Monthly Archives: January 2013

AIG Declines to Join Shareholder Lawsuit against U.S.

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

Last week, the American International Group (AIG) board considered whether to join a lawsuit against the U.S. government alleging the terms of the company’s $182 billion bailout and takeover were too onerous.  The company’s directors heard arguments from the plaintiff in the case, former AIG CEO Maurice Greenberg, and lawyers for the Treasury Department. After the presentations, the board decided not to join.

The initial class action suit was filed in 2011 in both the Southern District of New York and the Court of Federal Claims by Mr. Greenberg’s new company Starr International Co. The suit, filed  on behalf of AIG shareholders, alleges that the Federal Reserve’s and the Treasury’s bailout resulted in dilution of AIG shareholder equity violating the takings clause of the Fifth Amendment. The complaint alleges that issuing additional shares was necessary to accommodate the government’s demand for an 80 percent equity stake. Eventually, the shares were issued without shareholder approval and in contravention of a shareholder vote rejecting the issuance, states the complaint. The complaint alleges that the resulting dilution of shareholder equity and voting power from the additional shares constituted a taking of private property without due process of law.  The complaint similarly alleges that the 14.5 percent interest rate charged on federal loans was a punitive attempt to provide a backdoor bailout to the rest of the financial industry.

In July 2012, the Court of Federal Claims rejected the Treasury’s motion to dismiss as to the takings claims, finding that the complaint sufficiently identified government actions requiring just compensation. In so doing, the court rejected the government’s argument that shareholders did not have a cognizable property interest in the equity and voting power associated with their shares. The Southern District of New York Court, however, dismissed the claims as to the Federal Reserve. That case is currently pending appeal in the Second Circuit.

AIG’s consideration of the lawsuit spurred controversy given the perception of success regarding the bailout.  AIG has been running commercials exclaiming “Thank you America.” However, its decision not to join the suit could open it to potential additional shareholder litigation if it misses out on a sizeable settlement attained by Mr. Greenberg.

Firm Advice: Your Weekly Update

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

While much attention has been paid to increasing taxes on high-income earners as a result of the fiscal cliff compromise (the American Taxpayer Relief Act of 2012), less attention has been paid to the compromise’s corporate tax provisions. In a recent Tax Department Update, Latham & Watkins summarizes the effects of the compromise on both individuals and businesses. The Update also covers the compromise’s effects for various energy-related credits, including the extension of a tax credit for qualified wind facilities. The Update is available for download here.

As part of the Dodd-Frank Act’s requirement for regulated and centralized derivatives trading, many nonfinancial companies that use derivatives may be required to register with the CFTC. However, there is an exception for a “nonfinancial end user.” In general, to qualify as a non-financial end user, the company must not be a swap dealer, major swap participant or other “financial entity.” Additionally, the derivatives must be used as for commercial, rather than investment, purposes. WilmerHale’s recent Corporate and Futures and Derivatives Alert provides a thorough explanation of the application of this exception for nonfinancial companies.

Gibson Dunn recently hosted its ninth-annual webcast, “Challenges in Compliance and Corporate Governance.” Corporate Counsel viewed the webcast and derived seven takeaways for 2013.  Among these lessons is that firms should broaden their focus. Between the SEC’s regulations on conflict minerals and sanctions on Iran, broad-based compliance efforts are necessary.  Another lesson is that firms should not forget the compliance tone in the middle. While many compliance officers focus on setting the tone for upper management, it is often middle managers who receive tips and should be trained on proper compliance procedures.  Check out the other takeaways here.

 

The Section 83(b) Election and the Fallacy of “Earned Income”

By Professor Matthew A. Melone, Lehigh University | Posted on

[Editors Note: This post is part of a series by authors in the forthcoming edition of the Berkeley Business Law Journal, which in conjunction with the Berkeley Center for Law, Business and the Economy, sponsors this blog. Professor Melone teaches graduate and undergraduate courses at Lehigh University’s College of Business and Economics. His research interests include federal income taxation and corporate governance. He has written extensively about comparative forms of doing business, executive compensation, partnership taxation, and accounting standards.]

The controversy over the taxation of income derived from “carried interests” and the apparent consensus that the taxation of such income unjustifiably converts erstwhile labor income into favorably taxed capital gains provide stark evidence of the degree to which a consensus has emerged that equity gains during the course of one’s employment are attributable to labor and should be taxed accordingly. Critics of the taxation of “carried interests” have also set their sights on what they believe is the corporate counterpart to such interests – the section 83(b) election. This election allows the recipient of non-vested stock to lock in the compensatory element of the transaction at the time that the stock is granted. Post-grant appreciation is taxed at capital gain rates. I agree that the election should be eliminated, but not because it fails to capture the essence of the transaction, but because it does precisely that. Therefore, the current elective treatment should be made mandatory.  (more…)

Firm Advice: Your Weekly Update

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

Late last year, the Federal Reserve issued guidance on its new framework for supervising large financial institutions.  The Federal Reserve’s primary objectives will be to increase the resiliency of financial institutions, and to reduce the impact of an institution’s failure on the broader economy.   Changes include a greater emphasis on recovery and orderly resolution planning as required by Dodd-Frank.  In a recent publication, Sullivan & Cromwell reviews the specifics of the recent changes and explains how their implementation may differ from the previous regulatory framework.

