Yearly Archives: 2021

First Independent Report on Proxy Voting Advisory Firm Best Practices

Posted by Stephen Davis (Harvard Law School), on
Wednesday, July 14, 2021
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Stephen Davis is a Senior Fellow at the Harvard Law School Program on Corporate Governance.

All six of the world’s leading proxy voting advisors have met best practice industry standards for service quality, integrity, and communications, according to a first-ever assessment by an impartial international panel composed of investors, company executives, and academics. However, in its debut annual report released July 1, the Independent Oversight Committee (IOC) also called on the six to adopt a battery of improvements in practice and disclosure. Find the annual report at Best Practice Principles (BPP) Oversight Committee | Best Practice Principles for Shareholder Voting Research (bppgrp.info).

The industry of firms offering shareholder voting analysis and research has drawn rising stakeholder attention to the roles they play in the market, the IOC annual report asserts. Depending on their business model, services provide institutional investors with research, data, and/or advice they can use to make informed voting decisions at listed companies around the world. Since voting today involves how investors manage risk, value, and opportunity more than routine compliance, their ballot choices—and the research inputs they use to reach them—bear more directly than ever before on the future governance and strategic directions, and the electoral fate of board directors, of publicly-traded companies worldwide. With such relevance comes elevated expectations and scrutiny. Certain issuers, and regulators such as the Trump-era SEC and current Australian Treasury, have called on the proxy voting analysis and research industry to step up transparency and accountability. ESMA, the European Securities and Markets Authority, has been especially proactive in encouraging private and public sector solutions.

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Don’t Take Their Word For It: The Misclassification of Bond Mutual Funds

Posted by Huazhi Chen (University of Notre Dame), Lauren Cohen (Harvard Business School), and Umit Gurun (University of Texas at Dallas), on
Wednesday, July 14, 2021
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Huazhi Chen is Assistant Professor of Finance at the University of Notre Dame’s Mendoza School of Business; Lauren Cohen is the L.E. Simmons Professor in the Finance & Entrepreneurial Management Units at Harvard Business School; and Umit G. Gurun is the Ashbel Smith Professor at the University of Texas at Dallas. This post is based on their recent paper.

Information acquisition is costly for investors—the exact cost of which depending on timing, location, a person’s private information set, etc. To this end, delegated portfolio management is the predominant way in which investors are being exposed to both equity and fixed income assets. With over 16 trillion dollars invested, the US mutual fund market, for instance, is made up of over 5,000 delegated funds and growing. While the SEC has mandated disclosure of many aspects of mutual fund pricing and attributes, different asset classes are better (and worse) served by this current disclosure level. Investors have thus turned to private information intermediaries to help fill these gaps.

In our paper, we show that for one of the largest markets in the world, US fixed income debt securities, this has led to large information gaps that have been filled by strategic-response information provision by funds. The reliance on (and by) the information intermediary has resulted in systematic misreporting by funds. This misreporting has been persistent, widespread, and appears strategic—casting misreporting funds in a significantly more positive position than is actually the case. Moreover, the misreporting has a real impact on investor behavior and mutual fund success.

Specifically, we focus on the fixed income mutual fund market. The entirety of the fixed income market is similarly sized to equites (e.g., 40 trillion dollars compared with 30 trillion dollars in equity assets worldwide). However, bonds are both fundamentally different as an asset cash-flow claim, along with having different attributes in delegated portfolios. While equity funds hold predominantly the same security type (e.g., the common stock of IBM, Tesla, etc.), each of a fixed income funds’ issues differ in yield, duration, covenants, etc.—even across issues of the same underlying firm—making them more bespoke and unique. While the SEC mandates equivalent disclosure of portfolio constituents for equity and bond mutual funds, this data is more complex in both processing and aggregating to fund-level measures for fixed income.

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What Companies Need to Know About Modern Ransomware Attacks and How to Respond

Posted by Antonia M. Apps, Adam Fee, and Matthew Laroche, Milbank LLP, on
Wednesday, July 14, 2021
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Antonia M. Apps and Adam Fee are partners and Matthew Laroche is special counsel at Milbank LLP. This post is based on their Milbank memorandum.

