Yearly Archives: 2022

SEC Survives Initial Challenge in First Enforcement Action Alleging “Shadow Trading”

Posted by Caitlyn Campbell and Paul Helms, McDermott, Will & Emery LLP, on
Wednesday, February 23, 2022
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Caitlyn Campbell and Paul Helms are partners at McDermott, Will & Emery LLP. This post is based on their MWE memorandum. Related research from the Program on Corporate Governance includes Insider Trading Via the Corporation by Jesse Fried (discussed on the Forum here).

On January 14, 2022, the US District Court for the Northern District of California denied an individual defendant’s motion to dismiss in SEC v. Panuwat, an insider trading case accusing a former pharmaceutical company employee of trading in a competitor’s stock ahead of a merger. This novel US Securities and Exchange Commission (SEC) enforcement action involves “shadow trading”—using inside information relating to one company to trade the stock of a separate, but comparable, company.

According to the SEC’s complaint, Matthew Panuwat was the senior director of business development at a mid-sized biopharmaceutical company. Panuwat allegedly purchased short-term stock options in a competing company in the same industry a few days before his employer announced its acquisition by a global pharmaceutical company. Panuwat allegedly learned that investment bankers had identified the comparable company as part of its analysis, and he anticipated that the acquisition would lead to an increase in the competitor’s share price. Following the announcement of the acquisition, the competitor’s share price rose approximately 8%, and Panuwat’s trades allegedly generated profits of $107,066.

This action is the first time the SEC has tried to extend the “misappropriation theory” of insider trading to trading in the securities of one company while in possession of material nonpublic information about another comparable company. Under the misappropriation theory, a person violates the law when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. Here, the court held that the SEC adequately pled that the information about the acquisition was nonpublic, confidential and material to the competitor; that Panuwat breached his duty to his employer by using information to purchase the stock options; and that he acted with the requisite scienter.

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Monetization is the Key to Measuring Corporate Environmental Performance

Posted by Nicholas Z. Muller (Carnegie Mellon University), on
Wednesday, February 23, 2022
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Nicholas Z. Muller is Lester and Judith Lave Professor of Economics, Engineering, and Public Policy at Carnegie Mellon University Tepper School of Business. This post is based on his recent paper. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita; 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).

Investing according to environmental, social, and governance (ESG) criteria has gained considerable momentum, influencing enormous flows of capital. Numerous financial products track aspects of ESG performance. In a recent working paper, I argue that most prior metrics focusing on environmental performance have mismeasured firm conduct in two ways. And the paper demonstrates that the tools and data needed to improve upon current products are available for use.

The first serious flaw is that most indices track physical emissions instead of monetary damage. The emphasis on emissions likely arises because calculating damage is more difficult than simply tabulating tonnage. Advances in modeling now enables connecting emissions to monetary cost. My working paper shows how to estimate damages and how incorporate these external costs into firm value. Second, many major products track only firms’ carbon intensity. This narrow perspective, in part, stems from the focus on emissions. In the U.S. economy, CO2 emissions totaled about 5 billion tons in 2019. In contrast, combined emissions of common air pollutants amounted to under 100 million tons in the same year. So, if an analyst is only considering firms’ total emissions, it would seem that tracking CO2 sufficiently captures firms’ environmental performance.

So, what’s wrong with measuring carbon intensity in tonnage? First, recent research indicates that, globally, damage from fine particulate matter (a type of local air pollution) is between two and three-times greater than the damages from CO2 over the past 20 years. An index only measuring carbon intensity clearly misses important determinants of firms’ environmental conduct. If the goal of ESG investing is to better align capital allocations with actual firm conduct, a carbon-only index falls short.

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SEC Revisits Pay-for-Performance Proposal

Posted by John R. Ellerman, Mike Kesner, and Ira T. Kay, Pay Governance LLC, on
Wednesday, February 23, 2022
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John R. Ellerman is partner emeritus, Mike Kesner is partner, and Ira T. Kay is a managing partner/founder at Pay Governance LLC. This post is based on their Pay Governance memorandum. Related research from the Program on Corporate Governance includes 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.

Background

In April 2015, the Securities and Exchange Commission (SEC) proposed an amendment to Item 402 of Regulation S-K, which included specific terms and provisions for the disclosure of pay for performance (P4P) reporting. [1] The P4P proposal emanated from the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). One of the key unfulfilled provisions of Dodd-Frank is the requirement that registrants disclose how the named executive officers’ “compensation actually paid” relates to the registrant’s financial performance in both tabular and narrative disclosures.

