Governance & Compliance Insider

On April 7, 2020, the SEC updated its prior guidance for conducting shareholder meetings in light of COVID-19 concerns to address delays in printing and mailing of proxy materials and clarify that its guidance applies for special meetings of shareholders, as well as annual meetings.  Previously, the SEC had advised issuers of its view that an issuer that has already mailed and filed its definitive proxy materials may notify shareholders of a change in the date, time, or location of its annual shareholder meeting without mailing additional soliciting materials or amending its proxy materials if it: Issues a press release announcing the change; Files the announcement as definitive additional soliciting material on EDGAR; and Takes all reasonable steps necessary to inform intermediaries in the proxy process, and other relevant market participants, of the change. Issuers must still be mindful of applicable notice provisions under state law.  For example, on April 6, 2020, the Governor of Delaware issued an order providing, in effect, that a Delaware corporation switching from a physical meeting to a virtual meeting would be deemed in compliance with Delaware notice requirements if they comply with the SEC’s guidance on making such a change. The SEC’s updated guidance would allow issuers experiencing COVID-19-related delays in printing and mailing the “full set” of proxy materials to use the “notice only” delivery option, even if the issuer does not meet all of the notice and timing requirements of Rule 14a-16.  To rely on the Staff’s position, the issuer must provide shareholders with proxy materials sufficiently in advance of the meeting to review those materials and exercise their voting rights under state law in an informed manner, and announce the change in delivery method using the three steps described above.  Affected issuers should also continue to use best efforts to send paper copies of proxy materials and annual reports to requesting shareholders, even if delayed.

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.

I live and work in the Seattle area. As a result of COVID-19, school districts are now closed for 6 weeks, Seattle public libraries are closed for a month, a number of restaurants have closed for the time being and my beloved Mariners’ baseball season has been postponed (along with most other sporting events). As we adjust to the current realities of dealing with COVID-19, the staff of the SEC has been providing timely, practical advice and assistance to issuers. On March 4th, they provided filing relief for companies affected by COVID-19, while simultaneously reminding them of their disclosure obligations relating to the rapidly evolving impact of COVID-19. Today, the staff provided guidance to companies who wish to hold virtual annual meetings, or change the date, time or location of an annual meeting. Changing the date, time or location of an annual meeting If an issuer has already mailed and filed its definitive proxy materials but wants to change the date, time or location of the meeting, it need not mail additional soliciting materials or amend its proxy materials if the issuer promptly: issues a press release announcing such change; files the announcement as definitive additional soliciting material on EDGAR; and takes all reasonable steps necessary to inform other intermediaries (such as any proxy service provider) and stock exchanges of such change. For issuers who have not yet mailed and filed their definitive proxy statement, it may be prudent to include disclosure regarding potential changes to the timing or location of the annual meeting. Holding Virtual or Hybrid Meetings For issuers who desire to hold a virtual meeting (no in-person meeting and participation solely through electronic means) or a hybrid meeting (consisting of both an in-person meeting and participation through electronic means), the staff expects issuers to provide clear and timely instructions regarding access, participation and voting at the meeting. Shareholder Proponents For shareholder proponents who are required to “appear and present” their proposal, the staff encourages issuers to provide shareholder proponents with the ability to present their proposal through alternative means, such as by phone. The inability of a proponent to present their proposal due to factors relating to COVID-19 will be considered by the staff to be “good reason” under Rule 14a-8 and so cannot form a basis to exclude future proposals by that proponent during the next two years. State Law Considerations Prior to changing the date, time or location of an annual meeting or changing to a virtual meeting, issuers should review state law and their articles and bylaws to ensure the issuer remains compliant with all notice and meeting requirements.

The Securities and Exchange Commission issued an order today providing filing relief for companies that are affected by the coronavirus.  In the order, the Commission notes that disruptions to transportation, and limited access to facilities, support staff, and professional advisors as a result of COVID-19, could hamper the efforts of public companies and other persons with filing obligations to meet their filing deadlines. 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 April 30.  In the reports, companies must disclose that they are relying on the order and state the reasons why they could not file their reports on a timely basis. As conditions to the filing relief, companies must be unable to meet their filing deadlines due to circumstances related to COVID-19. They must furnish in a report on Form 8-K or Form 6-K, by the later of March 1 or the original filing deadline, (1) a statement that they are relying on the order; (2) a brief description of the reasons why they could not file the report on a timely basis; (3) the estimated date of filing; (4) if appropriate, a risk factor explaining, if material, the impact of COVID-19 on their business; and (5) if the report cannot be filed on a timely basis because of the inability of a third party to furnish a required opinion, report or certification, a signed statement by the third party. Companies may also be exempt from Exchange Act requirements to furnish proxy and other soliciting materials under certain conditions, where the shareholder has a mailing address located in an area where the common carrier has suspended delivery service as a result of COVID-19, and the companies have made a good faith effort to furnish their proxy materials.

At the SEC's open meeting yesterday (November 5, 2019), the Commissioners approved two new proposed rules in their ongoing efforts to modernize proxy solicitation and shareholder proxy access, as follows: (1) amendments to certain procedural requirements, including ownership requirements, documentation requirements, meetings to discuss proposals and limitations on the number of proposals submitted, and resubmission thresholds for shareholder proposals, and (2) amendments to proxy rules conditioning the availability of certain existing exemptions from the information and filing requirements of the proxy rules for proxy voting advice businesses upon compliance with additional disclosure and procedural requirements. Comments on the proposals are due on or before 60 days after publication in the Federal Register. For more information on the proposed rules, see our recent eUpdate available here: dorsey.com/newsresources/publications/client-alerts/2019/11/sec-adopts-proposed-rules-requirements.

Yesterday the SEC announced the agenda for its upcoming open meeting to be held on Tuesday, November 5 at 10:00 a.m. EST. All SEC open meetings are webcast and a hyperlink to the webcast will be posted to www.sec.gov shortly before the start of a meeting. The SEC has indicated that the agenda, in part, will focus on “continued efforts to facilitate constructive shareholder engagement and enhance transparency, improve disclosures, and increase confidence in the proxy process.” We expect to provide further analysis following the open meeting and on any proposals once they are published. More information about the specific agenda items for the open meeting can be found in our eUpdate here:  dorsey.com/newsresources/publications/client-alerts/2019/10/sec-to-discuss-proxy-adviser-regulation.

