Thursday, April 10, 2014

Is Shareholder Activism a Participatory Sport?

[I]t is counterproductive for investors to turn the corporate governance process into a constant Model U.N. where managers are repeatedly distracted by referenda on a variety of topics proposed by investors with trifling stakes. Giving managers some breathing space to do their primary job of developing and implementing profitable business plans would seem to be of great value to most ordinary investors. -Hon. Leo E. Strine Jr., Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law, 114 COLUMBIA L. REV. 449, 475 (2014).

When was the last time you remember the U.S. Chamber of Commerce, the National Association of Corporate Directors, the National Black Chamber of Commerce, American Petroleum Institute, the Latino Coalition, Financial Services Roundtable, Center On Executive Compensation, and the Financial Services Forum joining forces on an issue? Well yesterday they signed on to a petition for rulemaking that was submitted to the SEC regarding the resubmission of shareholder proposals that “fail to elicit meaningful shareholder support.” 

Shareholders who own at least $2,000 worth of a company’s stock for at least one year may require a company to include one shareholder proposal in the company’s proxy statement to all shareholders under Rule 14a-8(b) of the ’34 Act. Under Rule 14a-8(i)(12), companies may exclude shareholder proposals from proxy materials under thirteen circumstances, including but not limited to proposals that deal with substantially the same subject matter as another proposal that has been previously included in the company’s proxy materials within the preceding 5 calendar years and did not receive a specified percentage of the vote on its last submission.  Specifically a company can exclude a proposal (or one with substantially the same subject matter) if it failed to receive 3% support the last time it was voted on if voted on once in the last five years, 6% if it was voted on twice in the last five years, and 10% if it was voted on three or more times in the past five years for resubmission.  Note that the SEC itself proposed and then withdrew the idea of raising the threshold to 6%, 15% and 30% in 1997.  The Resubmission Rule is supposed to protect the interests of the majority of shareholders so that a small minority cannot burden the rest of the shareholders with proposals that the majority have repeatedly expressed that they have no interest in and to ensure that management can focus on issues that are important to the company.

Why is this important? The petition includes the following enlightening statistics:

1)  The two largest proxy advisory firms, Institutional Shareholder Services (ISS) and Glass Lewis command 97% of the market for proxy advisory firms meaning that they can, in the petitioners view, “dictate” what should be included in proxy solicitations. Proposals favored by ISS may receive up to 24.7% greater support than those do not have their support and proposals favored by Glass Lewis may receive up to 12.9% greater support, all independent of other factors.

2) According to the Manhattan Institute, since 2011, 437 shareholder proposals relating to questions of social policy have been submitted just to the Fortune 250. These proposals have been opposed by an average of 83.7% of votes cast.

3) Between 2005-2013, 420 shareholder proposals focusing on environmental issues were proposed to US companies but only one passed (I would note that many environmental issues never make it to the proxy because shareholders are now engaging with management earlier).

4) Between 2005-2013, 237 labor-related proposals were submitted to US companies. Only three proposals received majority support and the other 234 labor-related proposals received less than 20% support.

5) A Navigant study estimates that companies incur direct costs of $87,000 per proposal or $90 million annually in the aggregate.

6)  The website shareholderactivist.com calls shareholder activism a "participatory sport" where investor activists submit similar proposals to multiple companies so that they can "advance a larger agenda.”

The petitioners argue that the current Resubmission Rule fails to protect shareholders and forces the majority of shareholders to “wade through and evaluate” numerous proposals that have already been “viewed unfavorably” by 90% or more of shareholders year after year and have no realistic likelihood of winning the support of a substantial number of shareholders. The petitioners recommend that the SEC reconsider the Resubmission Rule because the existing rule was adopted without cost-benefit analysis. To better serve shareholders, the petitioners contend that SEC should significantly increase the voting percentage of favorable votes a proposal must receive before the company is obligated to include a repeat proposal in subsequent years in its proxy. To read the Petition for Rulemaking click here. The comment period for the SEC will be open soon.

As a side note, my business associations class studied Rule 14a-8 and drafted their own shareholder proposals last week. I saw one of my students today and excitedly told her I was working on this blog post and that we were going to discuss this proposal on Monday. Her response- oh no- will we have to know this for the final?  Must be the end of the semester.

 

April 10, 2014 in Business Associations, Corporate Governance, Corporations, Current Affairs, Financial Markets, Law School, Marcia L. Narine, Securities Regulation, Teaching | Permalink | Comments (0)

Thursday, April 3, 2014

Whistle While You Work

As regular readers of this blog may know, I sit on the Department of Labor's Whistleblower Protection Advisory Committee. The Occupational Health and Safety Administration, a division of the Department of Labor, may not be the first agency that many people think of when it comes to protecting whistleblowers, but in fact the agency enforces almost two dozen laws, including Sarbanes-Oxley and the Consumer Financial Protection Bureau's law on whistleblowers.  The Consumer Financial Protection Act was promulgated on July 21, 2010 to protect employees against retaliation by entities that offer or provide consumer financial products.

Today OSHA released its interim regulations for protecting CFPB whistleblowers.  The regulation defines a “covered person” as “any person that engages in offering or providing a consumer financial product or service.” A “covered employee” is “any individual performing tasks related to the offering or provision of a consumer financial product or service.” A “consumer financial product or service” includes, but is not limited to, a product or service offered to consumers for personal, family, or household purposes, such as residential mortgage lending and servicing, private student lending and servicing, payday lending, prepaid debit cards, consumer credit reporting, credit cards and related activities. The Consumer Financial Protection Act protects “covered employees” of “covered persons” from retaliation who report violations of the law to their employer, the CFPB, or any other federal, state, or local government authority or law enforcement agency. Employees are also protected from retaliation for testifying about violations, filing reports or refusing to violate the law.

