Governance & Compliance Insider

The Securities and Exchange Commission has extended an earlier order, so that subject to certain conditions that we reported on here, public companies may have an additional 45 days from the original due date to file their Exchange Act reports that are otherwise due between March 1 and July 1, 2020. Companies relying on this relief, in compliance with the conditions imposed by the order, will preserve their eligibility to use registration statements on Forms S-3, F-3 and S-8, as long as they were current and timely in their Exchange Act filing requirements as of the first day of the 45-day of the relief period, and they file their reports due during the relief period.  In addition, those companies will be permitted to rely on Rule 12b-25 if they are unable to file the required reports on or before the extended due date.  Rule 12b-25 provide an additional 15-calendar day grace period for annual reports, and a five-calendar day grace period for quarterly reports, under certain circumstances.

As more annual meetings may be held virtually this year, and many board meetings are being held telephonically due to social distancing or travel restrictions caused by COVID-19, working remotely has created a number of logistical challenges for companies, including the gathering of manually executed signature pages for electronic filings with the SEC. The Staff of the SEC has now provided guidance to help address this concern. On March 24, 2020, the Staff* of the three divisions of the SEC issued a staff statement regarding Rule 302(b) of Regulation S-T, which generally requires filers to obtain manual signatures for all documents filed electronically with the SEC, on or before the time of the electronic filing. The Staff still expects that those subject to Regulation S-T will comply with Rule 302(b) to the fullest extent practicable based on their particular facts and circumstances. However, in light of the COVID-19 pandemic, the Staff indicated it will not recommend enforcement action with respect to Rule 302(b) under the following circumstances: The signatory retains a manually signed signature page or other document (such as a power of attorney) and provides the document to the filer “as promptly as reasonably practicable,” for retention pursuant to Rule 302(b); The document indicates the date and time when the signature was executed; and The filer establishes and maintains policies and procedures governing this process. The signatory may also provide to the filer an electronic record (such as a photograph or pdf) of the document when it is signed. Based on this statement, the Staff would permit a filing on the basis of a manual signature which is scanned and emailed, or otherwise electronically delivered, to the filer, but even electronic delivery would not be necessary as long as the filer’s policies and procedures provide for identification of the signatory and confirmation of the date and time of the signature, for example by an email or phone call. The Staff notes that if a signatory is telecommuting, the signatory could execute a hard copy of the signature page remotely, and deliver the page to the filer upon his or her return to the place of business. However, it is less clear whether a filing can be made on the basis of a purely electronic signature, for example, on a board portal document. And in fact, the Staff reiterates the language of Rule 302(b)’s adopting release, that the requirement to retain the paper original of authentication documents was “established to provide a satisfactory means by which signatories could authenticate and adopt their typed signatures appearing on filed documents for evidentiary purposes.” Filers that are subject to Regulation S-T should establish and maintain policies and procedures to ensure that they receive the original documents, whether by mail or at the next in-person meeting, if they are planning to rely on the relief provided by the Staff statement. *The statement was a joint statement of the staff of the Division of Corporation Finance, the Division of Investment Management and the Division of Trading and Markets. It reflects the views of the three divisions indicated and is not a rule, regulation or statement of the Securities and Exchange Commission.

Prior to the open of markets in the U.S. on March 23, the Federal Reserve announced that it is committed to using its full range of tools to address the coronavirus pandemic. The steps announced by the Federal Reserve are described in this eUpdate.