Overview Earlier this month, the SEC's Division of Corporation Finance announced that its staff may respond orally instead of in writing to some shareholder proposal no-action requests, beginning with the 2019-2020 proxy season.   Furthermore, the staff may now more frequently decline to state a view on the no-action request, whereas in the past, it had typically concurred or disagreed with a company's asserted basis for exclusion. As background, companies submit no-action requests in order to exclude shareholder proposals from their annual meeting proxy statements.  When these requests are granted under Rule 14a-8 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the staff will not recommend that the SEC take enforcement action in response to the exclusion of a shareholder proposal.  Over the last proxy season (since October 1, 2018), more than 230 no-action requests were submitted to the SEC for review..  Transitioning to oral responses is intended to make the process more efficient for the staff in light of the large volume of requests.  The staff still intends to issue a response letter where it believes doing so would provide value, such as more broadly applicable guidance about complying with Rule 14a-8. The SEC’s announcement lacked a number of important details and leaves much to speculation. It remains to be seen how frequently the staff will issue oral versus written determinations.  In remarks before the U.S. Chamber of Commerce in July, Director of the Division of Corporation Finance Bill Hinman had commented that under an updated process, requests based on difficult topics, such as the ordinary business exclusion, would likely continue to receive responses from the staff.  In the announcement, the staff reiterates that board analysis is often useful for requests on the basis of the ordinary business or economic relevance exceptions. Whether the staff responds orally or in writing, it will inform the proponent and the company of its position, which may be that the staff concurs, disagrees or declines to state a view, with respect to the company’s asserted basis for exclusion. As discussed below, in light of the revised no-action process, it becomes more important for companies to designate an appropriate and prepared representative to receive the staff's call and to keep a careful record of the discussion. For more discussion on the SEC's announcement, see the Observations and Recommendations below, and register for our upcoming webinar, Shareholder Proposals: Strategies and Tactics. Observations and Recommendations There will be more flexibility for staff, but likely less information publicly available. Until now, companies and proponents have been able to review a complete database of the staff's responses, which have all been issued in written form, to discern trends, and to observe consistencies as well as inconsistencies in the determinations.  Under the updated process, it is not clear whether the staff will provides public access to its oral responses.  SEC Rule 81 only provides for public access to the staff's written communications in connection with no-action requests, as soon as practicable after the response has been sent or given.  If their oral responses are not made public, and if they have more flexibility to decline to state a view, the staff will also have more latitude to make case-by-case determinations under less scrutiny. Faster responses to no-action requests?  In keeping with the staff's commitment to a more efficient process, oral versus written responses may facilitate more prompt turnaround on no-action requests, though the staff has made no such commitment. The staff likely will not provide information in calls beyond what is stipulated in the announcement. In each case, the staff will communicate their determination with respect to the asserted basis for exclusion, to both the company and the proponent.  However, we do not expect additional substantive information to be communicated verbally.  The staff will avoid conflicting messages, or unnecessarily prejudicing either party, for example, by providing one party with more detail or nuance than has been received by the other party.  Furthermore, the staff is unlikely to entertain additional requests, such as requests for reconsideration, on a call.  This approach would be aligned with the spirit of previous guidance.  In SLB 14B, the staff stated that "In order to ensure that the staff's process is fair to all parties, we base our determinations on the written materials provided to us. While we will respond to telephone questions from the company or the shareholder proponent regarding the status of a request, we do not discuss the substantive nature of any specific no-action request with either the company or the shareholder proponent. Therefore, we request that any additional information that the company or the shareholder proponent would like to provide be submitted to us and the other party in writing." Written no-action letters may contain more guidance, and they will receive more scrutiny.  Currently, the staff will often issue a determination with little or no explanation for why they concur or disagree with the bases cited in the no-action request.  Since the staff has now specified that written letters will now be issued where they may provide "broadly applicable guidance," we expect that the letters will contain more substantive guidance than they have in the past. Companies will need to carefully assess alternatives if the staff declines to state a view on any particular request.  Negotiated withdrawals may become even more attractive. The announcement confirms that if the staff declines to state a view on any particular request, the interested parties should not interpret that position as indicating that the proposal must be included. In such circumstances, the staff is not taking a position on the merits of the arguments made, and the company may have a valid legal basis to exclude the proposal under Rule 14a-8. As an alternative,  the parties may seek formal, binding adjudication on the merits of the issue in court—an option that has always been available but rarely pursued. It is unclear how frequently the staff will decline to take a view on a no-action request.  There are certain bases for exclusion that may more readily invite this position.  For example, where companies cite a violation of law as a basis for exclusion under Rule 14a-8(i)(2), the staff may be more likely to defer to rulings by courts, the SEC or other state or federal authorities, as the staff largely did in their response to Johnson & Johnson regarding a proposal for the adoption of mandatory arbitration bylaws, discussed here. Without a definitive staff determination, and faced with the unappealing prospect of litigation, parties may accelerate the already existing trend towards negotiated withdrawals on a broad range of shareholder proposals.  In the absence of a withdrawal, the company still has the option either to exclude the proposal without a staff concurrence, which carries some risk of potential litigation, or present it for a shareholder vote. Will companies exclude shareholder proposals without staff concurrence? Some commentators posit that the staff’s refusal to state a view will provide companies with more latitude to exclude proposals, but it appears that investor and proxy advisory firm pressure will discourage companies from unilaterally excluding proposals.  While it is the exception rather than the rule that proponents have resorted to litigation in the past to challenge the exclusion of a shareholder proposal, coalitions of investors are finding that the influence and the resources to do so in order to pressure companies into settlement.  Furthermore, institutional investors and proxy advisory firms may take a dim view of a company's unilateral determination to exclude a proposal.  Under their existing voting policies, ISS and Glass Lewis may recommend votes against directors of companies that exclude proposals without a no-action determination or court order, though these policies may be modified in light of the staff's expanded ability to decline to state a view. Will there be more shareholder proposals submitted and voted on? The staff's potential refusal to take a view creates greater uncertainty around the no-action process. The absence of a complete written record of the staff’s position on no-action letter request during a proxy season will make it more difficult to assess the probability of success going forward. This lack of transparency may deter companies from making requests, particularly where they are not confident that there is a firm basis for exclusion.  As a result, the announcement may encourage a greater number and a greater variety of shareholder proposals to be submitted, and once submitted, to be voted on instead of excluded. Designate an appropriate and prepared representative and keep a record on conversations with the staff. In light of the revised no-action process, companies should designate an appropriate and prepared representative to receive the staff's calls.  This representative should be an individual who is generally familiar with the no-action process and with the specific request at issue, such as the general counsel, the corporate secretary or outside counsel.   If the staff does not concur with the company's position, the company likely will not be able to make requests on the call, but will continue to be able to make subsequent, written requests for reconsideration. The representative should be provided with guidelines for conducting the call and asking appropriate questions in order to obtain as much clarity as possible. The company should also create a record of its written and oral communications with the staff.  The record will provide a basis for a report to the board and the company's decision-makers with regard to current and future shareholder proposals.  

