The Law and other Anomalies -

On a recent visit to Boston, Attorney Steve Shapiro (General Counsel to the American Civil Liberties Union) outlined matters before the Supreme Court today, or likely to arise in the coming 2012-2013 session. 

I.    Obama - Care

The gorilla in the room is litigation concerning the healthcare law (designated derisively by some as “Obama Care” but we in Massachusetts really know it more by its original name: “Romney Care”).  In an unprecedented move, the Court extended its usual one hour argument time by a factor of six in order to hear arguments on specific issues posed by the Court itself:

• Is the case ripe to be decided today since most of the provisions, including the requirement to obtain health insurance (the so-called “individual mandate”), don’t take effect until 2014? 
• Since the IRS can collect the penalty for violating the individual mandate only by offsetting tax refunds, and since there is an established rule of law that you can challenge a federal tax provision only after the tax is paid, will it ever be possible to challenge the law from the “tax” standpoint? 
• Can a citizen be forced to buy a commercial product such as insurance? 
• If the Supreme Court strikes the individual mandate, what other parts of the law if any are so inter-related that they must also be stricken? 

Why is the Civil Liberties Union interested in the healthcare law, bearing in mind it is not overtly a civil liberties statute and the ACLU has taken no position as to whether the healthcare law is wise legislation?  The reason has to do with Commerce Clause of the Constitution; the ability of the Federal government to pass the healthcare law is dependent upon whether such legislation fits within the constitutional grant of authority to the Federal government to regulate interstate commerce, and a broad reading of the Commerce Clause of the Constitution is necessary in order to support a variety of civil rights legislation which is similarly premised. 

Shapiro noted that there is political pressure on the Supreme Court to decide this issue now, regardless of the technicalities as to whether it is “ripe.”  As to the question of whether the case is appropriate for decision where the “tax” has yet to be collected, Shapiro points out that the Administration has firmly taken the position (requisite in the current economic climate) that the IRS-collected penalty is simply not a tax.  Indeed, its collectability is only as an offset from otherwise government-owed refunds which may never arise. 

Whether a citizen can be forced to buy insurance is fascinating.  It seems clear that State governments could in fact impose such a requirement, because it is an exercise of the general police powers.  But the Federal government only has those powers which are expressly afforded to it by enumeration in the Constitution.  All other powers are retained by the people and the States.  Thus for example, the similar Massachusetts Healthcare Law cannot be attacked on the ground of lack of government authority. 

In a way it is therefore a shame for the Administration that it has claimed that the penalty is not a tax, since the Federal government clearly is entitled to levy tax pursuant to the Constitution. 

Challengers to the law say that the Commerce Clause cannot support the legislation.  It may be true that if an individual chooses to buy health insurance he then participates in the interstate commerce business of the healthcare system.  But, say opponents, the statute is focused on individuals who do not buy health insurance and, consequently, uninsured individuals subject to this law are by definition not involved in interstate commerce relative to healthcare, as they do not participate.  The government counters by saying that in fact all Americans participate at some point in time, this is a matter not of “if” but simply “when.”  If someone who is not insured requires healthcare, and he does not have insurance, by law he cannot be denied medical care and ultimately that care is paid for by all Americans as part of the interstate commerce of healthcare. 

Shapiro noted that two popular provisions of the healthcare law clearly are within the constitutional powers of the Federal government: that insurers cannot deny coverage for pre-existing conditions, and that insurers cannot increase charges for insurance based upon one individual’s health history.  Since the Constitution grants to the Federal government all other power necessary to effect otherwise constitutional actions, the individual mandate perhaps can be backed into a convenient parking space of constitutionality through this argument, without reference to the Commerce Clause. 

Query: let us say it is true that the Federal government can require an individual to buy health insurance because the Federal government supports a national healthcare system which in turn is part of interstate commerce.  Does that also mean the government can require all citizens to buy a General Motors car because we bailed out GM?  Shapiro suggests that the issues are analytically the same but the political ramifications vastly different. 

How will the case come out?  As in the past, Justice Kennedy is thought to be the key.  But the general thinking is that if the healthcare law is to be stricken, the vote will be five to four.  If, however, there are in fact five votes to retain all aspects of the law (that is, if Kennedy votes in favor of the law), then the vote is liable to be six to three.  Why is that?  Because at that point the Chief Justice is expected to vote to uphold the statute, because then the Chief Justice will be entitled to write the legal opinion, and he would want to write the legal opinion in the narrowest possible terms. 

II.  Immigration

The second leading and as yet undecided case before the Supreme Court is the Arizona “show me your papers” law which requires the police, upon any otherwise permissible detaining of a person (including for example running a red light), if that officer also has a “reasonable suspicion to believe” that a person is in the country illegally, to ask the detainee to prove his legality (green card or some such).  If you cannot, you are to be taken into custody and a call placed to Immigration. 

The key question here is the basis for “reason to suspect” that someone is in the U.S. illegally.  Shapiro's position is that this is an open door in Arizona to racial profiling to accomplish Arizona’s overtly articulated goal: attrition through forced immigration of minorities out of the State. 

The fight over the Arizona Immigration Law is the exact reverse of the fight over the healthcare law: the cases are mirror images.  Why is that?  It is again a question of who has authority to take action.  Under the healthcare law the question is whether the Federal government has authority to act under its constitutionally specified powers (the Commerce Clause).  In the Arizona “show me your papers” case, the question is whether the State has the authority to take any action with respect to immigration which is clearly a primary Federal function. 

Opponents of the law say that immigration is a Federal matter and the States are preempted from acting upon it.  And here the issue is compounded by history.  Historically, immigration indeed was a Federal prerogative both in terms of articulating the law and enforcing it.  In the last Bush Administration, the President’s legal office stated that the Federal government could share enforcement of Federal policy with the States, and that the States therefore could have concurrent authority.  The Obama Administration, although urged to reverse this position, declined to do so.  Consequently the Obama Administration now cannot maintain that the States have no power whatsoever to enforce in the area of immigration.  Now the Obama Administration is therefore required to take the following position: States cannot enforce Federal immigration laws inconsistently.  The response of the State is obvious and based on the facts:  “we do in fact consistently enforce.” 

Shapiro suspects the Supreme Court may indeed uphold the “show me your papers” portion of the Arizona Immigration Law (other provisions clearly will fall), but will still leave open the issue of discriminatory application.  And in that regard, there ultimately may be a victory for the opponents of the law; business and agricultural interests in Arizona (and similar States that have adopted similar laws) have realized that clamping down on immigrants is bad for business, and the political will to enforce the law in a discriminatory manner may well have dissipated. 

