Securities Mosaic® Blogwatch
August 9, 2022
How Common Are Negative First-Day IPO Returns?
by Jacqueline Rossovski, Brian M. Lucey and Pia Helbing

Investors generally expect companies to make a successful and profitable debut on the stock market with their initial public offering (IPO). However, some stock market launches fall short: The price of shares in Deliveroo’s $2.8 billion IPO in 2021, for example, fell by more than 26 percent when launched on the London Stock Exchange, and the price of Uber shares issued in its $75.46 billion IPO in 2019 dropped, 7.6 percent after their first day of trading on the New York Stock Exchange.

In 2021, around $143 billion worth of shares were issued in U.S. IPOs, but more than 25 percent of those shares showed negative returns on their first day of trading. A quarter is not a small number, considering that an IPO is a time-consuming exercise in valuing the shares and a significant turning point for the company as it transitions from private to public trading.

Pricing an IPO is, however, a difficult endeavor due to an unobservable market price and limited historical data. Therefore, the underwriter typically organizes roadshows to determine the potential market demand. However, to minimize risks, the offer price is, in most cases, set lower than prevailing market expectations. This problem of underpricing is a phenomenon that continues to preoccupy researchers and has been the subject of theoretical reflection and debate since the 1970s.

Accordingly, most of the studies on IPOs focus on underpricing. In a new paper, we look at the other side: IPOs that experience negative returns on the first day of trading. We identify this as a negative event and label this as overpricing, which is the extent of the negative ratio between offer price and first close. Using all common stock IPOs between 2000-2020, we confirm previous evidence of positive average first-day IPO returns of 21.11 percent. In contrast, however, we also note the extent and magnitude of overvaluation, as a substantial 21.27 percent of IPOs record negative first-day returns, making this a common feature of U.S. IPO markets.

We find that this overpricing is pervasive, occurring across industries in 15-30 percent of IPOs and raising significant questions. Do overpriced and underpriced IPOs share characteristics? What are the determinants of negative first-day returns? What can we learn from overpriced IPOs?

To answer these questions, we derive a theoretical framework from the extensive underpricing literature, as we assume that, to some extent, underpricing and overpricing have similar causes. We confirm that the presence of information asymmetries between the different parties involved as well as uncertainty about future cash flows play a role in overpricing. First, we consider specific features of the IPO mechanism to approximate uncertainty before the IPO. Second, following agency-related ideas, we include characteristics of corporate governance in our analysis, as investors are likely to demand signals to eliminate potential agency problems. Third, firm-specific characteristics affect the valuation of an IPO.

We find that more IPOs with negative first-day returns occur at lower offer prices and smaller transaction sizes. We also find that 80 percent of overpriced IPOs occur when the opening price is lower than the set offer price in the latest prospectus. We also find that IPOs with negative first-day returns have fewer over-allotment shares than IPOs with positive first-day returns. Over-allotment shares allow underwriters to stabilize the share price after the IPO if necessary. A surprising 69 percent of shares in our sample were listed on NASDAQ with negative initial returns after their IPO. When considering the underwriter, which plays a key role in the IPO process, it appears that less reputable and prestigious underwriters are more likely to lead the client companies to negative returns on day one. The overpriced IPOs in our sample also have smaller boards and networks and fewer directors of retirement age. In addition to these results, however, it is not surprising that the firms with an overpriced IPO have higher leverage as well as lower profitability.

With this research, we hope to contribute to the debate on IPOs in several ways. First, this study uses an extensive hand-curated data sample of 2,111 IPO firms from 2000 to 2020, of which over 21 percent have negative first-day returns. Second, to the best of our knowledge, this is the first study that explicitly focuses on negative first-day returns and provides empirical evidence. Third, we identify determinants of IPO overpricing and contrast these with what we already know about IPO underpricing. We find that some characteristics’ impact show symmetry while others affect overpricing differently.

This post comes to us from Jacqueline Rossovski, a PhD candidate, at Trinity Business School of Trinity College (Dublin); Brian M. Lucey, a professor at Trinity Business School of Trinity College (Dublin), Ho Chi Minh City University of Economics and Finance, and Jiangxi University of Finance and Economics; and Pia Helbing, an assistant professor at The University of Edinburgh. It is based on their recent working paper, “On the Extent of Negative First-Day IPO Returns,” available here.

August 9, 2022
Wachtell Lipton Discusses Delaware Approval of Officer Exculpation from Personal Liability in Charters
by Theodore N. Mirvis, David A. Katz and Sabastian V. Niles

For over 45 years, Delaware law has permitted directors of Delaware corporations to be exculpated from personal monetary liability to the extent such protections are set forth in the certificate of incorporation, subject to certain exceptions.  However, such protective statutory provisions did not reach officers.  As contemplated in our April 2022 memorandum, Delaware has now adopted important amendments to Delaware’s General Corporation Law that would expand the right of a corporation to adopt an “exculpation” provision in its certificate of incorporation to cover not only directors (as has been allowed and widely adopted since 1986, following Smith v. Van Gorkom) but now also corporate officers.

The officer liability exculpation provision is not self-effectuating; instead, the amendment to Delaware law allows companies to take action to adopt exculpation provisions that protect covered officers from personal liability on the same basis as directors – that is, for all fiduciary duty claims other than breaches of the duty of loyalty, intentional misconduct or knowing violations of law – with an additional exception that claims against officers will not be barred “in any action by or in the right of the corporation.”

Under the newly amended provision of Delaware law, covered officers eligible for such exculpation from liability, if implemented by the corporation, will include the president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer or chief accounting officer, the company’s most highly compensated executive officers as identified in SEC filings and certain other officers who have consented (or deemed to have consented) to be identified as an officer and to service of process.  Companies and boards themselves will retain the right to bring appropriate actions against officers, and this additional exception will permit stockholder derivative claims against officers for breach of the duty of care to continue to be brought if demand requirements are met.

We believe that Delaware corporations should consider proposing amendments to their exculpation provisions to extend the protection to corporate officers.  Companies going public (e.g., through an IPO or spin-off or certain other transactions) can implement these protections in a straightforward manner as part of the new company’s certificate of incorporation.  Companies that are currently publicly traded may amend their charter to reflect such a provision through a board-sponsored proposal that would be voted on by the shareholders at a stockholder meeting, with the benefit of the disclosures and solicitation made via the company’s proxy statement.

An illustrative form of charter provision is set forth below; companies with existing director only provisions may want to consider tailored officer-specific exculpation clauses that are separate and apart from the director liability provisions:

No director or officer of the Company shall be liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director or officer, as applicable, except to the extent such an exemption from liability or limitation thereof is not permitted under the Delaware General Corporation Law (the “DGCL”) as presently in effect or as the same may hereafter be amended.  No amendment to or repeal of this provision shall apply to or have any effect on the liability or alleged liability of any director or officer of the Company for or with respect to any acts or omissions of such director or officer occurring prior to such amendment or repeal.

Leading Delaware corporate law experts advocated for this protective amendment in an article published last year entitled “Optimizing the World’s Leading Corporate Law: A 20-Year Retrospective and Look Ahead,” and the highly respected Delaware Corporation Law Council carefully considered and proposed the specific text of the amendments for adoption.  Eliminating the unequal and unfair targeting of officers for negligence claims in stockholder litigation, including but not limited to the M&A context, is a prudent and value-enhancing step, which warrants the support of major institutional investors and the proxy advisory firms.