On January 30, 2020, the SEC issued new guidance to companies that use key performance indicators and metrics in their MD&A. Concurrently, the SEC also proposed amendments that would significantly simplify and modernize the requirements for a company’s MD&A and related financial disclosures. New MD&A Guidance The SEC’s new guidance is effective immediately, and applies to all key performance indicators and metrics used in a company’s MD&A. In the guidance, the SEC notes that the metrics used in MD&A vary significantly from company to company. Some relate to external or macro-economic factors, while others are industry or company specific, such as same store sales or revenue per customer. The Guidance reminds companies that, in addition to complying with any more specific requirements, such as the requirements applicable to non-GAAP measures, they must ensure that when presenting a given metric they include such further material information, if any, as may be necessary in order to make the presentation of the metric, in light of the circumstances under which it is presented, not misleading. The guidance states the SEC’s expectation that a metric will be accompanied by: A clear definition of the metric and how it is calculated; A statement indicating the reasons why the metric provides useful information to investors; and A statement indicating how management uses the metric in managing or monitoring the performance of the business. Companies are cautioned to also consider whether there are estimates or assumptions underlying the metric or its calculation, and whether disclosure of such items is necessary for the metric not to be materially misleading. The guidance advises a company changing the method by which it calculates or presents a metric from one period to another or otherwise, to consider the need to disclose, to the extent material: The differences in the way the metric is calculated or presented compared to prior periods; The reasons for such changes; The effects of any such change on the amounts or other information being disclosed and on amounts or other information previously reported (potentially including a recalculation of metrics disclosed in prior periods, if necessary to place the current disclosure in an appropriate context); and Such other differences in methodology and results as would reasonably be expected to be relevant to an understanding of the company’s performance or prospects. Finally, the guidance reminds companies of the requirement to maintain effective disclosure controls and procedures. Where key performance indicators and metrics are material to an investment or voting decision, the company should consider whether it has effective controls and procedures in place to process information related to the disclosure of such items to ensure consistency as well as accuracy. The full text of the guidance is available here. Proposed Amendments to MD&A and Related Disclosures The SEC’s proposed amendments to MD&A and related disclosures are subject to a comment period ending 60 days after the publication of the proposed rules in the Federal Register, and final rulemaking action. If adopted, the amendments would eliminate certain of the requirements of MD&A and related financial disclosures for SEC reporting companies, including: Elimination of the 5-year table of selected financial data; Elimination of the 2-year table of quarterly financial data, and related information; Elimination of the table of contractual obligations; and Elimination of the discussion of inflation and changing prices, except where material. The amendments would also modernize a number of other aspects of MD&A. If adopted, the amendments would require a company to disclose: The objective of the MD&A; The reasons for material changes in line items; Critical accounting estimates; Material cash requirements, their general purpose and anticipated source of funds; and Known events that are reasonably likely to cause a material change in the relationship between costs and revenues (e.g., higher labor costs). Finally, the amendments would reword and reorder certain other portions of the MD&A instructions, and would expressly permit MD&A for interim (i.e., quarterly) periods to include a comparison of the current period against either the comparable period of the preceding year, or alternatively, the most recent preceding interim period. To the extent that foreign issuers are currently subject to these requirements, the proposed amendments would also apply to the forms filed by such issuers with the SEC. The full text of the proposed amendments is available at here.  

Preparations for annual reporting on Form 10-K and the 2020 proxy season have begun in earnest for many companies. We have summarized certain governance and disclosure developments that should be considered in the course of preparing these filings and you can find them here. For additional background, please contact us for materials from our presentation, “Preparing for the 2020 SEC Reporting Season.”

The 10-K and proxy season begins in a little over a month for companies with calendar fiscal year-ends.  The following governance and disclosure developments should be considered in the course of preparing these filings. For additional background, see our presentation and supplemental materials for Preparing for the 2019 SEC Reporting Season. Proxy Statement Impact of the government shutdown: During the government shut down, the SEC is operating with a skeleton staff, with no capacity for reviewing preliminary proxy statements or no-action requests. Companies that need to file preliminary proxy materials should continue to file them in accordance with Rule 14a-6(a) of the Exchange Act, at least ten calendar days prior to the date the definitive materials are first sent or given to shareholders.  If companies are not advised by SEC staff within that period that there will be a review, they should proceed with the definitive filing and distribution of proxy materials. While the Division of Corporation Finance has not discussed how no-action requests for shareholder proposals will be handled during the government shutdown, companies should continue to make the submission required by Rule 14a-8(j) via email if they intend to exclude a shareholder proposal.  