Governance & Compliance Insider

On March 9, 2017, the Senate Banking Committee passed a series of four bills focused on deregulation, including one that would make it easier for privately held companies to issue stock awards through equity compensation plans. Each of the bills was a bipartisan effort. One bill eases certain restrictions on reporting on exchange traded funds (ETFs). The bill would address securities laws and regulations that discourage broker-dealers from publishing research on ETFs by directing the Securities and Exchange Commission (SEC) to provide a safe harbor for research reports that cover ETFs. The second bill proposes to ease reporting thresholds for privately held corporations when issuing stock awards. Currently, under Item 701 under the Securities Act of 1933, as amended, if the sales price or amount of securities sold in any 12-month period under a private company’s equity compensation plans exceeds $5 million, then the company must provide certain information to the holders of the equity compensation securities, which many companies consider onerous and inappropriate for a privately held corporation. The bill would increase that threshold to $10 million and have it adjusted for inflation. A third bill would raise to 250 from 100 the number of investors venture capital funds can acquire before triggering SEC registration requirements under the Investment Company Act of 1940, as amended. The final bill would credit stock exchanges for any fees they have overpaid the SEC. The bills have been reported to the Senate, placed on the Senate legislative calendar and are awaiting further action by the Senate. Companion bills in the House are moving through the House Finance Committee.

On March 1, 2017, the United States Securities and Exchange Commission (SEC) published the taxonomy for the eXtensible Business Reporting Language (XBRL) for financial statements prepared in accordance with International Financial Reporting Standards, as issued by the International Accounting Standards Board (IFRS). Accordingly, foreign private issuers that prepare their financial statements in accordance with IFRS may immediately begin submitting their financial statements in SEC filings in the XBRL format. While Rule 405 of Regulation S-T would require foreign private issuers that prepare their financial statements in accordance with IFRS to submit financial data in XBRL upon publication of the taxonomy, the SEC has stated that such foreign private issuers are only required to submit financial data in XBRL with their first annual report on Form 20-F or 40-F for a fiscal period ending on or after December 15, 2017. Therefore, foreign private issuers who prepare their financial statements in accordance with IFRS are not required to submit XBRL data for the fiscal year ended December 31, 2016. The full text of the SEC’s release can be found at the following link: https://www.sec.gov/rules/other/2017/33-10320.pdf See our previous postings on the topic here: SEC delays XBRL compliance for foreign private issuers that prepare their financial statements in accordance with IFRS SEC Mandates Use of XBRL for Financial Statements

We reported in September 2016 on proposed Securities and Exchange Commission rules requiring the use of hyperlinks to exhibits in most registration statements and periodic and current reports. On March 1, 2017, the SEC adopted final rules, largely in line with the proposed rules, amending Item 601 of Regulation S-K and Rules 102 and 105 of Regulation S-T. Read more in our eUpdate here: https://www.dorsey.com/newsresources/publications/client-alerts/2017/03/sec-adopts-use-of-exhibit-hyperlinks-in-filings

In a recent case, Wadler v. Bio-Rad Laboratories, Inc. case number 3:15-cv-02356 (2016), the federal court in the Northern District of California ruled that the plaintiff and former general counsel of Bio-Rad Laboratories could use attorney-client privileged information to support his claim of whistleblower retaliation. The court determined that the Sarbanes-Oxley Act’s whistleblower protections preempt the state ethical rules against disclosure of attorney-client privileged information. In reaching its determination, the court noted that this ruling reflects “a reasonable balancing of conflicting policies to the extent that it protects attorney whistleblowers from retaliation even as it requires them to report violations.” The jury awarded the plaintiff $8 million, including $5 million in punitive damages, finding that the plaintiff’s report of suspected payments in violation of the Foreign Corrupt Practices Act was a substantial motivating factor in Bio-Rad’s decision to terminate him in 2013 after serving as Bio-Rad’s general counsel for nearly 25 years. The SEC filed an amicus brief in support of the plaintiff’s claim, arguing that the federal whistleblower scheme would be “seriously undermined” if attorney-client privilege prevents attorney-whistleblowers from using their reports of potential violations as evidence in anti-retaliation litigation. The Wadler decision may signal a shift in judicial attitude toward the protections afforded in-house attorneys who act as whistleblowers. Previously, courts have not permitted attorney whistleblowers to use attorney-client privileged materials in litigation against their former employers. For example, in 2013, the Second Circuit Court of Appeals ruled that a former general counsel violated New York Rules of Professional Conduct when he used attorney-client privileged materials as evidence in a whistleblower retaliation suit (United States ex rel. Fair Laboratory Practices Associates v. Quest Diagnostics Inc.). The SEC has indicated a willingness to consider the extent of retaliation that a whistleblower suffers when determining the amount of the whistleblower award. In 2015, the SEC announced a maximum whistleblower award payment of 30% of the amounts collected in connection with In the Matter of Paradigm Capital Management, Inc. and Candace King Weir, File No. 3-15930 (June 16, 2014) because the whistleblower was retaliated against as a result of reporting to the SEC. If other courts follow the precedent established in Wadler, employees in general, and in-house attorneys in particular, may find it easier to support claims of whistleblower retaliation.

