Earlier this week, a federal district court judge issued an unpublished opinion in a long-running clawbacks case. Even though the case doesn’t create formal precedent, it may affect decision-making as we all look to finalize Dodd-Frank clawback policies by December 1st of this year. Specifically, it emphasizes that it’s important to follow state law contract principles when you put a policy in place, if you want to be able to enforce the company’s rights under that policy down the road. Enforceability matters because under the new listing standards and SEC rule, companies aren’t required to merely adopt a clawback policy, they are also required to comply with the policy by recovering erroneously paid incentive compensation reasonably promptly – with delisting at stake.
In Monday’s case, the judge granted summary judgment in favor of Hertz’s former CEO, shutting down the company’s 2019 claim that he had breached the company’s clawback policy – as well as representations in his separation agreement – by creating a “tone at the top” that may have led to inappropriate accounting decisions. Although the former CEO settled with the SEC in 2020, he continued to fight reimbursing the company. Mike Melbinger blogged about this case at the “motion to dismiss” stage in 2021.
Hertz alleged that this was a case of misconduct that caused a restatement. It sought to claw back incentive-based compensation that was paid in prior years based on achievement of later-restated revenue, by way of the company clawback policy. It also sought to rescind golden parachute payments that it made to the former CEO under his separation agreement. Both the clawback policy and the separation agreement required a finding of gross negligence, fraud or willful misconduct.
The holding underscores that adopting a clawback policy is only one step in the process of recovering compensation – a point that Ron Mueller reiterated in yesterday’s webcast and has been preaching at our “Executive Compensation Conference” for many years. If there were doubts about whether to have executives agree in writing to be bound by company policies, this decision supports the notion that you do need a contractual basis for enforcement. And according to this opinion, simply incorporating a general policy into other agreements doesn’t work. Here’s an excerpt (citations omitted):
Hertz argues that the Clawback Policies were incorporated into “various other agreements” with Frissora and as such, are enforceable through this incorporation (“Incorporation Argument”). Specifically, Hertz argues that the following documents incorporate one or both Clawback Policies: (1) Frissora’s Employment Agreement, which Hertz argues incorporates both Clawback Policies because it states that the violation of a “material company policy” constitutes a defined cause to terminate Frissora’s employment; (2) the Separation Agreement, which Hertz argues incorporates the 2014 Clawback Policy by reference; and (3) Hertz’s “bylaws,” which Hertz argues incorporate both Clawback Policies because they “impose on [Frissora] and other senior executives the solemn duty of abiding by and enforcing company policies.” …
The Court agrees with Frissora that Hertz can only argue that the Clawback Policies are stand-alone contracts. Accordingly, if the Court finds that they are not enforceable contracts, then Hertz’s breach of contract claims under Counts I and II will fail.
The court went on to explain that the company’s clawback policies – which were set forth in board resolutions, incorporated into the company’s standards of business conduct, and described in public filings – were simply mechanisms by which Hertz would enter future contracts, and were not themselves enforceable contracts. The court also determined that the company’s general standards of business conduct weren’t enforceable contracts because (according to the court) they:
– Contained “only vague and aspirational language,”
– Had no yardstick by which to measure compliance with the standards,
– Stated that they were a “guide” not a “contract,” and
– Did not expressly have employees indicate that they would agree to be legally bound by the document.
There were some procedural & litigation strategy issues at play throughout all these findings, which also affected the court’s decision to reject the company’s attempt to rescind the payments under the separation agreement. And it’s possible Hertz will appeal. Nevertheless, this case shows that you need to keep basic contract principles in mind for company policies if you want to be able to enforce them. Also see question #1467 in our “Q&A Forum” on CompensationStandards.com, which discusses contractual interpretations of bylaws vs. policies.
We’ll be posting memos about this case in our “Clawbacks” Practice Area on CompensationStandards.com – and rest assured we’ll also be discussing the implications at our “20th Annual Executive Compensation Conference,” which is coming up virtually on September 22nd and, as always, follows our “Proxy Disclosure Conference” on September 20-21. Here are the agendas for that pair of conferences. If you haven’t already signed up, now is the time! You can register online (via the “virtual conferences” drop-down), call 800.737.1271, or email sales@ccrcorp.com.
It can be hard to keep track of what data in SEC filings needs to be tagged using inline XBRL. Fortunately, Vanderbilt Prof. Josh White recently flagged an Appendix to the SEC’s 2023 Semi-Annual Report to Congress on Machine Readable Data for Corporate Disclosures that provides an itemized list by filing type of which data must be tagged using inline XBRL. You may want to hang onto this one for your next form check.
