writing process must be independent of the investment banking function.  The quote above, if true, suggests that this may not have been the case.

Second, the SEC (along with the NY AG's Office) brought actions against ten brokers alleging that research analysts were subjected to "inappropriate influence by investment banking at the firm."  The firms entered into a global settlement.  One of those firms included Lehman.  According to the Release:  

Lehman has agreed to sever the links between research and investment banking, such that: research and investment banking are physically separated with completely separate reporting lines; analysts' compensation cannot be based directly or indirectly upon investment banking revenues; investment bankers may no longer evaluate analysts; investment bankers will have no role in determining what companies are covered by the analysts; and research analysts will be prohibited from participating in efforts to solicit investment banking business, including pitches and roadshows. In addition, Lehman must disclose on the first page of each research report whether the firm does or seeks to do investment banking business with that issuer, and when Lehman decides to terminate coverage of an issuer, Lehman must issue a final research report discussing the reasons for the termination.

For a list of the specific undertakings, go here.  In other words, the article in the NYT does not make out a clean case for insider trading but it does raise concerns over the obligations of large brokers to keep their investment banking and analyst functions separate. 

Having said that, it is likely not an easy violation to prove.  It would probably have to be shown that reports were altered as a result of pressure from the investment banking arm of the firm.  The allegations quoted above suggest the importance of business considerations in writing research reports but stop short of stating that the approach resulted from pressure by the investment banking arm. 

Monday
May212012

The NYT, the SEC and Insider Trading

The NYT published a piece over the weekend on insider trading (Is Insider Trading Part of the Fabric?).  The article examines allegations of insider trading based on analyst reports produced at Lehman Brothers.  The reports were produced by analysts at the firm then allegedly used by Lehman in connection with proprietary trading and tipped to select clients.  As the article stated:

What exactly happened at Lehman? Mr. Parmigiani says traders there were routinely advised of changes in analysts’ company ratings before those changes were made public. That way, Lehman could profit on subsequent market moves. Here is how he describes it: First, research officials tipped off the traders; then Lehman’s proprietary trading desk, which cast bets with the firm’s own money, positioned itself accordingly. Lehman salespeople also alerted favored hedge funds. Only later, he says, were ratings changes made public.

Information on these trades were given to the SEC and, while an investigation was conducted, the implication was that the SEC simply lost interest.  Id.  ("But then, as the financial crisis flared that summer, the S.E.C.’s interest waned. After Lehman failed, Mr. Parmigiani got a call from two of the lawyers, signaling that the S.E.C. was probably not going to pursue the matter."). 

Moreover, the article quoted a reaction by Senator Grassley, a frequent critic of the SEC.  According to Senator Grassley:

This case emphasizes serious questions about the S.E.C.’s culture of deference to Wall Street and big players going back a long time. The S.E.C. obtained what appears to be clear evidence of, at a minimum, disregard for regulations designed to ensure that Wall Street firms can’t leak inside information to preferred clients prior to public announcements. Yet there appears to have been no consequences.

The article, however, completely sidestepped the most significant problem confronted by the SEC in bringing insider trading cases.  The law of insider trading has been so mangled by the Supreme Court that most of the behavior mentioned in the NYT piece probably does not even constitute insider trading.  It may violate other provisions of the securities laws but not those governing insider trading.  How could that be the case? 

It all started with Dirks v. SEC, 463 US 646 (1983), a piece of judicial activism designed to limit the reach of the prohibitions on insider trading.  The opinion for the most part contained faulty analysis that confined insider trading to circumstances involving a breach of a fiduciary "duty" by an insider.  To fill the gaps created by Dirks, the SEC had to develop an alternative theory of insider trading, misappropriation.  The theory posited that insider trading occurred when persons traded in violation of a "duty" of trust and confidence, an approach eventually affirmed in US v. O'Hagan, 521 U.S. 642 (1997).  

