Opening Remarks by Chairman Clayton at the Meeting of the Asset Management Advisory Committee

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent remarks at the Meeting of the Asset Management Advisory Committee. The views expressed in this post are those of Mr. Clayton and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Thank you, Ed [Bernard]. [1] I would like to welcome everyone to the second meeting of the Commission’s Asset Management Advisory Committee. I am glad that the Committee is able to meet virtually today.

Thank you to everyone participating, including Commissioners Peirce and Lee; our panelists; and the members of the Committee. I would like to particularly thank Ed for his leadership in crafting the agenda for today’s meeting, and Dalia and her team for their many contributions in a compressed timeframe. Thank you also to the Commission staff in the Office of Information Technology and the Office of the Secretary, whose work allowed us to hold today’s meeting remotely. And, importantly, thank you to all of those interested individuals who are listening to our meeting through the Commission’s website.

I look forward to hearing the Committee’s insights into the effects of the pandemic on the asset management industry and, in particular, our long-term Main Street investors. An essential component of our national response to, and recovery from, COVID-19 will be the continuing, orderly operation of our markets and the continued flows of capital and credit throughout our economy. The asset management industry has a pivotal role to play in both orderly market operation and the generation and absorption of capital flows. Investment funds and advisers are an important link between these market realities and the interests of our long-term Main Street investors. As the effects of COVID-19 and our societal response unfold, it is important that we discuss these matters in real time and with clear heads.

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Recommendation from the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee Relating to ESG Disclosure

Allison Bennington is a member of the SEC Investor-as-Owner Subcommittee. This post is based on the recommendations of the Investor-as-Owner Subcommittee by Ms. Bennington; Anne Sheehan, Chair of the SEC Investor Advisory Committee; and John Coates, Chair of the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee.

For close to 50 years, the SEC has periodically contemplated whether ESG [1] disclosures are material and should be incorporated into its integrated disclosure regime for SEC registered Issuers. [2] This recommendation asserts that the time has come for the SEC to address this issue. Addressing ESG disclosure now will (a) provide investors with the material, comparable, consistent information they need to make investment and voting decisions, (b) provide Issuers with a framework to disclose material, decision-useful, comparable and consistent information in respect of their own businesses, rather than the current situation where investors largely rely on third party ESG data providers, which may not always be reliable, consistent, or necessarily material,(c) level the playing field among all US Issuers regardless of market cap size or capital resources, (d) ensure the continued flow of capital to US Issuers, and (e) enable the SEC to take control of ESG disclosure for the US capital markets before other jurisdictions impose disclosure regimes on US Issuers and investors alike.

Background to Recommendation:

The SEC Investor Advisory Committee has held three sessions on the topic of ESG Disclosures in 2016, 2018 and 2019. [3] We have heard the perspectives of a variety of market participants and have evaluated their supporting documentation. Members of this Committee have also spoken with a number of investment advisors, asset managers and asset owners, US and foreign Issuers, third party data providers, NGO’s, and proponents of third-party disclosure frameworks. The message that we have heard consistently is that investors consider certain ESG information material to their investment and voting decisions, regardless of whether their investment mandates include an “ESG-specific” strategy. Our work has informed us that this information is material to investors regardless of an Issuer’s business line, model or geography, and is different for every Issuer. Yet, despite a plethora of data, there is a lack of material, comparable, consistent information available upon which to base some of these decisions.

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Material Adverse Effect Clauses and the COVID-19 Pandemic

Robert T. Miller is a Professor of Law at the University of Iowa College of Law. This post is based on his recent paper. Related research from the Program on Corporate Governance includes Allocating Risk Through Contract: Evidence from M&A and Policy Implications by John C. Coates, IV (discussed on the Forum here) and The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

In a working paper just posted on SSRN, I consider whether the COVID-19 pandemic, the governmental responses thereto, and a company’s actions taken in reaction to both of these are likely to constitute a “Material Adverse Effect” (MAE) within the meaning of a typical MAE clause in a public company merger agreement. In addition to the conclusions about COVID-19 and MAEs summarized below, the paper also reviews important Delaware caselaw on MAEs, identifies open problems in those cases, and suggests a more comprehensive theory of MAEs that rationalizes the caselaw and solves most of the open problems.

As to COVID-19 and MAEs, although in any particular case everything will depend on the exact effects on the company and the precise wording of the MAE clause, nevertheless because MAE definitions tend to follow common patterns, some general conclusions about typical MAE clauses are warranted, including the following:

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On the Purpose of the Corporation

Martin Lipton is a founding partner, and William Savitt and Karessa L. Cain are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Mr. Savitt, Ms. Cain, and Steven A. Rosenblum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here) and Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

The growing view that corporations should take into account environmental, social and governance (ESG) issues in running their businesses, and resistance from those who believe that companies should be managed solely to maximize share price, has intensified the focus on the more fundamental question of corporate governance: what is the purpose of the corporation?

