Yearly Archives: 2019

The Specter of the Giant Three

Posted by Lucian Bebchuk (Harvard Law School) and Scott Hirst (Boston University), on
Tuesday, May 21, 2019
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Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance, and Director of the Program on Corporate Governance, both at Harvard Law School. Scott Hirst is an Associate Professor of Law at the Boston University School of Law and Director of Institutional Investor Research at the Harvard Law School Program on Corporate Governance. This post is based on their forthcoming article, available here.

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 Future of Corporate Governance Part I: The Problem of Twelve by John Coates; and New Evidence, Proofs, and Legal Theories on Horizontal Shareholding by Einer Elhauge (discussed on the Forum here).

We recently posted on SSRN our study The Specter of the Giant Three. The study will be published in a Boston University Law Review symposium issue on institutional investors.

Our study examines the substantial and continuing growth of the so-called “Big Three” index fund managers—BlackRock, Vanguard, and State Street Global Advisors. We show that there is a real prospect that the Big Three will grow into the “Giant Three,” and that they will come to dominate shareholder voting in most significant public companies.

Our new study is part of a larger, ongoing project on stewardship by index funds and other institutional investors in which we have been engaged. This study complements our earlier study of index fund stewardship, Index Funds and the Future of Corporate Governance: Theory, Evidence and Policy, forthcoming later this year in the Columbia Law Review. That study of index fund stewardship builds, in turn, on the analytical framework put forward in our 2017 article with Alma Cohen, The Agency Problems of Institutional Investors.

We begin by analyzing the drivers of the rise of the Big Three, including the structural factors that are leading to the heavy concentration of the index funds sector. We then provide empirical evidence about the past growth and current status of the Big Three, and their likely growth into the Giant Three. We extrapolate from past trends to estimate the future growth of the Big Three. We estimate that the Big Three could well cast as much as 40% of the votes in S&P 500 companies within two decades. We argue that policymakers and others must recognize—and must take seriously—the prospect of a Giant Three scenario. The plausibility of this scenario exacerbates concerns about the problems with index fund incentives that we identify and document in our earlier work.

A more detailed overview of our analysis follows:

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SEC Staff Roundtable on Short-Term/Long-Term Management of Public Companies, Our Periodic Reporting System and Regulatory Requirements

Posted by Jay Clayton, U.S. Securities and Exchange Commission, on
Tuesday, May 21, 2019
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Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent public 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.

Our capital markets benefit from a level of retail investor participation that is unparalleled among the world’s large industrialized countries. Our Main Street investors who, day in and day out, put their hard-earned money to work for the long term are the reason why we have the deepest, most dynamic and most liquid capital markets in the world.

Today’s Main Street investors have a substantial responsibility to fund their own retirement and other financial needs. As a result of increased life expectancy and a shift from defined benefit plans (e.g., pensions) to defined contribution plans (e.g., 401(k)s and IRAs), the investing interests and needs of our Main Street investors have changed. Put simply, our Main Street investors are more than ever focused on long-term results. We also must recognize that our Main Street investors who have entered retirement or have another expense, such as paying for tuition or an unforeseen event, need liquidity. In other words, at some point, long-term investors do become sellers.

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SEC Guidance on Auditor Independence

Posted by Charles F. Smith and Andrew J. Fuchs, Skadden, Arps, Slate, Meagher & Flom LLP, on
Tuesday, May 21, 2019
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Charles F. Smith is partner and Andrew J. Fuchs is an associate at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum.

In remarks made in December 2018, the Securities and Exchange Commission’s (SEC) Chief Accountant Wesley Bricker reaffirmed that auditor independence remains one of the SEC’s areas of focus. Consultations with the SEC about specific auditor independence questions influence the staff’s recommendations to the commission regarding updating or expanding the independence rules and existing staff guidance, Bricker said. Indeed, the SEC is currently considering amendments to those rules related to certain lending relationships as a result of these consultation trends.

Despite the SEC’s affirmation of the importance of these consultations in identifying emerging and recurring auditor independence issues, the SEC does not make its specific guidance on individual consultations publicly available. It is important for public company audit committees to understand these limitations in this complex area. There also is an opportunity for the SEC to improve its process by making its specific guidance public.

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Share Buybacks Under Fire

Posted by Lizanne Thomas, Robert A. Profusek, and Lyle G. Ganske, Jones Day, on
Tuesday, May 21, 2019
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Lizanne Thomas, Robert A. Profusek, and Lyle G. Ganske are partners at Jones Day. This post is based on their Jones Day memorandum. Related research from the Program on Corporate Governance includes Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay, by Jesse Fried (discussed on the Forum here), and  Short-Termism and Capital Flows by Jesse Fried and Charles C. Y. Wang (discussed on the Forum here).

