Monthly Archives: July 2020

Seventh Circuit Holds That Price Impact Must Be Decided at the Class Certification Stage

Meredith Kotler, Mary Eaton, and Doru Gavril are partners at Freshfields Bruckhaus Deringer LLP. This post is based on their Freshfields memorandum

The Seventh Circuit Court of Appeals has just issued a decision of special interest to defendants in securities class actions under Section 10(b) of the Exchange Act. The Court vacated the district court’s certification of a class in a lawsuit against Allstate, holding that the district court failed to consider defendants’ evidence that the misrepresentations alleged by plaintiffs had no impact on Allstate’s stock price. Such evidence, the Court explained, could rebut the presumption of reliance on the market price, as the Supreme Court made clear in Halliburton II.

This new ruling has multiple implications for the defense of securities class actions. First, district courts cannot fail to consider defendants’ evidence at class certification stage, merely because the same evidence may also be relevant to merits issues. Second, where applicable, defendants should consider offering expert analysis at the class certification stage severing the “transaction causation” link between the alleged misrepresentation and the market price. Third, defendants must be careful about the probative value of the evidence they offer: as discussed below, the Court expressed skepticism that “no price movement” is the same thing as “no price impact.” We discuss below why we believe plaintiffs—not defendants—should bear the burden of distinguishing between these two concepts.


Our Approach to Sustainability

Sandra Boss is Global Head of Investment Stewardship at BlackRock, Inc. This post is based on a BlackRock report authored by Ms. Boss, Michelle Edkins, Amra Balic, Gassia Fox, Jon Posen, and Jim Badenhausen. 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).

This past January, BlackRock wrote to clients about how we are making sustainability central to the way we invest, manage risk, and execute our stewardship responsibilities. This commitment is based on our conviction that climate risk is investment risk and that sustainability-integrated portfolios, and climate-integrated portfolios in particular, can produce better long-term, risk-adjusted returns.

Our efforts around sustainability, as with all our investment stewardship activities, seek to promote governance practices that help create long-term shareholder value for our clients, the vast majority of whom are investing for long-term goals such as retirement. This reflects our approach to sustainability across BlackRock’s investment processes, in which we use Environmental, Social, and Governance factors in order to provide clients with better risk-adjusted returns, in keeping with both our fiduciary duty and the range of regulatory requirements around the world. As a result, we have a responsibility to our clients to make sure companies are adequately managing and disclosing sustainability-related risks, and to hold them accountable if they are not.


The Real Effects of Modern Information Technologies

Itay Goldstein is the Joel S. Ehrenkranz Family Professor at the Wharton School of the University of Pennsylvania; Shijie Yang is Assistant Professor at the Chinese University of Hong Kong, Shenzhen; and Luo Zuo is Associate Professor of Accounting at Cornell University SC Johnson College of Business. This post is based on their recent paper.

Modern information technologies have greatly facilitated timely dissemination of information to a broad base of investors at low costs. In our paper entitled The Real Effects of Modern Information Technologies,  we exploit the staggered implementation of the EDGAR system from 1993 to 1996 as a shock to information dissemination technologies to examine their effects on the real economy. Our first hypothesis is that the EDGAR implementation leads to an increase in the level of corporate investment through the equity financing channel. This hypothesis follows from the conventional wisdom that greater and broader information dissemination leads to an increase in the amount of total information in the marketplace, which improves the functioning of the financial market and firms’ access to external capital, thereby allowing firms to tap into new investment opportunities.

Our second hypothesis is that the EDGAR implementation affects the sensitivity of corporate investment to stock prices through the managerial learning channel. The idea that prices are a useful source of information goes back to Hayek (1945). Stock prices can reveal traders’ private information that is otherwise not available to managers, and hence can affect managers’ forecasts about their own firms’ fundamentals and their investment decisions. The managerial learning perspective predicts that the investment-to-price sensitivity depends on the extent to which prices reveal new information to managers (i.e., revelatory price efficiency), which can be and is often different from the extent to which prices reflect all available information (i.e., forecasting price efficiency).


Supreme Court Holds That CFPB’s Structure Is Unconstitutional

Rachel Rodman and Scott Cammarn are partners and Nihal Patel is a special counsel at Cadwalader, Wickersham & Taft LLP. This post is based on their Cadwalader memorandum.