Given that companies must submit no-action requests no later than 80 calendar days before filing definitive proxy statements, it is likely that the SEC staff will have a chance to review and respond to submissions under Rule 14a-8 once the shutdown ends.  If the current shutdown is still in effect at the time that the proxy statement is filed, a company would have to decide whether it has a basis to exclude the proposal without the benefit of a no-action letter. See this update and this update on the shutdown’s impact on capital markets regulation and this 19-firm memo prepared during the last shutdown. Gender diversity voting policies:  For meetings held after January 1, 2019, Glass Lewis will generally recommend votes against nominating committee chairs (and potentially other nominating committee members) on boards with no female directors.  ISS will do so for meetings held on or after February 1, 2020.  Mitigating circumstances disclosed in the proxy statement may influence their recommendations. Rapidly evolving disclosure of environmental and social programs:  More companies are dedicating sections of their proxy statements to describing these initiatives, or referring to applicable disclosure on their websites or in their responsibility reports, while being careful not to incorporate by reference these materials into their filings. Expanding duties for compensation committees: These committees are overseeing broader issues of human capital management beyond director and executive officer compensation, sometimes in response to allegations of sexual harassment and other misconduct, followed by investor questions.  Semler Brossy reports that one-third of DJIA (Dow Jones Industrial Average) 30 companies have a board compensation committee with broader responsibilities, e.g., leadership development and/or other HR areas - many of which signal their breadth in their name, such as Talent & Development Committee or Human Resources Committee. Updated tax policy discussions in the CD&A: Companies historically may have disclosed that they use best efforts to obtain tax deductions for executive compensation above the $1 million cap under Section 162(m) of the Internal Revenue Code.  Since the exemption for performance-based compensation has been eliminated under the Tax Cuts and Jobs Act, with limited grandfathering for compensation payable pursuant to a written binding contract in effect on November 2, 2017, this disclosure now should be updated. CEO pay ratio in year two: Companies may keep the median employee from last year, unless there were significant changes to (i) the employee population, (ii) employee compensation arrangements or (iii) the original median employee’s circumstances, so that the company reasonably believes its pay ratio disclosure would significantly change.  In cases (i) and (ii), the median employee should be re-identified.  In case (iii), the company may use another employee whose compensation is substantially similar to the original median employee based on the compensation measure used to select the original employee.  If the same median employee is used, briefly disclose the basis for the reasonable belief. Say-on-frequency for smaller reporting companies: A non-binding say-on-frequency vote is due for those companies that had their last vote in 2013, including most smaller reporting companies.  Shareholders may cast an advisory vote on whether to hold the advisory vote on executive compensation ("say-on-pay") every year, every two years or every three years.  Per Rule 14a-21 of the Exchange Act, include (i) a statement that the vote concerning the frequency of the say-on-pay vote is being provided as required pursuant to Section 14A of the Securities Exchange Act of 1934, as amended; (ii) a description of the general effect of the say-on-frequency vote, such as whether it is non-binding; and (iii) the current frequency of the say-on-pay vote and when the next say-on-pay vote will occur.  Emerging growth companies ("EGCs") are exempted from say-on-pay and say-on-frequency votes.  The SEC also expanded the definition of "smaller reporting company" this year.  See discussion below. Guidance for equity compensation plan proposals: The SEC updated its guidance related to equity compensation plan proposals, see Section 161 of the Proxy Rules and Schedules 14A/14C C&DIs.  Among the clarifications provided: Companies should be prepared to disclose all material terms of a plan, even when the proposal is for an amendment of an existing plan.  Furthermore, a New Plan Benefits Table (listing benefits or amounts that will be received by each of the named executive officers and certain groups under the proposed plan) will only be called for if the plan is: (i) a plan with set benefits or amounts (e.g., director option plans); or (ii) one under which some grants or awards have already been made subject to shareholder approval. Annual Report on Form 10-K Disclosure simplification:  As a result of the SEC’s Disclosure Update and Simplification rulemaking, certain 10-K disclosure can be eliminated, because the information is  outdated or duplicative of information already included in the financial statements in accordance with GAAP or in the MD&A when material to the business. Part I, Item 1, Business: Companies are no longer required to disclose: three years of segment level financial information, amounts spent on R&D financial information by geographic area risks associated with foreign operations and a segment’s dependence on foreign operations facts indicating why performance in certain geographic areas may not be indicative of current or future operations (but consider for the MD&A) reference to the SEC’s Public Reference Room, physical address and phone number (but disclose the SEC website, a statement that SEC filings are available there, and the company’s website) Part II, Item 5, Market for Registrant’s Common Equity: Companies are no longer required to disclose: high and low sales prices for common equity traded over the last two fiscal years (but disclose trading symbols for each class of common equity traded) frequency and amount of cash dividends declared restrictions that currently or are likely to materially limit a company’s ability to pay dividends on its common equity (including restrictions on subsidiaries to transfer funds) Part II, Item 7, MD&A: Companies should discuss changes in financial condition and results of operations based on geographic area, if they are material to an understanding of the business. Part IV, Item 15, Exhibits: Companies are no longer required to provide a ratio of earnings to fixed charges as an exhibit. Update those risk factors:  Not only should companies consider new and emerging risks, they should review the status of existing risks.  