Stock buybacks reached record levels in recent years, fueled in part by the 2017 tax cuts, shareholder activism, and record low borrowing costs. S&P 500 companies repurchased a record $770 billion in shares in 2018, and forecasts for 2019 are even higher, with companies expected to repurchase $940 billion—using almost a third of the aggregate $3 trillion in cash reflected on the balance sheets of the S&P 500.

Stock buybacks have, however, been sharply criticized of late and have been ensnared in the bitter partisanship in Washington. For example, Senators Schumer and Sanders penned an op-ed in The New York Times outlining a plan to limit buybacks to companies that pay workers at least $15 an hour and provide paid sick time. Others have advocated for restrictions on executives’ abilities to sell their shares following a buyback announcement or to require additional disclosure about the board’s reasons for choosing a share repurchase. Are these criticisms justified, or have buybacks been targeted unfairly?

One of the chief arguments against buybacks is that companies that repurchase shares are using capital for a short-term purpose—returning cash to shareholders—at the expense of long-term goals.

One of the chief arguments against buybacks is that companies that repurchase shares are using capital for a short-term purpose—returning cash to shareholders—at the expense of long-term goals, such as R&D, capital improvement, and worker training. In fact, some companies have used this “short-termism” argument to resist demands by shareholder activists to implement substantial returns of capital.

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Global Divestment Study

Posted by Paul Hammes, Rich Mills, and Carsten Kniephoff, Ernst & Young LLP, on
Monday, May 20, 2019
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Paul Hammes is Global Divestment Leader, Rich Mills is Americas Divestment Leader, and Carsten Kniephoff is Europe, Middle East, India and Africa Divestment (EMEIA) Leader at Ernst & Young LLP. This post is based on an EY memorandum by Mr. Hammes, Mr. Mills, Mr. Kniephoff, and Paul Murphy.

In their quest for greater value, C-suites across the globe face a myriad of forces affecting divestment plans—from shifting customer expectations, to technology-driven sector convergence, to ongoing shareholder pressure. Companies are streamlining operating models so that they can pivot more quickly in pursuit of new growth opportunities and stay competitive. In particular, they are using divestments to fund new investments in technology, products, markets and geographies.

This is keeping the appetite for divestments near record levels, with 81% of companies saying the desire to streamline the operating model will impact their divestment plans over the next 12 months. They continue to divest businesses no longer core to the portfolio or best left in the hands of another owner. As companies reshape their portfolios, they are building greater trust with stakeholders and mitigating pressure from activists.

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How Horizontal Shareholding Harms Our Economy—and Why Antitrust Law Can Fix It

Posted by Einer Elhauge (Harvard Law School), on
Monday, May 20, 2019
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Einer Elhauge is the Petrie Professor of Law at Harvard Law School. This post is based on Professor Elhauge’s recent paper.

Related research from the Program on Corporate Governance includes Horizontal Shareholding (discussed on the Forum here) and New Evidence, Proofs, and Legal Theories on Horizontal Shareholding (discussed on the Forum here), both by Einer Elhauge; The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); and Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here).

In my initial Harvard Law Review article on horizontal shareholding, I showed that economic theory and two empirical studies of airline and banking markets indicated that high levels of horizontal shareholding in concentrated product markets can have anticompetitive effects. I argued that those anticompetitive effects could help explain longstanding economics puzzles, including executive compensation methods that inefficiently reward executives for industry performance, the sharp rise in the gap between corporate profits and investment, and the growing increase in economic inequality.

My claims have all been hotly contested. However, as I show in a new paper, new proofs and empirical evidence strongly confirm my economic claims. One new economic proof establishes that, if corporate managers maximize either their expected vote share or re-election odds, they will maximize a weighted average of their shareholders’ profits from all their stockholdings and thus will lessen competition the more that those shareholdings are horizontal. Another new economic proof shows that with horizontal shareholding, corporations maximize their shareholders’ interests by making executive compensation less sensitive to their own firm’s performance because that reduces competition between firms in a way that increases shareholder profits. Neither new proof requires any communication or coordination between different shareholders, between different managers, or between shareholders and managers.

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Unleashing the Power of Diversity Through Inclusive Leadership

Posted by Tina Shah Paikeday (Russell Reynolds Associates) and Jean Lee (MCCA), on
Monday, May 20, 2019
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Tina Shah Paikeday leads global D&I Consulting Services at Russell Reynolds Associates and Jean Lee is president and CEO of the Minority Corporate Counsel Association (MCCA). This post is based on a joint memorandum from Russell Reynolds and MCCA by Ms. Shah Paikeday, Ms. Lee, Jacob Martin, Cynthia Dow, and Sophia Piliouras.

The Slow Road to Diversity

For decades, the legal profession has attempted to hire and recruit more diverse talent, yet progress has been slow. Although people of color (including those who identify as Asian, Black or African American, Hispanic, or Latinx) comprise a growing number of law firm associates, they remain significantly under-represented at higher levels. Between 2007 and 2017, the proportion of equity partners who are people of color grew from 6 percent to 9 percent, according to MCCA/Vault data, even though under-represented attorneys have accounted for around 20 percent of all law firm hires in each year during that time frame. The situation is particularly acute for women of color, who comprise just 3 percent of equity partners—up from less than 2 percent in 2007.

