Securities Mosaic® Blogwatch
October 14, 2013
FDIC Statement Inveighs Against D&O Insurance Exclusions and Coverage for Civil Money Penalties.
by Kevin LaCroix

In an unusual step, the FDIC, the federal regulator responsible for insuring and supervising depositary institutions, has weighed in on financial institutions' purchase of D&O insurance. The FDIC's October 10, 2013 Financial Institutions Letter, which includes an "Advisory Statement on Director and Officer Liability Insurance Policies, Exclusions and Indemnification for Civil Money Penalties" (here), advises bank directors and officers to be wary of the addition of policy exclusions to their D&O insurance policies and also reminds bank officials that the bank's purchase of insurance indemnifying against civil money penalties is prohibited.

The agency's brief two-page letter opens with the observation that the FDIC has "noted an increase in exclusionary terms or provisions contained in depositary institutions' D&O insurance policies." The agency notes that the addition of these exclusionary provisions "may affect the recruitment and retention of well-qualifies individuals," and that when the exclusions apply, "directors and officers may not have insurance coverage and may be personally liable for damages arising out of civil suits."

The FDIC is concerned that bank officials "may not be fully aware of the addition or significance of such exclusionary language." Accordingly, the agency urges officials to apply "well-informed” consideration to the potential impact of policy exclusions. The agency urges "each board member and executive officer to fully understand the answers to the following questions" especially when considering renewals and amendments to existing policies:

  • What protections do I want from my institution's D&O policy?
  • What exclusions exist in my institution's D&O policy?
  • Are any of the exclusions new, and if so, how do they change my coverage?
  • What is my potential personal exposure arising from each policy exclusion?

The letter also states that banks' boards of directors should "also keep in mind" that FDIC regulations "prohibit an insured depositary institution or [holding company] from purchasing insurance that would be used to pay or reimburse an institution-affiliated party (IAP) for the cost of any civil money penalty (CMP) assessed against such person in an administrative proceeding or civil action commenced by any federal banking agency."

The letter goes on to note that the agency's regulations prohibiting insurance indemnifying against civil money penalties "do not include an exception for cases in which the IAP reimburses the depositary institution for the designated cost of the CMP coverage."


On the one hand, the FDIC's warnings about the need for bank officials to be well-informed about their D&O insurance and to be wary about the addition of policy exclusions are simply good advice. Indeed, the warnings represent worthy counsel for officials at any corporate entity, not just at banking institutions. All corporate officials should be attentive to their D&O insurance, and the questions that the FDIC suggests are good questions for the directors and officers of any institution.

However, the FDIC is not just offering disinterested guidance here. The FDIC doesn't say it, but it has a very specific concern in mind. The FDIC is worried about the inclusion in banks' D&O insurance policies of a so-called "regulatory exclusion" precluding coverage for claims brought by regulatory agencies such as the FDIC. Although these exclusions are still somewhat unusual, when a policy has one of these exclusions, the FDIC is unlikely to be able to recover under the policy for any claims the agency files against a bank's directors and officers. (For background about the regulatory exclusion, refer here.)

The likeliest time for a D&O insurer to try to add a regulatory exclusion is when a financially troubled bank seeks to renew its insurance. The insurer, concerned that the bank might fail, wants to protect itself against possible liability for any post-closure claims that the FDIC might bring in its capacity as receiver of the failed bank.

The FDIC is (as discussed further below) in the midst of filing and pursing a host of lawsuits against the former directors and officers of many of the banks that failed between 2007 and the present. In these lawsuits and in other suits that the agency might want to pursue, the FDIC may be stymied in trying to secure a recovery if the failed bank's D&O insurance policy has a regulatory exclusion. The FDIC has issued its advisory statement because it wants to try to enlist banking officials' assistance in trying to ward off the inclusion of these kinds of exclusions on D&O insurance policies.

The problem for both bank officials and for the FDIC is that if a bank is sufficiently troubled, no amount of attentiveness will be sufficient to ward off the addition of exclusionary provisions. Banks that are in troubled condition are likely to find that they have few D&O insurance options and that the only coverage they can obtain is an insurance program that includes a regulatory exclusion or other coverage limiting provisions.

Nevertheless, while in some circumstances (especially with regard to troubled banks) there may be little that bank officials can do about the addition of coverage narrowing policy provisions, there is certainly nothing wrong with urging bank officials to be attentive to the changes in their coverage on renewal. The FDIC's suggestion that bank officials stay informed about changes in their D&O insurance is, as noted above, good advice.

Because the FDIC's letter went to all banking exclusions and by its terms is meant to apply with respect to all institutions, insurance professionals that work with reporting institutions should expect that their banking clients will be presenting them with these questions and should be prepared to answer their client's questions.

For their part, banking officials should consider whether their advisors are adequately answering their questions. Although it is true in most corporate contexts, it is particularly true in the context of banking institutions that the firms and their directors and officers should be sure that their insurance advisor is knowledgeable and experienced. In looking for answers to the FDIC's suggested questions, bank officials will want to assess whether their advisors' answers show that their advisor is sufficiently knowledgeable and experienced to counsel them with regard to these important insurance issues.

