On Monday, Judge Rakoff issued an order excluding expert testimony provided by BofA. This is no small matter. BofA has made widespread use of experts in the case. As the court described:
- For its part, the Bank, on December 10, served the reports of no fewer than six purported experts, namely, Irving S. Becker, who opined on the issue of executive compensation; Stephen B. Blum, who opined on accounting issues; Prof. Joseph A. Grundfest of Stanford Law School, who opined on the issue of materiality; Prof. William W. Holder of the University of Southern California Business School, who opined on accounting issues; Prof. R. Glenn Hubbard of Columbia Business School, who opined on the issue of materiality; and Morton A. Pierce, Esq., who opined on disclosure practices.
So what happened?
It seems that the Bank, as part of its defense, has alleged that "shareholders already knew, as a result of widespread media reports, that Merrill was expected to pay billions of dollars in year-end bonuses." In other words, knowledge of the impending payment of the bonuses was part of the "total mix" of available information.
There are, however, two problems with the argument.
First, while the concept of total mix is imbedded into all of the antifraud provisions, its significance varies depending upon the particular provision at issue. Thus, total mix in the context of Rule 10b-5 means any information known to the market. But the SEC did not bring an 10b-5 case against BofA. The Amended Complaint prudently limits the claims to Section 14(a) (specifically, Rules 14a-3 and 14a-9). In this context, "total mix" means not the total mix of available information to the market place, but the total mix of information available to shareholders.
In general (as one need only look to TSC Industries, 426 U.S. 438 (1976) for support), this means the total mix of information actually distributed to or received by shareholders. In other words, shareholders are not obligated to consider what the market knows before voting. Instead, they need only consult the proxy materials (including the annual report in most cases) that was provided by the company. Thus, while some shareholders likely knew about the bonuses from the media reports, others did not because it was not mentioned in the proxy materials.
Judge Rakoff did not exactly exclude the information on this basis. But he did rely on representations in the proxy statement where BofA informed shareholders that "You should rely only on the information contained or incorporated by reference into this document." In fact, even without the statement the total mix analysis would have compelled the same result.
In any event, BofA's attempt to argue otherwise caused the Judge to suggest hypocrisy.
- In effect the Bank is arguing that, even tough it expressly warned its shareholders to disregard the media, it can now defend itself by asserting that a reasonable shareholder would have disregarded these warnings and, by consulting the media, perceived the Bank's alleged lies were immaterial. Even a zealous advocate might perceive that such an argument hints at hypocrisy.
Second, the SEC again, in an artful piece of strategy, didn't exactly allege that the misstatement was the failure to disclose the bonuses. Instead, BofA violated Rule 14a-9 by failing to disclose that it had already approved the bonues. As the complaint notes: "The omission of Bank of America's agreement authorizing Merrill to pay discretionary year-end bonuses made the statements to the contrary in the joint proxy statement and its several subsequent amendments materially false and misleading."
As a result, predictions by the media that bonuses would be paid were irrelevant to whether BofA misstated the already approved nature of the payments. As Judge Rakoff noted:
- The fact that the media were predicting, as the Bank claims, that Merrill would in fact pay bonuses is entirely irrelevant to any aspect of this issue, for the alleged falsehood consisted of representing as a contingency what was in fact an agreement already reached, and it does not appear that virtually any of the media reports disclosed that agreement.
This can only be seen as a blow for the defense proposed by BofA. Nonetheless, it is largely black letter law (except for the reference to "hypocrisy") and a correct statement of the securities laws. The SEC gets credit on this one for good lawyering, starting with a carefully drafted complaint.
For the opinion and other primary material, check out the DU Corporate Governance web site.
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Wednesday, January 06, 2010Delaware's Top Five Worst Shareholder Decisions for 2009 (Conclusion) (UNPUBLISHED)
J. Robert Brown 
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The system of corporate governance in the United States has many positive aspects. The degree of disclosure in this country likely exceeds all others. But there is one place where the development of the law has bordered on the irrational. In a country of 300 million people, the substance of most aspects of corporate governance are determined by the State of Delaware, a tiny place geographically (save Rhode Island, it is the smallest state in the country) and demographically (the 45th smallest state based upon the 2000 census).
It is also a state with a financial incentive to skew the law in a manner that maximizes revenue. Foreign corporations allow Delaware to avoid charging a sales tax. As we quoted in an earlier post:
- The revenue that the legal industry generates for the State of Delaware is also of vital importance to the First State and its residents as well. Over $709 million or 21.6 percent of all of the state's general fund revenue in fiscal year 2007 came from the corporate franchise tax and related fees. Corporations generated another $15 million in special fund revenue and about $10 million for local governments.
This represents only a portion of the economic benefits gained by the state. Yet this is the state that determines the standards for board behavior in the largest companies in the country (and the world).
