Lessons from the Chancery Court Decision in P3 Health Group

Gail Weinstein is Senior Counsel, Steven J. Steinman and Brian T. Mangino are Partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Mr. Mangino, Andrew J. Colosimo, Randi Lally, and Erica Jaffe and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? (discussed on the Forum here) by John C. Coates, Darius Palia, and Ge Wu; and The New Look of Deal Protection (discussed on the Forum here) by Fernán Restrepo and Guhan Subramanian.

In P3 Health Group, private equity firm Hudson Vegas Investments SVP LLC, which was the second-largest unitholder of P3 Health Group Holdings, LLC (the “Company”), challenged the Company’s de-SPAC merger. The Company’s sponsor, private equity firm Chicago Pacific Founders Fund, L.P., controlled the Company (a Delaware LLC) by virtue of its majority equity ownership, board designees, and contractual rights. Hudson claimed that the merger, which stripped it of $100 million of stock options and its contractual rights with respect to the Company and was effected over its objection, violated its contractual veto right over affiliated transactions.

The Delaware Court of Chancery recently issued five important decisions in the case (dated November 3, October 31, October 28, October 26, and September 12, 2022), rejecting dismissal of most of Hudson’s claims.

Background. Chicago Pacific provided the start-up capital for the Company and soon thereafter, Hudson invested $50 million in the Company. Soon thereafter, a de-SPAC merger was structured with Foresight Acquisition Corp. (a SPAC formed by an unaffiliated businessperson), which contemplated a three-way merger that included another Chicago Pacific portfolio company (known as “MyCare”). Hudson objected to the transaction. Chicago Pacific and the Company then restructured it to exclude MyCare (but allegedly contemplated including MyCare later in a follow-on transaction). Hudson unsuccessfully sued to enjoin the merger. Following the closing, Hudson asserted claims against Chicago Pacific and certain of its and the Company’s key managers and officers for their roles in arranging the merger. Hudson also added a claim that its initial investment in the Company was fraudulently induced. In a series of recent pleading-stage decisions, Vice Chancellor Laster rejected dismissal of most of the plaintiff’s claims.


Weekly Roundup: November 18-24, 2022

More from:

This roundup contains a collection of the posts published on the Forum during the week of November 18-24, 2022

Remarks by Commissioner Uyeda at the 2022 Cato Summit on Financial Regulation

SEC Releases Final Rules Regarding Clawback Policies for Public Issuers

Boards: Stepping Up as Stewards of Sustainability

Updating Annual Report Risk Factors

The Evolution of ESG Reports and the Role of Voluntary Standards

Bylaw Amendments, Shareholder Activism, and Flying Close to the Sun

Fifth Circuit Declines to Rehear Sweeping Decision That Hamstrings SEC’s Enforcement Program

Boardroom Racial Diversity: Evidence from the Black Lives Matter Protests

The Playing Field

EU’s New ESG Reporting Rules Will Apply to Many US Issuers

Universal Proxy Creates New Type of Proxy Fight

Review of Comments on SEC Climate Rulemaking

Review of Comments on SEC Climate Rulemaking

Cynthia A. Williams is Visiting Professor of Law at Indiana University Maurer School of Law and Professor of Law Emerita at the University of Illinois College of Law; and Robert G. Eccles is Visiting Professor of Management Practice at Oxford University Said Business School. This post was authored by Professor Williams, Professor Eccles, Nathan Chael, Christy O’Neil, and Alex Cooper.


 In June, the comment period closed on the SEC’s proposed rulemaking on “The Enhancement and Standardization of Climate-Related Financial Disclosures” (the Proposal). The SEC received more than 5,000 comments on the Proposal. The Commonwealth Climate and Law Initiative has conducted a review and analysis of the more than 1,000 comments made by trade associations, politicians, NGO and third sector entities, companies, investors and academics, as well as lawyers, professional organisations, regulators and standards bodies (these latter four groups are categorised as Other in the chart below as the absolute numbers are relatively small). Form letter comments and comments made by individuals were excluded from the review on the basis that the review focused on certain arguments which were not commonly addressed in such comments.

