What's a related-party transaction? The case of News Corp.

Everyone's favourite hate figure is in the news again. Rupert Murdoch, along with all the directors of the US-based News Corp., is facing a lawsuit brought by shareholders about the board's decision in February to buy Shine Group of the UK for £413 million. Shine, a television production and concept company, was the creation of Murdoch's daughter, Elisabeth. The suit, brought by Amalgamated Bank as trustee for a variety of mutual and pension funds, alleges nepotism in no uncertain terms. Indeed, the language of the complaint is robust, even by the standards of litigious America: "Once the prodigal daughter is back into the News Corp fold, she will vie with her brothers, Board members James Murdoch and Lachlan Murdoch, for the position of successor to Rupert Murdoch's global media dynasty. In short, Murdoch is causing News Corp to pay $675 million for nepotism," it alleges. The quote comes from the second page of a 46-page filing with the Chancery Court of Delaware, where News Corp. has its nominal seat. The suit claims that the board approved the merger "without question or challenge to Murdoch". The deal was "unquestionably unfairly priced", based on comparable transactions elsewhere. "Further, even if there were some business justification for News Corp to acquire a television production company, there is no reason for it to acquire Shine in particular except to reward Murdoch's family member and to perpetuate his family's involvement in the senior management of News Corp," it continues.

EU's governance forum wants more disclosure of related-party deals

The European Corporate Governance Forum, a body that advises the Commission of the European Union on company law, wants to see tighter measures to let shareholders know about transactions that companies undertake with related parties. Directors, it says, should provide leadership, but that authority is not absolute. It "should be balanced with a requirement to inform shareholders of important developments and in certain instances to seek authorisation for their actions either from independent agencies or from the shareholders themselves". It suggests a variety of rules, including:

• A one per cent threshold: Deals worth less than one per cent of the assets of a company wouldn't need to be reported, but independent directors "should take particular care" that such deals are in the interests of minority shareholders.
  
• A five per cent threshold: Deals that add up to five per cent of assets over any 12-month period would trigger a requirement for a shareholder vote on further such deals.
  
• Between the thresholds: Once aggregate deals reach one per cent of assets, they would have to be disclosed to shareholders individually, though no right of approval would accrue until the deals reach five per cent.
  
• Five per cent deals: Individual deals worth five per cent of assets or more would need specific shareholder approval, with the related party excluded.

In all board deliberations, the related party should abstain, the forum concludes. The European Commission intends to consult on these recommendations in a Green Paper on the Corporate Governance Framework, due shortly. That it's a Green rather than White Paper suggests this is still some distance from becoming law.

Source document: The Forum statement is a one-page pdf file.

French regulator urges investors not to exercise proxies by proxy

The "Anglo-Saxon" proxy voting agencies have become the focal point of shareholder activism and, for some, raise concerns about how voting can become detached ownership and economic interest. The French securities regulator AMF has joined the listed of complainants, with a statement to institutional investors reminding them of their need to take share ownership seriously. It singles out the "Anglo-Saxons", though France had home-grown proxy agencies, but the point is a general one. Using a proxy voting agency is does not release the investors from responsibilities for monitoring corporate policy and decisions. It wants the agencies to make clear statements about their voting policies and disseminate them publicly. They should communicate with the companies concerned as well, giving them the chance to comment on recommendations within the documents. It also wants greater vigilance to prevent conflicts of interest.

Source document: The AMF statement is a three-page pdf file, in French.

How sceptical should an auditor be?

That question underpins a consultation undertaken in the UK by the Financial Reporting Council, the accountancy watchdog, and the Financial Services Authority, still for a while the market regulator. The answers it received voice many of the usual platitudes, but some interesting insights appear, not least about how difficult it is to strike the balance. The accounting firm KPMG, for example, wants to support measures that enhance "well informed scepticism", but it then explains why it's so difficult. Being well informed is a requirement of the auditors. They must understand the businesses they audit – and understand them well – if they are to be able to judge accurately the accuracy of the accounts. But getting close to the business means getting close to the company. So "a balance needs to be struck to prevent the auditors become so familiar that they lose their sense of objectivity or professional scepticism", it writes. Moreover, the main "downside" of time and cost seen by the FRC and FSA in their paper isn't particularly important, KPMG says, when set alongside the risk that "unwarranted overt scepticism" will be perceived by the client as "aggressive" and "translated as a lack of trust". Such a defensive reaction by the client can result in a lack of openness and a poorer quality audit.

