Securities Mosaic® Blogwatch
October 19, 2017
Corporate Monitors Need Better Regulation
by Veronica Root

When a corporation engages in misconduct, courts, regulators, or prosecutors often arrange for the appointment of a monitor—an independent, private outsider—to oversee remediation efforts at the firm. As I’ve described previously, the expansive use of monitors has become common, with some private companies even appointing them voluntarily. Monitors oversee an array of remediation efforts, from ending collusive activity, to compensating foreclosure victims, to ensuring that healthcare providers adhere to legal and regulatory mandates.

The variety of situations involving monitors has made regulating them a challenge. Creating a single regulatory or statutory scheme would be difficult, given that so many different kinds of federal and state officials use monitors. Monitors also come from a variety of professions and include lawyers, auditors, and even consultants of some kind.

In a recently published article, I recount the lack of regulation of monitors and argue that they are constrained primarily by their desire to preserve their own reputations. Monitors will only obtain repeat business if they demonstrate qualities that make them acceptable to regulators or prosecutors and the corporations found to have engaged in wrongdoing. They must demonstrate independence and the ability to be firm with the monitored corporation without being unreasonable or onerous from that corporation’s point of view.

My article argues that the reliance on reputation, while understandable and possibly even beneficial, leaves a variety of common questions surrounding monitorships unanswered. For example, when and how to disclose information obtained and generated by the monitor was again left undecided by the Second Circuit last summer. Additionally, legal scholarship has not addressed how to appropriately facilitate monitor independence from the monitored corporation and the interested government agent. Moreover, there are currently no reliable mechanisms for punishing monitor misconduct.

Regulators and prosecutors at both the state and federal levels have indicated that they will continue to use monitors, which means these important questions need to be answered sooner rather than later.

This post comes to us from Professor Veronica Root at the University of Notre Dame Law School. It is based on her recent article, "Constraining Monitors," available here.

October 19, 2017
Weil Discusses Risks of Classifying Employees as Independent Contractors
by Christopher J. Cox, David R. Singh and Liani Kotcher

Recently, we have seen a rise in class actions filed against employers for improperly classifying their employees as independent contractors. While misclassification issues are nothing new, the proliferation of nontraditional jobs grows every year—especially with the advancement of technology and the ability of service providers to work remotely from anywhere in the world. In this brave new world, employers may struggle with how to define their workforce. Current labor laws recognize workers providing services can be categorized as either an independent contractor or an employee, and employees are generally protected by more employment rights. On one hand, classifying service providers as independent contractors can be more efficient and cost-effective for a company. On the other hand, misclassifying service providers can have dire consequences, leaving a company exposed to expensive class actions for wage, hour, and other Labor Code violations— not to mention staggering governmental fines and penalties.

In this article, we outline the current legal landscape governing classification of service providers and give guidance for employers on how to properly classify their work force.

Classification Standards

Both the federal government and various individual state governments have their own individual independent tests to determine whether a service provider is an employee or an independent contractor. To make things even more complicated, various departments within the federal and state governments may also have their own differing tests. However, at their common core, all these tests are primarily focused on the degree of control a company exerts over the service provider and the independence of the provider. By way of example, we highlight below the standards used by two federal departments most often interested in provider classification—i.e., the United States Department of Labor and the United States Internal Revenue Service—as well as by a state agency.

United States Department of Labor

The Department of Labor ("DOL") is tasked with overseeing compliance with the Fair Labor Standards Act ("FLSA")1. The FLSA2 includes minimum wage and overtime pay requirements for nonexempt employees.3 The DOL generally relies on the six elements identified by the U.S. Supreme Court4 and subsequent case law to determine whether to apply the FLSA.5 While the factors considered can vary and no one set of factors is exclusive, these are the following six elements generally considered when determining whether an employment relationship exists under the FLSA:

  1. The extent to which the work performed is an integral part of the employer’s business. If the work performed by a worker is integral to the employer’s business, it is more likely that the worker is economically dependent on the employer and less likely that the worker is in business for himself or herself.
  2. Whether the worker’s managerial skills affect his or her opportunity for profit and loss. Analysis of this factor focuses on whether the worker exercises managerial skills and, if so, whether those skills affect that worker’s opportunity for both profit and loss.
  3. The relative investments in facilities and equipment by the worker and the The worker must make some investment compared to the employer’s investment, and bear some risk for a loss, in order for there to be an indication that he/ she is an independent contractor in business for himself or herself.
  4. The worker’s skill and initiative. To indicate possible independent contractor status, the worker’s skills should demonstrate that he or she exercises independent business judgment. Further, the fact that a worker is in open market competition with others would suggest independent contractor status.
  5. The permanency of the worker’s relationship with the Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee, as opposed to an independent contractor.
  6. The nature and degree of control by the Analysis of this factor includes who sets pay amounts and work hours and who determines how the work is performed, as well as whether the worker is free to work for others and hire helper.
United States Internal Revenue Service

The Internal Revenue Service ("IRS") administers federal payroll taxes, including social security, Medicare, federal unemployment insurance, and federal income tax withholding, and ensures that employers pay taxes, make the appropriate withholdings, and obtain certain insurance coverage on behalf of their employees. To determine whether a service provider is an employee or an independent contractor, the IRS utilizes a test different from the DOL’s six-element test. Historically, the IRS utilized a 20-Factor Test, but the IRS has recently grouped the 20 factors into three primary categories of evidence to support the level of control and independence.6

The first category—"Behavioral"— refers to facts showing whether a company has a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. Within this category, the IRS examines four subcategories:

  1. Type of instructions given. An employee is generally subject to the business’s instructions about when, where, and how to work.
  2. Degree of instruction. More detailed instructions indicate that the worker is an employee.
  3. Evaluation systems. If an evaluation system measures the details of how the work is performed, then these factors would point to an employee.
  4. Training. If the business provides the worker with training on how to do the job, this is strong evidence the worker is an employee.

