Monthly Archives: August 2022

Weekly Roundup: August 5 – 11, 2022

Posted by the Harvard Law School Forum on Corporate Governance, on
Friday, August 12, 2022

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This roundup contains a collection of the posts published on the Forum during the week of August 5 – 11, 2022.

Chancery Decision Expands the Court’s Approaches on Director Independence

Posted by Gail Weinstein, Steven J. Steinman, and Brian T. Mangino, Frank, Harris, Shriver & Jacobson LLP, on Friday, August 5, 2022
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SEC Expects to Issue Final Clawback Regulations by October ’22

Posted by Mike Kesner and John Ellerman, Pay Governance LLC, on Friday, August 5, 2022
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Amendments to Form 13F

Posted by Stephen P. Wink and Naim Culhaci, Latham & Watkins LLP, on Saturday, August 6, 2022
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Back to Basics: Board Committees

Posted by Natalie Cooper and Robert Lamm (Deloitte LLP), and Randi Val Morrison (Society for Corporate Governance), on Saturday, August 6, 2022
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SEC Proposes Narrowing Grounds for Excluding Shareholder Proposals

Posted by Richard Alsop, Harald Halbhuber, and Lona Nallengara, Shearman & Sterling LLP, on Sunday, August 7, 2022
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SEC Reverses Aspects of Proxy Voting Advice Regulations

Posted by Marc Treviño and Bob Downes, Sullivan & Cromwell LLP, on Monday, August 8, 2022
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Does ESG Negative Screening Work?

Posted by Robert Eccles (Oxford University), Shivaram Rajgopal (Columbia University), and Jing Xie (Hong Kong Polytechnic University), on Monday, August 8, 2022
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Welcoming the Universal Proxy

Posted by Kai Liekefett, Derek Zaba, and Leonard Wood, Sidley Austin LLP, on Monday, August 8, 2022
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Emerging Fraud Risks to Consider: ESG

Posted by Michael Brodsky and Amy Edwards, Deloitte, on Tuesday, August 9, 2022
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Hidden Gems: Do Compensation Disclosures Reveal Performance Expectations?

Posted by C. Edward Fee (Tulane University), Zhi Li (Chapman University), and Qiyuan Peng (University of Dayton), on Tuesday, August 9, 2022
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Delaware and Caremark: An Update

Posted by Theodore N. Mirvis, David A. Katz, and Sabastian V. Niles, Wachtell, Lipton, Rosen & Katz, on Tuesday, August 9, 2022
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Second Circuit on Stating a Claim for Scheme Liability

Posted by Israel David, Samuel P. Groner, and Harrison D. Polans, Fried, Frank, Harris, Shriver & Jacobson LLP, on Wednesday, August 10, 2022
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The Market for CEOs: Evidence from Private Equity

Posted by Paul A. Gompers (Harvard Business School), Steven N. Kaplan (University of Chicago), and Vladimir Mukharlyamov (Georgetown University), on Wednesday, August 10, 2022
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Twitter v. Musk: Plaintiff’s Response to Defendant’s Counterclaim

Posted by Anna Restuccia (Harvard Law School), on Wednesday, August 10, 2022
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Proposed Amendments to the Shareholder Proposal Rules

Posted by Marc S. Gerber, Richard J. Grossman, and Raquel Fox, Skadden, Arps, Slate, Meagher & Flom LLP, on Thursday, August 11, 2022
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Statement by Commissioner Uyeda on Proposed Joint Amendments to Form PF

Posted by Mark T. Uyeda, U.S. Securities and Exchange Commission, on Thursday, August 11, 2022
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Statement by Chair Gensler on Proposed Joint Amendments to Form PF

Posted by Gary Gensler, U.S. Securities and Exchange Commission, on Thursday, August 11, 2022
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Statement by Chair Gensler on Proposed Joint Amendments to Form PF

Posted by Gary Gensler, U.S. Securities and Exchange Commission, on
Thursday, August 11, 2022
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Gary Gensler is Chair of the U.S. Securities and Exchange Commission. This post is based on his recent public statement. The views expressed in the post are those of Chair Gensler, and do not necessarily reflect those of the Securities and Exchange Commission or the Staff.

