PVP Q&A: Our Interpretations of the SEC’s New PVP Rules

Mike Kesner and John R. Ellerman are partners and Ira T. Kay is Managing Partner and Founder at Pay Governance LLC. This post is based on their Pay Governance memorandum. Related research from the Program on Corporate Governance includes Stealth Compensation via Retirement Benefits and Paying for Long-Term Performance (discussed on the Forum here) both by Lucian A. Bebchuk and Jesse M. Fried. 

Introduction

The Securities and Exchange Commission (SEC) released its final rules regarding the mandated “Pay Versus Performance” (PVP) disclosure on August 25, 2022. The new rules are the culmination of various proposals by the SEC dating back to 2015 when the agency first issued proposed PVP disclosure rules required by the Dodd-Frank legislation. Pay Governance LLC summarized the new rules in a recent Viewpoint (see SEC Releases Final Rules Regarding Pay-Versus-Performance (PVP) Disclosures, dated August 31, 2022).

After further analysis of the new rules and the opportunity to discuss them with clients and colleagues, we have prepared this follow-up Viewpoint to share additional insights in the form of Questions and Answers (Q&As) which we believe will help enhance clients’ understanding of the rules and their implementation. We plan on providing additional Viewpoints including an executive summary, sample graphics, and the narrative disclosures that can be used to illustrate the PVP relationship in the near future.

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Enforcement Waves and Spillovers

Jonathan M. Karpoff is Professor of Finance and Business Economics at the University of Washington Foster School of Business. This post is based on a recent paper, forthcoming in Management Science, by Professor Karpoff, Ms. Hae Mi Choi, Ms. Xiaoxia Lou, and Mr. Gerald S. Martin.

We document and examine the consequences of an important feature of enforcement activity for financial misrepresentation, that many enforcement actions for financial misrepresentation occur in industry-specific waves. In particular, one-quarter of all enforcement actions for misrepresentation initiated by the U.S. Securities and Exchange Commission or Department of Justice are clustered in 27 industry-specific waves (in 21 different industries) during our sample period of 1978-2015. As examples, the microchip industry experienced a wave of enforcement actions targeting 19 different firms during the 42-month period from August 2004 to January 2008, and the pharmaceutical industry experienced a wave of 16 targeted firms from 2001-2005.

Enforcement waves have important consequences for firms’ stock price dynamics and information spillovers that affect the share values of industry peer firms. Figure 1 illustrates the pattern of returns when firms are targeted for enforcement action during waves. The first firm in an enforcement wave experiences an abnormal stock return that averages –19.3% on the day its misconduct is revealed. There is a spillover on other firms in the same industry, which experience an average abnormal stock return of –0.30% on the same day. Subsequent targets in the enforcement wave have successively smaller drops in share values and smaller spillover effects on other firms in the same industry. By the end of the wave, newly targeted firms experience relatively small drops in share values (–13.2%) and the spillover effects on other firms are close to zero.

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​In re BGC Partners: Maybe Entire Fairness Review Isn’t So Bad After All

Ethan Klingsberg and Meredith Kotler are partners and Marques Tracy is an associate at Freshfields Bruckhaus Deringer LLP. This post is based on their Freshfields memorandum and is part of the Delaware law series; links to other posts in the series are available here.

Eight years ago, the Delaware Supreme Court in Kahn v. M&F Worldwide Corp. (“MFW”), [1] affirmed then-Chancellor Strine’s decision holding that the business judgment rule could apply to controlling stockholder mergers if certain necessary conditions were met. In articulating the new standard that the Supreme Court would ultimately adopt, the Chancellor expressed optimism that controlling stockholders would be more likely to start embracing the ab initio conditions if the presumption of the business judgment rule would be available.

While the lure of the business judgment rule is unquestionably appealing to many controlling stockholders, others remain unwilling to face the execution risks that can arise from a non-waivable majority-of-the-minority condition or to limit their flexibility at the outset of negotiations for an undefined period of time. Recent Court of Chancery decisions demonstrate that the Court will carefully review compliance with the MFW conditions and apply entire fairness if those conditions are not met. At the same time, the Court has also shown its willingness, most recently in In re BGC Partners, Inc. Derivative Litigation, [2] to find transactions entirely fair after trial where the evidence establishes a robust special committee process, and where the defendants have presented a strong record to support a fair price.

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2022 Proxy Season – Shareholder Proposal Review

Thomas P. Skulski is Managing Director – Proxy and Glenn O’Brien is an Analyst at Morrow Sodali. This post is based on their Morrow Sodali memorandum.

In late 2021 the SEC announced that it would take a new approach to the economic relevance and ordinary business exemptions through the no-action process. This led to the SEC allowing fewer shareholder proposals to be omitted by issuers, and the first half of 2022 saw a significant increase in shareholder proposals that went to a vote.

A total of 538 shareholder proposals reached a vote in the first half of 2022. This is a significant increase from 385 in the first half of 2021. Of note, this increase in volume did not coincide with an increase in the number of proposals that received a majority vote. In 2021, 76 proposals received a majority vote, compared to 73 in 2022.

