Corporate Law & Governance Update | November 2019
LAWYER SPOTLIGHT ON CORPORATE PURPOSE
Board and executive leadership of large nonprofit health systems should note evolving trends concerning corporate social responsibility (CSR), corporate purpose and corporate accountability. They also should note the social and economic factors motivating these trends and the potential they have to manifest as either governance best practices or federal law—for example, the possible application of the proposed Accountable Capitalism Act (Warren Proposal) to the largest nonprofit health systems.
The ultimate results of these trends could have a profound effect on organizational mission, director fiduciary duties, board composition, strategic planning and the extent of federal regulation of nonprofit healthcare. The corporate general counsel can provide valuable assistance to the board and management in their consideration of the key issues.
A number of factors are prompting the current public dialogue on corporate purposes. These include various CSR initiatives, including those promoted by Blackrock CEO Laurence Fink; the Business Roundtable’s August 19, 2019, release of its “Statement on the Purposes of the Corporation”; and the various corporate accountability proposals offered by several progressive presidential candidates.
CSR and Accountability Initiatives
The CSR concept calls upon companies to serve a wider societal purpose beyond (but in addition to) matters of its economic performance. This concept is based upon the perspective that government is no longer capable of fully addressing the future needs of society. Private corporations are thus being asked to “fill the gap” and help respond to these concerns.
Thought leaders such as Blackrock’s Mr. Fink perceive a connection between financial performance and social purpose, and call for a new model of corporate governance that includes a continuous involvement with the company’s long term strategy. The Business Roundtable’s controversial August 19 statement contains a commitment from its signatories (CEOs of 181 major corporations) to lead their companies for the benefit of all stakeholders: customers, employees, suppliers, communities and shareholders. Specifically, they commit to:
Deliver value to customers
Invest in employees
Deal ethically and fairly with suppliers
Support the communities in which they work
Generate long term value for shareholders, “who provide the capital that allows companies to invest, grow in and innovate.”
Renewed Emphasis on Corporate Accountability
The progressive political movement extends CSR to matters of corporate accountability, describing the practice of shareholder primacy as the “root cause of many of America’s fundamental economic problems.” New progressive legislative proposals reflect an interest in obtaining greater “accountability” from the corporate sector. These proposals incorporate concepts such as the federalization of large corporations, statutory board diversity quotas, corporate “public benefit” requirements, and the right of employees to select a portion of a corporation’s board directors. By their literal reading, these proposals do not currently appear to exempt charitable corporations from their provisions.
Of these proposals, the most detailed and far-reaching is the Warren Proposal. This proposed legislation was originally introduced in August 2018 and is expected to be re-introduced shortly by Senator Elizabeth Warren (D-MA) and Assistant House Speaker Ben Ray Luján (D-NM). Highlights of this proposal include:
Federal Charter. The Warren Proposal requires corporations with more than $1 billion in annual revenue to obtain a federal charter. In the proposal’s current form, this requirement does not appear to be limited to public companies. Thus, literally taken, it would apply to nonprofit health systems with annual revenues in excess of $1 billion.
General Public Benefit. The terms of this charter would require directors of chartered companies to consider not just the interests of shareholders, but those of employees, customers and the communities in which those corporations operate. Specifically, a US corporation must have the purpose of creating a “general public benefit,” meaning a material positive impact on society resulting from the company’s business and operations, taken as a whole.
Employee Directors. The proposal also provides that at least 40% of the corporation’s directors must be selected by employees, under rules to be established by the US Securities and Exchange Commission. State attorneys general would be authorized to submit petitions to the new Office of United States Corporations to revoke a charter based on a history of egregious and repeated illegal conduct and a failure to take meaningful corrective action.
These CSR/corporate accountability trends provide a significant prompt for nonprofit healthcare systems to re-evaluate the scope, sufficiency and flexibility of their purpose statement (especially as it relates to their strategic initiatives). Systems should also monitor the extent to which public companies in the healthcare sector implement CSR principles, and the possibility that such activities may further blur the important distinction (for tax exemption purposes) between the for-profit and nonprofit healthcare delivery models.
NEW NACD REPORT
The National Association of Corporate Directors’ (NACD’s) latest Blue Ribbon Commission Report provides important suggestions relating to the structure of the board’s deliberation and decision-making processes.
Entitled “Fit for the Future: An Urgent Imperative for Board Leadership,” the report speaks to “major, fast-moving, economic, technological, and social trends and their long term implications for board oversight.” The report builds upon NACD data that reflects significant leadership concern with the need for change in board composition and operations in order to address these trends.
Of surveyed directors:
69% believe that exponential technological change will affect how boards govern their respective companies in the future.
81% expect much greater board engagement on new elements of growth and risk.
76% expect board structures to become more dynamic.
74% expect that directors will be called upon to significantly increase their time commitment to address board service demands.
The report recommends four governance shifts for boards to implement in response to these trends:
Deeper, more proactive board engagement with management on entirely new and fast-changing elements of strategy and risk
A more strategic, forward-looking approach to board renewal through the lens of evolving business needs
A more dynamic and flexible board operating model and structure
Increased internal and external transparency about board operations
More rigorous accountability for the board and individual directors.
DIRECTOR LIABILITY DEVELOPMENTS
The Delaware courts are sending an important new message on their expectations for boardroom attentiveness, and it’s a message that corporate directors, executives and their advisors should take seriously.
