Yearly Archives: 2022

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

Posted by Taryn Zucker, Lauren Lee, and Evelyne Kim, Freshfield Bruckhaus Deringer LLP, on
Wednesday, August 3, 2022
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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.

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The Expanded Role of the Compensation Committee

Posted by Ani Huang, and Richard Floersch, HR Policy Association, on
Wednesday, August 3, 2022
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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:

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Putting Financial Reporting Standards Into Practical Perspective

Posted by Robert Eccles (Oxford University) and Kazbi Soonawalla (Oxford University), on
Tuesday, August 2, 2022
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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.”

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How Continuous Voting with UPC Will Change Proxy Contests

Posted by Michael R. Levin, The Activist Investor, on
Tuesday, August 2, 2022
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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 compliance: new 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.

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Sale of Portfolio Company is Subjected to Entire Fairness Review

Posted by Gail Weinstein, Steven J. Steinman, and Brian T. Mangino, Fried, Frank, Harris, Shriver & Jacobson LLP, on
Tuesday, August 2, 2022
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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. Soran, Randi 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.

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Digital Asset Securities Regulation: A Petition for Rulemaking from Coinbase

Posted by Paul Grewal, Faryar Shirzad, and Thaya Knight, Coinbase, on
Monday, August 1, 2022
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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.

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The Single-Owner Standard and the Public-Private Choice

Posted by Charles Korsmo (Case Western Reserve University) and Minor Myers (University of Connecticut), on
Monday, August 1, 2022
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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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A New Chapter in Cyber

Posted by Mary Galligan and Carey Oven, Deloitte LLP, on
Monday, August 1, 2022
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Mary Galligan is a Managing Director and Carey Oven is national managing partner at the Center for Board Effectiveness and chief talent officer at Deloitte LLP. This post is based on their Deloitte memorandum.

Escalating risk, regulatory focus can drive board oversight of governance

An SEC proposal issued in March 2022 to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and incident reporting has sparked increased discussions about cyber risk in many corporate boardrooms. At many companies, boards are asking questions about what measures they should consider taking that would help to enhance governance and improve risk management, which may also help prepare the company to meet likely new requirements.

Even before the proposal was issued, oversight of cybersecurity risk had become an increasing area of focus for boards. A survey by Deloitte and the Center for Audit Quality of 246 audit committee members published in January 2022 found that two-thirds of participants with oversight responsibility for cybersecurity expected to spend more time on the topic in the coming year. [1] In addition, 62% identified cybersecurity as one of the company’s top risks to focus on in 2022. [2]

If adopted as proposed, the SEC’s new rules would require prompt reporting of material cybersecurity incidents and disclosures in periodic filings focused on:

  • Policies and procedures to identify and manage cybersecurity risks
  • Management’s role in implementing cybersecurity policies and procedures
  • Corporate directors’ cybersecurity expertise, if any, and the board’s oversight of cybersecurity risk
  • Updates about previously reported material cybersecurity incidents

The SEC received nearly 150 comment letters on the proposal and is expected to issue final requirements later in 2022.

Leading up to the proposal, cyber incidents have increased in recent years, both in frequency and magnitude. Cyberthreats have become more complex as threat actors use more sophisticated techniques. At the onset of the pandemic, the cyberattack surface expanded significantly, and risk persists for many companies that are maintaining hybrid work arrangements. Companies face threats related to the theft of information, disruption of functions, ransomware demands, destruction of hardware and software, and corruption of data.

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What Do Elevated Shareholder Expectations Mean for Large Company Boards and Compensation Programs?

Posted by Todd Sirras, Austin Vanbastelaer, and Justin Beck, Semler Brossy, on
Sunday, July 31, 2022
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Todd Sirras is a Managing Director; Austin Vanbastelaer is a Senior Consultant and Justin Beck is a Consultant at Semler Brossy. This post is based on a Semler Brossy memorandum by Mr. Sirras, Mr. Vanbastelaer, Mr. Beck, Alexandria Agee, Sarah Hartman, and Kyle McCarthy.

Related research from the Program on Corporate Governance includes The Perils and Questionable Promise of ESG-Based Compensation (discussed on the Forum here) and The Illusory Promise of Stakeholder Governance (discussed on the Forum here) both by Lucian A. Bebchuk and Roberto Tallarita; and Does Enlightened Shareholder Value add Value (discuss on the Forum here) and Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) both by Lucian A. Bebchuk, Kobi Kastiel and Roberto Tallarita.

Large companies are receiving lower shareholder support for Say on Pay proposals than ever before. Average Say on Pay vote support for S&P 500 companies declined for a fifth consecutive year in 2022. Meanwhile, the average vote for Russell 3000 companies not in the S&P 500 (“R3000x”) stayed constant over the same five-year period. The 2.6 percentage point gap between average vote support in the S&P 500 (87.5%) and the R3000x (90.1%) in 2022 is the widest since Say on Pay voting began in 2011.

