Thursday, October 24, 2013
Now that juries and the DOJ have spoken, will boards be more active in shaping ethical culture in the C-Suite?
CEOs and executives just can’t get a break in the news lately. A jury found both former Countrywide executive Rebecca Mairone and Bank of America liable for fraud for Countrywide’s “Hustle” loans in 2007 and 2008 (see here). Martha Stewart has had to renegotiate her merchandising agreement with JC Penney to avoid hearing what a judge will say about that side deal in the lawsuit brought against her by Macy’s, with whom she purportedly had an exclusive merchandising deal (see here). JP Morgan Chase is in talks to pay $13 billion to settle with the Department of Justice over various compliance-related failures, but the company still faces billions in claims from angry shareholders. The company isn’t out of the woods yet in terms of potential criminal liability (see here). CEO Jamie Dimon isn’t personally accused of any wrongdoing, and in fact has been instrumental in achieving the proposed settlements. But in the past he has faced questions from institutional shareholders about his dual roles as chair of the board and CEO. Those questions may come up again in the 2014 proxy season.
The Bank of America verdict and the recent JP Morgan Chase settlement may herald a new age of prosecutions and settlements both for institutions and executives for compliance failures and criminal activity. With the recent announcement of a $14 million dollar award for an SEC whistleblower coupled with the SEC's pronouncements about getting its "swagger" back, we can expect more legal actions to come as employees feel incentivized to come forward to report wrongdoing.
So what is the role of the board in directing, managing, and shaping corporate culture? In my former life as a compliance officer this issue occupied much of my time. My peers and I scoured the newspapers looking for cautionary tales like the ones I recounted above so that we could remind our internal clients and board members of what could happen if they didn’t follow the laws and our policies.
Bryan Cave partner Scott Killingsworth has written a white paper on the importance of the board in monitoring the C-Suite. He examines the latest research in behavioral ethics citing Lynne Dallas, Lynn Stout, Krista Llewellyn, Maureen Muller-Kahle, Max Bazerman and Francesca Gino, among others. It’s definitely worth a read by board members in light of recent headlines. The abstract is below:
The C-suite is a unique environment peopled with extraordinary individuals and endowed with the potential to achieve enormous good – or, as recent history has vividly shown, to inflict devastating harm. Given that senior executives operate largely beyond the reach of traditional compliance program controls, a board that aspires to true stewardship must embrace a special responsibility to support and monitor ethics and compliance in the C-suite.
By themselves, the forces at large in the C-suite would challenge the ability of even the most conscientious and rational executives to make consistently irreproachable decisions. The C-suite environment is characterized by the presence of power, strong incentives and huge temptations (financial and other), high ambition, extreme pressure, a fast pace, complex problems and few effective external controls. The problem of C-suite ethics has a deeper dimension, though, than the mere impact of strong pressures upon rational decision-makers. Recent behavioral research brings the unwelcome news that the subversive effects of these pressures are magnified by systematic, predictable human failings that can prompt us to slip our moral moorings and overlook when others do so. We are just beginning to understand the insidious power that such factors as motivated blindness, attentional blindness, conflicts of interest, focused "business-only" framing, time pressure, irrational avoidance of loss, escalating commitment, overconfidence and in-group dynamics can exert below the plane of conscious thought, even over people who have good reason to consider themselves ethically strong. and behaviorally upright.
But we also know that organizational culture can
dramatically affect both ethical conduct and reporting of misconduct, by
establishing workplace norms, harnessing social identity and group loyalty and
increasing the salience of ethical values. How can these learnings inform the
board’s interaction with, and monitoring of, the C-suite? And how can the board
help forge a stronger connection between the C-Suite and the organization’s
compliance and ethics program? This paper suggests several key strategies for
dealing with different aspects of this complex problem.