In the United States, the process by which shareholders submit proposals to be voted on at a company’s annual meeting has long been a mechanism used to promote often obscure special interests and social issues. In recent years, however, as environmental, social and governance (ESG) topics have become more mainstream, the market has seen a surge in this type of proposal. In 2018, Russell 3000 companies received a record 144 proposals requesting action on social and environmental issues, making this category larger than any other. In a recent article, The Wall Street Journal reported that the increase in support for ESG-related proposals has risen from “middle single digits from 2000 until 2008 to 24% in 2018.” Another record. As we draw closer to the end of the 2019 proxy season, it is clear that the momentum in this area continues. New Fronts in Environmental Proposals In the same article, the WSJ reported on a new front involving proposals focusing on plastic waste, a trend we previously noted in our March chemical industry update. The WSJ further noted that most of the companies that had received the proposal about plastic waste agreed to implement the request in order to avoid including it in their proxy statements. Proposals are often withdrawn when companies and proponents reach a compromise approach. This is a tactic that has risen in popularity in recent years as ESG topics have garnered more support from the broader shareholder base. In another article, the WSJ highlighted this trend, explaining that about 49% of environment-related shareholder proposals were withdrawn last year, compared with 33% two years prior and that “roughly 45% of shareholder proposals related to social issues, including income inequality, political-spending disclosure and animal testing, were withdrawn last year, up from 34% two years earlier.” Another development involves proposals related to climate change. This category itself is not new, and in fact these proposals have dominated in recent years, even gaining majority approval in some cases. This year, however, some companies found a degree of success via the no-action letter process. At least two companies obtained permission from the SEC to exclude a proposal that (if passed) would have required them to disclose how their operations align with the greenhouse gas reduction targets under the Paris Climate Accord. The SEC explained in one of the no-action letters: “the Proposal would micromanage the Company by seeking to impose specific methods for implementing complex policies in place of the ongoing judgments of management as overseen by its board of directors.” This success, however, is limited. The SEC declined to issue no-action letters on other types of climate change proposals, and more carefully crafted proposals are likely to survive review next year. The Future of ESG-related Shareholder Proposals The SEC announced last fall it was conducting a review of the proxy system. The shareholder proposal process was included as one of the areas due for an overhaul. While it remains unclear what form changes may take, it is possible the SEC will issue guidance after this proxy season. Proposed rulemaking could also follow. One anticipated rule change would be to raise the stock ownership threshold required for submitting a shareholder proposal (currently, a de minimis $2,000 in shares). Another would be to increase resubmission thresholds. Such steps will certainly make a dent in the number of overall proposals, particularly from shareholders who don’t have a financially meaningful stake in a company. However, many ESG proposals—such as the new ones about plastic waste—are backed by non-governmental organizations who either have meaningful resources themselves or who partner with larger shareholders. As such, absent some broader change to the shareholder proposal process (such as expanding the bases on which companies can seek to exclude proposals), we don’t expect the popularity of ESG-related shareholder proposals to diminish anytime soon.

On February 11, 2019, the Staff of the Division of Corporation Finance granted no-action relief permitting Johnson & Johnson to omit a shareholder proposal from its proxy statement.  The shareholder proposal requested mandatory arbitration of shareholder claims arising under the federal securities laws. The Staff relied on Rule 14a-8(i)(2), which permits exclusion of a proposal that, if implemented, would cause the company to violate any state, federal or foreign law to which it is subject.  Johnson & Johnson argued that the proposal, if implemented, would result in a violation of both federal and state law, but the SEC granted no-action relief specifically on the basis of state law.  Among the company's submissions, the Staff recognized of the legal authority of the New Jersey Attorney General, who issued an opinion that implementation of the proposal would result in a New Jersey state law violation. The decision was sufficiently significant that SEC Chair Jay Clayton issued an accompanying statement, noting that mandatory arbitration provisions have garnered a great deal of attention, and that it is a complex matter requiring careful consideration. Chairman Clayton supported the Staff's recommendation, citing the New Jersey Attorney General's submission.  Chairman Clayton also agreed with the Staff's decision not to address the legality of mandatory shareholder arbitration under federal securities laws, and he expressed the view that any SEC policy decision on this subject should be made by the Commission instead of the Staff. Rule 14a-8(i)(2) permits the exclusion of shareholder proposals that would result in a violation of any state, federal or foreign law, including but not limited to corporate and securities laws.  Other examples where the Rule 14a-8(i)(2) exception has been successfully invoked include a written consent proposal that violated state laws requiring unanimous shareholder written consent (Lowe's Companies (March 10, 2011)) and a proposal to amend governing documents to require that at least 50% of board nominees shall be minorities (Safeway Inc. (March 28, 2005)). As with Rule 14a-8(i)(1), which permits exclusion of proposals that are not proper subjects for shareholder action, the company must provide a supporting opinion of counsel when the basis for exclusion is a matter of state or foreign law, and in cases involving Delaware law, the Staff may request a legal interpretation from the Delaware Supreme Court.  The Staff will permit proponents to convert mandatory proposals into precatory proposals if the mandatory nature of the proposal creates the potential violation.

On February 6, 2019, the SEC's Division of Corporation Finance released Compliance and Disclosure Interpretations (identical Questions 116.11 and 133.13) advising companies on how they should disclose directors' self-identified specific diversity characteristics (such as race, gender, ethnicity, religion, nationality, disability, sexual orientation or cultural background) in proxy statements. In brief, Corp Fin would expect the company's discussion of directors' experience, qualifications, attributes or skills pursuant to Item 401(e) of Regulation S-K to identify these self-identified diversity characteristics to the extent that they were considered by the nominating committee, and the individual director consented to the disclosure of those characteristics. Similarly, in these circumstances, the description of how a board implements any policies it follows with regard to the consideration of diversity in identifying director nominees under Item 407(c)(2)(vi) should include a discussion of how the company considers self-identified diversity attributes. With board diversity at an increasing premium, and an expanding definition of diversity, self-identified diversity is likely to become a more frequent practice during the director recruitment and nomination process.  Particularly in ambiguous circumstances, those companies that rely on self-identification without a more thoughtful examination of a director candidate's historic affiliations and their engagement in the claimed communities, and without consideration of the diversity of thought or perspective that the candidate is ultimately expected to contribute, will do so at their own hazard and at the candidate's hazard, as suggested by Elizabeth Warren's unfortunate claim to Native American ancestry based on 1/64 to 1/1024 ancestry and the ensuing backlash.

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.