On June 29, the Supreme Court issued its long-awaited opinion in Seila Law LLC v. Consumer Financial Protection Bureau, finally resolving the question that has dogged the new agency since its inception: Is the leadership structure of the Consumer Financial Protection Bureau (CFPB) constitutional? Writing for a 5-4 majority, Chief Justice John Roberts ruled that the CFPB structure—“an independent agency that wields significant executive power and is run by a single individual who cannot be removed by the President unless certain statutory criteria are met”—violates the Constitution’s separation of powers.

For financial services companies regulated by the CFPB, the most important aspect of Seila Law is not the headline constitutional defect, but the remedy. Choosing “a scalpel rather than a bulldozer,” the Court did not invalidate the CFPB. The Court held 7-2 that the Director’s constitutionally offensive removal protection could be severed from the CFPB’s other authorities, thus bringing the Director (and with her, the CFPB) under Presidential control, while leaving the CFPB’s other powers in place.

While Seila Law is an important case in the evolving doctrine of separation of powers as applied to independent agencies, the case has three immediate consequences for financial services companies. First, the CFPB is here to stay, and its broad authorities and other controversial aspects (such as its insulation from Congressional appropriations) remain intact. Second, the CFPB’s Director is now directly accountable to the President, significantly raising the stakes in the 2020 election for the agency’s regulatory and enforcement agenda. Third, the Court left one important question unanswered: it declined to address the effect of its ruling on prior CFPB rules and enforcement actions. While we believe the agency will attempt to cure the constitutional defect, we expect continued litigation—and uncertainty—on this issue.


Going Dark: SEC Proposes Amendments to Form 13F

Adam O. EmmerichDavid M. Silk, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. The following post is based on a Wachtell Lipton memorandum by Mr. Emmerich, Mr. Silk, Mr. Niles, and Oluwatomi O. Williams. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here) and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

The SEC has proposed an amendment to Form 13F that would exempt from filing all money managers holding less than $3.5 billion of “13(f) securities.” The threshold would apply without regard to the fund’s overall size or total assets under management. Increasing the threshold to $3.5 billion from the current cut-off of $100 million would slash the number of reporting filers by 90%, from 5,089 to 550, effectively abolishing Form 13F as a reporting system for most investors, including many activist and event-driven hedge funds, and preserve it only for the largest index funds and asset managers.

Form 13F generally requires investment managers holding more than $100 million of such 13(f) securities (typically Exchange-traded equity securities, certain options and warrants, shares of closed-end investment companies and certain convertible debt securities) to disclose their holdings within 45 days of the end of each quarter, and is often the primary means by which investors, companies and other market participants first learn or verify that an activist hedge fund is accumulating or has accumulated a significant (but less than 5%) position in a target company’s stock. Because many activists do not own $3.5 billion of 13(f) securities, adoption of this revision would permit them to “go dark” and make it significantly more difficult to determine whether an activist, or a “wolf pack” of activists, owns a stake in a company. Indeed, as we have previously discussed, activist “tipping” could well result in only the wolf pack—and not the target company or other shareholders—being aware of the ownership stake until the moment that the activist strike occurs.


Navigating Insolvency Risk in COVID-19 Distressed Companies

Pamela S. PalmerHoward M. Privette, and Douglas D. Herrmann are partners at Troutman Pepper. This post is based on a Troutman Pepper memorandum by Ms. Palmer, Mr. Privette, Mr. Hermann, and Samantha K. Burdick.

As COVID-19 related economic disruptions place unprecedented stress on cash flows, the risk of insolvency is a new and growing concern for many businesses. Against the backdrop of a decades-long growth in corporate debt, boards of directors are making decisions that have the potential for pitting the interests of creditors against the interests of equity shareholders. As the financial health of a business deteriorates, its directors should be cognizant that their fiduciary duties may shift or expand with respect to these different constituencies if and when the company actually crosses over into insolvency.

With a focus on comparing California and Delaware law, this post briefly describes how insolvency can affect directors’ fiduciary duties, and discusses ways that directors can minimize the risk of personal liability as those duties shift.