An abstract discussion may not be sufficient if an existing risk has materialized.  Earlier this year, as reported here, Altaba (formerly Yahoo! Inc.) agreed to pay a $35 million penalty to settle charges that it misled investors by failing to disclose one of the world’s largest data breaches thus far.  Among its violations, Yahoo's post-breach disclosure in quarterly and annual reports was too general, stating that the company faced only the risk of, and negative effects that might flow from, data breaches.  The company failed to disclose the actual breach or its potential business impact and legal implications. Continue to mind the GAAP: In a recent SEC cease-and-decease order discussed here, ADT was fined $100,000 for failing to give “equal or greater prominence” to the most directly comparable GAAP measures in accordance with Item 10 of Regulation S-K.  The company highlighted non-GAAP measures in the headlines and bullets summaries of two earnings releases, without disclosing the GAAP measures until later in the earnings releases. Leasing and revenue recognition accounting standards: Public entities besides EGCs must adopt the leasing accounting standard (FASB ASC Topic 842) for annual reporting periods beginning after December 15, 2018, including interim reporting periods within that reporting period.  For calendar year-end companies, they will adopt the standard on a modified retrospective basis on January 1, 2019, with an initial application date of January 1, 2017.   Section 11200 of the SEC Financial Reporting Manual clarifies that filing a registration statement with an earlier comparative period (eg, January 1, 2016) does not change the date of initial application. Last year, public entities adopted the revenue recognition accounting standard (FASB ASC Topic 606) for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that period.  SEC Chief Accountant Wes Bricker has indicated that revenue recognition disclosure will be a top issue for comment this season, and the SEC staff has encouraged companies to refine and supplement their annual disclosures included in subsequent quarterly filings. Areas of judgment, such as identification of performance obligations and the application of principal vs. agent guidance have been the most frequently discussed topics in consultations with the Office of the Chief Accountant.   Section 11100 of the SEC Financial Reporting Manual addresses certain disclosure issues related to the adoption of ASC 606.  For instance, for companies that adopted ASC 606 using the full retrospective approach, they do not need to apply the standard when reporting selected financial data in the 10-K for periods prior to those periods that are retroactively adjusted, but they must provide information regarding comparability of data presented pursuant to Instruction 2 to the Item 301. Updates to the 10-K cover page were made in connection with rulemaking for smaller reporting companies and inline XBRL reporting (see our Preparing for the Proxy Season presentation for a markup). No delivery of hard copies of proxy materials to the NYSE, if the hard copies have been filed in EDGAR.  Nasdaq had abolished this requirement earlier. More companies qualify as “Smaller Reporting Companies:” During 2018, as discussed here, the SEC expanded the definition of “smaller reporting company” to include (i) those companies with public float of less than $250 million as of the last business day of their second fiscal quarter, and (ii) those companies with less than $100 million of annual revenues and either no public float or public float of less than $700 million.  As a result, additional companies now qualify to provide scaled disclosure in this year’s Form 10-K and proxy statement.  If and until the SEC makes corresponding amendments to the definitions of “accelerated and “non-accelerated” filers, smaller reporting companies with public float of $75 million or more will continue to be accelerated filers that must comply with shorter filing deadlines and provide an auditor’s attestation of management’s assessment of internal control over financial reporting required under Sarbanes-Oxley Act Section 404(b). And coming up for future 10-Qs and 10-Ks: Effective for quarters beginning after November 5, 2018 (which means Q1 2019 for calendar companies), amended Rules 8-03(a)(5) and 10-01(a)(7) under Regulation S-X require quarterly (vs annual) analysis of changes in stockholders’ equity and the amount of dividends per share for each class of shares for “the current and comparative year-to-date [interim] periods, with subtotals for each interim period.”   These changes were adopted as part of the Disclosure Update and Simplification rulemaking discussed above. A discussion of critical audit matters, which are related to accounts or disclosures that are material to the financial statements, and involved especially challenging, subjective, or complex auditor judgment, will be included in audit reports for fiscal years ending on or after June 30, 2019 for large accelerated filers and in audit reports for fiscal years ending on or after December 15, 2020 for all other companies to which these requirements apply.  