Long-term (and other) institutional investors should support this change given their broad support for provisions that exculpate directors for duty of care liability, the realities that officers work under the direction and oversight of boards that are typically comprised of super-majorities of independent directors; that there is more disclosure than ever about corporate transactions and implementation of business strategies; and that disciplining managers for concerns about their diligence, rather than their loyalty, is a primary function of the board.  Given these realities, we believe that the only effect of allowing duty of care suits against officers when such claims cannot be brought against directors is to increase the cost and therefore settlement value of stockholder suits with little or no discernable value to the corporation or its stockholders, who ultimately bear those costs either directly or indirectly through increased insurance premiums.

The passage of this important amendment by Delaware is a positive recognition that the current imbalance in the law should be redressed.  Our hope is that business leaders will work together with leading institutional investors to take advantage of this opportunity to make our system of representative litigation more cost-effective and equitable.

This post comes to us from Wachtell, Lipton, Rosen & Katz. It is based on the firm’s memorandum, “Delaware Approves Permitting Exculpation of Officers from Personal Liability in Corporate Charters,” dated August 3, 2022.

August 9, 2022
Delaware and Caremark: An Update
by David Katz, Sabastian Niles, Theodore N. Mirvis, Wachtell Lipton

Recent Delaware decisions have reminded boards of directors of the obligation to make a good faith effort to put in place a compliance system designed to help ensure that their companies operate within the bounds of the law and that their products, services, and operations do not cause harm to consumers, community members, or the environment. That duty—famously associated with the Delaware Court of Chancery’s 1996 decision in Caremark—is a core responsibility of independent directors, working in concert with company management, that requires them to make a good faith effort to identify the key compliance risks the company poses to others and faces itself, and to put in place a reasonable oversight structure to address them.

In 2019, the Delaware Supreme Court’s decision in Marchand reminded boards that although the Caremark standard only requires a good faith effort to put in place and attend to a reasonable compliance structure, a plaintiff could state a claim against directors by pleading facts suggesting that the board failed to make any effort to ensure that a board-level system of oversight was in place to address a mission critical risk. In that case, the company’s sole business was to make ice cream and there was no board-level process for monitoring the safety of its products, which caused the death and illness of consumers in a listeria outbreak. Just last year, the Court of Chancery issued a high profile decision in the Boeing case, applying Marchand in the face of detailed fact pleadings suggesting that the company had no board-level process for overseeing the company’s effort to ensure the safety of its aircraft.

In those and other cases, the increasing use of books and records demands by plaintiffs to plead their claims has been illustrated. Because the Delaware courts have long made clear—including in Marchand and Boeing—that Caremark requires a good faith effort by the board, not perfection, and that the board will only face liability if the evidence demonstrates that a board has not made a good faith effort to fulfill its duties, plaintiffs have sought books and records to sustain their difficult burden to plead a viable claim. When these books and records do not reflect that a company had in place a board structure that attended to core business and legal risks, the plaintiffs cite to that lack of effort in an effort to plead a complaint that cannot be dismissed on motion.


For these reasons, we have urged that companies ensure that their board-level committee structures address all mission critical risks and that the board’s efforts in holding meetings and receiving information in aid of its monitoring responsibilities are well documented. Taking these steps are beneficial on several levels. Most important, tone and involvement at the top on important compliance matters helps companies best position themselves to function safely and lawfully. Because managing complex business entities invariably involves risks, these actions are also helpful in the event that something goes wrong despite the company’s good faith efforts at prevention. A documented board-level compliance system makes it much more difficult for a plaintiff to plead a viable Caremark claim. With increased attention to these subjects, two-thirds of the Caremark cases filed after Marchand have been dismissed on motion.

In a recent decision, Chancellor McCormick of the Court of Chancery underscored the utility of thoughtful consideration of board risk management and compliance structures. City of Detroit Police and Retirement Sys. v. Hamrock, C.A. No. 2021-0370-KSJM (June 30, 2022). The decision addressed a Caremark claim against the board of a natural gas company, NiSource, in the wake of a horrific explosion that occurred during the replacement of an old cast-iron pipe that resulted in one death, multiple injuries, and devastation to a small community.

Despite the mission critical nature of the safety issue—which was undisputed—the claim was dismissed. Important to that result was the fact that the company had a board-level committee specifically charged with addressing the core risks posed by its business—including the risks of explosion. Although the company’s compliance efforts did not prevent the tragedy that inspired the suit, the record that the committee met regularly, received reports on related safety issues, and was actively engaged in attempting to have the company improve its safety practices was critical to the court’s ruling that the plaintiffs had not met their burden to plead bad faith. Importantly, the books and records provided to the plaintiffs documented that the board was active in addressing the key safety issues involved in running a natural gas business.

As important, the Hamrock opinion, consistent with Caremark and Marchand, focused on whether the plaintiffs had met their burden to plead an absence of board effort amounting to bad faith, and not whether the board could be faulted for any form of negligence. The opinion specifically rejected the plaintiffs’ claim that board-level discussion on two occasions was too infrequent, holding that the record was sufficient to demonstrate plaintiffs’ failure to meet “the high ‘utter failure’ standard, even as understood through the refined lens of Marchand and Boeing.” And the court held that the board’s knowledge of “general risks” arising out of noncompliance with pipeline safety regulations in other parts of the company’s business was not a sufficient “red flag” of a “specific corporate trauma” to constitute a basis for Caremark liability.

Hamrock underscores that even in a very difficult and sad situation, directors face a very limited risk of personal liability if they use their business judgment and work with management to put in place and attend in good faith to a sound compliance structure that addresses the company’s central risks, and documents its efforts in doing so. In that regard, our comprehensive memorandum, Risk Management and the Board of Directors, is available here.

August 9, 2022
Emerging Fraud Risks to Consider: ESG
by Amy Edwards, Kimia Clemente, Krista Parsons, Maureen Bujno, Michael Brodsky, Deloitte


Many audit committees are highly focused on the risk of financial statement fraud, but a case is growing for audit committees to expand their discussion of fraud risk to encompass a growing variety of environmental, social, and governance (ESG) issues. ESG-related topics increasingly appear on audit committee agendas and factor into financial reporting discussions, but they tend to arise less often in the context of discussions about fraud risk.

Investors continue to demonstrate interest in understanding risks related to ESG issues, which is helping fuel regulatory focus on reporting and disclosures. The SEC has already issued proposals to expand disclosures related to cybersecurity and climate issues, and further proposals are expected in areas such as human capital. These proposals are likely to significantly increase the scope of information that will be included in regulatory filings in the coming years.

In preparation for expected new reporting requirements, many companies are in the process of developing more robust ESG-related disclosure controls and procedures as well as internal control over financial reporting (ICFR). Some companies are developing ESG-related metrics for financial reporting and for incorporation into incentive compensation.

Ahead of these possible rule changes, fraud risk in this area should be top of mind for audit committees and a focal point in fraud risk assessments overseen by the audit committee. Many companies are currently providing information to investors that is not governed by the same types of controls present in financial reporting processes.


