Monthly Archives: August 2021

SEC Maintains Focus on Contingent Liabilities

John F. Savarese and Wayne M. Carlin are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum.

An SEC enforcement action announced today highlights a continuing focus on timely disclosure of contingent liabilities. The SEC’s order in In the Matter of Healthcare Services Group, Inc. found that HSG improperly delayed recording or disclosing anticipated losses in pending litigation. The SEC noted that the case resulted from its EPS Initiative, in which the agency deploys data analytics to search for indicators of improper earnings management. The SEC also charged HSG’s CFO, for deciding not to record the loss contingency, and the company’s controller, for a separate series of violations involving improper reductions in other expenses. The parties settled without admitting or denying the SEC’s findings, and HSG agreed to pay a $6 million civil penalty.

As the SEC Order recites, HSG was a defendant in several class action lawsuits alleging claims under various wage-and-hour labor laws. On two different occasions, HSG entered into proposed settlement agreements relating to certain of these lawsuits. Court approval was required for each settlement to become final. In several reporting periods, HSG did not accrue any loss contingency despite entry into settlement agreements, submission of those agreements for court approval, and grants of preliminary approval by the court.

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Weekly Roundup: August 20–26, 2021


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This roundup contains a collection of the posts published on the Forum during the week of August 20–26, 2021.

The Difference Between Purpose and Sustainability (aka ESG)


A New Variation in SEC Insider Trading Enforcement


Surging M&A Megadeals Top Records In Q2


Shell to Appeal Court Ruling in Netherlands Climate Case


Continued Scrutiny of SPACs and Media Statements


The SEC’s Clear Reminder About the Need for Quality Cybersecurity Disclosures


Obfuscation in Mutual Funds


The Board’s Role in Sustainable Leadership



Are CEOs Different?


More Myths from Lucian Bebchuk


Delaware Court Rejects Buyer’s Claim of an MAE


When the Local Newspaper Leaves Town: The Effects of Local Newspaper Closures on Corporate Misconduct


ESG Trends and Hot Topics



Stock-Option Financing in Pre-IPO Companies


SEC’s Ongoing Scrutiny of Executive Perquisites and Benefits

SEC’s Ongoing Scrutiny of Executive Perquisites and Benefits

Sonia Gupta Barros, W. Hardy Callcott, and Barry W. Rashkover are partners at Sidley Austin LLP. This post is based on a Sidley memorandum by Ms. Barros, Mr.Callcott, Mr. Rashkover, and Sarah K. Gromet. Related research from the Program on Corporate Governance includes Stealth Compensation Via Retirement Benefits by Lucian Bebchuk and Jesse M. Fried.

On August 4, 2021, the U.S. Securities and Exchange Commission (SEC or Commission) announced settled charges against National Beverage Corp. (NBC) relating to NBC’s failure to disclose executive perquisites provided to its CEO. [1] The SEC’s fifth perquisite case in a little over a year, this settlement signals the Commission’s continued focus on undisclosed perks, a priority articulated in 2020.

In National Beverage Corp., the SEC charged NBC with failure to evaluate and disclose executive perquisites granted to its CEO. According to the settlement, NBC’s CEO took 33 trips between 2016 and 2020 that were financed by NBC but not “integrally and directly related to the CEO’s job duties.” NBC failed to disclose the cost of these trips in its proxy statements and Forms 10-K, resulting in understated CEO compensation of approximately $1.5 million between fiscal years 2016 and 2020. The SEC determined that this failure stemmed from NBC’s inadequate controls relating to perquisite disclosures, noting that NBC did not analyze whether the CEO’s flights were directly related to his duties, nor did NBC provide adequate training to employees tasked with drafting the executive compensation sections of NBC’s proxy statements. As a result, the SEC found that NBC violated Sections 13(a) and 14(a) of the Exchange Act and Exchange Act Rules 13a-15(a), 13a-1, 12(b)-20, 14a-3, and 14a-9. [2] NBC agreed to a civil penalty of $481,000 to settle the SEC’s charges. [3]

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Stock-Option Financing in Pre-IPO Companies

David Larcker is 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 Edward Watts is Assistant Professor of Accounting at Yale School of Management. This post is based on their recent paper.

We recently published a paper on SSRN, Stock-Option Financing in Pre-IPO Companies, that examines a new industry in which specialty-finance companies provide capital to employees and executives to facilitate the exercise of stock options in pre-IPO companies.

