The Delaware Chancery’s refusal to dismiss a derivative allegation in a suit claiming that Goldman Sachs directors were paid excessively may soon provide a decision that offers companies guidance on setting board of director pay (Stein v. Blankfein, Court of Chancery of the State of Delaware, C.A. No. 2017-0354-SG (Del. Ch. May. 31, 2019). This guidance may come despite the court’s initial doubts that the facts, when more fully developed, would yield a holding against Goldman.

If the case is not settled before the next phase of the case, the Chancery’s application of the “entire fairness” standard may provide greater clarity on how directors are paid and whether pay levels are excessive. The “entire fairness” standard, as applied to director pay setting, was articulated in the 2017 Investor’s Bancorp case, and has a standard that is less differential than the “business judgment rule”. (See “Delaware Supreme Court ruling moves the goalposts on director compensation,” Executive Pay Matters, February 16, 2018).

The initial court decision raises several notable issues.

(more…)

Shareholders and regulators across the globe are demanding improvements in board oversight of corporate culture. Institutional investors seek to better understand companies’ approaches to human capital management (“HCM”), tone at the top, and the attendant reputational risks.

Corporate culture is a business issue for companies and their boards. The new generation of workers weighs workplace culture when choosing their jobs, and the protracted low rates of unemployment have added fuel to the talent war. Best-in-class companies are therefore seeking to distinguish their corporate cultures from those of their peers in ways that will attract and retain today’s top talent. Carefully focused, boards could play a significant role in this effort, even if they remain unmoved by the demands of their other stakeholders.

(more…)

Our paper, A Tale of Two Markets: Regulation and Innovation in Post-Crisis Mortgage and Structured Finance Markets, takes the occasion of the tenth anniversary of the financial crisis to review recent developments in the structured products market, connecting the emergent pattern to post-crisis regulation.

The financial crisis stemmed from excessive risk-taking and shabby practices in the “subprime” segment of the home mortgage market, a market that got its financing from an array of “toxic” products and investment vehicles created in the structured credit market—private-label mortgage-backed securities (PLS), collateralized debt obligations (CDOs), collateralized debt obligations squared (CDO²s), synthetic securitizations, and structured investment vehicles (SIVs). These products provided the funding for the mortgage lending that enabled housing prices to be bid up in an unsustainable bubble.

(more…)

During the first weekend of August, the United States (U.S.) again experienced two deadly mass shootings, the first one taking place in a Walmart store in El Paso, Texas, the second in the Oregon Historic District in Dayton, Ohio. The shootings, which occurred within less than 24 hours of each other, left 32 people dead and dozens more injured. In the wake of these events the issue of gun violence and gun control has once more become a focal point of public debate in the U.S., which, according to the Gun Violence Archive, already experienced more than 270 mass shootings, defined as a shooting incident where four or more people (not including the perpetrator) are shot or killed, since the beginning of 2019. As of today, three weeks after the shooting in Dayton on August 4, 2019, a further 25 mass shootings have taken place across the U.S.

Despite recurring outcry and raging debate following previous prominent mass shootings—including those at Sandy Hook Elementary School in Newton, Connecticut, in December 2012, at a nightclub in Orlando, Florida, in June 2016, and at Marjorie Stoneman Douglas High School in Parkland, Florida, in March 2018—legislative responses have been hampered by lawmakers’ divisions about how, or if, to address the issue. After the recent events in El Paso and Dayton the public debate focused anew on the issue of background checks.

(more…)

A new statement from the Business Roundtable commits to stakeholder interests instead of making the primary purpose of the company shareholder value. Long-term shareholders are increasingly committed to explicitly ESG investing, which values stakeholder interests as a way to minimize investment risk. But I am skeptical about what the CEO signatories to this statement have in mind for six reasons.

1. We’ve seen this before. The last time the BRT deployed stakeholder rhetoric it was during the 1980’s era of hostile takeovers, when a feint to the interests of anyone other than shareholders was the best way to entrench management. The CEOs who signed this statement know that accountability to everyone is accountability to no one. It’s like a shell game where the pea of any kind of obligation is always under the shell you didn’t pick. It’s shoot an arrow at the wall and then draw a bull’s-eye around it goal-setting.