The second category—Financial—refers to facts that show whether the business has the right to control the economic aspects of the worker’s job. Within this category, the IRS examines five subcategories:

  1. Significant investment. An independent contractor often has significant investment in equipment used in working for someone else.
  2. Unreimbursed expenses. Independent contractors are more likely to have unreimbursed expenses than are employees.
  3. Opportunity for profit or loss. Having the possibility of incurring a loss indicates that the worker is an independent contractor.
  4. Services available to the market. An independent contractor is generally free to seek out business opportunities.
  5. Method of payment. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time, while an independent contractor is usually paid by a flat fee for the job.

The third category—Relationship—refers to facts showing how the worker and business perceive their relationship to each other. Within this category, the IRS examines four subcategories:

  1. Written contracts. A contract stating that the worker is an employee or an independent contractor is helpful but not determinative of worker status.
  2. Employee benefits. Businesses generally do not grant benefits such as insurance, pension plans, paid vacation, sick days, and disability insurance to independent contractors.
  3. Permanency of the relationship. If a worker is hired with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship.
  4. Services provided as key activity of the business. If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities.

The company must weigh all these factors and there is no "magic" or set number that makes the worker an employee or an independent contractor. The key is to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination. If a company is still unable to determine worker status after using this test, it can request the IRS to make a determination by filing
a Form SS-8; but beware, the IRS may be quick to classify a service provider as an employee.

Individual States

In addition to the various federal tests, each state also may have its own test to determine worker status, and each may differ from the federal standard. Additionally, the exact test used by the state may depend on which agency is interested in the classification. In California, for example, the Employment Development Department ("EDD"), the Division of Workers’ Compensation, the Contractors State Licensing Board, the California Department of Labor Standards Enforcement, and the Franchise Tax Board each have their own test.

By way of illustration, consider the test used by the California EDD, which administers California’s payroll taxes, including Unemployment Insurance, Employment Training Tax, State Disability Insurance and California Personal Income Tax withholding. The EDD utilizes a "Main Test" and then ten secondary factors.7 The Main Test used by the EDD asks whether the company has the right to control the manner and means in which the worker carries out the job. Under this test, the right of direction and control, whether or not exercised, is the most important factor in determining an employment relationship. The right to discharge a worker at will and without cause is strong evidence for the right of direction and control. When it is not clear whether the company has the right to direct and control the worker, the company must look further into the actual working relationship by weighing the ten secondary factors:

  1. Is the worker engaged in a distinct trade or occupation? Does the worker make his or her services available to the general public? Does the worker perform work for more than one firm/company at a time? Does the worker hire, supervise, or pay assistants? Does the worker have a substantial investment in equipment and facilities.
  2. Is the work done without supervision? In the geographic area and in the occupation, is the type of work usually done under the direction of a principal without supervision?
  3. Is the work highly skilled and specialized? Is the worker trained by the principal? Does the worker personally perform the services?
  4. Does the principal furnish/provide the tools, equipment, materials, supplies, and place of work? Does the worker perform the services on the principal’s business premises?
  5. Are the services provided on a long-term or repetitive basis?
  6. Method of payment; is the worker paid based on time worked or on completion of the project?
  7. Are the services an integral part of the principal’s business?
  8. What type of relationship do the parties believe they are creating?
  9. What is the extent of actual control by the principal? Does the worker have the right to terminate the relationship without liability? Does the principal provide instructions on how to do the work? Does the principal establish the work hours or the number of hours to be worked? Does the principal require the work to be done in a particular order or sequence? Does the principal require oral or written reports from the worker?
  10. Is the work performed for the benefit of the principal’s business?
Consequences of Misclassification

A service provider mischaracterized as an independent contractor can bring wage, hour, and other violations under the various federal and state employment statutes. For example, a service provider may be owed unpaid overtime, waiting time penalties, wage statement violations, or missed meal and break penalties. These claims may be brought by an individual or as part of a state-wide or nation-wide collective class action, and claims may be brought in state court or federal court depending upon what statute the claims are asserted under.8 Awards may be significant if a plaintiff succeeds on the merits of his or her lawsuit, particularly where the underlying statute provides for some form of punitive damages. Under the FLSA, for example, plaintiffs can seek liquidated damages and recover up to double what is owed to them.

Currently, we are experiencing an uptick in employer misclassification lawsuits—especially class actions. This increase in litigation is likely due to both (1) an increase in businesses characterized by a fissured workplace and a business model relying upon independent contractors or other contingent workforce arrangements (e.g., ride share companies, food and other goods delivery services, high technology companies, and start-ups), and (2) an increase in the number of employee protection laws allowing civil liability for misclassification.

For example, California passed Senate Bill 459 (the "Worker Classification Bill") in 2011 to prohibit "willful misclassification" of employees as independent contractors.9 This California law requires "willful" misclassification, which is defined to mean "avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor." Violators who willfully misclassify are subject to civil penalties between $5,000-$15,000 per violation and if "pattern or practice" is shown, the penalties jump to $10,000-$25,000 per violation. Perhaps most concerning to California business executives is that this law also contains a provision that imposes "joint and several liability" on persons who knowingly advise an employer misclassify such individuals to avoid employee status.10 Pursuant to this law, we are already seeing class actions filed against CEOs and board members of companies accused of misclassifying service providers.11

In addition to costly civil litigation, regulatory agencies such as the DOL and the IRS and their state equivalents may initiate an enforcement action against businesses that misclassify independent contractors.12 These agencies have identified industries subject to targeted enforcement of independent contractor misclassification, including:13

  • Construction;
  • Transportation and trucking;
  • Cable companies;
  • Janitorial services;
  • Landscaping and nurseries;
  • Security services;
  • Nursing;
  • Child care;
  • Home health care;
  • Internet services;
  • Restaurants and catering services;
  • Staffing services;
  • Hotels and motels; and
  • Oil and gas.

