The Law and Other Anomalies

What will be the major issues for public companies in the 2019 proxy season?  An expert panel convened by the National Association of Corporate Directors – New England on January 15 suggested these:  is your Board composition appropriately diverse, and what does diversity mean; is your audit committee competent to fulfill its obligations as they have evolved over time; has the annual shareholder selection of your auditing firm become too automatic and should this function be highlighted in the proxy statement; is the company overpaying its Board?

The panel, included a representative from the institutional advisory firm ISS.  ISS now will consider whether your board is sufficiently diverse, bearing in mind that statistics indicate that diverse boards perform better for shareholders.  ISS threatens adverse advice starting in 2020 if there is no diversity, but diversity is not defined.  Glass-Lewis (another advisory firm) may offer negative comment during 2019, depending upon the facts.  Diversity in the past has been focused primarily on gender diversity; a robust discussion of diversity in a proxy statement might well address other kinds of diversity, and also the question of the number of diverse members.  For example, is placing only one woman on the board effective?  The panel noted that SEC disclosure requirements concerning diversity are “lame” and that most of the diversity pressure comes from the investment community.

Have auditing committees become the “dumping ground” for all sorts of complex issues?  Members of the audit committee with financial expertise may not be the right people to deal with all sorts of risks, notwithstanding the New York Stock Exchange manual assigning risk evaluation to that committee (a requirement the panel says is typically ignored).  Why for example does cyber risk or reputational risk or political risk end up with the audit committee?  A suggestion was made that the proxy statement might provide more granular disclosure, indicating which committees are evaluating which types of risks, and how?

The panel then held an inconclusive discussion concerning auditor selection, suggesting that proxy disclosure might benefit from discussing the decisional process.  It was noted that large companies run both higher costs and certain risks in replacing established auditing firms, given complexity and the lack of familiarity with operations for a new firm.  Additionally, many large companies utilize a variety of accounting firms, one being the auditor but others being retained for tax or other advice, making replacement difficult (auditing firms cannot provide most other services to a client beyond the audit).  For example, if no change in auditors has been made, perhaps the proxy statement ought to explain why.  In candor, this issue to my mind is not ripe for proxy statement inclusion, given that the average public company proxy statement now is about 100 pages already.

The year 2018 saw an increase in negative shareholder votes on “say on pay.”  While the absolute number of “no” votes was still low (an increase from 2017 to 2018 from 34 to 53), the panel suggested that shareholder rejection rates might increase, particularly if the stock market continues to lose ground, causing investor satisfaction to decline.

Lastly, it was suggested that this is the year to completely readdress proxy Risk Factors, rather than simply repeating them.  With market developments in terms of valuation, tariffs, political risk, cyber risk, LIBOR, regional and global tensions, a complete redrafting of Risk Factors may be in order.

The current issue of a leading life settlements industry newsletter predicts that 2019 should be a good year to invest in life settlements because it is a growing recognized investment class; but also and frighteningly, because aging boomers will need to sell their policies for cash in order to pay for their own health care!

Life settlement investment works like this: you buy a life insurance policy on the life of Mr. Smith for a sum of money you calculate as follows: you pay say $10X dollars for a policy that on death pays say 20X; and the cost of premiums is $X a year; you calculate how long Mr Smith will live based on health, age, actuarial tables, etc.; you “bet” that Mr Smith will die sooner rather than later so that you collect your $20X life insurance death benefit before your cost to purchase + premiums you paid + your cost of money is less than the $20X proceeds– much less.

Obviously you can get lucky with Mr Smith (next week he is hit and killed by a driver-less car, for example), but there is risk; he may have great genes or a propensity for diseases which modern medicine can treat, and he lives to be 110.  So the safe approach, aside from getting good actuarial tables, is to buy a variety of policies so that statistically the portfolio will protect you from buying a policy on a small number of unlucky — that is long-lived — people.  This business concept gave birth to both a recognized industry and an investment class.

Back to the boomers selling their policies in order to pay health care costs.  This is facially unsettling, yes?  What about the benefits of Social Security, Medicare, Medicaid, the support structure we are supposed to have in order to protect our aging population?  In a related development, a US House bill, which in fact died at the end of the last Congressional session, sought to permit seniors selling their policies to avoid paying taxes on the proceeds provided the proceeds were used for healthcare, including long-term care.  It is expected that the bill will be re-introduced next session.

I guess the lesson here is that if you have sizable life insurance which you no longer believe you need to maintain, you should get a quote to sell the policy and compare it to any cash surrender value you might receive from the insurance company; particularly for term policies, with no surrender value and possibly lower premium costs, you may well find yourself with a hidden profit center by selling your policy, even after you adjust for any tax burden.

