Monthly Archives: June 2022

The Impact of Technology on Climate Oversight: What Board Directors Need to Know

Maria Castañón Moats is Leader and Mira Best is Technology Impact Leader at PricewaterhouseCoopers LLP. This post is based on their PwC 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); 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); and Corporate Purpose and Corporate Competition by Mark J. Roe (discussed on the Forum here).

Corporate boards are experiencing the impact of climate change on multiple fronts. Mounting pressure from regulators, investors, shareholders, consumers, and their workforce is forcing companies to rethink their carbon emissions. Worsening droughts, fires, floods, and storms have prioritized the need to focus on the health of our communities and ecosystems. Beyond social responsibility, there’s also economic cost tied to each of these challenges.

Studies have repeatedly shown that companies that take climate change risks seriously report better financial results and post stronger stock market performance than their peers that do not. As a newer focus area, shareholders are increasingly probing the integration of climate-related risks into strategy and operations, and are allocating capital to help companies increase the sustainability of their supply chains. Regulators and lawmakers are similarly responding to this sentiment with plans to bolster disclosure requirements.

Hundreds of companies worldwide have made “net zero” pledges to balance their greenhouse gas emissions with the amount they remove from the atmosphere. However, such pledges may not be taking into account the emerging issue of emissions from company supply chains. Greenhouse gas emissions from a company’s supply chain can be 5.5 times higher than from its enterprise operations, according to the Climate Disclosure Project. Although difficult to track, focusing comprehensively on the end-to-end supply chain should be a priority for companies that truly want to mitigate their climate impact.

Fortunately, advanced technologies are emerging to help companies address their carbon footprint. Blockchain and artificial intelligence technologies are powerful tools for companies that want to tackle not just their own climate impact but those caused by suppliers, transportation networks, and warehouses. It’s important for board directors to understand how these technologies work in order to best fulfill their role in overseeing corporate strategy—particularly as it pertains to climate risk.


Value Creation in Shareholder Activism

Rui Albuquerque is Professor of Finance at Boston College Carroll School of Management; Vyacheslav Fos is Associate Professor of Finance at Boston College Carroll School of Management; and Enrique Schroth is Professor of Finance at EDHEC Business School. This post is based on their recent paper. 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); and Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here).

In our new paper, Value Creation in Shareholder Activism, we measure value creation by activist investors via structural estimation of a model of the choice between passive investment and activism. Our estimates imply that average returns following activist intent announcements consist of 74.8% expected value creation, or treatment, 13.4% stock picking, and 11.8% sample selection effects. Higher treatment values predict improvements in firm performance and lower proxy contest probabilities, whereas abnormal announcements returns do not, suggesting that our estimate identifies more effective activism campaigns.

Activist shareholders play an important role in modern corporate governance. A key question is how much value they create. The existing literature searches for answers in the abnormal stock returns observed around the announcements of new activist positions. The consensus is that these returns are significantly larger than those following the announcement of new passive positions. Indeed, in our data, the average return following the public announcement of activist intent via the filing of a Schedule 13D with the Securities and Exchange Commission (SEC) is 6.34%. Following announcements of passive investment, i.e., Schedule 13G filings, the return is only 0.59%.

Which aspects of activism could explain why the stock market rewards activist positions with a higher announcement return than passive positions? First, activist investors may indeed increase value by influencing the firm’s corporate policies, i.e., the treatment effect of activism. Second, activist investors could be better at identifying undervalued stocks. That is, if instead of filing a Schedule 13D the activist had filed a Schedule 13G, the announcement return would have been higher than the average return to a Schedule 13G announcement by other investors. Finally, because the investor strategically chooses to be an activist or to remain passive, the observed average announcement return for either type of filing includes a sample selection component.


