Securities Mosaic® Blogwatch
May 26, 2016
Pro-Golfer Phil Mickelson Pays $1M to SEC to Settle Civil Insider Trading Claims, But Escapes Criminal Charges in Light of Newman
by Christine Hanley, James Thompson and Stephen Knaster

On Thursday, May 19, 2016, the U.S. Attorney’s Office for the Southern District of New York announced the arrest of renowned sports bettor William "Billy" T. Walters on an alleged years-long insider trading scheme conducted with his friend and business partner, Thomas C. Davis. According to the indictment, from 2008 to 2014, Mr. Walters executed a series of profitable stock trades in Dean Foods and Darden Restaurants based on inside information repeatedly and systematically provided to him by Mr. Davis. The U.S. Attorney’s Office alleges that these trades netted Mr. Walters over $40 million and charged him with conspiracy, securities fraud, and wire fraud.

Mr. Davis, who sat on Dean Food’s board of directors during the relevant time period and was purportedly being considered to join Darden’s board, pled guilty to the scheme whereby he provided Mr. Walters with information about the two companies in exchange for Mr. Walters providing capital for joint business ventures and loaning Mr. Davis roughly $1 million, which was never repaid.

Notably absent from the criminal indictment was any reference to pro-golfer Phil Mickelson. Instead, Mr. Mickelson was named as a defendant in an SEC civil action arising from the same conduct. See Sec. & Exchange Comm. v. Walters, 1:16-cv-03722, (S.D.N.Y. May 19, 2016). Specifically, the SEC civil action alleged that Mr. Walters encouraged Mr. Mickelson to buy Dean Foods stock on the basis of inside information that Mr. Walters had acquired from Mr. Davis. Mr. Mickelson, who allegedly owed Mr. Walters money at the time, complied with Mr. Walters’ request and allegedly earned $931,000 as a result. Without admitting any wrongdoing, Mr. Mickelson agreed to disgorge the full amount, as well as to pay $105,000 in prejudgment interest.

So how did Mr. Mickelson manage to avoid criminal charges when the other defendants didn’t? The reason is likely a recent Second Circuit decision that heightened the evidentiary hurdles for prosecutors to bring insider trading charges against downstream tippees. See United States v. Newman, No. 13-1837, 773 F.3d 438 (2d Cir. 2014). Under Newman, the government must prove that a defendant knew that the original tippers in the tipper-tippee chain disclosed confidential information in exchange for a personal benefit. Thus, "to sustain an insider trading conviction against a tippee, the Government must prove each of the following elements beyond a reasonable doubt: (1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade in a security or tip another individual for personal benefit." Id. at 450.

Although federal prosecutors have declined to comment on whether Newman impacted the government’s decision not to charge Mr. Mickelson, the general consensus among those following the litigation is that it is the reason. Under Newman, the government would have been required to prove that Mr. Mickelson (1) knew the tip originated with Mr. Davis, and (2) knew that Mr. Davis received a benefit in exchange for passing the information to Mr. Walters – a hefty undertaking. In fact, federal prosecutors have been outspoken regarding the impact of Newman, warning that it would "create[] an obvious road map for unscrupulous behavior," and be "a potential bonanza for friends and family of rich people." At the press conference regarding the above charges, the U.S. Attorney stated: "Conduct we think is nefarious, and undermines faith in the market and the fairness of the markets, will not be able to be prosecuted because of the Newman decision."

May 26, 2016
The Uber Problem Facing Workers
by Keith Cunningham-Parmeter

Customers sure love Uber. If you ask them to describe their experience with the ride-share firm, most Uber passengers will gladly tick off a long list of superlatives: Innovative! Economical! Revolutionary!

But a less-flattering picture of Uber has recently surfaced in courtrooms across the country. Told by aggrieved drivers, this countervailing narrative depicts Uber as a company that cheats its workers out of wages and denies them basic workplace rights. In fact, earlier this year, Uber agreed to pay upwards of $100 million to drivers in California and Massachusetts for alleged employment law violations.

So which is it? Is Uber a boon to passengers or just another abusive employer wrapped in an app?

Although the question appears in a novel setting (the sharing economy) the legal issue is actually a familiar one to employment lawyers: whether the law should treat workers as "employees" or "independent contractors." Because only "employees" enjoy most workplace rights such as overtime and antidiscrimination protections, businesses like Uber attempt to avoid these responsibilities by denying their status as employers.

The independent contract categorization not only separates workers from employment protections it also denies them basic workplace benefits as well. As putative "independent contractors" Uber drivers do not receive unemployment insurance, workers’ compensation, or employer contributions to Social Security. The ride-share firm gains immediate economic advantages from this strategy, as it can save up to thirty percent in payroll costs simply by classifying its drivers as nonemployees.

Although Uber is the most visible firm engaged in this practice, up to thirty percent of American businesses misclassify their workers as "independent contractors." But just because a company calls its workers "independent contractors" does not mean that the law will actually treat them as such. Although the tests for determining employee status differ somewhat between the states, the concept of control usually sits at the center of most judicial analyses of the topic. The more control that a firm exercises over working conditions, the more likely that the worker is an employee.

