Proxy Voting and the Future of Corporations

November 29, 2018

Corporate Governance Update: Proxy Voting and the Future of Corporations

David A. Katz and
Laura A. McIntosh*

A significant debate has developed in recent months regarding the purpose and future of corporations, the primacy of shareholder interests, and the role of the regulatory environment. The outcome could have a lasting impact on public companies. A recently released framework for public discussion in the British Academy, “The Future of the Corporation: Towards Humane Business,” centers around the view that the purpose of corporations is not simply to maximize shareholder value. The framework suggests further that corporations should specify their purposes, that some corporations with public and social functions should be required to align their purposes with social purposes, and that regulations should promote and even ensure the alignment of corporate with social purposes. This view is far removed from the general American view of the purpose of a corporation—i.e., to maximize shareholder value—and the perceived purpose of the regulatory environment—i.e., to facilitate corporations’ efforts to maximize shareholder value and to protect shareholders from misconduct.

The common understanding of the purpose of a corporation appears to be evolving in parallel to that of the purpose of the shareholder franchise. The annual vote long has been seen as an opportunity for equity holders to express their view as to whether a given corporate action would maximize the financial value of their shares. Under an expanded view of corporate purpose, the shareholder vote would become a regular opportunity for shareholders to express their values rather than simply their opinion as to how best to maximize value. Using the latitude afforded by the Exchange Act Rule 14a-8 shareholder proposal process, it is already common for shareholder votes to address a wide array of social issues such as board composition and environmental concerns, which do not directly affect a company’s financial performance during the time horizon of its strategic plan.

At the same time that shareholder votes are coming into focus as potential vehicles for social change, the proxy process is undergoing intense scrutiny by the SEC. There is an unprecedented consolidation of ownership in the U.S. equity market, with over 80 percent of the market value of the Russell 3000 and the S&P 500 now held by institutional investors. The upshot of this concentration is that a small number of governance experts and fund managers are making voting decisions that have enormous impact across the corporate landscape. In this context, proxy advisors have become increasingly important, and correspondingly controversial, components of the proxy process.

SEC Proxy Roundtable

The much-anticipated SEC staff roundtable on the proxy process that was held earlier this month included the perspectives of proxy advisors, issuers, investment firms, index funds, institutional investors, academics, and policymakers. All seemed to agree that, from a logistical standpoint, proxy advisors have become an essential component of the annual proxy season process. None of the panelists advocated for further regulation of proxy advisors. The general view of most panelists was that additional regulation likely would be burdensome and costly for the clients of proxy advisory services, which ultimately would increase the expense of the proxy process to the detriment of shareholders.

Panelist and former Senator Phil Gramm observed that institutional investors and investment advisors can and do pressure companies to pursue social agendas through proxy voting, while proxy advisors do the same with their highly influential voting recommendations. Senator Gramm highlighted the conflict that exists when funds have the authority to cast votes that potentially enhance their own reputation and marketability rather than maximizing the returns to individual investors. Proxy advisors with no fiduciary responsibilities have incentives that are even further removed from those of individual investors. His concern is that the social positions promulgated by institutional investors and proxy advisors are neither sufficiently popular with individual shareholders nor sufficiently value-maximizing to be enacted through legislative or executive action. Senator Gramm advocated for reducing the safe harbors available to those who vote or advise on voting shares of which they are not the beneficial owner, adding that it is the role of the SEC to protect investors from having their money used not in their own interests but to the advantage of investment advisors, index funds, and proxy advisors. In comments made at the roundtable, SEC Chair Jay Clayton emphasized the need for the SEC to protect the individual investor against suboptimal or blanket voting policies. He requested comments aimed at improving the quality of the voting decisions in each case for the benefit of the long-term Main Street investor.

Chairman Clayton and Senator Gramm represent the traditional view of the purpose of a corporation and the purpose of a shareholder vote. The competing vision of corporate purpose conceives of the corporation as a vehicle for long-term value creation, with “value” not described in purely financial terms but incorporating other elements of economic prosperity and social welfare. There is a view among some institutional investors that long- term economic value will be best achieved through the pursuit of certain types of social purposes alongside wealth maximization, such as environmental protection and gender diversity. But does that view represent and protect the interests of the individual shareholder? And will incorporating societal judgments regarding long-term economic value into corporate governance jeopardize the wealth-maximization function of corporations? If the pursuit of long-term economic value—however that concept may be defined by various market participants and regulators—is not financially beneficial to the individual shareholder, it is likely to result in the reduction of capital, productivity, and ultimately overall prosperity.

In the traditional paradigm, individual shareholders invest their money in the stock market in order to maximize their wealth. They realize their returns, and they use their earnings at their discretion. If they wish to pursue a social agenda, they may choose to make political donations, charitable gifts, or targeted investments in explicitly socially-oriented funds or companies. Investing in the stock market and using the proceeds for social change are two different activities. Under the competing new paradigm, the act of investing, even in broad index funds or companies without public or social purposes, would not be separable from agenda- driven activism, due to the pressure generated by powerful proxy voters. This may be unattractive and disadvantageous to the vast majority of investors who use index fund investing simply as a financial tool and have widely divergent social views, including perhaps the view that businesses should not adopt social agendas. Voting decisions aimed at wealth-maximization in the timeframe of a company’s strategic plan are likely to be the best way that an investment advisor or fund, as an agent representing many thousands of shareholders, can come closest to representing the preferences of their retail investors or beneficiaries.

Legislative and Regulatory Activity

Legislative and regulatory actions are hovering in the wings as the curtain falls on 2018. On Capitol Hill, Senator Elizabeth Warren’s Accountable Capitalism Act, introduced in August 2018, aims to federalize the largest U.S. corporations. There are also two bipartisan pieces of legislation in the works: the Corporate Governance Reform and Transparency Act (CGRTA), which was passed by the House in December of 2017 and was the subject of a June 2018 hearing in the Senate, and the Corporate Governance Fairness Act, which was introduced earlier this month in the Senate. Both of the bipartisan legislative efforts aim to regulate proxy advisors and hold them to higher standards of conduct.

On the regulatory front, just days before the SEC roundtable, the SEC withdrew two key no-action letters regarding proxy advisory firms. (Of note: The withdrawal of the Egan-Jones and ISS letters is a provision in the CGRTA.) This action may indicate that the current level of institutional investor reliance on proxy advisors will be unsustainable in a shifting regulatory environment, though the message is complicated by the fact that the SEC’s Staff Legal Bulletin 20, which cites the two letters, was left in place. In any case, a theme to emerge from the roundtable was that, leaving aside the controversial topic of proxy voting recommendations, proxy advisors reduce costs for institutional investors in terms of research and workflow management. At this point, it may be that proxy advisors’ role in the substantive and logistical task of making and implementing voting decisions throughout the proxy season has become too big to eliminate, absent some fundamental changes in the proxy voting process.


In recent decades, the enduring value of corporations has been under assault from short-term investors such as hedge funds. Quarterly earnings pressure and the growing power of shareholder activists are two forces that have pushed executives toward maximizing very short-term profits at the expense of the company’s longer-term interests and investors. A focus on short-term gains is often counterproductive to long-term value creation, as it hinders the capital investment that produces sustained economic prosperity. The rise of concentrated stock ownership in large, long-term investors has been beneficial insofar as it has helped to turn the tide against short-termism. To the extent that the false urgency of short-term economic interests is being displaced by productive collaboration among corporations, shareholders, and other stakeholders, this is a positive development. At the same time, it is important to tread carefully here to avoid turning corporations into vehicles for social engineering. Proponents of broadening the definition of corporate purpose as a defense against short- term profit-seeking should be wary of going too far in the other direction. A balanced approach, in which informed investors evaluate and support chief executives as they pursue wealth-maximization over the company’s strategic timeframe, would be optimal.

The vision expressed in “The Future of the Corporation,” which merges corporate economic purposes with social purposes, would enable regulators to enact social change on a scale that otherwise would require governmental action. Absent the federalization of corporate law in the United States, the diversity of state law will continue to give companies greater latitude to choose their own regulatory context. However, regulators are not the only powerful force in the current environment, and the enormous pressure that can be brought to bear by the collective ownership of institutional shareholders is a daunting prospect. A state-based system of corporate law and governance cannot protect corporations from institutional investors’ agendas as effectively as it protects corporations from federal intervention. The best bulwark against overreach by institutions, proxy advisors, and other activists is a continued focus on the interests of the individual Main Street investor. As Chairman Clayton reminded the roundtable participants, the goal of proxy voting reform should be to get closer to the point at which each vote cast is a high-quality decision taken in the interests of the individual owner. Corporate law and regulation predicated on the long-term financial interests of shareholders has produced American economic success for generations. The current debate over social purposes, and the ramifications for the long-term financial interests of public company shareholders—particularly in the context of large-scale institutional proxy voting—deserve the attention of Main Street and institutional investors. An excellent result would be greater transparency and proxy process reforms that promote the interests of shareholders.

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Warren Bill: Stakeholder Primacy

August 15, 2018

By Martin Lipton

Corporate Governance; Stakeholder Primacy; Federal Incorporation

          Senator Elizabeth Warren has introduced legislation to make all corporations with $1,000,000,000 of annual revenue subject to Federal corporate governance (by requiring them to be chartered as a United States corporation).  The Bill rejects shareholder primacy and embraces stakeholder governance; not less than 40% of the directors to be elected by the employees.

The Federal charter would provide that directors consider the interests of all corporate stakeholders – including employees, customers, suppliers, shareholders, and the communities in which the corporation operates.  The Bill also has a director business judgment provision, promoting long-term investment and facilitating rejection of takeover bids, modeled on constituency statutes in some 30 states.

The Bill prohibits officers and directors from selling shares within 5 years after receiving them.

Political contributions are prohibited unless approved by 75% of the directors and 75% of the shareholders.

While the Bill has a number of provisions that would reduce short-termism and virtually eliminate attacks by activist hedge funds, most corporations will oppose the legislation and forego the benefits, if the price is Federal chartering.  The Bill is another step in the effort to promote long-term sustainable investment and reject shareholder primacy.  In light of the positions recently taken by BlackRock, State Street and Vanguard, the Investment Stewardship Group, The World Economic Forum and many institutional investors and asset managers, it is clear that the effort to reverse shareholder primacy will continue to pick up steam.

Martin Lipton

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Gender Diversity and Board Quotas

July 26, 2018

Corporate Governance Update: Gender Diversity and Board Quotas

David A. Katz and
Laura A. McIntosh∗

California has made headlines this summer with legislative action toward instituting gender quotas for boards of directors of public companies headquartered in the state. The legislation has passed the state senate; to be enacted, it must be passed by the California state assembly and signed by the governor. In 2013, California became the first state to pass a precatory resolution promoting gender diversity on public company boards, and five other states have since followed suit. The current legislative effort has come under criticism for a variety of reasons, and, while it is not certain to become law, it could be a harbinger of a broader push for public company board gender quotas in the United States. It is worth considering whether quotas in this area would be beneficial or harmful to the larger goals of gender parity and board diversity.

The California Bill

The bill that passed the California State Senate at the end of May 2018 would, if enacted, require any public company with shares listed on a major U.S. stock exchange that has its principal executive offices in California to have at least one woman on its board by December 31, 2019. By year-end 2021, such companies with five directors would be required to have two women on the board, and companies with six or more directors would be required to have three women on the board.

Section 1 of the California bill (SB 826) presents an argument in favor of establishing gender quotas: More women directors would be beneficial to California’s economy in various ways, yet progress toward gender parity is too slow. The bill cites studies indicating that companies perform better with women on their boards and observes that other countries have used quotas to achieve 30 percent to 40 percent representation. The bill notes that, of California public companies in the Russell 3000 as of June 2017, 26 percent had no women on their boards, while women composed 15.5 percent of directors on boards that have at least one woman. The bill cites further studies showing that, at current rates, it could take approximately four decades to achieve gender parity on boards. And finally, Section 1 of the bill concludes by citing studies suggesting that having at least three women directors increases board effectiveness.

∗ David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.


The Opposing View

The California bill has been controversial. The California Chamber of Commerce filed an opposition letter on behalf of numerous organizations arguing that the bill would violate state and federal constitutions and conflict with existing California civil rights law, on the basis that it requires a person to be promoted—and another person disqualified—simply on the basis of gender. California legislators dispute that the bill requires men to be displaced by women, noting that boards can simply increase their size. This may be easier said than done, however: Because the required quota increases with board size, a company with a four-man board that did not wish to force out a current director would need to add three women to accommodate the requirements of the law by 2021. Suddenly expanding from four to seven would entail a very significant change to board dynamics. For a previously well-functioning board, the negative effects of a change that dramatic could outweigh the benefits of gender diversity.

Further, the bill’s opponents argue that prioritizing only one element of diversity would be suboptimal, especially at time when many California companies are engaged in addressing and increasing diversity by focusing on all classifications of diversity. Advocates for greater representation of ethnic minority groups on boards have expressed concerns that prioritizing gender will be detrimental to progress toward greater ethnic diversity. For purposes of increasing overall diversity, quotas are not a solution that can be applied broadly; if quotas such as those in the California bill were established not only for gender but for ethnic and other categories of diversity, the project of board composition would soon become a near-impossible logic and recruitment puzzle, as nominating committees struggled to meet mandated quotas, expertise needs, and director independence requirements, all within the board size parameters set forth in the company’s organizing documents. Board functioning and effectiveness would be severely compromised by the legislative micromanaging of board composition.

Thanks to the establishment of quotas in various European countries over the past 15 years, there is evidence as to the effect of gender quotas for boards. A 2018 Economist study found that, despite high expectations, the effects of quotas were, in some ways, disappointing. According to the Economist, greater numbers of women on boards did not necessarily produce better performance or decision-making, nor was there a trickle-down effect of boosting women’s progress to senior management jobs.

On the other hand, fears about unqualified women being put on boards, or a few qualified women being overboarded, also did not materialize. While there is a great deal of evidence showing that having women directors does produce more effective boards—and there are even indications in Europe that diverse boards are less likely to be targeted by shareholder activists—the Economist study shows that diversity achieved through government-imposed quotas may not be as beneficial as diversity achieved through private-ordering efforts.


The Big Picture

Progress toward gender diversity in the board room is accelerating. In the first fiscal quarter of 2018, nearly one-third of new directorships in the Russell 3000 went to women, and for the first time, fewer than 20 percent of companies in that index had all-male boards. Institutional investors, corporate governance activists, and many large companies have been at the forefront of this progress. State Street and BlackRock have been leaders on this issue in the United States. Similarly, in the UK—a country that has made significant efforts to improve gender diversity on boards while also resisting the imposition of quotas—the large investment funds Legal & General Investment Management and Standard Life Aberdeen Plc have said that they will vote against boards that are composed of less than 25 percent or 20 percent women, respectively. British institutional investor Hermes has said that it expects boards to include at minimum 30 percent women, and it led a failed opposition to the reelection of the chairman of mining group Rio Tinto Plc due to lack of diversity on the board. Given the effectiveness of recent efforts by the private sector, and in light of the intense resistance to quotas in the business community, government intervention to establish quotas may be unnecessary as well as undesirable.

Recent research shows that simply adding women to boards does not necessarily improve board performance. As common sense would suggest, it turns out that to be a positive factor, the gender composition of the board must be considered along with the skills and knowledge of the board as a whole in the context of the organization and its stakeholders. A 2017 academic study indicated that the “right” level of gender diversity may be proportionate to the number of female stakeholders—employees, clients, and suppliers, for example—and may vary across countries and cultures. In certain circumstances, the appropriate gender diversity ratio might well be over 50 percent women. The authors of the study caution against selecting directors based on quotas if, in so doing, gender diversity is prioritized over the expertise needs of the board.

Overall board diversity, including gender and ethnic minorities, has never been higher. According to a comprehensive 2018 study by James Drury Partners, overall board diversity is now at 34 percent for America’s 651 largest corporations, as measured by revenue and market capitalization. The level of board diversity is increasing, as 49 percent of the 449 newly elected directors at these companies represent diverse groups. Of particular note, the study revealed that the diversity distribution of the 6,225 directors currently serving on the boards of these companies corresponds very closely to the diversity of the population in the executive ranks of 222 companies studied by McKinsey & Co. and While there clearly is more room for progress toward greater diversity at both the executive and board levels, this data point shows that boardrooms are indeed mirroring the increasingly diverse leadership of U.S. business.

The benefit of mandatory quotas, as the business community has seen through European examples, is that they compel companies and shareholders to focus on board composition and to establish more formal recruitment processes in order to find the necessary directors. Such developments are certainly beneficial. That said, boards can and should focus on composition and recruitment in the absence of quotas, and indeed they are doing so to a greater


extent than ever before. Proponents of gender diversity can be heartened by recent developments in the United States, as organic and market-driven efforts have produced results that increase the business community’s enthusiasm for diverse boards. A real danger of legislation like the California bill is that context-free quotas may have the effect of destabilizing boards and undermining the business case for increased gender diversity. Were that to occur, then not only boards themselves, but stakeholders, the business community, and the larger societal goals of gender parity and board diversity would suffer as well.

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How To Gain Gender Equity in the Boardroom?

By Steve Odland

International Women’s Day highlights the unique contributions women have made and continue making to our society. However, economically speaking, women are both powerful and underrepresented.

In the United States, women now comprise six in 10 of today’s college graduates. They also account for nearly half the workforce and hold more than half of the country’s personal wealth. Women also influence 70% to 80%of all purchasing decisions worldwide. Yet, despite this substantial impact, women hold only about one in five board seats at both Fortune 500 and Fortune 1000 companies.

The need for more women on boards extends beyond simply having a more proportionate share of seats at the table. Today’s companies face extraordinary competition in an economy that puts an unprecedented premium on knowledge. To maintain or gain an edge over their competitors, companies must harness all available talent, and that means fully leveraging the best and brightest women in today’s talent pool.

And that should be a priority in the boardroom.

Indeed, there’s a correlation between companies with gender-diverse boards and those that enjoy greater returns on equity, sales, and invested capital, according to research from McKinsey & Company.

Putting more women on boards also makes for good corporate governance.

A high-performing board consists of a group that generates and carries out the best ideas. Those ideas arise only when a diverse pool of thought is brought to the table. With a gender imbalance, boards can experience “group think” and fail to see and account for perspectives that could enhance company performance. In contrast, boards with gender diversity more closely reflect society and thus may have better insight into their multiple constituents, which include customers, employees, owners and operating communities.

In light of these benefits, how can companies increase female representation on their boards?

A simple yet effective approach calls for filling every other vacant seat with a woman. If companies adopted this “Every Other One” approach while retaining existing female seats, women would occupy about a third of board seats in five years – certainly a step in the right direction.

Gender parity would eventually follow.

Skeptics often argue that a supply problem stands in the way of adding substantially more women to corporate boards.

This argument is simply false. There are about 150 female Russell 3000 CEOs, 60 women CFOs in the S&P 500, 330 women CHROs in the S&P 500, 5,145 female law partners, and 165,000 female-owned firms with revenues greater than $1 million. If boards consider such talent, progress will be easy. But, if boards look only for female CEOs within the Fortune 500, then they have created a supply problem.

Companies can achieve greater female representation rather quickly if they expand the criteria for directors. Nominating committees, specifically, should consider appointing successful female divisional presidents, small- to medium-business owners, entrepreneurs, management consultants, non-profit executives, foundation heads, financial service executives and university presidents. This constitutes just a partial list of the sources of likely qualified candidates.

Women make up the majority of all of business’s constituencies, and yet they currently don’t have the chance to influence the decisions that impact them.

Without companies taking purposeful steps, the gender imbalance on corporate boards will remain stark.

It’s been long contended that board diversity would increase as women comprised a growing portion of the workforce, yet progress has moved and still moves at a snail’s pace.

On International Women’s Day and through Women’s History Month, we should reflect on the many contributions made by women. As we do, let’s also remember the contributions they could make if we added them to corporate boards. “Every Other One,” it’s the least we can do.

Steve Odland is the CEO of the Committee for Economic Development and sits on the board of directors for General Mills, Inc. and Analogic Corporation. He also is the former CEO of Office Depot and AutoZone.

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Reconcile Shareholder Time Horizons

January 19, 2018

SEC Chair Addresses Activism and Shareholder Engagement

          At today’s SEC-NYU Dialogue on Securities Market Regulation held at NYU’s Stern School of Business, SEC Chairman Jay Clayton provided opening remarksfocusing on the interplay between shareholder activism and shareholder engagement.  Chairman Clayton framed the concern:

The governance structure of public companies reflects the reality of capital allocation in a well-functioning free market economy:  capital is allocated predominantly on a collective but widely distributed basis; in practice, companies have many shareholders who have no connection to one another.  Various factors drive this approach to collective capital allocation, including that, first, in a global economy, firms have necessarily become large (and therefore very few can be funded by a single investor or small group of investors).  Second, from an investor’s perspective, diversification across investment opportunities has proven to be a prudent and attractive strategy.  As a result, firm ownership is diffused and ever-changing.  This is fertile ground for the age old problems of collective action.  How do we address collective action problems?  There are several proven approaches but, for companies, we have long settled on the approach of selecting dedicated individuals to oversee the company’s affairs and imposing on them a fiduciary duty.

Chairman Clayton noted that in response to principal/agent concerns, the SEC has “mandated or suggested rule sets — including disclosure requirements and incentive driving requirements and prohibitions — that have reduced the opportunities for misalignment between shareholders and managers.”  Recognizing that markets constantly change, Chairman Clayton comments that the SEC needs to continually reexamine its rules, noting that in recent years there has been an even larger separation between companies and their true beneficial owners:

[I]ncreasingly, a second layer of separation between ownership and control has opened between the ultimate owners of capital and corporate management.  Shareholders invest in investment vehicles — mutual funds, ETFs, etc. — which in turn own the shares of operating companies.  In theory, a daisy chain of fiduciary duties keeps these interactions focused on the interests of the ultimate beneficial owner, but it also means that the principal-agent issues are multi-layered. . . .  Shareholders can have vastly different investment time horizons.  As a well-known specific example, we have seen many cases where some shareholders believe capital should be reinvested while others believe it should be returned to shareholders through buy backs or dividends. . . .  Should index funds seek guidance from investors in the fund, or clearly disclose their engagement policies such that potential investors could self-select into their desired category?

Acknowledging that shareholder engagement can be valuable, Chairman Clayton observes that there are real costs to engage that make it uneconomic for many investment funds.  Since funds often compete on fees, many have outsourced their voting decisions to proxy advisory firms.  Importantly, Chairman Clayton makes the point that the director-centric model addresses this issue: “Let’s not forget that the director-officer fiduciary duty model itself was designed to, and does effectively, if not perfectly, address the fundamental problem of fair and efficient collective action.”

          Since very few public companies are actually immune to activism and activism is not disappearing, Chairman Clayton notes: “So it is more important than ever for shareholders to understand and evaluate activists’ long-term impact on companies and shareholder value.  In particular, to what extent do shareholder campaigns launched by activist investors create value for all shareholders?  What is the effect of these campaigns on long-term value?”

          In conclusion, Chairman Clayton harkens back to the fundamental problem that exists in today’s proxy voting model, the fund investor who is focused on long-term value creation for his or her retirement is absent from the equation:

The engine of economic growth in this country depends significantly on the willingness of Main Street investors to put their hard-earned capital at risk in our markets over the long term.  If our system of corporate governance is not ensuring that the views and fundamental interests of these long-term retail investors are being protected, then we have a lot of work to do to make it so.

Unfortunately, the Chairman is correct – we have a lot of work to do to turn away from the short-term focused incentive structure that drives our markets and many activist investors, to one that creates real value over the long-term.

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BlackRock Advocates Societal Role

January 16, 2018

BlackRock Supports Stakeholder Governance

                    BlackRock CEO, Larry Fink, who has been a leader in shaping corporate governance, has now firmly rejected Milton Friedman’s shareholder-primacy governance and embraced sustainability and stakeholder-focused governance.  January 2018 BlackRock letter to CEOs.

                    In our Some Thoughts for Boards of Directors in 2018, we noted:

          The primacy of shareholder value as the exclusive objective of corporations, as articulated by Milton Friedman and then thoroughly embraced by Wall Street, has come under scrutiny by regulators, academics, politicians and even investors.  While the corporate governance initiatives of the past year cannot be categorized as an abandonment of the shareholder primacy agenda, there are signs that academic commentators, legislators and some investors are looking at more nuanced and tempered approaches to creating shareholder value.

                    In his letter, Larry Fink says:

          We also see many governments failing to prepare for the future, on issues ranging from retirement and infrastructure to automation and worker retraining.  As a result, society increasingly is turning to the private sector and asking that companies respond to broader societal challenges.  Indeed, the public expectations of your company have never been greater.  Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.

          Without a sense of purpose, no company, either public or private, can achieve its full potential.  It will ultimately lose the license to operate from key stakeholders.  It will succumb to short-term pressures to distribute earnings, and, in the process, sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth.  It will remain exposed to activist campaigns that articulate a clearer goal, even if that goal serves only the shortest and narrowest of objectives.  And ultimately, that company will provide subpar returns to the investors who depend on it to finance their retirement, home purchases, or higher education.

                    Most importantly, the letter sets out the type of engagement between corporations and their shareholders that BlackRock expects in order to secure its support against activist pressure.  While the whole letter needs to be carefully considered in developing investor relations engagement practices, the following is of special note,

          In order to make engagement with shareholders as productive as possible, companies must be able to describe their strategy for long-term growth.  I want to reiterate our request, outlined in past letters, that you publicly articulate your company’s strategic framework for long-term value creation and explicitly affirm that it has been reviewed by your board of directors.  This demonstrates to investors that your board is engaged with the strategic direction of the company.  When we meet with directors, we also expect them to describe the board process for overseeing your strategy.

          The statement of long-term strategy is essential to understanding a company’s actions and policies, its preparation for potential challenges, and the context of its shorter-term decisions.  Your company’s strategy must articulate a path to achieve financial performance.  To sustain that performance, however, you must also understand the societal impact of your business as well as the ways that broad, structural trends – from slow wage growth to rising automation to climate change – affect your potential for growth.

                    While the BlackRock letter is a major step in rejecting activism and short-termism and is a practical guide as to investor relations, it stops short of a critical step in assuring corporations that their efforts are bearing fruit—it does not commit BlackRock to publicly state its support for a corporation under attack by an activist seeking to impose financial engineering or other short-term action before the corporation has to endure a proxy fight.  This type of early concrete support would be a major factor in supporting sustainability and long-term investment.

Martin Lipton

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New Tax Law Implications

December 23, 2017

What the New Tax Rules Mean for M&A

          President Trump has signed into law the most sweeping changes to business-related federal income tax in over three decades.  The new law, referred to as the Tax Cuts and Jobs Act (the “Act”), is expected to have far-reaching implications for domestic and multinational businesses as well as domestic and cross-border transactions, impacting the structure, pricing and, in some cases, viability of broad categories of deals.  Among other things, the Act lowers tax rates on corporations and income from pass-through entities, permits full expensing of certain property, imposes additional limits on the deduction of business interest and adopts certain features of a “territorial” tax regime.  By lowering tax rates, the new law makes conducting business in the United States more attractive.  But, to pay for the reduced rates, the Act includes numerous revenue-raising provisions as well.  The changes will shift transaction dynamics in complex and potentially unanticipated ways that will unfold over time, raising challenging interpretive questions that taxpayers and advisors will be grappling with for years to come.  By vastly reducing the incentive for U.S.-parented multinationals to hold cash offshore, the new law is expected to free up cash for M&A activity, capital expenditures, debt repayment or stock buybacks.

          Reduced Corporate Tax Rate. The Act makes the United States far more hospitable to multinationals and removes perceived incentives to re-domicile by permanently reducing the corporate federal income tax rate to 21% effective in 2018 (and, relatedly, repealing the corporate alternative minimum tax).  As a result, the corporate federal income tax rate will be lower than the corporate income tax rates imposed by many major trading partners of the United States.

We expect this reduced rate, coupled with the accelerated recovery of capital expenditures and changes to the international tax regime described below, to influence transaction structures.  For example, asset purchases may become more attractive relative to purchases of stock, the tax-free treatment of spin-offs may become less important, and “inversions” will be less attractive.

          Pass-Through Tax Changes.  In conjunction with the reduction in the corporate rate, the new law permits noncorporate investors in businesses (other than specified service businesses) conducted through partnerships, S-corporations or sole proprietorships to deduct approximately 20% of their business income.  As a result, private equity funds may prefer to own portfolio companies in partnership form (with appropriate blocker corporations for tax exempt and foreign investors).

          Expensing.  Taxpayers will be entitled to deduct immediately 100% of the cost of depreciable tangible assets, including (in a change from current law relating to bonus depreciation deductions) assets acquired from a third party, for the next five years.  The move to expensing will certainly influence transaction structures.  In a carve-out transaction or other acquisition of a privately held domestic business, the immediate expensing rule is likely to make asset acquisitions more attractive to a buyer than acquisitions of stock.

          Limitations on Interest Expense.  The Act limits deductions for net business interest expense to 30% of an amount that approximates EBITDA (and, beginning in 2022, EBIT).  This limitation will change the calculus for debt-financed acquisitions of domestic corporations by domestic or foreign acquirors.  These limitations could force private equity buyers to write larger equity checks and could lead to fewer highly leveraged deals generally.

          Executive Compensation.  The new law further limits the deductibility of executive compensation and eliminates the performance-based exception to this limitation (see our memo of December 4, 2017 for a discussion of these changes and their implications).   In light of the corporate tax rate reduction in 2018 and the tightening of the limitation on executive compensation deductibility, companies should consult with their tax advisors prior to year-end to ensure that 2017 bonuses payable in 2018 will be deductible this tax year.

          Participation Exemption.  In a move toward a “territorial” tax regime (i.e., a regime that exempts income from foreign sources) akin to that of major trading partners of the United States, the new law generally eliminates federal income tax on dividends received by a domestic corporation from a 10% owned foreign corporation and may eliminate tax on a portion of the gain realized by a domestic corporation on the sale of a 10% owned foreign subsidiary.

The new law transitions to territoriality by requiring a one-time income inclusion by 10% U.S. shareholders of historic earnings of a foreign subsidiary generally at a tax rate of 15.5% or 8%, depending on whether the foreign subsidiary’s earnings were invested in cash or other assets, respectively.  Although this transition tax may be paid in installments over a period of eight years, U.S.-parented multinationals that historically have treated earnings of their foreign subsidiaries as permanently reinvested for financial accounting purposes may face a more immediate financial statement impact.

The new international tax regime also includes rules that are intended to deter domestic corporations from shifting profits out of the United States.  To this end, the Act taxes 10% U.S. shareholders on the “global intangible low-taxed income” of a foreign subsidiary (generally, the foreign subsidiary’s earnings in excess of a deemed 10% return on tangible assets of the foreign subsidiary) and provides a favorable deduction relating to a domestic corporation’s exports.

          Enhanced Inversion Deterrence.  The Act specifically deters “inversions.”  For domestic corporations that expatriate after enactment, the Act increases the excise tax on stock compensation of insiders from 15% to 20%, increases the tax on the one-time inclusion of foreign subsidiary earnings described above to 35%, and taxes dividends paid to noncorporate domestic shareholders of the foreign parent as ordinary income.

          Earnings Stripping.  The Act also targets deductible payments made to non-U.S. affiliates in multinational groups by imposing a minimum 10% tax (5% in 2018) on income of large domestic corporations before any deductions for payments to related foreign parties, and by prohibiting deductions for certain interest and royalty payments by a domestic taxpayer to related foreign parties.  Multinational groups will need to review their intra-group financing structures to assess the impact of these rules and the new limitations on interest expense deductions described above.

          Carried Interest.  Finally, the Act contains a constraint on “carried” interests issued in connection with the performance of investment services, requiring a three-year holding period in order for the service provider to obtain the long-term capital gain rate.  Given the typical holding period for most private equity investments, we don’t expect this change to have much, if any, impact on M&A activity.

          The Act makes fundamental changes to the U.S. taxation of domestic and multinational businesses and will affect transaction structures and financing in a variety of contexts.  Careful planning and analysis of each transaction will be required in light of the changed landscape brought about by the Act.

Deborah L. Paul
T. Eiko Stange
Joshua M. Holmes

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Duty Of A Board

ByMartin Lipton, Steven A. Rosenblum, Karessa L. Cain, Sabastian V. Niles, Vishal Chanani, Kathleen C. Iannone

The ever-evolving challenges facing corporate boards prompts an updated snapshot of what is expected from the board of directors of a major public company – not just the legal rules, but also the aspirational “best practices” that have come to have equivalent influence on board and company behavior. In the coming year, boards will be expected to:

  • Oversee corporate strategy and the communication of that strategy to investors;
  • Set the tone at the top to create a corporate culture that gives priority to ethical standards, professionalism, integrity and compliance in setting and implementing strategic goals;
  • Choose the CEO, monitor the CEO’s and management’s performance and develop a succession plan;
  • Determine the agendas for board and committee meetings and work with management to assure appropriate information and sufficient time are available for full consideration of all matters;
  • Determine the appropriate level of executive compensation and incentive structures, with awareness of the potential impact of compensation structures on business priorities and risk-taking, as well as investor and proxy advisor views on compensation;
  • Develop a working partnership with the CEO and management and serve as a resource for management in charting the appropriate course for the corporation;
  • Oversee and understand the corporation’s risk management and compliance efforts, and how risk is taken into account in the corporation’s business decision-making; respond to red flags when and if they arise (see Risk Management and the Board of Directors);
  • Monitor and participate, as appropriate, in shareholder engagement efforts, evaluate potential corporate governance proposals and anticipate possible activist attacks in order to be able to address them more effectively;
  • Evaluate the board’s performance on a regular basis and consider the optimal board and committee composition and structure, including board refreshment, expertise and skill sets, independence and diversity, as well as the best way to communicate with investors regarding these issues;
  • Review corporate governance guidelines and committee charters and tailor them to promote effective board functioning;
  • Be prepared to deal with crises; and
  • Be prepared to take an active role in matters where the CEO may have a real or perceived conflict, including takeovers and attacks by activist hedge funds focused on the CEO.

To meet these expectations, major public companies should seek to:

  • Have a sufficient number of directors to staff the requisite standing and special committees and to meet expectations for diversity;
  • Have directors who have knowledge of, and experience with, the company’s businesses, even if this results in the board having more than one director who is not “independent”;
  • Have directors who are able to devote sufficient time to preparing for and attending board and committee meetings;
  • Meet investor expectations for director age, diversity and periodic refreshment;
  • Provide the directors with the data that is critical to making sound decisions on strategy, compensation and capital allocation;
  • Provide the directors with regular tutorials by internal and external experts as part of expanded director education; and
  • Maintain a truly collegial relationship among and between the company’s senior executives and the members of the board that enhances the board’s role both as strategic partner and as monitor.
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ISS Final 2018 Voting Policies

November 17, 2017

By Andrew R. Brownstein
David A. Katz
Andrea K. Wahlquist
Sabastian V. Niles
S. Iliana Ongun

ISS Announces Final 2018 Voting Policies

          Proxy advisory firm Institutional Shareholder Services (ISS) has announced its final U.S. voting policies for the 2018 proxy season, which will apply to stockholder meetings held on or after February 1, 2018.  ISS had previously released draft proposals on several (though not all) of the topics in October.  Changes to non-U.S. voting policies were also announced.

          Shareholder Rights Plans.  In order to “simplify” ISS’s approach to rights plans and “to strengthen the [ISS] principle that poison pills should be approved by shareholders in a timely fashion,” ISS will now recommend voting against all directors of companies with “long-term” (greater than one year) unilaterally adopted shareholder rights plans at every annual meeting, regardless of whether the board is annually elected.  Short-term rights plans will continue to be assessed on a case-by-case basis, but ISS’s analysis will focus primarily on the company’s rationale for the unilateral adoption.

          “Excessive” Non-Employee Director Compensation.  ISS will recommend voting against or withholding votes from members of board committees responsible for setting non-employee director compensation when there is a “pattern” (over two or more consecutive years) of “excessive” non-employee director pay without a compelling rationale or other mitigating factors.  Because “excessive” pay would need to be flagged for at least two years under the new policy, ISS will not make negative vote recommendations on this basis until 2019.

          Disclosure of Shareholder Engagement.  In considering whether to recommend against compensation committee members of companies whose Say-on-Pay proposals received less than 70% of votes cast, ISS considers the company’s disclosure regarding shareholder engagement efforts.  ISS provided guidance regarding the level of detail included in such disclosures, including whether the company disclosed the timing and frequency of engagements with major institutional investors and whether independent directors participated; disclosure of the specific concerns voiced by dissenting shareholders that led to the Say-on-Pay opposition; and disclosure of specific and meaningful actions taken to address the shareholders’ concerns.

          Gender Pay Gap Proposals and Board Diversity.  ISS will vote case-by-case on requests for reports on a company’s pay data by gender, or a report on a company’s policies and goals to reduce any gender pay gap, taking into account the company’s current policies and disclosure related to its diversity and inclusion policies and practices, its compensation philosophy and its fair and equitable compensation practices.  ISS will also take into account whether the company has been the subject of recent controversy or litigation related to gender pay gap issues and whether the company’s reporting regarding gender pay gap policies or initiatives is lagging its peers.  ISS also noted that it would highlight boards with no gender diversity, but would not make adverse vote recommendations due to a lack of gender diversity.  In addition, ISS revised its “Fundamental Principles” to state that boards should be sufficiently diverse to ensure consideration of a wide range of perspectives.

In Canada where there are new disclosure requirements on companies’ gender diversity policies, ISS is introducing a new policy on board gender diversity that will generally recommend withhold votes for the chair of the nominating committee if a company has not adopted a formal written gender diversity policy and no female directors serve on its board.

          Pledging of Company Stock.  ISS has codified its existing practice to recommend withhold votes against the members of the relevant board committee or the entire board where a significant level of pledged company stock by executives or directors raises concerns absent mitigating factors.

          Pay-for-Performance Analysis.  In connection with its pay-for-performance analysis, ISS will consider, in addition to other alignment tests, the rankings of CEO total pay and company financial performance within a peer group measured over a three-year period.

          Other Changes.  ISS has further revised its voting recommendations on climate change shareholder proposals in order to promote greater transparency on these matters.

*   *   *   *

          While we do not expect the ISS policy changes to significantly affect the 2018 proxy season, we believe that ongoing company engagement with its institutional investors will continue to be essential to counteract adverse ISS recommendations.

Andrew R. Brownstein
David A. Katz
Andrea K. Wahlquist
Sabastian V. Niles
S. Iliana Ongun

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2018 Proxy Season


By Frank Glassner

For those who want to start preparing for the 2018 proxy season, our preliminary list of important considerations is set forth below:
Directors’ and Officers’ Questionnaires
We are not aware of any regulatory changes that would require directors’ and officers’ questionnaires to be updated.
Say-on-Pay Frequency Vote
Rule 14a-21(b) requires a say-on-pay frequency vote every six years. Many issuers included a frequency vote in their 2017 proxy because they were subject to the initial rules when they became effective for shareholders’ meetings occurring on or after January 21, 2011. However, “smaller reporting companies” as of January 21, 2011, and new smaller reporting companies after that date, were not required to hold a frequency vote until the first meeting occurring on or after January 21, 2013. Thus, for many smaller reporting companies the outside date for the next say-on-pay frequency vote may be pushed out until the 2019 proxy season. However, each issuer should review its own facts and circumstances.
Issuers that formerly qualified as “emerging growth companies” (EGCs) under the JOBS Act should also remain mindful of say-on-pay requirements as issuers that no longer qualify as EGCs lose their exemption from the requirements under Exchange Act Sections 14A(a) and (b). Such former EGCs are required to begin providing say-on-pay votes within one year of losing EGC status (or no later than three years after selling securities under an effective registration statement if an issuer was an EGC for less than two years). Typically, such companies will also hold say-on-pay frequency votes when they hold their first say-on-pay vote as a non-EGC.
And if you hold a frequency vote, do not forget the requirement to amend your Form 8-K that discloses voting results to “disclose the company’s decision in light of such vote as to how frequently the company will include a shareholder vote on the compensation of executives in its proxy materials until the next required vote on the frequency of shareholder votes on the compensation of executives.” The amendment must be made within 150 calendar days after the end of the meeting at which the say-on-pay frequency vote was held.
Pay Ratio Disclosure
In February 2017, then acting Chairman Michael S. Piwowar announced his intention to conduct a review of the Dodd-Frank pay ratio rule. The Financial CHOICE Act, introduced and passed in the House in June 2017, would repeal the pay ratio disclosure rule, but the legislation has not progressed to the Senate. There has been no subsequent indication that implementation of the rule will be delayed, so the pay ratio rule will be effective for the upcoming proxy season. The rule requires a public company to disclose the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer. The disclosure is required for proxy statements that include information about a fiscal year that begins after January 1, 2017.  A new public company will have to disclose a pay ratio for the first fiscal year after the year it becomes a reporting company. The SEC’s FAQs are a good source of further detailed information regarding implementation and calculation of the ratios as well.
ISS Proxy Voting Policies
ISS is in the process of formulating changes to its voting recommendation policies and has released its 2018 policy survey. The survey generally foreshadows changes to policies for the upcoming proxy season. This year’s survey demonstrates an increased focus on gender diversity in board composition, shareholder authorization for share issuances and buybacks, implications of virtual/hybrid shareholder meetings, and disclosure of pay ratios. We recommend that issuers monitor ISS’ new and updated policies, including ISS’s official proxy voting guidelines, which are typically issued in December for the upcoming proxy season.
Hyperlinking of Exhibits
The SEC has adopted rules which will require public companies to include a hyperlink to each exhibit identified in an exhibit index. This includes Form 10-K.  The final rules will take effect on September 1, 2017. The rule is applicable to smaller reporting companies unless they make EDGAR filings using the ASCII format. ASCII filers have an additional year to comply with the rule. If a public company becomes aware of an inaccurate hyperlink, the link must generally be corrected in a manner specified in the rules.
Form 10-K Cover Page
The SEC revised the cover page of Form 10-K when adopting rules to incorporate certain provisions of the JOBS Act. Broadly speaking the cover page has been revised to include a “check the box” item to indicate that the person filing the report is an “emerging growth company” and an additional box to check as follows: “If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.”
Inflation-adjusted threshold for EGCs
The SEC also revised the definition of “emerging growth company” to provide an inflation-adjusted threshold for the annual gross revenue amount that determines EGC status. Until further revised by the SEC in five years (as required per the statutory language of the JOBS Act), the maximum inflation-adjusted EGC revenue threshold is $1,070,000,000.
Resource Extraction Rules
The resource extraction rules, which would have required disclosures from companies engaged in the oil, natural gas, and mineral extraction industries to disclose payments made by the companies to governments beginning in 2019, were eliminated by Congressional action under the Congressional Review Act in February 2017.
Conflict Minerals Rules
The SEC staff issued no-action guidance which stated the staff would not recommend enforcement if a Company did not report under Item 1.01(c) of Form SD to describe the results of due diligence conducted on its supply chain to determine origination of conflict minerals used in its products. This survey suggests many issuers continued to respond to Item 1.01(c) notwithstanding the staff guidance.
Providing Paper Copies of Annual Reports to the SEC
Exchange Act Rule 14a-3(c) and Rule 14c-3(b) require registrants to mail seven copies of the annual report sent to security holders to the Commission “solely for its information.” A similar provision in Form 10-K requires certain Section 15(d) registrants to furnish to the Commission “for its information” four copies of any annual report to security holders. The SEC staff advised in a Compliance and Disclosure Interpretation that it will not object if a company posts an electronic version of its annual report to its corporate web site by the dates specified in Rule 14a-3(c), Rule 14c-3(b) and Form 10-K respectively, in lieu of mailing paper copies or submitting it on EDGAR. If the report remains accessible for at least one year after posting, the staff will consider it available for its information.
Inline XBRL
The SEC has proposed rules that would require financial statements to be provided in the Inline XBRL format. Final rules have not been issued. Inline XBRL allows filers to embed XBRL data directly into an HTML document, eliminating the need to tag a copy of the information in a separate XBRL exhibit. Inline XBRL would be both human-readable and machine-readable for purposes of validation, aggregation and analysis. However, the SEC has not enacted final rules requiring the use of Inline XBRL. While the SEC permits the use of Inline XBRL, we suggest checking with your auditor first as to any sensitivity to providing information in this manner.
PCAOB’s Changes to Audit Report
The Public Company Accounting Oversight Board adopted a new auditor reporting standard that will require audit reports to include additional information about the audit. Specifically, auditors will be required to describe “Critical Accounting Matters” encountered during the audit and the auditor’s response to them, or state that no Critical Accounting Matters were encountered. Generally speaking, Critical Accounting Matters are matters that require especially challenging, subjective, or complex auditor judgment.
In addition to Critical Accounting Matters, the new standard makes the following changes:

  • Independence—a statement that the auditor is required to be independent;
  • Addressee—the auditor’s report will be addressed to the company’s shareholders and board of directors or equivalents (additional addressees are also permitted);
  • Enhancements to basic elements—certain standardized language in the auditor’s report has been changed, including adding the phrase whether due to error or fraud, when describing the auditor’s responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements; and
  • Standardized form of the auditor’s report—the opinion will appear in the first section of the auditor’s report and section titles have been added to guide the reader.
The new standard will not apply to public companies unless/until it receives SEC approval. To date, the SEC has published the PCAOB standard for comment but final rules have not been adopted. The PCAOB standard provides that all provisions other than those related to critical audit matters will take effect for audits of fiscal years ending on or after December 15, 2017. Provisions related to critical audit matters will take effect for audits of fiscal years ending on or after June 30, 2019, for large accelerated filers; and for fiscal years ending on or after December 15, 2020, for all other companies to which the requirements apply. In other words, if the SEC approves the PCAOB standard late in 2017 or early in 2018, the components other than the Critical Accounting Matters will apply to annual reports for 2017. Auditors may elect to comply before the effective date, at any point after SEC approval of the final standard.
Communication of Critical Audit Matters is not required for audits of brokers and dealers reporting under the Exchange Act Rule 17a-5; investment companies other than business development companies; employee stock purchase, savings, and similar plans; and EGCs. Auditors of these entities may choose to include critical audit matters in the auditor’s report voluntarily.
Revenue Recognition and Lease Accounting
For the 2017 Form 10-K, Staff Accounting Bulletin No. 74 requires companies to provide transition disclosures of the impact that a recently-issued accounting standard will have on its financial statements when that standard is adopted in a future period. Public companies will need to address the new revenue recognition standard and the new lease accounting standard. Public companies will apply the new revenue standard to annual reporting periods beginning after December 15, 2017. Public companies will apply the new lease accounting standard for fiscal years beginning after December 15, 2018.
While public companies generally have their hands full planning for proxy season and preparing for shareholders meetings, we recommend significant thought be given to preparing for the first quarter 10-Q when the new revenue recognition standard will be adopted. We have set forth our thoughts on the initial MD&A and reviewed disclosures made by some of the early revenue recognition adopters.
In addition, public companies that adopt the new revenue recognition standard using the full retrospective method may encounter difficulties if a Form S-3 is filed after the first quarter of 2018. Item 11(b)(ii) of Form S-3 requires restated financial statements to be filed if there has been a change in accounting principles that requires a material retroactive restatement of financial statements. This would require filing of restated financial statements for 2015, 2016 and 2017 significantly in advance of the 2018 Form 10-K, and restated 2015 financial statements would not otherwise be required. This can be avoided if the Form S-3 is filed during the first quarter of 2018. Form S-8 does not include an identical provision but General Instruction G.2 of Form S-8 requires that “material changes in the registrant’s affairs” be disclosed in the registration statement.
T+2 Settlement
The SEC has adopted new rules requiring settlement of securities transactions on a T+2 basis, as opposed to the existing T+3 basis. The new rule is effective September 5, 2017.  One effect of the new rules is that the ex-dividend date will be just one trading day prior to the record date. References to the ex-dividend date should be adjusted accordingly in announcement of dividends.
NYSE Dividend Notification Requirements
The SEC has approved a change to the NYSE’s rules which requires listed companies to provide dividend notifications to the Exchange at least 10 minutes prior to disseminating them publicly when the notification is made outside of Exchange trading hours of 7:00 a.m. ET and the end of the NYSE trading session (4:00 p.m. ET). No change is being made to the NYSE’s rules with respect to dividends between 7:00 a.m. ET and the end of the NYSE trading session.
Following SEC approval of the revised rule, the NYSE filed a further proposed rule change to delay implementation of the rule. According to the NYSE, the delay is necessary to provide listed companies with additional time to prepare to comply with the new requirements and for the NYSE to provide the necessary support to its staff in reviewing notifications. The NYSE plans to provide reasonable advance notice of the new implementation date to listed companies by emailing a notice to them that will also be posted on The new implementation date will be no later than February 1, 2018.
Rule 14a-8: Shareholder Proposals
Companies should be mindful in the upcoming proxy season of the potential for the typical shareholder proponents and other activist shareholders to submit shareholder proposals under SEC Rule 14a-8 seeking to further shareholders’ ability to nominate directors, which is referred to as proxy access. Shareholder proposals focused on proxy access were the most common type of shareholder proposal in the 2017 proxy season and all signs suggest this trend will continue. As a result, companies that have not yet adopted proxy access should be prepared to receive shareholder proposals recommending adoption of such a provision. Companies that have already adopted a proxy access provision should be prepared to receive shareholder proposals focused on broadening applicable thresholds for shareholder nomination of directors such as eliminating limits on shareholder aggregation.
Other popular topics for shareholder proposals in 2018 are expected to address independent board chairs, board diversity and social, environmental and political proposals.
Rule 14a-8 has not been amended to limit shareholder proposals and provisions of the Financial Choice Act seeking to do so have not advanced to the Senate for consideration. In addition, absent some unanticipated action by the SEC under new Chairman Jay Clayton, the SEC’s interpretation of Rule 14a-8 as embodied in the no-action letter process to exclude proposals is not expected to change in 2018.
Other Regulatory Initiatives
Proposed rules have been issued on the following topics, but final rules have not been adopted:

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Three Reasons People Don’t Get a Board Seat


By Frank Glassner

Well-credentialed candidates who are in search of their first board seat routinely approach me and I repeatedly hear the following refrain: “I’ve been trying unsuccessfully to get a board seat for years. None of the advice I’ve received has been helpful.” As someone who is in boardrooms on a weekly basis, I don’t think that this austere success quotient is very surprising. Personally, I would attribute most failures to these three reasons.
You’re getting unrealistic advice. 
There are approximately 15,000 publicly traded companies in the United States, which means that more than 90 percent of public companies are outside of the Fortune 1000. Math alone dictates that a board candidate has a low chance of garnering a mid- or large-cap board seat. Put differently, in 2017 and beyond, unless you’re a well-known current or former CEO (or an otherwise prominent person), your chances of securing a spot on a Fortune 1000 company board for your first governance experience are slim.
Consequently, taking board search advice from mid- and large-cap executives or service providers that predominantly cater to those companies is of limited value. The small-cap ecosystem, where the majority of first-time candidates will serve, is notoriously idiosyncratic; you either understand how to navigate it, or you don’t.
Your networking is counterproductive. 
Telling everyone in your network you’d like to be on a board is an incomplete—and poor—statement of intention. In the past 7 years, more than 200 board candidates have contacted me. I’ve not gone out of my way to help anyone who’s stated: “I would love to find a board seat.” When I hear that, the former institutional investor in me recoils. What I hear instead is, “Hi, I’d like to find a part-time job I perceive to be high paying. Within reason, any company will do, because I can’t be bothered to proactively narrow my search aperture.” The only people I’ve assisted are those who have spent considerable time and effort to identify specific companies they are keen to serve, and who can make a compelling case for their candidacy. Boards only need directors who are uniquely suited to drive shareholder value and who display a passion for undertaking their prospective roles.
Start with CEOs. 
While it’s true that independent nominating and governance committees in Fortune 1000 companies predominantly select those boards, outside of that continuum very little has changed. Any experienced institutional investor will tell you that CEOs still choose board members at most public companies. Since your board appointment is likely to originate with the CEO, once you select a company to target, you should try to make your case to the decision maker sooner as opposed to later.
Board candidates also need to face reality about how much money they might actually make as public company directors. The majority of candidates who approach me get all of their information from the large-cap focused New York Times or Wall Street Journal, and believe that any smart person with some extra time on his or her hands can make $250,000 per year for each board seat. That is fiction.
If a tennis court represents the number of public company directors in the United States, the number of directors making more than $250,000 per year from board service (much less from a single board seat) is more or less equivalent to the size of a small dining room table. In fact, there are thousands of public company directors in the United States who barely make enough each year from their board stipends to buy a small dining room table.
Taking some time to right size your board search expectations is worth the effort. After securing that first board seat, many friends and colleagues have emailed me to say that it’s the most challenging —and the most rewarding—job they have ever had.
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Activism and Board Diversity

Corporate Governance Update:  Activism and Board Diversity

David A. Katz
Laura A. McIntosh*

Activism at public companies can reduce board diversity, or it can increase it, depending on the circumstances.  In recent years, activist hedge funds have installed dissident nominees who collectively have trailed the S&P 1500 index significantly in terms of gender and racial diversity.  In contrast, institutional shareholders and asset managers are promoting board diversity to an unprecedented extent, with concerted public efforts already producing results.  Several institutional investor initiatives, announced earlier this year, and the New York Comptroller’s Boardroom Accountability Project 2.0, announced earlier this month, may be game-changing initiatives on the path to greater board diversity.