III.    Murderous Children

More consistent with the kinds of cases with which the ACLU generally deals are two pending cases involving whether imposing a criminal sanction of life in prison without parole, in cases of murder, can be applied to a minor.  The contrary argument is that it is cruel and unusual punishment violative of the Constitution’s Eighth Amendment.  The Supreme Court previously has held that a sentence of life without chance of parole constitutes cruel and unusual punishment for a minor in all non-homicide cases. 

At this point two cases are pending under an Alabama law against two fourteen year olds (at the time of the crime), one of whom pulled the trigger in a murder and the other of whom was found guilty of murder under the time honored “felony murder rule” (any participant in a criminal act which is a felony, where that criminal act results in someone’s murder, is himself guilty of that murder). 

Shapiro expects that the Alabama law will be determined to be unconstitutional because the Alabama law requires a life sentence without parole in such a case.  He expects that the Court will say that the judge must be left with some discretion with respect to sentencing.  Query whether the Court will go further?  Query whether the Court will establish an absolute minimum age with respect to which a life without parole sentence will always constitute cruel and unusual punishment.  Conveniently in the argument before the Supreme Court in the two Alabama cases, lawyers for the minors claimed that the appropriate absolute minimum age is fifteen while the State of Alabama claimed it was thirteen, artificial line drawing with respect to two defendants who happened to be fourteen years old. 

IV.    Congressional Medal of Honor

Other interesting cases this term include:

United States v. Alverez (a pending case asking whether the statute which criminalizes lying about receiving a military honor such as the Congressional Medal of Honor violates the First Amendment right of free speech); and

Two decided Fourth Amendment search and seizure cases (United States v. Jones asked whether the police with no warrant can put a GPS tracking device on your automobile, answered in the negative by this Court in a rare nine to nothing decision; as compared to Florence v. Board of Freeholders, which asked whether a New Jersey jail can routinely strip search each person held in the jail, no matter how minor the offense and how short the incarceration, an exercise of police power upheld by a five to four vote).  Shapiro suggested that the difference between the decisions in the Jones and Florence cases is one of Court “empathy;” the Justices could imagine, and be shocked by, the government putting a GPS device on their own cars parked in the Supreme Court parking lot (they actually asked the government attorney during argument if the government felt it had the power to do so, and received an affirmative response!) while, it was suggested, the Justices simply could not imagine themselves in a position of being stripped and searched because they ran a red light). 

V.  Coming Attractions

What is liable to come up in the next term?  (The Supreme Court operates on what is an academic year, the cases start getting heard in the Fall and all must be decided by the following June 30^th.) 

There is likely to be another case on whether affirmative action is supportable in university admission settings, re-examining the acceptance of such a criterion in the University of Michigan case several years ago.

There may be a challenge to Section 5 of the 1965 Voting Rights Act, which requires States with a history of voting discrimination to obtain affirmative Department of Justice pre-approval of any change in their voting rules (Obama’s DOJ has struck down two such laws, while allowing a change in Wisconsin voting laws without DOJ review because Wisconsin had no history of voting discrimination). 

It is likely that California Proposition 8 (defining legal marriage as only between a man and a woman) will come before the Court (the statute had been stuck down by three judge panel of the Ninth Circuit [California] Court of Appeals). 

ACLU hopes to bring up the case of Clapper v. Amnesty International, where ACLU raises the Fourth Amendment protection against unlawful search and seizure in a wire-tapping for national security purposes without judicial oversight.  This case presents an anomalous twist: generally you can only challenge United States Federal surveillance powers if you have standing because you have been under surveillance, but under the national securities regime you may well not know that you are under surveillance, and if you ask you will not be told because it is of course a secret national security matter.  This surveillance right was struck down by a three-judge panel of the Second Circuit [New York] Court of Appeals), but the en banc Second Circuit (a conclave of all the judges who sit on the Circuit) was divided six to six. 

Finally, it was asked whether any more litigation was liable to reach the Supreme Court out of the Gitmo detentions.  While there is of course no definitive answer, Shapiro noted that at present all detainee cases go to the Federal District Court for the District of Columbia, which has granted the government broad license to detain a wide variety of suspects, and has determined that although a given detention may in fact be unlawful there is no ready remedy because the detained individuals cannot be set free in the United States and the courts cannot compel deportation. 

The other day at UMass Boston, MassMEDIC (the trade organization of Massachusetts medical device companies) held its 16^th Annual Conference.  It was well attended, and my prior blog post reported Covidien CEO Jose Almeida’s comments for the advancement of the United States medical device industry. 

Another speaker, Yair Holtzman, is a director at WTP Advisers of White Plains, New York, where he focuses on business advisory services to the life science industry.  A CPA and MBA, Yair ambitiously traced the current and future states of R&D in device development.  Let me take a stab at summarizing the high points. 

In the past, the United States has been dominant in the medical device market through a combination of its head start with a large number people working within the field, deep expertise, entrepreneurial investment, a robust middle class that drove medical device advances, and a group of patients who could afford to be price-insensitive when it came to buying medical services.  A large number of hospitals, and the leadership of the FDA in device safety, didn’t hurt. 

International R&D, as many have noted, is greatly increasing.  Reimbursement has become an issue in the United States, creating concern for ROI that can be derived from R&D efforts.  Added pressure was placed on U.S. ROI for many other reasons, as outlined by Covidien’s Almeida (see the May 1^st post).  China and India have growing middle classes and growing expertise; they may well develop medical device products and not even bother to have them cleared in the United States.  Approval of devices in Europe takes half the time of FDA review; Brazil, India and China are becoming very entrepreneurial and are attracting substantial investment.  Germany and Israel have substantial medical device expertise.

 For these reasons the United States, historically a leader in the production and consumption of medical device advances, may find itself left behind the rest of the world. 

Joining the cacophony in criticizing the Affordable Care Act, which in 2013 will assess a 2.3% excise on the gross income of medical device companies regardless of whether or not a profit has been made, Holtzman anticipated that the effect would be “devastating” and urged that the excise be repealed.  Also in order is a reinstatement of the R&D tax credit, which expired at the end of 2011. 

What else must be done in the future?  First, greater speed and predictability must become part of the FDA approval process.  Second, a continuation in the trend to reduce R&D costs through joint ventures and through “farming out” R&D functions must continue.  Third, the industry must recognize certain trends in healthcare: mobile health, personalized medicine, economic efficiency demanded by patients and their reimbursers, and the need for disruptive technologies which will create a paradigm shift in costs and outcomes.  Analytics to demonstrate both health and financial outcomes must become part of device development. 

Holtzman observed a trend in the United States to develop incremental products, as opposed to developing disruptive technologies through R&D expenditure, with the “disruptive” perhaps more likely to be generated offshore.  This development is not beneficial to U.S. industry, to say the least. 

