Monthly Archives: July 2019

Increased Shareholder Activism at Banking Organizations?

Steve WoloskyAndrew Freedman, and Ron Berenblat are partners at Olshan Frome Wolosky LLP. This post is based on their Olshan memorandum. 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).

On April 23, 2019, the Federal Reserve Board (the “FRB”) invited public comment on a proposal to revise the FRB’s rules for determining whether an entity controls a bank or bank holding company (“banking organization”) for purposes of the Bank Holding Company Act of 1956, as amended (the “Act”). The proposal is intended to clarify, in particular, how the FRB decides whether an entity exercises a “controlling influence” over a banking organization. If an entity has a controlling influence and, thus, control over a banking organization, the entity generally becomes subject to regulation as a bank holding company under the Act. The FRB’s current framework for making control determinations is complex and, as the FRB acknowledges in its opening statements on the proposal, “difficult for the public to understand and apply with confidence.”

As a result of the current uncertainty surrounding whether an investment in and/or engagement with a banking organization would constitute control under the FRB’s current framework and the consequences of becoming subject to the burdens imposed by bank holding company regulation, our shareholder activist clients have generally shied away from campaigns at banking organizations. The prospect of being regulated as a bank holding company and subject to FRB examination and supervision just for seeking to catalyze positive change at a bank could be unnerving to an activist to say the least.


EVA as a Performance Measure in Executive Incentive Plans

Joseph Bachelder is special counsel at McCarter & English LLP. This post is based on an article by Mr. Bachelder published in the New York Law Journal. Howard Berkower, a partner with the firm, and Andy Tsang, a senior financial analyst with the firm, assisted in the preparation of this post. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Economic Value Added (EVA) is a measure of a business enterprise’s economic performance based on what is added to that enterprise’s value by its operating earnings (net of tax) reduced by the enterprise’s “capital costs.” The concept of EVA was introduced in the 1980s by the management consulting firm of Stern Stewart & Co. That firm obtained a trademark for the term EVA and subsequently transferred it to Stern Value Management, Ltd. This post discusses recent developments in EVA, how the EVA formula works and the use of EVA as a performance metric in executive incentive compensation plans.

Recent Developments in EVA

On February 12, 2018 Institutional Shareholder Services (ISS), the largest proxy advisory firm in the U.S., acquired EVA Dimensions, an EVA-based research firm founded by G. Bennett Stewart III, one of the co-founders of Stern Stewart & Co. Mr. Stewart currently serves as Senior Advisor to ISS. On March 18, 2019 ISS issued a report, entitled “Using EVA in Pay-for-Performance Analysis.” In that report ISS recommends the use of EVA as a tool to assess the alignment of pay and performance and indicates that during the 2019 proxy season it will be including in its proxy reports to investors a set of metrics based on EVA. (ISS distributes to its subscribers proxy reports providing its voting recommendations in connection with shareholder meetings of public corporations, including recommendations on shareholder votes regarding executive compensation.) In the report, ISS indicates that, at least during 2019, EVA-based metrics will not impact on its proxy voting recommendations and that it also is not taking a position as to whether it favors or disfavors the use of EVA as a metric in executive incentive plans.


Shareholders and Stakeholders Around the World: The Role of Values, Culture, and Law in Directors’ Decisions

Amir Licht is Professor of Law at the Interdisciplinary Center Herzliya and Renée B. Adams is Professor of Finance at the University of Oxford’s Saïd Business School. This post is based on their recent paper.

Controversies over the right way to handle shareholder and stakeholder relations have never been deeper despite decades of debate. In recent work, Nobel laureate Oliver Hart discusses whether, and should, “the board of directors of a public company [has] a legal duty to maximize shareholder value?” In mid-2016, The Wall Street Journal ran a story on a growing trend among leading U.S. chief executive officers (CEOs) to flex their corporate muscles for social causes such as gay and transgender rights. Only a year earlier, however, the Chief Justice of the Delaware Supreme Court, Leo Strine, Jr., sternly warned against “the dangers of denial”:

Despite attempts to muddy the doctrinal waters, a clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare.

