Yesterday, the SEC adopted updated interpretive guidance regarding how companies can use their websites. Here is Corp Fin’s opening statement – and here is the press release (which includes a video from SEC Chair Chris Cox). The interpretive release is not yet available.
Based on comments made during the open Commission meeting and the press release, we know the SEC’s guidance is principles-based that relies on a facts-and-circumstances analysis and is divided into four parts as follows:
1. Reg FD Guidance - How information posted on a company’s site can be considered “public” and provides guidance to help companies comply with Regulation FD. The upcoming release contains factors to help determine whether online information is considered “public” so that subsequent communications would not constitute disclosure of material non-public information, including whether:
(i) a company site is a recognized channel of distribution
(ii) online information is considered broadly disseminated
(iii) information has been posted for a sufficiently long period of time so that it has been absorbed by investors
In addition, the release addresses when disclosure of information on a site is considered adequate to make such information “public” for purposes of the alternative public disclosure prong of Regulation FD (the default prong is furnishing a Form 8-K). At the open Commission meeting, it was predicted that fewer Form 8-Ks will be filed under this guidance.
2. How Liability Standards Work Online - What the liability framework is for electronic disclosure, including how companies can provide access to archived data without it being considered reissued or republished; how companies can link to third party information; appropriate use of summary information; how antifraud provisions apply to statements made by the company in blogs and electronic shareholder forums, and more.
3. No Disclosure Controls Necessary for Website – How information posted on company sites would not be subject to rules relating to disclosure controls and procedures (unless the information is the type to satisfy a ’34 Act obligation). This information remains subject to Rule 10b-5 liability.
4. Printer-Friendly Functionality Not Required – How information need not satisfy a “printer-friendly” standard, unless other rules explicitly require it.
Once the interpretive release itself is available, I’ll blog more including how it stacks up against my ten cents. Dominic Jones has more on yesterday’s open Commission meeting in his IR Web Report blog.
Gulp! The SEC’s View on Lawyer Negligence
A few weeks ago, the SEC issued an order – regarding “In the Matter of Scott G. Monson” – dismissing an enforcement action against the former in-house lawyer of a broker-dealer (this action related to an appeal by the SEC from an administrative law judge’s dismissal of cease-and-desist proceedings). The lawyer had a background in family and real estate law, etc. and took this job without any securities law background; he drafted an agreement based on a sample – and botched the job.
Although the issues in this action are fact-specific, the SEC’s order has some interesting things to say about enforcement actions against lawyers in general. In the order, the SEC acknowledges that “as far as we are aware, we have not sanctioned attorneys in litigated enforcement proceedings based on alleged negligent acts or omissions they may have committed in providing non-public legal advice to clients.”
But then the SEC’s order goes on to list the types of cases that the SEC will pursue against lawyers – and notes that this case doesn’t require the SEC to address the appropriate parameters of lawyer liability in administrative enforcement proceedings because the record didn’t show that the in-house lawyer acted negligently by a preponderance of the evidence. Keith Bishop (who is now at his new firm Allen Matkins) served as an expert for Monson.
All the Latest: Two New Blogs to Check Out
Long-time blogger Bruce Carton – a former SEC Enforcement Staffer – is back with his UnusualActivity.com blog; check out his piece on the death of ShareSleuth.com.
And a former SEC Corp Fin accountant – John Feeney – who has been advising the CFO & audit committee community on strategic financial reporting issues for past ten years has launched his “StreetDisclosure.com Blog“; John provides his first-hand account working with IFRS in this entry.
Over the past six months or so, sovereign wealth funds have increasingly been the subject of debate – in the media and in Congress – for taking stakes in distressed companies in the US and Europe. This debate has taken on many forms (eg. Boeing’s loss of a $40 billion contract to a joint venture that includes AirBus) and arguments (eg. Warren Buffett’s take from his annual letter).
As noted by RiskMetrics a while back, European Union regulators proposed guidance to member states to align policies on sovereign wealth fund investments and to aid international bodies in their efforts to craft a voluntary code of conduct to oversee these practices. Last Fall, the International Monetary Fund began to develop a code of conduct to address these issues, a project which continues – and the Organization for Economic Cooperation and Development is developing best practices guidance for countries receiving these types of investment.
During this upcoming DealLawyers.com webcast – “The Rise of Sovereign Fund Investing” – an expert panel will analyze the issues that should be considered for a sovereign wealth fund investment.
