Corporate governance - Vigil

A report published by the United States Government Accountability Office (GAO) earlier this month has further highlighted the dearth of comparable, decision-useful ESG disclosures sought by investors. Commissioned by U.S. Senator Mark Warner, the report noted that most institutional investors contacted by the GAO seek ESG information to enhance their understanding of risks and to assess long-term value. The report also noted challenges with understanding and interpreting both quantitative and narrative ESG disclosures, and that the quality and relevance of such disclosures to investors remain highly variable. Following the release of the GAO report, Senator Warner called on the U.S. Securities and Exchange Commission (SEC) to establish a task force to determine a robust set of quantifiable and comparable ESG metrics to be disclosed by all public companies. Senator Warner had previously pushed for more extensive disclosure of human capital-related metrics in light of their materiality to most businesses.

Ever since the COVID-19 pandemic started to spread around the globe, business leaders have faced myriad unexpected dangers (and sometimes opportunities) that require attention and quick decisions under exceptionally stressful and rapidly evolving conditions. How directors may best discharge their fiduciary duties in this extraordinary environment will depend on the particular circumstances they face, and they should seek counsel to help guide them through a given situation. As a general matter, some of the things directors can do are:
(1) Actively monitor the performance of the business and work with management to identify risks that COVID-19 poses for the company and how best to manage those risks.
(2) For public reporting companies and companies raising capital, consider the company’s disclosures and guidance regarding the risks and impacts of COVID-19 on the business.
(3) Pay close attention to changes in the company’s financial condition, with particular focus on liquidity. Is the company at risk of insolvency? Is it still solvent?
(4) Monitor the company’s financial and other contractual obligations and understand management’s plans to meet those obligations in the near term.
(5) Critically assess the need for, sources of, and effect of additional fundraising.

On June 23, 2020, the Division of Corporation Finance (CF) and the Office of the Chief Accountant of the US Securities and Exchange Commission (SEC) released guidance that provides additional views on disclosure related to COVID-19, supplementing earlier guidance provided on March 25, 2020 and April 3, 2020, respectively. [...] The latest guidance reiterates earlier statements encouraging companies to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively revise and update disclosures as facts and circumstances change. In the new guidance, CF provided the following to help companies analyze their specific facts and circumstances:
(A) What are the material operational challenges that management and the Board of Directors are monitoring and evaluating? [...]
(B) Have COVID-19-related impacts affected your ability to access your traditional funding sources on the same or reasonably similar terms as were available to you in recent periods? [...]
(C) If you include metrics, such as cash burn rate or daily cash use, in your disclosures, are you providing a clear definition of the metric and explaining how management uses the metric in managing or monitoring liquidity? [...]
(D) Have you reduced your capital expenditures and if so, how? Have you reduced or suspended share repurchase programs or dividend payments? 

Experienced litigators know that an adverse appellate decision (even from the U.S. Supreme Court) rarely ends their case. The question is instead: What is the next move? What defenses do we fall back on? So it is likely to be with Liu v. SEC,[1] which, by an 8-1 margin, resolved that the SEC does have the authority to order disgorgement. Still, the Court subjected this authority to the important qualifications that: (1) the ill-gotten gains consist only of the net gains (with all “legitimate expenses” being deducted); (2) the recovery is returned to the injured investors (and thus not transferred to the U.S. Treasury); and (3) there is no “joint and several liability,” unless the parties were engaged in “concerted wrongdoing” — a phrase that would suggest conspiratorial liability, except that the Court carefully avoided using this phrase. Each of these conditions can spawn a host of subsidiary issues. In addition, the Court remanded the case to the Ninth Circuit to consider if further exceptions should be carved out. Procedurally, this was a questionable move. On remand, the Ninth Circuit will be asked to consider whether the SEC can transfer the disgorgement it obtains to the Treasury if it is infeasible to identify and compensate the victims. Yet, because the victims are easily identifiable in Liu, and because a trustee has been appointed who seems intent on distributing the funds to them, there is little need to address this question in this case. 

