Yearly Archives: 2021

Q2 2021 Quarterly Outlook

Posted by Angie Storm and Robin Van Voorhies, KPMG, on
Tuesday, July 6, 2021
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Angie Storm is Partner and Robin Van Voorhies is a Director at KPMG. This post is based on a KPMG memorandum by Ms. Storm, Ms. Van Voorhies, and Carol Clarke.

The latest on SPACs

Although special purpose acquisition companies (SPACs) have been around for decades, they have recently exploded in popularity. While SPACs can offer certain advantages over IPOs, such as quicker access to the capital markets, their use can also raise challenges. The SEC and others are monitoring the SPAC boom and responding as needed.

Warrants issued by SPACs (April 2021). The Office of the Chief Accountant and the Division of Corporation Finance issued a joint statement on two accounting considerations for warrants issued by SPACs.

  • Indexation. An equity-linked financial instrument (or embedded feature) must be considered indexed to an entity’s own stock to qualify for equity classification. Provisions that change the settlement amount of the warrants based on the characteristics of the holder preclude equity classification. Warrants with these provisions are classified as liabilities and measured at fair value.
  • Tender offer provisions. Certain cash tender offer provisions that require the SPAC to settle its warrants for cash preclude equity classification. Warrants with these provisions are classified as liabilities and measured at fair value.

The joint statement also discusses filing and other considerations if the registrant and auditor determine that there is an error in previously filed financial statements related to these warrants.

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Shareholder Liability and Bank Failure

Posted by Felipe Aldunate (Pontifical Catholic University of Chile), on
Tuesday, July 6, 2021
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Felipe Aldunate is Assistant Professor of Finance at the Pontifical Catholic University of Chile. This post is based on a recent paper authored by Mr. Aldunate; Dirk Jenter, Associate Professor of Finance at the London School of Economics; Arthur G. Korteweg, Associate Professor of Finance and Business Economics at the University of Southern California Marshall School of Business; and Peter Koudijs, Professor of Finance and History at Erasmus University Rotterdam.

Because of limited liability, bank shareholders often prefer banks to take high risk, to the detriment of depositors and the stability of the banking system. Using data on the performance of U.S. banks during the Great Depression, we find strong evidence that increasing shareholder liability can be an effective tool to reduce bank risk taking and distress. Our results are relevant for current initiatives to increase bank stability.

Since the beginning of modern banking in the early 19th century, policy makers and regulators have tried to rein in bank risk. One often-used tool was to force bank shareholders to face some form of additional liability. From 1817 onwards, shareholders in most U.S. banks had so-called “double liability.” Double liability stipulates that, in case of bank failure, the banking supervisor levies a penalty on shareholders (up to the par or paid-in value of their shares) that is used to satisfy the bank’s depositors and other creditors. This system remained the norm until 1933, when the American banking system was restructured. All else equal, double liability should reduce shareholders’ risk taking preferences, potentially reducing bank failures.

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Supreme Court Confirms that “All” Evidence Rebutting Price Impact Must Be Considered on Motions to Certify Securities-Fraud Classes

Posted by John F. Savarese, Kevin S. Schwartz, and Noah B. Yavitz, Wachtell, Lipton, Rosen & Katz, on
Tuesday, July 6, 2021
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John F. Savarese and Kevin S. Schwartz are partners, and Noah B. Yavitz is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum. Related research from the Program on Corporate Governance includes Rethinking Basic by Lucian Bebchuk and Allen Ferrell (discussed on the Forum here).

Over the past decade, as we have noted, the Supreme Court has guided lower courts on how they should evaluate defense challenges to efforts by shareholder plaintiffs to certify putative classes in federal securities-fraud claims against corporate issuers. On Monday, the Court waded back into these troubled waters, emphasizing that lower courts must consider “all probative evidence” in evaluating whether alleged corporate misstatements were so “generic” that they could not have had an impact on a stock’s market price and hence that a proposed class should not be certified, and thus remanding the case to the Second Circuit Court of Appeals to reconsider the defendants’ arguments in light of all such evidence. See Goldman Sachs Grp., Inc. v. Arkansas Teacher Ret. Sys., No. 20‑222 (U.S. June 21, 2021).

Shareholder plaintiffs had alleged that defendant Goldman Sachs maintained an improperly inflated stock price by making broad assertions about how carefully it managed potential conflicts of interest among its banking clients. Seeking to invoke the Basic v. Levinson “fraud-on-the-market” presumption that shareholders rely upon, and the stock price necessarily incorporates, all corporate statements, 485 U.S. 224 (1988), plaintiffs argued that such rosy statements must have been false because certain conflicts later came to light, causing a price decline. In opposing class certification, Goldman Sachs argued—unsuccessfully in the courts below—that its alleged misrepresentations (e.g., “[o]ur clients’ interests always come first”) were too generic to have affected its share price.

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A Critique of the Insider Trading Prohibition Act of 2021

Posted by Stephen M. Bainbridge (UCLA), on
Monday, July 5, 2021
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Stephen M. Bainbridge is the William D. Warren Distinguished Professor of Law at UCLA School of Law. This post is based on his recent paper. Related research from the Program on Corporate Governance includes Insider Trading Via the Corporation by Jesse Fried (discussed on the Forum here).

