Monthly Archives: July 2020

Synthetic Governance

Steven Davidoff Solomon is Professor of Law at the UC Berkeley School of Law. This post is based on a recent paper by Professor Davidoff Solomon; Byung Hyun Ahn, a doctoral student at the Haas School of Business at UC Berkeley; Jill Fisch, the Saul A. Fox Distinguished Professor of Business Law at the University of Pennsylvania Law School; and Panos N. Patatoukas, associate professor at the Haas School of Business at UC Berkeley. Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here) and The Perils of Small-Minority Controllers by Lucian Bebchuk and Kobi Kastiel (discussed on the Forum here).

Scholars, practitioners and policymakers continue to debate what constitutes “good” corporate governance. Investors threaten to vote against directors of issuers with defective governance practices while, at the same time, call for regulators to ban particularly controversial practices such as fee-shifting bylaws and dual class voting structures. Although empirical studies have failed to develop conclusive evidence linking specific governance provisions to firm value, the debate has become increasingly heated and political.

In Synthetic Governance, we provide a possible solution to the debate. As we explain, the rise of index investing offers a low-cost market-based tool by which asset managers can give investors the opportunity to vote with their feet by selecting a rules-based investment strategy that screens portfolio companies according to specified governance criteria. Investors with particular corporate governance preferences could, by selecting a bespoke governance index, and mechanism, invest according to those preferences. At the same time, governance-based indexes can provide valuable data on the relationship between corporate governance and firm value.


Five Key Points About the DOL’s New Fiduciary Rule

Karen Shriver is an associate and Greg Nowak and Michael Crumbock are partners at Troutman Pepper. This post is based on a Troutman Pepper memorandum by Ms. Shriver, Mr. Nowak and Mr. Crumbock, Greg Parisi, Terrance James Reilly, and Evelyn Traub.

On June 29, 2020, the U.S. Department of Labor (DOL) announced a new proposed class exemption to certain prohibited transaction restrictions in the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code of 1986, as amended (the Code), entitled “Improving Investment Advice for Workers & Retirees.” The proposed exemption is intended to help workers and retirees by preserving the wide availability of investment advice arrangements and products for retirement investors. The proposed exemption is expected to be well-received by “investment advice fiduciaries,” because it is broader and more flexible than the DOL’s pre-existing prohibited transaction class exemptions which generally provide relief for more discrete transactions. Here are five things you should know about the proposed exemption.

1. Background

In 1975, the DOL established a five-part test for fiduciary status under ERISA. The Code uses identical wording for the five-part test in its definition of fiduciary. Under both ERISA and the Code, a person is an investment advice professional if the person renders “investment advice” for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, OR has any authority or responsibility to do so.


SEC Identifies Private Fund Deficiencies

Brian T. Daly and Marc E. Elovitz are partners at Schulte Roth & Zabel LLP. This post is based on their SRZ memorandum. 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) and Insider Trading Via the Corporation by Jesse Fried (discussed on the Forum here).

On June 23, 2020, the SEC Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert [1] that highlights commonly encountered deficiencies in examinations of hedge fund managers and private equity fund sponsors.

At the outset, the Risk Alert connects its observations with respect to private investment funds with the current Commission’s repeated focus on retail investors, noting that private funds “frequently have significant investments from pensions, charities, endowments and families.” Indeed, the Risk Alert is described as not only useful information for advisers to private funds; it is offered “to provide investors with information concerning private fund adviser deficiencies.”

While the Risk Alert does not establish new standards of conduct, it does provide a concise summary of three categories of deficiencies the examination staff stated that it finds in its reviews of advisers to private funds. These findings are consistent with what we have observed on examination of private fund advisers.


Equity Market Structure Regulation: Time to Start Over

Paul G. Mahoney is the David and Mary Harrison Distinguished Professor at the University of Virginia School of Law. This post is based on his paper, forthcoming in the Michigan Business & Entrepreneurial Law Review.