Governance, social and environmental proposals all increased in volume in 2022. Most notably, social proposals increased from 99 to 215 year over year, making up 39% of all shareholder proposals. Governance proposals made up just under half of the total shareholder proposals, which is a drop from 59% in 2021. Environmental proposals made up approximately 15% of all shareholder proposals in both 2021 and 2022.

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Know Your Customer: Informed Trading by Banks

Rainer Haselmann is Professor of Finance, Accounting, and Taxation at Goethe University Frankfurt, Christian Leuz is Charles F. Pohl Distinguished Service Professor of Accounting and Finance at the University of Chicago Booth School of Business, and Sebastian Schreiber is Professor of Finance , Accounting and Taxation at Goethe University Frankfurt. This post is based on their recent paper.

Related research from the Program on Corporate Governance includes Insider Trading Via the Corporation (discussed on the Forum here) by Jesse M. Fried.

Since the implementation of the Glass-Steagall Banking Act of 1933 concerns about combined banking operations, i.e., commercial and investment banking within the same universal bank, faded. Notwithstanding, the Global Financial Crisis in 2008 reinvigorated the debate about separating commercial and investment banking, resulting in the Volcker Rule and general requirements for ethical walls. In particular, universal banks could use borrowers’ confidential information when selling securities to investors or trading in capital markets. Despite the persisting political and scholarly debate, it is surprising how little we know about banks’ use of private information and banks’ proprietary trading in general. One reason is that internal information flows cannot be directly observed, and proprietary trading data is not readily available.

This study aims to demystify information transmission within universal banking systems. We combine detailed German data on banks’ proprietary trading with lending data, both provided by German supervisory agencies. Due to the granularity of our data, we are for the first time able to identify instances when banks likely make informed trades in their borrowers’ stocks. Focusing on banks’ trades in stocks of their clients around important corporate events, we find that relationship banks build up positive (negative) trading positions in the two weeks before events with positive (negative) news. This is particularly true when these events are unscheduled, and banks unwind positions shortly after the event. This finding is remarkable, as it should be more difficult to build positions in the ‘right’ direction ahead of unscheduled events.

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Section 220 Decisions Amplify Stockholders’ Rights to Inspect Books and Records

Gail Weinstein is Senior Counsel and  Scott B. Luftglass and Peter L. Simmons are Partners at  Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Luftglass, Mr. Simmons, Mr. Epstein, Mr. Richter, and Mr. Mangino, and is part of the Delaware law series; links to other posts in the series are available here.

In recent years, the Court of Chancery’s docket increasingly has been occupied with Section 220 actions by stockholders seeking to inspect corporate books and records to investigate possible corporate wrongdoing or mismanagement. In part to curtail premature or frivolous litigation, the Court of Chancery has encouraged stockholders to conduct such investigations before deciding whether to bring litigation. Stockholders have heeded this call, and in many cases the information obtained through a Section 220 investigation has provided a basis for more particularized allegations, which has resulted in more cases surviving the pleading stage of litigation than in the past (particularly in the Corwin, MFW and Caremark contexts). At the same time, the Delaware courts have been wrestling with the proper contours of stockholders’ rights in Section 220 cases. In this Briefing, we discuss the three most recent Section 220 decisions and offer related practice points.

The Most Recent Section 220 Decisions

  • In NVIDIA v. Westmoreland (July 19, 2022) [1], the Delaware Supreme Court upheld the Court of Chancery’s ruling that hearsay evidence (if reliable) can be used by stockholders in a Section 220 proceeding not only to show the requisite “credible basis” (which Supreme Court precedent already had established) but also to show the requisite “proper purpose.”
  • In Hightower v. SharpSpring (Aug. 31, 2022) [2], after the company provided formal board materials in response to a Section 220 demand relating to the company’s sale process, the Court of Chancery ordered the production of additional documents in light of the failure of the stockholder disclosure regarding certain key events to “match up” with the board minutes.
  • In Rivest v. Hauppauge Digital (Sept. 1, 2022) [3], the Court of Chancery, emphasizing that there is no “presumption of confidentiality” for documents produced in response to a Section 220 demand, rejected the company’s request for confidentiality that was based only on a “standard” concern (that all companies would have) about use of its information by competitors.

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How cyber governance and disclosures are closing the gaps in 2022

Chuck Seets is Americas Assurance Cybersecurity Leader and  Pat Niemann is Americas Audit Committee Forum Leader at EY. This post is based on their EY memorandum.

Cybersecurity is reaching an inflection point. Risks are growing and broader regulations are looming. Some companies are keeping pace, but others are lagging, both in disclosures and warding off threats. To close these gaps, directors should foster a culture of cooperation while elevating the tone at the top.