The Insider Trading Prohibition Act (“Act”) passed the U.S. House of Representatives by a wide bipartisan margin on May 18, 2021, and is now awaiting Senate action. The Act’s proponents claim that the bill makes only modest changes in the definition of insider trading as it has been developed in the courts, while at the same time creating “a clear definition of insider trading . . . so that there is a codified, consistent standard for courts and market participants.” Unfortunately, the Act neither codifies nor clarifies.

The Act Likely Will Expand the Current Prohibition

At present, insider trading liability is premised on a breach of a duty of disclosure arising out of a fiduciary relationship or some similar relationship of trust and confidence. The Act changes the focus to whether information was wrongfully used or communicated, which is defined as using or communicating information obtained through such means as “theft, bribery, misrepresentation, . . . misappropriation, or other unauthorized and deceptive taking of such information,” or “a breach of any fiduciary duty, a breach of a confidentiality agreement, a breach of contract, a breach of any code of conduct or ethics policy, or a breach of any other personal or other relationship of trust and confidence for a direct or indirect personal benefit (including pecuniary gain, reputational benefit, or a gift of confidential information to a trading relative or friend).”

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Early Insights to 2021 Annual General Meetings Annual Corporate Governance Review

Posted by Hannah Orowitz, Talon Torressen, and Michael Maiolo, Georgeson, on
Monday, July 5, 2021
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Hannah Orowitz is Senior Managing Director of Corporate Governance; Talon Torressen is Director of Research; and Michael Maiolo is a Senior Institutional Analyst at Georgeson. This post is based on their Georgeson memorandum.

Introduction

With only one month remaining in the 2021 proxy season, an examination of early voting statistics [1] among Russell 3000 companies reveals that investors’ heightened focus on environmental, social and governance (ESG) risks and opportunities are having a meaningful impact on the 2021 season.

This is not surprising, given the continued focus paid to this topic by a range of major institutional investors. The rapid shift in investor voting both with respect to shareholder proposals and director elections year over year has resulted in several groundbreaking results:

  • A total of 30 environmental and social proposals have already passed, the highest number on record and a 50% increase compared to the total number of such proposals receiving majority support during the 2020 proxy season
  • More than one third of environmental shareholder proposals voted on to date have passed
  • The election of three dissident directors occurred, on the basis of investors’ climate concerns, including support from BlackRock, Vanguard and State Street
  • Record-breaking support for shareholder proposals focused on plastic pollution, political contributions and board diversity
  • A sizeable increase in negotiated settlements of shareholder proposals as compared to the 2020 and 2019 proxy seasons

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Why ExxonMobil’s Proxy Contest Loss is a Wakeup Call for all Boards

Posted by Rusty O'Kelley and Andrew Droste, Russell Reynolds Associates, on
Monday, July 5, 2021
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Rusty O’Kelley is a co-leader and Andrew Droste is a Board Specialist at the of the Russell Reynolds Associates Board & CEO Advisory Partners for the Americas. This post is based on their Russell Reynolds memorandum. 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).

Over the past five years, the largest institutional investors have been increasingly vocal and specific about their expectations of boards and directors regarding board composition and ESG. Despite this, they have rarely acted on those concerns when it comes to director voting. However, the ExxonMobil proxy fight may be a sign things have changed. Twenty twenty-one will go down as the year that large institutional investors aligned their voting with market communications and voted out three sitting board members at ExxonMobil. The world’s largest shareholders have now demonstrated that they are willing to act and that they expect executives to take action on ESG and climate change. Importantly, this is a lesson that board composition matters and director skills need to align with a company’s strategy.

At the end of May, the US proxy season reached its apex and the long-awaited contest between ExxonMobil and Engine No. 1 came to a vote. Engine No. 1, an activist hedge fund with just .02% ownership in the company, argued throughout the contest that there were shortcomings in oil and gas experience on ExxonMobil’s board, slow strategic transitioning to a low carbon economy, and historic underperformance and overleverage relative to peers. The fund proffered four board director candidates to ExxonMobil investors, three of whom were ultimately elected to the 12-member board—and as a result, three sitting board members were ousted.

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Chancery Denies Corwin Cleansing In Light of Process Concerns

Posted by Matthew J. Dolan, Sidley Austin LLP, on
Sunday, July 4, 2021
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Matthew J. Dolan is partner at Sidley Austin LLP. This post is based on his Sidley memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

Last month Vice Chancellor Zurn issued a significant, 200+ page decision on a motion to dismiss filed by defendants in the ongoing Pattern Energy transaction litigation, captioned In re Pattern Energy Group Inc. Stockholders Litigation, C.A. No. 2020-0357-MTZ. As we previously reported, class actions had been filed in Chancery Court and Delaware Federal District Court following the $6.1 billion going-private sale of Pattern Energy Group, Inc. to Canada Pension Plan Investment Board (“Canada Pension”). Both cases present overlapping breach of fiduciary duty claims. The Chancery Court case has moved forward faster, with that Court now issuing a decision denying defendants’ motion to dismiss. The decision is a reminder to directors and their advisers that without careful adherence to an independent sales process and transaction structure, directors risk losing the liability protections that Delaware law otherwise provides.