On January 10, 2019, the Division of Corporation Finance of the Securities and Exchange Commission updated its Frequently Asked Questions (FAQs) about how to handle certain filing matters during the U.S. government shutdown, which is now entering its fourth week. (See, sec.gov/page/corpfin-section-landing.) The staff revised questions 4 and 5 and added new questions 6 and 9. Question 4 was revised to emphasize that Rule 430A is only available to add pricing information to registration statements declared effective prior to the government shutdown (i.e., by December 26, 2018). Issuers whose registration statements were not declared effective before the shutdown are not eligible to use Rule 430A. Question 5 was revised to specify the “magic words” that must be included in an amendment to a registration statement to remove the delaying amendment language and start the 20-day clock to take the registration statement effective. The amendment must include the statement: “This registration statement shall hereafter become effective in accordance with the provisions of section 8(a) of the Securities Act of 1933.” Registrants who amended their registration statements to remove the delaying amendment without including the “magic words” will need to file amendments to add them. New question 6 adds clarity for registrants who have unresolved staff comments on their filings and wish to amend their registration statements to remove the delaying amendment. The staff stated that registrants could nevertheless remove the delaying amendment, but reiterated that responsibility for complete and accurate disclosure lies with the registrant and others involved in the preparation of the registration statement. Finally, new question 9 indicates that issuers may request relief under Rule 3-13 of Regulation S-X, which provides that the SEC may permit the omission of one or more of the financial statements required by Regulation S-X or the filing of appropriate substitute financial statements “where consistent with the protection of investors.” During the shutdown, however, such requests must relate to a demonstrable emergency and the protection of a significant property interest. Whether Rule 3-13 proves useful as a practical matter during the shutdown remains to be seen. Below are (1) the revised text of questions 4 and 5 with new language shown in blue text, and (2) the text of the new questions 6 and 9. Question Answer 4.  If my registration statement was declared effective prior to the shutdown (my effective date was December 26, 2018 or earlier) what happens if I don’t price my offering within the 15-day time period provided in Rule 430A?       Because your registration statement was declared effective prior to the shutdown, you are eligible to use Rule 430A and you may file post-effective amendments, as necessary, under Rule 462(c) to restart the 15-business-day period so that, at the time of pricing you will be able to include the pricing information in a 424(b) prospectus supplement. Post-effective amendments filed pursuant to Rule 462(c) are effective upon filing. Alternately, at the time of pricing, you could file a post-effective amendment under Rule 462(c), prior to the time confirmations are sent or given, to include the information omitted under Rule 430A. NOTE: You cannot rely on Rule 462(c), however, to include the pricing information if the post-effective amendment includes substantive changes from, or additions to, the prospectus in the effective registration statement. 5.  Now that the shutdown is in effect, can I file an amendment to my current registration statement to remove the delaying amendment so my registration statement will be effective in 20 days?                   Yes. If you choose to remove the delaying amendment, your registration statement will not become effective until 20 days have passed. If the SEC’s operational status does not change and you wish to further delay the effective date of your registration statement, you may file another pre-effective amendment during the 20-day period. The registration statement would not become effective until 20 days after the latest pre-effective amendment that does not include a delaying amendment. If the SEC’s operating status changes to operational and your registration statement is not yet effective, we would consider a request to accelerate to an earlier date. We may ask you to amend the registration statement to include the delaying amendment. NOTE: Simply omitting the delaying amendment from an amendment will not begin the 20-day period. [Emphasis added.] A company that intends to remove the delaying amendment must amend its registration statement to include the following language provided by Rule 473(b) - “This registration statement shall hereafter become effective in accordance with the provisions of section 8(a) of the Securities Act of 1933.” It must also amend to include all information required by the form, including the price of the securities it will sell. Rule 430A is not available in the absence of a delaying amendment because Rule 430A is only available with respect to registration statements that are declared effective by the Commission or the staff. 6.  Can I amend to remove the delaying amendment while I have outstanding, unresolved staff comments on my filings?   Yes. As in all situations, responsibility for complete and accurate disclosure lies with the company and others involved in the preparation of a company’s filings. If you amend your filing to remove the delaying amendment and our operating status changes prior to your effective date, we may ask you to amend your filing to include the delaying amendment so that we may work with you to resolve outstanding comments. 9.  Will the Division consider a request for emergency relief under Rule 3-13 of Regulation S-X?           During a lapse in appropriations, the Division’s activities are limited. The Anti-deficiency Act generally prohibits agencies from continued operation in the absence of appropriations, but contains exceptions, one of which is for emergencies involving the protection of property. Thus, an agency may act where there is some reasonable likelihood that the protection of property would be compromised, in some significant degree, by delay in the performance of the function in question. In an emergency where Rule 3-13 may provide relief for registrants, the Division may grant an application where consistent with the limitations discussed below [sic]. Submit requests to CFEmergency@sec.gov and describe the emergency and the significant property interest to be protected.   More information about the SEC's plan of operations and the effect on securities offerings, public company reporting, investment companies, and securities markets during the government shutdown can be found in our prior blog post here: governancecomplianceinsider.com/u-s-government-shutdown-impacts-sec-operations-edgar-and-other-filings-enforcement-and-regulatory-activities/, and also on Dorsey's website here: dorsey.com/newsresources/publications/client-alerts/2019/01/government-shutdown-limits-sec-operations.  