On February 14, 2017, President Trump approved a joint resolution of Congress that disapproves the SEC’s rule requiring specific disclosures by resource extraction issuers, effectively repealing the rule. The rules required resource extraction issuers to disclose payments made to the U.S. federal government or foreign governments, including foreign subnational governments, for the commercial development of oil, natural gas or minerals. Compliance under the rules for resource extraction issuers would have begun for fiscal years ending on or after September 30, 2018. The quick death of these rules are somewhat ironic given the time and energy taken to adopt them in the first place. Consider the timeline: 2010 - Dodd-Frank Wall Street Reform and Consumer Protection Act enacted, which mandated the implementation of the resource extraction rules 2012 - First set of rules adopted 2013 - Rules vacated by the U.S. District Court for the District of Columbia 2015 - After Oxfam America Inc. brought suit in an effort to expedite the long-delayed rules, a federal judge held that the SEC had “unlawfully withheld” agency action by failing to promulgate final rules on this topic 2015 - SEC re-proposes rules 2016 - SEC adopts final rules 2017 - Rules disapproved under the Congressional Review Act While the mandate to implement these rules still exists under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Congressional Review Act bars the enactment of a new rule that is substantially in the same form as the repealed rule. These rules, like the conflict minerals rules, attempted to further social policy through public company disclosure requirements. The aim here was to promote and support “global efforts to improve transparency in the extractive industries . . . to help combat global corruption and empower citizens of resource-rich countries to hold their governments accountable for the wealth generated by those resources.” While the goal is a worthy one, it was unclear whether the disclosure required by these rules would effectively and efficiently advance that goal. Congress and the White House were concerned with the regulatory burden and competitive disadvantage that these rules imposed. The White House’s Statement of Administration Policy noted that the “rule would impose unreasonable compliance costs on American energy companies” and could put American resource extraction issuers at a “competitive disadvantage in cases where their foreign competitors are not subject to similar rules.” Reducing the regulatory burden on public companies is both useful and necessary. However, there is one unfortunate aspect of this repeal. The rules provided for alternative reporting, so that issuers could comply with SEC disclosure obligations with a report complying with the requirements of an alternative reporting regime, such as Canada’s Extractive Sector Transparency Measures Act and the EU Accounting Directive and the EU Transparency Directive. For companies with operations in multiple jurisdictions, the recognition of an alternative reporting regime was a welcome attempt to address concerns of duplicative reporting requirements and implement mandated rules in a more efficient and cost-effective way for many issuers. This allowance was similar in concept to the Canadian Multi-Jurisdictional Disclosure System (the MJDS), a widely used alternative reporting regime for certain types of Canadian issuers. Successful implementation and use under an alternative reporting regime under the repealed rules by a wide variety of resource extraction issuers might have nudged the SEC to consider broader use of alternative reporting systems. On the whole, the repeal of resource extraction issuers is a positive development. Now if we could just eliminate the conflict minerals disclosure rules and the CEO pay ratio rules...

On January 6, 2017, the SEC Staff granted no-action relief that would allow companies to exclude shareholder proposals preventing management or the board from accessing preliminary voting results on uncontested matters prior to the annual meeting, including a running tally of votes for and against, and using that information to solicit votes. See, The Boeing Company, Ferro Corporation, Honeywell International Inc., L-3 Communications Holdings, Inc., NiSource Inc., and Praxair, Inc. Under the shareholder proposals, this enhanced confidential voting requirement would apply to management or board-sponsored resolutions seeking approval of executive pay or for other purposes, including votes mandated under applicable stock exchange rules; proposals required by law, or the company’s bylaws, such as say-on-pay votes; and Rule 14a-8 shareholder proposals included in the proxy. The proposals would not apply to director elections, or contested proxy solicitations, except at the board’s discretion, and they would not prevent companies from monitoring voting for purposes of achieving a quorum.  In its no-action letters, the companies cited a history of relief granted for shareholder proposals that seek to restrict management’s access to preliminary voting results, to manage the conduct of annual shareholder meetings, and to restrict a company’s solicitation of its shareholders. The Staff concluded that the companies may rely on the “ordinary business” basis for exclusion under Rule 14a-8(i)(7), and noted that each proposal “relates to the monitoring of preliminary voting results with respect to matters that may relate to [the company’s] ordinary business.”  The Staff does not conclude that the monitoring of preliminary voting results and the solicitation of votes per se are part of ordinary business operations, which leaves open the question of whether the proposals would survive if they were limited to matters that the Staff deems unrelated to the company’s ordinary business.  This series of no-action letters represents the latest volley in the debate over the disparity between boards and management versus shareholder proponents, in terms of their ability to access voting information and to communicate with shareholders on proposals. As described in the 1998 amendments to Rule 14a-8, the underlying policy of the “ordinary business” basis for exclusion is “to confine the resolution of ordinary business problems to management and board of directors, since it is impracticable for shareholders to decide how to solve such problems at an annual shareholders meeting.” There are two frequently cited considerations for evaluating whether an activity is within the ken of “ordinary business”: (1) whether the tasks are “so fundamental to management’s ability to run a company on a day-to-day basis that they could not, as a practical matter, be subject to direct shareholder oversight,” and (2) whether the proposals seek to “micro-manage” the company by “probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.”

For public companies whose fiscal year is the calendar year, the 10-K season is quickly approaching. One technical change to Form 10-K this year is the addition of new Item 16 (Form 10-K Summary). As you may recall, the Fixing America's Surface Transportation Act, more commonly known as the FAST Act, which became law in December 2015, was primarily a transportation bill, but also contained a number of changes to the federal securities laws. One of the FAST Act’s securities law provisions instructed the SEC to issue regulations, within 180 days of the FAST Act’s enactment, that would permit issuers to submit a summary page on Form 10-K, but only if each item on that summary page included a cross-reference (by electronic link or otherwise) to the material contained in the Form 10-K to which that item related. Accordingly, in June 2016, the SEC adopted an interim final rule that expressly allowed issuers to include, at their option, a summary page in their Form 10-Ks. As noted in the SEC’s adopting release, prior to the enactment of the FAST Act, nothing prohibited issuers from voluntarily including a summary page in their Form 10-Ks. And, because both the FAST Act and the interim final rule required that any summary page included in a Form 10-K meet certain specified requirements, an issuer actually had more flexibility regarding the content of any summary page it chose to include in its Form 10-K prior to the SEC’s adoption of the interim final rule. In any event, historically, most issuers have not included a summary page in their Form 10-Ks, and we do not expect this to change in the near term. However, as a technical matter, when issuers file their Form 10-Ks this year, they should remember to include new Item 16 (Form 10-K Summary) at the end of Part IV. Most of the issuers that have thus far included new Item 16 in their Form 10-K filings, but that have not included a summary page, have inserted “none” for this item.