The question has elicited an immense range of proposed answers. The British Academy’s Future of the Corporation Project, led by Colin Mayer, suggests that the purpose of the corporation is to provide profitable solutions to problems of people and planet, while not causing harm. The Business Roundtable has articulated a fundamental commitment of corporations to deliver value to all stakeholders, each of whom is essential to the corporation’s success. Each of the major US-based index funds has also expressed their views about the purpose of the corporations in which they invest, which, considered collectively, can be summarized as the pursuit of sustainable business strategies that take into account ESG factors in order to drive long-term value creation. On the other hand, the Council of Institutional Investors, some leading economists and law professors, and some activist hedge funds and other active investors continue to advocate a narrow scope of corporate purpose that is focused exclusively on maximizing shareholder value. The Covid-19 pandemic has brought into sharp focus the inequality in our society that, in considerable measure, is attributable to maximizing shareholder value at the expense of employees and communities.

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Three Is Not A Trend: Another Caremark Claim Survives A Motion To Dismiss, But Does Not Reflect A Change In The Law

Nicholas D. Mozal is counsel and David Seal is an associate at Potter Anderson & Corroon LLP. This post is based on their Potter Anderson memorandum 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 Monetary Liability for Breach of the Duty of Care? by Holger Spamann (discussed on the Forum here).

The Delaware Court of Chancery recently denied another motion to dismiss a Caremark claim in Hughes v. Hu. [1] Under In re Caremark International Inc. Derivative Litigation, [2] directors have a duty to exercise oversight and monitor a corporation’s operational viability, legal compliance, and financial performance and reporting. Hughes is now the second decision, after In re Clovis Oncology, Inc. Derivative Litigation, [3] to allow a Caremark claim to proceed beyond the pleadings stage since the Delaware Supreme Court reversed the Court of Chancery’s dismissal of a Caremark claim in Marchand v. Barnhill. [4] It would be a mistake, however, to read Hughes as an extension of those decisions and only in that context. Indeed, Hughes understandably does not even cite Clovis. The better reading is that Hughes, like the Court of Chancery’s 2013 decisions in Rich v. Yu Kwai Chong [5] and In re China Agritech, Inc. Shareholder Derivative Litigation, [6] reflects the particular accounting and oversight difficulties witnessed in certain Chinese businesses that have gained access to the United States capital markets through a reverse merger. In short, the actions of the audit committee in Hughes are in no way analogous to how the vast majority of audit committees and their advisors operate to ensure a board fulfills its Caremark duties by exercising appropriate oversight. Nevertheless, Hughes reiterates the reasons why it is important for boards and committees to continue adhering to those best practices. In addition, Hughes addresses the importance of maintaining proper records and indicates how those records may be useful in responding to stockholder demands for books and records pursuant to 8 Del. C. § 220.

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Board Oversight in Light of COVID-19 and Recent Delaware Decisions

Holly J. Gregory is partner, Thomas A. Cole is senior counsel, and Claire H. Holland is special counsel at Sidley Austin LLP. This post is based on a Sidley memorandum by Ms. Gregory, Mr. Cole, Ms. Holland, Sharon R. Flanagan, Sara B. Brody. This post 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 Monetary Liability for Breach of the Duty of Care? by Holger Spamann (discussed on the Forum here).

In times of crisis, the risk of shareholder derivative litigation rises as boards of directors face heightened scrutiny of their actions. While business judgment protection applies to good faith board efforts to navigate a crisis, boards and their advisors should be mindful of guidance that the Delaware courts have issued in the past year, including in a Delaware Chancery Court case decided on April 27, regarding the circumstances in which a claim can move forward seeking to hold directors personally liable for a failure of oversight.

The 1996 Delaware Chancery Court decision in In re Caremark Int’l Inc. Deriv. Litig. clarified that directors are responsible for overseeing that the company has in place information and reporting systems reasonably designed to provide the board and senior management with timely, accurate information sufficient to support informed judgments about compliance risk. [1] Since then, shareholder plaintiffs have tried to hold directors liable for a variety of corporate missteps on the basis that directors failed in their oversight role. These claims—known as Caremark claims—have until recently typically been dismissed in early pleading stages (before discovery) for failure to state a claim. Indeed, these types of claims are regarded as among the most difficult on which to establish director liability (although Caremark claims survived motions to dismiss in a few rare cases prior to 2019). [2] Nonetheless they are attractive to plaintiffs because an oversight failure sufficient for a Caremark claim constitutes a breach of the duty of loyalty and good faith which cannot be exculpated under Delaware law. Because most Delaware corporations provide in their charters that directors will not be held personally liable for breaches of the duty of care, this is one of the few remaining avenues to seek monetary damages from directors personally absent a conflict of interest situation.

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The Blue Bell Dairy CEO Indictment and its Implications for Executive Liability

Michael W. Peregrine and David S. Rosenbloom are partners at McDermott Will & Emery LLP. This post is based on their McDermott Will & Emery memorandum.

The May 1, 2020 federal felony indictment [1] of former Blue Bell Creameries LLP CEO Paul W. Kruse provides an important lesson to governing boards and their senior executives on the regulatory risks associated with communications during times of corporate crisis, especially communications with public health and safety implications.