Many companies such as Uber disclaim their status as employers by asserting that they do not exercise daily, direct control over workers. But such a binary approach to control unnecessarily constrains the meaning of employment. In fact, employment status has never depended on whether firms control the minutia of workplace details. Rather, businesses today become employers when they meaningfully influence working conditions, even if contractual layers obscure that power. Courts can adopt this broader understanding of employment by shifting the focus of any control-based analysis from daily supervision to a firm’s influence over all working conditions. For example, if a large company such as Uber controls key aspects of its relationship with so-called "independent contractors" (such as the manner in which a service is delivered, the price paid for the service, and the timeline for delivering the service) then this direct control over these labor-based outcomes establishes effective control over the manner and means of work.

In addition to expanding the subjects of control, courts should also evaluate the direction that control travels between firms and workers. When a business reserves most relevant forms of power over workers (such as how they do their jobs or how much they get paid), this type of one-way control gives rise to employment responsibilities given that workers have no meaningful say over their jobs. Conversely, evidence of bidirectional control—in which workers and firms codetermine working conditions—suggests that workers are more like entrepreneurs and less like employees.

Reflecting the broader vision of control outlined here, two recent federal court decisions involving ride-share defendants provide a roadmap for evaluating employment relationships in the sharing economy. Last year, in O’Connor v. Uber Technologies, Inc., a federal judge in California held that employment determinations involving ride-share drivers should focus less on drivers’ control over hours and more on Uber’s control over drivers once they log on the Uber app.

By examining other ways in which Uber exercised control over drivers beyond scheduling, the O’Connor court expanded the relevant subjects of control. For example, the court noted that Uber set the price that customers paid for rides and prohibited drivers from negotiating their own wages. In addition, the court explained how Uber maintained a detailed performance protocol that directed drivers to dress professionally, send clients texts, open doors for clients, and turn the radio off or play soft jazz or NPR.

The O’Connor court explained how Uber monitored its "partners’" compliance with these mandates with customer star ratings and made deactivation decisions based on this feedback. By casting customers as supervisors, Uber retained a great deal of control over drivers, just as traditional employers monitor their employees’ performance.

Like Uber, the ride-hailing company Lyft recently agreed to settle a class action brought by drivers soon after receiving an unfavorable court ruling on the issue of employee misclassification (both the Lyft and Uber settlements are currently pending court approval). In Cotter v. Lyft, Inc., a federal court in California explained how Lyft gave drivers its "Rules of the Road," which directed them to keep their cars clean, help passengers with luggage, hold umbrellas for passengers, not accept cash, play the passengers’ preferred type of music, and greet passengers with a fist bump and smile.

Although Lyft exercised a great deal of control over the workers when they were on duty, drivers also enjoyed many freedoms such as the ability to choose their work hours and select the neighborhoods where they would drive. Based on these factors, the Cotter court held that the control analysis favored the drivers, but not so much as to conclusively categorize them as Lyft’s employees.

As these two leading decisions from the sharing economy made clear, peer-to-peer work can expand the control analysis in several new directions. For example, on the issue of scheduling, ride-share drivers behave somewhat like independent contractors who choose their own hours. On the other hand, once drivers report to work, on-demand platforms expect them to accept new assignments and reserve the right to deactivate members who decline such assignments—a far cry from the type of entrepreneurial power retained by independent contractors who can accept and reject jobs as they see fit (not to mention negotiate their own pay rates).

The sharing economy also expands the possible subjects and methods of control. For example, although no supervisor physically observes drivers’ work, the star-rating system used by ride-hailing platforms enables firms to monitor and enforce their conduct codes. Finally, the direction of control travels differently with peer-to-peer work. While sharing platforms hold unidirectional control over some subjects (pay, performance, and supervision), control takes a bidirectional course with regard to other subjects (hours and work location).

The Uber and Lyft litigation represents only the beginning of a much larger wave of cases brought by peer-to-peer workers. Indeed, soon after announcing settlements in California and Massachusetts earlier this year, Uber was hit with a nationwide lawsuit involving drivers in forty-eight other states.

As both the O’Connor and Cotter decisions make clear, companies that disclaim their status as employers may still effectively control workers’ daily existence. Whether it is Uber telling its drivers to play soft jazz or Lyft ordering its drivers to greet passengers with a fist bump, businesses that control contractual outcomes frequently control working conditions as well. Given these realities, courts must fully assess all aspects of workplace control, from its direction to its diverse subjects. Armed with this refocused vision of control, courts can assign responsibility to firms that retain ultimate authority over the manner and means of modern work.

The preceding post comes to us from Keith Cunningham-Parmeter, Professor of Law at Willamette University. The post is based on his paper, which is entitled "From Amazon to Uber: Defining Employment in the Modern Economy", forthcoming in the Boston University Law Review and available here.

May 26, 2016
Investors and Board Composition
by Lars-Erik A. Hjelm, Casey K. Richter & Samuel Wolff
Editor's Note:

Paula Loop is Leader of the Governance Insights Center at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Ms. Loop and Paul DeNicola. The complete publication, including footnotes and appendix, is available here.

