Monthly Archives: March 2019

SEC Enforcement for Internal Control Failures

Nicolas Grabar and Sandra L. Flow are partners and Alexander Janghorbani is a senior attorney at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Mr. Grabar, Ms. Flow, Mr. Janghorbani, Alejandro Canelas Fernandez, and Tapan Oza.

On January 29, 2019, the SEC announced four settlements with publicly-traded companies for failure to maintain adequate internal control over financial reporting (ICFR). None of the companies was charged with making false or inaccurate statements, either about its ICFR or otherwise; indeed, each had repeatedly disclosed material weaknesses in ICFR over many years.

These cases are interesting for at least three reasons:

  • They were announced together to send a message about the SEC’s focus on its agenda to strengthen accounting and controls at public companies.
  • The cases are about controls, and not about disclosure. Material weaknesses in ICFR are not just a disclosure issue: a continuing failure to maintain adequate controls is a violation of law, even if the failure is fully disclosed and there is no other disclosure problem.
  • The cases join several recent instances in which the SEC has shown a willingness to use the internal controls provisions of the Securities Exchange Act of 1934 independently of specific disclosure requirements.

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Remarks Before the Council of Institutional Investors

Hester M. Peirce is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on her recent remarks before the Council of Institutional Investors Spring Conference, available here. The views expressed in this post are those of Ms. Peirce and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Thank you, Mary [Francis], for that kind introduction and for the opportunity to be here today. Before I begin, I will give my standard disclaimer. The comments I make today represent my own views and not necessarily those of the Commission or my fellow Commissioners.

I consider it a great honor to have some time with you here this morning. You represent such an important group of participants in our markets with an aggregate of approximately $4 trillion dollars in member assets under management invested in the markets. [1] You bring remarkable sophistication and great wisdom to the job of investing and you do so on behalf of many Americans. Your views, therefore, on how we can make our capital markets function even better than they already do are of real interest to me.

Institutional investors are the market’s repeat, long-term, and bulk players. Costs that are not important to the occasional investor add up to amounts that matter greatly to investors that trade frequently or in large size. It is helpful for me to know, for example, the types of information you find to be material in making decisions about where to trade. [2] More generally, your voices are very important in discussions about whether and how to change market structure in both the equity and the fixed income markets. In particular, you have emphasized the importance of market transparency in our thinking about effective market structure.

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The End of “Corporate” Governance: Hello “Platform” Governance

Mark Fenwick is a Professor at Kyushu University Graduate School of Law; Joseph McCahery is Professor in the Department of Business Law at Tilburg University; and Erik P. M. Vermeulen is Professor of Business & Financial Law at Tilburg University. This post is based on their recent paper.

A significant development in the global economy over the last two decades has been the emergence of businesses that define and organize themselves as “platforms.” By platform, we refer to any organization that uses digital and other emerging technologies to create value by facilitating connections between two or more groups of users. Think Amazon, Facebook, or Uber.

The type of connection varies depending on the platform. Some platforms facilitate connections between the buyer and seller of goods (Amazon); some facilitate connections between those wanting a service and those willing to provide it (Uber); and others simply facilitate connections (information exchange) between friends (Facebook). There is enormous diversity of use cases for the platform model: exchange platforms, service platforms, content platforms, software platforms, social platforms, investment platforms and smart contract platforms. But what is common to all platforms is that they make connections between “creators” and “extractors” of value and the platform generates a profit from making these connections, either by taking a commission or through advertising.

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Driving the Conversation: Long-Term Roadmaps for Long-Term Success

Ariel Fromer Babcock is director, Allen He is a senior research associate, and Victoria Tellez is a research associate at FCLTGlobal. This post is based on their FCLTGlobal memorandum. Related research from the Program on Corporate Governance includes The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here); The Uneasy Case for Favoring Long-Term Shareholders by Jesse Fried (discussed on the Forum here); and Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law by Leo E. Strine (discussed on the Forum here).

Despite clear evidence that investors prefer long-term communications focused on a few key drivers of performance, companies remain mired in information demands from all sides. Long-term roadmaps are a form of investor communication that brings together a unified articulation of how a company will create long-term value with the most relevant metrics to track long-term performance. They have a proven record at leading companies, and evidence suggests that the majority of investors (especially long-term investors) prefer this approach. By focusing on key elements of performance such as competitive advantages, long-term objectives, and a strategic plan matched with clear capital allocation priorities, companies can build buy-in among long-term investors who support a focus on long-term value creation.

Why Long-term Roadmaps?

Survey after survey indicates that investors prefer forward-looking, long-term guidance around a company’s strategy and expected performance.

This post, which represents the collective effort and experience of FCLTGlobal’s Members, academic experts, and other investment leaders, suggests a way to shift the investor relations conversation from quarterly “hits” and “misses” toward how companies create long-term value.

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An Early Look at 2019 US Shareholder Proposals

Subodh Mishra is Executive Director at Institutional Shareholder Services, Inc. This post is based on an ISS paper by Kosmas Papadopoulos, Managing Editor and Executive Director with ISS Analytics, the data intelligence arm of Institutional Shareholder Services. Related research from the Program on Corporate Governance includes Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

In the U.S., shareholder proposal filings have historically played an important role in advancing corporate governance and in highlighting key risks related to environmental and social issues. Some of the major shifts in governance practices during the past two decades—including the annual elections of directors, the adoption of majority vote standard for director elections, and the adoption of proxy access among large firms—were largely prompted by shareholder resolution campaigns. Shareholder proposals have also served as a driving force for greater corporate awareness of environmental and social risks, such as climate change risk management, diversity and inclusion in the workplace, and sustainability reporting.

