Monthly Archives: August 2022

Delaware Approves Permitting Exculpation of Officers from Personal Liability

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.

For over 45 years, Delaware law has permitted directors of Delaware corporations to be exculpated from personal monetary liability to the extent such protections are set forth in the certificate of incorporation, subject to certain exceptions. However, such protective statutory provisions did not reach officers. As contemplated in our April 2022 memorandum, Delaware has now adopted important amendments to Delaware’s General Corporation Law that would expand the right of a corporation to adopt an “exculpation” provision in its certificate of incorporation to cover not only directors (as has been allowed and widely adopted since 1986, following Smith v. Van Gorkom) but now also corporate officers

The officer liability exculpation provision is not self-effectuating; instead, the amendment to Delaware law allows companies to take action to adopt exculpation provisions that protect covered officers from personal liability on the same basis as directors—that is, for all fiduciary duty claims other than breaches of the duty of loyalty, intentional misconduct or knowing violations of law—with an additional exception that claims against officers will not be barred “in any action by or in the right of the corporation.” 

Under the newly amended provision of Delaware law, covered officers eligible for such exculpation from liability, if implemented by the corporation, will include the president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer or chief accounting officer, the company’s most highly compensated executive officers as identified in SEC filings and certain other officers who have consented (or deemed to have consented) to be identified as an officer and to service of process. Companies and boards themselves will retain the right to bring appropriate actions against officers, and this additional exception will permit stockholder derivative claims against officers for breach of the duty of care to continue to be brought if demand requirements are met.


SEC Proposes to Narrow Three Substantive Exclusions in the Shareholder Proposal Rule

Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum.

[This post revises and updates my earlier post on this topic primarily to reflect the contents of the proposing release.]

At an open meeting last week, the SEC voted, three to two, to propose new amendments to Rule 14a-8, the shareholder proposal rule. Under Rule 14a-8, a shareholder proposal must be included in a company’s proxy materials “unless the proposal fails to satisfy any of several specified substantive requirements or the proposal or shareholder-proponent does not satisfy certain eligibility or procedural requirements.” The SEC last amended Rule 14a-8 in 2020 to, among other things, raise the eligibility criteria and resubmission thresholds. The SEC is now proposing to amend three of the substantive exclusions on which companies rely to omit shareholder proposals from their proxy materials: Rule 14a-8(i)(10), the “substantial implementation” exclusion, would be amended to specify that a proposal may be excluded as substantially implemented if “the company has already implemented the essential elements of the proposal.” Rule 14a-8(i)(11), the “substantial duplication” exclusion, would be amended to provide that a shareholder proposal substantially duplicates another proposal previously submitted by another proponent for a vote at the same meeting if it “addresses the same subject matter and seeks the same objective by the same means.” Rule 14a-8(i)(12), the resubmission exclusion, would be amended to provide that a shareholder proposal would constitute a “resubmission”—and therefore could be excluded if, among other things, the proposal did not reach specified minimum vote thresholds—if it “substantially duplicates” a prior proposal by “address[ing] the same subject matter and seek[ing] the same objective by the same means.” The SEC indicates that almost half of the no-action requests the staff received under Rule 14a-8 in 2021 were based on these three exclusions. In his statement, SEC Chair Gary Gensler indicated that the proposed amendments would “improve the shareholder proposal process” by providing “greater certainty as to the circumstances in which companies are able to exclude shareholder proposals from their proxy statements.” In the proposing release, the SEC contends that the amendments “are intended to improve the shareholder proposal process based on modern developments and the staff’s observations” and “would facilitate shareholder suffrage and communication between shareholders and the companies they own, as well as among a company’s shareholders, on important issues.” Notably, however, the two dissenting commissioners seemed to view the proposed changes—even though they stop well short of revamping the 2020 eligibility criteria and resubmission thresholds—as an effort to undo or circumvent the balance achieved by the 2020 amendments without actually modifying those aspects of the rules. For example, new Commissioner Mark Uyeda said that the proposed amendments could “effectively nullify the 2020 amendments to the resubmission exclusion and render this basis almost meaningless.”