For the most part, a duty of trust and confidence is imposed on employees by the employer.  If an employee uses confidential information when trading, he or she engages in insider trading.  But the theory has a flaw.  When the employer uses the same information, it is not insider trading.  An employer that sets the obligation of confidentiality can set it aside.  To the extent, therefore, that analysts at Lehman Brothers produced reports that were used by the Lehman trading desk for proprietary trades, it is probably not insider trading.  Lehman, rather than the trading employees, benefited from the trades. In other words, employees did not violate a duty of trust and confidence by engaging in behavior that benefited Lehman. 

What about tipping the information to favored clients?  In Dirks v. SEC, an insider "tipped" information to an analyst.  The Court held that this was not insider trading.  In other words, selective disclosure of inside information is not necessarily insider trading.  To the extent that Lehman employees gave the information to favored clients in order to personally benefit, they may have violated the prohibitions on insider trading.  To the extent, however, that they gave the information to favored clients to benefit Lehman, it may not be insider trading. 

It may be the case that this sort of behavior ought to be insider trading.  But the reality is a great deal more complicated.  And, contrary to the suggestions in the NYT article, the problem is not the SEC's unwillingness to bring a case.  The problem is the complexity and irrationality of the law on insider trading. 

If the NYT wants to point the finger of blame for failing to bring an insider trading case under the alleged facts mentioned in the article, the finger should be pointed not at the SEC but at the US Supreme Court. 

Sunday
May202012

Rajat K. Gupta on Trial: Gupta Loses on Motions 

In United States v. Gupta, No. 11 Cr. 907(JSR), 2012 WL 1066804 (S.D.N.Y. Mar. 27, 2012), the Southern District of New York dismissed four motions filed by defendant Rajat Gupta.

Gupta filed a motion to dismiss Count 2 of his criminal indictment on January 3, 2012. Gupta argued that the language of the indictment, including phrases such as “at least approximately 350,000 shares,” and “certain Galleon Funds,” violated his Fifth Amendment rights by allowing the government to prove charges based on evidence that may not have been presented to the Grand Jury.  The court denied this motion for two reasons.

First, the court stated Gupta’s claim that the Grand Jury was not presented with evidence was based on “sheer conjecture.” Grand Jury proceedings are confidential and have been historically protected as such. The court refused to inquire into the Grand Jury proceedings, stating it would require something “far more definite” before it would do so.

Second, the court explained that there is no requirement for specific and exact numbers of shares, or specific entities that traded shares, in Grand Jury proceedings on insider trading. An indictment that describes a crime “with enough detail to provide fair notice and protect against double jeopardy” is constitutional and meets the requirements of Rule 7 of the Federal Rules of Criminal Procedure (“Fed. R. Crim. P.”). The court reasoned that Count 2 of the indictment met this standard because it provided Gupta with specific information he allegedly passed to Rajaratnam, the dates shares were traded, information showing the trades occurred through Galleon, and the minimum number of shares allegedly traded. The court stated this gave Gupta the ability to adequately prepare for his defense and the ability to invoke the double jeopardy clause in any subsequent trial if need be.

Gupta also filed a motion to consolidate several counts of the indictment as multiplicitous on January 3, 2012. The court denied this motion as premature for failing to satisfy the two reasons to consolidate. Multiplicitous counts should be consolidated because “charging multiple counts for the same offense ‘may improperly prejudice a jury by suggesting that a defendant has committed not one but several crimes.’” The court advised Gupta that it never reads or sends the indictment to the jury, and that opening statements do not include a recital of the counts; therefore, there is no potential for prejudice until much later in the trial. At that point the court will be able to evaluate a multiplicity claim.

The second reason for consolidation is to avoid the potential for a defendant to be punished twice for the same crime in violation of the double jeopardy clause of the Constitution. The court reasoned this concern arises at the sentencing stage and should not be addressed during the pre-trial phrase. Accordingly, the court dismissed without prejudice the motion to consolidate the counts as premature, allowing Gupta to raise the claim again if and when it becomes ripe.

