Monthly Archives: November 2019

PCAOB Corporate Governance

Cydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Posner.

Yikes! What is going on at the PCAOB? You may recall that, back in 2018, former staffers at the PCAOB and former partners of KPMG were charged by the SEC in connection with “their participation in a scheme to misappropriate and use confidential information relating to the PCAOB’s planned inspections of KPMG.” You know, that case where the former PCAOB staffers were accused of leaking to KPMG the plans for PCAOB inspections of KPMG—“literally stealing the exam.” (See this PubCo post.) The same scheme led the U.S. Attorney’s Office for the SDNY to file criminal charges against the former staffers, and some have actually been sentenced to prison. But that’s not even the half of it.

As reported by the WSJ, the PCAOB “has slowed its work amid board infighting, multiple senior staff departures, and allegations that the chairman has created a ‘sense of fear,’ according to a whistleblower letter and people familiar with the situation….The regulator has issued 27% fewer audit-inspection reports this year, board data show, as senior staff positions remain unfilled for months.” What’s more, that same whistleblower complaint— submitted by a group of employees to the board in May and to the SEC in August—precipitated the appointment of Harvey Pitt, former SEC Chair, to review “PCAOB corporate governance.”


Speech by SEC Chairman Clayton at the University of Pennsylvania: Modernizing our Regulatory Framework: Focus on Authority, Expertise and Long-Term Investor Interests

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s Distinguished Jurist Lecture at the University of Pennsylvania, 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 providing me the opportunity to deliver this year’s Distinguished Jurist Lecture. This is a special honor for me. Philadelphia is my hometown. Penn is my alma mater—two times. And, I miss teaching here.

In particular, I miss the students and their wonderfully insightful questions. I also miss co-teaching with my good friend, Joe Frumkin. Joe has long supported, and spurred my participation in, the Institute of Law and Economics. Thank you Joe for your friendship and support.

Today, I am pleased to discuss:

(1) the Commission’s actions over the past year, with reference to our “organic” and transparent approach to our agenda setting, and certain key modernization efforts and a more general discussion of modernization as an effective policy-making lens for an administrative agency;

(2) our “engagement agenda” with a focus on market monitoring and a few words about the important topics of investor education and oversight and enforcement; and

(3) how our mission, market realities, the statutory constructs under which we operate, and other factors, including hopefully, a dose of practical wisdom, inform our efforts more broadly, with a specific discussion of the relationship among scope of authority, scope of actions and independence. [1]

Fall of the Ivory Tower: Controlled Companies and Shareholder Activism

Amy Freedman is Chief Executive Officer, Michael Fein is Executive Vice President, Head of US Operations, and Ian Robertson is Executive Vice President, Communication Strategy at Kingsdale Advisors. This post is based on a their Kingsdale memorandum. Related research from the Program on Corporate Governance includes Against All Odds: Hedge Fund Activism in Controlled Companies by Kobi Kastiel.

Despite longstanding complaints about governance and the tyranny of a few who may or may not hold a meaningful economic interest in the company they founded and/or now control, investors have continued to allocate to controlled or quasi-controlled companies. What has changed is that minority shareholders are no longer content to sit quietly and go along for the ride, increasingly demonstrating they are willing to pull on the few levers of activism and change available at these companies.

Companies that were set up to inoculate themselves from the whims of shareholders have now become targets. Even if directors aren’t at risk of losing their seats in a vote, they are at risk of losing their reputations and being embarrassed into change.

While governance concerns usually provide the thin edge of the wedge to begin the advancement of change, the underlying driver for a minority shareholder is usually a dissatisfaction with the way the controlling entity is running the business—not just in terms of current performance, but also in a lack of willingness to explore other accretive opportunities that may impact the controller’s vision for the company and status quo.


JV Directors Duty of Loyalty

Meghan McGovern is a Business Analyst, Tracy Branding and Lois D’Costa are Directors, and James Bamford is a Managing Director at Water Street Partners LLC. This post is based on their Water Street memorandum.

