Category: Corporate Governance

California to appeal decision striking down board gender diversity statute

The California Secretary of State has announced that she has directed counsel to file an appeal of the May 13 verdict of the Los Angeles Superior Court in Crest v. Padilla, which ruled unconstitutional SB 826, California’s board gender diversity statute. Crest v. Padilla was filed in 2019 by three California taxpayers seeking to prevent implementation and enforcement of the law. Framed as a “taxpayer suit,” the litigation sought a judgment declaring the expenditure of taxpayer funds to enforce or implement SB 826 to be illegal and an injunction preventing the California Secretary of State from expending taxpayer funds for those purposes, alleging that the law’s mandate was an unconstitutional gender-based quota and violated the Equal Protection Provisions of the California Constitution. After a bench trial, the Court agreed with the plaintiffs and enjoined implementation and enforcement of the statute. (See this PubCo post.) This verdict follows summary judgment in favor of the same plaintiffs in their case against AB 979, California’s board diversity statute regarding “underrepresented communities,” which was patterned after the board gender diversity statute. (See this PubCo post.)  

Is some investor support for climate-related shareholder proposals declining?

In this paper, BlackRock Investment Stewardship provides a preview of its perspective on climate-related shareholder proposals up for votes during the current proxy season. In 2021, BIS “supported 47% of environmental and social shareholder proposals,” but, BIS observes, the results in 2022 are expected to fall well short of that level.  Why is that? Because, in the view of BIS, “many of the climate-related shareholder proposals coming to a vote in 2022 are more prescriptive or constraining on companies and may not promote long-term shareholder value.” In addition, BIS advises that its vote determinations will also be affected by the current geo-political context—particularly the impact on climate-related proposals of the Russian invasion of Ukraine —as well as “energy market pressures and the implications of both for inflation.”  BlackRock is reportedly the largest asset manager worldwide, overseeing about $10 trillion in assets.  But other asset managers are not all that far behind.  Will they follow the same path?

California court determines board gender diversity statute violates California Constitution

You might remember that the first legal challenge to SB 826, California’s board gender diversity statute, Crest v. Alex Padilla, was a complaint filed in 2019 in California state court by three California taxpayers seeking to prevent implementation and enforcement of the law. Framed as a “taxpayer suit,” the litigation sought a judgment declaring the expenditure of taxpayer funds to enforce or implement SB 826 to be illegal and an injunction preventing the California Secretary of State from expending taxpayer funds and taxpayer-financed resources for those purposes, alleging that the law’s mandate is an unconstitutional gender-based quota and violates the California constitution.  A bench trial began in December in Los Angeles County Superior Court that was supposed to last six or seven days, but closing arguments didn’t conclude until March. (See this PubCo post.)  The verdict from that Court has just come down.  The Court determined that SB 826 violates the Equal Protection Provisions of the California Constitution and enjoined implementation and enforcement of the statute. This verdict follows summary judgment in favor of the same plaintiffs in their case against AB 979, California’s board diversity statute regarding “underrepresented communities,” which was patterned after the board gender diversity statute. (See this PubCo post.)  The Secretary of State has not yet indicated whether there will be an appeal.  In light of pressures from institutional investors and others for board gender diversity, together with the Nasdaq “comply or explain” board diversity rule (see the SideBar below), what impact the decision will have on board composition remains to be seen.

Corp Fin posts sample comments related to Ukraine disclosure

Corp Fin has posted a sample comment letter to companies about potential disclosure obligations arising out of the Russian invasion of Ukraine, the international response to it and related supply chain issues.  Corp Fin wants companies to provide more “detailed disclosure, to the extent material or otherwise required,” about the direct or indirect impact on their businesses of their exposure to or business relationships with Russia, Belarus or Ukraine, any goods or services sourced in those countries and supply chain disruption. The letter provides a useful resource to help companies think through how their businesses have been or may be affectedCorp Fin has posted a sample comment letter to companies about potential disclosure obligations arising out of the Russian invasion of Ukraine, the international response to it and related supply chain issues.  Corp Fin wants companies to provide more “detailed disclosure, to the extent material or otherwise required,” about the direct or indirect impact on their businesses of their exposure to or business relationships with Russia, Belarus or Ukraine, any goods or services sourced in those countries and supply chain disruption. The letter provides a useful resource to help companies think through how their businesses have been or may be affected, even if they don’t have operations in Russia or Ukraine.

After dam collapse, SEC alleges false safety claims in sustainability reports and SEC filings

As described in this press release, the SEC has filed a complaint against Vale S.A., a publicly traded (NYSE) Brazilian mining company and one of the world’s largest iron ore producers, charging that it made “false and misleading claims about the safety of its dams prior to the January 2019 collapse of its Brumadinho dam. The collapse killed 270 people, caused immeasurable environmental and social harm, and led to a loss of more than $4 billion in Vale’s market capitalization.” The SEC alleged that Vale “fraudulently assured investors that the company adhered to the ‘strictest international practices’ in evaluating dam safety and that 100 percent of its dams were certified to be in stable condition.” Significantly, these statements were contained, not just in Vale’s SEC filings, but also, in large part, in its sustainability reports.  According to Gurbir Grewal, Director of Enforcement, “[m]any investors rely on ESG disclosures like those contained in Vale’s annual Sustainability Reports and other public filings to make informed investment decisions….By allegedly manipulating those disclosures, Vale compounded the social and environmental harm caused by the Brumadinho dam’s tragic collapse and undermined investors’ ability to evaluate the risks posed by Vale’s securities.” Notably, the press release refers to the SEC’s Climate and ESG Task Force formed last year in the Division of Enforcement “with a mandate to identify material gaps or misstatements in issuers’ ESG disclosures, like the false and misleading claims made by Vale.” The SEC’s charges arising out of this horrific accident are a version of “event-driven” securities litigation—brought this time, not by shareholders, but by the SEC.

