Monthly Archives: June 2020

An Early Look at the 2020 Proxy Season

Hannah Orowitz is Managing Director of Corporate Governance and Brigid Rosati is Director of Business Development at Georgeson.

With only one month remaining in the 2020 proxy season, an examination of early voting statistics [1] among Russell 3000 companies reveals that climate-related investor concerns are having a meaningful impact on the 2020 season. This is not surprising given the focus paid to this topic by both BlackRock and State Street in their respective CEO letters published in January of this year. We saw this impact not only through increased support for climate-focused shareholder proposals, but also as a notable factor influencing the degree of support for director elections. The impact of climate concern is affecting other “traditional” governance-focused shareholder proposals as well, such as those seeking to separate the roles of board chair and CEO.

Beyond climate-focused proposals, an examination of environmental and social (E&S) shareholder proposals generally shows that diversity-focused proposals are also garnering significant shareholder support this season. A look at governance shareholder proposals illustrates that measures seeking to remove supermajority vote requirements, implement shareholder rights to act by written consent or to call a special meeting are still receiving strong shareholder support. Support for proposals seeking to separate the roles of chair and CEO appears to be increasing significantly this season.


Loss Causation in Securities Fraud Cases Brought After a Crisis

Roger Cooper is partner and Elsbeth Bennett and Brendan Jordan are associates at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary memorandum. Related research from the Program on Corporate Governance includes Rethinking Basic by Lucian Bebchuk and Allen Ferrell (discussed on the Forum here).

The economic disruptions caused by COVID-19 are causing many to question whether a new wave of investment losses are on the horizon and whether a corresponding wave of investor-led litigation reminiscent of financial crisis era litigation will follow. In a significant decision for defendants, the New York Supreme Court Commercial Division recently reminded would-be plaintiffs of the challenges of proving a fraud claim arising out of investment losses in times of crisis; critically, it requires proving that the alleged fraud—and not the intervening crisis—caused the plaintiff’s loss.

On Friday, May 8, 2020 the New York Supreme Court Commercial Division entered an order granting summary judgment in favor of Merrill Lynch, dismissing an investor plaintiff’s fraud claim arising out of its investment in a 2006 collateralized debt obligation (“CDO”) that had been arranged by Merrill Lynch. [1] The court dismissed the plaintiff’s claim because the plaintiff failed to raise a triable issue of fact demonstrating that its investment losses in the CDO were caused by Merrill Lynch’s alleged misrepresentations or omissions, as opposed to the broader 2007-2009 financial crisis that affected the entire CDO market. This decision, arising from the financial crisis of over a decade ago, highlights the significant hurdle for investors contemplating securities fraud actions arising out of the COVID-19 pandemic.


The Ripple Effect of EU Taxonomy for Sustainable Investments in U.S. Financial Sector

Alexandra Farmer is partner at Kirkland & Ellis LLP’s Sustainable Investment & Global Impact Practice Group, and Sarah Thompson is regulatory partner in the Investment Funds practice in the London office of Kirkland & Ellis International LLP. This post is based on a Kirkland memorandum by Ms. Farmer, Ms. Thompson, Paul Tanaka, Jennie MorawetzLisa Cawley and Donna Ni.

Environmental, Social and Governance (ESG) Funds have demonstrated competitive financial performance in recent years, and were found by a recent Morningstar survey to be more resilient than their conventional counterparts to the financial impacts of the COVID-19 pandemic. As U.S. investors increasingly take ESG factors, and particularly climate change, into account, they should monitor and, where warranted, incorporate emerging EU guidelines. Adopted by the Council of the EU on April 15, 2020, with specific criteria being developed throughout 2020 and 2021, the “EU Taxonomy” aims to provide a unified classification system for “green” and “sustainable” economic activities under the EU’s sustainable finance regulations. Regardless of regulatory applicability, non-EU funds may face pressure by EU-based or other ESG-minded investors to disclose the percentage of investments that are aligned with the EU Taxonomy and ultimately may face pressure to allocate capital towards such investment activities. Accordingly, funds that are already invested in EU Taxonomy-aligned activities may want to consider adopting the framework quickly to benefit from the “first mover advantage.” Finally, funds in jurisdictions without clear guidelines may benefit from utilizing EU Taxonomy terminology to provide some clarity to investment professionals and protection against “greenwashing” claims.

