Today is the “Proxy Disclosure Conference”; tomorrow is the “16th Annual Executive Compensation Conference.” Note you can still register to watch online by using your credit card and getting an ID/pw kicked out automatically to you without having to interface with our staff. Both Conferences are paired together; two Conferences for the price of one.
– How to Attend by Video Webcast: If you are registered to attend online, just go to the home page of TheCorporateCounsel.net or CompensationStandards.com to watch it live or by archive (note that it will take about a day to post the video archives after it’s shown live). A prominent link called “Enter the Conference Here” – on the home pages of those sites – will take you directly to today’s Conference (and on the top of that Conference page, you will select a link matching the video player on your computer: HTML5 or Flash Player). Here are the “Course Materials.”
Remember to use the ID and password that you received for the Conferences (which may not be your normal ID/password for TheCorporateCounsel.net or CompensationStandards.com). If you are experiencing technical problems, follow these webcast troubleshooting tips. Here is today’s conference agenda; times are Central.
– How to Earn CLE Online: Please read these “FAQs about Earning CLE” carefully to see if that is possible for you to earn CLE for watching online – and if so, how to accomplish that. Remember you will first need to input your Bar number(s) and that you will need to click on the periodic “prompts” all throughout each Conference to earn credit. Both Conferences will be available for CLE credit in all states except for a few – but hours for each state vary; see this “List: CLE Credit By State.”
10b-5 Liability: Exec Gets Sanctioned for “Failure to Correct”
Earlier this year, John blogged that the US Supreme Court gave the SEC a big win when it held – in Lorenzo v. SEC – that individual anti-fraud liability can apply under Rules 10b-5(a) and (c) to someone who “disseminates” false or misleading statements, even if that person didn’t “make” the statement under Rule 10b-5(b). Now, the 10th Circuit has become the first circuit court to apply Lorenzo – and it couldn’t have gone much better for the SEC. This Arnold & Porter memo explains the facts of this case – Malouf v. SEC:
Dennis Malouf served as an executive at both a securities brokerage and an investment adviser. He subsequently sold his interest in the brokerage in a transaction in which he continued to receive installment payments based on the commissions the brokerage collected from securities sales. Malouf facilitated these installment payments by routing client trades through the brokerage without disclosing his financial interest to clients or to the investment adviser and despite knowing that the investment adviser represented that Malouf did not have any conflicts of interest.
The Securities and Exchange Commission (SEC) brought an enforcement action against Malouf, and the Tenth Circuit affirmed an administrative law judge’s finding that Malouf had violated Exchange Act Rules 10b-5(a) and (c) and Sections 17(a)(1) and (a)(3) of the Securities Act. The Tenth Circuit reasoned that Malouf had engaged in an unlawful fraudulent scheme because he knew that a conflict existed while the investment adviser was telling clients that he was independent and, despite this knowledge, failed to take steps to correct the misstatements or to disclose the conflict. The Tenth Circuit rejected Malouf’s argument that the SEC had “obliterated[d] the distinction” between Rule 10b-5 subsections (b) on one hand and (a) and (c) on the other because, as the Court in Lorenzo expressly held, defendants could be liable under sections of the Securities Act and Rule 10b-5 dealing with fraudulent schemes in connection with misstatements without having been the “maker” of misstatements.
Malouf was fined $75,000, had to disgorge $562,000 in profits, and is now barred for life from working in the securities industry. To me, it seems pretty clear that someone should correct known misstatements about their own conflicts – and if you dig into the facts of this case, you’ll see that the defendant was also involved with causing the misstatement in the first place. But, this wasn’t a slam dunk case for the SEC since there’s still some uncertainty around how Lorenzo will be applied. The memo notes that the holding gives the SEC even more encouragement to pursue anti-fraud charges against individuals who aren’t “makers” of statements. We don’t know yet whether plaintiffs will try to extend these theories to private class actions. . .
Delaware Company Adopts “Gender Quota” Bylaw
A Delaware-incorporated company that’s headquartered in California has filed a Form 8-K to report adoption of a “board diversity” bylaw. The 8-K says that the company took this step to implement the requirements of SB 826, the California law that requires female representation on boards. This blog from Allen Matkins’ Keith Bishop dives into the details:
The Bylaw operates by dividing NantKwest’s board into two classes. To be qualified for a “Class 2 Directorship”, the individual must self-identify her gender as a woman, without regard to her designated sex at birth. Consonant with SB 826, the number of Class 2 Directorships will eventually depend upon the “number of directors”. All directorships that are not Class 2 Directorships are Class 1 Directorships.