Retaliation is broadly defined as firing or laying off, reducing pay or hours, reassigning, demoting, denying overtime or promotion, disciplining, denying benefits, failing to hire or rehire, blacklisting, intimidating, and making threats. An employee or representative who believes that s/he has suffered retaliation must bring a claim within 180 days after the alleged retaliatory action. If OSHA finds that the complaint has merit, the agency will issue an order requiring the employer to put the employee back to work, pay lost wages, restore benefits, and provide other relief. Either party can request a full hearing before an ALJ of the Department of Labor. A final decision from an  ALJ may be appealed to the Department’s Administrative Review Board and an employee may also file a complaint in federal court if the Department of Labor does not issue a final decision within certain time limits.

Although the statute is part of Dodd-Frank, the CFPB whistleblowers don’t get the same monetary benefits as Dodd-Frank whistleblowers who go to the SEC. The SEC Dodd-Frank whistleblower rule allows the recovery of between 10-30% of any monetary award of more then $1million of any SEC enforcement action to those individuals who provide original information to the agency. The SEC announced that in 2013 it awarded $14,831,965.64 during its fiscal year to 4 whistleblowers based on 3,238 tips. The vast majority—more than $14 million went to a single individual.  The top three allegations involved corporate disclosures and financials (17.2%), offering fraud (17.1%) and manipulation (16.2%). 

Should there be such a disparity between those whistleblowers who protect consumers and those who protect investors? Maybe not, but studies consistently show that whistleblowers don’t report to government agencies for the money so perhaps the absence of a large financial reward won’t be a deterrence. Time will tell as to whether any of these whistleblower laws will prevent the next financial crisis. But at least those who work in the financial sector will have some protection.

 

 

 

April 3, 2014 in Corporations, Current Affairs, Ethics, Financial Markets, Marcia L. Narine, Securities Regulation | Permalink | Comments (0)

Sunday, March 23, 2014

The Weekly BLT for March 23, 2014

I'm trying out a new weekly blog post theme, "The Weekly BLT," wherein I highlight a few interesting business law tweets that I've come across in the past week that have not yet made it to the BLPB.

 

 

March 23, 2014 in Business Associations, Constitutional Law, Corporate Governance, Corporations, Financial Markets, LLCs, Stefan J. Padfield | Permalink | Comments (0)

Thursday, March 20, 2014

Some light reading just in time for proxy season

It’s proxy season and the Conference Board has released a series of reports on investor engagement and corporate governance. In “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?” the authors provide a 76-page overview of the evolution of US corporate governance, describing key trends and issues.

The report begins by discussing the history of the allocation of roles and responsibilities for governance of public companies. If I thought my law students would read it, I would assign this section to them.  The second part of the paper addresses the legal, social and market trends that have influenced the historical allocation of rights. Specifically, it reviews:

a) the increasing influence of institutional investors resulting from the concentration of ownership in institutional investment, changes in voting rules and practices and more assertive shareholder activism;

b) shifting conceptions about the purpose of the corporation and the duty to maximize corporate value, with a strong emphasis on shareholder wealth maximization;

c) decreased public trust of business leaders following the corporate scandals of 2001-2002 and 2007-2008;

d) federal regulation intended to enhance the influence of shareholders and increase board and management accountability;

e) continuing related to executive compensation and incentives; and

f) the growth of proxy advisory firms in the shareholder voting process. 

Some interesting statistics:

a) in 2013, 25% of all shareholder proposals were sponsored by two individuals and their family members and family trusts;

b) from 2006-2013, 33% of shareholder proposals submitted to Fortune 250 companies were sponsored by investors affiliated with labor; 26% by corporate gadflies; 25% by religious, social impact and public policy organizations; and 15% by other individual investors;

c) 241 activist campaigns were launched in 2012 up from 187 in 2009;

d) 69% of proxy contests against the management of Russell 3000 companies during the 2013 proxy season were launched by activist hedge funds; and

e) one third of the activist hedge fund contests sought full control of the board.

The third part of the report briefly summarizes but does not provide any conclusions about the work of Professors Bainbridge, Stout, Anabtawi, Bebchuk, Laverty, and others. It considers the following questions (but does not answer them):

a) Do federal mandates undermine the benefits of a historically state-driven corporate law?

b) Are further changes to board processes and composition desirable?

c) Should shareholders assume a more active role in corporate governance?

d) Do proxy advisory firms replace, rather than augment, the shareholder voice, and should the proxy advisory industry be subject to greater regulation and oversight?

e) Can changes to voting mechanisms improve the effectiveness of corporate governance?

f) Is short-termism a cause of concern, and is so, what are its causes and remedies?

g) What new challenges are presented by vote decoupling, high-speed trading, and hyper portfolio diversification?

In next week’s post I will discuss the “Guidelines for Engagement” and the “Recommendations of the Task Force on Corporate/Investor Engagement.” In the meantime, I highly recommend downloading these complimentary reports.

March 20, 2014 in Business Associations, Corporate Governance, Corporations, Current Affairs, Financial Markets, Marcia L. Narine, Securities Regulation, Teaching | Permalink | Comments (0)

Wednesday, March 19, 2014

The New Face of Shareholder Activism

I am interested in the behavior of institutional investors, including defined benefit plans and large mutual funds, primarily because they trade in people's retirement savings.   Institutional investors and hedge funds are some of the only remaining investors under the big umbrella heading of "shareholders" that have the resources and incentive to act the way that corporate law theorizes shareholders should act.  They become the lab rats and the test case of governance experiments and debates.

Notably, the passivity of institutional investors has been described, empirically documented by number of initiated shareholder proposals and with voting records on such proposals, and debated at considerable length.  Alan Palmiter, Jill Fisch, Roberta Romano, as well as a recent article by Gilson & Gordon and many others have all grappled with the evidence for and against and provided theories that augment or diminish the view of passivity by institutional investors.

