SEC Chair Gary Gensler testified yesterday before the Senate Committee on Banking, Housing and Urban Affairs. Here are his prepared remarks – and here’s the 2-hour C-SPAN video.
Chair Gensler covered human capital disclosures as well as cybersecurity, climate risk, SPACs, China-based companies, Rule 10b5-1, crypto and more. As regular readers of this blog know, Chair Gensler has initiated projects on all of those topics and variousremarks have suggested that he is in the “cryptocurrency is a security” camp.
Yesterday’s testimony reinforces the expectation that we’ll see proposed rulemaking for additional human capital disclosure, on top of the incremental disclosure requirements that were adopted late last year. What are companies doing so far in response to those 2020 amendments? This DFIN memo highlights recent Form 10-K disclosure from three companies about the specific topics of employee turnover & talent management. Here are some takeaways from the samples:
– ConocoPhillips included an employee demographics table. It showed the percentage of male & female employees, and the percentage of “person of color” and non-POC employees, in the categories of all employees, all leadership, top leadership and junior leadership. The company committed to publicly disclose its next Consolidated EEO-1 Report (which is now available on the company’s Diversity & Inclusion page).
– Cummins disclosed that its Board “recast our Compensation Committee as the Talent Management & Compensation Committee to reflect the Board’s commitment to overseeing and providing guidance to our leadership team in this important work.
– Signet Jewelers also added “Human Capital Management” to the title of its Compensation Committee, and described the board’s oversight role on those activities.
At our “Proxy Disclosure & Executive Compensation Conferences” – coming up virtually on October 13th – 15th – we’ll be covering new expectations for human capital management and diversity & inclusion, Form 10-K disclosures, and how to effectively share your progress. Check out the full agenda – 17 panels over 3 days. Register today so that you’re armed with these insights as you head into the 2022 proxy season! Members of our sites can attend for a discounted rate!
The Aspen Institute recently published a 34-page collection of essays that explore whether & how adding “employee directors” to boards would allow for better decision-making about corporate risks & opportunities. Doug Chia authored one of the six included essays and shared excerpts from each one. From Doug’s blog:
Expanding Diversity in the Boardroom by Adding Worker Voice
By David Berger (Partner, Wilson Sonsini)
How times have changed. Now that cracks are appearing in the ideology of shareholder primacy, it is time to reconsider the potential benefits from having some directors chosen by employees. Several studies have shown that employee representation on board provides for better performance on a variety of ESG measures, including climate policy, community support and job security (but interestingly not necessarily higher wages). Simply put, the empirical evidence does not support the grave concerns raised about having employees represented on boards, while the most current studies show that adding employees to the board furthers many of the ESG goals that are broadly supported today, including by such organizations as the Business Roundtable.
Director Perspectives: The Value of Worker Voice
By Michelle Greene (President Emeritus and Board Member, Long-Term Stock Exchange)
Workers have valuable perspectives to inform decision-making, reduce risk, and identify untapped opportunity. This perspective is particularly valuable to U.S. boards, which often lack consistent ways of hearing it. As societal and worker expectations evolve, U.S. companies must ensure that the worker voice is heard loud and clear as part of the boardroom conversation, including potentially by making worker-representatives members of the board.
Reimagining Board Committees to Accommodate Worker Voice
By Doug Chia
Demands for worker voice are on the rise, and if trends continue, boards could soon be challenged to accommodate worker voice more formally in corporate governance. Rather than being caught flat-footed, boards can start reimagining now. Looking at their own committees would be a good place for boards to start.
Those Who Work are Labor Investors: Recognizing the Two Core Constituencies of Capitalist Firms
By Isabelle Ferreras (Senior Tenured Fellow, Belgium National Fund for Scientific Research)
Firms are political entities with key economic dimensions, whose very existence is made possible by the joint investment of labor and capital. But despite the fact they would not operate without the former, firms currently only recognize the rights of the latter, those who contribute financial capital, via the structuring of capital investment in the corporate structure which is given a monopoly of the – political – rights to govern the firm. Labor investors should be recognized as the forgotten constituency of the firm, and as such, should be afforded the same rights in its government. Corporate law should require that labor investors, as capital investors, benefit from at least the same rights as those enjoyed by capital investors, and have thus a defining role in strategic corporate decisions.