Keith highlights that nothing in SB 826 requires companies to amend their bylaws – and that doing so might cause issues under California’s Civil Rights Act. He also raises a few questions about how this particular bylaw will operate.
In our “Q&A Forum,” we have reached query #10,000 (although the “real” number is much higher since many queries have others piggy-backed upon them). So crazy. There was a time that I thought I should quit this gig when we hit 5000. For me, answering the questions is one of the hardest parts of this job. The first 14 years handling the queries was rough (even with help from many folks, including Alan & Dave) – but since John came on board three years ago, it’s been easy for me because he’s been the master handling that task.
Anyway, I know this is patting ourselves on the back – but it’s 17 years of sharing expert knowledge and it’s quite a resource. Combined with the “Q&A Forums” on our other sites, there have been well over 30,000 questions answered. We beat Alan Dye to the punch, as he has over 9600 questions answered over on Section16.net. He’ll get to 10,000 soon enough…
You are reminded that we welcome your own input into any query you see. And note there is no need to identify yourself if you are inclined to remain anonymous when you post a reply (or a question). And of course, remember the disclaimer that you need to conduct your own analysis & that any answers don’t contain legal advice.
It’s funny to me that this is even considered news. But it is rare these days. Corp Fin has posted a broad notice that it’s hiring lawyers with varying levels of experience. My 5-minute video about how to land a job at the SEC is exactly 10 years old. I looked a lot younger then…
Yesterday, ISS released the results of its benchmarking survey for the annual update of its voting policies. Here’s a summary:
1. Board Gender Diversity– Responses to ISS’ question about views on the importance of gender diversity on boards showed that majorities of both investors (61 percent) and non-investors (55 percent) agreed that board gender diversity is an essential attribute of effective board governance regardless of the company or its market. Among those who did not agree with that view, investors tended to favor a market-by-market approach and non-investors tended to favor an analysis conducted at the company level.
2. Director Overboarding – Investors and non-investors diverged on the question of measurement of how many boards is too many for an individual director. A plurality (42 percent) of investor respondents selected four public-company boards as the appropriate maximum limit for non-executive directors. A plurality of investor respondents (45 percent) also responded that two total board seats is an appropriate maximum limit for CEOs (i.e., the CEO’s “home” board plus one other). A plurality of non-investors responded that a general board seat limit should not be applied to either non-executives (39 percent) or CEOs (36 percent), and that each board should consider what is appropriate and act accordingly.
3. Climate Change Risk Oversight – A majority (60 percent) of investor respondents answered that all companies should be assessing and disclosing climate-related risks and taking actions to mitigate them where possible. 35 percent of investor respondents answered “Maybe” to the following statement about how companies should approach this issue: each company’s appropriate level of disclosure and action will depend on a variety of factors including its own business model, its industry sector, where and how it operates, and other company-specific factors and board members.
Only 5 percent of investors indicated that the possible risks related to climate change are often too uncertain to incorporate into a company-specific risk assessment model. Non-investor responses to those same three issues were 21 percent, 68 percent and 11 percent respectively. The actions that investors considered most appropriate for shareholders to take at companies assessed to not be effectively reporting on or addressing their climate-related risks were engagement with the company (96 responses), and considering supporting shareholder proposals on the topic (94 responses). Based on the number of non-investor responses, these two options were also ranked first and second in popularity by non-investors.
4. Mitigating Factors for Companies with Zero Women on Boards – ISS announced in 2018 that it is introducing a new U.S. Benchmark Voting Policy for 2020 to generally vote against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) at companies when there are no women on the company’s board, but with some mitigating factors that may be taken into account.
Respondents this year were asked whether ISS should consider other mitigating factors, beyond a firm commitment to appoint a woman in the near-term and having recently had a woman director on the board, when assessing such companies. Investor respondents were less likely than non-investor respondents to say that other mitigating factors (such as adopting an inclusive Rooney Rule-style procedure for candidate searches or maintaining an active recruitment process despite the absence of a boardroom vacancy) should be considered and may be sufficient to avoid a negative recommendation on directors.
5. Combined CEO/Chair– Investor respondents cited poor company responsiveness to shareholder concerns as the most commonly chosen factor that strongly suggested the need for an independent board chair. This was followed by governance practices that weaken or reduce board accountability to shareholders (such as a classified board, plurality vote standard, lack of ability to call special meetings and lack of a proxy access right). For non-investors, the most commonly chosen factor was a poorly-defined lead director role, followed by poor company responsiveness to shareholder concerns.
Is the SEC Seeking to Replace PCAOB’s Kathleen Hamm?
