Tag Archive: Regulation

A Seminal Challenge for the Audit and Compliance Committee

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Michael Peregrine

Federal deregulation efforts are taking place while at the same time we are witnessing heightened expectations of governance accountability. The rapid convergence of these two trends is creating a seminal challenge for the audit and compliance committee of many corporate boards.

At the surface, it is hard to spot any corporate negatives to the administration’s deregulation initiatives. Indeed, boards may well embrace the expectation of relaxed regulations and more limited civil and criminal enforcement activity.

Yet, there is a legitimate concern that executives and line managers who are ordinarily prone to “push the edge of the envelope,” may interpret deregulation as a “green light” to pursue   business strategies that may be legally problematic. This attitude could threaten the authority and influence of the committee’s compliance agenda.

This relaxing of executive attitudes towards legal boundaries would come at the worst possible time, with emerging expectations of fiduciary obligations heading in exactly the opposite direction. Rather than relaxing expectations of compliance program oversight, these trends (reflected in court decisions, regulatory actions, and academic commentary) would hold directors more directly accountable for corporate compliance failures. “Where was the board when all this was going on?”  Now especially, the audit and compliance committee is well advised to be pro-active in asserting its oversight powers.

These converging initiatives are highlighted by several recent developments.

Deregulation Developments

The “Brand Memorandum” from the Department of Justice (DOJ) is the most recent compliance extension of administration-driven deregulation. The specific focus of the Brand Memorandum is to (i) confirm that the DOJ may not use its enforcement authority to effectively convert agency guidance into binding rules; and (ii) prohibit DOJ attorneys from using noncompliance with guidance documents as a basis for proving legal violations in civil enforcement actions, including but not limited to actions brought under the False Claims Act.

Examples of such guidance include documents such as preamble commentary, manuals, bulletins, fraud alerts, policy guidance, advisory opinions, and national and local coverage determinations. Often times, such guidance is woven into corporate compliance programs and risk guidelines, as may be relevant to a particular industry sector.

The Brand Memorandum provides defendants with a valuable tool in defending FCA actions—whether brought by the DOJ or relator’s counsel—that attempt to use alleged noncompliance with agency sub-regulatory guidance as support for a False Claims Act theory. It does not, however, suggest any relaxation of existing DOJ enforcement practices.

The pending release of long-anticipated revisions to the controversial Yates Memorandum would likely add to the audit and compliance committee’s burden. According to Deputy Attorney General Rod Rosenstein, the changes to Yates will be “modest,” and are intended to address possible ambiguities and potentially inconsistent applications of policy.

The main idea of the Yates Memorandum, holding individuals accountable for corporate wrongdoing where appropriate, is expected to be kept in place. But the corporate compliance concern is the potential for organizational misperceptions that because of the Brand Memorandum, “Yates has been repealed,” and that individual accountability is no longer a focus of government enforcement policies.

Board Accountability Developments

The Delaware Supreme Court requires a very high burden of proof to sustain a claim for breach of the director’s Caremark compliance program oversight duty. However, leading governance observers acknowledge the potential that, given harsh fact patterns (e.g., material harm to consumers or shareholders), courts may less strictly apply the Caremark standard in the future. A recent decision of the Federal District Court in Northern California, involving a derivative action against the officers and directors of a financial services firm for breach of fiduciary duty, lends credence to this concern.

There, the court denied a motion to dismiss filed by the defendant officers and directors. The court was sufficiently persuaded by the totality of red flags of which the board was allegedly aware, and the fact that many of them were presented in the form of direct communications and reports to the board. The court also appeared persuaded by the fact that many of the defendant officers and directors also served on committees with direct oversight over the alleged conduct that was the source of the losses cited in the complaint. Thus, the case continues.

The Federal Reserve Bank’s February enforcement action against Wells Fargo & Co., with its concurrent impact on officers and directors, is the most recent indication that regulatory agencies may be willing to hold directors personally accountable for serious corporate compliance and conduct failures occurring during the period of their board service. The Fed clearly sought to hold governance responsible for the weakness of the company’s risk management and legal compliance programs. It is conceivable that this enforcement action may serve as a model for other regulatory agencies confronting issues associated with corporate compliance breakdowns.

More generally notable are efforts such as the New York City Comptroller’s Boardroom Accountability Project 2.0, which is intended to improve the quality of boards of directors.

A Possible Approach

Boards may need to take proactive steps in order to counter the consequences of the convergence of deregulation and accountability. It may be important to send a clear message throughout the organization that corporate policies on legal compliance, corporate conduct, and legal risk evaluation of business initiatives will not change—and may even be strengthened.  This action would build upon the elements of director accountability increasingly identified by courts and regulatory entities; i.e., that compliance committees should be particularly engaged in monitoring the legal risks of business strategies.