With four out of the six major companies mentioned in the Journal being Delaware corporations, one may wonder what their top managers were thinking when they decided to take such bold moves, arguably in breach of applicable law. In this study, we set out to examine the hotly-debated issue of the relative importance of formal (legal) versus informal (cultural) institutions and of personal values for strategy formation and corporate governance. We hypothesize and show that values and culture play an important role in corporate leader’s decision-making and that the law does not trump them.


Weekly Roundup: July 5–11

More from:

This roundup contains a collection of the posts published on the Forum during the week of July 5–11.

2019 Midyear M&A Trends

Director Independence and Oversight Obligation in Marchand v. Barnhill

The State of Play on Clawbacks and Forfeitures Based on Misconduct

Caremark Liability for Regulatory Compliance Oversight

Emerging Technologies, Risk, and the Auditor’s Focus

Fiduciary Violations in Sale of Company

The Job Rating Game: Revolving Doors and Analyst Incentives

Statement on Retirement of Chief Justice Strine

Regulating Libra

Bad Faith Monitoring on Food Safety Issues

Mens Rea for Investment Advisers Act Violations

Mens Rea for Investment Advisers Act Violations

John J. Sikora, Jr. is partner and Jack M. McNeily is an associate at Latham & Watkins LLP. This post is based on their Latham memorandum.

On April 30, 2019, the United States Court of Appeals for the District of Columbia Circuit issued its decision in The Robare Group, Ltd., et al. v. Securities and Exchange Commission. The court’s ruling upheld the Securities and Exchange Commission’s (the Commission’s or the SEC’s) holding that the defendants violated Section 206(2) of the Investment Advisers Act (the Act) by negligently failing to disclose their conflict of interest arising from an incentive arrangement in place with Fidelity Investments Inc. (Fidelity) and reversed the Commission’s holding that the defendants violated Section 207 of the Act by willfully filing Form ADV, which did not mention the conflict of interest.

The ruling is instructive to registrants in two key respects. First, it essentially converts Section 207 into a scienter-based violation. Second, it reinforces the ease with which the SEC can establish negligence under Section 206(2) for conduct that plainly falls short of compliance with an adviser’s fiduciary duty to clients.


Opt-In Stewardship: Toward an Optimal Delegation of Mutual Fund Voting Authority

Sean J. Griffith is T.J. Maloney Chair and Professor of Law at Fordham Law School. This post is based on his recent article, forthcoming in the Texas Law Review. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here); and The Future of Corporate Governance Part I: The Problem of Twelve by John Coates, IV.

Corporate ownership in the U.S. has been re-institutionalized. Individual investors are now much less likely than they once were to hold shares of corporations directly. Instead, individuals now typically invest through mutual funds, especially index funds. As a result, mutual funds now own about one-third of the total U.S. stock market, and the “Big Three” fund families—Blackrock, Vanguard, and State Street—are the largest blockholders in the vast majority of large publicly traded companies. The big mutual funds have thus become a central locus of power in American corporate governance.

Mutual fund voting presents both problems and solutions. On the one hand, mutual fund voting is problematic because it contradicts a basic axiom of good corporate governance: the union of voting rights with economic returns. Mutual funds separate economic returns (which go to the investors) from voting rights (which go to the fund), thus introducing the potential for a divergence of interests. This realization has raised concerns about how mutual funds will use their massive economic and political power, leading to congressional hearings and regulatory reform initiatives.


Bad Faith Monitoring on Food Safety Issues

Brian Frawley, Joseph Frumkin, and Krishna Veeraraghavan are partners at Sullivan & Cromwell LLP. This post is based on their Sullivan & Cromwell 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).

