In recent years, there has been increasing criticism from regulators, academics, and others of the practice of directors relying solely on the investment bankers involved in the transaction at issue to provide fairness opinions with respect to that transaction.  The reason for this is clear:  a potential conflict of interest.  As one academic has explained, under the typical investment banking fee arrangement, “compensation is a success fee payable to the bank at transaction milestones such as announcement or completion,” and the “investment bank therefore has a hefty incentive to ensure that the contemplated transaction for which it will issue a fairness opinion progresses to completion.”  But, S. Davidoff writes that conflict arises where a bank is asked to opine and advise on a transaction that it stands to benefit from only if the transaction transpires. In fact, under the fee structure explicated above the bank will not be paid if it cannot find fairness.”

The reason directors secure fairness opinions, as BusinessWeek has explained, is to “give directors a shield in court when unhappy shareholders sue.  The opinions are evidence that the directors checked with outside experts to make sure that the deal is fair to shareholders whom they represent.”  As FINRA put it in November, 2007, fairness opinions “are routinely used by directors . . . to satisfy their fiduciary duties to act with due care and in an informed manner.”

While fairness opinions are regularly published in proxy materials relating to major transactions, the primary intended beneficiaries of fairness opinions are not shareholders, but rather directors.  The principle purpose of the fairness opinion is to provide directors with expert assurance that the consideration in the transaction is fair from a financial point of view so that the directors can better defend against any later charge that they failed to discharge their fiduciary obligations in this regard.

Four developments have served to heighten the focus on the conflicts present when the same investment bank that is at the center of a transaction also provides the fairness opinion.  First, in a December, 2005 opinion, the Delaware Chancery Court denied a motion by the directors of TCI for summary judgment dismissal of a complaint challenging their approval of TCI’s acquisition by AT&T.  The opinion stated that hiring the same financial advisors for both deal-making and fairness opinions “raises questions regarding the quality and independence of the counsel and advice received,” noting that “the contingent compensation of the financial advisor, DLJ, of roughly $40 million creates a serious issue of material fact” as to whether the directors could rely on DLJ’s fairness opinion.  In light of this development, Valuation Research advises that corporations “obtain fairness opinions from independent providers,” and that using the same bankers that are doing the deal to provide a fairness opinion may leave “the board members relying on a biased fairness opinion, and thus exposed to lawsuits.”

Second, in the wake of the TCI-AT&T decision, an increasing number of articles began to appear in scholarly journals, legal periodicals, and director-oriented publications highly critical of the practice of relying solely upon a fairness opinion from an investment bank that stands to receive a large fee if, but only if, the transaction is found to be fair and closes.  As one such article in the Los Angeles Business Journal, harshly asserted, “the investment bankers stand to make s lot of money on this deal, but only if it closes.  How, then can they be objective in determining whether the transaction is fair to . . . public shareholders?  The simple, inescapable answer is that they can’t and won’t.”

Third, under FINRA Rule 2290, effective December 8, 2007, fairness opinions must specifically disclose not only contingent-fee conflicts but also past and future business relationships that might lead to a potential conflict of interest when providing a fairness opinion.

Fourth, there has been an ongoing shift in the views of company executives and board members about independent fairness opinions.  This was confirmed in a 2006 survey conducted by Mergermarket at the behest of Houlihan Lokey Howard & Zukin, which reported that a “new fairness opinion paradigm” is emerging.  Specifically, the survey found that, while “24 months ago it was relatively uncommon for companies to actively seek independent (i.e., separate from their M&A advisor) fairness opinions,” now more than half of the executives and directors surveyed said they “were not comfortable having their M&A advisor also act as their fairness opinion provider.” In fact, the survey “respondents felt that the greatest impact of [FINRA Rule 2290] would be an increase in the number of corporations that require a second fairness opinion.”  

