Monthly Archives: May 2019

Statement on Proposed Amendments to Sarbanes Oxley 404(b) Accelerated Filer Definition

Robert J. Jackson, Jr. is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on his recent public statement. The views expressed in the post are those of Commissioner Jackson and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Thank you, Mr. Chairman, and thank you to the Staff in the Division of Corporation Finance, including John Fieldsend, Elizabeth Murphy, Felicia Kung, Lindsay McCord, and Director Bill Hinman, for their work in developing today’s release. I also appreciate the efforts of my colleagues in the Division of Economic and Risk Analysis, especially Director SP Kothari, Chyhe Becker, and Tara Bhandari.

Today [May 9, 2019] my colleagues propose to roll back the requirement that auditors attest to the adequacy of certain companies’ internal controls. The proposal’s analysis of the costs of attestation is based on data that’s over a decade old, and the proposal makes no real attempt to assess the investor-protection benefits of gatekeepers in our markets. Having conducted my own analysis using data from today’s marketplace, it’s clear that this proposal has no apparent basis in evidence. Accordingly, I respectfully dissent.

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In the wake of the Enron and WorldCom accounting debacles that cost American families more than $85 billion, Congress passed the Sarbanes-Oxley Act, requiring companies, executives, and auditors to comply with new rules to restore public trust in our markets. SOX changed corporate oversight across America, making directors and auditors a more independent, meaningful check on executives.


Weekly Roundup: May 3–9, 2019

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This roundup contains a collection of the posts published on the Forum during the week of May 3–9, 2019.

When Dual-Class Stock Met Corporate Spin-Offs

Aiming Toward the Future

Operating Principles for Impact Management

Delaware M&A Appraisal After DFCDell and Aruba

Stress Testing the Banking Agencies

Entry Competition in Takeover Auctions

Critical Audit Matters—What to Expect

The Effect of Minority Veto Rights on Controller Tunneling

Putting Companies in the Driver’s Seat to Enhance ESG Reporting

Cyber Lessons and #MeToo Risk

Statement at Open Meeting on Proposed Amendments to Sarbanes Oxley 404(b) Accelerated Filer Definition

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.

Good morning. This is an open meeting of the U.S. Securities and Exchange Commission, under the Government in the Sunshine Act. Our only item on the agenda today is a recommendation from the Division of Corporation Finance to propose amendments to the definitions of “accelerated filer” and “large accelerated filer.”

Once again, the measured, thoughtful work of the Division of Corporation Finance shines through.

The matter before us today can be fairly characterized as a retrospective review of one component of the Sarbanes-Oxley Act of 2002. In this regard, I’ll take a step back and note that there are many components of Sarbanes-Oxley. And, with the benefit of hindsight, it is clear many of the legislation’s key elements, like the independent audit committee and enhanced auditor independence requirements, have made our markets what they are today—a place where Main Street investors have a high degree of confidence in the quality of the financial statements and other financial disclosures they receive from our public companies.


Aruba and the Flawed Corporate Finance of Dell and DFC Global

Charles Korsmo is Professor of Law at Case Western Reserve University School of Law and Minor Myers is Professor of Law at Brooklyn Law School. This post is based on a recent article by Professors Korsmo and Myers, forthcoming in the Emory Law Journal, 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 Using the Deal Price for Determining “Fair Value” in Appraisal Proceedings (discussed on the Forum here) and Appraisal After Dell, both by Guhan Subramanian.

The Delaware Supreme Court’s recent opinion in Verition Partners v. Aruba Networks marks the Court’s first tentative steps to make sense of DFC Global and Dell, the Court’s major rulings on the appraisal remedy from 2017. The two opinions, strewn with conflicting asides and observations, were equal parts momentous and muddled. Their problems run deeper, however, than simply the widespread confusion over their precise meaning. As we explain in a recent article, The Flawed Corporate Finance of Dell and DFC Global, the Court made a number of serious missteps in applying basic principles of modern finance. These mistakes colored all of the legal conclusions that the Delaware Supreme Court drew in reliance upon them and threaten to have deleterious and wide-ranging effects on Delaware law. The Court’s efforts in Aruba mark only the beginning of a long-term clean-up effort.

