Monthly Archives: July 2019

Model Stewardship Code for Long-Term Behavior

Bhakti Mirchandani is Managing Director at FCLTGlobal. This post is based on a FCLTGlobal memorandum by Ms. Mirchandani, Steve Boxer, Evan Horowitz, and Victoria Tellez. Related research from the Program on Corporate Governance includes Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy (discussed on the forum here) by Lucian Bebchuk and Scott Hirst; and The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here).

A good stewardship code helps clarify the responsibilities of institutional investors, laying out core principles to foster a shared understanding among stakeholders including regulators, investors, and investees.

To ensure that stewardship codes put primary emphasis on long-term value creation, FCLTGlobal has worked with its members to identify seven principles of long-term ownership that could be incorporated into new or revised stewardship codes. These codes represent the highest common denominator of high-quality codes around the world, using principles that are equally applicable for asset owners and asset managers. Given FCLTGlobal’s mission of focusing capital on the long term, our interest is in the subset of stewardship that is concerned with fostering an ownership mindset to promote long-term value. Valuable work has been done by International Corporate Governance Network (ICGN) and others on the broader universe of issues that can be addressed via stewardship codes. [1]


The Job Rating Game: Revolving Doors and Analyst Incentives

Elisabeth Kempf is Assistant Professor of Finance at the University of Chicago Booth School of Business. This is based on her recent article, forthcoming in the Journal of Financial Economics.

Investment banks frequently hire analysts from rating agencies. A widespread concern is that this “revolving door” encourages leniency among rating analysts who hope to exchange optimistic credit ratings for well-paying future jobs. For example, a prominent narrative of the financial crisis is that conflicts of interest due to the revolving door contributed to inflated credit ratings, which in turn enabled the financial meltdown: “You are rating someone and then you want to go work for them and make much more money—the notion that you would be critical of some entity and then hope they hire you goes against what we know about human nature” (former Representative Barney Frank in an interview with the Wall Street Journal).

Theoretically, it is not obvious whether the revolving door between rating agencies and investment banks will reduce or improve ratings accuracy. On the one hand, if analysts get hired as an explicit quid pro quo for favors to their future (or potential) employers, then they may indeed be encouraged to be lenient (Stigler (1971); Peltzman (1976); Eckert (1981)). On the other hand, if analysts are also hired for their expertise, they will have a greater incentive to invest in their qualifications or to signal their expertise during their employment at the agency (Che (1995); Salant (1995); Bar-Isaac and Shapiro (2011)). While previous work on revolving doors in the context of rating agencies has focused on capture concerns, my article, forthcoming in the Journal of Financial Economics, sheds light on the magnitude of potential positive incentive effects.


Fiduciary Violations in Sale of Company

Amy Simmerman and David Berger are partners at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR memorandum by Ms. Simmerman, Mr. Berger, Ryan Greecher, Brad Sorrels, and Nate EmeritzThis post is part of the Delaware law series; links to other posts in the series are available here.

On June 21, 2019, Vice Chancellor Kathaleen S. McCormick of the Delaware Court of Chancery issued an opinion addressing a number of significant issues relating to the proper conduct of an M&A process. [1] In denying all defendants’ motions to dismiss, the court first held that the selling company had failed to disclose certain material information to stockholders in seeking their approval of the deal, and as a result, the deferential standard of review set forth by the Delaware Supreme Court in Corwin did not apply to the transaction. As described in more detail below, the court further held, for purposes of a motion to dismiss, that the stockholder plaintiff adequately had alleged that the board breached its fiduciary duty of loyalty in managing various aspects of the sale process. The court also refused to dismiss the plaintiff’s aiding and abetting and civil conspiracy claims against the selling company’s longtime financial advisor that was also its largest stockholder, as well as against the acquiror of the company. The case provides a valuable reminder about potential pitfalls in M&A events and areas of potential risk in resulting stockholder litigation.

The Decision

The various claims in this case are based on a core set of allegations arising out of the plaintiff’s second amended complaint. Those allegations included the following:


Emerging Technologies, Risk, and the Auditor’s Focus

Julie Bell Lindsay is Executive Director, Anita Doutt is CAQ Professional Practice Fellow, and Catherine Ide is Senior Managing Director of Professional Practice and Member Services at the Center for Audit Quality. This is based on their CAQ memorandum.


Emerging technologies are altering the financial reporting environment substantially, and this change is accelerating. For example, artificial intelligence (AI), robotic process automation, and blockchain are changing the way business gets done, and auditors are leading by transforming their own processes.