Over the past 15 years, stock trading has switched from a mostly manual to a mostly automated process. The SEC’s Regulation NMS provides a regulatory framework for the new world of electronic exchanges. My recent paper, Equity Market Structure Regulation: Time to Start Over, forthcoming in the Michigan Business & Entrepreneurial Law Review, argues that Regulation NMS has not achieved its goals and should be replaced with a simpler, less prescriptive system.

In the early 2000s, the NYSE and Nasdaq dominated trading in large-company stocks. Today, trading is fragmented among 13 different exchanges, with three more on the way. The NYSE and Nasdaq previously used different trading systems. The NYSE operated a physical trading floor. On Nasdaq, competing dealers posted buying and selling prices electronically and brokers transacted with them by telephone.

Today, all exchanges are primarily electronic and automated. Brokers enter orders directly into the exchange’s hardware and software system, which continuously and automatically executes all trades that can be made. An exchange today is a computer server and a set of rules incorporated into code.


A Flowchart of the Delaware Standards of Review

Matthew M. Greenberg is a partner and Taylor B. Bartholomew, and Christopher B. Chuff are associates at Troutman Pepper. This post is based on their Troutman Pepper memorandum and is part of the Delaware law series; links to other posts in the series are available here

In the context of an M&A transaction, practitioners are routinely left to navigate the various standards of review that are applied by the Delaware courts to evaluate whether a Delaware corporation’s directors have complied with their fiduciary duties. Determining which standard of review will apply to a given transaction is particularly critical—depending on the applicable standard, a Delaware court may heavily scrutinize a transaction or determine that the directors may face personal liability for their decisions in connection with the transaction. The flowchart below has been prepared to serve as a quick-reference tool for M&A practitioners when determining which standard of review might apply. While this chart has been prepared in accordance with applicable case law decided to date, it is important to bear in mind that each step set forth below necessarily involves a fact-intensive analysis and that this flowchart should not be exclusively relied upon.

The flowchart is available here.

CEO Succession Plans in a Crisis Era

Rusty O’Kelley III, Margot McShane, and Justus O’Brien are co-leaders of the firm’s Board & CEO Advisory Partners at Russell Reynolds Associates. This post is based on their Russell Reynolds memorandum.

CEO succession planning is one of the most important responsibilities of a corporate board, and one of the most challenging. In the best of circumstances, directors are working thoughtfully to anticipate the future, develop potential successor candidates over several years, and to ultimately have one of them step into the top spot. In emergencies or other unexpected circumstances, there is a great sense of uncertainty as to whether the board is selecting the best leader, or just the best leader available right now. It is an expensive question to answer. By one estimate, replacing an ill-chosen or short-tenured CEO leads to a loss of $1.7 billion in shareholder value in addition to a loss of organizational confidence and momentum.

According to forthcoming research from Russell Reynolds Associates and The Conference Board, more than 60 percent of directors surveyed stated that their board had not reviewed or updated the succession plan for the CEO and other key executives in light of the health risks posed by the COVID-19 crisis. The sector with the highest share of corporate boards that did review the CEO succession plan is Consumer Staples (25 percent of all respondents in this sector), while the sector with the lowest share is Materials (11.1 percent). Interestingly, the largest companies were by far those with the highest shares of cases where the board of directors did not review the CEO succession plan (70.3 percent of those with annual revenue of $10 billion and over and 80 percent of those in the Financials and Real Estates sectors with asset value exceeding $100 billion).


The Board’s Role in Guiding the Return to Work

Erica Volini, Steve Hatfield, and Jeff Schwartz are principals at Deloitte Consulting LLP. This post is based on their Deloitte memorandum.


We began discussing this publication in January 2020, before global pandemic and social unrest became central topics of everyday conversation. The impact of COVID-19 is devastating at the individual, local, national, and global level. It has created huge immediate changes to how and where people interact, and how business is done. For many organizations, it has also thrust the future of work (FOW) to the forefront, as management and workers grapple with changes today and prepare for a different and uncertain tomorrow. In many ways, the current environment has illuminated possibilities and opportunities that many organizations previously shied away from, but that are now accelerating the pace of change as management meets the challenges of now in preparation for now and the future.

