Monthly Archives: August 2020

Statement by Chairman Clayton on Modernizing the Framework for Business, Legal Proceedings and Risk Factor Disclosures

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent statement at an open meeting of the SEC. 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.

Good morning. This is an open meeting of the U.S. Securities and Exchange Commission, under the Government in the Sunshine Act. I would like start today’s meeting by welcoming Commissioner Crenshaw to her first open meeting.

Today, we are considering amendments to modernize the description of business, legal proceedings, and risk factor disclosures that companies are required to make under Regulation S-K. These amendments are part of the Commission’s broader efforts to retroactively review and improve our public company disclosure framework and related requirements.

First, I want to put this work in context. The rules we adopt today update various Regulation S-K items that essentially have not changed in over 30 years. Our economy, and the world economy, have changed markedly in that time, and many of our rules, which were well rooted in the characteristics of the economy of the 1970s and 1980s, simply have not kept up. Here, I note that in general, the longer you wait to update these regulations, particularly prescriptive regulations—I think of it like years of deferred maintenance in a home—the harder it can be to do. I applaud the staff for their years-long efforts and thoughtful approach to modernize these and other disclosure requirements as well as similar efforts they have undertaken with respect to many of our other rules.


Statement by Chairman Clayton on Modernization of the Accredited Investor Definition

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent public statement. 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.

Today [Aug. 26, 2020], the Commission adopted final rules to modernize and add much needed flexibility to the definition of “accredited investor” by adding new categories of qualifying individuals and entities that have demonstrated financial sophistication such that they should not be excluded from the very large, multifaceted and important private capital markets. The private capital markets are important to investors and issuers of various types, as well as our economy more generally. The accredited investor definition is the principal test for investor participation in significant segments of our private capital markets. It also plays an important role in other state and federal securities law contexts.

The test for individuals to qualify as accredited investors has largely remained unchanged for over 35 years. [1] This test relies exclusively on a person’s income and net worth. If you make enough money or have sufficient assets, you are eligible to participate, and if you do not, you generally are not eligible. The Commission’s use of income or wealth as the exclusive proxy for an individual’s financial sophistication and ability to assess and bear risk has long been unsatisfactory. Individual investors who do not meet the wealth tests, but who clearly are financially sophisticated enough to understand the risks of participating in unregistered offerings, are denied the opportunity to invest in our private markets. For example, using only a binary test for wealth disadvantages otherwise financially sophisticated Americans living in lower income/cost-of-living areas.


Joint Statement by Commissioners Lee and Crenshaw on the Failure to Modernize the Accredited Investor Definition

Allison Herren Lee and Caroline Crenshaw are Commissioners at the U.S. Securities and Exchange Commission. This post is based on their recent public statement. The views expressed in the post are those of Commissioner Lee and Commissioner Crenshaw, and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff

The accredited investor definition is the single most important investor protection in the private market. [1] Today’s [Aug. 26, 2020] amendments purport to “update” that definition while leaving in place 38-year old wealth thresholds, declining to index the thresholds to inflation, and declining to provide economic analysis to show how the failure to index will affect American investors—the bulk of whom are seniors—going forward.

With its actions today, the Commission continues a steady expansion of the private market, affording issuers of unregistered securities access to more and more investors without due regard for the risks they face, and without sufficient data or analysis to ensure that our policy choices are grounded in fact rather than supposition.


Comment on the Proposed DOL Rule

Sarah Keohane Williamson is CEO and Victoria Tellez is a Senior Research Associate at FCLTGlobal. This post is based on their FCLTGlobal comment letter to the U.S 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), 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), and Companies Should Maximize Shareholder Welfare Not Market Value, by Oliver D. Hart (discussed on the Forum here).

