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Governance Roundup

June 9, 2016

This article focuses on leaked emails that lift the curtain on the SEC’s reluctance to pursue financial firms in the wake of the meltdown; how ESG (environmental, social  and corporate governance) investing has gone from niche to mainstream; how BlackRock expresses concern over short-term focus but votes for pay packages that support it; the impact of MetLife’s successful gambit to avoid the “too big to fail” label; progress in the disclosure of gender pay equity; Martin Lipton advising corporate America to engage with big investors on long-term, sustainable value creation; State AGs’ investigating Exxon Mobil on climate change disclosure; and Sen. Elizabeth Warren’s request that the SEC investigate financial firms over the fiduciary standard debate.

Leaked emails reveal SEC reluctance to pursue penalties following the 2008 financial meltdown.1

Former SEC lawyer James Kidney provided internal documents to Pro Publica and The New Yorker showing that the SEC could have pursued tougher penalties for the financial firms involved in the sub-prime collapse:

“This appears to be an unbelievable fraud,”2 he wrote to his boss, Luis Mejia. “I don’t think we should bring it without naming all those we believe to be liable.”

* * *

   Kidney became disillusioned. Upon retiring, in 2014, he gave an impassioned going-away speech, in which he called the SEC “an agency that polices the broken windows on the street level and rarely goes to the penthouse floors.”

American Airlines CEO to serve without a contract.3

“This was done at my request, because it didn’t seem right to me that I should be the only person at American with an employment contract,” Parker said in a letter to employees.

Goldman Sachs says that ESG investing is “Niche no longer.”4

In a Goldman Sachs podcast, John Goldstein, co-founder of Imprint Capital and a managing director of Goldman Sachs Asset Management, explains that “investing for ESG requires the same rigor and discipline as ‘traditional’ investing, and the distinction between the two is growing increasingly irrelevant. With better tools to parse data and an ever-expanding understanding of risk, ESG investing has gone from niche to mainstream.”

China extends investor rights.5

China will give more rights to stakeholders (including shareholders and employees) to challenge abuse by majority holders, give them access to books and records, give them first right of refusal to purchase shares that become available, and give them clearer rights in filing legal challenges.

BlackRock criticized for not putting customers’ money where its mouth is.6

In The New York Times, Gretchen Morgenson pointed out that BlackRock CEO Larry Fink is critical of firms’ short-term focus but fails to object to pay plans that incentivize it:

   But if Mr. Fink really wants to get the attention of company executives on stock buybacks and other corporate governance issues, why doesn’t BlackRock vote more often against C.E.O. pay packages of companies that play the short-term game?

   Executive compensation is inextricably linked to the shareholder-unfriendly actions Mr. Fink has identified; voting against pay packages infected by short-termism would help curb the problem.

   But BlackRock rarely takes such a stance. From July 1, 2014, to last June 30, according to Proxy Insight, a data analysis firm, BlackRock voted to support pay practices at companies 96.2 percent of the time.

On pay issues, anyway, Mr. Fink’s big stick is more like a wet noodle.

Did a judge just invalidate some of Dodd-Frank’s most important protections?

Stephen J. Lubben writes in The New York Times7: “I think we have to ask if a single federal judge didn’t just blow a huge, MetLife-size hole in Dodd-Frank.”  One of the key provisions of the post-financial meltdown reforms was the authority for the government to designate certain financial institutions as “too big to fail,” which would impose specific requirements to ensure soundness.  The theory was parallel to the assessment that would be made by any kind of underwriter, with the idea that if a company was so important to the financial system and the economy it could not be allowed to fail.  The government as its ultimate guarantor could require evidence of stability, with higher capital requirements and increased scrutiny by regulators.

But MetLife challenged its designation under this law, and a federal judge has agreed.  While the judge did not say that the “too big to fail” provision of the law was invalid as a whole, her willingness to overrule the regulators’ determination calls into question the viability of the designation for any firm.  What is particularly frustrating is that the judge is keeping the decision “under seal” (secret), making it difficult to understand the factual basis for her reasoning and the likelihood of a successful appeal.

Reportedly, Prudential and AIG are considering similar challenges.

Shareowner initiatives on pay equity show results. 

Two of the world’s biggest internet companies, Amazon and Expedia, announced their intention to close the gender pay gap following shareowner proposals for pay equity disclosure from Arjuna Capital, the activist arm of Boston investment firm Baldwin Brothers Inc. and a shareowner in many of the country’s biggest tech outfits. 
Amazon said they had essentially achieved that goal already and Expedia said it would be achieved by October of 2016.  Similar Arjuna proposals at Intel and Apple have resulted in better disclosure on pay equity and commitments to improvement.  In February, Intel reported it had reached 100% gender pay parity. Apple said that the female employees were making 99.6 cents to every man’s dollar, excluding bonuses and stock. Of course, that is a very big exclusion, which makes it likely that Arjuna will be back for more.

Martin Lipton advises corporate clients on responding to investor priorities for sustainable growth.

The leading advisor to corporate executives and boards has new advice8 about how to respond to shareowners and get ahead of ISS and activist hedge funds.  His rhetoric may be skewed, but the advice is pretty much what investors (and ISS and activist hedge funds) have been asking corporate executives to do for many years:

   Recognizing that the incentive for long-term investment is broken, leading institutional investors are developing a new paradigm for corporate governance that prioritizes sustainable value over short-termism, integrates long-term corporate strategy with substantive corporate governance9 and requires transparency as to director involvement. We believe that the new paradigm can reduce or even eliminate the outsourcing of corporate governance and portfolio oversight to ISS and activist hedge funds.

