Monthly Archives: September 2019

Board Compliance

Brandon L. Garrett is the L. Neil Williams, Jr. Professor of Law at Duke Law School. This post is based on a recent article, forthcoming in the Minnesota Law Review, by Professor Garrett; John Armour, the Hogan Lovells Professor of Law and Finance at the University of Oxford; Jeffrey N. Gordon, Richard Paul Richman Professor of Law at Columbia Law School; and Geeyoung Min, Assistant Professor at Michigan State University College of Law.

Do corporate boards care about compliance? Surely, they should, because of the potentially catastrophic consequences of ignoring it. Take the example of the recent compliance failures at Wells Fargo, the large bank, which pioneered a strategy of “cross-selling” financial products to its customers. This turned out to be profitable, and the bank sought to maximize its roll-out by setting branch staff powerful financial incentives to maximize sales of financial products to its customers. Unfortunately, these incentives triggered widespread fraud on the part of the bank’s employees, with customers discovering products had been charged to their names without their consent. After the Wells Fargo scandal broke, regulators identified numerous weaknesses in the firm’s compliance programs that had permitted the misconduct to go unchecked. The bank paid about $2 billion in fines and fired over 5,000 employees; the CEO resigned after Congressional hearings. In response, the Board commissioned an outside investigation into how this compliance failure happened on its watch. Yet, federal regulators were deeply unsatisfied with the Board’s response. In early 2018, the Federal Reserve took the unusual step of restricting the growth of the bank as four Board members departed; the Fed also sent a letter to the former lead independent director, describing his “many pervasive and serious compliance and conduct failures.”


Finalized Changes to Volcker Rule

Lee Meyerson is head of Simpson Thacher’s Financial Institutions Practice, and Keith Noreika is a partner at Simpson Thacher & Bartlett LLP. This post is based on a Simpson Thacher memorandum by Mr. Meyerson, Mr. Noreika, Adam Cohen, and Spencer Sloan.

Federal financial regulators responsible for implementing the Volcker Rule have issued a final rule to revise a number of provisions of the Volcker Rule’s 2013 implementing regulations (the “2013 Rule”). The final rule, which is largely similar to the agencies’ proposed rulemaking issued in June 2018, generally seeks to clarify certain definitions, exemptions and compliance requirements under the 2013 Rule, and to tailor compliance requirements to be commensurate with a banking entity’s level of trading activity.

The final rule’s changes relate primarily to the Volcker Rule’s proprietary trading and compliance program requirements. While the agencies adopted certain limited changes to the Volcker Rule’s covered fund-related provisions, the agencies noted that they continue to consider other aspects of the covered fund provisions on which they sought comment in the 2018 proposal, and intend to issue a separate proposed rulemaking that specifically addresses those areas.

The final rule will be effective on January 1, 2020. Banking entities will have a one-year grace period, until January 1, 2021, to fully comply with the final rule’s amendments, but may also voluntarily comply, in whole or in part, with the amendments prior to such compliance date.

Following is a high-level summary of certain key features of the final rule.


Remarks to the Economic Club of New York

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s remarks to the Economic Club of New York, 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.

Thank you for having me and thanks to those who have contributed to today’s event—in particular, the Economic Club, Chair, Marie-Josée [Kravis], President, Barbara [Van Allen], as well as panelists Bob [Pisani] and Harold [Ford].

I am grateful to be back. The Economic Club is where I gave my first public speech as SEC Chairman in July 2017. In that speech, I discussed the principles that would guide my SEC Chairmanship. [1] I believe we—and “we” is important to me—have followed those principles. We—our exceptional Division and Office heads and the approximately 4,400 dedicated women and men, who are the SEC—have accomplished a substantial amount. [2] Yet, let there be no doubt. There is more to do.