Hedge Fund Activism

          Since the early 2000s, a number of studies have demonstrated that companies with women on their boards consistently experience a wide range of benefits, including higher average returns on equity, higher net income growth, lower stock volatility, and higher returns on invested capital.  Whether because of improved group dynamics, a shift in risk management, increased ability to consider alternatives to current strategies, or a focus on governance generally, board gender diversity produces stronger boards.  While the argument for gender diversity may have begun from notions of equality, experience has shown a compelling financial rationale.

          With the evidence for board diversity very much in the public domain, the behavior of hedge fund activists seeking board representation has been somewhat puzzling.  Hedge fund activism has been notably counterproductive in terms of gender diversity on public boards.  A 2016 Bloomberg analysis of the years 2011 through 2015 found that women represented only five percent of the candidates successfully placed on boards by activist funds, a significant finding during a period in which women represented about 19 percent of S&P 500 directors and in which female candidates were nominated to fill 26 percent of open seats at S&P 500 companies.  At companies targeted by hedge funds during the same years, the proportion of all-male boards increased from 13 percent to 17 percent, while in the S&P 1500 that proportion significantly declined.

To continue reading, please click here.

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2017 Proxy Proposals

August 7, 2017


With thanks to Gibson, Dunn & Crutcher LLP

A. Shareholder Proposals Submitted
1. Overview
For 2017 shareholder meetings, shareholders have submitted approximately 827 proposals, which is significantly less than the 916 proposals submitted for 2016 shareholder meetings and the 943 proposals submitted for 2015 shareholder meetings.
For 2017, across four broad categories of shareholder proposals—governance and shareholder rights; environmental and social issues; executive compensation; and corporate civic engagement—the most frequently submitted were environmental and social proposals (with approximately 345 proposals submitted).
The number of social proposals submitted to companies increased to approximately 201 proposals during the 2017 proxy season (up from 160 in 2016). Thirty-five social proposals submitted in 2017 focused on board diversity (up from 28 in 2016), 34 proposals focused on discrimination or diversity-related issues (up from 16 in 2016), and 19 proposals focused on the gender pay gap (up from 13 in 2016).
Environmental proposals were also popular during the 2017 proxy season, with 144 proposals submitted (up from 139 in 2016). Furthermore, there was an unprecedented level of shareholder support for environmental proposals this proxy season, with three climate change proposals receiving majority support and climate change proposals averaging support of 32.6% of votes cast. This compares to one climate change proposal receiving majority support in 2016 and climate change proposals averaging support of 24.2% of votes cast. As further discussed below, the success of these proposals is at least in part due to the shift in approach towards environmental proposals by certain institutional investors, including BlackRock, Vanguard and Fidelity.
2. Types of Shareholder Proposals
The most common types of shareholder proposals in 2017, along with the approximate numbers of proposals submitted, were:
  • social (201 proposals);
  • environmental (144 proposals, including 69 climate change proposals);
  • proxy access (112 proposals); and
  • political contributions and lobbying disclosure (87 proposals).
By way of comparison, the most common types of shareholder proposals in 2016 were:
  • proxy access (201 proposals);
  • social (160 proposals);
  • environmental (139 proposals, including 63 climate change proposals); and
  • political contributions and lobbying disclosure (91 proposals).
3. Proponents
As is typically the case, John Chevedden and shareholders associated with him (including James McRitchie, Kenneth and William Steiner, and Myra Young) submitted by far the highest number of shareholder proposals for 2017 shareholder meetings—approximately 203, which is 24.5% of all shareholder proposals submitted to date in 2017. Other proponents reported to have submitted or co-filed at least 20 proposals each include: As You Sow Foundation (48, largely focused on environmental matters); Trillium Asset Management (42, largely focused on environmental matters); the New York City Comptroller (39, largely focused on governance/shareholder rights and environmental matters); Walden Asset Management (23, largely focused on environmental and political matters); Mercy Investment Services (21, largely focused on environmental and social matters); the New York State Common Retirement Fund (25, largely focused on political matters); and NorthStar Asset Management (20, largely focused on social matters).
B. Shareholder Proposal No-Action Requests
1. Overview
During the 2017 proxy season, companies submitted 288 no-action requests to the Staff as compared to approximately 245 during the 2016 proxy season. In 2017, the percentage of no-action requests that were granted by the Staff increased to 78%, the highest level in at least four years. The following table summarizes the responses to no-action requests that the Staff issued during the 2017 and 2016 proxy seasons:


2. Reasons for Exclusion in 2017
Based on a review of no-action letters issued during the 2017 proxy season, the Staff concurred that shareholder proposals could be excluded for the following principal reasons:
  • 37.6% based on ordinary business arguments;
  • 32.8% because the company had substantially implemented the proposal; and
  • 17.5% based on procedural arguments, such as timeliness or defects in the proponent’s proof of ownership.
Of the shareholder proposals for which no-action relief was denied, 47.2% were challenged as being related to the company’s ordinary business operations under Rule 14a-8(i)(7), making ordinary business the most common basis for denial as well as success for a no-action request. Other frequently unsuccessful arguments included that the proposal was vague or false and misleading (45.3% of denials), that the company had substantially implemented the proposal (30.2% of denials), and that there was a procedural defect in the submission of the proposal (17.0% of denials).
Three aspects of the foregoing data are worth noting:
  • The success during 2017 of ordinary business arguments, with 37.6% of no-action requests granted on that basis, up from 32.2% in 2016.
  • The continued success of substantial implementation arguments. This marks the second straight year in which approximately one-third of all no-action requests were granted because the Staff concurred that the company had substantially implemented the proposal. During the 2017 proxy season, 32.8% of such no-action requests were granted, down slightly from 34.3% in 2016 but up from 21.0% in 2015.
  • The continued decrease in exclusions based on procedural arguments, with 17.5% of no-action requests granted on that basis in 2017, down from 23.1% in 2016 and 35.0% in 2015.
a) Increase in Exclusions Based on Ordinary Business
Several new types of shareholder proposals were excluded based on ordinary business arguments during the 2017 proxy season, including proposals relating to (i) requests for reports on human lead exposure; (ii) a new version of minimum wage reform proposals; (iii) a new type of pharmaceutical pricing proposals; and (iv) a report on certain religious freedom principles. In addition, the Staff agreed that certain environmental and social proposals were excludable on ordinary business grounds because the proposals sought to “micromanage” the company, as further described below.
i. Requests for Reports on Human Lead Exposure
During the 2017 proxy season, at least two companies received what appears to be a new type of environmental proposal. Specifically, The Home Depot, Inc. and Lowe’s Companies, Inc. each received a shareholder proposal asking them to “issue a report, at reasonable expense and excluding proprietary and privileged information, on the risks and opportunities that the issue of human lead exposures from unsafe practices poses to the company, its employees, contractors, and customers.” The supporting statement mentioned that companies should consider improving their lead safety practices through “consumer education on lead-safe practices, free or discounted lead testing products, and dedicated lead safety personnel.”
While proposals that focus on the adverse effects on the environment and/or public health are typically not excludable, both companies submitted no-action requests to the Staff arguing that this particular proposal was excludable because (1) the supporting statements made it clear that it related to ordinary business matters, namely, the products and services that these companies offer to their customers, and (2) the proposal did not otherwise focus on a significant policy issue.
Ultimately, the proposal submitted to The Home Depot, Inc. was withdrawn, and the Staff granted the no-action request submitted by Lowe’s Companies, Inc. While the Staff did not provide any additional insight into its decision, the Lowe’s decision confirms the well-established principle that proposals relating to both ordinary business matters and social policy issues may be excludable.
ii. Minimum Wage Shareholder Proposals
This proposal, which asks companies to adopt principles for minimum wage reform, is similar to the proposals submitted by Trillium Asset Management and several religious orders in 2016, with one important distinction described below.
Specifically, last year, five of the six submitted proposals were successfully challenged under Rule 14a-8(i)(7) as relating to the companies’ ordinary business operations (specifically, general compensation matters). Seeking to avoid exclusion on ordinary business grounds this year, the proponents (Trillium Asset Management and Zevin Asset Management) revised the proposal to include a specific disclaimer regarding general compensation matters by stating that the proposal did not “seek to address the [c]ompany’s internal approach to compensation, general employee compensation matters, or implementation of its principles for minimum wage reform” and giving the board discretion to determine the appropriate timing for publishing the principles.
Five companies that received the proposal this year (including The TJX Companies, Inc. and Chipotle Mexican Grill, Inc., both of which received a minimum wage proposal last year as well) submitted no-action requests to the Staff arguing, among other things, that the proposals were excludable on ordinary business grounds (as relating to general compensation matters) with some letters explicitly noting that the issue of minimum wage is not a significant policy issue and that the Staff has never viewed it as such. The no-action requests also maintained that, in spite of the proponent’s disclaimer, the supporting statement still addressed the wage practices (i.e., general compensation matters) of each company that received the proposal.
The Staff agreed that the proposal could be excluded on ordinary business grounds, noting that the proposal “relates to general compensation matters, and does not otherwise transcend day-to-day business matters.”
iii. Pharmaceutical Pricing Proposals
This season saw the return of a shareholder proposal campaign targeting how pharmaceutical companies determine the price of their products. At least ten pharmaceutical companies received proposals requesting that the board “issue a report listing the rates of price increases year-to-year of the company’s top ten selling branded prescription drugs between 2010 and 2016, including the rationale and criteria used for these price increases, and an assessment of the legislative, regulatory, reputational and financial risks they represent for the company.” The last campaign that similarly focused on the pricing of pharmaceutical products asked companies during the 2015 proxy season to prepare reports “on the risks to [the companies] from rising pressure to contain U.S. specialty drug prices.” Those proposals were found to be not excludable under Rule 14a-8(i)(7) by the Staff because they focused on “fundamental business strategy with respect to … [companies’] pricing policies for pharmaceutical products.”
During the 2017 proxy season, the 10 companies that received this new drug pricing-related proposal sought no-action relief under Rule 14a-8(i)(7), with many arguing that this proposal was different from the 2015 adverse precedents because in those instances, the proposals “focused on the company’s fundamental business strategy with respect to its pricing policies for pharmaceutical products rather than on how and why the company makes specific pricing decisions regarding certain of those products.” The companies also argued that “[u]nlike the requests in, the primary focus of the [current proposals] … is on obtaining explanation and justification for product-specific and time period-specific price increases.” Most of the proponents, on the other hand, cited those same 2015 letters and argued that they stood for the proposition that “[i]t is abundantly clear that the pricing of their drugs … is a significant policy concern for drug manufacturers.” The Staff concurred that the proposals were excludable on ordinary business grounds because they related “to the rationale and criteria for price increases of the company’s top ten selling branded prescription drugs in the last six years.”
iv. Report on Certain Religious Freedom Principles
During the 2017 proxy season, the National Center for Public Policy Research and its leaders submitted a new type of proposal to at least eight companies asking them to produce a report (1) detailing risks and costs associated with pressure campaigns to oppose religious freedom laws, public accommodation laws, freedom of conscience laws and campaigns against candidates from Title IX exempt institutions, (2) detailing risks and costs associated with pressure campaigns supporting discrimination against religious individuals and those with deeply held beliefs, and (3) detailing strategies that they may deploy to defend their employees and their families against discrimination and harassment that is encouraged or enabled by such efforts.
While the proposals were framed as asking for a “[r]eport on certain non-discrimination principles,” eight companies sought no-action relief on ordinary business grounds as relating to management of workforce and/or public relations. The Staff concurred in the exclusion of five of these proposals under Rule 14a-8(i)(7), as relating to companies’ ordinary business operations. These no-action letters demonstrate that merely labeling a proposal as implicating discrimination issues is not sufficient to avoid evaluation of whether a proposal seeks to address ordinary business operations.
v. Micromanagement Exclusions
During the 2017 proxy season, some companies were also able to exclude proposals on ordinary business grounds because they impermissibly sought to “micromanage” the company. These letters are notable because the Staff has rarely concurred with no-action requests based on the micromanagement prong of the ordinary business exception. For example, Deere & Co. and another company were able to exclude on ordinary business grounds a proposal requesting that the company “generate a feasible plan for the company to reach a net-zero GHG emissions status by the year 2030 … and report the plan to shareholders” because, according to the Staff, the proposal sought to “micromanage the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.”
b) Continued Success in Exclusions Based on Substantial Implementation
While substantial implementation continued to be a popular basis for exclusion during the 2017 proxy season, 54.8% of the no-action requests granted on this basis concerned “amend proxy access” proposals, as further discussed below. Overall, approximately 34 companies were able to exclude “amend proxy access” proposals based on arguments that the existing terms of their proxy access bylaws substantially implemented the proposal. As further discussed below, an additional 13 companies were able to exclude “adopt proxy access” proposals on the basis of substantial implementation arguments because of their adoption of a proxy access bylaw prior to their annual meetings.
c) Decrease in Exclusions Based on Procedural Arguments
As noted above, the number of exclusions based on procedural arguments continued to decrease in 2017, with 17.5% of no-action requests (or 33 of 189) granted on that basis in 2017, down from 23.2% in 2016 (or 33 of 142) and 35.0% in 2015 (or 46 of 133). The most common procedural argument that failed to obtain no-action relief in 2017 was based on the one-proposal limitation. Under Rule 14a-8(c), each shareholder may submit no more than one proposal to a company for a particular shareholders’ meeting. All seven no-action requests asserting that a submission violated the one-proposal rule did not prevail on this argument
C. Shareholder Proposal Voting Results
Based on the 331 shareholder proposals for which ISS provided voting results in 2017, proposals averaged support of 29.0% of votes cast, slightly down from average support of 29.8% of votes cast in 2016. The proposal topics that received high shareholder support, including four categories of proposals that averaged majority support, were:
  • Board Declassification: Three proposals voted on averaged support of 70.2% of votes cast in 2017, compared to three proposals with average support of 64.5% in 2016;
  • Elimination of Supermajority Voting Requirements: Seven proposals voted on averaged support of 64.3% of votes cast, compared to 13 proposals with average support of 59.6% in 2016;
  • Adopt Proxy Access: Eighteen adopt proxy access proposals voted on averaged support of 62.1% of votes cast. In 2016, average support for proxy access proposals where the company had not previously adopted some form of proxy access was 56.0%.
  • Majority Voting in Uncontested Director Elections: Seven proposals voted on averaged support of 62.3% of votes cast, compared to 10 proposals with average support of 74.2% in 2016;
  • Written Consent: Twelve proposals voted on averaged support of 45.6% of votes cast, compared to 13 proposals with average support of 43.4% in 2016;
  • Shareholder Ability to Call Special Meetings: Fifteen proposals voted on averaged support of 42.9% of votes cast, compared to 16 proposals with average support of 39.6% in 2016; and
  • Climate Change: Twenty-eight proposals voted on averaged support of 32.6% of votes cast, compared to 37 proposals with average support of 24.2% in 2016.
Overall, approximately 10.9% of shareholder proposals that were voted on at 2017 shareholder meetings received support from a majority of votes cast, compared to 14.5% of proposals in 2016. The table below shows the principal topics addressed in proposals that received majority support:
II. Key Shareholder Proposal Topics and Trends During the 2017 Proxy Season
A. Environmental Proposals
The total number of environmental proposals increased in 2017, with shareholders submitting approximately 144 environmental proposals for 2017 meetings compared to 139 in 2016. Overall, the 55 environmental proposals voted on received average support of 28.9% of the votes cast, compared to 71 that received average support of 25.1% of votes cast in 2016.
The largest group of environmental proposals related to climate change, with 69 such proposals submitted in 2017 compared to 63 in 2016. The 28 climate change proposals voted on in 2017 averaged support of 32.6% of votes cast. Three climate change proposals received a majority of the votes cast, as further discussed below. Climate change proposals were submitted not just to oil and gas companies, but also to companies in the financial services and technology industries. ISS recommended that shareholders vote “for” 23 of the 28 proposals (or 82.1%) voted on in 2017 and “for” 27 of the 37 proposals (or 73.0%) of the proposals voted on in 2016.
In addition to climate change proposals, environmental proposals submitted in 2017 included:
  • 28 proposals related to environmental impacts on the community or supply chains, including impacts of deforestation and pesticides (with 11 such proposals voted on averaging 23.6% support);
  • 24 proposals calling for reports on sustainability (with nine such proposals voted on averaging 30.0% support);
  • 12 proposals focusing on renewable energy (with four such proposals voted on averaging 18.3% support); and
  • Nine proposals focusing on recycling (with three such proposals voted on averaging 24.3% support).
1. Three Climate Change Proposals Receive Majority Support and Pass in 2017
As mentioned above, three climate change proposals received majority support. Various factors may have contributed to the success of these proposals. Most notably, in March, BlackRock announced in its 2017-2018 engagement priorities that it expects boards to have “demonstrable fluency in how climate risk affects the business and management’s approach to adapting and mitigating the risk,” and that where it has concerns that a board is not “dealing with a material risk appropriately,” it may signal that concern through its vote. Vanguard also updated its proxy voting guidelines in 2017 to state that it would evaluate each environmental proposal on the merits and may support those with a demonstrable link to long term shareholder value.
The three climate change proposals that passed specifically called for a report on the impact of climate change policies, including an analysis of the impacts of commitments to limit global temperature change to two degrees Celsius. The three companies where this proposal passed were the following:
  • Occidental Petroleum Corp. received the proposal from Wespath Investment Management, the Nathan Cummings Foundation and other investors, including the California Public Employees’ Retirement System (“CalPERS”), and it received support of 67.3% of votes cast by the company’s shareholders, including BlackRock, a 7.8% owner. In an unprecedented move, BlackRock issued a press release announcing that it had supported the shareholder proposal.
  • PPL Corp., a utility holding company, received the proposal from the New York State Common Retirement Fund, and it received support of 56.8% of votes cast by the company’s shareholders, including CalPERS and other pension funds.
  • Exxon Mobil received the proposal from the New York State Common Retirement Fund, and it received support from about 62.1% of votes cast by the company’s shareholders.
These votes reflect the new willingness of institutional investors to support environmental proposals and the effect of increased pressure from their clients to influence companies on environmental issues. In addition, the same proposal was submitted to 18 other companies and voted on at ten companies, where it averaged 45.6% of votes cast.
B. Board Diversity Proposals
Board diversity continues to remain at the forefront of corporate governance discussions as investors and shareholder activists are increasingly pushing for gender diversity on the boards of U.S. public companies. Most recently, BlackRock and State Street Global Advisors announced plans to drive greater gender diversity on boards through active dialogue with companies. These institutional investors have indicated that, if progress is not made within a reasonable time frame, they plan to use their proxy voting power to influence change by voting against certain directors, such as members of nominating and governance committees.
As such, perhaps unsurprisingly, in 2017 the number of board diversity proposals reached an all-time high. Thirty-five proposals calling for the adoption of a policy on board diversity or a report on steps to increase board diversity were submitted in 2017 as compared to 28 proposals submitted in 2016. As in 2016, a substantial number of board diversity proposals were withdrawn, likely due to commitments made by companies to the proponents of these proposals, such as adopting board recruitment policies inclusive of race and/or gender.
Of the 35 proposals submitted in 2017, eight proposals have been voted on and received, on average, 28.3% of votes cast, as compared to six proposals in 2016, which received, on average, 19.1% of votes cast. ISS recommended that shareholders vote “for” all but two of the proposals voted on in 2017 and “for” all but one of the proposals voted on in 2016.
Two board diversity proposals submitted in 2017 received majority support, as compared to one in 2016. One of the successful proposals was submitted by the City of Philadelphia Public Employees Retirement System to Cognex Corp. requesting that the company’s board adopt a policy for “improving board diversity [by] requiring that the initial list of candidates from which new management-supported director nominees are chosen . . . by the Nominating and Corporate Governance Committee should include (but need not be limited to) qualified women and minority candidates.” Cognex Corp. had no women on its board of directors. The proposal received 62.8% of votes cast. The second proposal asked a different company to prepare a report (at a reasonable expense and omitting proprietary information) on steps the company is taking to foster greater diversity on its board. The proposal received the support of 84.8% of votes cast.
These results, along with the continued investor focus on board composition and board diversity, mean that board diversity will continue to be raised in shareholder engagements, and that shareholder proponents likely will continue to use the Rule 14a-8 shareholder proposals process as a way to push for greater board diversity.
C. Other Diversity-Related Proposals
Approximately 34 proposals submitted to companies in 2017 related to discrimination and diversity concerns, compared to 16 such proposals in 2016. These proposals included 20 proposals calling for the preparation of a diversity report, eight proposals calling for policy amendments to prohibit discrimination based on sexual orientation and gender, and six proposals calling for a report on company non-discrimination policies. On average, the eight proposals related to discrimination and diversity concerns that were voted on in 2017 received support from 24.2% of the votes cast. ISS recommended that shareholders vote “for” all but three of these proposals voted on in 2017 and “for” all but two of these proposals voted on in 2016.
D. Gender Pay Gap
Approximately 19 proposals submitted in 2017 concerned the gender pay gap, compared to approximately 13 such proposals submitted for 2016 meetings. Among the 19 proposals were 17 proposals requesting reports on the gender pay gap (two of which also requested a report on any race or ethnicity pay gaps), one proposal requesting evidence that no gender pay gap exists, and one proposal requesting disclosure of the number of women at each compensation percentile. The proposals calling for a report on the gender pay gap include seven proposals submitted to financial institutions and credit card companies requesting a report on whether the company has a “gender pay gap,” the size of the gap, and its policies and goals to reduce the gap. On average, the eight gender pay gap proposals that were voted on received support from 18.8% of the votes cast. ISS recommended that shareholders vote “against” all eight of these proposals in 2017 but “for” three out of the five proposals voted on in 2016.
E. Pay Disparity
Approximately 14 proposals regarding pay disparity were submitted in 2017, as compared with nine in 2016. Among these proposals were two general types: proposals related to employee wages (eight proposals) and proposals requesting a report on the ratio between compensation paid to senior management and the median employee (six proposals). On average, the three pay disparity proposals that were voted on in 2017 received the support of only 5.3% of the votes cast. ISS recommended that shareholders vote “against” all three of these proposals voted on in 2017 and “against” both of these proposals voted on in 2016.
Among the proposals related to employee wages were six proposals requesting that companies adopt principles for minimum wage and/or guaranteeing a living wage (five of which were submitted by either, or both of, Trillium Asset Management and Zevin Asset Management) and two proposals requesting a report on incentive risks for low-paid employees.
Although the six pay ratio proposals represent a three-fold increase over the two pay ratio proposals submitted for 2016 meetings, the number remained well below the 15 pay ratio proposals submitted in 2015. Pay ratio is likely to become a focus in upcoming months for companies and the investors eager to obtain this information, as under current SEC regulations, the pay ratio rule will generally require companies to disclose a pay ratio in their 2018 proxy statements. Assuming no change in current regulations, the impact of this 2018 pay ratio disclosure on shareholder proposals may become apparent during the subsequent proxy season (i.e., in 2019).
F. Virtual Annual Meeting-Related Proposals
In recent years, an increasing number of companies have opted to hold exclusively virtual annual shareholder meetings. These annual meetings are commonly referred to as “virtual-only annual meetings.”
After not submitting shareholder proposals on this topic during the 2015 and 2016 proxy seasons, some proponents submitted proposals in 2017 requesting that companies that previously held virtual-only annual meetings adopt a corporate governance policy to initiate or restore in-person annual meetings. Notably, none of these proposals have gone to a vote.
Instead, in a decision critical for companies that currently hold or are contemplating switching to virtual-only annual meetings, the Staff issued a no-action letter for the 2017 proxy season permitting HP Inc. to exclude a shareholder proposal submitted by John Chevedden and Bart Naylor that objected to virtual-only annual meetings. The Staff concurred that the proposal could be excluded under Rule 14a-8(i)(7) on the grounds that the “determination of whether to hold annual meetings in person” is related to the company’s ordinary business operations.
Since then, investors (including the New York City Comptroller, Walden Asset Management, the Interfaith Center on Corporate Responsibility, CalPERS, and the Council of Institutional Investors (“CII”)) have continued to advocate against virtual-only meetings through their own policy pronouncements and direct communications with companies holding virtual-only meetings. For instance, in the spring of 2017, the New York City Comptroller sent letters to more than a dozen S&P 500 companies that held virtual-only meetings in the prior year (or had announced that they would do so in the future) urging them to host in-person annual meetings instead, but noting that it welcomed and encouraged the use of new technologies to expand shareholder participation (i.e., in the context of “hybrid” annual meetings that allow both live and on-line participation). Furthermore, under its updated proxy voting guidelines, the New York City Comptroller, on behalf of four New York City pension funds, has indicated that the pension funds “may oppose all incumbent directors of a nominating committee subject to election at a ‘virtual-only’ annual meeting.”
G. Proxy Access Proposals
Although proxy access was the second most common shareholder proposal topic in 2017, the spotlight has waned on this issue as proxy access has become the majority practice in the S&P 500 (over 60% have adopted as of the end of the 2017 proxy season). Proxy access refers to the right of shareholders under a company’s bylaws to nominate candidates for election to the board and have the shareholder nominees included in a company’s proxy materials.
After two years of growing pains, proxy access has become the latest widely-accepted governance change among large-cap companies, following in the footsteps of previous shareholder-advocated governance changes, such as the replacement of plurality with majority voting in uncontested director elections and the declassification of boards. Likewise, the core provisions in proxy access bylaws are now settled (i.e., ownership of 3% of a company’s shares for at least three years, and the right to nominate up to 20% of the board by a shareholder or group of up to 20 shareholders).
Approximately 112 proxy access proposals were submitted for 2017 meetings, representing significantly fewer than the 201 proposals submitted for 2016 meetings and only slightly more than the 108 proposals submitted for 2015 meetings. Of the 112 proxy access proposals, 59 proposals requested the adoption of a proxy access bylaw (“adopt proxy access proposals”) and 53 proposals requested amendments to an existing proxy access bylaw (“amend proxy access proposals”). Thirty-four of the adopt proxy access proposals and nearly all of the amend proxy access proposals were submitted by John Chevedden (in his own capacity and on behalf of others), while an additional 18 adopt proxy access proposals were submitted by the New York City Comptroller.
The 18 adopt proxy access proposals voted on received average support of 63.1% of votes cast, while the 20 amend proxy access proposals voted on received average support of 28.5% of votes cast. A total of 13 proxy access proposals (all adopt proxy access proposals) received a majority of votes cast. ISS recommended that shareholders vote “for” all of the proxy access proposals voted on in 2017 and “for” all but one of the proxy access proposals voted on in 2016.
The main proxy access development in 2017 related to proposals seeking to amend an existing proxy access bylaw to increase the number of shareholders permitted to constitute a nominating group. The Staff generally agreed with companies that they could exclude these proposals as substantially implemented, provided that the no-action request demonstrated how the existing aggregation limit achieved the proposal’s goal of providing a meaningful proxy access right.
As in 2016, a number of companies also obtained no-action letters concurring that a proposal seeking adoption of proxy access had been substantially implemented when the companies responded to the receipt of an adopt proxy access proposal by adopting a proxy access bylaw prior to their annual meetings, even though the companies’ bylaws varied in certain respects from the proxy access terms requested in the proposals.
III. Potential Reform of Shareholder Proposal Rule
There have been growing calls over the last decade to amend Rule 14a-8, the SEC’s shareholder proposal rule, to update various thresholds in the rule and to address some of the ways in which the rule has been abused. For example, in 2014, the U.S. Chamber of Commerce, along with eight other business organizations, petitioned the SEC to raise the existing threshold for the excludability from company proxy materials of shareholder proposals previously submitted to shareholders that did not elicit meaningful shareholder support. The petition requested that the SEC reconsider its resubmission rule by conducting a thorough cost-benefit analysis of the current rule and creating new threshold percentages based on the conclusions gleaned from its cost-benefit analysis.
More recently, the House Republicans’ proposal for financial regulation reform, the CHOICE Act, tackled the issue. The legislation, which passed the House by a 233-186 vote in early June, would amend the shareholder proposal rule to (1) increase the holding period for the shareholder proponent from one year to three years; (2) require that a shareholder hold 1% of a company’s outstanding stock (and eliminate the option to satisfy this requirement by holding $2,000 in stock) for the holding period; (3) prohibit the submission of proposals other than by the shareholder (so-called “proposals by proxy”); and (4) increase the percentage of support that a proposal must have received the last time it was voted on in order to be resubmitted. The proposed resubmission thresholds would exclude proposals that previously were voted on in the past five years and most recently received less than 6% (currently 3%) if voted on once, 15% (currently 6%) if voted on twice, and 30% (currently 10%) if voted on three times.
The CHOICE Act has faced strong opposition from institutional investors, including CII, which sent a letter to House members urging them to oppose the bill. While the legislation’s prospects in the U.S. Senate are uncertain, the SEC may consider Rule 14a-8 amendments (although that is more likely to occur once the two vacancies on the Commission are filled).
IV. Top Take-Aways for 2017 Season
Based on the results of the 2017 proxy season, there are several key take-aways to consider:
  • First, 2017 was the year for both environmental and social proposals to take center stage, and the spotlight on these issues is likely to continue to shine brightly in 2018.
    • Over 40% of shareholder proposals submitted in 2017 dealt with environmental and social issues, making this the largest category of shareholder proposals for the first time since 2014.
    • The key environmental proposals in 2017 were climate change proposals (69 in 2017, with those voted on averaging 33.8% support); environmental impacts on communities or supply chains (28 in 2017, with those voted on averaging 23.6% support), and reports on sustainability (24 in 2017, with those voted on averaging 30.0% support). The key social proposals to watch are board diversity proposals (35 in 2017, with those voted on averaging 28.3% support); diversity-related proposals (34 in 2017, with those voted on averaging 24.2% support); and gender pay gap proposals (19 in 2017, with those voted on averaging 18.8% support).
    • With the Administration’s decision to withdraw from the Paris Climate Accord and decrease federal support for environmental initiatives, the focus on private sector environmental initiatives has increased, including through the submission of shareholder proposals. In this context, engagement on climate-related matters has become more important, as several institutional investors have indicated that company engagement and responsiveness on these issues can sway their votes.
    • With several institutional investors increasingly willing to support environmental proposals, companies should consider whether to take additional actions with respect to their sustainability practices and how these efforts are communicated to investors.
  • Second, in the area of virtual-only annual meetings, the stage is set for increased debate over this hot-button issue.
    • Companies now have solid no-action request precedent to exclude these shareholder proposals. That being said, certain investors are very vocal about their opposition to virtual-only meetings. Their activism (both leading up to and during the meeting) may discourage some companies from making a move to virtual-only meetings.
    • Companies that are currently holding virtual-only annual meetings may face increasing pressure to either hold hybrid annual meetings or to enhance virtual-only meetings to make them as interactive as possible (i.e., as close to a physical annual meeting as possible). This would include live audio and/or video participation for all shareholder participants, which is something most companies that hold virtual-only annual meetings currently do not accommodate.
  • Third, although the spotlight on proxy access has waned, this has become the latest standard governance practice.
    • Companies that have not yet adopted proxy access are likely to continue to face shareholder proposals on this topic in the coming years, and these proposals are likely to continue to receive significant support—in 2017, adopt proxy access proposals voted on received average support of 63.2% of votes cast.
    • Accordingly, companies that have not yet adopted proxy access may consider whether to do so—and this may arise either in response to a shareholder proposal or due to the desire to align with majority practice among S&P 500 companies. Likewise, companies that previously adopted proxy access, particularly those that were early adopters of proxy access, may want to revisit their bylaws and consider whether their provisions align with the terms adopted by the majority of adopters.
  • Lastly, the momentum to amend Rule 14a-8 is growing, albeit slowly.
    • There is increasing support for amendments to the shareholder proposal rule to update various thresholds in the rule and address some of the ways in which the rule has been abused. Rule 14a-8 was last amended in 2010 to no longer permit the exclusion of proxy access shareholder proposals. However, there have been calls for some time to address other aspects of the rule. Top items on the reform list for Rule 14a-8 include increasing the holding period and ownership requirements for shareholder proponents and increasing the resubmission thresholds for proposals that were voted on in prior years.
    • The CHOICE Act takes a comprehensive approach to amending the rule and aims to address these “top items” on the reform list as well as to prohibit submission of so-called “proposal by proxy” (i.e., ability of a proponent to act as a designee for an actual shareholder with respect to a proposal). Given the scope of the reforms in the CHOICE Act, and with a new Administration and growing support for deregulation, changes to Rule 14a-8 may finally happen. Even without Congressional action, the SEC could take action on its own to amend Rule 14a-8 with its rulemaking authority.
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Common-Sense Capitalism

July 27, 2017

Corporate Governance Update: Common-Sense Capitalism

David A. Katz and ∗

Laura A. McIntosh

Recent developments in corporate governance indicate a welcome emphasis on common sense principles. Over the past year, leaders of prominent companies and institutional investment funds have proposed principles and a framework intended to guide U.S. corporate governance toward practices that promote the sustainable creation of long-term value. The shared goal of these two separate projects—the Investor Stewardship Group’s “Corporate Stewardship and Governance Principles,” released in 2017, and “Commonsense Principles of Corporate Governance,” an open letter released in 2016—is to bolster companies’ ability to generate prosperity for American investors. Prioritizing practicality over prescription should improve the quality and effectiveness of corporate governance, to the benefit of all market participants.

Stewardship and Governance Principles

The Investor Stewardship Group—a collective of U.S.-based institutional investors and global asset managers—launched an initiative in January 2017 to establish a framework for standards of stewardship and corporate governance to promote long-term value creation in American business. The ISG represents $17 trillion in assets under management and is led by the participating firms’ senior corporate governance practitioners. The framework, set to become effective in January 2018, contains six principles for investor stewardship and six principles for corporate governance. While the framework has no legal force, it is modeled on the “comply or explain” governance frameworks that exist in the United Kingdom and elsewhere and is intended to stand as an unofficial national code of fundamental governance principles. The framework is not intended to be prescriptive and is expected to be revised periodically as consensus around stewardship and governance evolves. Since it lacks any enforcement or self- policing mechanism, the principles will only become meaningful through widespread adoption by market participants.

The stewardship principles highlight two positive trends in corporate governance. The first is that business leaders are uniting to promote cooperation and improve communication among companies, large investors, and shareholders. The second is that institutional shareholders may be reclaiming much of the authority they ceded to proxy advisory firms in recent decades. One of the stewardship principles is that institutional investors are responsible for proxy voting decisions and should monitor the activities and policies of proxy advisors, and another is that institutional investors should address and resolve differences with companies in a constructive and pragmatic manner. These principles are designed to increase accountability, improve communication, and create a sense of shared responsibility between investors and companies. If successful, they will go a long way toward reducing the heretofore outsized influence of proxy advisors in the corporate governance sphere. Pending legislation in Congress that would regulate proxy advisory firms may accelerate this development. Without undue pressure from proxy advisors to conform to one-size-fits-all governance practices, and with the support of their institutional investors, companies should benefit from greater flexibility to implement the practices that are most effective in their particular circumstances.

The corporate governance principles set forth by the ISG cover topics such as director independence and leadership and board responsiveness to shareholders. They also address board accountability, shareholder voting rights, and management incentive structures and are elaborated with fairly detailed guidance on each point. While the principles do advocate some policy positions, such as proportional voting and proxy access, these specifics are less important than the overarching themes of accountability, transparency, and effectiveness. Under this framework, a company with a compelling record of furthering the key governance principles, albeit through different governance practices, should find support among its investors.

The 2016 open letter, “Commonsense Principles of Corporate Governance” is a separate effort, operating at a higher level of generality than the ISG principles. The letter was signed by ten well-known corporate leaders in a range of industries, including the chief executives of General Motors, JPMorgan

Chase, Berkshire Hathaway, GE, and Blackrock. The signatories emphasized that public companies hold a public trust, and that the financial future of American families depends on the success of America’s business sector and public confidence in America’s financial markets. While acknowledging a diversity of opinion on corporate governance matters, the letter proposed a baseline for constructive dialogue on matters of governance. The recommendations in the letter hewed to a number of well-established principles: director independence and leadership, board diversity, financial accounting transparency, and constructive shareholder engagement. The letter also encouraged companies to provide quarterly earnings forecasts only when beneficial to shareholders and not as a matter of obligation. While not a dynamic project like the ISG framework, the letter has the potential to be significant, as it indicates that American business leaders today are focused on promoting rationally-based, prosperity-oriented corporate governance. With continued engagement between institutional investors and public companies, there is an opportunity to foster lasting change in the corporate governance paradigm.

Looking Ahead

As corporate law is a matter of state, rather than federal, law, corporate governance generally is not within the purview of the Securities and Exchange Commission. The diversity of state corporate law is a valuable feature of the U.S. business landscape. While many countries have uniform governance codes, corporate governance in the United States is a patchwork of state law, stock exchange rules, federal requirements, and prevailing norms. Nonetheless, the SEC can be a factor in encouraging the current trend toward common sense governance, a project which would seem to align with the agenda of SEC Chairman Jay Clayton. Chairman Clayton indicated this month, in his first official speech, that his tenure will prioritize “the long-term interests of the Main Street investor.” The SEC is undertaking initiatives to improve the quality and utility of disclosures provided to investors through simplification, modernization, and an emphasis on readability. Chairman Clayton also intends to empower individual investors through education and information resources. As disclosures become more legible, and as shareholders become better informed, the quality of communication between companies and investors should improve significantly, producing more meaningful dialogue, more responsive boards, greater credibility between investors and management teams, and better governance overall.

In recent decades, there has been at times a counterproductively antagonistic relationship between institutional investors and corporations. Efforts such as the ISG framework may help to shift this dynamic into a constructive and cooperative one. Companies and their long-term investors should be united in their shared goals of prosperity and good governance, and both should seek governance norms that help to produce sustainable growth and success. The framework established by the ISG potentially represents a new phase in corporate governance. Inspired by the common-sense guidance of business and regulatory leaders, corporate governance is poised to move into its next phase: one in which ethical principles and good business values are implemented across the marketplace as context-driven accountability and shared economic success.

∗ David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.

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Boards Should Focus On The Long Term

Martin Lipton
Daniel Bulaevsky

June 30, 2017

The Classified Board Duels

          Professor Lucian Bebchuk has engaged in two rounds of law-review-article duels with Professor Martijn Cremers and Professor Simone Sepe over classified boards.  The weapons were statistics (and common sense).  Cremers and Sepe wore the classified-board-stakeholder colors; Bebchuk, the agency-model-shareholder-democracy colors.  Cremers’ and Sepe’s riposte was decisive. 

          The field for these duels was chosen by Bebchuk in 2011 when he chartered the Harvard Law School Shareholder Rights Project (the “Harvard Project”).  Bebchuk described the Harvard Project as an academic program designed to “contribute to education, discourse, and research related to efforts by institutional investors to improve corporate governance arrangements at publicly traded firms.”  In practice, it worked to eliminate the classified-board moat protecting companies from short-termism and attacks by activist hedge funds.  Over the course of three academic years from 2011 to 2014, the Harvard Project submitted declassification proposals to 129 companies, resulting in 102 declassifications.

          Bebchuk’s Harvard Project sparked sharp criticism.  Former SEC Commissioner Daniel Gallagher’s and Stanford Professor Joseph Grundfest’s Did Harvard Violate Federal Securities Law? The Campaign Against Classified Boards of Directors (2014) argued that it “relie[d] on the categorical assertion that staggered boards are associated with inferior financial performance” and that the proposals omitted disclosure of significant, conflicting research.

          Scholars with sharpened statistics followed suit.  Cremers’ and Sepe’s The Shareholder Value of Empowered Boards (2016), as well as their follow-on piece Staggered Boards and Long-Term Firm Value, Revisited (2017) coauthored with Lubomir Litov, employed lengthy time-series studies showing that classification (declassification) is associated with an increase (decrease) in firm value.  These studies exposed the limitations of prior cross-sectional studies:  namely Bebchuk’s The Costs of Entrenched Boards (2005), which succumbs to the reverse causality fallacy.  They provided “no support for the entrenchment view.”  In light of their findings, the authors urged policy reform to make classification boards quasi-mandatory, exclude shareholder declassification proposals and impose a supermajority requirement on board declassification proposals.  They believed this reform would “restore a board’s ability to credibly commit shareholders to long-term value creation, which is in their own and society’s best interests.”

