We’re regularly posting new podcasts for members! They’re perfect for drive-time if you’re traveling over these final summer weekends. Here are the latest episodes:
– Why the securities laws should impose an affirmative duty to disclose material information
– How market confidence would improve if insiders were required to make Section 16 filings *before* they trade, and if Rule 10b5-1 reforms were adopted
– Federal corporate governance concepts including independent board chairs, employee representatives on the compensation committee, and more
– Giving “say-on-pay” more teeth
– Why the SEC’s current focus on ESG disclosure is misplaced
– Marian’s career path from being a senior proxy research analyst at Glass Lewis, to Chevron, to Charles Schwab, to her current role as Head of ESG Strategy & Engagement at Uber
– What’s surprised Marian as she’s progressed in her career
– What major governance shifts Marian has noticed over the years in her different roles
– One thing Marian would like people to know about ESG and investor engagement isn’t typically discussed
– What Marian thinks women in the corporate governance field can add to the current conversation on the societal role of companies
I blogged last week about the SEC’s insider trading case against Medivation’s former biz dev guy – and I confess I struggled with the headline! I wasn’t really sure what to make of the allegations. Thankfully, a couple of members sent resources – and we’ve been posting additional memos in our “Insider Trading” Practice Area. This Wachtell Lipton memo expands on issues the case could turn on:
Most corporate insider trading policies include a provision similar to Medivation’s prohibition of trades in the securities of other companies on the basis of the employer’s information. But the Panuwat allegations are quite different from the concerns that usually animate such policies; for example, companies recognize that their employees may learn of confidential plans to enter into a material contract with a supplier, to acquire a target company, or to terminate a material relationship with a vendor, and accordingly, their policies prohibit trading in the securities of the supplier, target or vendor before the news becomes public.
By contrast, the connection between the information that Panuwat allegedly received and the company in whose securities he traded was indirect, and the information did not arise from any dealings between his employer and Incyte. As the Panuwat litigation proceeds, the issue of materiality is likely to be hard-fought. The courtroom battle can be expected to center on issues such as how likely or uncertain it was that the Medivation news would affect Incyte’s stock price, as well as on the indirect nature of the connection between Medivation’s information and the securities in which Panuwat traded. The case will likely also test the SEC’s assertion that Panuwat misappropriated Medivation’s information when he traded. The courts will ultimately need to determine whether the misappropriation theory of insider trading liability extends to these facts.
In this 20-year old article, Yale Law Prof Ian Ayres & Stanford Law Prof Joe Bankman call this type of transaction “trading in stock substitutes” – and say that it’s legal and somewhat common. A similar analysis from just last year by Mihir Mehta, David Reeb and Wanli Zhao calls it “shadow trading.” According to the authors, shadow trading remains pretty widespread. But it’s an untested legal theory because it’s almost never prosecuted – in part because it’s difficult to detect. This new case suggests that the SEC’s data analytics are getting more advanced, and now a court has a chance to weigh in on whether or not this activity is legal. Here’s another nugget from the study:
Firms have incentives to prohibit employees from using their private information to facilitate shadow trading as the public revelation of such activities could adversely affect their business relationships and thus, their operations and profits. … [F]irm-mandated prohibitions appear to be effective. Our results show that shadow trading is significantly higher when source firms do not prohibit employees from engaging in shadow trading relative to when they prohibit shadow trading. Although mostly untested in the U.S. judicial system, such company regulations arguably create a fiduciary responsibility for employees not to exploit their private information in economically-linked firms.
As I pointed out last week, Medivation’s policy did contain that type of broad prohibition, according to the SEC’s complaint. That could end up being an important fact. For more analysis, see this Cooley blog.
SEC Enforcement has been busy on insider trading cases. Last week, they also announcedcharges against former employees of a popular streaming service who were allegedly tipping non-public info about subscription numbers to friends & family who traded in advance of earnings announcements – to the tune of $3 million in profits. In another recently announced case, the complaint alleges that the wife of a guy on a deal team traded in target stock unbeknownst to her spouse. All good fodder for your compliance programs…
Here’s something our colleague Lawrence Heim blogged last week on PracticalESG.com:
I’ve advocated for replacing outdated “sustainability” lingo with the more up-to-date (and perhaps better-marketed) term “ESG.” But according to this recent survey from the US Chamber of Commerce, NSADAQ, the Silicon Valley Leadership Group and other trade organizations, the initialism may be picking up some baggage of its own.