While organizations continue to work through the near- and long-term effects of the pandemic, one of our initial observations is that companies leaning in on their future of work agenda appear to be better positioned to weather the impacts of this global disruption. These companies have strategized and planned for the what, who, where, and how of a shifting work landscape, proactively expanding their future of work portfolio over time, providing options for ongoing “forever” virtual work options, addressing and bolstering immediate needs for technology and connectivity, and implementing new ways of looking at jobs and interactions with the organizational ecosystem. [1] The pandemic appears to be accelerating these companies into the “new normal”—navigating the disruptions while improving their market positioning and brand. We refer to this strategy as “returning to work in the future of work”.


Comment Letter on DOL Proposed Rule on ESG Investments

Robert A.G. Monks is Chairman and Nell Minow is Vice Chair of ValueEdge Advisors. This post is based on their recent comment letter to the Department of Labor. 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 Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Robert H. Sitkoff and Max M. Schanzenbach (discussed on the Forum here).

We have the strongest possible objections to the proposed rule on the appropriate consideration of ESG or any other non-traditional factors for plan investments, which fails as a matter of process, substance, cost-benefit analysis, regulatory policy, economics, consistency with other Administration policy, and clarity. It addresses a “problem” that is never documented based on claims and assertions of costs and benefits that are recklessly unsubstantiated. Most dangerously, it departs from every previous precedent in the history of EBSA and its predecessor, PWBA, which one of this comment’s signatories headed in the Reagan administration. We have already submitted a comment with Jon Lukomnik and a distinguished group of co-signatories. This comment is a supplement to the earlier filing, and we may file further if other comments require a response or other relevant information becomes available.


Corporate Governance Update: Raising the Stakes for Board Diversity

David A. Katz is partner and Laura A. McIntosh is consulting attorney at Wachtell, Lipton, Rosen & Katz. This post is based on an article first published in the New York Law Journal. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite by Alma Cohen, Moshe Hazan, and David Weiss (discussed on the Forum here).

While diversity on boards of directors has been a high-profile issue for many years, and public companies have made notable progress in diversifying their boards over the past two decades, public companies now face increased pressure to move beyond verbal commitments and incremental progress. Investors, proxy advisors, and activists are demanding data-driven, measurable changes. They are leveraging litigation, legislation, shareholder proposals, and direct engagement to push companies to increase their commitment to diversity, to disclose their diversity data, and to make significant financial investments in diversity initiatives. Both gender and racial diversity are in the spotlight now.

A recent lawsuit by a shareholder of Oracle Corporation has opened a new line of attack on companies that have been slow to diversify their board membership and executive leadership team. The complaint alleges that Oracle’s failure to appoint racially diverse directors and officers—while making public statements avowing a commitment to racial diversity—constitutes securities fraud. The premise of the lawsuit, and the relief sought, are likely to provoke significant debate and some degree of change, regardless of the outcome of the litigation.


Statement by Commissioner Roisman at Open Meeting to Adopt Amendments to the Proxy Solicitation Rules

Elad L. Roisman is a Commissioner at the U.S. Securities and Exchange Commission. The following post is based on Commissioner Roisman’s recent statement at an open meeting of the SEC. The views expressed in this post are those of Mr. Roisman and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Thank you, Chairman Clayton. I want to express my gratitude for your continuing commitment to improving the proxy system, as well as for your thoughtful leadership throughout the process of developing this rulemaking in particular. Thank you also to Director [Bill] Hinman, Val Afshar, Director [S.P.] Kothari, Director [Dalia] Blass, and Tara Varghese for your presentations and all of the incredible work you and your teams have put into these recommendations. You should be very proud.


From the outset of my tenure as an SEC Commissioner, I have focused on reviewing the proxy voting infrastructure, seeking to learn more about how it is operating in practice, where our rules should be modernized, or where the system could be improved. [1] Early on, I realized that we needed to update and clarify our rules that are relied on by businesses that provide professional proxy voting advice and other services to investment advisers as well as other institutional investors.


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