While fairness opinions are regularly published in proxy materials relating to major transactions, the primary intended beneficiaries of fairness opinions are not shareholders, but rather directors.  The principle purpose of the fairness opinion is to provide directors with expert assurance that the consideration in the transaction is fair from a financial point of view so that the directors can better defend against any later charge that they failed to discharge their fiduciary obligations in this regard.  Under new FINRA Rule 2290, however, the directors will be put on specific notice of conflicts, if there are any, that may call into question the reliability of the fairness opinion.   The disclosure of such conflicts, in turn, will raise questions as to whether the directors receive any benefit from relying on the fairness opinion.  Indeed, plaintiffs’ lawyers will likely argue that, because of the newly-mandated disclosures, the directors were on notice that the fairness opinion was not reliable and thus acted improperly in purporting to rely on it.  In such circumstances, directors will likely increasingly conclude that, to better protect themselves, they would be well served to secure an independent fairness opinion.

Donald G. Kempf Jr. is a senior advisor at Broadpoint Gleacher Securities Group.  He has previously been general counsel at Morgan Stanley and a partner at Kirkland & Ellis.

FINRA records that the number of new arbitration cases filed with the regulator in the first three months of 2009 jumped 86 percent from the last three-month period, to a total of 1,715. New cases in 2008 were already 54 percent greater than those filed in the previous year, and FINRA anticipates the total this year to hit 7,000, up from about 5,000 in 2008.

The most popular complaint is breach of fiduciary duty, with many investors charging their brokers and dealers with failing to act in the best interests of their clients. 946 such cases were filed in the first three months of 2009, with 758 filings of misrepresentation and 631 alleging negligence.

Other statistics affirm a general distrust on the part of an investing public that has lost so much in the market decline. One survey conducted by the Boston Consulting Group (BCG) saw that only 22 percent of American consumers said they trusted investment advisors to protect their assets.

“When assets decline 30 or 40 percent in value, you realize there are few active advisors who have actually been able to make a difference in terms of performance relative to the market,” said a partner and managing director with the BCG.

Mary Schapiro headed FINRA until she became chairman of the SEC last month. She fell under scrutiny when the Senate questioned her about the lack of oversight by FINRA of Bernard Madoff’s operations.

FINRA’s interim CEO Stephen Luparello was also vigorously questioned by congressional committees examining the handling of Madoff’s ponzi scheme.

Ketchum is currently CEO of the oversight body, NYSE Regulation, and is chairman of FINRA’s board of governors. He will continue his role as FINRA board chairman and told the NYT that he has a “very effective and very aggressive” enforcement team.

”We have to eliminate the stovepipes,” Ketchum said, adding that lacking oversight of investment businesses forces FINRA to operate ”with a blindfold, with our hands tied behind our backs.”

Before becoming chief regulatory officer of the NYSE in 2004, Ketchum was general counsel of the corporate and investment bank of Citigroup Inc. Prior to that, he worked at the National Association of Securities Dealers, the Nasdaq Stock Market and the SEC, where he headed the market regulation division.

Though outgoing SEC head Chris Cox had been slated to serve in his office until 2010, the events of the credit crisis—and Cox’s perceived failure to adequately address it—reportedly sent him packing early in the new Democratic administration took over.

Schapiro, who previously held top posts at the Financial Regulatory Authority and the Commodity Futures Trading Commission, begins her new job with the mission of bringing the SEC back to relevance in a financial landscape recently dominated by the Treasury and Federal Reserve Bank.

The SEC has been widely criticized for its failure to curtail the downfall of the economy. The latest incident of failed oversight involves the $50 billion “Ponzi” scheme allegedly perpetrated by Bernard Madoff—despite repeated red flags throughout his years of operation.

Schapiro is currently CEO of the Financial Industry Regulatory Authority, the securities industry’s regulatory body. She faces her Senate hearing tomorrow.