In a decision issued [June 19, 2019] in Marchand v. Barnhill et al., No. 533, 2018 (Del. June 19, 2019), the Delaware Supreme Court reversed the dismissal of a stockholder derivative lawsuit against the members of the board of directors and two officers of Blue Bell Creameries USA, Inc., a leading manufacturer of ice cream products. The lawsuit arose out of a serious food contamination incident in 2015 that resulted in widespread product recalls and was linked to three deaths. The Delaware Supreme Court, applying the “duty to monitor” doctrine enunciated in In re Caremark International, Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), and noting the very high hurdle to claims under it, nonetheless ruled that the plaintiff had adequately alleged the requisite bad faith by the members of the Blue Bell board. Plaintiff did so by using information obtained in a Section 220 books and records demand to show facts supporting their contention that the Company did not have in place “a reasonable board-level system of monitoring and reporting” with respect to food safety, which the Court deemed to be “a compliance issue intrinsically critical to the company’s business.” After concluding that “food safety was essential and mission critical” to Blue Bell’s business, the Supreme Court ruled that bad faith was adequately pled by alleging “that no board-level system of monitoring or reporting on food safety existed.” The Court thus declined to dismiss a claim that the directors breached their duty of loyalty, potentially exposing directors to non-exculpated (and potentially not indemnifiable) monetary damages.


Regulating Libra

Ross Buckley is the KPMG Law-KWM Professor of Disruptive Innovation at the University of New South Wales Sydney; Dirk A. Zetzsche is Professor and ADA Chair in Financial Law at the University of Luxembourg and Director of the Center for Business & Corporate Law at Heinrich Heine University in Duesseldorf; and Douglas Arner is Kerry Holdings Professor in Law at the University of Hong Kong. This post is based on their recent paper.

On June 18, Facebook announced its proposal to launch a new cryptocurrency next year, named the Libra. In a new paper we analyse how Libra will work, discuss the governance of the organization behind it (the Libra Association), explore its transformative potential, and consider its likely regulatory implications.

Libra will serve as e-money. Its value will be tied to a basket of major government-issued currencies and for each Libra issued an equal value of such currency, or highly liquid government bonds, will be placed on deposit with a reliable repository. Libra will be a stablecoin—a cryptocurrency the value of which is tied to that of fiat currency. Libra is not the first stablecoin, but it will be the first stablecoin with such breathtaking global reach and utility as Facebook has over 2.3 billion active monthly users.

Libra’s usefulness may initially be limited in highly developed countries with good payment systems, but it will be potentially transformative for many of the 1.7 billion people who today lack access to the most basic financial services. Libra is mobile money in the Kenyan M-Pesa sense, but on a global scale: AliPay and WeChatPay for all.


Statement on Retirement of Chief Justice Strine

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent 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. Leo Strine, Chief Justice of the Delaware Supreme Court, is a Senior Fellow of the Harvard Law School Program on Corporate Governance. Posts about his recent studies issued by the Program are available here, here, and here.

Yesterday, Chief Justice Leo Strine announced his retirement after more than twenty years on the Delaware Court of Chancery and Supreme Court of Delaware, two of the most important courts for our markets and our investors.

Chief Justice Strine deserves our thanks for bringing his unparalleled combination of energy, intellect, experience, legal knowledge and pragmatism to the bench. His contributions have extended well beyond the courtroom and the Commission has benefited substantially from his willingness to engage with us on a range of topics important to our investors and our markets. Finally, and critical to the work of the SEC, it is clear to me that the interests of our Main Street investors have always been at the front of Chief Justice Strine’s mind.

Thank you for your service Chief Justice Strine.

Protecting Main Street Investors: Regulation Best Interest and the Investment Adviser Fiduciary Duty

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent speech in Boston, Massachusetts, 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 evening and thank you for being here. [1]

As many of you know, in June, the Securities and Exchange Commission adopted a package of rules and interpretations that will enhance the quality and transparency of retail investors’ relationships with broker-dealers and investment advisers. Importantly, they bring the legal requirements and mandated disclosures for broker-dealers and investment advisers in line with reasonable investor expectations. These actions do not attempt to favor one type of service or relationship. Rather, they are designed to increase investor protection while preserving access for Main Street investors—both in terms of choice and cost—to a variety of investment services and products.

Our rules and interpretations benefit from and build upon the Commission’s extended history of broker-dealer and investment adviser regulation, the substantial experience and expertise of our staff, our analysis over many years of prior efforts to modernize and improve regulation in this area, and the many thoughtful comments and other feedback we received on our proposals. [2] Without question, these actions, individually and collectively, will significantly benefit Main Street investors.


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