The review classified the major arguments used in each comment, but focused on arguments related to legal authority, Scope 3 emissions disclosures, and materiality and the 1% threshold. The review also categorized every commentator as For, Against, or Neutral with respect to the Proposal in general terms; a commentator who made suggestions in relation to the Proposal may have nevertheless been categorised as generally For the Proposal. This article summarises the key findings of the review at a high level.


Universal Proxy Creates New Type of Proxy Fight

Garrett Muzikowski is a Director, Pat Tucker is a Senior Managing Director, and Alanna Fishman is a Managing Director at FTI Consulting. This post is based on their FTI Consulting memorandum. Related research from the Program on Corporate Governance includes Universal Proxies (discussed on the Forum here) by Scott Hirst.

In American politics there has been a long tradition of candidates for elected office running on a campaign platform defined solely by one issue. These politicians often have a view that simply by running for election it will drive attention to the issue, thus forcing change. This is exactly what happened when the U.S. Securities and Exchange Commission put into effect the Universal Proxy rules this September—it opened the door for single issue candidates in the annual election of board directors. The potential rise of single-issue candidates has important implications for how boards engage with investors, discuss oversight of key issues and protect the reputation of board members.

Proxy Fights a Mandate for Change

Prior to the universal proxy, traditionally contested director elections were primarily the territory of hedge funds in pursuit of strategic change at the company. An activist investor would focus on persuading shareholders that the company needs to change and all or some of the current board members are not up to the task. Investors voting by proxy were forced to choose either the management card, representing the existing board, or the dissident card, representing the activist’s nominees. Winning a proxy contest was as much winning a mandate for change as it was securing the election of new directors.

With the universal proxy, all nominees appear on one slate – even if multiple activists put forth dissident nominees at the same annual general meeting. Investors will now be able to hand-pick their own combination of directors they’d like to elect.

Universal Proxy Collides with Shareholder Influence Evolution

The adoption of the universal proxy comes at a time when the market is already witnessing an unprecedented level of shareholder influence. Two powerful trends in the market highlight this paradigm shift. First, shareholders now have the ability to drive favorable proxy outcomes with minimal amounts of investment. The days of needing 5% or more of shares outstanding to have influence are gone. Second, the investors that are pushing companies to change through shareholder proposals or other avenues have never been more prevalent or impassioned. Equally influential is the fact that the universal proxy rules lower the costs of a proxy campaign.

Universal proxy has connected influence, interest and cost in a way that opens the door for more funds to consider putting forth a board candidate for election.


EU’s New ESG Reporting Rules Will Apply to Many US Issuers

Michael Mencher and Emma Bichet are Special Counsels; and Jack Eastwood is a Trainee Solicitor at Cooley. This post is based on their Cooley memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here); and Will Corporations Deliver Value to All Stakeholders? (discussed on the Forum here) both by Lucian Bebchuk and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy – A Reply to Professor Rock (discussed on the Forum here); Leo E. Strine, Jr.; Stakeholder Capitalism in the Time of COVID (discussed on the Forum here); by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita. 

New environmental, social and governance (ESG) reporting requirements in the European Union and the US are set to fundamentally change the nonfinancial reporting landscape. The new EU rules will require ESG reporting on a level never seen before, and will capture a whole host of companies that previously were not subject to mandatory nonfinancial reporting requirements, including public and private non-EU companies that meet certain EU-presence thresholds. For US issuers, the new EU rules will result in mandatory reporting on a broader set of ESG topics than those required under current and proposed Securities and Exchange Commission (SEC) rules.

Even if your business is not covered by the new reporting requirements, we anticipate that you will feel the impact of these requirements if your business is part of the value chain of an entity that is required to report. We expect to see companies sending and receiving ESG questionnaires to gather the data necessary for their ESG reports.