As I’ve blogged about several times over the years, one of the oddest provisions of Sarbanes-Oxley was Congress creating the PCAOB with a dotted line to the SEC. That means the SEC decides who gets appointed to the Board of the PCAOB. That has resulted in a few battles over time. Here’s an excerpt from this MarketWatch article by Francine McKenna:
Kathleen Hamm says her work as a member of the Public Company Accounting Oversight Board, the audit-industry regulator, is not done. But the Securities and Exchange Commission apparently thinks otherwise, and posted for her job over the summer. Hamm stepped into a term in 2017 that had approximately two years remaining, expiring this October. She is eligible for reappointment to the second five-year term, through 2024, but now she’s had to reapply for her job and she’s not sure why.
“I am seeking reappointment to continue the important work I began 20 months ago,” Hamm said in a statement provided by the PCAOB spokeswoman to MarketWatch. “My efforts have centered on protecting investors by applying my expertise and experience in technology, risk management, and compliance to upgrading and modernizing the PCAOB’s approach to cybersecurity and emerging technologies, both at the board and among the audit firms we oversee.”
Hamm was appointed to the PCAOB board after the SEC announced in December 2017 that it would appoint a full slate of five new members to replace all incumbents. The SEC had never before declined to reappoint PCAOB members who were eligible to serve another term, and it was the first time in the PCAOB’s 15-year history that the entire board was replaced all at once.
The new board members came on with staggered terms to fill out. Hamm is the second board member to have her term come up; Duane DesParte was renewed without fanfare after his original term expired after six months. Hamm said she’s pushed for an increased focus on the control systems that auditors use to ensure that they consistently deliver high-quality audits for the benefit of the investing public. “I would like the opportunity to continue to drive this vital initiative as well,” she said in her statement.
Jim Daly Retires!
Happy retirement to long-time Staffer Jim Daly! As noted in this press release, Jim served in Corp Fin for 38 years in a variety of positions – the latest being Associate Director – and mentored hundreds of folks as they came up through the ranks. He surely will be missed!
Recently, the PCAOB sanctioned PWC as a result of partners having a financial relationship with a bank the firm audited. Then the firm lied to the banks audit committee when it sent a letter to the committee saying there were no independence issues. The rules on this issue is not new. The SEC sanctioned another of the Big 4 firms – EY – as a result of similar problems some 30 years ago.
I too have served on an audit committee where a Big 4 firm sent us a letter saying there were no independence issues, only to find out the firm was aware of issues they withheld from the committee. This is a huge issue for audit committees and investors. The PCAOB’s sanction of $100k is a slap on the wrist in this instance. Which perhaps explains why we continue to see this type of behavior by the firm’s go unabated.
Does the PCAOB Undermine Auditor Professionalism?
Congrats to Dan Goelzer & Tom Riesenberg for launching their new blog – “The Audit Blog.” Here’s the intro from Dan’s blog about the PCAOB’s impact on auditor professionalism:
In 2002, the Sarbanes-Oxley Act created the Public Company Accounting Oversight Board and transformed public company auditing in the United States from a self-regulated, to a regulated, profession. The PCAOB’s statutory mission is to “further the public interest in the preparation of informative, accurate, and independent audit reports” — in other words, to improve audit quality. Based on objective measures, such as frequency of restatements and magnitude of financial reporting failure market losses, most observers would probably agree that the PCAOB has made considerable progress toward accomplishing that goal.
A separate issue is how PCAOB oversight has affected the experience of being a public company auditor and auditors’ perceptions of their professionalism. Three academic researchers, Kimberly D. Westermann, California Polytechnic State University, Jeffrey Cohen, Boston College, and Greg Trompeter, University of Central Florida, have undertaken to explore that topic. Their findings raise questions about the long-term impact of PCAOB oversight on the auditing profession.
CAMs: Snapshot of Filings By Types of Disclosures
Recently, Deloitte put together this nifty chart indicating what types of matters where deemed “CAMs” in recent filings by large accelerated filers. Check it out…
For the many of you that have registered for our Conferences coming up next Monday, September 16th, we have posted the “Course Materials” (attendees received a special ID/PW last week via email that will enable access to them; note that copies will be available in New Orleans). The Course Materials are better than ever before – with numerous sets of talking points. We don’t serve typical conference fare (ie. regurgitated memos and rule releases); our conference materials consist of originally crafted practical bullets & examples. Our expert speakers certainly have gone the extra mile this year!
Here’s some other info:
– How to Attend by Video Webcast: If you are registered to attend online, just go to the home page of TheCorporateCounsel.net or CompensationStandards.com to watch it live or by archive (note that it will take a few hours to post the video archives after the panels are shown live). A prominent link called “Enter the Conference Here” – which will be visible on the home pages of those sites – will take you directly to the Conference (and on the top of that Conference page, you will select a link matching the video player on your computer: HTML5, Windows Media or Flash Player).