Share Repurchases on Trial: Large-Sample Evidence on Market Outcomes, Executive Compensation, and Corporate Finances

Nicholas Guest is an Assistant Professor of Accounting at Cornell University Johnson Graduate School of Management; S.P. Kothari is the Gordon Y Billard Professor of Accounting and Finance at MIT Sloan School of Management; and Parth Venkat is an Assistant Professor of Finance at the University of Alabama Culverhouse College of Business. This post is based on their recent paper.

Related research from the Program on Corporate Governance includes Short-Termism and Capital Flows (discussed on the Forum here) by Jesse Fried and Charles C. Y. Wang; and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay (discussed on the Forum here) by Jesse Fried.

Many in politics and the media question the economic efficacy and ethical provenance of share repurchases, a ubiquitous corporate financial activity. Most recently, the federal government’s proposed 2022 budget disclosed their aims to curb repurchase activity with a one percent tax on all repurchases and to bar executives from selling shares for three years after a repurchase (see recent coverage by the New York Times). Our key question is whether evidence supports the critiques used to justify these and other anti-repurchase initiatives.

Our primary contribution is large-sample evidence on the trends and effects of share repurchases by US corporations. Specifically, we document trends in repurchases, and compare trading volume, share price performance, CEO pay, and corporate financial activities (e.g., investment and profitability) of firms in three groups: those that intensively repurchase shares, those that do so sparingly, and those that do not at all. We also provide a brief outline of the common economic rationale for and criticisms of share repurchases. However, our goal is not to rehash the numerous conceptual rationales in defense of share repurchases, nor argue that there are no cases when repurchases could be misused. Instead, we provide large-sample evidence on whether repurchases are systematically abusive, as suggested by some proponents of significant regulation.

There are several reasons why corporations might prefer using share repurchases instead of or in addition to dividends, including (i) maintaining flexibility in determining the amount of cash returned to shareholders, (ii) an ability to award repurchased shares to employees as equity compensation, (iii) a modest tax advantage to shareholders (that became less pronounced after the 2003 dividend tax cut), and (iv) the ability to send a credible signal of the firm’s (good) prospects.


West Virginia v. EPA Casts a Shadow Over SEC’s Proposed Climate-Related Disclosure Rule

Taryn Zucker is counsel and Lauren Lee and Evelyne Kim are associates at Freshfields Bruckhaus Deringer LLP. This post is based on their Freshfields memorandum.

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? (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; and 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.

The U.S. Supreme Court’s 6-3 decision in West Virginia v. EPA may call into question whether the U.S. Securities and Exchange Commission (“SEC”) has the legal authority to adopt and enforce its proposed climate-related disclosure rule. In its June 30, 2022 ruling, the Court limited the Environmental Protection Agency’s (“EPA”) ability to regulate greenhouse gas emissions from power plants by holding that Section 111(d) of the Clean Air Act did not authorize the EPA to devise emissions caps based on the generation shifting approach used in the Clean Power Plan.

The Court’s opinion relied on the “major questions doctrine,” which provides that in certain “extraordinary cases,” administrative agencies must have “clear congressional authorization” to make decisions of vast “economic and political significance.” Though the Court did not outline a specific test for what constitutes an “extraordinary case,” it discussed factors such as whether an agency is relying on ambiguous statutory text to claim a significant expansion of power and whether the agency lacks expertise in the subject matter. In doing so, the Court’s decision could provide a legal basis for challenges to other economically and politically significant regulatory efforts, such as the SEC’s proposed climate-related disclosure rule.

The opinion also provided a broad interpretation of legal standing to bring a claim against an administrative agency by finding that the petitioners had standing despite the EPA’s stated intention not to enforce the Clean Power Plan and instead engage in new rulemaking. This broad interpretation of standing potentially increases the scope of challenges that could be brought against administrative agencies, such as the SEC, as petitioners may be deemed to have standing to challenge proposed rules, or those that have been denounced or unenforced.


