Monthly Archives: February 2020

The Strategic Audit Committee: a 2020 Preview

Krista Parsons is Managing Director and Robert Lamm is Independent Senior Advisor at the Center for Board Effectiveness, Deloitte & Touche LLP. This post is based on their Deloitte memorandum.


To anyone familiar with the role and responsibilities of audit committees, it will come as no surprise that the audit committee is sometimes called the “kitchen sink” committee. That is because at many companies, any topic that isn’t clearly the responsibility of another committee or the full board frequently ends up on the audit committee agenda.

Due to this and other factors, the audit committee agenda is usually jam-packed, and audit committees need to be strategic, prioritizing the matters they handle and using their time efficiently and effectively. The need for this strategic approach will almost surely increase in 2020, as the number and complexity of issues faced by boards and audit committees continue to grow.


A big part of being strategic is the setting of priorities—determining which matters the audit committee should focus on, and how best to execute its responsibilities.


Stewardship and Collective Action: The Australian Experience

Tim Bowley is a Sessional Lecturer in the Faculty of Law at Monash University and Jennifer G. Hill is Professor and Bob Baxt AO Chair in Corporate and Commercial Law in the Faculty of Law at Monash University. This post is based on a chapter in Global Shareholder Stewardship: Complexities, Challenges and Possibilities (Dionysia Katelouzou and Dan W Puchniak eds, Cambridge University Press, forthcoming). 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); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (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); and The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

The global financial crisis gave rise to competing narratives about shareholders and their engagement in corporate governance. According to one narrative, which was common in the United States, shareholders were complicit in the crisis, by placing pressure on corporate managers to engage in excessive risk-taking to increase profitability.

An alternative narrative prevailed in other jurisdictions, such as the United Kingdom and Australia, where the real problem was perceived to be lack of shareholder participation in corporate governance. According to this narrative, greater engagement by shareholders is a beneficial corporate governance technique.

Institutional investor stewardship codes (“stewardship codes”), which now exist in many jurisdictions, embody this second, more positive narrative regarding the role of shareholders in corporate governance. Stewardship codes reflect the growing importance of institutional investors in capital markets, and a belief that increased engagement by institutional investors can improve corporate decision-making and provide protection against inappropriate risk-taking by corporate managers.


Proposed Amendments to Financial Disclosure and Guidance on Use of Metrics in Management Discussion and Analysis

Mark S. Bergman is a partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on his Paul, Weiss memorandum.

On January 30, the U.S. Securities and Exchange Commission (the “SEC”) published proposed amendments (the “Proposed Amendments,” available here) to modernize, simplify and enhance certain financial disclosure requirements set forth in Regulation S-K. The Proposed Amendments cover Item 301 (Selected Financial Data), Item 302 (Supplementary Financial Data) and Item 303 (Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)). Concurrently, the SEC also published separate guidance (the “MD&A Guidance,” available here) highlighting certain disclosure considerations when including performance indicators or other metrics in an MD&A.

The Proposed Amendments and the MD&A Guidance follow on from a series of recommendations in the SEC staff’s Report on Review of Disclosure Requirements in Regulation S-K (available here), mandated under Section 108 of the Jumpstart Our Business Startups Act. The modifications and recommendations reflected in the Proposed Amendments and the MD&A Guidance aim to improve “the quality and accessibility of registrant’s presentation of financial results and performance metrics” with the goal of assisting investors’ capital allocation decisions, while reducing registrant’s compliance burden and costs. The Proposed Amendments include conforming amendments to Forms 20-F and 40-F, as appropriate (since these Forms do not cross-reference Regulation S-K as do the Forms for domestic registrants).


Financial Institution Developments

Edward D. Herlihy and Richard K. Kim are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum.

Last week, the Board of Governors of the Federal Reserve System approved a final rule to codify its standards for determining whether one company has control over another. The final rule takes effect on April 1 and completes the process that the Federal Reserve began last April by issuing a proposal seeking public comment. Despite extensive industry input that urged the Federal Reserve to take a more expansive view, the Federal Reserve generally dismissed the comments received and largely adopted the control rule as initially proposed. Although this was disappointing to many in the industry, the impact of the control rule will nevertheless be significant with clear winners and losers. Beneficiaries of the final rule include investors in banks, including private equity and activists, who are permitted more board seats and governance rights than under the prior policy. Conversely, banks looking to invest in fintech and other companies, as well as fintech companies seeking to own banks, did not receive the flexibility that they had been seeking.


