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From Securities Regulation Daily, January 31, 2019

SRI panelists advise on crisis management, board obligations, ESG reporting; highlight M&A trends

By Amy Leisinger, J.D.

A board’s obligation is to do what is right for the company, and directors should bring their own experiences and an element of skepticism to decision-making process, Delaware Supreme Court Chief Justice Leo Strine noted.

Preparation is key in responding to potential corporate crises, according to panelists at Northwestern’s Securities Regulation Institute. Even in times of normal business activity, boards of directors must remain engaged and vigilant, as well as aware of shifts in shareholder engagement and industry developments; an increased push for additional environmental, social and governance (ESG) disclosures may require companies to rethink the information they provide to shareholders, they explained. Companies should also be aware of current trends in mergers and acquisitions and consider the ramifications of inclusion or non-inclusion of "sandbagging" clauses regarding potential indemnification and "residuals" clauses in connection with the due diligence process, the panelists opined.

Crisis management. Corporations must focus on the short term while planning for long term, as crisis preparation and prevention are just as important as taking remedial steps like instituting training and cultural changes after a crisis, according to the panelists. Munger, Tolles & Olson’s Brad Brian emphasized the need to retain competent outside counsel as necessary, organize a factual investigation (potentially very quickly), and determine as soon as possible whether there is evidence of an ongoing criminal violation and/or a need to communicate with government enforcement agencies. In addition, he explained that a company should avoid silos within the business and take steps to keep all interested parties and advisors on the same page; the company also may need to take time to address employees, Brian stated. David Katz of Wachtell, Lipton, Rosen & Katz suggested that under reacting to a crisis could be worse than an overreaction. A company must consider the role of the board of directors in a crisis; additional oversight and independent investigations and even a special committee may be necessary in terms of conflicts, he said.

Sara Moss, general counsel for Estee Lauder, elaborated on this issue, stressing the importance of thinking about corporate reputation when a crisis hits, particularly with regard to the roles of a parent and subsidiaries. Joele Frank of Joele Frank, Wilkinson Brimmer Katcher agreed, noting that a good communications strategy will not make a deal but that a bad strategy can break one; in order to prevent a deal leak, companies must be disciplined in communicating, she said.

Remediation after a crisis is crucial, but a company must look for root causes to prevent it from happening again, according to the panelists.

Board considerations. In the a keynote address, Delaware Supreme Court Chief Justice Leo Strine discussed the social obligations of corporations and the need for independence and responsiveness on the part of directors.

"An independent director is a director who has no reason at all to give a hoot about the corporation," he said.

The economy is seeing a decline in the voice and leverage of workers, according to the Chief Justice, and the institutional power of corporations has grown. Further, post-Citizens United, corporations are spending money to influence politics without particularized consent from stockholders. Investors do not invest in 401(k)s for a company to speak on their behalf politically, he noted. If corporate governance does not become more responsive to desires of super majorities, companies themselves will be affected, Strine opined.

If we want corporations to be more responsible, we need to recalibrate, he concluded.

ESG and sustainability reporting. Sustainability goes beyond climate change to cover other social and environmental issues and can contribute to longevity of a corporation, according to Thomas Riesenberg of the Sustainability Accounting Standards Board. SASB wants corporations to use all of its standards, including ESG disclosures, and, if an element is not material, to include an explanation as to why it is not provided. While the disclosures are not done systematically across companies and are not comparable between companies, investors are asking for these features, and SASB is working to achieve these goals, he stated.

Elizabeth Ising of Gibson, Dunn & Crutcher noted that ESG disclosure means different things to different companies and that some argue there already is a framework in the U.S. that covers these disclosures: the materiality standard. In addition, she cautioned, companies should be aware of the potential for ESG disclosures to serve as basis for litigation claims, particularly when they make specific statements about future action that do not come to fruition. She advised companies to use aspirational language, as well as disclaimers setting context and forward-looking language, and to encourage appropriate internal collaboration so that all parties are aware of the statements that have been made.

Every company has ESG risks and should take time to consider whether disclosures should be provided, Courteney Keatinge of Glass Lewis concluded.

Mergers and acquisitions. Panelists also highlighted some recent issues in M&A, paying special attention to certain clauses included (or not included) in merger agreements. In particular, the panelists considered "sandbagging" clauses, which provide a right for a buyer aware of an inaccurate representation by a seller that does not disclose its finding until closing to make a claim for indemnification. Richard Climan of Hogan Lovells said that only about 6 percent of agreements have anti-sandbagging provisions and that half of agreements are silent on the issue. Some stay silent out of naivete or poor drafting, but some on the buy-side are under the impression that silence is the legal equivalent of including a pro-sandbagging clause, he noted. When a court requires justifiable reliance to make regarding a misstatement, a buyer could not justifiably rely on a representation they knew was false, Climan explained, but after a 2018 Delaware Supreme Court decision on a separate issue, Delaware courts have come to be regarded as in favor of sandbagging when an agreement is silent on the issue. Vice Chancellor Andre Bouchard opined that sellers should not assume that silence is golden, and the panelists urged parties to include a specific clause addressing preexisting knowledge of a buyer.

The panelists also considered the importance of a "residuals" clause governing a buyer’s future disclosure or use of information learned about a seller and its products and services during the due diligence process. Heather Meeker of O’Melveny & Myers noted that a "use" restriction could be hard to meet—an individual affiliate with a buyer could use information or data unconsciously. A residuals clause stating that information retained by buyer’s employees without outside aid could be effective, but sellers may want to consider protecting extremely sensitive information until the parties are reasonably sure that the deal is going through, the panelists explained.

Statistically, the panelists noted, almost tech deals account for 19 percent of total M&A in the U.S. by deal volume and have ranked among the highest totals in recent years. According to the panelists, this can create dissonance because tech companies tend to operate differently than larger, traditional, hierarchical organizations; "freedom to operate" provisions governing the ability to check broadly for patent infringement could cause problems not normally encountered in the M&A process, they noted. Companies should use their own engineers in tech deal due diligence and determine early on what valuation techniques will be the most reliable, the panelists concluded.

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