Yearly Archives: 2021

Litigation Risk and Debt Contracting: Evidence from a Natural Experiment

Posted by Zhihong Chen (Hong Kong University of Science and Technology), Ningzhong Li (University of Texas), and Jianghua Shen (Xiamen University), on
Tuesday, August 3, 2021
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Zhihong Chen is Associate Professor of Accounting at the Hong Kong University of Science and Technology; Ningzhong Li is associate professor, at the University of Texas at Dallas Naveen Jindal School of Management; and Jianghua Shen is Assistant Professor of Accounting at Xiamen University. This post is based on their recent paper, forthcoming in the Journal of Law and Economics.

Nevada is second to Delaware in attracting out-of-state incorporations, with 8% of all public incorporations by firms in states outside the firms’ headquarters states. In June 2001, Nevada changed its state corporate law by substantially reducing the legal liability for breaching fiduciary duties (the legislative change, hereafter). Under the new Nevada corporate law, by default, directors and officers (D&Os) of firms incorporated in Nevada are not liable for breaching their fiduciary duties unless their behaviors involved intentional misconduct, fraud, or a knowing violation of law, whereas prior to the change, by default, D&Os have such liability. This legislative change was implemented swiftly and applied to all firms incorporated under Nevada corporate law without a requirement for shareholder approval. In our paper forthcoming in the Journal of Law and Economics, we use the exogenous decrease in legal liability of D&Os due to the legislative change to study how litigation risk affects loan contract terms and related borrower-lender agency conflicts.

Agency theory suggests that borrowers and lenders have major conflicts when borrowers are insolvent or close to insolvency. To the extent that D&Os owe fiduciary duties to the lenders when a borrowing firm is insolvent and possibly when it is in the “zone” or “vicinity” of insolvency, the legislative change reduces the lenders’ legal tools to enforce their rights. Therefore, we predict that the legislative change will exacerbate borrower-lender conflicts. Anticipating the increased conflicts, lenders will impose more unfavorable loan contract terms, such as higher interest rates and more restrictive covenants.

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SEC Focuses Enforcement Efforts on SPAC Transactions

Posted by Marc Berger, Michael Osnato, and Brooke Cucinella, Simpson Thacher & Bartlett LLP, on
Tuesday, August 3, 2021
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Marc Berger, Michael Osnato, Jr., and Brooke Cucinella are partners at Simpson Thacher & Bartlett LLP. This post is based on a Simpson Thacher memorandum by Mr. Berger, Mr. Osnato, Ms. Cucinella, Joshua Levine, Nicholas Goldin, and Regina Wang.

In one of the first major enforcement actions charging a special purpose acquisition company (“SPAC”), the SEC recently charged SPAC Stable Road Acquisition Company, its sponsor SRC-NI, its CEO Brian Kabot, the SPAC’s proposed merger target Momentus Inc., and Momentus’s founder and former CEO Mikhail Kokorich with misleading claims about Momentus’s technology and the national security and foreign ownership risks associated with Kokorich. While the facts of the case reflect a straightforward alleged offering fraud, the SEC’s public remarks about the matter, as well as the creative remedies, reflect the agency’s intense ongoing focus on the SPAC market and apparent intention to send a strong message to market participants.

Momentus, an early-stage space transportation company, aspires to provide satellite-positioning services with in-space propulsion systems powered by water plasma thrusters. Stable Road completed its initial public offering (“IPO”) for $172.5 million in November 2019, with proceeds held in trust for the benefit of shareholders until completion of a business combination. In late August or early September 2020, Stable Road began due diligence on Momentus’s technology, and on October 7, a merger between Stable Road and Momentus was announced. Before publicly announcing their merger agreement, Momentus and Stable Road disclosed information to potential private investment in public equity (“PIPE”) investors. On November 2, 2020, Stable Road filed a Form S-4 registration statement, which it amended on December 14, 2020 and March 8, 2021.