The results are predictable. Incorporation in Delaware usually means reincorporation. Reincorporation is ordinarily done through a merger. Under the laws of all 50 states, a merger can only be initiated by the board of directors. States that want to attract corporations (and their tax dollars) must appeal to management. Delaware does that with a law that is extraordinarily pro-management in its orientation.
This can be seen from the cases decided in 2009. The cases selected as the worst have a decidedly pro-management flavor. They reaffirmed the ostrich approach, permitting management to remain unaware of critical matters within the corporation, including those that affect the voting rights of shareholdes or the solvency of the company. They continued to deny shareholders the right to information on matters of clear importance to owners. Finally, they continued to diminish the role of the duty of loyalty, despite clear circumstances suggesting a conflict of interest.
The cases explain why the process of creeping preemption of corporate governance continues. Bills in the House and the Senate would once again preempt Delaware law in connection with compensation committees, compensation consultants, and, if the Senate Bill gets adopted, with respect to the test for excessive compensation. A review of the worst five decisions for 2009 illustrates why this is occurring.
Executive Compensation, Sandy Weill, and Subservient Boards (UNPUBLISHED)
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Citigroup has always been an interesting story. In Opening Japan's Financial Markets, a book I published back in 1994, I wrote a chapter on Citigroup's (ne Citibank) unique efforts to crack the otherwise very closed world of Japanese banking. It has a rich history and while there have been many mistakes, it has also had a history of innovation.
Citigroup has fallen on hard times. Over the weekend, The New York Times published a story about Sandy Weill, the architect of Citigroup. The story has a number of themes, including Weill's "responsibility" for current crisis at the Bank (“'One of the major mistakes that I made was my recommending Chuck Prince,' he says of his handpicked successor, who ran the company from 2003 to 2007."), and his irrelevancy to any solution (when approaching the Citigroup board in 2007 to become involved, "No one responded to his offers.").
We don't have an opinion on Weill's leadership although he did grow Citibank into the world's largest financial institution. Likewise, whatever his mistakes, the article points out that he has taken a considerable portion of his wealth and donated it to assorted charitable causes, not something that everyone with a comparable net worth can say.
Mostly, though, we found insightful some of Weill's approach to compensation. The piece noted that, after retiring, Weill was "horrified" at having been "cast as a greedy, out-of-touch Wall Streeter taking advantage of taxpayers" The basis?
- One news item, in particular, was crushing: Last winter, The New York Post ran a picture of Mr. Weill on its front page with the headline, “Pigs Fly: Citi Jets Ex-C.E.O. to Cabo.” He had taken the corporate plane to vacation in Mexico, weeks after Citi had accepted a $45 billion taxpayer bailout. The flight provoked a public outcry and media frenzy.
Weill responded honorably by issuing a press release and promising "to never again use the Citi jet." He likewise terminated his consulting contract in which he got the "jet, as well as office space, cars and security."
But the fact that he had the benefits at all was the more interesting note and reminiscent of a time when imperial CEOs could receive from subservient boards compensation packages that continued the corporate largess even into retirement and even though the retiring CEOs had the net worth and income to pay any such expenses directly.
It was the era of Jack Welch at GE, who received post-retirement benefits that included, among other things, court side tickets and unlimited use of the corporate jet. Both Welch and Weiss became rich heading their respective companies. Yet despite the wealth, they accepted post-retirement packages that provided them with services and assets that their great wealth could easily afford. Somehow using corporate assets provided greater satisfaction than using their own.
With public attention, both CEOs ultimately decided to give back or reduce significantly these post-retirement benefits. But for every CEO that acted this way, there were no doubt plenty of others that merrily continued to use the corporate jet and take advantage of other similar benefits. In other words, morality and principled behavior is not an adequate check on this type of largess. It instead takes an active, strong board of directors. Unfortunately this was not typically the case then and is not typically the case today.
The types of benefits given to Weiss-Welch are probably not as common today. More rigorous disclosure requirements have made it harder to keep these types of post-retirement packages out of the public eye. Yet the problem of subservient boards that pay excessive compensation remains unchanged. It remains the great unfixed problem of the current financial crisis and, from all indications, will remain unfixed once the crisis ends.
Delaware's Top Five Worst Shareholder Decisions for 2009 (#1): The Delaware Courts and the Utter Lack of Diversity (UNPUBLISHED)
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There is a problem of diversity in the board room. There are few women CEOs. Only slightly more than 10% of the directors are women or people of color. This compares with countries like Norway that have legislatively commanded companies to increase gender representation on their boards to at least 40% (a change that appears to be working).
The lack of diversity is harmful. It ensures that boards will be filled with persons coming from similar backgrounds with similar views. It deprives CEOs of a wider range of views that could improve the effectiveness of decisionmaking.
A similar lack of diversity exists within the Delaware courts. The judges on the Supreme Court and Chancery Court have almost identical backgrounds. There is only one woman. There are no people of color. Most come from defense oriented law firms. In other words, when they address corporate governance legal issues, there is little that would suggest a diversity of views or considerations.
