Yearly Archives: 2020

Delaware Chancery Court Clarifies the “Ab Initio” Requirement

Jason Halper and Nathan Bull are partners and Sara Bussiere is an associate at Cadwalader, Wickersham & Taft LLP. This post is based on Cadwalader memorandum by Mr. Halper, Mr. Bull, Ms. Bussiere, Jared Stanisci, Victor Bieger, and Victor Celis. This post 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 Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

In In re HomeFed Corp. Stockholder Litigation (“HomeFed”), the Delaware Court of Chancery considered on a motion to dismiss whether a squeeze-out merger by a controlling stockholder complied with the procedural framework set forth in Kahn v. M&F Worldwide Corp. (“MFW”). In MFW, the Delaware Supreme Court held that the business judgment rule—rather than the entire fairness standard—applies to a controlling stockholder transaction if the transaction is conditioned “ab initio,” or at the beginning, upon approval of both an independent special committee of directors and the informed vote of a majority of the minority stockholders.

In HomeFed, however, the court denied a motion to dismiss by the defendants, the directors of HomeFed Corporation (“HomeFed”) and its controller Jeffries Financial Group, Inc. (“Jeffries”), crediting allegations that Jeffries did not commit to the dual MFW protections before commencing discussions with HomeFed’s largest minority stockholder. In addition, the court found that a one-year “pause” in negotiations between Jeffries and HomeFed’s special committee did not “reset” the ab initio requirement of MFW.


SEC Expands Population Eligible to Participate in Certain Private Offerings

Jenna E. Levine and Raaj S. Narayan are partners and Ram Sachs is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell Lipton memorandum.

The SEC yesterday [August 26, 2020] voted 3-2 to adopt amendments expanding the definition of “accredited investor,” with related expansions to the entity types that may qualify as “qualified institutional buyers” under Rule 144A.  These changes, which will become effective sixty days after publication in the Federal Register, are part of the SEC’s broad ongoing project to harmonize the exempt offering framework in recognition of the growing importance of the private market and will enable additional individuals deemed to have sufficient knowledge or expertise to participate in private offerings currently open to wealthy individuals without meeting the existing wealth-based criteria.  SEC Chairman Jay Clayton explained that these changes are intended to advance the policy goal of “‘identify[ing] investors that have sufficient financial sophistication to participate in investment opportunities’ in the private capital markets.”

Under the current asset and income-based approach, individuals must generally have a net worth of at least $1 million (excluding the value of their primary residence), or an annual income of at least $200,000 for the last two years ($300,000 for married couples), with a reasonable expectation of that level for the current year.  The definition also includes certain entities with assets over $5 million.  The new rules expand the scope to include individuals with certain professional certificates or credentials as determined by the SEC, which the adopting release indicates the SEC believes provide a reliable indication of the ability to appropriately assess an investment opportunity and make informed decisions on asset allocation and risk tolerance.  The initial qualifying certifications are FINRA Series 7, 65, and 82 licenses.  It is specifically contemplated that the SEC may expand the list in the future after observing the impact of the initial rule change.


Meaningful Communications with Stakeholders During COVID-19

Eric Knachel is senior consultation partner at Deloitte & Touche LLP. This post is based on his Deloitte memorandum. 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); Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here); and  For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

As companies prepare to report another quarter of doing business in a pandemic, they have the benefit of drawing on the experiences and lessons learned from the last two quarters. It is important that companies reflect on the lessons learned and foresee what financial reporting issues may lie ahead, the accounting topics that are going to be trending, the related challenges that will arise and ways to resolve them in order to avoid business disruption and continue creating value.

A recurring theme of the myriad of financial reporting issues associated with COVID-19 is the need for robust and transparent disclosure and communication. Given the continuous and rapidly evolving economic impact of the pandemic, management should consider how it can provide timely updates to stakeholders and investors regarding the pandemic’s current and future impact on the company, as well as share plans, to the best extent possible, to evolve and thrive regardless of industry.

There are three broad-based categories of communications that companies should focus on, especially as they are wrapping up Q2 and hurtling towards Q3: transparent disclosures regarding key assumptions and critical estimates, communications around non-GAAP measures, and effective COVID-19.