2016 was a busy year for securities law developments, with the SEC adopting and proposing new rules and issuing significant interpretations that will affect SEC reporting companies in the coming years. We have highlighted a few of these recent developments in this post as companies prepare for the upcoming reporting cycle. With the new incoming U.S. administration it is important to note that some of the rules that were adopted by the SEC in the past few years may be repealed or amended, and some of the rules that are currently being finalized by the SEC may not be adopted or may be further modified or delayed. New Rules and Interpretations Proxy Cards – “Clear and Impartial” On March 22, 2016, the SEC released a proxy card interpretation, which serves as a reminder that proxy cards must “clearly and impartially” identify each item to be voted on by shareholders. The full text of the SEC’s interpretation can be found here: https://www.sec.gov/divisions/corpfin/guidance/exchange-act-rule-14a-4a3-301.htm Paper Copies of Annual Reports On November 3, 2016, the SEC released an interpretation which stated that companies may post an electronic version of its annual report to shareholders on its corporate web site by the dates specified in Rule 14a-3(c), Rule 14c-3(b) and Form 10-K, respectively, in lieu of mailing paper copies or submitting it on EDGAR. The report must remain accessible for at least one year after posting. See our previous post on this topic here: http://governancecomplianceinsider.com/sec-staff-makes-life-a-little-easier-for-reporting-companies-by-permitting-annual-reports-to-shareholders-to-be-posted-on-company-websites/ NASDAQ Golden Leash On July 1, 2016, the SEC approved a change to the NASDAQ Listing Rules that will require NASDAQ listed companies to publicly disclose “golden leash” arrangements. “Golden leash” arrangements are generally defined as agreements or arrangements made by activist shareholders to pay a director or director nominee in connection with his or her service on, or candidacy for, a company’s board of directors, usually in connection with a proxy fight. The final rules for “Golden Leash Arrangements” are described further in our complete summary here: https://www.dorsey.com/newsresources/publications/client-alerts/2016/07/disclosure-of-golden-leash-arrangements Form 10-K Summary Disclosure On June 1, 2016, in accordance with the Fixing America’s Surface Transportation Act (the “FAST Act”), the SEC issued an interim final rule amending Form 10-K by adding a new Item 16 to permit companies to provide certain summary disclosure in the annual report, provided that each item in the summary includes a cross-reference by hyperlink to the related more detailed disclosure in the report to which the item relates. The new summary section is not required and the SEC has provided issuers with flexibility on how best to prepare the summary. The full text of the SEC’s interim final rule can be found at the following link: https://www.sec.gov/rules/interim/2016/34-77969.pdf The FAST Act is further described in our summary here: https://www.dorsey.com/newsresources/publications/client-alerts/2015/12/fast-act-company-disclosure-capital-markets-access Non-GAAP financial measures On May 17, 2016, the SEC issued new interpretations regarding the use of non-GAAP financial information by public companies. The new interpretations provide specific guidance for certain types of non-GAAP financial information including providing examples on how to describe GAAP measures with equal or greater prominence and how to avoid making non-GAAP measures misleading. See our summary here: https://www.dorsey.com/newsresources/publications/client-alerts/2016/05/tighten-use-of-non-gaap-financial-measures Pay Ratio Disclosure Most public companies will be required to make the pay ratio disclosure following their first full fiscal year beginning on or after January 1, 2017. For a typical, calendar-year reporting company, the first pay ratio disclosure would be made in its proxy statement for its 2018 annual meeting. The SEC released an interpretation on October 19, 2016 to provide additional guidance on the upcoming disclosure requirements. For a summary of the interpretations see our discussion here: https://www.dorsey.com/newsresources/publications/client-alerts/2016/10/new-cdis-help-issuers For a discussion of the final rules see our summary here: https://www.dorsey.com/newsresources/publications/client-alerts/2015/08/sec-issues-final-rule-for-pay-ratio-disclosure Disclosure of Government Payments by Resource Extraction Issuers On June 27, 2016, the SEC adopted rules requiring disclosure of government payments by resource extraction issuers.  The rules will require resource extraction issuers to disclose payments made to the U.S. federal government or foreign governments, including foreign subnational governments, for the commercial development of oil, natural gas or minerals. Resource extraction issuers are required to comply with the new rules starting with their fiscal year ending no earlier than September 30, 2018.  A resource extraction issuer with a December 31 fiscal year end will be required to file its first resource extraction payment report no later than 150 days after December 31, 2018, which is May 30, 2019. The full text of the final rules are found here: https://www.sec.gov/rules/final/2016/34-78167.pdf Proposed Rules Mining Disclosure Rules The SEC proposed new rules relating to disclosure by companies engaged in material mining operations in SEC reports. The proposed rules were subject to a comment period that was extended to September 26, 2016. The SEC is in process of reviewing the comments and we anticipate that new proposed rules or final rules will be released in 2017. The proposed rules are summarized here: https://www.dorsey.com/newsresources/publications/client-alerts/2016/07/new-mining-disclosure-rules Clawback Policies On July 1, 2015, the SEC proposed rules regarding clawback policies and disclosure, requiring the recovery of incentive-based compensation of officers in cases of material non-compliance with accounting reporting requirements. The SEC received comments on the proposed rules and the SEC is in the process of drafting new rules. We anticipate that new rules will be adopted in 2017. The proposed rules are summarized here: https://www.dorsey.com/newsresources/publications/client-alerts/2015/07/sec-issues-proposed-rules-for-clawback-policies Proxy Cards – Universal Ballots On October 26, 2016, the SEC proposed the mandated use of universal ballots in contested director elections at annual meetings. A universal ballot or proxy card is a single proxy card that includes the names of both management and dissident nominees. The universal ballot would allow shareholders to vote for any combination of director nominees using one proxy card. The proposed rules are summarized here: https://www.dorsey.com/newsresources/publications/client-alerts/2016/10/sec-proposes-universal-ballots