Sovereign Wealth Funds: The SEC’s Perspective
Several months ago, John Olson posted this blog on Harvard Law School’s “Corporate Governance Blog”: “I’m posting a too little noticed speech by SEC Chairman Cox, delivered a month ago in Washington, in which he discusses the growing concerns with the role of sovereign wealth funds and government-affiliated public companies in global securities markets and the impact of such government-related concentrations of capital, and related market influence, on corporate ethics and policy, transparency and the integrity of financial reporting. What about the values of corporate governance, and shareholder power, when the controlling interest or “golden share” is held by a government, particularly a government that itself does not practice transparency or tolerate democracy as we know it?”
In addition, there is this Congressional testimony:
A member recently asked how many companies participate in taking environmental and social surveys, ratings, etc., such as the Carbon
Disclosure Project, Dow Jones Sustainability Index, etc. Please take a moment for this survey:
Recently, I blogged about an interesting new website that has the potential to empower investors more. In this podcast, Andy Eggers discusses his website “ProxyDemocracy.org,” including:
- Where did you get the idea for the site? How long did it take to launch?
- What features does ProxyDemocracy.org currently have?
- Any plans to tweak things going forward?
- What have been the biggest surprises in how the site is used so far?
Just Mailed: July-August Issue of The Corporate Counsel
We have just wrapped up the July-August issue of The Corporate Counsel, which includes pieces on:
- Correcting CEO/CFO Certifications—New S-K Interps
- De-Mystifying the 135-Day Rule on the Age of Financial Statements When 1933 Act Registration Statement is Effected
- “No View” on Bebchuk Proposal
- Disclosing Pending Government Investigation—Qui Tam Actions
- Recent Uptick of Software Revenue Recognition Accounting Problems
- SEC Backs Off Inflation Adjustment
- PCAOB Inspection Tidbits
- Staff’s Non-Use of E-Mail–A Few Insights
- Clarifying California’s Updated Stock Option Regs—Expansion by Regulation of Its Rule 701-Like Statutory Exemption
- North Dakota’s New Corporation Law—Now, We Get It!
Wanna Feel Good? Remember You Aren’t Taking the Bar Exam
A member sent this in: It’s that time of year when graduating law school students find out what pain is really about – studying for the bar exam (I’ll spare you my nutty bar exam experience). A member just sent me this: In this recent decision, the Delaware Supreme Court affirmed the decision of the Delaware Board of Bar Examiners refusing denying Papdima’s request for partial certification of her qualifications to take the Delaware Bar Examination.
Papadima studied civil law for four years at the law schools of the University of Bucharest in Romania and the University of Paris receiving a joint degree in 2003 and received an LLM from the University of Paris in 2004 and an LLM from Harvard Law in 2006.
Unfortunately, the Delaware Board of Bar Examiners determined that Papadima failed to satisfy the qualifications to take the Delaware Bar examine because neither the University of Bucharest nor the University of Paris, from which she received undergraduate law degrees, is approved by the American Bar Association and the LLM. she received from Harvard Law School is not the equivalent of a juris doctor degree from an ABA approved law school.
What made this case particularly interesting was that Papadima has been a member of the Bucharest Bar since 2004, a member of the Paris Bar since 2006, and a member of the New York Bar since 2007 and is currently a member in good standing of all three Bars. In addition, Papadima spent several months in 2004-2005 practicing Romanian law with Linklaters in its Romanian office and after receiving her LL.M. from Harvard Law School in 2006, worked at Latham & Watkins in New York for approximately a year. Best of all, Papadima is currently employed for a one-year clerkship in the Delaware Supreme Court, assigned to Justice Jack B. Jacobs (who disqualified himself sua sponte).
We just put the finishing touches on the Summer issue of our new newsletter, InvestorRelationships.com. This newsletter is complimentary, as well as all the issues for the remainder of ’08. You simply sign-up online to gain free access to it (and be notified when the next issue is available).
- Non-Deal Roadshows: Latest Developments and Trends
- Lessons Learned: How Funds Vote on Proxy Proposals
- Hedge Fund Attacks: Eight Lessons Learned from the In-House Perspective
- How Blogging Can Enhance Your Investor Relationships (and Your Career)
- My Ten Cents: The SEC’s Coming Guidance on IR Web Pages
- SEC Staff Says “No” to Non-GAAP Financial Statements
Earning Trust: The Mantra of Bloggers
At the NIRI Annual Conference last month, one of the panels I served on was “Is Your Company or IR Dept Ready for a Blog? Innovative Communication Methods for the 21st Century.” In describing why I think blogging is important for IROs, I discussed how effective a vehicle a blog can be to get people to trust you – if you do it right – because they can get a window into who you are. This allows IROs to get outside the staid press release environment that they typically live in to show their constituents – investors, analysts, employees and potential investors – that they can be trusted. And “trust” is the name of the game in investing (and also in life, but that is a different story.)