Additionally on January 3, 2012, Gupta filed a motion to strike prejudicial surplusage pursuant to Fed. R. Crim. P. 7(d). He sought to remove the phrases “for example” and “among other things” when used in allegations relating to how he profited from the alleged conspiracy from the indictment. The court stated that while this motion was filed to strike prejudicial surplusage, the motion argued that the language impermissibly broadened the indictment, allowing the Government to introduce evidence never presented to the Grand Jury. The court dismissed this argument, as it did in Gupta’s motion to dismiss; it is “unsupported speculation” and the phrases do not alter the allegations, but merely indicate the evidence to be presented will not be limited to items listed in the indictment.  For these reasons, the court dismissed the motion to strike.

Gupta also filed a Fed. R. Crim. P. 7(f) motion on January 3, 2012, seeking a court order requiring the Government to supply particulars detailing:

  • “Gupta’s alleged management role and economic interest in an entity called ‘Galleon International’”;
  • “the ‘ownership stake’ that Rajaratnam ‘awarded’ Gupta in Galleon Special Opportunities”;
  • “‘financial benefits’ Gupta ‘received and hoped to receive’ as a result of his ownership interest in the Voyager fund”;
  • "the number of specific shares involved in the alleged trades based on insider information, i.e. particularizing what is meant by ‘at least approximately 350,000 shares’ of Goldman Sachs in March 2007 (sic)";
  • “the specific Galleon funds involved in each trade”; and
  • "the quantity, cost, and strike price of the ‘call option contracts’ described in Count One.”

The court stated Gupta had already received this information through the indictment, the discovery already provided by the Government, discovery available through the SEC civil case, Rajaratnam’s previous criminal proceedings, and a bill of particulars already provided by the Government. Even if the information sought had not been available to Gupta from these other sources, the court stated that the “highly specific evidentiary detail” sought is not appropriate for a bill of particulars. Therefore, the court dismissed the motion.

The primary materials for this case may be found on the DU Corporate Governance website.

Saturday
May192012

Does JP Morgan's $[2] Billion Loss Implicate Board Oversight? (Part 2)

Last week I blogged (here) that if we assume a corporate board’s duty of oversight includes monitoring risk exposure, then it should constitute a per se violation of that duty for a board to rule on a particular risky strategy without understanding the nature of the risk.  Stephen Bainbridge disagreed (here) for the following reasons:   First, such a rule would discourage appropriate risk-taking. 

As the federal Second Circuit explained in Joy v. North … "[B]ecause potential profit often corresponds to the potential risk, it is very much in the interest of shareholders that the law not create incentives for overly cautious corporate decisions.” 

Second, such a rule would run counter to the business judgment rule, which precludes courts from imposing liability for bad business decisions. 

As Chancellor Chandler correctly recognized in Citigroup, "asking the Court to conclude … that the directors failed to see the extent of Citigroup’s business risk and therefore made a ‘wrong’ business decision by allowing Citigroup to be exposed to the subprime mortgage market…. [constitutes the] kind of judicial second guessing [that] the business judgment rule was designed to prevent, and even if a complaint is framed under a Caremark theory, this Court will not abandon such bedrock principles of Delaware fiduciary duty law.” 

Finally, per se rules are inappropriate in this context because what courts really should be doing is “reconciling the competing claims of authority and accountability” by “balancing competing concerns” rather than blindly applying bright-line rules.

As a general matter, I don’t disagree with any of Bainbridge’s propositions.  However, I believe they are all subject to exceptions, and a failure to demonstrate a proper understanding of relevant risk exposure may constitute such an exception.  To begin with, we want to encourage appropriate risk-taking, not recklessness.  One cannot optimize risk exposure without understanding the complexities of the particular strategy.  As Frank Partnoy discussed in terms of the recent financial crisis (here):

[O]ne of the great ironies, I think, of the financial crisis was that the senior people at the Wall Street banks apparently didn't understand or capture the magnitude of their own financial institutions' exposure to these risks, which is really stunning, if you think about it, that the people who are in charge of these banks don't know what will happen when there's a 30 percent decline in housing prices. If you think about it, if you're the director or the CEO of a bank, isn't that the one thing you should understand? What will happen to my institution if the following financial variable changes by 30 percent? That kind of worst-case scenario analysis is why you're being paid millions of dollars. That's precisely what these people should have been doing.