The Department of Labor (“The Department”) is inviting public comments on a proposal to codify a regulatory structure for the Department’s current “Investment duties” regulation at 29 CFR 2550.404a-1. This amendment would assist ERISA fiduciaries in establishing regulatory guidelines for plan fiduciaries in light of recent environmental, social, and governance (ESG) investment trends. The Department of Labor has voiced concerns that these trends may lead plan fiduciaries to “choose investments of action to promote environmental, social, and public policy goals unrelated to the interests of plan participants and beneficiaries in financial benefits from the plan and expose plan participants and beneficiaries to inappropriate investment risks”.

Based on FCLTGlobal’s review of existing academic evidence, our own analysis, and research informed by our multi-year conversations with our Members and other experts, we suggest the Department carefully consider the following:

  • The duty of ERISA fiduciaries is to provide financial retirement benefits often many years into the future
  • Considering the long-term performance of companies and investments is critical to providing those benefits
  • Ignoring long-term trends that may affect the financial value of investments because they fall into the category of ESG issues would be a violation of fiduciary duty


McDonald’s Clawback Suit Against Former CEO: A Cautionary Tale

Scott Spector, David Bell, and Elizabeth Gartland are partners at Fenwick & West LLP. This post is based on their Fenwick memorandum 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 Rationalizing the Dodd-Frank Clawback by Jesse Fried (discussed on the Forum here).

McDonald’s Corporation has joined a growing list of companies that have taken action to forfeit unpaid compensation or demand repayment of compensation previously paid to a former CEO, including equity awards or proceeds from the sale of equity awards, pursuant to company clawback policies. The McDonald’s complaint against its former CEO serves as a cautionary reminder to companies and boards that a clawback situation can heighten a company’s litigation exposure, trigger embarrassing and potentially damaging publicity, and raise questions about the adequacy of the board’s governance and oversight.

In the case of McDonald’s, the situation comes at a significant cost of having to litigate to obtain repayment of severance and equity awards paid to the CEO upon his termination of employment, plus the cost of multiple investigations by the McDonald’s board of directors following from their initial conclusion that the termination of the CEO should be treated as a termination “without cause” enabling the CEO to receive full severance benefits upon his negotiated termination.

Summary of Complaint

On August 10, 2020, McDonald’s filed suit in the Delaware Court of Chancery against its former CEO, Steve Easterbrook, accusing him of lying, concealing evidence and fraud after entering into a separation agreement with Easterbrook on November 3, 2019. In November 2019, McDonald’s announced Easterbrook’s termination following the board’s determination that he violated company policy and demonstrated poor judgment involving a non‑physical consensual relationship with an employee (via text messages and video calls), and that the board determined that the termination was to be one “without cause” permitting Easterbrook to receive full benefits under the McDonald’s severance plan in excess of $40 million.


Comment on the Proposed DOL Rule

Mindy S. Lubber is President and CEO of Ceres, Inc. This post is based on her comment letter to the Department of Labor.

I am writing regarding the Department of Labor Employee Benefits Security Administration’s proposed rule, Financial Factors in Selecting Plan Investments, Regulatory Identifier Number (RIN) number 1210-AB95.

Ceres is a nonprofit organization working with institutional investors and companies to build sustainability leadership and drive solutions throughout the economy. We support the Investor Network on Climate Risk and Sustainability, which consists of over 175 institutional investors managing more than $29 trillion in assets, who advance leading investment practices, corporate engagement strategies, and policy and regulatory solutions to address sustainability risks and opportunities. Ceres has worked closely with institutional investors since our founding in 1989, and with an expanding group of investors since the founding of our Investor Network 17 years ago.

I am concerned that the proposed rule would undermine fiduciaries from assessing and managing financially material environmental, social and governance (ESG) risks and opportunities in their investments. Members of our Investor Network have found that evaluating ESG issues provides a clearer picture of financial risks in their portfolios, enabling them to pursue a range of strategies to reduce those risks, including ESG integration in analysis and investment decisions, investing in companies with superior ESG performance, corporate engagement, and advocating for policy and regulatory solutions.