For the Summer issue of InvestorRelationships.com – the one noted above – I wrote a piece that persuasively argues why you should blog – and three considersations to determine if you have an inner blogger in you. The article will be relevant for lawyers as well as IROs. You can get this article for free if you provide us with your contact information.
More on Investor Relations and Blogs
Recently, I did a podcast with Lynn Tyson of Dell about the “DellShares” blog. Rob Williams, one of Lynn’s co-bloggers, was on the panel mentioned above and was great. Learn what transpired during the panel from several others who covered some of our roundtabling in these blogs:
- Ryan Lejbak’s blog (and here is a follow-up video with IRO blogger Rob Williams from Dell)
By the way, Ryan also uploaded this interview with me on YouTube if you want to see what I really look like. It’s pretty daunting to have a camera stuck in your face. I enjoyed doing the same thing to others during the Society’s Annual Conference…
Lately, there have been plenty of rumors about the health of Apple CEO Steve Jobs and whether he remains healthy. Until Apple finally clarified the situation on Wednesday, the company’s stock price had taken a hit since the market believes he is key to the company’s future (actually, the company didn’t clarify – rather, it was reported in this NY Times’ article based on comments made by Jobs to some of his “associates”).
And the market was wary of statements from the company that Jobs had a “common bug” or that “the matter was private” because the company has a history of not being upfront about his medical condition (Jobs had a rare form of pancreatic cancer four years ago; the company waited nine months to disclose it). In fact the company is still not being forthright, this reporter had to put clues together to come up with his own diagnosis of what surgical procedure Jobs recently had.
So the securities law issue arises: does Apple have a duty to disclose Jobs’ current condition? This is not a new issue and one that pops up periodically on our “Q&A Forum” in all shapes and sizes. Under the SEC’s rules, companies typically don’t have an affirmative duty to disclose unless a Form 8-K is triggered or a periodic report (eg. 10-Q or 10-K) is due (I say “typically” because there are other ‘disclose or abstain’ circumstances to consider).
On the other hand, the company may have a duty to update if they have an outstanding statement that the CEO’s health is sound. Given that an Apple spokesperson said Jobs’ gaunt appearance at a recent event was due to a “common bug,” there is an argument that the company had a duty to update (or was misleading to begin with).
Clearly, Jobs is very important to investors and many articles have been written that essentially argue that by taking the job of CEO, you relinquish your right to privacy; here are articles from the Financial Times; TheStreet.com; and below is an excerpt from this San Mercury News article:
No hard rules guide how companies handle health issues of their executives. But corporate governance experts say companies need to be forthcoming when health issues affect the ability of executives to perform. That does not mean, though, that Jobs has to submit details of his health simply to allay the worries of investors, said Charles Elson, director of the Center for Corporate Governance at the University of Delaware. “If his health is such that he can’t carry out his job, the company must disclose that,” he said. “It’s only material if it affects his ability to carry out his responsibilities. Up to that point, it’s up to him.”
But it is the board’s role to keep tabs on the health of its chief executive and have emergency, and long-term, succession plans in place, said Nell Minow, editor of the Corporate Library, a corporate governance research group. “The primary issue is, the board needs to be on top of it,” she said. In general, such information is best kept private, otherwise “it can create more uncertainty than is necessary,” Minow said. However, she was critical of Apple CFO’s Oppenheimer’s response that “Steve’s health is a private matter.”
“That’s what we in Washington call a non-denial denial,” Minow said. “It’s very important that investors are confident of his health. He is responsible for a large part of the company’s success. He’s the one who holds up the iPhone and says, ‘Here’s what I did.’”
Looking beyond the SEC’s rules, companies also need to consider the rules of the stock exchange where their stock is listed. Since Apple is listed on Nasdaq, Rule 4310(16) requires the company: “except in unusual circumstances, a Nasdaq-listed issuer shall make prompt disclosure to the public through any Regulation FD compliant method (or combination of methods) of disclosure of any material information that would reasonably be expected to affect the value of its securities or influence investors’ decisions. The issuer shall, prior to the release of the information, provide notice of such disclosure to Nasdaq’s Market Watch Department if the information involves any of the events set forth in IM-4120-1.” Under this guideline, the importance of disclosing a CEO’s illness would depend on the “materiality,” which would take into consideration a mix of factors including the relative importance of the CEO and the magnitude of the illness.
In comparison, Section 202.05 of the NYSE Listed Company Manual states that companies are “expected to release to the public any news or information which might reasonably be expected to materially affect the market for its securities.” However, the SROs rarely enforce their own listing standards, particularly in this area where “materiality” remains relatively subjective.