In today’s business environment, companies face numerous challenges that can impact success—from emerging technologies to changing regulatory requirements and cybersecurity concerns. As a result, the expertise, experience, and diversity of perspective in the boardroom play a more critical role than ever in ensuring effective oversight. At the same time, many investors and other stakeholders are seeking influence on board composition. They want more information about a company’s director nominees. They also want to know that boards and their nominating and governance committees are appropriately considering director tenure, board diversity and the results of board self-evaluations when making director nominations. All of this is occurring within an environment of aggressive shareholder activism, in which board composition often becomes a central focus.

Shareholder activism and board compositionpwc-1


At the same time, a growing number of companies are adopting proxy access rules—allowing shareholders that meet certain ownership criteria to submit a limited number of director candidates for inclusion on the company’s annual proxy. It has become a top governance issue over the last two years, with many shareholders viewing it as a step forward for shareholder rights. And it’s another factor causing boards to focus more on their makeup.

So within this context, how should directors and investors be thinking about board composition, and what steps should be taken to ensure boards are adequately refreshing themselves?

Assessing what you have–and what you need

In a rapidly changing business climate, a high-performing board requires agile directors who can grasp concepts quickly. Directors need to be fiercely independent thinkers who consciously avoid groupthink and are able to challenge management—while still contributing to a productive and collegial boardroom environment. A strong board includes directors with different backgrounds, and individuals who understand how the company’s strategy is impacted by emerging economic and technological trends.

Sample board composition grid: What skills and attributes does your board need?


In assessing their composition, boards and their nominating and governance committees need to think critically about what skills and attributes the board currently has, and how they tie to oversight of the company. As companies’ strategies change and their business models evolve, it is imperative that board composition be evaluated regularly to ensure that the right mix of skills are present to meet the company’s current needs. Many boards conduct a gap analysis that compares current director attributes with those that it has identified as critical to effective oversight. They can then choose to fill any gaps by recruiting new directors with such attributes or by consulting external advisors. Some companies use a matrix in their proxy disclosures to graphically display to investors the particular attributes of each director nominee.

Board diversity is a hot-button issue

Diversity is a key element of any discussion of board composition. Diversity includes not only gender, race, and ethnicity, but also diversity of skills, backgrounds, personalities, opinions, and experiences. But the pace of adding more gender and ethnic diversity to public company boards has been only incremental over the past five years. For example, a December 2015 report from the US Government Accountability Office estimates that it could take four decades for the representation of women on US boards to be the same as men.[1] Some countries, including Norway, Belgium, and Italy, have implemented regulatory quotas to increase the percentage of women on boards.

Even if equal proportions of women and men joined boards each year beginning in 2015, GAO estimated that it could take more than four decades for women’s representation on boards to be on par with that of men’s.
—US Government Accountability Office, December 2015

According to PwC’s 2015 Annual Corporate Directors Survey, more than 80% of directors believe board diversity positively impacts board and company performance. But more than 70% of directors say there are impediments to increasing board diversity.[2] One of the main impediments is that many boards look to current or former CEOs as potential director candidates. However, only 4% of S&P 500 CEOs are female,[3] less than 2% of the Fortune 500 CEOs are Hispanic or Asian, and only 1% of the Fortune 500 CEOs are African-American.[4] So in order to get boards to be more diverse, the pool of potential director candidates needs to be expanded.

Is there diversity on US boards?


Source: Spencer Stuart US Board Index 2015, November 2015.

SEC rules require companies to disclose the backgrounds and qualifications of director nominees and whether diversity was a nomination consideration. In January 2016, SEC Chair Mary Jo White included diversity as a priority for the SEC’s 2016 agenda and suggested that the SEC’s disclosure rules pertaining to board diversity may be enhanced.

While those who aspire to become directors must play their part, the drive to make diversity a priority really has to come from board leadership: CEOs, lead directors, board chairs, and nominating and governance committee chairs. These leaders need to be proactive and commit to making diversity part of the company and board culture. In order to find more diverse candidates, boards will have to look in different places. There are often many untapped, highly qualified, and diverse candidates just a few steps below the C-suite, people who drive strategies, run large segments of the business, and function like CEOs.

How long is too long? Director tenure and mandatory retirement

The debate over board tenure centers on whether lengthy board service negatively impacts director independence, objectivity, and performance. Some investors believe that long-serving directors can become complacent over time—making it less likely that they will challenge management. However, others question the virtue of forced board turnover. They argue that with greater tenure comes good working relationships with stakeholders and a deep knowledge of the company. One approach to this issue is to strive for diversity of board tenure—consciously balancing the board’s composition to include new directors, those with medium tenures, and those with long-term service.

This debate has heated up in recent years, due in part to attention from the Council of Institutional Investors (the Council). In 2013, the Council introduced a revised policy statement on board tenure. While the policy “does not endorse a term limit,”[5] the Council noted that directors with extended tenures should no longer be considered independent. More recently, the large pension fund CalPERS has been vocal about tenure, stating that extended board service could impede objectivity. CalPERS updated its 2016 proxy voting guidelines by asking companies to explain why directors serving for over twelve years should still be considered independent.