“She will face some tough questions . . . about Bernie Madoff,” said Joe Borg, director of the Alabama Securities Commission, but overall “she might be the right candidate at this time on most of the issues”.

Schapiro’s methods of dealing with previous problems has raised concerns. David Tittsworth, the director of the Investment Advisor Association, said: “The single biggest concern that we have [about her] is that when she was at Finra she was in favour of a self-regulated regime for investment advisers . . . We oppose that.”

However, many say that her experience would be invaluable if there were a merer of the SEC and the CFTC. Schapiro rebuilt the NASD in 1996 after a price-fixing scandal. She rebuilt it into a strong watchdog and enforcer and then became a driving force behind merging the regulatory functions of the NASD and the New York Stock Exchange. Last year they combined to form Finra.

“She has a lot of credibility . . . and she is a good person at this time to bridge the gap between where we are now and where we need to go [in regulation]“, said Gary DeWaal, general counsel of Newedge, a global brokerage firm.

The merger under question is that between the National Association of Securities Dealers (NASD) and NYSE Regulation, Inc., the former regulation arm of the New York Stock Exchange. The two regulatory organizations were merged to form the Financial Industry Regulatory Authority (FINRA) in July of 2007.

Schapiro, who headed the NASD up to its merger, at which point she took the reins at FINRA, is accused of making false claims on the behalf of the Internal Revenue Service (IRS) in regard to payouts made to member firms of the NASD. The firms, many of whom are plaintiffs in the suits, were offered $35,000 apiece in efforts by the NASD to get the merger approved.

Schapiro claimed at the time that this figure was the most allowed by the IRS, though the tax agency did not actually issue a ruling on the matter until months later. The lawsuits use this error as their basis.

“Our cases raise questions about the transparency, truthfulness and candor of the NASD and its leadership in a major financial transaction with its own members,” said Jonathan W. Cuneo, the lead prosecutor in both cases.

“These lawsuits are meritless, and the second suit is just a dressed-up version of the first one that was rejected by a federal judge,” said F. Joseph Warin, a lawyer representing Schapiro. “The second suit was filed days after Ms. Schapiro was nominated to become chairman of the SEC. It looks to me like a desperate effort to leverage Mary’s nomination to squeeze money out of FINRA before her confirmation vote.”

The SEC, including its offices in New York, Washington DC, and Boston, made a series of investigations into Bernard L. Madoff Investment Securities from 1992 onward, but were unable to determine any but the most lenient of errors on the part of the fund. In their investigations, SEC officials questioned whether Madoff’s fund was guilty of “front running,” obtaining better prices for premium clients, but determined no foul play.

An additional investigation by the Financial Industry Regulatory Authority (FINRA) found only minor technical violations, and did not pursue the possibility of greater abuses. FINRA’s current chairman, Mary Schapiro, has been nominated by President-elect Obama to fill the head position at the SEC in the new presidential administration.

The failure to properly assess what has recently turned out to be the largest Ponzi scheme in history is yet another black eye for the SEC, which has seen its credibility plummet through the credit crisis. SEC critics claim that the agency has been either un- or under-responsive in dealing with the movement of the market in the months leading to and within the economic downturn.

The SEC also ignored accusations by Harry Markopolos, a rival investment banker of Madoff’s, who claimed in 2005 that Madoff’s fund was “the world’s largest Ponzi scheme.” A subsequent investigation by the SEC uncovered no evidence to back up Markopolos’s allegations.

The SEC meets today with Congress to discuss the Madoff case.

Yet board members are increasingly giving them greater credence in deal deliberations. That’s because they can provide important legal cover for the board that it is acting in a fair manner and using sound business judgment. Although a fairness opinion is, by its nature, of limited scope and purpose, its usefulness as an additional level of due diligence can be enhanced if board members actively engage with financial advisors to understand the scope of the fairness opinion, challenge its conclusions, and appreciate its inherent limitations.

