Securities Mosaic® Blogwatch
April 3, 2018
“Forcing the Offer”: Considerations for Deal Certainty and Support Agreements in Delaware Two-Step Mergers
by Piotr Korzynski, Baker & McKenzie

In the four and a half years since the Delaware legislature adopted Section 251(h) of the Delaware General Corporation Law (DGCL) and offered streamlined mechanics for closing two-step mergers, Delaware practitioners have made increasing use of the provision. The provision, subject to certain conditions, permits an acquiror’s near-simultaneous closing of an exchange or tender offer for a controlling stake in a target in the first transaction step and a merger for the remaining outstanding stake in the target immediately after in a final, second step. In its initial year, Section 251(h) was utilized in over 20% of deals involving Delaware public company targets and 33 of 41 Delaware two-step mergers. [1] In 2014, following the success of that first year, the legislature liberalized the use of Section 251(h) by, among other things, striking the condition that the provision was inapplicable to transactions involving “interested stockholders” (i.e., owners of 15% or more of a target company’s outstanding voting stock at the time of target board approval of the merger agreement). Such condition had restricted Section 251(h) transactions to true third-party transactions and likely depressed its use in the first year. By its third full year, nearly 25% of deals involving Delaware public company targets and 49 of 52 Delaware two-step mergers utilized Section 251(h).


As the provision has quickly become a linchpin of Delaware M&A, this post considers a buyer’s ability under Delaware law to gain closing certainty in two-step mergers via support agreements with controlling target company stockholders. As used here, “support agreements” are agreements between a potential buyer and controlling target company stockholders in which, at deal signing, such stockholders agree to exchange or tender some or all of their shares as soon as or shortly after the first-step tender or exchange offer commences, thereby giving a buyer assurance of substantial and even decisive stockholder support for the merger. At bottom, just as in the pre-Section 251(h) era, a buyer must carefully structure such agreements to avoid a deal becoming an impermissible fait accompli under the Delaware Supreme Court’s long-standing decision in Omnicare v. NCS Healthcare, with special attention to the mechanics of consummating an exchange or tender offer. [2]

The Three Pillars of Omnicare

In 2003, in Omnicare, the Delaware Supreme Court enjoined a one-step merger between Genesis Health Ventures and its target, NCS Healthcare. The court held that the NCS directors were precluded from exercising a continuing obligation to discharge their fiduciary duties after announcement of the merger agreement because (1) the board approved voting agreements with NCS stockholders holding in excess of 50% of the outstanding voting power, ensuring approval of the merger at the NCS stockholder meeting; (2) the merger agreement included a “force-the-vote” provision requiring that NCS hold a stockholder vote notwithstanding any change in the NCS board’s recommendation of the merger (including in respect of any competing offers); and (3) the merger agreement did not include a “fiduciary out,” i.e., a right of NCS to terminate the merger agreement to accept a superior, competing offer. The NCS directors’ hands, in other words, were tied—at signing, the deal was a fait accompli in respect of any superior offers, subject only to a procedural stockholder vote and customary closing conditions. Such a scenario, the Delaware Supreme Court ruled, was illegal per se, regardless of any robust auction process or even the behest of controlling stockholders.

Omnicare’s progeny support the case’s applicability to a two-step merger. In 2011, for example, the Delaware Chancery Court’s decision in In re OPENLANE, Inc. Shareholders Litigation upheld a merger approved by a majority of target stockholders by written consent the day after the merger agreement was signed and which did not include a fiduciary out. The court upheld the merger as stockholders could freely choose to sign the written consent; the result was not predetermined; and the target was not precluded from entertaining other offers because if the consents were not secured within 24 hours, the target could terminate the merger agreement. OPENLANE made clear that Omnicare’s application was not limited to mergers approved at stockholder meetings, and there is little doubt that two-step mergers would be subject to an Omnicare analysis. Indeed, under Delaware law, the ultimate effect of an exchange or tender of shares in the first step of a two-step merger under Section 251(h) is the same as a vote at a stockholder meeting or execution of a written consent: each tender or exchange is an approval of the underlying transaction by the applicable stockholder and ultimately contributes to effectuating the transaction, subject to a transaction’s other terms and conditions.

Though Omnicare has been much criticized by some practitioners and its applicability narrowed by subsequent cases, the case remains good law in Delaware with respect to its particular “lock-up” scenario, and in any Delaware target two-step merger, proposed support agreements will have to be prepared in an overall deal structure that distinguishes itself from some or all three key defects identified in Omnicare.

Two-Step Mergers and Controlling Stockholders: Fiduciary Outs and Ratchet Downs Are In

At first blush, a two-step buyer might distinguish its deal from Omnicare by altogether avoiding support agreements. Understandably, this has not been the standard practice in Delaware two-step mergers involving controlling stockholders, given that in such contexts a buyer would likely want to both raise deal certainty and signal to the market support for the transaction from the party or parties holding controlling shares. Indeed, in a review of post-Omnicare two-step mergers both pre- and post-Section 251(h) involving Delaware public company targets with 50% or greater controlling stockholders, [3] nearly all (22 of 24 deals) included support agreements from the controlling stockholders. Thus, the prevailing question for buyers in such deals apparently has been not whether to pursue support agreements but what such agreements should look like. The prevailing response has been to include a fiduciary out in the merger agreement: in a plurality of the controller deals with support agreements (eight of 22), controlling stockholders pledged the tender or exchange of all their shares unless the merger agreement was terminated, which merger agreement included a target termination right to take a superior offer, and such termination was the only avenue for reducing or terminating the tender obligation in connection with a board’s exercise of fiduciary duties in respect of superior, competing offers.

Though a fiduciary out alone would seemingly be enough to avoid Omnicare’s prohibition, in an additional 13 deals, a fiduciary out was one of two (or in a couple of cases, three) mechanisms reducing the tender obligations under the applicable support agreement. In nine of these 13 deals, the primary recurring additional mechanism was some form of a “ratchet down” of tender obligations (e.g., upon a certain event other than merger agreement termination, the tender obligations were reduced to 34.99%, paused entirely for the period of board recommendation change or terminated entirely at board recommendation change). In the remaining four deals (and two of the nine ratchet deals), the additional mechanism was an express cap on the shares subject to the support agreement, as the parties did not subject all of their shares to the support agreement. The caps were generally between 31.99% and 39.99%, with one deal at 14.9%. The latter cap, however, was addressed not to Omnicare concerns but to Section 251(h)’s prior restriction against transactions involving interested stockholders, [4] which restriction, as noted above, has since been lifted.

Finally, one deal among the 22 controller deals with support agreements conditioned the controlling parties’ tender obligations on the acquiror’s deal financing being secured as the only apparent Omnicare mechanism for avoiding the deal becoming a fait accompli.

“Forcing the Offer:” Understanding Exchange or Tender Offers as Votes

Interestingly, only one of the 21 controller deals reviewed above included what might be called a “force-the-offer” arrangement akin to a force-the-vote provision in a one-step merger. Among one-step mergers involving controlling stockholders post-Omnicare, an accepted deal structuring practice has been to retain a force-the-vote provision as in Omnicare itself but to ratchet down the level of guaranteed support from over 50% to around 33% following a board recommendation change. The arrangement avoids a fait accompli in the ultimate vote but still gives a buyer a clear up-or-down vote on its proposed deal notwithstanding any interlopers. The only two-step merger among the controller deals that appears to have applied this logic onto an exchange or tender offer was Liberty Interactive Corporation’s 2015 cash-and-stock acquisition of zulily, inc. for about $2.3 billion. There, a support agreement was entered into by zulily stockholders representing 87.5% of the outstanding voting power and included a ratchet down of support to 34.99% in the event of, among other things, the board’s subsequent recommendation against the deal in connection with a superior offer. The merger agreement also included a fiduciary out for zulily, but with a twist: zulily could terminate the merger agreement to take a superior offer only after 45 days had passed from its board’s recommendation change. In effect, that 45 day waiting period created a window in which Liberty could nonetheless force the offer on zulily stockholders notwithstanding a competing superior offer and hold a referendum on its deal.

While the ultimate legal effect, noted above, of a tender or exchange of shares is the same as a vote of such shares at a stockholder meeting, the dynamics of an exchange or tender offer are fundamentally different from a discrete vote at a meeting or sign-and-consent. From the buyer’s perspective, to truly parallel a force-the-vote requirement, a force-the-offer mechanic would have to frame a clear referendum on the offer itself. Under SEC rules, offers must initially be held open for at least 20 business days, and following material amendments to an offer, an additional 5 business days. From these SEC rules, two-step merger parties typically provide for the initial required 20 business day offer period and then a default right of the buyer to renew the offer period thereafter for some shorter periods until the merger agreement is terminated. In this process, any major conditions to the offer will have a significant effect on the level of interim stockholder tenders or exchanges; for example, if an offer period would otherwise end with an antitrust waiting period still in effect under the Hart-Scott-Rodino Act, few stockholders, all things being equal, will have tendered or exchanged shares, most waiting for announcement of that condition having been satisfied. One would expect a buyer, especially if faced with an uncertain antitrust clearance period or other uncertain condition, to push for a force-the-offer period to be the time between a board recommendation change for a superior offer and some range of days following the satisfaction of all conditions to the offer other than (1) the tender or exchange of a minimum number of shares needed for approval of the merger and (2) those other conditions that could only be satisfied as of closing.

In this respect, the zulily mechanic is not as buyer-friendly as a more conditional mechanic, since the force-the-offer period was simply 45 days from the recommendation change, without regard to what conditions to the offer were or were not otherwise satisfied. The zulily mechanic might, however, be more Omnicare-friendly, since the force-the-offer period runs for a less open-ended period than the conditional mechanic noted above and so is likely less preclusive of competing bids. The extent to which, however, parties would be concerned with such preclusive effect would be dictated by the deal context as a matter of law and negotiating leverage. If a robust auction process led to the transaction, for example, then parties could more defensibly exclude a fiduciary out from a merger agreement that might otherwise be dictated by Delaware law and could instead focus on distinguishing their structure from Omnicare by a force-the-offer mechanic alone and one with a more open-ended force-the-offer period than in Liberty-zulily.


In the Section 251(h) era, the three pillars to Omnicare’s holding—voting agreements guaranteeing a majority vote in favor of a deal, a force-the-vote provision, and no fiduciary out—remain essential for understanding the limits of just how much support buyers of Delaware corporate targets can lock up via support agreements. Considering these three factors, practitioners seem to have relied on fiduciary outs, together with a ratchet down of tender obligations, to avoid impermissible fait accomplis in two-step mergers with controlling stockholders and support agreements. Among the deals reviewed here, only one deal, the Liberty-zulily merger, included what one might consider a force-the-offer provision, or a provision conceptually equivalent to the force-the-vote provision in Omnicare, while also providing a ratchet down of tender obligations. Buyers subsequently considering a force-the-offer provision might want to take account of how such a provision might be more aggressively drafted to frame a clear referendum for stockholders on a buyer’s proposed deal (and perhaps to offer some additional deterrence to interlopers in light of a longer potential pursuit period). Ultimately, of course, the mix of particular deal protections a buyer or seller can secure consists of not only what the law allows (including in respect of market checks on deal consideration that might separately require fiduciary outs in Delaware) but also the relative negotiating leverage among the parties.



Based on FactSet/MergerMetrics.(go back)


The two-step mergers under discussion here do not include going-private transactions involving controlling stockholders wherein such stockholders themselves initiate a two-step merger. Such transactions are inherently fait accomplis in respect of stockholder approval and subject to procedural safeguards arising from a separate landmark Delaware Supreme Court decision, Kahn v. Lynch.(go back)


Generally as reported by DealPoint as of March 12, 2018 from among deals with at least one stockholder owning at least 30% of outstanding shares.(go back)


In the year that Section 251(h) included an interested stockholder restriction, commentators observed that DGCL Section 203, from which the interested stockholder definition was drawn in Section 251(h), broadly defined “ownership” of 15% of a company’s outstanding shares such that a support agreement might imbue a buyer with ownership of a counterparty shareholder’s shares, thereby violating the then-applicable 251(h) restriction.(go back)
April 3, 2018
Disclosing Corporate Lobbying
by John Keenan, Timothy Smith

Corporate lobbying disclosure remains a top shareholder proposal topic for 2016. At least 66 investors have filed proposals at 50 companies asking for lobbying reports that include federal and state lobbying payments, payments to trade associations used for lobbying, and payments to any tax-exempt organization that writes and endorses model legislation. Political activity remains a top investor topic for the sixth consecutive year, with more than 90 proposals filed for 2016 that seek disclosure of either lobbying or political contributions.

Reflecting investors’ interest in disclosure of corporate political spending, a rulemaking petition at the Securities and Exchange Commission (SEC) to require disclosure of corporate political spending has received a record level of support. More than 1.2 million comment letters have been submitted¾the vast majority in support of the proposed rule. Moreover, according to a 2015 survey, a majority of public company board members believe that the SEC needs to develop mandatory disclosure rules for corporate political contributions. [1] Still, the SEC has yet to act, and in December 2015 Congress passed the budget bill that included a rider that bars the SEC from issuing political spending disclosure rulemaking.


Proponents believe that disclosure allows shareholders to evaluate whether lobbying is consistent with a company’s expressed goals and is in the best interests of the company and shareholders. Corporate reputation is an important component of shareholder value, and controversial lobbying activity can pose significant reputational risk.

Undisclosed company payments to trade associations used for lobbying are a notable shortcoming in current reporting that allow companies to influence policy anonymously. Trade associations are not required to disclose their members or source of funds used for lobbying, and the amounts are substantial. For example, the U.S. Chamber of Commerce (“Chamber”) spent $208 million to lobby in 2014 and 2015, and over $1.2 billion on lobbying since 1998.

Investors believe companies need to safeguard corporate reputations that may be affected by controversial political spending, including through third party involvement. For example, if a company takes steps to address climate change while simultaneously supporting trade groups that oppose legislative or regulatory efforts to limit its effects, then they are contributing to positions that run counter to company climate policy. Noting this contradiction, companies such as Apple and PG&E previously ended their membership in the Chamber because of its stance on climate change and opposition to EPA regulation. More recently, the Chamber has opposed the EPA Clean Power Plan rulemaking and sued the EPA. Chamber member companies with climate change policies that received resolutions include: AbbVie, Alphabet (formerly Google), American Express, AT&T, Bank of America, Citigroup, ConocoPhillips, Facebook, General Electric, IBM, Johnson & Johnson, Motorola Solutions, Travelers Companies, Verizon and UPS.

CVS Health’s decision last July to end its membership in the Chamber over the organization’s efforts to lobby against anti-smoking laws in countries around the globe provides another case in point. CVS Health stated that the Chamber’s position on tobacco products is inconsistent with its business focus on health. Health care companies that are members of the Chamber and received shareholder proposals include AbbVie, Anthem, Johnson & Johnson and Pfizer.