The survey – reflecting responses from 436 CEOs, CFOs, GCs, corporate secretaries, IR and sustainability folks at companies across industries and market caps – is aimed at influencing the SEC’s potential ESG disclosure proposals. Only 8% of the respondents feel that “ESG” encompasses a generally understood set of issues that can be easily defined by regulators. 61% said it’s a subjective term that means different things to different companies and can’t be easily defined by regulators.
Here are some of the other findings:
– 59% of the respondents have increased the amount of climate disclosure they provide since 2010, with half of those doing so in their Risk Factors disclosure (Item 105 of Regulation S-K).
– Half of the respondents think standard ESG disclosure frameworks are confusing and address immaterial information – but they use them anyway: 44% use SASB, 31% use GRI and 29% use TCFD. Surprisingly, 41% of respondents do not rely on any standard-setting body in developing their ESG disclosures for SEC or other communications.
– There is overwhelming agreement (95%) that shareholders are the intended audience of ESG disclosure. Other audiences receiving more than 80% of votes are employees, customers and ESG standards/ratings bodies.
– Despite effort put into the disclosures, one-third of the respondents “seldom” hear feedback from shareholders, with only 41% indicating they “sometimes” hear from shareholders.
– 63% communicate to shareholders about climate change.
– 89% support tailoring ESG disclosures for smaller and/or newly public companies.
– 24% of companies would support CEO/CFO certifications of climate change disclosures, with 22% supporting a requirement for third-party assurance. 47% oppose executive certifications and 57% oppose assurance. A mere 28% of respondents currently engage third parties for assurance or audits of their ESG disclosures.
What This Means
Regulators may take the report findings as weighing in favor of principles-based disclosure, which could simplify the SEC’s rulemaking effort. The downside of principles-based disclosure is that it may not provide the comparability that investors are looking for. And if it doesn’t, then companies might still find themselves wading through mountains of surveys and conflicting disclosure requests.
ESG and sustainability professionals should thoughtfully consider what I believe is a most important message: even though “ESG” has the attention of executives and management at the moment, that may be tenuous. Without a regulatory mandate, executives may question the value of costs/efforts that are voluntary, fractious, inconsistent, do not lend themselves to comparability with peers, and which result in limited feedback from intended recipients. Where ESG initiatives are clear and direct operational or strategic business imperatives, executives will support them as such.
The SEC announced last week that it’s releasing free “Application Programming Interfaces” that aggregate Edgar submission history and XBRL data. While institutional investors already use XBRL to analyze massive amounts of data, the retail crowd has largely ignored the resource. APIs could change that, because they’ll allow developers to create apps that directly cater to individuals.
The APIs are updated in real-time as filings are made – with submission APIs having a processing delay of less than a second and the xbrl APIs having a delay of under a minute (potentially longer during peak filing times). Time will tell whether the meme stock traders will take advantage of this new information flow. The SEC even has a page that shows how to program with these APIs. It could be a good time to learn how to code!
More than one-third of organizations worldwide have experienced a ransomware attack or breach in the last year, according to a survey announced recently by International Data Corporation. Thankfully, the incident rate is much lower in the US compared to the rest of the world – and the survey found that companies that are further along with their digital efforts are less likely to experience an event. That said, another attack on a sophisticated US company was also in the news earlier this month. The press release lays out some of the survey’s key findings:
– The incident rate was notably lower for companies based in the United States (7%) compared to the worldwide rate (37%).
– The Manufacturing and Finance industries reported the highest ransomware incident rates while the Transportation, Communication, and Utilities/Media industries reported the lowest rates.
– Only 13% of organizations reported experiencing a ransomware attack/breach and not paying a ransom.
– While the average ransom payment was almost a quarter million dollars, a few large ransom payments (more than $1 million) skewed the average.
Greater awareness of ransomware incidents has prompted organizations to undertake a variety of actions in response. These include reviewing and certifying security and data protection/recovery practices with partners and suppliers; periodically stress-testing cyber response procedures; and increased sharing of threat intelligence with other organizations and/or government agencies. Greater incident awareness has similarly prompted requests from boards of directors to review security practices and ransomware response procedures.
