Monthly Archives: August 2020

Best Buys and Own Brands: Investment Platforms’ Recommendations of Mutual Funds

Howard Jones is an Associate Professor of Finance at University of Oxford Saïd Business School. This post is based on a recent paper, forthcoming in The Review of Financial Studies, by Professor Jones; Gordon Cookson, Associate Director at KPMG UK; Tim Jenkinson, Professor of Finance at the University of Oxford Saïd Business School; and Jose Vicente Martinez, Assistant Professor of Finance at the University of Connecticut.

Retail investors in mutual funds are faced with a bewilderingly wide choice of products. Traditionally, they would be guided by their broker, but increasingly they are investing in mutual funds through online investment platforms, or ‘fund supermarkets’. These platforms produce recommendations of funds to help investors make their choice. Using a unique, largely non-public, dataset sourced from the United Kingdom financial regulator, the Financial Conduct Authority (FCA), we address three questions about these ‘best-buy’ lists— how they are drawn up, whether investors follow them, and whether they add value. We investigate whether platforms’ recommendations are tilted towards two categories of funds from which they are especially likely to benefit: funds affiliated with the platforms themselves and those which share a large part of their own commission revenues with the platforms.

Background and Data

In the United States, the distinction between brokers and investment platforms is not clear-cut, as many brokers also operate platforms and do not break out the flows through different channels—nor do they publish their fund recommendations in a systematic way. Prior research working with U.S. data has found that broker-mediated mutual funds have higher fees and worse performance (Bergstresser, Chalmers, and Tufano 2009; Chalmers and Reuter 2012; Del Guercio and Reuter 2014), and that the incentives of brokers intermediating mutual funds, notably revenue sharing, drive flows into those funds (Christoffersen, Evans, and Musto 2013). However, these studies have not been able to separate recommendations from other, unobservable benefits which brokers may provide to retail investors, such as advice on the appropriate mix of asset classes. The U.K. platforms we study are intermediaries which limit their advice to recommendations, which they make freely available across a wide range of asset classes and regions. Moreover, our regulator-sourced dataset includes non-public details of the fees charged by asset managers, the fraction of these fees shared with platforms and, for two of the platforms, the investor flows into mutual funds that were channeled through the platforms. We are therefore able to make a more direct link between recommendations on the one hand, and incentives, flows, and fund performance on the other than has been possible hitherto.

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Chancery Court Rules That Pre-Closing Attorney Client Privilege Over Deal Related Communications Stays with Sellers

Doru Gavril and David Livshiz are partners and Scott Eisman is special counsel at Freshfields Bruckhaus Deringer LLP. This post is based on a Freshfields memorandum by Mr. Gavril, Mr. Livshiz, Mr. Eisman, Paul Humphreys, Umer Ali, and Hadar Tanne. This post is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Court of Chancery (Vice Chancellor Zurn) recently held in DLO Enterprises, Inc. v. Innovative Chemical Products Group, LLC, 2020 WL 2844497 (Del. Ch. June 1, 2020), that the seller in an asset transaction retains attorney-client privilege over its pre-closing deal communications unless the asset purchase agreement explicitly provides otherwise. This rule, the court explained, contrasts with the default rule in a merger, where the privilege over the target’s pre-closing communications by operation of law, upon the effectiveness of the merger, vests in the surviving corporation (absent any contractual provision to the contrary). The court also observed that parties in an asset transaction can contract around the default rule for asset sales by specifying that the buyer acquires the privilege in whole or in part, or that the privilege is waived. While the DLO decision clarifies the default allocation of privilege in asset sale transactions, we do expect further litigation concerning the contractual language shifting the default privilege presumption. The decision also leaves open the treatment of attorney work product, which is not coextensive with the attorney-client privilege and which was not explicitly addressed in DLO.