Why (and How) Workers Should Be Represented on U.S. Corporate Boards
By Lenore Palladino (Assistant Professor of Economics and Public Policy, University of Massachusetts Amherst and Fellow at Roosevelt Institute)
Workers are crucial stakeholders for the success of large corporations, the drivers of the U.S. economy. The economic model of shareholder primacy, in which shareholders (through financial intermediaries) solely elect directors to corporate boards, does not reflect the institutional factors that contribute to innovative enterprises and does not accurately reflect the role of shareholders in 21st century corporations. There is growing consensus that shareholder primacy should be replaced with a stakeholder theory of the corporation; one key element is to include worker representatives on U.S. corporate boards. Though such a policy reform will only be effective if it is enacted along with other reforms to U.S. industrial relations, and certainly faces political headwinds, worker representation on corporate boards is a key policy that can encourage innovation and sustainable prosperity in the 21st century.
From Shareholder Primacy to a Dual Majority Board
By Julie Battilana (Joseph C. Wilson Professor of Business Administration at Harvard Business School) & Isabelle Ferreras (Senior Tenured Fellow, Belgium National Fund for Scientific Research)
Measured either normatively or through contribution to productive processes, labor investors are not the “junior partner” of capital. They are an equal constituency of the firm, in need of enfranchisement and a coequal role in making its main decisions, including the selection of the CEO and strategic choices that will affect labor as much as capital investors and their respective returns on investment. Labor investors ought to have “the collective right to validate or veto these decisions.” All workers should not only be able to vote for union representation to bargain over wages and working conditions that concern the entire industry, but also should be able to choose their representatives at the firm level so that they can participate in decision making about the life of the firm such as the choice of the CEO, what product and market strategies it should pursue, what to prioritize in times of crisis, and how profits are shared.
The mandatory compliance date has arrived for the MD&A and financial disclosure rules that the SEC adopted late last year. Tune in tomorrow for the webcast – “MD&A and Financial Disclosures: What To Do Now” – to hear Sidley’s Sonia Barros, Skadden’s Raquel Fox, E&Y’s Mark Kronforst, Morrison & Forester & TheCorporateCounsel.net’s Dave Lynn, and Shearman & Stearling’s Lona Nallengara, all experienced former Corp Fin Staffers, continue the discussion from our January webcast of the many issues to watch out for when updating your disclosures.
If you attend the live version of this 60-minute program, CLE credit will be available. You just need to submit your state and license number and complete the prompts during the program.
We also acknowledge our oversight in scheduling the live program on Yom Kippur and profusely apologize. As always, the audio archive will be available shortly after the program airs, and the transcript will be available within 2-3 weeks. We respect and care for our Jewish community members and will not schedule future programs on this important holiday.
Programming Note: This blog will be off tomorrow in honor of the holiday; returning Friday.
You can still register for our popular conferences – the “Proxy Disclosure & 18th Annual Executive Compensation Conferences” – to be held virtually Wednesday, October 13th – Friday, October 15th. We’ll be covering the changing expectations from investors and other stakeholders – with practical guidance on how to use the annual reporting season to your advantage.
For more details, check out the agenda – 17 panels over 3 days. Our speakers are fantastic and this is truly a “can’t miss” event for anyone involved with proxy disclosures, corporate governance, and executive pay.
Conference attendees will not only get access to our unique & valuable course materials (coming soon) – we’ll also be making video archives and transcripts available after the conference, so that you can refer back to all of the practical nuggets when you’re grappling with your executive pay decisions, disclosures and engagements. Plus, our live, interactive format gives you a chance to earn CLE credit and ask real-time questions.
Register today! As an added benefit to our members, this year we are offering a discounted conference rate to those who have a paid subscription to any one of our sites.
Dave blogged last month about SEC Chair Gary Gensler publicly committing to protect investors from fraud in the crypto space – a signal that he would be open to the SEC playing a greater regulatory role in the world of digital assets. Last week, the CLO of Coinbase – the largest US crypto exchange – blogged that the company had received a Wells notice from the Staff about its crypto lending program. Coinbase’s CEO also took to Twitter about the exchange.
As we explain in our “SEC Enforcement” Handbook, a Wells notice is a statement by the Enforcement Division that they’ve reached a preliminary conclusion to recommend an enforcement action – but a majority of Commissioners still have to approve to institute the proceeding. Absent an extension, the Staff has 180 days after sending the Wells notice to decide whether to recommend enforcement to the Commissioners.
Some companies don’t disclose their receipt of a Wells notice, they wait until there’s an enforcement action. So it’s interesting here that Coinbase made the whole thing public right away. In a predictable argument that the regulatory crowd would say is against their own interests, crypto fans seem to be siding with the company in wanting the SEC to step away.
The company seems startled by the notice because it had been “proactively engaging with the SEC” about this product, which would allow Coinbase to lend out USD Coin (a stablecoin) from deposited funds in exchange for interest, a portion of which is paid to the depositors. Now, the SEC is saying it will bring an enforcement action if Coinbase offers the product without registration.