Years ago (six? more?) Congress legislated that the SEC should design a mandatory disclosure comparing CEO comp to the median compensation of all entity employees.  It took the SEC years to institute that disclosure requirement, during which time its bald impact was softened to permit companies with odd situations to, for example, make estimates or report sampling in some instances.  But even as enacted, the rule seemed to many (and to me) silly.  Using disclosure to control what was perceived to be runaway executive compensation seemed likely to be ineffectual as proposed, not to mention possibly just unwise; perhaps a CEO should even be rewarded for creating a vast difference between his or her comp and that of the other employees, having found inexpensive labor sources, perhaps even overseas.

So now we have an SEC requirement to effect a relatively complex computation comparing CEO comp to the median cost of labor in an entity, and no one is paying attention, right?

Well, not quite right; but, there is a twist.

Today, there is as much interest in income disparity across all of society is there is concerning CEOs within one company.  Investors, worried about the long-term societal implications of growing income discrepancies across our whole society, now are suggesting that the statistic be used as a window into the company’s approach to its entire workforce.  That kind of interest, perfectly logical, once was viewed as wholly operational and thus shareholders were to hold their tongues; the ratio was a way for shareholders to get a voice in this key operational metric.

Meanwhile, the prestigious Corporate Counsel blog, which I swear I recall at one time derided gathering the ratio statistic, now wants comp committees to pay attention because the effect of detailed disclosure of CEO pay has, to date, simply driven boards to continue to pay CEOs in the top quartile, in a rush to the top.  What board wants to tell shareholders, in effect, “we have chosen to lead your company a person who is average”?

People who slam-dunk or hit 40 home runs out-earn most CEOs.  The market-place speaks to us.  It may be that the solution to leveling comp in our overall society lies with the taxing authorities, as unsettling as that prospect always has been.  Or adoption of an enlightened social policy that recognizes the risk of social upheaval as outweighing what has become our sense of the free labor market.  Neither of those discussions is much informed by the SEC ratio disclosures.

The wires this week are all aflame with the news of passage of the new Farm Act, which was promptly signed by the President.  The bill legalizes hemp, a plant with substantial industrial use which has been banned in the US because of its chemical relationship to cannabis.  One cannot fail to note the business buzz about, and substantial investment in companies involved in, the cannabis business.

Hemp has very low content of THC, which is the stuff that gives weed its kick, and higher content of CBD, another derivative of marijuana which is non-hallucinogenic and which is removed from the controlled substance list by the Farm Bill.  The impact on the THC side of the business is the subject of current trade speculation, although since now-legal CBD can be derived from marijuana there will be at least some positive effect; query whether this is another step towards Federal acceptance of marijuana, thus ending the absurd stand-off between the States and the Feds.

A footnote from the trade press: looks like cannabis beer is on the horizon; various companies have formed cannabis partnerships or undertaken research.

Seems Harvard is under attack by everyone these days.  One group has sued claiming bias in favor of white undergraduate applicants to the detriment of Asian students.  But Harvard Law School, including particularly the Harvard Law Review, is being sued on behalf of white males, claiming the membership on the prestigious Board of Editors and the selection of articles is biased in favor of “racial, gender and sexual orientation-based diversity.”

While I must confess that no one ever chased me to either join or write for the Review notwithstanding my patent male white-ness, I always understood that election to the Review was merit based and, hence, I was confident that my exclusion was wholly appropriate.  Further, it seems unclear who if anyone should be sued; the Review is a separate entity not owned or run by the University.  And while I guess I can understand why the same claims are being asserted against NYU and its law school also, the naming of US Secretary of Education Betsy DeVos seems attenuated.

Perhaps if I had in fact been named to Law Review I would have better understanding of the legal issues involved here.

But since the lawsuit names no one who has been or is about to be injured by whatever the policies of Review may be, I don’t understand how someone can bring a lawsuit in order to establish an idea or practice, as opposed to the seeking of a judicial determination of an actual case.  Indeed, lawyers for the University argued as much in Federal Court yesterday.

Not to slip into policy debate, particularly as my fact base is derivative and limited, but if the demographics of our country are changing then we would expect that the Review membership and the mix of submitting scholars would change also.  Further, one must suspect that if history is any guide, then the need for remedial action is to protect groups other than white males at Harvard Law School.

I must stop posting now and sit by my mailbox, awaiting my Law Review invitation.  It is about five decades late.  Mail service is so slow around the Holidays….