The agency's separate statements about insurance for civil money penalties are interesting and represent something of a public clarification of a long-standing issue. By way of background, under FIRREA and related regulations, civil money penalties may be assessed for the violation of any law, regulation, as well as for a violation of any condition imposed in writing by the appropriate Federal banking agency in connection with any written agreement between a depository institution and the agency.

As discussed in a prior guest blog post on this site (refer here), the FDIC had informally been taking the position that bank's D&O insurance policies should not provide for the indemnification of civil money penalties. However, this type of coverage has long been available in the insurance marketplace and many D&O insurance policies currently in place expressly provide for the insurance of these penalties. One of the ways that banks and their insurers have sought to address possible agency concerns about the insurance is by having the individuals protected by the civil money penalty provisions reimburse the bank for the cost of the civil money insurance protection. As noted in the guest blog post, "This was based on the assumption that if the bank could prove that the directors and officers paid for the coverage personally, that the FDIC wouldn't object to the coverage."

These insurance industry practices continued because certain assumptions were being made about the agency's approach to these issues. With the FDIC's issuance of the Advisory Statement, the agency's views are now clear - banks are "prohibited" from purchasing insurance that would pay or reimburse for civil money penalties, and there is no exception from the regulations that allows the insured individuals to reimburse the bank for the civil money penalties protection.

The agency's issuance of the Advisory Statement and the clarification of the agency's position with respect to insurance for civil money penalties does raise the practical question about what banks and their insurers should do with respect to the many insurance policies that are currently in force providing insurance for civil money penalties. One immediate question that comes to mind is whether or not the policies should now be specially endorsed to remove the endorsements providing for civil money penalty coverage. Alternatively, some may feel that it is sufficient simply to allow the current policies to run through their natural expiration and at renewal a new policy can be put in place without the civil money penalties provisions.

It seems likely that banking officials will also now want to know if there is anything else that they can do to protect themselves from their exposure to possible civil money penalties against them. Among the topics that are likely to be discussed in the months ahead is the question whether the FDIC's Advisory Statement prohibiting banks from purchasing insurance the includes indemnification against civil money penalties does not prohibit individuals from buying insurance on their own to protect themselves from civil money penalty exposures.

The discussion of these latter possibilities would have to include consideration of (1) whether the operative regulations and the Advisory Statement preclude purchase of insurance protection against civil money penalties by individuals as well as by depositary institutions; and (2) whether the agency's clarification that there is no exemption in the regulation allowing individuals to reimburse banks for the purchase of insurance for civil money penalties protection in and of itself precludes the individuals' purchase of this type of insurance, or at a minimum effectively communicates what the agency's view would be on the issue.

Finally, there is the practical question of whether insurers would even be interested in trying to offer separate policies for individuals providing insurance for civil money penalties, given the likely low premiums involved and the prospects - for both the insured persons and for the insurers - of running afoul of the FDIC. In the past, the insurers have shown little interest in offering this type of product.

FDIC Updates Failed Bank Lawsuit Information: On October 11, 2013, the FDIC updated the page on its website on which the agency tracks the lawsuits it has filed in its capacity as receiver for failed banks against the banks' former directors and officers. As of the latest update, the agency has now filed a total of 81 lawsuits against the former directors and officers of failed banks, including a total of 37 so far this year. (By way of comparison, the agency filed only 25 during all of 2012.)

The updated page also notes that as of October 8, 2013, the agency has authorized suits in connection with 127 failed institutions against 1,029 individuals for D&O liability. These figures are inclusive of the 81 filed D&O lawsuits naming 616 former directors and officers. In other words, based solely on the number of authorized suits, there may be a backlog of as many as 46 lawsuits yet to be filed.

While the number of lawsuits and authorized lawsuits continue to increase, the number of bank failures seems to have slowed. As also reflected on the agency's website, there have been no bank failures in the last month.

Third Quarter Claims Trends Update: On October 17, 2013, I will be participating in Advisen's Third Quarter Claims Update, along with AIG's Rich Dziedziula, Joseph O'Neil of the Peabody & Arnold law firm, and Advisen's Jim Blinn. The free one-hour webinar, which will begin at 11:00 am EDT, will discuss recent corporate and securities lawsuit filing trends as well as key developments to watch. Further information about the webinar including sign up information can be found here.

October 14, 2013
FINRA's Minor Rule Violation Letter Plan Expanded
by Joel Beck

Effective September 26, 2013, FINRA's Minor Rule Violation Letter plan has been expanded to include additional rules for which rule violations can be resolved through an MRV as opposed to only a formal disciplinary action such as an AWC or complaint. This is a positive development that gives the regulator another tool in its toolbox, and provides firms with the possibility to resolve minor matters through the MRV plan as opposed to more costly, and more publicly disclosable, actions.