          Cremers and Sepe then turned to the Harvard Project.  Board Declassification Activism:  The Financial Value of the Shareholder Rights Project (2017) treated the Harvard Project as a “quasi-natural experiment” to again measure value implications of classifications.  These data provided a source of exogenous variation, useful to avoid the flaws in prior cross-sectional studies, because the Harvard Project plausibly had “a direct, causal impact” on classification decisions.  And the results remained the same.  They found that Harvard Project targets that declassified declined in value, more so than non-Project targets, and that such declines appeared “directly attributable to . . . declassification.”  Further, these results were especially strong for firms with large research and development investments.  Consistent with recent studies, they concluded that “classified boards may serve a positive governance function in some companies, thus challenging the ‘one-size-fits-all’ approach to board declassification exemplified by the [Harvard Project] and, more generally, most activist investors and proxy advisory firms.”

          In Recent Board Declassifications:  A Response to Cremers and Sepe (2017), Bebchuk and Alma Cohen contend that, “appropriately interpreted,” Cremers’ and Sepe’s 2017 study contradicts their own 2016 study because it “provide[s] some significant evidence that declassifications are beneficial and no evidence that they are value-reducing.”  Bebchuk and Cohen focus on non-Project declassifications, which they believe are more important than Project declassifications (reasoning that the Harvard Project was limited in time and scope), and claim that firm values did not decline after non-Project declassifications.  They turn only briefly to Project declassifications, finding that the results do not “provide a basis for concluding that [such] declassifications reduced value.”  Bebchuk and Cohen conclude that the results “fail to provide any basis for opposing declassifications,” which justifies the apparent retreat from the policy proposal in the 2016 article (i.e., the relatively weaker language in the 2017 article).

          In response to Bebchuk and Cohen, Cremers’ and Sepe’s Board Declassification Activism:  Why Run Away from the Evidence? (2017) reiterates their findings and argues that Bebchuk’s and Cohen’s critique is unwarranted because, put simply, it ignores the evidence.  That is, the critique essentially disregards the main result that firm values declined after Project declassifications; cherry-picks data, sidestepping or downplaying key results; draws conclusions on statistically and economically insignificant results, defying the “basic econometric precept that no inferences can be drawn when results lack statistical significance” and incorrectly focuses on non-Project declassifications while failing to interpret them in connection with Cremers’ and Sepe’s prior studies.  Finally, Cremers and Sepe show that their 2017 study reinforces, and not belies, their policy proposal with new data:  a $90 to $149 billion decline in value associated with Project declassifications that their policy would have mitigated “if not altogether prevented.”

          The costs of Bebchuk’s actions are real.  He has exposed hundreds of major U.S. companies to short-term pressures and attacks by activist investors to the detriment of those companies, their shareholders and, more generally, the economy.  With the growing recognition by major institutional investors, asset managers and academics that short-termism and activism are antithetical to the interests of all stakeholders, including shareholders, and society generally, one hopes that Bebchuk and his cohorts would cross the Charles River and join their Harvard Business School colleagues, Jay Lorsch, William George, Joseph Bower and Lynn Paine in supporting long-term investment and rational, not shareholder-only, governance.  In a recent article, Bower and Paine sum up the damage done by one-size-fits-all, shareholder-centric governance:

To us, the prospect that public companies will be run even more strictly according to the agency-based model is alarming. Rigid adherence to the model by companies uniformly across the economy could easily result in even more pressure for current earnings, less investment in R&D and in people, fewer transformational strategies and innovative business models, and further wealth flowing to sophisticated investors at the expense of ordinary investors and everyone else.

Martin Lipton

Daniel Bulaevsky

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Boards Should Focus On Cybersecurity

David A. Katz
Laura A. McIntosh*

          Recent global cyberattacks have rudely reminded corporate America that cybersecurity risk management must be at the top of the board of directors’ corporate governance agenda.  Companies have no choice but to prepare proactively, while directors must understand the nature of cybersecurity risk and prioritize its oversight.  Preparation, monitoring, emergency response, and disclosure are topics that boards should consider regularly to properly oversee cyber-risk management.  Boards should receive periodic updates from management and its expert advisors on the rapidly developing regulatory cybersecurity environment and on the company’s compliance with applicable cybersecurity standards.

Regulatory Environment

          A wide range of regulatory efforts are underway with respect to cybersecurity.  President Trump signed an executive order this month requiring federal agencies to proactively assess and manage their cybersecurity risks; while the order does not apply to public companies, it highlights the importance of vigilant attention to addressing cyber threats.  Federal banking regulators are in the process of establishing cyber-risk management standards for major financial institutions.  And on Capitol Hill, a draft bill was introduced last year that would apply Sarbanes-Oxley certifications and internal controls requirements to a company’s information and technology systems and cybersecurity-related controls; while its passage is unlikely, it indicates legislative attention to this issue.

          The Securities and Exchange Commission is expanding its focus on cybersecurity.  The Enforcement Division has pursued charges in several cases relating to failures to adequately protect customer data, and the SEC’s Office of Compliance Inspections and Examinations indicated that reviewing cybersecurity compliance procedures and controls would be a priority in 2017.  The SEC has expressed support for the widely utilized NIST Framework, indicating that boards should work with management to ensure that their corporate policies conform to the Framework’s guidelines, which are in the process of being updated.

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Managing For The Long-Term

The Error at the Heart of Corporate Leadership


The time has come to challenge the agency-­based model of corporate governance. Its mantra of maximizing shareholder value is distracting companies and their leaders from the innovation, strategic renewal, and investment in the future that require their attention. History has shown that with enlightened management and sensible regulation, companies can play a useful role in helping society adapt to constant change. But that can happen only if directors and managers have sufficient discretion to take a longer, broader view of the company and its business. As long as they face the prospect of a surprise attack by unaccountable “owners,” today’s business leaders have little choice but to focus on the here and now.

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Shareholder Activism

The attached article, Corporate Governance Update: Preparing for and Responding to Shareholder Activism in 2017, was published in the New York Law Journal on March 23, 2017

March 23, 2017

Corporate Governance Update: Preparing for and Responding to Shareholder Activism in 2017

David A. Katz and Laura A. McIntosh*

Activist investors are taking advantage of favorable conditions in the 2017 market environment to further their activist agendas. Activists have an estimated $243 billion in assets under management and are eager to recoup losses from 2016, when the S&P 500 outperformed activist funds as a whole. Companies should review their overall preparedness, take a close look at their potential vulnerabilities to activist attack, and proactively shore up any weaknesses to the extent possible. Anticipating likely avenues of attack will help boards of directors to be prepared and, if necessary, to implement promptly a disciplined and focused plan of response.


Principles of Preparation

Preparation is an ongoing process. Corporate leadership can anticipate an activist approach by evaluating the business through the eyes of a short term financial investor and understanding how that perspective may differ from that of a long-term, patient investor. Applying an activist investor’s mindset to assess and test capital allocation and other strategies for “unlocking value” can be extremely useful for the board and management team, with the caveat that understanding that mindset does not mean the company should necessarily adopt and implement it. Companies should also remain aware of the takeover landscape in their industry, with an eye to which players may be interested in acquiring them for operational or synergistic reasons, or which may enter the fray if an activist investor puts them “in play.”

The core strategy of activist funds is to drive a wedge between the company and its shareholders, or between management and the board. By embarrassing management or the directors, by suggesting that management has not capitalized on available opportunities, or by undermining board confidence in management, the activist creates exploitable weakness in the leadership of the target. Thus, potential target companies need to stay a step ahead and focus on preventing seeds of division from taking root.

Management should keep the board fully informed of their ongoing analysis of likely activist approach tactics. Management should also focus on building and maintaining credibility with shareholders as well as other key stakeholders. While the primary engagement between the company and its institutional investors should be led by management, in some proactive investor relations programs, major institutional shareholders may be afforded the opportunity to engage with independent directors. Such meetings can be very valuable in terms of corporate preparedness, as investors may expose reports of activist activity previously unnoticed by management and may better attune a board to governance and other concerns held by significant institutional investors. In situations where these concerns are unnoticed or not addressed, the activist investor is likely to receive support from frustrated institutional investors.

There are often early warning signs to indicate that an activist approach may be in the offing. Analyst reports suggesting structural changes, extremely pointed questions during a question and answer session on an earnings conference call or during an investor conference, changes in the shareholder base, and activist interest in other industry players are all potential indicators of activist interest. Activist investors are very resourceful and may reach out to investor relations or individual directors before approaching senior management. In these circumstances, all substantive contacts from an activist should be referred to the chief executive, who should be prepared to handle an initial conversation or direct who will handle the initial contact. It can be difficult to walk back statements made during early contacts with an activist, and directors may not have the same perspective (or the same information) as the chief executive.


Principles of Response

It is essential that the company speak with one voice: that of the chief executive, backed by a unified board. The CEO, in consultation with the chairman or lead director, should coordinate the company’s response to all activist approaches, overtures, and conversations. Whether or not an activist should be given direct access to the CEO is a tactical decision that should be considered in light of the particular circumstances. While activists may seek to contact board members directly, directors should understand that engaging personally means that their involvement may be publicized, and they should be accordingly circumspect. The CEO should consult with the board and seek advice, with honest and open discussion kept confidential within the boardroom walls. Independent directors can be an important part of the outreach to the activist and institutional investors, but their involvement needs to be carefully choreographed and coordinated. Speaking with a single, consistent voice throughout the activist engagement is essential.

Utilizing advisors well-schooled in activist situations is important. Outside counsel, investment bankers, public relations professionals, proxy solicitors and similarly experienced advisors are important sources of information regarding tactics and approaches for dealing with an activist. These advisors tend to be most useful when they have familiarity with a company before an activist is on the scene but can be useful additions to a team when faced with an activist attack. Directors and management need to remember, though, that most investors want to hear directly from the board and the management team and not have their message filtered by or through advisors. Activists will engage directly with institutional investors, and companies need to do the same.

If at all possible, a company should attempt to keep its discussions with activists private. Once a situation becomes public, the target company’s options narrow dramatically. An activist becomes invested in extracting changes for which it can publicly take credit. Moreover, a public situation can create tension with institutional shareholders, who are likely to interpret “long term” as a matter of months and “value” as any amount above their basis in the stock. If an activist approach does become public, the best initial response is simply a statement that the board welcomes, and will consider, input from its shareholders. The board should call a meeting with the management team and consider further communications. Communications outreach may include a press release affirming the board’s openness to shareholder input, calls to or meetings with the largest shareholders, outreach to key media contacts, and possibly communications with employees and other important stakeholders. An investor presentation deck should be drafted or updated to reflect the situation and the company’s strategy. Each decision made by a company in this context needs to be measured against the standard of whether it is likely to win a vote in support of management or lose a vote to the activist.

While the nature of a company’s response must be determined by specific circumstances, constructive engagement is often preferable to taking an antagonistic stance. Many activists will listen to reasonable arguments, particularly in private. They will want to know that their views are being taken seriously and that the board is open to change and willing to consider potential alternatives that are not in the current strategic plan. That said, management and any directors involved should not be too trusting in a “private” discussion. They should act and speak as though anything they do or say will be made public. Conversations, emails, and other communications will be considered fair game for activists to quote, publicize, and use in proxy materials and fight letters opposing management’s slate. Moreover, the public dialogue is asymmetrical: Activists will not hesitate to quote a company representative out of context, make personal attacks, and use aggressive language, while the company itself cannot respond in kind. Companies that stoop to the level of the activist will find themselves punished by investors.

Fundamentally, the company must not allow activists to gain the “moral high ground” of corporate governance or shareholder rights. It is the board, and not an activist, that represents the interests of all shareholders. It is the board, in its business judgment, and not an activist, that determines good governance for the company. The board and management should be confident in their leadership and in their judgment and communicate their positions as effectively as possible to the shareholder base. Meanwhile, management must remain focused on the business itself and conduct itself in a manner that preserves credibility and is consistent with the company’s stated long-term strategy. The activist situation can create additional challenges, as activists often contact other large shareholders, business partners, institutions, private equity funds and other potential acquirors, former and current employees, and competitors’ shareholders. However, if the company concludes that an activist-sponsored strategy is unwise or counterproductive, management and the board should have courage and confidence in declining to pursue it. -5- Management and the board must then convince shareholders that the company’s conclusion is correct.

While an activist situation can seem urgent and fraught, a board does have time and flexibility in responding. The risk of legal liability is low, as long as the board acts in a deliberative manner, on an informed basis. A well prepared and unified board and management represent a strong bulwark against activist attacks.

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America’s Leadership Divide Is the Nation’s Biggest Enemy

Right now, a new Administration and Congress are struggling to resolve public policy issues that are crucial to the well-being of the American people. And the struggle is all the more challenging because of extremes divisions between and even within the political parties. Not only is our nation’s level of consensus low, but also the trend line is stuck steeply in the wrong direction.

Clearly, however, continued American economic success, and “exceptionalism,” is impossible without social cohesion and a sense of broadly shared public purpose. It is time for the business community to point out and build upon all of the fundamental values that all Americans share. Before our countrymen drain all of our energy fighting among ourselves, we all need to wake up and remember that we are on the same team, and that we need to succeed together.

Although U.S. business itself is under widespread scrutiny, business supplies the jobs and the incomes and the growth that all Americans need. And business leaders need to step up and engage with elected officials regarding public policy. They must put their native skills to work in public debate over the crucial issues of the day that can make the difference between prosperity and stagnation. This role dates back to the era of business statesmanship, where respectful dialog allows thinkers to disagree but in the process to find and agree upon a better way.

In recent years, particularly during and since the financial crisis, the U.S. economy has not grown the jobs and the incomes that people want and expect. Our nation’s business leaders have the expertise to address these concerns. But they cannot point the way from the bottom of the fox hole. Sure, stepping forward and speaking out publicly is a risk, but so is business. And so is the future of the nation.

Business leaders need to speak up to educate the public about the policy issues that hold the key to job and income growth and how business and markets can help to set the stage for growth and prosperity.

For example, the rising cost of health care is draining both government – federal, state and local – and private – business and household – budgets. In particular, dollars that businesses pay out for health insurance premiums cannot be used to pay higher cash wages – or for R&D, or for other investments that create innovation and jobs. Market-driven incentives can make the provision of health care more cost-effective. But people want assurances that they will still have coverage, and that the quality of their care won’t suffer. If our policymakers face up to the issues and talk straight to the American people, there is an answer.

Businesses want to generate jobs and pay good and growing wages, but taxes and regulations can get in the way. Still, government needs to pay its bills – which it is hasn’t done in many years – and regulations can level and smooth the business playing field, not just tilt and block it. Business leaders can respond to popular concerns and make government tax and regulatory systems work better at the same time. We need an adult conversation about how to do that.

We need to put business expertise to work to find solutions – publicly acceptable solutions – to these pressing public problems. But perhaps even more important these days, business leaders can also demonstrate how to work with others who have the same love of country but different political views, and how they can find common ground to build a future where everybody wins.

Competition and markets can drive our economy forward. Sound public policies can build the system to reward everyone who plays by the rules and puts his shoulder to the wheel. Anything short of a combination of both of those ingredients leaves our nation vulnerable in today’s globalized economy, and therefore threatens our leadership in every phase of geopolitical life. America’s unique form of capitalism is too good to lose. Let’s engage, and ensure its sustainability.

Steve Odland and Joe Minarik are coauthors of the book, Sustaining Capitalism: Bipartisan Solutions to Restore Trust & Prosperity. Odland is CEO of the Committee for Economic Development (CED), a nonprofit, nonpartisan, business-led public policy organization that delivers analysis and solutions to our most critical issues. He is also former CEO of Office Depot and AutoZone. Minarik is senior vice president and director of research at CED. He was the chief economist of the Office of Management and Budget under the Clinton Administration.

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Board Need Diversity

Corporate Governance Update:  Prioritizing Board Diversity

David A. Katz
Laura A. McIntosh

          In what has been called a “breakout year” for gender diversity on U.S. public company boards, corporate America showed increasing enthusiasm for diversity-promoting measures during 2016.  Recent studies have demonstrated the greater profitability of companies whose boards are meaningfully diverse.  In many cases, companies have collaborated with investors to increase the number of women on their boards, and a number of prominent corporate leaders have publicly encouraged companies to prioritize diversity.  The Business Roundtable, a highly influential group of corporate executives, recently released a statement that explicitly links board diversity with board performance in the two key areas of oversight and value creation.  Likewise, a group of corporate leaders—including Warren Buffett, Jamie Dimon, Jeff Immelt, and Larry Fink, among others—published their own “Commonsense Principles of Corporate Governance,” an open letter highlighting diversity as a key element of board composition.

Momentum toward gender parity on boards is building, particularly in the top tier of public corporations.  Pension funds from several states have taken strong stances intended to encourage meaningful board diversity at the 25 percent to 30 percent level.  Last year, then-SEC Chair Mary Jo White cited the correlation of board diversity with improved company performance and identified board diversity as an important issue for the Commission, signaling that it may be a priority for regulators going forward.  Boards should take note of the evolving best practices in board composition and look for ways to improve, from a diversity standpoint, their candidate search, director nomination, and board refreshment practices.  We recommend that boards include this issue as part of an annual discussion on director succession, similar to the annual discussion regarding CEO succession.

Diversity and Performance

          A board of directors has two primary roles: oversight and long-term value creation.  This year, the Business Roundtable released updated governance guidelines that link a commitment to diversity to the successful accomplishment of both goals.  Its 2016 guidelines include a statement on diversity that reads, in part, “Diverse backgrounds and experiences on corporate boards … strengthen board performance and promote the creation of long-term shareholder value.”  In a statement accompanying the guidelines, Business Roundtable leader John Hayes noted that a “diversity of thought and perspective … adds to good decision-making” and enables “Americans, as well as American corporations, to prosper.”  Board success and competence thus is recast to include diversity as an essential element rather than as an afterthought or as a concession to special interests.

          Similarly, the “Commonsense Principles of Corporate Governance” outlined over the summer by a group of corporate leaders highlights diversity on boards—multi-dimensional diversity—and correlates that diversity with improved performance.  The signers of the principles, including an activist investor, a pension plan, and various chief executives, stated unequivocally in their accompanying letter that “diverse boards make better decisions.”  A consensus seems to be emerging among corporate leaders that, as stated by the Business Roundtable, boards should include “a diversity of thought, backgrounds, experiences, and expertise and a range of tenures that are appropriate given the company’s current and anticipated circumstances and that, collectively, enable the board to perform its oversight function effectively.”  With regard to oversight, a recent study by Spencer Stuart and WomenCorporateDirectors Foundation found that female directors generally are more concerned about risks, and are more willing to address them, than are their male colleagues.  Boards should, where possible, develop a pipeline of candidates whose career paths are enabling them to acquire the relevant professional expertise to be valuable public company directors in their industry.

In order to promote diversity in board composition, boards should become familiar with director search approaches to identify qualified candidates that would not otherwise come to the attention of the nominating committee.  Executive search firms, public databases, and inquiries to organizations such as 2020 Women on Boards are a few of the ways that boards can find candidates that may be beyond their typical field of view.  Organizations exist to help companies in their recruitment efforts.  Crain’s Detroit Business, for example, has compiled a database of qualified female director candidates in Michigan, who are invited to apply and are vetted for inclusion.  Boards may wish to commit to including individuals with diverse backgrounds in the pool of qualified candidates for each vacancy to be filled.

The Future of Diversity

          In 2016, shareholder proposals on board diversity met with increased success.  The numbers are still small:  Nine proposals made it onto the ballot last year, nearly double the total in 2015 and triple the total in 2014.  Nonetheless, support reached unprecedented levels in certain cases:  A diversity proposal—which was not opposed by management—at FleetCor Technologies  received over 70 percent shareholder support.  Another diversity proposal—which was opposed by management—at Joy Global  received support from 52percent of the voting shares (though the proposal did not pass due to abstentions).  Diversity proposals are generally supported by the proxy advisory firms, including Institutional Shareholder Services and Glass Lewis.

Perhaps more significantly, shareholder proposals in several cases resulted in increased board diversity without ever coming to a vote.  The pension fund Wespath submitted proposals this year seeking to increase diversity at three major corporations, and in each case withdrew the proposals when the subject companies agreed to add women to their boards.  A spokesperson for Wespath stated that the fund had privately communicated their desire for increased diversity and had filed proposals as a “last resort” to spur change.

In a similar effort, CalSTRS recently submitted 125 letters to boards at California corporations whose boards had no women directors; in response, 35 of the companies appointed female board members.  CalSTRS has indicated that if its private approaches are unsuccessful, it will proceed with shareholder proposals.  The Wespath and CalSTRS examples are valuable for boards.  Listening to investors, being responsive, and staying out in front of issues to forestall shareholder proposals is far better than reacting to frustrated investors who feel compelled to resort to extreme measures to get corporate attention.  It is also greatly preferable to a situation in which activist investors press for legislative actions such as quotas or other mandatory board composition requirements, as we have seen in other countries.

2017 is likely to be a year in which progress toward greater board diversity significantly accelerates.  Indeed, it is becoming clear that gender diversity—if not gender parity—one day will be a standard aspect of board composition.  While the process of realizing that future should not be artificially or counterproductively hastened, it should be welcomed as a state of affairs that will be beneficial to all corporate constituents and, beyond, to the greater good of U.S. business and American culture.

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Mergers And Acquisitions

By Wachtell Lipton

January 6, 2017

M&A activity in 2016 had a slow start and a strong finish, reaching $3.7 trillion globally, behind 2015, but the third-busiest year on record. Deals involving U.S. targets were strong at just under $1.7 trillion, and represented a share of total global deal value comparable to 2015. Overall, 2016 had its share of large deals, albeit trailing 2015 levels, with 45 deals over $10 billion (compared to 69 in 2015) and 4 deals over $50 billion (compared to 10 in 2015). The year also set a record in announced friendly deals that were withdrawn or terminated, many due to regulatory issues, with $567 billion of U.S. M&A deals falling into this category.

A variety of macroeconomic factors drove the level of M&A activity in 2016. As in 2015, increasingly scarce opportunities for organic growth, coupled with relatively inexpensive debt financing, fueled strategic acquisitions. Equity markets started off the year sluggish but later rebounded, enhancing the ability of strategic acquirors to use their stock as acquisition currency. In step with the increasing value of equity markets, U.S. M&A volume peaked in October, breaking the record for the highest monthly U.S. M&A volume. Commodities likewise started out slowly, but gained momentum as the year progressed.

The unexpected Brexit vote in June 2016 appeared to have had some impact on European M&A, and the process of extricating the United Kingdom from the European Union is only just beginning, with the possibility of significant events in 2017. Technology, real estate and utility & energy were among the most active industries in M&A. Markets have rallied following the U.S. elections in November, as investors appear to be anticipating a mix of deregulation, tax reform and infrastructure spending that will boost economic activity, without significant concern about trade conflicts and further geopolitical shocks.

Although interest rates have recently increased modestly, in light of both the U.S. elections and the increase in rates by the Federal Reserve in December 2016 and its signal of further increases in 2017, borrowing costs remain at low levels. Prognostication is a dangerous sport even in times of relative predictability, and 2016 was anything but predictable. However, to the extent these trends continue, M&A activity can be expected to remain at relatively high levels in 2017.

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CEO Pay Ratio Rule

Although the future of the CEO pay ratio rule is somewhat uncertain, the corporate community continues to move forward to prepare for its eventual effectiveness in 2017 (and the attendant disclosures in the 2018 proxy season).
While much attention has been given to the potential impact of this new disclosure, both externally (the various constituencies that will see and react to this information) and internally (your employee population), an ancillary consequence of the disclosure has been less discussed. Specifically, we’re talking about the potential state and local provisions that may tie directly to a company’s pay ratio.
As you may recall, over the past few years there have been a couple of initiatives introduced that would link the operation of a new law or regulation to the disclosed CEO pay ratio. For example, in 2014 a California legislator introduced a bill that would have modified the state’s corporate income tax rate to a sliding scale based on a company’s pay ratio. The rate would have been as low as 7% percent on the basis of net income if the ratio was no more than 25 to 1. At the other end of the scale, the rate would have been as high as 13% if the ratio was more than 400 to 1. Although the bill passed out of two state Senate committees, ultimately it failed on the Senate floor (in a tight 19-17 vote). In addition, in the same year the Rhode Island legislature considered a bill that would have given preferential treatment in receiving state government contracts to companies whose pay ratio between its highest-paid executive and its lowest paid full-time employee was 31-1 or less.
While, to our knowledge, neither initiative has made it all the way through the legislative process, the underlying concept is alive and well. On December 8, The New York Timesreported that the City Council of Portland, Oregon had voted to impose a surtax on companies whose CEOs earn more than 100 times the median pay of their rank-and-file workers. As indicated in the Times, “[t]he tax will take effect next year, after the Securities and Exchange Commission begins to require public companies to calculate and disclose how their chief executives’ compensation compares with their workers’ median pay.”
The article to goes on to say that the idea may not be limited to Portland: Portland officials said other cities that charge business-income taxes, such as Columbus, Ohio, and Philadelphia, could easily create their own versions of the surcharge. Several state legislatures have recently considered bills structured to reward companies with narrower pay gaps between chief executives and workers.
It certainly appears that if the CEO pay ratio rule goes forward, we may see more proposed laws and rules that seek to “piggy-back” on the disclosure.
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New Paradigm for Directors 2017

Some Thoughts for Boards of Directors in 2017

By Martin Lipton, Steven A. Rosenblum and Karessa L. Cain

December 6, 2016

I. Introduction

Some Thoughts for Boards of Directors in 2017

The evolution of corporate governance over the last three decades has produced meaningful changes in the expectations of shareholders and the business policies adopted to meet those expectations. Decision-making power has shifted away from industrialists, entrepreneurs and builders of businesses, toward greater empowerment of institutional investors, hedge funds and other financial managers. As part of this shift, there has been an overriding emphasis on measures of shareholder value, with the success or failure of businesses judged based on earnings per share, total shareholder return and similar financial metrics. Only secondary importance is given to factors such as customer satisfaction, technological innovations and whether the business has cultivated a skilled and loyal workforce. In this environment, actions that boost short-term shareholder value—such as dividends, stock buybacks and reductions in employee headcount, capital expenditures and R&D—are rewarded. On the other hand, actions that are essential for strengthening the business in the long-term, but that may have a more attenuated impact on short-term shareholder value, are de-prioritized or even penalized.

This pervasive short-termism is eroding the overall economy and putting our nation at a major competitive disadvantage to countries, like China, that are not infected with short-termism. It is critical that corporations continuously adapt to developments in information technology, digitalization, artificial intelligence and other disruptive innovations that are creating new markets and transforming the business landscape. Dealing with these disruptions requires significant investments in research and development, capital assets and employee training, in addition to the normal investments required to maintain the business. All of these investments weigh on short-term earnings and are capable of being second-guessed by hedge fund activists and other investors who have a primarily financial rather than business perspective. Yet such investments are essential to the long-term viability of the business, and bending to pressure for short-term performance at the expense of such investments will doom the business to decline. We have already suffered this effect in a number of industries.

In this environment, a critical task for boards of directors in 2017 and beyond is to assist management in developing and implementing strategies to balance short-term and long-term objectives. It is clear that short-termism and its impact on economic growth is not only a broad- based economic issue, but also a governance issue that is becoming a key priority for boards and, increasingly, for large institutional investors. Much as risk management morphed after the financial crisis from being not just an operational issue but also a governance issue, so too are short-termism and related socioeconomic and sustainability issues becoming increasingly core challenges for boards of directors.

At the same time, however, the ability of boards by themselves to combat short-termism and a myopic focus on “maximizing” shareholder value is subject to limitations. While boards have a critical role to play in this effort, there is a growing recognition that a larger, systemic recalibration is also needed to turn the tide against short-termism and reinvigorate the willingness and ability of corporations to make long-term capital investments that benefit shareholders as well as other constituencies. It is beyond dispute that the surge in activism over the last several years has greatly exacerbated the challenges boards face in resisting short-termist

pressures. The past decade has seen a remarkable increase in the amount of funds managed by activist hedge funds and a concomitant uptick in the prevalence and sophistication of their attacks on corporations. Today, even companies with credible strategies, innovative businesses and engaged boards face an uphill battle in defending against an activist attack and are under constant pressure to deliver short-term results. A recent McKinsey Quarterly survey of over a thousand C-level executives and board members indicates most believe short-term pressures are continuing to grow, with 87% feeling pressured to demonstrate financial results within two years or less, and 29% feeling pressured over a period of less than six months.

II. The Emerging New Paradigm of Corporate Governance

One of the most promising initiatives to address activism and short-termism is the emergence of a new paradigm of corporate governance that seeks to recalibrate the relationship between corporations and major institutional investors in order to restore a long-term perspective. In essence, this new paradigm conceives of corporate governance as a collaboration among corporations, shareholders and other stakeholders working together to achieve long-term value and resist short-termism.

A core component of this new paradigm is the idea that well-run corporations should be protected by their major shareholders from activist attacks, thereby giving these corporations the breathing room needed to make strategic investments and pursue long-term strategies. In order to qualify for this protection, a corporation must embrace principles of good governance and demonstrate that it has an engaged, thoughtful board and a management team that is diligently pursuing a credible, long-term business strategy. A corporation that meets these standards should be given the benefit of the doubt by institutional investors, and its stock price movements and quarterly results should be considered in the context of its long-term objectives. The new paradigm contemplates that investors will provide the support and patience needed to permit the realization of long-term value, engage in constructive dialogue as the primary means for addressing issues, embrace stewardship principles, and develop an understanding of the corporation’s governance and business strategy.

A number of groups have recently issued corporate governance principles and guidelines that outline the respective roles and responsibilities of boards and other stakeholders in the new paradigm. The Commonsense Principles of Corporate Governance was issued earlier this year by a group of large companies and investors led by Jamie Dimon of JPMorgan Chase, and an updated Principles of Corporate Governance 2016 was issued by the Business Roundtable. The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth was prepared by Martin Lipton and issued by the International Business Council of the World Economic Forum. Each of these corporate governance frameworks is a synthesis of prevailing best practices for boards with an amplified emphasis on shareholder engagement, rather than an articulation of new ways to structure and manage the board’s oversight role. In effect, they provide a roadmap for how boards can build credibility with shareholders and how shareholders can support such boards in the event of an activist attack focusing on short-term goals or proposals.


To be clear, the new paradigm does not foreclose activism or prevent institutional investors from supporting an activist initiative where warranted. Underperforming companies may be able to benefit from better board oversight, fresh perspectives in the boardroom, new management expertise and/or a change in strategic direction. Responsible and selective activism can be a useful tool to hold such companies accountable and propel changes to enhance firm value, and institutional investors can benefit from the budget and appetite of activists who drive such reforms. However, the new paradigm seeks to restore a balanced playing field, so that activism is focused on improving companies that are truly mismanaged and underperforming, rather than on using financial engineering indiscriminately against all companies in an effort to boost short-term stock prices.

III. Support for the New Paradigm

There have been a number of recent developments that suggest this new paradigm of corporate governance may be gaining real traction and that, although it is a non-binding framework susceptible to diverging interpretations, it can make a tangible difference in the outcomes of activist attacks and the long-term strategies adopted by corporations. Indeed, the effectiveness of a private ordering approach to reform is clearly demonstrated by the widespread adoption of standardized governance practices by most public companies. For example, only 10% of S&P 500 companies now have a classified board structure, and approximately 43% have recently adopted a proxy access bylaw. A key driver of the impact of this private ordering exercise is the remarkable concentration of power over virtually all major corporations in the hands of a relatively small number of institutional investors. As these major institutions have pushed for such governance practices, and as large public companies have adopted them, it is reasonable to look to the institutional investors to use their additional power to promote the long- term sustainable success of the companies in which they invest.

Thus, it is encouraging that several leading institutional investors have expressed grave concern that short-termism and attacks by short-term financial activists are significantly eroding long-term economic prosperity. BlackRock, State Street and Vanguard have each issued strong statements supporting long-term investment, criticizing the short-termism afflicting corporate behavior and the national economy, and rejecting financial engineering to create short-term profits at the expense of sustainable value. In his annual letter to CEOs, BlackRock’s Larry Fink emphasized that reducing short-termist pressures and “working instead to invest in long-term growth remains an issue of paramount importance for BlackRock’s clients, most of whom are saving for retirement and other long-term goals, as well as for the entire global economy.” State Street Global Advisors recently issued a statement acknowledging the “inherent tension between short-term and long-term investors,” and expressed concern that settlements with activists may promote short-term priorities at the expense of long-term shareholder interests.

In addition, FCLT Global (formerly Focusing Capital on the Long Term), which started as an initiative in 2013 by Canada Pension Plan Investment Board and McKinsey & Company, recently grew into an independent organization with BlackRock, The Dow Chemical Company and Tata Sons added as founding members in addition to a number of leading asset managers, asset owners, corporations and professional service firms who are also members. The organization’s mission is to develop practical tools and approaches that encourage long-term behaviors in business and investment decision-making. In the U.K., leading British institutional


investors, acting through The Investment Association, have issued a Productivity Action Plan that “seeks to deliver ambitious and achievable remedies to the ills of some of the most serious causes of short-term thinking in the British economy.”

In academic circles, the concerns expressed by institutional investors about activism and short-termism have been echoed in a growing body of research. The notion that activist attacks increase, rather than undermine, long-term value creation has now been discredited by a number of studies. Furthermore, after decades of academic thinking animated by agency cost theory and a conviction that expanding shareholder rights will reduce such costs and thereby increase firm value, a new study suggests an important counterweight—namely, “principal costs,” which have been largely overlooked by academics. In Principal Costs: A New Theory for Corporate Law and Governance, Professors Zohar Goshen and Richard Squire posit that there is an unavoidable tradeoff between principal costs and agent costs, and that the optimal balance and governance structure for any given company will depend on firm-specific factors, such as industry, business strategy and personal characteristics of investors and managers. This principal cost theory casts doubt on the core assumptions that have been used by academics to justify activism and a one- sided embrace of increasing shareholder power.

Finally, there have been a number of initiatives brewing in the political and regulatory arena which suggest that, in the absence of an effective private sector solution, legislative reforms are on the horizon. For example, this past spring, the Brokaw Act was introduced in the Senate to call for amendments to Section 13(d) reporting rules that would require greater transparency from activist hedge funds who accumulate large stealth positions in public company securities. Co-sponsoring Senator Jeff Merkley remarked, “Hollowing out longstanding companies so that a small group of the wealthy and well-connected can reap a short-term profit is not the path to a strong and sustainable economy for our nation.” Shortly thereafter, the Corporate Governance Reform and Transparency Act of 2016 was introduced in the House of Representatives to propose an oversight framework for ISS and Glass Lewis.

In addition, a variety of other ideas are being actively considered in a number of jurisdictions, including tax reforms to encourage long-term investment and discourage short-term trading; prohibiting quarterly reports and quarterly guidance; regulating executive compensation to discourage managing and risk taking in pursuit of short-term objectives; imposing enhanced disclosure obligations on both corporations and institutional investors; and imposing fiduciary duties on institutional investors and asset managers to take into account the long-term objectives of the ultimate beneficiaries of the funds they manage.

In short, there is growing recognition by corporations, investors, academics, policymakers and other stakeholders that short-termism is a profound threat to the long-term health of the economy, and that activism has been a significant source and accelerant of short- termist pressures.

IV . Conclusion

We conclude our Thoughts for 2017 as we began, by noting that the most important issue that boards confront today is to work with management to convince investors and asset managers to support investments for sustainable long-term growth and profitability and to deny support to


activist hedge funds seeking short-term profits at the expense of well-conceived, long-term strategies. We urge boards of directors to approve The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth, issued by the International Business Council of the World Economic Forum, and to authorize their corporations to endorse it, to work with management to obtain its acceptance and endorsement by the investors and asset managers who are invested in their corporations, and to support the efforts of the World Economic Forum and others, in order to combat short-termism and promote investment for long-term sustainable growth.


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Sustaining Capitalism Book Now Available


Our new book, Sustaining Capitalism: Bipartisan Solutions to Restore Trust & Prosperity, now is available on Amazon.

In the wake of the financial disruptions of the last decade, most notably here in the United States but also in many other developed and developing free-enterprise economies, the most basic optimistic assumptions and attitudes about growth and prosperity have eroded. Today’s economy and society are reminiscent of the United States in the 1930s when fear begat fear, and the economy remained stagnant until the onset of World War II shocked it to life. People talked then of a “crisis of capitalism,” and believed that the booming wartime economy could fall right back into the Great Depression when the war ended.

And that is where we, the Committee for Economic Development (CED), enter this story. This book takes its inspiration from CED’s founding in 1942, when a small circle of U.S. business leaders gathered to identify solutions that would restore order to a global economy. Similarly, it was in response to a more recent crisis in American capitalism, following the financial downturn of 2008, that CED launched a multi-year research project on sustainable capitalism. This book, designed for business leaders and policymakers, is the culmination of those research efforts. Its publication appropriately coincides with the 75th anniversary of CED.

We at CED see an urgent need for revisions in both business practices and public policy if our economic system is to reestablish consistent economic growth and regain the trust of the American public. We write this book as our contribution toward resuming respectful dialog among what have become disparate and distrustful public factions. And we hope to convince our fellow business leaders that we need to engage the entire business community in public dialog and dedication to private best business practices. In the chapters that follow, we remind our readers of why the free enterprise system has earned—and deserves—its reputation as the preeminent form of economic organization, respond to what we believe are inaccurate accusations toward that system, and focus on remedies to legitimate concerns.

The analyses and recommendations presented in this book, aligned with other activities the CED is undertaking in connection with its 75th anniversary, underscore our fervent belief in the free-market economic system—our nation’s brand of capitalism, which has brought wealth and higher living standards to the United States and countries throughout the world. We see no more important task than to pursue CED’s ideals: long-term economic growth; efficient fiscal and regulatory policy; competitive and open markets; a globally competitive workforce; equal economic opportunity; and nonpartisanship in the nation’s interest. In short, we seek to make American capitalism sustainable, and to unite Americans of differing persuasions behind the core principle that the U.S. free-market economic system can be made to work for all of us.

Although the term “sustainable” has environmental connotations today, we use the word in its more traditional business sense, meaning long-term successful duration. We do not directly address environmental sustainability in this volume.

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ISS’s 2017 Policy Survey Results

   October 4, 2016

ISS’s 2017 Policy Survey Results

          Institutional Shareholder Services (ISS) recently published the results of its annual survey of investors and companies, which it uses to inform possible changes to its proxy voting policies. As issuers proceed with off-season shareholder engagements and prepare for the 2017 proxy season, these results suggest areas of potentially increased focus.  Unsurprisingly, ISS’s investor and company respondents do not always see eye-to-eye.

  • Director Tenure:  The majority of investor respondents expressed serious concern at excessively lengthy director tenure, with 53% identifying the absence of any newly-appointed independent directors in recent years as problematic and 68% pointing to a high proportion of long tenured directors as the trigger for concern.  On the other hand, 34% of non-investors believed that long board tenure, by itself, is not a concern and a number of corporate respondents noted that a long tenure can be beneficial as depth of experience gives directors greater confidence, independence from management, and historical context for evaluating corporate strategy and performance.  We have previously discussed our view that the inordinate focus on director tenure is generally misplaced, and that investors and companies would be better served by addressing underlying issues and concerns directly rather than using board tenure as a proxy.
  • Overboarding of Executive Chairs:  Investor respondents strongly (64%) favored the policy of subjecting executive (non-CEO) chairs to the stricter overboarding policies that apply to CEO chairs (i.e., no more than three total boards instead of five).  Only 38% of non-investors support the stricter standard for executive chairs.  Several respondents, both investor and non-investor, indicated a preference for case-by-case determinations as the role and responsibilities of an executive chair vary from company to company.
  • Non-TSR Financial Metrics When Assessing “Pay-For-Performance”:  Investors (79%) and non-investors (68%) alike supported including metrics beyond total shareholder return in ISS’s quantitative “pay-for-performance” models.  Respondents from both groups suggested including return on investment (e.g., ROIC), earnings (e.g., EPS, EBITDA), and revenue (e.g., absolute revenue, revenue growth) metrics in the models.  Several investors and non-investors viewed industry-tailored and company-specific performance metrics to be most appropriate.
  • Dual-Class Stock:  While a majority of investor respondents supported ISS recommending against directors at newly public companies with multiple classes of stock having differential voting rights, a significant portion of investors and a majority of non-investors supported a negative recommendation only if such provisions were put in place permanently (that is, with no sunset provision), and many non-investors (46%) wholly opposed negative ISS recommendations in the IPO context.  Many company respondents encouraged a case-by-case approach or argued that investors who object to a capital structure should not invest in the company.
  • Say-When-On-Pay:  Two-thirds of investor respondents supported annual advisory votes on compensation, but only 42% of non-investors supported an annual standard.
  • MUTA:  With respect to several protective Maryland takeover law provisions, the ISS survey asked if an adverse recommendation should be issued against Maryland-incorporated companies that do not pre-emptively “opt-out” of certain state law rights.  ISS currently does not and instead takes into account company-specific circumstances to consider withhold recommendations only if a company affirmatively invokes Maryland law provisions to “unilaterally” amend the charter or bylaws to “diminish” shareholder rights in a “materially adverse” way or fails to respond adequately to a majority-supported shareholder proposal asking the company to “opt-out.”  On this topic, ISS did not ask if continuing its current approach was acceptable nor use a more nuanced survey approach like that taken with dual-class stock. On the survey methodology used (with which we take issue), a significant majority of investor respondents supported an adverse ISS recommendation where a Maryland company has not opted out of the state takeover provisions. Conversely, 56% of corporate respondents indicated that a negative recommendation would not be warranted.

With these survey responses in mind, ISS will issue proposed voting policy updates later this fall in some or all of these policy areas; the draft policy updates will be subject to a comment period prior to being finalized in November or December of this year.

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UK Parliament Begins Governance Inquiry

The Business Innovation and Skills Committee of Parliament has begun an inquiry into corporate governance.  It has invited comments on directors duties, executive pay and composition of boards with a list of questions in each category.

          In announcing the inquiry, the chairman of the committee stated that principle purposes were to determine whether under existing law, corporate governance encourages companies to achieve long-term prosperity and assures fair treatment of employees.  That the inquiry is focused on a stakeholder approach to corporate governance is made clear by the first three questions it poses:

  • Is company law sufficiently clear on the roles of directors and non-executive directors, and are those duties the right ones?  If not, how should it be amended?
  • Is the duty to promote the long-term success of the company clear and enforceable?
  • How are the interests of shareholders, current and former employees best balanced?

          In addition to combatting short-termism, promoting long-term investment and protecting employees, the inquiry is focusing on executive compensation and its relation to companies long-term performance.

          Lastly, the inquiry poses the following questions about the composition of boards:

  • How should greater diversity of board membership be achieved?  What should diversity include, e.g. gender, ethnicity, age sexuality, disability, experience, socio-economic background?
  • Should there be worker representation on boards and/or remuneration committees?  If so, what form should this take?

          While the outcome of the inquiry is not certain, it is clear that corporate governance in the U.K., in the U.S., and in the EU has again become a serious political issue.  If companies and investors do not find a mutual path to governance that promotes long-term investment and accommodates employee, customer, supplier and community interests, legislation will result.  That legislation may not be to the liking of either companies or investors.

Martin Lipton

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Taking Short-Termism Seriously

September 12, 2016

In a recent blog post on the Conference Board Governance Center’s website, “Activists Are Not the Culprit:  So Don’t Shoot the Messenger,” Charles Nathan argues that criticism of short-termism is simultaneously misguided and hopeless.  We agree with his ultimate practical advice—that companies have to engage more effectively with their major institutional shareholders to persuade them of the merits of long-term strategies—but he is wrong to dismiss concerns about short-termism and to surrender to its inevitability.

          Nathan acknowledges both that “the bulk of institutional investors—the mutual fund complexes (whether actively managed or indexed) and managers of public and private pension funds and foundations—are long-term investors” and that “the institutional investment managers who manage the overwhelming majority of funds invested in the stock market, are motivated by a single over-riding imperative—gathering funds to manage and retaining those funds” and thus may have a “bias towards shorter-term alternatives.”  However, having observed this fundamental misalignment between the interests of the ultimate beneficial owners of corporations – ordinary working people who are looking for their retirement savings to grow steadily over the course of decades – and the incentives of the intermediaries who invest on their behalf, Nathan simply surrenders to its inevitability:  “Inveighing against quarterly capitalism and its hand maidens, no matter how impassioned, is just not going to change the stock market’s behavior.”  In other words, all money managers are short-termist, so get over it.

          We disagree that we should resign ourselves to short-termism as the “unalterable bottom line.”  After three decades of turbulence in the corporate governance arena, we believe we are nearing an inflection point, as an increasing number of investors, stakeholders, academics, advisors, politicians and policymakers are recognizing the far-reaching and damaging effects of short-termism.  Short-termism and activism are significant contributors to diminished GDP and to economic decline.  They reflect a systematic failure to harness and cultivate the value of human capital and strategic investments, and they accelerate social inequality and concomitant political tensions.  To the extent that individual money managers are biased towards the short term for self-interested reasons, notwithstanding the damage to the long-term economy as a whole, this is all the more reason to bring attention to the problem and combat it.

          Recognizing the financial, social and political effects of short-termism and activism, during recent years, a growing number of institutional investors have publicly renounced financial engineering to achieve short-term results at the expense of long-term investment and have encouraged corporations to develop and pursue long-term strategies and reject short-termist demands by activists.  These investors, led by BlackRock, State Street and Vanguard, have called on corporations to resist financial engineering, to pursue long-term strategies and to embrace transparency and engage with their investors on a regular basis to cultivate an understanding of their performance and strategy.  Corporations that implement the governance “best practices” advocated by these investors, with an amplified emphasis on engagement, transparency and ongoing collaboration with investors, to demonstrate that they are diligently pursuing well-conceived strategies developed with the participation of independent and engaged directors and executed by a competent management team, should be assured that, in exchange, these investors will be patient and support the corporation in resisting short-term pressures.

          We expect that, contrary to Nathan’s expectation for the unrestrained continuance of short-termism and activism, the major institutional investors, which in the aggregate control most of the significant publicly held corporations, will follow through on their assurances to corporations that they will support them in their long-term strategies and in their resistance to short-termism and activists. The increasing membership by institutional investors in organizations such as Focusing Capital on the Long Term, and the endorsement by a number of institutional investors of the Commonsense Principles of Corporate Governance announced in July, are concrete support for our optimism.