The Sales Process

Pattern Energy was formed nine years ago by Riverstone Pattern Energy Holdings, L.P.(“Riverstone”), a private equity fund, for the purpose of operating renewable energy facilities developed by another Riverstone affiliate. (The summary of pertinent background facts is taken from the Chancery Court’s lengthy recitation of transaction found in its Order from pages 4 to 81.) Riverstone is not a Pattern Energy stockholder. Instead, plaintiffs alleged that Riverstone exercised control through Pattern Energy’s primary upstream supplier of energy projects (“Supplier”), which provided most of Pattern Energy’s business. Pattern Energy was itself a limited partner in Supplier, and Riverstone controlled Supplier. Importantly, the applicable partnership agreement prohibited Pattern Energy from selling its stake in Supplier without Supplier’s consent, although a transaction could potentially be structured to avoid triggering this consent right. This effectively gave Riverstone (through Supplier) a veto right on a sale of Pattern Energy’s stake in Supplier.

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Statement by Commissioner Peirce on the IFRS Foundation’s Proposed Constitutional Amendments Relating to Sustainability Standards

Posted by Hester M. Peirce, U.S. Securities and Exchange Commission, on
Saturday, July 3, 2021
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Hester M. Peirce is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on her recent public statement. The views expressed in this post are those of Ms. Peirce and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

The International Financial Reporting Standards (“IFRS”) Foundation oversees the International Accounting Standards Board, one of the world’s preeminent accounting standard-setters. In recent months, the IFRS Foundation’s gaze has drifted to sustainability reporting. In September 2020, the IFRS Foundation began formally exploring the creation of an International Sustainability Standards Board under the Foundation’s governance structure.

Earlier today, I submitted a comment letter responding to the IFRS Foundation’s proposed amendments to its constitution that would make the creation of the International Sustainability Standards Board possible. [1] I urge the IFRS Foundation not to wade into sustainability standard-setting because doing so would (i) improperly equate sustainability standards with financial reporting standards, (ii) undermine the Foundation’s current important, investor-centered work, and (iii) raise serious governance concerns. The letter is included as an appendix below.

Strong financial reporting standards are the bedrock of our capital markets. They enable investors to make informed decisions about how to allocate capital. We must be careful not to compromise accounting standard-setting in an effort to achieve objectives other than high-quality financial reporting, no matter how noble those objectives may be.

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Key Considerations for Companies Looking to Integrate ESG and DE&I Into Compensation Programs

Posted by Blair Jones, Semler Brossy, on
Friday, July 2, 2021
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Blair Jones is Managing Director at Semler Brossy Consulting Group. This post is based on her Semler Brossy 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).

Eager to give greater attention to stakeholders beyond investors, corporate boards have been adding environmental, social and governance (ESG) issues to their agenda. Prompted by institutional investors and proxy advisors—and from other stakeholder groups— they’ve begun considering translating those concerns into their executive pay packages. At Semler Brossy, we’ve seen a dramatic increase in client inquiries on this challenge.

Linking ESG metrics to executive pay is a powerful way to drive change, but compensation is a sensitive instrument, so we urge caution. Compensation real estate is limited. Each new metric may dampen the emphasis on existing metrics. It is important to balance all incentive metrics to gain the most powerful effect. Companies can be most effective with ESG metrics starting with just the most relevant issues for them and their industry or sector, rather than trying to address all ESG elements.

Companies can assess a number of worthy goals against the company’s specific strategy for customers, employees and other stakeholders. Where can you make the biggest impact or where do you have the biggest gaps? What metrics best drive competitive advantage? Are you looking to limit a major risk or capture a big opportunity?

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The False Hope of Stewardship in the Context of Controlling Shareholders: Making Sense Out of the Global Transplant of a Legal Misfit

Posted by Dan W. Puchniak (National University of Singapore), on
Friday, July 2, 2021
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Dan W. Puchniak is associate professor of law at the National University of Singapore. This post is based on his recent paper, forthcoming in the American Journal of Comparative Law. 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); Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); and The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

The 2008 Global Financial Crisis (GFC) rocked the foundation of the United Kingdom’s financial system. As the dust settled, the UK tried to figure out what went wrong. An autopsy of UK corporate governance revealed that it had developed an acute problem. Institutional investors had come to collectively own a substantial majority of the shares of listed companies, but often lacked the incentive to use their collective ownership rights to monitor them. The failure of these rationally passive institutional investors to act as engaged shareholders—or, as is now the popular vernacular, to be “good stewards”—allowed corporate management to engage in excessive risk taking and short-termism, which were primary contributors to the GFC.

In 2010, the UK enacted the world’s first stewardship code (UK Code) to solve this problem. The goal of the UK Code was to incentivize passive institutional investors to become actively engaged shareholder stewards. After a decade, there are still divergent views on whether the UK Code will ever be able to achieve this goal.

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