Last Friday, ISS released new and updated FAQS on U.S. Equity Compensation Plans, as summarized below. These FAQs provide new and updated guidance on ISS’s evaluation of equity compensation plan proposals, including treatment of performance-based awards in burn rate calculations, bundling of plan amendment proposals, updates to ISS’s Equity Plan Scorecard (EPSC) policies, and the EPSC as it applies to newly public companies. Since 2015, ISS has evaluated proposals for equity compensation plans and certain amendments to these plans using the EPSC. The ESPC analysis is based on three pillars: Plan cost ("shareholder value transfer" or SVT), relative to the company's market and industry peers, Plan features, and The company's historical grant practices, including its 3-year average burn rate relative to market and industry peers. ISS scores proposals according to factors under each of these three pillars, using its proprietary model. Proposals may receive a maximum of 100 total points, with a threshold of 53 points required to receive a favorable recommendation (absent egregious factors). Summary of New and Updated FAQs 19. If a company grants performance-based awards, how will the shares be accounted for the purposes of calculating burn rate? Both time- and performance-based awards will be counted in the year in which they are granted for the burn rate calculation, but performance-based awards will be counted in the year in which they are earned if the company provides a table of awards granted and earned each year for the past three years, either in the 10-K or proxy statement. There’s a sample table in the FAQ. The aggregate of performance-based awards from all plans to all participants must be disclosed, and not just awards for NEOs. For performance awards that are subject to additional time vesting, the shares generally will be counted at the end of the time-vesting period if the number is disclosed. ISS advises companies to continue to make the additional disclosure, so that ISS may capture performance awards going forward and to provide a clear view of the year-to-year status of the performance award program. 28. How does ISS evaluate an equity plan proposal seeking approval of one or more plan amendments? If the proposed amendments do not request additional shares (or other modifications deemed to potentially increase cost), ISS will make a recommendation based on an analysis of whether the amendments are deemed to be “overall beneficial or contrary to shareholders’ interests.” If the proposed amendment is bundled with a material new share request (or are deemed to potentially increase cost), or this is the first time shareholders may vote on the plan, then ISS generally will support the amendments if there is a passing EPSC score, unless the amendments represent a “substantial diminishment to shareholders’ interests.” ISS will generally support proposals seeking approval of performance measures for Section 162(m) tax deductibility purposes, unless they are bundled with other plan amendments. For ISS’s treatment of bundled amendments, see FAQ #30. 30. How are proposals that include 162(m) reapproval along with plan amendments evaluated? ISS encourages companies to unbundle plan amendments from proposals seeking 162(m) reapproval, since the latter are generally supported by ISS (see FAQ #28). ISS will analyze bundled amendments to determine whether they are, on balance, positive or negative with respect to shareholders' interests. ISS may consider both an EPSC score and/or the balance of positive and negative impacts from the bundled amendments. 32. How does ISS view a plan amendment to increase the tax withholding rate applicable upon award settlement? This type of amendment is generally viewed as an administrative change neutral to shareholders' interests. However, if the plan contains a liberal share recycling feature (such as recycling of shares tendered as payment for an option exercise, shares withheld to cover taxes, shares added back that have been repurchased using stock option exercise proceeds, and stock-settled awards where only the actual shares delivered are counted against the plan reserve), then a company can mitigate ISS’s concern by providing that only the number of shares withheld at the minimum statutory rate may be recycled, even if the tax withholding is at a higher rate. See also, Nasdaq Doesn’t Require Shareholder Approval of Equity Compensation Plan Amendments to Increase Tax Withholding. 36. What changes were made to the EPSC policy for 2017? Effective for meetings as of Feb. 1, 2017, the following adjustments will apply to EPSC evaluations: Payment of dividends on unvested awards (new factor): Full points will be earned if the equity plan expressly prohibits, for all award types, the payment of dividends before the vesting of the underlying award. Accrual of dividends that are only payable upon vesting is allowed. No points will be earned if this prohibition is absent or incomplete (i.e. not applicable to all award types). Minimum vesting terms (updated factor – see also, FAQ #47): Full points are awarded only if the equity plan specifies a minimum vesting period of one year for all equity awards. Also, no points will be earned if the plan allows for the administrator to reduce or eliminate the one-year vesting requirement. Companies are permitted to carve out 5% of equity awards granted under the plan, which do not have to be subject to the minimum vesting requirement. Burn rate data: For companies with between 33 and 36 months of trading history at the applicable quarterly data download date, the EPSC model index will be based on whether the company has disclosed three years of burn rate data. Special Cases models apply for companies with 32 or fewer months of trading history. Factor scoring adjustment (see also, FAQ #42 and 43): Scoring for certain EPSC factors has been adjusted, though ISS does not provide specifics under its proprietary model. 41. How will equity plan proposals at newly public companies be evaluated? Newly public companies, including recent IPOs, spinoffs, and bankruptcy-emergent companies, may be evaluated under an EPSC model that includes fewer factors. In addition to these FAQS, ISS also released new and updated FAQs on U.S. Executive Compensation Policies and updated Pay-for-Performance Mechanics (which details ISS’s new Relative Pay and Financial Performance Assessment).