Saturday, October 19, 2013
Stephen Davidoff recently posted a piece on DealBook entitled “A Push to End Securities Fraud Lawsuits Gains Momentum,” in which he notes that “Halliburton is asking the Supreme Court to confront one of the fundamental tenets of securities fraud litigation: a doctrine known as “’fraud on the market.’” He goes on to provide a lot of interesting additional details, so you should definitely go read the whole thing, but I focused on the following:
In its argument, Halliburton is asking the Supreme Court to confront one of the fundamental tenets of securities fraud litigation: a doctrine known as “fraud on the market.” The doctrine has its origins in the 1986 Supreme Court case Basic v. Levinson. To state a claim for securities fraud, a shareholder must show “reliance,” meaning that the shareholder acted in some way based on the fraudulent conduct of the company. In the Basic case, the Supreme Court held that “eyeball” reliance — a requirement that a shareholder read the actual documents and relied on those statements before buying or selling shares — wasn’t necessary. Instead, the court adopted a presumption, based on the efficient market hypothesis, that all publicly available information about a company is incorporated into its stock price…. A group of former commissioners at the Securities and Exchange Commission and law professors represented by the New York law firm Wachtell, Lipton, Rosen & Katz have also taken up the cause. In an amicus brief, the group argues that, in practice, the Basic case has effectively ended the reliance requirement intended by the statute, something that is not justified. They rely on a forthcoming law review article by an influential professor, Joseph A. Grundfest of Stanford Law School. Professor Grundfest argues that the statute on which most securities fraud is based — Section 10(b) of the Exchange Act — was intended by Congress to mean actual reliance because the statute is similar to another one in the Exchange Act that does specifically state such reliance is required.
This got me to thinking about how I might introduce the fraud-on-the-market reliance presumption to students the next time I teach it. This is what I came up with as a possibility:
Assume you know that a particular weather app is 100% accurate. Assume also that you know all your neighbors check the app regularly. If in deciding whether you need an umbrella you simply look out your window to see whether any of your neighbors are carrying one, rather than checking the weather app, are you not still actually relying on the weather app? The fraud-on-the-market presumption of reliance effectively answers that question in the affirmative. In the securities context it provides that instead of reviewing all publicly available disclosures when deciding to buy or sell securities, it is enough for you to simply “look out your window” at the market price because we assume the market price reflects the consensus equilibrium of all publicly available information.
One might protest that the plaintiff should still have to prove that all the neighbors are in fact checking the weather app, and this is in fact the case when we require plaintiffs seeking the benefits of the FOM presumption to prove the relevant market is efficient. Alternatively, one might protest that the idea that the actions of your neighbors reflect well-enough the information provided by the weather app is questionable, but since Eugene Fama just won the Nobel prize in economics it might be an uphill battle to overturn the presumption on that basis. Another objection might be that we don’t need the presumption because there are enough alternative mechanisms to hold corporate actors accountable for fraud, and it is certainly the case that when the Supreme Court adopted the FOM presumption, a large part of the rationale was the perception that there was a need for the presumption in order to facilitate actions that would otherwise never be brought in any form. What I see as a possible obstacle to this approach is that, while one may debate whether the Roberts Court is in fact pro-business, I do believe it is concerned about appearing overly so – and authoring a decision that states we no longer need the FOM presumption because alternative corporate accountability mechanisms are working so efficiently strikes me as just throwing fuel on that fire when the Court could arguably reach the same result by continuing to tighten up class-action law generally. Finally, one might object that the FOM presumption actually allows folks who just run out of the house without either checking the app or looking out their window to claim the presumption, but at least a partial answer to this objection is that the Basic decision itself provides that: “Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance,” Basic Inc. v. Levinson, 485 U.S. 224, 248 (1988), and this is typically understood to at least include plaintiffs who are, to continue the analogy, rushing out of the house because they don’t have time to grab an umbrella.
Obviously, the issues are ultimately more complicated than the foregoing suggests, but it is just intended to serve as an introduction, which can be expanded to account for more complicated matters as the discussion proceeds. I’d be curious to hear what readers think needs to be added/amended to make this introduction work.