Nor does there seem to be much impetus to change. This year a Chancery Court judge resigned. The pool of applicants seeking the position consisted mostly of lawyers with similar backgrounds. There were no people of color and only one woman. The prize, as it always does, went to a Caucasian male with a mostly defense oriented background.
Diversity on the court might well result in judges with a broader viewpoint. Like diversity in the boardroom, diversity on the court might improve the decision making process. This in turn would enhance the credibility of the court on matters of corporate governance and perhaps slow the rapid pace of federal preemption.
When asked about changes in the legal profession and the lawyers practicing before the Delaware courts, Chief Justice of the Delaware Supreme Court explained that: "The Bar is much more diverse than it was in 1970 or even in 1990 and it is becoming increasingly so, which is a positive factor." Perhaps that diverse bar will one day have a diverse court to consider its views.
Bank of America and a Lesson on the Total Mix (UNPUBLISHED)
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Bank of America and a Lesson on the Total Mix
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The saga of SEC's case against the Bank of America in connection with the failure to disclose the bonuses paid by Merrill Lynch just before the merger continues.
On Monday, Judge Rakoff issued an order excluding expert testimony provided by BofA. This is no small matter. BofA has made widespread use of experts in the case. As the court described:
- For its part, the Bank, on December 10, served the reports of no fewer than six purported experts, namely, Irving S. Becker, who opined on the issue of executive compensation; Stephen B. Blum, who opined on accounting issues; Prof. Joseph A. Grundfest of Stanford Law School, who opined on the issue of materiality; Prof. William W. Holder of the University of Southern California Business School, who opined on accounting issues; Prof. R. Glenn Hubbard of Columbia Business School, who opined on the issue of materiality; and Morton A. Pierce, Esq., who opined on disclosure practices.
So what happened?
It seems that the Bank, as part of its defense, has alleged that "shareholders already knew, as a result of widespread media reports, that Merrill was expected to pay billions of dollars in year-end bonuses." In other words, knowledge of the impending payment of the bonuses was part of the "total mix" of available information.
There are, however, two problems with the argument.
First, while the concept of total mix is imbedded into all of the antifraud provisions, its significance varies depending upon the particular provision at issue. Thus, total mix in the context of Rule 10b-5 means any information known to the market. But the SEC did not bring an 10b-5 case against BofA. The Amended Complaint prudently limits the claims to Section 14(a) (specifically, Rules 14a-3 and 14a-9). In this context, "total mix" means not the total mix of available information to the market place, but the total mix of information available to shareholders.
In general (as one need only look to TSC Industries, 426 U.S. 438 (1976) for support), this means the total mix of information actually distributed to or received by shareholders. In other words, shareholders are not obligated to consider what the market knows before voting. Instead, they need only consult the proxy materials (including the annual report in most cases) that was provided by the company. Thus, while some shareholders likely knew about the bonuses from the media reports, others did not because it was not mentioned in the proxy materials.
Judge Rakoff did not exactly exclude the information on this basis. But he did rely on representations in the proxy statement where BofA informed shareholders that "You should rely only on the information contained or incorporated by reference into this document." In fact, even without the statement the total mix analysis would have compelled the same result.
In any event, BofA's attempt to argue otherwise caused the Judge to suggest hypocrisy.
- In effect the Bank is arguing that, even tough it expressly warned its shareholders to disregard the media, it can now defend itself by asserting that a reasonable shareholder would have disregarded these warnings and, by consulting the media, perceived the Bank's alleged lies were immaterial. Even a zealous advocate might perceive that such an argument hints at hypocrisy.
Second, the SEC again, in an artful piece of strategy, didn't exactly allege that the misstatement was the failure to disclose the bonuses. Instead, BofA violated Rule 14a-9 by failing to disclose that it had already approved the bonues. As the complaint notes: "The omission of Bank of America's agreement authorizing Merrill to pay discretionary year-end bonuses made the statements to the contrary in the joint proxy statement and its several subsequent amendments materially false and misleading."
As a result, predictions by the media that bonuses would be paid were irrelevant to whether BofA misstated the already approved nature of the payments. As Judge Rakoff noted:
- The fact that the media were predicting, as the Bank claims, that Merrill would in fact pay bonuses is entirely irrelevant to any aspect of this issue, for the alleged falsehood consisted of representing as a contingency what was in fact an agreement already reached, and it does not appear that virtually any of the media reports disclosed that agreement.
This can only be seen as a blow for the defense proposed by BofA. Nonetheless, it is largely black letter law (except for the reference to "hypocrisy") and a correct statement of the securities laws. The SEC gets credit on this one for good lawyering, starting with a carefully drafted complaint.
For the opinion and other primary material, check out the DU Corporate Governance web site.