The SEC recently issued a no-action letter to Morgan Stanley that will streamline the process for its wealth management clients to participate in IPOs. The SEC said it would not object to Morgan Stanley’s proposed use of conditional offers to buy shares (“COBs”) prior to the effectiveness of IPO registration statements under specific conditions. The no-action request and the SEC’s letter confirm that COBs, if properly implemented, may be used in registered offerings, and when read together, outline detailed procedures to follow in order to use COBs. Read more in our eUpdate here: https://www.dorsey.com/newsresources/publications/client-alerts/2016/12/sec-endorses-use-of-conditional-offers

As the 2017 proxy season begins to unfold, proxy access continues to be a focus of shareholder proposals. Last year, companies that had already adopted mainstream proxy access bylaws, or that were planning to put mainstream proxy access bylaws up for a shareholder vote, were largely successful in being able to exclude shareholder proposals to adopt proxy access bylaws on the grounds that such proposals had already been “substantially implemented.” This year, companies have received a wave of new shareholder proposals seeking to amend their existing proxy access bylaws. Until recently, the SEC staff had generally denied requests to exclude such proposals. In two recent no-action letters, however, the staff has provided relief where the company adopted several of the requested amendments. In addition, for the first time in the United States, a shareholder attempted to use a proxy access bylaw to nominate a director candidate and to have that candidate included in the company’s proxy statement. Read more about these recent developments in our full summary here: https://www.dorsey.com/newsresources/publications/client-alerts/2016/12/recent-developments-in-proxy-access

On November 18, 2016, the SEC’s Division of Corporation Finance issued a set of compliance and disclosure interpretations (“C&DIs”) pertaining to abbreviated debt tender offers, which were the subject of an SEC no-action letter in early 2015. The new C&DIs offer important clarifications regarding abbreviated debt tender offers and the previous no-action letter guidance. Read more in our full summary here: https://www.dorsey.com/newsresources/publications/client-alerts/2016/11/guidance-provided-by-sec

Over the last few months, the SEC has obtained a string of cease and desist orders against SEC reporting companies, both domestic and foreign, to enforce an often overlooked rule adopted under Dodd-Frank.  Rule 21F-17 provides that “[n]o person may take any action to impede an individual from communicating directly with the [SEC] staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement … with respect to such communications”. Many practitioners thought little about this rule until this summer.  In recent cease and desist orders involving Health Net, BlueLinx and Anheuser-Busch InBev, the SEC has made clear that it believes that a confidentiality clause violates Rule 21F-17 if, read on its face, it would prevent an individual from voluntarily communicating with the SEC regarding potential securities law violations (something that is not “required by law”) or if the clause would require the individual to obtain anyone’s consent or provide notice to anyone in order to engage in such communications.  In other words, the SEC now views “standard” confidentiality clauses included in employment, separation, confidentiality and other agreements and policies entered into with employees and other individuals as violating U.S. federal securities laws unless they include a specific carve out allowing whistleblowing. In recent months, the SEC has imposed fines ranging from $250,000 to more than $6 million on companies using such clauses in their agreements, and required such companies to take remedial actions, including informing current and former employees of their right to communicate with the SEC regarding potential securities law violations.  In several cases, the SEC did not allege that any of the affected persons was a whistleblower or had been impeded from being a whistleblower, just that the language used in the agreements was impermissible.  The SEC has also taken the position in recent actions that any purported waiver of an individual’s right to obtain a whistleblower award from the SEC is impermissible. While the cease and desist orders have, to date, been limited to SEC reporting companies, Rule 21F-17 does not appear limited to public companies.  Accordingly, private companies subject to U.S. jurisdiction should also consider their compliance with Rule 21F-17. Because the offending language is language that many consider “standard” for employment, separation, confidentiality and other agreements, as well as corporate governance policies such as codes of conduct and ethics, many companies will need to modify their corporate governance policies and their existing and template agreements to comply with the new interpretations.  We have developed language for confidentiality clauses and corporate governance policies that is intended to comply with the SEC’s new interpretations, and have worked with a number of companies to implement compliance regimes.  For further information or for assistance in complying with Rule 21F-17, please contact the author or your other Dorsey contacts.