Resetting Expectations (and Goals) on Stock Price Mega Grants

Jonathan Katz and Michael Arnold are partners at Cravath, Swaine & Moore LLP. This post is based on a Cravath memorandum by Mr. Katz, Mr. Arnold, John White, Eric Hilfers, and Matthew Bobby. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Over the last few years, as many companies (particularly those with a technology focus) went public, either through traditional IPOs, direct listings or de-SPAC transactions, a very popular compensation trend emerged whereby founders and/or CEOs were granted large incentive awards with vesting tied to very challenging stock price goals. These goals often required the achievement of stock prices that were multiples (in some cases many multiples) of the baseline price to yield any value. These so-called “moonshot” awards gained popularity, in part, due to their success at a few high profile companies where incredible share price growth succeeded in unlocking the value of these high-risk/high-reward incentives.

As has been well documented, the share prices of many companies (particularly many of these same tech companies) have declined. These declines have occurred due to one or a combination of factors, such as valuations returning to less frothy levels, macroeconomic headwinds, interest rate increases and/or geopolitical factors. This means that many of these moonshot programs are deeply “out of the money” and Boards of Directors are beginning to grapple with the consequences, including considering how to restore performance incentives to potentially achievable (yet in many cases still challenging) levels to capture the awards’ intended effect.

This post summarizes some of the reasons why resetting goals may be desirable, discusses some of the challenges associated with doing so and provides some practical guidance for directors, management or advisors seeking to revisit the terms of the awards.


Disclosure of the Extent to which Firms Invest in their Workforce

Colleen Honigsberg is an Assistant Professor at Stanford Law School; and Shivaram Rajgopal is the Roy Bernard Kester and T.W. Byrnes Professor of Accounting and Auditing at Columbia Business School. This post is based on a rulemaking petition submitted to the U.S. Securities and Exchange Commission by The Working Group on Human Capital Accounting Disclosure.

This post is based on a petition submitted by The Working Group on Human Capital Accounting Disclosure, pursuant to Rule 192(a). The Working Group on Human Capital Accounting Disclosure respectfully submits this petition pursuant to Rule 192(a) of the Securities Exchange Commission Rules of Practice. We ask that the Commission develop rules to require public companies to disclose sufficient information to allow investors to assess the extent to which firms invest in their workforce.

Our Working Group is composed of leading academics, former Commission officials, and market participants who focus on the law and economics of human capital management:

  • Ralph Richard Banks, Jackson Eli Reynolds Professor of Law at Stanford Law School;
  • Paul Brest, Former Dean and Professor Emeritus at Stanford Law School;
  • John Coates IV, John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School and former General Counsel and Acting Director of the SEC’s Division of Corporation Finance;
  • Gerald Davis, Gilbert and Ruth Whitaker Professor of Business Administration at the University of Michigan Ross School of Business;
  • Joseph A. Grundfest, William A. Franke Professor of Law and Business at Stanford Law School and former SEC Commissioner;
  • Colleen Honigsberg, Associate Professor of Law at Stanford Law School;
  • Robert J. Jackson, Jr., Pierrepont Family Professor of Law at New York University School of Law and former SEC Commissioner;
  • Shivaram Rajgopal, Roy Bernard Kester and T.W. Byrnes Professor of Accounting and Auditing, Columbia Business School;
  • Ethan Rouen, Assistant Professor of Business Administration and Faculty Co-Chair, Impact- Weighted Accounts Project at Harvard Business School; and
  • Daniel Taylor, Arthur Andersen Professor of Accounting at The Wharton School of the University of Pennsylvania and Director of the Wharton Forensic Analytics Lab.

Professors Honigsberg and Rajgopal serve as co-Chairs of our Working Group. We act in our individual capacities; our institutional affiliations are noted for identification purposes only.

We differ in our views about the regulation of firms’ relationships with their employees generally. But we all share the view that investors need additional information to examine whether and how public companies invest in their workforce—and that the Commission’s rules should therefore require that information to be disclosed. Here, we focus on key elements of that information that we all agree are important.