Remember to use the ID and password that you received for the Conferences (which may not be your normal ID/password for TheCorporateCounsel.net or CompensationStandards.com). If you are experiencing technical problems, follow these webcast troubleshooting tips. Here are the conference agendas; times are Central.
– How to Earn CLE Online: Please read these “FAQs about Earning CLE” carefully to see if it’s possible for you to earn CLE for watching online – and if so, how to accomplish that. Remember you will first need to input your bar number(s) and that you will need to click on the periodic “prompts” all throughout each Conference to earn credit. Both Conferences will be available for CLE credit in all states except for a few – but hours for each state vary; see our “CLE Credit By State” list.
– Register Now to Watch Online: There is still time to register for our upcoming pair of executive pay conferences – which starts on Monday, September 16th – to hear Keith Higgins, Meredith Cross, etc. If you can’t make it to New Orleans to catch the program in person, you can still watch it by video webcast, either live or by archive. Register now to watch it online.
– Register to Watch In-Person in New Orleans: Starting next Thursday, you will no longer be able to register online to attend in New Orleans – but you can still register to attend when you arrive in New Orleans! You just need to bring payment with you to the conference and register in-person. Through the end of next Thursday, you can still register online to attend in-person in New Orleans. And you can always register online to watch the conference online…
More on “Directors, How Well Do You Really Know the Shareholders You Represent?”
Recently, I blogged about a cute little cocktail party story where a director failed to follow-up with probing questions to a retail shareholder he met at a party. One of our members had this comment in reaction:
David Shaw’s story likely is the fault of lawyers. Indeed, many lawyers routinely tell directors they have no right to speak for the corporation and have no obligation to do so. These lawyers proceed, telling clients that a corporation must speak with one or two – perhaps three (for example, CEO, CFO and IR head) voices – and no more. Threat of liability is the clear concern, but perhaps overstated today relative to the need for companies – and their directors – to understand the perspectives of other stakeholders.
SEC Sanctions for 10-K Misrepresentation on Loan Covenant Compliance
In this blog, Stinson’s Steve Quinlivan describes the facts behind the SEC’s recent enforcement action against a company – Omega Protein – for its 10-K disclosure that it “was in compliance with all of the covenants contained” in its borrowings (repeated in three subsequent 10-Qs)…
A few months ago, we blogged about how Corp Fin was considering changing how their “referee” role. Well, that change has happened. On Friday, Corp Fin announced that some of its no-action responses going forward may be in oral form rather than in writing. A written response can be expected if Corp Fin “believes doing so would provide value, such as more broadly applicable guidance about complying with Rule 14a-8.”
Here’s a few “food for thought” items to start with (thanks to Ron Mueller & Dave Lynn for their 10 cents on some of these):
1. Will There Really Be No Writings?– Good lawyers like to see things documented, particularly if they achieve a result they seek. So mere oral responses may feel like kissing your sister. Surely, Corp Fin will have some type of writing somewhere about their decision?
This announcement seems like the kind of approach that Corp Fin’s accounting staff has employed over the years for financial statement waivers – and that Chief Counsel’s office has used with S-3 eligibility waivers. In both situations, I believe the Staff still puts an internal (ie. nonpublic) note up on Edgar, so maybe they will do the same thing here. Of course, if this writing is nonpublic, that’s not doing you much good…
2. Can I Record My Conversation With Corp Fin? – If a Staffer leaves a voicemail as its oral response, you’ll at least have some sort of “writing” that you can archive and share with your working group. But what if you pick up the phone when they call? Can you tape it? Or should you just write a memo to the file memorializing the conversation?
I guess you’ll find out when you ask (I wouldn’t record the convo without the Staffer’s permission). But I threw this item in here so I can go back in the day to when I started in Corp Fin in the late ’80s. Back before computers. We wrote comment letters by hand – they would eventually get typed up by a secretary. But the Corp Fin “branches” had one secretary for about 10 lawyers. So comment letters didn’t get typed up until the deal went to market in most cases. Instead, Staffers would call and read off their comments over the phone – and the law firm on the other side would record the conversation and transcribe it. So there is some sort of precedent…
3. What Happens If Corp Fin Doesn’t Take Any Position? – Corp Fin’s announcement states that the Staff’s failure to take a position on a no-action request should not be construed as an indication that the company’s failure to include a shareholder proposal in its proxy materials is a violation of Rule 14a-8. As noted in this Gibson Dunn blog, the Staff may now more frequently decline to give a definitive response. That used to be rare – perhaps now it will be more common.