The New York Times DealB%k published an article yesterday, New Alliances in Battle for Corporate Control, describing the coordination between institutional investors (both pension funds and mutual funds) and hedge fund activists.  Drawing from industry sources, the article describes informal coordination of activists courting institutional investors' votes before shareholder meetings, which is just what we would expect and consistent with how we probably teach proxy contests and shareholder proposals to our students.  The article also adds new dimensions describing how institutional investors may solicit hedge fund investment in poorly performing companies providing them with investment ideas, targets and strategies.

"Periodically, we are approached by large institutions who are disappointed with the performance of companies they are invested in to see if we would be interested in playing an active role in effectuating change," said William A. Ackman, founder of the $13 billion hedge fund Pershing Square Capital, who is best known for his positions on J. C. Penney and Herbalife. Institutional investors even have an informal term for this: R.F.A., or request for activist.

Evidence of this successful strategy is found in the success rate of hedge fund proxy proposals of which over 20% succeed last year, up from 9% in 2011.

-Anne Tucker

 

March 19, 2014 in Business Associations, Corporate Finance, Corporate Governance, Financial Markets | Permalink | Comments (0)

Thursday, March 6, 2014

More protection for SOX whistleblowers- are private contractors ready?

This week in Lawson v. FMR, LLC the Supreme Court extended the reach of Sarbanes-Oxley to potentially millions more employers when it ruled that SOX's whistleblower protection applies to employees of private employers that contract with publicly-traded companies. In 2002, Congress enacted SOX with whistleblower protection provisions containing civil and criminal penalties. The law clearly protects whistleblowers who work for publicly-held companies, and courts have generally ruled against employees who work for privately-held firms. But the Department of Labor’s Administrative Review Board has ruled that contractors at public companies enjoy whistleblower protection as well. The Supreme Court agreed with that assessment, with Justice Ginsburg writing for the majority. The dissent, written by Justice Sotomayor, noted the "stunning reach" based on the majority's interpretation and opined that the extension was not what Congress intended.  The plaintiffs in Lawson did not work for Fidelity, but were contracted to provide advice to Fidelity Mutual Fund customers. Plaintiffs voiced concerns to management regarding problems with cost-accounting methodologies and the alleged improper retention of millions of dollars in fees. Because Fidelity has no employees of its own, it was not a party to the suit.

This development will likely be among the many that the Whistleblower Protection Advisory Committee will discuss at our meeting next week. I sit on a 12-person committee comprised of management, labor and the public for a two-year term, and we are reviewing two dozen laws that OSHA enforces to protect employees. SOX is just one of the financial laws covered by OSHA for whistleblower purposes. Although the comment/question period for the committee meeting is officially closed, those who want to submit comments or questions can still do so through http://www.regulations.gov. The meeting is open to the public on March 11th from 9 a.m. - 5 p.m. in Room N-3437 A-C, U.S. Department of Labor, 200 Constitution Ave., NW, Washington, DC 20210

 

 

 

 

 

March 6, 2014 in Business Associations, Corporate Governance, Corporations, Current Affairs, Ethics, Financial Markets, Marcia L. Narine, Securities Regulation | Permalink | Comments (1)

Monday, March 3, 2014

Book Review: Harriman vs. Hill

What happens if short sellers of stock are unable to cover because no one has any shares to sell? That’s one of the many interesting issues in the new book, Harriman vs. Hill: Wall Street’s Great Railroad War, by Larry Haeg (University of Minnesota Press 2013). Haeg details the fight between Edward Henry Harriman, supported by Jacob Schiff of the Kuhn, Loeb firm, and James J. Hill, supported by J.P. Morgan (no biographical detail needed), for control of the Northern Pacific railroad. Harriman controlled the Union Pacific railroad and Hill controlled the Great Northern and Northern Pacific railroads. When Hill and Harriman both became interested in the Burlington Northern system and Burlington Northern refused to deal with Harriman, Harriman raised the stakes a level by pursuing control of Hill’s own Northern Pacific.

I’m embarrassed to admit that I wasn’t aware of either the Northern Pacific affair or the stock market panic it caused. I had heard of the Northern Securities antitrust case that grew out of the affair; I undoubtedly encountered it in my antitrust class in law school. (Everything the late, great antitrust scholar Phil Areeda said in that class is still burned into my brain.)

I’m happy I stumbled across this book, and I think you would enjoy it as well. Harriman vs. Hill has everything needed to interest a Business Law Prof reader: short selling; insider trading; securities fraud; a stock market panic; a hostile takeover; a historical antitrust case; and, of course, J. P. Morgan. This was a hostile takeover before hostile takeovers were cool (and before tender offers even existed, so the fight was pursued solely through market and off-market purchases).

The book does have a couple of shortcomings. One is a polemic at the end of the book against the antitrust prosecution. The antitrust case was clearly a political play by Theodore Roosevelt, and Haeg may be right that the railroads’ actions were economically defensible, but his discussion is a little too one-sided for my taste. Haeg also has a tendency to put thoughts into the characters’ minds (Hill might have been thinking . . .), but he only uses the device to add factual background, so it isn’t terribly offensive. Finally, Haeg occasionally gets the legal terminology wrong. For example, he refers to the railroad holding company “that the U.S. Supreme Court narrowly declared unconstitutional,” when what he means is that the court upheld the law outlawing the holding company. He only makes legal misstatements like that a couple of times, but those errors are very grating on a lawyer reading the book.

Still, in spite of those minor flaws, this is a very good book and I highly recommend it.