The reality remains that since someone’s health is such a sensitive topic, there isn’t a standard practice – but that companies must take care not to be misleading nor create a duty to update. And I won’t go down the path of when a CEO’s health is so debilitated that their responsibilities are diminished to the point that they don’t truly function in the position of that officer, which arguably could trigger a Form 8-K under Item 5.02…that’s another kettle of fish to fully analyze…
California Finally Resolves Conflict with E-Proxy
On Tuesday, California Gov. Schwarzenegger signed Senate Bill 1409 into law, which amends Section 1501 of the California Corporations Code so that California’s annual report delivery requirement piggyback’s on the SEC’s eproxy rules and resolve the conflict I’ve been blogging about for some time. It seemed like this bill would be signed back in February; obviously, not a high priority.
Specifically, the bill states that the California annual delivery requirement “shall be satisfied if a corporation with an outstanding class of securities registered under Section 12 of the Securities Exchange Act of 1934 complies with Section 240.14a-16 of Title 17 of the Code of Federal Regulations, as it may be amended from time to time, with respect to the obligation of a corporation to furnish an annual report to shareholders pursuant to Section 240.14a-3(b) of Title 17 of the Code of Federal Regulations.”
This bill has been approved as an urgency statute and is effective immediately; obviously too late for the past proxy season but “good to go” for next year. Hat tip to Paul Blumenstein of DLA Piper and we have begun posting memos on this development in our “E-Proxy” Practice Area.
Lifehack: Enhance Your Productivity
Check out the website called “Lifehack” for some ideas about how to live your life. Here is a blurb about “10 Overrated Business Books & What To Read Instead.” And my favorite is “How to Write in a Thousand Words or Less” – that’s my philosophy for all our newsletters…
On Tuesday, the US Treasury Advisory Committee on the Auditing Profession (ACAP) – co-chaired by former SEC Chair Arthur Levitt and former SEC Chief Accountant Don Nicolaisen – issued a Second Draft Report, which is now subject to a 30-day comment period. Here are the comments submitted on the first draft.
And on Monday, the International Accounting Standards Committee Foundation, which oversees the International Accounting Standards Board (IASB), issued a Discussion Document – the “Public Accountability and the Composition of the IASB – Proposals for Change” – that has a September 20th comment deadline.
Meanwhile, the SEC’s Advisory Committee on Improvements to Financial Reporting (CIFiR) is expected to issue its final report sometime after meeting by teleconference on July 31st. The final report should look similar to its draft final report, with some editorial changes voted on during a July 11th meeting, as described in this entry on FEI’s “Financial Reporting Blog.” Hat tip to Edith Orenstein who write FEI’s “Financial Reporting Blog” for keeping us up-to-speed on all these developments.
Marty Dunn’s “Pro or Troll” on Shareholder Proposals
Test your skills with our new game – “Pro or Troll #9: Shareholder Proposal Process,” to see if you are up to speed on all the lore and latest developments about the hottest topic, shareholder proposals – courtesy of Marty Dunn of O’Melveny & Myers.
RiskMetrics’ Preliminary Post-Proxy Season Report
Earlier this week, RiskMetrics posted its “Preliminary U.S. Postseason Report.” Interestingly, RiskMetrics observes that the bear market tempered activism at the end of the day, with notable exceptions relating to some executive compensation pay packages and hedge fund-led attacks. Here is an excerpt from the Report regarding “say on pay”:
According to results available as of July 15th, “say on pay” proposals have averaged 42.7% support over 52 meetings this year, up slightly from 42.5% support over the same number of meetings in 2007. Shareholders at nine companies, including Lexmark International and Apple, gave greater than 50% support to “say on pay” proposals through July 15, compared with eight during all of 2007. Notably, all of this year’s proposals earned at least 30% support, except at Wal-Mart where officers and directors control a 43.4% stake.
A few weeks ago, I blogged about the idea of someone creating an online auction of voting rights for annual shareholder meetings. I asked members if they saw any legal hurdles to this potential project. Here are a few of the responses:
1. No Idea is New – Your idea reminded me of a long-ago attempt to divide up the bundle of rights that are represented by a share of common stock. Twenty years ago, American Express developed the idea of Unbundled Stock Units – “USUs” – under which a shareholder could exchange a share of common stock for a unit consisting of a 30-year bond, an Incremental Dividend Preferred Share, and an Equity Appreciation Certificate.