The committee may thus choose to increase its focus on, among other steps, ensuring that (i) the business strategies approved by the board are consistent with the risk management capabilities of the company; (ii) the company’s risk management and legal compliance programs are sufficiently robust to prevent improper behavior; (iii) the board has sufficient information to carry out its responsibilities; (iv) robust inquiry and demand for further information is made about serious compliance issues that come to the board’s attention; and (iv) corporate culture recognizes the importance of adherence to internal policies, and awareness of regulatory agency guidance documents.

Michael W. Peregrine, a partner at the law firm of McDermott Will & Emery, advises corporations, officers, and directors on matters relating to corporate governance, fiduciary duties, and officer and director liability issues. His views do not necessarily reflect the views of the firm or its clients. Mr. Peregrine thanks his partner, Tony Maida, for his contributions to this post.

Separating Signal from Noise: How Corporate Boards Are Making Sense of the New Administration

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A few weeks into the Trump presidency, it is tempting to obsess about the political rhetoric and soundbites coming out of Washington, DC. While the first month of this new administration is certainly unprecedented in style, method, and message, the real cumulative impact on business remains unclear.

The combination of the chaotic start, the many political appointee vacancies across key departments and agencies, conflicting policy views between a Republican White House and Republican-controlled Congress on key issues, and ongoing investigations makes it challenging for businesses to respond and separate signal from noise.

Nevertheless, a recent pulse survey conducted by the National Association of Corporate Directors (NACD) offers some early insight into how companies and their boards are starting to navigate this new political environment.

Trump Blog Graphs-011. A small majority of respondents (51%) is positive or very positive about the possible impact of the new administration on the growth prospects for their companies in the next 2 years. Almost 29 percent of respondents rated the possible “Trump effect” on business as either negative or very negative.

The differences in outlook are likely influenced by the relative dependence of individual companies on the benefits of international trade, the expected industry benefits of deregulation and infrastructure spending, and perceptions about the impact of a changing US leadership role in the global economy and security architecture.


2. Corporate tax reform, deregulation, and trade protectionism are the most highly ranked “policy” topics that respondents plan to discuss at their next board meeting.
That’s not surprising since the (gradual) effect of policy changes in these three areas can significantly alter cost and revenue Trump Blog Graphs-02projections for business. The big question for many boards and executive teams will be whether the potential
fallout from trade protectionism (actions by the United States and possible retaliation by its trading partners) would offset any gains from a reduced tax and regulatory burden.

Trump’s unorthodox approach of injecting himself in the daily business of individual companies and their decisions seems to concern fewer respondents. Only 13 percent plan to discuss reputational exposure and management at their next board meeting.


3. Fifty-one percent of companies are now reassessing core assumptions about the impact of new and proposed policies on their strategic growth plans,
which is an important exercise when so many key variables are moving or likely to move in the near future (for example, corporate tax rates, inflation, value of the dollar, interest rates, and import/export barriers).

Trump Blog Graphs-03Also, in response to the speed and ferocity with which consumers in this very polarized environment now react to corporate actions, many business leaders are beginning to proactively communicate the authenticity of their brand and their company’s contributions to society. More than 44 percent of respondents report that their companies are now reaffirming their core values and commitments to key stakeholder groups.

4. Only 25 percent of respondents decided to introduce scenario planning exercises to adapt to changes in the operating environment. Of that group, 85 percent are considering discontinuous scenarios based on major swings in key economic indicators, while 76 percent are scenario planning different outcomes from the planned overhaul of the US corporate tax system. Other macro-issues, for which boards will use scenario-planning in the coming months, include the possible repeal of the Affordable Care Act, the commercial fallout of trade protectionism, and the impact of significant geopolitical crises.

If used effectively, these scenario exercises can help open the minds of decision-makers—corporate directors included—to different signals, and prepare for surprises that directly affect the business strategy. Leading companies actively monitor for such signposts that would trigger course corrections in their strategic pathway.

To help corporate directors sense and respond to changes in this operating environment, NACD continuously assesses and interprets the impact of emerging issues. Every week we post our most recent analyses in our Emerging Issues Resource Center. Stories are accessible to all members.

Proxy Season 2017: More Pressure on Social Issues, Focus on Value

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This is the first in a series of blogs that will help your board prepare for Proxy Season 2017.

Proxy Season 2017 will give voice to the usual variety of governance issues we cover in our resource center on preparation for proxy season, but this year shareholder resolutions are highly likely to take a turn towards social issues.

Figure1Proxy

Click to enlarge Figure 1 in a new window.

With an expected regulatory downshift under the incoming Trump Administration, standard-setting for business conduct may move from the government to the corporate sector, with shareholders and socially conscious directors driving the trend in myriad areas, from industry-specific concerns such as animal welfare to broader issues such as climate change. To be sure, we will continue to see proxy resolutions in the dozen general categories that have become hallmarks for activists, but the rise in attention to social issues by activists seems inevitable (See Figure 1).