To help stem the tide of ransomware incidents, agencies across the US government have launched StopRansomware.gov – a “one-stop shop” for individuals and businesses to find the latest alerts & resources about attacks and how to report them. Here’s an excerpt from the DOJ’s announcement:
Ransomware is a long-standing problem and a growing national security threat. Tackling this challenge requires collaboration across every level of government, the private sector and our communities. Roughly $350 million in ransom was paid to malicious cyber actors in 2020, a more than 300% increase from the previous year. Further, there have already been multiple notable ransomware attacks in 2021, and despite making up roughly 75% of all ransomware cases, attacks on small businesses often go unnoticed.
Like most cyber attacks, ransomware exploits the weakest link. Many small businesses have yet to adequately protect their networks, and StopRansomware.gov will help these organizations and many more to take simple steps to protect their networks and respond to ransomware incidents, while providing enterprise-level information technology (IT) teams the technical resources to reduce their ransomware risk.
DHS, DOJ, the White House and our federal partners encourage all individuals and organizations to take the first step in protecting their cybersecurity by visiting StopRansomware.gov.
Yesterday, the SEC announced a $6 million settlement with a company that allegedly reported inflated earnings per share for several quarters, which caused the company to meet analysts’ consensus estimates when it otherwise would’ve missed. It sounds like the fine could’ve been worse – the order calls out the company’s cooperation and prompt remedial acts. The SEC also charged the company’s CFO & controller.
According to the SEC’s order, the problem arose in part out of the company’s failure to record & disclose litigation-related loss contingencies in the appropriate quarters, in addition to other shortcomings in disclosure controls. Here’s an excerpt:
Had the company properly recorded the financial impact of the loss contingencies at the time they were probable and reasonably estimable, the company would have reported lower EPS and missed research analysts’ consensus EPS estimates in many of the applicable quarters, including by as little as a penny. The company also would not have been able to report multiple quarters of EPS growth, including then-record-high EPS. For the quarters when the company eventually accrued for the loss contingencies, the accruals contributed to the company’s reporting of a net loss and loss per share, or reporting EPS that missed consensus estimates by a wide margin.
Consequently, the company’s financial statements filed with the Commission were materially misleading during these periods.
This enforcement action underscores a few things. One, loss contingencies are always a tricky disclosure topic, and you should check out our “Contingencies” Practice Area and our “Legal Proceedings Handbook” for help – in addition to following your auditor’s guidance. Second, the SEC takes reporting errors particularly seriously when they make the difference between meeting or missing expectations.
Lastly, this is the third action to result from the Enforcement Division’s EPS Initiative – which, according to the SEC, “uses risk-based data analytics to uncover potential accounting & disclosure violations caused by, among other things, earnings management practices.” John blogged about the first two actions last fall.
It’s hard to believe we’ve spent only two years analyzing the decision of 200 CEOs to sign the Business Roundtable’s “Statement on the Purpose of a Corporation” – and ostensibly change life as we know it. I don’t know about you, but it feels now like I was born thinking about corporate purpose. My mom read me bedtime stories about Milton Friedman & the BRT as a child, and I used the word “stakeholder” in my wedding vows. But alas – no – it really has been only two years.
To mark the anniversary, Harvard Law Profs Lucian Bebchuk and Roberto Tallarita released this analysis of “stakeholder” companies’ governance documents, proxy statements and other statements & actions – and highlighted their findings in this WSJ op-ed last week. Here are the big takeaways:
1. Examining the almost one-hundred BRT Companies that updated their corporate governance guidelines in the sixteen-month period between the release of the BRT Statement and the end of 2020, we find that they generally did not add any language that improves the status of stakeholders and, indeed, most of them chose to retain in their guidelines a commitment to shareholder primacy;
2. Reviewing all the corporate governance guidelines of BRT Companies that were in place as of the end of 2020, we find that most of them reflected a shareholder primacy approach, and an even larger majority did not include any mention of stakeholders in their discussion of corporate purpose;
3. Examining the over forty shareholder proposals regarding the implementation of the BRT Statement that were submitted to BRT Companies during the 2020 or 2021 proxy season, and the subsequent reactions of these companies, we find that none of these companies accepted that the BRT Statement required any changes to how they treat stakeholders, and most of them explicitly stated that their joining the BRT Statement did not require any such changes.