Wednesday, October 16, 2013
The 2013 Nobel Prize in Economics winners were announced earlier this week and the award was shared by three U.S. Economists for their work on asset pricing. Eugene Fama of the University of Chicago, Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale University share this year’s prize for their separate contributions in economics research.
The work of the three economics is summarized very elegantly in the summary publication produced by The Royal Swedish Academy of Sciences titled “Trendspotting in asset markets”. The combined economic contribution of the three researchers is described below:
The behavior of asset prices is essential for many important decisions, not only for professional investors but also for most people in their daily life. The choice on how to save – in the form of cash, bank deposits or stocks, or perhaps a single-family house – depends on what one thinks of the risks and returns associated with these different forms of saving. Asset prices are also of fundamental importance for the macroeconomy, as they provide crucial information for key economic decisions regarding consumption and investments in physical capital, such as buildings and machinery. While asset prices often seem to reflect fundamental values quite well, history provides striking examples to the contrary, in events commonly labeled as bubbles and crashes. Mispricing of assets may contribute to financial crises and, as the recent global recession illustrates, such crises can damage the overall economy. Today, the field of empirical asset pricing is one of the largest and most active subfields in economics.
This year’s award has several implications for those of us interested in the legal side of law and economics. First, Fama is the grandfather of the efficient capital market hypothesis, the foundation for fraud on the market, a economics elements incorporated into securities fraud litigation.
Second, Fama’s inclusion in the award is being heralded by some as a win, or vote of confidence, for free marketers whose regulatory view (that markets should be largely unregulated) rests on the fundamental assumption that markets are efficient. On the other hand, Shiller’s inclusion in the award challenges the coup that can be claimed by free marketers because Shiller has long questioned the efficiency of the markets. John Cassidy at The New Yorker writes “Shiller, in showing that the stock market bounced up and down a lot more than could be justified on the basis of economic fundamentals such as earnings and dividends, kept alive the more skeptical and realistic view of finance that Keynes had embodied in his “beauty contest” theory of investing.” Market efficiency, or lack thereof, are key arguments against and for market regulations. Trends in support for either theory or validation of one could signal future approaches to regulation.
Finally, the focus on asset pricing, particularly Fama’s work has some potential implications for the mutual fund industry. Fama’s efficiency view of the markets largely discounts the value of actively managed funds, once costs and annual fees are deducted because the market, if efficient, cannot consistently be beaten. This last thread regarding fund management is a theme woven into some of my more recent research on the regulations, risks, and ownership anomalies facing retirement investors. More on this later, with links to newly published papers of course, but for now read the Nobel summary document included above and briefly contemplate taking the time to audit an economics course next semester—I am going to browse the b-school catalogue now.
Monday, October 14, 2013
The JOBS Act offers two new opportunities to offer securities on the Internet without Securities Act registration. Both the Rule 506(c) exemption and the new crowdfunding exemption could be used to sell securities on web sites open to the general public. But could a single web site offer securities pursuant to both exemptions at the same time (assuming the SEC eventually proposes and adopts the regulations required to implement the crowdfunding exemption)?
Background: The two exemptions
Rule 506(c) allows an issuer to publicly advertise a securities offering, as long as the securities are only sold to accredited investors. Rule 506(c) is not limited to Internet offerings, but it could be used by an issuer to advertise an offering on an Internet site open to the general public—as long as actual sales are limited to accredited investors.
The new crowdfunding exemption, added as section 4(a)(6) of the Securities Act, allows issuers to sell up to $1 million of securities each year. The offering may be on a public Internet site, as long as that site is operated by a registered securities broker or a “funding portal,” a new category of regulated entity created by the JOBS Act.
Could a single intermediary do both 506(c) and crowdfunded offerings?
Yes, but only if the intermediary is a federally registered securities broker.
