Monthly Archives: September 2019

Directors’ Duties in an Evolving Risk and Governance Landscape

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy, and William Savitt is a partner at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell 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).

The stakes for responsible corporate stewardship have never been higher.

Corporations today account for a greater proportion of our collective productivity than ever before. Of the 100 largest economies in the world, 71 are corporations, and only 29 are countries. U.S. corporations alone generated profits of $2.3 trillion in 2018—the highest in history. Reflecting their unprecedented scale, U.S. corporations have been blamed for accelerating environmental degradation and aggravating disparities in income and wealth. Calls for the exercise of corporate social responsibility have become increasingly urgent. Recognizing this urgency, the Business Roundtable last month embraced broad stakeholder governance and urged corporate leaders to focus on sustainable value creation. Yet, as directors of U.S. corporations seek to answer these calls, they remain subject to countervailing market pressure to deliver outsized stockholder returns in compressed time horizons.

To allow directors to mediate this challenge, and to facilitate responsible long-term corporate decision making, we have long supported a stakeholder-centered model of corporate governance and cautioned against rote application of the entrenched shareholder-primacy model. Recognizing that investors, and the asset managers who represent them, share with the rest of society an interest in sustainable prosperity, we have sponsored The New Paradigm—a reconception of corporate governance as a collaboration among shareholders, managers, employees, customers, suppliers, and the communities in which corporations operate.


The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi

Joseph A. Grundfest is William A. Franke Professor of Law and Business at Stanford Law School. This post is based on his recent paper, 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 The Market for Corporate Law by Michal Barzuza, Lucian A. Bebchuk, and Oren Bar-Gill and Federal Corporate Law: Lessons from History by Lucian Bebchuk and Assaf Hamdani.

The Securities Act of 1933 provides for concurrent federal and state jurisdiction. Securities Act claims were historically litigated in federal court, but in 2015 plaintiffs began filing far more frequently in state court where dismissals are less common and weaker claims more likely to survive. D&O insurance costs for IPOs have since increased significantly. Today, approximately 75% of defendants in Section 11 claims face state court actions. Federal Forum Provisions [FFPs] respond by providing that, for Delaware-chartered entities, Securities Act claims must be litigated in federal court or in Delaware state court.

In Sciabacucchi, Chancery applies “first principles” to invalidate FFPs primarily on grounds that charter provisions may only regulate internal affairs, and that Securities Act claims are always external. In so concluding, Sciabacucchi adopts a novel definition of internal affairs that is narrower than precedent, and asserts that plaintiffs have a federal right to bring state court Securities Act claims. It describes all Securities Act plaintiffs as purchasers who are not owed fiduciary duties at the time of purchase. The opinion constrains all actions of the Delaware legislature relating to the DGCL to comply with its novel definition of “internal affairs.”


New Policy for Shareholder Proposal Rule

Joseph A. Hall is a partner, and Betty M. Huber and Ning Chiu are counsel at Davis Polk & Wardwell LLP. This post is based on their Davis Polk memorandum.

Staff may not take a position or may respond orally to some no-action requests

On September 6, the SEC staff announced a new policy regarding its administration of the shareholder-proposal rule, Rule 14a-8 under the Securities Exchange Act of 1934. As before, the staff will monitor and provide informal guidance regarding shareholder proposals submitted pursuant to Rule 14a-8. Where a company seeks to exclude a proposal by submitting a no-action letter request, the staff will continue to review the request.

Under the new policy, instead of responding in writing that it concurs or disagrees, in some cases the staff may respond only orally. It may also, orally or in writing, decline to state a view with respect to the company’s reasons for excluding the proposal. Where the staff declines to take a view on a no-action letter request, the interested parties should not interpret that position as indicating that the proposal should or should not be included in the proxy statement for shareholder vote. The announcement made clear that under those circumstances, the staff is not weighing in on the merits of the argument and the company may have a valid legal basis on which to exclude the proposal. The parties may choose to seek adjudication of the issue in court.


Accounting Firms, Private Funds, and Auditor Independence Rules

David Wohl is a partner at Weil, Gotshal & Manges LLP. This post is based on his recent Weil memorandum.

The SEC recently charged a large public accounting firm (Accounting Firm) with violations of its auditor independence rules (Independence Rules) in connection with more than 100 audit reports involving at least 15 audit clients, including several private funds. [1] According to the SEC’s order, the Accounting Firm represented that it was “independent” in audit reports issued on the clients’ financial statements. However, the SEC found that the Accounting Firm or its affiliates provided prohibited non-audit services to affiliates of those audit clients (including to portfolio companies of the private funds), which violated the Independence Rules. The prohibited non-audit services included corporate secretarial services, payment facilitation, payroll outsourcing, loaned staff, financial information system design or implementation, bookkeeping, internal audit outsourcing and investment adviser services. The SEC also found that certain of the Accounting Firm’s independence controls were inadequate, resulting in its failure to identify and avoid these prohibited non-audit services.


Words Speak Louder Without Actions

Doron Levit is Assistant Professor of Finance at The Wharton School of the University of Pennsylvania. This post is based on a recent article by Professor Levit, forthcoming in the Journal of Finance. Related research from the Program on Corporate Governance includes Letting Shareholders Set the Rules and The Case for Increasing Shareholder Power, both by Lucian Bebchuk.

Information and control rights are central aspects of leadership, management, and corporate governance. In practice, communication of private information and intervention in the decision-making process are common remedies for information asymmetries and conflicts of interest in a wide range of situations. The interplay between communication and intervention, however, is little understood.

