Yearly Archives: 2020

Statement Chairman Clayton on Transparency for Investors and at the Commission

Posted by Jay Clayton, U.S. Securities and Exchange Commission, on
Thursday, August 6, 2020
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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.

Good morning. This is an open meeting of the U.S. Securities and Exchange Commission, under the Government in the Sunshine Act. Today we have two items on the agenda, both examples of our continued work to enhance transparency for investors and at the Commission. [1] Today’s agenda items illustrate that the Commission’s transformative work in the area of modernizing our disclosure framework and Commission transparency need not pause while the Commission is also monitoring, and responding to, the effects of COVID-19 on our markets, our registrants and our investors.

Tailored Shareholder Reports, Treatment of Annual Prospectus Updates for Existing Investors, and Improved Fee and Risk Disclosure for Mutual Funds and Exchange-Traded Funds; Fee Information in Investment Company Advertisements

I will now turn to the first item. Over the past few years, our staff—across Divisions and Offices—have worked tirelessly to modernize and improve our disclosure system. [2] Today’s proposal would transform, for the benefit of investors, our disclosure framework for mutual funds and exchange-traded funds (“ETFs”), increasing accessibility, readability and transparency. As I discussed at our last Open Commission Meeting a few weeks ago, mutual funds and ETFs have become the primary way in which many Main Street investors access our capital markets. To put in perspective the importance of these investment products, and, as a result, the importance of clear, concise fund disclosure, we should look at the number of Americans this proposal would impact. Over 101 million individuals—representing almost 45 percent of U.S. households—own shares in registered investment companies, while almost 100 million individuals own shares in mutual funds in particular. If recent trends persist, these numbers will continue to increase in the coming years.

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ESG Shareholder Engagement and Downside Risk

Posted by Andreas Hoepner (University College Dublin), on
Thursday, August 6, 2020
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Andreas Hoepner is Professor of Operational Risk, Banking & Finance at the University College Dublin Smurfit Graduate Business School. This post is based on a recent paper by Professor Hoepner; Ioannis Oikonomou, Associate Professor in Finance at the University of Reading ICMA Centre; Zacharias Sautner, Professor of Finance at Frankfurt School of Finance & Management; Laura T. Starks, the Charles E. and Sarah M. Seay Regents Chair in Finance at the University of Texas at Austin McCombs School of Business; and Xiaoyan Zhou, Postdoctoral Research Associate at the University of Oxford-Smith School of Enterprise and the Environment. 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).

Direct institutional investor engagement on aspects of corporate environmental, social and governance (ESG) performance has become increasingly prevalent in financial markets worldwide. Given the frequency of recent tail risk events such as the Deepwater Horizon Oil Spill, the Equifax Hack or the Covid-19 pandemic among others, it is not surprising that many institutional investors actively engage with their portfolio firms to reduce ESG risk exposures. Specifically, the goal is to achieve higher standards of ESG practices because these practices are believed to serve as an insurance mechanism against value-destroying tail risk events. Often the engaging shareholders are large institutional investors, also called “universal owners” due to their highly diversified, long-term portfolios. These portfolios, which reflect global financial markets, are exposed to ESG risk because of externalities from economy-wide factors, such as climate change, as well as externalities from individual portfolio firms (that also affect other firms in their portfolios).

In our research we analyze whether ESG engagements result in subsequent reductions in downside risk at portfolio firms. We employ proprietary engagement data provided by a large institutional investor, who is considered to be (one of) the most influential activists when it comes to promoting and developing firms’ ESG standards. While this institutional investor invests its own money in the engaged firm, the unique business model is to speak on behalf of other large investors in its ESG engagement activities, with currently more than $1 trillion in assets under advice (as of Q1 2020). In our study, we analyze 1,712 engagements across 573 targeted firms worldwide, covering the years 2005 through 2018. The institutional investor provided us with full access to the engagement database, including engagement activities, action reports, and the investor’s measures of engagement success. We find that over this period corporate governance engagements are the most common, accounting for 43% of all engagements. These engagements frequently center on executive pay and board structure. Engagements focusing on environmental issues, especially climate change, constitute 22% of the sample, while engagements on social (20%) and strategy (16%) are a little less common.

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Statement by Commissioner Roisman on Proposal to Improve Information Available to Fund Investors

Posted by Elad L. Roisman, U.S. Securities and Exchange Commission, on
Thursday, August 6, 2020
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Elad L. Roisman is a Commissioner at the U.S. Securities and Exchange Commission. The following post is based on Commissioner Roisman’s recent public statement. The views expressed in this post are those of Mr. Roisman and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Thank you to Director [Dalia] Blass and her excellent team in the Division of Investment Management for your several years of work developing today’s proposal to improve the information available to fund investors. Thanks also to the team in our Division of Economic and Risk Analysis, who worked hard to evaluate the costs and benefits of the many variables in this proposal, as well as all of the other SEC staff, past and present, who worked on this project.

