Category: Corporate Governance
Is there a place for more inside directors on corporate boards?
In this article in the Harvard Business Review, a law professor from the University of Calgary makes “The Case for More Company Insiders on Boards.” From the end of World War II to the 1970s, he observes, the composition of most boards of U.S. companies was predominantly insider—75% of board directors were insiders in the decade after World War II. But, he maintains, that changed “in the wake of the rising distrust of all American institutions” after Viet Nam and Watergate in the 1970s, as new concepts of corporate governance emerged and the NYSE began to adopt listing rule changes, such as a requirement for independent audit committees. And after the Enron and WorldCom financial scandals of the 2000s, further changes in corporate governance requirements and expectations for board independence ultimately made the overwhelming prevalence of independent directors on corporate boards and committees de rigueur. By 2005, the author reports, 75% of directors of large U.S. public companies were independent and, as of 2023, that percentage had risen to 85%. But is that necessarily a good thing? Maybe not so much, the author contends. Rather, he maintains, the “empirical research on director independence suggests…that business leaders should re-consider the merits of inside directors.”
SEC approves Nasdaq proposal related to bid price compliance periods and reverse splits
In July, the SEC posted a Nasdaq rule change proposal to “modify the application of the bid price compliance periods where a listed company takes an action to achieve compliance with the bid price requirement and that action causes noncompliance with another listing requirement.” (See this PubCo post.) The proposed rule change was designed to address instances where, to regain compliance with the minimum bid price required by Nasdaq listing rules, a listed company implements a reverse stock split; however, while the reverse split may bring the company into compliance with the minimum bid price requirement, it may also, at the same time, lead to non-compliance with another listing rule—particularly, the requirements for the number of publicly held shares and number of public holders, triggering a new deficiency process with a new time period for the company to seek to regain compliance. That’s excessive, Nasdaq said, and too confusing for investors, possibly adversely affecting investor confidence in the market. Because Nasdaq believed it was inappropriate for a company to receive additional time to cure non-compliance with the newly violated listing standard, it sought, with the proposal, to eliminate the additional compliance period that would otherwise result from the newly created deficiency. But by August, the SEC hadn’t yet approved the proposal and extended the deadline for approval. Now, Nasdaq has filed Amendment No. 2 to the proposal—primarily clarifications—and the SEC has just given its approval to the proposal as amended. As a result, companies will need to carefully calculate the potential impact of a reverse split on other listing requirements to avoid these consequences where possible.
SEC charges director with proxy violation for failing to disclose personal relationship bearing on independence
Last week, the SEC announced settled charges against James R. Craigie, a former CEO, Chair and board member of Church & Dwight Co. Inc., an NYSE-listed “manufacturer of consumer-packaged goods,” for “violating proxy disclosure rules by standing for election as an independent director” without advising the board that maybe he really wasn’t quite so independent after all. This omission, the SEC alleged, caused the company’s proxy statements “to contain materially misleading statements.” Maybe you guessed that we’re not talking here about any of the NYSE-enumerated relationships that vitiate independence? No, we’re talking about something closer to the concept of “social independence”—something more amorphous than conventional, stock-exchange-defined independence—that some suggest can be even more compromising at times than the conventional variety. Craigie was alleged to have a “close personal friendship with a high-ranking Church & Dwight executive,” including paying more than $100,000 for the executive and his spouse to join Craigie and his spouse on “six trips that spanned eight countries on five continents.” Because Craigie never disclosed the relationship to the board and encouraged the executive to do the same, the SEC charged, the board was not aware of the relationship and the company’s proxy statements characterized Craigie incorrectly as an independent director. According to the Associate Director of the SEC’s Division of Enforcement, “[s]hareholders expect independent directors to exercise autonomous judgment in their decision making, free from undisclosed conflicts….By concealing his relationship with a company executive, Mr. Craigie undermined the board’s director independence process and compromised the company’s disclosures.” Craigie agreed to a five-year officer-and-director bar and to pay a civil penalty of $175,000. The case raises the thorny question of where to draw the line on personal relationships. Is an occasional dinner acceptable? If so, what about a weekend trip? A vacation trip? How many trips is too many? Just how thick do the personal connections have to be to taint independence? Caution seems to be the prescription here.
NYSE withdraws proposal to extend time period for completion of de-SPAC transaction
In April, the NYSE proposed a rule change that would have amended Section 102.06 of the Listed Company Manual to allow a SPAC to “remain listed until forty-two months from its original listing date if it has entered into a definitive agreement with respect to a business combination within three years of listing.” (See this PubCo post.) The current rule imposes a three-year deadline for a SPAC to complete its de-SPAC merger. At the end of last week, the SEC posted a notice that the NYSE had withdrawn the proposal to extend the period that the SPAC can remain listed if it has signed a definitive de-SPAC merger agreement. Why?
