Category: Corporate Governance
Are boards overseeing AI?
Is there a hotter topic in the business world than AI? AI offers major opportunities for progress and productivity gains, but substantial risks as well. According to FactSet, 179 companies in the S&P 500 used the term “AI” during their earnings call for the fourth quarter of 2023, well above the 5-year average of 73. Among these companies, “the average number of times ‘AI’ was mentioned on their earnings calls was 13, while the median number of times ‘AI’ was mentioned on their earnings calls was 5. The term ‘AI’ was mentioned more than 50 times on the earnings calls of nine S&P 500 companies.” Similarly, Bloomberg reports that “[a]t least 203, or 41%, of the S&P 500 companies mentioned AI in their most recent 10-K report, Bloomberg Law’s review found. That’s up from 35% in 2022 and 28% in 2021. A majority of the disclosures focused on the risks of the technology, while others focused on its benefit to their business.” One of the many challenges that AI presents is on the corporate governance front, in particular board oversight, a topic addressed in this recent paper from ISS, AI Governance Appears on Corporate Radar. For the paper, ISS examined discussions of board oversight and director AI skills in proxy statements filed by S&P 500 companies from September 2022 through September 2023 to “assess how boards may evolve to manage and oversee this new area of potential risks and opportunities.”
Auditor problems are not just auditor problems
On Friday, SEC Enforcement charged audit firm BF Borgers CPA PC and its owner, Benjamin F. Borgers, with “massive fraud” involving “deliberate and systemic failures” to comply with PCAOB standards in auditing and reviewing financial statements incorporated into more than 1,500 SEC filings from January 2021 through June 2023. The charges also included “falsely representing to their clients that the firm’s work would comply with PCAOB standards; fabricating audit documentation to make it appear that the firm’s work did comply with PCAOB standards; and falsely stating in audit reports included in more than 500 public company SEC filings that the firm’s audits complied with PCAOB standards.” In settlement, the audit firm agreed to pay a $12 million civil penalty, and Benjamin Borgers agreed to pay a $2 million civil penalty, along with censures, cease-and-desists and permanent suspensions from appearing and practicing before the SEC as accountants. According to SEC Enforcement Director Gurbir S. Grewal,
“Ben Borgers and his audit firm, BF Borgers, were responsible for one of the largest wholesale failures by gatekeepers in our financial markets….As a result of their fraudulent conduct, they not only put investors and markets at risk by causing public companies to incorporate noncompliant audits and reviews into more than 1,500 filings with the Commission, but also undermined trust and confidence in our markets. Because investors rely on the audited financial statements of public companies when making their investment decisions, the accountants and accounting firms that audit those statements play a critical role in our financial markets. Borgers and his firm completely abandoned that role, but thanks to the painstaking work of the SEC staff, Borgers and his sham audit mill have been permanently shut down.”
This case has received an unusual amount of press—for an audit firm that many have never even heard of before—because Borgers was the auditor for the social media company of a certain former president. (See, e.g., the NYT, CNBC, CBS News) But, as we’ve often seen in other contexts, such as auditor independence (see, e.g., this PubCo post), this case also illustrates the importance for companies to keep in mind that these types of violations may have serious consequences not only for the audit firm, but also for the audit clients. In fact, in this case, the staff of Corp Fin and the Office of Chief Accountant issued this Staff Statement on Issuer Disclosure and Reporting Obligations in Light of Rule 102(e) Order against BF Borgers CPA PC.
Is the proxy advisory industry a net benefit or cost to shareholders?