The new requirement does not apply to emerging growth companies. Inline XBRL, which allows filers to embed financial data into the body of an SEC filing, rather than attaching the data as an exhibit, must be implemented as early as fiscal periods ending on or after June 15, 2019 for large accelerated filers; fiscal periods ending on or after June 15, 2020 for accelerated filers and fiscal periods ending on or after June 15, 2021 for all other filers. And coming up for future proxy statements: Effective for proxy statements filed during fiscal years beginning on or after July 1, 2019 (July 1, 2020 for smaller reporting companies and emerging growth companies), companies must describe any practices or policies that they have adopted regarding the ability of employees, officers or directors to engage in hedging transactions.  Companies may either disclose the full policy, or a "fair and accurate" summary of the policy.  Summaries must include the categories of persons and the categories of transactions specifically permitted or disallowed.  Companies that have not adopted hedging policies must disclose that fact or state that hedging transactions are permitted.

ISS released its annual update of frequently asked questions on its US Compensation Policies on December 20, 2018 (preliminary updates had been released in November). The updates are effective for shareholder meetings occurring on or after February 1, 2019. There are nine new or materially updated questions, which are summarized below: #19 Will any of the quantitative pay-for-performance screens change in 2019?  No.  The screens will continue to use GAAP/accounting performance measures, but ISS will display Economic Value Added (EVA) measures on a phased-in basis over the 2019 proxy season and will continue to explore their future use to add insight to financial performance.  (EVA can measure a company's residual wealth by deducting its cost of capital from its operating profit, adjusted for taxes on a cash basis.) #21 Given the use of TSR in ISS' quantitative screen, does ISS prefer companies use TSR as an incentive program metric?  While it recognizes investors' preference for objective and transparent metrics, ISS does not endorse or prefer the use of total shareholder return (TSR) or any specific metric in executive incentive programs. #42 How does ISS analyze "front-loaded" awards intended to cover future years?  ISS is unlikely to support grants that cover more than four years (ie, the grant date plus three future years), and for these types of grants, commitments not to grant additional awards over the covered period should be firm.  Usual pay-for-performance considerations will be more closely scrutinized. #47 Which problematic practices are mostly likely to result in an adverse recommendation?  Additional problematic pay practices that are likely to result in adverse vote recommendations on compensation committee members and/or say on pay proposals now include: (1) excessive termination payments (not just change in control payments) exceeding three times base pay and annual bonus, and (2) a "good reason" termination definition that presents windfall risks. #48 How does ISS evaluate "Good Reason" termination definitions?  ISS will scrutinize "Good Reason" definitions to ensure that the circumstances are reasonably viewed as an adverse constructive termination, and to determine whether there is a potential windfall risk.  Circumstances reflecting potential performance failures, such as bankruptcy or delisting, will be considered problematic. #50 If a company becomes a "smaller reporting company" under the SEC's revised definition, how will ISS assess reduction in compensation disclosure?  ISS notes that smaller reporting companies (SRCs) are still required to hold say on pay votes, and so while they may use scaled compensation disclosure requirements, SRCs should continue to provide sufficient disclosure to enable investors to make an informed say on pay vote.  This means that SRCs should think carefully before eliminating CD&As, and at minimum, ensure that there is sufficient narrative for shareholders to meaningfully assess compensation philosophy and practices. #59 How would ISS view any compensation program changes made in light of the removal of 162(m) deductions?  While shifts away from performance-based compensation to discretionary or fixed pay elements did not make the list of problematic pay practices most likely to result in an adverse recommendation, ISS will still consider these shifts to be problematic pay practices and will view them negatively. #67 How does ISS apply its policy around "excessive" levels of non-employee director pay?   If ISS determines that a NED’s pay is a quantitative pay outlier (see FAQ below), it will perform a qualitative evaluation of the company’s disclosed rationale to determine if concerns are adequately mitigated.  The updated FAQs list a number of circumstances that will typically mitigate concern around high non-employee director (NED) pay, including onboarding grants, special payments related to corporate transactions or special circumstances, and payments for specialized scientific expertise as may be necessary in certain industries.  As a reminder, last year, ISS had announced a policy to recommend against board members responsible for approving NED pay when there is a recurring pattern of excessive pay magnitude without a compelling rationale in two or more consecutive years.  ISS subsequently updated its methodology to identify pay outliers, and in consideration of the updates, ISS had postponed issuing adverse recommendations until meetings occurring on or after February 1, 2020. #68 What is ISS' methodology to identify non-employee director pay outliers?  The updated FAQs clarify that the methodology identifies pay outliers above the top 2-3% (vs the top 5%) of all comparable directors within the same two-digit GICS group and index grouping (eg, S&P 500).  The revised methodology acknowledges that there are pay premiums for non-executive chairs and lead independent directors, and in limited instances, the methodology also makes allowances for narrow distributions of NED pay, where there is not a pronounced difference in pay between the top 2-3% of directors and the median director.