Proxy Season Rising Demand for Board Oversight of ESG

Peter Reali is Senior Director of Responsible Investing and Anthony Garcia is Director of Responsible Investing at Nuveen, LLC. This post is based on their Nuveen 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) and Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

The 2019 proxy season was marked by an increased willingness among shareholders to hold boards accountable on director elections, say- on-pay, and environmental, social and governance (ESG) shareholder proposals. For example, almost 5 percent of directors received less than 80 percent support for her/ his election, which is the highest proportion since the aftermath of the financial crisis. [1] This suggests that investors are beginning to hold boards accountable for failing to improve governance practices and integrate ESG considerations into their overall strategy and oversight responsibilities.

Election of Directors

The most notable example of investors holding boards accountable took place at companies lacking gender diversity at the director level. Looking at boards prior to proxy season, the number of S&P 500 companies with no female board representation was only 1 percent; [2] whereas nearly 25 percent of Russell 2000 companies still had no gender diversity at the board level prior to this year’s proxy season. [3] This disparity between large-cap companies and mid- and small-cap companies was part of the impetus for the Nuveen Responsible Investing team’s “Women on Boards” engagement initiative, which began in 2018.


A Tale of Two Markets: Regulation and Innovation in Post-Crisis Mortgage and Structured Finance Markets

Adam J. Levitin is the Agnes N. Williams Research Professor at Georgetown University Law Center and William W. Bratton is Nicholas F. Gallicchio Professor of Law and Co-Director, Institute for Law & Economics at the University of Pennsylvania Law School. This post is based on their recent paper.

Our paper, A Tale of Two Markets: Regulation and Innovation in Post-Crisis Mortgage and Structured Finance Markets, takes the occasion of the tenth anniversary of the financial crisis to review recent developments in the structured products market, connecting the emergent pattern to post-crisis regulation.

The financial crisis stemmed from excessive risk-taking and shabby practices in the “subprime” segment of the home mortgage market, a market that got its financing from an array of “toxic” products and investment vehicles created in the structured credit market—private-label mortgage-backed securities (PLS), collateralized debt obligations (CDOs), collateralized debt obligations squared (CDO2s), synthetic securitizations, and structured investment vehicles (SIVs). These products provided the funding for the mortgage lending that enabled housing prices to be bid up in an unsustainable bubble.


Making a Comeback: SEC Fines for Regulation FD Violations

Susan S. Muck and Michael S. Dicke are partners and Vincent Barredo is an associate at Fenwick & West LLP. This post is based on their Fenwick memorandum.

For the first time in six years, the U.S. Securities and Exchange Commission issued an enforcement action against a company solely for Regulation FD violations. On Aug. 20, the SEC announced that it charged life sciences company TherapeuticsMD (TMD) with violations of Regulation FD for selectively communicating to sell-side analysts information about interactions between TMD and the U.S. Food and Drug Administration (FDA) regarding the potential approval of one of TMD’s drugs. To settle the matter, TMD agreed to pay a $200,000 fine.

Especially for younger public companies, it is a good reminder of the necessity of having robust disclosure controls over the public dissemination of material information. The fact pattern also serves as a warning for officers of public companies to resist the natural temptation to provide analysts additional details and commentary about unfavorable public news where that same commentary is not also disseminated publicly through an FD-compliant method.

Regulation FD

Regulation FD prevents the selective disclosure of material non-public information to analysts, other securities market professionals or individual stockholders. Regulation FD requires issuers to make simultaneous disclosure of material information to market professionals and to the public generally. If an issuer unintentionally discloses material information selectively to market professionals, it must remedy that action by making prompt public disclosure of the information.


Proxy Plumbing Recommendation

Anne Sheehan is Chair of the SEC’s Investor Advisory Committee (IAC) and John C. Coates is a Committee member and the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School. This post is based on a recent IAC recommendation.

