Articles / Corporate Governance
“Passive” Investors’ Impact on Corporate Governance
As stated in the brief description in the introduction, while the role and impact of activist investors on corporate governance receives lots of coverage and scrutiny, the role of the passive investor is less well understood. The Investor Responsibility Research Center Institute (IRRCi) published a study in December which looks at this question. The researchers wanted to determine whether so-called “passive investors” play any role in shaping companies’ governance policies. The conclusion: “passive investors play a key role in influencing firms’ governance choices; ownership by passively managed funds is associated with more independent directors, the removal of takeover defenses, and more equal voting rights.”
“The research finds that passively managed mutual funds, and the institutions that offer them, use their large voting blocs to exercise voice and exert influence on firms’ governance.” Moreover, the research revealed that “ownership by passively managed mutual funds is associated with significant governance changes such as more independent directors on corporate boards, removal of takeover defenses and more equal voting rights. These governance changes, in turn, are shown to improve firms’ long-term performance.”
While the study is not an “easy read,” it is worthy of a skim and a deep dive into those sections which discuss the mechanisms by which passive investors influence governance.
 “Passive Investors, Not Passive Owners”, Investor Responsibility Research Center Institute, December 10, 2015
The Corporate Risk Factor Disclosure
As most know, the SEC mandates that companies disclose risk factors affecting the company in their annual filings and in their offering documents and other filings. Additionally, the relevant rules require that the risk factors be described “in plain English” (Form 10-K instructions) and “be concise and organized logically” (Section 503(c) instructions). In other words, the risk disclosures need to be written in such a way that they may be understood and are clear and concise. The rationale of the rules is simple: investors need to understand the risks faced by companies they invest in or are contemplating investing in so that they may make rational and fully informed investment decisions.
Given the criticality of risk to investors’ evaluation of an investment, the question arises: are company risk disclosures achieving the desired result? Do they succeed in informing investors of the risks faced by companies sufficient to make an informed investment decision? The Investor Responsibility Research Center Institute (IRRCi) set out to answer these questions in a study published last week.
In its study, IRRCi reviewed the risk disclosures of “50 large companies, including the five largest publicly traded companies in ten different industries with an aggregate market capitalization of approximately $8 trillion.” The results, as described by Jon Lukmonnic in a press release accompanying the study:
“Instead [of clear, concise, plain English disclosures specifically affecting the company as required by the regulations and rules], we see corporate disclosures that read like a laundry list of generic risks couched in legalese and lacking meaningful specificity. This is not helpful for investors trying to understand corporate risks, and it certainly does not enable investors to distinguish between the relative risk profile of different companies or the relative importance of the risks on the laundry list.”
The Study’s key findings:
- Companies generally are not using specific or effective language to describe their risk factors.
- Disclosures generally are lengthy, and companies with a lower risk profile in particular have opportunities to reduce the extent and number of risk factors disclosed.
- Competition, global market factors and regulatory matters are the most common risks cited by all companies but are often discussed generically.
- When companies use specific language to discuss risk mitigation efforts and/or changes in the nature of the risk, those disclosures tend to be minimal (e.g., a couple of words or a sentence) and are overshadowed by the prevalent use of vague, boilerplate language throughout the risk factor disclosures.
- The disclosures may serve as an indicator of what a broad base of companies view as emerging risks.
- Cybersecurity is one area where companies have responded to recent concerns expressed by investors and policymakers with disclosure that discusses the extent, effects and management of cyber risks.
A free webinar will be held on Tuesday, February 9, 2016, at 12:00 PM ET to review the findings and respond to questions. Those who can take the time and have an interest should register. Here’s a link to the registration page:
“The Corporate Risk Factor Disclosure Landscape,” Investor Responsibility Research Center Institute, January, 2016
Women on Boards
MSCI, a leading provider of research-based indexes and analytics, studied the 1,643 companies that are covered by the MSCI World Index and found that organizations with strong female leadership scored an average 10.1% return on equity from the end of 2009 to September 2015, compared with 7.4% for companies without women at the most senior levels. As the editors of the World Economic Forum’s Agenda put it: “It’s official: women on boards boost business.”
The full study, titled “Global Trends In Gender Diversity On Corporate Boards,” addresses a wide array of gender issues and is a good source of data. Other key findings regarding women on boards:
- Companies lacking board diversity tend to suffer more governance-related controversies than average.