Not all rule violations can be resolved through an MRV, as MRVs are reserved for the rules specified in the MRV plan (likewise, more serious violations, or repeat violations of these rules would likely not be resolved through an MRV as FINRA would likely seek to pursue more significant actions; further, FINRA is not constrained to resolve a matter through an MRV just because they can). But, when that list of eligible rules is expanded, it can only be viewed as a positive step for brokerage firms.

October 14, 2013
SEC Enforcement: Is the Swagger Back?
by Tom Gorman

The swagger is back according to SEC enforcement officials. Presumably that comment is meant to say that an enforcement program which once was viewed as among the best in government has returned to that rarified echelon. To be sure there is a lot of positive buzz about the program. New Chair Mary Joe White has in recent weeks addressed enforcement priorities (here), market structure (here) and last week what might be called enforcement omnipresence. But the swagger? Consider Ms. White's most recent remarks at the Securities Enforcement Forum, Washington, D.C. (Oct. 9, 2013)(here).


The focus of Ms. White's remarks last week was omnipresence, that is, SEC enforcement will be like the 24/7 news cycle everywhere, all the time bringing every case. While that is clearly not possible, the goal is to make it seem possible. The theory is simple: A cop on every corner bringing charges for every violation no matter how small prevents wrongful conduct thereby making investors feel safe. As Ms. White stated: "I recognize the SEC cannot literally be everywhere, but we will be in more places than ever before. Our aim is also to create an environment where you think we are everywhere - using collaborative efforts, whistleblowers and computer technology to expand our reach, focusing on gatekeepers to make them think twice about shirking responsibilities, and ensuring that even the small violations face consequences."

There are four building blocks to the omnipresent strategy. The first is expanding the reach of the agency by leveraging its resources. This means utilizing resources like the National Exam Program to help uncover potential violations. Whistleblowers also become a key component since they can give Enforcement Division critical leads. All of this is supplemented by working with partners such as the DOJ, FINRA and state authorities.

Technology can also help expand the reach of the agency. Specialized programs, coupled with big data, can aid enforcement efforts while expanding the horizon. In some instances the Commission is using analytics and related technology to conduct what the SEC Chair called "predictive analysis" to identify trends and streamline investigative efforts. In others specialized programs such as the Advanced Bluesheet Analysis Program for insider trading cases are used. That program "analyzes data provided to us by market participants on specific securities transactions. It identifies suspicious trading before market moving events. It also shows the relationships among the different players... " said Ms. White.

A second pillar of the strategy is to expand the focus on gatekeepers. One example of this focus is actions involving the boards of investment companies Those boards have a critical role in overseeing funds. Another is Operation Broken Gate, a recent initiative that focuses on auditors. Ensuring that gatekeepers fulfill their critical role, can help prevent violations of the law.

The third facet of the approach centers encouraging respect for the law through what Ms. White called the "broken window." If a window is broken an later repaired it demonstrates a commitment to the rules. If it is not, that fact suggests the opposite. To implement this approach the SEC will bring even small cases. A recent example it the series of strict liability actions based on short selling in violation of Regulation M.

Finally, the agency will prioritize large cases. Here Ms. White pointed to the Financial Reporting and Auditing Task Force created earlier this year. The task force "brings together an expert group of attorneys and accountants who are developing state-of the-art techniques for identifying and uncovering accounting fraud." Those cases are complex, resource intensive and time consuming, meaning it is essential that the agency prioritize them. By tying this point to the others, the SEC will endeavor to create the appearance of being "everywhere" to enhance enforcement.


Putting a cop on every corner - or creating the appearance that there is one - is a proven law enforcement approach. The omnipresence formula is thus not new or novel. Neither are its building blocks. Leveraging resources has long been an approach used by the resource-short Commission. Focusing on gatekeepers is a theory that traces to the earliest days of the Enforcement Division. Prioritizing large cases is not so much a strategy as a necessity given the limited resources available to the SEC.

The critical point here is how the building blocks are blended together. If the agency can effectively implement the theory it may become an effective enforcement approach. If omnipresence becomes an effective program it may be entitled to swagger. For now, however, it is all much like the poem Ode on a Greecian Urn penned long ago by the English poet John Keats' - potential, in the offing and possible.

October 14, 2013
SEC Chair Voice Doubts on Conflict Minerals Rules
by Celia Taylor

Previous posts have discussed in detail the conflict minerals rule promulgated by the SEC in order to implement Section 1502 of Dodd-Frank.  I noted in those posts that the SEC did not want to take on the task of crafting disclosure regulations aimed at ended conflict in the DRC, not because it in anyway disagreed with the aim of the regulations but because is questioned whether the SEC is the appropriate body to be tasked with that mission.  At the time the rule was under consideration then SEC Chair Mary Shapiro acknowledged that the Commission lacked expertise on the mining of conflict minerals and the disclosure matters mandated by the statute. 

