Securities Mosaic® Blogwatch
March 27, 2019
2019 Proxy Voting and Engagement Guidelines: North America
by Rakhi Kumar, Richard Lacaille, SSgA

State Street Global Advisors recently released their 2019 proxy voting and engagement guidelines. The guidelines consist of the 2019 Global Proxy Voting and Engagement Principles and six market specific proxy voting and engagement guidelines, including the North American guideline reproduced below. The guidelines are supplemented by the 2019 Global Proxy Voting and Engagement Guidelines for Environmental and Social Issues, which provides additional transparency into our approach to these important issues. The complete set of guidelines, including our Conflicts of Interest Policy and Issuer Engagement Protocol are available under the Voting Guidelines section of the Asset Stewardship website.

State Street Global Advisors’ North America Proxy Voting and Engagement Guidelines [1] address areas, including board structure, director tenure, audit related issues, capital structure, executive compensation, as well as environmental, social, and other governance-related issues of companies listed on stock exchanges in the US and Canada (“North America”). Principally, we believe the primary responsibility of the board of directors is to preserve and enhance shareholder value and protect shareholder interests. In order to carry out their primary responsibilities, directors have to undertake activities that range from setting strategy and overseeing executive management to monitoring the risks that arise from a company’s business, including risks related to sustainability issues. Further, good corporate governance necessitates the existence of effective internal controls and risk management systems, which should be governed by the board.

 

When voting and engaging with companies in global markets, we consider market specific nuances in the manner that we believe will most likely protect and promote the long-term economic value of client investments. We expect companies to observe the relevant laws and regulations of their respective markets, as well as country specific best practice guidelines and corporate governance codes. When we feel that a country’s regulatory requirements do not address some of the key philosophical principles that we believe are fundamental to its global voting guidelines, we may hold companies in such markets to our global standards.

In its analysis and research about corporate governance issues in North America, we expect all companies to act in a transparent manner and to provide detailed disclosure on board profiles, related-party transactions, executive compensation, and other governance issues that impact shareholders’ long-term interests. Further, as a founding member of the Investor Stewardship Group (“ISG”), we proactively monitor companies’ adherence to the Corporate Governance Principles for US listed companies. Consistent with the “comply-or-explain” expectations established by the principles, we encourage companies to proactively disclose their level of compliance with the principles. In instances of non-compliance when companies cannot explain the nuances of their governance structure effectively, either publicly or through engagement, we may vote against the independent board leader.

State Street Global Advisors’ Proxy Voting and Engagement Philosophy

Corporate governance and sustainability issues are an integral part of the investment process. The Asset Stewardship Team consists of investment professionals with expertise in corporate governance and company law, remuneration, accounting, and environmental and social issues. We have established robust corporate governance principles and practices that are backed with extensive analytical expertise to understand the complexities of the corporate governance landscape. We engage with companies to provide insight on the principles and practices that drive our voting decisions. We also conduct proactive engagements to address significant shareholder concerns and environmental, social, and governance (“ESG”) issues in a manner consistent with maximizing shareholder value.

The team works alongside members of State Street Global Advisors’s Active Fundamental and various other investment teams, collaborating on issuer engagements and providing input on company specific fundamentals. We are also a member of various investor associations that seek to address broader corporate governance related policy issues in North America.

State Street Global Advisors is a signatory to the United Nations Principles of Responsible Investment (“UNPRI”) and is compliant with the US Investor Stewardship Group Principles. We are committed to sustainable investing and are working to further integrate ESG principles into investment and corporate governance practices, where applicable and consistent with our fiduciary duty.

Directors and Boards

State Street Global Advisors believes that a well constituted board of directors, with a balance of skills, expertise, and independence, provides the foundations for a well governed company. We view board quality as a measure of director independence, director succession planning, board diversity, evaluations and refreshment, and company governance practices. We vote for the election/re-election of directors on a case-by-case basis after considering various factors, including board quality, general market practice, and availability of information on director skills and expertise. In principle, we believe independent directors are crucial to robust corporate governance and help management establish sound corporate governance policies and practices. A sufficiently independent board will most effectively monitor management and perform oversight functions necessary to protect shareholder interests. Further, we expect boards of Russell 3000 and TSX listed companies to have at least one female board member .

Director related proposals include issues submitted to shareholders that deal with the composition of the board or with members of a corporation’s board of directors. In deciding the director nominee to support, we consider numerous factors.

Director Elections

Our director election guideline focuses on companies’ governance profile to identify if a company demonstrates appropriate governance practices or if it exhibits negative governance practices. Factors we consider when evaluating governance practices include, but are not limited to the following:

  • Shareholder rights
  • Board independence
  • Board structure

If a company demonstrates appropriate governance practices, we believe a director should be classified as independent based upon the relevant listing standards or local market practice standards. In such cases, the composition of the key oversight committees of a board should meet the minimum standards of independence. Accordingly, we will vote against a nominee at a company with appropriate governance practices if the director is classified as non-independent under relevant listing standards or local market practice and serves on a key committee of the board (compensation, audit, nominating, or committees required to be fully independent by local market standards).

Conversely, if a company demonstrates negative governance practices, State Street Global Advisors believes the classification standards for director independence should be elevated. In such circumstances, we will evaluate all director nominees based upon the following classification standards:

  • Is the nominee an employee of or related to an employee of the issuer or its auditor?
  • Does the nominee provide professional services to the issuer?
  • Has the nominee attended an appropriate number of board meetings?
  • Has the nominee received non-board related compensation from the issuer?

In the US market where companies demonstrate negative governance practices, these stricter standards will apply not only to directors who are a member of a key committee but to all directors on the board as market practice permits. Accordingly, we will vote against a nominee (with the exception of the CEO) where the board has inappropriate governance practices and is considered not independent based on the above independence criteria.