Key Takeaways

  • The default rule in an asset purchase is that sellers retain privilege over their own pre‑closing deal communications unless the parties explicitly agree otherwise.
  • This rule differs from the default rule in a merger, where the surviving corporation acquires the privilege over the target’s pre-closing communications.
  • As with all default rules, the parties to the transaction may agree to alter these default rules through contract.
  • A seller in an asset sale might waive privilege over pre- and post-closing emails by transferring those email accounts to the buyer upon closing and continuing to use those transferred accounts after closing.

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Was the Business Roundtable Statement Mostly for Show? – (3) Disregard of Legal Constraints

Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance and Director of the 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, both at Harvard Law School. Related Program research includes The Illusory Promise of Stakeholder Governance.

Today is the first anniversary of the Business Roundtable (BRT) statement on corporate purpose. The statement, which was described by the BRT as “moving away from shareholder primacy,” was heralded by observers as “an important shift… in corporate America” and a “sea change in terms of how the core purpose of business is defined.” However, in a recent Wall Street Journal op-ed, and in our study The Illusory Promise of Stakeholder Governance on which the op-ed was based, we present evidence that the statement was likely a mere public-relations move rather than a signal of a significant shift in how business operates.

This post focuses on the BRT’s disregard of legal constraints under state corporate law. The post is the third of a series, published around the BRT statement’s first anniversary, aimed at providing Forum readers with a brief account of each of the pieces of evidence on the expected consequences of the BRT statement that our study puts forward. (The first post, which focused on the lack of board approval, is available here. The second post, which focused on the corporate governance guidelines of signatory companies, is available here.)

Disregard of Legal Constraints

The BRT statement proposes a new purpose for public corporations, but it does not discuss or even acknowledge the fact that public companies are subject to different state corporate laws. These state corporate laws vary significantly with respect to the power of directors and executives to embrace stakeholderism. Most importantly, our review indicates that about 70% of the U.S. companies that joined the BRT statement are incorporated in Delaware, which is widely viewed as a state with strong shareholder-centric corporate law.

An article by Leo Strine, who served as the chief justice of the Delaware Supreme Court at the time of the publication of the BRT statement, concludes that “a clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end,” and that Delaware corporations can consider stakeholder interests “only as a means of promoting stockholder welfare.” Similarly, at a recent roundtable on the subject of Delaware law’s approach to stakeholders, organized by Columbia Law School and Gibson Dunn, the consensus of the participants was in line with Chief Justice Strine’s above view.

The shareholder primacy approach of Delaware law is well summarized by then Chancellor William Chandler in the case of eBay Domestic Holdings, Inc. v. Newmark:

Having chosen a for-profit corporate form … directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of the stockholders. The “Inc.” after the company name has to mean at least that. Thus, I cannot accept as valid … a corporate policy that specifically, clearly and admittedly seeks not to maximize the economic value of a for-profit Delaware corporation for the benefit of its stockholders…

Given some expressed concerns about the compatibility of stakeholderism with Delaware law, Martin Lipton, a prominent supporter of stakeholderism, co-authored a client memorandum that purports to address “a number of questions [that] have been raised about the legal responsibilities of directors in … taking into account … [stakeholder] interests.” What is most interesting about the memorandum is not what it includes but what it does not. The memorandum cautiously avoids opining that taking into account stakeholder interests beyond what would be useful for shareholder value is permissible under Delaware law.

Therefore, it seems likely that Delaware corporations (and therefore a substantial majority of the companies joining the BRT statement) may not balance the interests of shareholders and stakeholders, or at least would face significant legal issues if they explicitly chose to do so. For present purposes, however, what is most important is that neither the BRT, nor the numerous Delaware companies that joined the BRT statement, acknowledged or addressed this legal issue.

This disregard of the issue is, once again, consistent with the view that the BRT statement was expected to be largely a public-relations move rather than a signal of a significant shift in how corporations treat stakeholders.