As an example, companies may voluntarily provide information on carbon emissions that has not been gathered, tested, and reported under the kind of internal controls that typically are present with financial reporting. This may suggest a heightened opportunity for people within the organization to manipulate ESG-related information.

Many companies are also developing or considering provisions that link ESG-related metrics to compensation or incentives. This is a factor that may elevate fraud risk. According to the classic fraud triangle theory developed by Donald Cressey, fraud risk is often escalated in an environment where three factors are present: financial pressure, opportunity, and rationalization. Compensation or financial incentives related to ESG can represent a source of financial pressure to commit fraud.

Escalating fraud risks

As reporting processes develop and mature in anticipation of regulatory requirements, audit committees can engage with management, including internal audit, fraud risk specialists, and independent auditors to understand the extent to which fraud risk is being considered and mitigated.

The Audit Committee Practices Report, which describes findings from a 2021 survey by Deloitte and the Center for Audit Quality, indicates audit committee members already see indications of increasing fraud risk. Nearly half (42%) of survey respondents indicated fraud risk had increased. Approximately three-fourths of respondents (74%) said their companies updated internal controls to address the remote work environment that sprang up quickly in the early stages of the pandemic, with larger companies more apt to have instituted fraud deterrent measures than smaller companies.

Risk related to occupational fraud, or instances of fraud committed from within the organization, is an important consideration for audit committees as they evaluate their companies’ ESG risks. Organizations lose 5% of revenue each year to occupational fraud according to the Association of Certified Fraud Examiners (ACFE). [1] Although financial statement fraud schemes are the least common form of occupational fraud, they are the costliest for companies, with median losses of $590,000, according to the ACFE.

ESG fraud risk is a growing area of focus for SEC enforcement as well. The SEC’s Division of Enforcement formed a Climate and ESG Task Force in 2021, and the SEC recently issued an enforcement action for alleged misstatements and omissions in fund disclosures regarding a mutual fund investment adviser’s incorporation of ESG factors into its investment process. Earlier in 2022, the SEC charged a mining company and an ore producer with making false and misleading claims about safety.

In addition, the SEC has proposed amendments to rules and disclosures that are intended to promote consistent, comparable, and reliable information for investment funds’ and advisers’ incorporation of ESG factors into investment practices. In a published statement with the proposal, SEC Chair Gary Gensler said investors may find it difficult to understand what some funds mean when they say they are an ESG fund. “There also is a risk that funds and investment advisers mislead investors by overstating their ESG focus,” he added.

Examples to consider: Climate and talent

ESG encompasses a wide variety of matters that vary by company based on its industry, stakeholders, and other facts and circumstances. Given the heightened focus on climate issues that many companies are facing, it may be useful to consider the potential fraud risks related to some specific aspects of ESG, such as climate and talent.

Climate factors driving ESG risk

In the area of climate, many companies are already voluntarily reporting certain climate-related metrics using a variety of frameworks available to them. Some of these metrics could be subject to regulatory requirements, including independent audits.

Such metrics can include greenhouse gas emissions, which may be segregated by scope, [2]  and metrics related to a company’s use of renewable energy in its effort to reduce fossil fuel consumption. Many companies are also reporting various metrics expressed as percentages or ratios to describe what portion of their energy consumption is derived from renewable sources. Similarly, some companies are developing or reporting metrics related to water consumption or water conservation.

With respect to climate-related initiatives and emerging metrics, audit committees can challenge management and auditors to consider numerous areas where fraud risk could be increasing:

Approach to climate. ESG-related reports and other information made available to investors may differ from information contained in financial statements and disclosures. Companies can evaluate whether information they are providing in regulatory filings is consistent with sustainability reports, press releases, websites, other regulatory filings, and industry reports. The novelty of ESG-related information and the information gathering process, as well as the reliance stakeholders may be placing on such information, can make it susceptible to fraud risk.

Impact on controls. Corporate culture, ownership, and governance structures often affect business practices and controls. The company’s focus on tone, training, and sensitivity to potential indicators of fraud can be expanded to include evolving or emerging ESG-related activities. Newer or less mature controls over reporting, ineffective controls, and the absence of controls can increase the opportunity for fraud to occur.

External risk factors. Evolving regulatory and stakeholder expectations on ESG matters may create pressure for management and the board to appear well positioned to meet targets or comply with future regulations. Pressures may be compounded by factors such as the company’s legal and regulatory environment; pressure from investors, lenders, customers, the media, and other interested third parties; changes to the profitability or nature of products and services as a result of ESG objectives; and changes in the business arising from environmental targets.

Internal risk factors. The development of key performance indicators (KPIs) that drive ESG-related programs may become relevant to the fraud risk analysis, including whether the KPIs are relevant and accurate and whether they are incorporated into key contracts or internal compensation programs.

Estimates. Some data or information that flows into ESG-reporting may involve estimates, judgments, or forecasts. Estimates and forecasts are by their nature subjective and are subject to manipulation or bias. Audit committees can ask management how reliable data sources are, whether they could be manipulated, and how management could potentially be motivated to intentionally manage these ESG metrics in ways that would serve management or the company’s best interests.

Talent factors driving ESG risk

Companies may also be facing increasing ESG-related fraud risk as a result of shifts in talent. Continual turnover, vacant or hard-to-fill positions, and ongoing remote work or hybrid work arrangements are factors that could contribute to heightened fraud risk. Consider some common talent-related scenarios that many companies are facing and how they may heighten fraud risk:

Turnover. Continual turnover or vacant positions could lead to questions about whether control activities are being executed and managed consistently, or whether duties are properly segregated. System access may be shifting frequently to address staffing challenges as well. Audit committees can challenge management regarding how people are properly trained and managed, whether contingency plans are in place for key personnel absences, and how access management is continually evaluated to mitigate fraud risk.

New responsibilities. Risks may arise as people assume responsibilities for ESG-related practices and reporting initiatives that are novel or unfamiliar to them. People may make mistakes. If the company’s culture does not permit people to make mistakes and correct them, some people may be tempted to cover or hide errors with fraudulent activity. The audit committee should understand corporate culture and management’s approach to reporting mistakes or errors.

Hybrid work. Enduring remote work or hybrid work arrangements can also prompt questions about how quality is managed and how disciplinary matters are handled. The audit committee can challenge how management is promoting culture and tone at the top in these types of environments.

Talent-related metrics. As part of their ESG strategies, some companies are developing talent-related metrics to report to stakeholders. For example, many companies are developing metrics that are meant to convey information about health and safety, engagement, culture, development, diversity, equity, and inclusion, among others. These are additional metrics that could be manipulated, so audit committees can challenge management regarding how the metrics are developed and what internal controls are in place to promote completeness, accuracy, and reliability of the metrics.

Call to action: Consider ESG in fraud assessments

Fraud risk assessments provide an important means of evaluating fraud risk that may be emerging with the company’s enterprisewide strategies and objectives, including ESG. Fraud risk assessments are intended to help management understand who could commit fraud, what type of schemes they might devise, where and how these schemes could be carried out, and what controls a company has or does not have in place, which may help identify potential gaps in the internal control framework that is intended to prevent and detect fraud.

COSO’s Internal Control—Integrated Framework, which most US public companies use as a guide to develop internal controls over financial reporting, includes a principle specifically focused on the importance of fraud risk. In an effort to help companies develop effective internal control with respect to sustainability reporting, COSO has launched a study to develop supplemental guidance and insights to its 2013 framework focusing on ESG.