Additionally, we may withhold votes from directors based on the following:

  • Overall average board tenure is excessive. In assessing excessive tenure, we give consideration to factors such as the preponderance of long tenured directors, board refreshment practices, and classified board structures
  • Directors attend less than 75% of board meetings without appropriate explanation or providing reason for their failure to meet the attendance threshold
  • CEOs of a public company who sit on more than three public company boards
  • Director nominees who sit on more than six public company boards
  • Directors of companies that have not been responsive to a shareholder proposal that received a majority shareholder support at the last annual or special meeting
  • Consideration can be warranted if management submits the proposal(s) on the ballot as a binding management proposal, recommending shareholders vote for the particular proposal(s)
  • Directors of companies have unilaterally adopted/ amended company bylaws that negatively impact our shareholder rights (such as fee-shifting, forum selection, and exclusion service bylaws) without putting such amendments to a shareholder vote
  • Compensation committee members where there is a weak relationship between executive pay and performance over a five-year period
  • Audit committee members if non-audit fees exceed 50% of total fees paid to the auditors
  • Directors who appear to have been remiss in their duties

Director Related Proposals

We generally vote for the following director related proposals:

  • Discharge of board members’ duties, in the absence of pending litigation, regulatory investigation, charges of fraud, or other indications of significant concern
  • Proposals to restore shareholders’ ability in order to remove directors with or without cause
  • Proposals that permit shareholders to elect directors to fill board vacancies
  • Shareholder proposals seeking disclosure regarding the company, board, or compensation committee’s use of compensation consultants, such as company name, business relationship(s), and fees paid

We generally vote against the following director related proposals:

  • Requirements that candidates for directorships own large amounts of stock before being eligible to be elected
  • Proposals that relate to the “transaction of other business as properly comes before the meeting,” which extend “blank check” powers to those acting as proxy
  • Proposals requiring two candidates per board seat

Majority Voting

We will generally support a majority vote standard based on votes cast for the election of directors.

We will generally vote to support amendments to bylaws that would require simple majority of voting shares (i.e. shares cast) to pass or to repeal certain provisions.

Annual Elections

We generally support the establishment of annual elections of the board of directors. Consideration is given to the overall level of board independence and the independence of the key committees, as well as the existence of a shareholder rights plan.

Cumulative Voting

We do not support cumulative voting structures for the election of directors.

Separation Chair/CEO

We analyze proposals for the separation of Chair/CEO on a case-by-case basis taking into consideration numerous factors, including the appointment of and role played by a lead director, a company’s performance, and the overall governance structure of the company.

Proxy Access

In general, we believe that proxy access is a fundamental right and an accountability mechanism for all long-term shareholders. We will consider proposals relating to proxy access on a case-by-case basis. We will support shareholder proposals that set parameters to empower long-term shareholders while providing management the flexibility to design a process that is appropriate for the company’s circumstances.

We will review the terms of all other proposals and will support those proposals that have been introduced in the spirit of enhancing shareholder rights.

Considerations include the following:

  • The ownership thresholds and holding duration proposed in the resolution
  • The binding nature of the proposal
  • The number of directors that shareholders may be able to nominate each year
  • Company governance structure
  • Shareholder rights
  • Board performance

Age/Term Limits

Generally, we will vote against age and term limits unless the company is found to have poor board refreshment and director succession practices. We will also vote against if the company has a preponderance of non-executive directors with excessively long tenures serving on the board.

Approve Remuneration of Directors

Generally, we will support directors’ compensation, provided the amounts are not excessive relative to other issuers in the market or industry. In making our determination, we review whether the compensation is overly dilutive to existing shareholders.

Indemnification

Generally, we support proposals to limit directors’ liability and/or expand indemnification and liability protection if he or she has not acted in bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his or her office.

Classified Boards

We generally support annual elections for the board of directors.

Confidential Voting

We will support confidential voting.

Board Size

We will support proposals seeking to fix the board size or designate a range for the board size and will vote against proposals that give management the ability to alter the size of the board outside of a specified range without shareholder approval.

Audit-Related Issues

Ratifying Auditors and Approving Auditor Compensation

We support the approval of auditors and auditor compensation provided that the issuer has properly disclosed audit and non-audit fees relative to market practice and the audit fees are not deemed excessive. We deem audit fees to be excessive if the non-audit fees for the prior year constituted 50% or more of the total fees paid to the auditor. We will also support the disclosure of auditor and consulting relationships when the same or related entities are conducting both activities and will support the establishment of a selection committee responsible for the final approval of significant management consultant contract awards where existing firms are already acting in an auditing function.

In circumstances where “other” fees include fees related to initial public offerings, bankruptcy emergence, and spin-offs, and the company makes public disclosure of the amount and nature of those fees which are determined to be an exception to the standard “non-audit fee” category, then such fees may be excluded from the non-audit fees considered in determining the ratio of non-audit to audit/audit-related fees/tax compliance and preparation for purposes of determining whether non-audit fees are excessive.

We will support the discharge of auditors and requirements that auditors attend the annual meeting of shareholders. [2]

Capital-Related Issues

Capital structure proposals include requests by management for approval of amendments to the certificate of incorporation that will alter the capital structure of the company.

The most common request is for an increase in the number of authorized shares of common stock, usually in conjunction with a stock split or dividend. Typically, we support requests that are not unreasonably dilutive or enhance the rights of common shareholders. In considering authorized share proposals, the typical threshold for approval is 100% over current authorized shares. However, the threshold may be increased if the company offers a specific need or purpose (merger, stock splits, growth purposes, etc.). All proposals are evaluated on a case-by-case basis taking into account the company’s specific financial situation.

Increase in Authorized Common Shares

In general, we support share increases for general corporate purposes up to 100% of current authorized stock.

We support increases for specific corporate purposes up to 100% of the specific need plus 50% of current authorized common stock for US and Canadian firms.

When applying the thresholds, we will also consider the nature of the specific need, such as mergers and acquisitions and stock splits.

Increase in Authorized Preferred Shares

We vote on a case-by-case basis on proposals to increase the number of preferred shares.

Generally, we will vote for the authorization of preferred stock in cases where the company specifies the voting, dividend, conversion, and other rights of such stock and the terms of the preferred stock appear reasonable.

We will support proposals to create “declawed” blank check preferred stock (stock that cannot be used as a takeover defense). However, we will vote against proposals to increase the number of blank check preferred stock authorized for issuance when no shares have been issued or reserved for a specific purpose.

Unequal Voting Rights

We will not support proposals authorizing the creation of new classes of common stock with superior voting rights and will vote against new classes of preferred stock with unspecified voting, conversion, dividend distribution, and other rights. In addition, we will not support capitalization changes that add “blank check” classes of stock (i.e. classes of stock with undefined voting rights) or classes that dilute the voting interests of existing shareholders.

However, we will support capitalization changes that eliminate other classes of stock and/or unequal voting rights.

Mergers and Acquisitions

Mergers or the reorganization of the structure of a company often involve proposals relating to reincorporation, restructurings, liquidations, and other major changes to the corporation.

Proposals that are in the best interests of the shareholders, demonstrated by enhancing share value or improving the effectiveness of the company’s operations, will be supported.

In general, provisions that are not viewed as economically sound or are thought to be destructive to shareholders’ rights are not supported.