Rule 506(c) does not limit who may act as an intermediary, but the crowdfunding exemption says that only registered brokers or funding portals may host crowdfunded offerings. By definition, funding portals appear to be limited to offerings under the crowdfunding exemption. A funding portal is “any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to section 4(6).” Exchange Act section 3(a)(80), as amended by the JOBS Act. Thus, funding portals could not act as intermediaries in Rule 506(c) offerings.
The JOBS Act does not impose a similar limitation on brokers, so brokers could act as intermediaries in both Rule 506(c) and crowdfunded offerings.
Could a broker include both types of offerings on the same web site?
The answer to this is probably yes.
Rule 506(c) does not limit the content of the web site, so any limitations are going to come from the crowdfunding exemption. Crowdfunding intermediaries are subject to a number of requirements, but the crowdfunding exemption does not appear to prohibit the inclusion of other offerings on the same web site.
Operating a dual site could be cumbersome. For example, Rule 506(c) offerings could appear on the site's main page, but no investor may see crowdfunded offerings until they satisfy the crowdfunding exemption’s investor education requirements. But unless the SEC rules implementing the crowdfunding exemption prohibit it, dual-exemption sites should be possible.
Could an issuer do a double-door offering, using a single web site to simultaneously sell the same securities in both types of offerings?
I have heard that some ill-advised fledgling intermediaries have plans to do this, but the answer to this question is no. The integration doctrine would not allow it.
Rule 506(c) incorporates the requirements of Rule 502(a) of Regulation D, and Rule 502(a) indicates that “[a]ll sales that are part of the same Regulation D offering must meet all of the terms and conditions of Regulation D.” Section 4(a)(6) of the Securities Act, the crowdfunding exemption, exempts “transactions” that meet the criteria of the exemption.
Under that transactional language, as consistently interpreted by the SEC and the courts over the years, the entire offering must comply with the requirements of the exemption, or none of the sales is exempted. An issuer cannot sell parts of a single offering pursuant to two separate exemptions.
Unless an integration safe harbor is available, and none would apply here, the SEC uses a five-factor test to determine whether ostensibly separate offerings are part of the same transaction. This test considers (1) whether the sales are part of a single plan of financing; (2) whether the sales involve issuance of the same class of securities; (3) whether the sales are made at or about the same time; (4) whether the issuer receives the same type of consideration; and (5) whether the sales are made for the same general purpose.
Under this test, an issuer could not sell a security pursuant to the Rule 506(c) exemption and at the same time sell the same security on the same web site pursuant to the crowdfunding exemption. Those two ostensibly separate offerings would be integrated and would have to fit within a single exemption. (There is vague language in the crowdfunding exemption that might arguably protect against integration, but the argument is a weak one. For a discussion of that argument see pp. 213-214 of my article here.)
Thursday, October 10, 2013
US Chamber of Commerce Event on the State of Corporate Governance and the 2014 Proxy Season-October 16
On October 16th, the US Chamber of Commerce’s Center for Capital Markets Competitiveness will host a half-day event to examine trends from the 2013 proxy season and look ahead to 2014. The day will start with a presentation from the Manhattan Institute about the 2013 season and then I will be on a panel with Tony Horan, the Corporate Secretary of JP Morgan Chase, Vineeta Anand from the Office of Investment of the AFL-CIO, and Darla Stuckey of the Society of Corporate Secretaries and Governance Professionals. Our panel will look back at the 2013 proxy season and discuss hot topics in corporate governance in general. Later in the day, Harvey Pitt and other panelists will talk about future trends and reform proposals, and depending on the state of the government shutdown, we expect a member of Congress to be the keynote speaker. The event will be webcast for those who cannot make it to DC. Click here to register.
Dodd-Frank requires the SEC to issue rules barring national exchanges from listing any company that has not implemented a clawback policy that does not include recoupment of incentive-based compensation for current and former executives for a three-year period. Unlike the Sarbanes-Oxley clawback rule, Dodd-Frank requires companies to recover compensation, including options, based on materially inaccurate financial information, regardless of misconduct or fault.