The proposals also continue to focus on reputational risks from involvement in the American Legislative Exchange Council (ALEC). ALEC is a tax-exempt organization that convenes state lawmakers and corporations to approve model legislation for passage at the state level. This legislation has included controversial bills on repealing state regulations on renewable energy, blocking paid sick leave, pre-empting minimum wage increases and opposing EPA regulation such as the Clean Power Plan. More than 105 companies have left ALEC in recent years, including 3M, BP, eBay, Facebook, Google, Microsoft, Shell, Visa and Yahoo. Prominent current ALEC members receiving 2016 proposals include: AT&T, Caterpillar, Chesapeake Energy, Chevron, Comcast, Devon Energy, Dominion Resources, Duke Energy, ExxonMobil, Honeywell, Nucor Corporation, Pfizer, Spectra Energy, Time Warner Cable, UPS and Verizon.

Opponents of disclosure, which have included many of the largest trade associations, claim that disclosure is a form of silencing speech. [2] Yet disclosure does not prohibit corporate lobbying in any way; it simply enables shareholders to evaluate whether lobbying is in the best interests of the company and shareholders.

This is the sixth year proposals asking for lobbying disclosure have been filed by investors. In 2015, 65 proponents filed 54 proposals, out of which 33 went to a vote and averaged 26 percent support. The proposals have led many companies to improve their lobbying disclosure, including disclosure agreements at more than 40 companies.

The investor coalition is comprised of public pension funds, labor funds, asset managers, individual investors, international investors, foundations and religious investors, many whom are members of the Interfaith Center for Corporate Responsibility. This initiative is coordinated and supported by AFSCME and Walden Asset Management, a division of Boston Trust & Investment Management Company.

Companies receiving lobbying disclosure resolutions for 2016 are:

AbbVie (ABBV)
Allergan (AGN)
Alphabet (GOOGL)
American Airlines Group (AAL)
American Express (AXP)
Anthem (ANTM)
AT&T (T)
Bank of America (BAC)
Boeing (BA)
Caterpillar (CAT)
CenterPoint Energy (CNP)
Charles Schwab (SCHW)
Chesapeake Energy (CHK)
Chevron (CVX)
Citigroup (-C-)
Comcast (CMCSA)
ConocoPhillips (COP)
Devon Energy (DVN)
Dominion Resources (D)
Duke Energy (DUK)
DuPont (DD)
Emerson Electric (EMR)
Enbridge (ENB)
Exxon Mobil (XOM)
Facebook (FB)
FirstEnergy (FE)
General Electric (GE)
Honeywell (HON)
Johnson & Johnson (JNJ)
Monsanto (MON)
Motorola Solutions (MSI)
Navient (NAVI)
Nucor Corporation (NUE)
Pfizer (PFE)
Philip Morris International (PM)
Raytheon (RTN)
Spectra Energy (SE)
Suncor (SU)
Tesoro Corp. (TSO)
Time Warner Cable (TWC)
TransCanada (TRP)
Travelers Companies (TRV)
Tyson Foods (TSN)
United Parcel Service (UPS)
Verizon (VZ)
Wal-Mart (WMT)
Walt Disney Company (DIS)
Wells Fargo (WFC)

Filers of lobbying disclosure resolutions for 2016 include:

Public Pension Funds
State of Connecticut Treasurer’s Office
Miami Firefighters’ Relief and Pension Fund
New York State Common Retirement Fund
City of Philadelphia Public Employees Retirement System

International Asset Managers and Pensions
ACTIAM (Netherlands)
AP7 Seventh Swedish National Pension Fund 

Labor Pension Plans and Organizations
CTW Investment Group
International Brotherhood of Teamsters
Le Fonds de Solidarité
United Steelworkers

Asset Management Companies
Boston Common Asset Management
Clean Yield Asset Management
Domini Social Investments
First Affirmative Financial Network
Newground Social Investment
Pax World Fund
Sustainability Group, Loring, Wolcott & Coolidge
Trillium Asset Management
Walden Asset Management
Walden Equity Fund
Zevin Asset Management

Brainerd Foundation
Center for Community Change
Nathan Cummings
Haymarket People’s Fund
Lemmon Foundation
Max and Anna Levinson Foundation
Merck Family Fund
Needmor Fund
Oneida Tribe of Indians Trust Fund for the Elderly
Christopher Reynolds Foundation
Russell Family Foundation
Swift Foundation
Tides Foundation 

Non-Profit Institutional Investors
As You Sow
Dwight Hall Socially Responsible Investment Fund at Yale
Manhattan Country School
Sum of Us 

Religious Filers
Benedictine Sisters of Baltimore – Emmanuel Monastery
Benedictine Sisters of Mount St. Scholastica
Benedictine Sisters of Virginia
Community Church of New York
Congregation of Benedictine Sisters, Boerne, TX
Congregation of Sisters of St. Agnes
Congregation of the Sisters of St. Joseph of Brighton
Daughters of Charity, Province of St. Louise
First Parish in Cambridge – Unitarian Universalist
Friends Fiduciary Corporation
Glenmary Home Missioners
Maryknoll Fathers and Brothers
Mercy Investment Services
Missionary Oblates of Mary Immaculate
School Sisters of Notre Dame Cooperative Investment Fund
Sinsinawa Dominican Sisters
Sisters of Charity of St. Vincent de Paul, Halifax
Sisters of Notre Dame
Sisters of Notre Dame de Namur-Boston
Sisters of St. Francis of Philadelphia
Sisters of the Holy Family, CA
Trinity Health
Unitarian Universalist Association
United Church of Canada 

Daniel Altschuler
Carol Master
Gwendolen Noyes
Bernice Schoenbaum

2016 Lobbying Disclosure Resolution Filed at ExxonMobil

Whereas, we believe in full disclosure of our company’s direct and indirect lobbying activities and expenditures to assess whether our company’s lobbying is consistent with ExxonMobil’s expressed goals and in the best interests of shareholders.

Resolved, the shareholders of ExxonMobil request the preparation of a report, updated annually, disclosing:

  1. Company policy and procedures governing lobbying, both direct and indirect, and grassroots lobbying communications.
  2. Payments by ExxonMobil used for (a) direct or indirect lobbying or (b) grassroots lobbying communications, in each case including the amount of the payment and the recipient.
  3. ExxonMobil’s membership in and payments to any tax-exempt organization that writes and endorses model legislation.
  4. Description of management’s and the Board’s decision making process and oversight for making payments described in sections 2 and 3 above.

For purposes of this proposal, a “grassroots lobbying communication” is a communication directed to the general public that (a) refers to specific legislation or regulation, (b) reflects a view on the legislation or regulation and (c) encourages the recipient of the communication to take action with respect to the legislation or regulation. “Indirect lobbying” is lobbying engaged in by a trade association or other organization of which ExxonMobil is a member.

Both “direct and indirect lobbying” and “grassroots lobbying communications” include efforts at the local, state and federal levels.

The report shall be presented to the Audit Committee or other relevant oversight committees and posted on ExxonMobil’s website.

Supporting Statement

As shareholders, we encourage transparency and accountability in ExxonMobil’s use of corporate funds to influence legislation and regulation. ExxonMobil spent $26.07 million in 2013 and 2014 on federal lobbying ( These figures do not include lobbying expenditures to influence legislation in states, where ExxonMobil also lobbies but disclosure is uneven or absent. For example, ExxonMobil spent $699,362 on lobbying in California for 2014 ( ExxonMobil’s lobbying on climate change has attracted media attention (“Exxon Knew about Climate Change Decades Ago, Spent $30M to Discredit It,” Christian Science Monitor, Sep. 17, 2015).

ExxonMobil is a member of the American Petroleum Institute, Business Roundtable and National Association of Manufacturers, which together spent over $65 million on lobbying for 2013 and 2014. ExxonMobil is also a member of the Western States Petroleum Association, which spent $13,553,942 on lobbying in California for 2013 and 2014. ExxonMobil does not disclose its memberships in, or payments to, trade associations, or the portions of such amounts used for lobbying. Transparent reporting would reveal whether company assets are being used for objectives contrary to ExxonMobil’s long-term interests.

And ExxonMobil does not disclose membership in or contributions to tax-exempt organizations that write and endorse model legislation, such as being a member of the American Legislative Exchange Council (ALEC). ExxonMobil’s ALEC membership has drawn press scrutiny (“ExxonMobil Gave Millions to Climate-Denying Lawmakers despite Pledge,” The Guardian, Jul. 15, 2015). More than 100 companies have publicly left ALEC, including BP, ConocoPhillips, Occidental Petroleum and Shell.




“The 2015 BDO Board Survey,” BDO, October 2015, p. 4.(go back)




Dave Levinthal, “Trade Groups to Top Corporations: Resist Political Disclosure,” The Center for Public Integrity, January 27, 2016.(go back)
April 3, 2018
Cleary Gottlieb Discusses the SEC’s New Cyber Unit, Six Months On
by Jonathan S. Kolodner, Rahul Mukhi, Matthew C. Solomon and Anne Titus Hilby

On September 25, 2017, the U.S. Securities and Exchange Commission (“SEC” or the “Commission”) announced the creation of a Cyber Unit within the Enforcement Division in order to further the Division’s “substantial expertise in the detection and pursuit of fraudulent conduct in an increasingly technological and data-driven landscape.”1 Commenting on the launch of the new unit, Enforcement Division Co-Director Stephanie Avakian described “[c]yber-related threats and misconduct” as “among the greatest risks facing investors and the securities industry.”2

In the six months since the Cyber Unit was launched, cybersecurity has remained at the forefront of the SEC’s priorities, repeatedly highlighted as a  focus  of  senior  SEC  officials’  public  comments3 and a prominent component of the SEC’s 2018 exam priorities.4 This article begins by highlighting certain of the SEC’s cyber enforcement actions since the Cyber Unit was formed, which unsurprisingly have focused on hacking as well as cryptocurrencies and initial coin offerings (“ICOs”). It then considers how these early actions, together with public statements and commentary from Enforcement Division leadership, are likely to translate into additional enforcement activity. In particular, we expect that the next wave of enforcement activity may involve cases against SEC registrants in connection with their failure to maintain adequate cybersecurity safeguards.

Early Enforcement Actions

The Cyber Unit was launched to focus principally on six areas of SEC enforcement: (1) “market manipulation schemes involving false information spread through electronic and sociaL media, (2)“hacking to obtain material nonpublic information,” (3) “violations involving distributed ledger technology and initial coin offerings,” (4) “misconduct perpetrated using the dark web,” (5) “intrusions into retail brokerage accounts,” and (6) “cyber-related threats to trading platforms and other critical market infrastructure.”5

While the Enforcement Division has taken action in a Number of these areas in recent years, enforcement efforts made public since the Cyber Unit was launched have been concentrated in two areas: alleged improper trading involving hacking, and fraud and misrepresentations related to cryptocurrencies and ICOs.6

Improper Trading Cases. In one of the Cyber Unit’s early enforcement actions, in October 2017, the SEC brought a fraud and market manipulation action against an individual for his role in an alleged scheme to gain unauthorized access to other individuals’ online trading accounts, place unauthorized trades through those accounts in order to affect the prices of various publicly traded securities, and then trade in those securities through his own accounts at a profit.7 The case is currently stayed    pending the parallel criminal proceedings brought by the U.S. Department of Justice (“DOJ”).8  Both cases remain pending.

In another case brought by the Cyber Unit in parallel with the DOJ earlier this month, the Commission filed insider trading charges against the former Chief Information Officer (“CIO”) of an Equifax business unit in connection with his trading in the company’s stock prior to Equifax’s public disclosure that it had been the victim of a massive data breach.9 The indictment alleges that the CIO used material non- public information about the breach to sell his Equifax stock before the breach was made public thereby avoiding approximately $117,000 in losses. Some of the alleged evidence against the CIO includes inculpatory text messages and Internet searches, including searches for terms related to the drop in stock price of another credit reporting agency that had faced a breach, shortly before the CIO executed his trades in Equifax stock.10 Both the SEC and DOJ cases remain pending.

Cryptocurrency and ICO Cases. Perhaps the clearest and most pronounced impact of the Cyber Unit to date is in the area of cryptocurrencies and ICOs. Here, the SEC has brought a number of actions against companies for allegedly operating unregistered exchanges,11 engaging in the unregistered offering and sale of securities,12 and misleading investors with claims of outsized returns and unsubstantiated product offerings.13 It has also suspended trading in the securities of a number of cryptocurrency-related enterprises following questions about the accuracy and adequacy of information about these companies, including their operations, compensation structures, and assets.14 Among the issues being litigated by the SEC, and by the DOJ in parallel criminal actions, is whether and when a cryptocurrency qualifies as a form of a security called an “investment contract” under the test set forth by the Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946).15 As of the time of this article, at least one SEC administrative order has found that ICO-based digital tokens to be issued on a distributed ledger constitute securities under Howey and its progeny,16 and the issue is currently under consideration in a DOJ prosecution in the Eastern District of New York.17

Looking Ahead

As described above, the SEC’s cyber enforcement has largely been concentrated in alleged improper trading involving hacking, and fraud and misrepresentation related to cryptocurrencies and ICOs since the launch of the Cyber Unit. The Unit’s focus on alleged illicit trading and fraudulent offering of securities is not surprising as these cases are a traditional focus of the Commission’s Enforcement Division. Looking ahead, the enforcement actions brought thus far by the Cyber Unit, as well as the Commission’s guidance and public comments by SEC officials over the past six months, provide a potential roadmap for the Unit’s priorities going forward, many of which may echo the SEC’s actions to date:

  • Continued enforcement relating to misconduct involving cryptocurrencies and fraudulent and prohibited trading practices. Avakian recently told an audience of investment advisers that the SEC has “dozens” of cryptocurrency investigations underway and that they should “expect to see more and more.”18 Separately, cybersecurity guidance the Commission released in February 2018 (“2018 Cybersecurity Guidance”) reminded public companies that the prohibition on trading on material non-public information includes material non-public information regarding cybersecurity incidents and cyber risks.19 SEC enforcement in these areas appears to be here to stay and will likely only increase.
  • Enforcement surrounding cyber-related disclosures, policies, and procedures. Cyber- related public company disclosures has also been identified as an “enforcement interest” for the Cyber Unit. The 2018 Cybersecurity Guidance expanded upon 2011 guidance20that public company disclosure requirements may apply to cyber incidents and risks.21  Factors that may inform whether a cyber risk or incident is material requiring disclosure include the harm the incident could cause to a company’s reputation, financial performance, or customer or vendor relationships, and an incident’s potential to lead to adverse actions such as a regulatory investigation or litigation.22 The 2018 Cybersecurity Guidance also recommended public companies implement and regularly assess corporate cybersecurity policies and procedures, including those related to disclosure of cyber incidents and risks as well as to the prevention of trading on material non-public information about such incidents and risks.23 Some SEC Commissioners have gone even further to call for new SEC rulemaking requiring the filing of a current report on form 8-K upon a material cyber event.24 Although the SEC has not yet brought a disclosure action related to cybersecurity risks or incidents, Yahoo! and Equifax have both publicly acknowledged receiving SEC inquiries following the disclosures of their respective data breaches.25
  • Enforcement against cyber-related misconduct to gain an unlawful market advantage. In an October 2017 speech, Avakian described misconduct, such as hacking, to gain unlawful market advantages as an area of “enforcement interest” for the Cyber Unit.26This was echoed in cases highlighted in the Enforcement Division’s most recent Annual Report27:  In late 2016, the SEC brought charges against three Chinese traders for allegedly trading on material non-public information obtained by hacking the computer systems of two large law firms.28 And in early 2017, the SEC brought charges against an individual who allegedly used a false EDGAR filing to manipulate the price of Fitbit stock for personal profit.29

Failure to Maintain Cybersecurity Safeguards:  The Next Wave?