We will generally support transactions that maximize shareholder value. Some of the considerations include the following:

  • Offer premium
  • Strategic rationale
  • Board oversight of the process for the recommended transaction, including, director and/or management conflicts of interest
  • Offers made at a premium and where there are no other higher bidders
  • Offers in which the secondary market price is substantially lower than the net asset value

We may vote against a transaction considering the following:

  • Offers with potentially damaging consequences for minority shareholders because of illiquid stock, especially in some non-US markets
  • Offers where we believe there is a reasonable prospect for an enhanced bid or other bidders
  • The current market price of the security exceeds the bid price at the time of voting

Anti–Takeover Issues

Typically, these are proposals relating to requests by management to amend the certificate of incorporation or bylaws to add or to delete a provision that is deemed to have an anti-takeover effect. The majority of these proposals deal with management’s attempt to add some provision that makes a hostile takeover more difficult or will protect incumbent management in the event of a change in control of the company.

Proposals that reduce shareholders’ rights or have the effect of entrenching incumbent management will not be supported.

Proposals that enhance the right of shareholders to make their own choices as to the desirability of a merger or other proposal are supported.

Shareholder Rights Plans

US We will support mandates requiring shareholder approval of a shareholder rights plans (“poison pill”) and repeals of various anti-takeover related provisions.

In general, we will vote against the adoption or renewal of a US issuer’s shareholder rights plan (“poison pill”).

We will vote for an amendment to a shareholder rights plan (“poison pill”) where the terms of the new plans are more favorable to shareholders’ ability to accept unsolicited offers (i.e. if one of the following conditions are met: (i) minimum trigger, flip-in or flip-over of 20%, (ii) maximum term of three years, (iii) no “dead hand,” “slow hand,” “no hand” nor similar feature that limits the ability of a future board to redeem the pill, and (iv) inclusion of a shareholder redemption feature (qualifying offer clause), permitting ten percent of the shares to call a special meeting or seek a written consent to vote on rescinding the pill if the board refuses to redeem the pill 90 days after a qualifying offer is announced).

Canada We analyze proposals for shareholder approval of a shareholder rights plan (“poison pill”) on a case-by-case basis taking into consideration numerous factors, including but not limited to, whether it conforms to ‘new generation’ rights plans and the scope of the plan.

Special Meetings

We will vote for shareholder proposals related to special meetings at companies that do not provide shareholders the right to call for a special meeting in their bylaws if:

  • The company also does not allow shareholders to act by written consent
  • The company allows shareholders to act by written consent but the ownership threshold for acting by written consent is set above 25% of outstanding shares

We will vote for shareholder proposals related to special meetings at companies that give shareholders (with a minimum 10% ownership threshold) the right to call for a special meeting in their bylaws if:

  • The current ownership threshold to call for a special meeting is above 25% of outstanding shares

We will vote for management proposals related to special meetings.

Written Consent

We will vote for shareholder proposals on written consent at companies if:

  • The company does not have provisions in their bylaws giving shareholders the right to call for a special meeting
  • The company allows shareholders the right to call for a special meeting, but the current ownership threshold to call for a special meeting is above 25% of outstanding shares
  • The company has a poor governance profile

We will vote management proposals on written consent on a case-by-case basis.

Super–Majority

We will generally vote against amendments to bylaws requiring super-majority shareholder votes to pass or repeal certain provisions. We will vote for the reduction or elimination of super-majority vote requirements, unless management of the issuer was concurrently seeking to or had previously made such a reduction or elimination.

Remuneration Issues

Despite the differences among the types of plans and the awards possible there is a simple underlying philosophy that guides the analysis of all compensation plans; namely, the terms of the plan should be designed to provide an incentive for executives and/or employees to align their interests with those of the shareholders and thus work toward enhancing shareholder value. Plans that benefit participants only when the shareholders also benefit are those most likely to be supported.

Advisory Vote on Executive Compensation and Frequency

State Street Global Advisors believes executive compensation plays a critical role in aligning executives interest with shareholder’s, attracting, retaining and incentivizing key talent, and ensuring positive correlation between the performance achieved by management and the benefits derived by shareholders. We support management proposals on executive compensation where there is a strong relationship between executive pay and performance over a five-year period. We seek adequate disclosure of various compensation elements, absolute and relative pay levels, peer selection and benchmarking, the mix of long-term and short-term incentives, alignment of pay structures with shareholder interests as well as with corporate strategy, and performance. Further shareholders should have the opportunity to assess whether pay structures and levels are aligned with business performance on an annual basis.

In Canada, where advisory votes on executive compensation are not commonplace, we will rely primarily upon engagement to evaluate compensation plans.

Employee Equity Award Plans

We consider numerous criteria when examining equity award proposals. Generally we do not vote against plans for lack of performance or vesting criteria. Rather the main criteria that will result in a vote against an equity award plan are:

Excessive voting power dilution To assess the dilutive effect, we divide the number of shares required to fully fund the proposed plan, the number of authorized but unissued shares and the issued but unexercised shares by the fully diluted share count. We review that number in light of certain factors, such as the industry of the issuer.

Historical option grants Excessive historical option grants over the past three years. Plans that provide for historical grant patterns of greater than five to eight percent are generally not supported.

Repricing We will vote against any plan where repricing is expressly permitted. If a company has a history of repricing underwater options, the plan will not be supported.

Other criteria include the following:

  • Number of participants or eligible employees
  • The variety of awards possible
  • The period of time covered by the plan

There are numerous factors that we view as negative. If combined they may result in a vote against a proposal. Factors include:

  • Grants to individuals or very small groups of participants
  • “Gun-jumping” grants which anticipate shareholder approval of a plan or amendment
  • The power of the board to exchange “underwater” options without shareholder approval. This pertains to the ability of a company to reprice options, not the actual act of repricing described above
  • Below market rate loans to officers to exercise their options
  • The ability to grant options at less than fair market value;
  • Acceleration of vesting automatically upon a change in control
  • Excessive compensation (i.e. compensation plans which we deem to be overly dilutive)

Share Repurchases If a company makes a clear connection between a share repurchase program and its intent to offset dilution created from option plans and the company fully discloses the amount of shares being repurchased, the voting dilution calculation may be adjusted to account for the impact of the buy back.

Companies will not have any such repurchase plan factored into the dilution calculation if they do not (i) clearly state the intentions of any proposed share buy-back plan, (ii) disclose a definitive number of the shares to be bought back, (iii) specify the range of premium/discount to market price at which a company can repurchase shares, and (iv) disclose the time frame during which the shares will be bought back..