Fairness opinions can help directors gain clarity into the soundness of a deal and underscore their duty of care to shareholders. However, they should not be seen as a good governance panacea and do not absolve directors from considering other factors in their deal deliberations. Nor are they a substitute for independent business judgment and scrutiny. The more involved the board is with its advisors throughout the process, the more insight it will glean to help it make the right business decision.

Getting At What’s Fair

Two recent developments affecting fairness opinions are worthy of closer attention by board members: a decision by the U.S. 7th Circuit Court of Appeals involving Credit Suisse and the recent adoption of the new rule (FINRA 2290) by the Financial Industry Regulatory Authority, a non-governmental regulator of securities firms.

The first sheds light on financial advisors obligations and responsibilities, and the advisors terms of engagement when they rely on the management of the advisor’s client (the seller in the Credit Suisse case) for financial information. In the Credit Suisse case, the court found that the bank acting as financial advisor to the buyer (a trust known as HA 2003 Liquidating Trust) was not grossly negligent and had fulfilled its responsibilities under the terms of its engagement when it delivered a fairness opinion based on financial projections provided by manage-ment of the seller. Subsequent to closing, the target company failed to achieve those expected results. The court found that Credit Suisse acted appropriately and in accordance with the terms of its engagement even though management had access to conflicting financial projections provided by another outside advisor that stood in stark contrast to the information management provided to Credit Suisse. The court ruled that Credit Suisse “did not write an insurance policy against managers’ errors of business judgment” and had acted appropriately in relying on the financial information provided by management without independently verifying that information and in accordance with its terms of engagement.

Additionally, because the Credit Suisse engagement agreement did not provide for updates, the court found that Credit Suisse had no obligation to update its fairness opinion between the time the fairness opinion was delivered and the deal closed, even though market conditions had deteriorated dramatically during that intervening period.

This decision highlights the importance of understanding the potential limitations of a fairness opinion created by the specific scope of work carried out by the financial advisor and the quality of information underpinning its analysis. When engaging financial advisors, boards should consider the context of the fairness opinion analysis and the potential limitations of that analysis.

Increased Disclosure

FINRA Rule 2290, adopted late last year, was the outcome of a process initiated a few years ago to review the role of fairness opinions in corporate control transactions. The basic question FINRA aimed to address was whether existing proxy disclosure requirements mandated by the Securities and Exchange Commission (SEC) are sufficient to inform investors about the subjectivity that goes into rendering fairness opinions as well as the potential for insider or advisor biases.

Rule 2290 does not actually prescribe methodology or the type of transactions requiring a fairness opinion. It does, however, prescribe additional disclosure requirements and procedures that FINRA member firms must follow when issuing fairness opinions.

FINRA maintains, as evidenced by Rule 2290, that shareholders are best served through further disclosure of conflicts and enhancement of advisor procedures. The rule requires all FINRA member firms that issue fairness opinions to disclose whether they have material relationships with any party to the transaction. They are also required to disclose whether their fee is contingent on the success of the transaction. Procedurally, FINRA member firms are required to have written procedures outlining processes and to disclose whether a fairness committee was involved in approving opinions issued. They must also disclose whether they have independently verified information relied upon in coming to a conclusion on fairness and whether they expressed any opinion on the fairness of compensation to be received by insiders as a result of the transaction relative to shareholders.

Although Rule 2290 formalizes some of the procedures and disclosures commonly provided by financial advisors, there are several potential implications that directors should understand. For example, the requirement that financial advisors disclose whether they have verified information used as a basis for issuing the opinion may cause more robust processes around record-keeping and information management, and may extend reasonable time-frames required for financial advisors to provide fairness opinions.

In addition, increased disclosure of conflicts and advisory relationships may open debate about the objectivity of fairness-opinion providers and could extend deliberations over business decisions. The board can take steps to minimize conflicts by forming a special committee of independent directors and hiring an advisor to provide a fairness opinion that is otherwise independent of the transaction and whose fee is not dependent on the success of the deal.