ESG Funds are growing exponentially and ESG index funds are outperforming non-ESG peers, even during COVID-19.

In 2019, assets managed by the 75 ESG Funds in Bloomberg’s annual survey of the largest ESG funds with five-year track records grew more than 34%, to $101 billion, as investors increasingly bet on securities with sustainable and ethical assurances. The same survey found that nine of the largest ESG mutual funds in the U.S. outperformed the Standard & Poor’s 500 Index last year, and seven beat their market benchmarks over the past five years. In the first quarter of 2020, ESG index funds outperformed their conventional counterparts in the face of the unprecedented COVID-19 pandemic and ensuing stock market decline. In an April 2020 article, Morningstar attributed this resilience to the funds’ ESG-driven investment strategies, stating: “The better relative performance of sustainable funds in the first quarter derives mainly from their focus on companies that have stronger ESG profiles/lower ESG risk.”


COVID-19: A Review of Recent Securities Fraud Enforcement Actions

Michael Bongiorno is partner, Jessica Lewis is counsel, and Sierra Shear is senior associate at Wilmer Cutler Pickering Hale and Dorr LLP. This post is based on a WilmerHale memorandum by Mr. Bongiorno, Ms. Lewis, Ms. Shear, Christopher Davies, Timothy J. Perla, and Robert Kingsley Smith. Related research from the Program on Corporate Governance includes Rethinking Basic by Lucian Bebchuk and Allen Ferrell (discussed on the Forum here).

As noted in our earlier alert concerning securities enforcement actions, as COVID-19 spread swiftly across the United States in the early months of 2020, the Securities and Exchange Commission (SEC) began issuing warnings about potential pandemic-related disclosures, fraud and disruptions to the financial markets. [1] On January 30, 2020, SEC Chairman Jay Clayton announced that the SEC staff would monitor and, to the extent necessary, provide guidance regarding disclosures “related to the potential effects of the coronavirus.” [2] Shortly thereafter, the SEC began assembling a cross-divisional working group to monitor “the real and potential effects of COVID-19 on public companies, including with respect to potential reporting challenges” and public disclosures. [3]

In addition to providing disclosure-related guidance, throughout the crisis the SEC also has “actively monitor[ed]” “markets for frauds, illicit schemes and other misconduct affecting investors relating to COVID-19.” Most recently, on May 12, 2020, SEC Co-Director of Enforcement Steven Peikin outlined the responsibilities of the Enforcement Division’s Coronavirus Steering Committee, which was created to respond to COVID-19-related enforcement issues, including microcap fraud, insider trading, accounting or other disclosure improprieties, and market-moving announcements by issuers in industries particularly impacted by the COVID-19 pandemic. [4] According to recent SEC public announcements, the Coronavirus Steering Committee has “developed a systematic process to review public filings from issuers in highly-impacted industries, with a focus on identifying disclosures that appear to be significantly out of step with others in the same industry.” [5] In addition to identifying “highly impacted” industries, the SEC has also noted that “microcap stocks may be particularly vulnerable to fraudulent investment schemes, including coronavirus-related scams.” [6]


Delisting Chinese Firms: A Cure Likely Worse than the Disease

Jesse Fried is the Dane Professor of Law at Harvard Law School and Matthew J. Schoenfeld is a Portfolio Manager based in Chicago. This post was authored by Professor Fried and Mr. Schoenfeld.

In May, the Senate unanimously passed a bill—the Holding Foreign Companies Accountable Act—designed to improve financial reporting by China-based firms trading on U.S. exchanges. Fraud at these firms—including most recently Luckin Coffee—has cost American investors tens of billions of dollars over the last decade. The bill thus targets a real problem. Unfortunately, its remedy is likely to hurt—not help— the American shareholders of these firms.