          If these private sector initiatives fail to gain real traction, we expect there will be a number of regulatory actions designed to discourage short-termism.  This regulatory impetus is evident in recent legislation introduced in Congress, the policy statements by Hillary Clinton in the U.S. and Theresa May in the U.K. and pending regulations in the EU.  In the absence of, or in addition to, new regulation, long-term shareholders may seek injunctive relief and monetary damages from investors and activists who overtly or tacitly cooperate to force a corporation to produce short-term gains at the expense of long-term, sustainable investment.  Such litigation might be brought on the grounds that the investors and the activists have effective control of the corporation and therefore have a fiduciary duty to the corporation and shareholders who are long-term investors.

          Major institutional investors have the capability and responsibility to restore a long-term approach.  Indeed, the ultimate beneficial owners they serve will be principal beneficiaries of a governance regime that is calibrated to produce long-term value creation and sustainable economic prosperity.  One way or another, we believe they will be successful in rebalancing the relationship between corporations and shareholders to facilitate rather than undermine this objective.

Martin Lipton
Andrew R. Brownstein
Steven A. Rosenblum
Trevor S. Norwitz
Karessa L. Cain
Sabastian V. Niles
Sara J. Lewis

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Making Capitalism Sustainable: Three Steps for CEOs

Business leaders have a unique opportunity.

Today over half of Millennials claim to reject capitalism. Left unaddressed, public discontent and other challenges facing capitalism could reach a tipping point, resulting in damage to the system that has created the greatest level of freedom and prosperity the world has ever seen. Backlash could encourage governments to become even more directive, imposing greater controls through a stricter tax and regulatory environment that would diminish the ability of companies to effectively produce goods, services, and innovations that benefit all of society.

Businesses need to adjust to societal demands rather than wait for government to react. In their roles as both the chief decision-makers and public face of their companies, business leaders have a unique opportunity and responsibility to steer capitalism towards greater sustainability.

While no silver bullet exists, CEOs can take the following steps:

First, they can lead companies for the benefit of all stakeholders, including customers, employees, owners, communities, and environment. The notion of “shareholders only” no longer is enough. CEOs should drive greater diversity in management teams and boards of directors. Today women earn more degrees than men and comprise about half the workforce, yet hold only one in five Fortune 500 board seats. A company-led approach can stave off regulatory solutions, like quotas, that boardrooms face in other countries like Finland and Denmark. If nominating committees adopt an “every other one” strategy, in which they appoint women to every other vacant seat, women would comprise a third of Fortune 500 board seats in just a few years and, in turn, would help support greater diversity in management.

Second, amid rising economic inequality, which now approaches the record levels of the 1930s, CEOs can increase investment in their employees’ education. Recently JP Morgan Chase made headlines by raising their minimum wage and committing to a greater investment in education to help employees climb the economic ladder. The company will focus more on training entry-level employees and will partner with organizations for career-focused education. Other CEOs have a compelling rationale to follow suit: as the economy places an increasing premium on knowledge, company performance increasingly will depend on education.

Finally, those at the helm can build trust by fighting crony capitalism. From no-bid contracts to regulatory loopholes to tax carve-outs, crony deals rightly lend support to the notion that the system favors the well-connected few over the many. Sustainable capitalism relies on fair competition on an impartial playing field in the marketplace, not in the lobbies of Congress. Executives should reassess the objectives of their political giving, and vocalize the need for the business community at large to refrain from opportunities that would lead to an artificial leg up in the marketplace.

Capitalism boasts a track record of unmatched prosperity. But if its challenges remain unsolved, dissatisfaction could lead to an economic environment that leaves both companies and the greater society less prosperous.

Steve Odland is CEO of the Committee for Economic Development and former CEO of Office Depot Inc. and AutoZone Inc. Follow him and CED on Twitter: @SteveOdland, @CEDUpdate.

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CEO Pay Ratio And Employees

August 4, 2016

By Dan Marcec, Director of Content & Marketing Communications, Equilar

335:1.    276:1.    247:1.    71:1.

Those figures represent alternative ways to calculate the ratio of CEO to worker pay in the U.S.—a ratio that every public company will be required to report for its own workers in 2018. Since the SEC passed this measure one year ago as a continuation of mandates from the Dodd-Frank legislation, the CEO Pay Ratio has become a lightning rod for discussion around executive pay.

The pay ratio is controversial for different reasons to different constituents. In the corporate governance universe, executive compensation professionals and the shareholders who vote on executive pay have debated the ratio’susefulness as a means to help them evaluate CEO pay. Companies are concerned about the costs involved—by some estimates, it will cost public companies a collective $1.3 billion to comply with the rule in its first year, and about half that amount every year thereafter. Meanwhile, opponents of what they describe as exorbitant CEO pay have said they would use the ratio to shame companies publicly.

Caught in the middle, HR departments will be assigned the daunting task of communicating this delicate information to company employees, and handling the influx of inevitable questions about what job is the median, how that compares across departments, and quite possibly, why the CEO gets paid so much. Undoubtedly they are asking how can they best communicate their own company’s ratio and educate employees on what it means.

Determining the CEO Pay Ratio

What makes the pay ratios reported by various sources thus far so vastly different? The largest of these figures cited above—335:1—is according to the AFL-CIO Executive Pay Watch. This accounts for the average reported total compensation for S&P 500 CEOs vs. the average for nonsupervisory workers in the U.S.

The smallest of these figures—71:1—was calculated by PayScale, which provides on-demand compensation data and software, comparing median cash compensation for 168 of the highest-paid CEOs in the annual Equilar 200 study to cash compensation of the median employee for those companies. This included all employee levels from individual contributor to executive level.

These differences reflect the fact that while companies will be required to provide disclosure of their CEO pay ratios beginning in 2018 public filings, there is some flexibility in the SEC rule that allows a company to select its methodology for identifying its median employee and that employee’s compensation.

The question remains how the ratio should be calculated to create the most direct comparison between how CEOs and employees are paid.

Executive vs. Employee Pay Strategies

It’s difficult to draw a direct comparison from executive to employee pay for several reasons. The AFL-CIO Executive Pay Watch included all reported CEO pay, which factors in equity compensation such as stock and options awards, while PayScale’s employee survey exclusively tracks salary information and thus compares more directly to the cash components of CEO pay in the form of salary and annual bonus.

On paper and in practice, stock and options make up a vast majority of CEO pay. Equity accounted for 68% of the reported compensation for the CEOs included in the Equilar 200 study used for the PayScale comparison. In other words, on average, less than one-third of these CEOs’ compensation was earned in cash. At the same time, CEO compensation reported in annual proxy statements often includes dollar values that are not paid in that year, because a significant portion of CEO pay is contingent on future performance. The ultimate value of those awards may be less or more than the reported numbers had indicated.

Meanwhile, non-executive employees may or may not receive company equity as part of their compensation. Even if employees do receive stock or options, they are less likely to be certain about the present value of their equity, and thus self-reported data may not fully capture the amount they ultimately realize as something tangible—even if it were accounted for in the pay ratio. As a result, survey data better reflects cash compensation, and an apples-to-apples comparison measuring the gap between CEO pay and their employees can help to normalize some of these discrepancies.

The highest-paid CEO on the Equilar 200 list—Dara Khosrowshahi of Expedia—provides a useful example of the differences between how pay is structured for CEOs versus most employees, and moreover, how that compensation is reported to the SEC.

In 2015, Khosrowshahi received stock options valued at more than $90 million on the day the award was granted. However, he will only realize that value if he hits aggressive performance goals. On top of that, the company has said it will not award him any more equity compensation until 2020. According to PayScale’s survey, the ratio of CEO pay—including equity—to the median employee would be nearly 1,000-to-1 at Expedia in 2015. In any other year, it would likely fall far closer to the 39:1 ratio shown in PayScale’s study, which represents the amount of cash Khosrowshahi took home in 2015.

Employee Perception of Executive Pay

The alternative ways to calculate the CEO pay ratio reflect another reality: While the figure may appear similarly across companies to the public, it will be calculated differently at every company. A new piece of information, never before disclosed by a majority of companies, will become publicly available—the median employee’s pay—and inevitably half of the company will fall below that mark.

So whether a particular company’s ratio is 335:1 or 71:1, HR departments will have to come up with detailed communications plans to address how the median employee was determined and why the ratio is what it is, especially if the figure may appear out of step compared to industry competitors.

To appraise employee sentiment on CEO pay, PayScale conducted a survey soliciting more than 22,000 responses on whether employees knew what their CEO’s compensation was, and if so, the degree to which they thought it was fair.

Overall, the findings showed more than half of employees were not aware of their CEO’s compensation (55%), and among those that did, nearly 80% believed it was appropriate. Meanwhile, more than half of respondents who felt that their CEO is overcompensated also reported that it negatively affects their view of the company (57%).

Unsurprisingly, employees at higher levels in their companies have more knowledge about and more readily approve of CEO compensation than employees at lower levels. In other words, the perception of the CEO’s compensation and its impact on the respondent’s opinion of the company is directly related their job level, according to the survey.

Though these responses may not be unexpected, they underscore the value of transparency in setting expectations about the forthcoming ratio and its influence on employee morale. If employees are surprised by revelations in the news or from a union advocate, they’re likely to be less informed than if it comes straight from the source.

Ultimately, CEOs are paid very differently than employees, and the data suggests that workers who understand the nuances are more receptive to learning more about why. HR departments and other internal communicators have the opportunity to gather information and data now so they can accurately tell their company’s story and dampen the noise from external parties that may try to tell that story for them.

For more information on PayScale’s employee survey, please visit .

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Corporate Culture and the Role of Boards

July 22, 2016

Corporate Culture

          The Financial Reporting Council has published a report on Corporate Culture and the Role of Boards that is as applicable to U.S. companies as it is to U.K. companies—indeed, it is applicable to all market economy companies.

          The report starts with the premise that corporate culture is the crucial element in how a company performs.  “A strong culture will endure in times of stress and mitigate the impact.  This is essential in dealing effectively with risk and maintaining resilient performance.”

          The report makes the following key points:

  1. Recognize the Value of Culture.  A healthy corporate culture is a valuable asset, a source of competitive advantage and vital to the creation and protection of long-term value.  It is the board’s role to determine the purpose of the company and ensure that the company’s values, strategy and business model are aligned to it.  Directors should not wait for a crisis before they focus on company culture.
  2. Demonstrate Leadership.  Leaders, in particular the chief executive, must embody the desired culture, embedding this at all levels and in every aspect of the business.  Boards have a responsibility to act where leaders do not deliver.
  3. Be Open and Accountable.  Openness and accountability matter at every level.  Good governance means a focus on how this takes place throughout the company and those who act on its behalf.  It should be demonstrated in the way the company conducts business and engages with and reports to stakeholders.  This involves respecting a wide range of stakeholder interests.
  4. Embed and Integrate.  The values of the company need to inform the behaviors which are expected of all employees and suppliers.  Human resources, internal audit, ethics, compliance, and risk functions should be empowered and resourced to embed values and assess culture effectively.  Their voice in the boardroom should be strengthened.
  5. Align Values and Incentives.  The performance management and reward system should support and encourage behaviors consistent with the company’s purpose, values, strategy and business model.  The board is responsible for explaining this alignment clearly to shareholders, employees and other stakeholders.
  6. Assess, Measure and Engage.  Indicators and measures used should be aligned to desired outcomes and material to the business.  The board has a responsibility to understand behavior throughout the company and to challenge where they find misalignment with values or need better information.  Boards should devote sufficient resource to evaluating culture and consider how they report on it.
  7. Exercise Stewardship.  Effective stewardship should include engagement about culture and encourage better reporting.  Investors should challenge themselves about the behaviors they are encouraging in companies and to reflect on their own culture.

Martin Lipton

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SEC Issues New Guidance on Non-GAAP Measures

May 20, 2016

The SEC Issues New Cautionary Guidance on Non-GAAP Financial Measures

By Andrew R. Brownstein
David A. Katz
Edward J. Lee
Sabastian V. Niles

          This week, the SEC’s Division of Corporation Finance released updated Compliance and Disclosure Interpretations (C&DIs) addressing non-GAAP financial measures.  The updated C&DIs impact certain practices that have been widely used by public companies and underscore the SEC’s recently heightened focus on how non-GAAP financial measures are used, including concerns expressed by SEC Chair White,  SEC Chief Accountant Schnurr, SEC Deputy Chief Accountant Bricker and other senior SEC officials, as well as PCAOB Chair Doty, regarding a perceived overemphasis on non-GAAP financial information in the public markets.

The updated C&DIs address a range of issues, including: what kinds of practices could be misleading; presenting corresponding GAAP measures with “equal or greater prominence” when required; prohibited per share presentations; and handling income tax items related to a given measure.  Per the C&DIs, examples of potentially misleading non-GAAP measures include: excluding normal, recurring cash operating expenses necessary to operate an issuer’s business; presenting measures inconsistently between periods without appropriate disclosure; adjusting non-GAAP measures for non-recurring charges but not for non-recurring gains during the same period; and substituting individually-tailored revenue recognition and measurement methods for GAAP.

With respect to “equal or greater prominence,” the C&DIs highlight several situations where, in the SEC’s view, a non-GAAP measure used in documents filed with the SEC or in earnings releases furnished with a Form 8-K would likely be impermissibly more prominent than the most directly comparable GAAP measure.  These include, among others: omitting comparable GAAP measures from headlines or captions; presenting a non-GAAP measure ahead of the comparable GAAP measure (including in a headline or caption); presenting a non-GAAP measure using a style of presentation (e.g., bold, larger font) that emphasizes non-GAAP over the comparable GAAP measure; presenting a full income statement of non-GAAP measures; describing non-GAAP measures (e.g., “record performance,” or “exceptional”) without an equally prominent description of the comparable GAAP measure; and excluding a quantitative reconciliation to the most directly comparable GAAP measure for forward-looking information (e.g., guidance or outlook) due to the “unreasonable efforts” exception of Regulation S-K, without disclosing that fact and identifying the information that is unavailable and its probable significance in an equally prominent location.

While non-GAAP financial measures will undoubtedly continue to be important and useful for companies and investors alike, management teams and audit committees of companies that disclose non-GAAP financial measures should carefully review the new C&DIs and consider whether to adjust their practices and disclosures in response to these updates and, more generally, to the SEC’s increased scrutiny of how non-GAAP measures are used and presented.

Andrew R. Brownstein
David A. Katz
Edward J. Lee
Sabastian V. Niles

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Questioning the ISS Study on the Impact of Board Leadership Structures on CEO Pay

By Lizanne Thomas, Jones Day

•  ISS did not provide transparency into its backup information and data.

• ISS seemingly overlooked the reality that a company’s performance has a more statistically significant impact on CEO pay than board leadership.

• ISS was quick to connect some dots but failed to connect them with the kind of precision that is expected of corporate America.

Institutional Shareholder Services (“ISS”) published a report in March 2016 arguing that CEO compensation is impacted by companies’ board structures. More specifically, ISS argues that CEOs of companies with boards chaired by an “insider” have higher compensation than CEOs of companies with boards chaired by an “outsider.”

Given ISS’s orientation toward one-size-fits-all corporate governance scorecards—and the fine print found on the last page of the report (warning readers that the information may not be accurate and that anyone who relies on the information does so at his or her own risk), we decided to dig into the report’s findings before accepting its conclusion. We think that our caution was warranted.

Generally, the report does not provide much transparency into its underlying data, which makes it difficult to analyze. Our requests for the backup information received no response. Nonetheless, we were able to use the data included in the report to rerun some of the calculations.

The report separates S&P 500 companies into four board categories—those chaired by: (i) an individual deemed by ISS to be an “insider,” (ii) the CEO of the company, (iii) an individual deemed by ISS to be an “affiliated outsider,” and (iv) an individual deemed by ISS to be an “independent outsider.” The report then concludes that:

• The average total compensation of CEOs in the insider and combined role categories is higher than the average total compensation of CEOs in the affiliated outsider and independent outsider categories, and

• Therefore, board structure has a significant impact on CEO pay.

Although the ISS report does not identify the companies it assigned to each of these categories, ISS does provide the identity of four companies in the “insider” category, and describes the compensation of these CEOs as being high outliers. Removing these so-called outliers from the “insider” category reduces the average total compensation for the “insider” category from $15.6 million to $11.8 million. In short, when the outliers are removed from the “insider” category, the resulting “insider” category’s average annual compensation is reduced by almost 25 percent and is almost equal to the average annual compensation of the “affiliated outsider” category.

We reviewed the proxies of the so-called “outliers” and discovered a few facts relevant to the conclusions drawn that were not mentioned by ISS:

• One outlier’s stock price increased 1600 percent over the five-year period ended December 31, 2014.

• Another outlier’s revenues almost doubled since its CEO took leadership and 98 percent of the CEO’s 2014 compensation was put at risk with stringent performance based measures.

• A third outlier decreased its then-CEO’s compensation three years in a row, and ultimately split the CEO position into two roles in response to shareholder feedback obtained in outreach efforts.

We believe that our findings demonstrate the danger in trying to adopt a one-size-fits-all approach to corporate governance and compensation practices. Public company boards and compensation committees use many types of information when making compensation decisions (feedback received through direct shareholder outreach efforts, performance measures, long-term strategies, etc.). Any report that attempts to identify a single reason for compensation variances among public company CEOs will, in our view, inevitably fail to account for valid variances.

Two of the so-called outliers, for example, adhered to ISS’s top corporate governance compensation policy—creating a meaningful link between pay and performance—by providing a large portion of their executives’ compensation packages in the form of performance-based/at-risk awards. The compensation packages of those CEOs have proven to create an effective incentive to maximize the value of their respective companies, as evidenced by the companies’ strong performances. Yet the strong performances, which resulted in high compensation, are not taken into account in ISS’s analysis.

The report also fails to acknowledge that a company’s revenue has a more statistically significant impact on CEO pay than does the category applicable to the company’s chair. In addition to testing the impact of the identity of the board chair on CEO pay, the report also analyzed the impact of:

• Three-year “indexed” total shareholder return of the company versus the S&P 500,

• Company revenues (averaged over the three-year period),

• The CEO’s tenure, and

• Whether there was a change in CEO during the course of the three years.

According to the report, in order to be statistically significant, the t-statistic of a variable must be greater than 2 or less than -2. Of the five variables tested, only two of the variables had t-statistics that were statistically significant: the chair code at -2.53 and the company revenue code at 5.36—more than two-and-a-half times greater. Any student of statistics would not “bury the lede” by focusing on a variable of lesser significance.

The authors of the ISS report nonetheless jump to the conclusion that “insiders” are not the best monitors of shareholder interests in the boardroom. This conclusion is unsupported as well as unfair, particularly given that, under stock exchange rules, CEO pay is set solely by independent directors and may not be set by “insiders.” In fact, CEO chairs cannot even serve on compensation committees. In our experience, compensation committees work hard to ensure an appropriate level of pay and linkage to performance. To blindly follow ISS’s conclusion would require shareholders to oust from the board the very leaders who have made many of these companies attractive investments in the first place and who have carefully applied the very principles that ISS espouses.

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SEC Grants No-Action Relief on Proxy Access Proposals

SEC Grants No-Action Relief on Proxy Access Proposals

Companies that have previously adopted mainstream proxy access bylaws received a vote of confidence from the SEC earlier this month when the agency issued 18 no-action letters on February 12th, 15 of which allowed the company to exclude related shareholder proposals on the basis of “substantial implementation” under Rule 14a-8(i)(10) of the Securities Exchange Act of 1934. Each of these companies successfully asserted that its proxy access bylaw fulfilled the “essential objective” of the shareholder proposal and, as a result, that the company had substantially implemented the proposal.  These recent no-action letters provide the first important guidance on how proxy access proposals will fare under Rule 14a-8(i)(10) following the issuance of SEC Staff Legal Bulletin 14H in October  2015 which severely limits the ability for companies to exclude shareholder proposals, including proxy access proposals, on the basis that they conflicted with management proposals under Rule 14a-8(i)(9).

Each of the 15 companies had received shareholder proposals after adopting a “3/3/20/20” proxy access bylaw permitting shareholders who continuously own 3% of shares outstanding for a 3-year period to nominate up to 20% of the board (and at least 2 directors).  Under the bylaws, no more than 20 shareholders can aggregate their shares to reach the 3% ownership threshold.  This version of proxy access is consistent with the minimum standard articulated by ISS in itsDecember FAQ.

The excluded shareholder proposals would have permitted shareholders who continuously own 3% of shares outstanding for a 3-year period to nominate up to 25% of the board (and at least 2 directors).  Typically, the proposals had no shareholder aggregation limit and also prohibited additional restrictions that did not apply to other board nominees.

Differences between company bylaws and shareholder proposals on director nominee caps and shareholder aggregation limits did not prevent the SEC from concluding that the proposals had been substantially implemented.  The companies had adopted modestly more restrictive director nominee caps (up to 20% of the board and at least 2 directors) than the shareholder proposals (up to 25% of the board and at least 2 directors).  In addition, in what was shaping up to be a potentially more significant point of contention, the company bylaws stipulated that no more than 20 shareholders could aggregate their shares to nominate a candidate, while the shareholder proposals typically had no shareholder aggregation limits.

Notably, the SEC Staff granted no-action relief even in situations where the proxy access bylaw contained eligibility restrictions for proxy access candidates that may not apply to other director nominees, including a candidate

  • who is nominated using the company’s advance notice provisions,
  • who receives third-party compensation,
  • who is not independent under applicable listing standards,
  • whose election would cause the company to be in violation of its charter documents or applicable regulations,
  • who is an officer or director of a competitor, as defined in Section 8 of the Clayton Antitrust Act of 1914,
  • whose business or personal interests within the preceding ten years would place them in a conflict of interest with the company or any of its subsidiaries such that it would cause them to violate any fiduciary duties of directors,
  • who is named subject of a pending criminal proceeding (excluding traffic violations and other minor offenses) or who has been convicted in such a criminal proceeding,
  • who is subject to any order of the type specified in Rule 506(d) of Regulation D promulgated under the Securities Act of 1933, as amended, and
  • who does not receive at least 25% of the votes cast in favor of the candidate’s election at a prior annual meeting.

While these eligibility restrictions provide important protections for the adopting companies, it remains to be seen whether ISS and investors will find them problematic notwithstanding the SEC’s finding of substantial implementation.

In the three instances when the SEC denied no-action relief, the companies required 5% vs 3% ownership of shares outstanding in order for shareholders to avail themselves of proxy access.

In the wake of these no-action letters, companies considering proxy access are likely to gravitate toward the models contained in the successful no-action letters, continuing the convergence of proxy access terms during the 2016 proxy season.  Proxy access adopters are expected to maintain a brisk pace, as companies now face a reduced risk of having bylaws challenged by shareholder proponents.

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Forum Selection Bylaw Upheld

By William Savitt, David E. Shapiro, Anitha Reddy

April 8, 2016

Forum-Selection Bylaws — Another Brick in the Wall

The Superior Court of California for the County of Los Angeles has added to a growing judicial consensus that forum-selection bylaws adopted in conjunction with public-company mergers will be enforced to direct transaction-related litigation to a single board-designated forum. RealD Inc. is a Delaware-chartered, California-headquartered corporation. When the company’s board of directors approved a merger agreement with Rizvi Traverse Management LLC, a California-based private equity firm, it also adopted a bylaw requiring that any fiduciaryduty litigation involving the company be brought in the courts of Delaware. A stockholder plaintiff nevertheless sued in California, claiming that RealD’s directors breached their fiduciary duties in approving the merger and that other parties aided and abetted that breach. Arguing that California was a more convenient forum, that no duplicative litigation was pending in Delaware (or anywhere else), and that claims against third-party defendants should not be subject to the RealD bylaw, the plaintiff urged the court to ignore the bylaw and allow his case to proceed. The California court refused. Finding that “litigating in Delaware will be reasonable and fair” and that “Delaware courts have special expertise in corporate matters,” the court rejected the plaintiff’s assertion that confining his suit to a Delaware forum would be inequitable. Forum-selection bylaws have proved resilient against attack, withstanding challenges in New York, Texas, California and several other jurisdictions. Deal planners should continue to consider and refine the state of the art in such bylaws, which are becoming an established tool to reduce the risk of opportunistic stockholder litigation.

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Incentive For Long-Term Investment Is Broken

March 14, 2016

Succeeding in the New Paradigm for Corporate Governance

By Martin LiptonSabastian V. NilesSara J. Lewis

          Recognizing that the incentive for long-term investment is broken, leading institutional investors are developing a new paradigm for corporate governance that prioritizes sustainable value over short-termism, integrates long-term corporate strategy with substantive corporate governance and requires transparency as to director involvement.  We believe that the new paradigm can reduce or even eliminate the outsourcing of corporate governance and portfolio oversight to ISS and activist hedge funds.

Based on a series of statements by these investors over the past few years, we offer practical options for companies to consider as they adjust to the new paradigm and decide what and how to communicate.  Each company should make its own independent decision as to content, persons, venues and intensity of its communications and what adjustments, if any, to its strategy and operations may be appropriate to meet the expectations of investors who have embraced the new paradigm.

What to Communicate

          Lead with the Strategy.  In the new paradigm, the company’s long-term strategy, its implementation and the company’s progress in achieving it take center stage.  Check-the-box governance fades into the background.  Define the company and its vision, explain key drivers of strategy and business outcomes and articulate how a portfolio of businesses and assets fit together and are reviewed.  Discuss key risks and mitigation methods and share how the company evaluates whether the strategy remains viable as the business environment, competitive landscape and regulatory dynamic change.  Discuss how a business model has transformed, and if the company is in the midst of a strategic transformation or a well-conceived turnaround plan that requires time to execute, explain it.

          Confirm Board Involvement in the Strategy.  The company should also explicitly describe how the board has actively reviewed long-term plans and that it is committed to doing so regularly.  Proactively share with these investors how directors are integrated into strategic planning, exercise robust oversight and test and challenge both strategy and implementation.  In the new paradigm, be clear and direct about the board’s role in guiding, debating and overseeing strategic choices.

          Make the Case for Long-Term Investments, Reinvesting in the Business for Growth and Pursuing R&D and Innovation.  The company should clearly explain how such investments are reviewed and articulate why and how they matter to long-term growth and value creation.  For investments that will take time to bear fruit, acknowledge that and explain their importance, timing and progress.

          Describe Capital Allocation Priorities.  This also includes discussing the board’s process for reviewing and approving capital allocation policies.  Where return of capital is a pillar of the company’s value creation framework, demonstrate thoughtfulness about the timing, pacing and quantum of buybacks and/or dividends and an awareness of relative tradeoffs.  If maintaining an investment-grade or fortress balance sheet is a priority, clarify why.

          Explain Why the Right Mix of Directors Is in the Boardroom.  Present the diverse skills, expertise and attributes of the board as a whole and of individual members and link those to the company’s needs and risks.  Be transparent about director recruitment processes that address future company and board needs.  Disclose the policy for ensuring that board composition and practices evolve with the needs of the company, including views on balance, tenure, retaining institutional knowledge, board refreshment and presence or absence of age or term limits.  Carefully explain procedures for increasing the diversity of the board and for ensuring that directors possess the skills required to direct the course of the company.  Discuss director orientation, tutorials and retreats for in-depth review of key issues.  Show that board, committee and director evaluations are substantive exercises that inform board roles, succession planning and refreshment objectives.

          Address Sustainability, Citizenship and ESG/CSR.  The company should integrate relevant sustainability and ESG matters into strategic and operational planning and communicate these subjects effectively.  Sharing sustainability information, corporate responsibility initiatives and progress publicly on the company’s website and bringing them to these investors’ attention are significant actions in the new paradigm.

          Articulate the Link Between Compensation Design and Corporate Strategy.  Describe how compensation practices encourage and reward long-term growth, promote implementation of the strategy and achievement of business goals and protect shareholder value.

          Discuss How Board Practices and Board Culture Support Independent Oversight.  Clearly articulate the actual practices and responsibilities of the lead director or non-executive chair, independent directors, committee chairs and the board as a whole in providing effective oversight, understanding shareholder perspectives, evaluating CEO performance and organizing themselves to ensure priorities are met.  Investor expectations are evolving in this regard, and the company should stay abreast of current expectations.

How to Communicate

          Periodic “Letters” to Investors.  Periodic “letters” to shareholders on behalf of the management and/or board focusing on the issues deemed important for satisfaction of the new paradigm are valuable.  Letters from management can articulate management’s vision and plans for the future, explain what the company is trying to achieve and discuss how it plans to win in the market.  Letters from the board can convey board-level priorities and involvement.  Depending on the circumstances, statements or letters may be separate, jointly signed by the CEO and the lead director or non-executive chair, come from particular committees as to matters within their ambit or be from the full board.

          Investor Days.  The company should use “Investor Days” to articulate a long-term perspective on company prospects and opportunities and provide “deep dives” into strategy, performance and capital allocation.  Challenges should also be candidly addressed and responsive initiatives outlined.  Deciding which long-term metrics, goals and targets should be shared is an area in active evolution.  All of the company’s major long-term investors, including “passive” investors and index funds, should be extended an invitation.  Key materials from a completed Investor Day can also be separately circulated to investors, including index funds.  The company may also invite directors to attend.  In certain cases, it may be useful for a director to participate in an Investor Day to validate and communicate board involvement and priorities.

          Quarterly Communications.  Quarterly earnings rituals remain, for now, a fact of life in the U.S.  Nevertheless, the company can place quarterly results in the context of long-term strategy and objectives, discuss progress towards larger goals and articulate higher priorities, all while eschewing quarterly guidance.

          Proxy Statements, Annual Reports, Other Filings and the Company’s Online Presence.  Proxy statements, annual reports/10-Ks, SEC filings, presentations and voluntary disclosures provide communication opportunities.  For example, the customary proxy section entitled “The Board’s Role in Risk Oversight” will ultimately evolve into section(s) covering “Board Oversight of Strategy and Risk.”  The company should present information online in readily accessible, user-friendly and well-organized formats.

          Investor Engagement.  Disciplined, direct and periodic two-way dialogue with institutional investors is advisable, supported by written communications and tailored presentations.  Opening channels of communication in advance of a crisis or activist challenge is extremely important.  Communicate engagement procedures and activity.  Prepare for director-level interactions with major shareholders and know when and how to involve director(s) – proactively or upon appropriate request – without encroaching upon management effectiveness.  Do not hesitate to reach out to investors, even during proxy season, if there is a matter of importance to discuss.  Coordinate internal outreach across the different categories of shareholders and have a superstar corporate governance executive and a superstar investor relations executive.

Martin Lipton

Sabastian V. Niles

Sara J. Lewis

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The New Paradigm for Corporate Governance

February 1, 2016

The New Paradigm for Corporate Governance, by Marty Lipton

Since I first identified a nascent new paradigm for corporate governance with leading major institutional investors supporting long-term investment and value creation and reducing or eliminating outsourcing to ISS and activist hedge funds, there has been a steady stream of statements by major investors outlining the new paradigm. In addition, a number of these investors are significantly expanding their governance departments so that they have in-house capability to evaluate governance and strategy and there is no need to outsource to ISS and activist hedge funds.

The following is a summary consolidation of what these investors are saying in various forums. Clearly articulated plans are necessary to gain and keep the support of these investors. A company should not leave an opening for an activist with a more attractive long-term plan. Board participation in the development and approval of strategy should be effectively communicated in letters to these investors, annual reports and proxy statements. The description should include the major issues debated by the board and how they were resolved. A company should recognize that ESG and CSR issues and how they are managed are important to these investors. A company should develop and communicate its procedures for engagement by management and directors with these investors. In addition, a company should facilitate direct engagement with directors by these investors who request it. A company should support national policies that are designed to achieve longterm value creation. A company should support major investment by government in infrastructure, a rational tax policy that encourages long-term strategies and other policies that encourage and support long-term growth on both a company and a macro basis. These investors do not favor stock repurchases at the expense of long-term investment. These investors recognize that there is no need for quarterly earnings guidance, if a company has a clearly articulated long-term strategy. These investors also recognize that quarterly guidance is inconsistent with the long-term investment strategies that they are encouraging.

In addition to the statements by, and actions of, these leading institutional investors, similar views are being expressed by The Conference Board, The Brookings Institution, The Aspen Institute, Focusing Capital on the Long Term (an organization formed to promote long-term investment), the chief economist of the Bank of England and numerous others. In addition, recent academic research has revealed the methodological fallacies in the so-called “empirical evidence” use by the academics who have argued that unrestrained attacks by activist hedge funds create longterm value for the targets of their attacks, thereby strengthening the ability of these institutions to refuse to support activist attacks on portfolio companies.

A recent article by Professor John Coffee of the Columbia Law School and the February 1, 2016 Letter from Larry Fink of BlackRock to the CEOs of the S&P 500 are must reads.

Martin Lipton

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February 22, 2016
Caroline Hayday and Sasha Belinkie, of Cleary Gottlieb Steen & Hamilton LLP, recently wrote this article of interest:

It is well known that specified employees of publicly-traded companies must wait at least six months following a separation from service to receive payments of deferred compensation triggered by such separation. The six-month delay requirement must be set forth in the plan establishing the right to the payment of deferred compensation on or before the date the applicable individual first becomes a specified employee. Failure to do so, either as a matter of documentary or operational compliance, could result in the imposition of draconian penalty taxes and interest charges on the service provider under Section 409A of the Internal Revenue Code of 1986 (the “Code”).

What is perhaps less well known is that a non-employee director may also be considered a specified employee. A specified employee is defined by reference to Section 416(i) of the Code and includes “an employee who, at any time during the plan year, is”:

  • An officer whose annual compensation is greater than $170,000 (up to the lesser of 10% and 50 employees);
  • A 5% owner; or
  • A 1% owner receiving annual compensation of more than $150,000.
While there has been some discussion about directors who also hold (formally or informally) an officer position, very little attention has been given to the two ownership prongs of the definition and how they might trigger specified employee status for non-employee directors. On their face the two ownership prongs do not appear to apply to non-employee directors since they simply refer to “employees”; the preamble to the regulations, however, declined to accept the request by certain commenters to limit the universe of specified employees to common law employees. Section 416(i)(3) of the Code provides that self-employed individuals described in Section 401(c)(1) of the Code “shall be treated as an employee,” with Section 401(c)(1) defining a self-employed individual simply as an individual who has earned income from self-employment. Since Section 401(c)(1) addresses qualification of retirement plans in which non-employee directors do not commonly participate, the broad definition of employee may not have been focused on non-employee directors, but it does not specifically exclude them from its reach. The Internal Revenue Service generally considers directors fees to be self-employment income (and in fact the proposed Cafeteria Plan Regulations specifically call out directors as being self-employed individuals). Furthermore, Dan Hogans, one of the IRS architects of Section 409A, noted at a 2007 Steptoe & Johnson LLP audio-conference (memorialized in the annotated Section 409A regulations) both that the determination of who is a specified employee is by reference to the top-heavy rules and that directors could be picked up on the basis of share ownership.
Both 1% and 5% ownership of a public company are certainly a significant stake that may be uncommon among non-employee directors, although that level of ownership may be more likely among founders and long-time directors. Companies should also be aware that the ownership need only exceed the requisite threshold at any point in the year and such ownership is determined pursuant to the attribution rules of Section 318 of the Code. Section 318 of the Code sweeps in significantly more than the beneficial ownership rules applicable to public disclosure (e.g., unvested stock options regardless of whether they would vest in the relative short term). These rules may also require attribution of the ownership by partnerships and corporations, relevant for representatives of private equity, hedge fund and venture capital firms who serve on the board of a company in which such a firm holds a stake (although in practice these representatives may not receive compensation for the board service that is settled upon ceasing to be a board member, making designation as a specified employee effectively irrelevant).
Absent additional guidance to the contrary, public companies should consider making sure that their arrangements with their non-employee directors are in documentary compliance on this point, and including non-employee directors in their internal process around determining who their specified employees are and which payments may need to be delayed. For example, many companies provide for director awards that are settled at the time of departure from the board (e.g., restricted stock units that settle upon ceasing to be a board member and deferred fee arrangements) and thus, to the extent the departing director is a specified employee, settlement of those awards would almost certainly need to be delayed the requisite six months.
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Short Termism Destroys Long Term Shareholder Value

This paper shows that an inflow of short-term institutional investors seems to pressure firms to cut R&D investment to report higher earnings and to generate positive earnings surprises, and also leads to temporary boosts in firm valuations. When these short-term investors subsequently leave, the reductions in R&D, higher earnings, and the increase in firm valuations are reversed. Our identification strategy exploits plausibly exogenous variation in the presence of short-term investors around Russell 2000 index inclusions, which are associated with a sharp temporary inflow of short-term institutions and a permanent increase in institutional ownership and analyst coverage.


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ISS Issues Executive Compensation Policies

In its latest update to compensation policies, ISS has highlighted three areas in particular:

  • FAQ #15 – Problematic Pay Practices and Equity Plans:ISS will now consider three-year average concentration ratios above 30% for the CEO or above 60% for the NEOs in aggregate as a signal that the equity plan is not broad-based;
  • FAQ #59 – Externally-Managed Issuers (EMIs):More detail on minimum levels of disclosure required to avoid the automatic ISS “against” recommendation; and
  • FAQ #61 – Subsequent event handling:More detail around how ISS will evaluate agreements or decisions in the current fiscal year (e.g. not in the year covered by the proxy statement – events subsequent to the fiscal year covered by the CD&A).

See the complete list of FAQ’s at the link above.

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Key Compensation Issues For 2016

January 8, 2016

Compensation Season 2016

          Boards of directors and their compensation committees will soon shift attention to the 2016 compensation season. Key considerations in the year ahead include the following:

1. Say-on-Pay. If a company anticipates a challenging say-on-pay vote with respect to 2015 compensation, it should proactively reach out to large investors, communicate the rationale for the company’s compensation programs and give investors an opportunity to voice any concerns. Shareholder outreach efforts, and any changes made to the compensation program in response to such efforts, should be highlighted in the proxy’s Compensation Disclosure and Analysis. ISS FAQs indicate that one possible way to reverse a negative say-on-pay recommendation is to impose more onerous performance goals on existing compensation awards and to disclose publicly such changes on Form 8-K, though the FAQs further note that such action will not ensure a change in recommendation. Disclosure of prospective changes to the compensation program will demonstrate responsiveness to compensation-related concerns raised by shareholders.

2. ISS. Management and compensation committees should understand the potential consequences of their decisions under applicable ISS policies, but should not waiver in their commitment to create a culture that attracts and retains talented personnel who will contribute to the long-term success of the company. The ISS position on a particular issue does not always serve the best interests of shareholders, and many large institutional shareholders have disclaimed ISS as a primary source of influence in favor of their own, internally generated policies. The most recent ISS pronouncements regarding executive compensation matters are summarized in our December 22, 2015 memorandum “ISS Publishes Updated FAQs Regarding 2016 U.S. Compensation Policies.”

3. New Dodd-Frank Regulations. Last year the SEC adopted final rules regarding pay ratio disclosure. Registrants must include the pay ratio disclosure for proxy statements filed in respect of the first fiscal year beginning on or after January 1, 2017. We continue to await final regulations regarding clawbacks, disclosure of pay for performance and disclosure of hedging by employees and directors. The SEC may finalize these rules as soon as early 2016.

4. Shareholder Activism and Change in Control Protections. Companies should ensure that they understand how their change in control protections function if an activist obtains a significant stake in the company or control of the board. Appropriate protections ensure that management will remain focused on shareholder interests during a period of significant disruption; inadequate protections can result in management departures at a time when stability is crucial. The best time to review these protections and ensure their adequacy is before an activist surfaces.

5. Equity Compensation Plan Matters. Companies should determine whether a share increase or new plan needs to be submitted to shareholders at this year’s annual meeting or whether the performance goals under their incentive plans require re-approval in order to preserve the plan’s exemption from tax code Section 162(m) and the continued deductibility of performance-based compensation. When seeking shareholder approval of an equity plan, companies should understand the likely voting recommendations of the proxy advisory firms, and consider whether additional plan changes or other steps will be required to ensure plan approval.

6. Compensation-Related Litigation. Set forth below are the principal categories of compensation-related litigation in recent years and some suggestions that may mitigate the likelihood of such actions.

  • Disclosure Regarding New or Amended Equity Plans. A robust description of the determination of the number of shares covered by a new or amended equity plan and the dilutive impact of the plan shares may reduce the likelihood of a lawsuit alleging inadequate disclosure.
  • Compliance with Plan Terms and/or Section 162(m). Care should be taken to administer plans in accordance with their terms, including applicable limits on share grants and cash incentive payments. Plans should be drafted to provide flexibility to grant non-deductible awards and should not commit to the preservation of deductibility, including when exercising administrative discretion. Proxy statements should include disclosure that highlights that flexibility and the possibility that even awards intended to be deductible may not be.
  • Director Equity Grant Limitations. Consider including in new or amended omnibus equity plans provisions specifying the precise amount and form of individual grants to directors or a meaningful director-specific individual award limit. These limits may help to avoid claims challenging the level of director compensation.

7. Excise Tax Exposure in M&A Transactions. M&A transactions may expose company employees to punitive taxes, including the 20% excise tax on golden parachute payments (Section 280G), the 15% excise tax on equity compensation awards in inversion transactions (Section 4985) and the 20% penalty tax on non-compliant deferred compensation (Section 409A). By planning ahead, companies may be able to mitigate or eliminate these tax exposures. Properly implemented non-compete arrangements and acceleration of taxable compensation into the year prior to a transaction closing may mitigate the 280G excise tax. An equity award cash out may avoid the application of the inversion excise tax.  And there is a robust corrections framework that allows companies to fix certain broken arrangements under Section 409A. Finally, where mitigation or remediation are impractical solutions to the application of one of these punitive taxes, make-whole arrangements may be appropriate.

8. Executive Succession. During the last twelve months, we have continued to witness a number of high profile CEO turnovers. Planning for succession of the CEO and other senior executives is critical for the long-term success and stability of any public corporation. The board should evaluate annually the status of future generations of company leadership, and the new year is a good time to highlight this priority item.

Michael J. Segal
Jeannemarie O’Brien
Adam J. Shapiro
Andrea K. Wahlquist
David E. Kahan

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ISS Publishes FAQs with Clarifications for 2016 Proxy Season

December 23, 2015

ISS Publishes FAQs with Clarifications for 2016 Proxy Season

          ISS recently published FAQs that clarify its approach on a variety of procedural and governance matters heading into the 2016 proxy season.  Among other things, the FAQs address ISS’s approach to evaluating board responsiveness to proxy access shareholder proposals that receive majority support.  As companies decide how to respond to the growing pressure to adopt proxy access, these FAQs indicate ISS’s position regarding responsiveness to precatory resolutions and certain “second level” proxy access design and drafting issues.

          Key Parameters of Proxy Access.  After a shareholder proposal seeking proxy access has passed, ISS may issue an adverse recommendation if the form of proxy access implemented or proposed by a company contains material restrictions that are more stringent than those included in the majority-supported proxy access shareholder proposal, including:

  • Ownership thresholds above three percent;
  • Ownership for more than three years;
  • Aggregation limits below 20 shareholders; and
  • A cap on nominees below 20 percent of the board.

Where the nominee cap or aggregation limit differs from that specifically stated in a shareholder proposal that received majority support, ISS will evaluate the differences on a case-by-case basis, taking into account (and expecting to see) disclosure regarding shareholder outreach efforts.  Most of the shareholder proxy access proposals that have previously passed asked companies to permit shareholders to “group” and aggregate shares they have individually held for 3 years in order to meet the 3% ownership threshold and were silent as to what a reasonable limit on aggregation would be; most (though not all) shareholder proponents have agreed to withdraw their proposals and major shareholders have been willing to support adopted proxy access bylaws where a company acts reasonably in selecting a group limit.  If shareholders passed a proxy access proposal with a 25% nominee cap, the company should be able to propose a 20% cap without receiving an adverse recommendation from ISS, assuming it can demonstrate in its proxy statement sufficient shareholder outreach and support.  The nomination cap is also an area where most shareholder proponents (and major shareholders) have been willing to show flexibility, and various approaches have emerged on the cap, including hybrid approaches that include both a percentage-based formulation and a numerical minimum or maximum.

          Restrictions or Conditions on Proxy Access Nominees.  On a range of “second-tier” issues that will have to be addressed as companies formulate proxy access bylaws to ensure that they are not abused, ISS will review proxy access implementation and restrictions on nominees on a case-by-case-basis.  ISS considers the following restrictions to be “especially problematic” and to “effectively nullify” the proxy access right:

  • Counting individual funds within a mutual fund family as separate shareholders for purposes of an aggregation limit; and
  • Imposing post-meeting ownership requirements for nominating shareholders.

In addition, ISS views the following restrictions as “potentially problematic,” especially when used in combination, in the context of evaluating board responsiveness to a shareholder-supported proxy access proposal:

  • Prohibiting resubmission of failed nominees in subsequent years;
  • Restricting third-party compensation of proxy access nominees (beyond requiring full disclosure of such arrangements);
  • Restricting the use of proxy access and proxy contest procedures for the same meeting;
  • How long and under what terms an elected shareholder nominee will count towards the maximum number of proxy access nominees; and
  • When the new proxy access right will be fully implemented and accessible to qualifying shareholders.

While these proxy access parameters are not generally inconsistent with the approach taken by the majority of companies that have recently implemented proxy access, this area is still in flux.  We would not expect ISS to issue withhold recommendations as a result of thoughtfully crafted and appropriate restrictions on the use of proxy access.  Companies evaluating proxy access should consider outreach with their shareholders, especially on areas where they may want to take a different position on certain limitations.  We also encourage companies implementing proxy access, whether preemptively or in response to the receipt or passage of a shareholder proposal, to do so in a measured fashion and to consult with counsel to distinguish between fundamental protections and those that might be considered inflammatory.

          Voting on Proxy Access Nominees.  ISS has also formulated a framework for evaluating proxy access nominees.  This set of criteria is in a sense broader than that used in evaluating directors in proxy contests and includes:

  • Nominee- and nominator-specific factors: the nominator’s rationale and critique of management or incumbent directors; the nominee’s qualifications and independence
  • Company-specific factors: the company’s performance relative to peers; background to the contested situation (if applicable); the board’s track record and responsiveness; director and nominee independence; the company’s governance profile; evidence of board entrenchment; current board composition (e.g., skill sets, tenure and diversity); ongoing controversies, if any
  • Election-specific factors: Whether the number of nominees exceeds the number of board seats; the voting standard for the election of directors

          Board Responsiveness to Passage of Independent Chair Proposals.  In evaluating board responsiveness to majority-supported independent chair proposals, ISS has stated that a policy that the company will adopt an independent chair structure upon the resignation of the current CEO would be considered responsive in the context of a company having previously lost the shareholder vote on an independent chair / separation of CEO-Chair proposal.  It will evaluate partial responses on a case-by-case basis, depending on the disclosure of shareholder input obtained through outreach, the board’s rationale and the facts and circumstances of the situation.  Board leadership structure remains an area where major institutional shareholders have shown flexibility where a company conducts effective outreach.