Today [Aug. 10, 2022], the Commission is considering whether to propose joint amendments with the Commodity Futures Trading Commission (CFTC) to Form PF, an important reporting tool that the Commission and the Financial Stability Oversight Council (FSOC) use, respectively, to protect investors and monitor systemic risk. I am pleased to support the proposal because, if adopted, it would improve the quality of the information we receive from all Form PF filers, with a particular focus on large hedge fund advisers.

In response to the 2008 financial crisis, Congress mandated the SEC and CFTC (the Commissions) to establish, after consultation with FSOC, reporting requirements for advisers to private funds. Congress felt it was necessary for there to be greater transparency for regulators into this field, which led the Commissions to adopt Form PF.

I had the privilege to serve as Chair of the CFTC when the Commissions jointly first adopted Form PF in 2011. As I said at the time, “With this final rule, regulators will gain transparency into an important sector of the financial marketplace to better assess risk to the overall system.” [1]

In the decade since, regulators have gained vital insight with respect to private funds through Form PF. Since then, though, the private fund industry has grown in gross asset value by nearly 150 percent and evolved in terms of its business practices, complexity, and investment strategies. [2] In response to the Commission’s years of experience with Form PF and the evolving private funds landscape, I asked the staff to recommend amendments to Form PF. We have considered these recommendations in two separate proposals.

In January 2022, the Commission proposed amendments to the SEC-only sections of Form PF. That proposal would, among other things, require certain advisers to hedge funds and private equity funds to provide current reporting of key events, and enhance reporting requirements for large private equity and large liquidity fund advisers.

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Statement by Commissioner Uyeda on Proposed Joint Amendments to Form PF

Posted by Mark T. Uyeda, U.S. Securities and Exchange Commission, on
Thursday, August 11, 2022
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Mark T. Uyeda is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on his recent public statement. The views expressed in the post are those of Commissioner Uyeda, and do not necessarily reflect those of the Securities and Exchange Commission or the Staff.

Thank you, Chair Gensler. Who benefits from investments in private funds and alternative investments? In many cases, they are the pensioners in a retirement plan or a university student who benefits from an endowment. In other words, Americans of all types benefit from a robust market for private funds that is diverse and provides sophisticated institutional investors and their advisers with choices to address different risk tolerances, investment strategies, and time horizons.

Since the enactment of the Dodd-Frank Act, advisers to private funds have been required to file Form PF, [1] which was adopted in 2011 and amended in 2014. As the title of Section 404 of that Act indicates, the requirement was to facilitate the “Collection of Systemic Risk Data.” [2] Yet today’s proposed amendments to Form PF, which come on the heels of an existing proposal to amend Form PF issued earlier this year [3] — would impose additional and more granular disclosures, with effects that could potentially reshape an industry that is already dominated by large fund advisers [4]

Form PF is intended to assist the Financial Stability Oversight Council (FSOC) in assessing systemic risk in the U.S. financial system. [5] When we consider a rulemaking proposal, one of the key steps is to identify the need for the rulemaking and explain how the proposed rule will meet that need. [6] Although the 303 page draft release, encompassing 103,223 words, sent to the Commissioners on Monday evening references “systemic risk” a total of 118 times, plus two additional references to “system risk,” the release largely does not describe or define what is meant by that term. [7] Merely stating over and over that the proposed amendments will help to monitor and assess systemic risk and provide additional information does not make it so. This shortcoming makes it difficult to evaluate the appropriateness of the proposed disclosures.

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Proposed Amendments to the Shareholder Proposal Rules

Posted by Marc S. Gerber, Richard J. Grossman, and Raquel Fox, Skadden, Arps, Slate, Meagher & Flom LLP, on
Thursday, August 11, 2022
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Marc S. Gerber, Richard J. Grossman, and Raquel Fox are partners at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on a Skadden memorandum by Mr. Gerber, Mr. Grossman, Ms. Fox, Brian V. Breheny, Ryan J. Adams, and Andrew T. Bond.

On July 13, 2022, the U.S. Securities and Exchange Commission (SEC), by a 3-2 vote, proposed amendments to the proxy rules that would narrow certain grounds under which companies may exclude shareholder proposals from their proxy statements. Specifically, the proposed amendments would modify the standards for exclusion under the “substantial implementation,” the “duplication” and the “resubmission” bases for exclusion under Rule 14a-8. Although presented as an effort to provide greater certainty and transparency to shareholder proponents and companies, the amendments (if adopted as proposed) likely would increase the number of shareholder proposals received by companies and make it less likely that proposals could be excluded.