ISS has published an executive summary of 2017 updates to its benchmark proxy voting policies for the Americas, EMEA, and Asia-Pacific regions.  The updated policies will generally be applied to shareholder meetings on or after February 1, 2017. U.S. policy changes are summarized below, and companies should keep them in mind as they consider policies on director compensation, dividend and vesting policies for stock awards, and shareholder rights to amend bylaws.  For companies contemplating IPOs, governance structures that have a material adverse impact on shareholder rights, including multi-class shareholder structures, generally will lead to recommendations against director candidates.  It’s worth noting that in certain situations where ISS finds a practice problematic, it will result in ongoing (versus one-time) recommendations against directors (see the last two policies described below). In December 2016, ISS will release a complete set of updated policies, and it will release updated Frequently Asked Questions ("FAQ") documents on certain U.S. policies, including the Equity Plan Scorecard. Non-Employee Director Pay:  While ISS does not evaluate stand-alone non-employee director (“NED”) plans according to its Equity Plan Scorecard he EPSC model, these plans do receive a standard cost evaluation for Shareholder Value Transfer (SVT).  Under the updated policies, NED pay proposals will be evaluated across “a broader range of factors and more nuanced consideration of director pay.”  ISS will assess advisory proposals seeking shareholder approval of NED pay, and certain NED equity plan proposals that are determined to be relatively costly, considering the following, additional qualitative factors: The relative magnitude of director compensation as compared to companies of a similar profile; The presence of problematic pay practices relating to director compensation; Director stock ownership guidelines and holding requirements; Equity award vesting schedules; The mix of cash and equity-based compensation; Meaningful limits on director compensation; The availability of retirement benefits or perquisites; and The quality of disclosure surrounding director compensation. This policy update is consistent with recent judicial scrutiny of director compensation.  In Calma v. Templeton, the Delaware Chancery Court denied Citrix’s motion to dismiss the plaintiff’s breach of fiduciary duty claim against the Citrix board of directors, and furthermore, held that director compensation decisions would be judged by the heightened entire fairness standard (versus the deferential business judgment rule), where the director compensation program did not include “meaningful limits.” Dividends and Minimum Vesting for Stock Awards:  ISS added a factor on dividend payments on unvested awards.  ISS will award full points if the equity plan expressly prohibits dividend payments for all award types before the vesting of the underlying award.  Accrual of dividends payable upon vesting is acceptable.  No points will be earned if this prohibition is absent or incomplete (i.e. not applicable to all award types).  Notably, a company's general practice of not paying dividends until vesting, if it is not memorialized in the plan document, is insufficient to earn full points. The minimum vesting factor was also updated so that an equity plan must specify a minimum vesting period of one year for all award types under the plan in order to receive full points for this factor.  No points will be earned if the plan allows for individual award agreements that reduce or eliminate the one-year vesting requirement. Restrictions on Shareholder Amendments to Bylaws:  ISS will make ongoing recommendations against governance committee members if the company's charter imposes undue restrictions on shareholders' ability to amend the bylaws.  These restrictions include but are not limited to a prohibition on the submission of binding shareholder proposals or ownership/holding requirements for such shareholder proposals that exceed those in the SEC’s Rule 14a-8. IPOs with Multi-Class Shareholder Structures:  If prior to or in connection with a company's public offering, the company or its board adopted bylaw or charter provisions materially adverse to shareholder rights, or implemented a multi-class capital structure in which the classes have unequal voting rights, ISS will generally recommend withhold or against votes on directors individually, committee members, or the entire board (except new nominees, who should be considered case-by-case).  Unless the adverse provision and/or problematic capital structure is reversed or removed, ISS will recommend a vote case-by-case on director nominees in subsequent years.  

On Thursday, December 8, Dorsey will present our annual review of developments and disclosure requirements for the upcoming proxy season. Click here for more information and to register for the event, which will be presented via webinar.

The SEC announced on November 14 that it had made an award of more than $20 million to another whistleblower.  This was the third highest award since the agency began paying them out in 2012, and it brings the total of such awards under the SEC’s program to more than $130 million.  Although the current whistleblower program has been criticized by conservative groups such as the U.S. Chamber of Commerce (in part because it does not require whistleblowers to give notice to their employer at the same time they give it to authorities), the program has relatively broad bi-partisan support and has given rise to a cottage industry of law firms specializing in representing whistleblowers.  Among supporters of whistleblowing generally are Senator Charles Grassley (R-Iowa), a key Trump ally during the presidential campaign, and Congressman Jeb Hensarling (R-Texas), chair of the House Financial Services Committee and chief proponent of legislation that would roll back most of the Dodd-Frank Act’s regulatory provisions.  Hensarling’s proposed legislation, the Financial Choice Act, however, does not touch the existing legislative structure for SEC whistleblower awards.  The Trump transition website calls for dismantling Dodd-Frank, but there are no specific references to whistleblower regulations in the writing on the wall.  So, speculation is widespread that the SEC’s whistleblower program, in some form, will survive the decimation of Dodd-Frank and the demise of its regulatory provisions. It is too soon to say what changes, if any, may be made to the program (for example, adding the simultaneous notice requirement or disqualifying anyone involved in criminal activity from receiving an award, as proposed by the Chamber).  It is also too soon to predict whether the surviving program would be used as forcefully going forward as it has been during the tenure of outgoing SEC Chair Mary Jo White (since the SEC enforcement staff must receive approval from the Commission, which will have a Republican majority, before proceeding with an enforcement action involving a whistleblower reward). Under the current framework, whistleblower awards may range from 10 percent to 30 percent of the money collected when the monetary sanctions exceed $1 million.  Whistleblower award payments are made from an investor protection fund established by Congress that is funded through sanctions paid by securities violators, so no money is taken or withheld from investors to pay the awards.

On November 17, 2016, the SEC issued a new interpretation stating that a company may conduct a generally solicited offering of securities under Rule 506(c) immediately following a completed securities offering made in reliance upon Rule 506(b), without invalidating the prior offering.  The SEC’s new interpretation will give companies more flexibility in their financing plans, allowing them to potentially take advantage of the best of both exemptions.  Many investors and companies prefer to participate in Rule 506(b) offerings, because these offerings do not require the investor to provide the company with detailed tax or other financial information in order to verify that the investor is an accredited investor, and do not require the company to due diligence the investor’s claim of accredited investor status.  However, companies may not always be able to raise sufficient funds from investors that are already known to the company.  Under the new interpretation, a company could complete tranche 1 of a financing with known investors, without engaging in general solicitation, in reliance upon Rule 506(b), relying on representations from the investors that they are accredited investors, and then following the closing of that tranche, begin to generally solicit investors that are not already known by the company, for tranche 2 of the financing in reliance upon Rule 506(c), requiring only the investors in tranche 2 to provide the more detailed tax or financial information required to verify their claim of accredited investor status.  The company would still need to satisfy the other requirements of Rule 506(c), and would need to consider whether any offerings subsequent to the Rule 506(c) offering could potentially be “integrated” with the Rule 506(c) offering. The full text of the SEC’s interpretation is provided below: Question 256.34 Question: An issuer has been conducting a private offering in which it has made offers and sales in reliance on Rule 506(b). Less than six months after the most recent sale in that offering, the issuer decides to generally solicit investors in reliance on Rule 506(c). Are the factors listed in the Note to Rule 502(a) the sole means by which the issuer determines whether all of the offers and sales constitute a single offering? Answer: No. Under Securities Act Rule 152, a securities transaction that at the time involves a private offering will not lose that status even if the issuer subsequently decides to make a public offering. Therefore, we believe under these circumstances that offers and sales of securities made in reliance on Rule 506(b) prior to the general solicitation would not be integrated with subsequent offers and sales of securities pursuant to Rule 506(c). So long as all of the applicable requirements of Rule 506(b) were met for offers and sales that occurred prior to the general solicitation, they would be exempt from registration and the issuer would be able to make offers and sales pursuant to Rule 506(c). Of course, the issuer would have to then satisfy all of the applicable requirements of Rule 506(c) for the subsequent offers and sales, including that it take reasonable steps to verify the accredited investor status of all subsequent purchasers. [November 17, 2016]