Andrew R. Brownstein
David M. Silk
David A. Katz
Trevor S. Norwitz
Sabastian V. Niles
S. Iliana Ongun

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Staggered Boards, Long-Term Investments and Long-Term Firm Value

December 3, 2015

Staggered Boards, Long-Term Investments and Long-Term Firm Value

          Recent econometric studies (“empirical evidence”) definitively rebut the position taken by the Harvard Law School Shareholder Rights Project (SRP) that classified boards are associated with lower firm value and inferior outcomes for shareholders. After correcting serious statistical and econometrical flaws in the studies put forth to support declassification, these new studies conclude that staggered boards result in long-term value creation:

  • A 2014 study, “Staggered Boards and Firm Value, Revisited” found that, when measured across the “time series,” firm value improves after firms stagger, and declinesafter firms destagger, with the effects stronger at firms seemingly more focused on the long-term. The study reinterprets traditional attacks against staggered boards, which purport to find a negative correlation in the “cross series” between staggered boards and firm value, by suggesting the decision to stagger is largely endogenous and related to ex ante, rather than ex post, lower firm value.
  • A 2014 study, “Board Destaggering: Corporate Governance Out of Focus?” found that activism, firm size, board size, prior performance, CEO tenure and governance arrangements influence decisions to destagger. After controlling for these endogenous factors, the study found that destaggering is associated with declines in long-term accounting performance and declines in R&D investment, “consistent with the reduced incentive horizon for directors following destaggering.”
  • A 2015 study, “Commitment and Entrenchment in Corporate Governance” found that “bilateral” protective arrangements that require shareholder approval – including staggered boards – are associated with increased firm value across the “time series.”
  • In addition, a 2015 study, “Do Staggered Boards Harm Shareholders?” contested the results of a 2013 study, “How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment” that purported to find that staggered boards harm firm value, based on stock price reactions to court rulings. Based on the same sample and methods, the 2015 study found no statistically significant evidence that staggered boards harm firm value.

          Concomitantly with the rise of the SRP, activist hedge funds have significantly grown in size and have piggybacked on the campaign against staggered boards and other governance “issues” as a lever to force firms into removing their takeover defenses, thus making them more vulnerable to short-termist pressures to deliver immediate shareholder returns. These attempts have been largely successful; over the last 10 years, the percentage of S&P 500 companies with classified boards has sharply declined from 47% to 10%, while at the same time S&P 500 companies have increased dividends and buybacks by 85% to nearly $1 trillion. This has been fueled by underinvesting in long-term growth and is in diametric opposition to the interests of institutional investors in long-term value creation, as evidenced by recent statements by Vanguard’s William McNabb, BlackRock’s Laurence Fink and State Street’s Ronald O’Hanley.

Hopefully these new studies will serve as a further wake-up call and make it clear that the recent trend of forcing companies to adopt one-size-fits-all governance “best practices” – at the expense of long-term investments and firm value – is misguided and must end.

Martin Lipton
Marshall Shaffer

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Hedge Fund Activism and Long-Term Firm Value

November 24, 2015

Hedge Fund Activism and Long-Term Firm Value

          A November 2015 article, Hedge Fund Activism and Long-Term Firm Value, by K.J. Martijn Cremers, Erasmo Giambona, Simone M. Sepe, and Ye Wang, is a very impressive econometric study showing that hedge fund activism more likely destroys long-term value, rather than creates it.  It shows that prior studies of the type Harvard Law School Professor Lucian Bebchuk relies on to validate his policy arguments supporting unfettered attacks by activist hedge funds do not warrant the credibility claimed for them.  Rather than summarize Hedge Fund Activism and Long-Term Firm Value, it can speak most definitively for itself:

“The ability of shareholders, especially activist hedge funds, to determine changes in corporate policies or firm control in the short-term complicates both managerial-decision making and the extent to which other stakeholders want to invest in their relationship with the firm. . . . In both cases, the result is a reduction in long-term firm value.  By enhancing shareholders’ ability to pressure directors and managers, hedge fund activism could thus exacerbate the shareholders’ limited commitment problem rather than acting as a beneficial corrective to managerial moral hazard.”

*          *          *

          “These results [which Bebchuk employs], however, need to be interpreted with caution, because the decision to target a particular firm at a particular time is an entirely discretionary choice by the activist hedge fund.  Hence, firms being targeted by hedge funds could potentially be substantially different from other firms, and this heterogeneity may be related to their subsequent performance rather than to the activist hedge fund campaign directly.  In order to better understand whether activist hedge funds tend to target a particular type of firms, we predict the determinants of activism through logit and Cox proportional hazard models.  These models suggest that prior firm performance is the key predictor of becoming a target in an activist hedge fund campaign.  Specifically, we find that firms are much more likely to become the target of hedge fund activism if they [have] been performing relatively poorly in the past one to five years – that is, hedge funds seem to primarily target relatively undervalued firms.”

“This result, in turn, raises the possibility that the increase in firm value documented by prior studies might be attributable to market mechanisms other than the intervention by activist hedge funds.  Indeed, in competitive markets, many different actors can intervene to turn things around at a relatively poorly performing company, including key employees, top executive management, directors, long-term shareholders, as well as other stakeholders like large customers or suppliers.  In order to address the possibility that other factors may explain the increase in firm value following hedge fund activism, we create a matched sample, where for each “target” firm that is targeted by an activist hedge fund we assign a “control” firm that has similar characteristics (using those characteristics that we document matter for being targeted) as the target firm in the year before the start of the target firm’s activist hedge fund campaign.”

*          *          *

          “[W]e find that when. . . long-term stakeholder relationships matter more to a hedge fund’s target, the targeted firms experience on average a more severe decline in Q in the three years after the intervention, relative to the firm value of the matched control firms.  Also in this case, our results are economically large and statistically significant.  For example, the group of firms in the industry with the most productive labor force that are targeted in hostile hedge fund campaigns have declined in value by 29.71% relative to the control firms in the three years after first being targeted, while the other firms targeted in hostile hedge fund campaigns declined in value by 7.75% relative to their control firms.”

“Our finds have significant implications for the current corporate governance debate, as they challenge the desirability of an indiscriminate expansion of shareholder rights.  While we recognize that managerial moral hazard or having entrenched managers and directors are concrete risks in corporate governance, our research suggests that facilitating the interventions of activist hedge funds might be an undesirable solution to address these risks.  Indeed, once one takes into account the full range of informational problems faced by shareholders – including both managerial moral hazard (or entrenchment) and the shareholder limited commitment problem – hedge fund activism may carry costs that seem to outweigh its potential benefits.  This also suggests that a desirable direction for future empirical research would be to investigate whether alternative corporate governance solutions exists that may better address the trade-offs posed by the multiple informational problems that imbue the shareholder-manager relationship.”

Other 2015 studies that reach the same conclusions are:

The Conference Board, Is Short-Term Behavior Jeopardizing the Future Prosperity of Business?

Yvan Allaire and Francois Dauphin, The Game of Activist Hedge Funds: Cui Bono?

John C. Coffee, Jr. and Darius Palia, The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance

Martin Lipton, Is Activism Moving In-House?

Martin Lipton

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Glass Lewis Announces 2016 Updates to Voting Policy Guidelines

Wachtell, Lipton, Rosen & Katz
(212) 403-1000 (Phone) | (212) 403-2000 (Fax)www.wlrk.comNovember 16, 2015

Glass Lewis Announces 2016 Updates to Voting Policy Guidelines

          Glass Lewis has released updated U.S. proxy voting guidelines for the 2016 proxy season.  Key areas of focus include:  (i) nominating committee performance; (ii) changing the Glass Lewis approach to exclusive forum provisions if adopted in the context of an initial public offering; (iii) director “overboarding;” (iv) evaluation of conflicting management and shareholder proposals when both are put to a vote of shareholders; and (v) withhold recommendations in the context of failures of environmental and social risk oversight.

         Nominating Committee Performance.  Beginning in 2016, Glass Lewis may consider recommending against the chairman of the nominating committee where a failure to ensure that the board has directors with relevant experience, either through director assessment or board refreshment, has contributed to a company’s poor performance.  Glass Lewis has not specified how it will define “poor performance” or how it will assess what contributed to such performance.  Nevertheless, we continue to believe that it is good practice for boards to engage in regular director evaluations and self-assessments.

          Exclusive Forum Provisions.  During the 2015 proxy season, Glass Lewis automatically recommended against the nominating committee chair at companies that adopted exclusive forum provisions prior to an initial public offering.  Beginning in 2016, Glass Lewis will no longer automatically recommend a “withhold” vote in such circumstances, but will instead weigh the presence of the exclusive forum provision in conjunction with the overall governance and shareholder rights profile of the newly public company.  At this time, Glass Lewis will continue automatically recommending against the chairman of the nominating committee when a company unilaterally adopts an exclusive forum provision without shareholder approval outside of a spin-off, merger or initial public offering.  We continue to believe that exclusive forum provisions have merit, but boards of directors need to understand the ramifications of implementing such provisions without shareholder approval.

          Overboarding.  Consistent with the recently announced proposed changes to ISS’s voting policies , Glass Lewis has lowered the number of board positions it views as acceptable:  (i) for executive officers with outside directorships, a limit of one outside public company directorship aside from their own; and (ii) for directors who are not executive officers, reducing the acceptable number of total public boards from the current six to five.  There will be a one-year grace period until 2017, during which time Glass Lewis would include cautionary language in research reports but would not recommend withhold votes for this reason.

          Conflicting Management and Shareholder Proposals.  In response to the SEC’s recent focus on the application of Rule 14a-8(i)(9), which allowed companies to exclude shareholder proposals that conflict with a management proposal, Glass Lewis has articulated how it will assess conflicting management and shareholder proposals.  Going forward, Glass Lewis will consider, among other factors, the nature of the underlying issue, the materiality of the differences between the terms of the shareholder proposal and the management proposal and the company’s overall governance profile, including its responsiveness to shareholders as evidenced by its response to previous shareholder proposals and its prior adoption of provisions enabling shareholder rights. 

          Environmental and Social Risk Oversight.  Glass Lewis expects to recommend against directors responsible for risk oversight where the board or management failed to sufficiently identify and manage a material social or environmental risk that did (or could) negatively affect shareholder value.  Consistent with past practice, Glass Lewis will also typically recommend against directors of companies with records of inadequate risk oversight (which would be assessed with the benefit of hindsight).

As companies and boards prepare for the 2016 proxy season, they should be mindful of the revised guidelines, but should not substitute such guidelines for their own independent judgments.

Andrew R. Brownstein            David M. Silk
David A. Katz                         Trevor S. Norwitz
Sabastian V. Niles                   S. Iliana Ongun


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ISS Announces Preliminary 2016 Voting Policy Updates

October 26, 2015

ISS Announces Preliminary 2016 Voting Policy Updates and Opens Comment Period

          Today, ISS announced it is considering changing its U.S. voting policies in three areas heading into the 2016 proxy season: (i) when a sitting CEO or a non-CEO director will be viewed as “overboarded” on account of service on multiple boards, (ii) unilateral board actions that reduce shareholder rights (with a focus on newly classified boards and supermajority voting provisions) and (iii) compensation disclosure at externally managed issuers .  Notably, the areas highlighted for change in the U.S. market do not address proxy access, “responsiveness” to majority-supported shareholder proposals or other current topics.  ISS is also proposing changes to non-U.S. policies, including with respect to Brazil, Canada, France, Hong Kong & Singapore, India, Japan, the Middle East & Africa and the U.K. & Ireland.

          Overboarding.  ISS is proposing lowering the acceptable number of board positions as follows:

1.  For CEOs with outside directorships, a limit of one outside public company directorship besides their own (with “Withhold” recommendations applying only to the CEOs’ outside boards); and

2.  For directors who are not the CEO, reducing the acceptable number of total public boards from the current six (the board under consideration plus five others) to a total of either: (a) five (the board under consideration plus four others) or (b) four (the board under consideration plus three others).

In all cases, there would be a proposed one-year grace period until 2017, during which time ISS would include cautionary language in research reports but would not recommend negative votes for this reason.

          Unilateral Board Actions.  ISS is anticipating generally issuing adverse vote recommendations for director nominees whenever the board of a post-IPO company unilaterally amends its governing documents to newly classify the board or establish supermajority vote requirements; such recommendations would continue until the unilateral action is reversed or ratified by a shareholder vote.  ISS is also considering whether or not to generally issue adverse recommendations if a pre-IPO board amends the company’s bylaws or charter prior to or in connection with the IPO to classify the board and establish supermajority vote requirements to amend the bylaws or charter. If this new policy were enacted, withhold recommendations would apply to director nominees at the annual meetings following completion of the IPO.  ISS also asks whether other board actions beyond self-classification and adopting new supermajority requirements should lead to adverse recommendations.

          Compensation at Externally Managed Issuers (EMIs).  ISS is proposing to generally recommend “Against” the say-on-pay proposal at EMIs (or the EMI’s compensation committee members, the compensation committee chair, or the entire board, as deemed appropriate, in the absence of a say-on-pay proposal on the ballot) “where a comprehensive pay analysis is impossible because the EMI provides insufficient disclosure about compensation practices and payments made to executives on the part of the external manager.”

          Comment Period, Timing and Other Potential Policy Changes. ISS will be seeking input on the updates outlined above using various channels, and formal written comments are due by November 9, 2015 (and may be submitted by e-mail to ).  ISS expects to release its final 2016 voting policies on November 18, and the final policies will apply to shareholder meetings taking place on or after February 1, 2016.  Note that in addition to releasing draft and final policies, ISS traditionally publishes new FAQs that clarify its positions and policies on various topics, and the final 2016 policies may feature significant changes beyond those outlined in today’s policy consultations and for which formal comment is being sought.

As always, neither boards nor investors should substitute ISS policies or pronouncements for their own independent, case-by-case, fiduciary judgments.

Andrew R. Brownstein
David M. Silk
David A. Katz
Sabastian V. Niles
S. Iliana Ongun

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Summary by Veritas Executive Compensation Consultants


Last week, ISS announced its findings from the 2015-2016 annual ISS policy survey, the second key milestone in benchmark policy development.  This year, 109 institutional investors, 257 corporate issuers, and 20 consultants/advisors to companies participated in the survey.  The findings from the policy survey can be found here, and below is a synopsis of the policy survey results.  Here are the key takeaways:

  • Investors generally favor stricter “overboarding” thresholds for CEOs and other directors;
  • Investors support ISS’ current proxy access responsiveness policy;
  • Investors support broadening the list of items covered by “unilateral reductions in shareholder rights” and holding directors accountable until rights are fully restored;
  • Investors want clear reconciliation of adjustments used in non-GAAP compensation metrics;
  • Investors do not favor performance-based equity compensation for directors;
  • Investors want longer “cooling-off” periods for former executives and service providers before considering those directors to be independent;
  • Investors are increasingly skeptical about the benefits of renewing NOL pills; and
  • Investors seek disclosure by externally managed companies of the relevant compensation payments and practices of the external manager. 

 Over the next several weeks, ISS will continue its policy-making process for policies that will be effective February 1, 2016.  There are two approximate dates you should circle on your calendar concerning ISS policy development. The first is October 26, which is when ISS will publish certain draft 2016 policy updates and solicit comment.  Second, ISS anticipates releasing final benchmark policy updates for proxy season 2016 on November 18.

Below are more detailed notes on the results of the policy survey.  

2015-2016 ISS Policy Survey Results Synopsis:

Compensation-related survey questions:

1. Adjusted performance metrics:  How should non-GAAP or other adjusted performance metrics be viewed in a compensation performance metric, and what types of adjustments to reported or GAAP metrics are appropriate for compensation purposes?

a.  81% of investors agreed that adjusted metrics are sometimes acceptable, depending on the nature and extent of the adjustments and the degree to which disclosure of their purpose is transparent.  Of those 81%, two-thirds believe that non-GAAP metrics are acceptable as long as performance goals and results are clearly disclosed and reconciled with comparable GAAP metrics in the proxy statement, and the reasons for the adjustments are adequately explained.

2. Director compensation:  What types of equity compensation are appropriate for non-executive directors?  Are performance shares or stock options appropriate for director compensation?

a.  71% of investors believe that stock in lieu of cash for a director’s retainer or meeting fees is acceptable, but only 37% believe that performance-vesting equity is acceptable.

3. Externally-managed issuers:  How should ISS treat say-on-pay resolutions for externally-managed issuers where there is limited or no disclosure regarding executive compensation payments or practices?

a.  71% of investors surveyed indicated that ISS should recommend a vote against a say-on-pay proposal filed by an externally-managed issuer with minimal (or no) disclosure about executive compensation payments or practices on the part of the external manager.


Governance-related survey questions:

1. Overboarding:  What constitutes an acceptable number of directorships for directors, should there be restrictions placed on other classes of directors other than active CEOs (active CFOs and law firm partners, for instance), and should there be any exceptions? 

a.  For directors who are not sitting CEOs, 34% of investors believe that a four-directorship limit is appropriate; 18% believe that five is acceptable, and 20% believe that six (the status quo in ISS benchmark policy) is acceptable.  16% said “it depends/other” with a plurality suggesting a three-directorship limit.

b.  For sitting CEOs, 48% of investors believe that two seats (including the CEO’s own company) is an appropriate limit, while 32% believe that three total (the status quo in ISS benchmark policy) is appropriate.

2. Proxy access:  What restrictions in board-implemented proxy access rights, deviating from those requested in a majority supported shareholder proposal, would investors find problematic enough to potentially warrant an “against” or “withhold” vote for directors?

a.  Survey responses on proxy access are generally in line with the ISS benchmark voting policy adopted for 2015.

b.  72% of investors think ISS should issue negative recommendations impacting director elections if management adopts a higher-than-3% requirement, with that figure rising to 90% if the threshold exceeds 5%.  90% of investors surveyed believe negative recommendations are warranted if the ownership requirement exceeds 3 years.

c.  76% of investors surveyed believe negative directors recommendations are warranted if the aggregation limit is fewer than 20 shareholders.

d.  79% of investors believe that ISS should issue negative recommendations if a cap on nominees is less than 20% of the existing board size (rounded down).

3. Director accountability for unilateral bylaw amendments:  What unilateral bylaw amendments do investors find objectionable, and how long should directors be held accountable?

a.  Surveyed investors found a wide range of reductions in shareholder rights objectionable; those include classifying the board (92%), establishing supermajority voting requirements for charter/bylaw amendments (89%), diminishing the right to call special meetings or act by written consent (85%), adopting fee shifting (78%), implementing dissident director nominee compensation restrictions (77%), and increasing advance notice requirements (64%). 

b.  A majority of investors surveyed – 57% – believe that directors should be held accountable (through withhold vote recommendations) until shareholder rights are fully restored.

c.  ISS did not seek input on unilateral adoption of exclusive forum provisions. In a similar question on last year’s policy survey, institutions expressed the least concern about unilateral adoption of exclusive forum provisions of any of the actions on that list. 

4. Pre-IPO bylaw amendments:  How should boards of companies that have recently had their IPO be held accountable for shareholder rights-limiting bylaw amendments adopted before the IPO?

a.  A plurality of investors (48%) believe that a pre-IPO company should not adopt bylaw/charter amendments that negatively impact shareholders’ rights before becoming public, but a large minority (32%) believe pre-IPO companies should be free to adopt whatever provisions they deem appropriate, so long as they are clearly disclosed prior to the IPO.

5. Director independence for former executives:  When should the clock start on the 5-year cooling off period for former executives serving as directors to regain ISS’ “independent” designation, and should a cooling-off period also apply to former service providers to the company (outside counsel or auditor, for instance)?  

a.  A plurality (46%) of investors believe the 5-year clock should begin after the individual retires from the board as well as from all executive posts.

b.  82% of investors surveyed believe that former employees providing significant professional services to the company should also be subject to some cooling-off period.

6. Capital allocation and share buybacks:  What five-year historical financial metrics would investors find helpful in evaluating the appropriateness of certain capital allocation decisions (including share buybacks) made by the board?

a.  At least 85% of investors surveyed believe that additional information on share buybacks, dividends, capital expenditures, and cash balances would help assess capital allocation decisions, share buybacks, and the efficacy of board stewardship.

7. Net Operating Loss (NOL) poison pills:  How do investors believe companies should use NOL pills, what features would investors find broadly objectionable, and how often should they be renewed?

a.  Investor skepticism on NOL pills is growing.  21% believe that NOL pills should not be renewed or extended, 35% believe a duration of three years is too long between renewals, and 17% say it depends, while only 27% believe a three-year term is appropriate.  This is compared against companies, 61% of whom believe that three years is appropriate.

b.  Many investors believe that certain governance features present when a company proposes a poison pill could trigger them to vote against the pill; at least 75% of investors surveyed believe that those include (in decreasing order of objection) unequal voting rights, supermajority voting requirements, no ability to act by written consent or to call a special meeting, having a classified board, or a recent history of proxy contests.  

8. Controlled companies:  Do investors treat controlled companies differently than non-controlled companies for proxy voting or engagement purposes?

a.  56% of investors distinguish between controlled and non-controlled companies when making investment decisions and proxy voting decisions.

b.  91% of investors characterized their engagement with controlled companies as less constructive/productive than engagements with non-controlled companies.

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Managing Like An Activist Destroys Long Term Value

Attached and below is a recent memo from Wachtell Lipton:

September 18, 2015

A New Paradigm for Corporate Governance

          Recently, there have been three important studies by prominent economists and law professors, each of which points out serious flaws in the so-called empirical evidence being put forth to justify short-termism, attacks by activist hedge funds and shareholder-centric corporate governance.  These new studies show that the so-called empirical evidence omit important control variables, use improper specifications, contain errors and methodological flaws, suffer from selection bias and lack real evidence of causality.  In addition, these new studies show that the so-called empirical evidence ignore real-world practical experience and other significant empirical studies that reach contrary conclusions.  These new studies are:

For an earlier recognition of these defects in the so-called empirical evidence see, The Bebchuk Syllogism.

          These new studies provide solid support for the recent recognition by major institutional investors that while an activist attack on a company might produce an increase in the market price of one portfolio investment, the defensive reaction of the other hundreds of companies in the portfolio, that have been advised to “manage like an activist”, has the potential of lower future profits and market prices for a large percentage of those companies and a net large decrease in the total value of the portfolio over the long term.  Recognition of the Threat to Shareholders and the Economy from Attacks by Activist Hedge Funds and Some Lessons from BlackRock, Vanguard and DuPont—A New Paradigm for Governance

          Hopefully these new studies will enable and encourage major institutional investors to recognize that they are the last practical hope in reversing short-termism and taming the activist hedge funds.  Institutional investors should cease outsourcing oversight of their portfolios to activist hedge funds and bring activism in-house.  Short of effective action by institutional investors, it would appear that there is no effective solution short of federal legislation, which runs the risk of the cure being worse than the illness.  For an interesting attempt to legislate institutional investor focus on long-term rather than short-term performance see, European Commission Proposes to Moderate Short-termism and Reduce Activist Attacks

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DOJ New Requirements for Cooperation Credit

Attached and below is a recent memo from Wachtell Lipton Rosen & Katz:

DOJ Adopts New Requirements for Corporations Seeking Credit for Cooperation In an important development for corporations responding to federal investigations, the Department of Justice yesterday announced revisions to its Principles of Federal Prosecution of Business Organizations (“Principles”). The new policies, set out in a memorandum authored by Deputy Attorney General Sally Yates and sent to federal prosecutors across the nation, instruct prosecutors to focus their efforts to secure evidence against individuals responsible for corporate wrongdoing. The memorandum (accessible here) specifically encourages increased attention by DOJ attorneys on considering cases against individual wrongdoers, and also establishes additional guidelines that federal prosecutors and civil enforcement attorneys must follow in conducting and resolving corporate investigations. Perhaps most important under the new Principles, it is now DOJ policy that in order to qualify for any cooperation credit, a corporation must identify “all relevant facts relating to the individuals responsible for the misconduct.” Only if a company satisfies that threshold requirement will DOJ give the company credit for cooperation and assess the remaining elements of the company’s cooperative efforts (e.g., by weighing the timeliness and proactive nature of the company’s internal investigation, the diligence, thoroughness and speed of the investigation, etc.). In other words, as Ms. Yates explained in a speech following the announcement of the new policies, cooperation credit is now “all or nothing,” and there is “[n]o more partial credit for cooperation that doesn’t include information about individuals.” In some respects, this announced policy is more of a codification and strengthening of preexisting DOJ practice than a watershed announcement of a new direction in governmental policy. As we have previously observed, DOJ has for some time based cooperation credit on whether a corporation’s investigation assisted the government in identifying and prosecuting culpable employees. See our memorandum dated January 28, 2015. An important issue—which we hope is not overlooked as part of this heightened attention to potential individual culpability—is that assessing the actions and mental state of individuals is complex and making cases against corporate officers and employees is often difficult. As the Yates memorandum acknowledges, in the corporate setting, knowledge and responsibility are often diffuse, and proving an individual’s culpable intent can be challenging. The new Principles also require government attorneys on both the civil and criminal sides to coordinate with one another from the earliest stages of an investigation, and they encourage civil enforcement attorneys to levy parallel civil charges against individuals and corporations even when criminal charges are also brought. DOJ has made much greater use of civil enforcement tools, where the burden of proof is only a preponderance of the evidence (not the reasonable doubt standard applicable in criminal cases), in pursuing financial crisis era cases. The focus on civil enforcement tools in the Principles suggests that DOJ may make even greater use of this weapon in its arsenal.

The revised Principles underscore that any corporate internal review or response to a government-initiated probe must be carefully designed to maximize the opportunity for the corporation to receive appropriate credit for its cooperation. Where the evidence establishes that particular employees committed wrongdoing, the Yates memorandum makes it clear that those matters must be addressed forthrightly. But there will still be investigations in which the evidence does not support cases against all the individuals whom the government might wish to pursue. We expect that prosecutors will continue to recognize that there are cases in which individuals should not be charged, but the investigation must be conducted in a credible manner that enables the prosecutor to be comfortable in reaching that conclusion. In other words, we trust that fairness will remain as important as cooperation.

John F. Savarese Ralph M. Levene Wayne M. Carlin Jonathan M. Moses David B. Anders Scott Stevenson

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Shareholder Activism Has Gone Overboard

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SEC Adopts Rule for Pay Ratio Disclosure

SEC Adopts Rule for Pay Ratio Disclosure

Rule Implements Dodd-Frank Mandate While Providing Companies with Flexibility to Calculate Pay Ratio


Washington D.C., Aug. 5, 2015 —The Securities and Exchange Commission today adopted a final rule that requires a public company to disclose the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees.  The new rule, mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, provides companies with flexibility in calculating this pay ratio, and helps inform shareholders when voting on “say on pay.”

“The Commission adopted a carefully calibrated pay ratio disclosure rule that carries out a statutory mandate,” said SEC Chair Mary Jo White.  “The rule provides companies with substantial flexibility in determining the pay ratio, while remaining true to the statutory requirements.”

The new rule will provide shareholders with information they can use to evaluate a CEO’s compensation, and will require disclosure of the pay ratio in registration statements, proxy and information statements, and annual reports that call for executive compensation disclosure.  Companies will be required to provide disclosure of their pay ratios for their first fiscal year beginning on or after Jan. 1, 2017.

The rule addresses concerns about the costs of compliance by providing companies with flexibility in meeting the rule’s requirements.  For example, a company will be permitted to select its methodology for identifying its median employee and that employee’s compensation, including through statistical sampling of its employee population or other reasonable methods.  The rule also permits companies to make the median employee determination only once every three years and to choose a determination date within the last three months of a company’s fiscal year.  In addition, the rule allows companies to exclude non-U.S. employees from countries in which data privacy laws or regulations make companies unable to comply with the rule and provides a de minimis exemption for non-U.S. employees.

The rule does not apply to smaller reporting companies, emerging growth companies, foreign private issuers, MJDS filers, or registered investment companies.  The rule does provide transition periods for new companies, companies engaging in business combinations or acquisitions, and companies that cease to be smaller reporting companies or emerging growth companies.

The rules will be effective 60 days after publication in the Federal Register.

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Risk Management and the Board of Directors

July 27, 2015

Risk Management and the Board of Directors

By Martin Lipton, Daniel A. Neff, Andrew R. Brownstein, Steven A. Rosenblum, Adam O. Emmerich, Sebastian L. Fain, David J. Cohen



Corporate risk taking and the monitoring of risks have continued to remain front and center in the minds of boards of directors, legislators and the media, fueled by the powerful mix of continuing worldwide financial instability; ever-increasing regulation; anger and resentment at the alleged power of business and financial executives and boards, including particularly as to compensation during times of economic uncertainty, retrenchment, contraction, and changing dynamics between U.S., European, Asian and emerging market economies; and consistent media attention to corporations and economies in crisis. The reputational damage to companies and their boards that fail to properly manage risk is a major threat, and Institutional Shareholder Services now includes specific reference to risk oversight as part of its criteria for choosing when to recommend withhold votes in uncontested director elections. This focus on the board’s role in risk management has also led to increased public and governmental scrutiny of compensation arrangements and the board’s relationship to excessive risk taking and has brought added emphasis to the relationship between executive compensation and effective risk management. This overview highlights a number of issues that have remained critical over the years and provides an update to reflect emerging and recent developments.

As we have said before, the board cannot and should not be involved in actual day-to-day risk management. Directors should instead, through their risk oversight role, satisfy themselves that the risk management policies and procedures designed and implemented by the company’s senior executives and risk managers are consistent with the company’s strategy and risk appetite, that these policies and procedures are functioning as directed, and that necessary steps are taken to foster an enterprise-wide culture that supports appropriate risk awareness, behaviors and judgments about risk and that ensures that risk-taking beyond the company’s determined risk appetite is recognized and appropriately escalated and timely addressed. The board should establish that the CEO and the senior executives are fully engaged in risk management and should also be aware of the type and magnitude of the company’s principal risks that underlie its risk oversight. Through its oversight role, the board can send a message to management and employees that comprehensive risk management is neither an impediment to the conduct of business nor a mere supplement to a firm’s overall compliance program, but is instead an integral component of strategy, culture and business operations. In addition, the roles and responsibilities of different board committees in overseeing specific categories of risk should be reviewed to ensure that, taken as a whole, the board’s oversight function is coordinated and comprehensive. In that regard, PricewaterhouseCoopers’ 2014 Annual Corporate Directors Survey reported that 84% of directors believe there is a clear allocation of risk oversight responsibilities among the board and its committees, which represents a modest increase from the prior year, but over half of these directors suggested the clarity of the allocation of these responsibilities could still be improved.

In the wake of numerous high-profile cases over the recent years, risks related to cybersecurity and IT oversight continue to be issues that merit ever-increasing attention and oversight. As recent examples have highlighted, online security breaches, theft of personal data, proprietary or commercially sensitive information and damage to IT infrastructure are omnipresent threats and can have a significant financial and reputational impact on companies. The prevalence of these risks has been exacerbated by rapid innovations in cloud computing, data aggregation, mobile technology and social media, among others. Despite the increased attention this issue has gained recently, a survey report issued last year by PricewaterhouseCoopers indicated that a majority of directors still believe that their board should increase its focus on IT risks such as cybersecurity. In addition, boards should be mindful of potentially enhanced disclosure requirements for cybersecurity risks. Last year, the SEC reviewed public company disclosures relating to cybersecurity risks and issued comment letters to approximately 20 companies, and in June, Luis A. Aguilar, a Commissioner of the SEC, gave a speech at The New York Stock Exchange in which he emphasized that ensuring the adequacy of a company’s cybersecurity measures is an increasingly important part of a board’s risk oversight function.

The focus on risk management is a top governance priority of institutional investors. A PricewaterhouseCoopers survey report issued in 2014 indicated that risk management remains a top priority for investors, and a 2014-2015 National Association of Corporate Directors (NACD) survey revealed that risk oversight was one of the top five issues discussed with institutional investors. In exceptional circumstances, this scrutiny can translate into shareholder campaigns and adverse voting recommendations from ISS. ISS will recommend voting “against” or “withhold” in director elections, even in uncontested elections, when the company has experienced certain extraordinary circumstances, including material failures of risk oversight. In 2012, ISS clarified that such failures of risk oversight will include, among other things, bribery, large or serial fines or sanctions from regulatory bodies and significant adverse legal judgments or settlements. As a case in point, in connection with the ongoing FCPA investigation at Wal-Mart, ISS recommended voting against the chairman, CEO and audit committee chair “due to the board’s failure to adequately communicate material risk factors to shareholders, and to reassure shareholders that the board was exercising proper oversight and stewardship and would hold executives accountable if appropriate.”

Tone at the Top and Corporate Culture

The board and relevant committees should work with management to promote and actively cultivate a corporate culture and environment that understands and implements enterprise-wide risk management. Comprehensive risk management should not be viewed as a specialized corporate function, but instead should be treated as an integral, enterprise-wide component that affects how the company measures and rewards its success.

Of course, running a company is an exercise in managing risk in exchange for potential returns, and there can be danger in excessive risk aversion, just as there is danger in excessive risk-taking. But the assessment of risk, the accurate calculation of risk versus reward, and the prudent mitigation of risk should be incorporated into all business decision-making. In setting the appropriate “tone at the top,” transparency, consistency and communication are key: the board’s vision for the corporation, including its commitment to risk oversight, ethics and intolerance of compliance failures, should be communicated effectively throughout the organization. As noted in a 2014 speech by SEC Chairwoman Mary Jo White, “[e]nsuring the right ‘tone at the top’ . . . is a critical responsibility for each director and the board collectively.” Risk management policies and procedures and codes of conduct and ethics should be incorporated into the company’s strategy and business operations, with appropriate supplementary training programs for employees and regular compliance assessments.


A board’s risk oversight responsibilities derive primarily from state law fiduciary duties, federal and state laws and regulations, stock exchange listing requirements, and certain established (and evolving) best practices, both domestic and worldwide.

Fiduciary Duties

The Delaware courts have taken the lead in formulating the national legal standards for directors’ duties for risk management. The Delaware courts have developed the basic rule under the Caremark line of cases that directors can only be liable for a failure of board oversight where there is “sustained or systemic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists,” noting that this is a “demanding test.” In re Caremark International Inc. Derivative Litigation, 698 A.2d 959, 971 (Del. Ch. 1996). Delaware Court of Chancery decisions since Caremark have expanded upon that holding, while reaffirming its fundamental standard. The plaintiffs in In re Citigroup Inc. Shareholder Derivative Litigation, decided in 2009, alleged that the defendant directors of Citigroup had breached their fiduciary duties by not properly monitoring and managing the business risks that Citigroup faced from subprime mortgage securities, and by ignoring alleged “red flags” that consisted primarily of press reports and events indicating worsening conditions in the subprime and credit markets. The court dismissed these claims, reaffirming the “extremely high burden” plaintiffs face in bringing a claim for personal director liability for a failure to monitor business risk and that a “sustained or systemic failure” to exercise oversight is needed to establish the lack of good faith that is a necessary condition to liability.

More recently, in Goldman Sachs Group, Inc. Shareholder Litigation, decided in October 2011, the court dismissed claims against directors of Goldman Sachs based on allegations that they failed to properly oversee the company’s alleged excessive risk taking in the subprime mortgage securities market and caused reputational damage to the company by hedging risks in a manner that conflicted with the interests of its clients. Chief among the plaintiffs’ allegations was that Goldman Sachs’ compensation structure, as overseen by the board of directors, incentivized management to take on ever riskier investments with benefits that inured to management but with the risks of those actions falling to the shareholders. In dismissing the plaintiffs’ Caremark claims, the court reiterated that, in the absence of “red flags,” the manner in which a company evaluates the risks involved with a given business decision is protected by the business judgment rule and will not be second-guessed by judges.

Overall, these cases reflect that it is difficult to show a breach of fiduciary duty for failure to exercise oversight and that the board is not required to undertake extraordinary efforts to uncover non-compliance within the company, provided a monitoring system is in place. Nonetheless, while it is true that the Delaware Supreme Court has not indicated a willingness, to date, to alter the strong protection afforded to directors under the business judgment rule which underpins Caremark and its progeny, boards should keep in mind that cases involving particularly egregious facts and circumstances and substantial shareholder losses could lead to a stricter standard, particularly at the trial court level. Companies should adhere to reasonable and prudent practices and should not structure their risk management policies around the minimum requirements needed to satisfy the business judgment rule.

Federal Laws and Regulations

Dodd-Frank. The Dodd-Frank Act created new federally mandated risk management procedures principally for financial institutions. Dodd-Frank requires bank holding companies with total assets of $10 billion or more, and certain other non-bank financial companies as well, to have a separate risk committee which includes at least one risk management expert with experience managing risk of large companies.

Securities and Exchange Commission. In 2010, the SEC added requirements for proxy statement discussion of a company’s board leadership structure and role in risk oversight. Companies are required to disclose in their annual reports the extent of the board’s role in risk oversight, such as how the board administers its oversight function, the effect that risk oversight has on the board’s process (e.g., whether the persons who oversee risk management report directly to the board as a whole, to a committee, such as the audit committee, or to one of the other standing committees of the board) and whether and how the board, or board committee, monitors risk.

The SEC proxy rules also require a company to discuss the extent to which risks arising from a company’s compensation policies are reasonably likely to have a “material adverse effect” on the company. A company must further discuss how its compensation policies and practices, including those of its non-executive officers, relate to risk management and risktaking incentives.

Industry-Specific Guidance and General Best Practices Manuals

Various industry-specific regulators and private organizations publish suggested best practices for board oversight of risk management. Examples include reports by the National Association of Corporate Directors (NACD)—Blue Ribbon Commission on Risk Governance and the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The 2009 NACD report provides guidance on and principles for the board’s risk oversight activities, the relationship between strategy and risk, and the board’s role in relation to particular categories of risk. These principles include understanding key drivers of success and risks in the company’s strategy, crafting the right relationship between the board and its standing committees as to risk oversight, establishing and providing appropriate resources to support risk management systems, monitoring potential risks in the company’s culture and incentive systems and developing an effective risk dialogue with management.

COSO published an internationally recognized enterprise risk management framework in 2004. The COSO approach presents eight interrelated components of risk management: the internal environment (the tone of the organization), setting objectives, event identification, risk assessment, risk response, control activities, information and communications, and monitoring. A COSO 2009 enterprise risk management release recommends concrete steps for boards, such as understanding a company’s risk philosophy and concurring with its risk appetite, reviewing a company’s risk portfolio against that appetite, and knowing the extent to which management has established effective enterprise risk management and is appropriately responding in the face of risk. In its 2010 progress report, COSO recommends that the board focus, at least annually, on whether developments in a company’s business or the overall business environment have “resulted in changes in the critical assumptions and inherent risks underlying the organization’s strategy.” By understanding and emphasizing the relationship between critical assumptions underlying business strategy and risk management, the board can strengthen its risk oversight role.

In June 2015, The Conference Board Governance Center published a report, The Next Frontier for Boards: Oversight of Risk Culture, that contains useful recommendations for board driven risk governance. Among other useful suggestions, the report suggests that boards receive periodic briefings (whether from chief internal auditors, outside subject matter experts or consulting firms) on board oversight of risk culture expectations.

With respect to cybersecurity risk management, the SEC has recently voiced its support of the Framework for Improving Critical Infrastructure Cybersecurity released by the National Institute of Standards and Technology (NIST) and indicated that as part of fulfilling their risk oversight function, boards should at a minimum work with management to ensure that corporate policies are in line with the Framework’s guidelines. The Framework includes a set of industry standards and best practices for managing cybersecurity risks, as well as encourages boards to think proactively with respect to cybersecurity threats with a view towards bolstering preparedness in the event of a cyberattack.


Risk management should be tailored to the specific company, but, in general, an effective risk management system will (1) adequately identify the material risks that the company faces in a timely manner; (2) implement appropriate risk management strategies that are responsive to the company’s risk profile, business strategies, specific material risk exposures and risk tolerance thresholds; (3) integrate consideration of risk and risk management into strategy development and business decision-making throughout the company; and (4) adequately transmit necessary information with respect to material risks to senior executives and, as appropriate, to the board or relevant committees.

Specific types of actions that the appropriate committees may consider as part of their risk management oversight include the following:

• review with management the company’s risk appetite and risk tolerance, the ways in which risk is measured on an aggregate, company-wide basis, the setting of aggregate and individual risk limits (quantitative and qualitative, as appropriate), the policies and procedures in place to hedge against or mitigate risks, and the actions to be taken if risk limits are exceeded;

• establish a clear framework for holding the CEO accountable for building and maintaining an effective risk appetite framework and providing the board with regular, periodic reports on the company’s residual risk status;

• review with management the categories of risk the company faces, including any risk concentrations and risk interrelationships, as well as the likelihood of occurrence, the potential impact of those risks, mitigating measures and action plans to be employed if a given risk materializes;

• review with management the assumptions and analysis underpinning the determination of the company’s principal risks and whether adequate procedures are in place to ensure that new or materially changed risks are properly and promptly identified, understood and accounted for in the actions of the company;

• review with committees and management the board’s expectations as to each group’s respective responsibilities for risk oversight and management of specific risks to ensure a shared understanding as to accountabilities and roles;

• review the company’s executive compensation structure to ensure it is appropriate in light of the company’s articulated risk appetite and risk culture and to ensure it is creating proper incentives in light of the risks the company faces;

• review the risk policies and procedures adopted by management, including procedures for reporting matters to the board and appropriate committees and providing updates, in order to assess whether they are appropriate and comprehensive;

• review management’s implementation of its risk policies and procedures, to assess whether they are being followed and are effective;

• review with management the quality, type and format of risk-related information provided to directors;

• review the steps taken by management to ensure adequate independence of the risk management function and the processes for resolution and escalation of differences that might arise between risk management and business functions;

• review with management the design of the company’s risk management functions, as well as the qualifications and backgrounds of senior risk officers and the personnel policies applicable to risk management, to assess whether they are appropriate given the company’s size and scope of operations;

• review with management the primary elements comprising the company’s risk culture, including establishing “a tone from the top” that reflects the company’s core values and expectation that employees act with integrity and promptly escalate non-compliance in and outside of the organization; accountability mechanisms designed to ensure that employees at all levels understand the company’s approach to risk as well as its risk-related goals; an environment that fosters open communication and that encourages a critical attitude towards decision-making; and an incentive system that encourages, rewards and reinforces the company’s desired risk management behavior;

• review with management the means by which the company’s risk management strategy is communicated to all appropriate groups within the company so that it is properly integrated into the company’s enterprise-wide business strategy;

• review internal systems of formal and informal communication across divisions and control functions to encourage the prompt and coherent flow of risk-related information within and across business units and, as needed, the prompt escalation of information to management (and to the board or board committees as appropriate); and

• review reports from management, independent auditors, internal auditors, legal counsel, regulators, stock analysts, and outside experts as considered appropriate regarding risks the company faces and the company’s risk management function, and consider whether, based on individual director’s experience, knowledge and expertise, the board or committee primarily tasked with carrying out the board’s risk oversight function is sufficiently equipped to oversee all facets of the company’s risk profile—including specialized areas such as cybersecurity—and determine whether subject-specific risk education is advisable for such directors.

In addition to considering the foregoing measures, the board may also want to focus on identifying external pressures that can push a company to take excessive risks and consider how best to address those pressures. In particular, companies have come under increasing pressure in recent years from hedge funds and activist shareholders to produce short-term results, often at the expense of longer-term goals. These demands may include steps that would increase the company’s risk profile, for example through increased leverage to repurchase shares or pay out special dividends, or spinoffs that leave the resulting companies with smaller capitalizations. While such actions may make sense for a specific company under a specific set of circumstances, the board should focus on the risk impact and be ready to resist pressures to take steps that the board determines are not in the company’s or shareholders’ best interest.

Situating the Risk Oversight Function

Most boards delegate oversight of risk management to the audit committee, which is consistent with the NYSE rule that requires the audit committee to discuss policies with respect to risk assessment and risk management. Financial companies covered by Dodd-Frank must have dedicated risk management committees. The appropriateness of a dedicated risk committee at other companies will depend on the industry and specific circumstances of the company. Boards should also bear in mind that different kinds of risks may be best suited to the expertise of different committees—an advantage that may outweigh any benefit from having a single committee specialize in risk management. To date, separate risk committees remain uncommon outside the financial industry. Regardless of the delegation of risk oversight to committees, the full board should satisfy itself that the activities of the various committees are coordinated and that the company has adequate risk management processes in place.

If the company keeps the primary risk oversight function in the audit committee and does not establish a separate risk committee or subcommittee, the audit committee should schedule time for periodic review of risk management outside the context of its role in reviewing financial statements and accounting compliance. While this may further burden the audit committee, it is important to allocate sufficient time and focus to the risk oversight role.

Risk management issues may arise in the context of the work of other committees, and the decision-making in those committees should take into account the company’s overall risk management system. Specialized committees may be tasked with specific areas of risk exposure. Banks, for instance, often maintain credit or finance committees, while energy companies may have public policy committees largely devoted to environmental and safety issues. Where different board committees are responsible for overseeing specific risks, the work of these committees should be coordinated in a coherent manner both horizontally and vertically so that the entire board can be satisfied as to the adequacy of the risk oversight function and the company’s overall risk exposures are understood, including with respect to risk interrelationships. It may also be appropriate for the committee charged with risk oversight to meet in executive session both alone and together with other independent directors to discuss the company’s risk culture, the board’s risk oversight function and key risks faced by the company.

The board should formally undertake an annual review of the company’s risk management system, including a review of board- and committee-level risk oversight policies and procedures, a presentation of “best practices” to the extent relevant, tailored to focus on the industry or regulatory arena in which the company operates, and a review of other relevant issues such as those listed above. To this end, it may be appropriate for boards and committees to engage outside consultants to assist them in both the review of the company’s risk management systems and also assist them in understanding and analyzing business-specific risks. But because risk, by its very nature, is subject to constant and unexpected change, boards should keep in mind that annual reviews do not replace the need to regularly assess and reassess their own operations and processes, learn from past mistakes, and seek to ensure that current practices enable the board to address specific major issues whenever they may arise. Where a major or new risk comes to fruition, management should thoroughly investigate and report back to the full board or the relevant committees as appropriate.