Board Practices to Consider

The primary responsibility for determining whether a fairness opinion will be obtained will continue to reside with the company’s board of directors. In turn, directors must be more vigilant than ever in demonstrating they have fulfilled their fiduciary obligation to shareholders. What follows are some items that should be on the to-do list when directors obtain a fairness opinion.

1. Assess Risk

Assessing risk is the starting point for determining whether a fairness opinion would be useful to directors in evaluating the fairness of the consideration to be paid or received in a transaction. Directors should consider the nature of the contemplated transaction and consider the following characteristics that may signal the need for a heightened level of board oversight, which is closely correlated with the need for a fairness opinion:

• Terms and conditions that depart from comparable transactions
• Non-competitive sale process
• Materiality of the transaction
• Multiple classes of equity with different rights
• Substantial executive severance in the event of a change of control
• Related party transactions
• Apparent investor conflicts
• A deal that is far afield from the company’s normal business or operations
• A deal driven by expected synergies
• The amount and type of consideration to be received/paid in the transaction

2. Manage Conflicts

Litigation risk may be heightened in situations in which there are perceived conflicts among parties involved in a transaction, such as a transaction between related parties or if a financial advisor acts in multiple capacities on the same transaction.

Although this does not necessarily indicate a real conflict, directors should have a heightened awareness of the perception of conflict and take action to demonstrate that they have considered such perceived conflicts. This may include forming an independent committee of directors to make key decisions regarding the pending transaction. In cases where a financial advisor is providing a fairness opinion as well as other services on the same transaction, the board may want to consider requiring the financial advisor to use separate teams for different activities and to have those teams observe ethical walls so information is not shared between teams. Or the board may opt to satisfy this need more directly, by engaging an altogether independent financial advisor.

3. Define Scope

Directors should be involved with financial advisors in establishing the scope of the fairness opinion analysis. It can make a big difference whether the scope of the analysis includes a specific consideration of the compensation arising from the transaction to a particular class of shareholders, or just considers transaction compensation as a whole. In addition, transaction compensation structure and the premium over market offered by the proposed counter-party, if any, that diverge from industry norms deserve a deeper dive since they are likely to attract a high level of investor scrutiny. Directors are well advised to engage in detailed discussions with financial advisors at the outset of the fairness opinion analysis to ensure that the scope of the analysis is commensurate with the needs of the transaction.

4. Consider Methodology

Financial advisors will determine methodology largely based on the specifics of the transaction and the nature of the business. This will be influenced by, among other things, any of the basic transactional business factors, including the type of transaction (merger of equals, acquisition, etc.), key risks and value drivers, the nature of the business and stage of development, expected growth and profitability, availability of information, and market capitalization. Financial advisors have wide latitude in applying methodologies, and directors are well advised to not only understand the methodologies, but also why the financial advisors applied them or chose not to use particular approaches. For example, were synergies explicitly considered? If so, how were they analyzed? How will a company engaged in several unique businesses be analyzed? Will those businesses be separately evaluated or will the advisor look at the company as a whole?

5. Understand Limitations

Directors must interpret fairness opinions subject to the limitations of the analysis conducted by the financial advisor. For example, although Rule 2290 requires financial advisors to disclose whether they have independently verified financial information underpinning their analysis, it is not common practice for financial advisors to do so. Directors will, therefore, typically need to conduct additional diligence to get comfortable with the quality of certain information.

6. Review Results

Boards hire financial advisors and pay them a fee for rendering fairness opinions. The value of a fairness opinion is not just in the physical letter delivered by a financial advisor but also the insight that the financial advisor can provide to help shed light on the business decisions boards must make. For this reason, directors are well advised to spend time with their financial advisors to understand the rationale behind their conclusions. Remember, a fairness opinion is the culmination of an extensive analysis and the synthesis of a variety of information that attempts to portray an accurate picture of a company and its intended transaction. What it may not be is objective in the most comprehensive sense of the word.

