Monthly Archives: March 2021

Gensler and SEC’s 2021 Examination Priorities Highlight ESG and Climate Risk

Betty Moy Huber, Aaron Gilbride, and David A. Zilberberg are counsel at Davis Polk & Wardwell LLP. This post is based on their Davis Polk 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); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here).

SEC Chair Hearing

[On March 2, 2021], the U.S. Senate Committee on Banking, Housing, and Urban Affairs held a nomination hearing to consider Gary Gensler’s candidacy for Chair of the Securities and Exchange Commission, or SEC. Throughout the hearing, Gensler fielded numerous questions on environmental, social and corporate governance and disclosure matters. This post synthesizes the most salient points from his testimony. The post also provides information on the SEC’s 2021 examination priorities and legislative bill activity occurring in parallel.

Climate Risk Disclosure

Gensler affirmed that as SEC Chair, he may pursue further climate-related disclosure requirements. He explained that in his view not only do investors want this information, but also that issuers would benefit from “such guidance.”

Political Contributions Disclosure

Gensler showed an interest in examining additional requirements related to political contributions, especially in light of investor attention, which he saw manifested in the nearly 80 shareholder proposals on this topic during last year’s proxy season. Rather than look at the financial significance of a single donation, he reiterated that his assessment would be grounded both in the legal test of materiality, defined as what reasonable investors want in the total mix of information, and in economic analysis.


Delaware Court Enjoins Poison Pill Adopted in Response to Market Disruption

Mark McDonald, James Langston, and Kyle Harris are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Mr. McDonald, Mr. Langston, Mr. Harris, Roger Cooper, and Pascale Bibi, and 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 Toward a Constitutional Review of the Poison Pill by Lucian Bebchuk and Robert J. Jackson, Jr. (discussed on the Forum here).

On February 26, 2021, the Delaware Court of Chancery (McCormick, V.C.) issued a memorandum opinion in The Williams Companies Stockholder Litigation enjoining a “poison pill” stockholder rights plan adopted by The Williams Companies, Inc. (“Williams”) in the wake of extreme stock price volatility driven by the double whammy of COVID-19 and the Russia-Saudi Arabia oil price war. While the pill adopted by the board in this case had unusual features (such as a 5% trigger and a broad “acting in concert” provision), the Court’s decision provides important reminders for boards in considering whether (and when) to adopt a poison pill in the face of a threat to the corporation. This includes the types of “threats” that will justify the adoption of a pill, and the scope of protections that will be considered a “proportionate” response to those legitimate threats.

Although the Court struck down the pill in this case, that should not prevent boards from considering adoption of a pill in a situation where they are facing an identifiable threat, whether from a potential takeover or activist shareholder, and tailoring the terms of such a pill to the threat posed.


SEC Announces It Will Aggressively Scrutinize Issuers’ Climate Change Disclosure

Marc E. Elovitz and Brian T. Daly are partners and Tarik M. Shah is an associate at Schulte Roth & Zabel LLP. This post is based on an SRZ memorandum by Mr. Elovitz, Mr. Daly, Mr. Shah, Craig S. Warkol, Kelly Koscuizka, and Christopher S. Avellaneda.

On March 3, 2021, the SEC’s Division of Examinations released its 2021 Examination Priorities (“Exam Priorities”). While the Exam Priorities address the Division of Examinations’ focus for all of the SEC’s registrants, certain focus areas will be of particular interest to private fund managers. Consistent with what we have seen during examinations over the last 12 to 18 months, those focus areas include conflicts of interest, compliance programs, ESG and climate change, digital assets, alternative data and structured products.

  • Compliance Programs. Not unexpectedly, the Division of Examinations will continue its focus on the overall strength of investment adviser’s compliance programs, to confirm that “policies and procedures are reasonably designed, implemented, and maintained.” Of particular relevance to private fund managers, the examination staff identified the following areas for assessment, “portfolio management practices, custody and safekeeping of client assets, best execution, fees and expenses, business continuity plans, and valuation of client assets for consistency and appropriateness of methodology.” This reinforces the SEC staff’s focus on ensuring that investment advisers understand and effect their core responsibilities under the Compliance Rule (Rule 206(4)-7), particularly following the Division of Examination’s November 2020 Risk Alert, which identified these same areas as being common sources of examination deficiencies.


Equality Metrics

Veronica Root Martinez is Professor of Law at the University of Notre Dame Law School; and Gina-Gail S. Fletcher is Professor of Law at Duke Law. This post is based on their recent paper. 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); Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here); and Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here).