MANY JOINT VENTURE BOARD DIRECTORS find themselves in a perceived state of conflicted interest: deference to their nominating shareholder versus loyalty to the joint venture company. The dilemma is a difficult one, as directors often receive conflicting guidance as to whether they should vote based on what is best for the venture in their own independent, professional judgment, which may limit their nominating shareholder’s interests outside the venture, versus simply voting what is in their shareholder’s interests, which may undercut venture performance and expose them to legal liabilities.

Directors on joint venture boards likely owe certain fiduciary duties to the company, most notably a duty of care and duty of loyalty. The duty of loyalty is especially tricky in joint ventures, as board directors who are employees of one shareholder are simultaneously a fiduciary to their employer and to all other shareholders. This issue of mutual agency introduces three types of conflicts: business opportunity conflicts (i.e., situations where a director needs to decide whether a new opportunity is best pursued through the venture or by their shareholder outside the venture); self-dealing conflicts (i.e., situations where the director needs to vote on whether the venture will buy, sell, or otherwise transact with their shareholder for products, services, technology, or other assistance, and the terms associated with such arrangements); and information disclosure conflicts (i.e., situations where a director must decide what potentially-valuable information can and cannot be shared between the venture and their shareholder).


How and Why Human Capital Disclosures are Evolving

Steve W. Klemash is Americas Leader at the EY Center for Board Matters; Bridget Neill is Americas Vice Chair, Public Policy at EY; and Jamie C. Smith is Associate Director at the EY Center for Board Matters. This post is based on their EY memorandum.

The talent paradigm is shifting. A company’s intangible assets, which include human capital and culture, are now estimated to comprise on average 52% of a company’s market value. [1] At the same time, the nature of work is rapidly evolving, new generations are reshaping the workforce and businesses are redefining long-term value and corporate purpose through a stakeholder lens.

In this era of disruption, talent and culture have leapt to the forefront of thinking around enabling strategy and innovation and creating long-term value. Accordingly, human capital has rapidly emerged as a critical focus area for stakeholders. There is clear and growing market appetite to understand how companies are managing and measuring human capital, demonstrated by:

  • Comments received by the U.S. Securities and Exchange Commission (SEC) on human capital matters, as articulated in the August 2019 proposed rule amendments to revise current business disclosure requirements
  • Influential investors like BlackRock and State Street Global Advisors making human capital and company culture engagement priorities
  • Market-driven frameworks such as the Global Reporting Initiative, the Embankment Project for Inclusive Capital and the Sustainability Accounting Standards Board (SASB) identifying human capital as a key value driver

Advancing disclosures to keep pace with this transformational view of human capital will be a journey. To better understand where companies are on this journey, we reviewed the proxy statements of Fortune 100 companies to see how leading companies are disclosing their governance and management of human capital.


Overboarding by Public Company Directors: 2019 Update

Steven M. Haas and Lawton B. Way are partners at Hunton Andrews Kurth LLP. This post is based on their Hunton Andrews Kurth memorandum.

Earlier this year, The Vanguard Group announced it would vote against any named executive officer (“NEO”) who sat on more than one outside public board and against non-executive directors who sat on more than four public boards. This policy is more restrictive than Institutional Shareholder Services’ (“ISS”) voting guidelines. It is an important reminder that institutional investors continue to develop their own voting guidelines that should be monitored by the companies in which they invest.

Overboarding Policies

Overboarding continues to generate discussion within the corporate governance community. Outside board service can be helpful in grooming senior management, gaining experience or insight, and developing important business relationships. Board service, however, can be demanding, and committing to too many boards can be time-consuming and a distraction. In response to investor concerns, the number of directors at Russell 3000 companies serving on five or more boards has decreased significantly since 2008.


Recent Cyber Attacks Target Asset Management Firms

Jeannie S. Rhee, Udi Grofman, and Jeh Charles Johnson are partners at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss memorandum by Ms. Rhee, Mr. Grofman, Mr. Johnson, Roberto Finzi, Richard C. Tarlowe, and Roberto J. Gonzalez.