Holtzman also noted that many VCs are establishing offshore presences, including in Israel and Singapore.  Hopefully some of his recommended changes (at the FDA and in tax policy) will again make domestic United States venture investment in medical device companies attractive, but Holtzman added that his firm has success in identifying grants, state credits and local incentives, as well as joint venturing approaches, in order to drive down R&D costs, speed development and thereby improve ROI. 

Interestingly, Holtzman’s remarks also reflected an anomaly which was apparent upon analysis of several recent life science conferences (not just medical devices).  On the one hand, the FDA is praised as setting the standard for review of medical technology which is emulated around the world, and which is one basis for historical American primacy in these markets; on the other hand, the FDA now also is criticized as one of the primary causes of the United States slipping behind the rest of the world. 

At the April Breakfast Meeting of the New England Chapter of the National Association of Corporate Directors, a panel of public company directors faced “the Enemy” in the person of Pat McGurn, who represents the ISS.  For the uninitiated, ISS stands for Institutional Shareholder Services, the company that advises institutional shareholders in public companies as to how they might want to vote on director elections and other proxy issues. 

McGurn noted that in 2011 the ISS made a favorable recommendation on “say-on-pay” votes in 88% of public companies (that is, ISS recommended that in 7 out of every 8 public companies the shareholders vote in favor of the compensation arrangements proposed by management and the board of directors in the advisory, non-binding shareholder votes mandated by Dodd-Frank).  Although it is early in the current proxy season for 2012, he noted that so far ISS has recommended favorably in 86% of the companies that have come before them. 

It should also be noted that historically most companies pass the say-on-pay test with an average positive approval of over 90% of the shareholder votes; in 2011 only 41 companies, or less than 2% of the Russell 3000 Index, actually failed.  Early indications indicate that similar results will obtain in 2012. 

McGurn noted that in 2013 the Dodd-Frank Act say-on-pay provisions become applicable to low cap companies for the first time, which may result in different statistics.  That is, if there is no change in the Federal administration, the suggestion being that a Republican victory might lead to a delay in implementation.  He noted that the April 5^th JOBS Act signed by the President delayed many otherwise mandated compensation disclosures for newly registered companies with sales below $1,000,000,000 which is, after all, most of them. 

What was the effect of a negative ISS recommendation in 2011?  According to McGurn, all but a small handful of boards receiving negative ISS recommendations, whether or not they received negative shareholder votes, responded in some fashion.  Almost all companies changed their compensation to link it better to actual performance.  Each of the three companies who received negative votes in 2011 and who have already had their 2012 annual meetings have received over 90% approval in their 2012 say-on-pay votes by the shareholders. 

The key is not only changing compensation to link it to company performance; the key is also outreach to investors to understand and meet their reactions.  Disclosure is much better of course, and this facilitates communication, but some companies also have been doing formal compensation roadshows. 

The problems with compensation are no longer extra perks, severance and the like, which McGurn described merely as “irritants.”  The issues now are actually tying compensation to performance, and addressing executive compensation which is a multiple of peer group mean compensation. 

There is something of a contrast between this relatively self-satisfied ISS report, on the one hand, and the extensive article in this past Sunday’s New York Times Business Section concerning executive pay.  Discussing pay for the top fifty public company executives whose information has already been reported in this proxy season, the Times article concludes that while executive compensation growth may have leveled off, it has leveled off at an extremely high point in terms of absolute dollars.  Even taking Apple’s CEO out of the equation (earning something in excess of $378,000,000, although most of it was indeed in stock and not cash), CEO compensation in numerous business sectors was significant. 

The panelists, chairs of compensation committees of public companies, had differing reactions.  One panelist noted that, in a highly successful company where compensation was discretionary (but it turns out not above mean), there was resistance to having ISS force mathematical metrics into the equation in order to define and calculate appropriate compensation.  There was also criticism of an over-emphasis on “total shareholder return” which is an important ISS metric; in technology companies with high potential volatility, an executive can be doing an excellent job and yet profitability can take a short term beating because of the realities of the marketplace. 

The ISS response was that they have lengthened their time horizon by which they are comfortable in measuring corporate performance, to take pressure off the very short term, but McGurn did note that his clients (ISS’s clients) are long-term investors, and at some point total shareholder return on investment becomes “the” metric in which his clients have an interest. 

There was also discussion of the somewhat opaque selection of peer groups in which ISS places each company (so that compensation can be measured against what are putatively the company’s peers).  McGurn noted that each company is placed in a peer group wherein that company is placed near the mean in terms of size, further noting that one of the largest determinants of absolute compensation is indeed the size of enterprise. 

In 2012, ISS sees as its hot spot the payment of executive compensation above the peer mean by companies showing mediocre performance, although McGurn assured the group that ISS has no particular performance metric and that each company is entitled to have its own metrics; what he is looking for, he says, is “evidence of intelligent design” as opposed to a rote set of numbers. 

Finally, the panel noted that an effort was being made to address the ratio of CEO compensation to the compensation paid to the rest of the executive team; they declared an end to “the rock star CEO.”  That announcement may come as a surprise to readers of the New York Times CEO survey. 

The Massachusetts Biotechnology Council meeting on The Business of Science concluded March 27, as it began: lots of discussion of the technology, interspersed with programs about the business and financial aspects of bio which all had the same themes: bio is the great wave of the future, Massachusetts is at the forefront, but other geographic bio clusters are hot on our heels and there are many ways we in Massachusetts can be overtaken and surpassed.

One interesting counterpoint came from an Indian panelist who noted that the suppositions that FDA was too slow and too conservative to the detriment of US bio in general, are simply inaccurate.  Notwithstanding the oft-recited tales of horrible delay in FDA, the timing of drug approval overseas in not faster and will not become faster because other countries rely on FDA to set the tone and the standard of review.  This assertion was not directly challenged but was, alas, simply ignored; the final speaker, who was from FDA, was asked in several ways why the FDA moved so slowly.

The FDA position, by the way, articulated by  Dr. Eric Perakslis (Informatics chief), is that they DO hurry when there is a clear unmet medical need; the FDA will be willing to incur risk if the benefit seems to balance it.  The biggest problem the FDA has these days, he noted, was in their newly established regulatory function over tobacco, where he wondered how to measure benefits against risks for a product having no benefits at all.  (My best guess is that Eric is not a big smoker.)

What is impeding Mass bio?  The state gifts ban (which kills interaction that leads to innovation); the unique Massachusetts ban on co-payment assistance which thereby imperils the payment stream; the failure of schools from elementary to Community colleges to train workers in requisite skill sets; anti-immigration laws that now overly restrict special visas; a lack of language skills among our workforce members; lack of government  funded apprenticeships in private industry thereby impeding hiring of skilled and experienced workers; the growth of viable bio clusters elsewhere with governmental support superior to that afforded in Massachusetts (citing particularly Germany and Singapore).

