Global Crises & Board Directors

How should corporate directors perform their fiduciary duties in the face of the numerous global crises currently assailing the operations of their corporations?

Dean Bhaskar Chakravorti of Tuft’s Fletcher School of International Affairs suggested the appropriate mind-set for corporate boards given always-arising crises (currently in climate, democracy, supply chains, wars, pandemics, inflation). His remarks were made during this morning’s program presented by the New England Chapter of National Association of Corporate Directors.

Directors serve companies the operations of which are impacted by all global crises, which interact in turn with pre-existing confusion emanating from the pandemic and prior US political divisiveness. Determining proper board response is complex as the interactions are complex, but the Dean recommended board focus on what he described as “contextual intelligence.”

That phrase means staying continually abreast of the non-business news as well as the business issues, determining specifically how that news will affect the company in real time, and recognizing also that crises today affect every facet of life and thus every company.

Directors typically have been trained to be expert in some important element of corporate governance or company operations.  How do they process the current world in light of its diversity of problems and impacts? A conscious effort must be made to evaluate the entire business landscape holistically, integrating prior knowledge with current global realities. In some ways, this invitation to make sure that directors openly engage in overviews echoes the solution presented a few years ago when, in evaluating enterprise risk, it was urged that corporate committees be established to capture input from a wide variety of corporate operations and groups (“silos”), to be sure that they were mixed together and evaluated as a whole.

While not possible in a blog format to capture ninety minutes of intense content, three examples were explored meaningfully:

Supply chains were upended by the pandemic and lately by government policies.  Just in time inventory that had been sourced world-wide has been replaced by stockpiling and recognition of needs for multiple sources. But those solutions can add expense and in the end, says the Dean, “the market always wins” as cost efficiency is paramount.  So change will be constant, responding back and forth to world events. Possible options for adopting supply chains quickly will arise as technology creates more and more data and suggests new solutions.

Boards should not follow the path which attracts capital markets, which are a poor indicator.  Capital markets seek the next new thing, invest because others are investing and trying to stay ahead of identifying future profit.

Finally, the dean emphasized the need for directors with broad management experience as being the people best trained historically to holistically evaluate and deal with crisis environments. These are people trained to “connect the dots.”  Directors without this experience have been  trained in narrow key specialties by academic institutions which have organized information in verticals to train specialists, not directors.  It almost sounded like a plea for eliminating term limits and favoring boards weighted towards graying heads and former CEOs.


SEC: Controlling How You Fire Staff?

I am not making this up.

When you fire someone you should obtain a Severance Agreement in exchange for granting severance pay or other considerations not otherwise mandated. Standard language in such agreements seeks to assure the employer, providing separation benefits, that the recipient has not filed claims against the employer with a government agency.

The SEC has a robust business in receiving information concerning corporate malfeasance and actually paying money to the person providing such information as the SEC finds actionable within its area (and anything significantly wrong and not disclosed where company shares are held publicly is likely a violation of SEC disclosure regulations).  And who is a better source of information of wrongdoing as an employee whose sense of company loyalty evaporates while being fired?

Language in separation agreements for public companies (and per one SEC regional director, also private companies) needs to be reconsidered in light of the SEC position.  Surely there is value to an employer to learn that a fired (or departing) employee has not filed a claim with a government agency, but: what if other agencies take the same  (SEC)  position; and today, if the separation agreement expressly must state “You need not tell me if you have filed a complaint with the SEC that may result in your receiving money as a whistleblower”– sort of feels like a hint or an invitation, doesn’t it.

Those of us who follow the SEC must confess that the whistleblower program has uncovered very very many illegal practices, to the material benefit of the integrity of the securities markets and the honest conduct of our country’s businesses.  Don’t assume that either the whistleblower program, or the SEC’s position on severance contracts, is going to disappear.

I need here to reiterate that whatever appears in my blog posts are my views, not necessarily the view of my law firm, and are NOT legal advice.  Talk to your lawyer.