In Seven Questions About Proxy Advisors, from the Rock Center for Corporate Governance at Stanford, the authors, David Larcker and Brian Tayan, examine the proxy advisory firm industry—all two of them. Well, actually, as the paper observes, there are a large number of small players, but Institutional Shareholder Services and Glass Lewis “control[] almost the entire market.” It’s well-known that recommendations from ISS and GL are considered important—sometimes even a major aspect of the battle—especially in contests for corporate control and director elections. But, the authors point out, the extent of their influence on “voting outcomes and corporate choices is not established, nor is the role they play in the market. Are proxy advisory firms information intermediaries (that digest and distill proxy data), issue spotters (that highlight matters deserving closer scrutiny), or standard setters (that influence corporate choices through their guidelines and models)? Because of the uncertainty around these questions, disagreement exists whether their influence is beneficial, benign, or harmful. Defenders of proxy advisors tout them as advocates for shareholder democracy, while detractors fashion them as unaccountable standard setters.” The paper examines “seven important questions about the role, influence and effectiveness of proxy advisory firms.” The authors explore why there is so much controversy about the purpose, role and contribution of proxy advisory firms, asking whether “the proxy advisory industry—as currently structured—[is] a net benefit or cost to shareholders?”
Cooley Alert: FTC bans noncompetes
The Federal Trade Commission has just voted, three to two, to prohibit post-employment noncompete agreements, with some limited exceptions. The ban will take effect 120 days after the final rule is published in the Federal Register. Why the ban? As discussed in this terrific new Cooley Alert, FTC Passes Sweeping Noncompete Ban, from our Labor and Employment group, the FTC noted that it views non-competes as “unfair method[s] of competition” that “restrict the freedom of American workers, suppress wages, and stifle new business and innovation.” The Alert indicates that the rule has an expansive application: in its definition of noncompetes, the rules sweeps in “certain provisions that are commonly thought to constitute alternatives to noncompetes.” In addition, the rule “broadly applies to noncompete agreements affecting virtually all workers—including employees, independent contractors, externs, interns, volunteers, apprentices or sole proprietors.” Under the rule, employers are required to “issue notices informing affected employees about the cessation of noncompete agreements.”
Cooley Alert—US Supreme Court: Pure Omissions Not Actionable Under Rule 10b-5(b)
Earlier this month, SCOTUS unanimously decided Macquarie Infrastructure Corp v. Moab Partners, holding that a pure omission of information required to be disclosed—in this case required in MD&A under Item 303—cannot form the basis of a private securities fraud action under Rule 10b-5(b). The Court was clear: “Pure omissions are not actionable under Rule 10b–5(b).” To be actionable under Rule 10b-5(b), the Court said, the omission must render an affirmative statement materially misleading. According to the Court, a “pure omission occurs when a speaker says nothing, in circumstances that do not give any particular meaning to that silence.” Actionable “[h]alf-truths, on the other hand, are ‘representations that state the truth only so far as it goes, while omitting critical qualifying information’…….In other words, the difference between a pure omission and a half-truth is the difference between a child not telling his parents he ate a whole cake and telling them he had dessert.” As discussed in this new Cooley Alert, US Supreme Court: Pure Omissions Not Actionable Under Rule 10b-5(b), from our Securities Litigation + Enforcement and Public Companies groups, the “decision emphasizes the importance of assessing whether statements could be construed as being misleading by omission.”
Strine highlights the importance of the “not-sexy” process of board minutes
In an article in the Fordham Journal of Corporate and Financial Law, “Minutes Are Worth the Minutes: Good Documentation Practices Improve Board Deliberations and Reduce Regulatory and Litigation Risk,” former Chief Justice of the Delaware Supreme Court, Leo Strine, discusses—convincingly—the importance of good “corporate minuting and documentation processes.” (See also this post presented on The Harvard Law School Forum on Corporate Governance.) Strine acknowledges upfront that the topic is “decidedly not sexy,” and “the favorite task of no one involved in the process.” Drafting minutes, he suggests, is the “equivalent of eating your least favorite vegetable, either you do it hastily, as infrequently as you can, or, if you can get away with it, not at all.” (Perhaps the leitmotif of this piece might be Strine’s evident hostility to vegetables. Later, he characterizes minutes as “the spinach that must be eaten.”) But, in his view, it is an “unquestionably essential, corporate governance task.” He contends that good quality minutes can reduce litigation risk. And he brings us the receipts, highlighting numerous Delaware cases “where the quality of these practices has determined the outcome of motions and cases,” underscoring the “importance of quality and timely documentation of board decision-making, the material benefits of doing things right, and the considerable downside of sloppy, tardy practices.” But that’s not all. He also invests the documentation process with a larger purpose: he contends that an effective process of crafting and reviewing minutes by the board, together with its counsel and advisors, can serve as an integral part of the board’s deliberative process in arriving at a sound decision based on its considered business judgment. With both of these benefits in mind, the article identifies several effective and efficient practices. Strine offers a lot of wise counsel that readers may want to heed.