Although the SEC has not yet issued rules on this provision, a number of companies have already disclosed their clawback policies, likely because proxy advisory firms Glass Lewis and Institutional Shareholder Services have taken clawback policies into consideration when making Say on Pay voting recommendations. Equilar has reviewed the proxy statements for Fortune 100 companies filed in calendar year 2013 for compensation events for fiscal year 2012. The organization released a report summarizing its findings, which are instructive.
Of the 94 publicly-traded companies analyzed by Equilar, 89.4% publicly disclosed their policies; 71.8% included provisions that contained both financial restatement and ethical misconduct triggers; 29.1% included non-compete violations as triggers and 27.2% had other forms of triggers. 68% of the policies applied to key executives and employees including named executive officers, while only 14.6% applied to all employees. 7.8% of clawback policies applied only to CEOs and/or CFOs. 35.9% of policies covered a range of compensation types including deferred compensation, sales commissions, flexible perquisite accounts and/or supplemental retirement plans.
The Equilar report provides language and links to the filings for Wal-Mart, Ignite Restaurant Group, CVS Caremark, Johnson & Johnson, AIG, Supervalu, Apple, IBM, Johnson Controls and ConocoPhilips. The report also notes that despite the early disclosures, they tend to fall short of the Dodd-Frank standard in that only 37.9% mention outstanding options. This will surely change once the SEC finalizes the rule.
Saturday, October 5, 2013
Michael B. Dorff has posted “The Siren Call of Equity Crowdfunding” on SSRN. Here is the abstract:
The JOBS Act opened a new frontier in start-up financing, for the first time allowing small companies to sell stock the way Kickstarter and RocketHub have raised donations: on the web, without registration. President Obama promised this novel form of crowdfunding would generate jobs from small businesses while simultaneously opening up exciting new investment opportunities to the middle class. While the new exemption has its critics, their concern has largely been confined to the limited amount of disclosure issuers must provide. They worry that investors will lack the information they need to separate out the Facebooks from the frauds. This is the wrong concern. The problem with equity crowdfunding is not the extent of disclosure. The problem is that the companies that participate will be terrible prospects. As a result, crowdfunding investors are virtually certain to lose their money. This essay examines the data on angel investing – the closest analogue to equity crowdfunding – and concludes that the majority of the issuers that sell stock to the middle class over the internet will lose money for investors, with many failing entirely. The strategies that help the best angels profit will not be available to crowdfunders. Plus, the losses most issuers inflict will not be offset by a few huge winners. Investors will not find tomorrow’s Googles on crowdfunding portals because they will not be there; instead, start-ups with real potential will continue to use other programs, such as the newly expanded Rule 506 exemption. This outcome is the inevitable result of the nature of start-up investing and crowdfunding. No amendments to the Act or rule-making by the SEC can prevent it. The only solution that will protect investors is to abolish equity crowdfunding for the unaccredited.
Friday, October 4, 2013
Too bad I didn't have this information from today's Wall Street Journal to add to my arsenal of reasons of why I think the Dodd-Frank conflict minerals SEC disclosure is a well-intentioned but bad law to address rape, forced labor, plundering of villages, murder, and exploitation of children in the Democratic Republic of Congo. I won’t reiterate the reasons I outlined in my two-part blog post a couple of weeks ago. According to press reports, while acknowledging her responsibility to uphold the law, SEC Chair Mary Jo White mirrored some of the arguments about discretion that business groups and our amicus brief raised on appeal to the DC Circuit, and further explained, “seeking to improve safety in mines for workers or to end horrible human rights atrocities in the Democratic Republic of the Congo are compelling objectives, which, as a citizen, I wholeheartedly share … [b]ut, as the Chair of the SEC, I must question, as a policy matter, using the federal securities laws and the SEC’s powers of mandatory disclosure to accomplish these goals.” I couldn’t agree more. While I have no problems with appropriate and relevant disclosure, corporate responsibility, and due diligence related to human rights, Congress should let the SEC focus on its mission of protecting investors, maintaining efficient markets, and facilitating capital formation.