In addition to the proposed US climate change reporting rules, preparation for reporting under the new EU rules will be an important topic for fall board meetings and nominating and corporate governance committees.

If you have any questions or would like training for your teams, please contact a member of Cooley’s international ESG team.

What are the new reporting requirements?

In the EU, political agreement has been reached on the new Corporate Sustainability Reporting Directive (CSRD), meaning that the draft will soon enter into law. The CSRD hugely expands the scope and content of current EU nonfinancial reporting obligations to capture a much wider range of entities and require reporting on a broader range of ESG topics in much more detail than before. The information is to be included in a separate section of the management report, subject to mandatory audit, and will feed into a publicly accessible EU website.

Notably, the CSRD applies to EU companies and public and private non-EU companies that meet the thresholds described below. As a result, US and other non-EU companies with EU business may be required to produce ESG reports in compliance with EU rules, even if such companies are not listed on a European exchange. Although non-EU companies have the most extended timeframe for reporting, many EU subsidiaries of non-EU companies will be required to report earlier. Non-EU companies with subsidiaries that are required to report earlier may, as a practical matter, want to consider reporting at the parent level early, instead of producing a separate subsidiary-level report, particularly those companies that already produce robust voluntary ESG disclosure.


The Playing Field

Ali Saribas is a Partner, Marianne Mitchell, and Anais Sachiko Gaiffe are Analysts at SquareWell Partners. This post is based on their SquareWell memorandum. Related research from the Program on Corporate Governance includes How Much Do Investors Care about Social Responsibility? (discussed on the Forum here) by Scott Hirst, Kobi Kastiel, and Tamar Kricheli-Katz; The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian Bebchuk, and Roberto Tallarita; Does Enlightened Shareholder Value add Value (discussed on the Forum here) by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita; Companies Should Maximize Shareholder Welfare Not Market Value (discussed on the Forum here) by Oliver Hart and Luigi Zingales; and Exit vs. Voice (discussed on the Forum here) by Eleonora Broccardo, Oliver Hart and Luigi Zingales.

The Playing Field

Each year, SquareWell Partners (“SquareWell”) publishes a study – The Playing Field – reviewing how 50 of the world’s largest asset managers (“Top 50”) are factoring governance and sustainability considerations within their investment decision-making processes and their approach to stewarding portfolio companies. This year’s study demonstrates that investors may have reached the saturation point of visible governance and sustainability integration (becoming a signatory to UN PRI, and establishing a responsible investment team, for example), giving the foundation for practical considerations on these topics for stewardship activities, and progress on how investors think about integration.

I. The Foundations Have Been Laid

Global asset managers have sought out many ways of establishing themselves as responsible investors, becoming signatories to the United Nations Principles of Responsible Investing (“UN PRI”, as well as other initiatives), and establishing the internal structures needed to manage the requirements of being modern stewards of capital. As of July 2022, unchanged from our 2021 study, all but one of the world’s Top 50 asset managers were signatories to the UN PRI. 48 have also now formed a dedicated responsible investment team (up from 46 the previous year, Figure 1), and 49 have established dedicated stewardship teams (up from 45 the previous year) to oversee engagement with portfolio companies’ governance and sustainability activities and instruct proxy voting decisions (Figure 2).

Asset managers have also adapted their offerings to include products such as thematic investments. These investments, offering clients focus on specific sustainability issues, have been adopted by 48 of the 50 top asset managers surveyed. Notably, we see that certain aspects of investors’ approaches to responsible investment, such as developing internal capability and offering innovative products, have become an expectation of large asset managers, rather than a differentiator.


Boardroom Racial Diversity: Evidence from the Black Lives Matter Protests

Anete Pajuste is Professor of Finance at Stockholm School of Economics (Riga), and Visiting Senior Fellow at the Program on Corporate Governance of Harvard Law School; Maksims Dzabarovs and Romans Madesovs are Researchers at the Stockholm School of Economics (Riga). This post is based on their article forthcoming in the Corporate Governance: An International Review. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite (discussed on the Forum here) by Alma Cohen, David Weiss, and Moshe Hazan; Will Nasdaq’s Diversity Rules Harm Investors? (discussed on the Forum here) by Jesse M. Fried; and Duty and Diversity (discussed on the Forum here) by Chris Brummer and Leo E. Strine, Jr.

