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[No. 121] Heads-Up on Dutch Code for Sound Banking Practices

In post No. 60 I wrote about the recommendations drafted by the Committee Maas, aimed at drawing lessons from the credit crunch. Last week, the Dutch National Bank and the Dutch Authority Financial Markets - finally? - responded to the draft recommendations. It's interesting reading.They're available here, together with some accompanying notes from the Dutch minister of finance.

[No. 120] The Business Judgment Rule: Standard of Director Conduct, or Judicial Review? [Updated]

I just came across the following video, that discusses the business judgment rule in the non-profit audit committee setting. Go to 1:20 for the details.

Remarkably, the commentator (the dog if you will), qualifies the business judgment rule as a standard of conduct for directors to follow, apparently referring to California corporate law.

That doesn't seem to be in line with the general approach that the business judgment rule is primarily a standard of review by the court, a tool of judicial review, not to be conflated with the fiduciary duties of care and loyalty resting on directors. See, e.g., Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2002) and Moran v. Household International, Inc., 490 A.2d 1059 (Del. Ch. 1985). Although there is a connection between these duties and the rule, they're not the same and should not be treated as such. For the gist of the rule, properly understood a policy of judicial non-review, see here.

Maybe this is just a "Californian" thing; see for example Briano v. Rubio, 54 Cal. Rptr. 2d 408, 415 (1996), Barnes v. State Farm Mutual Auto. Ins. Co., 16 Cal. App. 4th 365, 378 (1993) and Gaillard v. Natomas Co., 208 Cal. App. 3d 1250, 1264 (1989), oddly suggesting that California's statement of the duty of care in Section 309(a) of the Corporations Code codifies the business judgment rule. I guess codifying legal concepts doesn't always clarify things.

Updated

Steve Bainbridge weighs in on the discussion.

[No. 119] Two Interesting Links

1. Under Dutch corporate law, the doctrine of piercing the corporate veil does not lead an obscure existence; related case law is pretty abundant, although it's typically an application of the broader concept of tort. For a nice outline of the doctrine and case law see here. Recently, the Delaware Chancery Court had an opportunity to revisit this subject under Delaware law in Case Financial, Inc. v. Alden, C.A. No. 1184-VCP (Del. Ch. 2009). As usual, Francis Pileggi has the details.
2. Under Dutch corporate law, which applies the 'stakeholder' approach  and not some form of shareholder wealth maximization norm (US) or enlightened shareholder value model (UK), managing and supervisory directors are supposed to act in the best interests of the corporation and in doing so, pay appropriate attention to the interests of all the stakeholders involved - including shareholders, employees and creditors - in the decisionmaking process. Under Delaware, things are a bit different (as the focus is generally more on shareholders' interests), but that doesn't mean directors of Delaware corporations are never confronted with issues of competing interests, as shown by the recent case of In re Trados Incorporated Shareholder Litigation, C.A. No. 1512-CC (Del. Ch. 2009). Steve Bainbridge disagrees with the analysis applied by Chancellor Chandler, arguing directors should not owe fiduciary duties to preferred stockholders period.

[No. 118] New Bonus Regime in French Banking Sector

Pressed by the French president Nicolas Sarkozy, the French banking sector - including BNP Paribas SA and Société Générale SA - has agreed to implement a new bonus system. The gist of the system is:

• that French bankers can still get a bonus if they perform well,
• but a large part will be lost if less profit is made then expected,
• while only 1/3 will be paid immediately with the rest to come over a 3 year period, provided there is no reason for the remainder to be put on hold.

Also a French pay czar was appointed; the 76 year old Michel Camdessus, who was involved in some of the IMF's biggest-ever country bailouts in the 1987-2000 era (including Indonesia, Russia and Argentina).

Maybe the biggest stick used by the French government is simply the president's threat that non-complying banks will not be in a position to conduct business with the state. As Sarkozy allegedly said: "I want non-complying banks to be punished." Loud and clear.

For developments in the Netherlands see here and here. For the UK see here and here.

[No. 117] Re iBasis, Inc. v. KPN Delaware Litigation (and some additional comments)

Recently the well-known Dutch telecom company KPN got involved in litigation in Delaware, involving issues like minority freeze-out, entire fairness review and poison-pill defences. The Deal Professor has the details of the dispute, go and read his sound analysis. See here for iBasis, Inc.'s complaint, see here for KPN's answer and counterclaim.

Interestingly, VC Leo Strine of the Delaware Chancery Court agreed during a hearing on August 14 to expedite the claims of all of the parties and agreed to hold a hearing on October 8 and 9. The transcript of that hearing contains the usual Strine nuggets, including some remarks about Delaware case law on pill-pulling and the way things work in the Netherlands.

You know what you get in the Netherlands from the government?  You get a check that comes to you that's for your vacation.  Just like, if your kid's in school, you know what you get in the beginning of the year?  You get a check, I think, that helps with school supplies.  But they're socialists.  They were.  It's a cool country.  I like it.

Leaving aside whether this is spot-on (well, the coolness part is anyway), it's always good to hear somebody with the stature of VS Strine say things like these. Especially as some other folks from the US have recently started to bash our lovely capital Amsterdam for no apparent reason and without any - read: 0 - solid ground.

For a strong rebuttal to this nonsense on stilts, please do check the below video.

Back to VC Strine. Maybe his bias towards the Dutch was influenced a little by my 6 month stay at the Delaware Chancery and Supreme Court last year. Or so I like to tell myself...

[No. 116] Full Body Armor

Professor Steve Bainbridge has a funny post, in which he questions whether law professors should dress for success (i.e., wear a suit or not) based on related publications here and here, and provides the following personal input.

As for me? My position is rather different than Capers, of course. For one thing, I've been in this gig over 20 years. My rep -- for better or worse -- precedes me. So I don't worry too much about first impressions. Having my name on the case book spine probably helps too. For another, I teach second and third years. They're much less easy to impress with fashion and other superficialities than are first years.

I ditched ties, suits, sports coats, and all that nonsense when I moved from Illinois to UCLA. After all, while I've never seen one of my colleagues teach in flip-flops, I have seen more than one teach in Teva sandals.

Last year, I had occasion to update my formal and semi-formal wardrobe. In order to get my money out of the new suits, I started wearing them again. But I quickly concluded that it's just not me. I'm a comfort guy. I was grunge before anybody had ever heard of Kurt Cobain. If I thought I could get away with it, I teach in sweatpants and a vintage Redskins jersey. Indeed, as I told Jonathan Adler the last time this issue came up, I only wear "ties East of the Mississippi, and even then under some amount of duress."

So I retired my new suits to the back of the closet to await a professional trip back east, a funeral, certain weddings, and the like. My golf shirts and khakis came back to the front of the closet. In sum, back to business casual.

The whole discussion - pros, cons - amazes me. Maybe this is a typical American phenomenon. I guess business casual isn't a no-no, at least not in most Dutch academic circles the last time I checked, but for me the whole discussion is a non-starter: suit and tie throughout the week, aside for those couple of weeks in mid-summer when its insanely hot and there are hardly any living creatures at the university anyway. There are more important things in life to ponder about. But then again, I may be a bit biased as I went from law school straight into practice and after seven years in the litigation trenches, I simply can't imagine going to the office - including university - in anything short of a suit and tie. Well, maybe on "casual" Friday, but that's a whole other discussion.