The appraisal right is a statutory remedy that, in Delaware, entitles a stockholder to dissent from a merger transaction and instead receive the “fair value” of its shares, as determined in a proceeding before the Delaware Court of Chancery. In prior work, we documented the dramatic increase in the number and size of appraisal petitions earlier in this decade, primarily driven by sophisticated specialists who acquire positions in the target company following the announcement of a merger with the intent to demand appraisal. These so-called appraisal arbitrageurs are largely responsible for the transformation of the stockholder appraisal from a little-used curiosity to a potent option for dissenting stockholders and a topic of heated debate.


Cyber Lessons and #MeToo Risk

Laurie Hays is managing director and Jamie Singer is senior vice president at Edelman. This post is based on an Edelman memorandum by Ms. Hays, Ms. Singer, Harlan Loeb, and Lex Suvanto.

Five years ago, when the reality of the cyber security threat began reaching the boardroom and audit and risk committees, only 15 percent of directors felt “very confident” their board oversaw cyber risk adequately.

Today, cyber security preparedness and investments are front and center for directors. Increasingly, they are overseeing cyber security as a function of the audit committee with a top-level review headed by security experts. Seventy-two percent of board members in a recent survey by advisory firm BDO said their board is more involved with cyber security than a year ago.

Almost two years into the #MeToo movement, human capital risk is heading in the same direction, posing equally complicated high-stakes challenges for boards to assess the warning signs of misconduct by top management and take action to reduce risks. Culture and conduct, especially as it relates to senior management, is of increasing concern to investors, according to the 2019 Edelman Trust Barometer’s Institutional Investor Special Report.


Testimony Before the Financial Services and General Government Subcommittee of the U.S. Senate Committee on Appropriations

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent testimony before the Financial Services and General Government Subcommittee of the U.S. Senate Committee on Appropriations, 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.

Chairman Kennedy, Ranking Member Coons and Senators of the Subcommittee, thank you for the opportunity to testify today on the President’s fiscal year (FY) 2020 budget request for the U.S. Securities and Exchange Commission (SEC). [1]

It is an honor to appear before this Subcommittee again with my colleague, U.S. Commodity Futures Trading Commission (CFTC) Chairman Christopher Giancarlo. This is the fourth time we have testified together before Congress, and since he is planning on leaving the agency soon, I want to express my deep appreciation for his work on behalf of our markets, our investors and, importantly, our country. Over the past year, we and the staff of our respective agencies have collaborated on a number of issues to strengthen our markets, including developing and improving regulations for our swaps and security-based swap markets, preparing for the effects of Brexit and addressing issues raised by cryptocurrencies, initial coin offerings (ICOs) and similar products and technologies. In these and other matters on which we have worked together, Chairman Giancarlo has always had the interests of our country front of mind.


Putting Companies in the Driver’s Seat to Enhance ESG Reporting

Rakhi Kumar is Senior Managing Director and Head of ESG Investments and Asset Stewardship at State Street Global Advisors. This post is based on a publication prepared by State Street Global Advisors. 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) and Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

ESG. It’s one of the fastest growing areas of investment today. Representing 1-in-4 of every dollar that is professionally managed, sustainable investing is being integrated into portfolios at 17% each year. [1] And yet, for all the investor interest and excitement around ESG, companies struggle to understand what information to report, how to report it, and the relevance of ESG information to investors.

For State Street Global Advisors, we believe financially material ESG factors can impact a company’s long-term performance. Our goal is not just to build ESG portfolios but also to encourage companies to focus on issues that matter while providing them with the transparency to meet those expectations. This is the only way to create sustainable markets and long-term value for investors.

To drive progress in this area, we have been engaging with hundreds of companies to understand how they disclose and incorporate ESG into their long-term strategy. And now, we’ve built a tool we believe will incentivize companies to make a big leap forward.

Here’s how it works.