With increased attention on systemic racism in the aftermath of the killing of George Floyd (on May 25, 2020) and the widespread Black Lives Matter (BLM) protests, growing number of stakeholders recognize racial diversity on corporate boards (or rather lack thereof). After the BLM protests, institutional investors started to demand disclosure of boardroom racial composition and focused on inclusion and equal opportunities policies. Media drew attention to insufficient boardroom diversity, noting that “Corporate America has a long way to go to achieve meaningful black representation in its leadership ranks”, and a series of diversity driven derivative lawsuits against boards and officers were filed in the second half of 2020, containing allegations that despite publicly emphasizing the importance of diversity, the boards and management remained largely white and male. Furthermore, in August 2021, NASDAQ accepted a “comply or explain” Board Diversity Rule.

Our recent paper, forthcoming in the Corporate Governance: An International Review, empirically examines how investors assessed the racial diversity of corporate boards during the BLM protests and one year after the protests, using a sample of S&P500 companies. We posit that stock returns of companies with black representation in the board differ from those of companies without a single black director during the BLM protests, and the sign of this relationship depends on investor expectations about the costs and benefits of increasing racial diversity on the board. Given public pressure to improve boardroom racial diversity, our paper also addresses the following questions: How quickly companies added new diverse directors? And do we observe any potential deviations from “optimal” board structure?

At first sight, the lack of black representation on the board should have been a concern to investors during the BLM protests. Drawing parallels with the #MeToo Movement (beginning in October 2017) that shifted investors’ beliefs about higher risks associated with no or minimal board gender diversity and resulted in positive abnormal returns for firms with gender-diverse boards (Billings, Klein, and Shi, 2022), we would expect that firms with racially-diverse boards outperform other firms during the BLM protests. Similarly, if investors expect that companies with racially non-diverse boards end up having less capable boards and deviate from the “optimal” board structure under the public pressure to increase boardroom racial diversity (Ahern and Dittmar, 2012), we would observe negative abnormal returns for firms with racially non-diverse boards. Our empirical results are consistent with the above predictions and show a positive association between the representation of black directors and stock returns during the BLM protests, especially among the largest and most popular companies.


Fifth Circuit Declines to Rehear Sweeping Decision That Hamstrings SEC’s Enforcement Program

George S. Canellos and Tawfiq S. Rangwala are Partners, and John J. Hughes III is Special Counsel at Milbank LLP. This post is based on a Milbank memorandum by Mr. Canellos, Mr. Rangwala, Mr. Hughes III, and Michael Dauber.

After a sweeping defeat in the Fifth Circuit, the Securities and Exchange Commission (“SEC” or “Commission”) may be headed to the Supreme Court in an effort to salvage important tools in its enforcement arsenal. The SEC had asked the full Fifth Circuit to rehear a split 2-1 decision issued in May in Jarkesy v. SEC,[1] the latest in a series of judicial blows to the SEC’s expansive, decade-long reliance on administrative proceedings to seek monetary penalties from a wide range of entities and individuals.[2]

The Fifth Circuit denied the SEC’s en banc petition on October 21, 2022, leaving a certiorari petition as the only remaining avenue for the SEC to challenge a decision that threatens several important aspects of its enforcement powers. As the judges dissenting from denial of en banc review recognized, the decision “raises questions of exceptional importance.”[3] If left standing, Jarkesy potentially could cripple the ability of the Commission to hold gatekeepers and supervisors responsible for negligent oversight of those who commit fraud, opens the door to constitutional challenges to some SEC actions filed in federal court, and raises questions about the appropriateness of administrative settlements that the SEC continues to ink every day.