Lines of Communication and Information Flow

The ability of the board or a committee to perform its oversight role is, to a large extent, dependent upon the relationship and the flow of information between the directors, senior management, and the risk managers in the company. If directors do not believe they are receiving sufficient information—including information regarding the external and internal risk environment, the specific material risk exposures affecting the company, how these risks are assessed and prioritized, risk response strategies, implementation of risk management procedures and infrastructure, and the strengths and weaknesses of the overall system—they should be proactive in asking for more. Directors should work with management to understand and agree on the type, format and frequency of risk information required by the board. High-quality, timely and credible information provides the foundation for effective responses and decision-making by the board.

Any committee charged with risk oversight should hold sessions in which it meets directly with key executives primarily responsible for risk management, just as an audit committee meets regularly with the company’s internal auditors and liaises with senior management in – 9 – connection with CEO and CFO certifications for each Form 10-Q and Form 10-K. In addition, senior risk managers and senior executives should understand they are empowered to inform the board or committee of extraordinary risk issues and developments that need the immediate attention of the board outside of the regular reporting procedures. In light of the Caremark standards discussed above, the board should feel comfortable that “red flags” or “yellow flags” are being reported to it so that they may be investigated if appropriate.

Legal Compliance Programs

Senior management should provide the board or committee with an appropriate review of the company’s legal compliance programs and how they are designed to address the company’s risk profile and detect and prevent wrongdoing. While compliance programs will need to be tailored to the specific company’s needs, there are a number of principles to consider in reviewing a program. As noted earlier, there should be a strong “tone at the top” from the board and senior management emphasizing that non-compliance will not be tolerated. The compliance program should be designed by persons with relevant expertise and will typically include interactive training as well as written materials. Compliance policies should be reviewed periodically in order to assess their effectiveness and to make any necessary changes. There should be consistency in enforcing stated policies through appropriate disciplinary measures. Finally, there should be clear reporting systems in place both at the employee level and at the management level so that employees understand when and to whom they should report suspected violations and so that management understands the board’s or committee’s informational needs for its oversight purposes. A company may choose to appoint a chief compliance officer and/or constitute a compliance committee to administer the compliance program, including facilitating employee education and issuing periodic reminders. If there is a specific area of compliance that is critical to the company’s business, the company may consider developing a separate compliance apparatus devoted to that area.

Anticipating Future Risks

The company’s risk management structure should include an ongoing effort to assess and analyze the most likely areas of future risk for the company, including how the contours and interrelationships of existing risks may change and how the company’s processes for anticipating future risks are developed. Anticipating future risks is a key element of avoiding or mitigating those risks before they escalate into crises. In reviewing risk management, the board or relevant committees should ask the company’s executives to discuss the most likely sources of material future risks and how the company is addressing any significant potential vulnerability.

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The Changing Dynamics of Governance and Engagement

The attached article, Corporate Governance Update: The Changing Dynamics of Governance and Engagement, was published in the New York Law Journal on July 22, 2015.

July 23, 2015

Corporate Governance Update: The Changing Dynamics of Governance and Engagement

David A. Katz and Laura A. McIntosh

David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.

1 The Conference Board Governance Center White Paper, “What Is the Optimal Balance in the Relative Roles of Management, Directors, and Investors in the Governance of Public Corporations?” 2014, available at (subscription required).

As anticipated, the 2015 proxy season has been the “Season of Shareholder Engagement” for U.S. public companies. Activist attacks, high-profile battles for board seats, and shifting alliances of major investors and proxy advisors have created an environment in which shareholder engagement is near the top of every well-advised board’s to-do list. There is no shortage of advice as to how, when, and why directors should pursue this agenda item, and there is no doubt that they are highly motivated to do so. Director engagement is a powerful tool if used judiciously by companies in service of their strategic goals. As companies and their advisors study the lessons of the recent proxy season and look ahead, it is worth examining recent shifts in corporate governance dynamics. With an awareness of the general trends, and by taking specific actions as appropriate, boards can prepare and adapt effectively to position themselves as well as possible to achieve their strategic objectives.

Governance Dynamics Trends

Since 2000, the corporate environment has changed in many ways. A thoughtful white paper by The Conference Board discusses five of the most significant legal, social, and market trends during this time period that have contributed to the changing dynamics of corporate governance.1 These trends have been transformative, and, taken together, they are foundational to shareholder-director engagement today. The first is the increased influence of institutional investors. This is due primarily to the concentration of stock ownership in institutionally-held investment and savings accounts, and to a lesser extent to changes in voting rules and practices and proactive steps by institutional investors to influence corporate governance and direction. The second trend is a shift toward a purely commercial understanding of the purpose of a corporation. Though mid-20th century America generally agreed that a corporation had responsibilities to society as well as to its shareholders, in recent years the prevailing view held by many investors is that public corporations exist primarily to maximize shareholder value. Conflicting interpretations of this goal have produced a further debate as to whether the appropriate timeframe for doing so is the long- or short-term horizon.

The third trend is declining public trust in business and its leaders. Public confidence in corporate America plummeted with the collapse of Enron and WorldCom and the financial scandals that followed, and it was further undermined by the bankruptcies, bailouts, and stock market losses that accompanied the 2008-2009 financial crisis.

The fourth trend, largely a reaction to the third, is the expansion in federal regulations designed to increase the accountability of directors and senior management and provide shareholders with greater power. Federal regulations over the last decade and a half have, among other things, expanded the range of mandatory company disclosures, provided the U.S. Securities and Exchange Commission (SEC) with authority to introduce proxy access, diminished companies’ ability to exclude shareholder proposals from their proxy statements, required regular shareholder advisory votes on executive compensation, and identified shareholder fiduciary duties in certain types of proxy voting by some institutional investors.

This shift in the SEC’s focus recently was clearly articulated by SEC Commissioner Dan Gallagher in his last public speech as a Commissioner: “Part of the SEC’s tripartite mission is to protect investors. But too often, our concept of ‘investor protection’ reflects a prejudgment that a corporation is a democracy, where shareholders participate directly in the governance of the corporation.”2 Commissioner Gallagher went on to argue for a more traditional view of federal versus state regulation:

2 Securities and Exchange Commissioner Daniel M. Gallagher, “Activism, Short-Termism, and the SEC: Remarks at the 21st Annual Stanford Directors’ College,” June 23, 2015 (footnotes omitted), available at

3 Id.

4 See, e.g., David A. Katz & Laura A. McIntosh, “Corporate Governance Update: Important Proxy Advisor Developments,” Sept. 25, 2014, N.Y.L.J., available at

But, like the United States itself, a corporation can also be a republic, where shareholders elect directors, who in turn govern the corporation. The choice of a shareholder- or director-centric model is properly left to state law. The SEC increasingly has been disrespecting this distinction by interjecting opportunities for shareholder direct democracy into the securities laws. But the director-centric model is at least equally-well suited to the protection of investors, and so the SEC’s rules should provide enough flexibility to accommodate either approach.3

The fifth trend is the growing influence of proxy advisory firms. Proxy advisors successfully capitalized on the loss of public confidence in business leaders, the rise in share ownership of institutional investors, and the wide array of new regulations and governance requirements. Large investors turned to proxy advisors for guidance, smaller investors followed suit, and the soft power of proxy advisors has become disproportionately strong.4 Fortunately, over the last year or two, institutions and other large, influential investors have begun to distance themselves from proxy advisors. One factor in this reversal is the SEC’s issuance of Staff Legal -3- SLB 20 contained a number of elements that together have prompted institutional investors to take responsibility for their proxy votes rather than outsourcing them to advisors such as Institutional Shareholder Services Inc. (ISS). Some large institutional investors have created internal departments to handle much of the work they previously outsourced to proxy advisors. Investment advisors are evaluating and overseeing the work of their retained proxy advisory firms more closely. As Commissioner Gallagher might put it, institutional investors are starting to move from a “compliance mindset” on proxy voting to a “fiduciary mindset.”-4- -5-

Lipton, Rosen & Katz Client Memorandum, May 18, 2015, available at

14 Fink Letter, supra.

15 Id.

16 Society of Corporate Secretaries & Governance Professionals, “Role of Secretary,” 2015, available at

17 See Simon Osborne, “Rise of the Company Secretary,” Law Society Gazette, July 7, 2014, available at

18 Andrew Kakabadse & Nada Korac-Kakabadse, “The Company Secretary: Building Trust Through Governance,” Institute of Chartered Secretaries and Administrators/Henley Business School, University of Reading, 2014, at 7.

19 See Goldstein, supra, at 18.

DuPont did exactly what investment community leaders such as Laurence Fink have encouraged corporations to do—“engage with a company’s long-term providers of capital; … resist the pressure of short-term shareholders to extract value from the company if it would compromise value creation for long-term owners; and, most importantly, … clearly and effectively articulate their strategy for sustainable long-term growth.”14 In his April 2015 letter to chief executives, Fink promised that “[c]orporate leaders and their companies who follow this model can expect our support.”15 In the DuPont-Trian proxy fight, he and a sufficient number of other institutional shareholders held up their end of the bargain.

Some institutional investors have expressed concerns regarding the rapid increase in director engagement and how they, as large shareholders whose attention is much in demand, will allocate their resources to engage meaningfully. There is some concern that companies with smaller market capitalizations may find it difficult to engage the attention of large shareholders, as these investors are likely to prioritize engagement with companies in which they have more significant investments. Smaller companies may need to seek engagement earlier in the proxy season (or before the proxy season) in order to obtain meaningful access to their institutional investors.

The Corporate Secretary

The preeminence of corporate governance and the rise of shareholder engagement have resulted in a fundamental shift in the role of the corporate secretary. As the Society of Corporate Secretaries and Governance Professionals has observed, “In recent years the Corporate Secretary has emerged as a senior, strategic-level corporate officer who plays a leading role in the company’s corporate governance.”16 In addition, many corporate secretaries have become, as one commentator put it, “the primary point of information and influence between the executive management and the board.”17 A 2014 U.K. study concluded that “[t]he role is changing: it is increasingly outward-focused (incorporating investor engagement and corporate communications), and not just about internal administration.”18 A 2014 ISS report found that when investors reach out to engage with boards, they most frequently contact the corporate secretary. The second-most frequent point of initial contact for investor-driven engagement is the board chair (or lead director), with the investor relations office a weak third.19 When it is the -6- -7-

Role of the Board

Corporate governance trends have wrought many significant changes in the management and oversight of U.S. corporations. The priorities and responsibilities of directors, investors, and senior executives have changed to varying degrees as all of the corporate actors adapt to new requirements, societal trends, and the increasingly interconnected corporate environment. Through mechanisms such as majority voting—which is becoming more widespread each year—shareholders are increasing the accountability of directors in annual elections. The hope is that these changing dynamics will have a beneficial effect. As Chief Justice Leo Strine of the Delaware Supreme Court has written:

[I]t is clear that stockholders have more tools than ever to hold boards accountable and the election process is more vibrant than ever. The election of more accountable boards should come with less tumult, not more. More accountable boards should be given more, not less, leeway to make decisions during their term. This does not mean that corporation law should strip stockholders of their substantive rights to vote on mergers or major asset sales. But it does mean that the costs of further distracting corporate managers from focusing on managing the business to generate profit would outweigh the benefits that come from more corporate referendums.24

24 Leo E. Strine, Jr. “One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed For The Long Term Unless Their Powerful Electorates Also Act And Think Long Term?” 66 Bus. Law. 1, 23 (November 2010), available at

25 See, e.g., Del. Gen. Corp. L. § 141.

Perhaps one outcome of increased independent director engagement with shareholders will be a decline in corporate referenda, allowing directors to focus on creating value in the long term. To date, unfortunately, that has not been the case.

Though certain aspects of the role of the board may be changing, the fundamental role and responsibilities of the board hold constant. As a matter of state law, the board is charged with managing, or directing the management of, the affairs of the corporation.25 No matter how active or activist a company’s shareholders may become, their legal responsibilities extend only to the election of directors, votes on certain fundamental matters, and advisory votes on compensation. Some academics and activists argue that state law should be revised to expand the legal rights of shareholders; the merits of this suggestion are debatable, and in any event, it has not been implemented.

Shareholder influence likely will continue to grow, but the legal rights of shareholders remain limited, and the U.S. corporate model remains managerial and director-centric. Directors cannot allow their business judgment to be usurped or overly influenced by investors, advisors, or other board outsiders. Boards are encouraged to interact strategically with investors, to address their concerns, and to reinforce the company’s long-term goals, and at the -8-

same time to keep in mind that activism, corporate governance, and engagement change nothing about the fundamental fiduciary duties of directors.

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July 20, 2015
Recently, Steve Quinlivan of Stinson Leonard Street LLP authored a piece on
Members of the Dolan family hold 73% of the voting power of Cablevision Systems Corporation’s stock.  A shareholder commenced a derivative action regarding the executive compensation paid to Dolan family members serving as Executive Chairman and Chief Executive Officer and the Delaware Court of Chancery dismissed the claims.
In setting the compensation for the two family members that serve as Executive Chairman and Chief Executive Officer of Cablevision, the compensation committee used a peer group of 14 publicly traded companies.  The court, in analyzing the case, also looked to additional companies in Cablevision’s ISS peer group, for a total peer group of 26 companies.  18 members of the peer group had market capitalizations of over $10 billion and the average total revenue was $30.87 billion.  By comparison, Cablevision had a market capitalization of $4.39 billion and $19.58 billion in revenue.
Of the 17 peer companies with less than $30 billion in market capitalization, only two paid their CEO more than Cablevision paid its CEO.  The Executive Chairman earned more than 14 (of 17) CEOs at peer companies with a market capitalization below $30 billion.
The plaintiff claimed that the entire fairness standard should apply to review of the executive compensation rather than the business judgment rule.  The rational that was advanced was that transactions between controllers and a controlled company are reviewed under the entire fairness standard regardless of whether the transaction is approved by a committee or whether challenged in a merger or non-merger.
The Court agreed with the defendants’ analysis about the need to distinguish an independent committee’s compensation decisions from other matters warranting default entire fairness review. For example, major concerns in applying entire fairness review are informational advantages and coercion.  The Court noted the complaint does not support its allegations of leveraging control over the compensation committee with a factual basis to make that inference, and the Court did not believe the Executive Chairman and the CEO had a material informational advantage over the compensation committee about the value of their services. Additionally, the Court would not endorse the principle that every controlled company, regardless of use of an independent committee, must demonstrate the entire fairness of its executive compensation in court whenever questioned by a shareholder. Finally, the Court stated it was especially undesirable to make such a pronouncement here, where annual compensation is not a “transformative” or major decision.


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July 14, 2015

Responding to Institutional Investor Requests for
Access to Independent Directors

          Recent statements by BlackRock, State Street, Vanguard and other institutional investors clearly articulate their expectation that companies should provide access to independent directors and should adopt a structure for regular investor/director communications.  In responding to these requests, there is a range of approaches that companies could adopt which, in each case, should be tailored to the specific circumstances of the company.  Indeed, institutional investors have specifically stated that they do not seek any particular method to ensure access to, and relationships with, directors.  However, they have made it clear that it will color their attitude toward the company if the company first begins to provide access to directors only after the company has been attacked by an activist.

          This memo outlines some alternatives to consider in constructing a shareholder relations program that will facilitate the development of meaningful long-term relationships with investors while also striking an appropriate balance between the roles of management and directors.  In the case of an activist attack or other contested situation, these alternatives would need to be supplemented by an intensive campaign with participation by directors.

  • The board could establish a Shareholder Relations Committee. This board committee could be available to receive communications from investors and meet with investors. In addition, it could oversee board and director evaluations, which have increasingly become an area of focus for institutional investors.
  • The Lead Director and two or three other independent directors could join the CEO and head of investor relations on annual visits to the top 10 to 15  investors. The scope and substance of the agenda for those visits could be tailored to take into account, among other things, the investor’s areas of focus and level of familiarity with the company (for example, the agenda for a meeting with the proxy team at an index fund may vary substantially from the agenda for a meeting with an active fund manager).
  • When setting up other routine meetings between the company’s CEO/CFO and top investors, the investor relations team could periodically offer to make two or three directors available to join the meeting and/or to meet privately with investors.
  • Directors could attend an Investor Day and arrangements could be made for them to meet with the company’s top investors.
  • Investors could be invited to the annual shareholders meeting and arrangements could be made for them to meet with directors.
  • The role of the Lead Director in facilitating communications with investors could be highlighted. In particular, investors could be provided with the Lead Director’s contact information and could be advised that the Lead Director will work to facilitate direct contact with board members in appropriate circumstances.
  • The Lead Director, Shareholder Relations Committee or the full board could issue an annual letter to investors that describes the “tone at the top” and ongoing initiatives to understand the perspectives of shareholders, develop long-term relationships and further enhance board functioning.
  • The shareholder relations program could be managed by the CFO and investor relations team, in consultation with the company’s CEO and general counsel.

Martin Lipton

Karessa L. Cain

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SEC Proposes Compensation Clawback Rules

Wachtell, Lipton, Rosen & Katz

July 2, 2015

SEC Proposes Compensation Clawback Rules

          The SEC yesterday proposed its long-awaited compensation clawback rules under the Dodd-Frank Act. The proposed rules would require public companies to adopt and enforce compensation recovery policies that recoup from executive officers incentive compensation resulting from specified accounting restatements. Failure to comply with these rules would result in delisting by the applicable exchange.

          Which companies would be covered? With very limited exceptions, the rules would apply broadly to all issuers with listed securities, including foreign private issuers, emerging growth companies, smaller reporting companies, controlled companies and issuers of listed debt whose stock is not also listed.

          Which individuals would be covered? The recovery policy would apply to an issuer’s current and former executive officers who served in that capacity at any time during the applicable look back period. Under the proposed rules, “executive officer” means the issuer’s president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division or function and any other person (including executive officers of a parent or subsidiary) who performs similar policy-making functions for the issuer.

          What type of restatements would trigger application of the recovery policy? A restatement to correct an error that is material to previously issued financial statements would trigger application of the recovery policy. The determination regarding materiality would be based on facts and circumstances and existing judicial and administrative interpretations.

          How would the applicable look back period be determined? Incentive-based compensation received during the three completed fiscal years immediately preceding the date that a restatement is required to correct a material error would be subject to the recovery policy. Incentive-based compensation would be deemed received in the fiscal period during which the financial reporting measure specified in the incentive-based compensation award is attained, even if the payment or grant occurs before or after that period.

          What types of incentive-based compensation would be covered? Under the proposed rules, “incentive-based compensation” means any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure. “Financial reporting measures” include measures that are determined and presented in accordance with the accounting principles used in an issuer’s financial statements, as well as an issuer’s stock price and total shareholder return. Importantly, stock options and other equity awards that vest exclusively on the basis of service, without any performance condition, and bonus awards that are discretionary or based on subjective goals or goals unrelated to financial reporting measures, would not constitute incentive-based compensation.

          How would the recovery amount be determined? The recovery amount would equal the amount, calculated on a pre-tax basis, of incentive-based compensation received in excess of what would have been paid to the executive officer upon a recalculation of such compensation based on the accounting restatement. For incentive-based compensation that is not subject to mathematical recalculation based on the information in an accounting restatement (e.g., compensation based on stock price goals or total shareholder return), the recoverable amount may be determined based on a reasonable, documented estimate of the effect of the accounting restatement on the applicable measure.

For equity awards that are incentive-based compensation, if the shares or options are still held at the time of recovery, the recoverable amount would be the number of shares or options received in excess of the number that should have been received after applying the restated financial reporting measure. If options have been exercised, but the underlying shares have not been sold, the recoverable amount would be the number of shares underlying the excess options applying the restated financial measure. If shares have been sold, the recoverable amount would be the sale proceeds received by the executive officer with respect to the excess number of shares.

          Would the board have discretion whether to seek recovery? Board discretion would be very limited. An issuer would be required to recover compensation in compliance with its recovery policy except to the extent that pursuit of recovery would be impracticable because it would impose undue costs on the issuer or would violate home country law based on an opinion of counsel. Before concluding that pursuit is impractical, the issuer would first need to make a reasonable attempt to recover the incentive-based compensation. Finally, a board would be required to apply any recovery policy consistently to executive officers and an issuer would be prohibited from indemnifying any current or former executive officer for recovered compensation.

          What additional disclosure requirements would the new proposed rules impose? A listed U.S. issuer would be required to file its recovery policy as an exhibit to its Form 10-K. In addition, the proposed rules would require disclosure in an issuer’s annual proxy statement regarding the application of the recovery policy if, during the prior fiscal year, either a triggering restatement occurred or any balance of excess incentive-based compensation was outstanding. Required disclosure would include, for the prior fiscal year, (1) the names of individuals from whom the issuer declined to seek recovery, and (2) the name, and amount due from, each person from whom excess incentive-based compensation had been outstanding for 180 days or longer. In addition, any amounts recovered would reduce the amount reported in the applicable Summary Compensation Table column for the fiscal year in which the amount recovered initially was reported as compensation.

          When would the new rules become effective? The rules will not take effect for some time. There is a 60-day comment period applicable to the proposed rules. Thereafter the SEC must issue final rules. Once the final rules are published (the “SEC Publication Date”), each exchange will have 90 days to file proposed listing standards that must become effective within one year of the SEC Publication Date. Issuers would be required to adopt a compliant recovery policy no later than 60 days following the effective date of the applicable listing standards and to recover excess incentive-based compensation received on or after the SEC Publication Date if that compensation was based on financial information for any fiscal period ending on or after the SEC Publication Date. The additional proxy statement disclosures would apply immediately following the effective date of the applicable listing standards.

*        *        *        *        *        *

          Most public companies have adopted remuneration recovery policies and there is no meaningful disagreement that there are circumstances in which it is appropriate to recoup improperly awarded compensation. Recognizing that the statute does not leave much room for flexibility, the most troubling element of the proposed rules is that they impose a strict liability framework that strips a board of directors of discretion, continuing a trend that hampers a board’s ability to effectively direct a company.

Adam J. Shapiro
David E. Kahan

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Posted here are the Global Governance Principles published by the International Corporate Governance Network, or ICGN. An investor-led organization of governance professionals, ICGN’s mission is to inspire and promote effective standards of corporate governance to advance efficient markets and economies world-wide. Established in 1995 and present in over 50 countries, the ICGN membership includes global investors with assets under management in excess of US$18 trillion.

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May 26, 2015
As we hit the halfway point for the 2015 U.S. proxy season, a number of trends related to governance practices are carrying through from recent years, an analysis of ISS Voting Analytics data shows.
Director Elections
Shareholders have largely endorsed directors standing for election in 2015, with average support levels of upwards of 96 percent, similar to last year. However, as is the case every year, a number of directors have not fared well at the ballot box. Fourteen directors have failed to receive majority support so far this season, compared with 12 board members at this time last year.
The lion’s share (12 of the 14) of year-to-date 2015 failed director votes have been at firms outside the Russell 3000 index. On a sector basis, most of the failed director elections have occurred at firms in the Technology Media and Telecom sector (with seven failed votes) and financial services firms (3 failed votes). Companies in the financial services sector topped last year’s list with the most failed director votes.
Drivers of Low Votes
The primary drivers of low director support come as no surprise to governance observers. Similar to prior years, affiliated directors on key committees, non-responsiveness to majority supported shareholder proposals or majority opposed directors and say on pay plans, unilaterally adopted poison pills, unilaterally adopted bylaw amendments, directors sitting on too many boards, and persistent pay-for-performance concerns are the major drivers of low shareholder support for directors.
Shareholder Proposals
Of roughly 950 resolutions submitted at almost 500 firms for the 2015 proxy season, 600 shareholder proposals have so far appeared on proxy ballots at close to 350 companies. In aggregate, about 18 percent of the proposals have been withdrawn and approximately 14 percent excluded from ballots with the SEC’s assent. Voting Analytics has average investor support for the approximately 190 shareholder resolutions where vote results are currently available at 33.5 percent support. Twenty eight (or roughly 15 percent) of these have received majority support, with proxy access proposals accounting for almost half of the majority votes. For context, these tallies compare with about 560 proposals at almost 330 companies in all of 2014, which received, on average, 32.7 percent support, and 83 of which received majority votes.
Governance Proposals Most Ubiquitous
Governance proposals account for half of all resolutions on ballots this year, followed by environmental and social (E&S) proposals with 37 percent of the total tally, and compensation proposals at 13 percent.
Governance proposals have received 43 percent average support of votes cast “for” and “against,” whereas shareholders have supported E&S and compensation resolutions by 22.6 percent and 33.4 percent on average, respectively. Governance proposals have also drawn 25 of the 28 majority votes thus far this year, with the remaining three majority votes for compensation resolutions. No E&S proposals have thus far received majority support, in contrast to this time last year when a lobbying disclosure proposal obtained majority support in early May. In 2014, seven E&S resolutions received majority support – six of which were opposed by boards.
Proxy Access Aplenty
In terms of volume, proxy access is the highest-profile shareholder proposal topic this proxy season, with 84 shareholder proposals on the ballot to date, or more than four times the number of proposals that appeared on ballot in 2014. Nearly all of the proxy access shareholder proposals are modeled on the 3 percent-for-three-years formulation featured in the SEC’s vacated proxy access rule. Voting Analytics data shows that access proposals have so far received 54.9 percent shareholder support at the 32 companies where vote results are available. Fourteen have received majority support.
The boards of seven companies have sponsored proxy access proposals that compete with the shareholder proposals on ballot, with terms that are more restrictive. Of the two dueling proposal vote outcomes available, investors voted down the board-sponsored 5 percent-for-three-years proposal at AES Corp. (Governance Quickscore: 2) which received just 36 percent support, favoring the 3 percent-for-three-years shareholder proposal with more than 66 percent support. At Exelon (Governance Quickscore: 6), however, shareholders did the exact opposite, and passed the 5 percent-for-three-years board proposal with more than 52 percent support, whereas the 3 percent-for-three-years shareholder proposal received 44 percent support.
Continued Calls for Independent Board Chairs
After proxy access, the next most frequently occurring shareholder resolution is that calling for an independent board chair, with 64 proposals on ballot so far this year. Average shareholder support for the 29 proposals for which vote results are available currently stands at 29.5 percent, down slightly from last year’s 31.1 percent average support. So far in 2015, no independent chair shareholder proposals have received majority votes – the proposal at Baxter International (Governance Quickscore: 10) came close, with 48.9 percent shareholder support. Last year, four independent chair proposals received majority support, two of which are on ballot again in 2015.
Management Say on Pay Update
As expected in 2015, management say-on-pay (MSoP) ballot volumes are down thanks to the dearth of biennial and triennial advisory votes falling in the 2015 calendar year. For the typical proxy voter, this should translate to a 10 percent year-over-year drop in MSoP ballot volumes. For many investors, this may turn out to be a false economy, however, since the focus simply shifts to the compensation committee and the election of directors. Levels of support have, however, remained relatively unchanged from last year, with average shareholder support for MSoP proposals at 92.3 percent. Eleven firms have so far received less than majority support, compared with 16 failed votes at this time last year. Most of this year’s failed votes have occurred at Russell 3000 firms and in the Industrials sector.
Roller Coaster Rides
A number of boards witnessed reversals of fortune with year-over-year support for say on pay increasing by 50 percentage points or more. Support at Sensient Technologies (Governance Quickscore: 1, Compensation Pillar Quickscore: 3) jumped to 98 percent in 2015 from 46 percent support in 2014, and at FirstMerit Corporation (Governance Quickscore: 2, Compensation Pillar Quickscore: 6), shareholders approved say-on-pay by a margin of 93 percent this year, up from 42 percent support last year.
Other companies experienced the opposite reversal of fortune. Walter Energy (Governance Quickscore: 3, Compensation Pillar Quickscore: 9) saw support for say on pay drop by nearly 70 percentage points, from 95 percent in 2014 to 28 percent this year. Shareholders also thumbed down pay at Schnitzer Steel (Governance Quickscore: 9, Compensation Pillar Quickscore: 8) this year, with just 24 percent support, down from 76 percent support in 2014, and, at Nuance Communication, (Governance Quickscore: 10, Compensation Pillar Quickscore: 10), where the say on pay vote just barely passed last year with 51 percent support, votes in favor dropped significantly in 2015, with just 14.6 percent support. – Edward Kamonjoh, ISS’ Head of U.S. Strategic Research Analysis and Studies
Veritas Executive Compensation Consultants, (“Veritas”) is a truly independent executive compensation consulting firm., or contact CEO Frank Glassner via phone at (415) 618-6060, or via email at

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May 11, 2015
On April 29, the SEC announced that it had voted 3-2 in favor of proposing new rules requiring increased disclosure on the link between company performance and executive compensation. The proposed rules would implement a requirement mandated by Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. According to the SEC press release, the proposed rules would, “provide greater transparency and allow shareholders to be better informed when they vote to elect directors and in connection with advisory votes on executive compensation.”
What the Rules Would Do
If implemented as written, the new rules would require a new section in the compensation disclosure section of a company’s proxy or other relevant filing. The section would have to include a table showing the compensation paid to the company’s “principal executive officer,” as already disclosed in the summary compensation table; however, in the section that would be added under the proposed rules, this total compensation figure would be adjusted to reflect compensation “actually paid.” Amounts included in the summary compensation table for pension and equity awards would be adjusted. The table would also include the average compensation paid to the other named executive officers in the summary compensation table using the new methodology. The compensation disclosure would have to be for the previous five years.
The new rules would also require each company to include in the table its total shareholder return (TSR), using a specified definition of TSR, on an annual basis, also over a five-year look-back period. Additionally, the company would have to disclose TSR for each of the companies in its peer group, using the peers the company identified in either its stock performance graph or in its compensation discussion and analysis (CD&A).
Companies would also be required to tag the data interactively using eXtensible Business Reporting Language (XBRL).
Finally, using the information presented in the table, companies would have to describe the, “relationship between the executive compensation actually paid and the company’s TSR, and the relationship between the company’s TSR and the TSR of its selected peer group.” The company could fulfill this requirement through a narrative, a graphic representation showing the relationships, or some combination of the two.
Smaller reporting companies would only be required to provide the new disclosure for a three-year look-back period, and would not be required to disclose any peer TSR information.
Treatment of Pensions and Equity Awards
The difference between the amounts reported in the new disclosure table and the summary compensation table would stem from changes in the reporting of pension and equity award values. Pensions would be adjusted by subtracting the change in value to the pension, as reported in the summary compensation table, and then adding back the, “actuarially determined service cost for services rendered by the executive during the applicable year.”
To determine the disclosure in the new table, under the term “actually paid,” equity awards would not be disclosed until the day of vesting, and the value would be determined by fair value on the day of vesting, in addition to disclosing the fair value on the grant date. If the vesting date valuation assumptions are materially different from those in the company’s financial statements as of the grant date, then the company would be required to disclose the new fair value assumptions, as well.
Timing of New Rules
If the new rules receive final approval, all companies would have a phase in period. Most companies would be required to meet the new disclosure requirements in the next required filing, but they would only be asked to disclose the data with a three-year look-back period in the first relevant filing after the rules come into effect, adding a year of disclosure each subsequent filing for the next two filings, until the five-year look-back requirement is met.
Smaller companies would only be initially required to include two years’ of disclosure, adding the third year in the next relevant filing.
What the Rules Wouldn’t Do
As currently described, there are a few key points that the rules do not address.
Many companies craft long-term incentive plans with three year performance periods for payouts. The SEC rules require a five-year look-back period for comparing pay and performance, which may leave open some room for interpretation as to how the relationship between performance and pay over the disclosure period is best described effectively. This applies to options with three-year vesting periods, as well as performance-vesting awards with three-year performance periods.
Additionally, the performance period and pay period as required by the disclosure may not align, on an annual basis, with the company’s actual performance and pay periods, especially for companies with awards that do not vest at the calendar year end.
While the rules require the use of TSR as a performance metric, there is no requirement against using an additional performance metric, which some companies may find is more appropriate to their respective situation. Companies may choose to highlight pay for performance with other measures, such as earnings or return on invested capital, to draw attention to metrics believed to be more reflective of long-term performance and value creation.
Finally, the rules do not specify how companies would be required to treat the disclosure of compensation paid to multiple CEOs in a year where a company changed CEOs, and they also do not cover additional pay given in those years, either as part of the payments to the incoming or outgoing CEO.
Next Steps
If the rules receive approval from the Commission for publication, they will be published, and a 60-day comment period will open. 
P.S. – Let’s all keep in mind that there is a presidential election coming up shortly, and this is a hotly debated, and very unpopular subject……..
Veritas Executive Compensation Consultants, (“Veritas”) is a truly independent executive compensation consulting firm. 
We are independently owned, and have no entangling relationships that may create potentialconflict of interest scenarios, or may attract the unwanted scrutiny of regulators, shareholders, the media, or create public outcry.  
Veritas goes above and beyond to provide unbiased executive compensation counsel. Since we are independently owned, we do our job with utmost objectivity – without any entangling business relationships. 
Following stringent best practice guidelines, Veritas works directly with boards and compensation committees, while maintaining outstanding levels of appropriate communication with senior management. 
Veritas promises no compromises in presenting the innovative solutions at your command in the complicated arena of executive compensation. 
We deliver the advice that you need to hear, with unprecedented levels of responsive client service and attention. 

Visit us online at, or contact our CEO Frank Glassner personally via phone at (415) 618-6060, or via email at He’ll gladly answer any questions you might have. For your convenience, please click here for Mr. Glassner’s contact data, and click here for his bio.

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April 27, 2015
This year’s proxy season is turning out to be more hostile than ever, as companies fight back against hedge fund activists.
Companies typically have their annual meetings in the late spring, like the blooming of tulips, and they attract hordes of shareholder activists looking for profits. The activists will often try to elect directors, making proxy season not a reminder of the warming spring but a clarion call for the barbarians at the gate.
Last year, the activists won a series of stunning victories at Darden Restaurants, Sotheby’s and the real estate investment trust now known as Equity Commonwealth, among others. In each case, the companies refused to bow to the activist agenda, preferring instead to try to prevent the activists from electing directors. Each company lost after spending millions of dollars, wasting both money and their boards’ reputations.
The losses actually came as no surprise. In 2014, activists had a 73 percent success rate in electing directors, according to FactSet’s corporate governance database, SharkRepellent. Given the odds, many, including me, predicted that this year’s proxy season would be all about settling as companies sought to avoid these types of bloody losses. This would be the year that shareholder activists dominated completely as companies ran for cover.
We were wrong.
The companies are fighting back. According to the proxy-advisory firm Institutional Shareholder Services and data from SharkRepellent, about 32 out of 78 contests will go to a vote in the second quarter of 2015 alone. This compares with 33 out of 92 contests for all of 2014. Well-known names like Tempur Sealy International, DuPont, MGM Resorts, Macerich and Shutterfly are all fighting proxy contests and refusing to settle with activists.
What explains the surprising, fighting turn?
In large part it is the unique circumstances of each company.
The investment firm H Partners Management, which says it is the largest shareholder of Tempur Sealy, is seeking the ouster of the company’s chief executive, Mark A. Sarvary, which leaves no room for compromise.
At DuPont, the board offered to settle with Nelson Peltz’s hedge fund, Trian Partners, by offering a board seat to one of its candidates. But Trian, which owns 2.7 percent of DuPont, has refused these overtures because it did not include a spot for Mr. Peltz himself. Instead, Trian has preferred to accuse DuPont, which has performed reasonably well, of a laundry list of lapses, including overspending, bad corporate governance and poor negotiating skills in selling assets. This is a fight that should have long been over, except it took a detour into the personal.
Personality often plays a big role in these battles, pushing parties to contest rather than settle. The fight at Wynn Resorts is not a traditional shareholder activist battle but an internecine one between Stephen A. Wynn, the chief executive, and his former wife, Elaine, who is seeking to remain on the board. The messy battle involves a divorce decree and the sale of shares, and it has devolved into nasty accusations of incompetence and sexism.
The trend toward fighting rather than fleeing extends to the exotic, with activists singling out REITs in particular this proxy season. The investment firm Land and Buildings has taken aim at Macerich and the Associated Estates Realty Corporation. Macerich is notable because it adopted a “just say no” defense to a hostile takeover bid by Simon Property, refusing to negotiate with the company, which later withdrew its offer. That Macerich is now the target of an activist is no surprise and should be a cautionary tale to any company that simply refuses to entertain a hostile bid.
The horrible shareholder governance that is all too common in REITs is also drawing non-hedge-fund activists in. Unite Here, a labor union that also seems to like shareholder activism, is taking aim at Hospitality Properties Trust and Ashford Hospitality Trust, seeking to elect directors to improve their corporate governance. The REITs, true to form, are resisting.
What is also noteworthy about the 30 or so contests that Institutional Shareholder Services pegs as the most hostile is that with the exception of Trian, none of the biggest shareholder hedge fund activists — like Greenlight, Pershing Square, Elliot, Jana or Third Point — are involved. Even the Wile E. Coyote of shareholder activism, Carl C. Icahn, is absent.
For the most part this is because companies settled quickly in the face of attacks by these giants. Pershing Square took aim at Zoetis at the end of last year, but the company settled almost immediately. Mr. Icahn settled with Gannett and Manitowoc soon after he announced his positions in those companies.
Meanwhile, Greenlight has mostly been shorting companies; Third Point is digesting Sotheby’s and focusing on Japan; and Jana has focused on campaigns to maximize shareholder value at Qualcomm and Hertz without proxy campaigns. Elliot has been silent, also perhaps focusing on its current investments.
Instead, newer or lesser-known funds are leading the activist charge. For example, a hedge fund coalition led by Harry J. Wilson, a member of the government task force that administered General Motors’ bailout, sought a stock buyback from the automaker, which capitulated quickly. Sarissa Capital Management, a three-year-old fund, is conducting a proxy contest at Ariad Pharmaceuticals, which makes cancer drugs. Meanwhile, Land and Buildings, which is six years old, is taking on MGM International in addition to the two REITs.
Companies may be fighting back precisely because these hedge funds are relative newcomers, thinking they have a better chance against lesser-known funds without the experience or reputation of the biggest ones. The urge to fight may also be because of a change in mood.
Some of the big institutional investors are starting to question the shareholder activism boom. Laurence D. Fink, chief executive of BlackRock, the world’s biggest asset manager, with $4 trillion, recently issued a well-publicized letter that criticized some of the strategies pushed by hedge funds, like share buybacks and dividends, as a “short-termist phenomenon.” T. Rowe Price, which has $750 billion under management, has also criticized shareholder activists’ strategies. They carry a big voice.
There has been at least one notable corporate victory so far. Biglari Holdings, the restaurant company, fought off a proxy battle from Groveland Capital, which held only 0.2 percent of the company. While the chief executive, Sardar Biglari, holds about 19 percent, giving the company a head start, its victory is all the more remarkable because the company is a symbol of bad governance. It paid Mr. Biglari $34.4 million last year, prompting recommendations against the management slate from I.S.S. and Glass Lewis, the other big proxy adviser.
The shifting landscape of shareholder activism perhaps signals a transition. With more players and money pursuing it, companies seem to be adopting a more nuanced strategy that takes into account the fact that not all activists are alike. Activism this year has also mostly been a midcap affair, with hedge funds taking aim at only three companies with market values of more than $10 billion — G.M., DuPont and Macerich. The bulk has focused on companies worth $2 billion or less.
For those who are a bit weary of the knee-jerk response of companies to buy back shares or pay dividends at the first sight of a shareholder activist, this may be a welcome development. To be sure, sometimes the goals of activists are worthwhile, but Mr. Fink may be right that companies are rushing too fast to embrace short-term payouts at the expense of long-term value.
Still, whether the hostility of spring becomes perennial remains to be seen. It will depend on how this year’s contests turn out and whether companies find that fighting the shareholder activists is worth it. Take a seat at the ring.
Veritas Executive Compensation Consultants, (“Veritas”) is a truly independent executive compensation consulting firm. 
We are independently owned, and have no entangling relationships that may create potentialconflict of interest scenarios, or may attract the unwanted scrutiny of regulators, shareholders, the media, or create public outcry.  
Veritas goes above and beyond to provide unbiased executive compensation counsel. Since we are independently owned, we do our job with utmost objectivity – without any entangling business relationships. 
Following stringent best practice guidelines, Veritas works directly with boards and compensation committees, while maintaining outstanding levels of appropriate communication with senior management. 
Veritas promises no compromises in presenting the innovative solutions at your command in the complicated arena of executive compensation. 
We deliver the advice that you need to hear, with unprecedented levels of responsive client service and attention. 

Visit us online at, or contact our CEO Frank Glassner personally via phone at (415) 618-6060, or via email at He’ll gladly answer any questions you might have. For your convenience, please click here for Mr. Glassner’s contact data, and click here for his bio.


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CII Opposes Automatic Accelerated Vesting Of Unearned Equity

Screen Shot 2015-04-13 at 9.58.10 AM

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Unintended Consequences of Proxy Access Elections

Corporate Governance Update- The Unintended Consequences of Proxy Access Elections (dragged)

Corporate Governance Update- The Unintended Consequences of Proxy Access Elections (dragged) 1

Corporate Governance Update- The Unintended Consequences of Proxy Access Elections (dragged) 2

Corporate Governance Update- The Unintended Consequences of Proxy Access Elections (dragged) 3

Corporate Governance Update- The Unintended Consequences of Proxy Access Elections (dragged) 4

Corporate Governance Update- The Unintended Consequences of Proxy Access Elections (dragged) 5

Corporate Governance Update- The Unintended Consequences of Proxy Access Elections (dragged) 6

Corporate Governance Update- The Unintended Consequences of Proxy Access Elections (dragged) 7

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Enhancing Audit Committee Transparency–EY











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2015 ISS U.S. Compensation Policies

Above is the link to the new 2015 ISS document entitled 2015 U.S. Compensation Policies, Frequently Asked Questions.

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Engagement and Activism in the 2015 Proxy Season

January 29, 2015

Corporate Governance Update: Engagement and Activism in the 2015 Proxy Season

David A. Katz and Laura A. McIntosh∗


As the 2015 proxy season approaches, the dominant theme appears to be the interaction between directors and investors. Though, traditionally, there was little to no direct engagement, recent experience indicates that communication between these two groups is now on the rise, in some cases resulting in collaboration. This is potentially a beneficial development, particularly insofar as it may help companies and long-term investors work together to resist pressure from activist shareholders seeking short-term profits. In the current environment where activists and hedge funds appear to wield unprecedented financial and political leverage, and the influence of proxy advisors is as significant as it is controversial, the predominant trend seems to be “toward diplomacy rather than war.”1

Organizations such as the Shareholder-Director Exchange, which began last year to offer guidance to shareholders and boards on direct engagement, are promoting policies that may reduce the incidence, duration, and severity of contentious public disagreements. For many activist investors, however, controversy and not compromise is the goal, and these investors are likely to continue to engage in the more combative tactics of proxy fights, consent solicitations, withhold-vote campaigns, and proxy access proposals. More powerful than ever, these investors are using every tool at their disposal to discomfit their targets, and it seems no company is too big or too profitable to be immune from attack. The counter-current of high-profile activist aggression—particularly aimed at boards of directors— thus runs alongside the dominant theme of cooperation and engagement.


Direct Engagement on the Rise

Direct engagement between directors and shareholders traditionally has been rare, generally limited to annual meetings and proxy disclosures, and otherwise—particularly with respect to in-person interaction—occurring only in unusual circumstances. In recent years, however, as activism and shareholder rights have come to dominate the corporate governance landscape, communication with institutional investors has been understood as one of the more effective ways to address any simmering discontent and forestall issues before they become public controversies. Investor relations and communication primarily are handled by management and corporate officers, but recently there has been some momentum toward involving directors themselves. In December 2013, Mary Jo White, U.S. Securities and Exchange Commission chair, stated:

“Engagement with shareholders should mean more than just mailing out the annual proxy statement and conducting the annual meeting…. And the board of directors is—or ought to be—a central player in shareholder engagement.”2

White’s remarks quickly gained traction in the corporate governance arena. In July 2014, the Shareholder-Director Exchange—an organization that describes itself as “a working group of leading independent directors and representatives from some of the largest and most influential long-term institutional investors”3 —announced that it had sent a letter to the lead directors and corporate secretaries of every Russell 1000 company.4 The letter proposed that public company boards consider “adopting and clearly articulating a policy for shareholder-director direct engagement.”5

The signatory investor members of the Shareholder-Director Exchange represent over $10 trillion in assets under management and include prominent investment groups such as BlackRock, CalSTRS, and State Street Global Advisors. The letter cited the example of JP Morgan Chase & Co., which, in 2013, convened a group including board members and shareholders representing 40 percent of the shareholder base to discuss corporate governance issues. The Shareholder-Director Exchange has prepared a framework for direct engagement, the “SDX Protocol,” which was endorsed by JP Morgan Chase in its 2014 proxy.6

The SDX Protocol offers a 10-point set of guidelines for direct engagement between “longer-term” shareholders and directors. The Shareholder-Director Exchange emphasizes that the protocol is intended not to encourage the board to interfere with or usurp the investor relations function of management, but rather to consider direct engagement where doing so can be an effective aspect of the overall communications efforts of the company.7

The protocol advocates that boards adopt a clear policy for engagement (recommending a case-by case analysis of each decision to engage with a shareholder and suggesting that a board consider whether to post its policy on its website).8

Other points include identifying potential engagement topics, selecting participating directors, and planning and preparing for the engagement. The protocol sensibly recommends that companies review and update their policies annually and modify them to fit their own specific circumstances.9

Whether or not companies adopt the SDX Protocol, case-by-case decisions on director/investor engagement is something that public companies should consider. Direct engagement is not without its critics, who see a number of potential downsides of interaction. Legitimate objections include unfair access for large shareholders, potential management concerns about the undue influence of major shareholders on directors, and the inadvertent disclosure of information in violation of Regulation FD.10 Nonetheless, as the Shareholder-Director Exchange points out, “it is shortsighted for corporate boards to avoid engaging with their long-term investors when activists frequently meet with those same institutions to pursue corporate change.”11


The Politics of Activism

There is no question that shareholder activists have become more active, and

more successful in their activism, in recent years.12 With their unprecedented funds—reportedly close to $200 billion13—economically-motivated activists engage in more interventions, target larger companies, and enjoy significant support from traditional investors and political actors.14 According to a recent Credit Suisse report, there were 514 activist campaigns in 2014, the highest since the financial crisis, and a 20 percent increase over 2013.15 Activist shareholder interventions increased 88 percent between 2010 and 2013, while the average market capitalization of target companies increased to $8.2 billion in 2012 from $3.9 billion in 2011.16

The recently announced proxy fight for seats on the board of DuPont Co., initiated by long-time activist Nelson Peltz of Trian Fund Management, demonstrates that no company is too large to be targeted, and that outperforming the market does not insulate even a very large company from attack. The five largest companies ever engaged in activist proxy contests all were targeted within the last nine years—and in each case (other than DuPont, so far), the activists did achieve some elements of their strategic goals.17 In 2014, activists won a board seat in a record high of 73 percent of proxy fights, an increase from 63 percent in 2013.18

In addition, many activists have obtained board representation simply by threatening a proxy contest, as a number of companies have chosen to settle rather than bear the economic and reputational risks of a proxy fight. The introduction to the SDX Protocol lists a number of “red flags” that are likely to attract negative attention from activist organizations such as the Shareholder Rights Project at Harvard Law School.19

In recent years, the Shareholder Rights Project has operated to pressure public companies to declassify their boards of directors, and in nearly 100 cases—for better or worse—it has had the intended effect.20 The red flags cited by the SDX Protocol include both financial performance-related items such as shareholder return and corporate governance oriented items such as takeover defense plans. Based on the list, which is long and described as “growing,” the question for many companies is not whether they will experience the unwanted scrutiny of corporate gadflies and the unwelcome intrusions of activist investors, but when.