In the wake of the deaths of George Floyd and Breonna Taylor, protests engulfed U.S. cities during the summer of 2020 as activists, politicians, and everyday citizens demanded changes to the system of policing that has repeatedly resulted in the death of Black citizens at the hands of White police officers. Notably, these demands extended beyond the criminal justice system and led to an examination of the myriad of ways systemic racism and racial inequities pervade daily life in America—from education, to health care, to corporate America. Conversations that initially focused on the role of police within American society turned into larger debates about how to create an America that values Black lives; and these discussion spilled into living rooms, permeated workplaces, and ultimately infiltrated boardrooms across the U.S.

For the first time, since the founding of the Black Lives Matter (BLM) movement in 2013, many large, well-known corporations publicly aligned themselves with the growing social movement. Corporations’ responses ranged from a lack of support, on one end of the spectrum, to detailed statements in support of BLM, coupled with significant outlays of resources to address systemic inequality both internally and externally. The majority of corporations fell somewhere between these two extremes—that is, most corporations made statements broadly in support of the social movement, but committed to limited or no tangible actions to improve demographic diversity and enhance racial equality within their own corporate structures or their contracting partners’. Our Essay focuses on these corporations in the middle—corporations for which support of BLM has been little more than a marketing campaign. We examine how to incentivize corporations to move away from mere statements and towards the types of actions more likely to tackle systemic racism and racial inequalities in a sustained, meaningful manner. To achieve this goal, we suggest harnessing the power and influence of institutional investors to encourage firms to implement strategies crafted to address discrimination, bias, and racism within firms’ own organizational structures and supply chains.


Weekly Roundup: March 12–18, 2021

More from:

This roundup contains a collection of the posts published on the Forum during the week of March 12-18, 2021.

Trusting What You Can’t See: Audit Oversight and the PCAOB

2020 Say on Pay & Proxy Results

The SEC Should Address the Risk of Activist “Lightning Strikes”

Transparency and the Future of Corporate Political Spending

Delaware Chancery Court Invalidates “Anti-Activist” Poison Pill

C-Suite Challenge 2021: Leading in a Post-COVID-19 Recovery

How the COVID-19 Pandemic Influenced Incentive Plans

Speech by Acting Chair Lee on the Importance of Fund Voting and Disclosure

Allison Herren Lee is Acting Chair at the U.S. Securities and Exchange Commission. This post is based on her recent remarks at the 2021 ICI Mutual Funds and Investment Management Conference. The views expressed in the post are those of Acting Chair Lee, and do not necessarily reflect those of the Securities and Exchange Commission or the Staff. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here).

Good afternoon everyone, and thank you to the ICI for inviting me to speak with you today at the 2021 Mutual Funds and Investment Management Conference.

I gave my last in-person speech on March 5, 2020. It’s hard to believe that a full year has passed and we are still operating in a virtual environment. Among the many lessons this last year has taught, we’ve learned that we can still come together to exchange ideas as we do this week at the ICI’s conference. The exchange of information and ideas, the goal of any conference, relates to one of our underlying democratic norms: that knowledge is empowering. That principle is also the basis of shareholder democracy: through clear and timely disclosure, we empower investors to hold the companies they own accountable—including accountability on climate and ESG matters. But in a world where institutional investors play an unprecedented role in our economic future, the people in this virtual room are also increasingly key to making sure companies are accountable to their shareholders—on those very issues, which, it’s no secret, have long been a focus of mine in large part because it is the focus of investors representing tens of trillions of dollars.


Measuring Accounting Fraud and Irregularities Using Public and Private Enforcement

Christopher G. Yust is assistant professor of accounting at Texas A&M University Mays Business School. This post is based on a recent paper forthcoming in The Accounting Review authored by Mr. Yust, Dain Donelson, Antonis Kartapanis, and John McInnis.

Corporate accounting fraud has a significant negative impact on the economy and investors, so academic research on factors that make accounting fraud more or less likely to occur has substantial real-world and public policy implications. However, conducting such research is difficult because researchers cannot observe the incidence of fraud for most firms, corporate admissions of fraud are rare, and trials proving fraud are almost nonexistent. Thus, researchers are forced to rely on proxies for fraud to conduct empirical analysis. Our recent paper examines the use of both public and private accounting enforcement with appropriate screening to proxy for accounting fraud and demonstrates how this combined proxy improves research inferences.

The current dominant proxy for accounting fraud in research is public enforcement through the Securities and Exchange Commission (SEC). In contrast, relatively few papers, particularly in the accounting literature, use private enforcement via securities class actions (SCAs). However, we argue that the use of only public or private enforcement excludes credible fraud firm observations as the SEC lacks a sufficient budget to pursue all possible fraud and private litigants lack the incentive to pursue such cases if their expected costs exceed expected recoveries. Critically, the use of either enforcement regime does not only reduce statistical power but can also bias regression estimates.


How the COVID-19 Pandemic Influenced Incentive Plans

Mike Kesner is partner, and Joshua Bright and Linda Pappas are principals at Pay Governance LLC. This post is based on their Pay Governance memorandum. 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).