162(m) Plan Amendments If a plan would not normally meet our criteria described above, but was primarily amended to add specific performance criteria to be used with awards that were designed to qualify for performance-based exception from the tax deductibility limitations of Section 162(m) of the Internal Revenue Code, then we will support the proposal to amend the plan.

Employee Stock Option Plans

We generally vote for stock purchase plans with an exercise price of not less than 85% of fair market value. However, we take market practice into consideration.

Compensation Related Items

We generally support the following proposals:

  • Expansions to reporting of financial or compensation-related information within reason
  • Proposals requiring the disclosure of executive retirement benefits if the issuer does not have an independent compensation committee

We generally vote against the following proposal:

  • Retirement bonuses for non-executive directors and auditors

Miscellaneous/Routine Items

We generally support the following miscellaneous/routine governance items:

  • Reimbursement of all appropriate proxy solicitation expenses associated with the election when voting in conjunction with support of a dissident slate
  • Opting-out of business combination provision
  • Proposals that remove restrictions on the right of shareholders to act independently of management
  • Liquidation of the company if the company will file for bankruptcy if the proposal is not approved
  • Shareholder proposals to put option repricings to a shareholder vote
  • General updating of, or corrective amendments to, charter and bylaws not otherwise specifically addressed herein, unless such amendments would reasonably be expected to diminish shareholder rights (e.g. extension of directors’ term limits, amending shareholder vote requirement to amend the charter documents, insufficient information provided as to the reason behind the amendment)
  • Change in corporation name
  • Mandates that amendments to bylaws or charters have shareholder approval
  • Management proposals to change the date, time, and/or location of the annual meeting unless the proposed change is unreasonable
  • Repeals, prohibitions or adoption of anti-greenmail provisions
  • Management proposals to implement a reverse stock split when the number of authorized shares will be proportionately reduced and proposals to implement a reverse stock split to avoid delisting
  • Exclusive forum provisions

State Street Global Advisors generally does not support the following miscellaneous/routine governance items:

  • Proposals requesting companies to adopt full tenure holding periods for their executives
  • Reincorporation to a location that we believe has more negative attributes than its current location of incorporation
  • Shareholder proposals to change the date, time, and/or location of the annual meeting unless the current scheduling or location is unreasonable
  • Proposals to approve other business when it appears as a voting item
  • Proposals giving the board exclusive authority to amend the bylaws
  • Proposals to reduce quorum requirements for shareholder meetings below a majority of the shares outstanding unless there are compelling reasons to support the proposal

Environmental and Social Issues

As a fiduciary, State Street Global Advisors takes a comprehensive approach to engaging with our portfolio companies about material environmental and social (sustainability) issues. We use our voice and our vote through engagement, proxy voting, and thought leadership in order to communicate with issuers and educate market participants about our perspective on important sustainability topics. Our Asset Stewardship program prioritization process allows us to proactively identify companies for engagement and voting in order to mitigate sustainability risks in our portfolio. Through engagement, we address a broad range of topics that align with our thematic priorities and build long-term relationships with issuers. When voting, we fundamentally consider whether the adoption of a shareholder proposal addressing a material sustainability issue would promote long-term shareholder value in the context of the company’s existing practices and disclosures as well as existing market practice.

For more information on our approach to environmental and social issues, please see our Global Proxy Voting and Engagement Guidelines for Environmental and Social Issues available at https://www.ssga.com/about-us/asset-stewardship.html.

Endnotes

 

These Proxy Voting and Engagement Guidelines are also applicable to SSGA Funds Management, Inc.” SSGA Funds Management, Inc. is an SEC-registered investment adviser. SSGA Funds Management, Inc., State Street Global Advisors Trust Company, and other advisory affiliates of State Street make up State Street Global Advisors, the investment management arm of State Street Corporation.(go back)

 

Common for non-US issuers; request from the issuer to discharge from liability the directors or auditors with respect to actions taken by them during the previous year.(go back)
March 27, 2019
Does Protectionist Anti-Takeover Legislation Lead to Managerial Entrenchment?
by Marc Frattaroli

My article, titled Does protectionist anti-takeover legislation lead to managerial entrenchment?, forthcoming in the Journal of Financial Economics, investigates the implications of protectionist interventions into mergers and acquisitions for corporate governance.

Over the last few years, governments worldwide have intervened in a significant number of cross-border mergers and acquisitions, often citing national security concerns. Several countries including the United States, Germany, France, and the United Kingdom have also recently introduced or are contemplating the introduction of legislation that increases the scrutiny of foreign investments. The threat of a takeover is one of several possible ways to overcome the agency problem created by the separation of ownership and control in firms: If a firm’s management is implementing policies that are suboptimal for shareholders, a shareholder or third party can make a profit by acquiring the firm and replacing its management team. In theory, therefore, a reduction in this threat, such as through protectionist legislation, has the potential to entrench a firm’s management, i.e. might allow management to extract private benefits at the expense of shareholders.

 

While there is a large literature studying the connection between managerial entrenchment and anti-takeover legislation, most of it is based on the second generation of state-level anti-takeover laws introduced in the United States in the 1980s. It is unclear whether these results should apply to today’s protectionist interventions because they are different in nature and corporate governance standards worldwide have become significantly stricter over the last two decades.

My article tests whether protectionism leads to managerial entrenchment based on the Alstom Decree, a protectionist law introduced in France in 2014. The Alstom Decree designated the five industry sectors energy, water supply, transportation, electronic communications and public health, which together account for around 30% of all publicly listed French firms, as strategic to the country’s interests and enables the secretary of commerce to veto M&A transactions targeting companies operating in them if the bidder originates from abroad. Since the introduction of the Alstom Decree until early 2018, over a hundred transactions have been the subject of an investigation. In addition, the law also has the potential to deter M&A transactions ex ante, either because it increases the costs for the bidder through delays or less favorable deal terms or because the acquirer fears the transaction might not be approved.

I find that firms protected by the Alstom Decree, compared to unprotected firms, become substantially less likely to be the target of an acquisition or merger after the Decree’s introduction. An event study around its announcement further indicates that a portfolio holding a long position in protected firms and a short position of the same size in unprotected firms would have produced significantly negative abnormal returns. These results suggest that the protection provided by the Alstom Decree was indeed meaningful.

I then test whether this measurable decrease in the likelihood of being acquired affected corporate policies at protected firms. Jensen’s theory on the agency cost of free cash flow suggests that managers prefer to retain rather than distribute excess cash absent positive net present value investment opportunities. Following the theory, an entrenched manager will seek to decrease the amount of financial leverage (because debt financing commits part of the firm’s cash flow to interest payments) and decrease distributions to shareholders. I test whether the Alstom Decree is associated with changes in protected firms’ capital structure and payout policies, but do not find any evidence for such changes taking place.