Delaware’s Position on Director Independence: a Change in Approach?

Gail Weinstein is senior counsel and Steven Epstein and Warren S. de Wied are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. de Wied, Brian T. Mangino,  Andrew J. Colosimo, and David L. Shaw, 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 Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

In McElrath v. Kalanick (Jan. 13, 2020), the Delaware Supreme Court upheld the Court of Chancery’s decision that dismissed a derivative suit brought by a stockholder of Uber Technologies, Inc. (“Uber”) for damages arising from Uber’s 2016 acquisition of Ottomotto LLC (“Otto”). The Supreme Court agreed with the Court of Chancery’s determination that a majority of the Uber directors in office at the time the complaint was filed were independent and had not acted in bad faith–and, therefore, that pre-suit demand on the board to bring the litigation would not have been “futile” and so was not excused.
Key Point

  • The decision, in our view, does not necessarily suggest a change in the Delaware courts’ recent approach in determining director independence in the demand futility context. Delaware has consistently applied long-established principles for determining director independence. In recent years, however, when applying those principles in the demand futility context, the courts have appeared to more readily find non-independence than they had previously. Some commentators have suggested that the decision signals a return to the seemingly stronger presumption of independence of the past. While that is possible, we do not read the decision that way (as discussed below).
  • Separately, the decision reinforces that there continues to be a high bar to a finding of bad faith by directors–and that this, in combination with exculpation provisions, continues to make it highly unlikely that independent directors would have personal liability for alleged fiduciary breaches except in the most egregious cases.


Shareholder Governance, “Wall Street” and the View from Canada

Gesta Abols and Brad Freelan are partners at Fasken Martineau DuMoulin LLP. This post is based on their article published in The American Lawyer. Related research from the Program on Corporate Governance includes Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr. (discussed on the Forum here).

The Business Roundtable, a group of executives of major corporations in the United States, recently released a statement on the purpose of a corporation that reflects a shift from shareholder primacy to a commitment to all stakeholders. While the statement seems radical to some, it is consistent with recent Canadian corporate law. Boards of directors in Canada have had to make decisions incorporating the concepts expressed in the Business Roundtable statement for over a decade.

The primary concern expressed by those opposed to a shift from shareholder primacy is that it undercuts managerial accountability, thereby resulting in increased agency costs and undermining the overall effectiveness and efficiency of corporations. The experience in Canada suggests such concerns are largely overblown.

A stakeholder-based governance model rejects the idea that corporations exist principally to serve shareholders. Instead, a stakeholder-based governance model requires the consideration of various stakeholder groups to inform directors as to what is in the best interest of the corporation.


CEO Stock Incentives Increasingly Tied to Stock Ownership and Retention

Dan Leon is a senior associate and LaToya Scott is an associate at Willis Towers Watson. This post is based on a Willis Towers Watson memorandum by Mr. Leon, Ms. Scott, Robert Newbury, and Erik Nelson. 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 Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay, by Jesse Fried (discussed on the Forum here).

New findings confirm what we’ve long known: many companies are adding retention requirements to prevent executives from quickly selling equity earned through long-term incentives (LTI) post-vesting.

Willis Towers Watson’s Global Executive Compensation Analysis Team reviewed ownership guidelines and retention policies in effect during 2010, 2015, and 2019 among the S&P 500 and found that the number of companies with retention requirements has jumped from 35% in 2010 to 64% in 2019, approximately an 83% increase. This dramatic growth suggests that stock retention requirements could become as nearly universal as ownership guidelines.

The trend tracks companies’ practice of using stock ownership guidelines to require executives to own a specific amount of company shares to better align the interests of investors and executives. The most recent driver of this practice occurred in September 2019 when the Council of Institutional Investors (CII) suggested that ownership guidelines and retention policies should be included as part of an executive compensation program focused on building long-term (at least five years) shareholder value. Previously, in 2015, Institutional Shareholder Services (ISS) began to formally account for these policies while evaluating and scoring a company’s equity compensation plan.