Audit committees have an important role to play in promoting effective fraud risk assessments that include consideration of risk arising from ESG-related activities. It is the audit committee’s responsibility to receive and review disclosures from the CEO and CFO made in connection with the certification of the company’s quarterly and annual reports filed with the SEC in two critical areas. The first area includes significant deficiencies and material weaknesses in the design or operation of ICFR that may affect reporting; the second area is fraud, whether or not material, that involves management or other employees with a significant role in internal controls.

Audit committees should understand the company’s antifraud programs and controls, evaluate management’s process, and ask questions about the extent to which the company’s fraud risk assessments consider the risk of fraud in emerging or evolving ESG-related reporting activities.

Audit committees should also understand the independent auditor’s fraud risk assessment process and findings with respect to the antifraud programs and controls as well as the risk of management override of controls.

Some overarching principles for an effective fraud risk assessment typically include:

Time and resources. A robust fraud risk assessment is a part of an entity’s overall enterprise risk management program. It is typically performed by a cross-functional working group with the technical knowledge of fraud and fraud risk as well as the time, staff, and tools to perform a thorough assessment.

A working group made up of broad stakeholders may include members of finance, operations, technology, human resources, procurement, compliance, legal, and internal audit, with a particular focus on any operational or functional areas that may be working with or producing ESG-related information. The group should have assigned roles and responsibilities to address the various components of the risk assessment.

Control environments. While brainstorming about potential fraud schemes, the working group should set aside any consideration of the existing control environment. Fraudsters may not be aware of fraud prevention controls that may be in place or may work to circumvent them. When existing controls are not factored into the brainstorming, stakeholders can more easily envision potential incentives, opportunities, and rationalizations for committing fraud.

Specificity. The risk assessment should identify not only potential schemes, but potential methods to commit fraud and possible perpetrators as well. The more specific the identification of potential fraud risks, the more effectively the company can evaluate potential likelihood, impact, and mitigation strategies.

Consideration of risk. Once the group has identified fraud schemes, assessed the likelihood and impact of each, and prioritized them, then the group can evaluate controls and processes associated with each. The highest-risk scenarios should receive the highest level of attention. It is not uncommon for companies to allocate time and resources to potential fraud schemes that are not commensurate with the risk.

Consideration of emerging risks. This is an aspect of the risk assessment that is particularly relevant to ESG-related fraud risk. The assessment must consider emerging risks based on changes in the internal or external environment. These may include changes in the economy, new ways of doing business, new products or services, new technologies, increasing expectations from internal and external stakeholders, and other changes that may be relevant to the company.

Documentation and follow-up. Audit committees should ask management to share evidence of the risk assessment to understand the level of attention given to evolving ESG fraud risks and what measures are being taken to mitigate risks as ESG-related activities evolve.

Concluding insights

The topic of fraud risk is one that often makes people feel uncomfortable, especially when considering the possibility of fraud from within the company. It is common for management and audit committees to have faith and place trust in their people. This sense of confidence can translate to a sense of denial about the possibility that fraud could occur. It may be difficult for some management and audit committees to consider the possibility that the trust they have placed in people may have been misplaced.

In addition to internal fraud risks associated with ESG, audit committees can also be aware of possible external fraud risks that may arise resulting from ESG, such as cybersecurity.

Audit committees should understand who among senior management has responsibility for fraud risk management, understand what antifraud programs are in place, and evaluate whether there is sufficient visibility across the enterprise to promote a comprehensive approach. It is the audit committee’s responsibility ultimately to understand how effectively management has considered the risk of fraud and taken measures to mitigate it.

Assessing for fraud risk is not a prescriptive, check-box exercise. It is an ongoing, bespoke exercise that must be tailored to the specific facts and circumstances of each company, and it takes time and effort. As new fraud risks likely develop resulting from emerging or evolving ESG-related strategies and activities, a vigilant audit committee can help the company reduce its risk.


Questions for audit committees to consider:

As audit committees consider ESG-related fraud risks, they can ask management several questions to understand the company’s approach to mitigating these evolving risks:

  1. To what extent has management assessed the risk of fraud with respect to the company’s growing focus on ESG strategy and reporting as part of its enterprise-wide fraud risk assessment?
  2. Is the audit committee primarily responsible for ESG-related fraud risk, or is responsibility shared with other committees and/or the full board? How often does the audit committee discuss fraud risk, including ESG-related fraud risk?
  3. Which member of management has authority over fraud risk, and does this person have a comprehensive view of the ESG-related fraud risks that could be present? For example, does this person’s visibility and authority extend beyond financial reporting?
  4. How is management developing metrics that are provided to stakeholders related to ESG strategies or initiatives? How is management developing reporting mechanisms and addressing the potential for fraud in these ESG strategies and initiatives?
  5. What internal controls are in place with respect to the development of metrics and reporting mechanisms, especially those related to ESG? What process has management adopted for promoting completeness, accuracy, and reliability of ESG-related metrics and reporting?
  6. What fraud risks have been identified? How have they been evaluated and prioritized? What mitigation measures are being implemented?
  7. To what extent are these metrics and ESG-related reports reviewed by internal auditors and independent auditors?




Occupational Fraud 2022: A Report to the Nations, Copyright 2022 by the Association of Certified Fraud Examiners, Inc.(go back)


Scope 1 emissions are those directly attributable to a company. Scope 2 emissions represent indirect emissions resulting from, for example, energy a company purchases. Scope 3 emissions are indirect emissions deeper into a company’s value chain, such as those of a supplier.(go back)
August 9, 2022
Hidden Gems: Do Compensation Disclosures Reveal Performance Expectations?
by C. Edward Fee, Qiyuan Peng, Zhi Li

Performance-based stock grant is an increasingly popular form of incentive pay for public firm CEOs in U.S. Under these grants, executives are expected to receive different levels of stock payments (“threshold,” “target,” or “maximum”), contingent on the firm’s meeting pre-specified hurdles by the end of the performance evaluation period. In 2006, the SEC announced new disclosure rules that require firms to report “unearned shares” from outstanding performance-based stock grants in their proxy statement. Unearned shares are the number of shares that executives are expected to receive conditional on whether the firm meets predetermined performance hurdles by the end of the evaluation period.

In our paper, Hidden Gems: Do Market Participants Respond to Performance Expectations Revealed in Compensation Disclosures?, forthcoming in the Journal of Accounting and Economics, we examine whether the disclosed “unearned shares” provide new information about a firm’s future performance. We believe the new disclosure contains forward-looking information for two reasons. First, firms often cite performance expectations over the evaluation period to justify the reported unearned shares. Second, past literature has shown that firms choose specific performance measures that reflect their strategic priorities. These performance criteria, which are often not fully disclosed to the public, may capture information related to CEO actions and firm performance over the long run. However, the disclosure might not be informative. For example, the compensation committee and other corporate insiders might not be able to correctly forecast future firm performance and plan payouts. Or the firm could be unwilling to truthfully reveal inside information. Or the performance-based grants might be poorly designed to be informative, such as the performance hurdles are set at unreasonably high (low) level or the performance measures used are unrelated to firm value. Hence, whether the disclosure of unearned shares is informative is an empirical question.