Ransomware is an escalating and evolving cybersecurity threat facing organizations around the world. In 2020, ransomware attacks increased seven-fold by year end, with over 17,000 devices detecting ransomware each day. [1] As an added challenge, ransomware is more sophisticated than ever before with modern variants designed to inflict immense damage and perpetrators demanding higher payouts. In the past few months alone, ransomware has caused catastrophic disruptions to the business activities of, among others, Colonial Pipeline, food processing giant JBS USA Holdings Inc., and Ireland’s national health care system. [2] Successful attacks cost businesses millions of dollars, including disruption to business, personnel cost, device cost, network cost, lost opportunity, reputational harm, and a potential payment of a ransom. [3] Cybercriminals are demanding and making more and more money, with the average ransomware payout per event growing from approximately $115,000 in 2018 to more than $300,000 in 2020; and the highest ransom paid more than doubling from $5 million between 2015 and 2019 to $11 million in 2021. [4] Governments, law enforcement, and regulatory bodies have taken notice, with companies facing pressure to effectively prepare for and respond to ransomware attacks. [5]

Given the current threat environment, it is critical that companies seeking to manage their cybersecurity risks have some understanding of how ransomware has evolved to become one of the most damaging cybersecurity threats today. Companies are facing increased legal, regulatory, and political scrutiny in the wake of these attacks, which in turn requires companies to have appropriate management structures and controls in place, with board oversight, in order to anticipate and address the significant harms that can be caused from a ransomware attack. Below we examine the key features of modern ransomware that companies should be considering, including how ransomware actors are now targeting specific companies, threatening to post their victims’ most sensitive data online, and collaborating with other cybercriminals to increase the sophistication of attacks. After exploring modern ransomware, we then recommend guidelines for companies responding in the immediate aftermath of an attack so that companies are best positioned to contain the incident, resume normal business operations, and appropriately assess legal and regulatory risks.

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Say on Pay: Approval Slides as CEO Pay Rises

Posted by Samar Feghhi, Equilar, Inc., on
Tuesday, July 13, 2021
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Samar Feghhi is a Research Analyst at Equilar, Inc. This post is based on her Equilar memorandum. Related research from the Program on Corporate Governance includes The Growth of Executive Pay by Lucian Bebchuk and Yaniv Grinstein; the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, by Lucian Bebchuk and Jesse Fried; and Executive Compensation as an Agency Problem by Lucian Bebchuk and Jesse Fried.

Over the past year, COVID-19 has been the driving force behind shifting trends in corporate governance. With large unemployment rates at the beginning of the pandemic (13.8% in May 2020), a declining stock market and vast uncertainty, it has been a historical time to track whether the world’s most powerful executives would feel similar effects to the rest of the population. At the start, it seemed that they would. Executive compensation took a slight hit with CEO pay cuts and changes to long-term incentive plans, but the overarching question remained unanswered: Were these changes significant enough to align with the world’s hardships, or were companies more focused on retaining their highest-paid employees? With 2021 Say on Pay votes well underway, data surrounding executive compensation approval may provide an answer to this question and display if COVID-19 increased the disconnect between the boardroom and shareholders.

Equilar’s early look at 2021 Say on Pay results highlighted that out of the 43 companies in the Equilar 500 with disclosed votes, around 20% received under 70% approval (considered a failure by proxy advisory firm ISS). As of May 20, 247 Equilar 500 companies held their annual meetings with 8.9% in the under 70% mark and 3.6% receiving under 50%, or a failed vote.

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Venture Capital’s “Me Too” Moment

Posted by Sophie Calder-Wang (The Wharton School), Paul A. Gompers (Harvard Business School), and Patrick Sweeney (Harvard Business School), on
Tuesday, July 13, 2021
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Sophie Calder-Wang is Assistant Professor of Real Estate at The Wharton School of the University of Pennsylvania; Paul A. Gompers is Eugene Holman Professor of Business Administration at Harvard Business School; and Patrick Sweeney is a Research Associate at Harvard Business School. This post is based on their recent paper.

Over the last seventy years, female labor market participation has increased significantly. Women’s representation in highly compensated occupations such as law, medicine, consulting, and investment banking has steadily improved. Yet, the gender diversity in venture capital has lagged significantly behind: On average, only about 8% of venture capital investors hired are women over the past three decades.

In this study, we examine the impact of the gender discrimination lawsuit Pao v. Kleiner Perkins on gender issues in the venture capital industry. We have two main findings: First, we show that the Pao trial causes a significant increase in the hiring of women investors in venture capital from 2015 to 2019. We find significantly stronger effects in states with greater awareness of the trial, as measured by Google search trends. Second, we find that the increased hiring of women investors in venture capital is an important driver leading to more funding allocated to companies started by women founders.