As its profile rises, shareholder activism has become increasingly a socially charged issue, with some activists portraying themselves as Robin Hood-like characters in the corporate world21 and some populist politicians allying themselves with activist causes.22 This is heightened by an appeal to democratic values and an increasing focus on “shareholder rights,” rather broadly defined.23 For example, Institutional Shareholder Services (ISS) has announced that it will consider, for its revised Governance QuickScore 3.0 ratings, whether a board of directors has recently taken action that “materially reduces shareholder rights,” including eliminating the ability to call a meeting by written consent, lowering quorum requirements, classifying the board of directors, or increasing authorized capital. 24

Yet companies, boards, and other investors should keep in mind that shareholder activism is often merely a tactic in a self-interested investment strategy. Shareholder activists such as hedge funds typically are pursuing short-term financial gain at the expense of long-term shareholders and stakeholders. These funds welcome the support of academics and theorists who argue that disruption is good for the market; 25 however, a recent study by the Institute for Governance of Private and Public Organizations, after investigating these claims, found:

“[The] most generous conclusion one may reach from these empirical studies has to be that “activist” hedge funds create some short-term wealth for some shareholders as a result of investors who believe hedge fund propaganda (and some academic studies), jumping in the stock of targeted companies. In a minority of cases, activist hedge funds may bring some lasting value for shareholders but largely at the expense of workers and bond holders; thus, the impact of activist hedge funds seems to take the form of wealth transfer rather than wealth creation.”26

Activist hedge funds, in other words, keep their profits for themselves. Fortunately, investors can be and frequently are persuaded by a company’s management and directors to resist the initiatives of activist funds, even when the activists’ positions are backed by proxy advisory firms such as ISS and Glass Lewis. Investment managers such as BlackRock have made public statements in support of corporate America’s long-term strategic goals.27 BlackRock’s CEO recently wrote that “it is part of our collective role as actors in the global capital markets to challenge [the trend toward short-termism].”28 Despite the pressure to accede to activist demands, nonetheless it is the responsibility of the board of directors and the chief executive to, in the words of one Yale professor, “resist self-motivated activism that adds nothing.”29


The Proxy Battleground

The proxy statement continues to be the primary battleground for activist investors waging campaigns against their corporate targets. One source reports that in the 2014 proxy season, seeking boardroom representation was the most popular tactic, accounting for just over 40 percent of all activist interventions in the first half of last year.30 Meanwhile, proxy access proposals are surging in number this year, as activists attempt to enact so-called “private ordering” of proxy access in lieu of action by the SEC in this area. The New York City Comptroller has launched the “2015 Boardroom Accountability Project,” a national campaign for the widespread implementation of proxy access.31 The five pension funds of New York City are submitting precatory proxy access proposals simultaneously at 75 companies, chosen in order to spotlight the issues of climate change, board diversity, and CEO pay. The Boardroom Accountability Project’s requested proxy access bylaw would permit shareholders who own 3 percent of a company for 3 or more years the right to have their director candidates—up to one quarter of the board seats—listed in the company proxy. Since 2012, proxy access proposals with three percent/three year criteria have received shareholder approval at a rate of just over 50 percent.32

As with every shareholder proposal, proxy access proposals must meet certain formal and procedural requirements to be eligible for inclusion in the company proxy statement. Proxy access proposals have evolved in recent years, and their sponsors are often sophisticated investors, and as a result, most submissions are properly prepared. Without a procedural defect, these proposals can be difficult to exclude. The SEC has been unwilling to provide no-action relief on the exclusion of proxy access proposals on the basis of “substantial implementation,” meaning that the company has already adopted a form of proxy access with more stringent requirements.

This season, in the wake of a seemingly successful Whole Foods Market request—and in response to the large number of proxy access proposals submitted under the New York City initiative—numerous companies have submitted requests for exclusion under Rule 14a-8(i)(9), the rule that permits exclusion when there is a direct conflict with a management proposal on the same topic. However, reversing a December no-action letter stating that Whole Foods could exclude a proxy access proposal due to “direct conflict,” the SEC announced earlier this month that it would not, after all, provide no-action relief at this time with respect to any shareholder proposal on that basis. 33

The suspension of no-action relief is in effect pending a review of the “scope and application” of the rule.34 While no-action relief is not necessary for a company to exclude a shareholder proposal from its proxy materials, and while no-action letters are merely informal determinations with no binding effect, the SEC’s reversal of its no-action decision in this situation nonetheless is significant. The tortuous path of proxy access reform over the last decade is a reflection of its complexity and controversy.35 The SEC’s initial position on the Whole Foods proposal was consistent with prior determinations regarding Rule 14a-8(i)(9) on a wide range of governance topics, and its recent, unexpected action highlights the unusually high profile, and high stakes, of proxy access in the current environment. In our view, even if proxy access proposals are adopted, they are unlikely to have a meaningful impact, as hedge funds and other economically-motivated activists are much more likely to eschew proxy access due to its inherent limitations and instead bring the fight directly to the shareholders through a proxy contest. Proxy access is most likely to be utilized by special interests groups who cannot bear the cost of a proxy contest but want to have board representation to pursue their own agenda.


The 2015 Proxy Season

In 2015, public companies can expect an increase in both activist attention and the level of engagement expected by shareholders generally. Investors are eager for engagement. CMi2i, a capital markets research company based in the United Kingdom, recently surveyed global institutions managing over $6.7 trillion: 55 percent of respondents stated that they expect their level of engagement with portfolio companies to increase in 2015, while the remainder said that they expect it to remain the same.36 Only 13 percent of the respondents said that they do not have an active engagement policy with portfolio companies.37

Companies facing activist attacks, or considering a policy of direct engagement generally, should evaluate each situation on its own terms. Proactive and thoughtful communication with shareholders, whether involving the board directly or through traditional corporate channels, can be a powerful tool in promoting shareholders’ understanding and support of the company’s long-term strategy. Once an attack has commenced, effective, and possibly direct, communication with major shareholders may be crucial in gaining support for the board’s position versus that of the activist attackers. That said, the specifics of each situation will determine the best path of communication and engagement, and certainly any decision by boards to engage directly with shareholders should be made in close consultation with management and counsel.

Another recent phenomenon that occurred in 2014 and is likely to continue into 2015 is directly tied to the decrease in the number of public companies with staggered boards. In 2014, there were seven contests at companies with over $500 million in market capitalization that sought majority representation on the board of directors. 38 Given that ISS and shareholders appear to be more willing to support a change in the majority of the board, we could see an increase in activists seeking to take control of public companies without paying any premium for the shares. This should drive companies to engage more with their institutional shareholders to avoid this prospect.

The two themes of activism and engagement do, to a certain extent, overlap. One of the founders of the Shareholder-Director Exchange, a prominent corporate lawyer who also tried his hand at investment banking, has partnered with a former chief financial officer of JP Morgan Chase to start something new: “an activist hedge fund with a collaborative approach to management.” 39 As reported in the Wall Street Journal, the fund has begun with investments from more than a dozen current and former chief executive officers in addition to the founders.40

The fund expects to raise money from traditional investment groups such as pension funds and does not intend to launch proxy fights or release so-called “poison pen” letters. The inception of this fund is yet another signal that the lines between activism and mainstream investing are beginning to blur in today’s corporate environment. There is all the more reason for companies to be thoughtful in their engagement with investors and to take a long-term view of the future.


∗ David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.

1 See Janet Dignan, “Proxy Season 2015: Meeting the Challenge,”, Nov. 25, 2014, available at

2 U.S. Securities and Exchange Commission Chair Mary Jo White, “Remarks at the 10th Annual Transatlantic Corporate Governance Dialogue,” Dec. 3, 2013, available at

3 The Shareholder-Director Exchange, “Introduction and Protocol,” February 2014, available at (SDX Protocol).

4 PR Newswire, “Leading Public Company Directors and Representatives of Major Institutional Investors—United Under Shareholder-Director Exchange Banner—Announce New Steps Taken to Advance Growing Governance Movement,” July 22, 2014, available at—united-under-shareholder-director-exchange-banner—announce-new-steps-taken-to-advance-growing-governance-movement-268085121.html.

5 The Shareholder-Director Exchange, Letter dated July 2, 2014, available at

6 See id.

7 See SDX Protocol, supra note 3, at 4, 12.

8 See id. at 12.

9 See id. at 15.

10 See,e.g., Andrew Ross Sorkin, “Investors to Directors: Can We Talk?” Dealbook, July 21, 2014, available at

11 See SDX Protocol, supra note 3, at 2.

12 See, “Activist Investors Buoyed by Increased Success and Targeting Mid-Caps,” July 28, 2014 (finding that 60 percent of activist campaigns met their objectives in the first six months of 2014, compared to 56 percent throughout 2013), available at

13 See “Top Activist Hedge Funds Close in on $200 Billion Mark; ValueAct Capital, Elliott Management & JANA Partners Lead the Way,”, Jan. 19, 2015, available at

14 For further discussion of this topic, and of activism in corporate transactions, see Martin Lipton, “Dealing with Activist Hedge Funds,” Nov. 6, 2014, available at See also David A. Katz & Laura A. McIntosh, “Corporate Governance Update: Shareholder Activism in the M&A Context,” NYLJ, March 27, 2014, available at

15 Chris Young and Qin Tuminelli, “Activism Outlook for 2015” Credit Suisse (Jan. 25, 2015) (citing SharkRepellant).

16 See SDX Protocol, supra note 3, at 2 (citations omitted).

17 See Maureen Farrell, “The Largest Companies Ever Hit by Activist Proxy Fights,” MoneyBeat, Jan. 9, 2015, available at

18 See Dana Mattioli & Liz Hoffman, “New Activist Hedge Fund Has CEO Backing,”, Jan. 20, 2015 (citing FactSet), available at

19 See SDX Protocol, supra note 3, at 2-3.

20 See Shareholder Rights Project, “75% of 2014 Engagements Have Already Produced Agreements To Declassify: Towards Declassification at 100 S&P 500 and Fortune 500 Companies,” SRP News Alert, March 11, 2014, available at

21 See, e.g., Robin Hood Investors Conference (founded by Carl Icahn), available at

22 See, e.g., “Warren Pushes Exchanges on ‘One-Share, One Vote’ in Effort That Could Help Activist Hedge Funds,” MarketWatch, June 7, 2013, available at

23 See, e.g., Institutional Shareholder Services, “Investors Indicate Little Tolerance for Unilateral Boardroom Adoption of Bylaw Amendments That Diminish Shareholder Rights, Study Finds,” Sept. 29, 2014, available at

24 Institutional Shareholder Services, ISS Governance QuickScore 3.0: Overview and Updates, available by request at

25 See, e.g., Lucian Bebchuk et al., “The Long-Term Effects of Hedge Fund Activism,” Columbia L. R., June 2015 (forthcoming), available at

26 Institute for Governance of Private and Public Organizations, “‘Activist’ Hedge Funds: Creators of Lasting Wealth? What Do the Empirical Studies Really Say?” July 2014, at 17, available at

27 See Larry Fink, Chairman & CEO, BlackRock, Letter of March 21, 2014, available at

28 Id.

29 Jeffrey Sonnenfeld, “Activism Inside Out,”, Jan./Feb. 2015, available at (citing HFR).

30 See, supra note 12.

31 See City of New York, Office of the Comptroller, Boardroom Accountability Project, available at

32 For a more detailed discussion of proxy access proposals, see David A. Katz, “Proxy Access Proposals for the 2015 Proxy Season,” Nov. 7, 2014, available at

33 See David R. Fredrickson, Securities and Exchange Commission, Letter to Whole Foods Market, Inc., Jan. 16, 2015, available at 14a8.pdf.

34 See Securities and Exchange Commission, Public Statement, “Statement from Chair White Directing Staff To

Review Commission Rule for Excluding Conflicting Proxy Proposals,” Jan. 16, 2015, available at

35 The SEC proposed a proxy access rule in 2003 and in 2007 but did not approve a final rule until 2010. The rule was issued under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, became effective in November 2010, and then was vacated by the U.S. District Court for the District of Columbia in July 2011.

36 See CMi2i Annual Global Institutional Investor Survey, November 2014, available by request at

37 Id. at 8.

38 Young & Tuminelli, supra note 15 (citing SharkRepellant and excluding hostile bids).

39 See Mattioli & Hoffman, supra note 18.

40 See id.

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Attacks by Activist Hedge Funds Threaten Shareholders and Economy

Martin Lipton Sabastian V. Niles Sara J. Lewis

December 22, 2014, January 23, 2015

UPDATED Recognition of the Threat to Shareholders and the Economy from Attacks by Activist Hedge Funds Again in 2014, as in the two previous years, there has been an increase in the number and intensity of attacks by activist hedge funds. Indeed, 2014 could well be called the “year of the wolf pack.” With the increase in activist hedge fund attacks, particularly those aimed at achieving an immediate increase in the market value of the target by dismembering or overleveraging, there is a growing recognition of the adverse effect of these attacks on shareholders, employees, communities and the economy. Noted below are the most significant 2014 developments holding out a promise of turning the tide against activism and its proponents, including those in academia. Already in 2015 there have been several significant developments that are worth adding, which are included in bold at the end.

• Several institutional investors voiced concerns about activism this year, including Laurence Fink of BlackRock – first in March lamenting the cuts to capital expenditures and increased debt used to fuel dividends and share buybacks, which he views as having the potential to “jeopardize a company’s ability to generate sustainable long-term returns,” and then in December stating that “[s]trategies pursued by activist investors ‘destroy jobs.’”

• Tim Armour of Capital Group criticized the recent wave of share buybacks, explaining that “[w]e think companies should be run for the long-term and do not think forced steps should be taken to maximize short-term profits at the expense of having thriving enterprise.”

• William McNabb of Vanguard spoke out against the standard activist playbook of aggressively criticizing companies once problems emerge and endorsed a more low-key approach of engagement between directors and shareholders aimed to prevent problems before they happen.

• James Montier of GMO Capital presented compelling empirical evidence that, as Jack Welch once said, shareholder value maximization is “the dumbest idea in the world,” and demonstrating that, ironically, it has not benefitted shareholders themselves.

• Even activists themselves began to acknowledge how outlandish some of their stunts are; Jeffrey Ubben of ValueAct, for example, who favors a more behind-the-scenes, constructive style of activism, likened certain recent actions by other activists to “greenmail,” called certain activist tactics “corrupt” and accused one activist in particular of simply “entertaining himself.”

• In December, the Conference Board released a must-read presentation entitled “Activists and Short Term Corporate Behavior” that compiles data demonstrating that capital investment by U.S. public companies has decreased (and is less than that of private companies), that shortterm pressures are increasing and that hedge fund activism results not in the creation of value but in transfers of value from employees and bondholders to shareholders.

• William Galston’s editorial in the Wall Street Journal, “‘Shareholder Value’ Is Hurting Workers: Financiers Fixated on the Short-Term Are Forcing CEOs into Decisions That Are Bad for the Country,” as the title suggests, warned that activism is harming workers (pointing to the recent break-up of Timken as a prime example) and that if short-termism prevails, “we won’t have the long-term investments in workers and innovation that we need to sustain a higher rate of growth.”

• Dominic Barton, the global managing director of McKinsey, and Mark Wiseman, the president and CEO of the Canada Pension Plan Investment Board, joined to author an article in the Harvard Business Review, “Focusing Capital on the Long Term,” which suggests practical steps that major asset owners such as pension funds, insurance firms and mutual funds can take to minimize the detrimental effects of increased pressure from financial markets and the resulting short-termism, which they believe has “far-reaching consequences, including slower GDP growth, higher unemployment, and lower return on investment for savers.”

• A federal court in California found “serious questions” as to whether Valeant and Pershing Square violated the federal securities laws in connection with their joint hostile bid for Allergan and thereby, as a practical matter, put an end to this scheme until the issue is resolved.

• SEC Commissioner Daniel Gallagher and former Commissioner (and current Stanford Law Professor) Joseph Grundfest argued that the push for board declassification by Harvard Law School’s Shareholder Rights Campaign, initiated by Professor Lucian Bebchuk, was not only based on shoddy scholarship, it actually violated federal securities law antifraud rules.

• SEC Commissioner Gallagher also called for much-needed reforms to Rule 14a-8 to “ensur[e] that activist investors don’t crowd out everyday and long-term investors” by repeatedly bringing costly shareholder proposals (notwithstanding prior failures) that have little or no connection to company value.

• The SEC took a step toward limiting uncritical reliance on proxy advisory firms by issuing guidance indicating that, to fulfill their fiduciary duties to clients, investment advisers must establish and implement measures reasonably designed both to provide sufficient ongoing oversight of proxy advisory firms and to identify and address such firms’ conflicts of interest and errors in their voting recommendations.

• Economics Professor William Lazonick argued that share buybacks can boost share prices in the short term but ultimately disrupt income equality, job stability and overall economic growth, and research by Barclays cited in a Financial Times article called “Buybacks: Money Well Spent?” provided empirical support showing that the “buyback bonanza” indeed contributed to slower growth, including lower earnings retention not reflected in price-to-book value.

• A paper by Dr. Yvan Allaire entitled “The Value of ‘Just Say No,’” and also memos by our firm (here and here), demonstrated that an ISS client note entitled “The IRR of No,” which argued that companies that had “just said no” to hostile takeover bids incurred profoundly negative returns, suffered from critical methodological and analytical flaws that undermined its conclusions.

• Dr. Allaire also presented sophisticated analyses contained in three papers (“Activist Hedge Funds: Creators of Lasting Wealth? What Do the Empirical Studies Really Say?”; “Hedge Fund Activism and Their Long-Term Consequences; Unanswered Questions to Bebchuk, Brav and Jiang”; and in 2015 “Still unanswered questions (and new ones) to Bebchuk, Brav and Jiang”), consistent with our firm’s earlier observations, offering a devastating critique of Professor Bebchuk’s research claiming to show that attacks by activist hedge funds did not destroy long-term value.

• The argument made by Professor Bebchuk, together with Professor Robert Jackson, that poison pills were unconstitutional was similarly dismissed (some would say derided) as the graspingat-straws argument that it was and one wholly inconsistent with existing case law.

• Delaware Supreme Court Chief Justice Leo Strine, Jr.’s Columbia Law Review article, “Can We Do Better By Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law,” persuasively argued against allowing investment funds to prevail over the carefully considered judgments of boards of directors and at the expense of the long-term interests of the ultimate beneficiaries whose assets such funds manage.

• In an article entitled “The Impact of Hedge Fund Activism: Evidence and Implications,” Columbia Law School Professor John Coffee, Jr. rejected the so-called empirical evidence that Professor Bebchuk uses to “prove” that activist attacks are beneficial, and proposed various potential reforms and private ordering techniques (such as a “window-closing” poison pill) that could help mitigate activism’s pernicious effects.

• In “How to Outsmart Activist Investors,” Professors William George and Jay Lorsch of the Harvard Business School advised companies on how to fend off activist challenges, writing that they “remain unconvinced . . . that hedge fund activism is a positive trend for U.S. corporations and the economy.”

• Leiden University Professor Pavlos Masouros, in his book entitled Corporate Law and Economic Stagnation: How Shareholder Value and Short-Termism Contribute to the Decline of the Western Economies, convincingly outlined the chain of political, economic and legal events that led to the shift from a “retain and invest” corporate strategy to a “downsize and distribute” mentality, and the consequent stagnation in GDP growth.

• Cornell University Law School Professor Lynn Stout also published a book that challenges the ideology of shareholder value maximization, the title of which speaks for itself: The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public.

• Oxford University Professor Colin Mayer’s Firm Commitment: Why the Corporation Is Failing Us and How to Restore Trust in It set forth a new paradigm for thinking about corporations, in part to solve the “increasing[] difficult[y] for directors to do anything other than reflect what is perceived to be in the immediate interests of their most influential, frequently short-term shareholders.”

• The Delaware Court of Chancery, in Third Point LLC v. Ruprecht, confirmed the legitimacy of the use of poison pills – not only in the face of an inadequate takeover offer – but also in response to an activist threat.

• State Street Global Advisors issued an issuer engagement protocol that is intended to enable State Street to better understand issuers’ business strategy, management and operations. Hopefully, this will result in State Street supporting issuers’ long-term investment goals and mitigate exposure to activists’ short-term demands.

• Vanguard reviewed their proxy voting and engagement efforts, emphasizing an approach to governance characterized by “quiet diplomacy focused on results,” in which voting decisions are made based on “its own analysis, not the recommendations of third parties” and direct discussions with companies are prioritized to “permit a more nuanced and precise exchange of views than the blunt instrument of a shareholder vote.”

• Two prominent former JP Morgan deal makers announced the formation of Hudson Executive Capital, which they described as a new type of activist hedge fund that will collaborate with companies and their boards. The announcement stated that Hudson will -4- not conduct proxy fights or issue poison-pen letters. Their goal appears to be to have Hudson recognized as a traditional merchant bank and not an activist hedge fund.

• Well-known Yale School of Management Professor Jeffrey Sonnenfeld in an article in the January/February issue of Chief Executive said, “Vigilant CEOs have a right, and even a duty, to resist self-motivated activism that adds nothing. It’s worth noting that it wasn’t so very long ago that investors who resorted to such antics were called by the less salubrious term ‘green mailers.’”

• Guhan Subramanian, a Professor at both Harvard Law School and Harvard Business School and a long-time protégé-colleague of Lucian Bebchuk, has written an article for the March issue of the Harvard Business Review advocating a new form of corporate governance that reflects a need to “return to first principles rather than meander toward ‘best practices.’” His first principle is that “Boards Should Have the Right to Manage the Company for the Long Term.” His other recommendations are (1) replacing quarterly earnings guidance with long-term goals, (2) accepting staggered boards if they can be overcome by a shareholder-approved takeover bid, (3) accepting exclusive forum bylaws, (4) instituting meaningful board evaluation but no director age or term limits, and (5) giving shareholders an “orderly” voice.

We hope that the growing recognition of the analytical and methodological defects in the socalled empirical evidence put forward to justify activist hedge fund attacks by Professor Bebchuk and his cohorts and the growing recognition, not just in the business community, but in academia as well, of the serious threat of activism and short-termism to employees, communities and the economy will result in further action by responsible institutional investors to deny support to activist hedge funds and will also result in legislative, regulatory and judicial actions to dampen their abuses and lessen substantially their impact.

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Do Scholars Have A Duty To Maximize Shareholder Value?

January 15, 2015

Do Scholars Have a Duty to Maximize Shareholder Value? *

By Peter Tunjic

If Lucian Bebchuk still thinks he’s “mainly a kind of of ivory tower academic”, his record as a shareholder activist better get ready for a long fight.

Considered one of America’s leading scholars in law and economics, the director of Harvard’s Program on Corporate Governance has a reputation for aggressively championing the cause of big shareholders and their attacks on public companies.

Bechuk might insist he’s living a life of the mind, but he can’t run away from the pin striped shadow cast by his papers – “The Case for Increasing Shareholder Power“. “The Costs of Entrenched Boards“, “The Myth of the Shareholder Franchise“, “The Myth that Insulating Boards Serve Long term Value“, “The Long Term Effects of Hedge Fund Activism” “Toward a Constitutional Review of the Poison Pill“.   You don’t have to share the professor’s obvious intellect,  to appreciate his radical corporate governance agenda.

To a critical eye, the target of Bebchuk’s econometric research might seem as predictable as his findings.   Delivering the good news to Bill Ackman, Carl Icahn and their fellow hedge fund managers.  First, the fact that they’re the good guys and second, the “proof”  needed to convince institutional investor and policy makers to dismantle the corporate defenses that stand in the way of the activist’s latest business strategy.

The Professor has even invited his students to join him in the pursuit of greater shareholder power.

The Shareholder Rights Project was established by the Harvard Law School Program on Institutional Investors to “contribute to education, discourse, and research related to efforts by institutional investors to improve corporate governance arrangements at publicly traded firms.”  Omitted from the project’s benign mission was to change real world  election policies to reflect their professor’s research and their client’s commercial objectives.

In 2014, the Shareholder Rights Project at Harvard boasted that more than 60% of companies that received their proposal agreed to move to annual elections.  Opening the door to investor business strategies harder to execute when directors have staggered tenure.

Unexpectedly for a project sponsored by a lauded professor and an elite university, the Shareholder Rights Project actively prosecuted the investor’s agenda despite a substantial body of academic research that was contradictory to their claims in support of annual elections.   An omission that now has an SEC Commissioner and Stanford law professor publicly questioning whether Harvard violated US Federal Securities Law by not disclosing the full body of evidence.

Whether Harvard broke the law is probably moot.  If the critics of the Gallagher- Grundfest paper get their way, it is they who will be answering the questions.   But no judge can decide the question so obviously begged by the Shareholder Rights Project at Harvard –  Why is a professor and the world’s most famous university, presumably committed to principles of objectivity and intellectual integrity, pushing the interests of big investors on to their students, regulators and public companies? 


The Ivory tower moved into Wall Street forty years ago and the neighborhood has never really looked back.

The head of the Chicago School of Economics arrived with an unlikely promise – liberation from the tyranny of the free market.   No longer would investors need to justify their value to corporations.   In the future directors and managers would willingly yield their firm’s interests to Wall Street based on his remarkable academic discovery –  the duty to maximize their profits.

Better news was to come in 1976.   Rochester finance professors Michael Jensen and William Meckling published the “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure”.    Relying on the same discredited assumptions as Milton Friedman 6 years earlier,  their paper set out a practical guide to increasing shareholder wealth by paying managers in securities.

In what is arguably the best example of commercialization of research by a university, companies like IBM turned Jensen and Meckling’s math into their mantra.   James Montier writes “IBM’s mission statement was outlined by Tony Watson (the son of the founder) and was based on three principles…1) respect for individual employees, 2) a commitment to customer service and 3) achieving excellence.  By the early 1990’s not only had IBM had been transformed to fit its new found functions as the creator of shareholder value but so to had business schools.

Though executives are portrayed as the beneficiaries of this revolution, Bebchuk himself, leading the attack on executive remuneration, the real winner was the investment industry and the industrial complex it spawned.

At the time their findings were first published,  US Corporate equities as a percentage of US GDP was around 32%  it’s now  123% . Jensen and Meckling’s research had managed to do for the investment industry what performance enhancing drugs had done for the 1976 Olympics.

Since then, producing leaders perfectly sympathetic to the needs of Wall Street has arguably become the goal of business school.  Investors, the opportunistic beneficiaries of an education system that inexplicably tilts the playing field in their direction.  For more on the relationship between education and shareholder value read here.

Even today, Wall Street can still count on having strategic friends in high places.

A decade ago activist hedge funds held around US$12 billion under management.  That figure is now estimated to be over $US200 billion.  Activism has become an asset class in its own right with pension funds piling into activist business models over the targets of their attacks – Apple, Microsoft, Sony, DuPont, and PepsiCo.

Quick to assist hedge fund activists prove they’re running benign businesses worthy of encouragement are a group of academics led once again by Professor Bebchuk.  In the paper titled “The Long-Term Effects of Hedge-Fund Activism”, the Professor and others considered nearly 2,000 activist interventions by activist funds from 1994 to 2007.  Claiming triumphantly that based on their analysis:

Empirical studies show that attacks on companies by activist hedge funds benefit, and do not have an adverse effect on, the targets over the five-year period following the attack.

Only anecdotal evidence and claimed real-world experience show that attacks on companies by activist hedge funds have an adverse effect on the targets and other companies that adjust management strategy to avoid attacks.

Empirical studies are better than anecdotal evidence and real-world experience.

Therefore, attacks by activist hedge funds should not be restrained but should be encouraged.

I suggest a follow up study that considers whether this type of  research creates value for activist hedge funds.   Anecdotal evidence suggests a correlation between the publication of such papers and the growing fortunes of fund managers.

The Financial Post reports that activists are the fastest growing in the hedge fund industry.  Another report indicates activist funds have earned an annual return after fees of about 20% on average, compared to 8% for all hedge funds and 13% for the stock market since 2009.  Not to re-mention the explosive growth in funds under management.   Then there are the non financial measures of value such as the radical makeover from green mailers to democratic capitalists.

As far as I’m aware, of the hundreds of corporate governance studies in the last forty years, none have considered the effect of academic activism on Wall Street’s value.    Perhaps it’s time we knew the other side of the truth.


Peter Drucker said, “the best way to predict the future is to create it”.  He was referring to business managers, but he could equally have been referring to his academic colleagues in economics and law.

When Friedman and his fellow economists put shareholders in the center of the corporate universe encircled by all other stakeholders, they crossed the line from disinterested scholars pursuing the truth to the co-creators of the truth.  It is no accident of nature that:

“Corporations are almost universally conceived as economic entities that strive to maximize value for shareholders”

Bebchuk builds on this foundation of double hermeneutics and takes it a step further.   He wants to create the future in the image of his own research.

Not content to inquire into how managers maximize shareholders value in line with predictions,  the impatient professor feels compelled to give activist hedge funds the research ammunition and soldiers to breach the defenses of their public company prey.

Bebchuk even demands that his critics yield before his paper work:

Wachtell should engage with the evidence, not use the “opinions of wise people with considerable experience” to run away from it. To be a constructive contributor to policy debates, Wachtell should stop asserting that the professed beliefs of its partners or clients should serve as the factual premises of policymaking.

Friedrich von Hayek warned us about economists saying things like “Empirical studies are better than anecdotal evidence and real-world experience”.  In his1974 Nobel Memorial Lecture the famous economist and philosopher outlined the danger posed by scientific pretensions in the analysis of social phenomena.  Blaming those who use the  “pretense of knowledge” in their research as the reason why “as a profession we have made a mess of things”.

Donald Campbell expressed a similar fear:

“if we present our resulting improved truth-claims as though they were definitive achievements comparable to those in the physical sciences, and thus deserving to override ordinary wisdom when they disagree, we can be socially destructive.”

A warning that grows more ominous when the line between true scholarship and economic advocacy becomes blurred.

Who should policy makers believe as they are incredulously called to increase the opportunities for shareholders to make money under cover of decreasing the opportunities for managerial self interest?  Bebchuk who says trust in my data or the Nobel Laurette who warned us to never trust an economist who says trust in my data.


If the conclusion were not absurd, I’d think that Milton Friedman and all those who have stood on his shoulders had lost their mind and were under the mistaken impression that they too were under a duty to maximize shareholder value. Scholars do not owe a duty to shareholders.

In 1837  Ralph Waldo Emerson delivered to Harvard’s Phi Beta Kappa Society what is now referred to as “The American Scholar” speech.   The speech, considered by Oliver Wendell Holmes, Sr. to be America’s “Intellectual Declaration of Independence”  sets out the obligations that come with scholarship.

Howard Mumford Jones recounts the duty –  “The Scholar, said Emerson, is Man Thinking; and the principal instruments of his education are three – nature, books and action.  From nature rightly understood, he will learn that the laws of the universe are also the laws of the human mind.  The office of books is not to create book-worms but independent souls.  The life of action is not to be swallowed up in business, but to translate intellect into character.   And the final object of education is that the soul may be weaned from a passive clinging to what has been said and done in the world and prefer a vigorous intellectual independence”.

Two hundred years on and the focus is back on Harvard and its Shareholder Rights Project.

Witness as senior corporate and securities law professors from Boston University, Chicago, Columbia, Cornell, Duke, George Washington, Georgetown, Harvard, Michigan, New York University, Northwestern, Stanford, Texas, UCLA, Vanderbilt, Virginia and Yale defend students who tell half truths and seek to silence those who pursue the truth:

We are thirty-four senior professors from seventeen leading law schools whose teaching and research focus on corporate and securities law. We write to respectfully urge SEC Commissioner Daniel M. Gallagher, and his co-author Professor Joseph Grundfest, to withdraw the allegations, issued in a paper released last month (described on the Forum here), that Harvard and the Shareholder Rights Project (SRP), a clinic at its law school, violated the securities laws by assisting institutional investors in submitting shareholder proposals to declassify corporate boards.

In the last in this series, I asked whether corporate governance was groupthink masquerading as a paradigm.  This Statement of Thirty-Four Senior Corporate and Securities Law Professors Urging Commissioner Gallagher and Professor Grundfest to Withdraw Their Allegations against Harvard and the SRP is bad timing for those who protest my thesis.

The seventh sign of group-think is that members are under pressure not to express arguments against any of the group’s views.   Social pressure is applied to members who stand up and question the group’s judgement. The eighth and last sign of group think is the emergence of self-appointed “mindguards”.  Individual members take it upon themselves to protect the group and the leader from information that is problematic or contradictory to the group’s cohesiveness, view, and/or decisions.

Is this is what is to become of the American Scholar?  Self appointed arbiters of merit who invite comparison to a psychological condition.

Do those, like Yale Professor Jonathan Macey, who led the assault on the Gallagher- Grundfest paper, not see the problem?  By defending shareholders from managers and attacking those who stand in their way, like Lynn Stout and now the Commissioner and his co-author, he is choosing to side with one industry over the rest of the economy.

The concept of accountability is central to corporate governance.  I have little doubt that most people think that directors and managers have a mythical duty to maximize shareholder value.

Now, in this centenary year of the 1915 Declaration of Principles being published by the American Association of University Professors, both the duty and the accountability of the scholar are at risk of becoming a myth too:

Since there are no rights without corresponding duties, the considerations heretofore set down with respect to the freedom of the academic teacher entail certain correlative obligations….. The liberty of the scholar within the university to set forth his conclusions, be they what they may, is conditioned by their being conclusions gained by a scholar’s method and held in a scholar’s spirit; that is to say, they must be the fruits of competent and patient and sincere inquiry, and they should be set forth with dignity, courtesy, and temperateness of language. The university teacher, in giving instructions upon controversial matters, while he is under no obligation to hide his own opinion under a mountain of equivocal verbiage, should, if he is fit in dealing with such subjects, set forth justly, without suppression or innuendo, the divergent opinions of other investigators; he should cause his students to become familiar with the best published expressions of the great historic types of doctrine upon the questions at issue; and he should, above all, remember that his business is not to provide his students with ready-made conclusions, but to train them to think for themselves, and to provide them access to those materials which they need if they are to think intelligently.

The AAUP’s 1915 Principles go on to describe to whom the duty is owed.   The drafters were unequivocal.  The scholar’s duty then, as it remains now, is owed to the community at large:

The responsibility of the university teacher is primarily to the public itself, and to the judgment of his own profession; and while, with respect to certain external conditions of his vocation, he accepts a responsibility to the authorities of the institution in which he serves, in the essentials of his professional activity his duty is to the wider public to which the institution itself is morally amenable. 

A message that is repeated on the AAUP’s website today: http://american%20association%20of%20university%20professors/

The university is a public good, not a private profit-making institution, and corporations or business interests should not dictate teaching or research agendas“.

Reading these principles and reflecting on much of the state of corporate governance research it is clear that scholarship takes more than just rigorous empirical inquiry.

The integrity of truth in every field of university research, including corporate governance, depends on the allegiance of the professor to the public as a whole and their accountability to their duties.   Namely, the scholar’s rigorous method and, what sadly seems to have been forgotten in the pursuit of shareholder value, the scholar’s spirit.

* A work in progress….


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Recognition of the Threat to Shareholders and the Economy from Attacks by Activist Hedge Funds

Martin Lipton
Sara J. Lewis

Recognition of the Threat to Shareholders and the Economy from Attacks by Activist Hedge Funds

          Again in 2014, as in the two previous years, there has been an increase in the number and intensity of attacks by activist hedge funds.  Indeed, 2014 could well be called the “year of the wolf pack.”

With the increase in activist hedge fund attacks, particularly those aimed at achieving an immediate increase in the market value of the target by dismembering or overleveraging, there is a growing recognition of the adverse effect of these attacks on shareholders, employees, communities and the economy.  Noted below are the most significant 2014 developments holding out a promise of turning the tide against  activism and its proponents, including those in academia.

  • Several institutional investors voiced concerns about activism this year, including Laurence Fink of BlackRock – first in March lamenting the cuts to capital expenditures and increased debt used to fuel dividends and share buybacks, which he views as having the potential to “jeopardize a company’s ability to generate sustainable long-term returns,” and then in December stating that “[s]trategies pursued by activist investors ‘destroy jobs.’”
  • Tim Armour of Capital Group criticized the recent wave of share buybacks, explaining that “[w]e think companies should be run for the long-term and do not think forced steps should be taken to maximize short-term profits at the expense of having thriving enterprise.”
  • William McNabb of Vanguard spoke out against the standard activist playbook of aggressively criticizing companies once problems emerge and endorsed a more low-key approach of engagement between directors and shareholders aimed to prevent problems before they happen.
  • James Montier of GMO Capital presented compelling empirical evidence that, as Jack Welch once said, shareholder value maximization is “the dumbest idea in the world,” and demonstrating that, ironically, it has not benefitted shareholders themselves.
  • Even activists themselves began to acknowledge how outlandish some of their stunts are; Jeffrey Ubben of ValueAct, for example, who favors a more behind-the-scenes, constructive style of activism, likened certain recent actions by other activists to “greenmail,” called certain activist tactics “corrupt” and accused one activist in particular of simply “entertaining himself.”
  • In December, the Conference Board released a must-read presentation entitled “Activists and Short Term Corporate Behavior” that compiles data demonstrating that capital investment by U.S. public companies has decreased (and is less than that of private companies), that short-term pressures are increasing and that hedge fund activism results not in the creation of value but in transfers of value from employees and bondholders to shareholders.
  • William Galston’s editorial in the Wall Street Journal, “‘Shareholder Value’ Is Hurting Workers: Financiers Fixated on the Short-Term Are Forcing CEOs into Decisions That Are Bad for the Country,” as the title suggests, warned that activism is harming workers (pointing to the recent break-up of Timken as a prime example) and that if short-termism prevails, “we won’t have the long-term investments in workers and innovation that we need to sustain a higher rate of growth.”
  • Dominic Barton, the global managing director of McKinsey, and Mark Wiseman, the president and CEO of the Canada Pension Plan Investment Board, joined to author an article in the Harvard Business Review, “Focusing Capital on the Long Term,” which suggests practical steps that major asset owners such as pension funds, insurance firms and mutual funds can take to minimize the detrimental effects of increased pressure from financial markets and the resulting short-termism, which they believe has “far-reaching consequences, including slower GDP growth, higher unemployment, and lower return on investment for savers.”
  • A federal court in California found “serious questions” as to whether Valeant and Pershing Square violated the federal securities laws in connection with their joint hostile bid for Allergan and thereby, as a practical matter, put an end to this scheme until the issue is resolved.
  • SEC Commissioner Daniel Gallagher and former Commissioner (and current Stanford Law Professor) Joseph Grundfest argued that the push for board declassification by Harvard Law School’s Shareholder Rights Campaign, initiated by Professor Lucian Bebchuk, was not only based on shoddy scholarship, it actually violated federal securities law antifraud rules.
  • SEC Commissioner Gallagher also called for much-needed reforms to Rule 14a-8 to “ensur[e] that activist investors don’t crowd out everyday and long-term investors” by repeatedly bringing costly shareholder proposals (notwithstanding prior failures) that have little or no connection to company value.
  • The SEC took a step toward limiting uncritical reliance on proxy advisory firms by issuing guidance indicating that, to fulfill their fiduciary duties to clients, investment advisers must establish and implement measures reasonably designed both to provide sufficient ongoing oversight of proxy advisory firms and to identify and address such firms’ conflicts of interest.
  • Economics Professor William Lazonick argued that share buybacks can boost share prices in the short term but ultimately disrupt income equality, job stability and overall economic growth, and research by Barclays cited in a Financial Times article called “Buybacks: Money Well Spent?” provided empirical support showing that the “buyback bonanza” indeed contributed to slower growth, including lower earnings retention not reflected in price-to-book value.
  • A paper by Dr. Yvan Allaire entitled “The Value of ‘Just Say No,’” and also memos by our firm (here and here), demonstrated that an ISS client note entitled “The IRR of No,” which argued that companies that had “just said no” to hostile takeover bids incurred profoundly negative returns, suffered from critical methodological and analytical flaws that undermined its conclusions.
  • Dr. Allaire also presented a sophisticated analysis contained in two papers (“Activist Hedge Funds: Creators of Lasting Wealth? What Do the Empirical Studies Really Say?” and “Hedge Fund Activism and Their Long-Term Consequences; Unanswered Questions to Bebchuk, Brav and Jiang”), consistent with our firm’s earlier observations, offering a devastating critique of Professor Bebchuk’s research claiming to show that attacks by activist hedge funds did not destroy long-term value.
  • The argument made by Professor Bebchuk, together with Professor Robert Jackson, that poison pills were unconstitutional was similarly dismissed (some would say derided) as the grasping-at-straws argument that it was and one wholly inconsistent with existing case law.
  • Delaware Supreme Court Chief Justice Leo Strine, Jr.’s Columbia Law Review article, “Can We Do Better By Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law,” persuasively argued against allowing investment funds to prevail over the carefully considered judgments of boards of directors and at the expense of the long-term interests of the ultimate beneficiaries whose assets such funds manage.
  • In an article entitled “The Impact of Hedge Fund Activism: Evidence and Implications,” Columbia Law School Professor John Coffee, Jr. rejected the so-called empirical evidence that Professor Bebchuk uses to “prove” that activist attacks are beneficial, and proposed various potential reforms and private ordering techniques (such as a “window-closing” poison pill) that could help mitigate activism’s pernicious effects.
  • In “How to Outsmart Activist Investors,” Professors William George and Jay Lorsch of the Harvard Business School advised companies on how to fend off activist challenges, writing that they “remain unconvinced . . . that hedge fund activism is a positive trend for U.S. corporations and the economy.”
  • Leiden University Professor Pavlos Masouros, in his book entitled Corporate Law and Economic Stagnation: How Shareholder Value and Short-Termism Contribute to the Decline of the Western Economies, convincingly outlined the chain of political, economic and legal events that led to the shift from a “retain and invest” corporate strategy to a “downsize and distribute” mentality, and the consequent stagnation in GDP growth.
  • Cornell University Law School Professor Lynn Stout also published a book that challenges the ideology of shareholder value maximization, the title of which speaks for itself:  The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public.
  • Oxford University Professor Colin Mayer’s Firm Commitment: Why the Corporation Is Failing Us and How to Restore Trust in It set forth a new paradigm for thinking about corporations, in part to solve the “increasing[] difficult[y] for directors to do anything other than reflect what is perceived to be in the immediate interests of their most influential, frequently short-term shareholders.”
  • The Delaware Court of Chancery, in Third Point LLC v. Ruprecht, confirmed the legitimacy of the use of poison pills – not only in the face of an inadequate takeover offer – but also in response to an activist threat.

We hope that the growing recognition of the analytical and methodological defects in the so-called empirical evidence put forward to justify activist hedge fund attacks by Professor Bebchuk and his cohorts and the growing recognition, not just in the business community, but in academia as well, of the serious threat of activism and short-termism to employees, communities and the economy will result in further action by responsible institutional investors to deny support to activist hedge funds and will also result in legislative, regulatory and judicial actions to dampen their abuses and lessen substantially their impact.
Martin Lipton
Sara J. Lewis

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Thoughts On Activism

By Martin Lipton, Steven A. Rosenblum and Karessa L. Cain

Wachtell, Lipton, Rosen & Katz
(212) 403-1000 (Phone) | (212) 403-2000 (Fax)

Companies today are more vulnerable to activist attacks than ever before. Over the past decade or so, several trends have converged to foster an environment that is rife with opportunities for activists to extract value. These include the steady erosion of takeover defenses, the expansion of the ability of shareholders to pressure directors, the increasingly impatient and short-termist mindset of Wall Street, and a regulatory disclosure regime that is badly in need of modernization to reflect the current realities of rapid stock accumulations by activists, derivative securities and behind-the-scenes coordination among activist hedge-funds and investment-manager members of “wolf packs.”

          The number of activist attacks has surged from 27 in 2000 to nearly 250 year-to-date in 2014, in addition to numerous undisclosed behind-the-scenes situations.  Activist funds have become an “asset class” in their own right and have amassed an estimated $200 billion of assets under management.  In this environment, boards and management teams have been spending a significant amount of time preparing for and responding to activist attacks, and proactively considering whether adjustments to their companies’ business strategies are warranted in order to avoid becoming a target.

           Three decades of campaigns by public and union pension funds, Institutional Shareholder Services (ISS) and Council of Institutional Investors (CII), and their academic and corporate raider supporters, have served to promote majority voting standards, eliminate rights plans, declassify boards and otherwise shift power to shareholders.  This, in turn, has precipitated important changes to the governance landscape and played a key role in laying the groundwork for today’s activism.  Yesterday’s corporate governance crusades have turned an evolutionary corner in the last few years, to morph into the heavyweight attacks of today where entire boards of directors are ousted in proxy fights and a 3% shareholder can compel a $100+ billion company to accommodate its demands for spin-offs, buybacks and other major changes. 

          The  proliferation of activism has prompted much reflection and revisiting of the basic purpose and role of corporations.  As recently stated by the Financial Times’ chief economics commentator Martin Wolf, “Almost nothing in economics is more important than thinking through how companies should be managed and for what ends.”  Activist attacks vividly illustrate what is truly at stake in corporate governance debates—such as how to balance demands for stock prices that are robust in the short term without sacrificing long-term value creation, and whether maximization of stockholder value should be the exclusive aim of the corporate enterprise.  The special agendas, white papers and “fight letters” of activists are anything but subtle in framing these issues and have direct, real-world implications for the future paths of the corporations they target as well as the futures of employees, local communities and other stakeholders.  In short, the rapid rise in the number of activist attacks, the impact they are having on U.S. companies and the slowing of GDP growth, have added a new spark and sense of urgency to the classic debate about board- versus shareholder-centric models of corporate governance:  who is best positioned to determine what will best serve the interests of the corporation and its stakeholders? 