The attendees are all “bio people” and it is hard to separate their valid but survivable complaints from the truly existential threats to Massachusetts biotech companies; every industry has its burdens to bear, and bio is not the only industry that fairly can say that it is over-regulated, under-served by government, not supported by the educational system and, these days, denied essential capital. 

The one extremely positive message that came out of the meeting, however, and one message shared by attendees from within and outside  Massachusetts, is that everyone today believes that Massachusetts has innate advantages in Higher Education and entrepreneurship and that therefore, given appropriate nurturing, bio will be an economic and social engine for the region for a very long time.

This morning’s mail has upset a part of my world view.

Universities long have been accused of being bastions of populist, liberal thought; Northeastern elite universities (along with anomalous Berkeley, the Harvard of the West) have borne the brunt of this accusation. 

Such was not my experience at Harvard Law School; during my attendance (decades ago) it was the bastion of pro-corporate thinking.  Corporations should be minimally regulated so as to return greatest profit to their sole relevant constituency: the shareholders.

My 7:44 AM email today from The Harvard Law School Shareholder Rights Project reports that that group, “a clinical program through which Harvard Law School faculty, staff and students assist public pension funds and charitable organizations to improve corporate governance at publicly traded companies in which they are shareowners,” has been working all year to force public companies to de-stagger their boards.

They have submitted proposals to over 80 of the S&P 500, and 42 (one third of the S&P 500 with staggered boards) have agreed to move to annual elections of the entire board.  The list includes Alcoa, BlackRock, Cigna, Lilly, McDonald’s and PPG.

Several aspects are fascinating.  Leave it to Harvard to apply some of its student outrage in the support of retirement funds who have invested in public companies; not exactly the poor huddled masses being dragged upwards by the power of the law.  Leave it to Harvard to take the training ground of the conservative corporate advisors and turn it towards the “democratization” of corporate governance.  Leave it to Harvard to undertake the remaking of concepts of corporate governance in a way that empowers shareholders whose interests may be short-term and inconsistent with long-term measured corporate growth.

It is not clear where they will turn next, but this kind of success is not going to do anything except further inspire Professor Bebchuck and his hearty band.  The shopping list of corporate democracy demands includes broad proxy access, greater ratchet on comp,  independent board chairs, and independent board majorities.

While no doubt entrenched boards beholden to management sometimes in the past led to failure to respond to favorable takeover bids and to over-compensation of top executives, the causes for these lapses are many and complex and cannot be made to disappear by granting greater power to shareholders.  The small shareholder is and will remain without power.  The larger shareholders have, and are legally entitled to, their own agendas; those agendas may be short term and short sighted and not consistent with healthy corporate growth or innovation.

Two lessons emerge: first, this initiative will ultimate fuel the M&A market; second, directors had better start listening more closely to Professor Bebchuck, whose message and flat presentation have not exactly made him the darling of the corporate speakers’ circuit around Boston.  He is single-handedly remaking corporate governance in America and he is doing it under many radar screens that ought to be picking up the incoming blips.

Zaid Ashai invests money for Point Judith Capital, a private equity firm, and heads their Boston office.  On March 6^th through 8^th  , the Northeast Sustainable Energy Association held its Energy 12 Trade Show at the Seaport World Trade Center in Boston, and Zaid ran a seminar on the VC view of the building energy market. 

Money seems to be flowing into the business of managing energy.  The companies that are getting funded address the demand side: energy efficiency, use, tracking, management.  The supply side is sluggish for investors and may well stay that way for the near term, given the low price of natural gas.  Thus, investment in wind, solar (even though solar companies were lavishly represented at the Trade Show), batteries and the like will encounter difficulties in attracting investment capital. 

Point Judith looks to do Series A investments into the emerging markets, from the $500,000 to $3,000,0000 to $4,000,000 range.  What do they look for?  In order of priority: a management team with emotional self-intelligence and humility, a strong market, and thirdly the product.  Not surprisingly, they strongly recommend avoiding cold submissions to investors; it is common wisdom to try to be introduced to the money rather than simply tossing your business plan over the transom. 

Energy is a regulated and structured market and consequently great care has to be given to the strategy of the business plan.  Are you going to compete with or try to partner with the big players? 

Most interesting to me was the effort to apply information technology to the monitoring and management of the demand side of the energy market.  The goals are efficiency and low cost management of the energy supply.  With a tight economy, the business plan ought to aim to provide payback to customers in a shortened three year span rather than the traditional five year payback; customers also want a turnkey installation with a single installer, minimizing disruption and giving the customer “only one neck to ring.” 

Energy management companies which are drawing financing not surprisingly seem to address the larger markets: office, retail, education institutions, lodging.  Of course it makes sense to offer energy management solutions to customers who have a lot of energy to manage. 

Why don’t the energy suppliers, many of which are very large and sophisticated, enter into this market and blow away the emerging enterprises?  The thinking seems to be they are not fast enough or innovative enough to do this; software development in this area is being driven from the bottom up (as indeed in many other areas). 

To the shock of some of the attendees, it was noted that business buyers in this marketplace don’t much care about being green (although they may say otherwise as a marketing tool); they want low cost and reliability, and investors want companies that drive that result. 

The goal of United States energy policy is to provide 20% energy savings by the year 2050.  Point Judith Capital targets demand side management companies that will facilitate reaching that goal.  So while the Trade Show floor was flooded with portable toilets, triple pane windows, solar energy panel manufacturers and installers, and the like, the financial discussion was all about software solutions, and knowing when to shut down servers in data centers.  A brave new world. 

(Disclosure: my lawfirm has represented Point Judith.)

THE FUTURE OF U.S. MANUFACTURING

The stated theme of the recent meeting of the Association for Corporation Growth in Boston was to explore the prospects for a manufacturing resurgence in the United States, and a panel headed by MIT Professor Suzanne Berger took a pretty deep dive into that issue. 

Noting that the U.S. contributes 19.4% of the world’s manufactured goods, a statistic that has remained stable for about twenty years (although the number of workers declines, we make up for it in productivity), the panel agreed that manufacturing in the United States is here to stay and indeed will see something of a resurgence.  U.S. manufacturing will take place where technology and innovation are important to production.  “Cheapest country” manufacture will continue to focus on the less technologically sophisticated products.  U.S. workers provide the greatest per-capita value-added to manufacture of any country in the world, exceeding that of Japan and other developed countries and blowing away the value added component of Chinese labor. 

Manufacturing jobs are back; last month 50,000 U.S. manufacturing jobs were added and industry optimism is higher than in the last two years. 

What are the drags?  A significant shortage of skilled labor, together with higher U.S. operating expenses for manufacturing even putting aside the cost of labor; it is at least 20% more expensive to manufacture in the United States than elsewhere, by reason of tax load and government regulation. 

