Monthly Archives: February 2019

Guidance on Books-and-Records Inspection Rights

William SavittRyan A. McLeod and Anitha Reddy are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Savitt, Mr. McLeod, and Ms. Reddy and and is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Supreme Court this week offered important guidance on stockholders’ rights to inspect corporate books and records. KT4 Partners LLC v. Palantir Techs., Inc., No. 281, 2018 (Del. Jan. 29, 2019).

The case involved a stockholder’s demand under Section 220 of the Delaware General Corporation Law to obtain documents to investigate suspected wrongdoing by Palantir’s board. The trial court permitted Palantir to exclude email from its production and limited the stockholder’s ability to use the documents in litigation outside of Delaware. On appeal, the Supreme Court reversed on both issues.

As to the proper scope of inspection, the Court confirmed that a Section 220 petitioner is generally entitled to “everything that is ‘essential’” but no more than “what is ‘sufficient’” for its purpose. For that reason, the Court noted, inspections are often properly limited to formal board-level materials such as meeting minutes, resolutions, and presentations. Nevertheless, “§ 220 must be interpreted in light of companies’ actual and evolving record-keeping and communications practices.” In this case, the corporation had “a history of not complying with required corporate formalities” and had admitted that “there are no board-level documents” responsive to the request. In such circumstances, the Court held, an email production was required: “If a respondent in a § 220 action conducts formal corporate business without documenting its actions in minutes and board resolutions or other formal means, but maintains its records of the key communications only in emails, the respondent has no one to blame but itself for making the production of those emails necessary.”

With respect to the forum use restriction, the Court reaffirmed that courts may impose such restrictions on inspection demands to protect legitimate corporate interests (such as avoiding wasteful multiforum litigation) but stressed that the inquiry is case-specific. Here, a forum restriction would have the effect of multiplying, rather than consolidating, intracorporate disputes, because the corporation did not have a Delaware forum-selection bylaw and was already embroiled in related litigation in California.

The decision supplies corporations with yet another reason to take two prudent governance steps: (1) to document board actions with care (to avoid intrusive inspection requests from stockholders), and (2) to consider adopting forum-selection bylaws (to avoid the obligation to produce documents for use in foreign tribunals).

Public Letter following SEC Proxy Process Roundtable

Edward Knight is Executive Vice President and Global Chief Legal and Policy Officer at Nasdaq, Inc.; Tom Quaadman is Executive Vice President at the U.S. Chamber Center for Capital Markets Competitiveness; and Linda Moore is President and CEO at TechNet. This post is based on a comment letter by 318 signatory companies to the U.S. Securities and Exchange Commission.

We, the undersigned publicly traded companies, want to thank you for conducting the Roundtable on the Proxy Process on November 15, 2018. The U.S. proxy process is critical to public company governance, and we appreciate the Commission’s recognition that areas within the process need to be reformed.

These issues have real effects on the economy, job creation and global competitiveness. As many have communicated to the SEC in the past several years, these issues are part of a poorly-calibrated regulatory ecosystem that is producing fewer IPOs and driving many companies out of the public markets.

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Is There a First-Drafter Advantage in M&A?

Adam Badawi is a Professor at UC Berkeley School of Law and Elisabeth de Fontenay is an Associate Professor at Duke University School of Law. This post is based on their recent article, forthcoming in the California Law Review. Related research from the Program on Corporate Governance includes M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice and Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here), both by John C. Coates, IV.

Does the party that provides the first draft of a merger agreement get better terms as a result? There is considerable lore among transactional lawyers on this question, yet it has never been examined empirically. In a recent article, Is There a First-Drafter Advantage in M&A?, we develop a novel dataset of drafting practices in large M&A transactions involving U.S. public-company targets. We find that there is little or no advantage to providing the first draft with respect to the most monetizable merger agreement terms, such as merger breakup fees. Notwithstanding, we do find an association between drafting first and a more favorable outcome for terms that are harder to monetize, more complex, and that tend to be negotiated exclusively by counsel, such as the material adverse change (MAC) clause. These findings are consistent with the view that the negotiation process generates frictions and agency costs, which can affect the final deal terms and result in a limited first-drafter advantage.