In this evolving environment, it is more important than ever for the key players in financial reporting—auditors, audit committees, and management—to have a strong grasp of roles and responsibilities. As the use of emerging technologies in the financial reporting process increases, it becomes less likely auditors can design traditional substantive tests (e.g., test of details or substantive analytical procedures) that, by themselves, would provide sufficient appropriate audit evidence that respond to identified assertion-level risks. [1] This evolution in the sufficiency and source of audit evidence puts further emphasis on management’s internal control over financial reporting.

What are key technology risks to watch for? What are auditors focusing on when it comes to the impact of emerging technologies on business?

How are auditors evaluating whether management is properly assessing the impact of emerging technologies on internal control over financial reporting?

This post sheds light on these questions, with an eye on key technology developments: the internet of things (IoT), AI, and smart contracts. This resource builds on the Center for Audit Quality’s 2018 publication Emerging Technologies: An Oversight Tool for Audit Committees. [2]


Do the Securities Laws Promote Short-termism?

James J. Park is Professor of Law at UCLA School of Law. This post is based on his recent paper. 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); 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); and The Uneasy Case for Favoring Long-Term Shareholders by Jesse Fried (discussed on the Forum here).

Over the last several years, some of the most prominent representatives of Corporate America have argued that the pressure of quarterly reporting creates incentives for public corporations to focus on meeting the short-term expectations of the market rather than developing businesses that prosper over the long-term and make positive contributions to society. The scrutiny of quarterly reporting gained momentum in the fall of 2018 when President Trump asked the SEC to consider whether it should only require annual or semi-annual reporting to reduce the burden of quarterly scrutiny on public companies. The SEC responded to the Presidential request by asking for comments on the question of whether the “existing periodic reporting system . . . foster[s] an inefficient outlook among registrants and market participants by focusing on short-term results. . . .”

The proposal to eliminate quarterly reporting connects to a heated debate about whether short-termism, where public companies take “actions that are profitable in the short-term but value-decreasing in the long term,” is a significant problem. Over the last several years, legal scholars have generally focused on activist hedge funds as the primary driver of short-termism. Much of the debate has focused on the implications of such activism for corporate law.


Caremark Liability for Regulatory Compliance Oversight

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, Mr. Richter, Brian T. Mangino, Andrea Gede-Lange, and Randi Lally. This post is part of the Delaware law series; links to other posts in the series are available here.

In Marchand v. Barnhill (“Blue Bell”) (June 18, 2019), the plaintiff-stockholder claimed that the directors of Blue Bell Creameries USA, Inc., an ice cream manufacturer (the “Company”), breached their fiduciary duty of loyalty under Caremark by having failed to oversee and monitor the Company’s food safety operations. The suit was brought after an outbreak of listeria contamination in the Company’s ice cream led to the sickening and (in three cases) the death of consumers who ate the ice cream—as well as the recall of all of the Company’s products, the shuttering of all of the Company’s plants, and, ultimately, a liquidity crisis that led the Company to accept a dilutive private equity deal.

Caremark claims” are claims that directors breached the fiduciary duty of loyalty by not making “a good faith effort to oversee the company’s operations.” These claims, which if successful can result in personal liability for directors, are known to be (as the Supreme Court reiterated in Blue Bell) “among the most difficult of corporate claims” to pursue successfully—because a required element of a claim for breach of the duty of loyalty is “bad faith” (i.e., intentional wrongdoing) by directors. Caremark established that, with respect to a board’s oversight obligation, only a “sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to [personal] liability [of directors].”


Comment Letter Regarding SEC Interpretation of 14a-8(i)(7) Ordinary Business Exclusion

Ken Bertsch is Executive Director and Jeff Mahoney is General Counsel of the Council of Institutional Investors (CII). This post is based on a comment letter that CII submitted to the Securities and Exchange Commission Division of Corporation Finance. Related research from the Program on Corporate Governance includes The Case for Increasing Shareholder Power, by Lucian Bebchuk.

We are writing on behalf of the Council of Institutional Investors (CII), a nonprofit, nonpartisan association of public, corporate and union employee benefit funds, other employee benefit plans, state and local entities charged with investing public assets, and foundations and endowments with combined assets under management of $4 trillion. Our member funds include major long-term shareholders with a duty to protect the retirement savings of millions of workers and their families. Our associate members include a range of asset managers with more than $35 trillion in assets under management. [1]

We are writing to express concern about evolving SEC Division of Corporation Finance staff (Staff) views on the “ordinary business” exclusion of shareholder proposals (Rule 14a-8(i)(7)).