Misclassification audits, investigations, and lawsuits are increasingly common and can result in steep costs and penalties. An employer who misclassifies may be on the hook for back payment of employee taxes, unpaid unemployment and disability insurance, unpaid worker’s compensation coverage, and even large fines and penalties.14

It is worth noting that there has been recent speculation the DOL may be changing its position on enforcement. In June 2017, Alexander Acosta, the newly-confirmed Secretary of Labor in the Trump Administration, withdrew the DOL’s independent contractor misclassification guidance issued in 2015.15 Some believe that the decision by Secretary Acosta to withdraw the prior guidance on the six-element test signals the DOL will be more selective about what companies it goes after with its limited resources.

But even if this demonstrates a shift in enforcement position by the DOL, it is unlikely to change the legal landscape of independent contractor misclassification, which is now dominated primarily by private class action lawsuits and administrative proceedings, not actions commenced by the DOL.

Advice for Employers

There are a number of steps that employers can take to minimize the risk of misclassifying service providers and to show that their classification was reasonable and made in good faith. These steps include:

  • DO have an independent contractor agreement with the contractor, which must describe the scope of the work to be performed, the compensation paid, and the timing of the work, and clearly define the contractor’s tax obligations.
  • DON’T have the contractor complete an employee application.
  • DO ensure that the contractor has liability insurance, particularly if the contractor is a professional.
  • DO ensure that any professional contractor has a current professional license from the city/county in which he/she is operating.
  • DON’T set the contractor’s work hours.
  • DON’T provide the contractor with tools, equipment, software or supplies with which to perform his/her work.
  • DON’T provide the contractor any benefits that the business provides to its employees.
  • DON’T retain or terminate or attempt to retain or terminate assistants or employees for the contractor.
  • DO ensure that the contractor submits invoices for his/her work.
  • DO require payment to be rendered upon completion of a certain task or job. Do not pay by the hour, week or month unless a flat fee is agreed to be paid at regular intervals.
  • DO not pay contractor expenses. Businesses pay their own expenses, and expenses should be built into the contract for the cost of the entire job. The opportunity for profit or loss by the contractor helps to show financial independence from the employer.
  • DO require the contractor to complete Form W-9, Request for Taxpayer Identification Number and Certification.
  • DON’T complete an I-9.
  • DON’T provide an employee handbook.
  • DON’T conduct performance evaluations similar to employee evaluations.


  1. Although the FLSA sets the minimum wage and overtime standards, it does not prevent states from setting their own higher standards by enacting their own laws. Thus, many states additionally have their own versions of FLSA with more generous employee-friendly provisions.
  2. In addition to the FLSA, there are a multitude of other frequently litigated federal laws that cover employees but not generally independent contractors, including Title VII of the Civil Rights Act, the Equal Pay Act, the Age Discrimination in Employment Act, Americans with Disabilities Act, Occupational Safety and Health Act, Family and Medical Leave Act, and the National Labor Relations Act.
  3. See 29 U.S.C. §§ 203(e) and 207(a)).
  4. "The Supreme Court has indicated that there is no single rule or test for determining whether an individual is an employee or independent contractor for purposes of the FLSA. The Court has held that the totality of the working relationship is determinative, meaning that all facts relevant to the relationship between the worker and the employer must be considered." See compliance/whdfs13.htm.
  5. See
  6. See IRS website: businesses-self-employed/independent-contractor-self- employed-or-employee.
  7. See California Tax Service Center Website: http://www.
  8. We also occasionally see these claims brought before an administrative law judge, depending upon whether this is required under the applicable statute.
  9. Senate Bill No. 459, Chapter 706, An act to add Sections 226.8 and 2753 to the California Labor Code, relating to employment. Approved by Governor October 9, 2011. Filed with Secretary of State October 9, 2011.
  10. (Cal. Labor Code § 2753).
  11. In June 2017, a lawsuit was filed against Travis Kalanick, the former CEO and a current Board member, and Garrett Camp, the Chairman of the Board of Uber Technologies, Inc. See James Kalanick, No. BC666055 (Super. Ct. Los Angeles County, CA, June 22, 2017), assigned to Judge Maren E. Nelson.
  12. "Independent Contractor Classification" by Gabrielle Wirth, Dorsey & Whitney LLP, with Practical Law Labor & Employment PLI Thompson Reuters.
  13. See DOL’s Wage and Hour Division Budget Justification for 2015-2016 at documents/general/budget/2016/CBJ-2016-V2-09.pdf.
  14. See IRS website: businesses-self-employed/independent-contractor-self- employed-or-employee; Internal Revenue Code section 3509.
  15. United States Department of Labor News Release: "US Secretary of Labor Withdraws Joint Employment, Independent Contractor Informal Guidance," June 7, 2017, found at:

This post comes to us from Weil, Gotshal & Manges LLP. It is based on the firm’s client alert, "The Dangers of Misclassifying Employees as Independent Contractors," dated September 2017, and available here.

October 19, 2017
Rejection of the Universal Proxy Card
by Ning Chiu, Davis Polk
Editor's Note: Ning Chiu is counsel at Davis Polk & Wardwell LLP. This post is based on a Davis Polk publication by Ms. Chiu. Related research from the Program on Corporate Governance includes Universal Proxies by Scott Hirst (discussed on the Forum here).