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Quarterly Review of Shareholder Activism

Posted by Mary Ann Deignan, Jim Rossman, and Christopher Couvelier, Lazard, on
Monday, August 2, 2021
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Mary Ann Deignan is a Managing Director, Jim Rossman is Managing Director and Co-Head of Capital Markets Advisory, and Christopher Couvelier is a Managing Director at Lazard. This post is based on a Lazard memorandum by Ms. Deignan, Mr. Rossman, Mr. Couvelier, Rich Thomas, Lauren Ortner, and Michael Hinz. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

Observations on the Global Activism Environment in H1 2021

1. U.S. Activity Leads Global Market in H1 2021

  • 94 new campaigns were initiated globally in H1 2021, in line with H1 2020 levels
    • Year-over-year stability buoyed by a strong Q1, with Q2’s new campaigns launched (39) and capital deployed ($9.1bn) below multi -year averages
  • H1 was distinguished by several high-profile activist successes at global mega-cap companies, including ExxonMobil (Engine No. 1), Danone (Bluebell and Artisan Partners) and Toshiba (Effissimo, Farallon, et al.)
  • U.S. share of H1 global activity (59% of all campaigns) remains elevated relative to 2020 levels (44% of all campaigns) and in line with historical levels
    • The 55 U.S. campaigns initiated in H1 2021 represent a 31% increase over the prior-year period
  • After only initiating one new campaign in Q1 2021, Elliott launched five campaigns in Q2 2021 and returned to being the period’s most prolific activist
  • H1 2021 activity in Europe slowed following a record-setting end to 2020; the region’s 21 new campaigns included Elliott’s agitation at GlaxoSmithKline and Bluebell’s campaigns at Danone and Vivendi
  • 10 campaigns were launched at Japanese targets in H1, and the share of non-U.S. activity represented by Japanese targets (26%) reached the highest level in recent years
    • The activist success at Toshiba is viewed as a watershed moment in Japanese activism that may catalyze further scrutiny of Japan’s corporate governance system

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Rethinking Securities Law

Posted by Marc Steinberg (Southern Methodist University), on
Monday, August 2, 2021
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Marc I. Steinberg is the Radford Professor of Law at the Southern Methodist University Dedman School of Law. This post is based on his recently published book, Rethinking Securities Law (Oxford University Press).

My recently published book, Rethinking Securities Law (Oxford University Press 2021) (ISBN 978-0-19-758314-2), focuses on many key aspects of securities regulation and recommends meaningful reforms that should be implemented. The book addresses such fundamental subjects as the disclosure regimen of the federal securities laws, exempt offerings (for issuers as well as in the resale setting), the Securities Act registration framework, corporate governance, private securities litigation, insider trading, mergers and acquisitions, and the SEC itself. The book’s final chapter provides a summary of recommendations for adoption, numbering about 125 such recommendations.

Insofar as I am aware, this book is the first comprehensive treatment of revising the securities laws since the American Law Institute’s adoption of the Federal Securities Code over four decades ago. The book’s objective is to identify the deficiencies that currently exist, address their failings, proffer recommendations for correcting these deficiencies, and set forth an analytical prescription for remediation in an effort to espouse a sound and coherent securities law framework.

I am pleased thus far with the reaction to the book. For example, former SEC Chairman Harvey Pitt states: “For anyone who cares about strengthening capitalism, improving the efficiency of our capital markets, and protecting investors, Professor Marc Steinberg’s creative and thought-provoking book Rethinking Securities Law is a must read.” Professor Stephen Bainbridge of UCLA opines that Rethinking Securities Law “should be a strong candidate for law book of 2021….” And former SEC General Counsel Ralph Ferrara states: “… By substantially enhancing the rules-based consolidation of six separate securities statutes advocated by the American Law Institute, Steinberg has formulated an ecosystem of fairness and excellence to sustain access and exchange in our capital markets.”

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U.S. Companies Focus on Four Areas of Human Capital Management Disclosure

Posted by Scott Allen, Laura Wanlass, and Jacob Harden, Aon plc, on
Monday, August 2, 2021
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Scott Allen and Laura Wanlass are Partners and Jacob Harden is a Senior Consultant at Aon plc. This post is based on their Aon 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); Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (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).

As more companies provide required disclosure of their human capital management following a new SEC rule in 2020, we’re getting a more complete picture of disclosure trends and the topics that companies are providing details on. 

It’s been less than a year since a new disclosure rule by the Securities and Exchange Commission (SEC) took effect, which required companies to provide additional detail in their 10-K reports around their human capital management (HCM). The issue is a hot topic for institutional investors and their advisors, particularly since the COVID-19 pandemic, and many of them supported the SEC rule.