The text of her speech at Fordham Law School where she made these remarks and others about the need for agency independence and discretion is available here.
Monday, September 30, 2013
The crowdfunding exemption added by the JOBS Act allows issuers to sell securities to anyone, accredited or not, but the amount of securities each investor may purchase depends on the investor’s net worth and annual income. (For more on the new crowdfunding exemption, see my article here.)
Because of these requirements, it is important under both exemptions to know the net worth and annual income of each investor.
NOTE: Many people are referring to Rule 506(c) as “crowdfunding” but the actual crowdfunding exemption is something different. Brokers and others selling under Rule 506 began calling that crowdfunding as a marketing ploy to capitalize on the popularity of crowdfunding. Some academics have adopted that usage, which I think is unfortunate and only leads to confusion.
The simplest way to deal with these requirements would be to allow investors to self-certify. If an investor tells the issuer his net worth is $1.5 million, the issuer should be able to assume this is correct, unless the issuer has reason to suspect otherwise. This is not, unfortunately, the SEC’s approach in Rule 506(c). The SEC still has not adopted the rules required to implement the new crowdfunding exemption, but it’s unlikely to take this simple self-certification approach in those rules either.
In a Rule 506(c) offering, Rule 506(c)(2)(ii) requires “reasonable steps” to verify that any natural person who purchases is an accredited investor. The issuer may do that verification itself, or it may rely on written representations from registered broker-dealers, registered investment advisers, licensed attorneys, or CPAs that they have taken reasonable steps to verify the investor’s status.
Under the non-exclusive safe harbor in Rule 506(c)(2), those reasonable steps could include review of, among other things, the investor’s tax filings, bank statements, brokerage statements, credit report, tax assessments, and appraisal reports. Obtaining and reviewing this information will increase the cost of using the exemption and force investors to divulge confidential financial information that they would probably prefer to keep to themselves.
Why not self-certification? Obviously, people might lie. I might exaggerate my income or net worth in order to qualify to invest in a Rule 506(c) offering or to purchase more securities in an offering pursuant to the crowdfunding exemption. Securities would be sold under Rule 506(c) to investors who aren't supposed to buy them. In crowdfunding offerings, investors could buy more securities than they're supposed to buy.
But these requirements are designed to protect the investors. If I choose to lie about my status, why shouldn’t I forfeit that protection? Why should the issuer be burdened with additional costs just because some investors are willing to lie? As long as the issuer acts in good faith and has no reason to know an investor is lying, what’s the argument for punishing the issuer by denying the exemption? If we want to discourage people from lying about their net worth and annual income, we should punish the liars, not the innocent issuer.
Sunday, September 29, 2013
Arguably related to the SEC’s recently proposed CEO pay ratio rules, Alberto Salazar and John Raggiunti have posted “Why Does Executive Greed Prevail in the United States and Canada but Not in Japan? The Pattern of Low CEO Pay and High Worker Welfare in Japanese Corporations” on SSRN. Here is the abstract:
According to a list of the 200 most highly-paid chief executives at the largest U.S. public companies in 2013, Oracle’s Lawrence J. Ellison remained the best paid CEO and earned $96.2 million as total annual compensation last year. He has received $1.8 billion over the past 20 years. The lowest paid on the same list is General Motors’ D. F. Akerson who earned $11.1 million. The average national pay for a non-supervisory US worker was $51,200 last year and a CEO made 354 times more than an average worker in 2012. Hunter Harrison, Canadian Pacific Railway Ltd., was the best paid CEO in Canada for 2012 and received $49.2-million as total annual compensation, significantly higher than the 2011 best paid CEO, Magna’s F. Stronach who received $40.9 million. In 2011, the average annual salary was $45,488 and Canada’s top 50 CEOs earned 235 times more than the average Canadian. These executive pay practices contrast with the growing inequality in Canada, recently illustrated with the finding that 40% of Indigenous children live in poverty. In contrast, Japan’s highest paid CEO is Nissan Motor