The capital providers on the panel thought there was no lack of capital to finance American production, but were worried on a couple of other fronts:

• A foolish immigration policy that causes us to train engineers and others who can drive successful manufacture, and then making it impossible for them to stay in the United States. 
• A lack of an educational system designed to support development of the kinds of sophisticated factory labor that is required. 

There are functional dynamics which drive United States manufacture.  There remains substantial distrust of the ability to protect intellectual property offshore.  This pushes low tech manufacturing offshore, or manufacture of technological products where the obsolescence is so rapid that having the technology knocked off is irrelevant (as the United States will continue to re-engineer and improve what is marketable in a given space).  Also, attenuated supply chains make it difficult to rely on production that spends six weeks on a ship coming from China, particularly when goods are destined either for the United States economy or the South American economy; as just in time gets shorter, the  attenuation and reliability of the supply chain becomes more vital (witness the disasters in Japan and the impact on U.S. business). 

Perhaps the most interesting comment was related to the tax code.  Even the Obama program calls for the reduction only of corporate tax rates, but 70% of United States manufacturing is done by enterprises with flow-through tax treatment, which means that the individual tax rate is really the corporate tax rate for 70% of our domestic manufacture.  Does this matter?  Is this just a question of making sure that the rich owners of companies will have to pay their fair share of taxes?  The panel, which included one such owner, didn’t think so.  There seems to be at least anecdotal support for the proposition that lower tax rates for this population will cause greater investment in the growth of a company, and in the growth of the R&D function of a company.  Two-thirds of R&D in the United States is performed in manufacturing companies, and it is also thus essential that Congress pass a permanent R&D tax credit. 

In addition to tax, immigration and education reforms, the panel noted that American manufacture would be improved by a more friendly attitude on the part of EPA and OSHA, a clear and liberal policy toward stem cell research, and the establishment of trade agreements that foster U.S. exports. 

Is there an analogy between what has happened to agriculture and what has happened to manufacturing in the United States?  We have learned that 1% of the U.S. population can not only feed the United States but also create substantial exports of food stuffs.  We are a “category killer” when it comes to food.  Can American manufacturing become a “category killer” in the manufacture of technologically related goods?  The panel thinks yes.  The panel doesn’t think that a huge increase in the number of manufacturing jobs is a measure of United States manufacturing prowess.  The panel thinks that if we can get out of our own way, and educate and accept from overseas the necessary worker base, primacy of U.S. manufacturing will remain an economic fact in the world economy. 

This post continues an anecdotal review of the investment and M&A climate as the world does, or does not, emerge from the economic unpleasantness that started in 2008. 

Kevin Dunn and Ed Pendergast are managing directors of Dunn Rush & Co., a successful Boston based mid-market investment bank serving the M&A, recap, ESOP, private placement, financial advisory services marketplace.  Their experience is basically agnostic as to industry sector.  Kevin previously was Vice Chair of the US division of Canaccord Adams and CEO of Boston based Adams, Harkness & Hill; Ed is an active director of public and private companies and past Vice Chair of the Greater Boston Chamber of Commerce and past President of the Mass Society of CPAs and the New England Chapter of the National Association of Corporate Directors. 

Of course, statistics abound from all sources relative to the state of financial activity in the middle-market.  Dunn Rush statistics are consistent with those of other investment banks; number of deals and deal values in the mid-market, particularly transactions below $50,000,000, are recovering from 2009 levels, and multiples of EBITDA similarly are recovering. 

There continues to be a marked, indeed an even increased, size premium in middle-market M&A, which is to say multiples for larger acquisitions are more robust than for smaller ones.  Dunn Rush attributes this growing size premium to the investment appetites of many private equity firms that seem to insist upon, and are willing to pay for, companies with an EBITDA of more than $10,000,000.  This leaves smaller deals with less price competition.  Although pricing generally is back to 2007 levels, the size premium similarly has returned to the 2007 range. 

Their M&A in New England has not seen much impact from foreign buyers, and indeed on the sell side an approach to strategic buyers remains the norm.  However, the pressure for making sales has increased among clients.  Factors driving the urge to sell noted by Dunn Rush are the following: 

• Industry consolidation which makes competition by smaller companies more difficult. 

• Lack of available capital to expand. 

• Pent up demand, including age of owners (the sale of a business at lower recession multiples was less attractive and thus delayed).

• Political and marketplace uncertainty. 

• Possible fear that capital gains rates will increase (although this is likely not a significant driver). 

What companies are getting acquired in the New England marketplace?  Companies with cash flow are selling to financial buyers.  Strategic sales continue strong. 

The PE funds are “like a commodity” in how they operate; there are many, all chasing the same type of deals, and all with lots of money to spend.  This bids up the EBITDA-strong targets. 

Do certain sellers avoid private equity buyers?  The answer is yes, they don’t want to see their life’s work leveraged up to finance the acquisition, and their life’s work thereby possibly placed at risk.  Some sellers also still also want to protect their workforce.  All of this can be done but it comes at a cost, in terms of net price. 

If a company in New England is looking for financing for growth, but not to sell out, what about the availability of capital? 

Dunn Rush is not in the start-up market, which is a wholly different story involving venture capital, angels and the like.  (A future post will discuss some aspects of this market.)  Equity remains very difficult to raise.  There is a vigorous market in sub-debt with warrants, and also bank financing for worthy borrowers ($5,000,000 minimum generally applies).  The sub-debt market is strong with target yields of 18% or 20%, a mixed yield based upon the coupon plus the attached warrant.  This kind of financing is attractive from the lender standpoint because of the spread between cost of money and yield. 

As for the banks, the mid-cap regional banks are easier to access than the giant national banks, and Dunn Rush says they have excellent access in this regard; the larger banks “have their own problems” which are well known and beyond the scope of this post. 

Kevin and Ed are optimistic for both the US and the New England economy, and find that businesses are “doing fine this year” in the US.  This conclusion is generally consistent with my own observations, although early stage equity capital remains a big problem which is only partially being addressed by the angels moving up into, and PE firms moving down into, the VC space. 

At today’s MassBio (Biotechnology Council) meeting in Cambridge on new VC models for early stage financing, panelists painted a picture of changes in investor appetites and a more varied landscape for capital sources and exit opportunities.

Three fund managers (two independents and Reid Leonard who is Managing Director of Merck Research Venture Fund) noted a trend to smaller raises focusing on reaching more rapid inflection points for marketability and profit.  The days of nine-figure raises are over, as investors have learned that sometimes it is not good business to fund a decade-long quest to build a company and attempt to bring it public in the face of development risks and a recalcitrant IPO market.  Rather, investments with shorter-term goals and smaller cash needs, leading to licensing deals or acquisition by a large drug company, are becoming the norm.