Ellen Pao, a junior venture capital partner, filed a discrimination lawsuit in 2012 against Kleiner Perkins Caufield & Bayers, one of the oldest venture capital firms in the Silicon Valley. It went to trial in February 2015, and a jury in San Francisco rejected her gender discrimination claim on March 27, 2015. The Pao trial was closely followed by many major media outlets such as the New York Times, the Wall Street Journal, Financial Times, and Forbes. It also drew significant attention from many US-based venture capital firms.

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Delaware Supreme Court Provides Guidance Regarding D&O Liability Insurance Coverage

Posted by Nicole A. DiSalvo and Daniel S. Atlas, Skadden, Arps, Slate, Meagher & Flom LLP, on
Tuesday, July 13, 2021
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Nicole A. DiSalvo and Daniel S. Atlas are associates at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Supreme Court has issued two decisions over the past year that provide important guidance about directors’ and officers’ (D&O) liability insurance coverage. In RSUI Indemnity Company v. Murdock, the Supreme Court affirmed decisions holding that losses due to the fraudulent actions of an officer or director of a Delaware corporation are insurable under Delaware law. As part of its analysis, the Supreme Court conducted and affirmed a choice-of-law analysis to determine that Delaware law applied even though the D&O policy was negotiated and issued in another state. In In re Solera Insurance Coverage Appeals, the Supreme Court reversed a lower court ruling, holding instead that an appraisal action was not a “Securities Claim”—and therefore, not a covered claim—under the at-issue D&O policy.

RSUI Indemnity Company

In November 2013, David Murdock—Dole Food Company, Inc.’s CEO, director and 40% stockholder at the time—engaged in a going-private transaction, resulting in class action litigation and an appraisal action in the Court of Chancery in which former Dole stockholders challenged the fairness of the transaction and alleged breaches of fiduciary duty by Mr. Murdock and Dole’s president, COO and general counsel, Michael Carter. The court held in its post-trial opinion that Mr. Murdock and Mr. Carter breached their fiduciary duty of loyalty and “engaged in fraud” by, among other things, intentionally depressing Dole’s premerger stock price. [1]

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CEO Compensation: Evidence From the Field

Posted by Alex Edmans (London Business School), Tom Gosling (London Business School), and Dirk Jenter (London School of Economics), on
Monday, July 12, 2021
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Alex Edmans is Professor of Finance at London Business School; Tom Gosling is an Executive Fellow at London Business School; and Dirk Jenter is Associate Professor of Finance at the London School of Economics. This post is based on their recent paper. Related research from the Program on Corporate Governance includes the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, Executive Compensation as an Agency Problem, and Paying for Long-Term Performance (discussed on the Forum here), all by Lucian Bebchuk and Jesse Fried.

In our paper, CEO Compensation: Evidence from the Field, which was recently made available on SSRN, we survey over 200 directors of FTSE All-Share companies and over 150 investors in UK equities on how they design CEO pay packages: their objectives, the constraints they operate under, and the factors they take into account. The answers reveal several interesting results that challenge existing academic theories, which we organize into three groups:

Objective and constraints

We first ask respondents to rank the importance of three goals when setting CEO pay. 65% of directors view attracting the right CEO as most critical, while 34% prioritize designing a structure that motivates the CEO. For investors, these figures are 44% and 51% respectively. This reversal reflects a theme that recurs throughout our survey—directors view labor market forces, and thus the so-called “participation constraint”, as more important than investors, who prioritize the “incentive constraint”. Only 1% of directors and 5% of investors view keeping the level of pay down as their primary goal. This is consistent with CEO pay being a small percentage of firm value, while hiring a subpar CEO or providing suboptimal incentives has potentially large effects. READ MORE »

SEC Enforcement Action Highlights Need for Internal Communications About Cybersecurity Problems

Posted by Matthew Bacal, Robert Cohen, and Joseph Hall, Davis Polk & Wardwell LLP, on
Monday, July 12, 2021
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Matthew Bacal, Robert Cohen, and Joseph Hall are partners at Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum by Mr. Bacal, Mr. Cohen, Mr. Hall, Greg Andres, Angela Burgess and Martine Beamon.