Co.’s Carlos Ghosn who earned 988 million yen (US$10.1 million) in the year ended March 2013, little changed from the previous year and modestly improved from his US$ 9.5 million compensation for 2009. That does not even put him among the top 200 most highly-paid U.S. company chiefs and the top 20 best paid CEOs in Canada for 2012. Why are Japanese CEOs paid considerably less than their American or Canadian counterparts? This essay argues that the activism of long-term oriented institutional investors such as banks and the tying of executive pay to worker welfare in the context of a culture of intolerance to excessive executive compensation explain to a great extent the development of a pattern of low executive pay in Japan. The Japanese experience also demonstrates that lower executive compensation does not result in compromising firm performance and is a necessary condition to build a stakeholder-friendly corporation. For example, the CEO of Toyota (world’s biggest automaker), Akio Toyoda, earned 184 million yen ($1.9 million) in 2012, a 35 percent increase from the previous year. He is the lowest-paid chief of the world’s five biggest automakers and led Toyota to generate the highest return last year among the top five global automakers. Toyota’s outlook for increasing profit prompted the automaker to approve the biggest bonus for workers in the last years. Alan Mulally, Ford Motor’s chief and the best paid among the top five, took home $21 million in 2012.
Thursday, September 26, 2013
Do Corporations Have a Duty to Respect Human Rights? The View from Government, Investors and Academia
I have spent the past two days at West Virginia University attending a conference entitled “Business and Human Rights: Moving Forward and Looking Back.” This was not a bunch of academic do-gooders fantasizing about imposing new corporate social responsibilities on multinationals. The conference was supported by the UN Working Group on Business and Human Rights, and attendees and speakers included the State Department (which has a dedicated office for business and human rights), the Department of Labor, nongovernmental organizations, economists, ethicists, academics, members of the extractive industry (defined as oil, gas and mining), representatives from small and medium sized enterprises (“SMEs”), Proctor and Gamble, and Monsanto.
Professor Jena Martin organized the conference after the UN Working Group visited West Virginia earlier this year to learn more about SMEs and human rights issues. She invited participants to help determine how to ground the 2011 UN Guiding Principles on Business and Human Rights into business practices and move away from theory to the operational level. The nonbinding Guiding Principles outline the state duty to protect human rights, the corporate duty to respect human rights, and both the state and corporations' duty to provide judicial and non-judicial remedies to aggrieved parties. Transnational corporations applauded the Principles when they were released perhaps because they are completely voluntary, but also perhaps because those specific Principles that focused on due diligence on human rights impacts in the supply chain were drafted after years of consultation with businesses around the world.
The UN Working Group has the daunting task of rolling out the Guiding Principles to over 80,000 companies and their suppliers in 192 countries. Dr. Michael Addo of the Working Group confirmed that the conference was the first of its kind in the US where such a broad coalition of those affected by and thinking about these issues had convened to talk about how the Principles can work in the real world. Participants discussed the risk management issues associated with human rights due diligence including avoiding reputational harm; addressing investor and regulatory pressure; facing internal pressures (recruiting and employee morale); and improved efficiency for project planning, forecasting and value preservation. Other topics included strategies for transnational human rights litigation after the Supreme Court’s Kiobel decision, which significantly limited access to foreign litigants on jurisdictional grounds; the use of supplier codes of conduct as contractual vehicles; using contracts to implement the Principles; antitrust implications of consortiums working together to address human rights issues with suppliers; the benefits of hard law versus “soft law” (voluntary initiatives) in the human rights arena; how the US Government is using its laws, trading leverage, procurement and investing power to support the Principles both domestically and internationally; and recent steps in the European Union to implement the Principles.