One interesting logical anomaly seemed to capture the attendees: how do you measure success in a biopharma investment?  For a strategic or captive fund such as Merck, you might consider if it feeds the long term pipeline.  For a fund with a finite time line, say ten years, the metric is different, but even there different investors will have different targets.

Do you aim for a multiple of investment, which is how many GPs get compensated?  Do you aim for high IRR, which puts a premium on rapid exit and which assists in raising your next fund?  The fund managers also noted the interaction between funds at different points in their lives: a fund six years into its life and making its last investments has a different appetite and time-line from a fund making its first placements.  These tensions in goals lead some investors to attempt to invest alone and not in a syndicate, and that decision in turn puts further downward pressure on the size of any investment.  Some even expressed doubts that getting technology out of the Universities and into the marketplace is best accomplished by a for-profit model, as opposed to relying on foundations and pre-competitive consortia.

But clearly there are all types of investors out there; while some investors want to “build to sell” others retain the traditional approach of company-founding.  The art is to find the investor which matches the entrepreneurial vision. 

And finally, like all else in the world, the biopharma world is getting flat, as the technology is dispersed internationally and funds now look to ventures in Asia, particularly Korea, China and India.  Certainly tightening FDA regulatory oversight, a perception shared by all, helps to drive those deals out of the United States, a trend not at all restricted to the life sciences.

Karen Kaplan is President of the advertising agency Hill Holliday, chair-elect of the Greater Boston Chamber of Commerce, and has had a solid background of board service (presently she serves as Trustee at Fidelity Investments and a Director of DSM [Delta Dental, Doral, DentaQuest]).  She believes that the time has come for redefinition: we need the "modern director."

The modern director not only hears what is being said by various constituencies (not just shareholders) but also listens and takes action.  In remarks before the New England Chapter of the National Association of Corporate Directors, Kaplan noted today that social media and speed of information moving in the marketplace require immediate corporate response to crises, and in fact no company is fast enough to do effective damage control.  Rather, it is the task of the board to get ahead of the public by being responsive to their expressed perceptions before corporate actions run afoul of those perceptions.

Kaplan claimed that statistics showed that consumer loyalty was driven more by public perception of the selling company than by product features.  She pointed out how quickly the public perception can force reversal of a corporate strategy: Verizon abandoned its $2 charge for on-line payments within 24 hours of adoption in the face of viral outrage at what was seen as corporate greed. 

Which constituencies must be listened to?  Time Magazine's Man of the Year was a protester!

How do you recruit directors who are attuned to reading the input from the various constituencies that can affect profit and stock price?  How do you get ahead of the 99% and direct a company away from disaster?  Kaplan suggests that adding women and minorities and  people with very different backgrounds can help.

Discussion at the meeting included references to the Occupy movement; how long, it was asked, until the Occupy people, the 99%, buy a few shares of stock and start showing up at corporate annual meetings?  Followers of my blog posts know that I believe the Occupy movement did have clear primary focus and that its perceptions have inevitably entered into the national discussion at least in substance if not by direct attribution, but somehow I just don't see most Occupiers I met waving their ten share certificate and asking to be recognized by the chair.

Although it IS an interesting thought....

On December 7, Suffolk County Superior Court Judge Frances McIntyre issued an opinion that was reported as adverse to the Occupy Boston movement.  While the effect of her ruling will be the dismantling of the encampment, the ruling reflects a broader appreciation of the issues involved and deserves more careful analysis.

Before suggesting that analysis, a few words about what is happening in Dewey Square, which is directly below my office window.   Yesterday, based on the court ruling that ended the injunction against the city taking removal action, the Mayor announced that the occupation must cease by midnight yesterday, Thursday, or the city might take action against remaining protesters.  The police during the day circulated notices from the Rose Kennedy Greenway Conservancy, which owns the land underneath the tents, reflecting the same message.

Importantly the notice did not bar assembly or speech.  It stated that the park was closed from 11pm to 7am and that structures and personal property could not be left on site.  There was no suggestion that people could not assemble or speak, daily, while the park was open pursuant to standing park regulations.

During yesterday, debate and confusion filled the Occupy site and around 11pm last night some protesters promised to form a human chain around the site to protect if from police.  The numbers of people at the site actually increased by reason of the arrival of activists from other, closed Occupy city locations.  But meanwhile, very many tents were struck and removed.  Garbage trucks, some paid for by protester pooled funds, arrived to assist in the partial clean up of the debris.  Many protesters, true to their fundamental values as law-abiding folks, literally folded their tents and left, although some stayed to line up across the street and chant support.

Meanwhile, the Massachusetts Civil Liberties Union had lawyers on site and distributed information about the rights of anyone who was arrested; they counseled the writing of a lawyer's phone number on one's body because upon arrest all personal property was likely to be confiscated.  The Civil Liberties Union and the Massachusetts Chapter of the National Lawyers Guild contacted the Mayor's office and counseled restraint in Boston, which was described as a city with a long and honorable history of free speech and dissent.

The press arrived in force and there was extensive Boston news coverage; trucks from the three traditional networks, from Fox and from New England News Network pulled up onto the public sidewalks (no doubt an illegal act) and sent reporters and cameras into the site, where they were freely admitted by the reasonably small number of police and moved without confrontation among the protesters.  The reporters, who noted without irony that many people had seemed to appear as mere voyeurs while they themselves were of the same ilk and were distinguishable only in that they were being paid for their voyeurism, generally reported fairly about the factions within Occupy, those who did not want a police record and were leaving, those who were defiant and wanted to stay and be arrested to enforce the message.  There were, notably, no interviews I saw with the so-called "student anarchists" who reportedly were fomenting violent resistance and who were described as wearing black hats and masks.

Wooden pallets were piled up like barricades, then mostly placed flat and carted out to garbage trucks.  Last night trash was everywhere, and belongings were loaded into many large green trash bags that seemed to sit in the walkways unattended.  Two people dragged a tent into the middle of the street and asked to be arrested, and indeed were so obliged, but otherwise the police seemed to take no action.  Their restraint to date has been notable and in sharp contrast with prior Boston police actions concerning social protests; since the same police have been hanging around Occupy for a couple of months, I suspect that some sense of mutual respect, or at least tolerance, may explain in part this restraint.

This morning I walked around and then through the center of the Occupy site.  There were four police cars on the plaza, but no uniformed police inside the outline of the site.  Perhaps two thirds of the tents were gone.  There were no people within the tents or walkways, and very few on the plaza; much of the trash was cleared, and a couple of men from Occupy were loading handfuls of trash and tarps into the back of a garbage truck that was blocking one of the lanes on Atlantic Avenue.  The rumor was that the City was going to give the protesters until Sunday to clear out entirely, although there was no way to confirm that rumor.

