Monthly Archives: June 2019

OMB’s Guidance Memorandum to Independent Agencies

Hal S. Scott is the Emeritus Nomura Professor of International Financial Systems at Harvard Law School.

This short article is intended to stimulate discussion of the Office of Management and Budget’s (the “OMB”) April 11, 2019 Memorandum (the “OMB Memo”) regarding the obligations of independent agencies. The OMB Memo was issued to all federal agencies, including independent agencies, to establish a centralized review of agency rules by OMB’s Office of Information and Regulatory Affairs (“OIRA”). The need for such review was based on OIRA’s responsibility under the Congressional Review Act (the “CRA”) to determine whether regulatory rules are “major.”

The OMB Memo raises important legal and policy questions. It could be read to require, for the first time, that independent financial regulatory agencies (“IFRAs”) conduct a cost-benefit analysis under OIRA methodology of all proposed rules, and that such analysis be reviewed by OIRA. Additionally, if OIRA were to reject the adequacy of such cost-benefit analysis, OIRA might be able to prevent the rule from going into effect. Whether such OIRA powers can be justified under the CRA is an important legal question. The OMB Memo raises further legal questions as to whether it is consistent with outstanding Presidential executive orders and is by its own terms binding on the IFRAs rather than being merely precatory. In the big picture, the question is whether the OMB Memo is consistent with the purpose of the CRA, which is to permit congressional (not executive) veto of proposed regulations, and whether it excessively infringes on the independence of the IFRAs.


Do Investors Care About Carbon Risk?

Patrick Bolton is Barbara and David Zalaznick Professor of Business at Columbia Business School, and Marcin T. Kacperczyk is Professor of Finance at Imperial College London. 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), and Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

Almost no day passes without a major news story related to climate change. This week alone Thomson Reuters reported a study that found that the Canadian permafrost is thawing 70 years earlier than forecast. Another Thomson Reuters story the same week announced that Norway’s sovereign wealth fund was to divest its $1 billion stake in Glencore as a result of tighter legislation on responsible investment adopted by Norway’s parliament. And, yet another story in Pensions & Investment magazine reported on a meeting at the Vatican of top executives of energy companies promising to provide investors better information on how they are tackling climate change.

At the same time, considerable skepticism on the importance of climate change, or more generally, environmental, social, and governance (ESG) factors for investors remains. As Eccles and Klimenko (2019) point out in their recent Harvard Business Review article, The Investor Revolution: “The impression among business leaders is that ESG just hasn’t gone mainstream in the investment community.” This raises the question whether carbon risk is currently reflected in asset prices. Our paper is a first exploration into this question. We undertake a standard cross-sectional analysis, asking whether a carbon risk factor or carbon-emission characteristics affect cross-sectional U.S. stock returns.


Climate Portfolio Analysis: A Multifaceted Approach to Risk

Viola Lutz is Vice President, Head of Investor Consulting and Guido Lorenzi is an associate at ISS ESG. This post is based on their ISS ESG memorandum.


Climate portfolio analytics allows investors to assess and monitor risk exposure related to several climate-related issues, including emissions exposure, and physical and transitional risk. This article demonstrates the benefits of portfolio analysis related to climate change risk by providing a comparison of greenhouse gas emissions and climate risk exposure between the S&P 500 and the STOXX 600 indexes at the end of 2018. The absolute emission exposure of the S&P 500 is approximately 45 percent lower than the emission exposure of the STOXX 600, but STOXX 600 companies manage climate risks better than S&P 500 companies. A review of absolute emissions can help investors identify the largest greenhouse gas emitters in a portfolio today, but a more comprehensive forward-looking analysis is required to identify the climate leaders and laggards of tomorrow. Emissions estimations coming from the activity of the company and climate risk management are among the recommended disclosures included in the Guidelines on Reporting Climate-Related Information published by the European Commission on June 18th 2019.


Proxy Advisory Firms, Governance, Failure, and Regulation

Chester S. Spatt is the Pamela R. and Kenneth B. Dunn Professor of Finance at Carnegie Mellon University Tepper School of Business, Golub Distinguished Visiting Professor of Finance at MIT Sloan School of Management, and a senior fellow at the Milken Institute’s Center for Financial Markets. This post is based on his Milken Institute publication.

Proxy advisory firms have arisen due to market failures underlying voting and the broader system of corporate governance. However, proxy advisory firms, which are not subject to mandatory regulation, reflect market failures of their own. This analysis highlights the underlying frictions, such as the scale economies and public goods aspects to information production, the import of incentive conflicts faced by the advisory firms, the power of the proxy advisory firms, and the implications of the recommendations of the advisory firms and votes by different types of investors. Asset managers who emphasize stewardship are more supportive of management than are the proxy advisory firms. This paper also highlights the limitations of one-size-fits-all recommendations.

