Month: January 2023

Has the “internal affairs” doctrine been stretched too thin?

In this paper, Ann Lipton, an Associate Professor at Tulane Law School, contends that the “internal affairs” doctrine has gradually expanded its reach and, perhaps as a result, is now facing new challenges. As applied in Delaware—where it is applied most often—the doctrine, she argues, is “on a collision course with the legitimate regulatory interests of other states (and indeed the federal government).” Of course, many will strongly disagree with her argument, especially given the practical implications. Still, it may be worthwhile to gain some insight into her perspective.  Is it time to rethink the internal affairs doctrine? The author suggests that a more balanced, targeted approach would be more appropriate and more effective.

“Diversity washing” is the new greenwashing

Is greenwashing old news? The latest component of ESG to be subject to a good scrubbing is diversity: specifically, “diversity washing.”  What’s that? According to this paper authored by academics from several institutions, including Chicago Booth and the Rock Center for Corporate Governance at Stanford, there are a number of companies that actively promote their commitments to diversity, equity and inclusion in their public communications but, in actuality, their hiring practices, well, don’t quite measure up.  The authors label companies with significant discrepancies—companies that “discuss diversity more than their actual employee gender and racial diversity warrants—as ‘diversity washers.’” What’s more, the authors found, companies that engaged in diversity washing received better ratings from ESG rating firms and were often financed by ESG-focused funds, even though these companies were “more likely to incur discrimination violations and pay larger fines for these actions.” The authors cautioned companies that getting a handle on the level of misrepresentation in this area is important because “a failure to adequately address deficiencies in DEI has real effects on firms, including costly ESG audits initiated by activist shareholders, increased scrutiny from regulators, and bad publicity that can negatively affect customer loyalty.” Not to mention the “social and economic loss” for ESG investors.

Geopolitics moves from the cocktail party to the boardroom

According to experts cited in this article from the WSJ, “[g]overnments are increasingly using ‘financial levers’ to advance national security goals,” a development that “has clear implications for businesses.” The war in Ukraine, with its related Russia sanctions, as well as the ongoing political tensions—and related tariffs and trade restrictions—with other countries to which we have deep economic ties have led risk experts to anticipate “more volatility ahead rather than less.” To be sure, war, political tensions and economic instability can affect companies’ current and prospective businesses. The Global Risks Perception Survey released this month by the World Economic Forum ranked “geoeconomic confrontation” as number three among the top ten identified risks over the next two years.  Accordingly, conversations about geopolitics that, say, ten years ago might have been reserved for cocktail parties are now taking place among managements and boards, leading some companies to recognize the need for a “geopolitical risk management function.” In this article, “Board Oversight of Geopolitical Risks and Opportunities,” two academics at the IMD Global Board Center offer a framework designed to help boards implement effective oversight of geopolitical risk.   To provide some insight into how boards are currently implementing oversight of geopolitical risk, Corporate Secretary has published the findings of a survey of governance professionals in a new report, “Geopolitical and economic risks: Board oversight in an evolving world.” 

Renee Jones to leave SEC; Erik Gerding to be named Corp Fin Director

On Friday, the SEC announced the departure of Renee Jones as head of Corp Fin.  She has been Director of Corp Fin since June 2021 and will be returning to her position on the faculty of Boston College Law School.  In her place as Director of Corp Fin will be Erik Gerding, who is currently serving as Deputy Director of Corp Fin.  SEC Chair Gary Gensler praised Jones for leading Corp Fin “during a time when we have proposed—and in numerous cases adopted—critical reforms to benefit investors….I am grateful for her counsel, judgment, and deep understanding of the capital markets. Thanks to Renee’s leadership, we have enhanced investors’ access to the full, fair, and truthful information as required by our securities laws to make informed investment decisions.” Gerding remarked that he “look[s] forward to continuing the work that Renee led at the Division over the last year….” Will we see any difference in Corp Fin rulemaking? Time will tell.

Audit committee oversight of ESG fraud risk

In this article, accounting firm Deloitte observes that boards and managements often experience “denial” when the topic of fraud risk arises—no one wants to feel that the trust they place in their own employees is actually misplaced.  Still, fraud risk is one topic that typically finds its way onto the agendas of audit committees. Deloitte advises that, with the current attention to ESG and in anticipation of new rulemaking from the SEC on disclosure related to climate, human capital and other ESG-related topics (see this PubCo post), “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.” While audit committees focus primarily on financial statement fraud risk, Deloitte suggests that audit committees should consider expanding their attention to fraud risk related to ESG, an area that is “not governed by the same types of controls present in financial reporting processes,” and, therefore, may be more susceptible to manipulation. In their oversight capacity, audit committees have a role to play, Deloitte suggests, by engaging with “management, including internal audit, fraud risk specialists, and independent auditors to understand the extent to which fraud risk is being considered and mitigated.”