SEC re Asset Backed Securities

The SEC just issued a Rule prohibiting entities, which package and sell to the public asset-backed securities (ABSs), from taking market actions which would profit from a decline in value of those very same ABSs.  It is a usual practice to take certain classes of assets (home mortgages, credit card receivables, student loan obligations are typical), and bundle them together and sell the bundle to investors.

The evil to be prevented is for those entities who underwrite, sell or sponsor the creation of these bundles to take securities positions that will profit if the value of the bundle decreases (e.g. a short position).  The perceived conflict is that these parties are selling to the public a bundle the value of which they themselves believe will prove to be less valuable than the sale price from which they profited  upon issuance.

There are some technical exceptions; shorts are permitted if driven by general changes in interest rates or in currency values, and for certain investors who were holders of the security from the onset.

Those who accuse the SEC of being overly aggressive will smile upon learning that this marketplace limitation took a dozen years to promulgate, following a Congressional directive following market abuses in the 2008 financial melt-down.  It is notable that, on this new Rule, one of the two Republican SEC commissioners voted in favor, a rare instance of inter-party agreement on any matter of securities market regulation.

GAI–Hinton is Scared!?!

Who is Hinton?  The godfather of AI, winner of the Turing Prize, left Google earlier this year due to the potential “existential threat” that AI presents to the human species.  Single most quoted expert on GAI in the world, period.   Not a guy who has been educated by sci-fi movies.  He is not blindly following Skynet here….

Why is Hinton scared?  According to the ten-page New Yorker interview (November 20, 2023 issue): unlike human brains, which die when the carcass dies, digital intelligence can be used on many other computers simultaneously and forever. Thousands of neural networks “can learn ten thousand different things at the same time, then share what they’ve learned.”  As digital learning combines immortality and infinite replicability, “we should be concerned about digital intelligence taking over from biological intelligence.”

Hinton thinks machines do “think” like people.  Like people, computers work by analogy with a sprinkling of reason on top. In the next decade AI will overcome its current difficulties with “physical intuition,” which is part of animals but not wholly a matter of  intelligence (example: a cat with limited intelligence can still jump on a series of pieces of furniture and a machine cannot cause that happen–yet.)  Then AI’s skill set will be complete.

Hinton fears that the human drive for control will cause a dictator to deploy an autonomous lethal weapon.  And worse yet, since machines that are human-like will themselves crave more control by following neural paths similar to humans, “…how do you prevent them [computers]  from ever wanting to take control?  And nobody knows the answer.”

Lots of people with lots of technical skill are out in the marketplace, running the race to get their country or their company to a point of technical superiority.  Along comes “THE” expert in all of this, and he sounds like a screen-writer for James Cameron.

Let’s talk movies:

When John Badham  filmed War Games (incredibly, 40 years ago), the WHOPPER computer, which had started the ultimate world war just because it could, at the last minute stepped back and started a game of tic-tac-toe, observing that the only way to win the thermo-nuclear war game was “not to play.”  When Cameron did Terminator, his autonomous weapons system did not stop.  When Kubrick filmed Dr. Strangelove, the Russian autonomous weapons system did not stop.  Hinton is telling us that Badham wrote a fairy tale in War Games–that real GAI would not stop.

Yes, I “researched” this blog post in New Yorker magazine and in sci-fi movies.  But that is not what the godfather of GAI did–is it?



GAI Faces the Music

No, this is not a post about Sam Altman being ousted by Open AI (even though at this very moment the final outcome is unclear).  This post is about how another AI company was sued by music publishers, seeking to enjoin the use of copywritten words and music employed by AI to train its LLMs (large-language models).

When asked by users to write a poem in the style of a given writer, the program combined lyrics from songs from two different singing groups; the AI company neither asked permission for use nor gave credit to the artists. Can style plus phrases violate copyright?

These kinds of suits, filed in Federal court, are testing the degree of protection from using all types of intellectual property which is subject to copyright protection.  The LLMs plug in parts of protected works, and are following programming orders to use the information they absorbed from billions of scanned data points. [The AI company involved in this particular litigation had installed protections against certain  data use (no medical or legal advice, no support of illegal activities), but no guardrails re use of music to compose.]