As an update to our previous article on the first 100 10-K disclosures, this post includes an analysis of 725 companies who have filed since then—providing a more complete picture of disclosure trends and hot topics in HCM.

Quantitative and qualitative disclosures based on the new rule fit primarily into the 13 categories listed below. Using these categories, we calculated the prevalence of each along with the type of disclosure, with additional breakouts by industry.

  • Geography (distribution of workforce)
  • Turnover and attrition
  • Diversity
  • Hiring and promotion practices
  • Health and safety
  • Leadership development
  • Compensation and benefits
  • COVID-19 health measures
  • Talent development
  • Pay equity
  • Engagement
  • Collective bargaining agreements
  • Principles and values

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SEC Returns Spotlight to Cybersecurity Disclosure Enforcement

Posted by William Johnson, Scott Ferber, Matthew Hanson, King & Spalding LLP, on
Sunday, August 1, 2021
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William Johnson, Scott Ferber, and Matthew Hanson are partners at King & Spalding LLP. This post is based on a King & Spalding memorandum by Mr. Johnson, Mr. Ferber, Mr. Hanson, and Charles Cain.

On June 15, the Securities and Exchange Commission announced a settlement with First American Financial Corporation for what the SEC found were inadequate disclosure controls and procedural violations, revealed in connection with a cyber incident last spring. Since the SEC published guidance in early 2018 regarding disclosure principles related to cybersecurity vulnerabilities, it appears to have taken care to be thoughtful in not second-guessing companies’ good faith decisions about whether and when to disclose such vulnerabilities, bringing charges only in two cases where disclosure lagged awareness of the vulnerability by approximately two years. In the First American matter, however, the gap between awareness and disclosure was less than 6 months, but the SEC still found that the company’s policies and procedures were inadequate.

The SEC’s order in First American is consistent with its published guidance and public statements by SEC officials, all of which emphasized the need for company employees with knowledge of security vulnerabilities to share that information with those responsible for making SEC disclosures.

In a related development, recently the SEC’s Enforcement Division sent information requests to what appears to be a wide range of companies asking about how they responded to a high-profile software vulnerability that came to light in late 2020 involving an information technology company. The information requests in this new Enforcement sweep also ask recipients to provide information about other compromises, including those that were not disclosed at the time.

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Statement by Chair Gensler on Investor Protection Related to Recent Developments in China

Posted by Gary Gensler, U.S. Securities and Exchange Commission, on
Saturday, July 31, 2021
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Gary Gensler is Chair of the U.S. Securities and Exchange Commission. This post is based on his recent public statement. The views expressed in the post are those of Chair Gensler, and do not necessarily reflect those of the Securities and Exchange Commission or the Staff.

Recently, the government of the People’s Republic of China provided new guidance to and placed restrictions on China-based companies raising capital offshore, including through associated offshore shell companies. These developments include government-led cybersecurity reviews of certain companies raising capital through offshore entities.

This is relevant to U.S. investors. In a number of sectors in China, companies are not allowed to have foreign ownership and cannot directly list on exchanges outside of China. To raise money on such exchanges, many China-based operating companies are structured as Variable Interest Entities (VIEs).

In such an arrangement, a China-based operating company typically establishes an offshore shell company in another jurisdiction, such as the Cayman Islands, to issue stock to public shareholders. That shell company enters into service and other contracts with the China-based operating company, then issues shares on a foreign exchange, like the New York Stock Exchange. While the shell company has no equity ownership in the China-based operating company, for accounting purposes the shell company is able to consolidate the operating company into its financial statements.

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Trust: A Critical Asset

Posted by Don Fancher, Robert Lamm, and Debbie McCormack, Deloitte, on
Saturday, July 31, 2021
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Don Fancher is Principal of Risk & Financial Advisory at Deloitte Financial Advisory Services LLP; Robert Lamm is an Independent Senior Advisor and Debbie McCormack is Managing Director, both at the Center for Board Effectiveness, Deloitte LLP. This post is based on their Deloitte memorandum.