The Staff is taking the position that Coinbase’s “Lend” product may be a security that cannot be offered without registration or an exemption. Anne Lipton’s blog explains how the common law has developed to a point where the SEC is performing the test under both Howey and Reeves – and this blog from Adam Levitin analyzes how those tests apply to Lend. In short, he concludes that Lend fits one or both of the tests that define whether something is a “security.” Former SEC Enforcement Staffer John Reed Stark also took that stance in a popular LinkedIn post.
Yet, there could be a path out. Matt Levine pointed out that Section 3(a)(2) of the Securities Act – and the four-part Reeves test – could allow Lend to avoid regulation as a security. The catch is that Coinbase would then be subject to banking regulations, which it probably doesn’t want.
As expected, the SEC’s Investor Advisory Committee unanimously approved its recommendations on SPACs and Rule 10b5-1 reform at its meeting last week. This Cadwalader blog recaps the contrasting views that SEC Chair Gary Gensler and SEC Commissioner Hester Peirce expressed during the meeting on market regulation, technology and new financial products.
The remarks suggest that anticipated SEC rulemaking proposals will not be unanimously approved by the Commissioners. Here’s the summary:
In his address, Chair Gensler focused on investor protection, highlighting concerns raised by the behavioral design of online trading platforms, the insider trading enforcement regime, and special purpose acquisition companies (“SPACs”). As to current digital engagement practices (“DEPs”), Mr. Gensler described inherent conflicts of interest between financial intermediaries and investors, particularly when DEPs are optimized for revenues which could affect investment recommendations. Mr. Gensler discussed the SEC’s request for information and comment on the use of DEPs and asked for submissions from the Committee and other interested listeners. He noted the inherent biases of these business models should the underlying data reflect historical biases.
In addition, Mr. Gensler noted that the Committee’s recommendations for plans under SEA Rule 10b-5 (“Employment of manipulative and deceptive devices”) align with his previous request to SEC staff for proposed rulemakings. With regard to SPACs, Mr. Gensler stated that SPAC disclosures around dilution should be strengthened, and reported that the staff is developing rulemaking recommendations.
By contrast, Commissioner Peirce urged the Investor Advisory Committee to promote a regulatory process for digital platforms that considers investor opportunity as well as investor protection. Ms. Peirce contended that investors “at times may be willing to take on more risk than the regulator thinks is prudent,” and so the regulatory process should not undercut an investor’s ability to interact with the latest technologies, have access to new types of assets, and try new products and services. Ms. Peirce stated that a “healthy regulatory response” to such investor demand would not override investor decisions, but rather educate investors “using the same technologies through which they are investing.”
Last week, Vice Chancellor Zurn of the Delaware Court of Chancery determined that the shareholder derivative litigation against Boeing’s board of directors could proceed, based on allegations that the directors breached their duty of loyalty by not making a good faith effort to implement an oversight system and monitor it. The court dismissed the shareholders’ claims against the officers and the board for compensation decisions.
In light of the tragic loss of life that formed the basis for this lawsuit, the allegations here about the shortcomings in director decision-making are troubling, and that may have affected the opinion. The court noted that:
– Meeting minutes didn’t indicate rigorous director discussions of safety issues
– No board committee was charged with direct responsibility to monitor safety
– The board didn’t direct management to provide regular safety updates – it “passively” received updates at management’s discretion
– The Board publicly lied about whether & how it monitored the 737 MAX’s safety in order to preserve its reputation
Based on this, VC Zurn held that the board came up short on both Caremark prongs: it failed to establish a monitoring system and failed to respond to red flags. She also found that the plaintiffs adequately alleged scienter. Alarmingly for companies and their advisors, VC Zurn determined that the board’s remedial step of creating a safety committee after the crashes was evidence that, before the crashes, it had no oversight process at all – and knew it.
For 25 years, it was notoriously difficult for a Caremark claim to survive a motion to dismiss, even though the court has to accept the plaintiffs’ allegations as true at that stage of litigation. VC Zurn even acknowledged in her opinion that it’s extremely difficult to plead an oversight failure. Yet, a series of Caremark claims have proceeded past the motion to dismiss stage in just the past couple of years. As this Wachtell Lipton memo notes, that’s a big deal for the company and the board:
The company’s directors now face the prospect of intrusive document discovery, extensive depositions, and either an expensive settlement or a trial to defend the effectiveness of their oversight.
