Monthly Archives: November 2020

Compensation-Related Considerations for the 2021 Proxy Season

Maj Vaseghi and Lori Goodman are partners and Sarah Ghulamhussain is a senior associate at Freshfields Bruckhaus Deringer LLP. This post is based on a Freshfields memorandum by Ms. Vaseghi, Ms. Goodman, Ms. Ghulamhussain, and Jordan Salzman. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Companies poised to enter into the upcoming annual report and proxy season should start disclosure preparations early in order to address the complexities that will have inevitably resulted from an unprecedented 2020. In particular, companies will need to take proactive steps to evaluate the impact of the COVID-19 pandemic on executive compensation, the role of new human capital management disclosure requirements and continued focus on diversity and inclusion, knowing that this year’s disclosures are likely to be heavily scrutinized by investors, proxy advisors and other stakeholders given the volatility and ethos of the preceding months. This post identifies several key executive compensation and related governance issues to keep in mind:

1. Compensation discussion and analysis (CD&A) disclosure for compensation decisions made in connection with COVID-19

As has always been the case, companies should continue to strive to present the CD&A in a clear, well-detailed and balanced manner. This will be of increased importance as companies prepare to communicate executive compensation program changes prompted by the COVID-19 pandemic, and particularly the case for companies whose boards revised performance metrics or exercised discretion in determining incentive payouts. Compensation committees that have not already done so should develop a process and framework for reviewing the appropriateness of changes to compensation programs or in exercising discretion to determine 2020 annual incentive payouts. This process and framework will allow companies to explain the rationale behind the compensation committee’s decisions in the CD&A. For example, the CD&A may discuss whether the compensation committee reviewed the Company’s performance relative to its peers, its ability to meet cost cutting measures or liquidity objectives, or its ability to stage a recovery or prepare for one when approving compensation changes. A similar framework should be used in designing 2021 incentive programs and setting 2021 performance targets. For example, if an e-commerce company outperformed in 2020 due to COVID, is it appropriate to set 2021 financial targets below 2020 attainment levels? This is an issue that ISS has scrutinized in the past. Other design considerations compensation committees are assessing include using a range rather than a single target financial metric, increasing the use of relative rather than absolute performance measures and increasing the use of non-financial targets, such as strategic or sustainability goals. Moreover, while the CD&A requires only a discussion of compensation decisions related to the named executive officers, companies may choose to include a summary of the impact of COVID-19 on the broader workforce to provide context for executive pay decisions.

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Innovation in the Stock Market: Exchanges and ATSs

Gabriel Rauterberg is Assistant Professor of Law at the University of Michigan Law School. This post is based on his chapter in the forthcoming book Financial Market Infrastructures: Law and Regulation (Jens-Hinrich Binder and Paolo Saguato, eds.).

Is something wrong with the structure of the stock market? Both industry participants and scholars have recently faulted the equity market for its lack of innovation. Economists at Harvard, Chicago, and elsewhere have argued that the continuous nature of modern trading bakes in a problematic arms race among high-frequency traders for speed. Stock exchanges process incoming instructions to trade in the order they arrive and as quickly as possible, which can mean in millionths of a second or less. The result, they argue, is a wasteful race for speed in order to trade first on public information. This race would be eliminated if continuous trading was replaced with discrete, periodic auctions (“frequent batched auctions”), say once per thousandth of a second. The market, these scholars also claim, will not fix itself because the nation’s stock exchanges lack robust incentives to appropriately innovate. (See, e.g., Budish, Lee & Shim, 2020).

In a forthcoming paper, I start off with the fact that there are other important markets for trading stock besides the national stock exchanges. I argue that the innovation calculus for alternative trading systems (“ATSs”) differs markedly from exchanges. ATSs, like stock exchanges, are marketplaces in which traders interact to purchase and sell stock from one another. In fact, ATSs and exchanges often function very similarly, with the same trading mechanics, technology, and participants, and both satisfy the statutory definition of a stock exchange. The defining difference between them is that exchanges choose to register as self-regulatory organizations, with closer supervision by the Securities and Exchange Commission (“SEC”), while ATSs make use of an exemption from registration as exchanges to operate in a less regulated environment.

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Preparing for Shareholder Activism in the Wake of COVID-19

Keith E. Gottfried is partner at Morgan, Lewis & Bockius LLP. This post is based on his Morgan Lewis memorandum. Related research from the Program on Corporate Governance includes Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here).

The shock, turmoil, uncertainty, and lack of visibility that followed the immediate onset of the coronavirus (COVID-19) pandemic in March 2020 were significant factors accounting for why shareholder activism was relatively subdued during the 2020 proxy season. However, given that activist investors have now had more than eight months to acquire their “sea legs” and recalibrate their playbook for the evolving “new normal,” it is likely that, even as the COVID-19 pandemic shows no signs of abating, activist investors will be less reluctant to wage an activism campaign in whatever “new normal” we find ourselves in during the 2021 proxy season.