Roger Ailes, Fox News

Sharon Allen, Deloitte & Touche

Herbert M. Allison Jr., Director

Gavin Anderson, GMI

Philip A. Armstrong, GCGF

Norman R. Augustine, Director

Stephen Bainbridge, UCLA

Maria Bartiromo, CNBC

David Batchelder, Relational Investors

Lucian A. Bebchuk, Harvard Law

Irv Becker, Hay Group

Beverly Behan, Hay Group

Richard Bennett, The Corporate Library

Robert S. Bennett, Skadden Arps

Dennis R. Beresford, U. of Georgia

Ethan Berman, RiskMetrics Group

Ben Bernanke, The Federal Reserve

John Biggs, Director

Leon Black, Apollo

Lloyd C. Blankfein, Goldman Sachs

Richard Blumenthal, State of Conn.

Magnus Bocker, Nasdaq OMX

John C. Bogle, Hall of Fame

Richard Breeden, Breeden Partners

Catherine L. Bromilow, PwC

Beth A. Brooke, E&Y

Warren Buffett, Berkshire Hathaway

Peter Butler, Governance for Owners

Marshall Carter, NYSE Euronext

Martha Carter, RiskMetrics Group

John J. Castellani, Business Roundtable

William B. Chandler III, Chancery Court

Ram Charan, Charan Associates

Peter Clapman, Governance for Owners

John C. Coffee, Columbia Law School

Frederic W. Cook, Frederic W. Cook & Co.

J. Michael Cook, Director

Christopher Cox, SEC

Jim Cramer, TheStreet.com

Andrew Cuomo, State of New York

Kenneth Daly, NACD

Julie Hembrock Daum, Spencer Stuart

George L. Davis, Egon Zehnder Intl.

Stephen M. Davis, Millstein Center

James L. Dimon, JPMorgan

Samuel A. DiPiazza, Jr., PwC

Christopher Dodd, U.S. Senate

Amy Domini, Domini Social Investments

William H. Donaldson, Hall of Fame

Thomas J. Donohue, Chamber of Commerce

Ed Durkin, United Brotherhood of Carpenters

Theodore L. Dysart, Heidrick & Struggles

Jay Eisenhofer, Grant & Eisenhofer

Charles Elson, U. of Delaware

John Engler, NAM

Richard Ferlauto, AFSCME

Timothy Flynn, KPMG

Margaret “Peggy” Foran, Sara Lee

Cynthia M. Fornelli, CAQ

Barney Frank, U.S. Congress

William F. Galvin, State of Mass.

William W. George, Harvard Business School

Kayla Gillan, RiskMetrics Group

Robert J. Giuffra, Jr., Sullivan & Cromwell

Scott Goebel, Fidelity

Holly Gregory, Weil, Gotshal & Manges

Robert Greifeld, Nasdaq OMX

Joseph Grundfest, Stanford Law School

Steven Hall, Steven Hall & Partners

Robert Hallagan, Korn/Ferry Intl.

Laurence P. Hazell, Standard & Poor’s

Edward Herlihy, Wachtell Lipton

Robert Herz, FASB

John A. Hill, Putnam

Paul Hodgson, The Corporate Library

Christopher Hohn, TCI

Michele J. Hooper, Director

Anthony J. Horan, JP Morgan

Carl Icahn, Icahn Investments

Ray R. Irani, Occidental Petroleum

Edward Kangas, Director

Adam Kanzer, Domini Social Investments

Henry Keizer, KPMG

Donald Keough, Director

Joe Kernen, CNBC

Richard Ketchum, FINRA

Charles King, Korn/Ferry Intl.