On January 27, 2022, the SEC announced it is reopening the comment period for an additional 30 days for the P4P proposing release.2 The reopening pertains to both the initial release of 2015 as well as a new supplemental release stipulating additional reporting requirements being considered by the SEC. The supplemental release includes a proposal to expand the disclosure of financial measures the SEC believes would broaden investors’ understanding of the relationship of a company’s P4P. The new release is available on the SEC’s website.

The purpose of this post is to report on the additional disclosure of financial measures included in the January 27, 2022 proposal by the SEC.

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Stakeholder Capitalism in the Time of Covid

Posted by Lucian Bebchuk (Harvard Law School), Kobi Kastiel (Tel Aviv University), and Roberto Tallarita (Harvard Law School), on
Tuesday, February 22, 2022
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Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance at Harvard Law School; Kobi Kastiel is Associate Professor of Law at Tel Aviv University, and Lecturer on Law at Harvard Law School; and Roberto Tallarita is a Lecturer on Law and Associate Director of the Program on Corporate Governance at Harvard Law School. 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); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Will Corporations Deliver Value to All Stakeholders?, by Lucian A. Bebchuk and Roberto Tallarita.

In a study we recently released on SSRN, Stakeholder Capitalism in the Time of Covid, we use the COVID-19 pandemic to test the claims of supporters of stakeholder capitalism empirically.

The pandemic was preceded and accompanied by peak support for stakeholder capitalism, with corporate leaders broadly pledging to look after the interests of stakeholders. Our investigation, however, casts doubt on whether such rhetoric was matched by actions.

We conduct a detailed examination of more than 100 public company acquisitions, with an aggregate value exceeding $700 billion, that were announced during the first twenty months of the pandemic. We find that the contractual terms of those acquisitions provided large gains for target shareholders and corporate leaders themselves. However, even though the pandemic heightened risks for stakeholders, corporate leaders negotiated for little or no stakeholder protections.

In particular, although many transactions were viewed as posing significant post-deal risks for employees, corporate leaders generally didn’t bargain for any employee protections, including any compensation to employees that would be fired after the acquisition. And corporate leaders also didn’t negotiate for any protections to customers, suppliers, communities, the environment, or other stakeholders.

We conclude by discussing the implications of our findings for public policy and the heated debate on stakeholder capitalism.

Here is a more detailed account of our analysis:

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Guidance for Engaging on Climate Risk Governance and Voting on Directors

Posted by Rob Berridge, Ceres, on
Tuesday, February 22, 2022
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Rob Berridge is Senior Director of Shareholder Engagement at Ceres. This post is based on his Ceres 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); 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).

Climate change poses urgent and systemic risks to the economy and to investors, as well as serious material risks to companies. The extent of this risk, and that there is no avenue for diversifying away from it, means that investors and proxy advisory firms need reliable public information about a company’s climate-related risk oversight and its plans for transitioning to a net zero emissions future. For disclosure to be actionable and meaningful, it needs to respond adequately to the governance recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), which has received strong support from investors and companies, and the Climate Action 100+ Net-Zero Company Benchmark (the Net-Zero Company Benchmark), which is backed by the world’s largest investor initiative representing more than $65 trillion in assets.

This post serves as a resource for investors and proxy advisory firms. Companies may also want to use this post to prepare for engagements with their stakeholders.

This post provides details on topics that investors and proxy advisory firms may want to consider to inform their company engagements and decisions on whether to support the election of directors responsible for climate change risk oversight. This post covers practices in governance, reporting, and lobbying around climate change-related risks and opportunities, i.e., the direction in which all U.S. public companies should be moving on their journeys to address the net zero transition. Depending on their respective internal practices, investors and proxy advisory firms may determine if voting against or making a recommendation to vote against directors is appropriate for companies that lack one or more of these practices.

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SEC’s Proposed Buyback Disclosure Rules: Actions Companies Should Consider Taking

Posted by J.T. Ho, Carolyn Frantz, and Soo Hwang, Orrick, Herrington & Sutcliffe LLP, on
Tuesday, February 22, 2022
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J.T. Ho is partner, Carolyn Frantz is senior counsel, and Soo Hwang is counsel at Orrick, Herrington & Sutcliffe LLP. This post is based on their Orrick memorandum. Related research from the Program on Corporate Governance includes Short-Termism and Capital Flows by Jesse Fried and Charles C. Y. Wang (discussed on the Forum here); and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay by Jesse Fried (discussed on the Forum here).