Notably, unlike with respect to the 2020 proxy season, activist investors currently planning for the 2021 proxy season are making those plans aware of the existence of the COVID-19 pandemic and its evolving implications and having to anticipate and incorporate into their plans the possibility that, even if the current COVID-19 case surge is reversed and further extended lockdowns are avoided, the COVID-19 pandemic is not likely to materially subside between now and the end of the 2021 proxy season. In addition, as we will discuss below, we are likely at a point where the COVID-19 pandemic may be more of a catalyst for shareholder activism than an inhibitor. Accordingly, companies should not expect that shareholder activism during the 2021 proxy season will be as subdued as it was in 2020.

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When That Problematic Board Member Just Won’t Leave

Michael W. Peregrine is a partner at McDermott Will & Emery LLP. This post is based on his article, previously published in Forbes.

Sometimes a corporate director who’s the main source of a company’s reputational problems is the last one to recognize it.

That’s why, in order to protect the company from unwanted controversy and reputational harm, boards benefit from discreet tools to remove problematic officers and directors before their terms are up, and without going through a formal removal process. These self-executing tools are intended to resolve concerns without making a bad situation worse for the company, the board, and the implicated director.

Image problems arise from two circumstances that can pop up during a director’s term; the first class, circumstances of the director’s own doing; and the second class circumstances over which the director may not have had any direct responsibility. Once under public discussion, both types risk reputational harm to the company, interference or disruptions to the work of the board, and doubt (fair or unfair) on the fitness of the implicated director to serve.

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IPOs Surge While Market Tightens, But Opportunities Remain

John J. Mahon and Eleazer Klein are partners at Schulte Roth & Zabel LLP. This post is based on their SRZ memorandum.

Special purpose acquisition companies (“SPACs”) grabbed the investment spotlight this year and remain among the most active investment classes in the market. While the SPAC model has evolved over the better part of the past two decades, SPACs have recently enjoyed an unprecedented surge in popularity as a result of a number of high-profile SPAC launches and subsequent business combinations. In this year alone, as of Oct. 9, 2020, there have been 138 SPAC initial public offerings (“IPOs”) yielding $53.6 billion in gross proceeds—a record haul for new SPAC launches. [1] To put these numbers in proper perspective, from 2004 to 2018, approximately $49.1 billion was raised across 332 SPAC IPOs in the United States. [2]

Overview

Both the aggregate IPO proceeds raised, as well as the average SPAC IPO size, have jumped considerably in 2020. Not surprisingly, that type of success breeds imitation, and interest in prospective new SPAC IPOs remains relatively high. However, based on feedback we have received, demand for new SPAC IPOs appears to have tightened in recent weeks, potentially as a result of the large amount of IPO proceeds already raised in 2020. Accordingly, prospective sponsors may face increasing pressure to differentiate their proposed SPACs from other recent or proposed offerings. In contrast, we expect that potential SPAC investors may see increasingly attractive investment opportunities as the SPAC IPO market further tightens and sponsors become more flexible on terms. To that end, we have already seen movement towards incentivizing larger IPO investors through various economic incentives, including through access to sponsor-level economics.

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The CPA-Wharton Zicklin Model Code of Conduct

Bruce F. Freed is president of the Center for Political Accountability; Karl J. Sandstrom is senior counsel at Perkins Coie and formerly served on the Federal Election Commission; and William S. Laufer is the Julian Aresty Endowed Professor and Director of the Carol and Lawrence Zicklin Center for Business Ethics Research at The Wharton School at the University of Pennsylvania. This post is based on their recent memorandum. Related research from the Program on Corporate Governance includes Corporate Political Speech: Who Decides? by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here); The Untenable Case for Keeping Investors in the Dark by Lucian Bebchuk, Robert J. Jackson Jr., James David Nelson, and Roberto Tallarita (discussed on the Forum here); and The Politics of CEOs by Alma Cohen, Moshe Hazan, Roberto Tallarita, and David Weiss (discussed on the Forum here).

How can U.S. public companies protect against the risks inherent in spending to influence elections when politics is hyperpartisan, citizens are polarized and a controversy can ignite a wildfire virally and potentially affect a company’s bottom line?

The Center for Political Accountability and The Wharton School’s Zicklin Center for Business Ethics Research have produced a new Model Code of Conduct for Corporate Political Spending to address these issues. Expanded and updated from a Model Code written by CPA in 2007, it provides a framework to guide not only companies’ political spending, but also their assessment of its impact and related ethical and societal considerations.

As the new Code’s preamble states: “Whether a company is directly contributing to or spending in elections or indirectly participating through payments to political or advocacy organizations, a code commits senior management and directors to responsible participation in our nation’s politics.