In Jarkesy, the Fifth Circuit ruled that SEC administrative proceedings are unconstitutional for three independent reasons: (1) the SEC’s pursuit of monetary penalties for securities fraud in an administrative forum violated the petitioner’s Seventh Amendment right to a jury trial in federal court; (2) Congress violated the constitutional non-delegation doctrine by giving the SEC, as part of Dodd-Frank Act amendments to the securities laws, unfettered discretion to file certain enforcement actions in either district court or in an administrative forum; and (3) statutory restrictions on the removal of administrative law judges (“ALJs”) from office violate Article II of the Constitution.

Early commentary by legal scholars and practitioners has tended to emphasize that, while wide-ranging in its rebuke of the SEC’s reliance on ALJs, Jarkesy may be of limited short-term significance because the SEC has largely ceased bringing contested cases administratively in the wake of the Supreme Court’s decision in 2018 in Lucia v. S.E.C.[4] (which held that SEC ALJs are inferior executive officers who must be appointed by the President or the Commission, rather than by SEC staff) and other challenges to the constitutionality of the SEC’s administrative process. But the decision raises a host of thorny legal and practical questions that should influence advocacy and strategy in defending against SEC enforcement actions now that the full Fifth Circuit has chosen to leave the Jarkesy panel’s decision as the last word.


Bylaw Amendments, Shareholder Activism, and Flying Close to the Sun

Kai H. E. Liekefett and Derek Zaba are Partners, and Leonard Wood is a Senior Managing Associate at Sidley Austin LLP. This post is based on a Sidley piece by Mr. Liekefett, Mr. Zaba, Mr. Wood, and Beth E. Berg. This post is part of the Delaware law series; links to other posts in the series are available here.

A case presently before the Delaware Court of Chancery challenging a corporation’s advance notice bylaw amendments, initiated by activist investor Politan Capital Management LP in October 2022,[1] brings to mind the storied Icarus. In the legend, a master craftsman creates wings of feathers and wax for himself and his son to escape danger. He cautions his son Icarus not to fly too close to the sun, lest the wings melt. Icarus, carried away with this device figuratively and literally, flies too high and tumbles into the sea.

The defendant is a Delaware corporation that, facing a potential proxy battle with activist fund Politan, adopted several of the most aggressive advance notice bylaw provisions considered (and previously dismissed) by shareholder activism defense legal practitioners. These bylaws require that, for any shareholder’s notice of dissident director nominations to be valid, the shareholder’s notice of nominations to the company must identify, among other things, the investment fund’s limited partners, all understandings between the fund’s limited partners and any of their respective family members and cohabitants, and any plans the fund has to nominate directors at other public companies in the next 12 months.

While time will tell if these bylaw amendments can sustain the court’s scrutiny, they are doubtlessly flying close to the sun. When companies adopt these types of bylaws, and particularly if they do so in the face of an imminent proxy contest, they run a risk of undermining reasonable and appropriate advance notice bylaws.


The Evolution of ESG Reports and the Role of Voluntary Standards

Ethan Rouen is an Assistant Professor of Business Administration at Harvard Business School; Aaron Yoon is an Assistant Professor of Accounting Information and Management at Northwestern University Kellogg School of Management; and Kunal Sachdeva is an Assistant Professor of Finance at Rice University Jesse H. Jones Graduate School of Business. This post is based on their recent paper. Related research from the Program on Corporate Governance includes How Much Do Investors Care About Social Responsibility? (discussed on the Forum here) by Scott Hirst, Kobi Kastiel, and Tamar Kricheli‐Katz; and The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian Bebchuk and Roberto Tallarita.

At the start of the 21st century, almost no companies released ESG-related disclosures, but by 2021, most large publicly traded U.S. firms had converged around voluntary standalone ESG reports as a primary means of documenting their ESG activities.