In May, my wife and I traveled to Germany and Austria. It was our first trip abroad since the pandemic. The places and people were wonderful, and I really have to hand it to the Germans when it comes to a couple of things. First, they’re a lot better about confronting the dark parts of their history than we are, and second – on a much lighter note – if I ever became president, my first act would be to introduce legislation mandating Biergartens in every city.
Like I said, it was a great trip, but we were gone nearly three full weeks, so I eventually got very homesick. This Chuck Berry tune popped into my head as soon as we touched down on US soil and it captured how I felt at that moment better than anything I could say here.
We’ve been going through some challenging times as a nation, and it seems like we’re not real comfortable in our own skin just now. But a little time abroad does wonders for your perspective. My trip helped to remind me that, despite all our troubles, there’s a lot about this country that remains worth celebrating. Don’t take my word for it – just ask the Germans. So, let’s crank up our own volume & have a Glorious 4th! Our blogs will be back on Wednesday.
Earlier this week, Vanguard published a statement on its approach to board responsiveness to shareholders & other stakeholders. After a couple of pages devoted to the usual platitudes about the importance of engagement and the general need for directors to be responsive to shareholder input, Vanguard lowered the boom by laying out its policy on board responses to majority supported shareholder proposals:
When a board fails to respond to a proposal supported by a majority of its voting shareholders and the Vanguard-advised funds supported the proposal, the funds will generally vote against relevant members of the board. For example, concerns with compensation matters would likely impact votes on members of the compensation committee, while governance concerns would generally impact votes on members of the nominating/governance committee. A pattern of unresponsiveness to shareholder feedback (e.g., a failure to act, or slow action, on shareholder votes) may be an indicator of poor governance practices and may result in increasing levels of opposition to board members’ election.
Not surprisingly, Vanguard doesn’t specify what an appropriate “response” would be to a majority-supported shareholder proposal, which is probably impossible to do in the abstract. Nevertheless, companies need to know that their responsiveness to these proposals will be graded at the ballot box by one of their largest shareholders.
Vanguard’s policy may not have a significant impact on most companies, at least for now. That’s because, as SEC Commissioner Mark Uyeda pointed out in his speech at the Society for Corporate Governance’s conference earlier this week, the percentage of shareholder proposals receiving majority support has fallen precipitously in recent years. Only 5% of proposals received majority support this proxy season, compared to 19% just two years ago.
The May-June issue of the Deal Lawyers newsletter was just posted and sent to the printer. This month’s issue includes the following articles:
– Anatomy of a CVR: A Primer on the Key Components and Trends of CVRs in Life Sciences Public M&A Deals
– Chancery Ruling Highlights Important Role of Special Litigation Committees in Maintaining Board Control Over Derivative Litigation
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without in order to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.
Liz and Broc met up at the Society Conference in Salt Lake City this week and I just couldn’t resist sharing this picture of two of TheCorporateCounsel.net’s all-time greats with our readers. It feels like a Beatles reunion – minus Ringo, of course, but nobody misses him anyway!
Yesterday, the SEC announced settled enforcement proceedings against Marcum LLP, for what it contends were systemic quality control failures & audit standards violations in connection with audit work for hundreds SPAC clients. This excerpt from the SEC’s press release provides additional details on the proceeding:
Over a three-year period, Marcum more than tripled its number of public company clients, the majority of which were SPACs, including auditing more than 400 SPAC initial public offerings in 2020 and 2021. The strain of this growth, however, exposed substantial, widespread, and pre-existing deficiencies in the firm’s underlying quality control policies, procedures, and monitoring. These deficiencies permeated nearly all stages of the audit process and were exacerbated as Marcum took on more SPAC clients.
Moreover, in hundreds of SPAC audits, Marcum failed to comply with audit standards related to audit documentation, engagement quality reviews, risk assessments, audit committee communications, engagement partner supervision and review, and due professional care. Depending on the audit standard at issue, violations were found in 25-50 percent of audits reviewed, with even more frequent, nearly wholesale violations found as to certain audit standards across Marcum’s SPAC practice.
The SEC’s order alleges that “Marcum’s quality control and audit standard failures permeated most stages of engagement work—from client acceptance to risk assessments, audit committee communications, audit documentation, assembly and retention of audit documentation, engagement quality reviews, technical consultations, due professional care, and engagement partner supervision and review. At nearly every stage, Marcum lacked sufficient policies and procedures to provide reasonable assurance that engagements were conducted in accordance with professional standards.”