Comments on the proposal are due by the later of 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, meaning that comments will be due no earlier than September 12, 2022. As the amendments are proposed rather than final rules, companies currently receiving shareholder proposals should continue to analyze those proposals under the existing rules.

Background

Pursuant to Rule 14a-8, a company must include a shareholder proposal in the company’s proxy materials unless the proposal falls under any one of thirteen substantive bases for exclusion or the proponent or proposal fails to satisfy the eligibility or procedural requirements of the rule. When a company intends to exclude a shareholder proposal from its proxy materials, the company typically requests no-action relief from the Staff of the SEC’s Division of Corporation Finance (Staff).

As described in our earlier post, the Staff took a number of positions during the 2022 proxy season that overturned long-standing no-action letter precedent. The proposed amendments would codify some of those positions and narrow three of the substantive bases available to companies to exclude proposals.

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Twitter v. Musk: Plaintiff’s Response to Defendant’s Counterclaim

Posted by Anna Restuccia (Harvard Law School), on
Wednesday, August 10, 2022
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This post provides the text of the response filed August 4, 2022, by Twitter, Inc. to Elon Musk’s counterclaim (discussed on the Forum here). This post is part of the Delaware law series; links to other posts in the series are available here.

Plaintiff Twitter, Inc. (“Twitter”), by and through its undersigned counsel, replies as follows to the Verified Counterclaims (the “Counterclaims”) of Elon R. Musk (“Musk”), X Holdings I, Inc., and X Holdings II, Inc. (each a “Defendant” and together, “Defendants” or the “Musk Parties”) as follows.

Introduction

Musk begins his answer to Twitter’s claims for breach of their merger agreement with more than ninety pages of counterclaims. According to Musk, he—the billionaire founder of multiple companies, advised by Wall Street bankers and lawyers—was hoodwinked by Twitter into signing a $44 billion merger agreement.

That story is as implausible and contrary to fact as it sounds. And it is just that—a story, imagined in an effort to escape a merger agreement that Musk no longer found attractive once the stock market—and along with it, his massive personal wealth—declined in value. After spending months looking for an excuse to get out of the contract, Musk claimed to terminate it, explaining his supposed reasons for doing so in a July 8 letter to Twitter. When Twitter sued to enforce its rights and exposed the weakness of those reasons, Musk spent weeks coming up with more supposed reasons—the Counterclaims—which offer up an entirely new set of excuses for his breach.

The Counterclaims are a made-for-litigation tale that is contradicted by the evidence and common sense. Musk invents representations Twitter never made and then tries to wield, selectively, the extensive confidential data Twitter provided him to conjure a breach of those purported representations. Yet Musk simultaneously and incoherently asserts that Twitter breached the merger agreement by stonewalling his information requests. As explained below and will be demonstrated at trial, the Counterclaims are factually inaccurate, legally insufficient, and commercially irrelevant:

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The Market for CEOs: Evidence from Private Equity

Posted by Paul A. Gompers (Harvard Business School), Steven N. Kaplan (University of Chicago), and Vladimir Mukharlyamov (Georgetown University), on
Wednesday, August 10, 2022
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Paul A. Gompers is Eugene Holman Professor of Business Administration at Harvard Business School; Steven N. Kaplan is the Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business; and Vladimir Mukharlyamov is Assistant Professor of Finance at the McDonough School of Business at Georgetown University. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance (discussed on the Forum here) by Lucian Bebchuk and Jesse Fried.

A wide range of research examines the market for CEOs and executive mobility in public companies while largely ignoring the market for CEOs in private equity funded companies. The research on public companies typically finds low levels of mobility for CEOs, particularly recently. For example, Cziraki and Jenter (2021) study CEO changes at S&P 500 companies from 1993 and 2012 and find that internal promotions are much more common than external hires: 80% of new CEOs are insiders and 90% are either the hiring firm’s current executives, former executives, board members, or co-workers of its directors. Other work finds that external hires for public companies are generally less than 30% and never more than 50%, even when turnover is forced or performance related.