The SEC has proposed an amendment to Form 13F that would exempt from filing all money managers holding less than $3.5 billion of “13(f) securities.” The threshold would apply without regard to the fund’s overall size or total assets under management. Increasing the threshold to $3.5 billion from the current cut-off of $100 million would slash the number of reporting filers by 90%, from 5,089 to 550, effectively abolishing Form 13F as a reporting system for most investors, including many activist and event-driven hedge funds, and preserve it only for the largest index funds and asset managers. Form 13F generally requires investment managers holding more than $100 million of such 13(f) securities (typically Exchange-traded equity securities, certain options and warrants, shares of closed-end investment companies and certain convertible debt securities) to disclose their holdings within 45 days of the end of each quarter, and is often the primary means by which investors, companies and other market participants first learn or verify that an activist hedge fund is accumulating or has accumulated a significant (but less than 5%) position in a target company’s stock. Because many activists do not own $3.5 billion of 13(f) securities, adoption of this revision would permit them to “go dark” and make it significantly more difficult to determine whether an activist, or a “wolf pack” of activists, owns a stake in a company. Indeed, as we have previously discussed, activist “tipping” could well result in only the wolf pack—and not the target company or other shareholders—being aware of the ownership stake until the moment that the activist strike occurs.

The ever-evolving challenges facing corporate boards prompt periodic updates to a snapshot of what is expected from the board of directors of a public company—not just the legal rules, or the principles published by institutional investors and various corporate and investor associations, but also the aspirational “best practices” that have come to have equivalent influence on board and company behavior. The coronavirus pandemic and resulting recession, combined with the wide embrace of ESG, stakeholder governance and sustainable long-term investment strategies by the Business Roundtable, the World Economic Forum, the British Academy, BlackRock, Vanguard, State Street and other investors and asset managers is a decisive inflection point in the responsibilities of the board of directors of companies. [...] Directors need to grapple with a host of questions about the practical implications of this new paradigm, such as adjusting existing board functioning to reflect stakeholder governance, defining corporate “purpose” and shaping its “culture,” integrating ESG considerations into long-term business strategy and measuring and delivering sustainable value to all stakeholders. Directors are also facing questions about the contours of the board’s legal obligations, and what, if any, modifications should be made to communications and engagement efforts with shareholders and other stakeholders. In addition, the current pandemic has heightened emphasis on effective and adaptive crisis management and events of recent weeks have shone a light on the role of all market participants in combatting social and racial inequality.

Common ownership has garnered significant attention in both antitrust and corporate governance discourse. Scholars have long been concerned that monopolies, cartels, and other forms of coordination can harm consumers. In recent years, prominent scholars have also raised concerns regarding companies’ incentives to compete where major institutional shareholders hold large equity positions in all competitors. Yet, as the common ownership debate endures, another channel that may enable companies to coordinate, and has similar antitrust and governance concerns has received little attention. My paper, Horizontal Directors, spotlights the surprising prevalence of directors who serve on the boards of multiple companies within the same industry and who may also facilitate coordination that may lead to anticompetitive behavior. Against this empirical backdrop, the paper explores the benefits horizontal directors provide to companies and investors, as well as the antitrust and governance concerns that they may pose, and puts forward several policy recommendation to regulators and investors. [...] Investors, too, should direct their attention to the issue of horizontal directorship. Understanding that not all companies are created equal, investors may be better situated than regulators to account for the rise in horizontal directorships and to offer market based solutions to the inherent tension that these directors present. Whether viewing horizontal directors as a corporate governance liability or as a potential benefit, a strong case for improved disclosure exists. 

Three catalysts are causing a fundamental reorientation of domestic and international monetary and payment systems: Facebook’s Libra, China’s central bank digital currency (the Digital Currency / Electronic Payment (DCEP) system), and the COVID-19 pandemic. These catalysts stand in stark contrast to all previous disruptions and are the focus of our new paper. First, and crucially, each catalyst is likely to have a systemic effect on domestic and international payment systems. Second, all three systemic catalysts are operating concurrently. Third, all three are mutually reinforcing – developments and regulatory changes affecting one will often directly affect the others. While Bitcoin has drawn much attention since its launch in 2009, Facebook’s announcement of Libra in 2019 – its own cryptocurrency combined with a global digital payment system and digital identification system via Facebook/WhatsApp/Instagram Pay – was the first catalyst of sufficient scale and potential to lead central banks to rethink their approach to sovereign digital currencies (SDCs). It highlights the true potential of technology to revolutionize money and payment. While much of the focus so far has been on the role of distributed ledger technology and blockchain, centralized payment systems likewise have transformed as a result of technology – both retail (“fast payment systems”) and wholesale (“real time gross settlement systems”).

The pandemic is likely to have lasting, material repercussions for how health care enterprises approach corporate governance. These repercussions are separate and distinct from the board’s disaster-response duties that were summoned into application during the height of the health crisis. Rather, they relate to how certain traditional governance principles and practices are expected to change given the lessons and experiences that corporate leadership is gaining over the course of the pandemic.