Comment on the Proposed DOL Rule

Max M. Schanzenbach is the Seigle Family Professor of Law at the Northwestern University Pritzker School of Law and Robert H. Sitkoff is the John L. Gray Professor of Law at Harvard Law School. This post is based on their 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) and Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Robert H. Sitkoff (discussed on the Forum here).

We are writing in response to the above referenced proposed rulemaking by the Department of Labor (the “Department”) on financial factors in selecting plan investments (the “Proposal”), in particular environmental, social, and governance factors (“ESG”).

This response is based on our expertise in ESG investing, especially ESG investing by trustees and other fiduciaries. We have undertaken several years of scholarly study of ESG investing by fiduciaries, and recently published our conclusions in “Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee,” 72 Stanford Law Review 381 (2020) (“ESG Investing by a Trustee”) (discussed on the Forum here). In a consulting capacity for Federated Hermes, Inc., moreover, we have prepared several white papers and videos and conducted training sessions on ESG investing for trustees and other fiduciary investors.

Introduction

In general, we are supportive of the Proposal’s central purpose of subjecting ESG investing to the same fiduciary principles of loyalty and prudence that are applicable to any type or kind of investment. For the reasons elaborated in ESG Investing by a Trustee, doing so is consistent with the fiduciary principles codified by the Employee Retirement Income Security Act (“ERISA”), with the case law interpreting ERISA, and with the background common law of trusts.

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The SEC Takes Action on Proxy Advisory Firms

Nicolas Grabar and James Langston are partners and Helena Grannis is counsel at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary memorandum.

For more than a decade, the SEC has been wrestling with whether and how to regulate the activities of the proxy advisory firms—principally ISS and Glass Lewis—that have come to play such an important role in shareholder voting at U.S. public companies. On July 22, 2020, the SEC adopted rules and interpretive guidance that, together, are probably as far as it will go.

Very generally, the main impact of last week’s actions is that, beginning in the 2022 proxy season:

  • When a proxy advisory firm gives its clients voting advice about a typical shareholders’ meeting, it will have to provide the advice simultaneously to the company.
  • In case the company decides to respond to the proxy voting advice, the proxy advisory firm will need to develop procedures to alert its clients to the company’s response before the vote is cast.
  • If the client is a registered investment adviser, it will need to have procedures to consider any company response.

This represents a step back from the SEC’s November 2019 proposal, which would have prescribed a more complex interaction between the proxy advisory firm and the company.

Critics of the proxy advisory firms—already disappointed by the November 2019 proposal—will not be satisfied. On the other hand, the firms themselves and institutional investors, who generally opposed the proposal, were hoping it would be cut back further, or perhaps that it would expire unadopted in the peculiar circumstances of 2020. But now the current SEC has given the topic its best shot, and in the complicated eco-system that connects a public company with its shareholders—where asset managers play a decisive role and rely heavily on proxy advisory firms—this will provoke some adjustments but not fundamental change.

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Was the Business Roundtable Statement Mostly for Show? – (2) Evidence from Corporate Governance Guidelines

Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance and Director of the 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, both at Harvard Law School. Related Program research includes The Illusory Promise of Stakeholder Governance.

Tomorrow marks the first anniversary of the Business Roundtable (BRT) statement on corporate purpose. The statement, which was described by the BRT as “moving away from shareholder primacy,” was heralded by observers as “an important shift… in corporate America” and a “sea change in terms of how the core purpose of business is defined.” However, in a recent Wall Street Journal op-ed, and in our study The Illusory Promise of Stakeholder Governance on which the op-ed was based, we present evidence that the statement was likely a mere public-relations move rather than a signal of a significant shift in how business operates.

This post focuses on evidence obtained from a review of corporate governance guidelines. The post is the second of a series, published around the BRT statement’s first anniversary, aimed at providing Forum readers with a brief account of each of the pieces of evidence on the expected consequences of the BRT statement that our study puts forward. (The first post, which focused on the lack of board approval, is available here.)