We augment the work on public company CEOs by studying the market for CEOs among larger U.S. companies (enterprise value greater than $1 billion) purchased by private equity firms between 2010 and 2016. We find that 71% of those companies hired new CEOs under private equity ownership. Almost 75% of the new CEOs are external hires with 67% being complete outsiders. The most recent experience of 69% of the outside CEOs was at a public company with 32% at an S&P 500 company. Almost 50% of the external hires have some previous experience at an S&P 500 company. These results are strikingly different from studies that look at public companies. The external CEOs also tend to have previous experience in the same industry as the hiring company.

Next, we estimate the compensation of the buyout firm CEOs. The median buyout in our sample earned 2.5 times on its equity investment. Companies with external CEOs appointed at the time of the buyout receive significant compensation. Using the performance of the buyouts and survey evidence on buyout equity incentives, we estimate that buyout firm CEOs earned compensation substantially greater than that of CEOs of similarly sized public companies and of comparable magnitude to compensation of S&P 500 CEOs.

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Second Circuit on Stating a Claim for Scheme Liability

Posted by Israel David, Samuel P. Groner, and Harrison D. Polans, Fried, Frank, Harris, Shriver & Jacobson LLP, on
Wednesday, August 10, 2022
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Israel David and Samuel P. Groner are partners and Harrison D. Polans is an associate at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on their Fried Frank memorandum.

On July 15, 2022, the U.S. Court of Appeals for the Second Circuit issued a decision holding that Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2d Cir. 2005)—in which the court previously held that misstatements and omissions alone do not suffice for scheme liability under Rule 10b-5(a) and (c) of the federal securities laws—continues to retain its vitality after the Supreme Court’s decision in Lorenzo v. SEC, 139 S. Ct. 1094 (2019). Some further conspiratorial-like act in furtherance of the “scheme” is required. In Lorenzo, the Supreme Court had held that an individual who knowingly disseminated a false statement but did not create it could be found liable under subsections (a) and (c) of Rule 10b-5, which are often referred to as the “scheme liability” subsections of Rule 10b-5.

In SEC v. Rio Tinto plc, et al., No. 21-2042, 2022 WL 2760323 (2d Cir. July 15, 2022), the Second Circuit affirmed the dismissal of scheme liability claims against a company and its senior officers relating to their alleged misstatements and omissions concerning the valuation of an exploratory coal mine the company had acquired in Mozambique. Applying Lorenzo, the court held that while “misstatements and omissions can form part of a scheme liability,” an “actionable scheme liability claim requires something beyond misstatements and omissions” (such as dissemination of those statements).

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Delaware and Caremark: An Update

Posted by Theodore N. Mirvis, David A. Katz, and Sabastian V. Niles, Wachtell, Lipton, Rosen & Katz, on
Tuesday, August 9, 2022
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Theodore N. Mirvis, David A. Katz, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Monetary Liability for Breach of the Duty of Care? (discussed on the Forum here) by Holger Spamann.

Recent Delaware decisions have reminded boards of directors of the obligation to make a good faith effort to put in place a compliance system designed to help ensure that their companies operate within the bounds of the law and that their products, services, and operations do not cause harm to consumers, community members, or the environment. That duty—famously associated with the Delaware Court of Chancery’s 1996 decision in Caremark—is a core responsibility of independent directors, working in concert with company management, that requires them to make a good faith effort to identify the key compliance risks the company poses to others and faces itself, and to put in place a reasonable oversight structure to address them.

In 2019, the Delaware Supreme Court’s decision in Marchand reminded boards that although the Caremark standard only requires a good faith effort to put in place and attend to a reasonable compliance structure, a plaintiff could state a claim against directors by pleading facts suggesting that the board failed to make any effort to ensure that a board-level system of oversight was in place to address a mission critical risk. In that case, the company’s sole business was to make ice cream and there was no board-level process for monitoring the safety of its products, which caused the death and illness of consumers in a listeria outbreak. Just last year, the Court of Chancery issued a high profile decision in the Boeing case, applying Marchand in the face of detailed fact pleadings suggesting that the company had no board-level process for overseeing the company’s effort to ensure the safety of its aircraft.

In those and other cases, the increasing use of books and records demands by plaintiffs to plead their claims has been illustrated. Because the Delaware courts have long made clear—including in Marchand and Boeing—that Caremark requires a good faith effort by the board, not perfection, and that the board will only face liability if the evidence demonstrates that a board has not made a good faith effort to fulfill its duties, plaintiffs have sought books and records to sustain their difficult burden to plead a viable claim. When these books and records do not reflect that a company had in place a board structure that attended to core business and legal risks, the plaintiffs cite to that lack of effort in an effort to plead a complaint that cannot be dismissed on motion.