Using a sample of large U.S. public firms from 2006 to 2013, we identify 5,214 (37.20%) firm-years with reported unearned shares from outstanding performance stock grants. We classify them into three groups based on the reported level: Threshold, Target, and Maximum. There is significant variation in the reported level: 666 (12.77%) firm-years are in the Threshold group; 3,203 (61.4%) in the Target group; and 1,345 (25.80%) in the Maximum group. Firm-years where CEOs do not have outstanding performance stocks (8,803) are classified as “No Signal”, as no information can be inferred from them.

We first examine firm performance after compensation disclosure across the three disclosure groups. Firms in the Maximum group have significantly higher ROA, firm’s Q, sales growth, and profit margin than those in the Threshold group over the next two years after the disclosure. Similarly, firms in the Target group outperform firms in the Threshold group, but by a lower magnitude. Firms in the Maximum (Threshold) disclosure group also have superior (inferior) future operating performance compared with firms that do not have outstanding performance-based stocks (the No Signal group). Thus, it is unlikely that executives expect Maximum (Threshold) level of payouts simply because their firms set performance hurdles too low (high). Further, there is no evidence that the superior future performance of the Maximum (Target) group is driven by earnings management.

It is possible that the forward-looking information conveyed in unearned shares has already been covered by other information sources. We control for five potential information channels based on the literature: post-disclosure management earnings guidance raise; disclosure year positive 10-K sentiment based on textual analysis; net insider selling activities; unexplained CEO cash compensation; and analysts’ earnings forecast errors in the disclosure year. We find that the disclosed level of unearned shares is still highly correlated to firms’ future performances. In summary, unearned shares disclosure contains unique information that is not captured by a firm’s current performance, observable firm and CEO characteristics, or other known information channels.

We next examine whether investors could timely incorporate the information into asset prices. We find that there is no difference in market reaction around proxy filing dates between the Maximum and Threshold firms. However, investors are positively surprised when firms in the Maximum group announce earnings one year after the unearned shares disclosure. Moreover, firms in the Maximum group report earnings that significantly beat analysts’ forecasts over the next four quarters. In contrast, firms in the Threshold group have negative, though not significant, post-disclosure earnings surprises. These findings suggest that investors, including sophisticated analysts, having underestimated the correlation between disclosed unearned shares and future firm performance, are later surprised when actual performance is reported.

Lastly, we examine firms’ long-run abnormal returns following the compensation disclosure. We find that firms in the Maximum disclosure group experience significantly positive abnormal stock returns the following year, while those in the Threshold group experience significantly negative abnormal returns. The results hold after controlling for traditional risk factors, momentum, profitability, post-earnings- announcement drift (PEAD), and information from other public channels. A long–short portfolio that invests in firms in the Maximum group and shorts those in the Threshold group could earn significantly positive post-disclosure abnormal returns.

Given the well documented effect of long-run abnormal return driven by PEAD, we separate the firms into subgroups based on above- or below-median earnings surprises in the disclosure year. Within the Maximum and Target groups, only firms with below-median earnings surprises experience significant positive abnormal returns after disclosure; those with above-median earnings surprises earn risk-adjusted returns on average. Thus, the documented long-run return pattern is not driven by earnings drift. Instead, investors underreact to positive information embedded in compensation disclosure when it differs from the more visible earnings news.

Our paper shows that disclosed unearned shares from performance-based stock grants reveals valid forward-looking information about a firm. This new disclosure was mandated by a 2006 SEC rule change that aimed to raise the standards of compensation disclosure. Our findings suggest that under the enhanced disclosure rule, firms, on average, truthfully reveal new information to the public and that investors could improve market efficiency if they promptly incorporated such information into asset prices.

Our paper provides further evidence on the usefulness of compensation disclosure. As boards use internal signals to evaluate executives, compensation-related disclosure contains incremental information on firm performance that is beyond what is conveyed in financial statements. However, investors have limited ability to process public information that is difficult to process, and their underreaction to this information leads to predictable abnormal stock returns. Due to limited attention, investors might not look for, or find, performance-related information in a place as unlikely as compensation disclosures.

Our paper further contributes to the literature on the importance of corporate voluntary disclosure. Researchers and practitioners have expressed concern that, when the cost of misreporting is low, firms might strategically use disclosure to manipulate the market. As a result, investors are reluctant to take voluntary disclosure at face value. Our results, however, show that firms on average truthfully reveal their internal performance expectations when disclosing complex details of executive incentive pay. This evidence complements earlier findings that when firms voluntarily provide information that is hard for outsiders to verify, the disclosure is generally credible.

The complete paper is available for download here.

August 9, 2022
Chancery Court finds dual class stock amendment fits MFW framework, investor challenge fails
by Francis Pileggi

This post was prepared by Frank Reynolds, who has been following Delaware law and writing about it in various publications for over 30 years.

Delaware’s Court of Chancery recently dismissed a shareholder challenge to The Trade Desk Inc. (TTD) charter amendment that extended the advertising software company’s dual stock class structure and its CEO’s control, finding TTD met all six qualifications of the Delaware high court’s seminal MFW ruling, entitling it to deferential business judgment review in City Fund for Firefighters and Police Officers in the City of Miami v. The Trade Desk Inc.,et al. opinion issued, (Del. Ch. July 29, 2022).

In his July 29 memorandum opinion, Vice Chancellor Paul Fioravanti threw out the breach of duty charges that the City Fund for Firefighters and Police Officers in the City of Miami had brought against TTD officers and directors for allegedly helping CEO and controlling shareholder Jeff Green trick common shareholders into approving Green’s self-interested stock scheme.  He said the plaintiffs failed to show that investors were duped into voting for an amendment to delay the end of a dual stock class or were uninformed about Green’s supposed hidden urgency to dispose of his many Class B shares that carried ten votes per share.

The ruling called on the Chancery Court to apply the Delaware Supreme Court’s milestone MFW opinion, which set out the six conditions that could exempt a controller’s transaction from the heightened scrutiny of review under the exacting entire fairness standard announced in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (commonly referred to as the MFW standard.)  Since the TTD amendment fit the MFW framework, it only faced examination under the more lenient business judgment rule, the vice chancellor said.


According to the court record, Jeff Green co-founded TTD, a Ventura, California, technology company that markets “a software platform to provide data-driven digital advertising campaigns” and has served as its President, Chief Executive Officer, and as chairman of the Delaware-chartered company’s board of directors.  Green controlled a majority of TTD’s stock through his ownership of most of its Class B stock but that was due to change when the number of those non-public shares shrank.

After lengthy negotiations and the creation of a three-director special review committee, the TTD board company endorsed an extension of the projected sunset of the Class B shares and their conversion into the common Class A stock and that continued Green’s control at a crucial juncture.

After the pension fund filed its complaint, defendants moved to dismiss based on failure to plead a claim and the case focused on whether the disputed transaction fit the MFW framework by complying with six elements:

  • the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;
  • the Special Committee is independent;
  • the Special Committee is empowered to freely select its own advisors and to say no definitively;
  • the Special Committee meets its duty of care in negotiating a fair price;
  • the vote of the minority is informed; and
  • there is no coercion of the minority.