Many factors contribute to these statistics, but disproportionately high (and rising) attrition rates for attorneys who are people of color are a crucial one. [1] Last year, people of color comprised 17 percent of all attorneys, yet accounted for 22 percent of all departures. To truly accelerate diversity in their ranks, it’s clear that lawyers need new strategies.

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Evaluating Corporate Compliance—DOJ Guidelines for Prosecutors

Posted by Jeffrey Lehtman, Roxana Mondragon-Motta, and Seth Cowell, Wilson Sonsini Goodrich & Rosati, on
Sunday, May 19, 2019
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Jeffrey Lehtman is partner and Roxana Mondragon-Motta and Seth Cowell are associates at Wilson Sonsini Goodrich & Rosati. This post is based on their WSGR memorandum.

On April 30, 2019, Assistant Attorney General Brian A. Benczkowski announced the release of an updated version of the Criminal Division’s The Evaluation of Corporate Compliance Programs during a keynote address at the Ethics and Compliance Initiative 2019 Annual Impact Conference. This publication, which provides guidance to the Department of Justice’s (DOJ’s) white-collar prosecutors on their evaluation of corporate compliance programs, is an update to an earlier memorandum issued by the Fraud Section in 2017 and, according to the DOJ, is intended to align the guidance with other DOJ guidance and standards on point.

The guidance is meant to assist prosecutors who are investigating a company for violations of law in their evaluation of a company’s compliance program. The guidance is organized around three main questions that prosecutors are to ask in their evaluation of a company’s compliance program: 1) “Is the corporation’s compliance program well designed?”; 2) “Is the program being applied earnestly and in good faith?”; and 3) “Does the corporation’s compliance program actually work?” The answers to these questions ought to inform the DOJ’s decision on whether to prosecute, on any monetary penalties to recommend, and on what compliance obligations could be included in any corporate criminal resolution.

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Fraudulent Transfer Claims Against Shareholders

Posted by Michael L. Cook, Schulte Roth & Zabel LLP, on
Sunday, May 19, 2019
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Michael L. Cook is of counsel at Schulte Roth & Zabel LLP. This post is based on his Schulte Roth & Zabel memorandum.

The U.S. District Court for the Southern District of New York, on April 23, 2019, denied the litigation trustee’s motion for leave to file a sixth amended complaint that would have asserted constructive fraudulent transfer claims against 5,000 Tribune Company (“Tribune”) shareholders. In re Tribune Co. Fraudulent Conveyance Litigation, 2019 WL 1771786 (S.D.N.Y. Apr. 23, 2019). The safe harbor of Bankruptcy Code (“Code”) §546(e) barred the trustee’s proposed claims, held the court. Id., at * 12. Based on undisputed facts, it reasoned that the debtor, Tribune Company (“Tribune”) “was a ‘customer’ of CTC” [Computershare Trust Company, N.A.]; CTC was “acting as Tribune’s ‘agent or custodian’… ‘in connection with a securities contract’“; and that both entities were a “financial institution” as defined by the Code. Id., at * 9. Also, held the court, “at this stage of the litigation,” allowing the trustee to amend his complaint “would result in undue prejudice to the [defendant] Shareholders.” Id., at * 12.

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A “Draft Review” as a Safeguard on Proxy Advisors

Posted by Ted Allen and Gary A. LaBranche, National Investor Relations Institute, on
Saturday, May 18, 2019
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Ted Allen is Vice President and Gary LaBranche is President and CEO of the National Investor Relations Institute. This post is based on a letter sent by the National Investor Relations Institute to the U.S. Securities and Exchange Commission.

I am writing on behalf of the National Investor Relations Institute (NIRI) to offer additional comments on proxy advisory firms. [1] Founded in 1969, NIRI is the professional association of corporate officers and investor relations consultants responsible for communication among corporate management, shareholders, securities analysts, and other financial community constituents. Our more than 3,300 members represent over 1,600 publicly held companies and $9 trillion in stock market capitalization.

Our members play a vital role in communicating with institutional and retail investors on proxy voting matters. This role is especially critical when a company needs to engage with shareholders during a proxy contest or a “vote no” campaign, or after receiving a negative proxy advisor recommendation on an equity incentive plan or during a Say-on-Pay vote.

We are pleased to join with 318 issuers [2] around the country and a broad coalition of corporate organizations, including the Shareholder Communications Coalition, the Society for Corporate Governance, the U.S. Chamber of Commerce, Nasdaq, the Business Roundtable, the National Association of Manufacturers, the Biotechnology Innovation Organization, the Center On Executive Compensation, and Nareit, in urging the Commission to exercise greater oversight over proxy advisors.

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