While it is safe to assume that the Cyber Unit will pursue trading, cryptocurrency, and disclosure cases in the months ahead, there are also signs that the SEC may seek to bring enforcement actions in an area that has been somewhat less publicized—alleged failures to maintain reasonable cybersecurity safeguards. In the same October 2017 speech cited above, Avakian identified safeguarding information and ensuring system integrity as another area of “enforcement interest” for the Cyber Unit.30 Specifically, she noted that SEC Regulations S-P, SCI, and S-ID require that covered entities “understand the risks they face and take reasonable steps to address those risks,” including to put “reasonable safeguards in place to address cybersecurity threats.”31 While such cases  have  not been brought by the Cyber Unit to date, other Enforcement Division actions provide a roadmap of what some of these cases could look like.

Regulation S-P. Rule 30(a) of Regulation S-P, the so- called “Safeguards Rule,” requires SEC-registered brokers, dealers, investment companies, and investment advisers to “adopt written policies and procedures  that address administrative, technical, and physical safeguards for the protection of customer records and information.”32 These policies and procedures must be “reasonably designed” to (1) “[i]nsure the security and confidentiality of customer records and   information,” (2) “[p]rotect against any anticipated threats or hazards to the security or integrity” of such records and information, and (3) “[p]rotect against unauthorized access to or use of customer records or information that could result in substantial harm or inconvenience to any customer.”33

In 2016, the SEC brought an action against Morgan Stanley Smith Barney (“MSSB”), a registered broker- dealer and investment adviser, after an employee misappropriated personally identifiable customer information from 730,000 customer accounts, including names, phone numbers, addresses, account information, and securities holdings, and some of that data was later made available for sale online.34 The SEC found that MSSB violated the Safeguards Rule by failing to adopt written policies and procedures reasonably designed to protect customer records and information, such as authorization mechanisms restricting employee access to confidential customer data, auditing and/or testing such authorizations over the 10 years they had been in effect, or monitoring employee access to relevant databases for unusual or suspicious patterns.35 Under the terms of the settlement, MSSB paid a $1 million civil money penalty, agreed to cease and desist from violating the Safeguards Rule, and was censured.36 Although this action preceded the new Cyber Unit, it provides a useful roadmap of how the new Unit  might employ the Safeguards Rule as an enforcement tool in the wake of a data breach.

Regulation SCI. Rule 1001(a)(1) of Regulation SCI requires SCI entities, i.e., SCI self-regulatory organizations, SCI alternative trading systems, plan processors, or exempt clearing agencies subject to the SEC’s Automation Review Policies,37 to have and enforce “written policies and procedures reasonably designed to ensure that its SCI systems . . . have levels of capacity, integrity, resiliency, availability, and security, adequate to maintain the SCI entity’s operational capability and promote the maintenance of fair and orderly markets.”38 Such policies and procedures must include, among other things, “[b]usiness continuity and disaster recovery plans that include maintaining backup and recovery capabilities sufficiently resilient and geographically diverse and that are reasonably designed to achieve next business day resumption of trading and two-hour resumption of critical SCI systems following a wide-scale disruption.”39

Earlier this month, the Commission brought an action against the New York Stock Exchange and an affiliated exchange (together, “NYSE”) for failing to have in place adequate policies and procedures reasonably designed to ensure operational capability.40 In the event of a “wide-scale disruption” that left NYSE’s trading systems unable to operate, the exchanges planned to rely on the backup system of a third affiliated exchange which would support NYSE trading but report those intraday trades on its own (rather than NYSE’s)   tapes and conduct those trades according to its own rules.41 The Commission found this violated the requirement of Rules 1001(a)(1) and 1001(a)(2)(v) of Regulation SCI to have policies and procedures reasonably designed to ensure operational capability, including business continuity and disaster recovery plans “reasonably designed to achieve next business day resumption of trading and two-hour resumption of critical SCI systems.”42 SCI entities would do well to consider these requirements when planning for business continuity and operational capabilities following a wide-scale cyber- disruption.

Regulation S-ID. Regulation S-ID requires brokers, dealers, investment advisers, and investment companies, among others, to maintain a written program “designed to detect, prevent, and mitigate identity theft” in connection with certain covered accounts.43 Requirements of the program include having policies and procedures reasonably designed to identify, detect, and respond to red flags; policies and procedures reasonably designed to ensure periodic updates to the program in light of changes in the risks identity theft poses to customers and to the safety and soundness of the institution; and calibrating the program to the “size and complexity” of the institution and “nature and scope of its activities.”44

The MSSB and NYSE actions shed light on how the Cyber Unit might approach future actions for failure to maintain reasonable cybersecurity safeguards. Notably, both occurred following incidents that left individuals or  systems  vulnerable—in  one  case,  a  breach that exposed customer personally identifiable information, and actual trading disruptions in the other. And, both were pursued despite an absence of findings that the policies, procedures, or processes at issue caused obvious economic harm to customers or investors, i.e., that customers’ were the victims of actual identity theft as a result of the breach of their personal data or that they suffered losses or the inability to trade as a result of the backup systems employed.45


The Cyber Unit’s first six months have been marked by actions both in longstanding areas of SEC enforcement, such as prohibited trading practices, and emerging technologies and activities, such as cryptocurrencies and ICOs. Signals from the SEC and its senior leadership in speeches, reports, and guidelines, as well as cases and comments from other financial industry regulators, indicate that the SEC and other regulators are likely only to ramp up cyber-related enforcement going forward. One area that is worth watching is the SEC’s interest in bringing investigations and cases based on the failure to maintain adequate cybersecurity safeguards. While the SEC might be constrained in the number of such cases it could bring, given the limited number of regulated entities that have obligations to maintain such safeguards, all regulated entities will want to monitor the Cyber Unit’s actions in this area as a potential bellwether of the SEC’s interest in using its enforcement powers to promote prophylactic measures against cyberattacks while at the same time continuing to bring traditional reactive cases.


1 Press Release, SEC, SEC Announces Enforcement Initiatives to Combat Cyber-Based Threats and Protect Retail Investors (Sept. 25, 2017) (“Cyber Unit Press Release”),

2 Id.

3 See, e.g., Robert J. Jackson, Jr., Comm’r, SEC, Corporate Governance: On the Front Lines of America’s Cyber War (Mar. 15, 2018),; William Hinman, Dir. Div. Corp. Fin., SEC, Keynote Address at the PLI’s Seventeenth Annual Institute on Securities Regulation in Europe (Feb. 1, 2018),; Jay Clayton, Chairman, SEC, Opening Remarks at the Securities Regulation Institute (Jan. 22, 2018),; Stephanie Avakian, Co-Dir. Div. Enf’t, SEC, Securities Enforcement Forum Keynote Speech (Oct. 26, 2017) (“Avakian Cyber Unit Speech”),

4 See SEC Office of Compliance Inspections and Examinations, 2018 National Exam Program Examination Priorities 9 (Feb. 7, 2018) (“We will continue to prioritize cybersecurity in each of our examination programs. Our examinations have and will continue to focus on, among other things, governance and risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response.”), program-priorities-2018.pdf.

5 Cyber Unit Press Release.

6 A list of cyber-related SEC enforcement actions is available at enforcement-actions.

7 See Complaint ¶¶ 1-4, SEC v. Willner, No. 1:17-cv-06305 (E.D.N.Y. Oct. 30, 2017), ECF No. 1, pr2017-202.pdf.

8 See Willner, ECF No. 9 (Nov. 29, 2017); see also United States v. Willner, No. 1:17-cr-00620 (E.D.N.Y. Jun. 8, 2017).

9 See Complaint ¶¶ 1-2, SEC v. Ying, No. 1:10-cv-01069 (N.D. Ga. Mar. 14, 2018), pr2018-40.pdf; see also Rahul Mukhi, Alexis Collins & Kal Blassberger, DOJ and SEC Charge Former Equifax Executive With Insider Trading, Cleary Cybersecurity and Privacy Watch Blog (Mar. 15, 2018), former-equifax-executive-insider-trading/.

10 See Ying ¶¶ 42-43.

11 See, e.g., Complaint ¶¶ 52-54, SEC v. Montroll, No. 1:18- cv-01582 (S.D.N.Y. Feb. 21, 2018), pr2018-23.pdf.

12 See, e.g., Complaint ¶¶ 47-49, SEC v. AriseBank, No. 3:18-cv-00186 (N.D. Tex. Jan. 25, 2018), pr2018-8.pdf; Munchee Inc., Securities Act Release No. 10445 (Dec. 11, 2017),

13 See, e.g., Complaint ¶¶ 49-53, SEC v. PlexCorps, No. 1:17-cv-07007 (E.D.N.Y. Dec. 1, 2017), pr2017-219.pdf; Complaint ¶¶ 38-49, SEC v. Recoin Grp. Found., LLC, No. 1:17-cv-05725 (E.D.N.Y. Sept. 29, 2017), pr2017-185.pdf.

14 See, e.g., HD View 360 Inc., Exchange Act Release No. 82800 (Mar. 1, 2018), and o.pdf; PDX Partners Inc., Exchange Act Release No. 82725 (Feb. 15, 2018), and o.pdf; UBI Blockchain Internet, Ltd., Exchange Act Release No. 82452 (Jan. 5, 2018), and o.pdf; The Crypto Co., Exchange Act Release No. 82347 (Dec. 18, 2017), ve/susparch2017.shtml and o.pdf.

15 Under Howey, an investment contract is (1) an investment of money (2) in a common enterprise (3) with a reasonable expectation of profits (4) to be derived from the efforts of others. See 328 U.S. at 298-99; see also SEC v. Edwards, 540 U.S. 389, 393 (2004) (same).

16 See Munchee, at 1-2.

17 See Motion to Dismiss Indictment for Subject Matter Jurisdiction and Vagueness and Memorandum in Opposition to Motion to Dismiss the Indictment, United States v. Zaslavskiy, 1:17-cr-00647 (E.D.N.Y.), ECF Nos. 22 (Feb  27, 2018), 24 (Mar. 19, 2018).  While it does not appear that this issue has been decided in the context of the cryptocurrency-related actions brought by the Cyber Unit, federal courts in Texas and New York have granted preliminary injunctions in at least three of these actions. See AriseBank, ECF Nos. 61 (Mar. 9, 2018), 69 (Mar. 19, 2018); PlexCorps, ECF No. 25 (Dec. 14, 2017); Recoin Group, ECF No. 11 (Nov. 13, 2017).

18 Andrew Ramonas, SEC Working on ‘Dozens’ of Cyptocurrency Probes, Official Says, BLOOMBERG (Mar. 15, 2018), n57982089945/.

19 See SEC, Commission Statement and Guidance on Public Company Cybersecurity Disclosures, 83 Fed. Reg 8166, 8171-72 (Feb. 26, 2018), 8-03858/commission-statement-and-guidance-on-public- company-cybersecurity-disclosures.  For a complete analysis of the 2018 Cybersecurity Guidance, see SEC Issues Interpretive Release on Cybersecurity Disclosure, Cleary Cybersecurity and Privacy Watch Blog (Feb. 28, 2018), content/uploads/sites/458/2018/02/2018_02_28-SEC-Issues- Interpretive-Release-on-Cybersecurity-Disclosure.pdf.

20 See generally SEC Div. Corp. Fin., CF Disclosure Guidance Topic No. 2: Cybersecurity (Oct. 23, 2011), topic2.htm.

21 The 2018 Cybersecurity Guidance specifically noted disclosures related to regular periodic reports, registration statements, and keeping shelf registrations statements current.  See 83 Fed. Reg. at 8168-69.

22 See SEC Issues Interpretive Release on Cybersecurity Disclosure, at 2.

23 See 2018 Cybersecurity Guidance, 83 Fed. Reg. at 8171-72.

24 See Jackson, Corporate Governance: On the Front Lines of America’s Cyber War; Kara M. Stein, Comm’r, SEC, Statement on Commission Statement and Guidance on Public Company Cybersecurity Disclosures (Feb. 21, 2018), 2018-02-21.

25 See Equifax Inc., Quarterly Report (Form 10-Q), at 41 (Nov. 9, 2017) (explaining Equifax was “cooperating with federal . . . agencies and officials investigating or otherwise seeking information and/or documents, including through Civil Investigative Demands, regarding the cybersecurity incident and related matters, including . . . the U.S. Securities and Exchange Commission”), show.aspx?FilingId=12372346&Cik=0000033185&Type=P DF&hasPdf=1; Yahoo! Annual Report (Form 10-K), at 46 (Mar. 1, 2017) (explaining Yahoo! was “cooperating with federal, state, and foreign governmental officials and agencies seeking information and/or documents about the Security Incidents and related matters, including the U.S. Securities and Exchange Commission”), 12517065791/d293630d10k.htm#tx293630_29.

26 See Avakian Cyber Unit Speech.

27 See SEC Div. Enf’t, Annual Report A Look Back at Fiscal Year 2017, at 13 (Nov. 15, 2017), 2017.pdf.

28 See Complaint ¶¶ 1-13, 18-20, SEC v. Hong, No. 1:16-cv- 9947 (S.D.N.Y. Dec. 27, 2016), pr2016-280.pdf.

29 See Complaint ¶¶ 1-4, SEC v. Murray, No. 1:17-cv-03788 (S.D.N.Y. May 19, 2017), pdf. Earlier this month, Murray was sentenced to two years imprisonment after pleading guilty to charges brought by the DOJ for the same conduct. See False EDGAR Filer Sentenced to Two Years in Prison for Fitbit Manipulation Scheme, Litigation Release No. 24075 (Mar. 22, 2018) (citing United States v. Robert Murray, No. 1:17-cr-00452 (S.D.N.Y. May 5, 2017)).

30 See Avakian Cyber Unit Speech.

31 Id.

32 17 C.F.R. § 248.30(a).

33 Id.

34 See Morgan Stanley Smith Barney LLC, Exchange Act Release No. 78021, at 1 (June 8, 2016),   35 See id. ¶¶ 1-3, 8.

36 See id. ¶ 19.

37 See 17 C.F.R. § 242.1000; SEC, Regulation Systems Compliance and Integrity, 79 Fed. Reg. 72252, 72258-59 (Dec. 5, 2014).

38 17 C.F.R. § 242.1001(a)(1).

39 Id. § 242.1001(a)(2)(v).

40 See N.Y. Stock Exch. LLC, Exchange Act Release No. 82808 (March 6, 2018),

41 See id. ¶¶ 37-38.

42 Id. ¶ 39.

43 See 17 C.F.R. §§ 248.201(a) (listing regulated entities), (d)(1) (setting out requirements). A “covered account” is “[a]n account that a financial institution or creditor offers or maintains, primarily for personal, family, or household purposes, that involves or is designed to permit multiple payments or transactions, such as a brokerage account with a broker-dealer or an account maintained by a mutual fund (or its agent) that permits wire transfers or other payments to third parties,” and “[a]ny other account that the financial institution or creditor offers or maintains for which there is a reasonably foreseeable risk to customers or to the safety and soundness of the financial institution or creditor from identity theft, including financial, operational, compliance, reputation, or litigation risks.”