ADP rejected Pershing Square’s recommendation to use a universal proxy card, arguing that given the solicitation has already commenced, changing the voting procedures for a new and untested process could disenfranchise shareholders.

Pershing Square has nominated three candidates to ADP’s board. In September the activist wrote to the board calling for both sides to use a universal proxy card that would list all the nominees, calling it a “hallmark of good corporate governance” and citing to the CII report advocating for the practice. The activist had to seek approval from the company because the company nominees must consent to be named in its proxy statement. They also acknowledged that the company may have already sent proxy cards to their shareholders and additional details may need to be worked out with Broadridge, but given that a number of additional cards were likely to be mailed in any case, the company could include a new universal card in one of its mailings.

ADP rejected the request, citing several concerns. Since universal proxy cards are not widely used by U.S. public companies and have never been used by a large-cap, broadly held company, the risk for shareholder confusion is great. While the SEC has proposed rules for universal proxy cards, the rules have not been adopted and no procedures have been enacted to govern a contest where shareholders vote using such a card.

Trying out a new process for a company with a significant retail investor base of approximately 310,000 individual shareholders is particularly risky, and the existing “street name” structure also may not support universal proxies at this time. In addition, both sides have already distributed proxy materials. The use of a universal proxy card would require sending out new replacement materials, the implementation of new mechanics for collection and educating shareholders on the changes in voting procedures.

ADP concluded that all of these issues could lead to a more disruptive and complicated process that confuses investors who well understand and have long exercised the existing voting structures for proxy contests, and could ultimately interfere with the conduct of a fair election.

While it is unclear whether the SEC would proceed with the universal proxy card rules that were proposed under the prior chair, we will soon find out whether it is on the regulatory flex agenda as an item the Commission may take up.

October 19, 2017
The Impact of Shareholder Activism on Board Refreshment Trends at S&P 1500 Firms
by Subodh Mishra, Institutional Shareholder Services Inc.IRRC Institute
Editor's Note: Subodh Mishra is Executive Director at Institutional Shareholder Services, Inc. This post is based on a co-publication by ISS and the Investor Responsibility Research Center Institute. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here).

Few business-related topics provoke more passionate discussions than shareholder activism at specific companies. Supporters view activists as agents of change who push complacent corporate directors and entrenched managers to unlock stranded shareholder value. Detractors charge that these aggressive investors force their way into boardrooms, bully incumbent directors into adopting short-term strategies at the expense of long-term shareholders, and then exit with big profits in hand.

Lost in this heated long- versus short-term debate is the significant, real-time impact that such activism has on corporate board membership and demographics. ISS identified a recent surge in its evaluation of refreshment trends at S&P 1500 firms between 2008 and 2016 (see Board Refreshment Trends at S&P 1500 Firms, published by IRRCi in January 2017). This accelerated boardroom turnover coincided with an increase in activists’ success in securing board representation, particularly via negotiated settlements. A recent study of shareholder activism by Activist Insights pegged activists’ annual U.S. boardroom gains at more than 200 seats in 2015 and 2016. While a significant portion of this activism was aimed at micro-cap firms, threats of fights have become commonplace even at S&P 500 companies in recent years.

Despite activists’ recent boardroom gains, little attention has been paid to the influence of activism on broader board refreshment trends. Anecdotal media coverage, often fanned by anti-activist communications strategies, still tends to myopically focus on two long-standing dissident nominee stereotypes: the still-wet-behind-the-ears, 20- or 30-something-year-old hedge fund analyst, and the older, male, over-boarded crony of the fund manager.

These long-standing stereotypes appear to be outdated as activism has entered an era in which most dissident nominees have attenuated ties to their hedge fund patrons. The experience, qualifications, attributes, and skills of dissident nominees can appear indistinguishable from those of the incumbent directors whom they seek to supplant. Nominees’ backgrounds and experiences can become even more interchangeable with those of incumbent directors when the latter transfuse their own ranks with new blood during, or in anticipation of, an activist campaign. This heightened competition can leave shareholders with a bounty of fresh-faced, highly-qualified, independent candidates on both nominee slates. Highlighting this narrowing divide, dissidents’ “hand-picked” nominees have been known to reject their sponsors’ wishes and strategic plans (witness Elliott Management’s first tranche of candidates at Arconic, who were seated via a settlement, opposing the hedge fund’s second attempt to gain board seats). Similarly, nominees selected by incumbent directors to face off against dissident candidates sometimes end up endorsing the very shifts in strategic direction that they were recruited to fend off (witness the DuPont board’s “victory” over Nelson Peltz’s Trian Partners, followed by board-recruited director-turned CEO Ed Breen’s advocacy of a Peltzian-style breakup of the company).

To close this board refreshment information gap, IRRCi asked ISS to explore the broader impact of activism by focusing on nominees—regardless of the entity that backed them—and the impact of dissident campaigns on boards.


The complete publication (available here) examines the impact of public shareholder activism on board refreshment at S&P 1500 companies targeted by activists from 2011 to 2015. Public shareholder activism refers to any shareholder activism that (1) occurred between Jan. 1, 2011 and Dec. 31, 2015, and (2) was publicly disclosed. The study period concludes in 2015 so that data for a full calendar year following activist campaigns could be analyzed. Data was captured as of the shareholder meeting dates.

Part I examines individual dissident nominees on ballots (whether they ultimately joined the board or not) in proxy contests, directors appointed via settlements with activist shareholders, and directors appointed unilaterally by boards in connection with shareholder activism.

Part II examines changes to board profiles made in connection with public shareholder activism.