Amex said the USUs would let shareholders “choose between the various investment attributes of Share ownership.” It’s unclear from the prospectus what happened to the voting rights. I think you had to own all three parts of the USU to be able to vote. At the time, I recall that various commenters derided the concept because it separated out the rights of share ownership and USUs died on the vine. Here are the cover pages from the Form S-4 for the USUs.
2. Expect Screaming (and Lawsuits) – I think that state corporate legislatures, the SROs, proxy solicitation and advisory firms, underwriters, swap desks institutional investor-activists, academics and others will likely have 30 different views on the pluses and minuses of this, with plenty of lawsuits in between.
3. Practical Issues of Transferring Votes – One potential obstacle would be overcoming the trick of figuring out how the buyer would be able to get a proxy or voting instruction that ties into the record owner list. Perhaps what would trade would be the right to instruct the seller on how to vote the shares. Currently, exchanges prohibit trading of shares with proxies, so essentially the seller has to be selling the right to instruct the seller as to how to vote.
In particular, there would need to be a way for a broker to be instructed by the buyer (who might have a different broker) as to how to vote in time for the broker to instruct Broadridge to effect the instruction. I think this problem means you can’t just buy from the “market”; you have to know who your seller is (and the seller’s seller, if it’s a resale of the voting rights), unless you can find a way to create a proxy/instruction instrument that would itself trade.
Also, I don’t think management would be able to be a bidder as that would be vote-buying, unless they used their own money and not the issuer’s funds. The H-P case stands for the proposition that shareholders can buy votes, but management can’t (subject to an entire fairness test and maybe a shareholder vote).
- Distressed Debt Transactions: “Soup to Nuts”
- The SEC’s Cross-Border Proposal: Top Four Ways Deals Would Change
- The SEC’s New Cross-Border Guidance: Four “Don’ts” for Structuring Cross-Border Deals
- Follow-Up: How to Do a Deal Without Shareholder Approval: The Financial Viability Exception”
- Hedge Fund Attacks: Eight Lessons Learned from the In-House Perspective
- Jumping Through Standstills
- The Shareholder Activist Corner: Spotlight on Shamrock Activist Value Fund
- The Implications of CSX: Beneficial Ownership Reporting Through Total Return Swaps
In our “Q&A Forum,” we have reached query #4000 (although the “real” number is really much higher since many of these have follow-ups). Combined with the Q&A Forums on our other sites, there have been over 15,000 questions answered. That is one serious – and crazy – body of knowledge if I must say so myself.
You are reminded that we welcome your own input into any query you see. And remember there is no need to identify yourself if you are inclined to remain anonymous when you post a reply…
State of Restatements
In this report posted on our “Restatements” Practice Area, it appears as if perhaps Section 404 of Sarbanes-Oxley has had a positive effect on improving the quality of financial reporting (as well as quality of internal controls) at companies generally since restatements are now trending down, at least for companies over $75 million in market capitalization. On the other hand, it is possible that the Big Four (and the SEC Staff) have taken a more lax approach to restatements more recently compared to past years.
Analyzing trends is always dicey. For example, it is difficult to judge how the morphing of PCAOB Standard #2 into #5 has had on the number of material weaknesses being reported – albeit it is likely to have reduced the number of such instances. However, with a downward trend now in progress, those that argue that accounting rules are too complex have less to complain about…
Duty Of Disclosure: Delaware Chancellor Further Limits Availability of Damages
From Travis Laster: Recently, Delaware Chancellor Chandler – in In re Transkaryotic Therapies, Inc. – granted summary judgment in favor of three directors who were alleged to have breached their fiduciary duties by supporting and voting in favor of the acquisition of Transkaryotic Therapies by Shire Pharmaceuticals. Here is a copy of the opinion.
Much of the opinion consists of the Chancellor’s rulings on the plaintiffs’ allegations of bad faith and disloyalty. From a doctrinal and practitioner perspective, the more important discussion focuses on the duty of disclosure (pages 17-28).
In summary, the Chancellor characterizes the duty of disclosure as a doctrine designed for pre-vote adjudication, leaving very little room for any post-closing remedy. In his words, “the Court grants injunctive relief to prevent a vote from taking place where there is a credible threat that shareholders will be asked to vote without such complete and accurate information. The corollary to this point, however, is that once this irreparable harm has occurred –i.e. when shareholders have voted without complete and accurate information–it is, by definition, too late to remedy the harm” (page 25).
Based on this principle, the Chancellor granted summary judgment for the defendant directors: “I hold that this Court cannot grant monetary or injunctive relief for disclosure violations in connection with a proxy solicitation in favor of a merger three years after that merger has been consummated and where there is no evidence of a breach of the duty of loyalty or good faith by the directors who authorized the disclosures” (page 27).