1. Introduction

The role of public company shareholders in voting anchors our system of corporate governance. While a public company’s day-to-day business decisions are the responsibility of management and the board of directors, shareholders vote on a number of important issues that can affect the value of their shares. Annual shareholder meetings typically include votes for or against candidates for director positions, questions related to executive compensation plans, and proposals put forth by other shareholders. Special shareholder meetings involve votes on important corporate structure matters, such as a takeover offer, that are especially time sensitive. A small number of shareholders cast their votes at the meetings in person, while the vast majority cast their votes “by proxy” (online, by mail, or by phone).


Celebrity Stock Market

Victoria Schwartz is Associate Professor at Pepperdine University School of Law. This post is based on her article, recently published in the UC Davis Law Review.

We typically think of stock markets as a mechanism for connecting investors who buy and sell shares of ownership in public companies. This helps distribute the successes and share the risks of these companies across a wider range of individuals. Talented individuals with business ideas often get venture capital or other forms of investor financing for their startups, and ultimately often take their companies public. But what happens if an individual’s talent lies in a different direction such as music, or acting, or sports? Eventually these talented individuals may go on to become celebrities with extremely lucrative careers, but how do they pay the bills in the meantime? In The Celebrity Stock Market [52 UC Davis Law Review 2033 (2019)], I offer a possible solution to this problem.

The article explores the possibility of a celebrity stock market, in which investors can invest in the future of promising artists, athletes, entertainers, and other celebrities in exchange for shares in the aspiring celebrity’s future. By design, just like traditional stock markets, such celebrity stock markets would share risk between the aspiring celebrity and the investors by contractually providing the aspiring celebrity an up-front monetary payment in exchange for a share of future earnings for a contractually specified length of time. The contractually obtained interest in future earnings can then be distributed in the form of a stock-like mechanism that can be traded and whose value is linked to the earning potential and the associated personal “brand” of the aspiring celebrity.


The Standard of Review for Challenged Director Compensation

Amy Simmerman and John Aguirre are partners at Wilson Sonsini Goodrich & Rosati. This post is based on a Wilson Sonsini memorandum by Ms. Simmerman, Mr. Aguirre, Boris Feldman, Brad Sorrels, Ryan Greecher, and Lori Will. This post is part of the Delaware law series; links to other posts in the series are available here.

On May 31, 2019, Vice Chancellor Sam Glasscock of the Delaware Court of Chancery issued a decision refusing to dismiss a stockholder’s fiduciary duty claims challenging the compensation of Goldman Sachs’ board of directors. [1] The case highlights the type of claim potentially available to stockholders in challenging board (and sometimes executive) compensation, and it provides important guidance for boards when considering the possibility of such a challenge. The decision also reflects the relative uptick we have seen in demands and challenges from stockholders and plaintiffs’ attorneys relating to board compensation.


The Goldman Sachs decision builds on the Delaware Supreme Court’s 2017 ruling in Investors Bancorp, which concluded that director compensation involves an inherently conflicted decision on the part of a board and that, as a result, in a stockholder challenge to board compensation, a court may apply the entire fairness standard of judicial review, rather than the more deferential business judgment rule, absent adequate stockholder approval of the compensation at issue. [2] Under the entire fairness standard of review, the court examines the fairness of the compensation itself as well as the company’s processes relating to setting the compensation. Because the standard is fact-intensive and searching, it can result in protracted litigation that survives the pleadings stage. Importantly, Investors Bancorp further held that a stockholder vote approving director compensation can effectively preclude an entire fairness claim, but that the stockholder vote must approve specific amounts of compensation or self-effectuating formulas to be effective. This aspect of the ruling appeared to reverse several decisions from the Delaware Court of Chancery concluding that stockholder approval of director compensation within “meaningful limits” could eliminate entire fairness claims. Finally, the Investors Bancorp decision also permitted the plaintiff to challenge executive compensation paid to management members of the board where the board’s deliberations and approvals relating to that compensation appeared sufficiently intertwined with its decisions about director compensation.


Scarlet Letters: Remarks before the American Enterprise Institute

Hester M. Peirce is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on her recent remarks before the American Enterprise Institute, 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, Ben [Zycher]. I will begin with the standard disclaimer. My remarks represent my views and not necessarily those of the Commission or my fellow Commissioners.

I will next address a question that is undoubtedly in the mind of at least one person in the audience. Did her parents really do that to her? Is she named after Hester Prynne, the main character in Nathaniel Hawthorne’s Scarlet Letter? The answer is no; Hester is a family name, not a literary one. That said, I actually do not much mind the name or the question now that high school English class is a distant memory. Hester Prynne was a strong woman who accepted the consequences of her weak moment with quiet dignity.