Now Chair Mary Jo White is sounding the same note.  At a speech at Fordham the Chairwomen contrasted the method of implementation of the conflict minerals provision with an attempt in the 1970's by the SEC to implement a Congressional mandate that federal agencies consider environmental values as part of their regulatory missions.  The SEC responded by crafting a requiring certain environmental disclosures by way of a lengthy implementation process.  What is critical is that thought the process the SEC  maintained flexibility to respond to comments and concerns because the Congressional directive the SEC was acting under left discretion to the SEC to act creatively and in a manner it felt best accomplished the statute's general goal.  In contrast, according to Chairwoman White Section 1502 of Dodd-Frank was "quite prescriptive, essentially leaving no room for the SEC to exercise its independent expertise and judgment in deciding whether or not to make the specified mandated disclosures."

In addition to noting the lack of flexibility recent Congressional mandates have afforded the SEC, Chair White voiced a broader concern that this author and many others have long been stating.  She recognizes that the SEC cannot ignore statutory mandates directing the agency to engage in rule-making. 

As a prosecutor, I recognize that when Congress and the President enact a statute mandating such a rule, neither I nor the Commission has the right to just say "no."  We cannot say that a law does not comport with our mission as we see it, and ignore a Congressional mandate.  We cannot put it in a drawer or tuck it away.  That would be impermissible nullification of the law and independence run amok. 

However, she questions the wisdom of placing such a responsibility on the shoulders of the SEC, noting that the Congressional mandate in regard to conflict minerals seems

"more directed at exerting societal pressure on companies to change behavior, rather than to disclose financial information that primarily informs investment decisions.

That is not to say that the goals of such mandates are not laudable.  Indeed, most are.  Seeking to improve safety in mines for workers or to end horrible human rights atrocities in the Democratic Republic of the Congo are compelling objectives, which, as a citizen, I wholeheartedly share.

But, as the Chair of the SEC, I must question, as a policy matter, using the federal securities laws and the SEC's powers of mandatory disclosure to accomplish these goals.  

I could not agree more.  The SEC is being charged with ever expanding disclosure regulation obligations, some of which relate closely to the stated mission of the agency and seem logical for the agency to take on.  Others, like conflict minerals as well as others, have little to do with the core mission and would be better handled by other entities.  More disclosure is not the answer to all societal problems - instead, as noted by former SEC Commissioner Troy Paredes, it can lead to information overload and investor ennui.  Congress should be more thoughtful when considering disclosure as a panacea and if it concludes that disclosure is the answer, should more carefully allocate responsibility for it.

October 13, 2013
Insider Trading in the Derivatives Markets
by June Rhee

Editor's Note: The following post comes to us from Yesha Yadav of Vanderbilt Law School.

In my paper, Insider Trading in the Derivatives Markets, recently made available on SSRN, I argue that the prohibition against insider trading is becoming increasingly anachronistic in markets where derivatives like credit default swaps (CDS) trade. I demonstrate that the emergence of credit derivatives marks a profound development for the prohibition against insider trading, problematizing conventional theory and doctrine like never before. With the workability of current rules subject to question, this paper advocates for a rethinking of the present regulatory framework for one better suited to modern markets.

Lenders use CDS to trade the risk of the loans they make. And, when they engage in such trading, they are usually privy to vast reserves of confidential information on their borrowers. From a doctrinal perspective, CDS appear to subvert insider trading laws by their very design, insofar as lenders rely on what looks like insider information to transfer the risk of a loan to another institution. Fundamentally, insider trading rules prohibit trading based on information procured at an unfair advantage by those in a privileged relationship to a company. And, increasingly, insider trading laws are taking a fairly broad approach in preventing misuse of confidential information by those who acquire this information through their special access or through deception. For example, Rule 10b-5(2) can ground a claim for insider trading where someone trades on information obtained through a relationship of trust and confidence. In the CDS market, lenders usually buy and sell credit protection based, at least in part, on information they obtain in their relationship with the borrower, one ordinarily protected by restrictive confidentiality clauses. From the doctrinal viewpoint then, old laws and new CDS markets appear to exist in a state of serious tension. Put differently, either this thriving market is operating outside or at the margins of existing law - or the law itself has not adapted to the existence of these markets.

It is worth noting that finance theorists have long recognized that credit derivatives markets showcase an unmistakable tendency towards insider trading. This, they posit, can be seen in the uncanny ability of CDS markets to forecast events months and sometimes even years before they actually take place. Unsurprisingly, such prescience is especially likely for "negative" events that increase the chances of a debtor defaulting, that is to say, the kind of events that lenders care about and that drive lender decision-making about whether or not to purchase CDS protection.

From the theoretical perspective, the emergence of CDS markets inverts conventional theory underpinning the prohibition. Scholars have long argued that shareholders of a company systematically lose when its corporate insiders engage in insider trading vis-a-vis uninformed equity holders. CDS markets, however, profoundly challenge this theory. With respect to CDS, shareholders can emerge as winners by allowing lenders to use confidential information to trade CDS on company debt. Where lenders are able to hedge their risk using CDS, they may be more generous in extending credit to the borrower. In other words, by encouraging CDS trading on their company debt, shareholders can enjoy debt-driven growth, leaving creditors to internalize the down-side risk. This upside creates powerful incentives for shareholders to encourage lenders to use insider information to trade CDS on their company's debt.