Exit vs. Voice

Eleonora Broccardo is Associate Professor at the University of Trento; Oliver D. Hart is the Lewis P. and Linda L. Geyser University Professor at Harvard University; and Luigi Zingales is the Robert C. Mccormack Distinguished Service Professor of Entrepreneurship and Finance at University of Chicago Booth School of Business. This post is based on their recent paper.

The American Revolution started with a boycott of English tea, and the boycott of Montgomery buses was a key event in the civil rights movement. Not only are boycotts integral to American history, but they are also a very popular form of political engagement: 38% of Americans are currently boycotting at least one company.  Boycotts are becoming popular also in the investment world, in the form of divestment:  when Morningstar started ranking mutual funds based on their sustainable investing criteria, $24 billion flowed into “high sustainability” funds and $12 billion flowed out of “low sustainability” funds (Hartzmark and Sussman, 2019). What are the welfare consequences of these boycotts and divestments? How do they compare with other forms of political engagement at the corporate level?

In a recent paper we try to answer these questions.  For concreteness we focus on the case of an environmental externality, pollution. We assume that a fraction of the population is “socially responsible” in the sense that these individuals put a positive weight (the social responsibility parameter) on aggregate welfare when they make decisions. We study the welfare consequences if these socially responsible stakeholders exercise their exit option (divestment or boycott) or their voice one (engagement).


Weekly Roundup: August 28–September 3, 2020

More from:

This roundup contains a collection of the posts published on the Forum during the week of August 28–September 3, 2020.

ESG + Incentives 2020 Report

SEC Revises Regulation S-K

FedNow: The Federal Reserve’s Planned Instant Payments Service

The Performance of Hedge Fund Performance Fees

Delaware Public Benefit Corporations—Recent Developments

2020 Mid-Year Securities Litigation Update

Venture Capitalists and COVID-19

OCIE Publishes Risk Alert Regarding COVID19-Related Compliance Risks and Considerations

Performance-Induced CEO Turnover

Enacting Purpose within the Modern Corporation

Private Ordering and the Role of Shareholder Agreements

Evolving Executive Compensation Responses to the Global Pandemic

Evolving Executive Compensation Responses to the Global Pandemic

Mike KesnerSandra Pace, and John R. Sinkular are partners at Pay Governance LLC. This post is based on their Pay Governance memorandum.

Pay Governance has written a significant number of Viewpoints detailing the impact of the global pandemic on existing executive compensation programs as well as the issues to be considered by management teams and compensation committees as they navigate these unprecedented times. One of our guiding principles is to “put everything on the table” to ensure a full and thoughtful discussion of existing and future compensation arrangements.

Over the last several months, the global pandemic and economic slowdown has impacted people, communities, business operations, financial performance, and stock prices in varying degrees. There continues to be significant uncertainty as to when the pandemic will end and what the new normal will be. Business forecasting and planning are further complicated by the U.S. presidential election, which is less than 100 days away.

Pay Governance has been discussing multiple scenarios and potential compensation actions with our clients. We have also been tracking the disclosure of executive compensation changes made to date in order to catalog various responses and the underlying rationale for such changes.


Private Ordering and the Role of Shareholder Agreements

Jill Fisch is the Saul A. Fox Distinguished Professor of Business Law at the University of Pennsylvania Law School. This post is based on her recent paper. Related research from the Program on Corporate Governance includes Private Ordering and the Proxy Access Debate by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

On August 13, 2020, the Delaware Chancery Court issued its decision in Juul Labs, Inc. v. Daniel Grove, 2020 Del. Ch. LEXIS 264, holding that Grove’s statutory right to inspect the books and records of Juul, a Delaware corporation, were limited to those provided by Del. Gen. Corp. L. § 220. The court rejected Grove’s effort, based on the fact that Juul is headquartered in California, to exercise inspection rights pursuant to §1601 of the California statute., holding that stockholder inspection rights are a “core matter of internal corporate affairs” and that, as a result, only Delaware law could apply. The court further held that, pursuant to Juul’s exclusive forum charter provision, any effort by Grove to pursue inspection rights must be litigated in the Delaware Chancery court.