[No. 115] Determination of Fair Price in Mandatory Bid

As I've said before, the Enterprise Chamber of the Amsterdam Court of Appeal is the cental court in many proceedings that can be captured under the heading corporate litigation. Inquiry proceedings are the most important ones, but there are more. In this post I highlight one of them.

Pursuant to Dutch law, a shareholder in a listed company whose shareholding passes a certain threshold (in short: 30% of the voting rights in the general meeting) is obliged to make a public bid for the remaining shares, unless certain carve-outs apply.

In case of such a mandatory bid, the shareholder must offer a fair price (section 5:80a(1) Wft). A fair price is deemed to be the highest price that was paid in the year preceding the announcement of the mandatory bid by the bidder - or parties who act in concert with the bidder - for shares of the same category or class as covered by the mandatory bid (section 5:80a(2) Wft).

The law provides that, if an obligation to make a public bid exists and certain requirements are met, the Enterprise Chamber can be asked by either the bidder, the target company, another shareholder or a holder of a depository receipte issued in cooperation with the company to determine the fair price to be paid.

Today the Enterprise Chamber issued its first final judgment in such a proceeding. It ruled that the price paid under the bid was not a fair one and should be corrected upwarts for US$ 105 million, or € 4,10 per share (from € 20,11 to € 24,21), because the actual money value of the payment to the 73.2% shareholder of the company for those shares - which bid triggered the mandatory bid for the remaing shares - wasn't € 514,7 million but € 619,7 million. There are some details, but the gist of the ruling follows from the following paragraphs.

De "hoogste" prijs
3.38 Uit hetgeen in 3.7 tot en met 3.37 hiervoor is overwogen en nu van andere mogelijk terzake aan te brengen correcties niet is gebleken volgt, dat de geldswaarde van de door Ahold werkelijk voor haar belang in Schuitema ontvangen tegenprestatie niet € 514,7 miljoen bedraagt maar € 105 miljoen méér, ofwel € 619,7 miljoen. Per verkocht aandeel Schuitema (het ging om in totaal 25,6 miljoen aandelen) betekent dit een verhoging van € 4,10, derhalve tot € 24,21. Aldus zal de Ondernemingskamer voor recht verklaren dat de "hoogste prijs" in de zin van artikel 5:80a lid 2 Wft € 24,21 bedraagt.

Waarde van de aandelen Schuitema na de CKK transactie
3.39 De hiervoor vastgestelde "hoogste prijs" - zijnde de hoogste prijs die tijdens het jaar voorafgaande aan de aankondiging van het (verplichte) openbare bod door Skipper is betaald voor een aandeel Schuitema - wordt, gelijk de Ondernemingskamer heeft overwogen in haar beschikking van 23 oktober 2008, vermoed (ook) onder het bod een billijke prijs te zijn, doch dit vermoeden is op de voet van artikel 5:80b Wft voor weerlegging vatbaar. Zoals in de evengenoemde beschikking is overwogen, is het onderhavige verzoek van VEB c.s. op dit artikel gestoeld. Zij hebben daartoe gesteld dat ook de door Ahold ontvangen tegenprestatie niet billijk is in die zin dat daarin ten onrechte bepaalde waardevermeerderende omstandigheden en factoren (nog) niet tot uitdrukking zijn gekomen onderscheidenlijk zijn verdisconteerd en dat met die omstandigheden alsnog rekening moet worden gehouden bij de vaststelling van een billijke prijs voor het aandeel Schuitema.

3.40 In de meergenoemde beschikking heeft de Ondernemingskamer in dit verband overwogen dat in de door VEB c.s. aangevoerde argumenten geen (voldoende) concrete feiten en omstandigheden waren te onderkennen waaruit zou kunnen volgen dat de "hoogste prijs" (die op dat moment in absolute zin nog niet bekend was) niet een billijke prijs zal zijn en dat bij die stand van zaken in het midden kon blijven of de veronderstelling dat (ook) het verzoek van VEB c.s. in de eigenlijke zin van artikel 5:80b lid 1 Wft, op de voet van artikel 5:80b lid 3 Wft, ontvankelijk moet worden geacht, juist was.

3.41 Gelijk in 3.3 hiervoor is overwogen, zijn in de verdere loop van deze procedure meer concrete omstandigheden gebleken die erop wijzen dat de "hoogste prijs" ten tijde van het uitbrengen van het bod op de aandelen Schuitema mogelijk niet (meer) als de in artikel 5:80a lid 2 Wft bedoelde juiste, billijke prijs kan worden beschouwd, zoals VEB c.s. hebben gesteld. Die omstandigheden bestaan hierin dat de deskundigen, die het mede tot hun taak mochten rekenen zich over de ondernemingswaarde van Schuitema uit te laten, hebben geconcludeerd dat, samengevat, bij de waardebepaling van de onderneming van Schuitema - en, derhalve, van het aandeel Schuitema - na effectuering van de CKK transactie de indirecte invloed van die transactie in redelijkheid niet buiten beschouwing mag worden gelaten. VEB c.s. hebben in verband met (de bepaling van) de billijke prijs van het aandeel Schuitema geen (andere) voldoende concrete omstandigheden naar voren gebracht en van dergelijke omstandigheden is de Ondernemingskamer ook niet anderszins gebleken.

3.42 Skipper c.s. hebben erop gewezen dat, wat daarvan voorts zij, de door de deskundigen bij de kwantificering van de effecten van de CKK transactie tot uitgangspunt genomen bedragen niet juist zijn en voorts onder meer gesteld dat, indien toetsing van de billijkheid van de "hoogste prijs" aan de orde is, ook (andere) (markt)ontwikkelingen die zich na 22 april 2008 hebben voorgedaan, zoals het algemeen verslechterde beursklimaat en het gedaalde consumentenvertrouwen, moeten worden meegewogen en dat alsdan veeleer een neerwaartse bijstelling van de prijs zal resulteren.

3.43 Nu op grond van het voorgaande is gebleken dat in beginsel - alsnog - moet worden getoetst of de "hoogste prijs" (nog steeds) de juiste, billijke prijs is, stelt de Ondernemingskamer vast dat aldus - onder meer doch in de eerste plaats - de vraag naar de (in de beschikking van 23 oktober 2008 vooralsnog veronderstellenderwijs aangenomen) ontvankelijkheid van dit onderdeel van het verzoek van VEB c.s. - weer - actueel is. Zij overweegt dienaangaande als volgt.

3.44 In artikel 5:80b lid 3 Wft is bepaald dat een verzoek als bedoeld in het eerste lid van dat artikel niet ontvankelijk is indien de "hoogste prijs" niet ten minste 10% afwijkt van de gemiddelde beurskoers tijdens de periode van drie maanden voorafgaand aan de indiening van het verzoek. VEB c.s. hebben in dit verband gesteld, hetgeen Skipper c.s. niet hebben bestreden, dat de gemiddelde beurskoers van het aandeel Schuitema tijdens de evenbedoelde periode van drie maanden € 23,03 bedroeg. Nu een afwijking van ten minste 10% alsdan inhoudt dat de "hoogste prijs" ten minste € 2,30 meer (of minder) dan € 23,03 dient te bedragen en de Ondernemingskamer in rechtsoverweging 3.38 hiervóór heeft overwogen dat de "hoogste prijs" op € 24,21 dient te worden gesteld, moet worden geconcludeerd dat VEB c.s. niet in dit onderdeel van hun verzoek kunnen worden ontvangen.