CAQ’s 2024 audit committee practices report discusses priorities and practices
The Center for Audit Quality has released its 2024 “Audit Committee Practices Report: Common Threads Across Audit Committees.” The report highlights the top five audit committee priorities identified by committee members in a survey from CAQ and discusses practices to improve effectiveness and other observations. Interspersed throughout the report are recommendations and advice from the CAQ. What was identified by respondents as the “most important topic, risk, or issue” for their audit committees in the next 12 months? Not financial reporting or financial audits—core responsibilities for the audit committee—as you might expect. Nope, it was cybersecurity. According to the CAQ report, the scope of audit committee responsibilities “continues to expand beyond the traditional remit of financial reporting and internal controls, internal and external audit, and ethics and compliance programs. Topics like cybersecurity, artificial intelligence (AI), and climate are now regularly showing up on many audit committee agendas, especially when it’s a matter of complying with regulatory disclosure requirements.” Audit committee members and their advisors may want to check out the report.
Delaware Supreme Court applies MFW framework to other conflicted transactions
In In re Match Group, Inc. Derivative Litigation, the Delaware Supreme Court answered some important questions about the standard of review applicable to conflicted transactions under Delaware law. The first question relates to the application of the model used in Kahn v. M & F Worldwide Corp., commonly referred to as the “MFW framework.” In that 2014 case, the Delaware Supreme Court held that, instead of the more stringent “entire fairness” standard of review that would ordinarily apply in the context of mergers between a controlling stockholder and its corporate subsidiary, the business judgment standard of review should govern “where the merger is conditioned ab initio upon both the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care; and the uncoerced, informed vote of a majority of the minority stockholders.” The question remained, however, whether, in the context of conflicted controlling stockholder transactions that do not involve freeze-out mergers, MFW may be applied to invoke the business judgment rule. And in a related question, can the business judgment rule be applied if the “defendant shows either approval by an independent special committee or approval by an uncoerced, fully informed, unaffiliated stockholder vote,” but not both? In addition, the Court addressed the question of whether all members of an “independent special committee” must be “independent” to satisfy the requirements of MFW.
Morris Nichols discusses proposed new amendments to the DGCL
You might be interested in this recent Alert from the Delaware firm, Morris Nichols Arsht & Tunnell (including a more expansive article), which addresses amendments to the Delaware General Corporation Law just proposed by the Council of the Corporation Law Section of the Delaware State Bar Association. It’s worth emphasizing that the proposed amendments have not yet been submitted to the Delaware General Assembly for its consideration and approval, so they are not yet effective. As the Alert indicates, the proposed new amendments are designed to address the effects of recent Delaware cases highlighting “that the legal requirements identified in the cases were not necessarily in line with market practice. The Amendments are designed to bring existing law in line with such practice.”
Can director commitments policies help prevent overextended boards?
There is a lot going on at companies, and—you may be surprised to hear—not all of it is new regulation. There are new technologies, such as AI, global political instability and social change, not to mention ESG and cybersecurity. Many of these topics, as they affect a company, fall within the remit of the board for oversight. The energy and time necessary can be overwhelming. In this article, Director Commitments Policies, Overboarding, and Board Refreshment, proxy advisory firm Glass Lewis discusses one way to help ensure that directors have “sufficient time and energy to fulfill their duties and obligations to shareholders”: a director commitments policy. As a corollary, GL maintains, these policies can also serve to boost board refreshment, and can represent a vital measure of corporate governance.
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