Data was captured for all S&P 1500 directors with less than one year of tenure at meetings scheduled to be held between Jan. 1, 2011 and Dec. 31, 2015. The directors were then assigned to one of four classifications:

  1. All dissident nominees on ballots in proxy contests;
  2. Directors appointed or nominated by incumbent boards through publicly-disclosed settlements with activist shareholders;
  3. Directors appointed or nominated unilaterally by incumbent boards in connection with public shareholder activism; and
  4. Directors appointed or nominated prior to and not in connection with public shareholder activism.

If a definitive proxy contest was settled, directors added to the board as a result of the settlement were assigned to classification two.

Data for directors assigned to classification four was excluded, as it did not relate to the impact of public shareholder activism on board refreshment during the study period.

In Part II, board profile changes were assessed through a comparison of target boards in the year prior to shareholder activism and target boards in the year following shareholder activism. For example, there was shareholder activism at J. C. Penney in connection with the company’s 2011 annual meeting. The measure of change was therefore based on a comparison of the board profiles at the company’s 2010 and 2012 annual meetings. In cases where there were two or more consecutive years of shareholder activism, board profile changes were assessed through a comparison of target boards in the year prior to the first year of shareholder activism and target boards in the year following the final consecutive year of shareholder activism. For example, there was shareholder activism at Juniper Networks in both 2014 and 2015. The measure of change was therefore based on a comparison of the board profiles at the company’s 2013 and 2016 annual meetings.

Part II examines year-over-year trends. In these cases, study companies with two or more consecutive years of shareholder activism were excluded. Study companies were grouped by market-cap segments, i.e. S&P 500 (large-cap), S&P 400 (mid-cap), and S&P 600 (small-cap). Study companies that changed indexes over the course of the study were excluded from segment-level comparisons.

In Part II, references to changes in average director age and average director tenure at study companies (excluding those discussed in isolation) refer to averages of average company-level data. Company-level data provided average age and tenure for each specific company. For references to average age and tenure at study companies, these data points were calculated by averaging the company-level (rather than director-level) data points.

Key Findings Part I: Individual Director Demographics

Snapshot: Public shareholder activism generally leads to younger, more independent, but less diverse, board candidates who had previous boardroom experience and relevant professional pedigrees. Typically activists favor nominees with financial experience and incumbent boards favor nominees with executive experience.


Activism drives down director ages. Dissident nominees and directors appointed via settlements (hereinafter Dissident Directors) were younger, on average, than directors appointed unilaterally by boards (hereinafter Board Appointees) in connection with shareholder activism. Study Directors (the combination of Dissident Directors and Board Appointees), regardless of who recruited them, were generally younger than their counterparts across the broader S&P 1500 index. While Dissident Directors generally reflected a wider range of ages, insurgent investors and incumbent boards both favored individuals in their fifties when picking candidates. This preference for nominees in their fifties aligns with practices in the broader S&P 1500 index over the same period.

Activism does not promote gender diversity. Less than ten percent of Study Directors were women. While the rate at which females were selected as dissident nominees or Board Appointees in contested situations increased over the course of the study, it trailed the rising tide of female board representation in the broader S&P 1500 universe*.* There were zero female Dissident Directors in 2011, two in 2012, and three in 2013. Similarly, there were two female Board Appointees in 2011, but zero in both 2012 and 2013.

Activism does not promote racial/ethnic diversity. Less than five percent of Study Directors were ethnically or racially diverse. While minority representation across the entire S&P 1500 board universe slowly increased over the course of the study, from 9.3 percent in 2011 to 10.1 percent in 2015, the rate at which individuals with diverse ethnic and racial backgrounds were selected as Dissident Directors and Board Appointees was relatively uniform and trailed that of the broader index by more than five percentage points.

Activism boosts boardroom independence. Study Directors were generally more independent than their counterparts across the broader S&P 1500. Not surprisingly, dissident nominees and directors appointed to boards via settlements were more likely to be “independent” than directors appointed unilaterally by boards in connection with shareholder activism. It is worth pointing out that the measure of “independence” focused on a nominee’s degree of separation from management rather than from the dissident. Indeed, as the examination of prior boardroom experience suggests, there may be questions of independence from activist sponsors for a subset of Study Directors.

Prior boardroom experience is not required. Boardroom experience does not appear to be a prerequisite for contest candidates. More than half of Study Directors held outside board seats. While most of these directors sat on either one or two outside boards, a sizable minority pushed the over-boarded envelope. Six Study Directors served on four outside boards, four on five outside boards, and one on six outside boards. Many of these “busy” directors appear to be “go-to” nominees for individual activists. The serial nomination of favorite candidates raises questions about the “independence” of these individuals from their activist sponsors.

Investment professionals and sitting executives dominate the candidate pool for contested elections. Occupational data for the Study Directors demonstrates experience, qualifications, attributes, and skills (EQAS) preferences for nominees in contested situations. “Corporate executives” and “financial services professionals” were in a dead heat at the front of the pack. These favored occupations were not evenly distributed, as activists tended to select investors and incumbents tended to select executives. In fact, Dissident Directors were nearly three times more likely to be “financial services professionals” than Board Appointees, while Board Appointees were nearly twice as likely to be “executives” than Dissident Directors.

Part II: Board Profile


Snapshot: Public shareholder activism generally resulted in boards that are younger, shorter-tenured, slightly-larger, more independent, and more financially literate, but less diverse, than their pre-activism versions.


Activism-related turnover led to decreases in average director age and tenure at targeted boards. Dissident Directors averaged 53 years of age and Board Appointees averaged 56.3 years of age. Average director age decreased by 2.6 years to 59.6 years on Study Boards targeted by shareholder activists, while average director tenure decreased by 3.4 years to 6.1 years. For the broader S&P 1500 in 2015, average director age was 62.5 years and average tenure was 8.9 years.