For more than 20 years, those courts have applied the director-friendly Caremark standard of conduct for board risk-oversight duty. This standard of conduct supports the business judgment rule and requires allegations of bad faith in order to support a claim for breach of that duty by directors. Under that standard, misconduct could only be found (in simplest terms) if the directors either utterly failed to implement a risk information reporting system, or consciously failed to make sure that the system worked to get them the information they needed.
But that may now be changing, and not necessarily for the best interests of directors and their personal liability profile.
Two recently decided Delaware cases signal a significant shift in the application of the Caremark doctrine and its forgiving standard of director conduct. In both cases, the court allowed a breach of duty action to proceed based on allegations that the board missed or misinterpreted significant “red flags” of compliance problems. The fact that a compliance plan was actually in place wasn’t enough to provide a defense for the board. The courts focused more on the quality of the plan and on the quality of the board’s attentiveness, respectively. That’s both new and disturbing.
The concerns raised in these cases can be addressed through a series of measures focusing on greater director engagement in oversight and monitoring activity, and increased board sensitivity for possible red flags. The health system’s chief legal officer can be a significant resource in developing a plan of response for the board.
WEWORK’S LESSONS FOR INNOVATION INITIATIVES
The recent failure of the WeWork initial public offering (IPO) offers many useful lessons for health system innovation activities and investments regarding the continuing, broad-based value of traditional governance practices such as independent leadership, accountability and conflicts avoidance.
According to The Wall Street Journal, several aspects of the We Co. IPO filing prompted significant pushback from the financial markets. These included a variety of business transactions involving the WeWork founder and CEO that suggested a casual approach to self-dealing. Many of these transactions involved simultaneous oversight and ownership positions, personal leadership ownership in WeWork-leased property, and nepotism in executive leadership.
The scope and breadth of these conflicts and related party transactions may have negatively affected the viability of the proposed IPO. Yet these concerns have broader commercial relevance beyond the public offering process of a prominent startup enterprise. The financial markets’ response to the idiosyncrasies of WeWork’s leadership underscores the continuing relationship between effective corporate governance and enterprise value.
Attracting specific focus was We Co.’s approximately $6 million purchase of the trademark to the word “We” from a company controlled by its CEO/founder. The financial markets reacted negatively to these and other arrangements. While WeWork responded to these investor concerns with a series of new governance changes and provisions, ultimately the IPO was withdrawn.
The resulting message is that conflicts matter. There is a real sensitivity to suggestions of bias in the decision-making process. What was apparent to the financial markets in connection with WeWork may also be apparent to the stakeholders of health system innovation start-ups, investments and spin-off initiatives.
COMPLIANCE COMMITTEE OVERSIGHT
A series of significant recent developments should be considered for discussion at an upcoming meeting of the health system’s audit and compliance committee.
The first of these developments is the October 9, 2019, publication by the US Department of Health and Human Services (HHS) of proposed changes to the Stark Law, the Anti-Kickback Statute and the Civil Monetary Penalties Law. The proposed rules were promulgated as part of HHS’s Regulatory Sprint to Coordinated Care, which was launched in 2018 with the goal of reducing regulatory burden and incentivizing coordinated care. The proposed rules involve significant changes to key regulations. The committee should familiarize itself with the proposals to the extent necessary to work with the general counsel on relevant internal educational programming, risk evaluation and compliance plan changes.
The second development is the current focus on whistleblowers within the larger impeachment controversy in Washington, DC. The nature of the whistleblower process is basically as it is playing out now, but more dramatically and in public view: an internal mechanism for the confidential reporting of allegations of violations of law or workplace codes of conduct. For regulated companies, having a robust system in place that allows for whistleblowers to come forward and be protected is a critical element of an effective corporate compliance program. The current controversy offers the opportunity for the audit and compliance committee to look past the partisan divide and recognize the discrete relevance of a reliable whistleblower process to their companies and to the exercise of their fiduciary duties.
The third development is the October 17, 2019, letter of Senator Charles Grassley (R-IA) making inquiry of a large nonprofit, tax-exempt hospital’s compliance with IRC Sec. 501(r). The specific focus of the letter was on allegations concerning the health system’s debt collection practices (including litigation against former patients) in the context of the requirements of 501(r). The audit and compliance committee should be briefed on the significance of the Grassley letter given the committee’s oversight obligations with respect to 501(r) compliance, and the reputational and tax exemption concerns associated with the subject of the Grassley inquiry.
BOARD OVERSIGHT OF WORKFORCE CULTURE
Given its responsibility for the oversight of workforce culture, the board (or the appropriate committee) is well served by familiarizing itself with the 2019 edition of the McKinsey/LeanIn.Org report, “Women in the Workplace.”
Launched in 2015 through a collaboration between McKinsey & Company and LeanIn.Org, “Women in the Workplace” has become one of the largest comprehensive studies of the state of women in corporate America. For the last several years, the report has been included within a special section of The Wall Street Journal focusing on how companies are addressing diversity in the workplace.
The data and related recommendations contained in the report are highly relevant to matters of workforce culture and the board’s oversight of culture generally. The report is also germane to the board’s ability to address concerns regarding gender disparity in hiring, compensation and promotion, and regarding employee satisfaction and retention. The board may wish to make particular note of the report’s primary 2019 recommendation, relating to the “broken rung” of the ladder by which women can reach senior leadership positions (i.e., the difficulty in achieving the first step up to management level).