Secondly, if we understand the business judgment rule to be about distinguishing “honest errors” from “intentional misconduct,” then I think signing off on a particular strategy without an appropriate understanding of the risk is closer to intentional misconduct than honest error.   Post-2008 it is very difficult to take seriously any director’s claim that they didn’t realize they needed to get up to speed on risk-exposure.  Obviously, I would include reasonable reliance on an appropriate expert as satisfying this requirement, but you need more than the 2012 equivalent of Van Gorkom assuring you that house prices will go up forever.

Finally, while I agree courts frequently need the flexibility of standards that allow for the balancing of competing interests, a bright-line rule that requires directors to understand the risk-creating strategy they are reviewing as a part of their Caremark duties seems to me to appropriately give business leaders something else they crave: clear guidance.  In other words, where red flags present themselves in connection with a particularly risky investment strategy, a board would be on notice that ignoring those red flags without being able to verbalize the scope of the risk would constitute an utter failure of oversight.

PS--Over at the Glom (here), David Zaring has posted some great links on the JP Morgan loss.

Saturday
May192012

Rajat K. Gupta on Trial: The SEC’s Civil Complaint

On October 26, 2011, the day Rajat K. Gupta (“Gupta”) was arrested on five counts of securities fraud and one count of conspiracy to commit securities fraud, the Securities and Exchange Commission (“SEC” or “the Commission”) filed a civil complaint in the United States District Court for Southern New York, pursuant to its authority under Section 20(b) of the 1933 Securities Act and Section 21(d) of the 1934 Act. 15 U.S.C. § 77t(b), and 15 U.S.C. § 78u(d) respectively, alleging Gupta violated Section 10(b) of the Act, Rule 10b-5, and Section 17(a) of the Act.

The SEC brought suit against both Gupta and his alleged co-conspirator, Raj Rajaratnam (“Rajaratnam”). Rajaratnam was recently tried and convicted for insider trading; he was sentenced to 11 years in prison, and he received a $10 million fine, and a $53.8 million forfeiture. The complaint seeks permanent injunctions against Gupta and Rajaratnam, “enjoining each from engaging in the transactions, acts, practices, and courses of business…” The SEC seeks disgorgement of all profits and/or losses avoided. Gupta would also be barred from serving as an officer or director of any issuer that has a class of securities registered with the SEC or that is required to file reports and enjoined from associating with any broker, dealer, or investment advisor.

The complaint alleged an “extensive insider trading scheme conducted by Gupta and Rajaratnam.” The SEC alleged that Gupta disclosed material nonpublic information that he had access to as a result of his positions on the board of directors for Goldman Sachs Group, Inc. (“Goldman Sachs”) and The Procter & Gamble Company (“P&G”). Gupta allegedly called Rajaratnam on several occasions after board meetings, and Rajaratnam, as managing partner of large hedge fund investment company Galleon Management LLP (“Galleon”), would cause the fund to buy or sell shares to gain profit or avoid losses.