In response to the U.S. government shutdown that began on December 22, 2018, the U.S. Securities and Exchange Commission and its Divisions of Corporation Finance and Investment Management published public guidance regarding the impacts on their operations. Although electronic filings will continue to be accepted in many cases, as described below, nearly all SEC operations, including the review and processing of filings and enforcement and regulatory functions, will be curtailed. Issuers and practitioners should make contingency plans to address the effects upon ongoing or planned securities offerings, filings, and requests for interpretive guidance, among other things. SEC operational status: Government shutdown impact The SEC published its operations plan under a lapse in appropriations and government shutdown (Securities and Exchange Commission, Operations Plan Under a Lapse in Appropriations and Government Shutdown, https://www.sec.gov/files/sec-plan-of-operations-during-lapse-in-appropriations-2018.pdf), which went into effect on December 27, 2018. During the shutdown, the SEC will have limited operations and limited staff. The SEC will retain only an extremely limited number of excepted staff members available to respond to emergencies involving the safety of human life or the protection of property, including law enforcement. Of the approximately 4,400 staff employees, fewer than 300 excepted staff remain in service during the shutdown. In summary, during the shutdown, while SEC systems will continue to accept various electronic filings and submissions, the SEC staff will discontinue: processing and approvals of ‘33 Act filings and registrations, including review and acceleration of effectiveness of registration statements; ongoing enforcement litigation, except for emergency enforcement matters; all non-emergency rulemaking, interpretive advice, and no-action letters; processing new and pending exemptive relief applications; approving applications for registration by investment advisers; processing proposed self-regulatory organization (SRO) rule changes, including NYSE and Nasdaq rule changes; responding to requests for information under the Freedom of Information Act, absent compelling need; responding to tips, complaints, or referrals, although limited staff will attempt to respond to certain critical matters, including allegations of ongoing fraud and misconduct; and responding to complaints, questions, or requests for information. In addition, while the SEC will continue to accept comment letters, the SEC anticipates that there will be delays in posting them to the SEC website. The public reference room will be closed. EDGAR Filings and Rulemaking.  The shutdown will not affect the ability to submit EDGAR filings. Additionally, SEC personnel will be able to process requests for EDGAR access codes and password resets and answer questions about fee-bearing EDGAR filings and other emergency questions regarding EDGAR submissions. The Divisions of Corporation Finance, Investment Management, and Trading and Markets, and the Office of Compliance Inspections and Examinations, however, will not process filings, provide non-emergency interpretive advice, issue no-action letters, or conduct any other normal Division and Office activities. The SEC will discontinue all non-emergency rulemaking and processing new or pending applications for exemptive relief. New or pending registration statements and applications for exemptive relief will not be processed regardless of the status of any review of those filings. The Division of Corporation Finance also published a set of Frequently Asked Questions (FAQs), discussed below, regarding Issuers’ options with respect to new and ongoing securities offerings during the shutdown. Division of Corporation Finance FAQs.  The SEC’s Division of Corporation Finance (CorpFin) has posted on its website additional guidance regarding the impact of the shutdown (See, https://www.sec.gov/page/corpfin-section-landing). A limited number of CorpFin staff members are available during the shutdown to answer questions relating to fee calculations for EDGAR filings, but will not generally be available to respond to other questions. Issuers and their representatives seeking assistance in calculating a filing fee for a filing during the shutdown should submit their requests to CFEmergency@sec.gov. CorpFin also provided a series of FAQs containing guidance with respect to ongoing and new offerings of securities during the shutdown: If a company with an effective registration statement determines it must update the information in its prospectus before commencing its offering, it should not go forward with the offering without updating the prospectus. The company must decide whether it can update the prospectus without filing a post-effective amendment because the staff will not be in a position to declare that amendment effective. Similarly, a company with a previously qualified Form 1-A that must be updated should not go forward with its offering before updating its offering statement. The staff will not be in a position to qualify a post-qualification amendment filed on EDGAR. If a company does not price its offering within the 15-day time period provided in Rule 430A, the CorpFin FAQs indicate the company may file post-effective amendments under Rule 462(c), which are automatically effective upon filing, to restart the 15-business-day period so that, at the time of pricing, the registrant will be able to include pricing information in a 424(b) prospectus supplement. As an alternative, at the time of pricing, the registrant could file a post-effective amendment under Rule 462(c), prior to the time confirmations are sent or given, to include the information omitted under Rule 430A. Registrants should note, however, that a Rule 462(c) post-effective amendment may not include substantive changes or additions to the prospectus in the registration statement at the time it became effective. The CorpFin FAQs indicate that a registrant may file an amendment to a current registration statement to remove the delaying amendment, in which case the registration statement will be effective in 20 days. The CorpFin staff notes, however, that if the SEC’s operating status changes to operational and the registration statement is not yet effective, the staff will consider a request to accelerate to an earlier date or ask the registrant to amend the registration statement to include the delaying amendment. Companies considering this approach should be aware that Rule 430A is not available in the absence of a delaying amendment. As a result, when a company amends a registration statement to remove the delaying amendment, the registration statement and prospectus must also be amended to include all information required by the applicable form, including the price of the securities being offered. A registrant may also file a new registration statement without a delaying amendment during the shutdown. Again, however, the CorpFin staff notes that, if the SEC’s operating status changes during the 20-day period prior to effectiveness, the staff may ask the registrant to amend the document to include a delaying amendment. Investment Adviser Registration Depository (IARD) system.  The SEC’s IARD system will continue to accept filings, including amendments to Form ADV, Form ADV-W, and Form ADV-E filings, but the Office of Compliance Inspections and Examinations will not approve applications for registration by investment advisers and the Division of Investment Management will not provide interpretive advice regarding the Advisers Act, rules or forms or consider applications for exemptive relief under the Advisers Act. As a result, new or pending investment adviser applications will not be processed. Division of Investment Management FAQs.  The SEC’s Investment Management (IM) also posted additional guidance regarding the impact of the shutdown (See, https://www.sec.gov/investment-management). Investment companies can continue to make filings on EDGAR during the shutdown, but the IM staff will not be available to respond to any questions about pending matters, other than answering questions relating to fee calculations for EDGAR filings. The IM guidance notes that a significant percentage of investment companies’ filings, including post-effective amendments to registration statements, become effective automatically either immediately upon filing or following the passage of a certain number of days. These filings will continue to become effective automatically in accordance with the applicable rules. The IM staff will follow the procedures established by Corp Fin, described above, with regard to the acceleration of initial registration statements and other types of filings made by registered investment companies during the federal government shutdown. Questions relating to calculating filing fees should be directed to IMEmergency@sec.gov. Central Registration Depository (CRD) and Transfer Agent Registration Systems.  The CRD system, used for broker-dealer licensing and registration, will continue to accept filings, but the Division of Trading and Markets and the Office of Compliance Inspections and Examinations will not review pending filings, consider new or pending applications or registrations, provide interpretive advice, or issue no-action letters. In addition, the staff will not be available to conduct any other normal Division and Office activities. Electronic Form Filing System (EFFS).  The EFFS will continue to accept submissions by self-regulatory organizations (SROs), but any SRO proposed rule change submitted through EFFS during the shutdown will have as its filing date the next business day after the shutdown has ended and SEC opens for regular business. Days that the SEC is operating under its shutdown plan (i.e. while the lapse in appropriations continues) will not constitute “business days” under Section 19 of the Exchange Act and Rule 19b-4 thereunder. Enforcement/Litigation.  The Division of Enforcement will have only a limited staff, and ongoing litigation, examinations, and investigative work will be suspended, except for limited emergency enforcement matters, including temporary restraining orders and/or investigative steps necessary to protect public and private property, monitoring the SEC’s “tips, complaints, and referrals” system and web-based investor complaint system, and process referrals from SROs and others to identify matters that are emergencies and take follow-up steps relating to such emergencies. The SEC also will continue Market Watch activities and continue to monitor market technology operations and any broker-dealers reported as being in financial distress. Money market fund surveillance and monitoring will also continue. The staff will also continue monitoring any international market developments that might affect the United States. Emergency Contacts.  Page 16 of the SEC’s shutdown plan contains a list of emergency contact telephone numbers and email addresses to reach an extremely limited number of Commission staff members in each office and division who are available to respond to emergency situations.

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.