The recommendation before us is the latest step in an enormous effort to holistically evaluate existing disclosure rules to assess how they are meeting the needs of Main Street investors. [1] The proposed rule changes reflect feedback from investors as well as research on retail investor preferences and an acknowledgement of technological advancements that have developed since our existing disclosure rules were put in place. There is a lot for the public to comment on in the proposal, and I am very interested to review the feedback.

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On the Purpose and Objective of the Corporation

Posted by Martin Lipton, Steven A. Rosenblum, and William Savitt, Wachtell, Lipton, Rosen & Katz, on
Wednesday, August 5, 2020
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Martin Lipton is a founding partner specializing in mergers and acquisitions and matters affecting corporate policy and strategy, and Steven A. Rosenblum and William Savitt are partners Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Mr. Rosenblum, Mr. Savitt, Karessa L. Cain, Hannah Clark, and Bita Assad. 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 Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr. (discussed on the Forum here).

As we approach the first anniversary of the Business Roundtable’s abandonment of shareholder primacy and embrace of stakeholder governance, and the fourth anniversary of our development for the World Economic Forum of The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth, we thought it useful to consider in broader context the key issues of corporate governance and investor stewardship today. While there is no universal consensus, the question underlying these issues can be expressed as: What is the corporation trying to achieve? What is its objective?

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Contracts with (Social) Benefits: The Implementation of Impact Investing

Posted by Anne M. Tucker (Georgia State University), on
Wednesday, August 5, 2020
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Anne Tucker is Professor of Law at Georgia State University College of Law. This post is based on a recent paper, forthcoming in the Journal of Financial Economics by Professor Tucker; Christopher Geczy, Adjunct Professor of Finance at The Wharton School at the University of Pennsylvania; Jessica Jeffers, Assistant Professor of Finance at The University of Chicago Booth School of Business; and David Musto, the Ronald O. Perelman Professor in Finance at The Wharton School at the University of Pennsylvania.

In our paper, Contracts with (Social) Benefits (forthcoming Journal of Financial Economics), we ask how private market contracts adapt to serve social-benefit goals in addition to financial goals. In particular we consider the potential impact of these additional goals on canonical principal-agent problems: first between investors and the fund, and, later, between the fund and the portfolio companies in which the fund invests.

To examine contracting for impact, we analyze a unique set of impact fund legal documents compiled by the Wharton Social Impact Initiative (WSII). Documents include private limited partner agreements (LPAs), private placement memoranda (PPMs), term sheets, and letters of intent. These documents are a window onto the rapidly growing sector of private markets, which by 2019 exceeded 13,000 deals and $33 billion per year (GINN, 2019). In addition to contract observations summarized below, our paper provides a novel descriptive account of the impact funds contributing documents, and of the sector itself.

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Analysis of Proxy Advisors’ Recommendations During the 2020 Proxy Season

Posted by Kyle Isakower, American Council for Capital Formation, on
Wednesday, August 5, 2020
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Kyle Isakower is Senior Vice President of Regulatory and Energy Policy at the American Council for Capital Formation. This post is based on his ACCF report.

Introduction

A new analysis of companies’ supplemental filings to their proxy materials with the U.S. Securities and Exchange Commission (SEC) during the majority of the 2020 proxy season shows at least 42 instances where proxy advisors have formulated recommendations based on errors* or analysis disputed by the companies themselves.

For example, in one supplemental filing, a proxy advisor generated a recommendation using a disputed figure for a company’s net income, a basic but critical number. Another highlighted how a proxy advisor based its recommendation on a peer group that did not include the company’s actual competitors. Other filings showed instances where proxy advisors issued recommendations that appear to be contradictory with their stated policies.

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Comment Letter to DOL

Posted by Subodh Mishra, Institutional Shareholder Services, Inc., on
Tuesday, August 4, 2020
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Subodh Mishra is Managing Director at Institutional Shareholder Services, Inc. This post is based on a recent comment letter from ISS President & CEO Gary Retelny to the U.S. Department of Labor in response to potential amendments to the Employee Retirement Income Security Act of 1974 (ERISA). 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).

Institutional Shareholder Services Inc. (ISS) is pleased to submit these comments regarding the above-referenced proposal to amend the “Investment duties” rule under Title I of the Employee Retirement Income Security Act of 1974 (ERISA) [29 CFR §2550.404a-1]. Given the increasing importance of integrating environmental, social and corporate governance (“ESG”) factors into a prudent investment management strategy, ISS applauds the Department’s intent to clarify the sub-regulatory guidance in this area. Unfortunately, the proposed rule amendment adds more confusion than clarity, and would, we fear, work to the detriment of ERISA plan participants and their beneficiaries.