Without admitting or denying the SEC’s allegations, Marcum agreed to an order finding that the firm engaged in improper professional conduct within the meaning of Rule 102(e), violated multiple audit standards across numerous engagements, and violated Rule 2-02(b)(1) of Regulation S-X. Marcum also agreed to pay a $10 million penalty & to undertake remedial actions, including retaining an independent consultant and abiding by certain restrictions on accepting new audit clients.
The Association of Corporate Counsel recently released the results of its 2023 Law Department Benchmarking Survey, which covered 449 legal departments in companies of all sizes across 24 industries and 20 countries. Here are some of the key takeaways:
– Privacy is now the most common business function directly overseen by Legal (57% and six points more than reported in 2022) overtaking compliance, which traditionally tops the list (56%). An additional 19% of departments, however, indicated that compliance is a separate department that reports to legal. Therefore, in total, 77% of legal departments reported that the CLO ultimately oversees compliance compared to 70% that have oversight over privacy.
– The median total legal spend for all participating companies increased from $2.4 million last year to $3.1 million this year and although this increase occurred across companies of all sizes, the largest increases were driven by companies with greater than $20 billion in revenue, with a median total legal spend of $80 million this year compared to $50 million last year.
– The median total legal spend as a percentage company revenue (a key measure of Legal’s overall cost to the business) also increased to 0.63% compared to 0.56% last year. However, the total inside/outside spend distribution has remained roughly the same with 53% of total spend going to internal costs and 47% of total spend going to outside costs.
– About three in ten departments track internal diversity metrics related to the legal department’s composition, and 21% report tracking diversity metrics with respect to their outside counsel. There has been little movement in these numbers over the past three years despite the increased attention and desire to establish a more inclusive and equitable environment within the legal profession.
The increases in total legal spend are pretty eye-popping, particularly for large companies. A recent LegalDive.com article on the survey notes that although law firms increased their rates by an average of 5.5% in the first quarter of 2023, other factors, such as increased litigation and regulation, are more significant contributors to the jump in overall spending.
The members of the House of Representatives managed to pry themselves away from the cable news networks’ microphones long enough to pass a bunch of bipartisan legislation aimed at facilitating capital formation. Here’s the intro to this Mayer Brown blog:
In early June, the US House of Representatives passed two sets of bills focused on promoting capital formation. The bipartisan effort included bills that amend the accredited investor definition in order to increase the diversity of investors participating in the private markets. In addition, as the IPO market continues to suffer, the packages include bills that would enact legislation formalizing measures that already are permitted by SEC staff, such as, for example, expanding “testing-the-waters” accommodations to all issuers. Also, the package includes a bill directing the SEC to investigate the costs associated with going public for middle market companies.
The blog includes brief summaries of each piece of legislation as well as links to the text of the bills. It says that the next stop for this package is the Senate Committee on Banking, Housing, and Urban Affairs.
Artificial Intelligence is a topic that’s really exploded into public consciousness this year, so it isn’t surprising that AI risks are also beginning to feature prominently in some corporate risk factor disclosures. This Bryan Cave blog notes that companies are addressing AI risks either through standalone risk factors or as part of broader risk factor disclosures. The blog highlights the topical areas of these broader risk factors in which AI disclosures appear and provides several examples of standalone risk factors, including this one from DoorDash’s most recent Form 10-Q:
We may use artificial intelligence in our business, and challenges with properly managing its use could result in reputational harm, competitive harm, and legal liability, and adversely affect our results of operations.
We may incorporate artificial intelligence (“AI”) solutions into our platform, offerings, services and features, and these applications may become important in our operations over time. Our competitors or other third parties may incorporate AI into their products more quickly or more successfully than us, which could impair our ability to compete effectively and adversely affect our results of operations. Additionally, if the content, analyses, or recommendations that AI applications assist in producing are or are alleged to be deficient, inaccurate, or biased, our business, financial condition, and results of operations may be adversely affected.
The use of AI applications has resulted in, and may in the future result in, cybersecurity incidents that implicate the personal data of end users of such applications. Any such cybersecurity incidents related to our use of AI applications could adversely affect our reputation and results of operations. AI also presents emerging ethical issues and if our use of AI becomes controversial, we may experience brand or reputational harm, competitive harm, or legal liability. The rapid evolution of AI, including potential government regulation of AI, will require significant resources to develop, test and maintain our platform, offerings, services, and features to help us implement AI ethically in order to minimize unintended, harmful impact.
The blog says that only about 10% of companies in the major indices (S&P 500 and Russell 3000) are currently including a discussion of AI in their risk factor disclosures, but it also points out that companies addressing AI in their risk factors represent a broad range of industries tech & software.