SEC settles charges with McDonald’s and former CEO over deficient disclosures; two commissioners dissent

Inappropriate relationships with employees have landed a number of CEOs and other executives in hot water in the last few years, especially as the MeToo movement gained momentum. But these aren’t necessarily just employment issues, nor are they always limited to problems for the perpetrator.  The SEC has just announced settled charges against McDonald’s and its former CEO, Stephen Easterbrook, arising out of the termination of Easterbrook “for exercising poor judgment and engaging in an inappropriate personal relationship with a McDonald’s employee in violation of company policy.” The SEC alleged that Easterbrook made “false and misleading statements to investors about the circumstances leading to his termination in November 2019.” But how was McDonald’s alleged to have violated the securities laws? The SEC charged that McDonald’s disclosures related to Easterbrook’s separation agreement were deficient in failing to disclose that the company “exercised discretion in terminating Easterbrook ‘without cause,’” allowing Easterbrook to “retain substantial equity compensation.” The SEC’s Director of Enforcement asserted that, “[w]hen corporate officers corrupt internal processes to manage their personal reputations or line their own pockets, they breach their fundamental duties to shareholders, who are entitled to transparency and fair dealing from executives….By allegedly concealing the extent of his misconduct during the company’s internal investigation, Easterbrook broke that trust with—and ultimately misled—shareholders.”  According to the Associate Director of Enforcement, “[p]ublic issuers, like McDonalds’s, are required to disclose and explain all material elements of their CEO’s compensation, including factors regarding any separation agreements….Today’s order finds that McDonald’s failed to disclose that the company exercised discretion in treating Easterbrook’s termination as without cause in conjunction with the execution of a separation agreement valued at more than $40 million.” As reported by the WSJ, “[i]n a statement Monday, McDonald’s said, ‘The SEC’s order reinforces what we have previously said: McDonald’s held Steve Easterbrook accountable for his misconduct. We fired him, and then sued him upon learning that he lied about his behavior.’” Commissioners Hester Peirce and Mark Uyeda dissented from the Order, contending that the SEC’s interpretation of the disclosure rule was beyond the rule’s scope.

SEC crams much into packed Fall 2022 agenda

The SEC’s Fall 2022 Reg-Flex Agenda—according to the preamble, compiled as of October 6, 2022, reflecting “only the priorities of the Chair”—has just been posted, and it looks like the SEC will have another frenetic year ahead dealing with new and pending proposals—and so will we. Describing the new agenda, SEC Chair Gary Gensler said that it “reflects the need to modernize our ruleset, moving deliberately to update our rules in light of ever-changing technologies and business models in the securities markets. Our ability to meet our mission depends on having an up-to-date rulebook—consistent with our mandate from Congress, guided by economic analysis, and shaped by public input.” Here are the short-term and long-term lists, which show all Corp Fin agenda items scheduled for action by either April or October 2023, with the first four months looking especially jam-packed. There’s no dispute that the agenda is laden with major proposals, and many of these proposals—climate disclosure, cybersecurity, SPACs, share buybacks—are apparently at the final rule stage. Implementing all of these proposals, if adopted, would likely represent a challenge for many companies; whether overwhelmingly so remains to be seen.

Will companies need to provide more detailed country-by-country tax disclosure?

The topic of taxes—corporate, presidential and otherwise—seems to be trending these days, with calls for greater transparency coming from investors, analysts and others, including speakers at the SEC’s Investor Advisory Committee. They contend that some corporate tax practices may give rise to financial, legal and reputational risks that would be material for investors to understand. Currently, however, financial statements are required to include disclosure of the total taxes paid, but are not required to break out the amounts by country or state.  Consequently, investors and analysts say that they do not have sufficient visibility to understand the impact on companies of changes in tax laws or the tax environment in different jurisdictions or to otherwise evaluate companies’ exposure to tax risks.

SEC adopts new rules on 10b5-1 plans [UPDATED]

[This post revises and updates my earlier post primarily to provide a more detailed discussion of the contents of the adopting release.]

At an open meeting in December last year—happy new year!—the SEC voted to adopt new rules regarding Rule 10b5-1 plans. The vote was unanimous—albeit somewhat grudgingly in one case. Still, the notion of unanimity on an important Corp Fin regulation has seemed like something of a pipe dream in the last several years. Commissioner Mark Uyeda was even complimentary of the process employed for this rulemaking—and he is typically quite critical of the process (see this PubCo post)—noting that the process employed this time facilitated the development of more responsive final rules. And did I detect a note of relief in the Chair’s voice? Perhaps the unanimity was in part the result of concerns long expressed about potential abuse of Rule 10b5-1 plans—from studies reported in media to letters from Senators to recent probes conducted by the SEC and DOJ (see this PubCo post, this PubCo post and this PubCo post). These concerns have been percolating for many years, and the adoption of rules adding new conditions to the use of the Rule 10b5-1 affirmative defense and new disclosure requirements for 10b5-1 plans has long been anticipated. After all, these plans were one of the first rulemaking targets that SEC Chair Gary Gensler identified after he was sworn in as Chair: Rule 10b5-1 plans, he said in 2021, “have led to real cracks in our insider trading regime” and called for a proposal to “freshen up” these rules. (See this PubCo post.)  The final amendments add new conditions to the availability of the Rule 10b5-1(c) affirmative defense, including cooling-off periods for directors, officers and persons other than issuers, and create new disclosure requirements. According to Gensler, “[a]bout 20 years ago, the SEC established Exchange Act Rule 10b5-1. This rule provided affirmative defenses for corporate insiders and companies to buy and sell company stock as long as they adopted their trading plans in good faith—before becoming aware of material nonpublic information. Over the past two decades, though, we’ve heard from courts, commenters, and members of Congress that insiders have sought to benefit from the rule’s liability protections while trading securities opportunistically on the basis of material nonpublic information. I believe today’s amendments will help fill those potential gaps….These issues speak to the confidence that investors have in the markets. Anytime we can increase investor confidence in the markets, that’s a good thing. It helps investors decide where to put their money. It lowers the cost of capital for businesses seeking to raise capital, grow, and innovate, and thus facilitates capital formation.”