Plaintiffs focused on elements two and five, arguing that the independence of the special committee was tainted by director Lisa Buyer and the vote was uninformed because shareholders were kept in the dark about the scheduled end of the Class B stock and Green’s need to unload his shares.

The Special Committee’s independence

Plaintiff charged that the Chair of the committee, Buyer, had been a consultant for  Green during TTD’s initial public offering and received a large compensation for her services that compromised her neutrality.

But the vice chancellor noted that the MFW opinion requires an inquiry before such a determination. “This court is hesitant to infer materiality of compensation absent well-pleaded facts. The determination of whether a director’s compensation from the Company is sufficient to raise a reason to doubt her independence is a fact intensive inquiry. See In re MFW S’holders Litig., 67 A.3d at 510–13.

Plaintiff contended that Buyer caused the other two independent directors to function under a “control mindset” that skewed the committee’s decisions.

The decision

The court determined that, “Even assuming that Buyer’s TTD compensation creates a reasonable inference that her director compensation was material to her and that she was, therefore, not independent, the Plaintiff has not alleged facts that create a reason to doubt that a majority of the committee lacked independence or that Buyer so dominated the committee process that it undermined its integrity as a whole.”

“Plaintiff has not pleaded sufficient facts alleging that Buyer’s conduct dominated or subverted the Special Committee process so as render the entire committee defective, even if she was determined to be lacking in independence,” Vice Chancellor Fioravanti added, noting that the controlled mindset theory is not part of the MFW analysis.

Was the vote uninformed?

The court concluded that none of six alleged material non-disclosures altered the “total mix of information” available to the investors who needed to consider whether to vote for the extension amendment.

  • Green’s desire to sell Class B stock;
  • the Company’s expectations as to when the Dilution Trigger would likely be tripped;
  • advice that Centerview provided to the Special Committee;
  • Green’s counsel’s acknowledgement that a business rationale would be needed to justify any amendment to the Dilution Trigger;
  • the Special Committee’s efforts to obtain stockholder support for the Dilution Trigger Amendment; and
  • the Compensation Committee’s consideration of an equity grant to Green in December 2020

The court concluded that as Defendants aptly put it, “anyone reading the Proxy would understand both that Green desired to retain control through the Trigger Amendment and that the amendment would enable him to continue his (disclosed) historical practice of selling shares without losing that control.”

August 9, 2022
Chancery Finds Implied Agreement for Withdrawal of LLC Member
by Francis Pileggi

Any lawyer involved in litigation about issues surrounding an LLC member’s withdrawal from an LLC should become familiar with the recent decision in 5high LLC v. Feiler, C.A. No. 2022-0108-LWW (Del.Ch. Aug. 5, 2022).

Issue Addressed

Whether one of the original 50/50 members of an LLC resigned despite no written LLC agreement and no written resignation.

Essential Background Facts

Two members formed an LLC without a written LLC agreement but agreed orally that each would have a 50% ownership interest, each would co-manage the LLC, and each contributed an equal amount of capital. Shortly after the formation, one of the 50/50 members orally resigned and took several public actions to notify vendors, customers, employees, and others that he was resigning. The other 50% member orally accepted the resignation and the parties began exchanging draft formal documents–but they never signed a formal, written agreement to memorialize the resignation.

Important Legal Principles From Court’s Opinion

  • The Delaware Declaratory Judgment Act was an appropriate vehicle to present the issue for the Court to decide if one of the original 50/50 members remained as the sole member. Slip op. at 15-16 and n. 84.
  • The LLC Act allows an LLC agreement to be written, oral or implied. Slip op. at 18. See Section 18-101(9).
  • The court defines an implied agreement and explains how one can be formed by conduct of the parties. Slip op. at 18-19.
  • Subjective intent is not relevant to determining if an implied contract was formed, and silence or failure to object can be treated as acceptance. Id.
  • Based on the circumstances of this case, it was not necessary to invoke the magic word “resign”, and there was ample evidence presented at trial on a paper record, to permit an objective observer to conclude that the departing member’s behavior demonstrated his intent to sever all ties with the LLC–and the remaining member accepted that offer to sever ties.
  • The LLC Act provides default provisions, but the parties’ implied contract modified those default provisions. Slip op. at 20-21.
  • The LLC Act’s default provisions would otherwise have prevented the resigning member from withdrawing prior to dissolution or winding up of the LLC. Id. and n. 104. See LLC Act Section 18-603.
  • The implied agreement was not conditioned on a formal, written agreement being signed, and efforts to memorialize the implied agreement did not alter the implied agreement. Slip op. at 21.
  • The court’s statement of the law and its reasoning highlighted above might possibly be applied to other situations where, for example, parties may agree–in an implied contract–to settlement terms in other contexts without signing a formal, written agreement.
August 9, 2022
2nd Cir. Limits Reach of Dodd-Frank Whistleblower Incentives
by John Jenkins

A recent 2nd Circuit decision pared back the scope of the claims for which compensation may be received under Dodd Frank’s whistleblower provisions. Here’s the intro from this Sheppard Mullin blog on the decision:

In Hong v. SEC, No. 21-529 (2d Cir. July 21, 2022), the Court held that a person who provides the Securities and Exchange Commission (“SEC”) with information about potential securities laws violations is entitled to receive a whistleblower award under Section 21F of the Securities Exchange Act (15 U.S.C. § 78u-6) if the SEC itself brings a qualifying action, but not when the SEC shares the whistleblower’s information to other agencies who then bring an action in partial reliance upon it.

In this case, the whistleblower tipped the SEC off to some alleged shenanigans involving his employer bank’s portfolio of residential mortgage-backed securities.  The SEC didn’t take action but shared his information with the DOJ & the Federal Housing Finance Agency.  Ultimately, the bank settled with the agencies for $10 billion, so you can understand why this guy was hoping for a big payday.

However, the SEC contended that it wasn’t on the hook for whistleblower claims resulting from actions by other agencies.  It said that in order for actions by other agencies to qualify as “related actions” under Section 21F, there must also be an underlying SEC action.  The 2nd Circuit applied Chevron deference to the SEC’s interpretation of the scope of Dodd-Frank’s whistleblower provisions & ultimately ruled in the agency’s favor.

The blog says that the decision sets definitive limits on the reach of the Dodd-Frank Act’s whistleblower incentives and may also affect an individual’s assessment of whether to risk their career to come forward with information on potential wrongdoing.

John Jenkins

August 9, 2022
SOX 404: 18 Years of Internal Control Assessments
by John Jenkins

Section 404 of the Sarbanes-Oxley Act requires companies to review their internal control over financial reporting and report whether or not it is effective. Non-accelerated filers are required to provide management’s assessment of the effectiveness of their ICFR, while larger companies are required to accompany that assessment with an attestation from their outside auditors.

Audit Analytics recently issued its annual report on the most recent round of auditor attestations & management-only assessments of ICFR. This recent blog reviews the results of the past 18 years of experience under SOX 404, and makes several interesting observations:

– In FY 2021, 5.8% of SOX 404(b) auditor attestations disclosed ineffective internal controls. In contrast, 23.7% of management reports and 41.9% of management-only reports disclosed ineffective controls. These percentages represent increases from the levels seen in FY 2020, across all three report types.