Spotlight on Boards

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton and Carmen X. W. Lu. 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); Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here); and Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

The ever-evolving challenges facing corporate boards prompt periodic updates to a snapshot of what is expected from the board of directors of a public company—not just the legal rules, or the principles published by institutional investors and various corporate and investor associations, but also the aspirational “best practices” that have come to have equivalent influence on board and company behavior. The coronavirus pandemic and resulting recession, combined with the wide embrace of ESG, stakeholder governance and sustainable long-term investment strategies by the Business Roundtable, the World Economic Forum, the British Academy, BlackRock, Vanguard, State Street and other investors and asset managers is a decisive inflection point in the responsibilities of the board of directors of companies. The statement of corporate purpose by the World Economic Forum is a concise and cogent reflection of the current thinking of most of the leading corporations, institutional investors, asset managers and their organizations, so too governments and regulators outside the United States:

The purpose of a company is to engage all its stakeholders in shared and sustained value creation. In creating such value, a company serves not only its shareholders, but all its stakeholders – employees, customers, suppliers, local communities and society at large. The best way to understand and harmonize the divergent interests of all stakeholders is through a shared commitment to policies and decisions that strengthen the long-term prosperity of a company.


SEC Provides Further Guidance on Covid-19 Disclosure

Richard Bass is an associate and Gary Emmanuel and Thomas P. Conaghan are partners at McDermott Will & Emery. This post is based on a McDermott memorandum by Mr. Bass, Mr. Emmanuel, Mr. Conaghan, Robert H. Cohen, Ze’-ev D. Eiger and Eric Orsic.

On June 23, 2020, the Division of Corporation Finance (CF) and the Office of the Chief Accountant of the US Securities and Exchange Commission (SEC) released guidance that provides additional views on disclosure related to COVID-19, supplementing earlier guidance provided on March 25, 2020 and April 3, 2020, respectively.

In Depth

The latest guidance reiterates earlier statements encouraging companies to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively revise and update disclosures as facts and circumstances change.

In the new guidance, CF provided the following to help companies analyze their specific facts and circumstances:


GAO Report Highlights Dearth of ESG Disclosure

David M. Silk, David B. Anders, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Silk, Mr. Anders, Mr. Niles, Carmen X. W. Lu, and Ram Sachs. 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).

A report published by the United States Government Accountability Office (GAO) earlier this month has further highlighted the dearth of comparable, decision-useful ESG disclosures sought by investors. Commissioned by U.S. Senator Mark Warner, the report noted that most institutional investors contacted by the GAO seek ESG information to enhance their understanding of risks and to assess long-term value. The report also noted challenges with understanding and interpreting both quantitative and narrative ESG disclosures, and that the quality and relevance of such disclosures to investors remain highly variable. Following the release of the GAO report, Senator Warner called on the U.S. Securities and Exchange Commission (SEC) to establish a task force to determine a robust set of quantifiable and comparable ESG metrics to be disclosed by all public companies. Senator Warner had previously pushed for more extensive disclosure of human capital-related metrics in light of their materiality to most businesses.

The GAO’s findings echo similar sentiments among the investor community, who, along with other stakeholders, have noted the growing need to establish a standardized ESG disclosure framework to facilitate the disclosure of decision-useful information. Various private-sector initiatives are already in progress—the World Economic Forum’s International Business Council earlier this year released a consultation draft of core and expanded ESG disclosures drawing on metrics from existing ESG reporting frameworks. Likewise, the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) have pledged to work together to align ESG reporting standards.


Horizontal Directors

Yaron Nili is Assistant Professor of Law at the University of Wisconsin-Madison Law School. This post is based on his recent paper, forthcoming in the Northwestern University Law Review.

Common ownership has garnered significant attention in both antitrust and corporate governance discourse. Scholars have long been concerned that monopolies, cartels, and other forms of coordination can harm consumers. In recent years, prominent scholars have also raised concerns regarding companies’ incentives to compete where major institutional shareholders hold large equity positions in all competitors.

Yet, as the common ownership debate endures, another channel that may enable companies to coordinate, and has similar antitrust and governance concerns has received little attention. My paper, Horizontal Directors, spotlights the surprising prevalence of directors who serve on the boards of multiple companies within the same industry and who may also facilitate coordination that may lead to anticompetitive behavior. Against this empirical backdrop, the paper explores the benefits horizontal directors provide to companies and investors, as well as the antitrust and governance concerns that they may pose, and puts forward several policy recommendation to regulators and investors. Below I summarize some of the key findings:


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