ISS recently announced the 2019 updates to its proxy voting policies, which can be found here and which will be applied to annual meetings held on or after February 1, 2019. Among the various updates provided by ISS, the following policies are particularly relevant for our clients, because they expand the circumstances in which ISS may recommend votes against director candidates: Absence of Board Gender Diversity. Effective for meetings held on or after February 1, 2020, companies included in the Russell 3000 and S&P 1500 will be subject to greater scrutiny regarding board gender diversity. ISS will recommend a vote "against" or a "withhold" vote for the chair of a company's nominating committee (or other directors on a case-by-case basis) if there are no women on the company's board. ISS will consider certain mitigating factors in the event a company does not have any female directors, including a firm commitment statement in the proxy statement to appoint at least one female director to the board in the near term, the presence of a female on the board at the preceding annual meeting, and other relevant factors that ISS may deem applicable. One rationale for the change is that investors are showing a greater preference for increased boardroom gender diversity, with ISS reporting that only 3% of surveyed investors did not believe that a lack of gender diversity in the boardroom is problematic, while over 80% of surveyed investors believed that a lack of gender diversity is problematic. In addition, ISS reported the results of a recent study that found that female directors are more likely to possess the skills most sought after by boards, including, among other skills, audit, strategic planning, risk management, and corporate social responsibility. Poor Board Meeting Attendance. ISS also codified its approach to poor attendance by directors at board meetings without the director providing a reasonable justification for the director's poor attendance. In this case-by-case approach, ISS will continue recommending votes "against" or a "withhold" vote for directors with poor attendance and will also recommend voting "against" or a "withhold" vote for other directors in the following situations: After three years of poor attendance by any director, ISS will recommend a vote "against" or "withheld" from the chair of the nominating or governance committee. After four years of poor attendance by any director, ISS will recommend a vote "against" or "withheld" from the full nominating or governance committee. After five years of poor performance by any director, ISS will recommend a vote "against" or "withheld" from all director nominees. The policy may apply in certain situations involving non-consecutive years of poor attendance. Management Ratification Proposals. Similar to the new Glass Lewis policy on conflicting & excluded proposals, ISS is codifying its policy to recommend a vote "against" or "withheld" from individual directors, members of the governance committee, or even the full board, when a board asks shareholders to ratify existing charter or bylaw provisions, unless they align with best practice. ISS will take into account the following factors when making its recommendations: the presence of a shareholder proposal addressing the same issue on the same ballot; whether the provision at question was adopted in response to the above-mentioned shareholder proposal; the board's rationale for seeking the ratification of the provision; the disclosure of the actions to be taken by the board if the ratification proposal fails; the level of impairment to shareholder rights caused by the existing provision that the board is seeking to have ratified; the history of proposals on the same provision at prior company shareholder meetings; the company's ownership structure; and whether the board of used ratification proposals to exclude shareholder proposals in the past. The rationale for this policy is that the use of board sponsored proposals to ratify existing charter or bylaw provisions increased significantly during the most recent proxy season in response to the SEC's grant of no-action relief to certain companies that sought to exclude shareholder proposals from the ballot by including a conflicting proposal to ratify a charter or bylaw provision. Lack of Board Responsiveness to Failed Ratification Proposals. ISS will undertake a board responsiveness analysis if a majority of votes were cast against a proposal seeking to ratify an existing charter or bylaw provision at the prior year's meeting and the board fails to act. This change is being made to align this policy with the ratification proposal policy discussed above. Including Five-Year TSR in Initial Screen of Director Performance Evaluations. ISS updated its policy to consider not only one- and three-year, but also five-year, total shareholder returns in the initial screen of whether a company has exhibited sustained poor performance . Previously, five-year TSR was a secondary factor in the analysis. This change is intended to reduce the number of companies that undergo scrutiny for poor performance. In addition to policy changes that may affect ISS's support for director candidates, ISS also updated its financial performance methodology and its voting policies with regard to reverse stock splits and social and environmental proposals: Use of EVA Data in Financial Performance Assessment. During the 2019 annual meeting season, ISS research reports on companies in the U.S. and Canada will feature Economic Value Added (EVA) data as a supplement to GAAP-based measures. Moving into 2020, ISS will consider the inclusion of EVA-based measurements as part of its Financial Performance Assessment methodology. Circumstances in which ISS will Support Reverse Stock Splits. ISS made two changes with respect to the approval of reverse stock splits: First, ISS will recommend a vote "for" a reverse stock split if (1) the number of authorized shares available to the company is also proportionately reduced or (2) the effective increase in authorized shares is equal to or less than the allowable increase calculated in accordance with ISS policy. Second, rather than recommending a vote "against" a reverse stock split proposal that does not include the two factors listed above, ISS will take a case-by-case approach based on several factors, including but not limited to the following factors: (1) whether the company has received a notification of potential delisting from a stock exchange, (2) there is substantial doubt about the company's ability to continue as a going concern without additional financing, (3) the rationale provided by the company, or (4) other factors as applicable. Impact of Significant Controversies on Social and Environmental Proposals. ISS expanded the factors it will examine on a case-by-case approach to social and environmental proposals make clear that it will also consider whether there are significant controversies, fines, penalties or litigation associated with the company's social or environmental proposals.

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.

A recent SEC consent order against The Dow Chemical Company reminds companies that when evaluating whether or not to disclose a payment or benefit to an executive as a perk in a proxy statement, the fact that the item has a tangential business purpose, or is convenient for the company, is insufficient grounds to exclude the item as a perk.  In order to be excluded as a perk, the item must be "integrally and directly" related to the performance of the executive's duties.  Examples of items that typically should be classified as perks include country club memberships for mixed business and personal use, commuting expenses, and personal guests who join a business flight on the corporate jet. While companies may perceive individual perks as insignificant or as justifiable business expenses, these items can be significant in the aggregate, in hindsight and through a regulatory lens.  The consistent failure to disclose perks over a period of years may result in Commission sanctions and negative publicity, particularly for larger public companies and for companies who for a variety of reasons are the subject of closer Commission scrutiny. As background, on July 2, 2018, the SEC entered into a consent order against Dow, settling claims that from 2011 through 2015, the company did not adequately evaluate and disclose approximately $3 million in executive perks as "other compensation" in its proxy statements.  These authorized but undisclosed perks included personal use of the Dow aircraft and other expenses.  The consent order notes that though Dow applied procedures regarding the evaluation and disclosure of its executives' perks, it did not follow the Commission's standard regarding disclosure of perks, which provides that: • An item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive’s duties. • Otherwise an item is a perquisite or personal benefit if it confers a direct or indirect benefit that has a personal aspect without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees. Instead, the consent order finds, Dow incorrectly applied a standard whereby a business purpose related to the executive’s job was sufficient to determine that a benefit would not be a perquisite that required disclosure. Notably, the consent order also sanctions Dow for its disclosure controls.  According to the order, Dow did not adequately train employees in key roles, including those tasked with drafting the CD&A section of the proxy statement and compiling the executive compensation tables, to ensure that the proper standard was applied for perks disclosure.  Dow also had inadequate processes and procedures to ensure proper reporting of perks.  In addition to a $1.75 million penalty, the consent order requires Dow to hire an independent consultant for one year to review and make recommendations on Dow's policies, procedures, controls and training related to the evaluation of whether payments and other expense reimbursements should be disclosed as perks under securities laws.  