Id. § 248.201(b)(3).

44 See id. § 248.201(d).

45 Of course, cybersecurity priorities and enforcement authorities do not end with the SEC. Similar to Regulation SCI, the Financial Industry Regulatory Authority requires members to establish and maintain business continuity plans that address, at minimum, data back-up and recovery; operational assessments; critical business, constituent, and counterparty impacts; and customer access to funds and securities in the event of a significant disruption.  See FINRA Rule 4730. And the Regulation S-ID requirements are mirrored by CFTC rules instituting these requirements for certain CFTC-regulatees. See 17 C.F.R. §§ 162.30, 162.32; see also CFTC & SEC, Identity Theft Red Flags Rules, 78 Fed. Reg. 23638 (Apr. 19, 2013). In February 2018, the CFTC reached a settlement enforcing these parallel rules. See Jonathan S. Kolodner, Rahul Mukhi & Richard Cipolla, Recent Enforcement Actions by Regulators Show Continued Focus on Cybersecurity and Data Protection Issues, Cleary Cybersecurity and Privacy Watch Blog (Mar. 12, 2018), enforcement-actions-regulators-show-continued-focus- cybersecurity-data-protection-issues/#more-2107.

This post comes to us from Cleary, Gottlieb, Steen & Hamilton LLP. It is based on the firm’s memorandum, “Enforcement Activity in the SEC’s Newly-Created Cyber Unit: The First Six Months and What’s Next,” dated March 30, 2018, and available here.

April 3, 2018
How CEOs’ Personal Finances Affect Their Companies’ Financial Decisions
by Timo P. Korkeamaki, Eva Liljeblom and Daniel Pasternack

A number of recent studies have focused on how the behavior of chief executives affects their firms’ financial decisions. We contribute to this literature by looking at the connections between CEOs’ personal finances and those of their firms. Unique data from the Finnish tax authorities allow us to examine these connections in detail. Our dataset contains information on the personal indebtedness and personal securities holdings of CEOs of all publicly-traded firms in Finland. We avoid the challenges typical of U.S. studies, where the data limit the analysis of managers’ wealth to their stock and option awards.

Our analysis finds a positive link between the market risk of a firm and that of its CEO’s personal portfolio. We also find that connection to be weaker in firms that have powerful block-holders among their shareholders, suggesting that shareholders may not benefit when there is correlation between a CEO’s personal risk taking and that of the firm. Our results further indicate that when a manager’s personal wealth is closely tied to his firm’s, he becomes more risk averse. Interestingly, CEOs’ demographic characteristics are also reflected in how much risk their firms take. Wealthier CEOs tend to run firms that tolerate more risk, and the level of risk drops as the CEO’s tenure lengthens. These findings suggest that Finnish managers’ risk aversion decreases with wealth, in both absolute and relative terms. The small size of Finnish CEOs’ stock portfolios limits the depth of our analysis.

Our study yields a number of interesting conclusions. In aggregate, the CEO’s personal indebtedness is strongly linked to her firm’s capital structure, measured by book leverage and market leverage. When we consider the determinants of that relationship, we find that only powerful CEOs exhibit that connection. Obviously, less powerful CEOs would find it more difficult to impose their personal preferences on firm behavior. According to our results, either a dual role as chairman and a CEO or longer CEO tenure seems to be a prerequisite for the connection. When we conduct our analysis separately for sub-samples of powerful and weak CEOs, we find that the connection between personal leverage and firm leverage does not exist in firms where the CEO does not serve a dual role, and in firms where the CEO has been in office for less than our sample median of four years. Our finding related to tenure is also consistent with earlier studies, which find that changes in corporate capital structure happen slowly. As in the study of wealth portfolios, we find that the level of personal wealth tied to the firm weakens the relationship between personal finances and firm finances. That is consistent with the idea that in the presence of strong economic incentives, behavioral preferences of the manager become muted.

Establishing direction of causality is a typical concern in studies of the connections between CEOs and their firms. The question is whether CEOs’ personal preferences determine the firm’s financial decisions, or whether firms recruit managers whose personal preferences match those of the firm. We find, for instance, that the personal financial attributes of newly-appointed CEOs often deviate significantly from those of the firm and their predecessors. That finding supports the notion that CEOs make the firm behave according to their personal preferences, instead of firms choosing managers whose preferences match those of the firms.

Our findings have important implications for corporate governance. As measured by personal investment portfolios and use of personal debt, we find support for the notion that CEOs impose their personal preferences on their firms’ financial decision-making. We further find that such behavior is most prevalent in companies with weaker corporate governance, as CEO power and lack of shareholder power strengthen the matching relationship. Our results suggest that firms should pay attention to their CEOs’ personal preferences, and either limit their power to make financial decisions or hire managers whose priorities match those of the firm and its shareholders.

This post comes to us from professors Timo P. Korkeamaki, Eva Liljeblom, and Daniel Pasternack at the Hanken School of Economics and, in Mr. Pasternack’s case, Elite Alfred Berg / Elite Asset Management Plc. It is based on their recent papers, “CEO’s total wealth characteristics and implications on firm risk,”  available here, and “CEO power and matching leverage preferences,” available here.

April 3, 2018
2018 Proxy Season Preview
by Shirley Westcott, Alliance Advisors

This year’s proxy season will once again bring attention to shifting investor priorities, with environmental and social (E&S) issues at the forefront of engagement discussions and shareholder resolutions. Changes over the past year to the policies and voting practices of several major index investors, along with a bold pronouncement by BlackRock that corporations should “serve a social purpose,” underscore this progression.

How far this trend advances remains to be seen, but it will be a key development to watch throughout proxy season. Money managers are continuing to face pressure from social activists to align their voting practices with their stated positions on climate change—which was a driving force in catapulting three climate risk proposals over the majority threshold in 2017. More recently, elected officials have made demands that investment funds use their financial clout to pressure firearms companies to take steps to reduce gun violence. Activist hedge funds are also taking an increasing interest in corporate sustainability, which could lead to collaborations with other institutional investors on social responsibility campaigns.


As in 2017, E&S themes will dominate the shareholder proposal landscape. Of the submissions that have been publicized to date, nearly two-thirds deal with E&S topics and one-third of those fall into the environmental category. Like past years, many of these can be expected to be withdrawn following productive dialogues and company commitments. Others may be less likely to survive no-action challenges as a result of more flexible guidance from the SEC regarding ordinary business and economic relevance exclusions.

Filings of governance proposals will remain relatively low this season after reaching a high-water mark two years ago when there was a profusion of proxy access resolutions. Many standard governance measures—including proxy access—have already been widely adopted or are being addressed through engagement rather than proxy proposals.

Two standout issues from 2017—board diversity and climate change risk—are likely to gain more traction in 2018 as a result of stronger positions taken by several prominent asset managers. The recent deluge of sexual misconduct allegations and the #MeToo movement have also drawn investor attention to corporate culture and gender-related concerns, including pay equity, workforce diversity, and parental leave.

New and revived proposals on tap this year reflect media headlines, such as the opioid drug epidemic, fake news, cybersecurity, and gun violence. Also on activists’ radar are contentious holdovers from 2017—the proliferation of virtual-only annual meetings and dual-class stock.

At least for this year, investors and proxy advisors Institutional Shareholder Services (ISS) and Glass Lewis are taking a wait-and-see approach to the long-awaited debut of CEO/median pay ratios. Shareholders will also be closely monitoring revisions to executive compensation programs resulting from changes to the rules governing performance-based pay under the Tax Cuts and Jobs Act.

Highlights of the upcoming proxy season are discussed in more detail below.


Proxy Access

Shareholder proposals to adopt proxy access continue to diminish in volume after filings reached triple digits between 2015 and 2017. The pullback has been due to the increasing number of companies that have implemented the measure, which now stands at 66% of the S&P 500 Index, and because the lead sponsor—the New York City Comptroller (NYCC)—has moved on to another phase of its Boardroom Accountability Project.

Even in the absence of proxy proposals, other companies—including the remaining S&P 500 firms—could fall into line by virtue of investor pressure. Beginning in March, State Street Global Advisors (SSGA) will start screening S&P 500 companies for their adherence to the Investor Stewardship Group’s (ISG) governance principles. Companies that fail to comply with at least three of SSGA’s 13 screening guidelines or explain their reasons for non-compliance may face withhold votes from their independent board chair, lead director, or most senior independent director. Based on SSGA’s review of 2017 proxy filings, 13% of S&P 500 companies are non-compliant, primarily due to a lack of proxy access rights.

Still plentiful this year are resolutions sponsored by individual investors John Chevedden, James McRitchie, Myra Young, and Kenneth Steiner which seek to amend specific provisions in existing proxy access bylaws—primarily to allow unlimited group aggregations to meet the ownership requirement. In some cases, they also want to raise the board seat cap, either to the greater of two directors and 25% of the board, or to a minimum of two to three nominees depending on whether the board size is above or below 12 directors.

Last year’s “fix-it” resolutions—which essentially sought to increase aggregation limits to 40 or 50 shareholders—were excludable under Rule 14a-8(i)(10) if the petitioning company could demonstrate that it already had a meaningful proxy access right based on the makeup of its shareholder base. Issuers have been unable to exclude the 2018 proposals as substantially implemented because Staff concluded that their market standard proxy access bylaws did not compare favorably with the guidelines of the proposal. Nevertheless, support for fix-it proposals remains lackluster, averaging 27.6% so far this year, notwithstanding the backing of ISS. Glass Lewis generally opposes fix-it resolutions if the company’s bylaw conforms to broad market practice.

Virtual-Only Meetings

The trend towards digitally-enabled annual meetings is expected to accelerate as companies take advantage of technology to cut costs and enhance shareholder accessibility. Broadridge Financial Solutions said it expects to facilitate over 300 virtual meetings in 2018, up from 236 in 2017, though about 20% will be hybrid events, combining a physical meeting with an audio or webcast component.

Cyber-only meetings are a non-issue for most institutional investors since they do not typically attend annual meetings and conduct engagements with issuers throughout the year. However, these types of meetings are encountering resistance from activist shareholders who contend that online forums do away with their ability to directly confront boards and managements and raise challenging questions.

Last April, the New York City Pension Funds (NYC Funds) amended their voting guidelines to oppose nominating/governance committee members at S&P 500 companies that hold virtual-only meetings, which will be extended to all companies in 2018. Glass Lewis recently adopted a similar policy, which takes effect in 2019, though it will give governance committee members a pass if shareholders are afforded the same rights and opportunities to participate in the virtual-only meeting as they would at an in-person event.

Shareholder proposals to reinstate physical meetings have also reemerged this year, even though all of those submitted in 2017 were omitted as ordinary business. To date, two of the targeted companies—ConocoPhillips and Union Pacific—have acquiesced to the request, while a third proposal is pending at Comcast. Chevedden’s group is taking an indirect approach as well, by asking several firms—Alaska Air Group, PayPal Holdings, Intel and Union Pacific—to amend their proxy access bylaws, adopt written consent, or appoint an independent board chairman as a trade-off for their taking away shareholders’ right to attend an in-person meeting.

Companies that are contemplating a virtual-only meeting should take into account a number of factors, including whether there are any controversial items on the ballot, whether the company is facing any significant shareholder dissent, and whether past annual meetings have been widely or lightly attended. Additional guidance was issued in a 2012 industry committee report, “Guidelines for Protecting and Enhancing Online Shareholder Participation in Annual Meetings,” which is being updated for the 2018 proxy season.

Dual-Class Stock

Multi-class share structures with unequal voting rights will continue to face investor scrutiny after several high-profile initial public offerings (IPOs) of non-voting stock last year unleashed a firestorm of criticism.

In response to market pressure, S&P Dow Jones and FTSE Russell began excluding certain multi-class companies from their broad market indices last summer. MSCI has since extended its review of the matter, and in January issued a proposal to adjust the index weights of multi-class stocks to reflect both their free float and their disproportionate voting power. If implemented, the plan will apply to new listings in November 2018 and to existing constituents in 2021.

ISS and Glass Lewis have also instituted policies to generally recommend against boards or governance committee members of newly public companies with unequal voting stock unless they include a sunset provision to phase out their supervoting shares.

Beginning this year, Glass Lewis will additionally apply its board responsiveness policy to dual-class companies based on a majority vote of the low-vote shares.

Although most investors support equal voting rights for shareholders, several—including BlackRock, Vanguard Group, and SSGA—have publicly decried the indices’ ban because it could limit returns for their clients.

SEC Commissioner Robert Jackson echoed those sentiments and called on the national securities exchanges to consider addressing perpetual dual-class stock in their listing standards.

As of yet, the indices’ ban has not deterred companies from going public with multiple classes of shares. According to the Council of Institutional Investors (CII), 19% of last year’s IPOs had unequal voting stock, excluding foreign private issuers, special purpose acquisition companies, and master limited partnerships. However, 26% of these firms included time-based sunsets on their supervoting shares—a new record among IPOs.

No-Action Requests

New guidance from the SEC is providing issuers with more leeway in omitting certain types of shareholder proposals. Under Staff Legal Bulletin (SLB) 14I, companies relying on the ordinary business or economic relevance exclusions may include a board-level analysis in their no-action requests to support their argument that the issue raised in the proposal is not significant to the company’s business. In the past, Staff has had to make difficult judgment calls in this regard, which it feels boards are better positioned to address in the first instance. SLB 14I also adds procedural hurdles for shareholders who submit resolutions through a representative (“proposals by proxy”) and clarifies when issuers may exclude graphics and images from shareholder proposals.

To date, the Division of Corporation Finance has only rendered no-action decisions under the new framework in a handful of cases, though there many others pending dealing with proposal topics ranging from lobbying and political spending to climate change and human rights. Several cases where no-action relief was denied—Apple, AmerisourceBergen, Citigroup and Eli Lilly—are instructive regarding Staff’s expectations. In downplaying the significance of a proposal to business operations, companies should include a quantitative or similar analysis in their no-action requests and adequately address past shareholder votes on the matter. They should also verify that they have not made any contradictory statements in other communications, such as social responsibility reports, that highlight the importance of the issue to the business.

While it is too early to assess the impact of the new guidance on omissions, issuers are hopeful that, in the absence of legislation to reform the 14a-8 process, it may help curb the number of shareholder resolutions that simply promote social and political causes and often generate low support.

The conflicting proposal exclusion is once again drawing investor criticism after the SEC limited its application in 2015 following some controversy over proxy access resolutions. Earlier this year, AES and CF Industries Holdings were allowed to exclude proposals from John Chevedden to reduce the share ownership threshold for calling special meetings to 10%, based on Rule 14a-8(i)(9). In both cases, as well as several others pending, the management proposals are simply asking shareholders to ratify the retention of their current special meeting thresholds and provisions. Although there is precedent for the no-action decisions, CII protested to the SEC that companies are effectively “gaming the system.” In subsequent no-action letters to eBay, ITT, JPMorgan Chase and Capital One Financial, Staff resolved the matter by concurring with omission as long as the company included the following disclosures in its proxy statement, consistent with Rule 14a-9:

  • That it has omitted a shareholder proposal to lower the special meeting ownership threshold,
  • That the company believes a vote in favor of ratification is tantamount to a vote against a proposal lowering the threshold,
  • The impact on the special meeting threshold, if any, if ratification is not received, and
  • The company’s expected course of action, if ratification is not received.With this outcome, issuers now have an avenue for omitting often persistent requests to reduce their special meeting thresholds to 10% or 15%, particularly since the SEC has not permitted exclusion of these resolutions on substantial implementation grounds. So far, Chevedden and his affiliates have floated upwards of 40 “special meeting improvement” proposals for 2018—a 40% increase over last year.Separately, the SEC appears to have reversed course on omitting proposals calling for an independent board chairman that make reference to the New York Stock Exchange’s (NYSE) definition of “independent director.” In 2013, it permitted exclusion of such resolutions as vague and indefinite because they failed to explain the NYSE’s independence requirements, which Staff considered a central aspect of the proposal. This year the SEC denied Bloomin’ Brands and Sears Holding no-action relief for essentially identical proposals, though Staff did not provide any explanatory comments.