We believe director independence can be compromised at 12 years of service—in these situations a company should carry out rigorous evaluations to either classify the director as non-independent or provide a detailed annual explanation of why the director can continue to be classified as independent.
— CalPERS Global Governance Principles, second reading, March 14, 2016

<>Factors in the director tenure and age debate


Source: Spencer Stuart US Board Index 2015, November 2015.

Many boards have a mandatory retirement age for their directors. However, the average mandatory retirement age has increased in recent years. Of the 73% of S&P 500 boards that have a mandatory retirement age in place, 97% set that age at 72 or older—up from 57% that did so ten years ago. Thirty-four percent set it at 75 or older.[6] Others believe that director term limits may be a better way to encourage board refreshment, but only 3% of S&P 500 boards have such policies.[7]

Investor concern

Some institutional investors have expressed concern about board composition and refreshment, and this increased scrutiny could have an impact on proxy voting decisions.

What are investors saying about board composition and refreshment?


Sources: BlackRock, Proxy voting guidelines for U.S. securities, February 2015; California Public Employees’ Retirement System, Statement of Investment Policy for Global Governance, March 16, 2015; State Street Global Advisors’ US Proxy Voting and Engagement Guidelines, March 2015.

Proxy advisors’ views on board composition—recent developments

Proxy advisory firm Institutional Shareholder Services’s (ISS) governance rating system QuickScore 3.0 views tenure of more than nine years as potentially compromising director independence. ISS’s 2016 voting policy updates include a clarification that a “small number” of long-tenured directors (those with more than nine years of board service) does not negatively impact the company’s QuickScore governance rating, though ISS does not provide specifics on the acceptable quantity.

Glass Lewis’ updated 2016 voting policies address nominating committee performance. Glass Lewis may now recommend against the nominating and governance committee chair “where the board’s failure to ensure the board has directors with relevant experience, either through periodic director assessment or board refreshment, has contributed to a company’s poor performance.” Glass Lewis believes that shareholders are best served when boards are diverse on the basis of age, race, gender and ethnicity, as well as on the basis of geographic knowledge, industry experience, board tenure, and culture.

How can directors proactively address board refreshment?

The first step in refreshing your board is deciding whether to add a new board member and determining which director attributes are most important. One way to do this is to conduct a self-assessment. Directors also have a number of mechanisms to address board refreshment. For one, boards can consider new ways of recruiting director candidates. They can take charge of their composition through active and strategic succession planning. And they can also use robust self-assessments to gauge individual director performance—and replace directors who are no longer contributing.

  1. Act on the results of board assessments. Boards should use their annual self-assessment to help spark discussions about board refreshment. Having a robust board assessment process can offer insights into how the board is functioning and how individual directors are performing. The board can use this process to identify directors that may be underperforming or whose skills may no longer match what the company needs. It’s incumbent upon the board chair or lead director and the chair of the nominating and governance committee to address any difficult matters that may arise out of the assessment process, including having challenging conversations with underperforming directors. In addition, some investors are asking about the results of board assessments. CalPERS and CalSTRS have both called on boards to disclose more information about the impact of their self-assessments on board composition decisions.[8]
  2. Take a strategic approach to director succession planning. Director succession planning is essential to promoting board refreshment. But, less than half of directors “very much” believe their board is spending enough time on director succession.[9] In board succession planning, it’s important to think about the current state of the board, the tenure of current members, and the company’s future needs. Boards should identify possible director candidates based upon anticipated turnover and director retirements.
  3. Broaden the pool of candidates. Often, boards recruit directors by soliciting recommendations from other sitting directors, which can be a small pool. Forward-looking boards expand the universe of potential qualified candidates by looking outside of the C-suite, considering investor recommendations, and by looking for candidates outside the corporate world—from the retired military, academia, and large non-profits. This will provide a broader pool of individuals with more diverse backgrounds who can be great board contributors.

In sum, evaluating board composition and refreshing the board may be challenging at times, but it’s increasingly a topic of concern for many investors, and it’s critical to the board’s ability to stay current, effective, and focused on enhancing long-term shareholder value.

The complete publication, including footnotes and appendix, is available here.


[1] United States Government Accountability Office, “Corporate Boards: Strategies to Address Representation of Women Include Federal Disclosure Requirements,” December 2015.
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[2] PwC, 2015 Annual Corporate Directors Survey, October 2015.
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[3] Catalyst, Women CEOs of the S&P 500, February 3, 2016.
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[4] “McDonald’s CEO to Retire; Black Fortune 500 CEOs Decline by 33% in Past Year,” DiversityInc, January 29, 2015;
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[5] Amy Borrus, “More on CII’s New Policies on Universal Proxies and Board Tenure,” Council of Institutional Investors, October 1, 2013;
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[6] Spencer Stuart, 2015 US Board Index, November 2015.
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[7] Spencer Stuart, 2015 US Board Index, November 2015.
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[8] California State Teachers’ Retirement System Corporate Governance Principles, April 3, 2015,; The California Public Employees’ Retirement System Global Governance Principles, Updated March 14, 2016,
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[9] PwC, 2015 Annual Corporate Directors Survey, October 2015.
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May 26, 2016
Management Influence on Investors: Evidence from Shareholder Votes on the Frequency of Say on Pay
by David Oesch, Fabrizio Ferri
Editor's Note:

Fabrizio Ferri is Associate Professor of Accounting at Columbia Business School. This post is based on an article authored by Professor Ferri and David Oesch, Associate Professor of Financial Accounting at the University of Zurich.