The literature has also developed two competing hypotheses on managers’ preferred use for excess cash: empire building and the quiet life. The empire building hypothesis suggests that executives have an interest in increasing the size of their firm, as it is positively correlated with their prestige and compensation. The quiet life hypothesis on the other hand states that managers prefer to avoid difficult decisions and are just as unlikely to aggressively grow a business as they are to restructure it when they are protected. Furthermore, it suggests that they have a preference for paying higher wages and growing the size of their staff, which results in lower productivity and profitability when they are at liberty to do so. I attempt to find evidence for empire building or quiet life behavior at firms subject to the Alstom Decree by testing for changes in firm characteristics that should be affected according to the two theories of managerial preferences. I do not find that affected firms increase capital expenditures, R&D expenses or the number or volume of mergers and acquisitions they engage in. Therefore, I do not find any evidence for empire building. Also inconsistent with quiet life behavior, I do not find an increase wages or employment following the Alstom Decree, and protected firms’ operating performance remains unchanged.

The final firm policy I examine in the light of the Alstom Decree is executive compensation. The most direct way in which an entrenched manager can extract value from a firm is through his or her own compensation contract. In addition, the executive’s compensation contract is one of the most important tools for aligning incentives between shareholders and management. If shareholders or the board of directors were concerned that the Decree would lead to a decrease in managerial discipline, they might have taken measures to increase the performance-sensitivity of executive compensation to substitute for the loss in monitoring by the takeover market. I find limited evidence for an increase in total executive compensation and robust evidence for an increase in the pay-for-performance sensitivity following the Alstom Decree, where I measure the latter as the share of annual CEO compensation paid out in equity instruments.

In summary, my results suggest that a loss in efficiency stemming from an increase in managerial entrenchment cannot explain the negative impact the Alstom Decree had on shareholder value. The potential increase in executive compensation alone is too small to explain the law’s announcement return. I suggest an alternative explanation for the stock market reaction to the Alstom Decree that does not rely on managerial entrenchment: The incumbent shareholders frequently receive a large premium over the pre-offer share price during a takeover, and efficiency gains from removing bad management are only one reason for why the acquirer might be willing to pay such a premium. As protected firms are less likely to be acquired, the Alstom Decree caused a decrease in the expected value of future takeover premiums accruing to affected firms’ shareholders.

The complete article is available for download here.

March 27, 2019
Practical Implications of Proposed Testing the Waters for All Issuers under U.S. Securities Law
by Craig Chapman, David Lichtstein, David Ni, Eric Haueter, Jon Daly, Michael Hyatte, Sidley Austin

On February 19, 2019, the Securities and Exchange Commission (SEC) approved a proposed rule that, if enacted, would permit all issuers to use “test-the-waters” communications (TTW communications). Currently, only “emerging growth companies”—a defined term generally describing most initial public offering (IPO) issuers and other new entrants to the SEC reporting system—are permitted to engage in TTW communications under the Securities Act of 1933 (Securities Act). This alert provides some background on TTW communications, discusses the new proposal and concludes with our views of the practical implications of the proposal.

Background: Testing the Waters and the JOBS Act

In April 2012, President Barack Obama signed the Jumpstart Our Business Startups Act (JOBS Act) into law. The JOBS Act’s stated objective was to facilitate capital formation, particularly for emerging growth companies (EGCs). The JOBS Act added Section 5(d) to the Securities Act to permit TTW communications for EGCs. Section 5(d) allows EGC issuers, and persons acting on their behalf, to test the waters by oral or written communication with potential investors both before and after the filing of an IPO registration statement. Under Section 5(d), TTW communications are solely permitted with potential investors who are “qualified institutional buyers” (QIBs) or institutional “accredited investors” (IAIs), as defined by applicable SEC rules. Apart from TTW communications, after the filing of a registration statement, written communication offering a security is forbidden by Section 5(b) unless such communication is a prospectus that meets SEC requirements or is exempt from those requirements.

 

Following the enactment of the JOBS Act, the vast majority of IPOs have involved EGCs, which accounted for 87% of IPOs between 2012 and 2017, according to a November 2016 report by Ernst & Young, LLP. A significant number of EGCs engage in TTW communications. Industry research and Sidley’s experience suggest that EGCs, especially those in the healthcare, technology, media, telecommunications and energy industries, and potential underwriters acting on behalf of EGCs find TTW communications very useful in their efforts to raise capital.

The Proposed Rule 163B: Eligible Issuers and Permitted Communications

Proposed Rule 163B under the Securities Act aims to “allow all issuers, including non-EGC issuers, to engage in test-the-waters communications with potential investors that are, or that the issuer reasonably believes to be, QIBS or IAIs, either prior to or following the date of filing of a registration statement related to such offering.” The proposal would permit persons acting on behalf of the issuer, including prospective underwriters acting at the direction of an issuer, to effect TTW communications. The reasonable-belief requirement of Rule 163B applies equally to any person authorized to act on an issuer’s behalf, including underwriters. TTW communications made under the proposed rule are allowable so long as they are not intended to evade the requirements of Section 5 of the Securities Act.

Proposed Rule 163B and Section 5(d) differ in some significant respects. For example, the proposal would permit TTW communications if the party relying on the rule has a reasonable belief that all recipients of those communications are QIBs or IAIs, even if it turns out that they were not. It is not clear that the same result would follow under Section 5(d), which also requires that recipients be QIBs or IAIs but does not include a reasonable-belief qualification. The proposed rule would be the effective administrative repeal of Section 5(c) for offers to private equity funds, mutual funds or other “buy-side” institutions. Otherwise, the proposed rule largely mirrors Section 5(d). Rule 163B would be nonexclusive—issuers may rely on other Securities Act rules or exemptions, such as Section 5(d), Rule 163, Rule 164 or Rule 255 in holding exploratory communications with potential investors.

Under proposed Rule 163B, either the issuer or a party authorized to act on its behalf, such as an underwriter, may make TTW communications. The ability of a party authorized by the issuer to make TTW communications provides additional appeal over similar, existing rules. For example, Rule 163 under the Securities Act permits “well-known seasoned issuers” (WKSIs) as defined under Rule 405 to make oral and written offers before a registration statement is filed, subject to certain conditions. Rule 163 has proven to have virtually no practical use for WKSIs, however, because the SEC staff has construed the rule to be unavailable to underwriters acting on behalf of the issuer.