Slotsom
3.45 De slotsom is dat de Ondernemingskamer - uitsluitend - voor recht zal verklaren dat de billijke prijs in de zin van artikel 5:80a lid 2 Wft per gewoon aandeel Schuitema € 24,21 bedraagt en dat VEB c.s. niet ontvankelijk zullen worden verklaard in hun verzoek tot het vaststellen van een billijke prijs op de voet van artikel 5:80b lid 1 Wft.

For some background of the dispute see here and here.

[No. 114] Down to 3 [Updated]

The three final competitors for the open Vice-Chancellor slot on the Delaware Chancery Court are in.

UPDATED

And we're down to one: Travis Laster.

[No. 113] Options Backdating - Back on the Radar Screen

Early 2008 (Ondernemingsrecht 2008-1, nr. 16) I wrote about options backdating and related developments in the US. This concerns, in the words of Chancellor Chandler from the Delaware Chancery Court in Ryan v. Gifford,

an arguably questionable compensation practice. Commonly known as backdating, this practice involves a company issuing stock options to an executive on one date while providing fraudulent documentation asserting that the options were actually issued earlier. These options may provide a windfall for executives because the falsely dated stock option grants often coincide with market lows. Such timing reduces the strike prices and inflates the value of stock options, thereby increasing management compensation. This practice allegedly violates any stock option plan that requires strike prices to be no less than the fair market value on the date on which the option is granted by the board. Further, this practice runs afoul of many state and federal common and statutoy laws that prohibit dissemination of false and misleading information.

Back then these option schemes were not just frequently discussed in the corporate law arena (see in Delaware, e.g., Desimone v. Barrows and In re Tyson Food, Inc. Cons. Shareholder Lit.), but also in the criminal law arena. Quite some managers of large American corporations became subject of discussion, including Apple's Steve Jobs, while former Brocade CEO Greg Reyes was actually convicted in 2007 for stock-options backdating: a whopping 21 months of prison time and US$ 15 million fine. Although this 'criminalization' of issues related to options backdating was criticized heavily by some, public attention for this subject faded away the last year or so.

Until now. First, a new study was published,indicating that stockoptions backdating may have been a bigger problem than originally understood. This story was brought by the WSJ, that has had a focus on this subject from the beginning, Second, Reyes' conviction was reversed by the appellate court because of prosecutorial misconduct. So now the public prosecutor has to decide whether to drop the case or go into round 2, which will be a costly affair. So options backdating is back on the radar screen. No doubt Larry Ribstein will be grinding his axe again. Go and read his initial sceptical take on things here and here.

[No. 112] The SCOTUS and Jones v. Harris [Updated]

In post No. 19 I noticed an interesting discussion was going on between two of the most prominent circuit court judges and 'Law & Econonics' heavy-weights - Judges Frank Easterbrook and Richard Posner - in a corporate law controversy relating to the case Jones v. Harris, 537 F.3d 728 (7th Cir. 2008) (with the opinion from Eastebrook and a dissenting opinion from Posner).

The Supreme Court of the US granted certiorari and scheduled the oral argument for November 2, 2009. For some further background on the case see here.

The case caught new attention in the last days, apparently sparked by this insightful article in the WSJ. I especially recommend the additional analyses by Birdthistle, Oesterle and Bainbridge (in response to Oesterle).

UPDATED

The fun continues. Ribstein weighs in on the discussion. Birdthistle responds to Bainbridge and to Ribstein.

[No. 111] The Evolution of Ownership Disclosure Rules Across Countries

I've recently posted a new paper on SSRN, a joint project with Mathias Siems of the University of East Anglia and Cambridge University. It's a preliminary draft, and we're eager to receive comments and suggestions. Here's the abstract:

This paper examines the evolution of the duty to disclose major share ownership across countries. It is based on a variable on ownership disclosure of a shareholder protection index constructed at the Centre for Business Research of the University of Cambridge. This index comprises of data from 25 countries over 11 years (1995-2005). In the present paper we use descriptive statistics, tests of differences between means, and correlations between ownership disclosure and other variables in order to deepen our understanding of variations in the law on ownership disclosure over time and between countries.

Our main finding is that ownership disclosure rules have become more stringent over time. A break down of the results suggests that not legal origin, but the degree of countries’ economic development is a relevant factor in explaining the differences between countries. The differences have become smaller over time, though, as most countries had settled for a 5% threshold for ownership disclosure by the end of the sample period. Furthermore, we observe a large positive correlation between the variable for ownership disclosure and other variables that protect minority shareholders against controlling shareholders. The data also indicates that the stringency of countries’ ownership disclosure rules is positively correlated with the degree of dispersed ownership. In the paper, we offer various possible explanations for these results. We also use the results to obtain insight into how ownership disclosure rules are likely to evolve in the future.

The full paper can be found here.

[No. 110] The Business Judgment Rule and Corporate Risk-Taking

In my doctoral thesis, I argued for the introduction in Dutch corporate law of a Dutch business judgment rule, one that doesn't fully exclude the possibility to review corporate risk-taking (see, e.g., here, here and here). In my approach, assuming the director making the business judgment had no conflict of interests, the court can only review the preparation and substance of the business judgment for clear irrationality (not: objective unreasonableness, let alone unfairness). Irrationality - basically : inexplicable, absurd behavior - often justifies an additional finding of subjective bad faith (i.e., disloyal behavior), but I believe that in reality the two do not necessarily go hand in hand (in Delaware, a finding of irrationality/lack of any rational business purpose typically justifies a finding of bad faith; see here). This scope for substantive review - in fact judges really do review the substance, be it only marginally - leaves open the possibility, a remote one, that the director engaged in irresponsible risk-taking (from an ex ante perspective).

In Delaware, this has always been a difficult issue (see, e.g., Gagliardi v. Trifood International, 683 A.2d 1049 (Del. Ch. 1996)) that also came up in recent cases like AIG (discussed here and here) and Citigroup (discussed here). Interestingly, Professor David Rosenberg recently published an article touching on this very subject, entitled Supplying the Adverb: The Future of Corporate Risk-Taking and the Business Judgment Rule. The title, of course, subtly refers to the Gagliardi decision in which Chancellor Allen used the famous line "foolishly risky! stupidly risky! egregiously risky! - you supply the adverb." Here is the abstract.

The business judgment rule precludes judicial review of most decisions by corporate directors. The rule is necessary to protect directors from potential liability for 'good faith' decisions that ultimately end in failure. Courts and legal commentators have long emphasized the importance that the rule has in promoting the kind of risk-taking by corporations that has resulted in new ideas, new technologies and new markets. In recent years, Delaware courts have shown so much deference to risk-taking that they have misapplied the still-evolving doctrine of good faith. Professor Rosenberg argues that courts should use the same standards of good faith to evalute accusations of excessive risk-taking that they use to evaluate other kinds of director misconduct such as disloyalty and a failure to be adequately informed. This would go a long way to making Delaware fiduciary law more consistent as it is applied to a variety of alleged director misconduct, but would do little to damage the ability of directors to take the kind of beneficial risks that have been so central to the historical success of the American corporation.

Read the whole article here. It's a nice, fresh approach to a familiar subject.