(more…)

Another day, another data breach. This time at Capital One, the fifth largest credit card issuer in the United States.

Specifically, on July 29, 2019, FBI agents arrested Paige A. Thompson on suspicion of downloading nearly 30 GB of 100 million Capital One Financial Corp credit applications from a rented cloud data server. The FBI says Capital One learned about the theft from a July 17, 2019, email stating that some of its leaked data was being stored for public view on the software development platform Github. That Github account was for a user named “Netcrave,” which includes the resume and name of Paige A. Thompson. According to the FBI, Thompson also used a public Meetup group under the alias “erratic,” where she invited others to join a Slack channel named “Netcrave Communications.”

KrebsOnSecurity actually entered the open Netcrave Slack channel on July 30, 2019, and reviewed a June 27, 2019 commentary Thompson, which listed various databases she found by hacking into improperly secured Amazon cloud accounts, suggesting that Thompson may also have exfiltrated tens of gigabytes of data belonging to other major corporations.

(more…)

The academic literature has established that individual CEOs possess an idiosyncratic “style” which can be detected in their corporate decision making. One important, yet unexplored aspect of CEOs’ personal background that can influence their style, is the extent to which they possess hands-on innovation experience as inventors. In our recent article, we examine whether this dimension of a CEO’s personal background impacts upon a firm’s innovation activities.

A possible channel through which individuals acquire and refine specialized skills is through hands-on experience. In our study, we conjecture that  CEOs’ inventor experience may endow them with valuable innovation-related insights that translate into a superior ability to evaluate, select and execute innovation-intensive investment projects for the firms they lead.

(more…)

Gender diversity in the corporate boardroom is receiving significant belated attention. Much of that attention has revolved around prescriptive legislation, academic research, and business results—and one point of focus is an increase in the number of female directors. This article, however, outlines options under Delaware corporate law for jumpstarting an increase in the influence of female directors on board decision making—i.e., female board power. [1] That is, while female board perspectives may remain outnumbered at least in the near term, these corporate mechanisms may leverage existing female board power to prevent the female board perspective from being outweighed. In footnotes to this article, there are illustrative form provisions related to these concepts of Delaware corporate law. [2]

(more…)

Concerns about securities class actions typically focus on the low-value cases. These cases settle for relatively small amounts of money, raising concerns that they are motivated by the potential for a nuisance settlement, rather than a desire to target actual fraud. The cases at the other end of the spectrum with settlements of hundreds of millions of dollars look like success stories and therefore do not receive the same empirical scrutiny. These cases, however, pose risks of their own. In our paper Working Hard or Making Work? Plaintiffs’ Attorneys Fees in Securities Fraud Class Actions, we examine these mega-settlements, focusing specifically on the fees awarded to plaintiffs’ attorneys in these suits.

Mega-settlements stand apart as a distinct category of settlements in securities class actions. The bottom 90% of settlements—i.e., the settlements in the first nine deciles—average $11 million, with settlements in the ninth decile averaging $41.8 million. The settlements in the top decile, by contrast, average $295.5 million, more than seven times larger than the settlements in the decile below. Predictably, these settlements lead to significant fees for the plaintiffs’ attorneys—a mean of $39.5 million compared to a mean of $2.7 in the other nine deciles.

(more…)

Individual director assessments in the United States need an overhaul.

The annual board performance assessment, when conducted, tends to rely on director surveys and other self-evaluation tools. But more importantly, companies continue to forgo, or at least forgo reporting, a systematic process that extends beyond the collective performance of the board or its committees to also evaluate the contribution of individual directors, according to a a recent review of disclosure documents filed by companies in the Russell 3000 index.

Only 14.2% of the Russell 3000 companies report having instituted such an annual process at the individual director level, a share that has barely grown since 2016 (13.2%); in the S&P 500, the percentage remains shy of 30%.