Other benefits of proposed Rule 163B are that unlike Rule 163, the proposed rule is available to all issuers (not just WKSIs) and does not require issuers to file TTW communications with the SEC or to include any legends in those communications. However, the absence of a filing requirement does not prevent the SEC staff from requesting written TTW communications as supplemental information, which is its practice for EGCs relying on Section 5(d).

TTW communications constitute offers within the meaning of Section 2(a)(3) of the Securities Act, which means that any misleading statements or omissions in the communications will be exposed to potential liability under Section 12(a)(2) of the Securities Act and Rule 10b-5 under the Securities Exchange Act of 1934 (Exchange Act).

Proposed Rule 163B and Regulation FD

In the proposing release for Rule 163B, the SEC noted that issuers subject to the reporting requirements of the Exchange Act should consider whether Regulation FD (for “fair disclosure”) applies to their TTW communications. Regulation FD prohibits reporting issuers from selectively disclosing material non-public information to certain market professionals and shareholders without simultaneous public disclosure unless the recipients of the communication have agreed to maintain the information in confidence.

Practical Implications for Issuers and Underwriters

If the proposal is adopted without significant change, we believe Rule 163B will have limited benefits in promoting public offerings.

The proposed rule’s benefit will be extremely limited for any issuer with an effective shelf registration statement. Under existing rules and practices, issuers with an effective shelf registration statement are already able to offer their securities in prelaunch marketing so long as any written communications qualify as prospectuses meeting SEC requirements or are exempt from those requirements. WKSIs with automatic shelf registration statements, which constitute a large portion of SEC reporting companies, have very few restraints on the timing of offers. EGCs can continue to rely on Section 5(d).

As noted earlier, Rule 163B would be non-exclusive. Issuers may rely on other Securities Act rules or exemptions, such as Section 5(d), Rule 163, Rule 164 or Rule 255, in communicating with potential investors and to achieve similar objectives. Likewise, there are no limitations on TTW-like communications in unregistered offerings, such as Rule 144A and Regulation S transactions, as these are not subject to the prohibition of Section 5(c).

The proposed rule may be beneficial in mergers deemed to be offers and sales of securities under Rule 145(a) of the Securities Act and requiring registration. The present position of the SEC staff is that communications made prior to the filing of the registration statement covering the merger are objectionable except for communications with directors, executives and holders of 5% or more of the merger counterparty’s securities. Proposed Rule 163B would open up a channel for an issuer to communicate with QIBs and IAIs before the filing of a registration statement covering the merger.

The proposed rule may also be popular with certain other classes of issuers, such as IPO candidates not meeting the EGC criteria or an issuer without an effective shelf registration statement covering the securities being offered. And even IPO candidates that do meet the EGC requirements may choose to rely on Rule 163B instead of Section 5(d) because of the greater protection provided by the proposed rule’s reasonable belief standard for determining whether potential investors qualify as QIBs or IAIs.

Next Steps

The public comment period for proposed Rule 163B begins on April 29, 2019. For additional information, see the SEC’s press release describing the proposal, available at https://www.sec.gov/news/press-release/2019-14, as well as the proposing release, available at https://www.govinfo.gov/content/pkg/FR-2019-02-28/pdf/2019-03098.pdf.

The complete publication is available here.

March 27, 2019
Ropes & Gray Discusses How Notices and Deadlines Matter in Delaware
by Paul S. Scrivano, David Hennes, Jane D. Goldstein and Sarah Young

The recent Delaware Court of Chancery decision by Vice Chancellor Glasscock in Vintage Rodeo Parent, LLC v. Rent-A-Center, Inc.1 is illustrative of the principle that merger partners should not assume that anything less than strict compliance with notice requirements (particularly when they relate to termination rights) and deadlines in a merger agreement will be enforced.

In Rent-A-Center, the merger partners had extensive negotiations over the “end date” in the merger agreement, and under what circumstances it could be extended. The deal involved the $1 billion-plus acquisition by Vintage Capital of Rent-A-Center, a publicly traded company. Because the parties anticipated an extended antitrust review, the end date was initially set at six months, with each party having the unilateral right to extend the end date in certain circumstances by another three months (and a second unilateral right to extend for an additional three months) but only, in each case, if such party delivered a written notice of its election to extend the end date to the other party prior to the then current end date. If neither party elected to extend the end date, either party then had the right to terminate the merger agreement by providing notice of termination.

Between signing of the merger agreement and the initial six-month end date, Rent-A-Center’s business had improved such that Rent-A-Center’s board of directors no longer found the merger to be in the best interests of its stockholders. Rent-A-Center believed that Vintage Capital would almost certainly extend the end date (because the parties had been working on securing antitrust clearance), but determined to terminate the merger agreement if Vintage Capital did not exercise its right to extend the end date in the merger agreement. When the six-month end date passed, Vintage Capital had not given notice to extend the end date. Rent-A-Center immediately thereafter delivered a termination notice to Vintage Capital early the next day with a demand for payment of the negotiated termination fee, and issued a press release announcing the termination of the merger agreement. The Court described Vintage Capital as “blindsided”; Vintage Capital immediately disputed the termination notice as a “brazen example” of seller’s remorse and commenced litigation in the Delaware Court of Chancery seeking (among other things) an order that the merger agreement was still in force. In its complaint, Vintage Capital alleged that Rent-A-Center’s “post-signing change of heart and a desire to score a hefty reverse termination fee” were not grounds to terminate the merger agreement under Delaware law.

Vice Chancellor Glasscock considered, but rejected, Vintage Capital’s two principal arguments: (i) that the parties collectively took numerous actions intended to achieve regulatory approval, which approval was not anticipated until after the end date, and documents jointly executed by the parties evidenced Vintage Capital’s notice of its election to extend the merger agreement (or acted as a waiver by Rent-A-Center of the notice of election to extend), and (ii) Rent-A- Center engaged in a form of fraud by concealing its intent to terminate. In enforcing the terms of the Merger Agreement as written, Vice Chancellor Glasscock was left to the “startling conclusion” that Vintage Capital had simply forgotten to provide the extension notice by the required deadline. Consistent with the Delaware Supreme Court’s recent decision in Oxbow,2 which overturned a Court of Chancery decision that had found an implied covenant inconsistent with the plain language of the operative limited liability company agreement, Vice Chancellor Glasscock declined to allow Vintage Capital to escape the parties “contracted bargain” or deny Rent-A-Center the exercise of “its bargained-for contractual rights.” This forgetfulness had significant consequences—it potentially exposed Vintage Capital to pay a reverse termination fee on the order of 15.75% of equity value, or $126.5 million, to Rent-A-Center. That matter is being separately litigated.