[No. 109] CEO Mishaps

Something interesting is happening, corporate governance wise, at Dutch listed company Royal Wessanen.

On February 24, 2009, then CEO Ad Veenhof stepped down in that capacity. The reason was not disclosed. There were speculations that Veenhof got into a quarrel with the chairman of the supervisory board, both dominant characters.

Now we know. The comment to agenda item 2 for the general meeting of September 8, 2009, titled "Proposal to dissolve the labour contract with" Veenhof "by court decision" (the main item of the agenda), discloses the following.

ITEM 2
Proposal to dissolve the labour contract with Mr. A.H.A. Veenhof by court decision.

1. The dominant way of operating of Mr. Veenhof did neither permit a culture in which decisions were the result of deliberation nor allowed managers their own room to manoeuvre. The resulting position of dependency of management raised concern in the view of the Supervisory Board in the sense of sufficiently transparent lines of communication within Wessanen. The Executive Board functioned insufficiently as a team which was exemplified by such a large interference by Mr. Veenhof with financial matters that doubt was raised about the independency in the composition of reporting and results. A dominant style of leadership makes a company extra vulnerable in the sense of risk management, particularly in more difficult market circumstances. The recent developments at US subsidiary ABC represent a regrettable example of this empirical fact.
2. In the period following his reappointment in April of 2007, Mr. Veenhof failed to execute a vigorous implementation of the strategic view on the future of the company. Expectations have not been fulfilled. This was no longer acceptable given the disappointing results over a longer period of time.
3. In the second half of 2008 and in early 2009 the Supervisory Board became increasingly dissatisfied with the fact that the quality of the reported results decreased due to one-offs and cutting advertising and promotion expense. The latter erodes the company in the long term in favour of the result in the short term.
4. For a considerable time already the Supervisory Board has differed in opinion with Mr. Veenhof about the dividend policy. The Supervisory Board was in favour of a much more prudent approach, also in view of the absence of well defined plans for the future, the present market circumstances and the fact that the financing of the company is much more benefitted by strengthening of the balance sheet. The Supervisory Board has concluded that Mr. Veenhof showed too late too little willingness to adjust the dividend policy to the level that fits in with the current position of the company.
5. During the period following the press release on February 24, 2009, regarding the resignation at that day of Mr. Veenhof as CEO of the company, parties have tried in vain to reach agreement in confidential discussions regarding the departure of Mr. Veenhof from Wessanen.
6. Next to a contractual notice period of 12 months for the company the current labour agreement with Mr. Veenhof includes a contractual severance clause which is described below. The Supervisory Board will further discuss these matters during the shareholders meeting on September 8, 2009.

The contractual severance clause reads as follows:
In case the labour agreement ends by notice of the company or by dissolution at the request of the company, and, furthermore, if the prime or the sole reason for the company to do so is not based upon acts or omissions on the side of Mr. Veenhof, Mr. Veenhof will be entitled to:
1. a gross termination compensation equal to one time the gross fixed salary at the time the agreement is ended, added by the applicable pension contribution by the employer, and added by a bonus equal to the maximum incentive of 100% of base salary,
2. the unconditional delivery of all conditional and unconditional restricted shares that have been granted prior to the termination of this agreement.

Or at least, Wessanen's side of the story. Veenhof denies this reading of events. However this may be, this is not the sort of information that typically makes it into the general meeting's agenda.

Why is this an exception? Then we have to look at the core of the dispute. Anybody? Money. Parties were unable to reach an agreement. According to the labour contract, Wessanen owes Veenhof quite some Euro's, running into the millions (and not fully in line the with Dutch corporate governance code); unless the reason for the termination is based on misconduct by Veenhof. And the company is trying to argue just that, to get around the golden handshake.

I have a feeling this is not the last episode of this story.

[No. 108] Penalty for providing incorrect information

In post no. 59 I wrote about the fines the European Commission imposed on electricity producer Electrabel for gun jumping – i.e. acquiring control by a company over another company without prior approval of the competent competition authority under the applicable Merger control regulation. This month the Dutch Competition Authority (NMa) imposed fines of € 468.000 on Refresco – a manufacturer of soft drinks and juices – for another kind of infringement of the Merger control rules. The NMa found that Refresco provided the NMa with inaccurate and incomplete information in relation to a merger notification with respect to the acquisition of Schiffers Food B.V. – another manufacturer of soft drinks. According to the NMa this behaviour seriously undermines the effectiveness of merger control. It was only in third instance that Refresco provided the NMa with the correct information. From this information it followed that the production capacity was substantially higher compared to the information Refresco initially provided. Since the NMa only has only a short period of time to decide on basis of a notification whether or not a permit is necessary for the concentration, it is of great importance that the notification is supported with all the information that enables the NMa to make an assessment in an adequate and rightful way. This is all the more the case with data relating to information about the markets which are involved in the concentration, which information is essential for an assessment of the concentration.

[No. 107] New Heads Up on Review of Corporate Governance in UK Banks

In post No. 87 I wrote about an independent review of corporate governance in the United Kingdom led by Sir David Walker. The review is aimed at examining corporate governance in the UK banking industry and making recommendations to improve the system in view of the financial crisis, including in the following five areas:

1. the effectiveness of risk management at board level, including the incentives in remuneration policy to manage risk effectively;
2. the balance of skills, experience and independence required on the boards of UK banking institutions;
3. the effectiveness of board practices and the performance of audit, risk, remuneration and nomination committees;
4. the role of institutional shareholders in engaging effectively with companies and monitoring of boards; and
5. whether the UK approach is consistent with international practice and how national and international best practice can be promulgated.

His consultation document of mid June 2009 can be found here.

While we are waiting for the consultation period to expire in November 2009, the UK Financial Services Authority has today introduced a new code that will require large banks, building societies and broker dealers in the UK to establish, implement and maintain remuneration policies consistent with effective risk management. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000 (1.  maintaining market confidence, 2. promoting public understanding of the financial system, 3. securing the appropriate degree of protection for consumers and 4. fighting financial crime); it basically aims to promote efficient, orderly and fair markets, help retail consumers achieve a fair deal and improve its business capability and effectiveness. The new code, that applies to some 26 institutions, came with the following side-info from the FSA:

The new code is designed to achieve two objectives: firstly, that boards focus more closely on ensuring that the total amount distributed by a firm is consistent with good risk management and sustainability; and secondly that individual compensation practices provide the right incentives. Eight principles have also been added to the FSA’s handbook to ensure firms understand how the FSA will assess compliance. The code makes clear that it is not expected that firms will enter into contracts with individuals which provide guaranteed bonuses for more than one year. It is also expected that for senior employees two-thirds of bonuses will be spread over three years. Firms are expected to provide the FSA with a remuneration policy statement by the end of October. This will have to be signed off by remuneration committees and will enable the FSA to check compliance with the code. Non-compliant firms could face enforcement action or ultimately, be forced to hold additional capital should they pursue risky processes.

The new code can be found here. For some first reactions in the UK go here.