The Securities and Exchange Commission (SEC or Commission) has indicated that it may consider a proposal to raise ordinary business matters (1) based on the proposal’s subject matter, or (2) the degree to which the proposal seeks to “micromanage” a company “by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.” Our concern relates to recent no-action letters from the Staff that rely on the second prong of this exclusion—the “micromanagement” or “too-complex-for-shareholders” grounds for omission. We note that the Staff discussed this prong in Staff Legal Bulletin No. 14J, in October 2018. [2]


The State of Play on Clawbacks and Forfeitures Based on Misconduct

Jonathan M. Ocker is partner, Justin Krawitz is a senior associate, and Benjamin T. Gibbs is an associate at Pillsbury Winthrop Shaw Pittman LLP. This post is based on their Pillsbury memorandum. Related research from the Program on Corporate Governance includes Excess-Pay Clawbacks by Jesse Fried and Nitzan Shilon (discussed on the Forum here) and Rationalizing the Dodd-Frank Clawback by Jesse Fried (discussed on the Forum here).

Clawback policies have been common for some time. However, because implementation of the proposed Dodd-Frank clawback rules may never be finalized, companies are beginning to implement or update executive compensation recoupment and forfeiture rules on their own based on investor sentiment, good governance principles, and recent events at CBS (and other #MeToo moments), Nissan, Equifax and other examples of supervisory failure.


  • Companies should determine whether clawbacks are mandatory or discretionary, whether fault is required in the case of financial restatements, and whether clawbacks should extend beyond financial restatements.
  • Companies should revisit whether the definition of “cause” used in forfeiture provisions in their severance and employment agreements and equity plans should cover reputational harm and adverse publicity to the employer.
  • Companies should consider implementing clawback policies to improve their ISS Equity Plan Scorecard scores if their stock plans are up for shareholder approval.


An Overview of Vote Requirements at U.S. Meetings

Kosmas Papadopoulos is Managing Editor at ISS Analytics. This post is based on an ISS Analytics memorandum by Mr. Papadopoulos.

At the general meeting of Tesla Inc. on June 11, 2019, two management proposals seeking to introduce shareholder-friendly changes to the company’s governance structure failed to pass, despite both items receiving support by more than 99.5 percent of votes cast at the meeting. To get official shareholder approval, the proposals needed support by at least two-thirds of the company’s outstanding shares. However, only 52 percent of the company’s share capital was represented at the general meeting; based on turnout alone, there was no possible way for the proposal to pass.
As strange as the voting outcome at Tesla may seem, it is not a very unusual result. Every year, dozens of proposals are not considered to be “passed,” even though they receive support by an overwhelming majority of votes cast at the meeting. Supermajority vote requirements may be responsible for a large portion of these failed votes with high support levels (62 percent of instances since 2008). However, using a base of all outstanding shares for the vote requirement is an even more common corresponding factor (92 percent of instances). The increase in failed majority-supported proposals in recent years can be directly attributed to the change in the rules pertaining to the treatment of broker non-votes.

Director Independence and Oversight Obligation in Marchand v. Barnhill

Peter Atkins and Paul Lockwood are partners at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum and is part of the Delaware law series; links to other posts in the series are available here.

On June 18, 2019, in Marchand v. Barnhill, the Delaware Supreme Court, in an opinion written by Chief Justice Leo E. Strine, Jr. on behalf of a unanimous court, issued a decision reversing the Court of Chancery’s dismissal of a stockholder derivative suit alleging Caremark claims [1]—that the board failed to provide adequate oversight of a key risk area and thus breached its duty of loyalty. The case arose out of a listeria outbreak in ice cream made by Blue Bell Creameries USA Inc. that sickened many consumers, caused three deaths and resulted in a total product recall.

Key Determinations

The key Delaware Supreme Court determinations, both fact-driven, were:

  • Independence. The Supreme Court held that one director, viewed by the Court of Chancery as independent, was not independent based on the allegations in the complaint. As a result, the court found that a majority of the board was not independent and disinterested for purposes of the board’s consideration of a stockholder demand to file a lawsuit against directors and officers.
  • Oversight. For purposes of denying a motion to dismiss by the company, the facts alleged by the plaintiffs were sufficient to satisfy the high Caremark standard for establishing that a board breached its duty of loyalty by failing to make a good faith effort to oversee a material risk area, thus demonstrating bad faith.


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