That’s a problem, especially in an ever-changing, business-risk environment.

Performance assessment is an indispensable human capital management tool for today’s business organizations. It fosters accountability, encourages self-improvement, informs the talent development process, and ultimately ensures the alignment of skills with the company’s long-term strategy. And it’s just as critical at the top leadership level, including the leadership of the board of directors.

(more…)

On June 18, Facebook announced its proposal to launch a new cryptocurrency next year, named the Libra. In a new paper we analyse how Libra will work, discuss the governance of the organization behind it (the Libra Association), explore its transformative potential, and consider its likely regulatory implications.

Libra will serve as e-money. Its value will be tied to a basket of major government-issued currencies and for each Libra issued an equal value of such currency, or highly liquid government bonds, will be placed on deposit with a reliable repository. Libra will be a stablecoin—a cryptocurrency the value of which is tied to that of fiat currency. Libra is not the first stablecoin, but it will be the first stablecoin with such breathtaking global reach and utility as Facebook has over 2.3 billion active monthly users.

Libra’s usefulness may initially be limited in highly developed countries with good payment systems, but it will be potentially transformative for many of the 1.7 billion people who today lack access to the most basic financial services. Libra is mobile money in the Kenyan M-Pesa sense, but on a global scale: AliPay and WeChatPay for all.

(more…)

Good evening and thank you for being here. [1]

As many of you know, in June, the Securities and Exchange Commission adopted a package of rules and interpretations that will enhance the quality and transparency of retail investors’ relationships with broker-dealers and investment advisers. Importantly, they bring the legal requirements and mandated disclosures for broker-dealers and investment advisers in line with reasonable investor expectations. These actions do not attempt to favor one type of service or relationship. Rather, they are designed to increase investor protection while preserving access for Main Street investors—both in terms of choice and cost—to a variety of investment services and products.

Our rules and interpretations benefit from and build upon the Commission’s extended history of broker-dealer and investment adviser regulation, the substantial experience and expertise of our staff, our analysis over many years of prior efforts to modernize and improve regulation in this area, and the many thoughtful comments and other feedback we received on our proposals. [2] Without question, these actions, individually and collectively, will significantly benefit Main Street investors.

(more…)

Introduction

Emerging technologies are altering the financial reporting environment substantially, and this change is accelerating. For example, artificial intelligence (AI), robotic process automation, and blockchain are changing the way business gets done, and auditors are leading by transforming their own processes.

In this evolving environment, it is more important than ever for the key players in financial reporting—auditors, audit committees, and management—to have a strong grasp of roles and responsibilities. As the use of emerging technologies in the financial reporting process increases, it becomes less likely auditors can design traditional substantive tests (e.g., test of details or substantive analytical procedures) that, by themselves, would provide sufficient appropriate audit evidence that respond to identified assertion-level risks. [1] This evolution in the sufficiency and source of audit evidence puts further emphasis on management’s internal control over financial reporting.

What are key technology risks to watch for? What are auditors focusing on when it comes to the impact of emerging technologies on business?

How are auditors evaluating whether management is properly assessing the impact of emerging technologies on internal control over financial reporting?

This post sheds light on these questions, with an eye on key technology developments: the internet of things (IoT), AI, and smart contracts. This resource builds on the Center for Audit Quality’s 2018 publication Emerging Technologies: An Oversight Tool for Audit Committees. [2]

(more…)

Regulation Fair Disclosure (“Reg-FD”) was intended to stop the practice of selective disclosure, in which companies provided material information to select analysts and institutional investors prior to public disclosure. It achieved this goal by requiring that material disclosures be broadly disseminated to the public through non-exclusionary channels. While the underlying concept of broad non-exclusionary disclosures is simple, the legislative implementation of this regulation generated significant controversy. In particular, a number of stakeholders believed that the difficulty associated with identifying material disclosures and broad non-exclusionary methods of dissemination would discourage firms from providing informal communications that could potentially violate Reg-FD, thus leading to a deterioration in the overall level of disclosure. While a number of prior studies have documented that Reg-FD has eliminated certain selective disclosures, it remains unclear how Reg-FD affects the firm’s overall disclosure policy and information environment.