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The Road Ahead for Shareholder Activism

Gail Weinstein is senior counsel, and Warren S. de Wied and Philip Richter are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. de Wied, and Mr. Richter. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here), and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

Notwithstanding that shareholder activist funds themselves continue to have below-market returns, shareholder activism continues to expand and intensify. While many commentators have cited 2018 as a “record year” for activism in terms of number of campaigns, capital deployed, number of activists involved, first-time activists, and board seats obtained, the growth of activism from 2017 to 2018 was modest, particularly when campaigns against an announced merger and short seller campaigns are excluded. In addition, first time targets in the U.S. represented less than 43% of financial activist’s targets.

While statistically activism continues to grow, statistics alone do not tell the story. In our view, the activist investing market in the U.S. is mature. Moreover, the pervasiveness of activism has driven critical transformations in the mindset and actions of corporate boards, management teams and institutional investors. Although we expect that activism will continue to evolve and will remain a prominent feature of the corporate landscape and that new themes and changing market conditions will create opportunities for activists, we believe the road ahead contains many pitfalls for activists.

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Statement on Shareholder Proposals Seeking to Require Mandatory Arbitration Bylaw Provisions

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent public statement, available here. 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.

The issue of mandatory arbitration provisions in the bylaws of U.S. publicly-listed companies has garnered a great deal of attention. As I have previously stated, the ability of domestic, publicly-listed companies to require shareholders to arbitrate claims against them arising under the federal securities laws is a complex matter that requires careful consideration. [1]

On various occasions, I have been asked about this issue in the hypothetical context of whether the staff of the Division of Corporation Finance would declare effective the registration statement of a domestic company seeking to include mandatory arbitration provisions in its governing documents at the time of its initial public offering. In response to these inquiries, I stated that, if the issue were to arise in an actual initial public offering of a domestic company, it would not be appropriate for resolution at the staff level but would rather be best addressed in a measured and deliberative manner by the Commission.

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Corporate Sustainability: A Strategy?

Ioannis Ioannou is Associate Professor of Strategy and Entrepreneurship at London Business School and George Serafeim is Professor of Business Administration at Harvard Business School. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

In recent years, a growing number of companies around the world voluntarily adopt and implement a broad range of sustainability practices across the environmental, social and governance (ESG) domains. In doing so, they try to integrate sustainability into their strategy, business models, and organizational processes and structures (Eccles, Ioannou and Serafeim, 2014). In fact, the accelerating rate of adoption of these practices has also provoked an academic as well as a wider debate about the nature of sustainability adoption and its long-term implications for organizations: specifically, is the adoption of sustainability practices a form of strategic differentiation that can lead to superior financial performance or is it a strategic necessity that can ensure corporate survival but not necessarily outperformance?

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It’s Time to Adopt the New Paradigm

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton publication by Mr. Lipton. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Steven A. RosenblumKaressa L. CainSabastian V. NilesAmanda S. Blackett, and Kathleen C. Iannone.

Capitalism is at an inflection point. For the past 50 years, corporate law and policy has been misguided by Nobel Laureate Milton Friedman’s ex-cathedra doctrinal announcement that the sole purpose of business is to maximize profits for shareholders. Corporations have also been faced with technological disruption, globalization and the rise of China, capital markets dominated by short-term trading and focused on quarterly profits, and unrelenting attacks and threats by activist hedge funds. In response to these pressures, corporations focused primarily on increasing shareholder wealth in the short-term, at the expense of employees, customers, suppliers, long-term value and the local and national communities in which they operate. The prioritization of the wealth of shareholders at the expense of employee wages and retirement benefits, with a concomitant loss of the Horatio Alger dream, gave rise to the deepening inequality and populism that today threaten capitalism from both the left and the right.