In our paper, Management Influence on Investors: Evidence from Shareholder Votes on the Frequency of Say on Pay, forthcoming in the Contemporary Accounting Research, we try to quantify the influence of management recommendations on shareholder votes. In the post-Enron world, firms have become increasingly responsive to shareholder votes, even when non-binding. A key driver of voting outcomes is the recommendations issued by proxy advisors. For example, various studies estimate that ISS recommendations “move” about 25% of the votes, raising legitimate concerns about the quality of these recommendations, the degree of transparency and competition in the proxy advisory industry, potential conflicts of interest, etc. In contrast, we know very little about the influence of management recommendations on shareholder votes. The challenge in empirically evaluating this influence is that management recommendations are typically the same across firms and over time (i.e., in favor of management proposal and against shareholder), making it impossible to estimate their association with shareholder votes.

In this study we identify two settings offering variation in management recommendations. The first one is Section 951 of the Dodd-Frank Act. In addition to mandating a non-binding shareholder vote in 2011 on executive pay, known as “say on pay” (SOP), Section 951 mandated a non-binding vote on the frequency of future SOP votes (known as “say when on pay” vote), offering a choice between an annual, biennial or triennial frequency. In our sample of S&P 1500 firms, management recommended an annual SOP vote in about 60% of the cases, and a biennial or triennial vote in the rest of the cases. This unique case of cross-sectional variation in management recommendations allows us to estimate their influence on shareholder votes, which we quantify at 25.9% of the votes (after controlling for standard determinants of shareholder votes). We also find that the extent of management influence depends on management credibility with shareholders (as revealed by past shareholder votes).

The second setting is the case of shareholder proposals to declassify the board. Over the last decade, such proposals have been among the most frequent and successful in terms of voting outcome and firms’ subsequent adoption, reflecting the belief that classified boards hurt firm value. Declassifying the board requires an amendment of the certificate of incorporation, which, in turn, requires a shareholder vote. Hence, to declassify the board in response to a shareholder proposal winning a majority vote, the subsequent year the board must submit a management proposal to amend the certificate of incorporation to a shareholder vote. Between 2001 and 2012 we identify 129 firms where a shareholder proposal to declassify the board won a majority vote and was then followed by an analogous management proposal. Effectively, this means we can observe a time-series variation in management recommendations, from ‘against’ to ‘for’. Controlling for other determinants of votes, the difference in voting outcomes between the two subsequent proposals should capture the effect of the change in management recommendations and, thus, management influence on shareholder votes. Using this setting, we estimate management influence at about 24.4%.

Remarkably, our cross-sectional and time-series estimates of management influence, based on two different settings (frequency of SOP votes and board declassification), are quite close, at around 25%. The magnitude is large and may actually be understated, since we examine two settings where many institutional investors have strong predetermined preferences (in favor of annual SOP votes and in favor of declassifying board). Hence, the percentage of votes “in play” (and thus potentially subject to management influence) may be lower than in other voting settings.

Our estimates are based on associations between shareholder votes and management recommendations and thus are subject to the usual endogeneity concerns. In particular, an important concern is reverse causality. If management align their recommendations with expected voting outcomes, then the association would not reflect a causal effect of recommendations on votes, but, rather, the opposite. However, by construction, our board declassification test rules out this possibility. If management simply changed its recommendation to align it with shareholders’ preference after observing the voting outcome in favor of the shareholder proposal, there should be no association between the management recommendation and shareholder votes in the subsequent year (i.e. the voting outcome should be about the same in both years). Instead, we observe a 24.4% increase in votes for the proposal. Another concern is that maybe some shareholders who voted against declassification in the first year decided to vote in favor next year because they observed a majority vote (rather than because of the change in management recommendation). However, when we examine a subset of majority-vote shareholder proposals re-submitted the subsequent year (and opposed by management in both years), there is little change in voting outcomes. Hence, our estimate is likely to capture the change in management recommendation.

In addition to estimating management influence on shareholder votes, the study sheds some light on the consequences of such influence. In particular, we find that firms adopting a triennial frequency  in 2011—and, thus, facing the next SOP vote in 2014—were less likely to make changes to their compensation practices in response to negative SOP votes compared to firms adopting an annual frequency (and thus facing the next SOP vote in 2012). Our evidence of lower responsiveness by companies adopting triennial SOP votes is consistent with the view that a less frequent vote reduces management accountability. Furthermore, it may suggest that management used its significant influence over shareholder votes to institute a less frequent SOP vote and thus reduce scrutiny over executive compensation.