March 3, 2014 in Business Associations, Books, C. Steven Bradford, Corporate Governance, Corporations, Financial Markets, Merger & Acquisitions, Securities Regulation | Permalink | Comments (0)

Sunday, February 23, 2014

The Separation of Church and For-Profit Corporations

My co-blogger Haskell Murray recently posted “Religion, Corporate Social Responsibility, and Hobby Lobby” and asked me to respond, which I am happy to do. I will admit that I am still developing my thoughts on the issues raised by Haskell’s post, so what follows is a bit jumbled but still gives a sense of why I currently oppose for-profit corporations being permitted to evade regulation by pleading religious freedom (if you have not read Haskell’s post, please do so before proceeding):

1. Corporate power threatens democracy. Corporations and other limited liability entities have been controversial since their creation because, among other things, the combination of limited liability, immortality, asset partitioning, etc., makes them incredible wealth and power accumulation devices. Of course, on the one hand, this is precisely why we have them – so that investors are willing to contribute capital they would never contribute if they risked being personally liable as partners, and thus unique economic growth is spurred, a rising tide then lifts all ships, and so on. On the other hand, because of their unique ability to consolidate power, corporations are aptly considered by many to be one of Madison’s feared factions that threaten to undermine the very democracy that supports their creation and growth:

Besides the danger of a direct mixture of religion and civil government, there is an evil which ought to be guarded against in the indefinite accumulation of property from the capacity of holding it in perpetuity by ecclesiastical corporations. The establishment of the chaplainship in Congress is a palpable violation of equal rights as well as of Constitutional principles. The danger of silent accumulations and encroachments by ecclesiastical bodies has not sufficiently engaged attention in the U.S.

[More after the break.]

Continue reading

February 23, 2014 in Business Associations, Constitutional Law, Corporate Governance, Corporations, Current Affairs, Financial Markets, Food and Drink, Haskell Murray, Religion, Social Enterprise, Stefan J. Padfield | Permalink | Comments (3)

Friday, February 21, 2014

Combating Threats To The International Financial System (Call for Papers)

From the Faculty Lounge:

The New York Law School Law Review is calling for papers to be published in connection with its April 25, 2014 symposium, Combating Threats to the International Financial System: The Financial Action Task Force.

 

Although this symposium will specifically address the Financial Action Task Force, the symposium's companion Law Review publication will broadly examine contemporary threats to the international financial system, such as money laundering and terrorist financing. In examining these issues, the publication will address how these threats have been responded to in the past, as well as how they should be responded to at the international, federal, and state levels in the future.

 

The Law Review is currently accepting abstracts for papers to be considered for publication in the spring of 2015.  To be considered for publication, please send by March 28, 2014 an abstract of no more than 500 words in MS Word format, accompanied by a CV, to Editor-in-Chief G. William Bartholomew at [email protected]

 

Final papers will be due June 13, 2014, and may not exceed 35 pages in length (double-spaced, including footnotes).  Details on the symposium are here.

February 21, 2014 in Business Associations, Conferences, Current Affairs, Financial Markets | Permalink | Comments (0)

Thursday, February 6, 2014

Is the SEC making it harder for companies to comply with the law?

One of my favorite professors/bloggers, Mike Koehler has an interesting post describing how and why the former DOJ FCPA Enforcement Chief criticized the SEC's handling of the FCPA. I used to read Mike's blog daily during my in-house days, and I share his views on the FCPA enforcement regime. 

His post is below and reiterates what I wrote about here about the number of enforcement officers who leave office and question the way in which the FCPA is prosecuted:

This post has a similar theme to this prior post.  The theme is – all one has to do is wait for former DOJ and SEC FCPA enforcement officials to blast various aspects of the current FCPA enforcement climate. Touching upon the same issues I first highlighted in this August 2012 post titled “The Dilution of FCPA Enforcement Has Reached a New Level With the SEC’s Enforcement Action Against Oracle,” as well as prior posts herehere and here, a former Assistant Chief of the DOJ’s FCPA Unit (William Stuckwisch - currently a partner at Kirkland & Ellis) blasts certain aspects of SEC FCPA enforcement inthis recent article published in Criminal Justice.

The article begins:

“Imagine the following scenario: You have guided your client, a publicly traded company, through the long and winding process that is a Foreign Corrupt Practices Act (FCPA) internal investigation. Afterward, or increasingly more often simultaneously, you then lead your client through presentation of the results of the investigation to the United States Department of Justice (DOJ) and Securities and Exchange Commission (SEC) (collectively, “government”). Ultimately, neither the internal investigation nor the government’s investigation finds any improper payment (or offers of payments) to any foreign official, or any other knowing misconduct. As a result, the government cannot pursue substantive FCPA antibribery charges against your client, and the DOJ cannot pursue any other FCPA-related criminal charges. Just when you begin to savor this significant success, you are ripped back to reality, as the SEC informs you that, nevertheless, your client faces civil enforcement under the FCPA’s internal controls provision and demands a significant penalty.  Unfortunately, this scenario is not a hypothetical for the FCPA Bar to deliberate at conferences and include as footnotes in memoranda addressing real-world client issues. Instead, it mirrors the facts publicly alleged in the SEC’s August 2012 enforcement action against Oracle Corporation, a case considered by many FCPA practitioners to be a stunning result.  [...]  In Oracle, the SEC faulted the US parent corporation for not auditing local distributors hired by its Indian subsidiary, without alleging that the distributors (or anyone else) had made any improper payment to any foreign government official.  Oracle is the latest example of the SEC’s expansive enforcement of the FCPA’s internal controls provision, and it potentially paints a bleak picture—one in which the provision is essentially enforced as a strict liability statute that means whatever the SEC says it means (after the fact).”

Elsewhere, Stuckwisch, the lead author of the article, notes:

“[G]iven the highly subjective nature of the internal controls provisions, companies will continue to feel at the SEC’s mercy once it opens an FCPA investigation, even if no improper payments (or offers of payments) are ever found.”  [...]  In our view, the true lesson of Oracle is not that this particular type of internal control is required, but rather that the internal controls provision is so broad, and the statutory standard of reasonable assurances so subjective, that the SEC has an almost unfettered ability to insist on a settlement, including a civil penalty, at the conclusion of virtually any FCPA investigation. Companies may be willing to enter into such settlements—particularly because, in the absence of a parallel DOJ action, they need not make any factual admissions (due to the “neither admit nor deny” nature of SEC settlements in such circumstances), and the cost of a settlement is often lower than continuing investigative and representative costs. But such settlements can have severe, unintended consequences. Perhaps most significantly, these settlements can lead other companies to misdirect their scarce compliance resources.”