However, shareholders can also lose - and badly - through CDS trading on their company debt. Lenders can use insider information in a variety of ways - some of which may be far from beneficial for the company. Lenders might look for opportunities to extract private rents through their informational advantage at the expense of the company. For example, in the CDS market, lenders might increase their purchases of CDS protection, over-emphasizing their negative sentiment regarding the company. Such signaling can be damaging where it leads to negative spirals in the value of a company's securities, making it harder for the company to raise money (and easier for it to default). One factor is especially significant in this regard. As noted earlier, the CDS market is highly efficient in processing negative lender sentiment regarding a company. However, this efficiency may become problematic where it leads to CDS markets impounding bad news with such force and speed as to destabilize trading in a debtor company's other securities (e.g. shares and bonds).

These insights point to the need to re-conceptualize the doctrinal and theoretical bounds of the traditional prohibition. The operation of the CDS market - and the trading on insider information it can allow - shows that there are both costs and benefits to insider trading. As a starting point, the trade-offs suggest that insiders and investors might benefit from the ability to contract around the scope of insider trading liability. But, this solution is far from perfect. Such bargains depend on parity of negotiating position between insiders and company investors to be meaningful. In the case of CDS trading, such bargains may provide only weak protection for shareholders, given lenders generally enjoy considerable bargaining power vis-a-vis borrowers. This asymmetry makes it difficult for borrowers to make demands of lenders in how these lenders use the company's confidential information. Importantly, current laws seek to bring derivatives markets in line with the insider trading regime applicable to equity markets, promoting consistency and symmetry across markets. However, it is worth exploring whether this symmetry can be better achieved by bringing equity markets more closely in alignment with derivatives markets, in other words, by relaxing the prohibition in equity markets. In questioning whether such symmetry between markets is possible (or even desirable), it becomes evident that thorough review and re-thinking of the prohibition is sorely needed to achieve meaningful reform in this area.

The full paper is available for download here.

October 13, 2013
Delaware Supreme Court Lifts Injunction; Allows Vivendi/Activision Deal to Proceed
by Francis Pileggi

Activision Blizzard Inc. v. Hayes et al., No. 497-2013, order issued (Del. Oct. 10, 2013). In a rare ruling from the bench, after oral argument, the Delaware Supreme Court reversed an injunction granted by the Court of Chancery in Hayes v. Activision Blizzard Inc., No. 8885, 2013 WL 5293536 (Del. Ch. Sept. 18, 2013). The issue addressed was whether the structure of the deal qualified as the type of business combination that required a vote by public shareholders. In a unanimous ruling, Delaware's high court ruled that no vote was required. A formal opinion will follow. This is an example of how quickly the Delaware courts can decide cases. This final appellate ruling came about a mere month after the complaint was filed in the trial court.

Frank Reynolds of ThomsonReuters, who edits Westlaw's Delaware Corporate Journal, provides a helpful overview of the case.

October 13, 2013
Pensions Going Postal
by Susan Mangiero

Pension issues are hard to miss these days. What is notable is that pension plans influence corporate finance activity in several ways. First, they are collectively and, in some cases, individually, large and hard-to-ignore investors. Second, benefit economics can sometimes mean the difference between a deal such as a restructuring or merger or acquisition moving forward or getting stalled.

The over subscribed Initial Public Offering ("IPO") of the venerable postal system organization known as the Royal Mail Group, Ltd. ("Royal Mail") is a good example of pension plan sway.

Listed on the London Stock Exchange and trading under the ticker of RMG.L, Bloomberg reports that Royal Mail equity climbed nearly forty percent on its first day of trading with active volume early on. (See "Royal Mail Stock Jumps 38% on First Trading Day After IPO" by Kari Lundgren and Thomas Penny, Bloomberg, October 11, 2013). As a result of what most market participants call a successful launch, critics reiterated their plaint that Royal Mail should have gone for much more. Certainly the topic of pricing surfaced only to be met with concern about whether institutional investors would support the equity issue at a higher price. (See "Government tried to raise Royal Mail IPO price" by Himanshu Singh, CityWire Money, October 12, 2013). As it turned out, interest was strong and fears about a weak debut were ill-founded. According to Chief Business Correspondent for The Telegraph, Louise Armitstead, only 300 out of 800 pension fund and life insurance companies were able to get shares in Royal Mail with "the institutional offer [being] 20 times oversubscribed." (See "Royal Mail: 500 institutions miss out on shares amid record demand," October 10, 2013).