SEC’s Investor Advisory Committee discusses tracing in §11 litigation and shareholder proposals—will they recommend SEC action?
Last week, at the SEC’s Investor Advisory Committee meeting, the Committee discussed two topics described as “pain points” for investors: tracing in §11 litigation and shareholder proposals. In the discussion of §11 and tracing issues, the presenting panel made a strong pitch for SEC intervention to facilitate tracing and restore §11 liability following Slack Technologies v. Pirani. The panel advocated that the Committee make recommendations to the SEC to solve this problem. With regard to shareholder proposals, the Committee considered whether the current regulatory framework appropriately protected investors’ ability to submit shareholder proposals or did it result in an overload of shareholder proposals? Was Exxon v. Arjuna a reflection of exasperation experienced by many companies? No clear consensus view emerged other than the desire for a balanced approach and a stable set of rules. Recommendations from SEC advisory committees often hold some sway with the staff and the commissioners, so it’s worth paying attention to the outcome here.
PCAOB spotlight on auditor independence outlines considerations for audit committees
The PCAOB has released a new Spotlight on auditor independence, which provides observations from PCAOB inspections regarding independence issues and identifies considerations for both auditors and audit committees. Auditor independence has, for years, been a major focus of the SEC’s Office of the Chief Accountant, and current Chief Accountant Paul Munter has addressed the issue in a number of statements, characterizing auditor independence as a concept that is “foundational to the credibility of the financial statements.” (See, for example, this PubCo post and this PubCo post.) But auditor independence is not just an issue for auditors. It’s important for companies to keep in mind that violations of the auditor independence rules can have serious consequences not only for the audit firm, but also for the company as the audit client. For example, an independence violation may cause the auditor to withdraw the firm’s audit report, requiring the audit client to have a re-audit by another audit firm. What’s more, auditor independence violations can sometimes even result in charges against the company; for example, Lordstown Motors was charged with several Exchange Act violations in connection with misrepresentations and failures to include financial statements audited by independent auditors required in current and periodic reports. Munter has long recognized that the responsibility to monitor independence is a shared one: “[w]hile sourcing a high quality independent auditor is a key responsibility of the audit committee, compliance with auditor independence rules is a shared responsibility of the issuer, its audit committee, and the auditor.” As a result, in most cases, inquiry into the topic of auditor independence should certainly be a recurring menu item on the audit committee’s plate. Fortunately, the Spotlight offers advice, not only for auditors, but fortunately, also for audit committee members.
Center for Audit Quality comes to the rescue for audit committees tasked with AI oversight
In this 2023 article in Fortune, a survey of 2,800 managers and executives conducted by management consulting firm Aon showed that business leaders “weren’t very concerned about AI….Not only is AI not the top risk that they cited for their companies, it didn’t even make the top 20. AI ranked as the 49th biggest threat for businesses.” Has “the threat of AI been overhyped,” Aon asked, or could it be that the “survey participants might be getting it wrong”? If they were, it wasn’t for long. Fast forward less than a year, and another Fortune article, citing a report from research firm Arize AI, revealed that 281 of the Fortune 500 companies cited AI as a risk, representing “56.2% of the companies and a 473.5% increase from the prior year, when just 49 companies flagged AI risks. ‘If annual reports of the Fortune 500 make one thing clear, it’s that the impact of generative AI is being felt across a wide array of industries—even those not yet embracing the technology,’ the report said.” This widespread recognition of the potential risks of genAI will likely compel companies to focus their attention on risk oversight, and that will almost certainly entail oversight by the audit committee. To assist audit committees in that process, the Center for Audit Quality has released a new resource—an excellent new report, Audit Committee Oversight in the Age of Generative AI.
What were the major trends of the 2024 proxy season on ESG shareholder proposals?
This article from Morningstar published on the Harvard Law School Forum on Corporate Governance examines three major trends of the 2024 proxy season regarding environmental, social and governance shareholder proposals. The author, the Director of Investment Stewardship Research at Morningstar, reports that, while the number of ESG-related proposals increased, there was a “twist in the tale”: the increase primarily reflected a jump in anti-ESG proposals. Although support for ESG proposals on the whole was relatively flat at 23%, Morningstar found a “rebound in support for governance-focused proposals,” offsetting a decline in support for E&S proposals.
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