The Law and Other Anomalies

It used to be “employee management,” and then “HR;” now with the Great Resignation, the shrinking of the labor force, the reshaping of “work” via pandemic, and the inflation of wages, it is re-named “human capital” and it has become a major business problem, disclosure issue and board of directors focus.

And the subject of a two-hour deep dive by a panel convened this morning by the New England Chapter of the National Association of Corporate Directors, at which BU Professor Charles Tharp coordinated a panel discussion with Independent Director Cynthia Egan, Eastern Bank President Quincy Miller, and Melisa Means of Pearl Meyer’s Boston consultancy.  Below, some important director take-aways:

There is little doubt but that the SEC will propose enhanced disclosure requirements; given the schedule for rule-making, it is likely that change will  become effective in 2023 after debate of drafts in 2022.  Emphasis will be on disclosing demographics, costs (salary and wages being a huge burner of corporate capital), DEI, succession and enterprise risk.

Disclosure also likely will track board work on strategy, now widely ongoing in many companies.  Will disclosure of strategy serve to inform competitors to detriment of the discloser?  The panel thought not, as strategy depends on skill of execution and depth of adherence to that strategy within the culture and ethos of a company; indeed, general disclosure of approaches ought to assist all companies.

Structurally many companies are remaking their organizational approach to human capital, given both the business imperative and the reputational risk of failing to address the growing corporate awareness of the perceived obligations of business to cohorts other than shareholders, e.g. customers and society.  Board Committees are being renamed from “HR” to capture the concept of human capital.  The predicate for success is whether an enterprise philosophically embraces this shift by empowering relevant committees in terms of resources, recognition when fixing corporate strategy, and evaluating entity risk.

How will companies deal with driving equity in the new workplace?  Classic approach is to key executive compensation to success, often effective but much depends on corporate culture and on finding a metric to which management compensation responds.  Some companies use management of human capital as part of a holistic checklist in evaluating and compensating management; larger companies often specifically key part of compensation (particularly bonuses) to demonstration of meeting identified targets.  Of these companies, 10%  weight (of executive comp)  typically has been given, although it was suggested that something like 20% is required to really attract management focus.  On the other hand, since this metric often only affects bonus and not base, it was noted that even at 20% the impact on total executive comp may not be huge.  Further, making progress in pay, sex and racial equity is a slow process, and such metrics should be placed in the longer-term corporate plan (as is done for example by Pru and Starbucks).

How do you measure success, to trigger rewards to management?  One measure is simple headcount of employee population, but that is not alone sufficient. With respect to employee compensation, there are two statistics: the “raw” number (women earn 74 cents to each dollar earned by men) or the “adjusted” number (looking at each department, as they have differing natural pay scales and turnover rates affecting seniority).  Eastern Bank also measures success by measuring employee engagement: charitable engagement, community engagement, turnover, number of calls to the ethics hotline.

Another heads-up for boards: add to the report on risk management an analysis of risk presented by human capital management: defections, inability to hire, shortage of staff, payroll cost increases to be competitive.

Finally there was discussion of dealing with remote workers, who are anticipated to be a constant even when the pandemic is wholly quashed. Seemingly the push for human contact is less powerful than had been assumed, and can be addressed by modest in-office attendance. Can there be equal promotion when people do not come to the office? And, it was noted that remote workers tend to over-work and suffer mental stress.  (I note that there are contrary view in terms of which employee cohort needs the most attention– those who commute have more expense, commuting time and stress, greater child-care an elder-care burdens….)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We all know that over 340 people died on crashed 737s, that Boeing paid the DOJ $2.5 billion dollars for criminal conspiracy due to misrepresentations by employees to the FAA, that the chief pilot was indicted on criminal charges.  Now the Boeing directors have reached a proposed settlement of about $238 million to compensate pension funds which lost investment value in their Boeing holdings. (A court still needs to approve this settlement.)