In addition to the recent proposed rules regarding insider trading policies, the Securities and Exchange Commission has also proposed amendments to its rules regarding disclosure about stock buybacks. The proposed rules would require an issuer to provide a new Form SR before the end of the first business day following the day the issuer executes a share repurchase. The new Form SR would require issuers to identify the class and total amount of securities purchased, the average price paid, and whether the amounts were repurchased in reliance on the safe harbor found in Exchange Act Rule 10b-18 or pursuant to a Rule 10b5-1 plan.

Further, the proposed rules would also enhance existing periodic disclosure requirements regarding repurchases of an issuer’s equity securities. Among other requirements, issuers would be required to disclose in their 10-Ks and 10-Qs (and in the case of foreign private issuers, their 20-Fs) (i) the objective or rationale for the share repurchases, (ii) the process or criteria used to determine the repurchase amounts, (iii) whether the amounts were repurchased in reliance on the safe harbor in Exchange Act Rule 10b-18 or pursuant to a Rule 10b5-1 plan, and (iv) any policies and procedures relating to purchases and sales of the issuer’s securities by its officers and directors during a repurchase program, including any restriction on such transactions. Companies would also have to disclose whether their Section 16 officers or directors purchased or sold shares or other units subject to the repurchase plan within 10 business days before or after the announcement of a repurchase plan or program covering the same class of securities.

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2022 Global and Regional Trends in Corporate Governance

Posted by Richard Fields, Rusty O'Kelley III, and Laura Sanderson, Russell Reynolds Associates, on
Monday, February 21, 2022
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Rich Fields is leader of the Board Effectiveness Practice at Russell Reynolds Associates; Rusty O’Kelley III co-leads Board & CEO Advisory Partners in the Americas; and Laura Sanderson co-leads Board & CEO Advisory Partners in Europe. This post is based on their Russell Reynolds memorandum.

For the seventh consecutive year, Russell Reynolds Associates interviewed global institutional and activist investors, pension fund managers, proxy advisors, and other corporate-governance professionals to identify the corporate-governance trends that will impact boards and directors in 2022 and beyond. This year, we spoke to over 50 experts from major investors, regulators, advisors, and advocates.

Global Trends Predicted for 2022

1. Assertive investors willing to vote for change
2. Higher standards for climate disclosure and action
3. Enhanced board effectiveness becomes the norm
4. Further emphasis on equity, diversity, and inclusive culture initiatives at the board and corporate level

In the last few years, some governance observers and board members have predicted (or hoped) that shareholders’ and other stakeholders’ attention to these topics would wane. But the experts whom we interviewed could not have been clearer: these topics are more important than ever, and investors and others are poised to be more demanding than they have been in recent years.

More assertive, demanding investors who feel empowered to demand action and disclosure on a growing number of topics, and, with failure to meet those demands, more likely than ever to vote against companies and individual directors at annual shareholder meetings.

Higher standards for corporate attention to the climate as the materiality of climate change to individual businesses and society writ large is beyond question. As Larry Fink wrote in Blackrock’s 2022 letter to CEOs, “most stakeholders … now expect companies to play a role in decarbonizing the global economy.” [1]

Enhanced board-effectiveness practices become the norm as investors and other stakeholders realize that good composition, refreshment, and evaluation practices result in improved corporate performance and decreased risk exposure.

Urgency regarding equity and diversity initiatives both in the enterprise and the boardroom, as evidence mounts that diverse organizations outperform others and stakeholders demand progress without delay.

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The Supreme Court and the Pro-Business Paradox

Posted by Elizabeth Pollman (University of Pennsylvania), on
Monday, February 21, 2022
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Elizabeth Pollman is Professor of Law and Co-Director of the Institute for Law and Economics at the University of Pennsylvania Carey Law School. This post is based on her recent paper. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita; 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).

One of the most notable trends of the Roberts Court is expanding corporate rights and narrowing liability or access to justice against corporate defendants. Citizens United and Hobby Lobby are the most well-known cases in this vein, but they are not alone. In the last Term, the Court heard cases on important issues ranging from the constitutionality of nonprofit donor disclosure regulation to human rights in global supply chains.