The Expanded Role of the Compensation Committee

Ani Huang is President and CEO; and Richard R. Floersch is Senior Strategic Advisor at the HR Policy Association. This post is based on their HR Policy Association memorandum.

The scope of the Compensation Committee continues to expand, especially in the areas of human capital management, talent strategy, and diversity, equity & inclusion (DEI). A recent Center On Executive Compensation survey found that almost two-thirds of member companies have formally expanded the role of the Compensation Committee by either expanding the charter (35%) or both the charter and Committee name (32%). As an experienced Compensation Committee Chair put it, “I suspect that within one to two years, companies without an expanded Compensation Committee charter will be outliers.” As the remit of the Compensation Committee grows, Compensation Committee Chairs and CHROs are faced with the challenge of managing this growth with the full Board, Committee, independent compensation consultant and management.

This post is based on interviews conducted by the Center On Executive Compensation of 24 Compensation Committee Chairs, CHROs, and Compensation Consultants of large companies across multiple sectors regarding their experiences, learnings and advice on expanding the charter of the Compensation Committee. We hope the Guide will be useful to new and experienced CHROs alike as a collection of insights and tips for managing the charter, calendar, agenda, external resources, and education of the Committee.

The following contains a summary of chief learnings from our interviews regarding the factors driving the change, primary changes to the Committee’s makeup, agenda, and charter, new expectations for directors, and the benefits and challenges associated with an expanded Committee. As we learned during the interview process, each company is unique in how it approaches the evolving Compensation Committee remit. Throughout the post, we have provided the prevailing practices based on our interviews, plus a number of trend-forward or “best practices” that may not have hit the mainstream, but that work well for the companies using them.

Factors Driving the Change

Throughout our interviews, we heard the recurring theme of “the perfect storm” of factors driving a relatively rapid expansion of the Compensation Committee’s charter beyond the traditional charter. The primary factors mentioned include:


Putting Financial Reporting Standards Into Practical Perspective

Robert G. Eccles is Visiting Professor of Management Practice and Kazbi Soonawalla is a Senior Research Fellow in Accounting at Oxford University Said Business School. This post is based on the third part of a three-part series on financial reporting by Professor Eccles and Dr. Soonawalla.

In our previous post, The Complex, Contentious, and Changing Nature of Financial Reporting Standards, we show that financial reporting standards, despite what some might think, are hardly set in stone. An ever-changing world can lead to changes in standards, and the process for making these changes is a contentious one. It is thus fair to ask how useful having standards really is in the first place. The answer is that they are very useful because they provide the social construct for the measurement of financial performance. They are a necessary foundation for doing financial analysis, but the statements are not analyses themselves. The types of analysis done are a function of the user of the financial statements. It is also important to note that the preparation and audits of financial statements are done in a broader institutional context intended to ensure the quality of both.

Financial statements are the starting point for companies to provide information on their financial performance. Companies may have incentives to opportunistically use the discretion permitted in GAAP and elsewhere to present their financial performance in ways that favor them. They do this in three ways. First, they report so-called “non-GAAP” profit measures. As explained by the CFA Institute, “Non-GAAP earnings are an alternative method used to measure the earnings of a company. Many companies report non-GAAP earnings in addition to their earnings as calculated through generally accepted accounting principles.” The Institute notes that “The discrepancies between GAAP and non-GAAP earnings can thus be enormous,” but also acknowledges that “some asset managers believe that these alternate figures provide a more accurate measurement of the company’s financial performance” due to the fact that “Standard financial reporting requirements are fairly prescriptive.”


How Continuous Voting with UPC Will Change Proxy Contests

Michael R. Levin is founder and editor of The Activist Investor. Related research from the Program on Corporate Governance includes Universal Proxies (discussed on the Forum here) by Scott Hirst; The Long-Term Effects of Hedge Fund Activism (discussed on the Forum here) by Lucian Bebchuk, Alon Brav, and Wei Jiang; Dancing with Activists (discussed on the Forum here) by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch; and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System (discussed on the Forum here) by Leo E. Strine, Jr.