Stuckwisch’s final observation is of course spot-on and generally restates the thesis from my 2010 article “The Facade of FCPA Enforcement.

 

February 6, 2014 in Business Associations, Corporate Governance, Corporations, Current Affairs, Financial Markets, Marcia L. Narine, Securities Regulation | Permalink | Comments (0)

Sunday, January 26, 2014

Bullard on the SEC's Crowdfunding Proposal: Will it Work for Small Businesses?

Go here for the January 16, 2014 testimony of Mercer E. Bullard before the Committee on Small Business, United States House of Representatives, on the SEC's Crowdfunding Proposal.  Here is a brief excerpt (comment deadline is February 3):

The overriding issue for crowdfunding is likely to be how the narrative of investors frequently losing their entire investment plays out. If investors are perceived as losing only a small part of their portfolios because of business failures rather than fraud, or if their crowdfunding losses are set off by gains in other investments through diversification, the crowdfunding market could weather large losses and thrive. However, if fraudsters are easily able to scam investors under the cover of a crowdfunding offering, or stale financial statements routinely turn out to have hidden more recent, undisclosed financial declines, or there are investors who can’t afford the losses they incur, resulting in stories of personal financial distress – then crowdfunding markets will never become a credible tool for raising capital.

January 26, 2014 in Current Affairs, Entrepreneurship, Financial Markets, Securities Regulation, Stefan J. Padfield | Permalink | Comments (0)

Saturday, January 25, 2014

Pearce & Hopkins on “Regulation of L3Cs for Social Entrepreneurship: A Prerequisite to Increased Utilization”

John A. Pearce II & Jamie Patrick Hopkins have posted “Regulation of L3Cs for Social Entrepreneurship: A Prerequisite to Increased Utilization” on SSRN.  Here is the abstract:

One new business model is the low-profit, limited liability company (L3C). The L3C was first introduced in Vermont in 2008 and has since been adopted by several other states. The L3C is designed to serve the for-profit and nonprofit needs of social enterprise within one organization. As such, it has been referred to as a "[f]or-profit with [a] nonprofit soul."

In an effort to efficiently introduce the L3C business model, states have designed L3C laws under existing LLC regulations. The flexibility provided by LLC laws allows an L3C to claim a primary social mission and avail itself of unique financing tools such as tranche investing. Specifically, the L3C statutes are devised to attract the program related investments (PRIs) of charitable foundations. Despite these successes, adoption of the L3C form has been slower than proponents expected.

A similar business initiative has found great success in the United Kingdom (U.K.), where numerous proponents supported legislation designed to create hybrid business models that would promote social entrepreneurship. As a result, the U.K. created the Community Interest Company (CIC) in 2006, allowing more than 4,500 companies to register as CICs that offer a double bottom line (or dual benefit) to investors.

While CICs and L3Cs were created with the same double bottom line in mind, CICs face strict government regulations that provide investors with additional protections. These regulations have indirectly contributed to the success of many CICs by increasing investor confidence in the success of these businesses. In the United States, the flexibility of LLC statutes may provide L3Cs with unique funding options, but the lack of government regulation leaves investor outcomes uncertain and inhibits L3Cs from being a better-utilized business model for social entrepreneurship.

January 25, 2014 in Business Associations, Corporate Governance, Financial Markets, LLCs, Social Enterprise, Stefan J. Padfield, Unincorporated Entities | Permalink | Comments (0)

Thursday, January 16, 2014

Living in a Material World- From Naming and Shaming to Knowing and Showing: Will New Disclosure Regimes Finally Drive Corporate Accountability for Human Rights?

In my posts last Thursday (see here and here) and in others, I have explained why I don’t think that the Dodd-Frank conflicts minerals law is the right way to force business to think more carefully about their human rights impacts.  I have also blogged about the non-binding UN Guiding Principles on Business and Human Rights, which have influenced both the Dodd-Frank rule, the EU's similar proposal, and the State Department's required disclosures for businesses investing in Burma (see here). 

For the past few months, I have been working on an article outlining one potential solution.  But I was dismayed, but not surprised to read last week that the US government’s procurement processes may be contributing to the very problems that it seeks to prevent in Bangladesh and other countries with poor human rights records. This adds a wrinkle to my proposal, but my contribution to the debate is below:

Faced with less than optimal voluntary initiatives and in the absence of binding legislation, what mechanisms can interested stakeholders use as leverage to force corporations to take a more proactive role in safeguarding human rights, particularly due diligence issues in the supply chain?  Can new disclosure and procurement requirements provide enough incentives to have a measurable impact on the behavior of transnational corporations based in the United States? This Article argues that federal and state governments should take advantage of the fact firms are adapting to more rigorous transparency and due diligence demands from socially responsible investors, international stock exchange listing requirements, and enterprise risk management processes.

Corporations respond to incentives and penalties. Governments can and should  require stronger procurement contractual terms for contractors and subcontractors. The contract could require: (1) executive level, Sarbanes-Oxley like attestations regarding human rights policies and due diligence on impacts within the supply chain; (2) an audit by certified third parties and (3) suspension or debarment from contracts as well as clawbacks of executive bonuses and a portion of board compensation as penalties for false or misleading attestations.

Companies that do not choose to participate in government contracting programs will not have to complete the attestation or due diligence process but the benefits of participating will outweigh the costs.  The large number of participating firms will likely lead to the practice becoming an industry standard across sectors, thereby forestalling additional legislation, shareholder resolutions, and name and shame campaigns, and thus eventually leading to benefits for all stakeholders including those most directly affected.