- We did not find strong evidence that having more women in board positions indicate greater risk aversion
The full study “Global Trends In Gender Diversity On Corporate Boards”, MSCI, November, 2015
An excellent summary of the research in The World Economic Forum’sAgenda, December 8, 2015
Director/Attorney Privilege
Generally, communications between directors and their or their company’s lawyers are privileged. However, exceptions do exist and a recent Delaware decision addresses these exceptions. The Delaware Court of Chancery, in TCV VI L.P. v TradingScreen, held that certain communications between a special committee and the board and its lawyers had to be disclosed. Because of the importance of this issue to most directors and their counsel, I’ve described the case and its analysis in greater detail than normal for this newsletter. I hope those who are not directors or attorneys will either forgive me, or just skip to the last paragraph of this case’s description.
The case arose in the context of a dispute involving TradingScreen’s refusal to buy back preferred stock under a mandatory redemption provision in its charter. The board’s decision not to buy back the stock relied, in part, on the advice of its counsel. Thus, as the Court put it: “waiver of the attorney-client privilege—to some disputed extent—became necessary as a tactical matter. At issue, [is] the scope of the company’s waiver and whether the company is obligated to prepare a log identifying and supporting its partial redaction of some 1,900 documents on grounds of attorney-client privilege”
The Court first noted that TradingScreen had voluntarily disclosed certain documents and certain communications with its counsel, hence had voluntarily waived the attorney-client privilege with respect to the communications and documents it had voluntarily disclosed. That voluntarily waiver, however, raised the issue of the scope of the waiver. TradingScreen asserted that it’s waiver was limited to the voluntarily disclosed documents and communications, and no more. Plaintiffs argued a broader waiver.
The Court commenced its analysis by framing the issues presented as follows: “Plaintiffs’ motion presents two principal questions. First, what is the scope of Defendants’ waiver? In other words, what sorts of documents did Defendants—purposefully or otherwise—render discoverable by producing documents containing legal advice? Second, what must Defendants do to preserve the privilege for the unlogged redactions that appear in roughly 1,900 documents?”
Next, the Court reviewed and summarized the applicable legal standards, which bear repeating here:
The attorney-client privilege, as defined in Delaware Rule of Evidence 502, shelters certain communications from discovery on the rationale of “encourag[ing] full and frank communication between clients and their attorneys.” A party can waive this privilege voluntarily or, in certain circumstances, implicitly. One way a party can implicitly waive the attorney-client privilege is through the so-called “at issue” exception, which “exists where either (1) a party injects the privileged communications themselves into the litigation, or (2) a party injects an issue into the litigation, the truthful resolution of which requires an examination of confidential communications.” If either condition is met, the court has discretion to order disclosure of additional documents in the interest of fairness, even if “contrary to the [waiving] party’s actual intent.” The animating purpose of this fairness inquiry is preventing use of “the attorney-client privilege as both a ‘shield’ from discovery and a ‘sword’ in litigation.” Thus, the at issue exception reflects the principle that parties should not be able to use the attorney-client privilege to cherry-pick only the best morsels of evidence from a mixed batch concerning the same subject matter.
Francis Pileggi, in an excellent article describing the case in National Association of Corporate Directors’ Directorship magazine, summarizes the Court’s analysis thusly: “Directors must understand that a court decision that asserts that certain otherwise privileged communications between a board and its lawyers must be disclosed is not the product of a mathematically precise equation. Rather, that decision depends on what the court views as necessary as a matter of fairness.”
The Court also reviewed what parties must do in order to assert privilege. While the details of the requirements are not appropriate for this newsletter, I urge all attorneys practicing in the area to review the decision and its analysis. As the Court noted: “Although Delaware case law clearly establishes the requirements for drafting an adequate privilege log (the primary mechanism by which attorneys claim privilege for wholly-withheld documents), the standards applicable to redaction logs are less well-defined.” The Delaware Court reviewed in length the requirements and harmonized the differences among the reported decisions.
Returning to the directors’ perspective, the case highlights two important principles: 1) communications between directors and their and their company’s lawyers may be disclosed under certain circumstances, and 2) even if documents and correspondence between directors and counsel are privileged, precise details about the documents must be disclosed in privilege logs, hence as a practical matter much will be disclosed even if the privilege exists. As Pileggi concludes in his article: “This should serve as a useful reminder about the need for board members to be judicious in what they include in their communications with their attorneys.”
The complete TCV VI L.P. v TradingScreen opinion
“Director/Attorney Privilege: Communications Are Not Always Confidential,” an article by Francis Pileggi appearing in the National Association of Corporate Directors’ Directorship magazine summarizing the decision and discussing its implications
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