Catherine Kinney, NYSE Euronext

Jannice L. Koors, Pearl Meyer & Partners

Richard H. Koppes, Jones Day

Henry Kravis, KKR

Frederick J. Krebs, ACC

John A. Krol, Director

Robert Kueppers, Deloitte & Touche

Arthur Levitt, Hall of Fame

Martin Lipton, Wachtell Lipton

Jay W. Lorsch, Harvard Business School

Joann Lublin, Wall Street Journal

Steve Mader, Korn/Ferry Intl.

Ken Marzion, CalPERS

Mary Pat McCarthy, KPMG

Bill McCollum, State of Florida

Robert McCormick, Glass Lewis

Blythe J. McGarvie, Director

William McGuinness, Fried Frank

Patrick McGurn, RiskMetrics Group

W. James McNerney, Jr. Boeing

James P. Melican, PGI

Pearl Meyer, Steven Hall & Partners

Bill Miller, Legg Mason

Ira Millstein, Hall of Fame

Nell Minow, The Corporate Library

Robert A.G. Monks, author, Corpocracy

Peter Montagnon, ABI

Gretchen Morgenson, New York Times

Anne Mulcahy, Xerox

Anne Mule, Sunoco

Rupert Murdoch, News Corp.

Alan Murray, Wall Street Journal

Jim Naughton, Corporate Governance Blog

Thomas Neff, Spencer Stuart

Duncan Niederauer, NYSE Euronext

Joseph Nocera, New York Times

Floyd Norris, New York Times

Mark Olson, PCAOB

James Owens, Caterpillar

Michael Oxley, Hall of Fame

William Patterson, CtW

Henry M. Paulson, Jr. U.S. Treasury

Harry Pearce, Director

Harvey L. Pitt, Kalorama Partners

Becky Quick, CNBC

Carl Quintanilla, CNBC

David Rubenstein, Carlyle Group

Paul Sarbanes, Hall of Fame

Charles E. Schumer, U.S. Senate

Stephen A. Schwarzman, Blackstone

Mary Shapiro, FINRA

Damon Silvers, AFL-CIO

David W. Smith, SCSGP

Michael Smith, AIG

Jeffrey A. Sonnenfeld, Yale School of Management

Larry W. Sonsini, Wilson Sonsini

Andrew Ross Sorkin, New York Times

Myron T. Steele, Delaware Supreme Court

Leo E. Strine, Chancery Court

David N. Swinford, Pearl Meyer & Partners

John Thain, Merrill Lynch

Andrew Tuch, Corporate Governance Blog

James S. Turley, E&Y

E. Norman Veasey, Weil Gotshal & Manges

Stephen Wagner, Deloitte & Touche

Carol Ward, Kraft Foods

Henry Waxman, U.S. Congress

Ralph Whitworth, Relational Investors

John Wilcox, TIAA-CREF

Note: More than 100 individuals are named because some listings contain more than one person at the same company or in the same industry.

For the complete 2008 Directorship 100 article, click HERE.

The Securities and Exchange Commission issued a statement announcing that it and other regulators will immediately start investigating the intentional spread of false information intended to manipulate securities prices.

The SEC has been cracking down on short sellers suspected of spreading false negative information, with a focus on the troubled financial services sector. The new campaign is an attemp by the Commission to be more proactive about it. The move comes amid a meltdown of bank stocks and clamouring by some for an SEC investigation into market manipulation by short sellers. Most recently, law firm Wachtell, Lipton Rosen & Katz called on the agency to investigate. 

Examiners are focusing on enforcing broker-dealer and investment adviser compliance controls. Examinations will be conducted by the SEC’s Office of Compliance Inspections and Examinations, as well as the Financial Industry Regulatory Authority and New York Stock Exchange Regulation.

“The examinations we are undertaking with FINRA and NYSE Regulation are aimed at ensuring that investors continue to get reliable, accurate information about public companies in the marketplace,” said SEC Chairman Christopher Cox. “They will also provide an opportunity to double-check that broker-dealers and investment advisers have appropriate training for their employees and sturdy controls in place to prevent intentionally false information from harming investors.”