To reduce fraud, the Sarbanes-Oxley Act of 2002 requires audits of every U.S.-traded firm to be inspected by the Public Company Accounting Oversight Board. But U.S.-traded firms based in China, whose market capitalizations collectively exceed $1 trillion, refuse to comply. They and Beijing say PCAOB inspection of China-based audit records would violate state-secrecy laws. Why hide these records from the PCAOB? Inspections would likely turn up improper payments to officials, putting them at risk and embarrassing the Chinese Communist Party.


Climate Change Litigation Takes an Ominous Turn

William Savitt and Anitha Reddy are partners and Bita Assad is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum.

Last week witnessed a critical but largely unremarked advance for plaintiffs seeking to impose liability on major public companies for the social costs of climate change.

The Ninth Circuit’s ruling in City of Oakland v. BP PLC cleared the path for state-court litigation against corporate defendants on the theory that producing, distributing, using, or profiting from fossil fuels constitutes a “public nuisance.” The cities of Oakland and San Francisco sued large energy companies in California state court, seeking an order requiring them “to fund a climate change adaptation program for the cities.” The energy companies removed the case to federal court and moved to dismiss the complaint. The district court agreed with the energy companies that the cities’ state-law nuisance claim was governed by federal law. “If ever a problem cried out for a uniform and comprehensive solution,” wrote the district judge, it is the “geophysical problem” of climate change. “A patchwork of fifty different answers to the same fundamental global issue would be unworkable.” Unpersuaded, the Ninth Circuit concluded that the cities’ claim neither presented a “substantial question of federal law” nor was completely preempted by the federal Clean Air Act.

Stakeholder Capitalism and the Pandemic Recovery

Sanford Lewis is Director at the Shareholder Rights Group. This post is based on a Shareholder Rights Group memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here) and Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

As of this writing, the US COVID-19 pandemic impacts include 100,000 dead and almost 40 million newly unemployed. The reopening process is anticipated to yield a “roller coaster” recovery in which businesses will restart and then shut down again in response to workforce and regional outbreaks. Although all members of society are affected by this extended crisis, the pain is unequally distributed, with front-line workers and people of color among the hardest hit.

The pandemic is testing all of us, and it is also a litmus test for the 2019 pledge of 183 corporate CEOs to operate their businesses in the interests of employees, consumers, suppliers, and communities, as well as shareholders. When announced last year, it the new Statement on the Purpose of a Corporation (“the Statement”) by the Business Roundtable was seen by some as heralding a new era of Stakeholder Capitalism—an era of corporate responsibility to stakeholders that moved beyond shareholder primacy. Yet the Statement and the concept of Stakeholder Capitalism are devoid of implementing principles.

If stakeholder capitalism is to be made real, shouldn’t there be corresponding rules and concepts of stakeholder governance? Isn’t there a need for a coherent set of legal and operational principles for implementation? How will the fiduciary duties of directors and executives change to reflect these new commitments?


The Politicization of Corporate Governance—A Viable Alternative?

Tami Groswald Ozery is a co-editor of the Forum and Fellow at the Harvard Law School Program on Corporate Governance. This post is based on her recent paper, forthcoming in the American Journal of Comparative Law.

It is accepted almost as a truism that without robust and efficiency-driven legal institutions, markets are limited in their ability to sustain capital market growth. Beyond early stages of market development, local alternatives are expected to give way to certain traits of corporate capitalism if further growth is to be achieved. This prevailing expectation is shared among development theorists, law and finance researchers, and comparative corporate governance scholars and has been the basis of rich academic writing and international policy.

Four decades of economic development in China challenge these conventions. In my paper The Politicization of Corporate Governance—A Viable Alternative?, forthcoming in the American Journal of Comparative Law, I contrast the prevailing approach above with the role played by political institutions in the governance of Chinese firms. Despite their apparent similarities, Chinese public firms, and the domestic capital markets within which they operate, sustain strong idiosyncrasies that go against many fundamentals in economics and legal thought. China’s public firms continue to rely on political influence as a substitute for conventional notions of sound corporate governance. With modern firms with global prominence and a capital market that is the second largest in the world, corporate governance in China seems to have passed the point of an “adjust or perish” prognostic.