Most thinking and writing about the new universal proxy card (UPC) rule tends to consider basic compliancenew notices, the 67% requirement, or proxy contest costs. Some looks a little further, like how to navigate multiple activists at a company.

Yet, UPC opens up completely new opportunities to influence a portfolio company through BoD elections. The entire strategy around how to structure and solicit votes for an activist slate will change significantly. We’ve thought hard about that strategy under UPC, and explain here how that will work.

In short, shareholders will have much more influence over BoD composition. A shrewd activist investor anticipates this. Rather than an activist deciding how much incremental change to request in a BoD, an activist can position a proxy contest so that shareholders decide how much change they want. Activists can model a proxy contest using expected shareholder support to create the needed strategy, and plan a slate accordingly.

Contest Strategy

UPC changes the strategy, literally, in a proxy contest. This entails how many candidates an activist nominates for a BoD, whom to nominate, when to nominate them, and how to communicate these nominees to other shareholders.

One of the abiding frustrations of a proxy contest is how an activist needs to work really hard to win a substantial share of shareholder votes just to gain one or two seats on the BoD. UPC responds to this. Activist BoD representation can now reflect with more precision the extent of support it receives from shareholders.

Overall, with a sound UPC strategy, instead of settling for a couple or even just one seat, an activist can aim higher. Or, an activist that does win a meaningful number of votes, but falls short of a plurality, will still win BoD representation. The remainder of this post explains the thinking.


Sale of Portfolio Company is Subjected to Entire Fairness Review

Gail Weinstein is Senior Counsel, and Steven J. Steinman and Brian T. Mangino are Partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Mr. Mangino, Matthew V. SoranRandi Lally, and Mark H. Lucas, and is part of the Delaware law series; links to other posts in the series are available here.

In Manti Holdings v. The Carlyle Group (June 3, 2022), the Delaware Court of Chancery held that entire fairness review would apply to the challenged sale of The Carlyle Group’s portfolio company, Authentix Acquisition Corp., due to the pressure Carlyle allegedly exerted to cause a quick sale so that it could close out its fund, Carlyle Holdings, that had invested in the company. The court acknowledged that controlling stockholders generally have the same incentive as other stockholders to maximize stockholder value in a sale to a third party and that, as a result, a controller’s desire for liquidity typically has not been a basis for rejecting business judgment review of a challenged transaction. In this case, however, the court viewed Carlyle’s alleged desire to close out its fund as having rendered it conflicted such that the more stringent entire fairness standard of review was applicable. Vice Chancellor Glasscock wrote: “[T]he reality is that rational economic actors sometimes
do place greater value on being able to access their wealth than on accumulating their wealth.”

Key Points

  • The decision reinforces the court’s trend in recent decisions in finding it plausible that a sponsor’s desire for liquidity may create a disabling conflict. Notably, however, the factual context in which the court reached its decision included the board not having established a special committee to exclude the sponsor-affiliated directors; testimony that Carlyle exerted pressure on the directors to approve the merger; and a non-ratable benefit from the merger for the sponsor in obtaining a profit on its preferred stock investment while the holders of the common stock received almost nothing.

Background. To encourage Carlyle to invest in and become a controller of Authentix, the stockholders had entered into a stockholders agreement pursuant to which they agreed not to oppose any sale of Authentix approved by the board and by a majority of the outstanding shares (in other words, approved by the board and Carlyle). In 2017, the board and Carlyle approved a sale of Authentix to Blue Water Energy for $70 million. Under the terms of the stockholders agreement, the holder of the company’s preferred stock was entitled to receive the first $70 million of consideration paid in a sale of the company. Thus, with a sale at $77.5 million, Carlyle (as the holder of Authentix’s preferred stock) would make a profit on its preferred stock investment but the common stockholders (including the plaintiffs) would receive almost nothing for their stock. Litigation ensued. In previous decisions in the case, the court held that the terms of the stockholders agreement (i) constituted a waiver by the common stockholders of their statutory appraisal rights and (ii) did not preclude the plaintiffs from bringing a fiduciary suit against Carlyle and the Authentix directors. In this most recent decision, the court held that the plaintiffs had adequately stated a claim for breach of fiduciary duties by Carlyle and the Carlyle-affiliated directors on the Authentix board.