A few days later, those buyside squeaky wheels must be happy indeed. According to "Landsdowne grabs huge stake in Royal Mail sell-off" (October 11, 2013) by CNBC business editor, Helia Ebrahimi, sovereign wealth funds and hedge funds were each allocated about 50 million GBP and "that not enough stock was given to U.K. pension fund managers." Moreover, union workers continue to have questions about the economics of a proposal to limit Royal Mail employee benefits. In "Unite members vote against Royal Mail pensions cap," Professional Pensions reporter Taha Lokhandwala writes that the "announcement outraged unions as the scheme was in surplus at the time." Keep in mind that, the Royal Mail pension assets of 27 billion GBP and liabilities of 37.5 billion GBP were transferred to the U.K. treasury in 2012 in order allow Royal Mail a chance to better compete. See "Government to take over Royal Mail pension scheme deficit from next month,", Pinsent Masons, March 23, 2012.

In contrast to the appearance of a financial home run for the Royal Mail deal, with respect to excess demand for stock and a clean-up of the nearly 10 billion GBP unfunded pension deficit, The Deal reports a third missed contribution to the U.S. federal mail system's pension plan as it falls "behind by another $5.6 billion." In "U.S. Postal Service skips third pension payment" (October 6, 2013), author Lisa Allen quotes union representative Sally Davidow as blaming the 2006 Postal Accountability and Enhancement Act for "an onerous requirement that the service prefund 75 years' worth of retiree health benefits in 10 years, without allowing the agency to increase postage rates above inflation or offer new services to offset the added costs." With the price of a first class stamp soon to rise to 46 cents, and another hike for three cents more in the works, one wonders if the American mail service should look to its English counterpart and consider a pension transfer and privatization that might, if well structured, advantage employees and taxpayers alike.

October 11, 2013
Directors Survey: Boards Confront an Evolving Landscape
by Mary Ann Cloyd

Editor's Note: Mary Ann Cloyd is leader of the Center for Board Governance at PricewaterhouseCoopers LLP. The following post is based on the executive summary of PwC's Annual Corporate Directors Survey; the complete publication is available here. A previous PwC survey, concerning board composition, was discussed on the Forum here.

We are witnessing unprecedented change in the corporate governance world: new perspectives on boardroom composition, higher levels of stakeholder engagement, more emphasis on emerging risks and strategies, and the increasing velocity of change in the digital world. These factors, coupled with calls for enhanced transparency around governance practices and reporting, the very active regulatory and lawmaking environment, and the enhanced power of proxy advisors, are all accelerating evolution, and in some cases creating a revolution, in the boardroom.

In the summer of 2013, 934 public company directors responded to our 2013 Annual Corporate Directors Survey. Of those directors, 70% serve on the boards of companies with more than $1 billion in annual revenue. As a result, the survey's findings reflect the practices and boardroom perspectives of many of today's world-class companies. The focus of this year's research not only reflects in-depth analysis of contemporary governance trends, but also emphasizes how boards are reacting to a rapidly evolving landscape. These are the highlights:

  • Directors are even more critical of their fellow directors than last year: 35% now say someone on their board should be replaced (compared to only 31% in 2012). The top three reasons cited are diminished performance because of aging, a lack of required expertise, and poor preparation for meetings.
  • Replacing a fellow board member can be difficult; 48% cite impediments to doing so. The top inhibitor, cited nearly twice as often as any other factor, is that board leadership is uncomfortable addressing the issue.
  • Board service is not driven by money or ego. More than half of directors (54%) say that their primary motivation for sitting on a corporate board is intellectual stimulation, 22% see board service as a way to keep engaged, and 17% indicate they simply want to give something back. Remuneration is low on the list.
  • There is a dichotomy between directors who believe it's appropriate to communicate about governance issues directly with shareholders and those who do not. Just over 30% say it's "very appropriate" to communicate about corporate governance issues, and about a quarter say the same about executive compensation and director nominations. But the same or slightly more say director communication about these three areas is "not appropriate."
  • Regarding communication with other stakeholders, nearly half of directors say their boards either have no policy or one that's not useful. Considering the increasing frequency of stakeholder interactions, it's not surprising that about one-quarter of those without such a policy believe there should be one.
  • Boards continue to take action in response to say on pay voting results (70%) but few actually reduced compensation (3%). Over one-half of directors say that it would take a negative shareholder vote of 30% or more to cause them to reconsider executive compensation.
  • The number of directors who believe there is a clear allocation of risk oversight responsibilities among the board and its committees (80%) improved over the prior year by 17 percentage points. Yet half of those who say that there is clarity reflected that it still could be improved.
  • CEOs and directors have different perspectives on who influences company strategy or what threatens their company's growth prospects. As reported in PwC's 16th Annual Global CEO Survey, CEOs see more influence by the media and supply chain partners, while directors believe investors have more clout. Directors are significantly more concerned about the government impairing growth prospects.
  • Ninety-four percent of directors say they receive information on competitor initiatives and strategy, but nearly a quarter of them wish it were better.
  • Three-quarters of directors said their boards took additional action to oversee fraud risks. Six of 10 held discussions regarding "tone at the top," a 14 percentage-point increase from last year. Other actions included increased interactions with members of management below the executive level and having discussions about insider trading controls.
  • Directors reflected on the increasing importance of the IT revolution at their companies - 15% call IT critical, up from 13% in 2012, and the amount of time directors spent overseeing IT increased correspondingly. Despite the fact that about one-third of boards spent more hours overseeing IT, 61% want to spend even more time considering related risks in the coming year, and 55% say the same about IT strategy.
  • There was a jump in the use of outside consultants to advise boards on IT strategy and risk: from 27% last year to 35% this year. Even more are thinking about it. While most of these were hired on a project-specific basis, the percentage of consultants engaged on a continuous basis doubled from last year.
  • Almost a third of directors believe their company's strategy and IT risk mitigation is not adequately supported by a sufficient understanding of IT at the board level. And only about a quarter "very much" agree that the company provides them with adequate information for effective oversight.
  • The majority of directors have evolved their practices to be more engaged in overseeing traditional IT issues: the status of major IT implementations and the annual IT budget. These account for the highest levels of director engagement (80% and 63%, respectively). But directors say they are not sufficiently engaged in understanding the company's level of cyber-security spend (24%) and competitors' leverage of emerging technologies (22%).
  • Nearly two-thirds of directors (64%) believe recent regulatory and enforcement initiatives have not increased investor protections, and 77% don't believe such actions have increased public trust in the corporate sector. In addition, 51% think these efforts have not enhanced transparency to stakeholders "very much" or at all.
  • Nearly three-fourths of directors feel that increased regulation and enforcement initiatives have added costs to companies that exceed the benefits, and 56% believe they have put excessive burdens on directors. Over a third (36%) responded that such initiatives have contributed to unreasonable expectations of director performance.
  • Despite their perceived increased influence, proxy advisory firms appear to be losing ground when it comes to their credibility with directors. Directors' ratings of the firms' independence, thoroughness of work, and quality of voting recommendations all declined in 2013.