While the Department seems to recognize the economic relevance of ESG factors in theory, the Proposing Release nonetheless perpetuates outdated assumptions about ESG investing. As a result, the proposed amendment of Rule 404a-1 imposes unnecessary burdens on the selection of ESG investments, even where the fiduciary has found such investments to be prudent after evaluating them solely on pecuniary grounds. The permissible consideration of non-pecuniary factors under the proposed amendment is confusing as well. The Department characterizes this rulemaking as a confirmation of existing sub-regulatory guidance, but that is not the case. Whereas existing guidance employs an economic equivalence test for assessing alternative investments, the proposed rule requires that such alternatives be economically “indistinguishable.” In so doing, the proposal creates a new—and, ISS fears, unworkable—standard for ERISA fiduciaries.

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The Origins and Real Effects of the Gender Gap: Evidence from CEOs’ Formative Years

Posted by Ran Duchin (Boston College), Mikhail Simutin (University of Toronto), and Denis Sosyura (Arizona State University), on
Tuesday, August 4, 2020
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Ran Duchin is the William A. Fowler Endowed Professor at the University of Washington Foster School of Business; Mikhail Simutin is Associate Professor of Finance at the University of Toronto Rotman School of Management; and Denis Sosyura is Professor of Finance at Arizona State University. This post is based on their paper, forthcoming in The Review of Financial Studies.

In the paper The Origins and Real Effects of the Gender Gap: Evidence from CEOs’ Formative Years (forthcoming in the Review of Financial Studies), we provide the first systematic evidence on the socioeconomic backgrounds of U.S. CEOs. Using individual census records for the families where the CEOs grew up, we study how CEOs’ formative experiences affect their capital allocation decisions. Our main finding is that CEOs raised in male-dominated families—those where the father was the only income earner and had more education than the mother—hire fewer women and allocate smaller capital budgets to female managers. We argue that gender effects in financial policies originate in CEO beliefs developed during formative years.

Our study is motivated by an ongoing debate about whether male managers obtain more resources, such as pay, capital, or promotion opportunities, than their female peers. If such a gender gap exists, it remains unclear whether it reflects a potential bias of the decision makers or results from economic factors correlated with gender, such as productivity or risk aversion. Similarly, the effects on economic outcomes are not fully understood.

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Disclosure Regarding Director’s Conflict During Merger Negotiations

Posted by Jason Halper, Jared Stanisci, Victor Bieger, Cadwalader, Wickersham & Taft LLP, on
Tuesday, August 4, 2020
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Jason M. Halper is partner, Jared Stanisci is special counsel, and Victor Bieger is an associate at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Halper, Mr. Stanisci, Mr. Bieger, Nathan M. Bull, and Sara Bussiere. This post is part of the Delaware law series; links to other posts in the series are available here.

The Delaware courts have not been shy about warning of the dangers that can arise when merger negotiations are handed over to conflicted directors who fail to keep their boards fully informed about their divided loyalties. Over the last two years, the Delaware Supreme Court has faulted a director for lining up a buyer without disclosing that he had negotiated a lucrative equity roll-over deal on the side, and the Court of Chancery chastised a director (and his hedge fund sponsor) for engineering a quick sale of a company without disclosing to the rest of the board that he had been tipped off to the price the buyer had in mind. Directors have an “‘unremitting obligation’ to deal candidly with their fellow directors,” the Delaware courts have stressed, and that is no more true than when they are entrusted to lead merger negotiations.

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Blueprint for Responsible Policy Engagement on Climate Change

Posted by Veena Ramani, Ceres, on
Monday, August 3, 2020
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Veena Ramani is Senior Program Director, Capital Markets Systems at Ceres. This post is based on her Ceres 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) and Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here)

Context

In the last few years, expectations on whether—and how—companies should engage on climate change have evolved. Companies and investors now largely understand that climate change poses clear financial and even material risks to companies and industries across the economy. Additionally, climate change is now widely recognized as posing a systemic threat to financial markets writ large, with significant potential for disruptive impacts on overall economic stability and the lives and livelihoods of tens of millions of people across the U.S. and globally.

Recognizing the need to address the climate crisis, a growing number of companies are taking increasingly ambitious steps to address climate change across their performance and strategies. However, these efforts could be undermined if their lobbying on climate change, whether directly or through their trade associations, is not aligned with climate science. In fact, such misalignment could lead to inefficient corporate spending and reputational and financial risk. Companies that establish robust governance systems to address climate change as a systemic risk and align their lobbying efforts to support science-based climate policies will drive the creation of a regulatory environment that best positions them for resilient growth.

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