Board size remained relatively steady despite membership changes. Although average board size at Study Companies increased from nine to 9.4 seats, less than half (41.9 percent) of the Study Companies experienced a post-activism boost in board size. 18.3 percent of Study Companies experienced a decline in board size following shareholder activism, while board size was unchanged at 39.8 percent of Study Companies.

Board independence levels increased in connection with activism campaigns. Average board independence at Study Companies increased from 79.5 percent to 83 percent. More than 60 percent of study companies experienced an increase in independence, 21.5 percent experienced a decrease, and 18.3 percent experienced no change. Average board independence in the S&P 1500 was 80.6 percent in 2015.

Other boardroom service was generally unchanged by activism-fueled refreshment. The average number of outside boards on which Study Company directors served remained virtually flat, increasing from 0.8 to 0.9. Of the 89 Study Companies, the number without a director who sat on more than one outside board decreased from four to two. There was a correlation between company size and outside board service, as directors at S&P 500 and S&P 400 study companies sat on a higher average number of outside boards than their counterparts at S&P 600 study companies.

Activism was accompanied by an erosion of gender and racial/ethnic diversity on targeted boards. Study Company boards were less likely to have at least one female director following an activism campaign than they were preceding one, decreasing from 87.1 percent to 82.8 percent. Similarly, Study Company boards were less likely to have at least one minority director following an activism campaign than they were preceding one, decreasing from 55.9 percent to 51.6 percent. According to Board Refreshment Trends at S&P 1500 Firms, the proportion of S&P 1500 companies with at least one female director increased from 72 percent in 2011 to 82.7 percent in 2015 and the portion of S&P 1500 companies with at least one minority board member increased through the course of the study period to 56.8 percent.

Activism added financial expertise to boards. The proportion of board seats at Study Companies occupied by “financial experts” increased from 22.6 percent (189 of 835) to 24.5 percent (214 of 874). The number of Study Companies with at least one, two, or three “financial experts” also increased. (At U.S. companies, ISS considers a director to be a “financial expert” if the board discloses that the individual qualifies as an “Audit Committee Financial Expert” as defined by the Securities and Exchange Commission under Items 401(h)(2) and 401(h)(3) of Regulation S-K. Under the SEC’s rules, a person must have acquired their financial expertise through (1) education and experience as a principal financial officer (PFO), principal accounting officer (PAO), controller, public accountant or auditor or experience in one or more positions that involve the performance of similar functions, (2) experience actively supervising a PFO, a PAO, controller, public accountant, auditor or person performing similar functions; (3) experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements or (4) other relevant experience.)

Target company size impacted the effect of board refreshment. Larger Study Companies were more independent, more likely to have female and minority board members (both pre- and post- activism), and more likely to have financial experts in the boardroom than smaller-cap study companies. Relative to their larger peers, smaller Study Companies generally experienced more pronounced declines in average director age and tenure, but experienced more significant increases in average board size.

The complete publication is available here.

October 19, 2017
The Unicorn Governance Trap
by Renee Jones
Editor's Note: Renee M. Jones is a Professor at Boston College Law School. This post is based on her recent article, forthcoming in the University of Pennsylvania Law Review Online.

On October 3, the board of directors of Uber reached a truce after a tumultuous summer marked by high-profile resignations, bitter acrimony, and lawsuits among Uber’s principal investors. As reported, Uber’s board agreed to eliminate special voting rights accorded to early investors including Travis Kalanick, its former CEO. The board also set a timeline for a late-2019 initial public offering (“IPO”). It is somewhat ironic that months of roiling conflict at the quintessentially “disruptive” company were resolved through a retreat to the old-school convention of a “one share, one-vote” shareholder voting regime. Another key feature of the board’s rapprochement, a timeline for a future IPO, also harkens back to once-dominant venture capital financing norms. These proposed reforms align with recommendations included in my article, the Unicorn Governance Trap, forthcoming in University of Pennsylvania Law Review Online.

The breakdown of Uber’s board in the summer of 2017 was precipitated in part by former Attorney General Eric Holder’s scathing report on Uber’s corporate culture. Holder’s report focused on sexual harassment and other misconduct by senior Uber managers. At the time, Uber was grappling with a host of other controversies, including a messy lawsuit alleging complicity in the theft of intellectual property from a Google affiliated company, and a criminal investigation for using software to elude detection by local regulators as Uber commenced unauthorized operations in their cities.

Like Uber, other private companies have stumbled recently due to founder misconduct or fraud. Theranos was devastated in the fall of 2015 when investigations revealed that its main product, an innovative blood testing technology, did not really exist. In 2016, Zenefits’ CEO Parker Conrad was forced to resign when the company admitted to violating laws by allowing unlicensed employees to sell insurance. More recently, Social Finance CEO Mike Cagney resigned amid allegations of sexual harassment, lax internal controls, and a frat-like atmosphere at the $4 billion start-up.

The article highlights governance problems presented by persistent unicorns—privately-held companies with a market valuation of $1 billion or more. It argues that part of the explanation behind scandals at Uber and other unicorns lies in changes to the traditional venture capital (“VC”) structure for financing start-up companies and expanded opportunities for liquidity for their investors. These changes in the norms of start-up financing can be traced, in turn, to a series of Securities Exchange Commission (“SEC”) reforms instituted in recent decades. Together these reforms allow corporations to linger for protracted periods in a corporate “Neverland,” shielded from what had once been looming pressure to demonstrate to the world that they were ready to grow up and become publicly-traded companies.