Gibson Dunn notes: “In considering whether to omit a proposal in such situation, a company will need to consider the potential reaction of its shareholders, the risk of adverse publicity, possible reactions from proxy advisory firms (discussed below), the risk of litigation, and the possibility that including the proposal in its proxy statement will attract more proposals in future years.”
4. Why Bother Seeking No-Action Relief At All? – Unfortunately, this Corp Fin position doesn’t change anything for companies in terms of spending resources to seek no-action relief. (Remember that a no-action response only means that Corp Fin won’t refer the matter to the SEC’s Enforcement Division if a company excludes a shareholder proposal from the proxy. It ain’t a “get out of jail free” card).
Companies still are required by Rule 14a-8 to notify Corp Fin that they intend to omit a proposal and the “reasons” for excluding it, and since (at this point at least) we don’t have a good sense of when Corp Fin will respond with a definitive position, companies still have to make as strong of a case as they can because you don’t want to be so unconvincing that Corp Fin says (whether orally or in writing) that they don’t concur.
5. Will Corp Fin’s Announcement Result in More Lawsuits? – Corp Fin’s announcement notes – as has always been the case – that proponents & companies are free to seek adjudication of the Staff’s positions in federal court. Personally, I don’t think we’ll see more lawsuits.
For the bigger investors that have submitted shareholder proposals in the past, they may gravitate to other methods to pressure companies in the wake of the Staff’s new position – for example, engage in more “just vote no” campaigns or more joint activities with other investors to apply pressure. Lawsuits take too long, cost too much and the judges involved typically don’t know the nuances of the securities laws. But you never know, maybe we’ll see more litigation after all…
6. Will Corp Fin Give Broader Guidance More Frequently? – As noted in this Gibson Dunn blog, “The Staff announcement indicates that one instance in which the Staff will issue response letters will be to provide “more broadly applicable guidance about complying with Rule 14a-8.”
Although the Staff has on occasion used a Rule 14a-8 no-action response to elaborate on its interpretation of the rule, historically the Staff has utilized Staff Legal Bulletins to provide “more broadly applicable guidance” regarding its interpretation of Rule 14a-8. The Staff’s announcement appears to suggest that it now will more commonly spring guidance on the shareholder proposal community in the middle of the season and in the context of specific factual situations, which may make such guidance harder to apply in other contexts than if the Staff addressed such issues more generally.”
Tomorrow’s Webcast: “Secrets of the Corporate Secretary Department”
Tune in tomorrow for the webcast – “Secrets of the Corporate Secretary Department” – to hear Norfolk Southern’s Ginny Fogg and Home Depot’s Stacy Ingram debunk myths on how to run the corporate secretary department, as well as provide oodles of practice pointers on how to leverage outside resources & technology; tips for caring of the board; managing a budget; streamlining the board materials process; optimizing director orientation & education; and much more.
Poll: Desirability of Receiving Oral Responses to No-Action Requests?
Please take a moment to participate in this anonymous poll:
With everybody debating big picture issues like corporate purpose & stakeholder v. shareholder interests, this “Ethical Boardroom” article by Harvard’s Stephen Davis is a reminder that when it comes to good governance, there are more fundamental issues that need to be addressed – like making sure directors have the information they need to do their jobs.
The article points out that directors are “on the short end of a massive information imbalance.” They’re entirely dependent on management for their information flow, and even when they retain outside advisors, those advisors may be primarily loyal to management. This disparity gives management a routine advantage in influencing what gets on the board’s agenda and how matters are addressed. This excerpt says that the solution to this information imbalance may be an independent staff serving only the board:
Cementing the information imbalance is the fact that the typical company board has no everyday dedicated staff. Instead, directors rely on an executive – usually a company secretary or general counsel – who is accountable to and works for management. These officers are often the silent heroes of corporate life, as they attend to multiple, sometimes conflicting, constituencies and do so with high ethics and professionalism.
But make no mistake: they are not employed by and for the board. Indeed, outside observers would find it hard to fathom how companies go to such lengths to recruit great independent directors – only to make them largely dependent for help on the team they are supposed to oversee.
One of the interesting things that the article points out is that some companies have taken steps in this direction – although most of them appear to have done so in response to massive scandals. In that regard, in the wake of the Carlos Ghosn scandal, Nissan announced that it would establish an “office of the board” to improve the board’s ability to access information independently.