– The report includes a thorough breakdown of the control and accounting issues contributing to an ineffective control assessment. Notably, in FY 2021, a recurring control issue cited in adverse SOX 404 reports related to a lack of qualified accounting personnel. Other issues stem from this lack of highly trained company accounting professionals. This includes the inability to enforce a “segregation of duties” within the accounting function.

The blog notes that the significantly higher percentage of management-only reports disclosing ineffective controls reflect the demographics of companies required to file these reports. Large companies must file auditor attestations along with management reports on ICFR, while smaller companies are permitted to file management-only reports.

The recurring references to the lack of qualified accounting personnel are particularly troubling. Over the past few years, there have been numerous media reports about a potential shortage of accountants.  It looks like the chickens have come home to roost on this issue this year, and that the shortage will continue to place stress on companies’ internal controls in the future.

John Jenkins

August 9, 2022
SEC Reverses Aspects of Proxy Voting Advice Regulations
by Aaron Levine, Jordan Voccola, Marc Treviño, Natasha Rygnestad-Stahl, Robert Downes, Sullivan & Cromwell


On July 13, the SEC voted 3 to 2 (Commissioners Peirce and Uyeda dissenting) to adopt amendments to the rules governing proxy voting advice provided by proxy advisory firms. The 2022 Final Rule rescinds two sections of the rules governing proxy voting advice adopted by the SEC in July 2020. The 2022 Final Rule rescinds Rule 14a-2(b)(9)(ii) and includes conditions to exemptions from the proxy rules’ information and filing requirements that required proxy advisory firms to (1) make their advice available to the companies subject to their advice at or before the time that they made the advice available to the proxy advisory firm’s clients and (2) provide their clients with a mechanism by which they could reasonably have been expected to become aware of any written statements regarding the proxy advisory firm’s proxy voting advice by registrants subject of the advice. The 2022 Final Rule also rescinds Note (e) to Rule 14a-9, which set forth examples of material misstatements or omissions related to proxy voting advice, specifically providing that failure to disclose material information regarding proxy voting advice could be misleading. The SEC has also rescinded certain supplemental guidance released in 2020, which was prompted, in part, by the adoption of the rescinded rules.

The 2022 Final Rule will be effective on September 19, 2022.


In July 2020, the SEC adopted final rules regarding proxy voting advice provided by proxy advisory firms or proxy voting advice businesses (“PVABs”) (the “2020 Rules”). [1] The 2020 Rules comprised the following:

  • Rule 14a-2, which required PVABs to:
    • disclose conflicts of interest;
    • adopt and publicly disclose policies and procedures to provide proxy voting advice to registrants at or prior to dissemination to clients and to provide timely notice to clients of registrants’ responses;
  • Note (e) to Rule 14a-9, which clarified the applicability of the proxy rules’ antifraud provisions to proxy advice and added examples of when failure to disclose material information (e., the proxy advisor’s methodology, sources of information or conflicts of interest) regarding proxy voting advice could be considered misleading under Rule 14a-9; and
  • The definition of “solicitation,” which was amended to expressly include proxy voting advice and conditioned the availability of exemptions from the proxy rules’ information and filing requirements on proxy advisors meeting the above requirements.


The 2020 Rules came into full effect on December 1, 2021.

On June 1, 2021, Chair Gensler announced that the SEC was revisiting the agency’s regulation of proxy voting advice, including the 2020 Rules, [2] and the Division of Corporation Finance issued a statement that it would not recommend enforcement action with respect to the 2020 Rules while the SEC considered further regulatory action. [3]

On November 17, 2021, the SEC proposed amendments to the 2020 Rules that would rescind Rule 14a-2(b)(9)(ii) and Note (e) to Rule 14a-9, while leaving the remaining sections of the 2020 Rules intact (the “2021 Proposing Release”). [4] In the 2021 Proposing Release, the SEC stated that, following the adoption of the 2020 Rules, institutional investors and other clients of PVABs had expressed concerns about the rules’ impact on their ability to receive independent proxy voting advice in a timely matter. [5] Further, the SEC stated that, since the 2020 Rules were adopted, PVABs have continued to develop industry-wide best practices to address the concerns underlying the adoption of the 2020 Rules.

In the 2022 Final Rule, the SEC adopted the rules as proposed in the 2021 Proposing Release. [6] In Chair Gensler’s statement on the 2022 Final Rule, he noted that SEC had “determined that the risks [the 2020 Rules] impose to the independence and timeliness of proxy voting advice are not justified by their informational benefits.” [7] Commissioner Peirce, in dissenting from the adoption of the 2022 Final Rule, raised concerns that the frequent rule changes in this space was leading to “regulatory whiplash” for participants. [8]

Amendments to Rule 14a-2(b)(9)

The 2022 Final Rule removes Rule 14a-2(b)(9)(ii) (the “Information Availability Rule”) (as well as the related safe harbors and exclusions in Rules 14a-2(b)(9)(iii)-(vi)), [9] which required proxy advisor firms to both make their advice available to the company subject to that advice by the time it is disseminated to clients and provide clients with a mechanism by which they can become aware of a company’s statement in response before they vote. [10] The Information Availability Rule was intended to benefit shareholders by improving information availability so they could make more informed voting decisions. However, the SEC states in the Adopting Release that, since the enactment of the 2020 Rules, investors had expressed concerns about the rule’s impact on the cost, timeliness and transparency of the voting process. In rescinding the Information Availability Rule, the SEC concluded that, upon reevaluation, the benefits of the rule did not outweigh the costs. [11] While the 2022 Final Rule removes portions of Rule 14a-2(b)(9), some parts of the rule, including the conflicts of interest disclosure requirements promulgated in the 2020 Rules, remain in place. [12]

In connection with the adoption of the Information Availability Rule, the SEC had also released supplemental guidance to investment advisors about their proxy voting obligations (the “2020 Supplemental Guidance”). [13] The 2020 Supplemental Guidance was issued in part to address so-called “robo-voting,” or situations where advisers use a PVAB’s electronic vote management system, as well as client consent concerns related to the use of automated voting services. In an effort to limit such automated voting, the 2020 Supplemental Guidance recommended that an investment adviser consider disclosing (1) the extent of, and circumstances under which, it uses automated voting; and (2) how its policies and procedures address the use of automated voting in cases where it becomes aware before the submission deadline for proxies that an issuer intends to file or has filed additional soliciting materials regarding a matter to be voted upon. [14] The 2022 Final Rule rescinds the 2020 Supplemental Guidance in connection with the removal of the Information Availability Rule. [15]

Amendments to Rule 14A-9

The 2020 Rules added Note (e) to Rule 14a-9, which provided that the failure to disclose material information regarding proxy voting advice, such as a PVAB’s methodology, sources of information, or conflicts of interest, may, depending on the particular facts and circumstances, be misleading within the meaning of the rule. [16] Originally intended to clarify the application of Rule 14a-9 to proxy voting advice, the SEC concluded in the Adopting Release that they now believe Note (e) unnecessarily exacerbated legal uncertainty by creating a risk of confusion regarding the application of Rule 14a-9. [17] In the Adopting Release, the SEC provided two reasons why Note (e) could cause confusion. First, Note (e) concerns a particular type of solicitation, in contrast to the other paragraphs of the note that apply to all solicitations, which the SEC now believes could unintentionally suggest that proxy voting advice poses heightened concerns and should be treated differently than other types of solicitations under Rule 14a-9. Second, the SEC now reasons that identifying a PVAB’s methodology, sources of information and conflicts of interest as examples of material information could suggest PVABs have a unique obligation to disclose that information. In the Adopting Release, the SEC further clarified that, although the 2022 Final Rule would remove Note (e), material misstatements of fact in, and omissions of material fact from, proxy voting advice remain subject to liability under Rule 14a-9. [18]