I urge the Department to withdraw, or in the alternative, substantially modify the proposed rule. Specifically, I call on The Department to: (1) Acknowledge that ESG issues may in fact pose material short, medium and long term financial impacts and risks; (2) Clarify that when ESG issues present material risks or opportunities, the fiduciary duties under the U.S. Employee Retirement Income Security Act of 1974, as amended (ERISA), would compel qualified investment professionals to treat such ESG issues as economic considerations; (3) Retain the “tie-breaker” test, which allows for ESG factors to be considered for non-pecuniary reasons; and (4) Rely upon its existing, protective framework in whether a ESG fund (pecuniary or non-pecuniary) may constitute a QDIA or component of a QDIA.


For Whom Corporate Leaders Bargain

Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance at Harvard Law School; Kobi Kastiel is Assistant Professor of Law at Tel Aviv University, and a Research Fellow at the Harvard Law School Program on Corporate Governance; and Roberto Tallarita is Associate Director of the Program on Corporate Governance, and Terence C. Considine Fellow in Law and Economics at Harvard Law School. This post is based on their recent study. Related Program research includes The Illusory Promise of Stakeholder Governance.

At the center of a fundamental and heated debate about the purpose that corporations should serve, an increasingly influential “stakeholderism” view advocates giving corporate leaders the discretionary power to serve all stakeholders and not just shareholders. Supporters of stakeholderism argue that its application would address growing concerns about the impact of corporations on society and the environment. By contrast, critics of stakeholderism object that corporate leaders should not be expected to use expanded discretion to benefit stakeholders. In a new study we placed on SSRN, For Whom Corporate Leaders Bargain, we put forward novel empirical evidence that can contribute to resolving this key debate.

Although stakeholderism has enjoyed unprecedented levels of support in recent years, during the era of hostile takeovers many states already adopted “constituency statutes” that embraced an approach similar to that advocated by modern stakeholderists. Proposed as a remedy to eliminate or reduce the adverse effects of acquisitions on employees and other stakeholders, these statutes accorded corporate leaders the power to give weight to the interests of stakeholders when considering a sale of their companies. The current debate should be informed, we argue, by the lessons that can be learned from the results produced by this large-scale experiment in stakeholderism.

We therefore set out to investigate empirically whether constituency statutes actually delivered protections for stakeholders as was hoped for. Although constituency statutes have long been a common topic in corporate law textbooks, as well as the focus of many law review articles, thus far there has been no direct study of the terms of acquisition agreements negotiated in the shadow of such statutes. Using hand-collected data on a large sample of such agreements from the past two decades, we put forward novel empirical evidence on the subject.

We document that corporate leaders selling their companies to private equity buyers obtained substantial benefits for their shareholders as well as for themselves. By contrast, corporate leaders made little use of their power to give weight to the interests of stakeholders. Our review of the contractual terms of these deals finds very little protection provided to stakeholders from the risks posed by private equity control.

We conclude that constituency statutes have failed to deliver their promised benefits. These conclusions have implications not only for the long-standing debate on constituency statutes but also for the general debate on stakeholder capitalism. Our findings cast substantial doubt on the wisdom of relying on the discretion of corporate leaders, as stakeholderism advocates, to address concerns about the adverse effects of corporations on their stakeholders.

Below is a more detailed account of our analysis:


What Companies are Disclosing About Cybersecurity Risk and Oversight

Steve W. Klemash is Americas Leader at the EY Center for Board Matters; Jamie C. Smith is Investor Outreach and Corporate Governance Specialist at the EY Center for Board Matters; and Chuck Seets is Americas Assurance Cybersecurity Leader at EY. This post is based on their EY memorandum.

Cybersecurity risk is intensifying, particularly with widespread remote working and increased online interactions amid the pandemic. The rapid adaptation of multiple business processes and protocols to enable this virtual environment has exponentially increased the corporate attack surface and introduced new risks to the confidentiality, integrity and availability of critical company data and supporting systems.