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Peer Group Choice and Chief Executive Officer Compensation

David F. Larcker is James Irvin Miller Professor of Accounting at Stanford Graduate School of Business; Charles McClure is Assistant Professor at the University of Chicago Booth School of Business; and Christina Zhu is Assistant Professor at the Wharton School at the University of Pennsylvania. Related research from the Program on Corporate Governance includes The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers and Urs Peyer (discussed on the Forum here).

Our new study examines the board of director choice of peer firms used in setting CEO compensation. One controversial question is whether selecting relatively large, highly paid peer firms is appropriate. The common rationale is that many firms want to attract and hire highly talented executives from larger firms with higher levels of CEO pay. However, governance activists and proxy advisors believe some firms select peers that are larger and/or have higher compensation levels simply to justify a high level of CEO pay.

We provide a different interpretation of peer group choice than prior research on this topic. Previous studies tend to conclude that peer group choice is a result of aspirational labor market incentives and that corporate governance considerations are of minor importance. However, prior research tends to focus on large firms that confront considerable scrutiny regarding their corporate governance. In such a sample, it will be difficult to observe whether governance considerations affect observable board of director decisions such as CEO compensation. Using a comprehensive sample with many small and medium-sized firms that are less subject to public scrutiny, we find that both aspirational and rent extraction motivations influence the selection of peer groups for setting CEO compensation.

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Proposed “Test-the-Waters” Communications Rules

Steve Quinlivan is partner and Bryan Pitko is of counsel at Stinson Leonard Street LLP. This post is based on their Stinson Leonard Street memorandum.

The SEC has proposed new rules that would permit all issuers to solicit investor views about potential offerings to be taken into account at an earlier stage in the process than is the case today. The new rule and related amendments would expand the “test-the-waters” accommodation—currently available to emerging growth companies or “EGCs”—to all issuers, including investment company issuers. The ability for EGCs to engage in test-the-waters-communications was provided for under the JOBS Act.

The proposed rule eases regulatory burdens because Section 5(c) of the Securities Act prohibits any written or oral offers prior to the filing of a formal registration statement with the SEC. Once an issuer has filed a registration statement, Section 5(b)(1) limits written offers to a formal prospectus that conforms to the requirements of the Securities Act. As such, without the proposed rule change, most communications by issuers seeking to gauge investor interest would violate the Securities Act and constitute what is popularly referred to as “gun jumping.” According to the SEC, the ability of EGCs to engage in test-the-waters communications under the JOBS Act has not impaired investor protection.

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Change the Conversation—Redefining How Companies Engage Investors on Sustainability

Kristen Lang is a senior director at Ceres. This post is based on her Ceres 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).

When Ceres released The Ceres Roadmap for Sustainability—our vision for corporate sustainability leadership in the 21st century—in 2010, sustainable business leaders were easily identified and few in number. Now it is commonplace to find a “sustainability” or “corporate responsibility” section included on company websites. Increased public awareness, regulation and investor interest has made acknowledging environmental and social impacts, and claiming a commitment to be “sustainable,” a mainstream practice for doing business today.

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Reconsidering Stockholder Primacy in an Era of Corporate Purpose

David Berger is a partner at Wilson Sonsini Goodrich & Rosati. This post is based on a recent article by Mr. Berger, forthcoming in the Business Lawyer.

There is now a growing consensus that corporations must focus on corporate purposes beyond stockholder value. As Blackrock’s Larry Fink recognized in his 2018 letter to CEOs (and largely reiterated in his 2019 letter), “society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers and the communities in which they operate. Without a sense of purpose, no company, either public or private, can achieve its full potential.” [1] Similar views have been expressed by, among others, State Street, Vanguard and other institutional owners. [2]

Yet the continuing dominance of stockholder primacy ideology constrains the debate on corporate purpose by limiting the participants to stockholders, corporate leaders, corporate lawyers and scholars. Left out of this debate are the many who are significantly impacted by corporate behavior, including the communities where corporations are based, employees who rely on the corporation for the bulk of their income and wealth, consumers who use the corporation’s products, and broader governmental interests who expect the corporation to follow the rules of law established by society and which lack the resources to continually monitor the corporation to ensure that the established rules are being followed. In short, the constituents identified by Larry Fink and others as being at the core of the corporate purpose debate are the same groups excluded from participating in the debate over corporate purpose.

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Oral History Documentary Videos on Landmark Developments in Delaware Corporate Law

Michael Wachter is the William B. and Mary Barb Johnson Professor of Law and Economics and Co-Director of the Institute for Law and Economics, at the University of Pennsylvania Law School; Lawrence A. Hamermesh is Executive Director, Institute for Law and Economics at the University of Pennsylvania Law School; and Nadia Jannetta is Managing Director at the Institute for Law and Economics at the University of Pennsylvania Law School. This post is part of the Delaware law series; links to other posts in the series are available here.

The Institute for Law and Economics (ILE) at the University of Pennsylvania Law School has released two new oral history documentary videos that offer unprecedented insight into some of the most pivotal developments in corporate law. One of the new videos tells the story of the famous Walt Disney shareholder derivative litigation challenging Michael Ovitz’s massive severance compensation. The other video details the gestation and birth of Section 102(b)(7) of the Delaware General Corporation Law, permitting corporations to eliminate monetary liability of directors for certain breaches of fiduciary duties.

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