Board Memo 2021: A Guide to Taking On the Recovery Era

Pamela Marcogliese and Ethan Klingsberg are partners and Elizabeth Bieber is counsel at Freshfields Bruckhaus Deringer LLP. This post is based on their Freshfields memorandum.

Managing environmental, social and governance considerations

While ESG has been steadily increasing in importance year after year, the pandemic has catapulted the “E” (environmental) and the “S” (social) to the top of board agendas. As boards and management teams prepare for, and adapt to, the recovery period ahead, strategic and deliberate management and disclosure of E and S topics will provide a competitive advantage. In particular, boards should be mindful that:

  • investors and proxy advisory firms alike will be carefully scrutinizing executive compensation-related modifications in the proxy season ahead, and therefore companies should carefully craft disclosure explaining any changes;
  • as a result of mounting pressure from investors and other stakeholders—as well as recently adopted SEC rules focused on human capital management—companies will need to disclose more information about how they manage their most important asset, their workforce;
  • companies will also need to steer clear of new trends in litigation focused on diversity by ensuring they have a robust process for developing internal diversity-related goals and for disclosing their diversity initiatives, as well as avoid allegations of human rights violations by reviewing the adequacy of corporate compliance and supply chain programs;
  • investors and other stakeholders are expecting to see additional climate and other environmental-related disclosures, especially as the SASB and TCFD frameworks gain increasing traction, and the SEC is expected to adopt climate-related environmental disclosure requirements in 2021; and
  • there is mounting evidence that this focus on ESG and sustainability has concrete economic benefits for companies, as those with better ESG profiles and track records tend to have equity (and debt) that trades more favorably than companies with poorer performance, underpinning the expectation that the growing trends of green and other sustainability bonds will continue in 2021.

Adapting to significant changes in shareholder meeting practices

Another profound shift that has taken place over the past 12 months and is now expected to have lasting consequences is in relation to shareholder meeting practices. In particular:

  • we expect that, for many companies, the shift from in-person to virtual shareholder meetings will be permanent, with greater focus on logistics, accessibility concerns and a better simulation of the in-person experience; and
  • the SEC’s amendments to Rule 14a-8 (which governs the shareholder proposal submission process) coupled with the limitations imposed on ERISA fiduciaries’ ability to vote for shareholder proposals unless they demonstrably have an economic impact on the ERISA plan may severely curtail the ability for shareholders (especially smaller shareholders) to use the shareholder proposal process to influence corporate ESG agendas. The question that remains is whether the Biden administration will seek to reverse (at least to a certain extent) any of these changes.

Navigating the M&A landscape

The pandemic has altered the dynamics of M&A. However, the changes present significant opportunities for companies that are well-advised and well-prepared.

  • The recovery era will see enhanced dispersion, with winners and losers. This will create opportunities for stronger companies to capitalize on favorable M&A and financing environments, while requiring those that are more vulnerable to address their weaknesses and communicate the value of the standalone plan to investors more effectively.
  • We also expect that corporates will continue to play an increasingly proactive role in venture and growth-stage investments, creating significant growth opportunities while also posing unique liquidity and reporting challenges that boards and management teams will need to consider carefully.
  • In the tech sector, digital resilience will be critical to success through the recovery era and many companies will leverage M&A as the best way to build their technological capabilities. These businesses will need to navigate specific obstacles, including evolving IP and privacy regulations around the world, the more active role of CFIUS in reviewing and clearing transactions, and a more coordinated global antitrust environment that will have a significant impact on the tech sector.
  • Antitrust enforcement and the involvement of foreign investment review regimes, including CFIUS, is expected to increase with the potential to impact a greater number of transactions.
  • As a backdrop to this dynamic M&A landscape, companies will need to understand the changing business model of activism and adapt their business and practices accordingly—especially with ESG now often part of an activist’s core strategy—to keep hungry activists and other more active-leaning investors at bay after a more muted 2020.

Mitigating risk in an active enforcement and regulatory environment

Periods of crisis are generally followed by waves of enforcement activity and regulatory scrutiny. We expect the post-COVID recovery era to be no different. In particular:

  • regulators will look to prosecute any fraud and other misconduct by executives and employees during the crisis, leveraging an increased commitment to global co-operation and a more sophisticated arsenal of tools perfected following the financial crash of 2008;
  • privacy regulations are spreading to many jurisdictions, increasing the difficulties of compliance—and the risk of enforcement—for companies that operate globally;
  • the sanctions and trade arena promises to be highly fraught, with 2020 having been a particularly active year for sanctions against China and Chinese companies; and
  • companies (and higher income individuals) will face higher taxes, including an increase in the corporate tax rate from 21 percent to 28 percent and increased taxation of the revenue of multinational corporations if proposals issued by the incoming Biden administration are adopted into law.

Avoiding litigation risk

The pandemic has increased the role of the board in overseeing how companies have managed through the crisis. This is likely to continue as businesses shape how they will emerge from the economic downturn. However, this oversight exposes boards to increased scrutiny and litigation risk.

  • While Caremark failure of oversight claims are notoriously difficult to prove, the last year has shown that Delaware courts may sustain Caremark claims at the pleading stage when there are factual allegations of purported failure of oversight relating to “mission critical” risks. While these cases usually have unique facts, they nonetheless reaffirm the need for boards to maintain thorough, careful records reflecting the steps taken as part of their oversight duties.
  • There has also been continued increase in the use of Section 220 demands by stockholder plaintiffs to bolster their claims prior to litigation. A decision by the Delaware Court of Chancery raises further unanswered questions relating to the future use of Section 220 demands, including the ability of stockholders to bring inspection actions outside of Delaware, and the potential viability of contractual waivers of inspection rights.
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