Pay Ratios

2018 marks the inaugural year for the disclosure of CEO/median employee pay ratios as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Yet, for all of the time and resources expended by issuers in preparing the calculations, they appear to be a non-event for many mainstream investors. In a recent interview, Vanguard said that the pay ratios will do more to “inflame than inform,” while T. Rowe Price Group observed that this is “not an institutional investor issue—it’s a local newspaper issue.” Other institutions have indicated that they do not intend to use the pay ratios to inform their proxy voting or engagement unless they encounter extreme outliers or in cases of close calls on executive compensation votes. Similarly, the proxy advisors only plan to display the pay ratios in their research reports this year.

The key indicator this season—and the one that may cause more immediate backlash—is median employee pay. Labor and social activists may use it to fuel inequality campaigns, while employees may be demoralized if they discover they are paid below the median or that competitors pay more. To deflect adverse reactions, a few companies—such as AES and Marathon Petroleum—are including supplemental pay ratios or other context around their workforce, such as their use of part-time, seasonal, or temporary employees and foreign workers.

Although peer group comparisons won’t be feasible this season, Equilar and ISS have done some preliminary benchmarking. Equilar conducted an anonymous survey of 356 companies to identify the pay ratios they plan to report in their 2018 proxy statements. The results showed that companies with the highest revenue or the greatest number of employees had the largest median ratios: 263:1 for companies with over $15 billion in revenue and 318:1 for companies with over 2,310 employees. By industry, consumer discretionary companies, including retail and hospitality, had the highest median ratio (350:1) and energy firms had the lowest (72:1).

ISS did an “outside-in” look at pay ratios across Russell 3000 firms using Bureau of Labor Statistics data for average employee earnings. It similarly found that company size and industry had a significant impact on the numbers. The median CEO pay ratio for S&P 500 firms was 172:1—five times higher than that of Russell 3000 firms outside of the S&P 1500. Among industry groups, food and staples retailers had the highest ratio (143:1) and banks had the lowest (15:1).

The remaining Dodd-Frank rulemaking on compensation matters—clawbacks, employee and director hedging, and pay-for-performance—have been relegated to “Long-Term Actions” in the SEC’s latest Regulatory Flexibility Agenda. In a recent speech, SEC Chair Jay Clayton reiterated his commitment to completing these items and indicated that some of the executive compensation rules could be moved up to the short-term timetable when the next agenda is released.

Section 162(m)

Aside from pay ratios, companies will need to revisit their compensation programs due to changes to Section 162(m) of the IRS Code resulting from the Tax Cuts and Jobs Act. The new law eliminates the exception for qualified performance-based pay so that all annual compensation paid to a covered employee in excess of $1 million will no longer be tax deductible. The covered employee group now includes the CFO, and the status will be permanent for any executive who was a covered employee as of 2017. The new law also expands the definition of “publicly held corporation” to include companies that have publicly traded equity or publicly traded debt, as well as certain foreign private issuers. Compensation under written binding contracts in effect as of Nov. 2, 2017 will be grandfathered, so long as the contracts are not materially modified thereafter.

While the new regime will give issuers some additional flexibility in how they structure compensation plans, they need to be mindful that investors and proxy advisors will continue to expect pay programs to be largely performance-based. ISS, for example, said that it will continue to recommend against executive pay awards that are not reasonably linked to rigorous and transparent performance goals. Boards that switch to guaranteed or highly discretionary pay are likely to face investor backlash.

Director Compensation

In addition to executive plans, issuers will need to be more attentive to director compensation as a result of a change in ISS’s voting guidelines and recent shareholder litigation.

Pursuant to its 2018 policy updates, ISS will begin recommending against board committee members who are responsible for approving or setting non-employee director (NED) compensation if there is a pattern of excessive pay over multiple years without a compelling rationale. Historically, ISS has considered NED pay figures above the top 5% of comparable directors based on the index and industry median to be extreme outliers.

A recent derivative action will also impact how director plans are structured. In December, the Delaware Supreme Court ruled in In re Investors Bancorp, Inc. v. Stockholder Litigation that discretionary grants of director awards may be subject to review under the entire fairness standard, rather than the more deferential business judgement rule, even if they were granted under a shareholder-approved equity plan that contained meaningful limits on director compensation. The Court reasoned that the shareholder ratification defense would only apply when shareholders approved specific director awards or an equity plan that contained self-executing grants to directors.

As a result of the decision, Delaware companies could face more shareholder challenges to director compensation as unfair and excessive. To guard against this, companies should have a robust process in place for evaluating and approving director compensation packages, including a peer review to assess whether their director pay is reasonable. New or amended equity plans being submitted for shareholder approval should, at a minimum, include meaningful director-specific limits. To avail themselves of the shareholder ratification defense, companies should consider using non-discretionary formulaic grants for directors and obtaining shareholder approval of any extraordinary director grants.

Environmental & Social

Social Responsibility

The evolving views of institutional investors—particularly index funds—has vaulted sustainability and social responsibility into the limelight this year. In his recent annual letter, BlackRock CEO Larry Fink declared that portfolio companies must demonstrate a positive impact on society, lest they lose BlackRock’s support. BlackRock is backing this up in its updated 2018 voting guidelines which stipulate that it may vote against the election of directors or support a shareholder proposal where it has concerns that a company may not be dealing with E&S matters appropriately.

To support growing investor interest in E&S, ISS recently launched E&S QualityScore as a companion to its current governance ratings. The new system evaluates the quality of companies’ E&S disclosures relative to industry peers based on 380 factors used by certain standard-setters, such as the Global Reporting Initiative, Sustainability Accounting Standards Board, and the Financial Stability Board’s Task Force on Climate-Related Financial Disclosure (TFCD). ISS will initially grade about 1,500 companies in industries most exposed to E&S risks, such as energy, materials, and capital goods, and expand its coverage by mid-year to over 5,000 global companies. Like its governance ratings, E&S scores will appear in ISS’s proxy analyses but will not impact its voting recommendations.

Activist hedge funds are also jumping onto the environmental, social and governance (ESG) bandwagon. JANA Partners recently announced the launch of a social responsibility fund on the heels of a successful campaign with the California State Teachers’ Retirement System (CalSTRS) that urged Apple to enhance parental controls on iPhones. ValueAct Capital Partners is also taking advantage of the growing $114 billion market in impact investing with its own ESG-themed fund. Others, such as Trian Partners and Blue Harbor Capital, have incorporated ESG principles into their investment strategies, which may help them leverage ties with index funds, pension plans and other investors for their traditional activist campaigns. li> Despite this rising trend, prioritizing ESG has, in some cases, been at the expense of financial returns. Notwithstanding the long-running bull market, many public pension plans remain severely underfunded, which several studies attribute to politically-motivated investment decisions. According to the American Council for Capital Formation (ACCF), one third to one half of the worst-performing private equity (PE) funds in the portfolios of the New York City Employees’ Retirement System (NYCERS) and the California Public Employees’ Retirement System (CalPERS) are focused on ESG ventures, while none of their top-performing PE funds are in the ESG category. The NYCC’s recent decision to divest from fossil fuel companies over the next five years will undercut returns even more. A 2016 study by Boston College found that pension plans in states with divestiture requirements underperformed the returns of their peers by 40 basis points. Plan beneficiaries have also raised concerns. In a survey conducted by Spectrem Group, 86% of CalPERS members and 79% of NYC Fund members said that fund managers’ primary goal should be maximizing returns and not advancing social or political causes.

Board Diversity

Board diversity promises to be a dominant theme this proxy season and one where advocates are gearing up to make significant inroads. According to reports by Spencer Stuart and Equilar, female and minority representation on boards has increased only incrementally—typically 1% per year—though last year nearly half of S&P 500 board seats were filled by candidates from these groups. Small- and mid-cap companies still lag with 624 all-male boards among Russell 3000 firms, compared to only three at S&P 500 firms.

After years of letter writing and engagement, some investors remain dissatisfied with the pace of change and are expressing it with their proxy votes. Last year, SSGA voted against the chair or most senior member of the nominating committee at 394 U.S. companies that had all-male boards, while BlackRock backed eight board diversity resolutions at U.S. and Canadian companies and voted against the nominating committee members at five of the firms. And among the record number of board diversity proposals filed in 2017, two received substantial—and in one case overwhelming (84.8%)—majority support.

In 2018, investors are raising the bar even more on companies. BlackRock’s recently revised voting guidelines state that it expects to see at least two women on every company board. It plans to write letters to 300 Russell 1000 firms that do not meet this criterion to set a timeframe for improvement or potentially face votes against their directors in 2019. Similarly, CalSTRS revised its voting policies last fall to hold entire boards—not just nominating committees—accountable for a lack of progress on board diversity following engagement. California Treasurer John Chiang is further urging the two state pension plans to vote against boards that do not meet a diversity standard of 30% women and 30% diverse representation in terms of culture, ethnicity and sexual orientation by 2019.

In keeping with this trend, Glass Lewis announced in its recent policy updates that beginning in 2019 it will recommend against nominating committee chairs of Russell 3000 companies with all-male boards, unless they provide a sufficient rationale or disclose a plan to address the lack of female directors. ISS only plans to flag companies that have no women on the board in its proxy analyses. However, this could eventually change considering that ISS has adopted a policy similar to Glass Lewis’s for the Canadian market, which also takes effect in 2019.

Proxy access could become the next course of action for advancing diverse boards as well as specific director skill sets, such as environmental expertise. Last September, New York City Comptroller Scott Stringer launched a new phase of his Boardroom Accountability Project by calling on 151 portfolio companies to provide a standardized director skills and diversity matrix in their proxy statements. The letter recipients included 139 firms that have proxy access and 12 firms that are likely to adopt it in response to a majority-supported proposal in 2017. Although this is primarily an engagement project, the NYC Funds have filed—and in some cases withdrawn—several proposals to provide the requested matrix, including at Exxon Mobil and NRG Energy.

Corporate Culture

The recent wave of sexual harassment allegations has drawn investor attention not only to boardroom diversity but to corporate culture overall. One of the most high-profile cases to date—against Wynn Resorts founder and CEO Steve Wynn—exposed the potential for reputational and financial harm, including a $3.5 billion loss in market value and shareholder lawsuits. Yet a survey of 400 private and public company directors by Boardlist and Qualtrics found that 83% had not evaluated the company’s risks regarding sexual harassment or sexist behavior in the workplace, and 88% had not implemented a plan of action as a result of recent revelations in the media. The most common reasons directors had not addressed the issue was a perception that it was not a problem for their company or they did not feel that it was a board-level matter.

While boards should certainly be attuned to company policies and procedures on sexual misconduct—and even have an associated crisis response plan—shareholders are increasingly looking at gender diversity in the executive and managerial ranks as part of a broader solution.30 Following the departure of several Amazon Studio executives over sexual harassment claims, Change-to-Win Investment Group (CtW) submitted a resolution to the company to increase gender diversity on both the board and the senior executive team. Trillium Asset Management has proposed that Alphabet diversify the board’s executive committee in order to provide leadership and guidance to management in the wake of a Department of Labor investigation over gender pay discrimination. Both firms are also facing resolutions from Zevin Asset Management (ZAM) and Clean Yield Group to tie CEO pay to executive diversity goals. According to ISS, only 28 out of 2,300 U.S. firms include the improvement of culture or diversity in the performance goals for CEOs.

Problematic corporate cultures extend beyond sexual misconduct. Google is facing a class-action lawsuit for alleged discrimination towards employees with conservative viewpoints. This in turn inspired a new resolution by the National Center for Public Policy Research (NCPPR) that wants boardrooms to be inclusive of ideological diversity. The proponent notes that the targeted company—Facebook—and Silicon Valley in general operate in an “ideological hegemony” that eschews conservative people, thought and values. This was echoed by Facebook board member and Trump administration advisor Peter Thiel, who contends that Silicon Valley’s conformity of thought could harm its ability to innovate.

Human Capital Management

Concerns over the treatment of women in the workplace extend to equal pay, paid-leave benefits and opportunities for career mobility, and are the focus of several shareholder initiatives this year.

Arjuna Capital and Pax World are continuing their three-year-old campaign requesting companies to measure, publish, and take steps to close gender pay gaps. Having made inroads at technology firms, the proponents are honing their efforts on financial institutions in 2018. Already they’ve scored successes with seven of their nine targets, including Citigroup and Bank of America, which became the first banks to conduct and disclose the results of pay audits of their global workforces and commit to increasing the pay of women and minorities where warranted.

Social investment funds are also focusing on banks and financial institutions in their requests for workforce diversity reports, which would break down companies’ employee population by race, gender, and EEO-1 job categories. Last year these resolutions nearly tripled in volume and averaged 32% support, including a first-time majority vote at Palo Alto Networks. Another surge of proposals is on tap for 2018 in light of the Trump administration’s decision to suspend an Obama-era initiative that would have required large employers to expand their EEO-1 reporting to include employee pay levels.

Retailers are similarly in the crosshairs of equality campaigns since, like the financial sector, women make up a large share of the workforce but hold relatively few leadership positions. At Walmart, which produced an expansive diversity and inclusion report in 2017, Arjuna Capital is now asking for details on the potential reputational, competitive, and operational risks the company may face from emerging public policies and legislation on equal pay.

Separately, ZAM is working with Paid Leave for the United States (PL US) to identify companies with weak approaches to family leave, which is a key factor in addressing gender pay gaps. In conjunction with this, ZAM and other filers submitted first-time proposals at a handful of retail firms to report on their parental leave policies, which provide more generous benefits to birth mothers and corporate-level employees than to adoptive and LGBTQ parents and store-level workers. So far, most of the proposals have been withdrawn after the companies announced that they would expand their parental leave benefits for hourly workers.

Climate Change

2017 was breakout year for climate change campaigns with three landmark majority votes asking Exxon Mobil, Occidental Petroleum, and PPL to report on how they plan to adjust their business models in line with the Paris Accord’s goal of limiting global warming to 2° Celsius (“2° scenario” or “2DS”).

The results reflect a sea change in the attitude and voting practices of several major asset managers—BlackRock, Vanguard Group and Fidelity Management & Research—which for the first time supported some of the climate change resolutions last year. Of the three, Fidelity made the greatest shift in its voting, backing every one of the 2DS resolutions it voted on, while BlackRock and Vanguard only endorsed the two at Exxon and Occidental.