Having a baby as the result of an extramarital affair in seventeenth-century New England and refusing to name her partner in crime brought hard-hearted, merciless condemnation from the legal and religious authorities and the society at large. The community’s morality police did not bother themselves with much of an inquiry into the facts and circumstances and certainly did not consider whether a measure of mercy might be appropriate. These self-righteous authorities instead crafted a punishment designed to underscore the vast divide between their moral purity and Hester Prynne’s obvious moral depravity. They ordered Hester to wear a scarlet letter “A” for “adultery.” That letter, elaborately embroidered by Hester’s own hand, served to facilitate social shunning, inspire incessant gossip, ensure that Hester never forgot her transgression, and inflict on its wearer deep pain and intense self-loathing. Her shame was emblazoned on her dress for all, including Hester’s young daughter, to see.


Upstream Liability, Entities as Boards, and the Theory of the Firm

Andrew Verstein is Professor of Law at Wake Forest University School of Law. This post is based on his recent article, forthcoming in The Business Lawyer.

Directors have fiduciary duties, and the most litigated and most demanding of those duties is the duty of loyalty. The key questions for duty of loyalty litigation are director-by-director questions: Did this particular director have a conflict? Is it futile to make a demand on that particular director?

What does it mean to ask director-by-director questions if corporations have just one director, which is itself an entity? Shall we inquire about particular humans in the managing entity or limit our analysis to the entity itself? The question becomes richer and more important if the board-entities opt to bundle services: We know how to evaluate a conflict when a director urges the company to patronize her own accounting or banking firm. How should we evaluate the conflict if a managing entity opts to use its own accounting or banking department? Our conflict analysis is usually of contractual transactions but the essence of the Coasian firm is the absence of a contract to analyze. In a recently published essay, I explore how the duty of loyalty might work when entities manage entities and uncover important lessons about how loyalty works.

The impetus for the article is Outsourcing the Board, a book in which Professors Steve Bainbridge and Todd Henderson advocate that a legal entity (a “board service provider” or BSP) should be permitted to serve as the sole director of a corporate board.


OECD Corporate Governance Factbook 2019

Mats Isaksson is Head of Corporate Governance and Corporate Finance Division and Daniel Blume and Kenta Fukami are Senior Policy Analysts at the Organization for Economic Co-operation and Development (OECD). This post is based on their OECD memorandum. Related research from the Program on Corporate Governance includes The “Antidirector Rights Index” Revisited by Holger Spamann and The Elusive Quest for Global Governance Standards by Lucian Bebchuk and Assaf Hamdani.

The 2019 edition of the OECD Corporate Governance Factbook (the “Factbook”) contains comparative data and information across 49 different jurisdictions including all G20, OECD and Financial Stability Board members. The information is presented and commented in 40 tables and 51 figures covering a broad range of institutional, legal and regulatory provisions. The Factbook provides an important and unique tool for monitoring the implementation of the G20/OECD Principles of Corporate Governance. Issued every two years, it is actively used by governments, regulators and others for information about implementation practices and developments that may influence their effectiveness. It is divided into five chapters addressing: 1) the corporate and market landscape; 2) the corporate governance framework; 3) the rights of shareholders and key ownership functions; 4) the corporate boards of directors; and 5) mechanisms for flexibility and proportionality in corporate governance.

The corporate and market landscape

Effective design and implementation of corporate governance rules requires a good empirical understanding of the ownership and business landscape to which they will be applied. The first chapter of the Factbook therefore provides an overview of ownership patterns around the world, with respect to both the categories of owners and the degree of concentration of ownership in individual listed companies. Since the G20/OECD Principles also include recommendations with respect to the functioning of stock markets, it also highlights some key structural changes with respect to stock exchanges.


The Timing of Schedule 13D

Samir Doshi is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on his paper, available here. Related research from the Program on Corporate Governance includes The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here) and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon P. Brav, Robert J. Jackson Jr., Wei Jiang.

In the field of corporate law, timing is everything. Perhaps in no area is this more the case than in disclosure—specifically, the disclosure obligations of the Securities and Exchange Act of 1934. Implemented by a phalanx of SEC rules, the Act carefully prescribes how and when an investor must make public its equity position in a company. As every introductory corporate lawyer quickly comes to know, Section 13(d) of the Act requires that any person who acquires beneficial ownership of five percent or more of an issuer’s stock file a public statement announcing such ownership “within ten days.” This congressional attempt to “ensure that shareholders [are] promptly alerted to possible change[s] in company management and corporate control” often stands at the forefront shareholder activism battles.

Despite the provision’s undeniable significance, its meaning remains uncertain. Judges and commentators cannot agree whether the statute mandates filing within ten business days or ten calendar days. While a seemingly trivial distinction, by last count the timeliness of almost fifty percent of Schedule 13D filings hinged on just this issue. And yet, there is no settled answer to a simple question: when must a Schedule 13D be filed?


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