Rent-A-Center is a reminder to deal participants to ensure that they are scrupulously complying with their obligations under the merger agreement. Too often deal participants are too casual with obligations, sometimes with the erroneous belief that they would find relief in the courts if failure to strictly comply with contractual requirements were to occur. Rent-A-Center is a wake up call in that regard.

Rent-A-Center is also a cautionary tale of why one merger partner should never assume that the other merger partner still wants to do the deal as much as it does. There have been many situations over the years where a remorseful buyer or seller begins to look for any avenue out of the deal. This “sharp practice,” which term the Court used to characterize Rent-A-Center’s actions, was a clear result of one party’s failure to follow the strict requirements of the agreement at issue.

ENDNOTES

1 Vintage Rodeo Parent, LLC v. Rent-A-Center, Inc., C.A. No. 2018-0927-SG, 2019 WL 1223120 (Del. Ch. Mar. 14, 2019).

2 Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, No. 536, 2018, 2019 WL 237360 (Del. Jan. 17, 2019).

This post comes to us from Ropes & Gray LLP. It is based on the firm’s memorandum, “In Delaware, Notices and Deadlines Matter,” dated March 20, 2019, and available here

March 27, 2019
SEC Commissioner Jackson Discusses FAST Act Adopting Release
by Robert J. Jackson, Jr.

I want to begin by conveying my thanks to the staff in the Division of Corporation Finance for their hard work in developing today’s adopting release. I am especially grateful to Charles Kwon and Dan Greenspan, as well as Director Bill Hinman, for the time you spent with me and my office throughout this process.

Following up on a detailed report our staff sent to Congress under the Fixing America’s Surface Transportation (FAST) Act,[1] the Securities and Exchange Commission today adopts a final rule on information investors receive about the increasingly complex companies in our markets.[2] The rule reverses our staff’s recommendation that firms disclose a clear identifier of their corporate entities. The rule also removes our staff’s role as gatekeepers when companies redact information from disclosures—despite evidence that redactions already deprive investors of important information. For these two reasons, I respectfully dissent.

*          *          *          *

First, the financial crisis taught regulators that firms’ complex structures made it impossible to identify the corporate entities responsible for risk-taking. For more than a generation the market tried—and failed—to come up with a single identifier on its own.[3] The reason, of course, is the standard collective-action problem that our securities laws were written to solve. The few firms who tried to create a market-wide standard bore all of the costs of those efforts, giving individual firms no incentive to make the investments necessary to create a single, standard identifier across the marketplace.

That’s why investors, market participants, and regulators around the world support a single legal entity identifier (LEI), a 20–character code that identifies entities engaged in financial transactions. To encourage the use of LEIs, the Commission, the staff, and our own Investor Advisory Committee have long supported rules requiring firms that adopt LEIs to disclose them.[4] Today’s majority abandons those requirements, with little evidence or reasoning to support the change.

The majority seems to share industry’s intuition[5] that disclosing LEIs will be costly. Of course, the costs of disclosing a 20-character code are unlikely to be meaningful. The market might impose a penalty upon companies that do not obtain an LEI and then disclose that fact. But giving investors information they need to price decisions like that is a benefit, not a cost, of our securities laws.[6] Instead, the majority leaves investors wondering what the absence of an LEI disclosure means.

Second, the rule’s treatment of redactions from confidential filings is even more troubling. Historically, we’ve required firms to work with our staff when sensitive information is redacted from exhibits to registration statements. There are often good reasons for our staff to permit redactions. But recent research shows that redactions already include information that insiders or the market deems material—showing how important careful review of these requests can be for investors.[7]

Today’s rule removes both the requirement that firms seek staff review before redacting their filings and the requirement that companies give our staff the materials they intend to redact. The release doesn’t grapple with the effects of that decision for the marketplace. But one thing is clear: In a world where redactions already rob the market of information investors need, firms will now feel more free to redact as they wish. And investors, without the assurance that redactions have been reviewed by our staff, will face more uncertainty.

Both of these decisions reflect a troubling trend in our rulemaking: ignoring facts in favor of belief that the SEC can deliver a free lunch in finance. Students of markets know there’s no such thing. If more firms choose not to obtain LEIs, knowing that this choice will not be disclosed to investors, LEIs will become less useful, and the resulting risks will raise the costs of capital for all companies. If more firms redact their disclosures, knowing that our staff cannot intervene, investors will demand compensation for additional money they’ll spend to understand the risks they’re taking. Evidence from the market tells us that these redactions often include important information. And markets, not commissioners, are in the best position to say what information is important to investors.[8]

I am grateful to the staff for the hard work and long hours that this release reflects. But because the final rule prizes faith over facts, I respectfully dissent.

ENDNOTES

[1]See Staff of the U.S. Securities and Exchange Commission, Report on Modernization and Simplification of Regulation S-K (Nov. 23, 2016); see also Fixing America’s Surface Transportation (FAST) Act, Pub. L. No. 114-94, §§ 72001-03, 129 Stat. 1311, 1784-85 (2015).

[2]  It is well-documented that the structure of our equity and credit markets, and the law governing both, give firms strong incentives to adopt increasingly complex organizational structures. For a classic and compelling debate about the implications of those incentives for social welfare, compare Richard Squire, Strategic Liability in the Corporate Group, 78 U. Chi. L. Rev. 605 (2011) with Richard A. Posner, The Rights of Creditors of Affiliated Corporations, 43 U. Chi. L. Rev. 499 (1976).

[3]  Of course, some have managed, through decades of effort and investment, to create crucial reference points for market participants. Most famously, to address the slow settlement of securities transactions in the 1960s, at regulators’ urging Wall Street formed the Committee on Uniform Securities Identification Procedures (CUSIP), which today still provides the single securities identifier the market needs to function smoothly. CUSIP Global Services, About CGS (describing the 1964 genesis of that standard). Dun & Bradstreet’s Data Universal Numbering System is today “used to maintain up-to-date and timely information on more than 300 million global businesses,” Dun & Bradstreet, What is a D-U-N-S Number?, and the Markit Red Code helps the market avoid the need for “manual[] confirm[ation of] CDS reference data,” IHS Markit, RED for CDS. But each of these systems comes with its own costs—in particular, proprietary systems require subscription fees and that users limit the distribution of the data—which is why the market failed for decades to come up with a single, uniform identifier.

[4] Staff of U.S. Securities and Exchange Commission, supra note 1; see also U.S. Securities and Exchange Commission Investor Advisory Committee, Letter to Chair Mary Jo White (June 15, 2016); U.S. Securities and Exchange Commission, SEC Adopts Rules to Increase Transparency in Security-Based Swap Market (Jan. 14, 2015).