On November 17, 2016, Glass Lewis opened enrollment for its 2017 Issuer Data Report (IDR) program.  This program will cover companies in the United States, Canada, United Kingdom, Switzerland, Norway and all EU countries on a first-come, first-served basis.  Space is limited, so the enrollment will close on the earlier of January 6, 2017, or as soon as the annual limit for each of the the markets is reached. There is no charge for the IDR program, which enables public companies to see a data-only version of its Glass Lewis Proxy Paper report prior to Glass Lewis completing its analysis and recommendations relating to the company’s annual shareholder meeting.  The IDR allows companies to confirm the accuracy of the information used in Glass Lewis’ corporate governance analysis, including information relating to directors and board composition, governing documents, independent public auditor, compensation practices, summary compensation data and equity plans.  The IDR does not contain the Glass Lewis analysis or voting recommendations. Enrolled companies will receive their IDR approximately three to four weeks prior to their shareholder meeting.  While Glass Lewis generally provides companies 48 hours to review the IDR, in some circumstances, Glass Lewis will limit the review time to 24 hours.  Companies can provide corrections to Glass Lewis, with the public documentation supporting such corrections. For more information or to enroll, go to https://www.meetyl.com/issuer_data_report.

Glass Lewis released its updated policy guidelines for the 2017 proxy season for several countries, including the United States and Canada.  The most significant change in the United States guidelines relates to director overboarding and was expected.  The changes to the United States guidelines include: Director Overboarding Policy As indicated in last year’s guidelines, in 2017, Glass Lewis will generally recommend voting against a director who: Is an executive officer of any public company and serves on a total of more than two public company boards, or Serves on a total of more than five public company boards. Glass Lewis generally will not recommend that shareholders vote against overcommitted directors at the companies where they serve as an executive. Board Evaluation and Refreshment With respect to board evaluation, succession planning and refreshment, Glass Lewis clarified that it believes “the board should evaluate the need for changes to board composition based on an analysis of skills and experience necessary for the company, as well as the results of the director evaluations, as opposed to relying solely on age or tenure limits.” Governance Following an IPO or Spin-Off With respect to corporate governance at newly-public entities, Glass Lewis will review the terms of the company’s governing documents in order to determine whether shareholder rights are being severely restricted from the outset.  If Glass Lewis believes that the board has approved governing documents that significantly restrict the ability of shareholders to effect change, Glass Lewis will consider recommending shareholders vote against members of the corporate governance committee or directors that served at the time of adoption of the particular governing documents. For 2017, Glass Lewis has outlined the specific areas it reviews when determining if shareholder rights are being restricted, including: The adoption of anti-takeover provisions, such as a poison pill or classified board Supermajority vote requirements to amend governing documents The presence of exclusive forum or fee-shifting provisions Whether shareholders can call special meetings or act by written consent The voting standard provided for the election of directors The ability of shareholders to remove directors without cause The presence of evergreen provisions in the company’s equity compensation arrangements The updated proxy guidelines can be found here.

On November 10, 2016, GAMCO Asset Management filed a Schedule 13D/A and 14N announcing that it had used the proxy access bylaw at National Fuel Gas to nominate a director candidate for election to NFG’s board at the upcoming 2017 annual meeting of shareholders.  This nomination appears to be the first use of proxy access bylaws by a shareholder to nominate a director in the United States.  NFG adopted its proxy access bylaw in March of 2016.  Given the recent trend of companies adopting bylaws to grant proxy access to shareholders (approximately 40% of S&P 500 companies) and recent decisions by the Staff of the SEC Division of Corporate Finance to allow "fix-it" shareholder proposals to modify secondary features of proxy access bylaws (see, for example, H&R Block’s Rule 14a-8 No-Action Letter), we expect that more companies will be granting proxy access to shareholder nominees in the coming years. Companies should review their director nomination process and shareholder access bylaws as part of their preparations for annual report and proxy season to be prepared to adequately address potential shareholder nominations.  