Our post proceeds in three parts. First, we explain why prompt SEC action on this subject is necessary. Second, we draw on accounting principles to describe three straightforward recommendations for reform. Third, we consider potential costs and benefits of those reforms. We conclude that the SEC should promptly develop rules requiring firms to disclose information that will allow shareholders to assess public companies’ investments in their people—just as SEC rules have long facilitated analysis of public companies’ investments in their physical operations.


The Jarkesy Decision and Ramifications for Administrative Proceedings

Robert Stebbins is partner and Abigail Edwards and Ariel Blask are associates at Willkie Farr & Gallagher LLP.  This post is based on their Willkie memorandum.

On May 18, 2022, in Jarkesy v. S.E.C., a divided Fifth Circuit panel vacated the Securities and Exchange Commission’s (the “Commission” or the “SEC”) affirmation of an SEC administrative law judge’s (“ALJ”) determination that Jarkesy and Patriot28, LLC committed securities fraud. [1] The panel found that (1) the in-house adjudication of the case violated Petitioners’ Seventh Amendment right to a jury trial, (2) Congress unconstitutionally delegated legislative power to the SEC by authorizing it to determine whether to bring these types of cases in an Article III court [2] or before an ALJ, and (3) the ALJ removal protections violate Article II, Section III (the “Take Care Clause”) of the U.S. Constitution.


The SEC pursued this action through its administrative adjudication process. [3] Initial decisions in administrative proceedings can be appealed to the Commission and Commission decisions can be appealed to the federal court of appeals. That appellate review, however, is limited as findings of fact can only be overturned if they are supported by “substantial evidence” [4] and the Commission’s interpretation of the securities laws may also be entitled to Chevron deference. [5]

Historically, the remedies the SEC could seek against respondents in administrative proceedings were limited and until 1990 the Commission could generally only bring securities fraud actions and seek civil penalties in Article III courts. [6] The SEC was first authorized to impose money penalties in administrative proceedings with the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 but only with respect to entities that were required to register with the SEC, such as broker-dealers. [7]


SEC Enforcement Developments

Michael Birnbaum, Jina Choi, and Haimavathi Marlier are partners at Morrison & Foerster LLP. This post is based on their Morrison & Foerster memorandum.

In order to provide an overview for busy in-house counsel and compliance professionals, we summarize below some of the most important SEC enforcement developments from the past month, with links to primary resources. This month we examine:

  • The SEC’s continued focus on environmental, social, and governance (“ESG”) disclosures and cryptocurrency markets;
  • The SEC’s in-house courts under attack;
  • The Second Circuit’s decision in Noto v. 22nd Century Group, Inc.; and
  • The SEC’s billion-dollar case against a prominent investment adviser.

1. SEC Brings ESG Enforcement Action and Proposes New ESG Rules

On May 23, 2022, the SEC charged a registered investment adviser with misrepresenting its approach to ESG-related investments. In a settled order resolving a matter pursued by the SEC’s Climate and ESG Task Force, the SEC found that between July 2018 and September 2021, the adviser represented that all of its stock and bond picks had undergone quality reviews of ESG risks and opportunities associated with those investments, but numerous investments had no such quality review scores at the time of investment. The SEC found that the adviser included false or otherwise misleading statements in mutual fund prospectuses, statements to the funds’ boards, and in requests for proposals from investment firms considering investing in the funds at issue.

The adviser agreed to a $1.5 million fine, a cease-and-desist order, and censure for violations of various Investment Advisers Act antifraud provisions—none of which require a finding of scienter—and for lacking policies and procedures “reasonably designed to prevent the inclusion of untrue statements of fact” in their various disclosures. The adviser appears to have been spared more severe sanctions based on cooperation and remedial efforts that the SEC acknowledged in its order, including providing detailed factual summaries and substantive presentations on key topics and revising its disclosures and internal policies.