The return of some workers to a physical workplace is also raising new data security risks and privacy questions, with companies collecting data related to employee, contractor and customer health such as COVID-19 testing, temperature checks and contact tracing. At the same time, harnessing new and disruptive technologies—and enabling the trust of stakeholders and the marketplace in doing so—is key to helping organizations lead, innovate and differentiate.

In this environment, remaining cyber-resilient and building stakeholder trust in the company’s data security and privacy practices is a strategic imperative. Public disclosures can help build trust by providing transparency and assurance around how boards are fulfilling their cybersecurity risk oversight responsibilities.

For the third consecutive year, EY researchers have analyzed cybersecurity-related disclosures in the proxy statements and Form 10-K filings of Fortune 100 companies to identify emerging trends and developments and help companies identify opportunities for enhanced communication. We looked at 76 Fortune 100 companies that filed those documents from 2018 through May 31, 2020. We focused on the areas of cybersecurity board oversight (including board-level committee oversight and director qualifications), statements on cybersecurity and data privacy risks, and risk management (including cybersecurity risk mitigation and response efforts and engagement with external security consultants). We also examined the current regulatory and US public policy landscape as it relates to cybersecurity, as well as perspectives from investors, directors and EY cybersecurity professionals.


Funding the Future: Investing in Long-Horizon Innovation

Sarah Keohane Williamson is CEO, Ariel Babcock is Head of Research, and Allen He is Associate Director at FCLTGlobal. This post is based on their FCLTGlobal memorandum. Related research from the Program on Corporate Governance includes The Uneasy Case for Favoring Long-term Shareholders by Jesse M. Fried (discussed on the Forum here).

Executive Summary

Effective long-term capital allocation is fundamental for innovating and creating value; investment in research and development (R&D) fuels this growth. Successful R&D can be transformational for an organization and for broader society. But while worldwide spending on R&D has slowly increased, R&D returns have been declining. What’s driving this decline? Emerging evidence suggests a short-term mindset lies at the heart of this puzzle.

R&D spending, especially long-horizon R&D project spending, faces a unique set of short-term pressures relative to other types of long-term investment. When facing short-term financial pressures, behavioral biases including manager risk aversion and uncertainty around forecasting potential future returns (among other things) lead to a tendency among management teams to cut long-horizon projects first. The declining tenure of managers, the lack of innovation-linked metrics in incentive compensation plans, the typically asymmetric return profile of long-horizon projects, and an investment community that often ignores the potential impact of long-horizon innovation spending in a company’s valuation analysis all contribute to this problem.


Stockholders Versus Stakeholders—Cutting the Gordian Knot

Peter A. AtkinsMarc S. Gerber, and Kenton J. King are partners at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on a Skadden memorandum by Mr. Atkins, Mr. Gerber, Mr. King, and Edward B. Micheletti. 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).

Directors of most for-profit U.S. corporations have long considered the corporation’s relationships with customers, employees, suppliers and the communities in which they operate—sometimes referred to as “stakeholders” [1]—in the course of overseeing the building, operating and growing of the corporations’ businesses. In more recent years, the concepts of “stakeholders” and “stakeholder interests” have greatly expanded, with the interests generally falling under the umbrella of environmental, social and governance (ESG) matters. [2] Now current and ongoing events, including the COVID-19 pandemic and the increased attention to systemic racism following the killing of George Floyd, add new and increasing complexity for boards of directors as they consider stakeholder interests in the context of navigating their businesses through economic headwinds. Calls from some quarters for boards to focus on these stakeholder interests, while distinguishing them from stockholder interests, have sown confusion and misunderstanding. This article, through stating a series of guiding principles, attempts to “cut through it all” like the Gordian Knot, bring clarity to the discussion and provide real-world guidance for director decision-making.


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