Other institutional investors could follow suit, particularly as a result of pressure from their own shareholders and clients. Last year, Walden Asset Management withdrew proposals at BlackRock, Vanguard, and JPMorgan Chase after the firms agreed to review inconsistencies between their proxy voting records and their public stance on climate change. Walden and other filers have similar resolutions pending this year at Bank of New York Mellon and Cohen & Steers and withdrew a third at T. Rowe Price Group. Franklin Resources, which has received proxy voting review resolutions every year since 2014, wasn’t retargeted in 2018 because it improved its approach by voting for 24% of climate risk proposals in 2017, compared to 10% in 2016.

The proxy advisors have also amended their voting policies for 2018 to reflect their general support of resolutions to disclose climate-related risks. ISS’s policy now extends to proposals on how the company identifies, measures and manages such risks, in keeping with the recommendations of the TFCD, while Glass Lewis will largely back requests for climate change scenario analyses at companies in extractive or energy-intensive industries.

All of this has galvanized shareholder activists, who have filed a new round of 2DS proposals for 2018 with the expectation of generating a higher number of favorable votes or encouraging pro-action by companies. In addition to last year’s three majority vote companies, Duke Energy and Marathon Petroleum have produced or committed to producing climate impact reports, even though 2017 proposals received less than majority support. Several utilities targeted in 2018—CMS Energy, DTE Energy and WEC Energy Group—have also agreed to publish climate assessments.

Even so, not all company responses have satisfied investors. Exxon’s newly released report has already drawn criticism from proponents for concluding that aggressive climate policies pose little risk to its reserves because the demand for fossil fuels will remain strong for decades. Individual investor Steven Milloy went a step further by characterizing these reporting exercises as mere “greenwashing” to improve companies’ public image. In a proposal at Exxon that was later withdrawn, he asserted that many voluntary activities and expenditures touted as protecting the climate are a waste of corporate assets that fail to yield any meaningful benefits to shareholders, public health, or the environment. As a case in point, two years after BP and Royal Dutch Shell shareholders overwhelmingly passed 2DS resolutions, the companies still disclose only minimal information on how they are mitigating climate risks, and they have yet to set greenhouse gas (GHG) reduction targets or markedly improved their investments in low-carbon technology.

Although 2DS will be the most-watched environmental category this year, other climate-related resolutions could generate significant support. As You Sow and Miller/Howard Investments have filed resolutions at nine oil and gas producers to report on their efforts to monitor and minimize methane leakage. Prior support on these proposals has been strong, averaging 31.7% in 2017, including two resolutions that received votes in the 40% range.

Aside from energy firms, proponents are targeting a broad range of industries with resolutions to set goals to reduce GHG emissions or increase renewable energy sourcing. In the past, these measures have averaged support in the 20% range, though several this year have already yielded commitments from AES, American Electric Power, and Western Union. A proposal variation favored by Jantz Management and Amalgamated Bank—to assess the feasibility of achieving net-zero GHG emissions by a specific date—continues to be excludable as ordinary business.

Political Spending and Lobbying

Often tied to climate change are shareholder proposals requesting more disclosure around corporate lobbying and election spending. The lobbying resolutions, in particular, seek to uncover payments made to trade associations that are used for lobbying purposes because some organizations, such as the U.S. Chamber of Commerce and National Association of Manufacturers (NAM), have lobbied against the expansion of environmental regulations.

This year, NCPPR has countered with a similarly styled lobbying proposal at Duke Energy, but with a conservative angle that takes issue with liberal activists that work to defund pro-business organizations by attacking their members. One example is the American Legislative Exchange Council (ALEC), which is cited in over half of the lobbying resolutions filed this year by left-leaning shareholder proponents. NCPPR is encouraging companies to take an active role in combating attacks on free speech and freedom of association rights and to better explain the benefits of their involvement with groups that advocate for smaller government, lower taxes and free-market reforms.

As in past years, about 50 lobbying and 30 political contribution proposals are expected in 2018, with McRitchie and Young becoming first-time filers.

Although these have rarely received majority backing, support levels could eventually creep up. The Center for Political Accountability (CPA) and Fund Votes reported that of the 114 fund groups they track, 56 increased their support for political spending disclosure resolutions between 2016 and 2017. Nevertheless, some of the biggest mutual funds—BlackRock, Vanguard, Fidelity, and Capital Group’s American Funds—have maintained their longstanding approach of opposing or abstaining on all election spending resolutions.

NorthStar Asset Management is switching gears this year with a new proposal that asks Intel and Home Depot to conduct a cost-benefit analysis of their corporate and PAC political and electioneering spending during the most recent election cycle. Since 2011, NorthStar has shifted between resolutions calling for a shareholder advisory vote on political contributions or an alignment of corporate values and election-related expenditures. None have generated more than single-digit support.

Opioid Crisis

A coalition of 44 labor, religious, and public pension funds are asking 10 drug manufacturers and distributors to report on how they are addressing business risks resulting from the abuse of opioid painkillers. In separate resolutions, the proponents are also advocating measures to improve accountability, including appointing independent board chairs and expanding clawback policies to recover pay from executives who inappropriately promote opioid drugs.

The initiative builds on a 2017 campaign by the International Brotherhood of Teamsters, which resulted in governance reforms at Cardinal Health and McKesson. Both companies committed to separating their chairman/CEO positions, and McKesson additionally agreed to review its pay practices and conduct an investigation into its opioid-related business practices.

The first opioid proposal of the season was voted down by AmerisourceBergen shareholders with 41.2% support. Nevertheless, this was a striking showing since Walgreens Boots Alliance Holdings owns 26% of the company’s stock. Both ISS and Glass Lewis backed the initiative.

Drug Pricing

Faith-based organizations are revisiting the high cost of prescription drugs with two new proposals. One asks drug makers to review whether their executive incentive plans contribute to high drug pricing. The other asks them to report on business risks resulting from public pressure to curb prescription drug costs. Both are variations of 2017 proposals—all of which were omitted as ordinary business—which asked pharmaceutical companies to explain the price increases for their top-selling brand-name medicines over the previous five years.

Global Content Management

Arjuna Capital and the Illinois and New York State Treasurers have targeted social media firms Alphabet, Facebook and Twitter to report on how they are addressing business risks arising from platform abuses—including fake news, election interference, online sexual harassment, and hate speech. Trillium Asset Management filed a related proposal at Facebook to establish a board risk committee to deal with comparable issues. Last year, similarly-themed proposals—on the enabling of fake news—received only single-digit support, primarily because of the high insider ownership at these firms.

NCPPR has offered up an alternative resolution at Comcast, Time Warner and Walt Disney to adopt policies to ensure that their media outlets do not engage in the production and delivery of fake news. The proposal was omitted at Walt Disney as ordinary business and at Comcast on technical grounds.


Last fall’s massive data breach at Equifax, which affected 143 million Americans, has drawn heightened attention to companies’ cybersecurity management. This year, the New York State Common Retirement Fund (NYSCRF) has submitted a proposal at Express Scripts Holding to report on actions it has taken to mitigate cyber risks, noting that the healthcare industry incurs a disproportionate share of hacking incidents, according to government reports. In a similar vein, Trillium Asset Management has asked Verizon Communications to report on the feasibility of linking executive compensation to cybersecurity and data privacy metrics. Equifax itself is facing several shareholder proposals—as well as a potential “vote no” campaign by CtW—in an effort to bolster board oversight in the wake of the crisis.

In February, the SEC issued interpretative guidance to assist public companies in preparing their disclosures about cybersecurity. Expanding on guidance published in 2011, the release urges companies to inform investors about material cybersecurity risks and incidents in a timely fashion, including the concomitant financial, legal, or reputational consequences. It also expects firms to adopt policies and procedures to prevent corporate insiders from trading in the company’s stock prior to information about a breach being made public.

Gun Safety

In the aftermath of the February school shooting in Parkland, Florida, gun manufacturers and distributors are once again on the hot seat. This time, however, so are fund managers. In a recent letter, Senator Elizabeth Warren (D-Mass.) called on nine investment firms—including BlackRock, Vanguard and Fidelity—to use their financial leverage to demand that firearms companies take steps to reduce gun violence, including tougher self-regulation.42 So far, BlackRock has publicly detailed its engagement plans, while Vanguard and Fidelity are relying on “quiet diplomacy.”43 Other public officials are urging state pension plans to divest their holdings of gun stocks, while consumer advocates are pressing corporations to end their ties with the National Rifle Association.

After a one-year hiatus, faith-based investors have filed 2018 proposals at American Outdoor Brands and Sturm Ruger to report on steps they are taking to improve gun safety and to mitigate the harm associated with gun products. A third—at Dick’s Sporting Goods—was withdrawn after the company agreed to stop selling assault-style rifles and high-capacity magazines and ban the sale of guns to anyone under 21. Walmart and Kroger followed suit by raising the minimum age for firearms purchases at their stores to 21. Past resolutions dealing with gun violence—to adopt the Sandy Hook Principles—have received only tepid support. However, this year’s initiatives could gain traction in view of recent events, particularly since BlackRock is the largest holder of the two targeted companies.

Looking Ahead

As companies gear up for their upcoming annual meetings, several trends bear watching which will help shape post-season engagements and planning for 2019.

  • Board composition: Investors are becoming laser-focused on director skill sets to ensure that boards can effectively drive corporate strategy and oversee risk, particularly in emerging areas such as cybersecurity and climate change. Requests for more robust disclosures and matrix-style presentations are likely to escalate to help investors more easily assess director competencies.
  • Board diversity: Investors are stepping up their expectations on board gender diversity—both in terms of the number of female directors and the timeframe for achieving progress—and some will be leveraging their demands with votes against nominating committee members. Issuers should stay attuned to their major shareholders’ policies on this issue and be prepared to articulate how they intend to improve the gender makeup of their boards.
  • Gender pay disparity: Shareholder initiatives to close gender pay gaps are showing early success this year in the financial sector with a substantial number of negotiated withdrawals. Because the campaign will likely expand to other industries in the future, companies should consider preemptively conducting internal pay reviews.
  • Climate change: Oil, gas and power companies should be braced for high, if not majority, votes on 2DS resolutions, particularly if BlackRock and Vanguard back more of them than the two last year. Firms in other industries should monitor votes on other popular environmental proposals since shareholder campaigns are broadening to more sectors.
  • Proxy access: Companies that have not implemented proxy access should track the pace of adoptions and the extent to which they are migrating downstream to small- and mid-cap firms. Because of the proliferation of fix-it proposals and the difficulty of omitting them from ballots, issuers may wish to refrain from adopting access rights until they are approached with a shareholder proposal.
  • Pay ratios: As investors digest initial pay ratio disclosures, issuers should be attentive to any negative reaction and media reporting. They should also review the disclosures of industry peers, which shareholders and proxy advisors may use for benchmarking in future years.
  • No-action requests: In the coming months, issuers and investors will get more clarity on how the SEC is applying the SLB 14I framework in no-action decisions. This will aid companies in effectively challenging E&S resolutions in the future, as well as spur shareholder proponents to devise more reasonably crafted demands.

Overall, this year’s proxy season could be pivotal on a number of fronts. As the year progresses, Alliance Advisors will keep issuers apprised of new developments as they materialize.

The complete publication, including footnotes, is available here.

April 3, 2018
Broadcom’s Blocked Acquisition of Qualcomm
by Donald Vieira, Ivan Schlager, Joe Molosky, Michael Leiter, Michelle Weinbaum, Skadden

President Donald Trump’s recent executive order blocking Broadcom Limited’s acquisition of chipmaker Qualcomm, Inc. (the Order) is the latest in a series of significant actions and statements regarding the national security implications of trade policy. In December 2017, the president released his National Security Strategy, emphasizing economic security as a key component of national security, and specifically focusing on the regulation of international trade and foreign investment as a way to secure U.S. military and technological superiority. On March 12, 2018, President Trump issued the Order, citing national security concerns raised by Broadcom’s potential acquisition of Qualcomm.


These actions, coupled with recently announced tariffs on steel and aluminum as well as a Section 301 investigation into China’s intellectual property practices, illustrate that economic and trade issues are at the forefront of the Trump administration’s national security policy. They also indicate that the president is willing to use the significant power he possesses to police foreign investment, primarily in the form of the Committee on Foreign Investment in the United States (CFIUS), to advance the economic aspects of his national security policy.

The December 2017 National Security Strategy

In the newly released National Security Strategy, the Trump administration identified the three main challenges to U.S. national security as “the revisionist powers of China and Russia, the rogue states of Iran and North Korea, and transnational threat organizations, particularly jihadist terrorist groups.” The National Security Strategy is a congressional mandate derived from the Goldwater-Nichols Act, which requires the White House to produce an annual report to Congress on the country’s “worldwide interests, goals, and objectives” and propose short- and long-term uses of the “political, economic, military, and other elements of the national power.” The strategy must also communicate the U.S. defense capabilities necessary to deter aggression and the adequacy of such capabilities. Although the Goldwater-Nichols Act originally required annual reports to Congress, recent presidential administrations have produced such strategies on only a periodic basis.

The December 2017 strategy cautioned that “American prosperity and security are challenged by … economic competition.” The strategy focused heavily on China’s theft and exploitation of intellectual property, though it also acknowledged that “some actors use largely legitimate, legal transfers and relationships to gain access to fields, experts, and trusted foundries that fill their capability gaps.” This was possibly an allusion to gaps in the jurisdiction of CFIUS, the interagency committee tasked with reviewing the national security implications of cross-border transactions. The Trump administration also expressed concern as to the potential exploitation of U.S. personal data, stating that China is determined “to control information and data” by gathering data on an unrivaled scale.

In order to mitigate the perceived threats, the strategy signals that the administration intends to work with Congress to strengthen CFIUS while maintaining an investor-friendly climate. [1] Additionally, the strategy indicates that the administration will explore new legal and regulatory regimes to prevent and prosecute intellectual property violations, including establishing procedures to reduce “economic theft by non-traditional intelligence collectors.” Evidence of such measures include the recent initiation of trade investigations into Chinese practices as they relate to technology transfer, intellectual property and innovation, and the increasing complexity of CFIUS investigations involving Chinese entities.

Broadcom’s Bid for Qualcomm

Broadcom, with a market capitalization of roughly $107 billion, is the eighth-largest chipmaker in the world. The company, formerly named Avago, is the product of numerous acquisitions— most notably its $37 billion acquisition of California-based Broadcom in 2016, from which it gained its current name. Avago began life as an independent, Singapore-incorporated public company when it was spun out of U.S.-based Agilent (itself earlier spun out of Hewlett-Packard) in 2005. At the time, and since, Avago had little connection to Singapore other than its jurisdiction of incorporation, and the majority of its personnel and facilities remained in the United States. On November 2, 2017, Broadcom CEO Hock Tan—alongside President Trump, in the Oval Office—announced Broadcom’s plan to redomicile in the United States from Singapore.

Within days of its redomiciling announcement, Broadcom disclosed its hostile bid for Qualcomm. Qualcomm developed 2G and 3G wireless technology and is currently a leader in the development of 5G technology. Qualcomm resisted Broadcom’s bid, which resulted in Broadcom revising its bid on two separate occasions, for a final announced value of $117 billion. As part of its takeover bid, Broadcom initiated a proxy solicitation designed to elect six new directors selected by Broadcom to Qualcomm’s board. If all were elected, they would have represented a majority of Qualcomm’s board.