This is the year for directors to double down on closing the gaps in the company’s cybersecurity defense and disclosure practices. The risks companies face, already high, are multiplying and accelerating, marked this year by potential threats tied to the war in Ukraine. Meanwhile, more guidance on cyber oversight and disclosure is here or on its way, from the Securities and Exchange Commission (SEC or commission), which proposed new rules earlier in 2022; and from Congress, which recently passed far‑reaching legislation. Additionally, Institutional Shareholder Services Inc. (ISS) added 11 new cyber risk factors to its Governance QualityScore in 2021.

In our latest analysis of cyber‑related disclosures in the proxy statements and Form 10-K filings of Fortune 100 companies, we found more companies providing information about how they are rising to the challenges. Yet in some areas, the gaps in information are nearly universal. For instance, only 9% disclosed performing response readiness simulations.

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Stock Buyback Tax Raises Questions as to Application and Practical Effect

Joe Soltis, Claude Stansbury, and Robert Scarborough are partners at Freshfields Bruckhaus Deringer LLP. This post is based on a Freshfields memorandum by Mr. Soltis, Mr. Stansbury, Mr. Scarborough, Sarah Solum, and Daniel Fox. Related research from the Program on Corporate Governance includes Short-Termism and Capital Flows by Jesse M. Fried and Charles C.Y. Wang (discussed on the Forum here); and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay by Jesse M. Fried (discussed on the Forum here).

On August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (the “IRA”) into law. Although far from the sweeping tax reform that the Biden Administration had originally envisioned, one provision from the previously proposed “Build Back Better Act” that was included in the IRA is a new 1% non-deductible excise tax on stock repurchases by publicly traded U.S. corporations (the “Buyback Tax”).

Overview of the Buyback Tax

The Buyback Tax applies, with certain exceptions, to stock buybacks and other transactions effected after December 31, 2022 that are treated as redemptions for tax purposes. A corporation is generally treated as redeeming its stock if it acquires such stock from a shareholder in exchange for property (other than its own stock or rights to acquire its own stock), regardless of whether the stock is cancelled, retired, or held as treasury stock. Corporations subject to the Buyback Tax (“covered corporations”) include publicly traded U.S. corporations and publicly traded foreign corporations that have undergone certain “inversion” transactions since September 20, 2021. Repurchases by 50%-owned subsidiaries of a covered corporation are generally treated as having been made by the covered corporation itself. Foreign public companies, including foreign private issuers that are listed on U.S. exchanges, are generally not subject to the Buyback Tax, although a purchase by certain U.S. subsidiaries of a foreign public parent company’s stock may be subject to the Buyback Tax (with certain modification).

The Buyback Tax does not apply to stock repurchases (i) that are part of a tax-free reorganization in which the redeemed shareholder does not recognize gain or loss, (ii) where the redeemed stock (or stock of an equal value) is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or a similar plan, (iii) effected by a real estate investment trust (REIT) or regulated investment company (RIC), or (iv) to the extent treated as dividends for tax purposes. A de minimis rule exempts covered corporations that repurchase less than $1 million of their stock during a given taxable year, and the U.S. Department of the Treasury (“Treasury”) is directed to issue regulations that exempt certain repurchases by securities dealers. READ MORE »

The Irrelevance of Delaware Corporate Law

Robert J. Rhee is John H. and Marylou Dasburg Professor of Law at the University of Florida Levin College of Law. This post is based on his recent paper, forthcoming in the Journal of Corporation Law, and is part of the Delaware law series; links to other posts in the series are available here.

Is Delaware corporate law relevant? Relevance is a relational concept. Relevant to what? Rules of corporate law are considered in efficiency’s light. Efficient laws should enhance firm value. Is Delaware law more efficient than the laws of other states such that we should see a “Delaware premium”? Do inter-state differences in corporate law matter?

The idea of a “race” for quality has commanded the attention of scholars since the Cary–Winter debate. It is central to the question of federalism in corporate law. The advocates of Delaware law accept the view that it represents the product of a race to the top. But suppose the “race” is a figment of our theoretical imagination. Suppose there is no evidence of a Delaware valuation premium. If so, under the generally accepted measure of quality (efficiency and firm value), corporate law would be irrelevant. A much smaller camp in the academic debate has argued that corporate law is “trivial.” In The Irrelevance of Delaware Corporate Law, 48 J. Corp. L. (forthcoming 2022), I provide empirical support for the hypothesis that, despite the law’s purported aspiration for efficiency, inter-state differences in state corporate law have no basis in efficiency.

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Weekly Roundup: September 23-29, 2022


More from:

This roundup contains a collection of the posts published on the Forum during the week of September 23-29, 2022.

Boards Need More Women: Here’s How to Get There


How Compensation Decisions Support CEO Succession



Battle for Our Souls: A Psychological Justification for Corporate and Individual Liability for Organizational Misconduct



Empowering Corporate Compliance Functions in a Post-Pandemic Environment


Making it Count: Accountability is Needed to Fast-Track DE&I


The Market for Corporate Criminals


Clawback Policies: Evolving Market Norms and SEC Rules


Planning for Tomorrow’s Public Company CFO



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