In recent news, financial firms such as Lehman Brothers Holdings, Fannie Mae, and Freddie Mac were engulfed in government bailout and merger rumors. The announcement was timed to serve as a warning shot to traders prior to the beginning of the trading week, according to The Wall Street Journal.

In a statement issued by the FINRA, firms are reminded of NYSE regulations to monitor trading activity. The FINRA also warns that any market participants intentionally spreading false rumors will be rigorously investigated and subject to civil and criminal prosecution.

Executives at the investment bank have complained that the flight of capital was part of the reason it turned to JPMorgan Chase & Co. and the Federal Reserve Bank for financing and to stave off its outright collapse.

In a briefing to its clients last week, Weil, Gotshal & Manges forewarns that such “short and distort” conduct is at the very least being taken seriously by regulators here in the U.S. and the U.K. in anticipation of criminal indictments and possibly new regulations.

Testifying last week before the Senate Banking Committee, Securities and Exchange Commission Chairman Christopher Cox said that the SEC “takes very seriously its responsibility to investigate allegations [concerning the spreading of rumors designed to affect the market value of an issuer’s equity securities], and there have been ample allegations made.”

Similarly, in a joint news release issued late last month by the Financial Industry Regulatory Authority (FINRA), NYSE Regulation, and participants of the Options Regulatory Surveillance Authority said that “[m]arket participants should be especially aware that intentionally spreading false rumors or engaging in collusive activity to impact the financial condition of an issuer will not be tolerated and will be vigorously and aggressively investigated.”

Moreover, the U.K.’s Financial Services Authority (FSA) issued a warning stating it would “not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumors and dealing on the back of them.”

“Short and distort” conduct was also a topic at the annual Compliance and Legal Seminar of the Securities Industry and Financial Markets Association were enforcement officials from the SEC, FINRA and the FSA indicated that they are investigating this type of conduct.

Spreading false rumors in order to induce others to trade in a company’s securities may constitute market manipulation under Sections 9 and 10(b) of the Securities Exchange Act of 1934. On the Self-Regulatory Organization front, NYSE Rule 435(5) and its FINRA corollary prohibit member firms from circulating “in any manner rumors of a sensational character which might reasonably be expected to affect market conditions on the Exchange,” the Weil, Gotshal memo pointed out. Criminal charges were brought against the Toronto-based insurance conglomerate Fairfax Financial Holdings Ltd. against S.A.C. Capital Management and other defendants, alleging a “massive and fraudulent disinformation campaign” coupled with short-selling.

“The increased awareness of possible ’short and distort’ practices, the strong statements by securities regulators and the number of investigations currently pending suggest that an increase in regulatory enforcement and litigation in this area is likely,” the law firm memo concluded.

The likely nominees are two securities lawyers: Luis Aguilar, a partner with McKenna Long & Aldridge in Atlanta; and Elisse Walter, a senior executive vice president at the Financial Industry Regulatory Authority (formerly the National Association of Securities Dealers.)

According to his law-firm biography, Aguilar focuses on corporate governance, public and private offerings (IPOsand secondary offerings), mergers and acquisitions, mutual funds,investment advisers, broker-dealers, and other aspects of federal andstate securities laws and regulations.

The announcement ends speculation that the President would not fill the spots vacated by the resignations of Roel Campos and Annette Nazareth. The five-person commission can not have more than three members who are in the same political party as the president.

If the two are confirmed by the Senate, which is likely considering that they have the support of Reid and of President Bush, Aguilar would fill the seat formerly held by Campos that expires in June 2010 and Walter would fill Nazareth’s seat, which does not expire until mid-2012.

Both nominees have worked at the SEC in the past. Aguilar was a former SEC attorney and Walter was a deputy director in the SEC’s corporate-finance division.

A timetable for Senate confirmation has yet to be set.