In my article, Words Speak Louder Without Actions, which is forthcoming in the Journal of Finance, I show that the power of a principal to intervene in an agent’s decision exacerbates the underlying agency problem and as a result limits the ability of the principal to use her private information to influence the agent’s decision. The power to intervene can therefore be detrimental to the principal. This novel result has implications for the effectiveness of visionary management, the tension between the supervisory and advisory roles of corporate boards, and the value that sophisticated investors offer their portfolio companies.


Setting Directors’ Pay Under Delaware Law

Steve Seelig is Senior Director, Executive Compensation and Stephen Douglas is Senior Legislative and Regulatory Advisor, Technical Services at Willis Towers Watson. This post is based on their Willis Towers Watson memorandum and is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Chancery’s refusal to dismiss a derivative allegation in a suit claiming that Goldman Sachs directors were paid excessively may soon provide a decision that offers companies guidance on setting board of director pay (Stein v. Blankfein, Court of Chancery of the State of Delaware, C.A. No. 2017-0354-SG (Del. Ch. May. 31, 2019). This guidance may come despite the court’s initial doubts that the facts, when more fully developed, would yield a holding against Goldman.

If the case is not settled before the next phase of the case, the Chancery’s application of the “entire fairness” standard may provide greater clarity on how directors are paid and whether pay levels are excessive. The “entire fairness” standard, as applied to director pay setting, was articulated in the 2017 Investor’s Bancorp case, and has a standard that is less differential than the “business judgment rule”. (See “Delaware Supreme Court ruling moves the goalposts on director compensation,” Executive Pay Matters, February 16, 2018).

The initial court decision raises several notable issues.


Trends in Executive Compensation

Michael Kesner is a Consultant, Ed Sim is a Senior Manager, and Tara Tays is a Managing Director at Deloitte Consulting LLP. This post is based on their Deloitte memorandum. 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).

Executive compensation is not only a consideration close to the pocket book of CFOs but also a topic of increasing importance to managements and boards. As major economies show signs of recovering from the 2008 recession, compensation can become more decisive to retaining and motivating critical senior executive talent. But, executive compensation also continues to be scrutinized by major investors, proxy advisory firms and increasingly regulators—given the losses incurred by shareholders over the last couple of years. Thus, companies will have to critically review their existing compensation plans and how they adapt these plans for a changing economy. CFOs can play a critical role in framing the financial impacts of compensation plans and influence the public perception of these plans. This CFO Insights article lays forth some critical considerations for CFOs.


Modernizing Bank Merger Review

Jeremy Kress is Assistant Professor of Business Law at the Stephen M. Ross School of Business at the University of Michigan. This post is based on his recent article. forthcoming in the Yale Journal on Regulation.

The biggest irony of the 2008 financial crisis is that the market crash was both initially triggered and ultimately alleviated by massive bank mergers. A wave of mergers by Bank of America, Citigroup, JPMorgan, and Wells Fargo in the late 1990s created the “too big to fail” banks that became so central to the crisis. Less than a decade later, the federal government orchestrated multibillion-dollar emergency acquisitions by several of these firms to stem the panic. Thus, these four dominant banks—which control forty-two percent of the assets in the U.S. banking system—owe their existence to megamergers. Now, critics worry that that these firms are not only “too big to fail,” but also “too big to jail,” “too big to manage,” and “too big to supervise.”

Of course, this is not the first time that bank mergers have raised public policy concerns. In the 1950s, for example, a massive merger movement sparked fears of then-unprecedented consolidation in the financial sector. Many of these deals did not require federal approval. Several years later, Congress established a comprehensive oversight regime for bank mergers in an attempt to rein in unregulated consolidation. Under the Bank Merger Act of 1960, banks would have to get approval from their federal regulators before combining.


2019 Proxy Season Recap and 2020 Trends to Watch

Lyndon Park is Managing Director at ICR Inc. This post is based on his ICR memorandum.


At first glance, the patterns and trends of the 2019 proxy season don’t seem to indicate shifts that are beyond marginal in terms of proxy voting impact. But in closer analysis, in conjunction with recent investor behavior and industry trends (e.g., Business Roundtable Statement on the Purpose of a Corporation signed by 181 CEOs disavowing shareholder-centrism in favor of greater commitment to stakeholders and society), the results of the 2019 proxy season evince an already-shifting pattern of voter behavior, and contain important clues as to what companies must do to prepare for the 2020 proxy season.

Throughout this post, we will note some of the specific issues to watch out for 2020 proxy season.


Response to SEC Subcommittee Recommendations—Universal Ballot and Vote Confirmations

Dimitri T.G. Zagoroff is Content Manager and Internal Consultant at Glass, Lewis & Co. This post is based on his Glass Lewis memorandum. Related research from the Program on Corporate Governance includes Universal Proxies by Scott Hirst (discussed on the Forum here).

If effecting change at a single institution is like reversing the course of an aircraft carrier, revamping the proxy system is something akin to turning around a whole fleet. Undaunted by the task, it appears that the SEC’s Investor Advisory Committee has gotten nearly all of its own boats pointed in the same direction. At a meeting September 5th, the IAC’s Investor-as-Owner Subcommittee recommendation on proxy plumbing received overwhelming support from all but two members of the bipartisan committee.

The IAC, chaired by Anne Sheehan, former director of governance for CalSTRS, was established by Dodd-Frank to provide the Commission with findings and recommendations on issues ranging from governance standards to the functioning of the market. Following last year’s SEC Roundtable, the Investor-as-Owner Subcommittee was tasked with disentangling the inefficiencies and complex interests of the proxy system.


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