4. Reviewing all the corporate bylaws of the BRT Companies, we find that they generally reflect a shareholder-centered view;
5. Reviewing the 2020 proxy statements of the BRT Companies, we find that the great majority of these companies did not even mention their signing of the BRT Statement, and among the minority of companies that did mention it, none indicated that their endorsement required or was expected to result in any changes in the treatment of stakeholders;
6. We find that the BRT Companies continued to pay directors compensation that strongly aligns their interests with shareholder value. Furthermore, we document that the corporate governance guidelines of BRT Companies as of the end of 2020 commonly required such alignment of director compensation with stockholder value and generally avoided any support for linking such compensation to stakeholder interests.
Our findings support the view that the BRT Statement was mostly for show and that BRT Companies joining it did not intend or expect it to bring about any material changes in how they treat stakeholders. These findings support the view that pledges by corporate leaders to serve stakeholders would not materially benefit stakeholders, and that their main effect could be to insulate corporate leaders from shareholder oversight and deflect pressures for stakeholder-protecting regulation. Stakeholder governance that relies on the discretion of corporate leaders would not represent an effective way to address growing concerns about the effects corporations have on stakeholders.
Last year, Professors Bebchuk & Tallarita released findings that they said implied CEOs didn’t intend to change anything by signing the BRT Statement, and this additional research seems to point in the same direction. That’s actually consistent with what a lot of corporate governance folks have been saying since Day 1: the debate around this is mostly semantics, since what’s good for “stakeholders” can also benefit shareholders in the long run. Even shareholders seem to be on the “stakeholder” bandwagon at the moment, and it doesn’t seem like their initial concerns of executives using this Statement to insulate themselves have come to pass.
That said, I’m not sure that corporate governance guidelines and investor-focused proxy statements give a full picture of everything that companies have been doing during the last two years. A lot of companies are adding ESG metrics to executive pay programs, enhancing website sustainability reporting, and amending board committee charters to expressly assign responsibility for things like “human capital” oversight. In this Wachtell Lipton memo, Marty Lipton elaborates on all the corporate actions that Professor Bebchuk’s analysis arguably overlooks.
Whether these efforts have trickled down to benefit stakeholders is another question. Right now, it seems good for the bottom line to consider the interests of customers, employees & communities. Bebchuk & Tallarita believe it would be better for the government to protect stakeholders than to rely on corporations to consistently do so. As Ann Lipton reminded everyone in this Tweet, this whole debate is really about management power & accountability – not stakeholders.
Companies appear to remain committed to shareholder primacy: delivering a profit to shareholders in either the short term or the long term. But is that still what shareholders want? Since shareholders aren’t a monolith, there are mixed messages.
While traditional shareholder activists still seem poised to push for maximum shareholder returns from individual companies, big asset managers and pension funds have been signaling that they’re maybe less focused these days on returns from individual companies, and more concerned with the performance of their overall portfolio. That means “ESG” performance takes on more importance, because it reduces systemic costs & risks that could result from irresponsible behavior by an individual company. Even if that company is outperforming financially, its negative actions drag down the returns for the rest of the portfolio.
This inaugural annual report from The Shareholder Commons calls that phenomenon “beta stewardship” – and it walks through shareholder engagement campaigns and proposals that are advancing the concept. It is a perspective to keep in mind during off-season engagements, and means that it’s more important than ever to monitor and understand your shareholder base. Here are some additional points from the report to know as you prepare for your next proxy season:
TSC supported 24 shareholder resolutions at 23 companies during the 2021 proxy season. One proposal was withdrawn after reaching an agreement with the company. Of the remaining 23 proposals, three received at least 10% support from shareholders, six were excluded by the Securities and Exchange Commission (SEC), and seven reached the 3% threshold necessary for us to be able to provisionally file again in 2022. The complete results of these resolutions are included in the chart on page 10.
We worked on two distinct types of shareholder resolutions:
1. Disclosure of the costs imposed by society (i.e., externalized) by a company’s contribution to specific systemic risks. These risks include antimicrobial resistance, inequality, corporate governance failures, public health threats, and inadequate voting policies.
It’s our hope that these disclosures will provide the basis for a “gap analysis,” in which companies compare their ability to reduce a negative social or environmental impact under the constraint of optimizing their internal financial returns with their ability to reduce that impact if optimizing for systemic health. The goal behind disclosure is to provide investors, regulators, and policymakers with information needed to address systemic risks and to illustrate the gap between current investment perspectives and what could be achieved under a systems-first model.