LIBOR Transition: FASB Exposure Draft Would Ease Accounting Burden
This recent blog from Stinson’s Steve Quinlivan flags a new FASB exposure draft that would make life a little easier when it comes to accounting for the impact of the upcoming elimination of LIBOR. Why should you care? Well, here’s an excerpt about the accounting hurdles companies could face absent the proposed relief:
Without any relief by FASB any contract modifications resulting from contract modification to implement a new reference rate would be required to be evaluated in determining whether the modifications result in the establishment of new contracts or the continuation of existing contracts. The application of existing accounting standards on modifications could be costly and burdensome due to the significant volume of affected contracts and the compressed time frame for making contract modifications.
In addition, changes in a reference rate could disallow the application of certain hedge accounting guidance, and certain hedge relationships may not qualify as highly effective during the period of the market-wide transition to a replacement rate. The inability to apply hedge accounting because of reference rate reform would result in financial reporting outcomes that would not reflect entities’ intended hedging strategies when those strategies continue to operate as effective hedges.
The proposed ASU would simplify accounting analyses under current GAAP for contract modifications if qualifying criteria are met & would allow hedging relationships to continue without de-designation as a result of certain LIBOR reform-related changes in their critical terms.
The Martin Act Gets Its Claws Sharpened
I’ve previously blogged about New York’s formidable Martin Act, which the NY AG uses as the basis to investigate and prosecute . . . well . . . just about anything. Last year, the statute had its claws trimmed when the NY Court of Appeals pared back its limitations period for non-scienter based fraud claims from 6 years to 3 years. But this New York Law Journal article reports that last month, NY Governor Andrew Cuomo signed legislation that essentially undid the Court’s decision & restored the 6 year statute of limitations.
Last month, Delaware Chief Justice Leo Strine co-authored a NYT opinion piece about the failure of retirement & index funds to approach voting & corporate governance issues with the needs of their own investors – the workers who invest their retirement savings with them – in mind. Here’s an excerpt:
Growing inequality and stagnant wages are forcing a much-needed debate about our corporate governance system. Are corporations producing returns only for stockholders? Or are they also creating quality jobs in a way that is environmentally responsible, fair to consumers and sustainable? Those same corporations recognize that things are badly out of balance. Businesses are making record profits, but workers are not sharing in those gains.
This discussion is necessary. But an essential player is missing from the debate: large institutional investors. For most Americans, their participation in the stock market is limited to the money they have invested in mutual funds to finance retirement, usually in 401(k) accounts through their employers. These worker-investors do not get to vote the shares that they indirectly hold in American public companies at those companies’ annual meetings. Rather, the institutions managing the mutual funds do.
Institutional investors elect corporate boards. Institutional investors vote on whether to sell the company and on nominations for new directors, and whether to support proposed compensation packages for executives. At the average S. & P. 500 company, the 15 largest institutional investors own over half the shares, effectively determining the outcomes of shareholder votes. And the top four stockholders control over 20 percent.
What this all means is that corporate governance reform will be effective only if institutional investors use their voting power properly. Corporate boards will not value the fair treatment of workers or avoid shortcuts that harm the environment and consumers if the institutional investors that elect them do not support them in doing the right thing. And they are unlikely to end the recent surge in stock buybacks as long as there is pressure from institutional investors for immediate returns.
Among other things, Strine and his co-author, Kennedy School senior fellow Andrew Weiss, argue that mutual funds should have voting policies “tailored to the objectives of long-term investors,” and should include “environmental, social, and most important of all, employee factors” in their investment & voting decisions. They’d also like to see a reduction in the number of shareholder votes, noting that each year, mutual funds are required to cast over 30,000 votes at shareholder meetings.
The failure of financial intermediaries to serve the broader interests of the working investors they represent has been a recurring theme for Chief Justice Strine. In one recent article, the Chief Justice called out them out for allowing companies to spend “worker-investors” money on political activities promoting policies that negatively impact those investors. In another article, he criticized the current corporate governance system for giving the most power over corporate decisions to investors like hedge funds – whose interests are least aligned with those of average shareholders.
Financial Intermediaries: 3 Cheers for the Big 3?
Liz recently blogged about research suggesting that the major index funds were “patsies” for management. Between that research, Chief Justice Strine’s critique of their failure to serve the interests of their investors, & concerns expressed over the implications of their ever-growing ownership positions in U.S. companies, BlackRock, State Street & Vanguard could sure use a friend.
It looks like they may have just found one in a new study that says the Big 3 have both the ability & the incentive to police misconduct by their portfolio companies – and that there’s evidence that they’re doing exactly that. Here’s an excerpt from the abstract:
In this paper, I argue that the remarkable size, permanence, and cross-market scope of the Big Three’s ownership stakes gives them the capacity and, in some cases, the incentive to punish and deter fraud and misconduct by portfolio companies. Corporate governance and securities regulation scholars have argued that these institutions have generally overriding incentives to refrain from meaningful corporate stewardship, but the facts on the ground tell a somewhat different story.