As AI absorbs words, ideas and images from huge data bases, using those pieces to create new “works” from parts contained in the “original,” how close must a “copy” be in order to offend legal protections?   Does it matter that there is no specific intent to steal, since the product is created by a programmed device which pools everything? What sort of swimming lanes will courts or the Copyright Office mandate?  Is copying a “style” prohibited?  How to deal with “mash-ups” where fragments from different works are combined, yet fan-identifiable by viewers, readers or listeners?

When the U.S. Copyright Office asked for comments on what sort of  AI guard-rails should be imposed, it received 10,000 responses.  I wonder if the government is using artificial intelligence to digest all that data?  I wonder if those artificial intelligence programs will skew the comments in acts of self-protection?

Posted in AI

Why Class Actions Fail

The business press is always carrying stories about suits brought against companies because the company: made a public misstatement that affected the price of its publicly traded shares; the statement was later proven incorrect; and then the stock price fell and the purchaser of shares at the higher price suffered economic harm.  Such cases typically are brought as a “class action;” one or a few injured shareholders make a claim for themselves and for all other persons similarly harmed by the same facts.  Some law firms make their living by bringing such shareholder class actions.

When such suits are not settled and are looked at by the courts, many are thrown out.  The reason often is that the misstatements are not willful.  Generally speaking, to sustain such a suit it must be proven that a misstatement is untrue, is material, and was uttered with what is known in the law as “scienter,” an intent to defraud.  There are many cases where investors lose money based on relying on a statement about, say, a new product, wherein the statement proves false, loss is incurred, but the plaintiffs do not allege or cannot prove scienter.  A recent Massachusetts case against a company called Desktop Metal, Inc. was dismissed in part because there was no claim made that the statements about product quality and FDA compliance were uttered intentionally in order to defraud.

What if the company was just shooting from the hip by announcing that its new product was innovative and superior?  What if the announcement was believed by the company, but the company failed to investigate the marketplace and thus was negligent in its remarks? Scienter is absent, but the company did not do the right thing, and the investors did lose money through no fault of their own, in reliance on the company’s very own words.

The question of whether negligence, or gross negligence, can replace actual intent (scienter) has been much litigated and the details are beyond the scope of this blog, but at the risk of being simplistic let me tell you the answer (or at least “an” answer): Federal courts are divided on this issue, some insist on actual intent, while some will consider some severe degree of negligence (sometimes stated without clear definition as “recklessness”) as being the equivalent of scienter and thus justifying recovery for the shareholders.

I offer a take-away for all investors: be careful in relying on company pronouncements leading you to believe that share price will shoot up.  Most public companies do not want to mislead and all fear class actions, but it is possible that the investment community can receive from a company a patently incorrect statement of material fact which, on discovery of inaccuracy, tanks the share price, and not have any liability to injured shareholders.

SEC vs GAI– Say What?

In speeches in July and September, activist SEC Chair Gary Gensler has staked out an alleged case for SEC regulation of the new breed of Artificial Intelligence.  One would not expect to find the SEC delving deeply into AI, other than as part of its normal disclosure regime to make sure that all facts stated are complete and accurate in the offering and trading of securities.  After all, so many other Federal agencies are more closely implicated; witness the recent Executive Order previously reviewed in this space.

And indeed the brief for SEC involvement as stated by Gensler seems rather thin.

Since the data underlying AI can reflect bias, the SEC wants to make sure that potential investors will not be denied access to public markets based on bias in broker-dealer policing.

The SEC sees itself as interested in making sure that anyone’s use of AI does not breach the intellectual property of a third party.  Is that not a disclosure issue covered by current regulation?  And a matter for the courts?

There is a fear that only a few AI providers will achieve AI dominance in providing analytics to investors, causing distortion in the market, a herd effect or causing a recession.  Is this not an anti-trust issue, and how does that differ from the small number of dominant advisory services today?  And what is the alternative if in fact good AI, in everyone’s hands, creates more intelligent investors? Would the SEC ban AI because it is so good at advising?