Overall, the key message from our study is that, while concerns’ with the role of proxy advisors are legitimate, policy-makers and academics should be equally concerned with management influence on shareholder votes and, more generally, on the voting process.

The full paper is available for download here.

May 26, 2016
The Value of Offshore Secrets: Evidence from the Panama Papers
by Hannes Wagner, James O'Donovan, Stefan Zeume
Editor's Note:

Hannes Wagner is Associate Professor of Finance at Bocconi University. This post is based on paper authored by Professor Wagner; James O’Donovan of INSEAD; and Stefan Zeume, Assistant Professor of Finance at the University of Michigan.

On April 3, 2016, news sources around the world started reporting about a data leak of 11.5 million confidential documents concerning the business activities of Mossack Fonseca, a Panama-based law firm. The leaked documents implicate a wide range of firms, politicians, and other individuals to have used 214,000 secret shell companies to evade taxes, finance corruption, launder money, violate sanctions, and hide other activities. In our paper entitled The Value of Offshore Secrets—Evidence from the Panama Papers, which was recently made available on SSRN, we use this data leak to study whether and how the use of offshore vehicles creates firm value.

Because activities of offshore vehicles are generally unobservable, one needs to resort to revelations such as the Panama data leak to study whether and how such vehicles create shareholder value. The leak might negatively affect firm value if it makes it harder to avoid future taxes or to use offshore money to bribe foreign government officials to obtain government contracts; similarly, the data leak may result in regulatory punishment for past tax evasion and violations of anti-bribery regulation. Alternatively, if offshore structures were used to tunnel resources out of the firm at the expense of shareholders, the leak might increase firm value.

In order to assess the impact of the Panama Papers data leak on firm value, we use a sample of 26,655 publicly traded firms from 73 countries, with a total of 543,151 subsidiaries across 213 sovereign and non-sovereign territoriehas. We measure firm value by the stock price reaction of firms around April 3, 2016, the announcement of the data leak.

Specifically, our paper shows:

  • Firm Exposure to Implicated Tax Havens: Are firms using offshore subsidiaries to create shareholder value? Does the data leak destroy some of that value? We find that, around the world, the data leak erased $222-230 billion in market capitalization among circa 1,100 firms with subsidiaries in Panama, the British Virgin Islands, the Bahamas, or the Seychelles, the tax havens that were used predominantly by Mossack Fonseca. The drop in firm value reflects 0.5%-0.6% of affected firms’ market capitalization, and is more negative among firms with subsidiaries in the Bahamas (-1.3%), followed by Panama (-0.8%) and the British Virgin Islands (-0.7%).
  • Firm Exposure to perceivably corrupt countries: Are firms with operations in countries where high-ranked government officials were implicated by the data leak affected? We find that firms operating subsidiaries in countries perceived to be more corrupt than their home country experience 0.3% lower returns than similar firms without this exposure. Also, the impact of the data leak is more pronounced for firms that have activities in countries whose high-ranked government officials were implicated by name for suspected fraud, money laundering, bribes, or related activities by the data leak. Firms with at least one subsidiary in any of these ten countries lost 0.65% in market value.
  • Firm Exposure to Implicated Tax Havens and Implicated Countries: Were offshore facilities used to pay off corrupt politicians? Because bribe payments and contract allocation procedures are unobservable, our evidence is indirect. We find that, around the data leak, firms exposed both to tax havens implicated by the Panama Papers and to perceivably corrupt countries lose 0.3%-0.4% in value compared to similar firms. Firms with exposure to any of the four Panama Papers havens and nine of the ten countries directly implicated by the leak have negative returns. For instance, firms linked to Mossack Fonseca’s tax havens and operating in Iceland experienced negative abnormal returns of -1.4%. The data leak had linked Iceland’s Prime Minister Sigmundur Davíð to an undisclosed company in the British Virgin Islands.

Overall, our estimates suggest that investors perceive the leak to destroy some of the value generated from offshore activities. One potential channel is that shareholders are afraid the publicity might lead to governments cracking down on tax havens. That would mean companies could lose out on tax savings they had been accustomed to. A second channel is that some companies might have illegal activity exposed; such companies might pay hefty fines and may have to stop activities such as tax evasion and financing corruption, or violations of sanctions. A third channel is that customers of implicated companies might resent them dodging taxes in their home countries and boycott or avoid their products.

More broadly, the Panama data leak may indicate the end of offshore secrecy altogether. Part of the negative share price response documented in our paper may capture this, and any further revelations of similar activities may destroy further shareholder value. Notably, many of the details pertaining to the Panama Papers data leak are not yet available; for our tests, we rely on market data and news coverage up to April 7, 2016. Future revelations from the Panama Papers and responses by law enforcement, governmental agencies, and regulatory bodies will offer additional room to investigate what types of firms and what types of connections to havens and implicated countries create value.

The full paper is available for download here.