The complaint focuses on four alleged insider trading incidents. The first was trades that occurred before the $5 billion investment in Goldman Sachs by Berkshire Hathaway, which was publicly announced after market close on September 23, 2008. The SEC alleged that Gupta learned of the potential for the Berkshire investment during a board meeting on September 21, 2008. The next morning Gupta placed a four minute phone call to Rajaratnam’s office. Rajaratnam caused Galleon to purchase over 100,000 Goldman Sachs shares. The next day, September 23, Rajaratnam placed a call to Gupta’s office and then again directed Galleon to purchase 50,000 Goldman Sachs shares. A special telephonic meeting of the Goldman Sachs board was called at 3:15 p.m. on September 23, 2008. During the meeting the board approved the Berkshire investment and a public equity offering. Immediately after disconnecting from the board meeting, Gupta called Rajaratnam’s office. Just minutes before market close, Galleon purchased 217,200 Goldman Sachs shares. Goldman Sachs stock increased 6.36% the day following the announcement of the Berkshire investment. On September 24, 2008, Rajaratnam liquidated Goldman Sachs shares, generating $800,000.

The second alleged insider trading surrounded Goldman Sachs’ 2008 fourth quarter financial results. In October 23, 2008, during a telephonic board meeting, Gupta learned that Goldman Sachs was operating an estimated loss of $1.96 per share. Twenty-three seconds after disconnecting from the board meeting, Gupta placed a thirteen minute phone call to Rajaratnam. At the opening of the market the next day, Galleon sold all of this Goldman Sachs stock. Rajaratnam allegedly stated that he “heard the prior day from a member of the Goldman Sachs Board that the company was actually going to lose $2 per share.” Galleon avoided a loss of more than $3.6 million dollars by selling the Goldman Sachs shares before the public announcement of the quarter’s loss in December 2008.

The third insider trading alleged surrounded Goldman Sachs’ 2008 second quarter financials. One week before the announcement of Goldman Sachs’ financials, Gupta spoke with the company’s chief executive about the company’s strong financial position. Later that same night Gupta called Rajaratnam at his home. Minutes after the market opened the next day, Galleon purchased over 7,350 shares of Goldman Sachs stock. Over the next few days Rajaratnam purchased an additional 350,000 shares. Rajaratnam caused Galleon to sell call options, profiting by approximately $9.3 million. The following day after the announcement, Rajaratnam caused Galleon to sell Goldman Sachs shares, profiting by over $9 million.

The fourth alleged incident was based on P&G’s 2008 second quarter financials. On January 29, 2009, Gupta met telephonically with P&G’s Audit Committee and they discussed expectations for the company to grow 2-5% in the fiscal year. That afternoon, Gupta called Rajaratnam. Rajaratnam allegedly stated that “he had learned from a contact on Procter & Gamble’s Board that the company’s organic sales growth would be lower than expected.” Galleon then sold short 180,000 P&G shares. After the public announcement stock declined 6.39%, resulting in $570,000 of avoided loss.

As a director, Gupta owed fiduciary duties to Goldman Sachs and P&G. Disclosing material nonpublic information about the companies would constitute a breach of the fiduciary duty of confidentiality. Additionally, Goldman Sachs’s guidelines provided that board meetings were confidential, and directors who had knowledge of material nonpublic information were prohibited from buying or selling the company’s stock or recommending others do so. P&G’s policy prohibited directors in possession of material nonpublic information, from conveying the information to others.

The primary materials for this case may be found on the DU Corporate Governance website.

Friday
May182012

Rajat K. Gupta on Trial: The Criminal Indictment

On October 26, 2011, the FBI arrested Rajat K. Gupta, former chief executive of McKinsey & Company and director of Goldman Sachs and Procter & Gamble (“P&G”), after he was indicted by a grand jury on six counts (five counts of securities fraud and one count of conspiracy to commit securities fraud). On the same day, the Securities and Exchange Commission (“SEC”) filed a civil complaint in federal court against both Gupta and Raj Rajaratnam, the founder of Galleon Management (“Galleon”) and Gupta’s alleged co-conspirator. The civil case and the criminal charges leveled against Gupta come on the heels of the criminal trial and conviction of Rajaratnam.

The criminal indictment alleged the insider trading scheme arose from various business relationships and a personal friendship between Gupta and Rajaratnam. It was alleged that in 2008, Gupta, Rajaratnam, “and others known and unknown, participated in a scheme to defraud by disclosing material, nonpublic information relating to Goldman Sachs and P&G…and/or executing securities transactions on the basis of the [i]nside [i]nformation.”