The SEC already regulates brokers against use of analytics to establish systems that benefit brokers.  Brokers already are required to “know their customer.”  Trading markets should welcome precise analytics. Often accused of being a regulator in search of something to regulate, the SEC seems unhappy at being left at the AI starting gate, as if regulating AI is a race among government agencies.

Posted in AI

BlackRock Reports Gender-Diverse Corporations Perform Better

Yesterday BlackRock, the huge institutional investor, reported that “most gender-balanced companies [over the last 8 or 9 years] outperformed the least diverse companies by 29%, as measured by average return on assets.” Those companies with women in leadership and who take longer maternity leaves lead the pack.

Balanced middle management, by gender, also added to improved performance.

Not only do gender-balanced companies earn more, but female participation resonates in investment fund management (10.5% better over the last 16 years) and in startup success (twice as much return for invested dollar over male founders).

Other take-aways: the key is balance, not female preponderance; female representation deteriorates with seniority (glass ceiling).

One logical conclusion based on data may not be that women are necessarily superior to men in management of existing businesses, but that the advantage comes from balanced gender synergy. We may speculate that this result is driven by application of different viewpoints, life experiences and, perhaps (this is guess) temperament. (I hasten to add that I do not ascribe any such  difference in temperament to biology, as that difference may derive from life experiences.)

One is tempted to generalize this study as likely applicable to the discussion in the immediately prior post, discussing corporate efforts to eradicate corporate systemic racism to improve performance.  Such a generalization is appealing but as far as I know is not data-supported, and the BlackRock report does not so speculate.

Finally, since we are free to suggest and speculate, it may be possible that the superior performance of female money managers and corporate founders may derive from women being put through a more rigorous vetting before they attract capital, eg a reflection of suspicion of female ability; such a reason may subject women to a higher standard.  Or maybe, they are simply more skilled after all……


Systemic Racism Backlash: Board Response

In the face of growing backlash against DEI efforts in general and questions about the value of corporate positioning to root out alleged systemic racism, yesterday the New England Chapter of National Association of Corporate Directors presented a program on how Boards of Directors can best continue the fight against racial bias.

It should be pointed out that the positioning of the program was an assumption that systemic racism is present in corporate America, and that Boards needed to sharpen their attack notwithstanding that current events seem to attack that assumption: there is perceived to be a growing resistance to “woke” thinking, a belief that instituting racial preferences in hiring and promotion by definition disadvantage non-minority populations, and a presumed impact of the recent Supreme Court decision striking down previous use of equality metrics as practiced by colleges and universities.  As to the last point, everyone agreed that such thinking will in fact invade the corporate board room.

Harvard Professor Robert Livingston set the stage by identifying the perceived problem and the rationales available to decide to fight against racism in the corporate setting: it is morally correct, it is good for business as diversity improves outcomes, it is important in hiring and retaining employees. It was noted that while individual polls that favor anti-racism efforts are premised often on the moral case, 80% of Fortune 500 companies explain their programs based on the business case.  Unanswered was an explicit examination of the reason that large corporations adopt a business rationale; one expects that such an approach insulates against shareholder resistance where maximizing profit is important and some shareholders think that the cure of preference is worse than the problem itself. It does seem clear that corporate America remains generally aligned in the camp that systemic racism in business exists and is a bad thing; thus, the issue really is, how best to implement its eradication.

With that premise as grounding, the most interesting argument for how best to execute involves the recognition that hiring from the best schools or hiring people with the best grades, rigorously applied, tends to perpetuate racial bias.  It was suggested the companies must recognize that students without the educational and economic advantages of majority populations will not get into better schools and will not test higher and will thus look to be less attractive hires or promotion candidates.    It is, therefore, best to identify a band of favorable candidates, taking into account all factors including the challenges faced and overcome by those from less advantaged backgrounds, and then apply conscious decision to hire widely but only within that expanded “band” of candidates.

Other key take-aways: it is essential for the board to consider willingness of CEOs to undertake this effort, and essential for the board to “have the CEO’s back” in support; perhaps, make racial equity part of the corporate mission.  Companies without strong CEO buy-in fail in the fight against racism within. CEOs and leadership teams need to understand that the effort is “not about you” and your own initial views, but rather in furtherance of corporate goals. This thinking needs to exist also in the Nominating and Governance Committee, which screens board members who ultimately hire the CEO and set corporate tone.