Perhaps most strikingly, as the market continues to develop, the use of political substitutes not only has not receded, but has expanded and become more overt over time (with respect to firms with and without state ownership, and notwithstanding the locations of their listings). At its current inflection point, when the domestic demand for growth and the regime’s ability to sustain growth encounter great challenges, the Chinese government and specifically the Chinese Communist Party (CCP) have moved to exercise an even more direct and transparent role in market activity. Public firms in present-day China are increasingly governed by a politicized corporate governance in which political institutions with corporate governance capacities are deployed both inside and outside firms. In my paper, I shed light on this process, which I term the “politicization of corporate governance”; evaluate the viability of political governance for the Chinese capital market; and consider its practical and theoretical implications to the global corporate governance discourse.


Top 10 Key Trends at 2020 Proxy Mid-Season

Betty Moy Huber is counsel, Joseph A. Hall is a partner, and Paula H. Simpkins is an associate at Davis Polk & Wardwell LLP. This post is based on their Davis Polk memorandum.

It is impossible to discuss this proxy season without acknowledging the impact that the COVID-19 pandemic has had and its resulting highs and lows. While the virus has upended the planning and conduct of annual shareholder meetings, it has also caused regulators, issuers, third-party vendors and other market participants to collaborate to avoid significant disruption this season. The SEC has nimbly stepped into the fray with guidance and relief for issuers. State governments have issued emergency orders or amended legislation to allow for virtual shareholder meetings. Investors and proxy advisory firms have issued more flexible policies, all of which taken together has allowed meetings in the United States to proceed. Here are the key trends we are seeing mid-season:

1. Shift to Virtual Meetings

U.S. public companies are expected, as a result of the pandemic, to hold a record number of 1,500 virtual meetings this year as compared to only about 300 in 2019. Some investors and proxy advisors have traditionally expressed skepticism as to whether virtual meetings can provide the level of shareholder participation that physical meetings can, but this season has shown, based on reports from certain large-cap companies, that shareholder participation has in fact increased. Indeed, certain prolific shareholder proponents were able to “attend” more meetings this season with travel no longer a factor. Market participants were able to carry out the first ever contested virtual meeting. That’s good news. This virtual meeting “mass experiment,” however, has made more pronounced flaws in proxy plumbing. For companies that used multiple vendors to support their virtual meetings, vendors were asked to provide workarounds to compensate for clunky technology or privacy concerns, some of which were granted and some not, due to no fault of the providers or the companies, but to the limits of the system. We expect issuers to continue to host virtual meetings in 2021 and thereafter. When the dust settles this season, both issuers and investors will put forth best practices to try to address lingering concerns.


Mitigating Accounting Fraud Risk During the Pandemic: Regulators’ Concerns and Prospective Solutions

Colleen Conry, Jeremiah Williams are partners at Ropes & Gray LLP and Meaghan Schmidt is Managing Director at AlixPartners. This post is based on a Ropes & Gray memorandum by Ms. Conry, Mr. Williams, Ms. Schmidt, and James Tsaparlis.

The COVID-19 pandemic brought with it economic downturn forcing businesses to compete with fewer resources and major operational hurdles. Historically, economic downturn yields more accounting fraud: Old fraud is uncovered amid heightened financial scrutiny [1] while the conditions for new fraud flourish. [2] We saw this in the 2008 financial crisis, but expect swifter and fiercer enforcement this time around, as the DOJ focuses on coronavirus-related frauds [3] and the SEC bolsters its Enforcement Division to ensure that “Main Street investors are not victims of fraud.” [4] Now more than ever, businesses must be extremely careful in preparing their financial statements. In this post, we argue for risk-mitigation strategies to curtail accounting fraud in three key coronavirus-impacted areas: disclosures, revenue recognition, and impairment.

Two recent SEC publications provide insight into likely areas of concern. Accounting issues coming out of crisis include not only the statement of figures, but their associated explanations and disclosures. In guidance released on March 25, 2020, the SEC’s Division of Corporate Finance (the March 25 Guidance) underscored that it is closely monitoring how companies report the risks and effects of COVID-19. [5] The March 25 Guidance lists a number of questions to consider in assessing and disclosing the impact of COVID-19 and details the appropriate use of non-GAAP metrics for items impacted by COVID-19.


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