Learning from Corporate Governance Guidelines

Corporate governance guidelines (also called corporate governance principles or policies) are official governance documents that are typically approved by the board of directors. They are updated with some frequency and contain the main governance principles and procedures of a public company. Although governance guidelines mostly deal with governance processes, they also often contain general principles or specific provisions regarding the goals that directors must pursue.

These documents therefore provide a natural place to look for the company’s official position on corporate purpose. If companies whose CEOs signed the BRT statement are indeed committed to “moving away from shareholder primacy,” we should expect this commitment to be reflected in the companies’ governance guidelines.

To examine this aspect, we reviewed all the corporate governance guidelines of the U.S. public companies whose CEOs signed the BRT statement. Our findings, which will be fully detailed in a paper that we plan to issue this fall, indicate that these guidelines largely reflect having shareholder value as the sole goal. In The Illusory Promise, as well as below in this post, we illustrate the findings of this broad review by discussing the corporate governance guidelines of the companies in the “BRT Board Sample”—the 20 U.S. public companies whose CEOs sat on the board of the directors of the BRT at the time that the BRT statement was issued.

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Of the twenty companies in the BRT Board Sample, ten amended their governance guidelines after the issuance of the BRT statement. Nine of them, however, did not make any changes in their formulation of corporate purpose. In particular, some companies left unchanged the text that explicitly reflected shareholder primacy by prescribing that directors must:

  • “promote the interests of shareholders” (CVS);
  • “act solely in the best interests of the Corporation’s shareholders” (Duke);
  • “maximize shareholder value over the long-term” (Eastman); or
  • “serve the best interests of the Company and its shareholders” (Stryker).

The only company that amended its guidelines with language related to corporate purpose seems to be S&P Global. This company added to its guidelines a paragraph stating that “the interests of the Corporation’s shareholders are advanced by also considering and responsibly addressing the concerns of other stakeholders.” Even in this case, however, serving shareholder interests remains the purpose of the corporation, while “responsibly addressing” the concerns of other stakeholders is only a means of advancing these interests.

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How Shifting from In-Person to Virtual Shareholder Meetings Affects Shareholders’ Voice

Miriam Schwartz-Ziv is a Senior Lecturer at Hebrew University of Jerusalem. This post is based on her recent paper.

Shareholder meetings are one of the only opportunities most investors have to meet and interact with management, and to raise concerns regarding the firm. To the best of my knowledge, however, no study has investigated the content of shareholder meetings. In this paper, I examine the content of shareholder meetings, and focus on the transformation of shareholder meetings that occurred after Covid-19 led firms to move their shareholder meetings from an in-person format to a virtual one. I examine how this change affected shareholders’ voice.

In the first analysis, I code the transcripts and audio recordings for the 94 firms included in the S&P 500 for which transcripts and audio recordings are available for both 2019 and 2020. For each company I code transcripts of two shareholder meetings, one in the proxy season of 2019 (an in-person or hybrid meeting) and one in that of 2020 (a virtual-only meeting), making a total of 188 meetings.

When comparing the 2019 in-person shareholder meetings to the 2020 virtual ones, I find significant differences: the move to virtual meetings shortened the average meeting by 18% (from 39 to 32 minutes), decreased by 40% the time dedicated to providing a business update (from 14 minutes to 8), decreased  by 14% the average time spent on answering questions (from 12 minutes to 10), and decreased by 29% the average time spent on answering a question (from 3 minutes to 2). These figures demonstrate that while the virtual-meeting format has the potential to increase shareholders’ voice, since participation is less costly, frequently, less time is dedicated to addressing shareholders’ concerns. These figures may suggest that not having visibly present shareholders, and perhaps not observing shareholders’ responses throughout the meeting, ultimately leads to the communication of less information by the company to the shareholders.

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SEC Tightens Regulations on Proxy Advisory Firms

David A. Bell is a partner, Ryan Mitteness is an associate, and Soo Hwang is a Senior Attorney at Fenwick & West LLP. This post is based on their Fenwick memorandum.