A summary of selected insights reflecting the best of the boardroom is included in the first part of this report. The appendix includes other graphs and survey results.

October 11, 2013
In Decent Disclosure: FASBs Releases FAQs, IASB Sets Cross-Functional Team

Yesterday, the IASB announced the formation of a new cross-functional staff group to work on its Disclosure Initiative launched earlier this year. Concurrently, the FASB Board further publicized a Field Study and released a set of Frequently Asked Questions (FAQs) on its Disclosure Framework project.

IASB Forms Cross Functional Staff Group for Disclosure Initiative, From Standard-Setting, XBRL

The new staff group formed for the IASB's Disclosure Initiative combines staff whose focus is in the standard-setting arena, with staff from the International Financial Reporting Standards Foundation's eXtensible Financial Reporting Language (XBRL) team.

As noted in the IASB's press release:

The creation of a combined team of standard-setting and electronic reporting experts reflects the increasing importance of electronic filing of financial information.

Materiality Among Points of Focus in IASB Disclosure Initiative

Among the short-term points of focus in the IASB's Disclosure Initiative, as illustrated on this Disclosure Initiative Overview diagram published by the IASB, is Materiality. Other short-term points of focus include narrow-focused amendments to IAS 1, and a review of disclosure requirements in future Exposure Drafts (EDs). Items identified as "medium term steps" relate to certain specific standards, the Financial Statement Presentation Project, and a research project reviewing existing standards.

A lot of great information is available on the IASB's Disclosure Initiative- Project News History page, including a link to IASB Chairman Hans Hoogervorst's major speech given earlier this year, which we covered in, Breaking the Boilerplate; Mastering the Microwave: The IASB Has Something to Say.

Although the IASB's Disclosure Initiative project and the FASB's Disclosure Framework project are running independently, the two boards are able to observe each other's work, and comments have been made to that effect in remarks by members of the boards.

FASB Releases FAQs, Conducts Field Study, on Disclosure Framework Project

Separately but concurrent with the IASB's announcements above, the FASB has some announcements of its own on its Disclosure Framework project.

First, among the updated information noted with an asterisk on FASB's Disclosure Framework project page, updated as of Oct. 10, 2013, is that:

The FASB is in the process of conducting a field study to test public and private companies', and not-for-profit organizations' abilities to exercise discretion over which disclosures they provide in notes to financial statements.

To better understand the FASB's decisions to date on the Disclosure Framework project, which has been "bifurcated" so to speak into 2 components - i.e. how the FASB should reach decisions on requiring disclosures as part of its standard-setting role, and how entities should reach decisions on providing disclosures - the FASB published a document yesterday entitled Frequently Asked Questions About the FASB's Disclosure Framework Project.

There is much of interest to read in the FASB Disclosure Framework FAQs as it explains in brief, plain English terms how the FASB has deliberated to date on this project.

Of particular interest to people who may have been hoping this project would simplify Disclosures, reduce complexity, or rectify "disclosure overload," they answer may be - "maybe" - but that is not necessarily the uppermost goal of the project - although it maybe a secondary goal.