The first count was conspiracy to commit securities fraud. The indictment states that Gupta, Rajaratnam, and others “willfully and knowingly did combine, conspire, confederate and agree together and with each other to commit offenses against the United States…” The alleged conspiracy was carried out by Gupta disclosing Goldman Sachs and P&G inside information to Rajaratnam, “with the understanding that Rajaratnam would use the [i]nside [i]nformation to purchase and sell securities, and thereby receive illegal profits and/or illegally avoid losses.” Rajaratnam would then allegedly buy or sell securities based on the information or cause others to do so.

The indictment lists twenty-six overt acts to corroborate the conspiracy. These acts include the following:

  • Rajaratnam told a Galleon portfolio manager “he had learned from someone on the P&G Board that P&G was selling its Folgers business…”;
  • On June 10, 2008, Gupta and Rajaratnam traded telephone calls after Gupta spoke with a Goldman Sachs senior executive;
  • On June 11, 2008, Rajaratnam caused Galleon to purchase 5,500 Goldman Sachs shares;
  • On June 12, 2008, Rajaratnam caused Galleon to purchase an approximate total of 125,000 Goldman Sachs shares;
  • On September 23, 2008, Gupta telephoned Rajaratnam after meeting with Goldman Sachs’ Board regarding a Berkshire Hathaway investment;
  • After speaking with Gupta, Rajaratnam caused Galleon to purchase 217,2000 Goldman Sachs shares;
  • On October 23, 2008, after participating in a Goldman Sachs Board meeting, Gupta telephoned Rajaratnam;
  • On October 24, 2008, Rajaratnam caused Galleon to sell 150,000 Goldman Sachs shares;
  • On January 29, 2009, after a telephone call from Gupta, Rajaratnam told a Galleon portfolio manager “he had received certain information concerning P&G’s organic sales growth from a contact on the P&G Board”; and
  • On January 29, 2009, Galleon sold short 180,000 P&G shares.

A full list of the overt acts and the indictment can be found here.

The following five counts alleged securities fraud in violation of Rule 10b-5 by:

(a) employing devices, schemes, and artifices to defraud; (b) making untrue statements of material facts and omitting to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and (c) engaging in acts, practices, and courses of business which operated and would operate as a fraud and deceit upon any person, to wit, on the basis of [i]nside [i]nformation that [Gupta] disclosed... 

Counts 2 through 6 concern the following trades, respectively:  September 23, 2008 at 3:58 p.m., purchase of approximately 150,000 Goldman Sachs shares; September 23, 2008 at 3:58 p.m., purchase of 67,200 Goldman Sachs shares; October 24, 2008 at 9:31 a.m., sale of 50,000 Goldman Sachs shares; October 24, 2008 at 10:09 a.m., sale of 50,000 Goldman Sachs shares; and October 24, 2008 at 10:37 a.m., sale of 50,000 Goldman Sachs shares.

The United States seeks forfeiture of all money, or property acquired with money, that is traceable to the profits made from the alleged insider trading.

The primary materials for this case may be found on the DU Corporate Governance website.

Thursday
May172012

The SEC Fights Back

The SEC makes mistakes.  The Madoff fiasco is one of them; the lease on the building in DC that was never used is another.

But on the whole, the SEC is a highly professional, hard working place that has been a unfairly and relentless attacked for any number of things.  And, in the aftermath of Madoff, the Agency has often simply accepted its role as a pin cushion.

So it is nice to see the Commission becoming a bit more assertive and fight back against these sort of challenges.  The appeal of Judge Rakoff's decision to reject the Citigroup settlement, and more broadly reject the use of the neither "admit nor deny" approach was a case in point.  It is risky appealing bad rulings by the district court.  Bad district court cases can become bad appellate court cases.  But this time, the SEC decided that it could not let the matter rest.  Even judges need to know that the SEC will fight back.