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New Rule Governing Use of Derivatives by Registered Investment Companies and BDCs

John Mahon and Craig Stein are partners at Schulte Roth & Zabel LLP. This post is based on an SRZ memorandum by Mr. Mahon, Mr. Stein, Atul Joshi, and Karen Spiegel.

On Oct. 28, 2020, the SEC voted to adopt new Rule 18f-4 under the Investment Company Act of 1940, as amended (“1940 Act”), to provide a modernized and comprehensive regulatory framework for the use of derivatives by regulated funds, including mutual funds (other than money market funds), exchange-traded funds (“ETFs”), registered closed-end funds and business development companies (“BDCs”) (collectively, “funds”). [1] Subject to various conditions, Rule 18f-4 will allow funds to enter into derivatives transactions, notwithstanding the restrictions on the issuance of “senior securities” and the use of leverage imposed by Sections 18 and 61 of the 1940 Act. [2]

In connection with the adoption of Rule 18f-4, the SEC also amended Rule 6c-11 under the 1940 Act relating to leveraged/inverse ETFs and adopted new reporting requirements and amendments to certain disclosure forms. The new rule and related amendments will become effective 60 days after publication in the Federal Register, with a compliance date of 18 months after the effective date. Hedge funds and other private investment funds are not subject to the new rule or the related amendments.

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2020 Use of ESG Measures in Incentive Plans Report

Thomas Kohn is a Consultant and Erin Bass-Goldberg is Managing Director at FW Cook. This post is based on their FW Cook report. 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); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here); Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here); Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Introduction

Driven by multiple stakeholders embracing the premise that a strong ESG proposition is an essential element to sustainable long-term company performance, attention on company ESG behavior and transparency is rapidly increasing. Following are recent developments contributing to enhanced focus on ESG:

Institutional Investors: Large institutional investors are encouraging companies to increase transparency in their disclosure of various ESG measures. Examples include State Street’s August 2020 letter to companies advocating that they articulate “risks, goals, and strategy as related to racial and ethnic diversity” [1] and BlackRock’s January 2020 letter to companies stating that it “will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.” [2]

Employee and Shareholder Activists: A number of high-profile employee and shareholder activist criticisms on ESG issues have garnered significant media attention in recent years, including the heir to Disney criticizing the company for its pay practices, [3] Google employees’ protest over the company’s handling of sexual harassment allegations, [4] and the employee-backed shareholder proposal at Amazon for the company to release a comprehensive plan on addressing climate change. [5]

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Environmental Spinoffs: The Attempt to Dump Liability Through Spin and Bankruptcy

David F. Larcker is the James Irvin Miller Professor of Accounting at Stanford Graduate School of Business; Brian Tayan is a Researcher with the Corporate Governance Research Initiative at Stanford Graduate School of Business; and Andrew C. Baker is a student at Stanford University School of Law. This post is based on their recent paper.

We recently published a paper, Environmental Spinoffs: The Attempt to Dump Liability Through Spin and Bankruptcy, that examines the practice of companies spinning off their environmental liabilities into separate companies that prove to be inadequately capitalized to meet their obligations.

A core tenant of economics is that the creation of shareholder and stakeholder value requires a complete and accurate accounting of the costs and benefits of business decisions. If costs are ignored or excluded, corporate decisions are distorted, leading to investment that might not otherwise be approved or would be priced differently. The omitted costs, however, do not disappear. They shift to parties not represented in the transaction—and are typically borne by society and redressed through taxation, lawsuits, or regulation. This problem is known as the externality problem.

Examples of externalities are plentiful. In the financial crisis, the risk of inadequately structured mortgage loans and securitizations ultimately fell on U.S. taxpayers. The aggressive marketing and prescription of opioid painkillers has led to the addiction and death of thousands of Americans. Oil and gas extraction through hydraulic fracturing (“fracking”) has in some cases led to water and land contamination. And for many decades—leading up to and including today—industrial production has created byproducts that compromise land, water, or air quality, and require costly remediation. In all of these cases, society is the residual claimant, bearing the cost of outcomes that might never have occurred if they were properly included in the original business decision.

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Weekly Roundup: November 20–26, 2020


More from:

This roundup contains a collection of the posts published on the Forum during the week of November 20–26, 2020.

Acquisition Experience and Director Remuneration



Investing in a SPAC


Joint Statement by Commissioners Lee and Crenshaw on Amendments to Regulation S-K


Russell 3000 Database of Executive Compensation Changes in Response to COVID-19


Risks of Back-Channel Communications with a Controller


Cyber: New Challenges in a COVID-19–Disrupted World




SEC Enforcement Division Releases Final Chapter of Jay Clayton-Led SEC


Why Have CEO Pay Levels Become Less Diverse?



SEC Adopts Rules to Modernize and Streamline Exempt Offerings


EQT: Private Equity with a Purpose


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