Introduction

The responsibilities of boards of directors continue to evolve and increase, particularly given the events of the past year. In addition to perennial topics such as strategy, succession, financial reporting, compliance, and culture, boards are experiencing broader demands on their oversight from expanding stakeholder and shareholder considerations; continuing challenges of the ongoing global pandemic and its aftermath; and addressing the changing role of the corporation in society at large on matters such as racial justice and climate. The growth in the number and complexity of board responsibilities is taking place in an environment of growing skepticism towards our various institutions.

Against that background, companies and their boards can help to address these multiple challenges by considering one of the most critical assets not on their balance sheets―trust.

What is trust?

Trust has been defined as “our willingness to be vulnerable to the actions of others because we believe they have good intentions and will behave well toward us.” [1] However, particularly for a business enterprise, trust is not an ephemeral quality or attitude. Rather, it is a critical asset, albeit one that is not reported on the balance sheet or otherwise in the financial statements, as it has no intrinsic value.

However, trust is very real and concrete. When invested by leaders in relationships with stakeholders, it enables activities and responses that can help build or rebuild an organization and enable an organization to achieve its intended purpose. Trust can also be created across various groups within the organization―between the board and management, employer-employee, among the workforce, organization and stakeholder, vendors and customers. Conversely, a breach of trust can cause a company to lose significant value. For example, a Deloitte Canada analysis found that three large global companies, each with a market cap of more than $10 billion, lost from 20% to 56% of their value, or a total of $70 billion, when they breached their stakeholders’ trust. [2]

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Five Elements of Activist Stewardship: Insights from Two Letters

Posted by Robert G. Eccles (University of Oxford), on
Friday, July 30, 2021
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Robert G. Eccles is Visiting Professor of Management Practice at Oxford University Said Business School. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

Engine No. 1 and Elliott Advisors each invested millions of dollars to do careful and in-depth analyses prior to launching their campaigns to improve the performance of ExxonMobil and GSK, respectively. While Engine No. 1’s campaign has been successfully concluded, Elliott’s is still in its fairly early stages. Nevertheless, some insights can be gained by studying the letters which publicly launched each campaign. They reveal five elements of activist stewardship. They also raise five important questions every board member needs to be asking her or his self.

The proxy contest campaign against the Houston-based oil and gas giant ExxonMobil by the new activist investor Engine No. 1 continues to receive attention and accolades and deservedly so. With a tiny investment of $40 million but with strong support from CalSTRS, followed by CalPERS and Legal & General Investment Management and other major asset owners and asset managers, Engine No. 1 successfully placed three of its four candidates on the board of directors.

From its earliest days, in January Colin Mayer and I were optimistic about its prospects. I wrote about the campaign as it evolved, starting with ExxonMobils’ Magical Mystery Tour for its investors. Not long after I saw A Bad Moon Rising for the company, yet ExxonMobil bravely responded with six cute fables inspired by Aesop it prepared in advance of the annual shareholder meeting on May 26, 2021. The annual meeting itself was a well-choregraphed play in three acts, produced, directed, and starred in by Chairman and CEO Darren Woods. Following the meeting, ExxonMobil’s shareholders cheered Here Comes the Sun!

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The Small, Young Company Board

Posted by Adam J. Epstein (Third Creek Advisors LLC), Robert Lamm (Deloitte LLP), and Jim Parkin (Deloitte & Touche LLP), on
Friday, July 30, 2021
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Adam J. Epstein is Founder at Third Creek Advisors LLC; Robert Lamm is an Independent Senior Advisor at the Center for Board Effectiveness, Deloitte LLP; and Jim Parkin is Partner at Deloitte & Touche LLP. This post is based on their Deloitte memorandum.

Small companies, big challenges [1]

Small, growing companies can be faced with numerous challenges in addition to those noted. These challenges may include:

  • Thin trading volume
  • Limited or no interest on the part of equity research analysts
  • The absence, or the immaturity and/or lack of sophistication, of internal controls, disclosure controls, and other processes for timely, accurate, and complete financial reporting
  • A limited ability to forecast and prepare forward-looking financial plans
  • Limited or no C-suite experience in leading a public company [2]
  • Inadequate understanding of regulatory matters, including SEC and stock exchange rules, or accounting principles and what they require, including the costs of compliance and/or the consequences of noncompliance
  • A lack of attitudinal preparedness for being public and the many corporate and personal matters that need to be disclosed—the “goldfish bowl” syndrome
  • A lack of understanding of fiduciary duties and to whom they are owed

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