As a practical matter, the Transkaryotic decision obviously favors defendant directors, and it should increase their settlement leverage in cases where plaintiffs primarily assert disclosure claims but do not pursue injunctive relief. In other words, the cost of a post-deal clean-up settlement involving disclosure claims should go down. The logical response from the plaintiffs’ bar, however, should be to pursue more pre-closing disclosure-based injunction applications, since that is now the only real avenue available for a meaningful disclosure remedy and a commensurate fee award. In the long run, therefore, the Transkaryotic decision may result in more injunction applications and more disclosure litigation.
Two other points deserve brief mention. First, the Chancellor granted summary judgment on the claim that a director breached his fiduciary duties by soliciting so-called “empty votes” from stockholders who owned shares on the record date then sold them. The Court found that the director’s efforts to support the merger was “consistent with – rather than at odds with – his fiduciary duties” (page 39).
Second, the Chancellor permitted the plaintiffs to proceed with a challenge to the statutory validity of the merger, based on their assertion that the merger had not received sufficient votes. This challenge rested in part on testimony to the effect that the inspectors of election tallied the vote very quickly, yet the plaintiffs produced evidence of over-vote situations that would have taken additional time to resolve. Notwithstanding the passage of three years since the merger closed, the Court permitted the challenge to go forward. This holding emphasizes the need for care when tallying merger votes and counsels in favor of hiring a reputable outside firm, such as IVS, to act as the inspector for close votes.
I’ve been saying that companies should hire independent inspectors for a long time – and since you sometimes don’t know if your vote will be close until the last minute – you need to line up the inspector well in advance because they are in short supply!
As you have read, Dick Grasso won his case against the New York Attorney General a few weeks back. But if you read the media reports closely, you will notice he won on a technicality – he won because the NYSE changed its “form” since the lawsuit was filed, from a non-for-profit to a public company (a dissenting judge argues that NYSE still has a non-profit subsidiary, and thus is still subject to the New York non-profit rules).
Thus, according to the New York State Supreme Court’s decision, the Attorney General didn’t have the authority to challenge his compensation anymore, and Dick gets to keep his money without any adjudication of whether the amount was reasonable, whether he breached his fiduciary duties, or whether he (or anyone else) ever did anything wrong or improper in connection with his compensation. So although Dick’s been saying he was “vindicated,” it’s hardly so.
So what does this mean for you? It reminds us that a proper clawback can save a company the embarrassment of a lengthy court battle – and many millions of dollars (reportedly, the Grasso lawsuit cost the NYSE more than $70 million in legal fees). It’s time for you to go back and read our Winter 2008 issue of Compensation Standards to learn the “Ten Steps to a Clawback Provision with “Teeth.”
We are pleased to note a recent pair of reports from The Corporate Library that note the trend of clawback usage on the rise; one report noting the upward trend generally (13% of companies surveyed have them now, up from a handful a few years ago) and one report noting how clawbacks are more common at larger companies.
The Consultants Speak: How the Latest Compensation Disclosures Impacted Practices
We have posted the transcript from our recent CompensationStandards.com webcast: “The Consultants Speak: How the Latest Compensation Disclosures Impacted Practices.”
John Wilcox on “Say on Pay” as a Listing Standard
My good friend John Wilcox and I have been corresponding on “say on pay” and he’s given me permission to post his following thoughts on the topic. John recently left his job as TIAA-CREF’s SVP and Head of Corporate Governance (although he remains a senior advisor to TIAA-CREF) to become Chairman of Sodali. John constantly travels around the globe and is an intense student of governance frameworks used in other countries:
I agree that federal legislation or SEC rulemaking would probably not be the best way to implement an advisory vote on executive compensation. Nevertheless, I think the advisory vote would work best if it were applicable to all companies, rather than just to the few who act voluntarily. The best means to achieve universality without becoming prescriptive would probably be for the New York Stock Exchange and Nasdaq to adopt a listing standard calling for an advisory vote.
For example, a shareholder vote is now mandated for equity compensation under NYSE Rule 303A.08, “Shareholder Approval of Equity Compensation Plans.” The rule is straightforward. It reads as follows: “Shareholders must be given the opportunity to vote on all equity compensation plans and material revisions thereof . . . .”
If this approach were applied to an advisory vote, it would be minimally invasive and would permit a range of proposal formats. The rule might be entitled “Shareholder Advisory Vote on Compensation Disclosure,” and might read as follows: “Shareholders must be given the opportunity to cast a non-binding advisory vote on compensation plans disclosed in the proxy statement.”