[No. 106] Corporate Disaster Tourism [Updated]

In the last decade, we've seen our fair share of 'corporate scandals turned into bestselling books'. Think of the 2003 Ahold accounting affair (nicely documented here), the 2007 ABN Amro Bank takeover battle (nicely documented here) and the 2008 downfall of Fortis Bank (nicely documented here). This, of course, is not a typical Dutch feature; we all like a bit of voyeurism once in a while. Just look at the the many, many, many books that are published in the US about the start of the credit crunch and the way the US goverment tried to deal with the mess. The latest addition to the collection is David Wessel's In Fed We Trust: Ben Bernanke's War on the Great Panic. For a lousy $ 16.19, we can read about the bold adventures of Messrs. Bernanke, Paulson and Geithner. Although I have seen some displeased comments on minor issues (David Zaring wonders whether it would kill reporters to work with themes; fair enough), the book has been received quite well (see for example here and here). As described by one commentator:

Understanding what happened has become vitally important not just for bankers and economists, but for everyone affected by the fallout, which means ... well, just about everyone. For all of us then, David Wessel’s new book “In Fed We Trust” is essential, lucid - and, it turns out, riveting - reading. In these pages Mr. Wessel, the economics editor of The Wall Street Journal, chronicles how the Fed chairman Ben S. Bernanke, with Henry M. Paulson Jr., then the Treasury secretary, and a small group of associates, frantically worked to shore up the United States economy, capturing how this handful of people - “overwhelmed, exhausted, beseeched, besieged, constantly second-guessed” - tried to catch and stabilize one toppling fiscal domino after the next. In this volume Mr. Wessel uses his narrative gifts and a plethora of sources to give readers a vivid, highly immediate sense of what transpired in last-minute, high-pressure, seat-of-their-pants meetings in Washington and New York while placing these events in a broader historical context. He examines the Fed’s increasingly important (and increasingly debated) role as an economic first responder, looks at how personality and personal philosophy can inform policy making and offers a concise explication of the causes of what he calls “The Great Panic.”

Who would have thought, a book about the FED becoming a page-turner. Anyway, must-read stuff, not just for the American public.

UPDATED

On a related note: today the Dutch newspapers (see, e.g., here and here) are headlining about a letter sent by the president of the Dutch National Bank to the Minister of Finance, in which the former makes clear he is not amused about the crticism by members of Dutch parliament directed to the Dutch National Bank and him personally, implying in part that the bank did not deal adequately with the Icesave insolvency. I guess a research book about this issue is inevitable. A title suggestion: In DNB We Trust?

[No. 105] Waste

In post No. 25, I said a few things about the connection between irrationality, bad faith and waste under Delaware corporate law.

My analysis seems to be in line with a thoughtful recent decision by the Delaware Chancery Court. See, e.g., page 21 of the original opinion, where:

• the court links recognition by the board of a certain reality ("It is difficult to imagine that the Landry's board would not have recognized this reality"), that in my view touches on the board's state of mind;
• to the question whether the decision constituted "a rational exercise of business judgment";
• explaining (in footnote 36) that "what the plaintiff has stated here is a claim for waste. See Harbor Fin. P'rs v. Huizenga, 751 A.2d 879, 893 (Del. Ch. 1999) (holding that the fundamental basis for a waste claim rests on the pleading of facts that show that the economics of the transaction were so flawed that no disinterested person of right mind and ordinary business judgment could think the transaction beneficial to the corporation.)."

A nice analysis of the decision, that also treats the reader on other core elements of Delaware corporate fiduciary duty law, can be found here (courtesy of Steve Davidoff).

[No. 104] Some Recent Enterprise Chamber Case Law

In post No. 103 I discussed the last ruling by the Enterprise Chamber in the ASM International litigation, dated August 5, 2009. This concerned an inquiry proceeding, but the court is active in other fields of law as well.

That same day the court als rendered an interesting judgment in a so-called annual account proceeding, concerning the correctness of the annual accounts of Aegon and two subsidiaries over 2007. This litigation is connected to a broader dispute, that basically concerns the leeway the board of a certain foundation has to use the proceeds of the sale of assets (a block of shares) to Aegon, also in view of the foundation's articles of association (and changes made thereto). This multi-million dispute with several battle grounds has generated quite some media attention (see, e.g., here and here) and even led to discussion in parliament. As summarized by the court:

2.23 Na de verkoop van Optas N.V. is een geschil ontstaan tussen (het bestuur van) Stichting Optas enerzijds en de sociale partners, de havenwerkgevers en havenwerknemers, verenigd in Stichting BPVH anderzijds, omtrent de besteding van de van Aegon ontvangen koopsom. Stichting BPVH stelt zich op het standpunt dat Stichting Optas de koopsom zou moeten aanwenden om de pensioenaanspraken van de havenwerknemers te optimaliseren. Het bestuur van Stichting Optas stelt zich op het standpunt dat Stichting Optas zelfstandig en naar eigen goeddunken over de koopsom mag beschikken. De stichtingen zijn tot op heden niet in staat gebleken tot een vergelijk te komen. In de pers is meermalen ruchtbaarheid aan dit conflict gegeven, hetgeen heeft geleid tot vragen van leden van (de vaste commissie van Sociale Zaken en Werkgelegenheid van) de Tweede Kamer der Staten-Generaal welke zijn beantwoord in brieven van de minister van Sociale Zaken en Werkgelegenheid van 10 december 2007 en 10 maart 2008.

2.24 In juni 2008 heeft de minister van Sociale Zaken en Werkgelegenheid in deze kwestie tussen Stichting Optas en Stichting BPVH doen bemiddelen en - met Aegon - getracht een oplossing tussen partijen te faciliteren. Het bij brief van 3 november 2008 door Stichting Optas gedane aanbod om, kort gezegd, € 350 miljoen bij te dragen aan het verhogen van de pensioenaanspraken van de vervoer- en havenwerkers in ruil voor finale kwijting, is door Stichting BPVH afgewezen. Bij de Rechtbank te Rotterdam is thans een reeks voorlopige getuigenverhoren gaande betreffende de door Stichting BPVH gewraakte statutenwijziging(en) van Stichting Optas in 2000 onderscheidenlijk 2003. Voorts heeft Stichting BPVH op 10 februari 2009 de Rechtbank te 's-Gravenhage verzocht het bestuur van Stichting Optas te ontslaan.

The Enterprise Chamber ruling is far too complex and detailed to adequately highlight in a blog post. It suffices to say here that, although some of the annual accounts were not flawless (according to the Enterprise Chamber), the request made to the court to order certain amendments of these annual accounts was denied, as (a) the shortcomings were so immaterial c.q. (b) the substantive legal elements applicable here are so complex and not (clearly) laid down in existing legislation, that it cannot be said that these annual accounts do not provide a fair account of the size and composition of the corporations' assets and result. The court also noticed that defendants acknowleded these shortcomings and promised to make the necessary changes in line with this judgment.