The Enhancement and Standardization of Climate-Related Disclosures for Investors

Leo E. Strine, Jr. is the Michael L. Wachter Distinguished Fellow at the University of Pennsylvania Carey Law School; Senior Fellow, Harvard Program on Corporate Governance; of counsel, Wachtell, Lipton, Rosen & Katz; and former Chief Justice and Chancellor, the State of Delaware. This post overviews a comment letter that was submitted to the SEC by Mr. Strine and five other academics and practitioners.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and For Whom Corporate Leaders Bargain (discussed on the Forum here), both by Lucian A. Bebchuk and Roberto Tallarita; Stakeholder Capitalism in the Time of COVID (discussed on the Forum here), by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy – A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr.; and Corporate Purpose and Corporate Competition by Mark J. Roe (discussed on the Forum here).

This post overviews a comment letter that was submitted to the SEC by Alan L. Beller, Daryl Brewster, Robert G. Eccles, David A. Katz, Carmen X. W. Lu, and Leo E. Strine, Jr.

We are a group of commentators with diverse experience in securities and corporation law, business management, accounting, and corporate governance generally. Combined, we bring to bear well over a century’s work in areas bearing on these important issues, and although we have diverse experiences and viewpoints on many issues, we have a shared interest in helping the Securities and Exchange Commission (the “Commission” or the “SEC”) grapple with, and propose a cost-effective approach to, the urgent issue of providing American investors with important information on the effect climate change has on the companies in which they invest.

It is in that spirit that we express our gratitude for the opportunity to comment on the Commission’s proposal to require public disclosure to investors of meaningful information about the substantial risks that climate change poses for the issuers of publicly traded securities. These important disclosures will protect investors in those securities and help promote efficiency, competition, and capital formation.

To frame our comments, we wish to underscore our starting position. If the only choice were to have the rule adopted as proposed, or to not have the rule, we would support adoption of the rule “as is.” Our reasoning is simple. The rule as proposed will help provide investors with uniform, more comprehensive disclosures and greatly enhance the availability of comparable, reliable data and information regarding climate change and its risks. A more than sufficient number of investors of all types have credibly claimed and demonstrated that these disclosures will allow them to make more informed and better decisions regarding risks facing and valuation of the companies making these disclosures, and are therefore material to them and appropriate for their protection.

In our view, the proposed rule is a core exercise of the SEC’s well-established authority to require disclosure necessary and appropriate to protect the integrity of our nation’s securities markets and the investors in those markets. Indeed, to conclude otherwise would upend settled understandings of securities law, and deny investors of all classes access to quality disclosures to make prudent investing and voting decisions on issues that affect the future of American companies and the American economy.


The High Impact Behaviors of the Most Effective Directors

Rusty O’Kelley co-leads the Board and CEO Advisory Partners in the Americas, Rich Fields leads the Board Effectiveness practice, and Laura Sanderson co-leads the Board and CEO Advisory Partners in Europe at Russell Reynolds Associates. This post is based on a Russell Reynolds memorandum by Mr. O’Kelley, Mr. Fields, Ms. Sanderson, PJ Neal, Jemi Crookes, and Elena Loridas.

As Peter Drucker said, “culture eats strategy for lunch.” This is true in the best boardrooms as well.

Three years ago, we identified a group we call Gold Medal Boards; those where directors rate their board’s effectiveness highly (9 or 10 on a 1–10-point scale) and where the company has outperformed relevant TSR benchmarks for at least the last two consecutive years. If you were to step into a Gold Medal Boardroom, you would quickly notice a difference in the way directors behave, conduct themselves, and go about their work.

In fact, on every single one of the 28 measures of culture and behavior we reviewed, Gold Medal Board directors outperform their peers—sometimes by significant levels. Let’s take a look:

Director Communication

Source: Russell Reynolds Associates’ 2022 Global Board Culture and Director Behaviors Survey. Percentage of directors saying they “always” or “often” observed directors demonstrating the specific behavior. N=1,136. 2022.


Amendments to Expand Fund “Names Rule”

Eric Diamond, Donald Crawshaw, and William G. Farrar are partners at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell memorandum by Mr. Diamond, Mr. Crawshaw, Mr. Farrar, Nati Hyojin Kim, and Meng Yu.