Importantly, this observation is driven by lower support more broadly across the index rather than just a materially higher failure rate or a few isolated cases that drag the average down. A third of S&P 500 companies received lower than 90% support thus far in 2022, compared to an average of 24% over the prior five years.

Vote results between the two indices have diverged due to a fractured governance landscape and differentiated expectations for “good” governance at large- and small-cap companies. Institutional investors and proxy advisors are signaling increased expectations through policy expansion. Their company evaluations now consider a broader set of financial metrics beyond total shareholder return, and their stewardship priorities now focus heavily on environmental, social, and governance (ESG) topics. These are often introduced and applied most firmly to large companies. In some cases, investors have added proxy voting policies on ESG topics that apply only to companies in the S&P 500.

This evolving landscape makes it more difficult to anticipate an individual shareholder’s vote, which creates ambiguous expectations for large-cap companies, given the number of diverse institutional investors that hold stakes in the largest US companies. A combination of the pandemic, dynamic sociopolitical environment, and common large non-annual CEO awards in the tech and IPO space have impacted how investors interpret the appropriateness of CEO pay magnitude relative to performance and the broader stakeholder experience.

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Statement by Chair Gensler on Re-Proposed Amendments Regarding Exemption from National Securities Association Membership

Posted by Gary Gensler, U.S. Securities and Exchange Commission, on
Saturday, July 30, 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, the Commission unanimously voted to re-propose amendments to Rule 15b9-1 regarding when broker-dealers are required to register with the Financial Industry Regulatory Authority (FINRA). These amendments would cause some of the most active participants in our equity and fixed-income markets to be required to register with FINRA. I was pleased to support these amendments because, if adopted, they would modernize and improve market oversight for regulators.

Rule 15b9-1 was first put in place in 1965 and expanded in 1976, 46 years ago. The rule set forth an exemption designed for certain exchange floor members and other regional, specialized broker-dealers, allowing them not to register with the National Association of Stock Dealers (NASD), the predecessor to FINRA. The exemption applied to broker-dealers who typically were registered with the single exchange where they operated and met certain other criteria.

Nearly half a century later, our markets have drastically changed. The floor-based trading environment that existed when this exemption was adopted has given way to complex, high-volume, and cross-exchange electronic trading. Yet such complex and often high-frequency activity, made possible by highly-sophisticated technology, is regulated by a rule nearly as old as the first-ever cell phone. [1] Several currently-exempt firms have monthly trading volume valued in the tens of billions of dollars that is not subject to direct FINRA oversight. [2] Thus, today’s proposal updates and narrows the circumstances in which broker-dealers do not need to register with FINRA.

Currently, many broker-dealers conduct significant cross-exchange or off-exchange activity using the latest technology. Compared with the oversight that individual exchanges conduct on their own members, FINRA has the expertise for cross-market oversight. Thus, required FINRA membership for many of these currently-exempt firms would help enhance robust and consistent oversight. Furthermore, requiring firms to join FINRA helps to ensure that these firms report their activities in U.S. treasury markets.

In 2015, the Commission proposed changes to Rule 15b9-1. Informed by public comment, and in light of current markets, we have updated and re-proposed these amendments.

By extending FINRA oversight to potentially dozens of broker-dealers, the proposed amendments would strengthen oversight of firms trading securities across several markets, helping to protect investors and maintain fair, orderly, and efficient markets.

I’d like to thank the staff for their diligent work in preparing these amendments, including:

  • Michael Bradley, Haoxiang Zhu, David Saltiel, Andrea Orr, David Shillman, Eric Juzenas, Meredith Macvicar, David Michehl, Vince Vuong, Roni Bergoffen, Nicholas Shwayri, Mark Sater, and Marilyn Parker in the Division of Trading and Markets;
  • Cuyler Strong, Laura Tuttle, Jessica Wachter, Amy Edwards, Patti Vegella, Lauren Moore, Charles Woodworth, and Amy Edwards in the Division of Economic and Risk Analysis;
  • Ronesha Butler, Cynthia Ginsberg, Maureen Johansen, Dan Berkovitz, Meridith Mitchell, Malou Huth, and Robert Teply in the Office of the General Counsel.
  • Connie Kiggins and Carrie O’Brien from the Division of Examinations; and
  • Kristin Pauley and Armita Cohen from the Division of Enforcement.

Endnotes

1https://www.pcmag.com/news/the-golden-age-of-motorola-cell-phones(go back)

2See Exemption for Certain Exchange Members, Securities Exchange Act Release No. 34-95388 (July 29, 2022) (e.g., pp. 26-27) (“For example, of the estimated 66 broker-dealers that were exchange members but not FINRA members as of the end of 2021, 47 initiated orders in listed equities in September 2021 that were executed on or off an exchange. These firms’ September 2021 off-exchange listed equities dollar volume executed was approximately $789 billion, which was approximately 9.8% of total off-exchange volume of listed equities executed that month. Moreover, these firms’ September 2021 listed equities dollar volume executed on exchanges of which they are not a member was approximately $592 billion.”), available at https://www.sec.gov/rules/proposed/2022/34-95388.pdf.(go back)

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