A rule stated in such simple terms would enable companies to customize their advisory vote proposals to suit their circumstances. My belief is that companies drafting compensation disclosures with a view to a “pass/fail” advisory vote would try harder to achieve clarity and to highlight features of concern to shareholders, such as strategic links to performance and the creation of long-term value. Experience with mandatory votes under NYSE Rule 303A.08 demonstrates that companies are capable of making a good case for equity compensation when a vote is required.
I think it is unwise to argue that an advisory vote applied universally would be overly burdensome to shareholders. Shareholders must already shoulder the burden of reading dense and opaque compensation disclosures. Complaining about this responsibility surely does not serve the cause of transparency and good corporate governance, nor does it inspire confidence in the diligence of shareholders. Instead, shareholders should be pressuring companies to improve the quality of their disclosure, to provide summaries and to explain how pay and performance are linked. Incidentally, I have never heard shareholders complain about the burden of disclosure and voting rights on equity compensation plans under NYSE Rule 303A.08.
A fair argument can be made that CD&As are too complicated and the links between compensation and value creation are not clearly articulated, thereby creating an unacceptable burden on shareholders to digest and make sense of the data. If this is true, it is company executives, boards and compensation committees – not shareholders – who should be accountable. Simplification, clarification and better explanation of how compensation drives performance should be the responsibility of companies, not shareholders.
Shareholders have to read and evaluate compensation disclosures. However, if a company’s compensation narrative is not clear and convincing, shareholders should send the drafters back to the drawing board. An effective way to do this would be through an advisory vote.
If we see the advisory vote as the means to push for better compensation practices and clearer disclosure, rather than a means to punish companies, the concerns of both companies and shareholders are largely eliminated.
Some pretty fine analysis – and quick – from Travis Laster: Yesterday, the Delaware Supreme Court issued its much anticipated decision in CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008 (Del. July 17, 2008), which resolved two questions of law certified to the Court by the SEC. AFSCME proposed for inclusion on CA’s proxy statement a bylaw that would require the CA board of directors to reimburse the reasonable fees of any stockholder that sought to elect less than 50% of the board (i.e. a short slate) and succeeded in electing at least one director. Here is the court opinion and the related Corp Fin no-action response.
The Delaware Supreme Court split the baby on the two certified questions. Answering the first in the affirmative, the Court held that the bylaw was a proper subject for stockholder action. Answering the second in the negative, the Court held that if adopted the bylaw would violate state law. The net result is that the bylaw can be excluded from CA’s proxy statement under SEC Rule 14a-8(i)(2).
This is a very significant decision that will prompt much practitioner commentary and scholarly discussion. It is also a decision with implications that will take time and future decisions to work out. Here are some highlights:
As a threshold matter, the Supreme Court cut the recursive loop between Section 109 and Section 141(a) of the DGCL. Section 109(a) gives stockholders the statutory right to adopt bylaws, and Section 109(b) provides that the bylaws may contain “any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.” Section 141(a) vests the power to manage the business and affairs of every corporation in the board of directors, except as otherwise provided in the DGCL or in the certificate of incorporation. This has led to a running debate as to whether a bylaw under Section 109(b) can limit a board’s power under Section 141(a).
Consistent with Delaware’s historic model of director-centric governance, the Supreme Court makes clear that Section 141(a) has primacy over Section 109(b). After quoting Section 141(a), the Supreme Court notes that “[n]o such broad management power is statutorily allocated to the shareholders.” (p. 7).
The Court then holds “[t]herefore, the shareholders’ statutory power to adopt, amend or repeal bylaws is not coextensive with the board’s concurrent power and is limited by the board’s management prerogatives under Section 141(a).” (p. 7). In footnote 7, the Court addresses the statutory language of Sections 109 and 141(a), stating that Section 109 is not an “except[ion] … otherwise specified in th[e] [DGCL]” to Section 141(a). “Rather, the shareholders’ statutory power to adopt, amend or repeal bylaws under Section 109 cannot be ‘inconsistent with the law,’ including Section 141(a).”
In addressing the first certified question (whether the bylaw was a proper subject for stockholder action), the Supreme Court established an initial test for bylaw validity: “whether the Bylaw is one that establishes or regulates a process for substantive director decision-making, or one that mandates the decision itself.” The Court recognized that a bylaw that is appropriately process oriented can have some implications for board decision-making and the expenditure of corporate funds, giving as an example a bylaw that would require that all board meetings take place at the corporation’s headquarters and thereby necessitate expenditures for travel. (p. 16). Applying this test, the Court found that the primary function of reimbursement bylaw was process oriented. Although it called for the expenditure of funds, it sought to regulate “the process for electing directors –a subject in which shareholders of Delaware corporations have a legitimate and protected interest.” Based on this analysis, the Court held that the bylaw was a proper subject for stockholder action, thus answering the first questioning the affirmative.