 

 

January 16, 2014 in Business Associations, Corporate Governance, Corporations, Current Affairs, Ethics, Financial Markets, Marcia L. Narine, Securities Regulation, Social Enterprise | Permalink | Comments (1)

1 Report, 4 Issues

(1) Corporate Disclosures, (2) Indirect Advocacy, (3) Climate Change, and (4) Institutional Investors 

The Union of Concerned Scientists, an alliance of more than 400,000 citizens and scientists, released a report today: Tricks of the Trade: How Companies Influence Climate Policy Through Business and Trade Associations.  The report is based on data collected by CDP, an international not-for-profit that “works with investors, companies and governments to drive environmental disclosure”.  CDP administers an annual climate reporting questionnaire to more than 5,000 companies worldwide with the support of various institutional investors (722 institutional investors with over $87 trillion in capital). The 2013 questionnaire asked companies about climate policy influence, including board membership in trade associations, lobbying, and donations to research organizations.

Tricks of the Trade highlights outsourced political influence through the use of trade associations and interest groups that lobby on behalf of their members rather than the members engaging in these activities in their own name.  The report highlights 3 main issues:  (1) lack of transparency, (2) incongruence with the outsourced message among responding companies, and (3) the continued role that the Citizens United decision has on corporate spending and political discourse.

 Transparency:

  • Of the 5,557 companies that received the climate change questionnaire (through either CDP’s request or their voluntary participation), 2,323 responded, and only 1,824 (33 percent) of them replied publicly.
  • Ninety-seven Global 500 companies—the top 500 companies in the world by revenue—including Apple, Amazon, and Facebook, did not participate.  
  • In the Standard & Poor’s (S&P) 500—a market value index of large U.S. companies—166 companies, including Comcast and the Southern Company, did not participate.

The report highlights that proposed rules before the SEC for corporate political spending disclosures would address some transparency concerns and notes that the SEC has no plans to address this issue in 2014.  This is no small issue considering the number of institutional investors and amount of invested capital ($87 trillion, with a "T"!!) behind this initiatve.  CDP sends its survey to corporations on behalf of the signatory institutional investors who are shareholders.

These shareholder requests for information encourage companies to account for and be transparent about environmental risk. Transparency of this data throughout the global market place ensures the financial community has access to the best available corporate climate change information to help drive investment flows towards a low carbon and more sustainable economy

 Incongruence:

  • Ninety-five companies noted that at least one of their trade groups had a climate policy position that was partially or wholly inconsistent with their own, for a total of 172 such responses across all trade groups.

The 2013 questionnaire, while focused on climate change issues, is relevant to broader questions of corporate political influence and spending, the SEC’s agenda for 2014, and the role of corporate disclosures.   If you are teaching corporations/BA this semester, this 12 page report raises several issues that, in my opinion, would elicit a great classroom discussion when you get to the role and purpose of corporations,  sections on the disclosure regime of our securities markets, and even on shareholder rights to information.

-Anne Tucker

January 16, 2014 in Business Associations, Anne Tucker, Constitutional Law, Corporate Governance, Corporations, Financial Markets, Securities Regulation, Teaching | Permalink | Comments (0)

Saturday, January 11, 2014

Liang & Renneboog on “The Foundations of Corporate Social Responsibility”

Hao Liang & Luc Renneboog have posted “The Foundations of Corporate Social Responsibility” on SSRN.  Here is the abstract:

We investigate the roles of legal origins and political institutions – believed to be the fundamental determinants of economic outcomes – in corporate social responsibility (CSR). We argue that CSR is an essential path to economic sustainability, and document strong correlations between country-level sustainability ratings and various extensive firm-level CSR ratings with global coverage. We contrast the different views on how legal origins and political institutions affect corporations’ tradeoff between shareholder and stakeholder rights. Our empirical evidence suggest that: (a) Legal origins are more fundamental sources of CSR adoption and performance than firms’ financial and operational performance; (b) Among different legal origins, the English common law – widely believed to be mostly shareholder-oriented – fosters CSR the least, (c) Within the civil law countries, firms of countries with German legal origin outperform their French counterparts in terms of ecological and environmental policy, but the French legal origin firms outperform German legal origin companies in social issues and labor relations.Companies under the Scandinavian legal origin score highest on CSR (and all its subfields); (d) Political institutions – democratic rules and constraints to political executives – are not preconditions for CSR and sustainability, and sometimes even hinder CSR implementation. Our results are robust after controlling for corporate governance, culture, firm-level financial performance and constraints, and different indices of political institutions.

January 11, 2014 in Business Associations, Corporate Governance, Corporations, Financial Markets, Social Enterprise, Stefan J. Padfield | Permalink | Comments (0)

Thursday, January 9, 2014

Aaron Rodgers, Intel and the “Scarlet Letter” of Dodd-Frank- Part 2

On Tuesday, I attended the oral argument for the National Association of Manufacturers v. SEC—the Dodd-Frank conflict minerals case. Trying to predict what a court will do based on body language and the tone of questioning at oral argument, especially in writing, is foolish and crazy, but I will do so anyway.

I am cautiously optimistic that the appellate court will send the conflict mineral rule back to the SEC to retool based on the three arguments generated the most discussion. First, the judges appeared divided on whether the SEC  had abused its discretion by changing the statutory language requiring issuers to report if minerals “did” originate from the DRC or surrounding companies rather than the current SEC language of “may have” originated. This language would sweep in products in which there is a mere possibility rather than a probability of originating in covered countries. One judge grilled the SEC like I grill my law students about the actual statutory language and legislative intent, while another appeared satisfied with SEC’s explanation that issuers did not have to file if the lack of certainty was due to a small number of responses from suppliers or for lack of information. My prediction- if the SEC loses, they will have to rewrite this section to comport with Congressional intent.