Companies also need to be aware also in dealing with supplier cohorts and business partners–are they in the fight?  And when professional teams pitch a corporation for services, diversity in the pitch team should be considered.

Finally, the panel noted that today there is some growing societal resistance to the effort to fight systemic racism, and also a cadre of companies which adopt a stand against racism but fail to execute on the ground.


Aside from the moral perspective, do diverse teams result in better corporate performance?  This morning, as I write the above post, I note in one of my legal information services a report claiming improved corporate business performance in cases of at least gender diversity; post will follow if you are interested.

Update: Federal Regulation of AI

On October 30, the US Administration issued a 54 page detailed Executive Order setting forth a regulatory scheme to control the development, use, safety and accuracy of AI.  This Order fulfills the promise contained in the July Administration release assuring the public that the leading US AI companies had agreed to cooperate and lead in such an effort.

The new order is so detailed that it does not lend itself to summary in a blog post; and no doubt there will be dense press and other coverage of its details.  The over-all takeaways are these:

The Order reads like legislation.  It is 54 pages long with four pages of definitions.  It charges agencies of the Federal government to take affirmative action within specific time lines (often within  90 to 270 days) to assure the following: wide use of databases so that AI is less likely to be biased; establishment of incentives for small and emerging companies to focus on and be funded for focus on AI; protection of US security, infrastructure and personal information; specific focus on child protection; streamlining of patent standards and criteria for admission to the US of AI experts to drive innovation aiming at US primacy world-wide in AI development. Sections require protection of US workers, measuring  negative impact on the workforce and training to obtain new job opportunities.   Specific requirements are placed on specific US government individuals and agencies: cabinet heads of departments and others below cabinet rank.

A White House AI Council is established to monitor all of the above, consisting of 12 cabinet officers, the US Attorney General, and directors of key government agencies (NSF, OMB, etc.)

From a VC standpoint, there will no doubt be a plethora of companies seeking and obtaining government support in the race to develop and make safe the AI used by the government and by the economy generally.  VCs will need to obtain sophisticated expertise in AI to sort through the contenders when making their “bets.”

From an overall viewpoint, moving away from the details, here are some things to watch:

This is a piece of legislation in the form of an executive order, granular and detailed and calling for long-term government action and funding.  I believe it is structured in a way intended to move forward without Congressional review or approval.  I never express legal opinions in these posts and I particularly offer no view as to whether this Order exceeds Presidential authority.  Nor do I speculate as to the success of any challenge mounted to its provisions, although frankly I expect that the Order covers so much that there will be such challenges, particularly with respect to expenditures.

Moving from speculation into quicksand, I wonder how the Republican leadership will react.  There is indeed much in the Order declaring a desire to make US business the world leader in AI, but there are many other elements that one might suspect do not fit squarely into current Republican leadership thinking: coordination with international standards; scope of protection of labor; focus on making sure that the AI landscape is sensitive to gender rights, DEI and civil rights generally.  One branch of Republican thinking, in my personal opinion, tends to be adverse to strong activity by the Federal government in such matters.

And indeed and generally, this Order is a “big government initiative.”  Persons adverse to strong governance of markets and favoring the shrinking of government and leaving things to corporate America will find much to make them nervous about the completeness of the program set forth in the Order.  While it is unthinkable to have State-by-State regulation of AI, putting the Federal alternative on paper, as is done by the Order, does present a blueprint for huge Federal action and indeed regulation of myriad aspects of investment, business, labor and social policy.

I am quite sure that my law firm, Duane Morris, will be posting alerts from time to time about various aspects of government action driven by this Order.  May I invite you to go onto our firm website to receive these updates?  We have a robust practice group in AI, designed to keep our clients and friends updated on significant developments in law and regulation.

(To repeat the obvious and for avoidance of doubt, the legal and political views and content of my posts are personal and do not reflect the views of Duane Morris, LLP.)


Posted in AI