Rimming the site were protest signs; not that many, some defiant, some melancholy.  My favorite, based on the stated intent of some of the organizers to move to the Boston suburbs, read "Occupy Everything." 

The Mayor on morning radio, the same Mayor who once expressed support for Occupy and said there were no plans to remove the tents, expressed the wish to put this behind us and get on to the next step, "whatever that may be."  His employees had argued in court that the tents were a fire and health hazard at the same time he was saying there was no plan to clear them; but the court decision did not turn on those arguments.

The court decision was sympathetic with the purpose of the Occupy movement, which it characterized (I believe correctly) as an invitation to an important national dialog on the economy, the impact of concentrated wealth on the national social compact, and the need for government to focus on these issues notwithstanding the partisan turn of our national debate.  But the law is, as they say, the law and courts are of course the arbiters of that law.  High points of the decision:

*protesters have the right to assemble and speak, under the Constitution, and that includes certain actions (not just words) which are treated as "conduct-which-speaks."

*but what is protected is speech and assembly to speak, not the actual occupation which the court said "as a matter of law, is not speech.  Nor is it immune from criminal prosecution for trespass or other crimes."

*Occupy is subject to City and Park regulations, which the court found to be valid, although the setting up of tents and sleeping is expressive and symbolic conduct.

*The decision permits the protesters to vacate the site "and request permission to set up tents or other equipment for expressive purposes," although such actions must exclude overnight structures and sleeping in Dewey Square as same violates Conservancy guidelines.

While enforcing the law in logical fashion, the court diverted from strictly legal issues to make some social and political observations.  To say that Occupy lacks focus or solutions is to be, simply, wrong.  Every such social expression attracts all sorts of people and causes, but the theme of Occupy is and has been clear and has been consistent with reportage in all major news outlets which analyze the current reality of our country:  economic justice is in trouble today in America.  Let me quote the court itself:

"There can be no doubt that at this writing in Boston, and perhaps throughout the country, an enclave of tents and in a public park connotes the Occupy movement and their 99%/1% view.  Matters of finance and the present economic situation are of intense concern to many people.  There is considerable media attention devoted to Occupy sites, and most articles, per journalistic custom, restate the Occupy position. The media has clearly understood the plaintiffs' [protesters'] contribution to the national conversation."

Could have been written by one of the Occupy organizers....

Employees sometimes post unfavorable comments about their bosses or companies on Facebook or other social media sites.  Employers sometimes don't take too kindly to such criticism and may take adverse job actions in response.  So far so good.

But what happens when social media criticism reflects joint action by a group of employees?  Let's say one employee says to a group of employee friends that the company is stupid and unethical and underpays and its president is creepy and someone ought to do something about it?  And one of the group posts a comment to that effect?

Enter the National Labor Relations Board, which you may recall is charged with protecting group employee action from retaliation by employers.    This post I described is "protected concerted action" by employees and legally cannot result in retaliation.  Further, employer policies about social media cannot prohibit a wide range of posts, including the oft-banned comment that may damage the reputation or goodwill of the employer.

Interestingly, over-the-top language and personal affronts don't change the result; in one case a post described a boss as a "scumbag" and the NLRB did not care -- in the heat of labor disputes nasty things are said all the time.

Since NLRB rules in this area apply to all employers and not just those companies with a union presence, it is likely that management and even in-house counsel may lack sensitivity to these issues in both HR management and in drafting policies.  This area is a "gotcha" and one of those unfortunate ones where caerful study of the NLRB report, or actually undertaking the distasteful step of hiring counsel, may be indicated.

The National Association of Corporate Directors reports the median pay of a Fortune 200 director at $228,058, a tidy sum although not nearly enough if a derivative suit is filed against the board.  NACD does not report on any relationship between compensation and frequency of litigation.

Commentary on the survey attempts to make the point that weak boards of directors tend to lead to corporate catastrophe.  This surely is a conclusion that seems intuitive, but is it correct?

Fortune, as reported by CNN Money on line, collects anecdotal situations wherein problem boards ended up with big corporate problems to boot: News Corp, BP, etc.  These boards seem to lack truly independent directors (nothwitstanding regulatory requirements for public companies wherein carefully defined levels of independence are required to sit on audit and comp committees), coupled with long tenures, advanced age, lack of women or minorities, and with personal ties to top executives (which latter point is just another way of saying they lack independence).

Several issues suggest themselves.  Aside from linking some companies suffering catastrophe with a lack of strong directorship, the data does not seem to reach the question of whether poorly directed companies have a higher catastrophe RATE.  Many poorly directed companies dodge the bullet plenty.  Many well directed companies suffer major set-backs.

It is important not to use only hindsight.  It is easy, after a debacle, to go back and note that the board lacked certain attributes.  But if you did an audit of all companies, which would include the damned and the blessed, would failure follow the weakest board?

How many of us have seen very well run boards nonetheless get surprised by disaster?  The legal standard for boards is not to meddle in operations; boards do not have front-line responsibilities.  If there is risk identified, the board is supposed to inquire that the risk is being addressed, not itself seize control of a company at the operational level.  A board has a duty of care that includes using normally prudent practices to identify and cause to be addressed enterprise risk.  The management has the operational burden.

So perhaps the ultimate stopping place of the buck, at the board level, is the selection of the principal officers who DO have front line responsibility for execution?  And perhaps a non-independent board ultimately does tend to rule over a company that is disaster-prone because such a board elects cronies, retains its own membership too long, and becomes used to the nice dinners and dulled to their duties?

The last decade of corporate grief seems to this observer, indeed again anecdotally, to be spread widely across the spectrum of well-directed, ill-directed and non-directed businesses; if anyone out there has data that is more tightly ratcheted on a statistical demonstration of the avoidance of catastrophe (not the level of earnings, just the absence of disaster) in the presence of a younger and more rigidly "independent" directorship, I would be interested in hearing about it.

We strive for good directors and thus are invested in seeing better performance from boards which meet our preconceptions.  And surely independence on boards is a defense to many shareholder suits (put another way, woe be to the defendant director who can be painted in a lawsuit as a "crony" of the controlling person(s)),

And I haven't even gotten to the implicit age-ism in the equating of older directors with lousy boards....

At this morning's meeting of the New England Chapter of the National Association of Corporate Directors, the panel of senior board members  counseled a level of board activism that is at odds with the common wisdom that directors should set policy but not manage process or implementation.

Professor Walter Salmon, emeritus at Harvard Business School and an active board member of many public companies in the past, advised that in an acquisition the acquiror's directors must evaluate whether the deal is a "bet the farm" play for the acquiror.  If it is, he suggests that the board in effect hijack the project by establishing a special independent board committee, which committee in turn hires and receives the reports from the advisors to the company.  The effect is to remove the implicit bias that outside experts feel when management hires those advisers to evaluate a deal proposed by management in the first instance.