In a Comment in the Harvard Law Review, I examine a variety of recent Supreme Court cases through the lens of corporations to highlight this “pro-business” pattern as well as its contradictory relationship with counter trends in corporate law and governance. Two cases deserve particular attention: Americans for Prosperity Foundation v. Bonta and Nestlé USA, Inc. v. Doe.

In Americans for Prosperity, the Court endorsed a robust understanding of the First Amendment right to freedom of association for nonprofit corporations and other charitable organizations. In a splintered majority opinion, the Court held that a California regulation unconstitutionally burdened associational rights by requiring organizations to disclose their Schedule B to Form 990, containing information about major donors, to the state’s Attorney General’s Office for potential investigation into fraud and other wrongdoing. Notably, the Court broadly invalidated the state regulation and did not provide an in-depth examination of the interests, associational dynamics, or evidence of threats or chilling effects on organizations besides the litigants.

The Court arrived at its ruling by applying a narrow tailoring requirement to the standard of “exacting scrutiny.” Instead of focusing on the range of nonprofit organizations and the potential significance of their burdens, the Court justified invalidating the law on a facial challenge because of its view of the regulation — that the state’s investigative goals were merely for “administrative convenience” and not narrowly tailored. The Court’s willingness to strike down the regulation and raise the bar on the exacting scrutiny standard suggests that campaign finance regulations and other compelled disclosure regimes may be threatened in the future.

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Audit Committee Practices Report

Posted by Krista Parsons (Deloitte) and Vanessa Teitelbaum (Center for Audit Quality), on
Monday, February 21, 2022
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Krista Parsons is Managing Director and Audit Committee Programs Leader at the Center for Board Effectiveness, Deloitte & Touche LLP, and Vanessa Teitelbaum is Senior Director of Professional Practice at the Center for Audit Quality. This post is based on their Deloitte/Center for Audit Quality report.

Audit committee oversight is an important job that just keeps getting more complex. Since the Sarbanes-Oxley Act (SOX) came into play in 2002, audit committees have evolved and adapted to fulfill their unique and expanding role. Audit committees are charged with helping oversee financial reporting, audit processes, internal controls, ethics and compliance programs, and external and internal audit. Increasingly, such duties also include oversight of key risks, including cybersecurity and environmental, social and governance (ESG) reporting. Audit committees are being challenged by increased complexity in their core responsibilities, as well as scope creep across other areas within their organizations.

Against this backdrop, audit committee members often want to understand what their peers are doing to address this complexity and if there are leading practices they can employ within their own organizations. To this end, we are pleased to provide you with the inaugural edition of the Audit Committee Practices Report, a collaborative effort between Deloitte’s Center for Board Effectiveness (Deloitte) and the Center for Audit Quality (CAQ). The report is based on a survey of 246 audit committee members from predominantly large (greater than $700 million market cap), U.S.-based public companies. Conducted by Deloitte and the CAQ, the survey inquired about:

  • Areas of oversight
  • Key risks
  • Audit committee practices

This post provides information related to certain issues facing audit committees today and how peers may be responding. The survey results and related analysis can also serve as a benchmarking resource for gauging your own committee’s practices.

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Diversity Disclosure Ratings

Posted by Eric Shostal and Brianna Castro, Glass, Lewis & Co., on
Sunday, February 20, 2022
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Eric Shostal is Senior Vice President of Research and Engagement, and Brianna Castro is Senior Director of U.S. Research at Glass, Lewis & Co. This post is based on their Glass Lewis 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); and Will Nasdaq’s Diversity Rules Harm Investors? by Jesse M. Fried (discussed on the Forum here).

Background

Because company disclosure is a critical aspect of assessing the mix of diverse attributes and skills of directors, Glass Lewis tracks the quality of board diversity disclosures in company proxy statements.

Our 2021 Proxy Paper reports for companies in the S&P 500 index included an assessment of company proxy statement disclosures relating to board diversity, skills, and the director nominating process. Specifically, we reflected how a company’s proxy statement presented the following features:

  • Director Race and Ethnicity Disclosure: the board’s current percentage of racial/ethnic diversity;
  • Diversity Considerations for Director Candidates: whether the board’s definition of diversity explicitly includes gender and/or race/ethnicity;
  • Rooney Rule or Equivalent: whether the board has adopted a policy requiring women and minorities to be included in the initial pool of candidates when selecting new director nominees;
  • Director Skills Disclosure (Tabular): board skills disclosure.

This post provides insight into our findings for 2021 from these assessments of S&P 500 companies’ proxy disclosures.

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