As stated in the Disclsoure Framework FAQ:

  • The objective of the Disclosure Framework project is to improve the effectiveness of disclosures in notes to financial statements, not necessarily to reduce the volume of notes

On the subject of 'disclosure overload,' see, e.g. the KPMG - Financial Executives Research Foundation (FERF) report, Disclosure Overload and Complexity: Hidden in Plain Sight.

Additionally, the Disclosure Framework project will not necessarily be able to eliminate all "overlap" between FASB and SEC requirements (as noted in FAQ #5) and companies should take note that FASB is looking at interim as well as annual disclosures (see FAQ #6).

Cost-Benefit of Auditing Footnote Disclosures Among Considerations

FAQ#5 notes that the cost-benefit of requiring information to be included in footnote disclosures includes, among other things, the costs of auditing that information. As stated by FASB in the FAQ document:

  • The FASB would evaluate the timeliness of the information, the proximity to other relevant financial information, and incremental costs such as audit and process changes.

In other Disclosure Framework related news, see FASB's Summary of Board Decisions summing up decisions reached at its meeting earlier this week on the subject of The [FASB] Board's Decision Process.

FEI Webcast Oct. 23: PCAOB's Proposal on the Auditor's Reporting Model

If you are interested in issues relating to cost-benefit of your audit, and potential changes on the horizon arisin' from the PCAOB's proposed standard out for comment on the Auditor's Reporting Model, we invite you to FEI's October 23 webcast, featuring PCAOB Board Member Jay Hanson and PCAOB Chief Auditor Marty Baumann, reviewing the proposed standard. Questions can be submitted by listeners, and 1 CPE will be offered. Learn more about, and register for FEI's Oct. 23 webcast featuring Jay Hanson and Marty Baumann of the PCAOB on the proposed standard on the Auditor's Reporting Model, here.

October 11, 2013
Google: Great Deal or Greatest Deal?
by Ben Sperry

Critics of Google have argued that users overvalue Google's services in relation to the data they give away. One breath-taking headline asked Who Would Pay $5,000 to Use Google?, suggesting that Google and its advertisers can make as much as $5,000 off of individuals whose data they track. Scholars, such as Nathan Newman, have used this to argue that Google exploits its users through data extraction. But, the question remains: how good of a deal is Google? My contention is that Google's value to most consumers far surpasses the value supposedly extracted from them in data.

First off, it is unlikely that Google and its advertisers make anywhere close to $5,000 off the average user. Only very high volume online purchasers who consistently click through online ads are likely anywhere close to that valuable. Nonetheless, it is true that Google and its advertisers must be making money, or else Google would be charging users for its services.

PrivacyFix, a popular extension for Google Chrome, calculates your worth to Google based upon the amount of searches you have done. Far from $5,000, my total only comes in at $58.66 (and only $10.74 for Facebook). Now, I might not be the highest volume searcher out there. My colleague, Geoffrey Manne states that he is worth $125.18 on Google (and $10.74 for Facebook). But, I use Google search everyday for work in tech policy, along with Google Docs, Google Calendar, and Gmail (both my private email and work emails)... for FREE!*

The value of all of these services to me, or even just Google search alone, easily surpasses the value of my data attributed to Google. This is likely true for the vast majority of other users, as well. While not a perfect analogue, there are paid specialized search options out there (familiar to lawyers) that do little tracking and are not ad-supported: Westlaw, Lexis, and Bloomberg. But, the price for using these services are considerably higher than zero:

Can you imagine having to pay anywhere near $14 per search on Google? Or a subscription that costs $450 per user per month like some firms pay for Bloomberg? It may be the case that the costs are significantly lower per search for Google than for specialized legal searches (though Google is increasingly used by young lawyers as more cases become available). But, the "price" of viewing a targeted ad is a much lower psychic burden for most people than paying even just a few cents per month for an ad-free experience. For instance, consumers almost always choose free apps over the 99 cent alternative without ads.

Maybe the real question about Google is: Great Deal or Greatest Deal?

* Otherwise known as unpriced for those that know there's no such thing as a free lunch.

View today's posts

10/14/2013 posts

D & O Diary: FDIC Statement Inveighs Against D&O Insurance Exclusions and Coverage for Civil Money Penalties.
The Beck Law Firm, LLC Blog: FINRA's Minor Rule Violation Letter Plan Expanded
SEC Actions Blog: SEC Enforcement: Is the Swagger Back?
Race to the Bottom: SEC Chair Voice Doubts on Conflict Minerals Rules
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Insider Trading in the Derivatives Markets
Delaware Corporate and Commercial Litigation Blog: Delaware Supreme Court Lifts Injunction; Allows Vivendi/Activision Deal to Proceed
Pension Risk Matters: Pensions Going Postal
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Directors Survey: Boards Confront an Evolving Landscape
FEI Financial Reporting Blog: In Decent Disclosure: FASBs Releases FAQs, IASB Sets Cross-Functional Team
Truth on the Market: Google: Great Deal or Greatest Deal?

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