The second main issue concerned the SEC’s failure to apply a de minimis exception to the rule. NAM’s lawyer provided a real-life example of a catalyst used in producing automobiles that sometimes washed away during production but at other times could leave just one part per million of tin in the finished product. Judge Srinivasan pointed out that if the mineral could wash away but the product could still function, then perhaps it wasn’t “necessary” as the law required for reporting. Judge Sentelle raised a concern about “breaking new ground” by requiring the SEC to enact a de minimis exception. The SEC bolstered its argument by indicating that no commentator that had proposed such an exception during the rulemaking process  had provided a workable threshold. My prediction- this is a toss up. This was the SEC’s most successful argument of the day.

Many commenters believed that the third argument—the First Amendment claim-- was spurious and/or a Hail Mary plea when NAM first raised it last year. Yet this argument provided the most interesting discussion of the day, especially since Judge Randolph specifically reminded NAM’s counsel to discuss it and not save it for rebuttal as NAM had planned. NAM argued that by requiring companies to declare on their websites that their products were not “DRC-Conflict Free,” thereby denouncing their own products, this amounted to a “scarlet letter.” NAM conceded that the government could ask for the information and could post it, but maintained that requiring companies to “shame” themselves was unconstitutional. This argument gained traction with both judges Randolph and Sentelle, who called it “compelled speech.” The judges also questioned the SEC on: whether the SEC had ever or should focus its efforts on communications to consumers; how the SEC would enforce the rule, asking whether a group of scientists would do product inspections; how this rule would achieve Congress’ intent of securing the safety of the Congolese people; whether the government could require companies to indicate whether they had used child labor overseas; and whether the intent of the shaming provision was to cause a boycott- bingo! My prediction- the SEC loses on this provision.

If the SEC does have to go back to the drawing board, it will be interesting to see how current Chair Mary Jo White influences the rule given her public statements about the rule being out of the SEC’s purview. I hope that the European Commission, which has done an impact analysis, will pay close attention as they roll out their own conflict minerals legislation to the EU.

Many have asked what I think the government should have done to help the people of Congo. Put simply, the government could and should fund and enforce the DRC Relief, Security, and Democracy Promotion Act of 2006, which has over a dozen provisions addressing security sector reform, minerals, infrastructure and other matters that could provide a more holistic solution. Next week, I will blog about other ways that the government could incentivize business to address human rights issues around the world.

January 9, 2014 in Constitutional Law, Corporate Governance, Corporations, Current Affairs, Ethics, Financial Markets, Marcia L. Narine, Securities Regulation | Permalink | Comments (1)

Tuesday, January 7, 2014

CFTC and FERC Finally Play Nice(ish)

News Release

The Federal Energy Regulatory Commission (FERC) and the Commodity Futures Trading Commission (CFTC) have signed two Memoranda of Understanding (MOU) to address circumstances of overlapping jurisdiction and to share information in connection with market surveillance and investigations into potential market manipulation, fraud or abuse. The MOUs allow the agencies to promote effective and efficient regulation to protect energy market competitors and consumers.

Finally, the CFTC and FERC seem to have resolved some serious jurisdictional overlap problems between the agencies related to Dodd-Frank (section 720(a)(1)), which required the agencies to adopt a Memorandum of Understanding (MOU) to resolve several key issues. It’s taken a while to get here.  Recall that settling (or at least improving) jurisdictional questions became especially acute in the wake of the Brian Hunter case, where the CFTC joined the defendant against FERC claiming that the CFTC had exclusive jurisdiction over Hunter’s alleged trading violations.  The DC Circuit agreed with Hunter and the CFTC (opinion pdf). 

At long last, there are two MOUs, one related to jurisdiction (pdf) and the other related to information sharing (pdf). According to the FERC news release, the jurisdiction MOU provides a process the agencies will use to notify one another of  issues “that may involve overlapping jurisdiction and coordinate to address the agencies’ regulatory concerns.“  The information sharing MOU creates procedures for the agencies to share information “of mutual interest related to their respective market surveillance and investigative responsibilities, while maintaining confidentiality and data protection.”

Perhaps the more interesting news (H/T: Craig Silverstein & Nathan Endrud) is the possibility of new licensing for wholesale power and natural gas market participants to deal with the people actually committing fraud and/or manipulating markets.   There is not agreement from all the commissioners that this is necessary, but it is an idea of note for this continually evolving market. 

January 7, 2014 in Current Affairs, Financial Markets, Joshua P. Fershee, Securities Regulation | Permalink | Comments (0)

Sunday, January 5, 2014

Ashford on Binary Economics: The Economic Theory that Gave Rise to ESOPs

I am currently taking a break from the day-long AALS Section on Socio-Economics program.  The last session before lunch was entitled “Socio-Economics: Changing the Debate - Perspectives on Growth and Distribution.” During that session, Robert Ashford mentioned his paper “Binary Economics: The Economic Theory that Gave Rise to ESOPs,” and I thought I’d pass on the abstract to our readers:

Many people know about Employee Stock Ownership Plans (ESOPs) which, along with profit-sharing and pension plans, are treated as deferred compensation plans under Section 401 and related sections of the Internal Revenue Code. ESOPs have been established by thousands of American corporations, including some of the largest, and cover millions of employees. There is a national trade association (The ESOP Association), that is now celebrating its 50th year in existence, and other organizations established to support employee ownership, including the Ohio Center for Employee Ownership that first published this article in its publication entitled Owners At Work (2006/2007)

Most people aware of ESOPs, however, do not realize that ESOPs are part of a broader approach to expanded capital ownership, broader prosperity, and economic justice known as binary economics. Binary economics was first advanced by Louis Kelso, who is also widely known as the inventor of the ESOP. But Louis Kelso's approach to economic theory is only partially reflected in the present ESOP legislation. Binary economics offers a plan for more widespread economic prosperity for all people (not limited to employees) than is presently offered by mainstream economics.