In our paper, we contribute to our understanding of how Reg-FD may have influenced firms’ overall disclosure policy by examining one specific aspect—the adoption of new disclosure technologies. More specifically, we provide insights as to whether firms are reluctant to adopt new disclosure technologies without clear guidance from the SEC endorsing their use for the purposes of complying with Reg-FD. We focus on Twitter because prior studies have established that there are positive capital market benefits to Twitter usage, suggesting that Twitter would be broadly adopted if there were limited costs to doing so. In addition, firms do not have to use Twitter to disseminate information provided through traditional channels, which allows us to isolate the voluntary adoption of Twitter as a new disclosure medium.

(more…)

American corporate law is built on a metaphor of a race: states compete to supply corporate law. For nearly half a century, corporate law scholarship has revolved around endemic questions about whether other states put competitive pressure on Delaware, and whether this competition is normatively desirable.

There is a missing piece to this important body of scholarship. In my article, Delaware’s New Competition (forthcoming in the Northwestern University Law Review and available on SSRN), I introduce foreign nations as emerging lawmakers that compete with American states in the increasingly globalizing market for corporate law. In recent decades, entrepreneurial foreign nations in offshore islands—principally the Cayman Islands, the British Virgin Islands, and Bermuda—have attracted publicly traded American corporations by offering permissive corporate governance rules and specialized business courts.

(more…)

Retirement saving in the United States has changed dramatically. The classic defined-benefit (DB) plan has largely been replaced by the defined-contribution (DC) plan. With the latter, individual employees’ decisions about how much to save for retirement and how to invest those savings determine the benefits available to them upon retirement.

This system relies on employees to save and invest their money for retirement, decisions that they are poorly equipped to make. A variety of studies document low levels of financial literacy in the general population. People with low financial literacy are susceptible to a number of investment mistakes, including choosing products that do not meet their needs and paying excessive fees. They are also vulnerable to fraud. Moreover, investment decision-making is complicated. The typical 401(k) plan offers participants products that many of them do not understand. Effective retirement savings also requires people to begin saving early, to reallocate their portfolios periodically as they age and, when they retire, to determine how to manage the balance in their accounts to provide income for the rest of their lives.

Although financial illiteracy is a widespread problem, the evolution of workplace pensions exacerbates the problem by imposing responsibility for financial well-being in retirement on a group of people who are particularly ill-suited to the task. We term these people “workplace-only investors,” which we define as people whose only exposure to investment decisions is by virtue of their participation in an employer-sponsored 401(k) plan or equivalent DC plan; they do not have other retirement accounts or financial investments. We view workplace-only investors as forced or involuntary investors in that their participation in the financial markets is a product of their employment and unlikely the result of informed choice. They are a sizeable share of participants in DC pension plans.

(more…)

Public companies in the US and around the world are increasingly signing settlement agreements as a means to put shareholder activist campaigns to rest.

While companies are allured by the prospect of a quick end to the public side of an activist campaign, settlement agreements often invite new disruptions inside the boardroom and interrupt a board’s ability to concentrate on executing a long-term strategy. Moreover, settlement agreements are of increasingly shorter duration, meaning that the peace boards bargained for often becomes merely a fleeting respite from what is, in fact, a multi-year campaign of the activist.

The anatomy of a settlement agreement

At first sight, settlement agreements with activists have much to offer. The downside for the incumbent board is nearly always that one or more activist designees will join the board, often immediately. If the activist had leverage in the negotiations, it will have successfully pushed for “replacement rights”—the right of the activist to designate a replacement for any of its designees on the board who leave for ostensibly unforeseen reasons. Replacement rights create the possibility that an activist can replace a “good cop” that it first designated to the board with a “bad cop” who will push his or her agenda harder in the boardroom. Often, the activist designees are principals or employees of the activist fund. Regularly, settlement agreements provide that activist designees on the board will occupy seats on key committees.

(more…)