With that in mind, we note a small but important series of examples of the growing verve at the SEC.  Top officials have been responding to editorials and stories that contained criticism of the Commission.  An editorial on DealBook, Taking On the Little Guy, but Missing the Bigger Ones, criticized the SEC's enforcement record.  The editorial conceded that the SEC had done "a much better job of investigating financial crisis wrongdoing than the Justice Department. And it’s true.  But it’s like being proud that you’re the 'Dumb' of 'Dumb and Dumber.'”  Robert Khuzami, the Director of the Division of Enforcement, wrote a letter taking on the editorial and noting that the "assertion that the S.E.C. somehow 'missed the big guys' misses the mark."

Then there was the response by George Canellos, then the head of the NY regional office, now the deputy director of the Division of Enforcement, to the claim that the SEC exposed a whistleblower.  For a short time there was a raft of articles accusing the SEC of mishandling the situation.  After the Canellos letter was published, the issue quickly died down. 

These are small steps but they are necessary and overdue.    

Wednesday
May162012

Glass Steagall, The Capital Markets and the Volker Rule

Glass Steagall was adopted during the Great Depression.  The effect of the legislation was to keep commercial banking (deposits and loans) separate from investment banking (underwriting and M&A activity).  One consequence was that commercial banks were mostly kept out of the equity markets, reducing the amount of risk they could undertake.  This was not to say that commercial banking was risk free.  There were plenty of examples of banks failing because they found themselves over committed to a particular market segment, say energy, and collapsed with the market.

But Glass Steagall had another affect. As set out in The "Great Fall": The Consequences of Repealing the Glass-Steagall Act, Glass Steagall allowed for the rise of a world class, powerful set of investment banks.  In effect, the law prevented commercial banks from absorbing and taking over the investment banking industry. 

The takeover was inevitable because over time commercial banks have inherent advantages, including access to low cost funds (deposits) and access to the Federal Reserve window.  Moreover, as the article pointed out, just before Glass Steagall was adopted, the commercial banks were in the process of taking over the industry.  Indeed, Glass Steagall required some banks to separate their commercial and investment banking parts (JP Morgan & Morgan Stanley as one example). 

The consequence of separating the two areas meant that investment banks focused not on lending relationships but on relationships that centered around the capital markets.  They had an incentive to understand the capital markets and they had an incentive to encourage companies to rely on the capital markets.  In short, they were a class of intermediaries that promoted active capital markets.

With the end of Glass Steagall, commercial banks have, for the most part, taken over the investment banking business, just as they were seeking to do in the 1930s, before Congress acted.  Before the most recent financial crisis there were five world class investment banks:  Goldman, Morgan Stanley, Merrill, Bear Sterns, and Lehman.  Bear is part of JP Morgan; Merrill is part of BofA.  Lehman, of course, is gone.  Only Morgan Stanley and Goldman remain (afer both converted to commercial banks). 

Does it make a difference?  First, as one can see from the latest problems at JP Morgan, commercial banks engaging in market activities take on enormous risk.  But there is a deeper problem.  First, commercial banks can offer companies both lending and underwriting services.  In other words, they are not completely dedicated to the capital markets.  Second, at least historically, commercial banks, because of more extensive regulatory oversight, were more conservative.  They could be counted on not to push the capital markets envelope as hard as a traditional investment bank.  Both are bad for the capital markets.

The Dodd-Frank Act added the Volker Rule, a provision that prohibits banks from engaging in proprietary trading and from sponsoring a hedge fund.  This is not Glass Steagall.  Banks can still engage in market activities with their client's money.  Moreover, it does not guarantee a source of business for investment banks that do not want to engage in commercial banking activity.  Those subject to the Volker Rule can farm out their proprietary trading activity to another commercial bank. 

But this Blog will over time discuss the impact of the Volker Rule on the investment banking industry and the US capital markets.