On May 25, 2022, the Securities and Exchange Commission (the “SEC”) voted 3 to 1 [1] (Commissioner Peirce dissenting) to propose certain amendments [2] to Rule 35d-1 [3] (the “Names Rule”) under the Investment Company Act of 1940 (the “Investment Company Act”). The Names Rule is intended to ensure that the name of a registered investment company or business development company (“BDC” and, together, a “fund”) does not misrepresent the fund’s investments and risks. [4] The proposed amendments follow a number of public statements by SEC Chair Gensler and other commissioners, as well as actions by the SEC staff, suggesting a growing focus on “truth in advertising” [5] when it comes to fund naming and marketing to investors, particularly with respect to funds that market themselves as “green” or “sustainable” or otherwise focused on environmental, social or governance (“ESG”) criteria.

The proposed amendments would, among other things:

  • expand the scope of the current 80% investment policy requirement to apply to any fund name with terms suggesting that the fund focuses in investments that have, or investments whose issuers have, particular characteristics, including terms such as “growth” and “value” and names that indicate the fund incorporates ESG factors in its investment decisions;
  • impose enhanced fund prospectus disclosure requirements that would mandate a fund subject to the 80% investment policy requirement to define the terms used in its name, including the criteria the fund uses to select the investments that the term describes;
  • prohibit the use of ESG terminology in the name of so-called “ESG integration” funds (funds that consider one or more ESG factors alongside other, non-ESG factors in its investment decisions, but such ESG factors are generally no more significant than other factors in the investment selection process) as materially deceptive or misleading;


Enhancing the Transparency of ESG Investing and Stewardship

Nichol Garzon-Mitchell is Chief Legal Officer and Senior Vice President of Corporate Development at Glass, Lewis & Co. This post is based on her Glass Lewis 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); 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); and Exit vs. Voice by Eleonora Broccardo, Oliver Hart and Luigi Zingales (discussed on the Forum here).

With the growth of ESG investing has come heightened regulatory scrutiny. In the last Administration, the focus was on asset managers’ motives and particularly the dubious claim that ESG was a surreptitious effort to advance managers’ political preferences, rather than being used as a material risk-return characteristic. Now the focus has shifted to so-called “greenwashing”—the concern that some companies and funds overstate their ESG credentials.

In the wake of increased examination and enforcement activity on this issue, the U.S. Securities and Exchange Commission has now proposed its first rules and required disclosures for funds and investment advisers using ESG strategies. While the rules do not go as far as the European Union’s Sustainable Finance Disclosure Regulation (“SFDR”), if adopted they would substantially increase the disclosure obligations of funds and investment advisers that consider ESG factors. We encourage all interested parties to review the proposed rules and consider commenting on them. Given the priority the SEC has attached to this issue, funds and advisers may also want to consider planning a review of their ESG investment and stewardship approaches and disclosures in anticipation of some version of these rules being adopted in the coming year.


The SEC’s proposal comes against the backdrop of remarkable growth in ESG investing. As the SEC notes, inflows of capital to ESG investment products have increased exponentially over the last two decades. In fact, U.S. domiciled assets integrating ESG strategies grew 42% between 2018 and the end of 2020. Today, about one in three dollars of total U.S. assets that are professionally managed, representing some $17.1 trillion, are in a strategy that considers ESG.

The SEC has responded to this growth in several ways. Signaling the issue’s importance, the SEC formed a climate and ESG task force last year to identify and pursue “ESG-related misconduct consistent with increased investor reliance on climate and ESG-related disclosure and investment.” This task force has already produced results. The SEC recently took enforcement action against an investment adviser that “did not always perform the ESG quality review that it disclosed using as part of its investment selection process for certain mutual funds it advised.” And the Commission’s 2022 examination priorities include “greenwashing” as one of its five significant focus areas for the year.


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