The decision arose from an unusual procedural posture. Grove, a former Juul employee, had acquired his stock pursuant to an option agreement in which he agreed to waive his inspection rights under §220. In an effort to avoid the terms of the agreement, Grove asserted inspection rights under the California statute. Juul then filed an action in Delaware Chancery seeking a declaratory judgment that Delaware and not California law governed Grove’s rights, if any, to inspect Juul’s books and records.


Enacting Purpose within the Modern Corporation

Rupert Younger is Director at the Oxford University Centre for Corporate Reputation; Colin Mayer is the Peter Moores Professor of Management Studies at University of Oxford Saïd Business School; and Robert G. Eccles is Visiting Professor of Management Practice at Oxford University Said Business School. This post is based on an EPI report. Related research from the Program on Corporate Governance includes For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).

The Enacting Purpose Initiative (EPI) is a multi-institution partnership between the University of Oxford; the University of California, Berkeley; BrightHouse (a BCG company); the British Academy; Federated Hermes EOS; and Wachtell, Lipton, Rosen & Katz. The purpose of the EPI is to develop guidance for boards of directors, senior management, and investors for how companies can articulate, implement, and report on their purpose.

Recent calls for better articulation of purpose from global investment management firms, together with specific commitments on purpose by asset owners, are accelerating this momentum and elevating it to a critical board issue. To deliver value for different stakeholders, purpose has to be more than a marketing slogan or a vague set of values. It has to become an organizing principle, the reason why an organization exists. Boards of directors across all sectors today face a growing drumbeat of calls from multiple stakeholders including customers, employees, and suppliers for a clearer explanation of their organizational purpose.

What is purpose? Purpose reflects the raison d’etre of an organization, defining its reason to exist. Properly understood, it becomes the most important organizing principle within the organization, informing and guiding strategic decisions and activities. Today there is a greater emerging awareness and understanding of “purpose as strategy,” as distinct from the more standard and now common focus on “purpose as culture.” The COVID-19 crisis and calls for the need to “Build Back Better” have simply accelerated this trend.


Performance-Induced CEO Turnover

Dirk Jenter is Associate Professor of Finance at the London School of Economics & Political Science and Katharina Lewellen is Associate Professor of Business Administration at the Tuck School of Business at Dartmouth.

Replacing poorly performing CEOs is one of the key tasks of corporate boards and a potentially important source of CEO incentives. However, prior literature finds that forced CEO departures are rare, and that many CEOs remain in office in spite of poor performance. Our paper revisits this evidence and finds that performance-related turnovers are much more common than previously thought. We diverge from prior studies that classify turnovers into forced and voluntary and instead introduce the concept of performance-induced turnover, which we define as turnover that would not have occurred had performance been “good”.

To operationalize this, we estimate the turnover probability at high levels of performance and assume that any turnovers in excess of this probability are caused by performance being worse. Using this approach, we estimate that close to half of all CEO turnovers are performance induced, many more than the 20% of turnovers the prior literature classifies as forced. The key reason for this discrepancy is simple: turnovers classified as “voluntary” by prior studies are substantially more likely after poor performance, suggesting that many are in fact performance induced. This is especially true for turnovers of CEOs aged 60 or older, which standard algorithms classify as automatically voluntary.


OCIE Publishes Risk Alert Regarding COVID19-Related Compliance Risks and Considerations

Stacey Song and Jessica Forbes are partners and Joanna Rosenberg is an associate at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on their Fried Frank memorandum.

On August 12, 2020, the Office of Compliance Inspections and Examinations (“OCIE”) of the Securities and Exchange Commission (“SEC”) published a risk alert (“Risk Alert”) identifying a number of COVID-19-related issues relevant to SEC-registered investment advisers and broker-dealers (collectively, “Firms”). [1] OCIE had previously announced that it was actively engaged in ongoing outreach and having discussions with Firms to assess the impacts of COVID-19 on their businesses, including challenges to operational resiliency and the effectiveness of Firms’ business continuity plans. [2] The Risk Alert outlines risks and practices that OCIE identified through its industry outreach, as well as consultation and coordination with other regulators. OCIE’s observations and recommendations fall into the following broad categories: (1) protection of investors’ assets, (2) supervision of personnel, (3) practices relating to fees, expenses, and financial transactions, (4) investment fraud, (5) business continuity, and (6) the protection of investor and other sensitive information. We summarize these below.


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