Once ESOP participants understand binary economics, they may choose to advocate legislative reforms that will better serve their own economic interests and also the economic interests of their companies and the country as a whole. These reforms would transform ESOPs into much more powerful Super ESOPs in a full binary economy of the future. The Super ESOP will empower employees to acquire shares of stock in their companies entirely with the earnings of capital and on much more favorable terms than at present. Moreover, the Super ESOP will empower employees and others to acquire a diversified portfolio of shares in other credit-worthy companies entirely with the future earnings of the shares they acquire.

This article briefly describes the binary economics and its important connection with the ESOPs. For a fuller explication if binary economics, see the following four articles which can be downloaded for free from SSRN.COM: (1) Binary Economics - An Overview, (2) Binary Economics and the Case for Broader Ownership, (3) Capital Democratization, and (4) Memo on Binary Economics to Women and People of Color Re: What Else can Public Corporations Do for Your Clients?.

January 5, 2014 in Corporate Governance, Corporations, Financial Markets, Stefan J. Padfield | Permalink | Comments (0)

Friday, January 3, 2014

Blasi, Freeman & Kruse on “The Citizen's Share”

Yesterday, I attended the Annual Meeting of the Society of Socio-Economists.  Unfortunately, I was only able to participate in the second half of the program due to flight delays, but the discussions I did participate in were fantastic and I hope to publish a number of posts passing on some key points.  Today, I’d like to start by highlighting the book “The Citizen's Share: Putting Ownership Back into Democracy” by Joseph R. Blasi, Richard B. Freeman, and Douglas L. Kruse (I understand Joseph Blasi was one of the presenters at the meeting--though I was chairing a concurrent plenary session at the time).  Here is a description from the Yale University Press:

The idea of workers owning the businesses where they work is not new.  In America’s early years, Washington, Adams, Jefferson, and Madison believed that the best economic plan for the Republic was for citizens to have some ownership stake in the land, which was the main form of productive capital. This book traces the development of that share idea in American history and brings its message to today's economy, where business capital has replaced land as the source of wealth creation.   Based on a ten-year study of profit sharing and employee ownership at small and large corporations, this important and insightful work makes the case that the Founders’ original vision of sharing ownership and profits offers a viable path toward restoring the middle class. Blasi, Freeman, and Kruse show that an ownership stake in a corporation inspires and increases worker loyalty, productivity, and innovation. Their book offers history-, economics-, and evidence-based policy ideas at their best.

January 3, 2014 in Business Associations, Books, Constitutional Law, Corporate Governance, Corporations, Financial Markets, Stefan J. Padfield | Permalink | Comments (1)

Thursday, January 2, 2014

Can loyalty-driven securities solve the problem of short-termism? Probably not, according to a study.

The Generation Foundation (the “Foundation”), which focuses on sustainable capitalism, commissioned Mercer and Canadian law firm Stikeman Elliott LLP to study ways to foster more long-term thinking in the capital markets. In a prior report the Foundation proposed five actions to counteract the effects of short-termism including: (1) identifying and incorporating risks from stranded assets; (2) mandating integrated reporting; (3) ending the default practice of issuing quarterly earnings guidance; (4) aligning compensation structures with long-term sustainable performance; and (5) encouraging long-term investing with loyalty-driven securities. 

Loyalty-driven securities provide differentiated rights or rewards to shareholders based on their tenure of shareholding.  These rewards could include extra dividends, warrants or additional voting rights for owners who held shares for three years (or some other time period), limiting proxy access to shareholders of a specified minimum duration, or inferior voting rights for short-term shareholders.   The idea is not far-fetched. Apparently, the European Commission is considering proposals to reward certain shareholders with additional voting rights. 

In a report issued in December 2013 the Foundation, Mercer and the law firm outline the results of their legal review of almost a dozen countries and the interviews of over 120 experts. Interviewees included academics, pension funds, investors, and stakeholders such as GMI, Blackrock, UBS Global Asset Management, Ceres, the Conference Board, the Office of NYC Comptroller, Johnson & Johnson, Fidelity, Ira Millstein, CalSTRS, Aviva Investors and academics from Columbia and the London School of Economics. 

The report starts with the premise that “heightened interest in ‘short-termism’ also reflects the belief that causes of short-termism… are products of poorly designed organizational incentives and failures of corporate governance systems rather than simply a result of information asymmetry, technological innovation, or the cognitive limits of decision-makers.”

The study revealed that proposals to consider loyalty-driven securities --which are already allowed by law and in use in France -- met with considerable resistance.  Those who opposed them mentioned potential discrimination between shareholders; the risk of unintended consequences because it would favor certain types of investors such as passive investors; administrative complexities around share transfers, tracking of tenure and custody; the weakness of the incentive because the nature of the reward would not be enough to forego revenue; and finally a concern that loyalty-driven securities would not address the root causes of short-termism.

Three themes emerged from the interviews for continued study. First, the authors suggest longer time horizons for investment analysis and a review of different forms of capital including financial, physical and human.  Second, they recommend realigning frameworks for performance measurement and reward so that individuals will not be penalized for their longer-term decision-making. Third, they believe that investors may need more information and stronger relationships with companies so that they can have faith in long-term value creation and strategies and the executives in charge of implementation.

To effectuate this kind of change they recommend: better-informed fiduciary oversight; board and investment committee education programs; a database of sustainable financial market-certified candidates for board, trustee and investment committees; focus by policymakers and regulators on shaping laws conducive to long-term thinking; a live shadow-monitoring pilot to establish a set of metrics against which to monitor and report fund manager performance to clients; alignment of incentives related to executive compensation; a formal investor-issuer council for systemic risk; and a campaign to educate and encourage analysts and investors to question companies about their long-term strategy during  quarterly earnings calls.

Given my focus on corporate governance and sustainability, I read the report with great interest. Whether or not you favor loyalty-driven securities, the full report and appendices are worth a read. 

January 2, 2014 in Business Associations, Corporate Governance, Corporations, Current Affairs, Financial Markets, Marcia L. Narine, Securities Regulation | Permalink | Comments (0)