This recommendation relates to the U.S. proxy system. The proxy system is complex and multifaceted and will require an iterative, multi-step approach to improve it over a long period of time. We do not believe private actors will improve the system without SEC intervention. We have focused on areas that are clearly in need of immediate attention, that can attract a consensus from a wide array of stakeholders, and that we also believe are actionable by the Commission in a relatively short period of time. After setting out goals, noting reasons that private actors may lack incentives to improve the system on their own, reviewing evidence about problems with the current system, and noting the possibility of comprehensive, long-term, technology-based reform, we make four specific recommendations:

  • The SEC should require end-to-end vote confirmations to end-users of the proxy system, potentially commencing with a pilot involving the largest companies;
  • The SEC should require all involved in the system to cooperate in reconciling vote-related information, on a regular schedule, including outside specific votes, to provide a basis for continuously uncovering and remediating flaws in the basic “plumbing” of the system;
  • The SEC should conduct studies on (a) investor views on anonymity and (b) share lending, and
  • The SEC should adopt its proposed “universal proxy” rule, with the modest changes that would be needed to address objections that have been raised to that


The SEC and Regulation of Exchange-Traded Funds: A Commendable Start and a Welcome Invitation

Henry T. C. Hu is the Allan Shivers Chair in the Law of Banking and Finance at the University of Texas Law School and John D. Morley is Professor of Law at Yale Law School of Law. This post is based on their recent article, forthcoming in Southern California Law Review.

Exchange-traded funds (“ETFs”) are among the most important financial innovations of the modern era. ETFs offer individual and institutional investors alike a unique investment opportunity. Throughout the trading day, the ETF can be viewed as providing a nearly “frictionless,” often low-cost portal to and from a bewildering universe of plain vanilla and arcane asset classes, passive and active investment strategies, and long, short, and leveraged exposures. But ETFs also entail distinctive risks, flowing in part from their reliance on a unique market microstructure for its shares, the central feature of which is a device we refer to as the “arbitrage mechanism.” This device has sometimes failed dramatically in times of market stress, even among the most plain vanilla ETFs. Certain ETFs may present complex risks not only to their shareholders but to the asset markets that the ETFs invest in. Despite the importance of ETFs and the distinctive risks they pose, the United States does not have a dedicated system of ETF regulation or even a workable, comprehensive conception of what an ETF is. This Article addresses the problem by assessing the SEC’s recent effort in this area in light of the recommendations we provided in prior research.

In March 2018, we offered the first academic work to show the need for, or to present, a comprehensive regulatory framework for all ETFs. On June 28, 2018, just prior to that article’s scheduled publication, the SEC issued a proposal to change the way it regulates certain types of ETFs. On May 20, 2019, the SEC issued its “Precidian” exemptive order, allowing for the first time “non-transparent” actively managed ETFs—an order that we believe has surprising, hitherto unexplored implications for ETF regulation.


Executive Compensation and ESG

Janice Koors is senior managing director at Pearl Meyer & Partners, LLC. This post is based on a Pearl Meyer memorandum by Ms. Koors. 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) and Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

In the United States, environmental, social, and governance (ESG) issues have become a priority, especially for the largest public companies. In a 2017 survey, “Pearl Meyer Quick Poll: ESG and its Potential Link to Incentives,” [1] 60 percent of companies surveyed report that ESG issues are a top concern and of those, 34 percent indicated that ESG issues are firmly entrenched in their companies. From an external reporting perspective, the Governance and Accountability Institute, a consulting and research firm focused on sustainability issues, says that in 2015, 81 percent of the S&P 500 published corporate reports on their ESG positions, up from just 20 percent four years prior. [2] While not driven by disclosure regulation, the topic is receiving attention largely due to a combination of investor, employee, and customer interest.


Rule 14a-8 No-Action Requests

William H. Hinman is Director of the Division of Corporation Finance at the U.S. Securities and Exchange Commission.

After the recent proxy and shareholder proposal season, the Division considered whether additional guidance or changes to its process of administering Exchange Act Rule 14a-8 were warranted. As a result of that consideration, the staff focused on how it could most efficiently and effectively provide guidance where appropriate.

The staff will continue to actively monitor correspondence and provide informal guidance to companies and proponents as appropriate. In cases where a company seeks to exclude a proposal, the staff will inform the proponent and the company of its position, which may be that the staff concurs, disagrees or declines to state a view, with respect to the company’s asserted basis for exclusion. Starting with the 2019-2020 shareholder proposal season, however, the staff may respond orally instead of in writing to some no-action requests. The staff intends to issue a response letter where it believes doing so would provide value, such as more broadly applicable guidance about complying with Rule 14a-8.


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