The COVID-19 global pandemic has had a profound impact on the economy and forced many companies to make dramatic changes in staffing, operations, supply chains, and short- and long-term business plans. At the time this article is being written, close to 10 million fewer people are employed in the U.S. than at this time last year. Many companies acted swiftly at the onset of COVID-19 in the U.S. by implementing base salary reductions, enacting furloughs, suspending 401(k) matches, and taking other measures to reduce cost, improve cash flow, and strengthen balance sheets. By the end of April 2020, as lockdowns eased, the major stock indices started to recover, and companies showed their resiliency by adapting their operations to fit the new COVID-19-dominated environment.

As companies reset business plans and priorities in response to the pandemic, compensation committees and senior management teams also began to assess the pandemic’s impact on their incentive plans—both what had happened and what may yet happen—and discuss what actions, if any, might be appropriate to address these disruptions in compensation programs that were established prior to the onset of the pandemic.

Pay Governance reviewed the proxy filings of S&P 1500 companies (available as of February 8, 2021) with fiscal years (FYs) ending between April 30, 2020 and October 31, 2020 (“early filers”). We focused on disclosure related to 2020 annual incentives (AIs), long-term incentives (LTIs) with performance periods ending in 2020, and “in-flight” incentive awards (i.e., incentive awards with a performance measurement period that has not yet concluded). We also reviewed forward-looking disclosures about 2021 compensation structures to identify the key changes (or lack thereof) and researched how shareholders and the proxy advisory firms reacted to the changes.


Cleaning Corporate Governance: A New Open-Access Dataset on Firm- and State-Level Corporate Governance

Eric Talley is the Isidor & Seville Sulzbacher Professor of Law at Columbia Law School. This post is based on a recent paper forthcoming in the University of Pennsylvania Law Review, authored by Prof. Talley; Jens Frankenreiter, Postdoctoral Fellow in Empirical Law and Economics at the Ira M. Millstein Center for Global Markets and Corporate Ownership at Columbia Law School; Cathy Hwang, Professor of Law at the University of Virginia School of Law; and Yaron Nili, Assistant Professor of Law at the University of Wisconsin-Madison Law School. Related research from the Program on Corporate Governance includes Learning and the Disappearing Association between Governance and Returns, by Lucian Bebchuk, Alma Cohen, and Charles C.Y. Wang (discussed on the Forum here); and What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen, and Allen Ferrell.

In the iconic 1994 Tarantino film Pulp Fiction, Harvey Keitel makes a brief yet memorable appearance as Winston Wolfe (a.k.a., the “Cleaner”). His forte? Tidying up the inconvenient (and usually gruesome) messes perpetrated by others. Wolfe’s modus operandi was never pretty and rarely polite; but it was invariably effective.

Empirical corporate governance needs its own Winston Wolfe. Over the last thirty years, the field has risen in prominence by quantifying what was traditionally thought unquantifiable—text from state laws, federal regulations, and firm-level governance documents—to measure the quality of governance. Canonical studies have shown that countries with strong investor protections are more likely to have higher firm valuations, that more shareholder-friendly firms outperformed more management-friendly ones, and numerous other significant real-world predicted effects of governance on firm performance.

But beneath the field’s orderly veneer lurks an unsettling vulnerability: three decades of finance, economics, and legal studies in corporate governance have been built substantially on data sets with nearly unknown provenance.


Evaluating Executive Compensation in Times of Crisis

John Galloway is global head of investment stewardship at Vanguard, Inc. This post is based on a publication by Vanguard Investment Stewardship.

Our philosophy hasn’t changed

In our last Insights on compensation, we shared key considerations for well-structured executive compensation plans that could withstand the most challenging market and economic conditions, including a pandemic. Although we recognize the unprecedented challenges that companies have faced and that will continue to play out over the coming months, our philosophy on executive compensation has not changed. We look for compensation policies that incentivize long-term outperformance versus peers and drive sustainable value for a company’s investors.

Build long-term plans and stay the course

We continue to evaluate executive compensation case by case and look for a strong focus on performance and the long term. The Vanguard funds are more likely to support plans in which a majority of executive compensation remains variable, or “at risk,” with rigorous performance targets set well beyond the next quarter. Companies across all sectors have experienced varying levels of disruption from the COVID-19 pandemic, including many businesses that have had to fully or partly close following government-mandated lockdowns.

Vanguard understands that the crisis may have hurt companies’ performance. However, we remain steadfast in our view that compensation committees should not retroactively adjust performance targets or time horizons, despite the challenging environment. “At-risk” compensation should remain at risk, just as the Vanguard funds’ capital does—along with that of other shareholders. We believe that the experiences of shareholders and executives should be aligned in both good and challenging times.


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