          In this regard, a key question is whether activists actually create value.  It is clear that many activists have produced alpha returns for themselves and their investors.  Pershing Square, for example, realized an estimated $1 billion gain on its investment in Allergan on the day that Valeant announced its takeover offer for Allergan, and will reap an estimated $2.6 billion profit as a result of Actavis’s pending acquisition of Allergan.  However, it is far from clear that activists have more insight and experience in suggesting value-enhancing strategies than the management teams that actually run the businesses, or are more incentivized than boards and management teams (whose reputations, livelihoods and/or considerable portions of personal wealth tend to be tied to the success of the company) to drive such strategies.  By way of comparison, the management and operational changes that Pershing Square advocated for J.C. Penney had disastrous results for the company and Pershing Square realized steep losses on that investment. 

          Moreover, to the extent that activists do precipitate stock price increases, a further question is whether such gains come at the expense of long-term sustainability and value-creation.  To be sure, some activists tend to engage in a more constructive form of advocacy characterized by a genuine desire to create medium- to long-term value.  However, the far more prevalent form of “scorched-earth” activism features a fairly predictable playbook of advocating a sale of the company, increased debt or asset divestitures to fund extraordinary dividends or share buybacks, employee headcount reductions, reduced capital expenditures and R&D and other drastic cost cuts that go well beyond the scope of prudent cost discipline.

           The experience of the overwhelming majority of corporate managers and their advisors is that attacks by activist hedge funds are followed by declines in long-term future performance, and that such attacks (as well as proactive efforts to avoid becoming the target of an attack) result in increased leverage, decreased investment in capital expenditures and R&D, employee layoffs and poor employee morale.  A number of academic studies confirm this view and rebut the contrary position espoused by shareholder rights activists who believe that activist attacks are beneficial to the targeted companies and should be encouraged.  For example, a recent report by the Institute for Governance of Private and Public Organizations concludes:  “[T]he most generous conclusion one may reach from these empirical studies has to be that ‘activist’ hedge funds create some short-term wealth for some shareholders as a result of investors who believe hedge fund propaganda (and some academic studies), jumping in the stock of targeted companies.  In a minority of cases, activist hedge funds may bring some lasting value for shareholders but largely at the expense of workers and bond holders; thus, the impact of activist hedge funds seems to take the form of wealth transfer rather than wealth creation.” 

          The debate about whether activists create value underscores one of most critical factors in determining the outcome of activist attacks and the future direction of this trend:  credibility.  Starting with the Enron debacle and culminating in the financial crisis, the public confidence level in boards was impaired and shareholders became generally more skeptical of their oversight effectiveness.  Activists, in espousing the virtues of good corporate governance and shareholder rights, gradually rebranded and cleansed themselves of the raider stigma of the 1980s and gained mainstream credibility with shareholder rights proponents, the media, institutional investors and academia.  And some activists clearly have more reputational capital than others.  As hedge funds of varying degrees of firepower and sophistication have sought to claim the activist label, it is clear that not all activists have the same playbook, track record or approach to dealing with companies.  These macro trends boil down to specifics in each proxy fight, with the key questions being whether management and the board can articulate a credible and convincing case for the company’s business plan and demonstrate the results of that plan, and whether institutional investors will support a long-term growth strategy despite the allure of more immediate results.

          Against this backdrop, it is essential that boards not be unduly distracted from their core mission of overseeing the strategic direction and management of the business.  Directors should develop an understanding of shareholder perspectives on the company and foster long-term relationships with shareholders, as well as deal with the requests of shareholders for meetings to discuss governance, the business portfolio and operating strategy.  Directors should also work with management and advisors to review the company’s business and strategy with a view toward minimizing vulnerability to attacks by activist hedge funds.

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Glass Lewis 2015 Proxy Voting Guidelines

November 10, 2014
Glass Lewis recently posted its guidelines for the 2015 proxy season. Below is a summary of the changes to its policies for the upcoming proxy season. To view Glass Lewis’ 2015 proxy voting guidelines in detail, please click here.
Governance Committee Performance
Glass Lewis adopted a policy regarding instances where a board has amended the company’s governing documents to reduce or remove important shareholder rights, or to otherwise impede the ability of shareholders to exercise such right, and has done so without shareholder approval. Examples of Board actions that may cause such a recommendation include: 

  • The elimination of the ability of shareholders to call a special meeting or to act by written consent;
  • An increase to the ownership threshold required for shareholders to call a special meeting;
  • An increase to vote requirements for charter or bylaw amendments;
  • The adoption of provisions that limit the ability of shareholders to pursue full legal recourse – such as bylaws that require arbitration of shareholder claims or that require shareholder plaintiffs to pay the company’s legal expenses in the absence of a court victory (i.e., “fee-shifting” or “loser pays” bylaws);
  • The adoption of a classified board structure; and
  • The elimination of the ability of shareholders to remove a director without cause. In these instances, depending on the circumstances, we may recommend that shareholders vote against the chairman of the governance committee, or the entire committee.
Board Responsiveness To Majority-Approved Shareholder Proposals
Glass Lewis will generally recommend that shareholders vote against all members of the governance committee during whose tenure a shareholder proposal relating to important shareholder rights received support from a majority of the votes cast (excluding abstentions or broker non-votes) and the board failed to respond adequately. Examples of such shareholder proposals include those seeking to declassified board structure, a majority vote standard for director elections, or a right to call a special meeting. This policy has been expanded to specify that in determining whether a board has sufficiently implemented such a proposal, the quality of the right enacted or proffered by the board for any conditions that may unreasonably interfere with the shareholder’s ability to exercise the right (e.g., overly prescriptive procedural requirements for calling a special meeting) will be examined.
Vote Recommendations Following IPO
Glass Lewis has increased their scrutiny of provisions adopted in a company’s charter or bylaws prior to an initial public offering (“IPO”). While they will generally refrain from issuing voting recommendations on the basis of most corporate governance best practices (e.g., board independence, committee membership and structure, meeting attendance, etc.) during the one-year period following an IPO, they will scrutinize certain provisions adopted in the company’s charter or bylaws prior to the IPO. Specifically, Glass Lewis will consider recommending to vote against all members of the board who served at the time of the adoption of an anti-takeover provision, such as a poison pill or classified board, if the provision is not put up for shareholder vote following the IPO. Additionally, consistent with their approach to boards that adopt exclusive forum provisions or fee-shifting bylaws without shareholder approval, they will recommend that shareholders vote against the governance committee chair in the case of an exclusive forum provision, and against the entire governance committee in the case of a provision limiting the ability of shareholders to pursue full legal recourse (e.g., “fee-shifting” bylaws), if these provisions are not put up to shareholder vote following the IPO.
Glass Lewis Standards For Assessing “Material” Transactions With Directors
With regard to Glass Lewis’ $120,000 threshold for those directors employed by a professionals services firm such as a law firm, investment bank, or consulting firm, where the company pays the firm, not the individual, for services, we have clarified that we may deem such a transaction to be immaterial where the amount represents less than 1% of the firm’s annual revenues and the board provides a compelling rationale as to why the director’s independence is not affected by the relationship.
Advisory Vote On Executive Compensation
Discussion has been added to Glass Lewis’ approach to analyzing one-off awards granted outside of existing incentive programs. Specifically, when such awards have been made, Glass Lewis will examine the following criteria:

  • The description of the award;
  • The disclosed rationale for the award;
  • An explanation of why existing awards do not provide adequate motivation;
  • Whether the award is tied to future service and performance conditions; and
  • If (and how) regular compensation arrangements will be affected by the supplemental awards.
Glass Lewis has also provided clarification regarding their qualitative and quantitative approach to say-on-pay analysis.
Employee Stock Purchase Plans
Glass Lewis enhanced its guidelines for evaluating Employee Stock Purchase Plans (ESPP) by clarifying the key criteria it will examine when making vote recommendations. Glass Lewis generally views such plans favorably because they facilitate employee ownership. The proxy advisor’s underlying approach to reviewing ESPPs is based on the relevant regulatory limits and parameters, such as the expected discount and purchase period. Glass Lewis will also examine the cost of the plan compared to programs at similar companies (using a quantitative model) as well as the number of shares requested and the impact to shareholders from a dilution perspective.
Veritas Executive Compensation Consultants, (“Veritas”) is a truly independent executive compensation consulting firm. 
We are independently owned, and have no entangling relationships that may create potentialconflict of interest scenarios, or may attract the unwanted scrutiny of regulators, shareholders, the media, or create public outcry.  
Veritas goes above and beyond to provide unbiased executive compensation counsel. Since we are independently owned, we do our job with utmost objectivity – without any entangling business relationships. 
Following stringent best practice guidelines, Veritas works directly with boards and compensation committees, while maintaining outstanding levels of appropriate communication with senior management. 
Veritas promises no compromises in presenting the innovative solutions at your command in the complicated arena of executive compensation. 
We deliver the advice that you need to hear, with unprecedented levels of responsive client service and attention. 

Visit us online at, or contact our CEO Frank Glassner personally via phone at (415) 618-6060, or via email at He’ll gladly answer any questions you might have. For your convenience, please click here for Mr. Glassner’s contact data, and click here for his bio.

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Proxy Access Proposals for the 2015 Proxy Season

Proxy Access Proposals for the 2015 Proxy Season

          A number of U.S. companies have recently received “proxy access” shareholder proposals submitted under SEC Rule 14a-8.  Many of the recipients have been targeted under the New York City Comptroller’s new “2015 Boardroom Accountability Project,” which is seeking to install proxy access at 75 U.S. publicly traded companies reflecting diverse industries and market capitalizations.  Underlying the Comptroller’s selection of targets is a stated focus on climate change, board diversity and executive compensation.

These proposals are precatory and seek the submission to shareholders of a binding bylaw that would enable shareholders (or groups of shareholders) who meet specified criteria to nominate director candidates for election to the board and to have these nominees and their supporting statements included in the company’s own proxy materials.  If the proposal garners a majority shareholder vote at a company’s 2015 annual meeting, it would not become effective unless and until the shareholders approve an implementing bylaw amendment at the company’s 2016 annual meeting.

Companies that receive such proposals should first assess whether the shareholding, form and content requirements of Rule 14a-8 are satisfied.  The current wave of proxy access proposals has evolved to cure most substantive vulnerabilities and, absent procedural defects, the SEC has generallybeen unsympathetic to proxy access exclusion requests.  For example, the SEC has been unwilling to permit exclusion on the basis of “substantial implementation” where a company adopts its own version of proxy access that requires a higher shareholding amount or longer shareholding duration as compared to the thresholds proposed by the shareholder.  However, the SEC has not yet ruled on whether it will permit exclusion where the company submits its own, more stringent proxy access proposal to a shareholder vote and thus creates a “direct conflict” with the shareholder’s access proposal.  At least one company, Whole Foods, has such an exclusion request currently pending before the SEC.

Assuming that exclusion is not available, the company’s options for responding to the proposal include the following: (1) submit the proposal to a shareholder vote and make a board recommendation as to how shareholders should vote, (2) preemptively adopt a proxy access bylaw or submit a competing proxy access proposal with more stringent requirements, or (3) attempt to negotiate a compromise or alternative outcome with the shareholder proponent.

In weighing these options, a key consideration is whether the proposal is likely to receive majority shareholder support.  If the proposal receives the support of a majority of votes cast, proxy advisory firms such as ISS (as well as members of the investment community) will expect the board to be appropriately responsive to the proposal, such as by adopting a compliant form of proxy access.

In the three years since the SEC first permitted Rule 14a-8 shareholder proposals on proxy access, approval rates have been mixed.  Proposals that require a minimum stock ownership threshold of at least 3% of outstanding shares and a minimum continuous holding period of at least 3 years have had the most success, receiving a majority of votes cast at ten companies (including Verizon Communications (2013), CenturyLink (2013), Darden Restaurants (2013), Abercrombie & Fitch (2014) and Boston Properties (2014)).  However, similar proposals failed to receive such a majority vote at six companies (including The Walt Disney Company (2013), Walgreen’s (2014), Comstock Resources (2014) and Oracle (2014)).  In total, proxy access proposals submitted by shareholders with a 3%/3 year threshold have received an average vote in favor of approximately 50.1% over the period from 2012-2014, although we note that such results are subject to context-specific factors (e.g., large insider positions, activist campaigns, etc.) and companies should consider their own circumstances and shareholder base when considering how to respond.  Upcoming votes on proxy access at Cisco Systems on November 20 and at Microsoft on December 3 will provide further data points.

Many companies will likely conclude that this mixed record of voting results and delayed implementation of proxy access proposals weigh against taking action to proactively adopt proxy access.  However, a few companies—such as Kilroy Realty in 2014, and Western Union and KSW in 2012—have taken the approach of adopting and defending their own, more stringent versions of proxy access in order to defeat a shareholder-sponsored version with lower thresholds.  Alternatively, some companies have engaged in discussions with the shareholder proponent to ascertain whether it would support a different form of proxy access with more stringent requirements, such as a higher ownership threshold or longer holding period, in exchange for the company’s support for a revised proxy access proposal or earlier implementation of proxy access.  For example, Hewlett-Packard (2012) and McKesson (2014) negotiated withdrawals by agreeing to seek shareholder approval for proxy access in a future year, and Walt Disney (2014) settled with a shareholder proponent by agreeing to make other governance changes unrelated to proxy access.

While some proponents of proxy access claim that a “tipping point” of investor support has been reached, the reality is that many institutional investors do not reflexively support access proposals, even those crafted with thresholds mimicking the SEC’s now-withdrawn 3% / 3 years formulation.  Shareholders have many avenues for constructively influencing boards of directors, including with respect to board composition and, as we have longmaintained, proxy access is not an optimal or even necessary element of corporate governance.  In our experience, many major institutional investors are willing to engage in a case-by-case, fact-specific assessment of a company’s circumstances in deciding how to vote on proxy access, even in the face of supportive proxy advisory firm recommendations (ISS and Glass-Lewis can generally be expected to recommend in favor of 3% / 3 year proxy access formulations).

          We hope institutional investors will continue to be willing to take this case-by-case approach, despite the one-size-fits-all pressure being brought to bear by the New York City Comptroller.  We believe companies that have developed good relationships with their shareholders, and that are able to demonstrate that effective governance policies are already in place, should be well-positioned to try to resist these proxy access proposals through further engagement and investor outreach.

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The following summary was provided by:

Veritas Executive Compensation Consultants, (“Veritas”) is an executive compensation consulting firm. 
October 6, 2014
As part of its annual policy formulation process, each year ISS seeks feedback from institutional investors, public companies and consulting and legal communities on emerging corporate governance, executive compensation and other issues.
More than 370 total responses were received, including 105 individual institutional investors and 255 members of the corporate issuer community (including consultants/advisors).
The survey, conducted between July 17, 2014 and September 5, 2014, was structured around several high-level themes including:
  • Pay for performance;
  • Board accountability;
  • Boardroom diversity;
  • Equity plan evaluation;
  • Risk oversight and audit;
  • Cross-market listings; and
  • Environmental and social performance goals.
For more information about the survey and to view more detailed survey responses, please click here.
Pay for Performance
CEO pay limits relative to company performance resonate with investors
In response to whether there is a threshold at which the magnitude of CEO pay warrants concern even if the company’s performance is positive (e.g., outperforming peer group), 60% of investors indicated a concern. Support for alternative solutions varied as 27% favored relative proportional limits based on the degree of outperformance versus the company’s peer group; 19% favored absolute limits on CEO compensation regardless of performance; and 14% advocated for proportional limits on compensation in relation to absolute company performance.
In determining excessive pay magnitude, methods such as comparisons to median CEO pay at peer companies, CEO compensation to pay of other NEOs, and proportion of CEO pay to corporate earnings or revenue have all garnered support.
Positive changes in succeeding year may be a mitigating factor for pay-for-performance concerns for the year in review
When evaluating say-on-pay, 63% of investors (and 34% of issuers) indicate that positive changes to pay programs can somewhat mitigate pay-for-performance concerns. In contrast, 52% of issuers (versus just 14% of investors) indicate that they can substantially mitigate concerns.
Of those investors who indicate that positive changes to pay programs can somewhat or substantially mitigate pay-for-performance concerns, 90% expect disclosure of specific details of such positive changes (e.g., metrics, performance goals, award values, effective dates) in order for the changes to be considered.
European investors and issuers diverge on peer group comparisons in evaluating compensation practices
For European markets, 83% of investors indicate that a European pay for performance quantitative methodology, including the use of peer group comparisons, would be useful as a factor in such evaluations. A significant majority (87%) of investors would also like to see a comparison to cross-market industry sector peer groups. Regarding other factors of comparison, 74%, 83%, and 85% indicate that they would favor local market peer groups, regional peer groups (i.e., Europe-wide), and cross-market peer groups based on company size/capitalization, respectively.
However, 58% of issuers indicate peer group comparisons are not appropriate to gauge each individual company’s compensation practices.
Mixed views on the relationship between goal-setting and target award values
43% of investors (and only 3% of issuers) indicate that if performance goals are significantly reduced from one performance period to the next, target award levels should be commensurately modified to reflect the expected lower level of performance. By contrast, two-thirds of issuers (and 26% of investors) indicate that the compensation committee should have broad discretion to set both goals and target awards at levels deemed to be appropriate under the circumstances. In addition, 25% of issuers (and 19% of investors) indicate that performance goals should be set independently of target awards, which must be maintained at competitive levels in order to attract and retain top quality executives.
Unilateral Adoption of Bylaws
Investors indicate little tolerance for unilateral boardroom adoption of bylaw amendments that diminish shareholder rights
72% of investors indicate that a board should never adopt bylaw/charter amendments that negatively impact investors’ rights without shareholder approval. Other investor respondents say “it depends,” selecting from a list of factors (directors’ track record, level of board independence, other governance concerns, the type of bylaw/charter amendment, and the vote standard for amendments by shareholders) which appear to be relevant in evaluating board accountability. Specifically, more than 85% of investors view each of those factors as relevant.
Conversely, nearly one-half (44%) of issuers indicate that boards should be free to unilaterally adopt any bylaw/charter amendment(s) subject to applicable law, while 34% of issuers say “it depends.”
Investors and issuers diverge on pre-IPO adoption of shareholder unfriendly provisions
63% of investors indicate that directors should be held accountable if shareholder unfriendly provisions are adopted prior to a company’s IPO. When determining whether to hold directors accountable, 21% of investors indicate “it depends,” with common responses including the type of provisions and whether directors are willing to address the issues after the IPO. On the other hand, 62% of issuers do not believe directors should be held accountable for pre-IPO actions.
Boardroom Diversity
Investors and issuers take big picture approach on boardroom diversity
60% of investors and 75% of issuers indicate that they consider overall diversity (including but not limited to gender) on the board when evaluating boards. Meanwhile, 17% of investors and 7% of issuers indicate that they do not consider gender diversity at all when evaluating boards.
Equity Plans
Investors indicate that they would weigh a combination of plan features and grant practices as or more heavily than plan cost alone in a scorecard approach to evaluating U.S. equity-based compensation proposals
ISS plans to implement a “balanced scorecard” approach to evaluating plan proposals for U.S. companies that gives weight to various factors under three broad categories: (1) Cost, (2) Plan Features, and (3) company Grant Practices. With respect to how the plan Cost category should be considered in a scorecard, 70% of investors indicate weights ranging from 30% to 50%. 62% of investors suggest weightings from 25% to 35% for Plan Features; and 64% indicate weights ranging from 20% to 35% for Grant Practices. Weightings suggested by issuers were quite dispersed, but generally skewed somewhat higher with respect to Cost, and somewhat lower for Plan Features and Grant Practices, compared to investors.
Use of performance conditions is a very important factor for investors when voting on equity-based remuneration proposals in markets where levels of disclosure are generally poor
When assessing proposals to implement equity-based remuneration plans benefitting executives in markets where levels of disclosure are generally poor, all factors (pricing conditions, vesting periods, dilution, performance conditions, and plan administration features) are “very” or “somewhat” important to a majority of investors in their voting decision. Use of performance conditions is at the top of the list, deemed by 76% of investors as a factor to be “very important.”
Risk Oversight/Audit
Investors focus on boardroom oversight subsequent to incidents when evaluating the board’s role in risk oversight
Over the past few years, shareholders’ investments have been impacted by a number of well publicized failures of boardroom risk oversight. When evaluating the board’s risk oversight role, a majority of shareholders indicate that the role of the company’s relevant risk oversight committee(s), the board’s risk oversight policies and procedures, boardroom oversight actions prior to incident(s), boardroom oversight actions subsequent to incident(s), and changes in senior management are all either “very” or “somewhat” important to their voting decision on directors. Boardroom oversight action subsequent to an incident garners the highest percentage (85%) as a “very important” factor whereas only 46% indicate that changes in senior management are “very important.”
Investors consider disclosures concerning selection and tenure of audit firms to be very important when voting on auditor ratification and audit committee members
A slim majority of investors identify disclosures of the relevant factors the audit committee considers when selecting or reappointing an audit firm and the tenure of the current audit firm (53% and 51%, respectively) as “very” important factors in making informed voting decisions on auditor ratification and the reelection of audit committee members.
Cross-Market Companies
Investors and issuers provide mixed responses regarding policy selection treatment for cross-market companies
An increasing number of companies incorporate in one market but list in another (or multiple) geographic region. For example, some U.S.-based companies have inverted (reincorporated in non-U.S. markets with more favorable corporate tax regimes) and many non-U. S. companies have listed in the U.S. When asked how ISS should generally evaluate such companies, 47% of investors indicate that ISS should evaluate mainly under its policy guidelines for the main market of coverage, but for individual ballot items that arise from other regimes apply the policy of the market whose stock exchange rules or corporate statutes require the proposal to appear on the ballot. Other investor responses are split between evaluating entirely under ISS policy guidelines for main market of coverage (23%) and evaluating case-by-case depending on the nature of the proposal (24%).
Issuer responses are similar to those of investors with 41% indicating that ISS should evaluate mainly under its policy guidelines for main market of coverage, but for individual ballot items that arise from other regimes apply the policy of the market whose stock exchange rules or corporate statutes require the proposal being on the ballot; 29% indicate that ISS should evaluate entirely under its policy guidelines for the main market of coverage; and 26% indicate case-by-case, depending on the nature of the proposal.
Environmental & Social (E&S) Performance Goals
Investors and issuers differ on the appropriateness of quantitative E&S performance goals
When asked when it is appropriate for a company to utilize quantitative E&S performance goals, a majority of both investors and issuers, 57% and 75%, respectively, indicate a preference for case-by-case analysis (“it depends”). Of those investors, 89% consider if a company’s performance on a given environmental or social issue shows a negative trend or if the company has experienced significant controversies; 92% consider if the company has operations with significant exposure to potential regulatory or financial impacts; and 90% consider if the practice has become an industry norm. A slight majority (51%) indicate that it depends only if/when the quantitative goals are required by government regulations.
In contrast, with respect to issuers who select “it depends,” 65% indicate that only if/when the quantitative goals are required by government regulations and just under one-half (49%) indicate that it depends if a company’s performance on a given environmental or social issue shows a negative trend or if the company has experienced significant controversies.
Notably, 39% of investors indicate that it is appropriate for a company to always utilize quantitative E&S performance goals compared with only 7% of issuers. In the absence of quantitative goals, a significant majority of investors and issuers indicate that both company disclosure of a robust set of E&S policies, oversight mechanisms, and related initiatives, and/or company disclosure of E&S performance data for a multiyear period can be mitigating factors.
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Corporate Governance Update: Important Proxy Advisor Developments

September 25, 2014

Corporate Governance Update: Important Proxy Advisor Developments

By David A. Katz and Laura A. McIntosh*

As 2014 winds down and 2015 approaches, proxy advisory firms—and the investment managers who hire them—are finding themselves under increased scrutiny. Staff guidance issued by the Securities and Exchange Commission at the end of June1
and a working paper published in August by SEC Commissioner Daniel M. Gallagher2 both indicate that oversight of proxy advisory services will be a significant focus for the SEC during next year’s proxy season. Under the rubric of corporate governance, annual proxy solicitations have become referenda on an ever-widening assortment of corporate, social, and political issues, and, as a result, the influence and power of proxy advisors— and their relative lack of accountability—have become increasingly problematic.3 The SEC’s recent actions and statements suggest that the tide may be turning. Proxy advisory firms appear to be entering a new era of increasing accountability and potentially decreasing influence, possibly with further, more significant, SEC action to come.

The proxy advisory industry currently is dominated by two firms, Institutional Shareholder Services (ISS) and Glass Lewis & Co. With nearly 100% market share between them,4 their widespread influence in shareholder activism and proxy voting has resulted in calls from the business community for greater SEC 5 supervision of their business practices, potential conflicts of interest, and transparency.

The SEC will monitor shareholder voting decisions and corporate board elections in 2015 to evaluate the effect of the SEC staff’s recent guidance.6 It is clear that the SEC expects investment advisers to take a more active role in overseeing proxy advisory firms and holding these firms accountable both for the quality of their recommendations and the business practices that produce them. By leveraging the influence of their clients, it appears that the SEC hopes to put pressure on proxy advisors to reform from within. However, as many shareholder activists are also clients of these firms, it may not be easy to promote change.

Need for Reform

Commentators have for years lamented the undue influence of proxy advisory firms in corporate elections. James R. Copland of the Manhattan Institute has observed that an ISS recommendation in favor of a given shareholder proposal increases the approval vote by, on average, fifteen percentage points.7 In other words, as Copland puts it, “At least when it comes to shareholder proposals, a small, thinly funded outfit with 600 employees in Rockville, Maryland, is acting like an owner of fifteen percent of the total stock market.”8 In some instances, ISS’s influence can be even greater. In 2014, for example, shareholder proposals related to social and political issues received9 average support of 29% with ISS’s support, and only 5% if ISS recommended against. That is, ISS directly influenced nearly a quarter of the votes cast on these matters. Because the SEC’s rules for resubmission of a failed proposal by a shareholder in the next year’s proxy statement require that the proposal have received up to 10% of the vote (depending on how many years it has been submitted),10 the significant voting impact of an ISS recommendation can empower a proponent to resubmit a proposal year after year, imposing costs on the company and creating waste and negative publicity to the detriment of the company and its shareholders.

The problem of waste is exacerbated by the fact that ISS’s voting recommendations, on topics from compensation to social issues, have been dramatically out of line with voting results. One example is cumulative voting: ISS has supported 96% of proposals to adopt cumulative voting; however, out of 107 such proposals at Fortune 200 companies between 2006-2012, only one received majority support.11 As Copland notes, “The significant influence of ISS on corporate proxy voting—along with the large, systemic gap between its preferences and those observed in shareholders’ actual votes—raises questions about whether shareholder voting is working effectively to improve share value.”12

Proxy advisors’ influence, elevated to great heights by two 2004 no-action letters noted below, received an additional boost in 2010 from the passage of the Dodd- Frank Act. The legislation’s enshrinement of say-on-pay votes in the annual shareholder meeting raised the stakes for the shareholder vote and provided an annual opportunity for activist shareholders to, with the help of ISS, put public pressure on corporate issuers.13 The Manhattan Institute’s Copland observes that a negative recommendation from ISS on an executive compensation proposal has the effect of reducing shareholder support for it by 17 percentage points.14

In the 2014 proxy season, ISS’s negative recommendations increased and voting results for directors were low, reflecting activist shareholders’ perception that directors were insufficiently responsive to their concerns. One possible cause is a change in ISS’s policies, which now call for withhold recommendations for directors who did not, after the prior annual meeting, implement a shareholder proposal that received a majority of votes cast (as opposed to votes outstanding).15 This policy change likely has had the effect of incentivizing companies to avoid a vote by agreeing to adopt reforms proposed by shareholders, particularly if a proposal is likely to meet ISS’s new, lower standard and thus—if not adopted before the next shareholder meeting—lead to a withhold-the-vote recommendation for directors in the following year. The influence of ISS therefore does not merely affect vote results themselves, but also boards’ decisions as to which proposals actually will come to a vote.16

Recent SEC Guidance

On June 30, 2014, the SEC’s Divisions of Corporate Finance and Investment Management released new guidance regarding investment advisers’ responsibilities relating to proxy voting and their reliance upon proxy advisory firms. Under the “Proxy Voting Rule,” investment advisers have a fiduciary duty to their clients to vote their proxies in the clients’ best interests. Staff Legal Bulletin 20 (SLB 20) prompts investment advisers to take an active role on behalf of their clients, particularly in evaluating and overseeing any proxy advisory firm they may engage to help them fulfill their voting responsibilities. Investment advisers are required to adopt and implement written policies and procedures designed to ensure that they comply with the Proxy Voting Rule. The guidance states that investment advisers should take steps to demonstrate compliance, including reviewing, at least annually, the adequacy of their proxy voting policies and procedures to ensure that they are reasonably designed and being effectively implemented. SLB 20 suggests using proxy vote sampling to ensure that votes have been properly cast.

A key point emphasized in SLB 20 is that the Proxy Voting Rule does not require that investment advisers vote every proxy or take on all of a client’s proxy voting responsibilities.17 Although the SEC had previously conveyed this message in other materials,18 many investment managers interpreted two 2004 no-action letters19 to indicate that they were required to vote on all matters. This interpretation led to heavy reliance on proxy advisory firms, as investment advisers largely outsourced their voting responsibilities.20 The recent guidance refutes this interpretation and suggests a variety of arrangements in which a client and an investment adviser may allocate the proxy voting responsibilities between them as dictated by the best interests of the client. Possible alternatives include focusing resources only on particular types of proposals or establishing default voting parameters for proposals made by management or certain shareholder proponents. At the extremes, the parties may agree that the adviser will vote all of the client’s proxies, or not vote any proxies at all, regardless of whether the client votes them itself. The adviser and client may use a cost-benefit analysis and the preferences of the client to determine the best arrangement for fulfilling proxy voting responsibilities.21

SLB 20 urges investment advisers to be demanding clients themselves when it comes to their proxy advisory firms. The guidance states that, when considering whether to retain or continue utilizing a proxy advisory firm, an investment adviser should make certain that the firm “has the capacity and competency to adequately analyze proxy issues.”22 In addition to the quality of the firm’s personnel, investment advisers are urged to consider the “robustness” of the proxy advisory firm’s policies and procedures designed (a) to ensure that proxy voting recommendations are based on current, accurate information and (b) to identify and address any conflicts of interest and other considerations affecting the nature and quality of the advice and services provided.23 Moreover, the Proxy Voting Rule requires that an investment adviser must oversee a proxy advisory firm on an ongoing basis to ensure that the firm continues to guide proxy voting in the best interests of the investment adviser’s clients. If an investment adviser determines that a proxy advisory firm’s recommendation was based on inaccurate information, the adviser should investigate the error and determine whether such errors are being addressed by the proxy advisory firm. Corporate issuers should take note of this guidance and be proactive in reviewing the information in proxy voting reports and submitting any necessary corrections. The guidance emphasizes the fact that a proxy advisory firm’s business or conflicts policies can change from time to time, requiring an investment adviser to reassess its use of the proxy advisor. Accordingly, investment advisers should monitor changes in a proxy advisory firm’s conflicts or conflicts policies by, for example, requiring updates from the proxy advisory firm as to these matters.

For their part, proxy advisory firms are instructed to be more forthcoming with respect to conflict-of-interest disclosures, which are required when a material conflict exists. SLB 20 states that where a proxy advisory firm provides consulting services to a company on a matter that is also the subject of a voting recommendation (or provides a voting recommendation to clients on a proposal sponsored by another client, or has any other interest in a matter), it must make a fact-specific determination as to whether its relationship with the company or proponent is significant or its interest material. Generally speaking, the SEC considers “significant” and “material” any element that would reasonably affect a client’s assessment of the reliability and objectivity of the proxy advisor’s advice. If necessary, the proxy adviser must then take affirmative steps to disclose the relationship to the client receiving the voting recommendation. The guidance states explicitly that disclosure of a conflict cannot be boilerplate; rather, it should provide the recipient of the disclosure with sufficient information to understand the nature and scope of the conflict, including any steps taken to mitigate it, in order that the client may be able to assess the recommendation. Interestingly, despite the SEC’s push for more robust disclosure, the conflicts disclosure need not be provided publicly so long as it is provided to the client in a timely and relevant manner designed to allow the client to assess both the advice and the conflict at once. Investment advisers, recognizing the increasing significance of conflicts in the proxy advisory industry, may wish to require proxy advisory firms to disclose potential conflicts more broadly than is legally required so that the investment adviser itself can decide what it considers material. In some cases, investment advisers may wish to independently investigate and verify the disclosures provided by proxy advisers to ensure that they do not inadvertently breach their fiduciary duties to their clients by relying on inaccurate information.

The SEC notes that “investment advisers and proxy advisory firms may want or need to make changes to their current systems and processes in light of this guidance” and expects such changes in advance of the 2015 proxy season. Investment advisers should be mindful that they, and not the proxy advisors, are the entity that must fulfill a fiduciary duty to a client. Because of this, investment advisors should promptly evaluate (and create a record of their evaluation of) one or more proxy advisory firms to support a decision to hire one of them or continue to retain such services. From there, investment advisers should, as advised by SLB 20, ensure that their policies and procedures relating to ongoing oversight of a proxy advisory firm are effective and up-to- date.

U.S., Canadian and European Reforms

Commissioner Gallagher, in a working paper published in August, indicated that he supports additional reforms relating to proxy advisors. He observed that “over the past decade, the investment adviser industry has become far too entrenched in its reliance on these firms, and there is therefore a risk that the firms will not take full advantage of the new guidance to reduce that reliance.”24 Promising to closely monitor whether SLB 20 will ameliorate current problems, Commissioner Gallagher noted that public companies may be disregarded by proxy advisory firms and institutional investors when they have concerns about inaccurate information being used to create voting recommendations. His interest and engagement in this issue is such that he has asked that these companies send copies of their shareholder communications directly to his office.

Commissioner Gallagher has suggested that the two 2004 no-action letters should be withdrawn and replaced with Commission-level guidance reminding institutional investors of their responsibility to fulfill their fiduciary duties by taking the lead on voting decisions rather than deferring automatically to proxy advisory firms. He is not alone in this view; former SEC Chairman Harvey Pitt as well as Congressman Patrick McHenry have made similar proposals.25 Though he stops short of calling for comprehensive regulation, Commissioner Gallagher supports the idea of a universal code of conduct for proxy advisory firms to increase transparency and promote accountability and best practices.26

A recent proposal by the European Commission (EC), cited with approval by Commissioner Gallagher, would come close to implementing a universal code of conduct. This spring, the EC released a proposal for legislation designed to improve the accuracy and reliability of advice from proxy advisory firms.27 The EC report calls for action at the European Union level and emphasizes the broad-based need for increased transparency from proxy advisory firms. Under the proposed law, proxy advisors would be required to disclose, on an annual basis, substantial information relating to how their voting recommendations are determined, including their methodologies, their information sources, whether they have taken into account market, legal, and regulatory conditions, and the extent and nature of any dialogues they may have with the companies that are the subject of their recommendations.28 Further, proxy advisory firms would be required to promptly disclose any actual or potential conflicts or business relationships that could influence their recommendations, along with any actions they have taken to reduce or eliminate such conflicts.29

Canada, too, is increasing pressure on proxy advisors to be more transparent and accountable. In April, the Canadian Securities Administration (CSA) published for comment proposed guidance for proxy advisory firms.30 The policy-based approach would provide recommendations for best practices and disclosures on the part of proxy advisors. The proposed guidance highlights conflicts of interest, stating that “[e]ffective identification, management and mitigation of actual or potential conflicts of interest are essential in ensuring the ability of the proxy advisory firm to offer independent and objective services to a client.”31 Additional guidance focuses on transparency, accuracy, tailored governance recommendations, and communications with clients, market participants, the media and the public.32

2015 Proxy Season

At best, proxy advisors play an important role in making investment managers more informed, efficient stewards of their clients’ proxy voting. However, their influence has become so significant that it is crucial that their recommendations be as worthwhile, transparent, and objective as possible. As the focus shifts to the 2015 proxy season, companies should be mindful of the SEC’s increased scrutiny of investment advisers’ voting and use of proxy advisory firms. Corporate issuers can and should be proactive in obtaining and reviewing proxy voting reports relating to the company and promptly requesting any needed corrections of incorrect information. In cases of material misstatements or confusion created by the proxy voting reports, companies may wish to add their own corrections to their proxy materials or other shareholder communications. Companies should, as always, continue to engage directly with their large shareholders and make the case for supporting the recommendations of the board. Healthy communication with issuers will help enable institutional investors to make their own independent, informed decisions about voting matters.

A separate issue that has not been widely discussed is whether the proxy advisory firms should be required to make their reports public, since they influence such a large segment of the voting population. Although the proxy advisory firms currently are not required to publicly file their reports, if the goal is increased transparency, perhaps this should change. As the SEC monitors the proxy advisory firms in the coming months, appropriate consideration should be given to modernizing the antiquated proxy voting system and determining what additional steps, if any, should be taken to regulate these firms and their influence on public companies.

Companies concerned about the undue influence of proxy advisors have an engaged advocate in Commissioner Gallagher, and momentum may be building, both in the United States and abroad, toward further reform in this area. The upcoming proxy season will be a key time for the SEC to observe any ramifications of SLB 20 and to consider next steps. Fundamentally, the SEC has, with SLB 20, reminded investment managers that their fiduciary duties are incompatible with inattentive overreliance on proxy advisors. It remains to be seen what effect the new guidance will have, but if it proves to be effective, it may herald a new era of decreasing relevance for proxy advisory firms.




∗ David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.

1 Securities and Exchange Commission Staff Legal Bulletin No. 20, “Proxy Voting: Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms,” June 30, 2014 (“SLB 20”), available at

2 Commissioner Daniel M. Gallagher, U.S. Securities and Exchange Commission, “Outsized Power and Influence: The Role of Proxy Advisers,” Washington Legal Foundation Critical Legal Issues Working Paper Series, No. 187, Aug. 2014 (“Gallagher Paper”), available at

3 See, e.g., U.S. Chamber of Commerce, Center for Capital Markets Competitiveness, “Best Practices and Core Principles for the Development, Dispensation, and Receipt of Proxy Advice,” March 2013, at 2, available at Principles-for-Proxy-Advisors.pdf.

4 See U.S. Chamber of Commerce, Center for Capital Markets Competitiveness, supra, at 3 (estimating that the two firms together have 97% market share).

5 See Gallagher Paper, supra, at 12; see also Holly Gregory, “SEC Guidance May Lessen Investment Adviser Demand for Proxy Advisory Services,” Sidley Austin LLP Update, July 29, 2014, available at proxy-advisory-services/; Yin Wilczek, “Congress Will Act If SEC Fails To Move on Proxy Advisors,” Bloomberg BNA, June 27, 2014, available at

6 See Thomson Reuters Tax & Accounting News, “Scrutiny of Proxy Advisers to Continue,” July 28, 2014 (citing statements by Keith Higgins, director of the SEC’s Division of Corporate Finance, on July 24, 2014) available at newsstand/scrutiny-proxy-advisers-continue/.

7 See James R. Copland, “SEC Needs To Rethink Its Rules on Proxy Advisory Firms,” Washington Examiner, July 24, 2014, available at!.

8 Id.

9 Sullivan & Cromwell LLP, “2014 Proxy Season Review,” June 25, 2014, at 16 (“S&C Proxy Review”), available at

10 Securities Exchange Act of 1934, Rule 14a-8(i)(12).

11 See James R. Copland, “Politicized Proxy Advisers vs. Individual Investors,” Wall St. J., Oct. 7, 2012 (“Copland 2012”), available at

12 See id.

13 See David F. Larcker et al., “The Influence of Proxy Advisory Firm Voting Recommendations on Say- on-Pay Votes and Executive Compensation Decisions,” The Conference Board Director Notes, April 2012, available at

14 See Copland 2012, supra.
15 See S&C Proxy Review at 1.

16 See id. at 6.

17 SLB 20, Answer to Question 2; see also Gallagher Paper, supra, at 3, 13.

18 See, e.g., Investment Advisers Act Rel. No. 2106 (“We do not suggest that an adviser that fails to vote every proxy would necessarily violate its fiduciary obligations. There may even be times when refraining from voting a proxy is in the client’s best interest, such as when the adviser determines that the cost of voting the proxy exceeds the expected benefit to the client.”), available at 2106.htm.

19 Institutional Shareholder Services, Inc., SEC Staff Letter (Sept. 15, 2004), available at, Egan Jones Proxy Services, SEC Staff Letter (May 27, 2004), available at

20 “Reforming the Proxy Advisory Racket,” WSJ Review & Outlook, July 22, 2014, available at

21 SLB 20 clarifies that a proxy advisory firm engages in a “solicitation” under the federal proxy rules when it furnishes proxy advice. SLB 20, Answer to Question 6; see also Securities and Exchange Act of 1934 Rule 14a-1(l ) and Release No. 34-31326 (Oct. 16, 1992). Proxy advisory firms are therefore subject to the antifraud and other provisions of the proxy rules unless an exemption applies; merely distributing reports containing recommendations would not qualify as a solicitation. SLB 20, Answer to Question 8; see also Securities and Exchange Act of 1934 Rule No. 14a(2(b)(1) and Rule No. 14 a(2(b)(3). However, an exemption would not apply to a proxy advisory firm that allowed a client to establish general guidelines or policies, in advance of receiving proxy materials, that the firm would use to vote on behalf of its client. SLB 20, Answer to Question 7.

22 SLB 20, Answer to Question 3.

23 The U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness has released a set of best practices and core principles for proxy advisory firms that is a useful reference for investment advisers and proxy advisors alike. See U.S. Chamber of Commerce, Center for Capital Markets Competitiveness, supra.

24 Gallagher Paper, supra, at 16.

25 See David Scileppi, “Congress to the Rescue?: Congressman Hints at Legislation To Rein in Proxy Advisory Firms,” The Securities Edge, June 27, 2014, available at proxy-advisory-firms/.

26 Gallagher Paper, supra, at 17.

27 European Commission, “Proposal for a Directive of the European Parliament and of the Council amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement and Directive 2013/34/EU as regards certain elements of the corporate governance statement (Apr. 9, 2014), available at

28 Id. at Article 3i, “Transparency of proxy advisors.”

29 Id.

30 Canadian Securities Administration Notice and Request for Comment, Proposed National Policy 25-201, “Guidance for Proxy Advisory Firms,” Apr. 24, 2014 (“CSA Proposal”), available at The comment period closed on June 23, 2014.

31 Id. at 2. 32 Id. at 7-8.


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Treasury Announces First Steps to Reduce Tax Benefits of Corporate Inversions

Treasury Announces First Steps to Reduce Tax Benefits of Corporate Inversions


Unfair Practice Erodes the U.S. Tax Base

WASHINGTON – Today, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) issued a notice that takes targeted action to reduce the tax benefits of — and when possible, stop — corporate tax inversions. Companies are increasingly using the technique of inversion, whereby a U.S. based multinational restructures so that the U.S. parent is replaced by a foreign corporation, in order to avoid U.S. taxes. These transactions erode the U.S. tax base, unfairly placing a larger burden on all other taxpayers, including small businesses and hardworking Americans.

More than two years ago, President Obama laid out his framework for business tax reform. In addition, the Administration’s FY 2015 budget included a legislative plan to reduce the incentives to invert as well as make it more difficult to accomplish an inversion. Secretary Lew has been urging Congress to move forward with anti-inversion legislation, which is the only way to fully rein in these transactions.

“These first, targeted steps make substantial progress in constraining the creative techniques used to avoid U.S. taxes, both in terms of meaningfully reducing the economic benefits of inversions after the fact, and when possible, stopping them altogether,” said Treasury Secretary Jacob J. Lew. “While comprehensive business tax reform that includes specific anti-inversion provisions is the best way to address the recent surge of inversions, we cannot wait to address this problem. Treasury will continue to review a broad range of authorities for further anti-inversion measures as part of our continued work to close loopholes that allow some taxpayers to avoid paying their fair share.”

Genuine cross-border mergers make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the United States. But these transactions should be driven by genuine business strategies and economic efficiencies, not a desire to shift the tax residence of the parent entity to a low-tax jurisdiction simply to avoid U.S. taxes.

Specifically, today’s action eliminates certain techniques inverted companies currently use to gain tax-free access to the deferred earnings of a foreign subsidiary, significantly diminishing the ability of inverted companies to escape U.S. taxation.  It also makes it more difficult for U.S. entities to invert by strengthening the requirement that the former owners of the U.S. company own less than 80 percent of the new combined entity. For some companies considering mergers, today’s action will mean that inversions no longer make economic sense.

Treasury will continue to examine ways to reduce the tax benefits of inversions, including through additional regulatory guidance as well as by reviewing our tax treaties and other international commitments. Today’s Notice requests comments on additional ways that Treasury can make inversion deals less economically appealing.  Today’s actions apply to deals closed today or after today.

Fact Sheet: Treasury Actions to Rein in Corporate Tax Inversions



Actions under sections 304(b)(5)(B), 367, 956(e), 7701(l), and 7874 of the Code 
What is a corporate inversion?
A corporate inversion is transaction in which a U.S. based multinational restructures so that the U.S. parent is replaced by a foreign parent, in order to avoid U.S. taxes. Current law subjects inversions that appear to be based primarily on tax considerations to certain potentially adverse tax consequences, but it has become clear by the growing pace of these transactions that for many corporations, these consequences are acceptable in light of the potential benefits.
An inverted company is subject to potential adverse tax consequences if, after the transaction: (1) less than 25 percent of the new multinational entity’s business activity is in the home country of the new foreign parent, and (2) the shareholders of the old U.S. parent end up owning at least 60 percent of the shares of the new foreign parent. If these criteria are met for an inverted company, the tax consequences depend on the continuing ownership stake of the shareholders from the former U.S. parent. If the continuing ownership stake is 80 percent or more, the new foreign parent is treated as a U.S. corporation (despite the new corporate address), thereby nullifying the inversion for tax purposes. If the continuing ownership stake is at least 60 but less than 80 percent, U.S. tax law respects the foreign status of the new foreign parent but other potentially adverse tax consequences may follow. The current wave of inversions involves transactions in this continuing ownership range of 60 to 80 percent.
Genuine cross-border mergers make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the United States. But these transactions should be driven by genuine business strategies and economic efficiencies, not a desire to shift the tax residence of the parent entity to a low-tax jurisdiction simply to avoid U.S. taxes.
Today, Treasury is taking action to reduce the tax benefits of — and when possible, stop — corporate tax inversions. This action will significantly diminish the ability of inverted companies to escape U.S. taxation.  For some companies considering mergers, today’s action will mean that inversions no longer make economic sense.
Specifically, the Notice eliminates certain techniques inverted companies currently use to access the overseas earnings of foreign subsidiaries of the U.S. company that inverts without paying U.S. tax.  Today’s actions apply to deals closed today or after today.
This notice is an important initial step in addressing inversions.  Treasury will continue to examine ways to reduce the tax benefits of inversions, including through additional regulatory guidance as well as by reviewing our tax trea