May 26, 2016
This Week In Securities Litigation (Week ending May 26, 2016)
by Tom Gorman

In a holiday shortened week the Commission brought actions centered on: a transfer agent and one of its owners who conducted a fraudulent offering for another company and then sold unregistered shares into the market; a market manipulation that employed a false Section 13(d) filing used to artificially inflate the share price of a stock so the manipulator could sell options at a profit; and a financial fraud in which senior finance officers took advantage of the firm’s lack of effective internal controls to manipulate key financial statement metrics.

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 3 civil injunctive actions and 2 administrative proceedings, excluding 12j and tag-along proceedings.

Misrepresentations/unregistered offering: In the Matter of American Registrar & Transfer Company, Adm. Proc. File No. 3-17260 (May 25, 2016). Respondent American Registrar is a transfer agent. Respondent Christopher Day is a vice president and minority owner of the firm. In September 2010 RVPlus, then a firm whose shares were quoted on OTC Link, filed a registration statement with the Commission. It was signed by Mr. Day as the CEO and majority shareholder. The registration statement did not disclose that an unnamed Promoter actually controlled the firm and beneficially owned the shares held in Mr. Day’s name. In fact Mr. Day had agreed to serve as a nominee. In May 2012 Mr. Day assisted Promoter in selling most of RVPlus’ shares to Cary Peterson who then became the CEO of the firm. Mr. Day transferred at least 4 million shares to transferees of Mr. Peterson in a manner which disguised the fact that Mr. Peterson had directed the transaction. American Registrar enabled the unlawful re-sale of almost 500,000 unregistered shares of stock. The Order alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). To resolve the case American Registrar agreed to implement certain undertakings, including the retention of an independent consultant. The firm also consented to the entry of a cease and desist order based on Section 5 of the Securities Act and to a censure. The firm will pay disgorgement of $585, prejudgment interest and a civil penalty of $25,000. Mr. Day consented to the entry of a cease and desist order based on the two antifraud sections cited in the Order. He is also barred from serving as an officer or director of an issuer for three years and barred from the securities business and from participating in any penny stock offering with a right to reapply after three years. He will pay disgorgement of $30,000, prejudgment interest and a penalty equal to the amount of the disgorgement.

Manipulation: SEC v. Aly (S.D.N.Y. Filed May 24, 2016). Defendant Nauman Aly is a resident of Pakistan. In mid-April 2016 he is alleged to have manipulated the share price of Integrated Devices Technology, Inc. or IDTI, a high tech firm based in San Jose, California. Specifically, on April 12, 2016 he: 1) purchased out of the money call options for the stock; 2) filed a Schedule 13D with the SEC claiming a group had acquire 5.1% of the stock and was about to make a tender offer for all shares; 3) and sold the options for a profit of over $400,000 minutes after the filing was made droving up the share price. Shortly after the sale Mr. Aly is alleged to have filed a second Schedule 13D stating the group no longer owned over 5% because the options were sold. The company never received an offer, contrary to the representations in the first Schedule 13D filed. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The Commission obtained a freeze order over the trading profits on filing. The case is pending.

Financial fraud: In the Matter of Swisher Hygiene, Inc., Adm. Proc. File No. 3-17257 (May 24, 2014). The firm is a North Carolina hygiene and sanitation company. The financial fraud involved CFO Michael Kipp, Director of External Reporting Joanne Viard and Director of Financial Planning John Pierrard. In 2011 the firm actively acquired companies during a period when it lacked effective internal controls. Mr. Kipp directed that accounting entries be made which aggressively reevaluated and manipulated various acquisition-related reserves and expenses to increase earnings to certain targets tied to the expectation of firm lenders. As a result the firm issued quarterly reports beginning in the second quarter of 2011 which were materially false and misleading. The firm benefited by being able to use its artificially inflated stock price to make acquisitions. The Order alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). The company agreed to cooperate with the SEC on an on-going basis. It also consented to the entry of a cease and desist order based on the Sections cited in the Order. Imposition of a penalty was waived based on the $2 million penalty paid in the parallel criminal action. See U.S. v. Swisher Hygiene Inc., Case No. 3:15-cr-237 (W.D.N.C)( resolved with a deferred prosecution agreement). See also SEC v. Kipp, (W.D.N.C. Filed May 24, 2016)(action against former CFO and director of external reporting alleging violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)-5, 20(a) and 21F); SEC v. Pierrard (W.D.N.C. Filed May 24, 2016)(action against former director of financial planning alleging violations of Securities Act Section 17(a)(1) and Exchange Act Sections 10(b), 13(b)(2)(A), 13(b)(2)(B) and 13(b)-5).


Remarks: Richard G. Ketchum, Chairman and CEO, delivered remarks titled "Commerce and Compliance: It’s Not a Culture War" at the 2016 FINRA Annual Conference, Washington, D.C. (May 23, 2016). His remarks focused on culture and compliance (here).

Hong Kong

MOU: The Securities and Futures Commission entered into a memorandum of understanding with FINRA concerning mutual assistance in the supervision and oversight of regulated entities that operate on a cross-boarder basis in Hong Kong and the U.S.


Report: The Financial Conduct Authority issued a Research Report into the de-risking of banks (here).