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Towards Accountable Capitalism: Remaking Corporate Law Through Stakeholder Governance

Lenore Palladino is Senior Economist and Policy Counsel and Kristina Karlsson is a Program Associate at the Roosevelt Institute. This post is based on their Roosevelt Institute memorandum. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

Corporations today operate according to a model of corporate governance known as “shareholder primacy.” This theory claims that the purpose of a corporation is to generate returns for shareholders, and that decision-making should be focused on a singular goal: maximizing shareholder value. This single-minded focus—which often comes at the expense of investments in workers, innovation, and long-term growth—has contributed to today’s high-profit, low wage economy.

Many business leaders, policymakers, and average Americans accept this doctrine of corporate governance as “natural” law—the unshakeable reality of business. However, shareholder-focused corporations are not natural market creations, and the idea of “maximizing shareholder value” is relatively recent. This misguided focus, driven by the neoliberal conception of shareholders as the only actor within the firm who is critical to corporate success, is the result of decades of flawed theory in corporate law and policy. Increasing economic evidence suggests that shareholder primacy is not benefiting other corporate stakeholders, including workers, suppliers, consumers, or communities.

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As Luck Would Have It: Executive Compensation at Energy Companies

Lucas Davis is the Jeffrey A. Jacobs Distinguished Professor in Business and Technology at the Haas School of Business at the University of California, Berkeley; and Catherine H. Hausman is an Assistant Professor at the Gerald R. Ford School of Public Policy at the University of Michigan. This post is based on a VoxEU column and is related to their recent paperRelated research from the Program on Corporate Governance includes Executive Compensation as an Agency Problem and the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, both by Lucian Bebchuk and Jesse Fried.

Fortunes are made and lost every year as oil prices rise and fall, impacting the macroeconomy, the stock market, investment, and of course the value of oil and gas firms (Hamilton, 2009; Kilian and Park 2009; Baumeister and Kilian, 2016). What happens to the fortunes of the leaders of those oil and gas firms? In this post, we argue that the compensation of U.S. oil and gas executives is closely tied to oil prices—much more closely than economic theory would predict. Theory says that executives should be rewarded for the value they bring to a firm, and that they should be incentivized to take the best actions on behalf of the firm. With billions of dollars at stake each year, we argue that boards and shareholders may want to revisit how compensation is structured at these firms.

Executive compensation frequently comes under scrutiny, with shareholders as well as the general public asking questions such as whether executives are over-compensated (e.g., Costello 2011). This scrutiny at times zeroes in on oil and gas firms (Fowler and Lublin, 2013)—most recently related to questions about conflicts of interest at boards of directors (Casselman, 2009), other corporate governance concerns (Denning, 2018), and even climate change (Kent, 2018).

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Saying So Long to State Court Securities Litigation

Laurie Smilan is of counsel and Nicki Locker is partner at Wilson Sonsini Goodrich & Rosati. This post is based on their WSGR memorandum.

When Congress enacted the Securities Exchange Act of 1934, providing for federal regulation of securities traded on the public markets, it took the opportunity to consider conforming amendments to the sister statute regulating initial public offerings it had enacted the year before, the Securities Act of 1933. One such amendment would have done away with the ’33 Act’s concurrent jurisdiction and removal bar provisions, instead providing for exclusive federal jurisdiction like the new ’34 Act did. An ABA Special Committee had advocated for the change, which was included in the original Senate bill, out of concern that concurrent jurisdiction “will inevitably result in varied interpretations of the Act.” The Special Committee warned that “in view of the [‘33 Act’s] heavy liabilities,” “the resulting uncertainty” of “varied [and inconsistent] interpretations” by state and federal courts “will almost certainly operate as a detriment to legitimate business.” Unfortunately, the amendments were not adopted and the prophecy has proved prescient.

As senior SEC officials, the Treasury Department, and stock exchange leaders have recognized, the threat of protracted and often frivolous securities class action litigation has contributed to a decades-long decline in IPOs. Rather than risk becoming the target of vexatious securities litigation, companies increasingly choose private capital transactions or strategic combinations in lieu of going public, a phenomenon that has had significant detrimental effects on both the economy in general and small investors in particular. Congress attempted to stem the tide when it adopted the Private Securities Litigation Reform Act (“PSLRA”) in 1995. However, since that time, the number of public companies has been halved and the number of IPOs has declined from 949 in 1996 to an average of less than 150 per year.

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