The issue of addressing regulatory and investor pressure was particularly interesting to me, and I addressed it in my remarks (which I will blog about separately when my paper is complete). But here are some facts I shared with the audience. US investors, international stock exchanges and governments increasingly value information on environmental, social and governmental (“ESG”) factors. As of 2012, the governments or stock exchanges of 33 countries require or encourage some form of ESG reporting. Earlier this year, the European Union proposed a directive on nonfinancial disclosure, which would require large companies to report annually on their major environmental, social and economic impacts.
The US government is farther behind than the Europeans but is catching up. The Federal Acquisition Regulations now require prospective contractors and subcontractors to certify that they are not engaging in a variety of human trafficking activities in supplying end products, and require changes in contractual clauses and compliance programs as well as cooperation with audits and investigations. Since 2012, certain companies in California have had to publicly disclose their efforts to eliminate human trafficking and slavery from their supply chains.
Investors also seek nonfinancial information. Bloomberg publishes corporate ESG data for over 5,000 companies utilizing 120 ESG factors. Currently, 95% of the Global 250 issues sustainability reports, which generally include impacts on the environment, society and the general economy. But these reports may be of limited utility to investors because industries may view materiality differently. To address this gap, the Sustainability Accounting Standards Board ("SASB") is a 501(c)(3) organization developing standards for publicly-traded companies in the United States in ten sectors from 89 industries so that they can disclose material sustainability information (including human rights) in 10-K and 20-F filings by 2015. Once completed, the SASB framework, which adopts the SEC definition for materiality, may have significant impact because its advisory council consists of the former chair of FASB, who was also an IASB board member, institutional investors, academics, several large corporations, representatives from most of the major investment banks as well Institutional Shareholder Services (“ISS”), the influential proxy advisory firm. According to today's SASB newsletter, thus far over 850 people representing five trillion in market capital and 12 trillion in assets under management have participated in working groups. The materiality standards for the health care industry have been downloaded over 730 times since they were released at the end of July.
As more companies begin to incorporate the Guiding Principles and consider human rights in their enterprise risk management programs and not just as line items in a sustainability report, business practices will start to change because investors and members of the public will demand it. This year a pension fund filed shareholder proposals with three companies related to the Guiding Principles. All of them failed, including one in which a company indicated that they were already conducting the kind of diligence that the Principles recommend. ISS has issued guidance specifically on human rights impacts. It’s time for directors and executives to start considering their human rights footprint in anticipation of future requests for disclosures from investors, the government, regulators and the general public.
Sunday, February 6, 2011
Chancellor Chandler issued his ruling yesterday upholding the poison pill Airgas, Inc.'s board of directors adopted in response to Air Products and Chemicals, Inc.'s $5.8 billion hostile takeover ($70/share, all cash). Chancellor Chandler determined that the Airgas board of directors "acted in good faith and in the honest belief that the Air Products offer, at $70 per share, is inadequate.” (PDF of the case here, thanks to Francis G.X. Pileggi.)
One reason this decision bugs me is that I suspect a good number of people who don't like insider trading restrictions would be supportive of this decision. To me, it's the same question: What does the shareholder want for his or her shares? Period.
For some who don't like insider trading restrictions, they argue that, at least in non-face-to-face insider trading transactions, the sharedholder did not suffer harm. (See, e.g., Henry Manne.) Sharedholders were offered a price they deemed acceptable, and sold. Who cares who was on the other side of the transaction? I find parts of this rationale compelling, although I also find the property rights concerns related to insider trading even more compelling. (See, e.g., Professor Bainbridge.)
For me, the anti-insider-trading rationale holds true in this case, too. If shareholders would accept the price, and there is no concern about the value of the payment (and there can't be in an all-cash offer), the board should make their case and get out of the way.
The board is supposed to facilitate profit maximizing for shareholders. This can take many forms, and the process is subject to legitimate board decisions to balance short- and long-term prospects. Thus, there should be a lot of latitude for the board to exercise their authority, expertise, and judgment.
That said, I can't see a good justification for not presenting an all-cash offer to shareholders once (as was the case here) ample time has been given to entice other potential bidders into the game. That's one decision that should always be the sharedholder's call.