CFIUS Intervenes

On January 29, 2018, Qualcomm submitted a unilateral CFIUS notice requesting review of Broadcom’s actions aimed at electing a majority of directors at Qualcomm. CFIUS proceeded to review the proposed transaction and solicited information through phone calls, emails and meetings with both parties. On February 21, 2018, and March 2, 2018, Broadcom submitted letters to CFIUS with information relevant to the review.

Broadcom’s bid also faced political opposition. Sen. John Cornyn, R-Texas, one of the key sponsors of CFIUS reform, and Rep. Duncan Hunter, R-Calif., wrote letters urging the treasury secretary to review the proposed transaction ahead of an important Qualcomm shareholder vote scheduled for March 6, 2018. Notably, Sen. Cornyn’s letter argued that Broadcom would drastically cut Qualcomm’s investment in 5G wireless technology research and development, creating a market opening for China’s Huawei to move into a dominant position, potentially threatening U.S. national security.

On March 4, 2018, CFIUS filed an agency notice to broaden the scope of its review to cover the proposed hostile takeover itself. CFIUS also issued an interim order to the parties directing that Qualcomm’s annual stockholder meeting scheduled for March 6, 2018, be adjourned for 30 days to allow for further investigation by CFIUS. The interim order stipulated that Broadcom provide five business days’ notice before taking any action to relocate to the United States.

In a March 5, 2018, letter addressed to the parties, CFIUS enumerated several concerns with the transaction that it believed warranted a full investigation. These concerns included: (1) Broadcom’s reputation for reducing research and development, and the national security risk if China dominates the 5G space; (2) the amount of debt financing—$106 billion, the largest corporate acquisition loan on record—driving pressure for short-term profits; and (3) a potential disruption in supply to critical Department of Defense and other government contracts. In addition, the letter highlighted the ways in which CFIUS viewed Qualcomm as a preferred partner and provider of technology for U.S. infrastructure.

On March 8, 2018, CFIUS informed Broadcom that certain actions it had taken in furtherance of its efforts to relocate to the United States violated the five-business-day notice requirement from the interim order (e.g., participation in a Singapore court hearing and a filing to convene a Broadcom shareholder vote on the redomiciliation on March 23, 2018).

On March 10, 2018, Broadcom authored an open letter to the U.S. Congress promising to: (1) invest $1.5 billion in training and education for U.S. engineers; (2) not sell any critical national security assets to foreign buyers; (3) annually invest $3 billion in research and engineering after relocation; and (4) annually invest $6 billion in manufacturing from its future U.S. location. The letter highlighted Broadcom’s strong ties to the United States, including: (1) management by a board and executives, a majority of whom are U.S. citizens; (2) ownership by shareholders, 90 percent of whom are in the

United States and are largely the same as Qualcomm shareholders; and (3) employment of a workforce, with more than half of its employees already located in the United States. The letter also indicated Broadcom was in the final stages of relocating its domicile to the United States with an expected completion date of May 6, 2018.

On March 11, 2018, the Treasury Department sent the parties a letter updating them on the status of the CFIUS investigation. The letter listed alleged violations to the CFIUS interim order, including Broadcom’s filing and dissemination of a definitive proxy statement with the Securities and Exchange Commission on March 9, 2018. CFIUS thus required the parties to provide all responsive information relating to its concerns set forth in its March 5, 2018, letter by noon on March 12, 2018. Finally, CFIUS noted that “[i]n absence of information that changes CFIUS’ assessment of the national security risks posed by this transaction, CFIUS would consider taking further action, including but not limited to referring the transaction to the President for decision.”

The President’s Order

On March 12, 2018, after CFIUS had met with Broadcom, the president issued the order blocking the transaction. Specifically, the Order stated that “[Broadcom] and Qualcomm shall immediately and permanently abandon the proposed takeover.” The Order also stipulated that all 15 individuals listed on the proxy card filed by Broadcom were disqualified from standing for election as directors of Qualcomm and that Qualcomm was prohibited from accepting nominations or votes for any of those candidates.


Unprecedented Action Spurred by Jurisdictional Challenge?

A presidential order blocking a transaction is unusual, with only five occurring in CFIUS’ history. In this case, the Order was truly unprecedented, marking the first time in CFIUS’ history that a transaction was blocked before an acquisition agreement was even signed. Although CFIUS does not explain its jurisdictional theory, it is likely that it viewed the impending election of Broadcom-sponsored directors as potentially giving Broadcom influence or control over Qualcomm and thus provided sufficient justification for its intervention.

Moreover, CFIUS was undoubtedly aware of the impending limits of its jurisdiction based on Broadcom’s announced—and then accelerated—redomiciling to the United States. CFIUS’ authorizing statute empowers CFIUS and the president to act in investments made by foreign parties; given the totality of circumstances, it would be exceedingly difficult for CFIUS to claim Broadcom as a foreign party once it redomiciled in the United States. Thus, CFIUS likely believed it faced a do-or-die moment: block the transaction at an early stage or potentially lose all ability to influence the outcome of the transaction. It recommended the former, and the president acted accordingly.

Expanding Scope of CFIUS’ Concerns Regarding China

Although many in the press—undoubtedly in part because of CFIUS’ explicit reference—have characterized the president’s action as being motivated by concerns over China, Broadcom is not a Chinese entity and, to a great extent, its apparent ties to China look much like Qualcomm’s and many other non-Chinese global technology companies’. In this regard, CFIUS’ action highlights how its current view of concerns regarding China is expanding and may encompass a wide range of companies that—even if not Chinese—do business with or in China and hence, in CFIUS’ view, may be susceptible to Chinese influence in a manner that is detrimental to U.S. national security.

CFIUS: A Powerful but Narrow Tool

The Order also illustrates how CFIUS’ inherent characteristics could make it an attractive trade policy tool during periods of heightened trade and national security tensions. Unlike many other trade authorities, CFIUS is a relatively speedy, case-by-case authority with little precedent of judicial review. It is also far more efficient than other governmental trade authorities. The remarkable speed with which CFIUS advanced this matter to the president, and his correspondingly rapid action blocking the transaction, provides a degree of policy responsiveness that is largely absent across the rest of the U.S. government.

This case, however, also illustrates CFIUS’ inherent limitations to address broader concerns over domestic capabilities and capacity. Much of the justification found in CFIUS’ statements, as well as the argument included in congressional letters concerning the risks of the transaction, would apply equally to a purely domestic acquisition of Qualcomm by a U.S. company. Were a U.S. company to acquire Qualcomm with a “private equity-style direction”—as phrased by CFIUS—or purchase Qualcomm with an eye to radically reduce research and development spending, CFIUS would have no recourse. Thus, although in this case CFIUS was well-positioned to address perceived concerns, it is clearly insufficient to address the broader set of concerns identified in the December 2017 National Security Strategy and implicated by the United States’ declining technology edge in key areas of national security.

A New Paradigm?

We believe the Order is reflective of a significant change in CFIUS’ perspective on the national security risk of foreign investment in the United States and the use of CFIUS to advance the economic aspects of the administration’s national security policy. Others, however, have a legitimate belief that a variety of specific factors demonstrate that the Order does not represent a radical change for CFIUS. For example, Broadcom’s move to redomicile added significant complexity to the CFIUS-related issues and undoubtedly led to a hurried consideration of the substantive outcome of CFIUS’ response. In addition, the technology involved has long been central to CFIUS and broader U.S. government concerns, as is in part illustrated by recent White House contemplation of a larger U.S. government role in 5G networks and technology, and Obama-era reports regarding the importance of the semiconductor industry to national security. It has also been noted in the media that Qualcomm had a close and long-standing relationship with the U.S. government. As 2018 progresses, we will continue to further assess the impact of the president’s action as it relates to, or is reflected in reviews of, other transactions.


The president’s blocking of the Broadcom/Qualcomm transaction should be seen as part of the Trump administration’s heightened effort to guard against perceived national security concerns emanating from trade. Consistent with the December 2017 National Security Strategy and as evidenced by the Order, we expect that CFIUS reviews will increasingly reflect the positions set forth in the president’s policy. Consequently, more than ever, cross-border transactions require careful and early-stage diligence and analysis to understand fully how CFIUS may view national security issues.



For additional information about administration efforts concerning CFIUS reform, see the Skadden client alerts “Legislation Proposes Sweeping New Foreign Investment Review Authorities” and “Reform Proposes Sweeping Changes to CFIUS Reviews.”(go back)
April 3, 2018
Why Do Investors Hold Socially Responsible Mutual Funds?
by Arno Riedl, Paul Smeets

Socially responsible investments (SRI) are ever-increasing in importance. But why do investors buy these assets? There are three potential motives: (1) purely financial interest, (2) desire to create a positive social image, or (3) strong pro-social preferences.

The authors analyze a unique data set consisting of administrative data linked to survey responses and an incentivized experiment. The experiment is used to elicit intrinsic social preferences using real financial to incentives and participants (investors) know that they will remain anonymous. The importance investors place on their social image is measured by asking them how often they talk about their investments. Only when they talk about their investments others are able to observe that they invest socially responsible. The financial motives are assessed by looking at the actual performance of participants using the administrative data as well as survey data regarding their beliefs about performance of SRI and non-SRI equity funds.


This unique combination of different data sources allows the authors to see whether experimentally elicited prosocial preferernces of investors can explain their real-life investment behavior. The authors find that social preferences as well as social signaling are indeed an important determinant of socially responsible investment decisions. Financial motives on the other hand appear to be of limited importance. Moreover, investors are actually willing to forgo financial performance to invest in accordance with their social preferences.

Key Findings

16.2% of the investors in the sample can be classified as socially responsible investors, because they hold at least one SRI equity fund. These investors, on average, hold 4,574 euro in SRI equity funds, which corresponds to 23.0% of their total equity investments.

  1. Social preferences are key: An investor classified as prosocial is 14 percentage points more likely to hold an SRI equity fund than a selfish investor. This effect size is economically substantial as only 16% of the total sample holds an SRI equity fund.
  2. The social image matters: Social signaling is a motive for investors to hold SRI equity funds. Investors who talk more often about their investments are also more likely to invest in a socially responsible way.
  3. Donations complement SRI: Socially responsible investors donate about 41% more to charity than conventional investors. An important implication from this is that SRI and other charity giving are complements. That is, SRI does not decrease charitable giving. Rather to the contrary, those who are already willing to give also like to invest in SRI.
  4. Financial reasons matter only for some: In order to invest in concordance with their social preferences, some investors are willing to forgo financial performance. At the margin, however, pessimistic performance expectations reduce the likelihood to invest in a socially responsible way. 

Practical Relevance

Not only are investments in socially responsible assets vastly growing. This paper shows that this interest stems to a significant extent from investors trying to align their investments with their social preferences. In other words, these investors really want to invest in SRI because of its social impact.

These findings are of relevance for asset managers and pension funds. Being able to offer investors and pension fund contributors the possibility to invest in socially responsible assets allows people to invest more in line with their social preferences.

The complete article is available for download here.

April 3, 2018
Chancery Addresses Scope of Director Consent Statute and Civil Conspiracy Claims
by Francis Pileggi

In the context of cross-claims of fraudulent inducement by parties to a merger, the Court of Chancery discussed several principles of Delaware law that serve as useful references for those involved in corporate and commercial litigation.  The opinion in LVI Group Investments, LLC v. NCM Group Holdings, LLC, C.A. No. 12067-VCG (Del. Ch. Mar. 28, 2018), provides useful iterations of the following principles of Delaware law:

·     The extended scope of the director consent statute which allows for the imposition of personal jurisdiction on officers and directors of Delaware entities even when the claims are not for breach of fiduciary duty.  This opinion amplifies the Delaware Supreme Court’s recent Hazout decision which reversed decades of prior precedent on this topic, highlighted on these pages, interpreting Section 3114 of Title 10 of the Delaware Code.

·     The court also discusses the general rule that a civil conspiracy may not be formed between a director and the corporation that she represents, however, there are exceptions to this rule which are explored in this opinion.  For example, the court noted that it was unaware of any Delaware authority in support of a per se rule that a private equity firm and its principal cannot conspire with a company controlled, but not wholly owned, by them.  The court cited to several decisions addressing this issue including Prairie Capital III, L.P. v. Double E Holding Corp., 132 A.3d 35, 60 (Del. Ch. Nov. 24, 2015), which was highlighted on these pages.  The court also cited Prairie Capital for the principle that a corporate officer can be held personally liable for the torts he commits and cannot hide behind a corporate shield when he is a participant in the tort.

·     The court also considered the extent to which a fraud claim can be pursued in the presence of a non-reliance clause and an integration clause.  The court explained that this was not a bar to claims that representations within the agreement itself were fraudulently made.  See Abry Partners V, L.P. 891 A.2d at 1064 (“To the extent that the stock purchase agreement purports to limit the Seller’s exposure for its own conscious participation in the communication of lies to the Buyer, it is invalid under the public policy of this State.  That is, I find that the public policy of this State will not permit the Seller to insulate itself from the possibility that the sale would be rescinded if the Buyer can show either:  (1) that the Seller knew that the Company’s contractual representations and warranties were false; or (2) that the Seller itself lied to the Buyer about the contractual representations and warranty.”)  See also Prairie Capital III, L.P., 132 A.3d at 61. 

·     The court also explained that equitable fraud claims, also known as negligent misrepresentation claims, require a special relationship, such as a fiduciary relationship, as a prerequisite in order for the scienter requirement of common law fraud to be waived.

The post Chancery Addresses Scope of Director Consent Statute and Civil Conspiracy Claims appeared first on Delaware Corporate & Commercial Litigation Blog.

April 3, 2018
Delaware Contract Interpretation Principles
by Francis Pileggi

Recent decisions of the Delaware courts have provided arguments for considering a broader approach to the more traditional “four corners of the document” view of contract interpretation for so-called unambiguous agreements.  The recent Chancery decision in Plaze, Inc. and Apollo Aerosole Industries LLC v. Callas, C.A. No. 2017-0432-TMR (Del. Ch. Mar. 29, 2018), addresses contract interpretation in the context of post-closing issues arising from Plaze’s purchase of Apollo Aerosole Industries pursuant to a stock purchase agreement which included provisions for non-competition, non-solicitation, indemnification and post-closing adjustments. This decision refers to recent Supreme Court decisions that suggest a fresh approach to the traditional theory of contract interpretation of unambiguous agreements being typically limited to the four corners of the document. 

Highlights of Decision

The court began its analysis with the still applicable bedrock principle that Delaware applies to the objective theory of contracts, i.e.: “A contract’s construction should be that which would be understood by an objective, reasonable third party.”  See footnote 14.  The court acknowledged the traditional approach that provides for interpreting a contract based on the:  “parties’ intentions as reflected in the four corners of the agreement, construing the agreement as a whole and giving effect to all its provisions.”  See footnote 15.

But, citing to a recent Delaware Supreme Court decision, the most recent statement of Delaware law regarding contract interpretation provides for a more holistic approach expressed in the following quote:  “In giving sensible life to a real-world contract, courts must read the specific provisions of the contract in light of the entire contract.”  (citing Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co., 166 A.3d 912, 913-14 (Del. 2017)). 

