Corporate Governance

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There are a number of legislative proposals making their way through the House and the Senate that would affect public reporting companies and are gathering some momentum, so they bear watching.  Here are a few highlights:

  • Diversity Disclosure Requirements:  H.R. 970, which has been reintroduced in the House of Representatives, titled the “Improving Corporate Governance Through Diversity Act,” would amend Section 13 of the Exchange Act in order to require each issuer that is required to file an annual report to disclose data on the racial, ethnic and gender composition of the board of directors and the C-level executives of the issuer.  C-level executives would include the most senior executive officer, information officer, technology officer, financial officer, compliance officer, or security officer of the issuer.
  • Rule 10b5-1 Plans:  We have previously blogged about this one, which has been in the news recently.  House Financial Services Committee Chair Waters and Congressman McHenry reintroduced legislation, “The Promoting Transparent Standards for Corporate Insiders,” H.R. 624, which would require the SEC to review Rule 10b5-1 and to study gaps in coverage, consider whether to limit trading to issuer-adopted trading windows, curb the use of multiple trading plans, mandate a delay between adoption of a plan and the first trade pursuant to the plan, restrict an insider’s ability to modify or cancel a plan, require companies and insiders to make certain filings with the SEC, and mandate that boards adopt policies to monitor compliance with trading plans. The SEC would be required to issue a report on its study one year following enactment of the measure and promptly undertake necessary rulemaking.  The Council of Institutional Investors has written to Waters and McHenry supporting H.R. 624.
  • Stock Buyback Bill(s)?  Senator Sanders has indicated he plans to introduce legislation that would limit stock buybacks unless companies provide more extensive benefits to workers, such as an increased minimum wage and paid sick leave as well as satisfy certain pay ratios.  The text of the legislation would appear to track bills introduced in prior sessions of Congress (see, for example, S. 3640 introduced in November 2018 in the Senate and a companion bill, H.R. 7145, introduced in the House also in November 2018) although it has not been made available.  There was a recent op-ed piece in The New York Times, co-authored by Senators Schumer and Sanders (see: https://www.nytimes.com/2019/02/03/opinion/chuck-schumer-bernie-sanders.html) relating to their views.  In the meantime, Senator Rubio has outlined plans on share buybacks as part of a more comprehensive paper published by the US Senate Committee on Small Business and Entrepreneurship.
  • Corporate Political Disclosures:  Representative Carbajal has introduced legislation, titled the Corporate Political Disclosure Act 2019 (H.R. 1053), which would mandate disclosure of a company’s political activities during the prior year in its annual report and on its Internet website, which must be accessible to shareholders and to the public.

On February 6, 2019, the staff of the US Securities and Exchange Commission issued two identical Regulation S-K compliance and disclosure interpretations (C&DIs), which address the extent to which a director’s self-identified diversity characteristics need to be disclosed as director background or in connection with the discussion of a company’s policy with regard to the consideration of diversity in identifying director nominees. This Legal Update discusses the text of these C&DIs, along with related practical considerations.

To learn more, read our Legal Update.

In a recent paper, “Scaling Up: the Implementation of Corporate Governance in Pre-IPO Companies,” authors David F. Larcker and Brian Tayan review governance practices and how these evolve in the lead-up to an IPO. The authors studies 47 companies that completed IPOs from 2010 to 2018. On average, the companies in the sample set were nine years old at the time of their IPO. Though the authors note that there was great variability among the sample set in terms of the governance systems that were in place at the time of their IPOs, they were able to observe a number of common milestones. Almost all of the companies said they became focused on corporate governance in connection with planning for an IPO and that process, on average, began three years prior to the IPO. Also, generally at that time, the companies recruited their first independent directors. On average, prior to the IPO, companies added three independent directors. Approximately 77% of the sample set had a staggered board at the time of IPO. In approximately 53% of the surveyed companies, the founder served as the CEO at the time of the IPO. Those companies that brought in a non-founder CEO prior to the IPO did so in order to address some perceived managerial or commercial problem. The CFO who took the company public was on average hired three years prior to the IPO. Given the growth in the number of unicorns and the increasingly dispersed ownership of pre-IPO companies, it is surprising that governance practices have not changed much for these companies and that pre-IPO institutional holders do not press for more significant governance changes. The full paper can be accessed here: https://www.gsb.stanford.edu/faculty-research/publications/scaling-implementation-corporate-governance-pre-ipo-companies

In September, California mandated women directors on corporate boards.  In a new paper titled “Mandating Women on Boards: Evidence from the United States,” authors Sunwoo Hwang, Anil Shivdasani, and Elena Simintzi review the effects of mandating the inclusion of women on boards.

The California law requires that public companies headquartered in the state of California have at least one female director by end of 2019.  By year-end 2021, companies with six or more directors must have three female directors, boards with five members must have two female directors, and boards with four or fewer directors, must have at least one female director.  Noncompliance would result in potential fines. There are approximately 450 public companies in the Russell 3000 index headquartered in California with a market cap of nearly $5 trillion.

The authors present evidence that mandating gender diversity through legislation is expensive for shareholders.  This results from heightened costs for female directors, because there is a small supply and public companies will be pressed to comply at the same time resulting in competition.  In addition, the authors find costs will increase as a result of the possibility that companies will expand their boards in part to comply with the requirements.   Although the paper concludes that there is a lack of a consensus on the impact of regulations mandating gender diversity, it raises concerns.

Separate from the paper, commentators have raised concerns regarding the constitutionality of the California law.