The Adopting Release also reiterated that (1) PVABs are not liable for statements of opinion and (2) proxy voting advice requires subjective determinations and the exercise of professional judgment. [19]



Exemptions from the Proxy Rules for Proxy Voting Advice, SEC Release No. 34-89372 (July 22, 2020) [85 FR 55082 (Sept. 3, 2020)].(go back)


Chair Gary Gensler, Statement on the Application of the Proxy Rules to Proxy Voting Advice (June 1, 2021), available at back)


SEC Division of Corporation Finance, Statement on Compliance with the Commission’s 2019 Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice and Amended Rules 14a-1(1), 14a-2(b), 14a-9 (June 1, 2021), available at back)


See Proxy Voting Advice, Release No. 34-93595 (Nov. 17, 2021) [86 FR 67383 (Nov. 26, 2021)] (the “Proposing Release”).(go back)


Id. at 8.(go back)


Proxy Voting Advice, SEC Release Nos. 34-95266; IA-6068 (July 13, 2022) (“Adopting Release”).(go back)


Chair Gary Gensler, Statement on Adoption of Amendments to the Rules Governing Proxy Voting Advice (July 13, 2021), available at back)


Commissioner Hester Peirce, U-Turn: Comments on Proxy Voting Advice (July 13, 2021), available at back)


Rule 14a-2(b)(9) set forth two non-exclusive safe harbor provisions in paragraphs (iii) and (iv) intended to give assurance to PVABs that they have satisfied the conditions in Rules 14a-2(b)(9)(ii)(A) and (B). Rule 14a-2(b)(9)(iii) provided that a PVAB would be deemed to satisfy the requirement in paragraph (b)(9)(ii)(A) if it had written policies and procedures that were reasonably designed to provide a registrant with a copy of its proxy voting advice, at no charge, no later than the time such advice is disseminated to the proxy voting advice business’s clients. Rule 14a-2(b)(9)(iv) provided that a PVAB would be deemed to satisfy the condition in paragraph (b)(9)(ii)(B) if it had written policies and procedures that were reasonably designed to inform clients who receive proxy voting advice about a particular registrant in the event that such registrant notifies the PVAB that the registrant either intends to file or has filed additional soliciting materials with the SEC pursuant to § 240.14a-6 setting forth the registrant’s views regarding the advice.(go back)


Adopting Release, supra note 1, at 29.(go back)


Id. at 10.(go back)


Id. at 11.(go back)


Supplement to Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Release No. IA-5547 (July 22, 2020) [85 FR 55155 (Sept. 3, 2020)].(go back)


Id. at 6-7.(go back)


Adopting Release, supra note 1, at 41.(go back)


17 CFR 240.14a-9, Note (e).(go back)


Adopting Release, supra note 1, at 44.(go back)


Id. at 51.(go back)


Id. at 8, 54.(go back)
August 9, 2022
As Executive Compensation Booms, Closer Scrutiny Looms
by Miriam Robin

Stop us if you’ve heard this one before, but corporate CEOs made a lot of money last year.

According to a new report from the AFL-CIO, the chief executives of companies in the S&P 500 earned an average of $18.3 million in total compensation in 2021. That figure alone sounds staggering, but now consider that it was 324 times higher than the average employee’s pay and represents an increase of nearly 20% from 2020. Meanwhile, the report noted that U.S. workers effectively took a pay cut last year, as their wage growth of 4.7% lagged the inflation rate of 7.1%.

CEOs aren’t the only people in corporate America cashing in, either. Research from recruiting firm Major, Lindsey & Africa found that attorneys in the role of general counsel or chief legal officer in the U.S. reported an average compensation bump of 15% since 2020. Respondents to a survey conducted by the firm indicated their average total compensation has climbed from around $500,000 in 2020 to nearly $580,000.

Keep in mind that the raises for top executives are taking a bigger cut out of corporate profits now following adjustments to the tax code. Republican-led legislation signed into law in 2017 did away with the deduction for CEO compensation in excess of $1 million. After the first million dollars, companies are taxed at the corporate rate of 21% on the rest of executives’ total pay. A Wall Street Journal analysis determined that “about three dozen companies in the S&P 500 reported paying a combined total of just under $2.1 billion in taxes on nondeductible compensation over the past three years.”

Those kinds of eye-catching pay raises aren’t going to turn down the heat in debates over CEO-compensation issues any time soon. Take those convenient 10b5-1 plans, for instance. Referring to Rule 10b5-1 of the Securities and Exchange Act of 1934, they allow executives to skirt insider trading laws by establishing preset schedules for trading their companies’ stocks in the future.

Securities and Exchange Commission Chair Gary Gensler has left little room for misinterpretation when it comes to his feelings on 10b5-1 plans. With proposed amendments to the guidelines for the plans now on the table, CEO compensation packages getting even more lucrative should only give 10b5-1 reformers more ammunition in favor of stricter guardrails.

There’s also the matter of companies working to ensure that executive pay aligns with their longer-term objectives. To that end, boards of directors at North American companies are coming under scrutiny for how they’ve incorporated – or haven’t incorporated – performance on environmental, social and governance matters into compensation packages. A study published this month by IR Magazine and Corporate Secretary shows 37% of governance specialists at North American companies reported that ESG matters factor into executive pay at their companies. That significantly trails the rate of 60% among their European counterparts.

Expect those rates to increase among listed companies in the U.S. now that the SEC is installing disclosure rules for reporting on ESG issues. But will incorporating such metrics into compensation calculations take a bite out of those juicy CEO pay packages, or will they line make executives’ pockets even fatter going forward? Stay tuned.

View today's posts

8/9/2022 posts

CLS Blue Sky Blog: How Common Are Negative First-Day IPO Returns?
CLS Blue Sky Blog: Wachtell Lipton Discusses Delaware Approval of Officer Exculpation from Personal Liability in Charters
The Harvard Law School Forum on Corporate Governance: Delaware and Caremark: An Update
The Harvard Law School Forum on Corporate Governance: Emerging Fraud Risks to Consider: ESG
The Harvard Law School Forum on Corporate Governance: Hidden Gems: Do Compensation Disclosures Reveal Performance Expectations?
Delaware Corporate & Commercial Litigation Blog: Chancery Court finds dual class stock amendment fits MFW framework, investor challenge fails
Delaware Corporate & Commercial Litigation Blog: Chancery Finds Implied Agreement for Withdrawal of LLC Member Blog: 2nd Cir. Limits Reach of Dodd-Frank Whistleblower Incentives Blog: SOX 404: 18 Years of Internal Control Assessments
The Harvard Law School Forum on Corporate Governance: SEC Reverses Aspects of Proxy Voting Advice Regulations
Blog: Government Regulations & Compliance News - Intelligize: As Executive Compensation Booms, Closer Scrutiny Looms

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