Drawing on a comprehensive review of the Big Three’s enforcement activities and interviews with key decision-makers for these institutions, I show how they have been using engagement, voting, and litigation to discipline culpable companies and managers. I also identify the “pro-enforcement” incentives that explain these actions.
The study bases its conclusions on an analysis of the involvement of the Big 3 in direct securities litigation, litigation arising out of the financial crisis, “just vote no” activism against directors of companies involved in fraud or misconduct, and significant engagements. It’s an interesting perspective – and a much more effective defense of the Big 3 than the specious stuff they’re peddling.
Restatements: 2018’s Scorecard
Audit Analytics recently released its annual report on public company restatements. Here’s an excerpt from Audit Analytics’ blog with some of the highlights:
– After 12 years of decline, the number of reissuance (“Big R”) restatements increased slightly in 2018.
– Around 70% of restatements disclosed were revision (“Little R”) restatements.
– Total restatements dropped for four consecutive years to an 18-year low.
– There were 171 restatements filed by accelerated filers, and 229 restatements disclosed by non-accelerated filers.
– About 54% of the restatements disclosed by publicly traded companies had no impact on earnings.
Shortly before the BRT issued its statement redefining its position on corporate purpose, Andrew Ross Sorkin profiled Jamie Gamble in the NYT DealBook. Gamble is a former Wall Street lawyer who has had a conversion experience and now says that the corporate clients he worked for are legally compelled to act like Patrick Bateman. Here’s an excerpt from his manifesto:
The most important problem in the world is a reasonable sounding provision of the corporate law that governs most major U.S. companies. That’s a big claim. It’s also slightly misleading. A better answer is that the above complex network of horribles all connect back to a common root that is nourished and guarded by the extraordinary power of corporate “persons” who are legally obligated to act like sociopaths.
The rule: corporate management and Boards of directors are obligated by law to make decisions that maximize the economic value of the company. Colloquially: when you invest your money in a company, the people who run that company are required to do their best to bring you the highest possible financial return on your investment rather than using your money to pursue any personal or social agenda.
Sociopath? Yes. The corporate entity is obligated to care only about itself and to define what is good as what makes it more money. Pretty close to a textbook case of antisocial personality disorder. And corporate persons are the most powerful people in our world.
Gamble’s solution – or at least part of it – would be to include language in corporate bylaws requiring boards to consider the interests of a broad range of constituencies beyond shareholders whenever they make a decision. By making this mandatory & providing shareholders with the ability to sue directors for violating these provisions, he thinks the beast can be tamed.
Counterpoint: Like Heck It Does!
Sorkin’s piece initially attracted a lot of attention, but then it sort of got overwhelmed by the sound & fury surrounding the BRT’s decision to bid farewell to shareholder primacy. That’s too bad, because I think Gamble’s views about the legal obligations of corporate directors are based on a false premise, and it’s the same one that seems to have framed at least some of the reaction to the BRT’s new statement of purpose.
I doubt there’s a single corporate lawyer who would dispute the contention that true sociopaths are by no means absent from America’s boardrooms or C-suites. But does the law really require sociopathic behavior? UCLA’s Stephen Bainbridge says no way – and also says that Sorkin & Gamble’s arguments amount to “a mass dump of uninformed silliness.” (You won’t like the Prof. when he’s mad). Here’s an excerpt from his recent blog responding to the DealBook article:
This argument is patently absurd. The corporation is a legal fiction. To paraphrase the first Baron Thurlow, who observed that the corporation has neither a soul to be damned nor a body to be kicked, the corporation has neither a mind to be psychoanalyzed not a brain to be diseased. Corporations are run by people, so if “they” act like sociopaths, it must be because they are run by sociopaths. It is estimated that psychopaths make up at most 1% of the population, so are we to believe they are disproportionately located in corporate C-suites?
Second, both Gamble and Sorkin grossly misstate the law. Sorkin writes:
“It may be an oversimplification, but if they veer from seeking profits in the name of other stakeholders, shareholders may have a legal case against them.”
That is not an oversimplification; it is a gross oversimplification. Absent proof that the directors were engaged in a breach of the duty of loyalty or certain takeover situations, the business judgment rule would preclude courts from reviewing director decisions. To be sure, that is not the purpose of the business judgment rule, but that is its effect.