Company executives and public relations consultants often debate about what is too little or too much to say in a time of crisis. The Kruse prosecution is a reminder that there can be criminal implications to those debates, and sometimes there can be more risk in what a company does not say than in what it does say. The case also provides a cautionary note about the broad scope of anti-fraud enforcement authority available to the federal government. Together, these are risks that corporate leadership should discuss with their general counsel and the compliance officer, especially given the ongoing pandemic.

The most immediate of these lessons are the critical need (a) for corporate leaders to be extraordinarily careful with the transparency and accuracy of crisis communications, especially those relating to acute impact on consumers created by the company’s products or services; and (b) to confirm that the company’s compliance program adequately alerts the board to the presence of such risks.

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Recent Delaware Court of Chancery Decision Sustains Another Caremark Claim at the Pleading Stage

Meredith Kotler and Pamela Marcogliese 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. Related research from the Program on Corporate Governance includes Monetary Liability for Breach of the Duty of Care? by Holger Spamann (discussed on the Forum here).

After decades of routinely dismissing such claims, Vice Chancellor Laster’s recent 41-page decision in Hughes v. Hu represents the third time since the Delaware Supreme Court’s decision last year in Marchand v. Barnhill that the Court of Chancery has sustained a Caremark duty of oversight claim at the pleading stage. It remains unlikely that these recent decisions signal some change in the law, but rather reflect allegations of unique or extreme examples of certain corporate behavior. That said, these cases serve as a reminder of the importance of active, engaged board oversight of “mission critical” risk and compliance issues, and boards should take proactive steps to ensure that directors do not face personal liability for a failure of oversight.

Marchand, Clovis, and Inter-Marketing Group

Caremark claims, which allege failures of board oversight, have long been regarded by Delaware courts as “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” To plead and prove a Caremark claim, a stockholder plaintiff must show that the board either (i) “utterly failed to implement any reporting information restrictions or controls”; or (ii) having implemented them, “consciously failed to monitor or oversee their operations, thus disabling themselves from being informed of risks or problems requiring their attention.” Not surprisingly, these claims routinely fail at the pleading stage.

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Human Capital: Key Findings from a Survey of Public Company Directors

Steve W. Klemash is Americas Leader, Jennifer Lee is Audit and Risk Specialist, and Jamie Smith is Investor Outreach and Corporate Governance Specialist, all at the EY Americas Center for Board Matters. This post is based on their EY memorandum.

The focus on human capital and talent in corporate governance is intensifying, as more stakeholders—led by large institutional investors—seek to understand how companies are integrating human capital considerations into the overarching strategy to create long-term value. After all, a company’s intangible assets, which include human capital and culture, are now estimated to comprise a significant portion of a company’s market value.

Many influential groups, including the Global Reporting Initiative, the Embankment Project for Inclusive Capitalism, the Business Roundtable and the Sustainability Accounting Standards Board (SASB), have identified human capital as a key driver of long-term value. Recent developments reflect a clear and growing market appetite to understand how companies are managing and measuring human capital. This includes influential investors making human capital an engagement priority with directors, as well as comment letters from various stakeholders to the U.S. Securities and
Exchange Commission supporting greater human capital disclosure and asserting the importance of human capital management in assessing the potential value and performance of a company over the long term.

At the same time, there is an ongoing cultural shift brought about by new generations of workers, digitization, automation and other megatrends related to the future of work. In this new era, it is critical for management teams and boards to keep pace with this transformation and consider redefining long-term value and corporate purpose. Creating value for multiple stakeholders, including employees, will ultimately help build and sustain shareholder value over the long term. To better understand where companies are on this journey, Corporate Board Member, in partnership with the EY Center for Board Matters, surveyed 378 U.S. public company board members in the fall of 2019.

This post presents our findings.

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Whataday for Special Committees: Committee Formation Requirements in Non-MFW Scenarios

Barbara Borden is a partner and Caitlin Gibson is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Borden. Ms. Gibson, Koji Fukumura, and Peter Adams. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

In late February as the COVID-19 pandemic was accelerating, the Delaware Chancery Court issued an important decision that is likely to impact transactions during the expected recession. In Salladay v. Lev, C.A. No. 2019-0048-SG (Del. Ch. Feb. 27, 2020) (“Salladay”), the court held that a conflicted transaction—not involving a controlling shareholder—could only be cleansed through the use of a special committee under Trados II [1] if the special committee was constituted ab initio (i.e., from the outset). Salladay is the first time that a Delaware court has held that the ab initio requirement established by Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) and its progeny applies in a non-MFW scenario (i.e., in a transaction without a conflicted controlling shareholder). Accordingly, a conflicted transaction without a controlling stockholder, can be “cleansed” under Trados II and become eligible for review under the business judgment rule if an empowered special committee of independent directors is constituted at the outset before any substantive economic discussions occur and the other MFW standards relating to special committees are met. [2] However, if the special committee is not established ab initio, and there are disputed questions of fact about whether the conflicted transaction was properly cleansed under Corwin [3], then the director defendants will have the burden to prove that the transaction was entirely fair.

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