The SEC announced that it has voted to amend the definition of "smaller reporting company," or "SRC," expanding the population of companies that qualify for a range of scaled (reduced) disclosure requirements. The rules will become effective 60 days after publication in the Federal Register. Examples of scaled disclosure include that SRCs, in their annual reports on Form 10-K, are not obligated to include risk factors, and selected and supplementary financial data. They may include only two years of income statements (vs three years) and a comparison of two years (vs three years) of financial results. In their proxy statements, SRCs are not required to include a CD&A, CEO pay ratio and certain executive compensation tables. They may include fewer NEOs, and only two years of compensation in the Summary Compensation Table. Under the new definition, companies with a public float of less than $250 million (vs $75 million) will qualify as SRCs. A company with no public float or with a public float of less than $700 million will also qualify as an SRC if it had annual revenues of less than $100 million (vs $50 million) during its most recently completed fiscal year. Commission staff estimates that 966 additional companies will be eligible for SRC status in the first year under the new definition. The SEC released the following summary of the amendments to the definition of an SRC:   Criteria Previous SRC Definition Revised SRC Definition Public Float Public float of less than $75 million Public float of less than $250 million Revenues Less than $50 million of annual revenues and no public float Less than $100 million of annual revenues and no public float, or public float of less than $700 million For purposes of determining whether or not it is an SRC, a reporting issuer (vs. a non-reporting issuer filing its first registration statement) must measure its public float annually, on the last trading day of the second fiscal quarter of the previous fiscal year. Qualifying issuers are then eligible to use scaled disclosure rules for the first quarterly report on Form 10-Q for the fiscal year following the determination. Newly eligible SRCs may "early adopt" those rules for the quarterly report immediately following the determination. Once a company fails to qualify as an SRC, it may continue to report under SRC disclosure requirements through the end of that fiscal year. However, in order to re-qualify as an SRC, the company must meet more stringent qualification thresholds. The subsequent qualification thresholds, set forth in the table below, are set at 80% of the initial qualification thresholds in the table above. Criteria Previous SRC Definition Revised SRC Definition Public Float Public float of less than $50 million Public float of less than $250 million Revenues Less than $40 million of annual revenues and no public float Less than $80 million of annual revenues, if it previously had $100 million or more of annual revenues; and Less than $560 million of public float, if it previously had $700 million or more of public float. It is worth noting that a company may qualify as an SRC, but still be an accelerated filer. The amendments do not change the threshold in the “accelerated filer” definition that requires, among other things, that filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting. However, the SEC staff has begun to formulate recommendations to the Commission for possible additional changes to the “accelerated filer” definition to reduce the number of companies that qualify as accelerated filers. In addition to amendments to the definition of "smaller reporting company," the SEC also adopted amendments to Rule 3-05(b)(2)(iv) of Regulation S-X, in order to increase the net revenue threshold in that rule from $50 million to $100 million. As a result, companies may omit financial statements of businesses acquired or to be acquired for the earliest of the three fiscal years otherwise required by Rule 3-05 if the net revenues of that business are less than $100 million.

As companies prepare their Form 10-K and proxy statement disclosures, they will be challenged with disclosing the impact of the Tax Cuts and Jobs Act on performance results for the purposes of financial reporting as well as for compensation measurement. Here is a short list of issues to be aware of. Form 10-K Disclosure Implications of Tax Reform: Sections in the MD&A likely to be affected by tax reform include the discussion of operating results and financial condition and discussion of critical accounting estimates. Companies also are adding or modifying their risk factors to acknowledge the impact of the Tax Cuts and Jobs Act. In the MD&A, companies are required to describe any “known trends or uncertainties that have had or that the company reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” There are comparable requirements for known trends or uncertainties impacting liquidity and capital resources. Companies should be prepared to assess the potential impact of tax reforms including: Reduction of top corporate tax rate from 35% to 21% beginning in 2018 Capital expenditure deductions: Expensing of new and qualified property placed in service after September 27, 2017, through 2022 Limit on net interest deductions to 30% of EBITDA Net operating loss (NOL) deduction limited to 80% of taxable income with indefinite carryforward; carrybacks generally eliminated R&D expenditures paid or incurred after 2021 must be capitalized and amortized over a five-year period Adoption of a territorial tax regime: foreign source portion of a qualified dividend received by a 10% U.S. corporate shareholder is exempt from U.S. tax Deemed repatriation: 15.5% tax on post-1986 foreign earnings held in cash and an 8% rate on all other post-1986 earnings To the extent that companies use reasonable estimates of the tax reform impact in their disclosure in accordance with SAB 118, they may want to caution readers that they are in the process of determining the actual impact, and that their reasonable estimates are based on provisional amounts that may be adjusted upon obtaining, preparing, or analyzing additional information. Proxy Disclosure Implications of Tax Reform: Changes to Internal Revenue Code Section 162(m) will eliminate deductibility of compensation for “covered employees” (including now the CFO) over $1 million, even for qualified, performance-based compensation. However, arrangements in place before November 3, 2017, and that are not materially modified will be grandfathered; IRS guidance is forthcoming. Disclosure and governance considerations include: CD&A Disclosure: 162(m) deductibility will still be a relevant discussion for past awards and grandfathered awards and for distinguishing what’s deductible vs not deductible. CD&A Disclosure: Discuss tax reform impact on performance results, and whether those results are adjusted to exclude the impact of tax reform for compensation purposes (e.g., revaluation of deferred tax asset or deferred tax liability based on new corporate tax rate may result in a big non-cash gain or loss in Q4 of 2017). CD&A Disclosure: Elimination of 162(m) deductibility is a significant change for compensation programs going forward and may impact compensation design. D&O questionnaires: Continue to confirm that compensation committee members qualify as “outside” directors for purposes of certifying grandfathered awards and for certifying vesting of grandfathered performance awards. Covered employees: A “covered employee” will now be anyone who has ever been the CEO, CFO, or one of the three most highest compensated officers in any fiscal year beginning after December 31, 2016. Thus, the new rule is essentially “once a covered employee, always a covered employee.” If possible, employers should not structure one-off payments that would cause an individual to become one of the three highest compensated officers in a particular year, when he or she typically would not be one in other years. In addition, employers should track “covered employees” and their compensation arrangements.

On Tuesday, December 12, Dorsey will present our annual review of developments and disclosure requirements for the upcoming proxy season, including practical advice on how to prepare your proxy statement and annual report in 2018. Click here for more information or to register to attend in-person or via webinar: https://sites-dorsey.vuture.net/76/665/november-2017/12-12-preparing-for-the-2018-proxy-season(2).asp.