ESG reports are unstandardized in form and content, since they are not audited, mandated, or regulated in the United States (and most other jurisdictions), and the content of these reports continues to vary widely by firm and industry, as well as over time. ESG reports are among the fastest growing voluntary disclosures in history. Given the demand for this information and the current lack of uniformity, regulators are considering reporting mandates to provide frameworks for disclosing ESG activities.

Our Findings

In our paper, we examine the evolution of ESG reports for S&P 500 companies and explore how the content of ESG reports has evolved in the absence of regulation. We also document how this content changed around the introduction of voluntary disclosure standards that defined a comprehensive set of financially material ESG issues. We study ESG reports at two units of analysis: the document-year level and document-topic year level (“the topic level,” going forward). At the document-year level, we find that the percentage of firms releasing these voluntary disclosures increased from 35% to 86% during this period, although the length of these documents experienced more modest growth. We also find evidence that firms in the same sector increasingly use similar language over time, as do firms across sectors, meaning that firms may be coalescing around a common ESG vocabulary.

We next study the content in these reports (i.e., topic-level analysis) to understand the rich heterogeneity within these documents. We use a semisupervised machine-learning approach that is guided by the Sustainability Accounting standards Board (SASB) standards that identified material ESG issues to learn the meanings of all words and phrases within ESG reports. Specifically, we define topics based on the full set of ESG activities defined by SASB and provide a group of unique seed words for each topic from the standards to train a neural network model that learns the words and phrases used to describe each topic. The algorithm allows us to quantify the semantics, as opposed to the syntax, of each document and produce our topic scores, calculated as a weighted-frequency count of all words on that topic within the ESG report, the term frequency-inverse document frequency.

We find that the language used within topics has evolved as the operating environment has changed. For example, when discussing customer welfare in ESG reports, terms like “vaccine” were uncommon in 2010 but were identified by the algorithm as among the most important terms in 2020, a reflection of the COVID-19 pandemic. In addition to providing unique descriptive evidence of how disclosure language changes, this analysis shows the flexibility of the machine-learning approach in measuring text as language evolves.

We also find that firms devote most of their reports to topics that are material to their sector. We find that, on average, firms disclose 48% more on material topics relative to immaterial topics. We also exploit the staggered sector-level introduction of these standards and use a difference-in-differences empirical specification to uncover whether the amount of information related to material and immaterial topics changes as SASB provides voluntary disclosure guidance on ESG’s financial materiality. We find that the relative amount of material information increased by 11% after the release of voluntary standards.

Given the voluntary nature of both ESG disclosures and the adoption of SASB standards, understanding how firms converge toward material disclosures remains an outstanding but important question. To provide insights into the question of how convergence arises, we examine a subset of firms that were involved in the standard-setting process (i.e., potential disclosure leaders) and compare their disclosure practices to those of other early disclosers. We find that firms that helped develop the standards increased material disclosures at similar rates while the standards were being developed. On the other hand, the material information in the reports of other early disclosers was unchanged in the years leading up to the release of the standards but increased in the post-period in a way that resembled the IWG firms in the pre-period. These results provide evidence that standards, even voluntary ones, can serve as powerful guidance when a large sample of firms chooses voluntary disclosure in the absence of regulation. The analysis also suggests that disclosure leaders (i.e., IWG firms) can learn while doing, while other firms may be equally quick to respond once standards are known.

Concluding Remarks

We are among the first researchers to use state-of-the-art machine learning to clean, parse, quantify, and investigate not just the disclosure choice but also the heterogeneous content of ESG reports. We provide evidence that the content within ESG reports can converge toward material information in the absence of regulation, and that both firms and standard setters can play important roles in this process. Our findings suggest that well-defined voluntary standards and guidance can help improve ESG disclosures and should be of interest to investors and regulators. Our findings have implications on how firms’ disclosures may converge in response to a mandate. This is an important insight as regulators are considering ESG disclosure mandates (e.g., such as the ESG Disclosure Simplification Act of 2021 proposed by the U.S. Congress and the founding of International Sustainability standards Board).

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