May 26, 2016
Auditor Independence: Unintended Consequences of "Loan Rule" Violation
by Broc Romanek

The disclosure in this Form 8-K filed by Invesco reflects a question posed to the Big 4 recently by the SEC Staff. This position by the SEC seems like it could ultimately impact clients of the Big 4 if a passive investor (eg. large bank) holds more than 10% of a company’s equity and also provides a line of credit to the auditor. It appears that this could have unintended consequences unless the ultimate goal is for companies to have more auditor options than the Big 4. At this time, I hear that the Staff was allowing companies to file 10-Qs but there still isn’t a resolution on the underlying question. Here’s an excerpt from the Invesco 8-K:

PricewaterhouseCoopers LLP ("PwC") has advised Invesco Ltd. (the "Company") that PwC is in discussions with the Staff of the United States Securities and Exchange Commission (the "SEC") regarding the interpretation and application of Rule 2-01(c)(1)(ii)(A) of Regulation S-X (the "Loan Rule") with respect to certain of PwC’s lenders who own interests in closed-end and open-end mutual funds managed by the Company’s wholly-owned investment adviser subsidiaries.

The Loan Rule prohibits accounting firms, such as PwC, from having certain financial relationships with their audit clients and affiliated entities. The Loan Rule provides, in relevant part, that an accounting firm is not independent if it receives a loan from a lender that is a "record or beneficial owner of more than ten percent of the audit client’s equity securities." Under the SEC Staff’s interpretation of the Loan Rule, some of PwC’s relationships with lenders who own shares of certain closed-end and open-end funds within the Invesco investment company complex may be in violation of the Loan Rule, calling into question PwC’s independence with respect to such funds, such funds investment advisers and affiliated entities of such investment advisers, including the Company. PwC’s interpretation of the Loan Rule, in light of the facts of these lending relationships, leads it to conclude that there is no violation of the Loan Rule and its independence has not been impaired. PwC has advised the Company that it continues to have discussions with the SEC’s Staff to resolve this interpretive matter.

While PwC represented to the Company that it feels confident that PwC’s interpretation of the Loan Rule is correct, neither PwC nor the Company can be certain of the final outcome. In light of the circumstances described above, the Company is updating its risk factors by providing an additional risk factor set forth below.

PCAOB Inspections: Deficiencies Down at Larger Auditors (But Up for Smaller)

Recently, the PCAOB Staff released a "Staff Inspections Brief" that provides 2015 inspection observations. The number of audit deficiencies identified for annually inspected auditors (those with over 100 public clients) actually decreased. For auditors with less than 100 public clients (who are inspected every three years), the Staff found "an overall high number of audit deficiencies"...

And PCAOB Board Member Jeanette Franzel recently delivered this speech about how the PCAOB should modify its risk-based audit inspection approach to take into account the significant improvements in audit quality that have been happening...

Congress: House Passes 10-Year Audit Attestation Exemption Extension

Here’s the intro from this Cooley blog:

On Monday, the House passed the "Fostering Innovation Act of 2015," notwithstanding this letter to Paul Ryan and Nancy Pelosi from the SEC’s Investor Advocate urging a vote against it. The bill, which presumably now moves to the Senate for consideration, amends Section 404(b) of SOX (internal controls), "to provide a temporary exemption for low-revenue issuers from certain auditor attestation requirements."

More specifically, the bill would temporarily exempt from the SOX auditor attestation requirement — that the issuer’s auditor attest to management’s assessment of the effectiveness of the issuer’s internal control over financial reporting — any issuer that ceased to be an emerging growth company after the fifth anniversary of its IPO, had average annual gross revenues of less than $50 million as of its most recently completed fiscal year, and is not a large accelerated filer.

The issuer would become ineligible for the exemption at the earliest of the last day of its fiscal year following the tenth anniversary of its IPO, the last day of its fiscal year when its average annual gross revenues exceed $50 million, or the date on which it becomes a large accelerated filer.

Broc Romanek

May 25, 2016
The Corporate Counsel Report is here!
by Chris Hitt

We at Lexis Securities Mosaic are proud to announce the inaugural issue of the bi-weekly Corporate Counsel Report. This newest addition to our venerable suite of news emails is aimed at lawyers who represent the interests of corporations, offering a resource to help them keep on top of the fast-paced, multi-faceted, and rapidly changing world they inhabit.

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View today's posts

5/26/2016 posts

Securities Litigation, Investigations and Enforcement: Pro-Golfer Phil Mickelson Pays $1M to SEC to Settle Civil Insider Trading Claims, But Escapes Criminal Charges in Light of Newman
CLS Blue Sky Blog: The Uber Problem Facing Workers
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Investors and Board Composition
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Management Influence on Investors: Evidence from Shareholder Votes on the Frequency of Say on Pay
The Harvard Law School Forum on Corporate Governance and Financial Regulation: The Value of Offshore Secrets: Evidence from the Panama Papers
SEC Actions Blog: This Week In Securities Litigation (Week ending May 26, 2016) Blog: Auditor Independence: Unintended Consequences of "Loan Rule" Violation
Blogmosaic: The Corporate Counsel Report is here!

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