Although corporate scholars have taken note of the growing significance of unicorns, legal commentary has focused mainly on disclosure issues. There has been little academic discussion of the unique governance challenges posed by an increasing number of unicorns with no discernable plans to pursue an IPO, the traditional exit strategy for start-ups. The article argues that in the absence of an impending IPO, unicorns lack sufficient incentives to develop governance structures and practices appropriate for enterprises of their scale. At the same time, many VCs have made the strategic decision to cede control to founders at an early stage, hampering their ability to step in and prevent or correct misconduct. Uber investor Benchmark’s pending lawsuit against Travis Kalanick illustrates this governance trap. Despite lacking board control, Uber investors managed to force Kalanick to resign after Holder’s devastating report. Yet, after his resignation, Kalanick retained his board seat and allegedly interfered with the board’s efforts to select his successor.

An economy in which large-scale private enterprises characterized by a separation of ownership and control can grow and thrive presents challenges for corporate law theory. This phenomenon has been facilitated by the confluence of amendments to the federal securities laws and an increased willingness of private investors to cede control of the companies they finance to unseasoned and untested entrepreneurial CEOs. With the expansion of electronic trading in start-up company shares, the separation of ownership from control has become a new reality for many unicorns. These market developments have introduced to unicorns the same agency problems that plague public companies, without the tools—voting, litigation or exit—public company shareholders rely on to discipline managers.

The article explains how market trends and deregulatory reforms weakened or eliminated mechanisms that imposed discipline on start-up company founders. Recent scandals at unicorns suggest that investors have erred in placing blind faith in the honesty and capabilities of start-up founders. Policymakers should learn from these disasters and close regulatory loopholes that allow unicorns to persist in limbo between private and public status for extended periods of time.

The article provides an overview of how the IPO has shifted from the preferred exit strategy in the eyes of entrepreneurs to a regulatory morass to be shunned. It traces developments in the market for start-up company shares and regulatory reforms that facilitated the proliferation of unicorns. The article next highlights unique governance risks posed by unicorns, addressing both societal and investor protection concerns. Finally, the article offers suggestions on how to address unicorn risks and raises fundamental questions about the future of unicorns in our economy.

The full article is available for download here.

October 19, 2017
CEO, Attorney Plead Guilty to Market Manipulation
by Tom Gorman

Microcap fraud has long been a focus of the Commission. The U.S. Attorney’s Office has also brought a series of criminal cases centered on market manipulation charges involving these entities. This week prosecutors in the Eastern District of New York secured guilty pleas from the CEO of microcap firm and its attorney. U.S. v. Shapiro, Case No. 14-cr-399 (E.D.N.Y.).

Named as defendants are Ira Shapiro and Darren Ofsink. Mr. Shapiro is the CEO of CodeSmart Holdings, Inc. Mr. Ofsink is a Manhattan based attorney. Each defendant pleaded guilty to one count of conspiracy to commit securities fraud.

The charges stem from the participation by each defendant in an $86 million market manipulation scheme centered on the shares of CodeSmart. In May 2013, according to the charging documents, the defendants and others took CodeSmart, then a privately held firm, public through a reverse merger with a public shell company. The defendants and their confederates then obtained control of the free trading shares of the new public firm.

Subsequently, the defendants assisted in pushing the share price up to artificial levels. Beginning in May 2013, and continuing through August of 2013, the co-conspirators manipulated the share price of CodeSmart stock, raising it from $1.77 to as much as $6.94 per share – an increase of 291%. The share price then dropped back to $2.19.

From late August 2013 through late September 2013 the co-conspirators repeated the process. This time the stock price went from $2.19 to a high of $4.60, an increase of about 104%. Then the price dropped back about 116% to $2.13.

At its highest point the firm had a market capitalization of over $86 million. Yet the same day the firm filed a Form 10-K with the SEC reporting total assets of $6,000, revenue of $7,600 and a net loss of $103,141. By the end of December 2013 the share price of CodeSmart stock was $0.66. By the middle of the next year it was $0.01. The date for sentencing has not been set.

October 19, 2017
Revenue Recognition: PCAOB Guidance on New FASB Standard
by John Jenkins

Recently, the PCAOB issued this Staff audit alert to assist independent auditors in applying PCAOB standards when they audit their client’s implementation of FASB’s new revenue recognition standard. Topics covered include:

– Transition disclosures & adjustments
– Internal control over financial reporting
– Fraud risks
– Revenue recognition
– Disclosures

Here’s an excerpt from the alert’s discussion of key factors for auditors to consider when assessing the internal control implications of the new standard:

PCAOB standards require the auditor to obtain a sufficient understanding of each component of internal control over financial reporting to (a) identify the types of potential misstatements, (b) assess the factors that affect the risks of material misstatement, and (c) design further audit procedures.

Changes to company processes for the implementation of the new revenue standard can affect one or more components of internal control. For example, the auditor is required to obtain an understanding of the company’s control environment, including the policies and actions of management, the board of directors, and the audit committee concerning the company’s control environment.

Check out this recent blog from Steve Quinlivan for more on the PCAOB’s alert.

Revenue Recognition: SEC Comments for Early Adopters

This "SEC Institute" blog reviews Corp Fin’s comments on filings by two early adopters of FASB’s new revenue recognition standard. The Staff’s comments – which are set forth in full in the blog – focus on MD&A and financial statements. And their emphasis is on the adequacy of disclosure and seeking to understand how the company made judgments in applying the new principles-based standard.

While the two companies that received comments were able to resolve them quickly, the blog also includes a reminder that not all comments on new accounting standards have happy endings:

New accounting standards always draw attention from the SEC. Way back in the 1990s, SFAS 133 (now of course ASC 815) was issued to create dramatically different new guidance for derivative and hedge accounting. Louis Dreyfus Natural Gas early adopted the new standard. After certain issues were raised in an SEC review, Louis Dreyfus Natural Gas was forced to restate its initial application of the new derivative accounting model.