The expectation that courts will recognize and enforce the insolvency proceedings of foreign courts is essential to certainty and predictability of cross-border transactions.  This is especially important where the two nations’ bankruptcy laws materially differ.  Three recent decisions in the U.S. and U.K. call into question whether such an expectation is reasonable.  In one of the cases, the Fifth Circuit held unenforceable a $3.4 billion restructuring plan approved by a Mexican court as “manifestly contrary to the public policy of the United States.”  The Fifth Circuit took issue with the Mexican court’s decision that shareholders receive $500 million in value while higher-ranking creditors receive only 40 percent of their claims.  In a recent client alert, DLA Piper explains the implications of these decisions for certainty and predictability of cross-border transactions.

The U.S. District Court for the District of Columbia recently dismissed a lawsuit challenging recent amendments to CFTC Rule 4.5. With limited exceptions, the amendments require registration by investment companies that trade in futures, options, and commodities. The plaintiffs, the Investment Company Institute and the U.S. Chamber of Commerce, argued the amendments were arbitrary and capricious in violation of the Administrative Procedure Act and that the CFTC failed to perform adequate cost-benefit analysis. In rejecting these arguments, the court found that the link between unregulated derivatives and the financial crisis provided an adequate basis for the amendments. In a recent Client Alert, Ropes & Gray explains the court’s reasoning and the decision’s implications for registered investment companies.

Forthcoming in California Law Review: “From Independence to Politics in Financial Regulation” by Stavros Gadinis.

By Andrew B. Talai, J.D. Candidate 2014 | Posted on

Berkeley Law Professor Stavros Gadinis’s latest article, “From Independence to Politics in Financial Regulation,” is forthcoming in the California Law Review.  Professor Gadinis’s work focuses on the intersections between finance and government regulation.  This particular paper takes a global look at how governments reformed their “independent” financial regulatory agencies by making them more politically accountable after the 2007-08 financial crisis.

We at the Network found this article particularly interesting because it focuses on the fundamental—and often taken for granted—relationship between administrative law and business law.  In the United States, “agency independence has long been the hallmark of financial regulation.”  In fact, most governmental financial regulation occurs within the “headless fourth branch,” i.e., independent administrative agencies like the Federal Reserve (“the Fed”), Federal Deposit Insurance Corporation (“FDIC”), and Securities and Exchange Commission (“SEC”).

Historically, these governmental entities, corporations, boards, and commissions often have been insulated from direct democratic forces.  The theory is that, free from “generalist” whims and electoral politics, agency independence allows neutral “subject matter experts” to focus their particular skill and knowledge on the specialized problems they were commissioned to solve. Further, independent agencies bring the country long-term stability and uniformity.  Whereas elected politicians, so the theory goes, are often biased towards short-term goals to capture votes in the next electoral cycle.

When scholars speak of “independence” from political influence, they largely mean from the President’s removal power.  It has long been settled that Congress may “under certain circumstances, create independent agencies run by principal officers appointed by the President, whom the President may not remove at will but only for good cause.”  Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. __ (2010) (slip op. at 2).

However, too much independence can become a problem.  For example, in Free Enterprise Fund the Supreme Court held that a dual for-cause removal scheme Congress set up in the Sarbanes-Oxley Act was ultra vires of the Constitution’s separation of powers.  The Act placed members of the Public Company Accounting Oversight Board (“PCAOB”) under the SEC’s control, removable only for cause.  In turn, SEC commissioners were only removable by the President for-cause.  This novel structure, Chief Justice Roberts held, prevented the President from discharging his duty to “ensure that the laws are faithfully executed—as well as the public’s ability to pass judgment on his efforts.”

The anxiety that motivated Chief Justice Robert’s opinion in Free Enterprise Fund could partly be described as a fear of Congressional aggrandizement at the expense of the Chief Executive.  But it could also be described as a distrust of the growing independence of democratically unaccountable bureaucrats—the same distrust that Professor Gadinis comments on in his most recent article.

Professor Gadinis argues that a coalescence of unique atmospheric factors post the 2007-08 crisis led to a global shift from financial regulatory independence toward greater political accountability.  According to Professor Gadinis’s argument, those factors include (1) pervasive failures across multiple agencies charged with financial regulation, (2) failure of the market to self-correct, (3) fear of agency capture, (4) unprecedented voter interest, and (5) welcomed political assistance.

Professor Gadinis’s empirical data supports his premise in the United States, France, Germany, Australia, Belgium, Spain, Denmark, the United Kingdom and Ireland.  Only a few countries surveyed did not evince an increase in political accountability, and that was because they either already had a highly politically accountable system or were in the process of working out legislation.  In the United States, for example, one way this shift materialized was through the Dodd-Frank Act.  Significantly, the move toward political accountability did not take the traditional route, e.g., Appointment and Removal powers.  Instead, Congress sought to retain independent subject matter expertise, but at the same time make the Secretary of Treasury—who is directly accountable to the President—the final arbiter of agency decisions, rather than the agency head.

The upshot of all of this is that the administrative financial regulatory system in the United States, and likely worldwide has seen a paradigm shift.  While this shift can simply be seen as moving independent agencies back within the traditional executive agency structure, it is important to remain cognizant of the hazards of too much political influence.  After all, the benefits of the independence model are also the downsides of the political model.  Professor Gadinis discusses how, in the bailout context, considerations of electoral timing, adverse public opinion detached from economic reality, and opportunities for massive political contributions could improperly influence political actors.  Only time will tell where the line will be drawn in this canonical administrative law paradox.

Make sure to read the final version of the article in the California Law Review. The abstract is available after the jump. (more…)