Dialogue

Corporate leaders and major shareholders alike are recognizing the role that social issues can  play in corporate value. In 2016, corporate leaders and prominent investors issued “Commonsense Principles of Corporate Governance,” a collaborative document containing a key message: “Our future depends on…companies being managed effectively for long-term prosperity, which is why the governance of American companies is so important to every American.” Among their recommendations was the suggestion that boards pay attention to “material corporate responsibility matters” and “shareholder proposals and key shareholder concerns.”

As revealed in the NACD Resource Center on Board-Shareholder Engagement, proxy resolutions can play a role in raising board awareness of key issues. Although shareholder resolutions rarely win by a majority, and even then are only “precatory” (non-mandatory), they do raise boards’ awareness of issues and can spark change over time. Many of today’s governance practices began as failing proxy resolutions but ended up as majority practices, with or without proxy votes.

Take for example proxy bylaw amendments, which have only been fair game for proxy votes since spring 2012 (thanks to a new rule that removed director nominations from the list of topics disallowed for shareholder resolutions). That season saw only three proxy access resolutions at the largest 250 companies, and only one got a majority vote. Fast forward to spring 2016 when 28 companies had such votes, and nearly half succeeded in getting a majority vote. By December 2016, proxy access had been adopted by a majority of Fortune 500 companies, as Sidley Austin reports. Those early proxy access resolutions lost their early battles, but in the end, they won the larger war. The same could happen over time to social resolutions over the next four years.

Directors Want More Dialogue on Social Issues

Interestingly, directors seem to be intuiting that they will need to step up on social issues this year. The 2016-2017 NACD Public Company Governance Survey, which features responses from 631 directors surveyed in 2016, reveals a significant finding in this regard.  When asked to judge the ideal amount of time to be spent on various boardroom topics, directors ranked five topics as highest in terms of needing more discussion time:

  • director education;
  • executive leadership;
  • cybersecurity;
  • director succession; and
  • corporate social responsibility.

One in three respondents said they would like more time devoted to discussing the “social responsibility” topic. For all issues other than these five, fewer than a third of respondents said that the topics merited more board attention. While this is a relatively new question, NACD has asked similar questions in the past, and this is the first time our respondents have ever ranked social issues so highly as a “need to know” topic. 

A Gravitational Pull to Social Issues With a Strategic Slant

So what lies ahead for the next proxy season in the social domain? Aristotle is attributed with coining the phrase  “nature abhors a vacuum,” a theorem in physics aptly applied to the likely vacuum in new corporate rule-making in 2017. USA-first trade rules aside, we believe that shareholder activists may try to fill the break in Dodd-Frank rule making with their own social agendas.

As we go to press, attorney Scott Pruitt is slated to head his institutional nemesis, the Environmental Protection Agency, while Governor Rick Perry, former leader of oil-rich Texas, is in line to direct the Department of Energy. Neither man is likely to crack down on carbon-based fuels, so if shareholders want carbon reduction, they will need to redouble their own efforts—and indeed that seems to be the plan.

According to the environmental group Ceres, quoted in an overview by Alliance Advisors, LLC, U.S. public companies will face some 200 resolutions on climate change in 2017, up from a total 174 such resolutions during 2016. This prediction may be conservative. According to Proxy Monitor, in 2016 the 250 largest companies alone saw 58 environmental proposals—meaning that nearly one out of every four large companies faced one.

In other developments, As You Sow, a community of socially engaged investors, has already announced 46 of its own proxy resolutions, including three on executive pay. All the rest are on social issues, including climate change (11), coal (10), consumer packaging (5), and smaller numbers of resolutions in a variety of other social issues, including antibiotics and factory farms, genetically modified organisms, greenhouse gas, hydraulic fracturing, methane, nanomaterials, and pharmaceutical waste. The gist of many of these resolutions is to ask for more disclosure, including more information on the impact of current trends on the company’s strategy and reputation. For example, the “climate change” resolution in the Exxon Mobile proxy statement asks Exxon to issue a report “summarizing strategic options or scenarios for aligning its business operations with a low carbon economy.”

Similarly, the Interfaith Center on Corporate Responsibility has already announced the filing of five shareholder resolutions for the 2017 proxy of its longtime target Tyson Foods on a variety of issues, including one on the strategic implications of plant-based eating. Sponsored by Green Century Capital Management, the resolution seeks to learn what steps the company will take to address “risks to the business” from the “increased prevalence of plant-based eating.”

In the same vein, at Post Holdings, which holds its shareholder meeting January 28, a shareholder resolution from Calvert Investment Management asks for disclosure of “major potential risks and impacts, including those regarding brand reputation, customer relations, infrastructure and equipment, animal well-being, and regulatory compliance.” Note that animal welfare is only one factor here; Calvert is making a business case for the social change.

Visit our Preparation for Proxy Season Board Resource Center for more publications to equip your board for the season ahead.