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Hidden Gems: Do Compensation Disclosures Reveal Performance Expectations?

Posted by C. Edward Fee (Tulane University), Zhi Li (Chapman University), and Qiyuan Peng (University of Dayton), on
Tuesday, August 9, 2022
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C. Edward Fee is Professor of Finance at Tulane University Freeman School of Business; Zhi Li is Assistant Professor of Finance at Champan University George L. Argyros School of Business and Economics; and Qiyuan Peng is Assistant Professor of Finance at the University of Dayton. This post is based on their recent paper, forthcoming in Journal of Accounting and Economics.

Related research from the Program on Corporate Governance includes Stealth Compensation Via Retirement Benefits by Lucian A. Bebchuk and Jesse M. Fried.

Performance-based stock grant is an increasingly popular form of incentive pay for public firm CEOs in U.S. Under these grants, executives are expected to receive different levels of stock payments (“threshold,” “target,” or “maximum”), contingent on the firm’s meeting pre-specified hurdles by the end of the performance evaluation period. In 2006, the SEC announced new disclosure rules that require firms to report “unearned shares” from outstanding performance-based stock grants in their proxy statement. Unearned shares are the number of shares that executives are expected to receive conditional on whether the firm meets predetermined performance hurdles by the end of the evaluation period.

In our paper, Hidden Gems: Do Market Participants Respond to Performance Expectations Revealed in Compensation Disclosures?, forthcoming in the Journal of Accounting and Economics, we examine whether the disclosed “unearned shares” provide new information about a firm’s future performance. We believe the new disclosure contains forward-looking information for two reasons. First, firms often cite performance expectations over the evaluation period to justify the reported unearned shares. Second, past literature has shown that firms choose specific performance measures that reflect their strategic priorities. These performance criteria, which are often not fully disclosed to the public, may capture information related to CEO actions and firm performance over the long run. However, the disclosure might not be informative. For example, the compensation committee and other corporate insiders might not be able to correctly forecast future firm performance and plan payouts. Or the firm could be unwilling to truthfully reveal inside information. Or the performance-based grants might be poorly designed to be informative, such as the performance hurdles are set at unreasonably high (low) level or the performance measures used are unrelated to firm value. Hence, whether the disclosure of unearned shares is informative is an empirical question.

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Emerging Fraud Risks to Consider: ESG

Posted by Michael Brodsky and Amy Edwards, Deloitte, on
Tuesday, August 9, 2022
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Michael Brodsky is Managing Director and Amy Edwards is Audit & Assurance Senior Manager of the Fraud Risk Center, Deloitte & Touche LLP. This post is based on a Deloitte memorandum by Mr. Brodsky, Ms. Edwards, Krista Parsons, Maureen Bujno, and Kimia Clemente.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita; For Whom Corporate Leaders Bargain (discussed on the Forum here) and Stakeholder Capitalism in the Time of COVID (discussed on the Forum here), both 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 (discussed on the Forum here) by Mark J. Roe.

Introduction

Many audit committees are highly focused on the risk of financial statement fraud, but a case is growing for audit committees to expand their discussion of fraud risk to encompass a growing variety of environmental, social, and governance (ESG) issues. ESG-related topics increasingly appear on audit committee agendas and factor into financial reporting discussions, but they tend to arise less often in the context of discussions about fraud risk.

Investors continue to demonstrate interest in understanding risks related to ESG issues, which is helping fuel regulatory focus on reporting and disclosures. The SEC has already issued proposals to expand disclosures related to cybersecurity and climate issues, and further proposals are expected in areas such as human capital. These proposals are likely to significantly increase the scope of information that will be included in regulatory filings in the coming years.

In preparation for expected new reporting requirements, many companies are in the process of developing more robust ESG-related disclosure controls and procedures as well as internal control over financial reporting (ICFR). Some companies are developing ESG-related metrics for financial reporting and for incorporation into incentive compensation.

Ahead of these possible rule changes, fraud risk in this area should be top of mind for audit committees and a focal point in fraud risk assessments overseen by the audit committee. Many companies are currently providing information to investors that is not governed by the same types of controls present in financial reporting processes.

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