[5] The final rule offers no actual empirical evidence that disclosing LEIs imposes meaningful costs. At the proposal stage, our staff pointed out that “[m]any commenters supported requiring disclosure of LEIs, with most of them recommending that we require both the registrant and its subsidiaries to obtain and disclose LEIs.” Securities Act Rel. No. 10425 at fn. 216 (Oct. 11, 2017). Today, on the basis of a few evidence-free industry letters, the majority concludes that the file is now “mixed.” See Securities Act Rel. No. 10618 at Section II.C.2 (Mar. 20, 2019).

[6]  To the degree that the market might react negatively to the news that a firm did not obtain an LEI, rules requiring disclosure of that fact would simply induce firms to internalize investors’ preferences regarding LEIs when deciding whether or not to obtain one. Negative market reactions to a company’s decisions aren’t costs of disclosure rules; they convey the benefit of giving the company and its management reason to pursue investor preferences.

[7] See Anne Thompson, Oktay Urcan & Hayoung Yoon, What Information Do Firms Hide in Confidential SEC Filings? (working paper 2018) (also pointing out the troubling fact that redacted positive information is associated with insider purchases of stock).

[8] It might be argued that market forces will give registrants economic incentives not to redact excessively. That, of course, is a case against mandatory disclosure more generally; for a famous economic analysis of the flaws of that premise, see Merritt Fox, Retaining Mandatory Securities Disclosure: Why Issuer Choice is Not Investor Empowerment, 85 Va. L. Rev. 1335 (1999) (explaining why a voluntary disclosure regime cannot be expected to yield socially optimal information production). Consistent with that analysis, the evidence makes clear that firms often redact important information, see Thompson et al., supra note 6.

This post comes to us from Robert J. Jackson, Jr., a commissioner of the U.S. Securities and Exchange Commission.

March 27, 2019
Shareholder Proposals on Arbitration: “Heigh-Ho! Heigh-Ho! It’s Off to Court We Go!”
by John Jenkins

We’ve been following the saga of the “man bites dog” shareholder proposal asking Johnson & Johnson to adopt a bylaw mandating arbitration of securities claims.  Last month, the Staff granted the company’s request to exclude the proposal from its proxy statement on the grounds that its implementation would violate applicable state law.

SEC Chair Jay Clayton weighed in with his own statement on this controversial topic, in which he at one point suggested that a court would be a “more appropriate venue to seek a binding determination of whether a shareholder proposal can be excluded.” Cooley’s Cydney Posner reports that the proponent seems to have taken his advice – because the dispute is now in the hands of a NJ federal court.  This excerpt from her recent blog summarizes the proponent’s arguments:

The proponent argued that the proposal would not cause the company to violate federal law, because “the Federal Arbitration Act requires the enforcement of arbitration agreements, and Johnson & Johnson has been unable to identify any federal statute that ‘manifest[s] a clear intention to displace the Arbitration Act.’”

Nor, according to the proponent, would the proposal cause the company to violate NJ state law because “neither Johnson & Johnson nor the New Jersey Attorney General has identified any New Jersey statute or court decision that prohibits the enforcement of the arbitration agreements,” and, even if the NJ courts declined to enforce, that still would not mean that including the provision in the company’s bylaws would amount to a violation of NJ law.

That is, a “company does not ‘violate’ state law by entering into an arbitration agreement that happens to be unenforceable under the law of that state.” Finally, even if state law were shown to prohibit enforcement, it would be preempted by the Federal Arbitration Act and void. The proponent also stated that he intends to submit the “proposal again for the 2020 shareholder meeting, and it will continue submitting this proposal each year until the proposal is adopted by the shareholders.”

The proponent is seeking a declaratory judgment that J&J violated the securities laws by excluding the proposal, along with injunctive relief that would, among other things, require the company to include the proposal in supplemental proxy materials.

Audit Committees: PCAOB Promises More Communications

One of the perceived shortcomings of the PCAOB’s inspection process is that it sometimes reaches problematic conclusions about an accounting firm’s audit of a company without any input from the company itself. According to this recent annual “Staff Inspections Outlook for Audit Committees,” the PCAOB plans to increase its engagement with audit committees. Here’s an excerpt:

During 2019, we will provide an opportunity for audit committee chairs of certain companies whose audits are subject to inspection to engage in a dialogue with the inspections staff. The purpose of the audit committee dialogue is to provide further insight into our process and obtain their views. We expect to publish additional updates to audit committees regarding our inspections to provide observations from these interviews and our inspection findings.

The PCAOB went on to review its 2019 inspection priorities, and raised various topics – including sample questions – that audit committees might want to address with their auditors that relate to current issues of inspection focus.

Audit Committees: What If The PCAOB Calls?

So, what should you do if the PCAOB reaches out to your audit committee chair? This excerpt from a recent Stinson Leonard Street blog says you should watch your step:

We believe issuers should approach any such engagement cautiously, if at all. Perhaps the only circumstance for which this may be appropriate is upon assurance by the PCAOB that the inspection of the issuer is complete and final and no potential deficiencies were identified. Even then, issuers should consider whether there is any benefit to the dialogue. It is especially worth consideration because the PCAOB also announced it intends to publish additional updates to audit committees regarding its inspections including observations from these interviews and its inspection findings.

The blog points out that inspection findings can lead to restatements & potential liability for companies. Furthermore, issuers have no control over how the PCAOB will characterize the results of their engagement with the public. That means there is a risk that the audit committee chair or the company could be cast in a negative light.

The need to prepare for a possible phone call from the PCAOB may help address the chronic problem of audit committees sitting around with nothing to do, but if more assistance in keeping your committee busy is needed, check out this helpful list from PwC of 11,284 things that the audit committee should keep in mind for the end of the current fiscal quarter.

John Jenkins

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3/27/2019 posts

The Harvard Law School Forum on Corporate Governance and Financial Regulation: 2019 Proxy Voting and Engagement Guidelines: North America
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Does Protectionist Anti-Takeover Legislation Lead to Managerial Entrenchment?
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Practical Implications of Proposed Testing the Waters for All Issuers under U.S. Securities Law
CLS Blue Sky Blog: Ropes & Gray Discusses How Notices and Deadlines Matter in Delaware
CLS Blue Sky Blog: SEC Commissioner Jackson Discusses FAST Act Adopting Release
CorporateCounsel.net Blog: Shareholder Proposals on Arbitration: “Heigh-Ho! Heigh-Ho! It’s Off to Court We Go!”

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.