Prof. Bainbridge is absolutely right on the law (see also this 2015 NYT opinion piece by the late Prof. Lynn Stout). But if you asked directors & officers of public companies what they think their legal obligations are, my guess is that their responses would be pretty consistent with Gamble’s characterization of what the law requires. The “value maximization” imperative has been internalized by a whole lot of D&Os, and has been used to justify some pretty cold-blooded corporate decisions.
By the way, if this debate sounds familiar, pundit Matthew Yglesias tweeted a similar comment last year – and got clobbered by legal academics.
“Stakeholder Governance”: What Happens to the BJR?
This recent blog from Alison Frankel poses an interesting question: if corporations undertake obligations to “stakeholders” & not merely shareholders, what does that mean for the business judgment rule? Here’s an excerpt:
Law firms are beginning to contemplate whether corporate boards will continue to be entitled to the deference afforded by the business judgment rule – which broadly shields directors from liability as long as they’re deemed to have acted in the corporation’s interest – if their decisions are prompted by rationales other than maximizing profits.
That’s particularly relevant in Delaware, where, as Chief Justice Leo Strine explained in a 2015 paper, The Dangers of Denial, corporate law is resolutely focused on stockholder welfare. Strine (who is due to retire from the Delaware Supreme Court by the end of October), is of the view that Delaware precedent does not provide leeway for judges to sanction board decisions that subordinate shareholder interests.
In other words, if directors put the interests of other stakeholders first, they risk losing the protection of the business judgment rule – at least in Delaware. If that’s so, then isn’t Gamble right about the law obligating boards to act like sociopaths in the pursuit of value maximization?
Nope. Except in very limited situations, the authority provided to Delaware directors under Section 141(a) of the DGCL includes the authority to set the time frame for achieving corporate goals without – as the Delaware Supreme Court put it in Paramount Communications v. Time – a “fixed investment horizon.” Deterimining that time frame is a matter of business judgment.
So, if you’re a director who is thinking about the long-term, you’ve got plenty of discretion to conclude in good faith that considering the interests of other stakeholders may be helpful in maximizing long-term shareholder value. But that doesn’t mean that members of the only stakeholder constituency that can vote won’t still lean on you mighty hard to do otherwise.
The sound & fury surrounding the BRT’s pronouncement prompted it to issue a lengthy “clarification” of its position – and it draws heavily on the idea of promoting the interests of other constituencies as being essential in order to create long-term shareholder value.
Dorsey’s Whitney Holmes shared the following comment, which I think nicely summarizes the issue of what Delaware law requires:
I believe that much of the debate misses the point that impact investors understand and now the BRT are starting to understand: for a given corporate decision not involving a sale of corporate control (or enactment of a preemptive defense against an acquisition), if
– choice A demonstrably returns $100 to shareholders and no benefit to anyone else, and
– choice B demonstrably returns $90 to shareholders and a meaningful but unquantifiable benefit to another interest (e.g. the environment, the wellbeing of employees, the community in which a manufacturing facility sits, etc.) that cannot be supported by a vague future benefit to the corporation that might somehow, someday be worth $10 or more, do the corporation’s directors have discretion in line with their fiduciary duties to choose B over A?
He says the answer under Delaware case law is “no,” and I think that’s right. If you’re ultimately called upon to make some sort of corporate “Sophie’s Choice,” you can’t prefer other stakeholders to shareholders – but given the deference under the BJR to the board’s assessment of the future shareholder value a particular decision would create, it’s doubtful that a board would ever find itself in this position.
According to a recent University of Alabama study, when you draft your next 10-K, it might be a good idea to put down your copy of Reg S-K and pick up a copy of “The Power of Positive Thinking.” That’s because, according to this CLS Blue Sky blog on the study, an upbeat 10-K correlates with improved stock performance, while a more downcast filing can result in your stock taking a hit:
Our results show that positive (negative) sentiment predicts higher (lower) abnormal return over days (0, +3) around the 10-K filing date, i.e., the filing period. Both sentiment measures also predict higher abnormal return over event windows of up to one month after the filing period. This finding suggests that the market underreacts to positive sentiment and overreacts to negative sentiment in the 10-K filing during the filing period. Moreover, both sentiment measures are significantly related to abnormal trading volume around the filing date.
By the way, it looks like Norman Vincent Peale was on to something – because the study also says that that companies with happier 10-Ks also produce better results over the course of the year than their more dour counterparts.
Transcript: “Joint Ventures – Practice Pointers (Part II)”
We have posted the transcript for the recent DealLawyers.com webcast: “Joint Ventures – Practice Pointers (Part II).” Here’s the transcript for the first “Joint Ventures – Practice Pointers” webcast.
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