The SEC adopted new rules today that will require disclosure of a company’s hedging policies in proxy statements or information statements relating to the election of directors. The new rules are set forth in new Item 407(i) of Regulation S-K and require a company to describe any practices or policies it has adopted regarding the ability of its employees, officers or directors to engage in hedging transactions. The disclosure requirements can be satisfied by providing a “fair and accurate summary” of the hedging practices or policies, or by disclosing the practices or policies in full. If a summary is provided, it must include (i) the categories of persons covered by the policy or practice and (ii) the categories of hedging transactions that are specifically permitted or specifically disallowed. However, if a company has not established a hedging policy or practice it must disclosure that fact or state that hedging transactions are permitted. The rules do not require that companies prohibit or limit hedging transactions, or that companies adopt a policy relating to hedging. However, we expect that most companies will amend their current policies to address hedging if it is not already covered in existing policies. Implementation Dates: Except for “smaller reporting companies” and “emerging growth companies”, the new disclosure rules apply for proxy statements or information statements filed during fiscal years beginning on or after July 1, 2019. For “smaller reporting companies” and “emerging growth companies”, the rules apply for proxy statements or information statements filed during fiscal years beginning on or after July 1, 2020. Foreign private issuers will not be subject to the new disclosure requirements.

In August, the SEC adopted amendments updating and simplifying disclosure rules. See our prior summary here. Notable amendments included: the extension of a previously annual requirement to interim periods, to present a statement of changes in shareholders' equity and to disclose the amount of dividends per share for each class of shares (vs common shares only) (either in a separate statement or a footnote)(revised Rules 8-03(a)(5) and 10-01(a)(7) of Regulation S-X); the elimination of requirements to disclose pro forma information on business combinations in quarterly reports on Form 10-Q, because similar disclosure may be found in Form 8-K filings; the elimination of requirements in business descriptions to disclose financial information broken out by segment (Item 101(b) of Regulation S-K) and geography (Item 101(d)(2)), risks associated with, and dependence of a segment on, foreign operations (Item 101(d)(3)), and amounts spent on R&D (Item 101(c)(1)), because similar discussions may be found in the financial statement footnotes and/or the MD&A, when material; and the elimination of exhibits setting forth the computation of any ratio of earnings to fixed charges disclosed in an SEC report (Items 503(d) and 601(b)(12) of Regulation S-K), because US GAAP already requires the disclosure of components of the ratio. On www.thecorporatecounsel.net, Broc Romanek had blogged that it was unclear when the new rules become effective. The SEC staff has released C&DI 105.09 confirming that the amendments are effective for all filings made 30 days after publication of the final rule in the Federal Register, which for calendar year-end reporting companies, may include their Form 10-Qs for the third quarter of 2018, if the final rule is published soon. However, in light of the proximity of the anticipated effective date to the filing deadline, the staff will not object if companies first present the statement of changes in shareholders' equity (first bullet above) in the Form 10-Q for the quarter that begins after the effective date, ie, for the first quarter of 2019 for calendar year-end reporting companies.