Further, Professor Salmon suggested that a board committee be established to monitor the acquisition after it occurs, bearing in mind the many failures of acquisitions to enhance the acquiror.

Other panelists, Alan MacDonald (former CEO of Nestle) and Deborah McAneny (current lead independent director of a NYSE firm and director of another) each recounted serious corporate crises and counseled activist intervention by the board in fast-moving and unexpected situations where management might well be too close to the situation to have perspective.

We sometimes explain to directors that their job is "noses in, hands off" but the panel suggested that boards have a role, in crisis, in doing much more than suggesting strategic approaches to management, even though such activism can create tensions with the CEO.

And speaking of CEOs, Professor Salmon suggested that when things hit crisis mode a company was not necessarily well served to have sitting CEOs (a favorite choice of management) on the board because they may well not have the time that it takes to attend near-continuous board meetings that such a crisis may require.

Query whether the business judgment rule, that protects directors who exercise reasonable diligence from liability even for incorrect decisions, extends to protect directors who are at the cutting edge of board activism.  The usual lawsuit against directors is that they did not pay attention and did not do enough.  What if they jump in, fundamentally compel a prompt strategy, and that strategy is a failure?

It is not getting easier to be a corporate director....

There seems to be some confusion about what has happened to the movement to compel public companies to place shareholder nominees on the ballot for directorships.  Let me try to sort out the state of play:

1. Federal nomination rule defeated: The SEC adopted Federal Rules to compel companies to place nominees of certain shareholders on the ballot.  The National Chamber of Commerce and the Business Roundtable sued and successfully sank this proposal; the SEC gave up.

2. Companies themselves may elect to permit shareholder nominations:  A proposal to amend SEC Rule 14a-(1)(8) to permit a company to itself adopt a bylaw controlling shareholder rights to nominate directors was not objected to and has become effective as of September 20, 2011.  This Rule permits what is known as "private ordering;" a company can permit, or not permit, shareholder nominations and can define the conditions of those nominations.

3. Effect: What that means is that shareholders as a first step can compel a company to place in its proxy statement a proposal to set the terms for shareholder nominations.  This does NOT mean that now a shareholder can make a nomination and compel proxy inclusion of that nominee; that is the very thing that the rejected SEC rule calling for Federal nomination procedures attempted to achieve.

4. What can we expect?

5. Anticipated shareholder actions:  Activist shareholders, such as pension funds or aggressive hedge funds, my offer proposals for establishing a methodology to permit future shareholder nominations.  Companies with poor performance, or already under attack on other grounds, can expect an assault of this type during the coming proxy season (2012).  Such proposals must be made prior to the company's regular cut-off date for submission of proxy proposals by shareholders; figure four months before the anniversary of  last year's solicitation date.   That means the November-December time frame for most calendar year-end companies.

6. Possible pre-emptive board actions?:  Boards may choose to be pro-active in one of two ways.  A Board can itself forthwith amend its bylaws to provide a board-favored methodology for permitting nominations, stealing the thunder of any possible shareholder proposal.  If a company proposes a plausible methodology, then a shareholder will have to argue that ITS proposal is better; a weaker stockholder position.   Alternately, a well-run company with a confident board may try to seize the high ground by announcing that corporate success is the result of the company's excellent board succession processes and that the board will not recommend adoption of any shareholder proposal to institute shareholder nominations, all in hopes of scaring off or positioning any shareholder who would offer such a proposal.

7.Rating agencies:  The ISS, notable among the investor advisory services, has yet to speak as to its standards for evaluating boards that resist shareholder nomination proposals, and likely those that propound proposals which are insufficiently liberal in granting shareholder rights.

8. Nominator requirements:  Note that not every shareholder will be able to make a proposal for proxy inclusion; a shareholder must hold at lest $2,000 or 1% of the company's voting securities  for at least a year, and must hold them at meeting time.

9. State law important:  Since the SEC rule leaves it to the company to define the rules for shareholder nominations, if any, one must look at state law to see how to achieve an effective proposal (that is, a proposal to establish shareholder nominations which must be included in company proxy solitications, which proposal in turn MUST be included in a company proxy statement under SEC Rule 14-a).

10.Private companies: None of this affects private companies (although the Delaware corporate law specifically permits such a bylaw, for all companies that solicit proxies, and that general permission would extend theoretically to private companies; see section 112).

As with all things SEC, there is plenty more detail, and some forms (including form 8-K requirements), but the above should give a basic orientation as to what has, and has not, been adopted. 

Below is a link to my July article for InHouse, the newspaper for in-house attorneys.  It discusses the US Supreme Court view on bringing securities law class actions, with an interesting sidelight on how the SEC proposes to clamp down on lawyers defending companies and directors in those kinds of lawsuits.  Let me know your thoughts and, particularly for counsel, any recent experiences with the SEC involving resistance to the mounting of a vigorous defense.

 http://www.duanemorris.com/articles/static/honig_neih_0711.pdf

A brief article in the recent press reports that George Soros will convert his $25B hedge fund into a family office to avoid newly enacted SEC regulations affecting hedge fund advisers.  There are reports that many other hedge fund managers are considering following suit.

We must assume that surrendering a $25B business, and returning investor capital, is not a decision lightly undertaken.  Why would a smart guy like Soros do that?

Simply put, under Dodd-Frank the typical exemption from regulation under the Investment Advisers Act enjoyed by hedge fund managers was repealed.  The effect is to require hedge fund managers to register and be regulated.  However, Dodd-Frank mandated an escape clause from regulation for any fund that qualified as a family office. 

New SEC rules, effective August 29 of this year, establish a formally defined family office exemption from the effect of Dodd-Frank under the Investment Advisers Act.  (Historically, the SEC would consider exemptions from regulation for family offices on a case by case basis.)  The exemption is not so broad as some commentators had hoped; a family must wholly own and control the office and run money only for "family" as closely defined.  But for families of wealth, the exemption creates a business model that works well enough.  And seemingly, regular hedge fund managers of great personal means, such as Soros, can appreciate the continuation of freedom from regulation that until now they have so profitably enjoyed.  

For policy wonks, the SEC adopting release, which explains all this in great detail, is at  the SEC website.

We are left to ponder whether heightened regulation of hedge fund advisers, regulation that drives a successful adviser such as Soros who has created substantial returns to investors over the years, constitutes good policy.  Or does it just satisfy a desire to punish people who are getting "too rich" while many in society are struggling or sinking?  Is this SEC regulation just another facet of a social reaction, another aspect of the dynamic that also seeks a higher income tax treatment for the carried interests of the hedge fund managers?

In the unresolved debate between heightened regulation and the "free marketplace," Soros' decision marks the location of one of the minor battles, and it is unclear which side is the winner.