Raiding the cookie jar—“part of the art of the close”?

In this Order, the SEC brought settled charges against Rollins, Inc., a termite and pest control company—think “Orkin”—and its former CFO for earnings management.  In essence, the SEC alleged that the company adjusted the amounts in several of its corporate reserves, without support or documentation, to bump up its EPS so that its EPS would meet analysts’ consensus EPS estimates for two quarters.  The company would otherwise have missed those consensus estimates by a penny in each quarter. The SEC charged the company with securities fraud under the Securities Act, financial reporting violations under the Exchange Act and failure to maintain adequate internal accounting controls and imposed a civil penalty of $8 million. The CFO was also charged with similar violations and ordered to pay a civil penalty of $100,000.  According to Gurbir Grewal, Director of Enforcement, “[t]his is the fourth action and the highest penalty to date against an issuer in connection with the Division of Enforcement’s highly successful and continuing EPS Initiative, which uses data analytics to uncover hard-to-detect accounting and disclosure violations by public companies….The SEC staff’s ever-increasing sophistication with data made today’s action possible and underscores that we will continue to pursue public companies that lack adequate accounting controls and engage in improper earnings management practices.”

PCAOB talks to audit committee chairs about auditor oversight in 2021

Since 2019, as part of its strategy of enhancing transparency and accessibility through proactive stakeholder engagement, the PCAOB has been engaging with audit committee chairs at U.S. public companies that have had audits inspected by the PCAOB during the year.  The PCAOB staff continued this outreach to audit committee chairs during 2021, engaging in conversations with over 240 audit committee chairs. The results are discussed in this new report.  The discussions involved required communications between the auditor with the audit committee and discussions outside of required communications, auditor strengths and weaknesses, PCAOB inspection reports, quality control, use of technology and matters outside of the financial statements. The PCAOB believes that the audit committee’s oversight of the auditor and the audit process is a critical job. Accordingly, “engaged and informed audit committees can be a force for elevating audit quality to the benefit of investors and our capital markets broadly.”

Audit Analytics reports on cybersecurity disclosure

These days, with our government warning regularly about the likelihood of breaches in cybersecurity, concerns about cyber threats have only multiplied.  Introducing the SEC’s new proposal for cybersecurity disclosure in March (see this PubCo post), SEC Corp Fin Director Renee Jones said that, in today’s digitally connected world, cyber threats and incidents pose an ongoing and escalating threat to public companies and their shareholders. In light of the pandemic-driven trend to work from home and, even more seriously, the potential impact of horrific global events, cybersecurity risk is affecting just about all reporting companies, she continued. While threats have increased in number and complexity, Jones said, currently, company disclosure about cybersecurity is not always decision-useful and is often inconsistent, not timely and sometimes hard for investors to locate. What’s more, some material incidents may not be reported at all.  Audit Analytics has just posted a new report regarding trends in cybersecurity incident disclosures. The report indicates that, in 2021, there was a 44% increase in the number of breaches disclosed, from 131 in 2020 to 188 in 2021, the most breaches disclosed in a single year since 2011. And, since 2011, the number of cybersecurity incidents disclosed annually has increased nearly 600%. Interestingly, however, in 2021, only 43% of cybersecurity incidents were disclosed in SEC filings, the report said.

Board diversity statute for “underrepresented communities” held unconstitutional under California’s equal protection provisions

On April 1, the L.A. County Superior Court granted the plaintiffs’ motion for summary judgment in Crest v. Padilla, the taxpayer litigation challenging AB 979, California’s board diversity statute for “underrepresented communities.”  (See this PubCo post.)   Unfortunately, at the time, only a minute order was released, which did not offer any explanation of the Court’s reasoning.  Now, a new 24-page Court Order, which provides the Court’s reasoning, has been made available, and, in it, the Court concludes that the statute, Corporations Code § 301.4, violates the equal protection clause of the California Constitution on its face. Why? Because, in the Court’s view, § 301.4 treats similarly situated individuals differently based on suspect racial and other categories that are not justified by a compelling interest, nor is the statute narrowly tailored to address the interests identified. Will this case have a spillover effect on the decision currently pending of plaintiffs’ taxpayer challenge to California’s board gender diversity statute, SB 826? According to Reuters, the California State Senator who authored SB 826 said that “the case involved a ‘very different set of facts and distinctly different legal issues.’”

What’s happening with corporate political spending disclosure?

I have to admit I was surprised to read that, in the new $1.5 trillion budget bill, Congress has once again prohibited the SEC from using any funds for political spending disclosure regulation.  But there it is—Section 633—in black and white: “None of the funds made available by this Act shall be used by the Securities and Exchange Commission to finalize, issue, or implement any rule, regulation, or order regarding the disclosure of political contributions, contributions to tax exempt organizations, or dues paid to trade associations.”  That means that, for now anyway, private ordering—through shareholder proposals at individual companies and other forms of stakeholder pressure, including humiliation—will continue to be the pressure point for disclosure of corporate political contributions.  Those proposals have grown increasingly successful in the last couple of years. And, notably, it appears that the focus of many proposals has shifted recently, with more emphasis on apparent conflicts between stated company policies and values and the beneficiaries of those political contributions.