Following the 2016 election, corporate governance circles have focused intently on what will happen in the nation’s capital with regard to a potential roll back of the current regulatory regime. While attention given to Congress and the SEC for the possible direction of corporate governance is not misplaced, future changes in this arena will most likely come from investors, and they have their own agenda which is very different from that of the Trump administration. Regardless of, or perhaps in response to, any changes in the U.S. governance regulatory framework, investors and groups of investors are likely to continue to push for actions and disclosures beyond what is mandated and will use the their voting power to effect change. Public companies should also anticipate increased demand for the use of metrics and related disclosures that facilitate comparison, including in non-traditional performance areas such as certain environmental, social and governance matters where investors see a strong tie to long-term value creation. Read the full article here, as posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation.

For U.S. and Canadian companies with annual meetings to be held between September 16, 2017, and January 31, 2018, the window for alerting Institutional Shareholder Services (ISS) about changes to self-selected peer groups used for executive compensation benchmarking closes this Friday, July 21st, at 8:00 pm EDT. Information on self-selected peer groups may influence ISS as it constructs the peer groups that it uses in its pay for performance analysis in its voting reports. According to the ISS press release, companies that have made no changes to their previous proxy-disclosed executive compensation benchmarking peers, or companies that do not wish to provide this information in advance, do not need to participate. For companies that do not submit changes, the proxy-disclosed peers from the company’s last proxy filing will automatically be factored into ISS’ peer group construction process. More information on ISS’ peer group selection process, including a link to the form for submitting peer group changes, is available here.

This week, during his opening remarks at the 2017 National Conference of the Society for Corporate Governance, SEC Commissioner Michael Piwowar remarked on prospects for repealing or delaying the CEO pay ratio rule. Under the rule, most public companies must disclose the median of the annual total compensation of all employees (including non-U.S., part-time, temporary and seasonal workers), except for the CEO; the annual total compensation of the CEO; and the ratio of the two amounts, as calculated under proxy rules. The disclosure must be prepared for fiscal years beginning on or after January 1, 2017, which would be disclosed in 2018 proxy statements. Emerging growth companies, smaller reporting companies and foreign issuers are not subject to the rule. Commissioner Piwowar expressed his support for repealing the rule, which would require Congressional action. In terms of delaying effectiveness of the rule, he stated that public commentary would determine whether that alternative is feasible in light of the associated costs and benefits of implementing the rule. Though the latest comment period on the rule has ended, he urged interested parties to continue to submit comment letters describing specific reasons why the rule is burdensome, as well as proposed fixes. During the latest comment period, the SEC received approximately 180 unique comments, with 150 of those comments in favor of the rule. Given the approaching 2018 proxy season, we advise companies not to count on a repeal or delay of the rule. Companies should continue preparing for the CEO pay ratio disclosure, and keep in mind that there is significant latitude for how the ratio may be calculated, in accordance with Item 402(u) of Regulation S-K and related guidance in C&DIs 128C.01-128C.05. In particular: The median employee, which must be identified once every three years absent a significant change, may be identified from a survey of the entire employee population, a statistical sample or other reasonable method. A de minimis exemption allows companies to exclude non-U.S. employees who account for 5% or less of their employees, including employees whose inclusion would result in a violation of foreign privacy data laws. If certain employees are excluded, then all employees from that jurisdiction must be excluded. Companies may use a consistently applied compensation measure (“CACM”) other than annual total compensation to identify the median employee, as long as the CACM reasonably reflects the annual compensation of employees. For example, total cash compensation could be a CACM unless the company also distributed annual equity awards widely among its employees. Companies may select a determination date within three months prior to the end of their fiscal year, in order to determine employee population from which to identify the median. In applying the CACM to identify the median employee, companies are not required to use a compensation period that includes the determination date. Nor are they required to use a full annual period. As an example, the SEC states that a company may use annual total compensation from its prior fiscal year so long as there has not been a change in the registrant’s employee population or employee compensation arrangements that would result in a significant change of its pay distribution to its workforce. Workers whose compensation is determined by an unaffiliated third party may be excluded from the pay ratio calculation. This population may include leased workers, independent contractors who determine their own compensation, and even workers whose minimum level of compensation is set by the company. Companies should consider testing alternative methodologies in order to assess the quality and consistency of results. While there is considerable latitude to design a pay ratio methodology, companies should let reason be their guide and be prepared to explain the decisions that they make. Companies are required to describe in their proxy statements the methodology used, as well as any material assumptions, adjustments and estimates. Not surprisingly, CEO pay ratios have varied significantly depending on the companies surveyed and the methodology. The AFL-CIO’s annual report on CEO pay calculated a CEO-to-worker-pay ratio of 347-to-1 for 2016, based on the average total compensation package for 400 of the S&P 500 CEOs of $13.1 million last year, and the average annual cash income only (excluding fringe benefits) for America’s 100,525,000 rank-and-file workers of $37,632. In contrast, a 2016 Mercer study found the ratio among respondents to be less than 200-to-1.

As the 2017 proxy season winds down, one clear take-away is that shareholder proposals attempting to modify the terms of previously adopted mainstream proxy access bylaws did not fare well. Many of these proposals focused solely on the aggregation limit, seeking to increase the number of shareholders (usually 20) that are required to meet the minimum ownership threshold (usually 3% of outstanding shares) in order to nominate a director using the company’s proxy statement. Other proposals tried to amend multiple terms of the proxy access bylaw in order to make the provisions more shareholder-friendly. To date, none of these so-called “fix-it” amendments to mainstream proxy access provisions has received majority support, and the average support for all such proposals has been less than 30%. In addition, some companies were able to exclude proposals to amend the aggregation limits from their proxy statements by making a case under the SEC no-action process that the proposal had been “substantially implemented” where the company could provide specific information to support the view that it already had a meaningful proxy access right in place. Other companies facing fix-it amendments to multiple provisions were successful in excluding the proposal as “substantially implemented” where the company acted to adopt one or more of the amendments. See our prior memo here: Recent Developments in Proxy Access. Meanwhile, the trend of adopting mainstream proxy access provisions continues apace. Approximately 175 additional companies have adopted proxy access provisions since the end of the 2016 proxy season, and virtually all shareholder proposals seeking the adoption of proxy access bylaws have received majority support this year. More than 60% of companies in the S&P 500 now have some form of proxy access provision. The mainstream model adopted by a broad range of these companies allows shareholders owning 3% of shares outstanding for at least 3 years to nominate up to 20% of the board (or at least two members) with an aggregation limit of 20 shareholders to reach the ownership threshold. The ability of the mainstream model to withstand fix-it shareholder proposals this proxy season bodes well for this approach and may discourage fix-it proposals in future years.