Lipton tells executives to focus on long-term sustainable growth, to communicate strategy and board involvement effectively to shareowners, to make clear the connection between incentive compensation and strategic goals, and to engage in “[d]isciplined, direct and periodic two-way dialogue with institutional investors . . . , supported by written communications and tailored presentations. Opening channels of communication in advance of a crisis or activist challenge is extremely important.”

Investigations by California and New York Attorneys General into whether Exxon Mobil deliberately misled investors on climate change.

ValueEdge Advisors Vice-Chair Nell Minow wrote an op-ed published in Pensions & Investments10 asking whether climate change is the new tobacco:

   State attorneys general think so. California Attorney General Kamala D. Harris has joined New York Attorney General Eric Schneiderman in demanding documents from Exxon Mobil Corp. on what the company's executives knew and did with regard to the risks of climate change.  These documents could reveal that, like the tobacco executives, fossil-fuel company CEOs and boards acknowledged internally the damage caused by their products as they used company money to disguise the scientific findings and thwart regulation.

   When corporate managers divert company resources to the detriment of long-term value creation, it is time for shareholders and the government to step in.  That is why demands for documents from Exxon Mobil about any possible funding of climate-change-denial activity is vital to the interests of investors as well as taxpayers, regulators, scientists and everyone affected by climate change.

* * *

   Mr. Schneiderman, like his predecessor Eliot Spitzer in the pioneering investigation of Wall Street analysts, has the advantage of New York's Martin Act, an excellent tool for investigating complex issues of this kind. Within the realm of securities fraud, judges have ruled that it covers “all deceitful practices contrary to the plain rules of common honesty.” Therefore, it has often been used by New York regulators to tackle issues federal authorities have been unable to address.

Proxy access is increasingly being used to promote board-level attention to climate change risk:11

[P]roxy access may be more commonly used as a threat to compel board accountability than as a method of actually nominating directors.

   According to [an article in BNA Accounting Policy and Practice], concerns about climate change and the related financial risks may be “increasingly making their way up to the board level.”  A climate change expert who is also a corporate director argues that “[f]or those people thinking about long-term financial investments, you kind of have no choice but to think about climate change as a factor.”  However, a 2014 survey by PwC of over 800 public company directors regarding their attention to issues of corporate social responsibility, including climate change, showed that, in the preceding 12 months, only 6% spent substantial time discussing climate change, while 56% said that the board never discussed it at all and 22% said that they didn’t discuss it very much.

   In connection with revisions to its voting guidelines, CalPERS’ investment committee recently decided12 to start requiring that the boards of companies in which it invests must include people with expertise in climate change risk management strategies.  According to the head of corporate governance at CalPERS, “we need people on these boards of energy companies who can look forward and be part of that change, not resisting it.”

Elizabeth Warren calls for an investigation into financial firms pushing for changes to the fiduciary standard.  

Senator Warren’s question is similar to those raised by the California and New York Attorneys General regarding climate change.  She says that while they complained to the SEC that the fiduciary standard was too onerous, the financial firms were assuring their investors that they would have no trouble complying with it, and has asked the SEC to investigate.13 The standard at issue is this: when a company is hired to provide independent advice to participants in a retirement plan, should they be allowed to recommend their own products?  The standard Senator Warren supports would require that the interests of the client come before the interests of the company, which is what fiduciary means.

IRRCi publishes a new report on utilities, climate change, and politics:14

   This study examines in depth the current climate orientation of the boards of the 25 largest U.S. investor owned utilities by revenue. It aims to help investors and others evaluate these boards.  It also compares and contrasts the utilities and their boards using a variety of metrics designed by the Sustainable Investments Institute (Si2) with input from investors, governance experts and utility economists.  The resulting body of data can be used by investors who want to assess how the sector is responding to the challenges posed by climate change and a changing regulatory landscape, with an eye to how these changes will affect portfolio companies. It also allows companies to compare their board members’ orientation to peers.  The project consolidates and integrates data derived from studies of company sustainability reporting, corporate political activity and lobbying expenditures and the extent of climate risk disclosure and performance.

1  https://www.propublica.org/article/why-havent-bankers-been-punished-just-read-these-insider-sec-emails
2  https://www.propublica.org/documents/item/2805538-Unbelievable-Fraud.html
3  http://www.reuters.com/article/us-american-airline-ceo-idUSKCN0XQ1PC
4  http://www.goldmansachs.com/our-thinking/podcasts/episodes/04-21-2016-john-goldstein.html
5  http://www.forbes.com/sites/susanfinder/2016/04/22/chinas-highest-court-to-arms-investors-to-go-after-corporate-cheats/#3e1d1bf4107f
6  http://www.nytimes.com/2016/04/17/business/blackrock-wields-its-big-stick-like-a-wet-noodle-on-ceo-pay.html?_r=0
7  http://www.nytimes.com/2016/03/31/business/dealbook/metlife-decision-could-torpedo-dodd-frank-risk-protections.html?_r=1
8  https://corpgov.law.harvard.edu/2016/03/15/succeeding-in-the-new-paradigm-for-corporate-governance/
9  http://www.wlrk.com/docs/PDFPacketSucceedingwiththeNewParadigm.pdf
10  http://www.pionline.com/article/20160331/ONLINE/160329883?cslet=UnhOY2lLTDlMUEdkK2lvK3VyL0dPTzlxb083Z3MyekdNTEE9
11  https://cooleypubco.com/2016/04/22/how-do-activists-get-corporate-boards-to-focus-on-climate-change-issues-talk-softly-and-carry-a-big-stick/
12  http://www.governing.com/topics/finance/gov-climate-change-pension-calpers.html
13  http://www.wsj.com/articles/elizabeth-warren-takes-aim-at-insurance-executives-comments-on-fiduciary-rule-1459416604
14  http://irrcinstitute.org/reports/the-top-25-u-s-electric-utilities-climate-change-corporate-governance-and-politics/

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