3.24 Ofschoon aldus, op grond van hetgeen hiervoor is overwogen, is gebleken dat de presentatie van het beklemde vermogen in de (enkelvoudige) jaarrekeningen 2007 van Optas Pensioenen en Aegon niet geheel juist is, acht de Ondernemingskamer die tekortkomingen in casu (in aanmerking nemend dat de wettelijke beklemming als zodanig wèl in de toelichting op de onderscheiden jaarrekeningen is vermeld) zodanig ondergeschikt, althans is naar het oordeel van de Ondernemingskamer sprake van een zodanig complexe en niet (duidelijk) in de bestaande wet- en regelgeving voorziene materie, dat niet kan worden gezegd dat die enkelvoudige jaarrekeningen niet een getrouw beeld geven van de grootte en de samenstelling van het vermogen en het resultaat van Optas Pensioenen en Aegon, althans dat die jaarrekeningen op het punt van het beklemde vermogen alsnog dienen te worden aangepast. Bij dit oordeel heeft de Ondernemingskamer mede in aanmerking genomen dat Aegon c.s. ter terechtzitting hebben doen verklaren dat haar jaarrekeningen op het onderhavige punt (deels) onjuist zijn en dat zij deze voor het vervolg zullen inrichten met inachtneming van deze beschikking. Met betrekking tot de jaarrekening van Optas Schade en de geconsolideerde jaarrekening van Aegon kan niet worden gezegd dat is gebleken van enige (enigszins materiële) onvolkomenheid. De verzoeken van Stichting BPVH zullen derhalve alle worden afgewezen.

This is recommended reading for those with in an interest in annual account proceedings and/or those who follow the abovementioned dispute. The full version of the judgment can be found here.

[No. 103] Re ASM International Inquiry Proceeding [Updated III]

So, the Enterprise Chamber granted the request for an inquiry by investment funds (and ASM International shareholders) Hermes and Fursa into the policy and affairs of ASM International last Wednesday, in what already seems like a classic Enterprise Chamber decision when it comes to shaping the contours and discussion of what contemporary principles of corporate governance require. Although the fact patterns differ, when scanning this ruling I was immediately reminded of cases like HBG (see, e.g., here and here) and Rodamco North America (see, e.g., here, here and here). By the way, the request for a preliminary injunction was denied in the ruling, that seemingly was one of the - if not the - last of Huub Willems as chairman of the Enterprise Chamber.

This case shows again that there continues to be a tension between the authority of the directors to conduct - and supervise - the corporation's business on the one hand, and their duty to respect the position of the general meeting/shareholders on the other; a tension that is not always easy to solve in practice, especially when it comes to enterprise issues. I have no doubt that the case will play a role in the ongoing debate about the position of 'activist' shareholders under the current Dutch corporate governance model, also in view of recent legislative initiatives. Anyway.

The background of the dispute is, in short, that:

• certain shareholders have been pressing for a change in strategy (splitting the back-end from the front-end activities in order to increase the value of the former and review the survival rate of the latter) and regime;
• the company disagreed;
• these shareholders put on the agenda of the May 2008 general meeting the proposal to replace the CEO and a large block of the supervisory board by persons supported by the shareholders; and
• the foundation, that is formally independent but related to the company (see here), prevented approval of these proposals by exercising its call-option (as granted by the corporation) and thereby obtaining a controlling vote prior to the general meeting; eventually, the general meeting did not vote on these issues.

The discussion between the parties continued - led by the foundation - but was also put on hold mid 2008 by a third party offer on the front-end activities, that eventually went nowhere. Questions by the shareholders about the negotiations were apparently never really answered by the corporation. The parties continued to talk and almost reached an agreement early 2009, but eventually failed due to a controversy as to the composition of the management board.

The judgment basically consists of two parts: the first focuses on the management board and the supervisory board, the second focuses on the foundation. I will highlight these parts here, with some extra's on the side.

Part I

The Enterprise Chamber is highly critical of the course of events. It concludes that the facts show a listed corporation, that keeps pushing ahead in time its strategic problems c.q. trying to solve them in an inner circle of directors (the CEO and the supervisory directors) and controlling shareholder, and in order to do so uses its outdated governance model to close the ranks and act defensively towards the other shareholders. This, according to the court, is highly undesirable in view of 'principles of corporate governance' as these are understood in this era. It also concludes that external shareholders have hardly any influence on the corporation's (strategic) policy and are unable to effectively hold its organs accountable. It also notes that the high thresholds for appointing and dismissing managing and supervisory directors, in combination with the presence of the controlling shareholder, the disproportional power of the CEO and the non-critical position taken by the (chairman of the) supervisory directors, made things worse. I'll quote one section (3.11).

3.11 De Ondernemingskamer overweegt dat uit de gang van zaken zoals in 3.5 tot en met 3.10 hiervóór is samengevat, niet anders kan worden geconcludeerd dan dat een beeld naar voren komt van een beursvennootschap die haar problemen op het (ondernemings)strategische vlak steeds naar voren heeft geschoven althans steeds heeft gepoogd binnen de besloten kring van de eigen functionarissen (en met name de CEO en de commissarissen) en grootaandeelhouder af te wikkelen en zich daartoe jegens haar (overige) aandeelhouders, met behulp van haar gedateerde governance, defensief en gesloten heeft opgesteld. De Ondernemingskamer acht een dergelijke opstelling met het oog op de beginselen van behoorlijk ondernemingsbestuur zoals die naar thans vigerende opvattingen moeten worden begrepen, bepaald onwenselijk. Zoals Hermes c.s. hebben gesteld, hebben de externe aandeelhouders nauwelijks invloed op het (strategische) beleid van (de onderneming van) ASMI kunnen uitoefenen en haar organen niet effectief ter verantwoording kunnen roepen. De hoge drempels voor de benoeming en het ontslag van bestuurders en commissarissen, in combinatie met het grote minderheidsbelang van Del Prado Sr., de onevenredige macht van de CEO in het bestuur en de weinig kritische houding van (de voorzitter van) de raad van commissarissen zijn daaraan naar het oordeel van de Ondernemingskamer met name debet. Meer in het bijzonder overweegt de Ondernemingskamer als volgt.

But there is more. The court also blames, e.g., the supervisory board:

• for not taking its responsibility as to creating transparency towards the shareholders;
• for not seeing to it that no expectations were raised with the shareholders, as to changes in the appointment and dismissal procedure, that the corporation could not or was not willing to live up to; and
• for not really trying to mediate in the conflict between the management board and the external shareholders.

In view of all this (I even excluded some criticism), the court finds there are well founded reasons to doubt the correctness of ASM International's policy that justify an inquiry.

Part II

But the Enterprise Chamber isn't done yet. It continues with assessing the conduct of the foundation. No compliments here either. The court also finds well founded reasons to doubt the correctness of the corporation's policy as to the granting and exercise in 2008 of the call-option, mainly because the court has heavy doubts that the foundation in fact actually acted independently from the corporation (instead of using its position to secure the position of the directors so that they could solve the problems within that inner circle referred to above). I'll quote the key passage (s. 3.27):

Al met al zijn er naar het oordeel van de Ondernemingskamer zoveel aanwijzingen dat niet kan worden uitgesloten dat Stichting Continuïteit het zittende bestuur en de zittende commissarissen de hand boven het hoofd heeft gehouden teneinde binnen de besloten kring van de eigen functionarissen en grootaandeelhouder een afwikkeling van de problemen die ASMI op (ondernemings)strategisch en corporate governance gebied ondervond te faciliteren, dat ernstig moet worden betwijfeld of zij haar recht tot het nemen van de beschermingspreferente aandelen niet althans niet, minst genomen, in aanmerkelijke mate met het oog op die rol heeft uitgeoefend. Het komt de Ondernemingskamer voor dat de optie - in ieder geval - daarvoor niet was bedoeld. Het uitoefenen van de optie met dat doel zou, naar moet worden aangenomen, onrechtmatig zijn geweest.