The Effect of Minority Veto Rights on Controller Tunneling

Jesse Fried is the Dane Professor of Law at Harvard Law School; Ehud Kamar is Professor of Law at Tel Aviv University Buchmann Faculty of Law; and Yishay Yafeh is Professor at the Hebrew University of Jerusalem School of Business Administration. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Executive Compensation in Controlled Companies by Kobi Kastiel (discussed on the Forum here) and Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

Most public firms around the world have a controlling shareholder (“controller”). In these firms, a key governance objective is to protect minority shareholders from controller tunneling.

Standard tools—independent director approval for related-party transactions and the duty of loyalty—are often insufficient. Independent directors typically serve at the pleasure of the controller, undermining their objectivity (Bebchuk and Hamdani, 2017). And hurdles to litigation and controller-friendly substantive law tend to erode the effectiveness of the duty of loyalty (Enriques et al., 2017).

A potentially more powerful tool is mandating minority approval for related-party transactions (Goshen 2003; Djankov et al. 2008). This approach, now favored by the OECD, has become the law in Israel, Canada, Australia, Hong Kong, India, Indonesia, Mexico, and Russia. Delaware follows a softer approach: while not requiring minority approval, it applies more deferential judicial review to a related-party transaction in which the controller voluntarily gives veto rights to the minority. However, there is scant empirical evidence on whether any form of minority approval works.


Critical Audit Matters—What to Expect

Jennifer Burns is Audit & Assurance Partner at Deloitte & Touche LLP. This post is based on a Deloitte memorandum by Ms. Burns, Deborah DeHaas, Debbie McCormack, Maureen Bujno, Krista Parsons, and Bob Lamm.

The January 2019 edition of On the board’s agenda—The 2019 boardroom agenda: Something old, something new? suggested that the coming change in audit reports related to “critical audit matters” or “CAMs” would be one of the top issues of board and audit committee focus this year. Audit reports for large accelerated filers will include a new section addressing CAMs beginning for audits of fiscal years ending on or after June 30, 2019, and for other public companies in 2020. This will be a dramatic change in auditor reporting and is expected to generate significant media attention, particularly in the first year of adoption. What is the board’s role with respect to CAMs? How are CAMs identified? What is being done to prepare for CAMs and what might boards expect? This post discusses these questions and highlights considerations for boards in advance of the first auditor reporting of CAMs this summer.

What is the role of the board with respect to CAMs?

While oversight of financial reporting is delegated to the audit committee, boards should remain engaged and understand which areas may be identified as CAMs; this can be achieved through regular communications with the audit committee, auditor, and management. Audit committees, in exercising their oversight role, should engage with the auditor throughout the audit—during planning, interim periods, and at year-end—to understand the CAMs and any issues that may arise that may change the ultimate conclusion regarding CAMs. In addition, the board should understand how management and investor relations are preparing for implementation of CAMs.


Entry Competition in Takeover Auctions

Matthew Gentry is Lecturer in Economics at the London School of Economics & Political Science and Caleb Stroup is Assistant Professor at Davidson College. This post is based on their recent article, forthcoming in the Journal of Financial Economics. Related research from the Program on Corporate Governance includes The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

In our recent article titled, Entry and Competition in Takeover Auctions, just published in the Journal of Financial Economics, we investigate how the choice of sale mechanism affects fair value in corporate M&A transactions. In the past, negotiated sale prices were readily accepted as reliable evidence of a seller’s fair value (i.e., the highest reasonably-expected price). However, over time there has been increased scrutiny of sale processes by shareholders, Delaware Courts, and scholars in finance and economics, who have observed that deal premia might turn out to be higher if a company is sold via an auction-style process.

At the heart of this debate is lack of a clear understanding about whether fair value depends on the specific details of the sale process itself. For example, should target shareholders expect a higher sale price from an auction relative to a negotiated transaction? In the classic view, arms-length auction-style sale processes lead to higher prices, a view reflected by the injunction that directors act as “auctioneers” when selling their firm (Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986)). In this classic view, auctions are presumed to generate high prices via competition among a large pool of bidders for a selling company. This is because bidders face two types of pressure to raise their offer prices. The first is that target shareholders might walk away from the deal, the standard bargaining rationale present in negotiated transactions. The second is pressure from competing offers (i.e. from other bidders). In the classic view, auctions are expected to produce higher prices than negotiation-style transactions.


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