2. Conversion to a “public benefit corporation” structure. PBCs are a type of for-profit entity that allows the directors of a company to better serve the interests of diversified shareholders by prioritizing impacts on society, workers, communities, and the environment when those impacts are more likely to be important to such investors than the financial returns of that company.
We specifically targeted companies that were signatories to the Business Roundtable Statement on the “Purpose of a Corporation,” which suggested corporate America is refocusing on the interests of stakeholders. The goal behind these proposals is to demonstrate that investors can be aligned with a more stakeholder-oriented management style, but that such a re-alignment requires understanding the fiduciary duty to shareholders as encompassing the full range of their interests, including as diversified investors.
The report includes case studies of engagements on these proposals and says that TSC will continue its work in the coming year. TSC also notes that because its proposals are focused on portfolio-level effects, neither ISS nor Glass Lewis supported any of them in 2021.
Last week, United Therapeutics filed this proxy statement for a special meeting to approve the company’s conversion to a public benefit corporation. I taped a podcast earlier this year with Meaghan Nelson about Veeva Systems’ conversion.
Lynn blogged a few months ago about a change to Section 314.00 of the NYSE Listed Company Manual that was causing some hand-wringing. The new rule not only required advance approval by independent directors of “related party transactions” – it also defined that term to mean any transaction required to be disclosed pursuant to Item 404 of Regulation S-K, but without applying the $120,000 transaction value threshold of that Item. It wasn’t clear whether that meant that all transactions with related parties required advance approval, regardless of dollar value.
Late last week, the NYSE proposed an additional amendment to allow companies to continue to abide by the commonly accepted practice of applying the $120,000 transaction value from Item 404 of Reg S-K when determining whether a transaction requires review (or a lower dollar threshold, in some cases, for smaller reporting companies). While you still might need to amend your related party transactions policy to address the “pre-approval” part of the rule, the new amendment clarifies that it can stay largely aligned with the disclosure standard. This Gibson Dunn blog gives more detail:
In its latest proposal, the NYSE noted that the prior amendment had been intended to “provide greater clarity as to the types of transactions that were specifically subject to review and approval under the rule” but that “[i]n the period since the adoption of that amendment, it has become clear to the Exchange that the amended rule’s exclusion of the applicable transaction value and materiality thresholds is inconsistent with the historical practice of many listed companies, and has had unintended consequences.”
As such, the NYSE’s latest amendments to Section 314.00 “provide that the review and approval requirement of that rule will be applicable only to transactions that are required to be disclosed after taking into account the transaction value and materiality thresholds set forth in Item 404 of Regulation S-K or Item 7.B of Form 20-F, respectively, as applicable.” Notably, Item 404 of Regulation S-K only requires disclosure of transactions where the amount involved is greater than $120,000 and in which the related person “had or will have a direct or indirect material interest” in the transaction. The notes to Item 404 also contain various other exclusions.
The text of the NYSE’s latest amendment to Section 314.00 of the NYSE Manual follows (with deleted text shown in strikethrough):
A company’s audit committee or another independent body of the board of directors, shall conduct a reasonable prior review and oversight of all related party transactions for potential conflicts of interest and will prohibit such a transaction if it determines it to be inconsistent with the interests of the company and its shareholders. For purposes of this rule, the term “related party transaction” refers to transactions required to be disclosed pursuant to Item 404 of Regulation S-K under the Securities Exchange Act (but without applying the transaction value threshold of that provision). In the case of foreign private issuers, the term “related party transactions” refers to transactions required to be disclosed pursuant to Form 20-F, Item 7.B (but without regard to the materiality threshold of that provision).
The proposed rule took effect immediately, but can be suspended by the SEC within 60 days of the filing, and is open for comment for interested persons to submit written data, views, and arguments concerning the amendment. As a result of this latest proposal, NYSE-listed companies may still need to amend their related person transaction approval polices to address the “reasonable prior review” standard, but can otherwise more easily integrate the NYSE’s standards with those utilized for transactions under Item 404 of the SEC’s Regulation S-K, and have greater flexibility to establish reasonable processes for identifying and reviewing potentially disclosable transactions.