In addressing the second certified question, the Supreme Court held that the mandatory reimbursement bylaw as drafted by AFSCME was facially invalid because it could require a board to reimburse expenses in a situation where it could breach the board’s fiduciary duties to do so. Citing its QVC and Quickturn precedents, the Court held that a bylaw could not require the Board to breach its fiduciary duties. Despite the fact that the reimbursement bylaw permitted the board to determine what expenses were “reasonable,” the Court held that that language “does not go far enough, because the Bylaw contains no language or provision that would reserve to CA’s directors their full power” to deny all expenses. (p. 23). In other words, because there were hypothetical situations in which the bylaw could require a board to breach its fiduciary duties, the Court held the bylaw facially invalid.
Each of these holdings potentially has big implications for the future. Although many will likely view this as a loss for stockholders, I believe they should view the case as a significant win. Yes, the director-reimbursement bylaw was held invalid, but the Court held that the election process was a proper subject for stockholder action. A bylaw mandating the inclusion of stockholder nominees on the company’s proxy statement should fare much better under a CA analysis.
Outside the election process, the case is generally negative for stockholder-adopted bylaws. For example, the strong QVC/Quickturn analysis should doom any substantive component to a pill redemption bylaw, such as a requirement that directors not adopt or renew any pill that could be in place longer than a year.
In the unforeseen consequences department, CA opens the door to the broad use of facial challenges by creating a regime where it is actually easier to make a facial challenge than an as-applied challenge. Under the approach articulated in CA, a facial challenge must be granted and a bylaw stricken if there is any situation in which the bylaw could be held invalid. In contrast, in an as-applied challenge, the CA court noted that a bylaw is presumed valid. Traditionally in a facial challenge, a provision would be upheld if there are circumstances in which it could be valid, such that invalidity can only be tested in an as-applied context. The CA court reverses this approach.
Also in the unforeseen consequences department, directors may find that the CA decision’s broad extension of a fiduciary trump card causes more problems than it solves. Under the CA analysis, mandatory bylaws may no longer be mandatory. They rather appear to be subject to the directors’ overarching fiduciary duties. Directors who take action in reliance on a mandatory bylaw therefore can now be second-guessed on fiduciary duty grounds.
The most obvious circumstance where this can arise is with a bylaw providing for mandatory advancements. The Delaware courts have consistently enforced mandatory advancement bylaws, even if the board of directors believes the recipient of the advancements is a bad actor and that it would be a breach of the board’s duties to provide the advancements. Under CA, a board can argue that a mandatory advancement bylaw cannot trump its fiduciary duties, and therefore it has the discretion not to pay. The converse, however, is also true, and a board that advances funds pursuant to a mandatory advancement bylaw is now open to a claim that their fiduciary duties required them not to advance.
This could be particularly problematic for sitting directors, because a permissive decision to provide advancements is a self-interested transaction subject to entire fairness. While I expect that the Delaware courts will find a way to uphold mandatory advancement bylaws, they will have to distinguish CA to do it.
Similar arguments could arise in less obvious circumstances. For example, a common defensive bylaw eliminates the right of stockholders to call a special meeting. Under CA, if a stockholder asks the board to call a special meeting, it could be argued that the board cannot simply rely on the bylaw and inform the stockholder that it has no right to the call. Because the bylaw cannot trump the board’s fiduciary duties, the board must consider as a matter of fiduciary discretion whether to call the meeting notwithstanding the bylaw.
Here again, I expect that the Delaware courts will support boards who act in accordance with mandatory bylaws. The CA Court was careful to leave itself wiggle room for the future, cautioning that it could not “articulate with doctrinal exactitude a bright line” rule for stockholder-adopted bylaws (p. 12) and stressing that “[w]hat we do hold is case specific” (n.14). In the near term, however, CA may open directors up to fiduciary challenges on decisions that previously were not subject to challenge.
There is not inconsiderable tension between the holding that the reimbursement provision was procedural and thus a proper subject of stockholder action and the holding that the same provision was invalid because it mandated substantive board action without a fiduciary carve out. CA is thus a decision that simultaneously gives and takes away. It gives stockholders the ability to propose bylaws addressing the election process. At the same time, it takes away the ability to adopt mandatory bylaws (or at least those providing mandaotry reimbursements) by holding such bylaws invalid if they could force the board to violate its fiduciary duties. Only future decisions will reveal how this tension plays out.