The U.S. Securities and Exchange Commission on July 22, 2020, adopted amendments tightening regulation of proxy voting advice from proxy advisory firms (Release No. 34‑89372). The final rule implements additional regulations for proxy advisory firms, but stops short of some of the proposals included in the SEC’s original proposal (and described in our prior alert).

The final rule codifies the SEC’s interpretation set forth in August 2019 (and described in our prior alert) that voting recommendations and related materials provided by proxy advisory firms are “solicitations” subject to antifraud rules. In addition, the amendments add conditions that must be met in order for proxy advisory firms to rely on the exemptions historically available to them from filing full proxy solicitation materials (a key exemption for the conduct of their business). In particular, proxy advisory firms will need to include additional conflict of interest disclosure in their vote recommendation materials, provide their recommendation materials to the subject company not later than simultaneously with delivery to the proxy advisory firms’ clients, and provide access to responses by the subject company to the advisory firms’ recommendations.

Importantly for companies, the final rule does not give subject companies the opportunity to review and comment on proxy advisory firms’ recommendations prior to publication, or to explicitly require the proxy advisory firm to include a hyperlink to a response statement from the company with such recommendations at the time that they are sent.

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Investors and Companies Can Drive ESG Metrics Forward Together

Sarah Keohane Williamson is Chief Executive Officer and Ariel Fromer Babcock is Head of Research at FCLTGlobal. This post is based on their FCLTGlobal memorandum.

Investors want standardized reporting of sustainability and other non-traditional metrics. What will that look like on a global scale?

The growing role of sustainability and non-traditional metrics to inform the engagement between public companies and investors has become a critical issue. Investors are seeking metrics to evaluate a company’s approach to sustainability and its drivers of long-term growth. But the format of these metrics and disclosures has become a sticking point among issuers, investors, and standard setters.

Most institutional investors seek information on environmental, social, and governance issues to better understand risks that could affect companies’ performance over time. These investors use such disclosures to monitor companies’ risk management, inform their votes, or make decisions on stock purchases.

What institutional investment decision-makers need is clear: quantitative, assurable, universally applicable disclosures around what really drives businesses in the long run.

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Testing the Theory of Common Stock Ownership

Fiona Scott Morton is the Theodore Nierenberg Professor of Economics at Yale School of Management and Lysle Boller is a PhD student at Duke University. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); New Evidence, Proofs, and Legal Theories on Horizontal Shareholding by Einer Elhauge (discussed on the Forum here); and Horizontal Shareholding by Einer Elhauge (discussed on the Forum here).

In recent years, economists have become increasingly worried that the US (and perhaps global) economy is becoming less competitive. One possible reason relates to the changing ownership structure of US publicly-traded firms over recent decades. For half a century there has been a steady increase in institutional ownership in the US and a decline in the share of the average public company owned by retail investors. This changing ownership structure is closely related to the rise of diversified mutual funds, an invention that has been praised for providing consumers an inexpensive way to hold a set of diversified stocks. The broad availability of mutual funds has brought lower costs to savers, but there is a flip side to this coin—mutual funds (including index funds) often hold stakes in many competitors within the same industry. This pattern is referred to as “common ownership” or “horizontal shareholding.” The economics literature has long shown the potential for common ownership to be anticompetitive. A merger, for example, is a familiar setting where the same owner holds 100% of the two competitors; this purchase typically triggers a regulatory review due to concerns about possible declines in competition. A large institutional investor typically holds less, perhaps 4-7% of each rival, though there could be several similar investors of that size, making their total stake fairly large. For example, as of 2017, Vanguard held at least a 6% share in the six largest domestic airlines (Schmalz 2018), and Berkshire Hathaway held at least 7% in four of these same firms. The open empirical question this raises is whether there is a negative impact on product market competition from such institutional investor common ownership.
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