A recent flurry of cyber attacks on asset managers should remind asset management firms and other financial institutions that they are attractive targets for cyber-exploitation and need to remain vigilant and institute appropriate preventative controls and monitoring procedures, as well as post-attack action plans. [1]

Many companies still see cyber attacks as one-off, anomalous events. But as recent events have shown, few are immune from illicit cyber-penetration and the frequency of these attacks continues to increase.

A recent spate of business email compromise schemes have involved fraudulent email messages sent to fund executives and officers. [2] The emails notify the recipients that they have an encrypted message, which they can access by clicking a link. Clicking the link causes malicious software to download onto the user’s computer, gaining access to the user’s account and perhaps further penetrating the institution’s systems. While these and similar cyber schemes may sound like transparently suspicious and easy to detect attempts at blunt force penetration, their cost to businesses can be substantial, with some estimates exceeding $50 billion a year. [3] And considering the sheer volume of emails that asset management and other financial firms send and receive as a necessary part of conducting day-to-day business, even the most transparent cyber attacks are likely to succeed every once in a while.


Weekly Roundup: November 8–14, 2019

More from:

This roundup contains a collection of the posts published on the Forum during the week of November 8–14, 2019.

Designing Proposals with your Unique Investors In Mind

A Guidebook to Boardroom Governance Issues

Company Hedging Policies: Observations from New Proxy Disclosures

What Does the Growth of Impact Investing Mean?

Understanding the Impact of America’s Clampdown on Proxy Advisors

How Corporate Lawbreakers Get a Leg Up at the Justice Department

The 2019 CPA-Zicklin Index of Corporate Political Disclosure and Accountability

Index Funds and the Future of Corporate Governance: Presentation Slides

CEO Chairman. Two Jobs, One Person

PCAOB Selection Process and the GAO Report

PCAOB Selection Process and the GAO Report

Lynn E. Turner is former Chief Accountant at the U.S. Securities and Exchange Commission and currently senior advisor at Hemming Morse LLP.

The Public Company Accounting Oversight Board (PCAOB) was created when Congress passed the Sarbanes-Oxley Act of 2002 (SOX). The PCAOB is a five member quasi governmental board appointed by the SEC, with the obligation and responsibility to oversee the audits of publicly listed companies, and the audit firms who perform them. The stated purpose of the board is to “…protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports…” The members of the PCAOB are to be “…appointed from among prominent individuals of integrity and reputation who have a demonstrated commitment to the interests of investors and the public…” Two and only two of the board members can be CPA’s.


Do Corporate Governance Ratings Change Investor Expectations? Evidence from Announcements by Institutional Shareholder Services

Paul M. Guest is Professor of Corporate Finance and Marco Nerino is a PhD student, both at King’s Business School at King’s College London. This post is based on their paper, forthcoming in the Review of Finance.Related research from the Program on Corporate Governance Learning and the Disappearing Association between Governance and Returns by Lucian Bebchuk, Alma Cohen, and Charles C. Y. Wang (discussed on the Forum here) and What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen, and Allen Ferrell.

Corporate governance analysts are important information intermediaries in financial markets. They provide a wide range of services including data, analysis, ratings, proxy recommendations, and consulting. Academics, practitioners, and regulators have predominantly focused on proxy recommendations and their influence over firm governance choices and investor decisions. Therefore, our understanding of the determinants and effects of the other services provided by governance analysts is limited. An important and unresolved question is whether their governance ratings provide price relevant information. Understanding the importance to the market of the information provided by governance analysts is key to understanding how influential they actually are. In our paper Do Corporate Governance Ratings change Investor Expectations? Evidence from Announcements by Institutional Shareholder Services, forthcoming in the Review of Finance, we revisit this question, using an event study approach to establish whether governance ratings are price-relevant for security markets.

We focus our main analysis on 18,911 rating change announcements by Institutional Shareholder Services (ISS), the most influential (and sole surviving governance focused) rating firm in the U.S. over the past 20 years. To strengthen the reliability of our results, we remove confounding events, employ different counterfactuals and multiple event windows, and control for cross-correlation due to event clustering.


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