Equity awards and stock-option grants are a central element of compensation programs in pre-IPO companies. According to the National Association of Stock Plan Professionals (NASPP), approximately three-quarters of private companies offer stock options as part of their compensation mix. In Silicon Valley, where many technology and healthcare startups are located, over 90 percent offer stock options. Stock options are not just awarded to the highest-level executives. Half of companies distribute stock options to over 80 percent of their employee base; a third distribute them to all employees.

Companies include stock options in the compensation mix for attraction, retention, and incentive purposes. Because of the leveraged nature of stock-option payouts, stock options attract highly skilled and risk-tolerant employees who are willing to sacrifice current salary for the potential of much larger future pay if the company is successful through their efforts. By paying a portion of the compensation in equity, companies in the early stage of development can reduce cash outlays. Stock options also serve as retention tools, by encouraging employees to remain with the company until granted awards are fully vested and full value realized upon completion of a liquidity event.

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SEC Approves Nasdaq “Comply-or-Explain” Proposal for Board Diversity

Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite by Alma Cohen, Moshe Hazan, and David Weiss (discussed on the Forum here).

You probably remember that, late last year, Nasdaq filed with the SEC a proposal for new listing rules regarding board diversity and disclosure, accompanied by a proposal to provide free access to a board recruiting service. The new listing rules would adopt a “comply or explain” mandate for board diversity for most listed companies and require companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards. In March, after Nasdaq amended its proposal, and in June, the Division of Trading and Markets, pursuant to delegated authority, took actions that had the effect of postponing a decision on the proposal—until now. On Friday afternoon, the SEC approved the two proposals.

To refute potential criticism of the board diversity proposal as a quota in disguise, Nasdaq took great pains to frame its proposal as principally “a disclosure-based framework and not a mandate,” a presentation that the SEC’s Order has clearly embraced. The Nasdaq board diversity rule sets a “recommended objective” for most Nasdaq-listed companies to have at least two diverse directors on their boards; if they do not meet that objective, they would need to explain their rationales for not doing so. The proposal would also require listed companies to provide annually, in a board diversity matrix format, statistical information regarding the company’s board of directors related to the directors’ self-identified gender, race and self-identification as LGBTQ+.

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ESG Trends and Hot Topics

Catherine M. Clarkin and Melissa Sawyer are partners at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell memorandum by Ms. Clarkin, Ms. Sawyer, John Horsfield-Bradbury, Marc Treviño, Sarah Mishkin, and Sam Saunders. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance and Will Corporations Deliver Value to All Stakeholders?, both 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).

Key Developments

Hot topics in ESG for directors and executives to consider:

  • Regulators and investors are focused on ESG-related disclosure requirements, particularly on climate change and board and workforce diversity. Requirements are likely to be extended to US public companies and US investment funds, as well as private companies and subsidiaries operating in the EU and UK.
  • The risk of ESG-related litigation, regulatory action and shareholder proxy battles continues to grow. Companies should comprehensively review their ESG-related strategy and disclosure, including in materials not filed with authorities or used in securities offerings.
  • The global sustainable finance market is likely to be significantly boosted by new central bank and regulatory actions, but more rigorous criteria for ESG-labeled products are also being implemented. Companies should consider relevant opportunities to participate in this market.
  • Financial regulators are focusing on climate risk management and climate change’s effects on financial stability. Financial institutions should assess their current approach to climate risks and opportunities and prepare for related new requirements and supervisory expectations.

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When the Local Newspaper Leaves Town: The Effects of Local Newspaper Closures on Corporate Misconduct

Jonas Heese is Marvin Bower Associate Professor of Business Administration at Harvard Business School; Gerardo Pérez-Cavazos is Assistant Professor of Accounting at UC San Diego Rady School of Management; and Caspar David Peter is Associate Professor of Accounting at Erasmus University Rotterdam School of Management. This post is based on their recent paper, forthcoming in Journal of Financial Economics.

Is the local press an effective monitor of corporate misconduct? Examining this question is important as over the last two decades the circulation of local newspapers in the United States has decreased by nearly 50% according to the Pew Research Center. A concern is that less local news results in less local accountability and investigative reporting, and therefore increased local corruption and crime. Yet, little is known about whether the decline in local newspapers affects corporate misconduct. We study this question by examining the effects of local newspaper closures on facility-level violations of publicly listed firms using a dataset that encompasses a wide range of violations, such as workplace safety violations, environmental violations, and securities fraud.