Another recent Delaware Supreme Court decision also supports the view that the current approach that Delaware courts are taking even for unambiguous contracts allows for one to “step back” to view the context in which the parties reached an agreement.  See Heartland Payment Systems, LLC v. InTeam Assoc., LLC, 2017 WL 3530242, at *10 (Del. Aug. 17, 2017)(quoting Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co., 2017 WL 2774563, at *1 (Del June 27, 2017)). See also E. Norman Veasey & Jane M. Simon, The Conundrum of When Delaware Contract Law Will Allow Evidence Outside the Contract’s “Four Corners” in Construing an Unambiguous Contractual Provision,  72 Bus. Law. 893 (Fall 2017). The Court of Chancery very recently issued an Order with its findings on remand in the Heartland case.

The referenced article co-authored by former Chief Justice Veasey was published in the same year as two above Delaware Supreme Court decisions which arguably support the view that when construing even unambiguous agreements, the larger context in which the parties negotiated the agreements should be taken into account. 

The stock purchase agreement involved in this case provided for indemnification as the sole remedy for breach of representations or warranties, and also included several restrictive covenants and confidentiality provisions.  One of the issues was whether a post-closing separation agreement involving one of the executives superseded the indemnification provision.  That argument was unsuccessful and the court reasoned that the extensive indemnification provisions for breach of representations and warranties was not impacted by the post-closing separation agreement with one of the executives who allegedly violated the restrictive covenants and other provisions.

The post Delaware Contract Interpretation Principles appeared first on Delaware Corporate & Commercial Litigation Blog.

April 3, 2018
Supreme Court Addresses Forum Non Conveniens
by Francis Pileggi

A recent Delaware Supreme Court decision should be required reading for anyone involved with a forum non conveniens case in Delaware. Aranda v. Philip Morris USA Inc., Del. Supr., No. 525, 2016 (March 27, 2018), provides an overview of the Delaware law on forum non conveniens and clarified that even if it is a minority view among the 50 states, Delaware only requires that the trial court “consider” whether an alternative forum is available as part of its analysis, but the trial court is not required to find that an alternative forum is available before making its determination whether to dismiss a case based on forum non conveniens.  The court reviewed the three general categories of forum non conveniens cases.  The first type of case under that general category is referred to as:

(1) a first-filed Delaware case with no case pending elsewhere (the Cryo-Maid test);

(2) a second-filed Delaware case with another first-filed case pending elsewhere (the McWane test); and,

(3) a hybrid recently addressed by the Delaware Supreme Court in Gramercy Emerging Markets Fund v. Allied Irish Banks, P.L.C., 173 A.3d 1033 (Del. 2017), which involves a later-filed Delaware case pursued after another jurisdiction had dismissed the first-filed case based on forum non conveniens.  All three of the foregoing types of cases require some application of the forum non conveniens factors.  The difference is the presumptions applied in each category to the applicable factors.  See Slip op. at 11-12.

The court was aware of the competing arguments, and the majority of other states who approached the issue differently. The court also addressed the public policy issue involved.

In sum, Delaware’s high court was satisfied that the trial court did consider the availability of an alternative forum before dismissing the case on forum non conveniens grounds, but it concluded that whether an alternative forum was available is not a deciding factor.  Rather the trial court is only required to consider it as one of many factors.

The post Supreme Court Addresses Forum Non Conveniens appeared first on Delaware Corporate & Commercial Litigation Blog.

April 3, 2018
SEC Asset Valuation Claims Rejected on Summary Judgment
by Tom Gorman

The Commission lost virtually all claims in an asset valuation case brought against a fund and two of its officials. The action was one of several brought as part of the Commission’s Aberrational Performance Inquiry which, prior to this action, had spawned six cases. The Inquiry is a joint project of the Enforcement Division’s Market Abuse Unit and the Office of Compliance, Inspections and Examinations and the Division of Risk, Strategy and Financial Innovation. It focuses on identifying areas of inquiry by using a series of performance metrics to assess the performance of a hedge fund. Stated differently, it seeks to determine if there are outliers suggesting suspicious conduct. SEC v. Yorkville Advisors, LLC, Civil Action No. 12 CIV 7728 (S.D.N.Y. Opinion March 29, 2018).

The complaint

Named as Defendants were prominent hedge fund manager Yorkville Advisor, LLC and two of its principals Mark Angelo and Edward Schinik. Yorkville is a registered investment adviser founded by Mr. Angelo. Mr. Schinik served as CFO and COO. It managed the YA Global Investments (U.S.) LP fund, the YA Offshore Global Investments, Ltd. fund and the YA Global Investments, LP fund.

The investment strategy employed generally called for funds to be put into privately negotiated structured equity and debt in public and private companies. It provided alternative financing for microcap and small-cap publicly traded companies. The investments were structured in various forms including convertible securities, standby equity distribution agreements and convertible preferred securities. An important part of the profits achieved came from sale of securities obtained as part of the overall investment.

Yorkville’s ability to understand the valuation of its investments was critical to its strategy and results. The PPM given to investors specified that GAAP would be followed in calculating the net worth of each fund. Yorkville’s internal policies also required it to mark the funds’ investments at fair value. Until the market crisis the adviser used a valuation method it called in pitch materials the “Yorkville Method” which it claimed was GAAP compliant.

As the market crisis unfolded Yorkville had difficulty liquidating securities it obtained from the investments. In 2008 the adviser altered its branded valuation method, adopting a new approach. While it claimed that the new method was GAAP compliant in fact it was not, according to the complaint. Under the new method most of the convertibles were simply carried at face value rather than at current, fair and accurate valuations as required. No testing was done to validate the values. Indeed, the values of the collateral underlying the convertibles were unknown. As a result Yorkville overvalued a series of investments by at least $50 million as of December 2008 and $47 million as of the end of December 2009. The supporting documentation of the defendants reflected these over valuations, according to the complaint. The over valuations inflated the value of the funds which attracted investors and increased the fees that Yorkville charged.

Misrepresentations were also made to prospective investors to lure them into putting their money in the funds. Those concerned the collateral underlying certain securities obtained as investments, the liquidity of the Funds and their internal procedures.

The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisors Act Sections 206(1) and (2) and 204(4). It also alleges control person liability under Exchange Act Section 20(a).

The Court’s Opinion

Defendants moved for summary judgment. The motion focused primarily on the period 2008 and 2009 during which the SEC claimed there were fraudulent misrepresentations regarding the value of 15 Yorkville investments out of the 265 positions held along with certain other misrepresentations regarding the internal procedures and related issues. The Court granted the motion for summary judgment with very limited exceptions – a claim against Mr. Mr. Schinik and a negligence allegation regarding Mr. Angelo where there were conflicts of fact precluding summary judgment. Any liability of the firm would be determined by the outcome of those claims.

The positions at the center of the motion were valued at the lower of cost or market until gains were realized prior to 2008. Under this methodology the firm recognized unrealized losses but not unrealized gains. When FASB Statement 157 was adopted in 2008 the firm implemented fair market value accounting per that pronouncement. For the 15 positions involved here “fair value” was “more of an art rather than a science, due to their low to non-existent market activity,” according to the Court.

The adviser had a valuation committee that considered value issues and used various consultants. The value of the Funds’ assets were listed on various “one-pagers” and other materials furnished to investors. While the documents provided an overall value of the Funds’ assets, the value of each of the 15 positions at issue here was never listed. In addition, the financial statements for the period 2008 and 2009 were audited by an outside firm. As part of that process the audit firm selected certain investments for testing which included the majority of the 15 positions involved here.

The SEC’s allegations fall into two groups, according to the Court. The first group alleged misrepresentations regarding the value of the 15 positions. The second focused on what the Court called “one-off misrepresentations concerning the Fund’s internal procedures and financial health.” In a lengthy opinion reviewing each of the Commission’s claims, the Court concluded that either the evidence supporting the allegation was lacking or the asserted factual support was misstated, with the limited exceptions noted above.

The Court began by considering whether there was evidence supporting a finding of scienter under the motive and opportunity test. The Court rejected the SEC’s claim that motive and opportunity could be established from the firm’s compensation incentives. Neither that policy nor Mr. Angelo’s status as majority owner of the firm is sufficient for purposes of establishing opportunity. Likewise, the fact that the firm was suffering financial stress during the market crisis – what the SEC called being “’caught in a death spiral’” — also failed to establish the test used by the Second Circuit. And, while motive can be demonstrated by factual allegations that “corporate insiders allegedly engaged in misrepresentations in order to sell their own shares at inflated prices” as the SEC claims, that was not the case here. To the contrary “Defendants Angelo and Schinik “made their redemption requests when YA [Yorkville Advisors] was actively marking the Fund down by approximately $33 million . . . in October, November, and December 2008.” (emphasis original).

The Court also rejected the SEC’s claims that the evidence supported a strong inference of scienter. For example, the Commission claimed that Mr. Schinik’s intent was demonstrated by his failure to disclose what it called key documents to the outside auditors during the period as well as his affirmative misrepresentations regarding the 15 positions to the investors and auditors. The Court rejected these claims, noting “First and foremost, internal and external reviews of YA’s valuations of the 15 Positions never showed any evidence of fraud or deceit . . . [the valuation committee] met regularly and attempted to value assets that were inherently difficult to value and required subjective judgments, due to their illiquid and customized nature. There is no evidence that Defendants Schinik or Angelo instructed anyone to withhold material information from the VC [valuation committee], or delay the write down of any investment.”

The Court also rejected claims by the SEC that misrepresentations were made regarding the valuation policies. For example, the Commission argued that a letter to the outside auditors falsely claimed that “’In some cases, the General Partner employed financial models to determine a ‘best estimate’ valuation . . .’” was false because models were not used. The Court found, however, that “the record is replete with instances in which YA used financial models in connection with their investments.”

Finally, a claim by the SEC that red flags were not disclosed to the auditors is not supported by the evidence, according to the Court. For example, the agency claimed that Defendant Angelo did not disclose a “side agreement” he had signed to the audit firm. While this is correct, the SEC “never articulates why YA’s failure to disclose this agreement constituted an intent to defraud McGladrey [outside auditor] with respect to YA’s valuations. The SEC does not point to any specific information YA was trying to hide, let alone why it was material, or what benefit YA would have derived from withholding it. Without these accompanying allegations, the SEC’s accusations concern a mere failure to disclose,” like its other allegations, fail to support its fraud claims.



Program: Insights Into SEC Enforcement, is roundtable discussion of the Former Directors of the SEC’s Division of Enforcement that will be held on April 3, 2018 beginning a 4:30 p.m. at Georgetown University Law School. The program will be followed by a reception. Registration is available here without charge. The program is sponsored by the SEC Historical Society, the Federal Bar Association, and the Association of SEC Alumni.

The post SEC Asset Valuation Claims Rejected on Summary Judgment appeared first on SEC ACTIONS.

April 3, 2018
ISS Updates 15 Policy FAQs
by Broc Romanek

Oddly late for the proxy season, ISS updated its “FAQs on US Voting Procedures” late last week (changes are highlighted in yellow). In comparison, these FAQs were updated last proxy season in late February (arguably also late for those grappling with the proxy season). As noted in this Steve Quinlivan blog, the updates relate to:

– When are ISS’s proxy reports issued?
– How and when will ISS change a vote recommendation in a proxy alert?
– How can a company request engagement with the U.S. research analysts?
– When is the best time to request an engagement?
– What topics are generally discussed in engagements regarding non-contentious meetings?
– Is there a blackout period for engagement with research?
– What exceptions to the attendance policy apply in the case of a newly-appointed director?
– Proxy access proposals: How will ISS evaluate a Board’s implementation of proxy access in response to a majority-supported shareholder proposal?
– How will ISS apply the new 2018 policy whose previously-grandfathered poison pills will be expiring shortly?
– How do companies terminate poison pills prior to the expiration date?
– Does ISS still consider deadhand or slowhand provisions problematic?
– What if a company adopts a poison before the company goes public?
– Removal of Shareholder Discretion on Classified Boards
– Which types of charter/bylaw adoptions are likely to result in continued adverse voting recommendations?
– What is the purpose of the Governance Failures Policy?

Congress Boosts Edgar Funding – SEC May Move HQ

Over the past year, Broc has blogged repeatedly about the importance of Edgar – and its ongoing problems. So we had our fingers crossed when the SEC’s proposed budget for fiscal 2019 included requests for technology modernization & cybersecurity.

And now, the omnibus spending bill that’s supposed to fund the government for the balance of fiscal 2018 increases the SEC’s funding for IT initiatives by a cool $45 million (see pg. 231). There’s also $244 million available to relocate the SEC’s headquarters – a notion that has been floating around for a few years (see this blog) and that the GSA started more seriously pursuing last year.

What’s not in the budget? Well, page 240 says the SEC is prohibited from using funds to finalize, issue or implement any corporate political contributions disclosure requirement (something that’s been stipulated in the past few budget bills). And as far as I can tell, the budget doesn’t permanently rescind the SEC’s Dodd-Frank reserve fund – an idea that was discussed last year. Overall, the SEC’s $1.6 billion budget has remained essentially flat since 2016.

Dodd-Frank Reform: Hensarling Pressures Senate to Negotiate

Here’s an excerpt of this blog by Steve Quinlivan about the “Crapo bill” that the Senate has already passed:

The future of the bill in the House is uncertain. House Financial Services Committee Chairman Jeb Hensarling (R-TX) is seeking to include a “bucket of bipartisan bills” in the legislation which previously passed the House. In a TV interview, Representative Hensarling said: “We have called on the Senate to negotiate. Otherwise, the bill that the Senate passed – which is sitting on the Speaker’s desk – is going to remain on the Speaker’s desk until and unless the Senate negotiates. We are trying to negotiate in good faith. They have to give us some reason –you know, Maxine Waters voted for roughly half the bills we’re trying to negotiate with the Senate….so somebody needs to explain to me why they can’t accept this legislation.”

Some of the provisions Representative Hensarling is seeking to include are discussed in this Forbes article.

Liz Dunshee

View today's posts

4/3/2018 posts

The Harvard Law School Forum on Corporate Governance and Financial Regulation: “Forcing the Offer”: Considerations for Deal Certainty and Support Agreements in Delaware Two-Step Mergers
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Disclosing Corporate Lobbying
CLS Blue Sky Blog: Cleary Gottlieb Discusses the SEC’s New Cyber Unit, Six Months On
CLS Blue Sky Blog: How CEOs’ Personal Finances Affect Their Companies’ Financial Decisions
The Harvard Law School Forum on Corporate Governance and Financial Regulation: 2018 Proxy Season Preview
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Broadcom’s Blocked Acquisition of Qualcomm
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Why Do Investors Hold Socially Responsible Mutual Funds?
Delaware Corporate & Commercial Litigation Blog: Chancery Addresses Scope of Director Consent Statute and Civil Conspiracy Claims
Delaware Corporate & Commercial Litigation Blog: Delaware Contract Interpretation Principles
Delaware Corporate & Commercial Litigation Blog: Supreme Court Addresses Forum Non Conveniens
SEC Actions Blog: SEC Asset Valuation Claims Rejected on Summary Judgment Blog: ISS Updates 15 Policy FAQs

Blog posts are subject to copyrights held by the authors and are republished here with permission. Views expressed are those of the authors alone. Infringement Notification.