In order to facilitate discussion on the role of proxy advisory firms at the upcoming Roundtable on the Proxy Process, which is scheduled for November 2018, the SEC staff has determined to withdraw two no action letters that provided comfort to investment advisers in relying on proxy advisory firm recommendations: In Egan-Jones Proxy Services (May 27, 2004), the staff had confirmed that by voting based on the recommendations of an independent proxy advisory firm, an investment adviser could demonstrate the absence of a conflict of interest, and the fulfillment of fiduciary duties, provided that the investment adviser should first ascertain, among other things, whether the proxy advisory firm "(a) has the capacity and competency to adequately analyze proxy issues and (b) can make such recommendations in an impartial manner and in the best interests of the adviser's clients." In Institutional Shareholder Services, Inc. (September 15, 2004), the staff had confirmed that investment advisers should evaluate the independence of proxy advisory firms based on the facts and circumstances, and that a number of ways include a thorough review of the firm's conflict procedures and the effectiveness of their implementation; case-by-case evaluation of the proxy advisory firm's relationship with issuers; or other means to ensure the integrity of the firm. The withdrawal of these no action letters opens up for discussion, and creates uncertainty around, the circumstances in which investors may rely on proxy advisory firm recommendations and when a firm may be considered independent.  The withdrawal is the latest development in the call for additional rulemaking around proxy advisory firms.  Last December, the House passed the Corporate Governance Reform and Transparency Act of 2017, which would require proxy advisory firms to register with the SEC, disclose potential conflicts of interest and codes of ethics and publicize methodologies for formulating proxy recommendations.  Then earlier this year, six members of the Senate Banking, Housing and Urban Affairs Committee sent letters to ISS and Glass Lewis requesting information regarding their eligibility for exemption from proxy rules, accuracy of reporting and potential conflicts of interest. The SEC staff has not to date signaled any changes to its guidance in Staff Legal Bulletin No.20, which among other topics, addresses considerations that an investment adviser may wish to take when it retains a proxy advisory firm, an investment adviser's ongoing duty to oversee a proxy advisory firm that it retains, and an investment adviser's duties to ascertain the material accuracy of the facts upon which a firm's recommendations are based. The impact of proxy advisory firms' recommendations on institutional investor voting is debated.  A study by Choi, Fisch and Kahan (2010) found that proxy advisory firms have modest influence on voting outcomes, with an estimate that ISS recommendations shift 6%-10% of investor voting.  Similarly, a survey by Rivel (2016) found that only 7% of institutional investors say that proxy advisory firms are the "most influential" contributors to their policies, and that generally established best practices are the primary source of their voting policies and decisions.  A study by McCahery, Sautner, and Starks (2016) of 143 institutional investors concluded that they rely on the advice of proxy advisory firms to complement their decision making, rather than relying on them exclusively. However, investor voting decisions often are highly correlated with proxy advisory firm recommendations.  According to a report published by the Manhattan Institute in May 2018, a sample of voting records for 713 institutional investors in 2017 showed that they are significantly likely to vote in accordance with proxy advisory firm recommendations across a broad spectrum of governance issues.  For example, 95% of institutional investors vote in favor of a say on pay proposal when ISS recommends for it, while only 68% vote in favor when ISS is opposed. This correlation may suggest that proxy advisory firms have more influence than institutional investors appreciate or acknowledge.  It may also indicate that governance practitioners form a community, whether they work for investors or proxy advisory firms, and that they develop and are influenced by a common set of trends and "best practices," resulting in investor voting policies that synch with ISS or Glass Lewis voting policies.

At last Friday's ABA annual meeting, Bill Hinman (with the standard disclaimer that he is speaking for himself and not on behalf of the SEC) confirmed that the SEC will not be delaying implementation of the CEO pay ratio rule, which will require most public companies to report the pay ratio in their 2018 proxy statements, for the first fiscal year beginning on or after Jan. 1, 2017.  (Foreign private issuers, MJDS filers, emerging growth companies and smaller reporting companies are exempt from the rule.)  Bill Hinman is the Director of the SEC's Division of Corporation Finance. Director Hinman also mentioned that the Division will be issuing additional guidance on the CEO pay ratio rule in the near future.  This earlier blog entry includes a summary of the SEC's previous guidance on implementing the CEO pay ratio rule. In a recent Compensation Standards survey, Liz Dunshee reported on trending practices in pay ratio preparation.