Effects of Local Newspaper Closures

From a theoretical standpoint, the effect of local newspaper closures on firms’ legal violations is ambiguous. On the one hand, the local press could be an effective monitor of firms and hence affect corporate misconduct via investigations or dissemination. For example, similar to the national press, the local press could undertake original investigations to detect corporate fraud. Local newspapers may be especially effective in discovering the misconduct of local firms because of their proximity to local sources such as employees and local suppliers. The local press could also affect corporate misconduct by widely disseminating information about misbehavior.

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Delaware Court Rejects Buyer’s Claim of an MAE

Roger Morscheiser, Scott Petepiece, and George Casey are partners at Shearman & Sterling LLP. This post is based on their Shearman memorandum, 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 Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here).

On July 9, 2021, Vice Chancellor Slights of the Delaware Court of Chancery, in Bardy Diagnostics, Inc. v Hill-Rom, Inc. (Del. Ch. July 9, 2021), ordered specific performance to compel Hill-Rom, Inc. (“Hillrom”), a publicly held, global medical technology company, to close the acquisition of Bardy Diagnostics, Inc. (“Bardy”), a medical device startup, upon finding that Hillrom failed to prove that a significant decrease in the Medicare reimbursement rate for Bardy’s sole product offering constituted a Material Adverse Effect (“MAE”), as defined in the merger agreement.

Background

Bardy has a single product offering on the market: an ambulatory electrocardiogram device marketed as the Carnation Ambulatory Monitor (“CAM”) patch. One of Bardy’s largest sources of revenue is through Medicare reimbursements for the CAM patches. The Centers for Medicare & Medicaid Services (“CMS”), an arm of the federal Department of Health and Human Services, develops and administers Medicare’s reimbursement policy. CMS, in turn, authorizes a private entity, Novitas Solutions, Inc. (“Novitas”), to set the reimbursement rates applicable to the CAM patch, which in 2020, was approximately $365 per CAM patch.

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More Myths from Lucian Bebchuk

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton and William Savitt. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance and Will Corporations Deliver Value to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita (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).

Two years ago, the Business Roundtable (BRT) issued a “Statement on the Purpose of a Corporation,” signed by the CEOs of 184 major U.S. corporations, that rejected shareholder primacy, declared “a fundamental commitment to all [corporate] stakeholders” and linked corporate purpose to advancing and protecting the interests not just of shareholders, but of all corporate stakeholders. The BRT’s statement reflected rapidly growing momentum towards a more inclusive corporate governance regime and promised to accelerate stakeholder governance by committing business leaders to the interests of employees, customers, suppliers, communities and the environment.

The BRT statement elevated the topic of stakeholder capitalism to the top of national and global policy debate. In 2020, the World Economic Forum launched the new “Davos Manifesto” in support of stakeholder capitalism. Nearly every significant asset manager—including the “big three,” BlackRock, Vanguard and State Street—now insists that the companies in which they invest adopt sustainable stakeholder governance practices. At the urging of their investors, large companies are nearly uniformly undertaking efforts to make and measure progress in achieving sustainable, socially responsible operations. The signs of the step-up in the embrace of stakeholder governance by corporations and their major investors are everywhere.

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Are CEOs Different?

Steven N. Kaplan is the Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business, and Morten Sorensen is Associate Professor of Finance at Dartmouth University Tuck School of Business. This post is based on their recent paper, forthcoming in the Journal of Finance.

Evaluating leaders and managers is a central concern for companies and their boards. A critical question is how CEOs differ from other top managers. There is much anecdotal evidence and many studies of specific companies and individual leaders, but there is very little systematic evidence about what CEOs look like, how they differ from other top managers, and which candidates are more likely to eventually be promoted to the top spot. In a recent study, drawing on unique data with personality assessments of thousands of candidates, we contrast the types of individuals that are considered for CEO, CFO, and COO positions. We examine who among the considered candidates is more likely to be hired for each position. And focusing on candidates earlier in their careers, we predict who eventually becomes a CEO, CFO, and COO.

In a data collection that has lasted several years, we have processed about 2,600 candidates. We started with candidates assessed by ghSMART, a leading HR consulting firm that has developed a rigorous process using structured interview to classify each candidate’s personality. These assessments are typically performed as part hiring or retention processes, often for the due diligence process of venture capital and private equity firms evaluating investments in the companies. We combined ghSMART’s assessments with information gathered from public searches and other data sources to track each candidate’s subsequent career. The resulting data are unique. They contain a larger number of managers, each assessed using a structured and systematic process, spanning a wide range of companies, a range of positions, and a time period lasting more than a decade.

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