The Securities and Exchange Commission ("SEC") recently issued a new compliance and disclosure interpretation (the "New C&DI") in Question 116.25 regarding the availability of Form S-3 for the registration and sale of shares by companies with public float less than $75 million. Instruction I.B.6(a) to Form S-3 states that if a registrant has a public float of less than $75 million, the registrant may only register and sell securities via Form S-3 if the aggregate market value of the securities sold by or on behalf of the registrant during the 12-month period immediately prior to and including the date of the sale is no more than one-third of all common voting and nonvoting equity held by non-affiliates of the registrant. This instruction and accompanying rules and interpretive guidance are often referred to as the "Baby Shelf Rules." The new C&DI puts a stop to certain practices that were being used by registrants to work around the Baby Shelf Rules. Read more: https://www.dorsey.com/newsresources/publications/client-alerts/2016/11/sec-clarifies-baby-shelf-rules

On November 3, 2016, in a new C&DI, the SEC Staff stated they will not object if a company posts an electronic version of its annual report to shareholders on its corporate web site by the dates specified in Rule 14a-3(c), Rule 14c-3(b) and Form 10-K, respectively, in lieu of mailing paper copies or submitting it on EDGAR. The report must remain accessible for at least one year after posting.  This new C&DI provides some relief as previously companies had to mail seven hard copies of their annual report to shareholders to the SEC or submit it on EDGAR.  Prior to this new staff interpretation, the annual report to shareholders was one of the few documents still filed in hard copy with the SEC. The NYSE still requires three hard copies of the proxy materials (including the proxy card) to be filed no later than the date on which the materials are released to shareholders.  However, the NYSE does not expect hard copies of the annual report to shareholders.  NASDAQ companies are not subject to a similar requirement to provide hard copies of proxy materials or the annual report. Reporting companies should consider updating their annual meeting and proxy season procedures and checklists to take advantage of the new interpretation.

Institutional Shareholder Services (ISS) is rebranding its governance scoring solution “ISS QuickScore” to “ISS QualityScore,” though the underlying methodology appears very similar.  As in the past, covered companies can review, verify and provide feedback on the data used to determine their scores via a complimentary Data Verification tool accessed through the Governance Analytics platform.  See instructions for accessing the Data Verification tool here. Data verification for covered companies will be open from October 31, 2016, to November 11, 2016. The methodology for QualityScore does not appear to have changed significantly from QuickScore.  Like QuickScore, QualityScore uses a numeric, decile-based score that indicates a company’s governance risk relative to their index or region, and companies receive an overall QualityScore and a score for each of four pillars: Board Structure, Compensation/ Remuneration, Shareholder Rights, and Audit & Risk Oversight, which were the same four categories in the QuickScore methodology. A score in the 1st decile (QS:1) indicates relatively higher quality governance practices and relatively lower governance risk, and, conversely, a score in the 10th decile (QS:10) indicates relatively higher governance risk.  Unlike QuickScore, QualityScores will be refreshed daily. Companies may continue to have questions about the transparency of the weighting assigned to each governance factor.  Over 200 factors are analyzed, with the specific factors under analysis varying by region.  Each factor is assigned a weight, based on an understanding of the impact of governance practices, ISS voting policy, and prevailing governance standards within each region. New and updated factors address issues such as proxy access terms, board diversity metrics, exclusive forum provisions  and fee shifting provisions. Effective November 21, subscribers to ISS QualityScore will be able to view details on covered companies’ proxy access provisions, such as ownership thresholds, holding periods, and certain restrictions on the number of shareholder nominees and the ability to act in concert. QualityScore will also offer increased coverage of board composition issues, such as additional refreshment and diversity measures, for US companies. Subscribers will also have the ability to access and analyze the underlying data from which the scores are generated, allowing them to screen covered companies for particular governance practices, and to compare covered companies’ practices.

On October 26, 2016, in a split vote, the SEC proposed the mandated use of universal ballots in contested director elections at annual meetings. The proposed rules were controversial even before they were proposed – the House of Representatives approved a spending bill this summer that included a provision prohibiting the SEC from proposing or implementing the use of the universal ballots in contested elections. We expect the comments on the proposed rule to be voluminous and varied. The press release and fact sheet on the proposed rules can be found here, and the proposed rule release can be found here. The rules are described further in our complete summary here: https://www.dorsey.com/newsresources/publications/client-alerts/2016/10/sec-proposes-universal-ballots

On October 19th, the SEC released five new Compliance and Disclosure Interpretations (“CDIs”) relating to the upcoming “Pay Ratio Disclosure” requirements in Item 402(u) of Regulation S-K. Item 402(u) Pay Ratio Disclosure requirements, mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, require each covered public company to make annual disclosure of the ratio of its principal executive officer’s total annual compensation to the total annual compensation of an individual whose compensation is determined to be the median compensation of all of the company’s employees. Read our complete summary here:  https://www.dorsey.com/newsresources/publications/client-alerts/2016/10/new-cdis-help-issuers

Material amendments to equity compensation plans require shareholder approval under Nasdaq rules. Last week, Nasdaq posted a new FAQ #1269 regarding amendments to equity compensation plans to increase the tax withholding rate.  FAQ #1269 is set forth below. “Generally, an amendment to increase the withholding rate to satisfy tax obligations would not be considered a material amendment to an equity compensation plan. Allowing the holder of an award to surrender unissued shares to pay tax withholdings is similar to settling the award in cash at market price, and neither creates a material increase in benefits to participants nor increases the number of shares to be issued under the plan. This type of change also is not an expansion in the types of awards provided under the plan. This analysis is the same regardless of whether the plan allows the shares surrendered for tax withholdings to be added back to the pool of shares available for issuance as future awards. Accordingly, an amendment to an equity compensation plan to increase the withholding rate to satisfy tax obligations would not be considered a material amendment to the plan.” This interpretation is broader than the NYSE interpretation on the same issue.  In August, the NYSE published guidance regarding compensation plans, and in Question C-1, noted “an amendment to a plan to provide for the withholding of shares based on an award recipient’s maximum tax obligation rather than the statutory minimum tax rate is not a material revision if the withheld shares are never issued, even if the withheld shares are added back to the plan.” (emphasis added) For more information about the NYSE guidance published in August, please see our publication “NYSE Clarifies Answers to Certain FAQs on Equity Compensation Plans”