The Securities and Exchange Commission (SEC) announced a settled enforcement action on June 15 against a company for violating the requirement that public companies have controls and procedures to ensure that they make required disclosures in SEC filings. According to the SEC’s order, a cybersecurity journalist informed the company of a vulnerability in a proprietary application that the company used to store and share document images. The vulnerability exposed more than 800 million documents that contained sensitive personal information, although the SEC’s order did not say that anyone exploited the vulnerability to access the sensitive information. The company issued a statement for the journalist’s report the same day, and filed a Form 8-K four days later.

The SEC alleged that senior executives responsible for filing the 8-K were not aware that company personnel had identified the vulnerability months before, or that the issue was not remediated as company policy required. Unaware of that history, despite attending meetings with informed personnel, the senior executives did not evaluate whether to disclose the prior detection or the failed remediation. As a result, the SEC concluded that the company violated the disclosure controls rules, which require controls and procedures “designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits . . . is recorded, processed, summarized and reported, within the time periods specified” in SEC rules. Without admitting or denying the SEC’s findings, the company agreed to pay a penalty of approximately $0.5 million. Demonstrating a recent increase in interagency cooperation on cybersecurity issues, the SEC acknowledged the assistance of the New York State Department of Financial Services, which previously filed a related enforcement action against the company. [1]

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A Private Fund’s Guide to ESG Compliance

Posted by Ranah Esmaili, Stephen L. Cohen, and Nader Salehi, Sidley Austin LLP, on
Monday, July 12, 2021
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Ranah Esmaili, Stephen L. Cohen, and Nader Salehi are partners at Sidley Austin LLP. This post is based on their Sidley 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).

The U.S. Securities and Exchange Commission (SEC) has recently turned its attention to private fund managers that consider Environmental, Social and Governance (ESG) factors as part of their process for selecting portfolio investments. The SEC’s primary focus is on “greenwashing,” the practice of conveying a false image to investors that a product is ESG-friendly. The SEC’s Division of Examinations (EXAMS) has been examining private fund managers on ESG investment selection and portfolio management processes, use of proprietary and third-party scoring systems, marketing materials, proxy voting procedures, and policies and procedures relating to ESG.

In this post, we discuss the SEC’s recent focus on ESG, including the compliance risks associated with ESG investing, and identify concrete steps fund managers can take to ensure compliance. Those steps include conducting an internal review of ESG-related disclosures against practices, controls, and policies and procedures, and preparing for a possible SEC examination concerning ESG investing.

SEC’s ESG Developments

The SEC’s focus on ESG disclosure, which began under Acting Chair Allison Lee, continues to be a priority under Chair Gary Gensler, who was sworn into office on April 17, 2021.

On February 1, 2021, as one of her first significant public actions, Lee appointed the first-ever Senior Policy Advisor for Climate and ESG. The following month, Lee announced an Enforcement Task Force focused on climate and ESG issues and requested public input on climate change disclosures. While nearly all of the 15 questions posed in Lee’s request for public comment focused on public issuer disclosure, one item asked how the Commission’s rules should address “its oversight of certain investment advisers and funds.”

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Chair Gensler’s Remarks at the Asset Management Advisory Committee Meeting

Posted by Gary Gensler, U.S. Securities and Exchange Commission, on
Sunday, July 11, 2021
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Gary Gensler is Chair of the U.S. Securities and Exchange Commission. This post is based on his recent remarks before the Asset Management Advisory Committee. 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.

Thank you for the kind introduction. I enjoyed chatting with you a couple of weeks ago, Ed, and it’s good to meet with the whole committee for the first time.

I’m grateful for your time and willingness to give us advice on the asset management industry. I look forward to hearing the readouts from your various subcommittees on environmental, social, and governance investing; diversity and inclusion; and private investments.

I wanted to share some thoughts on these topics—in particular, on funds that hold themselves out to the public as investing with an emphasis on sustainability, and on diversity in the asset management industry.

First, on sustainability, I’d like to discuss fund disclosure and fund names.

The basic idea is truth in advertising. We’ve seen a growing number of funds market themselves as “green,” “sustainable,” “low-carbon,” and so on.

While the estimated size of this sector varies, one estimate says there are at least 800 registered investment companies with more than $3 trillion in ESG assets last year. [1] Suffice it to say there are hundreds of funds and potentially trillions of dollars under management in this space.

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