The directors were accused of gross negligence and, indeed, willful breach of fiduciary duty in ignoring warnings about safety issues in the rush to get to market.  A settlement means directors will not be faced with a trial as to their alleged willful misconduct.

More interesting than the money (if anything can be more interesting than money) is the shopping list of corporate changes to which Boeing is agreeing: instituting missing reporting systems on safety and concerning what is told the FAA, adding a director with aircraft experience so there are more intelligent eyes on the company, establishing an ombudsperson for five years, guaranteeing that at least three directors have engineering or safety experience, splitting the offices of CEO and board chair.

There is no “takeaway” from this settlement relating to willfully ignoring safety concerns –you don’t need courts to inform directors about that — but there is learning here as to the standard of care which directors must bring to supervising companies which face the public and involve physical risks.  The ERM (enterprise risk management) function needs to have robust reporting systems that report to the board; boards cannot say they did not know what they could have known.  The duty to oversee, born in case law but little used for many years, now is front and center as to board governance.

The SEC has just issued guidance requiring public companies to place on the agenda for shareholder meetings matters of general social importance even if they do not create material business impact on the registrant’s business.  This action is in furtherance of the concept that corporations have social responsibility that extends beyond shareholder investment returns.

While argument can be made, cogently, that in the long run investors get no return when the world collapses through global warming or through social protest, that range of thinking is not the typical purview of the SEC.  The new policy in effect reverses Trump regulation; now, the SEC will force onto the agenda “issues with a broad societal impact, such that they transcend the ordinary business of the company.”

It is not surprising that the two minority (Republican) members of the Commission objected to revision of contrary Trump era regulations, claiming that the SEC is erasing the prior SEC work with a “regulatory flavor-of-the-day” approach. That colorful characterization surely misses the point, since the Trump rules were themselves reflective of the Commission’s then-composition, and as SEC Chair Gensler noted in his related statement in support of the change, many members of the current staff “contributed” to the recent promulgation.

The disclosure trend can also be seen as consistent with the 2019 Business Roundtable Statement to the effect that corporations owe responsibilities to societal cohorts beyond the shareholders; this Statement was endorsed by very many companies including a large percentage of major US corporations.  Could the SEC action be seen as proof that one must be careful what one asks for?

In any event, the risk to management of ignoring for too long the strong wishes of shareholders is going to cause management to at last appear to embrace social values by placing such matters on the shareholder agenda and, thus, they will be forced in some manner to address those matters substantively.  Will major institutional shareholders also be forced by their constituents to push these agenda items on the companies in which they own shares?

 

The law is pretty clear today; persons within a public company cannot trade on material inside information, and their tippees cannot either, in virtually all cases. But what about someone who does not fall in one of those categories, who may appear shall we say “less than clean-handed,” but does not seem to owe any duty to, or have any relationship with, the company or its shareholders, nor the counter-party to the trades, nor the original source of the inside information itself.

A person convicted of deceptive trading as a criminal offense has petitioned the US Supreme Court to consider overturning his conviction; his conviction was confirmed by the Second Circuit Court of Appeals based on theories of conspiracy to commit securities fraud, computer intrusions, and securities fraud. The prosecution alleged appellants owed a duty to the trading public when they earned about $18M on their trades, but those trades were through exchanges and without dealing with the counterparties and the information was originally hacked by persons not known to the defendants.

Although the appeal addresses only the securities fraud convictions (seemingly it is clear that defendants re-hacked), the appeal does raise the issue that, by extension, the court reasoning could support a conviction in virtually every case where someone obtains inside information by virtually any means, however removed that person is from the company, tippees, buyers, sellers, anyone.

Do outsiders owe a floating duty to “the integrity of the marketplace”?  This is not a direction alien to past arguments by the SEC.  Where is the line?  Will the Supreme Court exercise discretion to hear this case?  Was the activity here so bad on its own that it supports a securities law conviction?