Securities Class Action Filings—2019 Year in Review

Alexander “Sasha” Aganin is senior vice president at Cornerstone Research. This post is based on a report by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse.

Executive Summary

For a third consecutive year, the number of new class action securities filings based on federal statutes remained above 400. Most notably, core filings surged to record levels. Market capitalization losses, as in 2018, surpassed $1 trillion.

Number and Size of Filings

  • Plaintiffs filed 428 new class action securities cases (filings) across federal and state courts in 2019, the most on record and nearly double the 1997–2018 average. “Core” filings—those excluding M&A filings—rose to the highest number on record.
  • Federal and state court class actions alleging claims under the Securities Act of 1933 (1933 Act) helped push filing activity to record levels. The number of 1933 Act filings themselves reached unprecedented levels.
  • Disclosure Dollar Loss (DDL) decreased by 14 percent to $285 billion in 2019.
  • Maximum Dollar Loss (MDL) also fell by 9 percent to $1,199 billion.
  • In 2019, eight mega filings in federal courts made up 52 percent of federal core DDL and 21 mega filings in federal courts made up 71 percent of federal core MDL. Both of these percentages track closely with historical averages. Filings with a DDL of at least $5 billion or an MDL of at least $10 billion are considered mega filings.


Unprecedented Enforcement Actions Against Eight Former Wells Fargo Executives

Brad S. Karp is chairman and Jessica S. Carey and Roberto J. Gonzalez are partners at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on their Paul, Weiss memorandum.

As the latest chapter in the aftermath of the Wells Fargo fake accounts scandal, on January 23, 2020, the Office of the Comptroller of the Currency (“OCC”) announced enforcement actions against eight former Wells Fargo executives for their roles in the bank’s “systemic sales practices misconduct.” [1] Five individuals—including the former head of the Community Bank, group risk officer, general counsel, chief auditor, and executive audit director—face a 100-page notice of charges that, if contested, would be heard by an administrative law judge. The OCC is seeking a $25 million penalty and an industry bar against Carrie Tolstedt, the former head of the Community Bank, and lesser penalties against the four other former executives. Three other individuals settled with the OCC, including former Chairman and CEO John Stumpf, who agreed to a $17.5 million penalty and an industry bar. [2]

The table below shows the civil monetary penalties sought or settled. According to the OCC, these amounts reflect each individual’s level of culpability and financial resources, including compensation previously clawed back by Wells Fargo.


SEC Calls “Time Out” on Proxy Advisor Guidance and ISS Litigation

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

You might recall that, at the end of October, proxy advisory firm ISS filed suit against the SEC and its Chair, Jay Clayton (or Walter Clayton III, as he is called in the complaint) in connection with the interpretation and guidance directed at proxy advisory firms issued by the SEC in August. (See this PubCo post.) That interpretation and guidance addressed the application of the proxy rules to proxy advisory firms, confirming that proxy advisory firms’ vote recommendations are, in the view of the SEC, “solicitations” under the proxy rules, subject to the anti-fraud provisions of Rule 14a-9, and providing some suggestions for disclosures that would help avoid liability. (See this PubCo post.) Then, in November, the SEC proposed amendments to the proxy rules to add new disclosure and engagement requirements for proxy advisory firms, codifying and elaborating on some of the earlier interpretation and guidance. (See this PubCo post.) As reported in Bloomberg, the SEC has now filed an Unopposed Motion to Hold Case in Abeyance, which would stay the litigation until the earlier of January 1, 2021 or the promulgation of final rules in the SEC’s proxy advisor rulemaking. In the Motion, the SEC confirmed that, during the stay, it would not enforce the interpretation and guidance. ISS did not oppose the stay, and the Court has granted that motion. As a result, this proxy season, companies should not expect proxy advisory firms to feel compelled to comply with the SEC interpretation and guidance, including advice to proxy advisors to provide certain disclosures to avoid Rule 14a-9 concerns.


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