The investor's side: The submission by the International Corporate Governance Network set a rather more sceptical tone about how well the auditors do at striking that balance. Among its comments: "ICGN believes that during the lead-up to the financial crisis, there was insufficient auditor scepticism as demonstrated by PricewaterhouseCoopers declaring Northern Rock a 'going concern'." The bank was forced into state ownership following an old-fashioned bank-run in August 2007. ICGN said the auditors' problems have been exacerbated, however, by frequent changes to accounting standards. It urges, therefore, a "return to greater prudence and emphasis to a high degree of auditor scepticism".

Source document: The FRC news release has a link to the lists of responses.

Term limits for CEOs?

The president of the United States has a term limit: two four-year terms in office. Why not the president of United States Steel Corp.? That's the gist of the question posed in a think-piece by a US legal scholar. Charles Whitehead isn't particularly advocating term limits, but rather asking why they seem never to be considered. After all, we've contemplated term limit for auditors and audit partners. In UK corporate governance since 2003 there has been an implicit term limit of nine years for independent non-executive directors. Why is the CEO any different? "The traditional answer," Whitehead says, "has been that CEOs are agents of the corporation, subject to control by the board, which holds primary responsibility for the firm's business and affairs." Senior managers are therefore shielded from outside interference. They can get on with executing long-term business strategies under the watchful eye of the board. The tenure of the CEO is therefore at the discretion of the board. Private ordering within the board, rather regulation or even shareholder democracy, determines when it's time to change course.

Whitehead argues, however, that recent regulation has called that deference into question. "New laws – in particular, Sarbanes-Oxley and Dodd-Frank – regulate director and officer conduct in response to the real possibility that long-term CEOs can control the board (rather than the other way around)," he writes. There's a new understanding of how shareholders, directors and officers interact.

Executive tenure: Putting a term limit on the CEO might actually lengthen CEO tenure. A variety of studies from a variety of directions suggest that CEOs' time in office has been getting shorter. In the wake of the Sarbanes-Oxley Act of 2002, Forbes magazine calculated that CEO average tenure was down to 3.5 years. A 2008 academic study using a broader dataset, reckoned that the average tenure was less than six years. Spencer Stuart, a firm of headhunters, said last year that CEOs spend 6.9 years in the top job and an average of 15.9 years of service with the company in all positions. Is Whitehead's suggestion an answer looking for a problem?

Source documents: The paper "Why Not a CEO Term Limit?", by Charles Whitehead of Cornell Law School will be published soon in the Boston University Law Review. The 2008 study "How Has CEO Turnover Changed?" by Steven Kaplan and Bernadette Minton, is a 50-page pdf file. The Spencer Stuart 2010 Board Index gives a wide overview of US boards.

It works! Ratings improve as agencies compete

Since the dot-com collapse in the early 2000s – and with greater impetus after the 2007-09 financial crisis – policy-makers have come to think that credit ratings are deeply flawed. The response, however, has been somewhat tentative, since there's no easy solution to the conflicts of interest inherent in the business of hiring someone to say bad things about you in public. In the European Union, credit rating agencies now have to register and be regulated directly by the European Securities Market Authority, a new piece of the EU bureaucracy that replaced the talking-shop known as European Committee of Securities Regulators in January. In the US, the Dodd-Frank legislation last year marked the latest in a series of policy-led attempts to ease the conflicts through tighter regulation. The US is something of a special case, but it's also an interesting hot-house for experimentation. There, credit ratings have long been enshrined in regulation. Municipalities needing to issue bonds were required by law to get credit ratings from a handful of nationally recognised statistical rating organisations. Widening the circle of NRSROs was one of the first responses to the dot-com crisis. Taking away the requirement for ratings – and with it quasi-official status of the agencies – is underway now.

From the laboratory: This scope for experimentation means that we can model different approach. According to a paper from scholars at Baruch College in New York, competition can be a viable alternative to regulation. Competition improves the timeliness of bond downgrades and helps investors assess the risks associated with their investments. "For three distinct financial scenarios we find that when there are multiple bond rating agencies rating the same issue, rating agencies provide investors with more accurate and/or more timely information about the riskiness of the rated debt issue," the authors write. In the case of new bonds, they found that increased competition led to more accurate pricing at the time of issuance. When companies had to restate earnings and recognise bond defaults, competition led to the more timely recognition of both unintentional restatements and default. If the implication is that if greater regulation of ratings drives up the cost and retards competition, could we be headed in exactly the wrong direction?

Source document: A working paper with the snappy title "How Increased Competition Among Credit Rating Agencies Improves Investor Awareness of Initial Bond Ratings, Accounting Restatements, and Bankruptcy Predictions," by Anna Bergman Brown, Joseph Weintrop and Emanuel Zur of Baruch College of the City University of New York, is a 53-page pdf file.