UCLA’s Stephen Bainbridge blogged that this case is another sign that Caremark claims are getting easier. He notes that the court took a much closer – and less favorable – look at board decisions than what you’d expect. Yet, as Kevin LaCroix blogged, the crashes at issue here “dramatically highlighted the critical importance of safety issues for Boeing.” And – hopefully – these types of events are rare. So, it’s too early to declare that every duty-of-oversight claim will proceed to the merits. But Kevin notes:
All of that said, I do think the recent spate of breach of the duty of oversight cases will encourage plaintiffs to pursue these kinds of claims and to include claims of breach of the duty of oversight in cases in which companies have experienced significant adverse circumstances in important operations. I suspect we are going to see an increase of claims of this type.
That makes it all the more important for other boards to review their risk management processes right now. Helpful steps could be:
– Document the board’s oversight of enterprise risk management, its process for asking questions & reviewing risks, and its evaluation of which functions are “mission critical”
– Ensure the board has a robust oversight process for key functions that create significant risk – and consider forming a dedicated board committee
– Document regular risk reporting to the committee & board, directors’ rigorous discussions & questions about risks, and board-directed risk reports
In her opinion last week, Vice Chancellor Zurn also made note of the lengthy tenure of many of Boeing’s directors and their skill-sets as “political insiders or executives with financial expertise.” She then discussed at length the transformation of the company from an organization run by engineers to one run by finance folks – recounting how the company moved its headquarters from Seattle 20 years ago in order to “escape the influence of the resident flight engineers.” The focus on cost-cutting allegedly impacted quality and resulted in more safety violations.
Our point today, however, is that 3G made cost-cutting a strategic goal for the company. It tied employees’ performance metrics and compensation to their ability to cut costs. Procurement division employees said internally that the former COO “push[ed] like crazy” for them to meet cost savings goals, and increased cost savings targets to unreasonable levels.
Faced with that relentless pressure to cut costs, employees then engaged in the prebate chicanery we mentioned above, and lots more.
That’s the lesson for internal control and compliance officers. If your business is based on a misguided strategic goal, eventually it will warp your corporate culture to the point where misconduct is the only way to execute the strategy — and then, all the internal controls in the world won’t do you any good.
The topics of board composition and director skills are huge right now. Tune in tomorrow for the free webcast – “The 21st Century Board: Changing Expectations For Diversity, Human Capital & Risk Oversight” – co-hosted by ISS Corporate Solutions and CCRcorp – to hear Digimarc Board Chair Alicia Syrett, Russell Reynolds’ Rusty O’Kelley, ISS Corporate Solutions’ Ben Magarik, and our very own Lawrence Heim of PracticalESG.com. They’ll be talking about the changing expectations of investors & stakeholders – and how boards are responding.
Tomorrow marks the twentieth anniversary of the September 11, 2001 terrorist attacks on the United States. It is hard to believe that twenty years have passed since that terrible day. I can still remember that morning so vividly – the sky was a crisp blue, the temperature was just right for a post-Labor Day morning and everyone was busy getting back into the swing of work after the end of the summer season.
I was in my office on the phone with a client when American Airlines Flight 11 crashed into the North Tower of the World Trade Center, and so I did not immediately know what was happening. My mother called while I was on the line and my assistant sent her to my voicemail – she was concerned because at the time I regularly traveled to New York and she wanted to see if I was OK. When I emerged from my office after the call, a group had gathered around a television to watch the events unfold, and it was then that we all watched in horror as United Airlines Flight 175 crashed into the South Tower. Having vividly remembered the 1993 World Trade Center attack, it was clear to me at that moment that this was no accident.
Within the hour, word came that American Airlines Flight 77 had crashed into the Pentagon, and the call was made to evacuate the building. At the time, I was working in the tallest office tower in Baltimore, and there was a concern that attacks could be unfolding in cities up and down the east coast. I distinctly remember exiting the fire stairs into a world that was transformed – the traffic was gridlocked as panicked office workers fled the city, cell phones did not work because the network was overwhelmed and there was a constant threat of the invisible enemy that could fall out of the sky at any moment.
After a taking circuitous route home, I was so relieved to be reunited with my family, but devastated to hear about the horrific loss of life that was unfolding as the Twin Towers fell, the Pentagon burned and United Airlines Flight 93 crashed in Pennsylvania. It was – and still is today – unthinkable that this despicable act of evil could be carried out against so many people who were simply trying to go about their lives and do their jobs.
We must always remember those who lost their lives on that day, and to this day – the flight crews, the passengers, the office workers, the incredibly brave first responders and many others who stepped in to help on the day of the attack and in the months after, as well as the members of our military who were killed or injured fighting the war on terror which followed that tragic day.
Please take a moment tomorrow to reflect on what it was like on that day twenty years ago, and please remember the fallen. I think that is the best way that we can all honor their sacrifice and secure their legacy.