Digital Asset Securities Regulation: A Petition for Rulemaking from Coinbase

Paul Grewal is Chief Legal Officer, Faryar Shirzad is Chief Policy Officer, and Thaya Knight is Senior Public Policy Manager at Coinbase. This post is based on a petition for rulemaking submitted by Coinbase to the SEC regarding Digital Asset Securities Regulation.

This post is based on a petition for rulemaking submitted to the SEC regarding Digital Asset Securities Regulation by Coinbase. Below is the text of a segment of the petition with minor adjustments to eliminate the correspondence-related parts.

Coinbase Global, Inc. (“Coinbase”) is filing this petition with the U.S. Securities and Exchange Commission (“Commission” or “SEC”) requesting that the Commission propose and adopt rules to govern the regulation of securities that are offered and traded via digitally native methods, including potential rules to identify which digital assets are securities. Digitally native securities are recorded and transferred using distributed ledger technology and do not rely on centralized entities or certificated forms of ownership that characterize traditional financial instruments. Transactions in these securities (henceforth “digital asset securities”) are executed and settled in real time, permanently recorded on blockchains, and visible with equal access to all market participants. This is a paradigm shift from existing market practices, rendering many of the Commission rules that govern the offer, sale, trading, custody, and clearing of traditional assets both incomplete and unsuitable for securities in this market.

The U.S. does not currently have a functioning market in digital asset securities due to the lack of a clear and workable regulatory regime. Digital assets that trade today overwhelmingly have the characteristics of commodities. Coinbase, like many other exchanges, has intentionally and conscientiously steered well clear of securities to ensure that we are able to operate in full compliance with applicable laws and regulations. However, new rules facilitating the use of digital asset securities would allow for a more efficient and effective allocation of capital in financial markets and create new opportunities for investors.

Globally, many jurisdictions are actively pursuing regulation that meets the specific needs of the crypto market, ensuring investors are well-protected. For example, the EU recently reached agreement on Markets in Crypto Assets (MiCA) regulation first proposed in 2020, and countries and markets such as Australia, Brazil, Dubai, Hong Kong, Switzerland, and the United Kingdom have taken important steps towards establishing (or have already established) regulations around crypto.


The Single-Owner Standard and the Public-Private Choice

Charles Korsmo is Professor of Law at Case Western Reserve University School of Law and Minor Myers is Professor of Law at the University of Connecticut School of Law. This post is based on their recent paper, forthcoming in the Journal of Corporation Law, and is part of the Delaware law series; links to other posts in the series are available here.

A fundamental question in corporate law is the nature of the stockholders’ ownership interest in the firm. Should a share of stock be viewed as a simple chattel, the value of which can be measured for all purposes by its trading price? Or should it be viewed as a partial claim on the firm as a whole, the value of which—for some purposes—cannot be determined without reference to the value of the entire firm to a single owner? This question arises in a number of contexts involving intra-corporate disputes, the most important of which is the merger. When examining whether a target board has satisfied its fiduciary duties, or when determining the “fair value” of the stockholders’ shares, a court must confront this fundamental question of the shareholders’ entitlement.

Delaware law has long entitled stockholders to a proportionate share of the value of the firm as a whole to a single owner and not simply the trading value of their fractionalized shares. This conception—the “single-owner” standard—was first articulated in the context of appraisal rights, and it has served for a century as the Atlas of Delaware’s corporate law, providing the theoretical foundation for its entire doctrinal universe, including merger landmarks like Unocal, Revlon, and the long line of their offspring. The single-owner standard provides the justification for allowing target boards to employ takeover defenses to fend off bids at a premium to the stock price and for the traditional measures of fair value in appraisal and breach of fiduciary duty actions.


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