"Black Monday": 30 Years Ago Today!

It’s hard to believe, but "Black Monday" – the great stock market crash of 1987 – happened 30 years ago today, October 19, 1987. This Bloomberg article recounts memories of that day from a cross-section of Wall Street players. So much that was once unthinkable has happened to the markets & the world since that day that I’m sure some of our younger readers are asking themselves "what’s the big deal?"

Well, the greatest single one day drop in Wall Street’s history didn’t occur in 1929 or 2008 – it happened on Black Monday in 1987. The market lost nearly 23% of its value in a single day. This quote from a trader will give you some sense of how many people felt that day:

I was so scared that I got $10,000 out of the bank, took it home, and stored it in the rafters.

Personally, I remember that day vividly. I was in a drafting session for a public offering, and the bankers kept nervously calling their office to find out how the market was doing. By the time the market closed, it was very apparent to everyone that our deal was stone dead.

John Jenkins

October 18, 2017
The SEC Wants to Know What's Next for Blockchain: Are You Keeping Up?
by Christine Hanley, James Thompson and Daniel Dunne

On October 12, 2017, the United States Securities and Exchange Commission’s Investor Advisory Committee met to discuss Blockchain technology and its impact on the securities industry. While Blockchain is best known as the decentralized accounting system that make transactions in Bitcoin and other cryptocurrencies possible, the panel of industry professionals and academics emphasized its potential to transform "mainstream" financial recordkeeping in a way that makes executing and recording all financial transactions more secure and efficient.

SEC Chairman Jay Clayton, who oversaw the proceedings, explained that the Commission seeks to explore the ways in which Blockchain can promote robust and competitive markets, while ensuring that investors are protected and federal securities laws are applied to transactions in cryptocurrencies made possible by the technology.

SEC Enforcement Related to Blockchain and Cryptocurrencies

In 2017, The SEC has been increasingly active with respect to Blockchain and cryptocurrencies, and Thursday’s Investor Advisory Committee meeting is just the latest example. Our Derivatives Group covered an SEC forum on Blockchain early this year, and on July 25, 2017, the Commission issued a Report of Investigation announcing that offerings of virtual currencies, known as "Token Sales" or "Initial Coin Offerings" ("ICOs") using Blockchain are subject to federal securities laws if they meet the Supreme Court’s Howey Test for determining whether a transaction qualifies as an "investment contract." (See our recent Blog post for analysis of the Report.) Last month, the SEC launched a Cyber Unit to target cyber-related misconduct including fraudulent ICOs. And on September 29, 2017, the Commission announced charges in connection with a pair of ICOs for violations of anti-fraud and registration provisions of the federal securities laws.

A Transformational Opportunity

Panelists Jeff Bandman, a former FinTech Advisor to the Chairman of the CFTC, Adam Ludwin, a developer of the technology, and Nancy Liao, a researcher at Yale Law School, explained that Blockchain is a "transformational" recordkeeping technology that has a wide application beyond cryptocurrency trading. Blockchain links together encrypted ledger entries called "blocks" into a chronological "chain," and then stores identical copies of the ever-expanding chain on millions of computers in the network. The result is a highly secure and accurate ledger that doesn’t need a central authority to maintain.

The panelists explained that as the technology continues to develop, it will provide a powerful platform to improve financial markets in the following ways:

  • Data security: Blockchain uses decentralized record keeping and advances in cryptography to safeguard data and protect against cyberattacks.
  • Investor Autonomy: End-users will be able to control who receives and has permission to access their financial data, investment and transaction history.
  • Efficiency: Blockchain speeds up transactions by eliminating the need for a centralized authority to act as a clearinghouse for financial transactions. It can also reduce transaction costs by replacing clunky accounting and payment networks.
  • Real-Time Regulation: Regulators will be able to detect and counteract predatory and deceptive practices at a much earlier stage because transaction data becomes available on the Blockchain ledger instantaneously.

The panel additionally discussed impediments to the SEC’s ability to adopt and regulate cutting-edge technologies like Blockchain. Bandman cautioned that ethical and procurement rules that are designed to prevent the government from distorting markets by favoring particular companies sometimes impede regulators from consulting with tech start-ups and accessing the latest technology. He suggested that Congress adopt a "Sandbox for Regulators," which would permit regulators to explore new financial technologies while complying with ethical and procurement requirements.

On July 21, 2017, Delaware—the state of incorporation of almost two-thirds of all U.S. publicly traded companies—passed an amendment to its General Corporation Law authorizing Delaware corporations to use Blockchain to create and maintain corporate records, including the corporation’s stock ledger. In-house and outside counsel should be aware of the significant cost-saving and data security advantages that Blockchain may offer their clients wholly apart from its application to cryptocurrencies, as well as developments in federal and state regulation. As the technology continues to develop over the next few years, these advantages will make it an increasingly attractive option for companies in a variety of industries.

View today's posts

10/19/2017 posts

CLS Blue Sky Blog: Corporate Monitors Need Better Regulation
CLS Blue Sky Blog: Weil Discusses Risks of Classifying Employees as Independent Contractors
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Rejection of the Universal Proxy Card
The Harvard Law School Forum on Corporate Governance and Financial Regulation: The Impact of Shareholder Activism on Board Refreshment Trends at S&P 1500 Firms
The Harvard Law School Forum on Corporate Governance and Financial Regulation: The Unicorn Governance Trap
SEC Actions Blog: CEO, Attorney Plead Guilty to Market Manipulation Blog: Revenue Recognition: PCAOB Guidance on New FASB Standard
Securities Litigation, Investigations and Enforcement: The SEC Wants to Know What's Next for Blockchain: Are You Keeping Up?

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