The problem that the right of inquiry only focuses on the legal entity and its organs, not on third parties, was solved by the court by reasoning that the foundation acted as co-policy maker of the corporation (s. 3.28).

Voor de doeleinden van het enquêterecht moet naar het oordeel van de Ondernemingskamer een dergelijke "bevriende" stichting, die door de uitoefening van haar optie eenzijdig en zonder dat daarvoor overigens de medewerking van de door haar te "beschermen" vennootschap vereist is, een beschermingsmaatregel in stelling brengt welke haar, beoordeeld naar stemgerechtigdheid, tot belangrijkste aandeelhouder van die vennootschap maakt en met welke maatregel zij ook beoogt diepgaand in de vennootschappelijke verhoudingen van de te "beschermen" vennootschap in te grijpen, onmiddellijk vóór en ten tijde van de uitoefening van haar optie geacht worden zodanig nauw bij (het beleid en de onderneming van) de te beschermen vennootschap te zijn betrokken dat zij ook wat betreft de uitoefening van haar optie als medebeleidsbepaler van die vennootschap heeft te gelden.

This type of approach is not unprecedented, but only applied in special circumstances.

Varia

I mention two additional points.

1. The Enterprise Chamber takes into account facts and circumstances that took place after the date of the filing of the original request. Although the court confirms this is not standard practice (also see its ABN Amro Bank decision of April 17, 2008, s. 3.13), it deems it justified in this case as these additional facts and circumstances all took place in the time-frame of the continued talks between the parties (as ordered by the court), the corporation was aware of these new facts and circumstances and also was in a position to respond to them (s. 3.4).
2. The Enterprise Chamber is obliged to take into account the interests of the parties involved when determining whether an inquiry should be ordered. The court does so, and concludes there are no reasons to deny the request, notwithstanding the well founded reasons to doubt the corporation's policy. One of the arguments by the company was that the inquiry isn't going to help the shareholders, as these events cannot be undone. The court rebuts this argument in part by saying that if the granting of the option was unlawful, this could result in liability of ASM International c.q. the foundation (s. 3.29). This is somewhat remarkable, as the right of inquiry does not deal with liability issues. But then again, the court only mentions this - as it has done in other cases - to rebut the argument by the corporation that the request should be denied because the shareholders lack sufficient interest. The court also finds that transparency is required and that only then the damaged relationships within the corporation can be restored (s. 3.31).

How will this proceed from here? My guess is that chances of Supreme Court litigation in this matter are rather high. And the outcome of such corporate governance related disputes is not always easy to predict, as evidenced by the discrepancy between the approach taken by the Enterprise Chamber and the Supreme Court in the ABN Amro Bank matter.

[No. 102] (De)Diversification of Portfolio Investments of Institutional Investors

Before the introduction of the Euro a lot of Dutch institutional investors had relatively large stakes in Dutch listed companies. Due to the introduction of the Euro in 1999, the unpredictability of the currency exchange rates in the Eurozone did no longer play a role. For the Netherlands, the direct result of the introduction of the Euro was that Dutch institutional investors began to dismantle their interests in Dutch companies and spread their interest throughout the Eurozone. This gave an additional impetus to the emergence of foreign, particularly British and American investors in Dutch companies. Nowadays, about 75% of the shares in Dutch listed companies are held by foreign investors.

The introduction of the Euro was not the only reason for the portfolio diversification of institutional investors. Both institutional investors and their employees are in fact largely judged on how they have performed against the market. That market is in this context expressed in various benchmarks such as MSCI World, an important benchmark for stocks. The variable remuneration of employees of institutional investors is often linked. This means that they have a strong incentive to ensure that the return on their investments matches the specific benchmark(s). That those for whom they eventually invest - pension participants, policyholders, etc. - often have an interest in good returns in the long run, is often not given a high priority.

The previous is confirmed by Johan van der Ende, as chief investment officer responsible for all investments of PGGM: ”Institutional investors often buy all the shares of a certain index, just out of concern to score less than the market average or the competitor" says Van der Ende. "With our long term horizon the short term result are less important. If we invest in fewer companies, we can follow them better. PGGM, plans to cut the number of equity investments from 4000 back to 400 in order to make the investment policy more workable and to be able to place a clear stamp on the companies they invest in."

I believe this to be a positive trend. With 'just' a couple of hundred of companies to invest in, the risk-diversification is achieved. Moreover it becomes more rational to monitor the results and management of companies and to participate in the decision making process.

[No. 101] Re ASM International Inquiry Proceeding [Updated II]

In post No. 43, I reported about the status mid-May 2009 in the ASM International inquiry proceeding. My closing remark was:

5. The parties will have to inform the court no later than June 5, 2009 whether they have been able to settle the dispute - also involving the question who the CEO of the company should be, in view of the future strategic course of the company - amicably. If not, the case will proceed. To be continued, no doubt.

Apparently, the litigants were not able to settle the case amicably, as today word came out that the Enterprise Chamber has ordered an inquiry into the policy and affairs of ASM International. I don't have a copy of the ruling yet, but some background information is available here, here and here, that suggests the inquiry should focus on the defensive measure taken by the company in 2008 to ward-off a change in the composition of the board of directors.

UPDATED

The ruling is available here.

[No. 100] Chairman of a One Tier Board: Non-Execs Only?

1. The Dutch legislator is preparing the introduction of an optional one tier board structure, in addition to the traditional dualistic system with a management board and a separate supervisory board (see, e.g., here). The current draft legislation clarifies that under Dutch law, the chairman of a one tier board can only be a non-executive director. This is in line with principle III.8 and the corresponding best practices of the Dutch corporate governance code ("One-tier management structure"), that provides the following:

Principle

The composition and functioning of a management board comprising both members having responsibility for the day-to-day running of the company (executive directors) and members not having such responsibility (nonexecutive directos) shall be such that proper and independent supervision by the latter category of members is assured.

Best practice provisions

III.8.1. The chairman of the management board may not also be or have been an executive director.

III.8.2 The chairman of the management board shall check the proper composition and functioning of the entire board.

III.8.3 The management board shall apply chapter III.5 of this code. The committees referred to in chapter III.5 shall consist only of non-executive management board members.

III.8.4 The majority of the members of the management board shall be non-executive directors and are independent within the meaning of best practice provision III.2.2.

This is also standard practice in the United Kingdom.

2. In the US, new proposals are being discussed that aim to prohibit a corporation's CEO from serving as the chairman of the corporation's board of directors. Jay Brown is in favor.

One of the most obvious areas of abuse concerns the resolute insistence by most public companies to have the CEO serve as chairman of the board.  (Some stats are here).  With the board responsible for supervising the CEO, the the combination of the two positions materially weakens the function. Moreover, the chairman has the authority to call meetings and exercise control over the issues placed on the agenda.

Nor is this the norm overseas.  Most other countries, including the United Kingdom, call for a separation.  Pressure is growing for this to occur in the United States.  Shareholders are agitating for a separation; a provision of the Shareholder Bill of Rights would require it for exchange traded companies.  This Blog called on the SEC to address the separation as part of its corporate governance agenda.  The call seems to have been answered.

Steve Bainbridge is not:

In sum, corporate governance is not an arena in which one size fits all. Different firms have different governance needs. Boards of directors should be free to select the governance structures optimal for their unique firm without having corporate governance activists putting them in a straight jacket.

For earlier rounds of this academic boxing match, see here. No doubt more debate to follow.

[No. 99] Pay Cszar Geithner's Outburst

Treasury Secretary Timothy Geithner blasted top U.S. financial regulators in an expletive-laced critique last Friday as frustration grows over the Obama administration's faltering plan to overhaul U.S. financial regulation, according to people familiar with the meeting.

The proposed regulatory revamp is one of President Barack Obama's top domestic priorities. But since it was unveiled in June, the plan has been criticized by the financial-services industry, as well as by financial regulators wary of encroachment on their turf.

Mr. Geithner told the regulators Friday that "enough is enough," said one person familiar with the meeting. (WSJ)

Lawrence Cunningham and Gordon Smith report.

[No. 98] Exculpation and Disculpation

Francis Pillegi has an instructive post covering some discussions at the Annual ABA Meeting in Chicago, mainly focusing on corporate director fiduciary duties of failing companies. He also touches upon remarks made about section 102(b)(7) DGCL. That section allows protection for directors (not officers) for claims against them for monetary liability for breaches of the duty of care. It does not cover breaches of the duty or loyalty (including bad faith conduct) or suits for injunctive relief.

(b) In addition to the matters required to be set forth in the certificate of incorporation by subsection (a) of this section, the certificate of incorporation may also contain any or all of the following matters:
(...)
(7) A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit. No such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective. All references in this paragraph to a director shall also be deemed to refer (x) to a member of the governing body of a corporation which is not authorized to issue capital stock, and (y) to such other person or persons, if any, who, pursuant to a provision of the certificate of incorporation in accordance with § 141(a) of this title, exercise or perform any of the powers or duties otherwise conferred or imposed upon the board of directors by this title.

Its rationale was explained by VC Strine in 2004 in the Production Resources Group, LLC v. NCT Group, Inc. litigation:

Section 102(b)(7) authorizes corporate charter provisions that insulate directors from personal liability to the corporation for breaches of the duty of care. This is an important public policy statement by the General Assembly, which has the intended purpose of encouraging capable persons to serve as directors of corporations by providing them with the freedom to make risky, good faith business decisions without fear of personal liability.

Section 102(b)(7) DGCL basically deals with exculpation, i.e. ex ante limitation of director liability for violation of the duty of care.  Although the exact application of this section isn't fully clear under Delaware law, mainly due to the fact that the Delaware Supreme Court repeatedly has labeled it an "affirmative defense" (see Steve Bainbridge's recent commentary and my analysis in Judicial Scrutiny of Director Conduct, Deventer: Kluwer 2007, no. 13), there is no doubt that this defense plays an important role in Delaware corporate litigation. Combined with the high threshold for establishing violation of the duty of care (i.e., gross negligence; see, e.g., the 2006 In re The Walt Disney Company Derivative Litigation ruling by the Delaware Supreme Court), the fact that most Delaware corporations have implemented an exculpatory clause in their certificate of incorporation explains why due care issues play a minimal role in director liability proceedings.

Dutch corporate law does not know a provision similar to section 102(b)(7) DGCL. In fact, it is held by most scholars that ex ante exculpation for director liability vis-a-vis the corporation (section 2:9 DCC) is not permitted. In practical terms, directors can avoid potential liability ex post by means of the general meeting deciding, typically based on the annual accounts of that previous year, that they will not be held liable by the corporation for acts disclosed to the general meeting prior to its decision. This phenomenon, called discharge of liability (decharge), is an annually recurring theme during the annual general meeting. Another possibility for individual directors to escape section 2:9 DCC liability is showing grounds that justify disculpation; this is also an ex post mechanism and occurs only during litigation, when the court has already held that there are grounds to establish director liability. These waters, however, are still muddy.

As I explained elsewhere, Dutch corporate law should also seriously consider allowing a limited ex ante mechanism, in terms of exculpation of corporate directors for personal liability based on due care violations. It makes sense, should be deemed possible under current law and would not affect that important corporate litigation avenue under Dutch law: the right of inquiry.

[No. 97] On Liberal and Conservative Accounting

In his recently published doctoral thesis On the nature of auditing: The Audit Partner Effect. Research on the effect of individual Audit Partners on Audit Quality and the Information Dynamics of Accounting Data, Joost van Buuren examined two fundamental accounting questions.

1. Do differences in audit quality amongst audit partners matter?
2. Are differences in audit quality influenced by strategic choices of audit partners to develop their own business cases?

He concludes that the nature of auditing is primarily ‘dynamic and organic’ (in the sense that no standard audit solutions are available, and that the level of audit quality delivered depends on the capabilities, motivation and effort of the individual audit partners and their audit teams) and indifferent to variables such as country, audit firm or the applied setting of Dutch municipalities and European listed companies. Accordingly, the study shows that the very nature of auditing is primarily dictated by ‘humaneness’; human capabilities and human behavior.

The answer to the first question is found by examining whether large audit firms - which are assumed to be a uniform group of high quality auditors - deliver a homogenous level of audit quality. The results show that statistically significant audit quality differences are observed amongst the large audit firms. These results imply that audit firm size is not a very reliable proxy for audit quality. To examine whether these differences in audit quality amongst large audit firms is due to differences in internal control and governance, I tested the degree of homogeneity of audit quality within large audit firms. The results suggest that 23% (Dutch municipalities) to 49% (European listed companies) of the audit partners deliver a level of audit quality which is of statistically significant difference compared to the audit firm’s average level of audit quality. These results do not support the assumption that large audit firms are very successful in governing their audit quality. On the contrary, I conclude that the average level of audit quality delivered by an audit firm is the bottom-up aggregation of audit quality delivered by individual audit partners.

The second question deals with whether the audit partner’s business case affects the level of audit quality delivered. Audit partners are expected to develop an audit partner business case in order to survive the highly competitive audit markets, and to meet the audit firm’s profit and revenue targets. I assume three principal audit partner business cases, resulting in three audit partner archetypes, namely the liberal, conservative and the high quality audit partner. The liberal audit partner is expected to specialize in the auditing of financial statements with a relatively high risk profile and charges the highest audit fees in order to reduce the audit risk to an acceptable low level. Second, the high quality audit partner is expected to specialize in high quality audits that maximize the usefulness of financial statements. High quality audit partners are expected to charge relatively high audit fees in order to guarantee the high level of audit quality delivered. The third audit partner archetype is the conservative audit partner, who is expected to specialize in low budget auditing which can be achieved by minimizing risks in the financial statements in order to reduce the audit risk. Hence the audit partner is able to reduce audit effort and charge relatively low audit fees. However, I suppose that the extent of achieving the audit partner business case - and the corresponding extent of commercial success - depends on the audit partner’s technical and communication capabilities. The existence of the three audit partner archetypes and the corresponding business cases is supported by empirical evidence. Therefore, I conclude that the level of audit quality is systematically affected by the business case of an audit partner.

Interestingly, Van Buuren found among other things that liberal accounting - in short: accounting that offers more leeway to present the numbers - often results in higher bills for the audited corporation (and vice versa), generally ranging somewhere between 5 to 8% compared to billing by firms that operate in a more conservative mode. The former model is linked by Van Buuren to PWC, the latter to KPMG.

It seems that PWC was not amused by this outcome, as it refused to comment and qualified the research as inadequate. Well, I guess bad publicity is still publicity.