TheCorporateCounsel.net

September 19, 2014

Corp Fin Comment Letters: Insiders Selling Ahead of Their Public Availability?

Geez, I don’t know what to make of this Forbes article – which describes this study that found an abnormal level of selling by insiders in the days before Corp Fin comment letters that contained revenue recognition comments were made public. The total amount of abnormal selling in the 2006-2012 study period was $463 million, or $356k on average. I suppose insiders should be savvy enough to understand accounting comments from Corp Fin and their implications – but I still tend to think this couldn’t be happening on a widespread basis? Let me know what you think.

Comment letters (and the related responses) are made public no earlier than 20 business days after all comments are resolved. Learn more in my “SEC Comment Letter Process Handbook.”

New Bill: “The CEO-Employee Pay Fairness Act”

Yesterday, Rep. Chris Van Hollen – the ranking democrat on the House Budget Committee – introduced “The CEO-Employee Pay Fairness Act.” The bill would prevent companies from obtaining Section 162(m) tax deductions for CEO bonuses unless certain employee salaries were raised. The bill’s goal is for companies to reward all workers — not just top executives and major shareholders — for the company’s gains in productivity. Here’s a Washington Post article – and here’s an article from The Hill…

Resource Extraction Rules: SEC Sued (Again)

As noted in this Bloomberg article, Oxfam America has sued the SEC in a Massachusetts federal court to force the SEC to adopt the resource extraction rules again. In July, a federal court in DC vacated the rules the SEC had already adopted. As noted in Steve Quinlivan’s blog, Oxfam cites the following as grounds for relief:

- Administrative Procedure Act (5 U.S.C. § 706(1)) provides a remedy to “compel agency action unlawfully withheld or unreasonably delayed.”
- Federal mandamus statute (28 U.S.C. § 1361) gives a federal district court jurisdiction to compel an agency of the United States to perform a nondiscretionary duty owed to a plaintiff as a matter of law.

- Broc Romanek

September 18, 2014

Corp Fin’s Comment Letters: WSJ Peeks Under the Hood

It was bound to happen. I just thought it would happen much sooner. It’s been just over a decade since Corp Fin began posting its comment letters (and the related responses) – but yet there has been scant mass media attention paid to them other than high profile IPOs. Some of us in the industry have tracked comment letter trends (see these memos in our “SEC Comment Process” Practice Area) – but the mass media has left this area alone for the most part. That’s why I was a little surprised to see this WSJ article entitled “To Be Clear, SEC Reviewers Want Filings in Plain English, Period”:

After combing through a 19,974-word filing for a securities offering, Securities and Exchange Commission senior counsel Catherine Gordon had some guidance for the company that drafted it. “In the second paragraph, add a comma,” she wrote to an attorney for the trust, sponsored by Incapital LLC, in December, “to improve readability.” Meet the stock market’s punctuation police. Corporate securities filings are plagued by some of the world’s most impenetrable prose, but it isn’t for lack of effort. Every year, SEC lawyers and accountants review several thousand of the more than half-million documents that companies file with the agency. And while they are primarily on the prowl for accounting inconsistencies and breaches of securities regulations, they also chase down typos, sentence fragments, jargon, puffery and sloppy punctuation.

Making sure corporate disclosures pass muster falls to the SEC’s 350-member Corporation Finance division—Corp Fin in the trade—which reviews every public company’s primary filings at least once every three years. Last year alone, the securities industry’s style police sent nearly 8,800 letters to more than 4,600 companies, according to LogixData, which analyzes SEC filings. The letters, which eventually become public, contained more than 66,000 questions, most seeking fuller disclosure or better adherence to accounting rules. But many would have been right at home in freshman English.

SEC staffers asked a brewer to provide the volume of a barrel, a wedding organizer to define “marriage-seeking profiles,” racing companies to describe their horses with complete sentences, a biopharmaceutical maker to explain aplastic anemia and an annuity company to punctuate the end of a sentence. In reply, they received nearly 8,700 letters containing more than 67,000 answers and proposed revisions. Incapital added the comma and agreed to additional changes prompted by 19 other queries in the letter from Ms. Gordon and her colleagues, including requests for more detail about investment practices and references to the “economic environment.” The SEC declined to comment on specific letters or to make staffers who sent them available for comment.

“Please use a readable type size throughout,” senior staff attorney Kathryn McHale wrote First Internet Bancorp in October after it filed to sell shares. “The summary selected financial data beginning on page 6 is too small.” The bank promised to increase the font size, though subsequent filings continued to use 8-point type for the numbers. Most of the rest of the text appears in 13-point type. First Internet said it used small type to fit figures for seven financial periods in the table. The company uses larger type where possible, and online filings mean readers can zoom in, spokeswoman Nicole Lorch said. “It was not our intention to obfuscate financial data,” she said.

Some inquiries get technical. Pamela Long, one of Corp Fin’s assistant directors, questioned Technology Applications International Corp. , a marketer of water purifiers and cosmetics based in Aventura, Fla., about this phrase: “rotatable perfused time varying electromagnetic force bioreactor.” She asked the company to explain what exactly it was, along with “how this enhances the product, if at all.” Technology Applications proposed a revision: “In use, the rotatable perfused time varying electromagnetic force bioreactor supplies a time varying electromagnetic force to the rotatable perfusable culture chamber of the rotatable perfused time varying electromagnetic force bioreactor to expand cells contained therein.”

Ms. Long wasn’t satisfied. “The revised disclosure uses a number of terms that are unclear to the reader and appear to be industry jargon,” she wrote, asking the company to revise. The company’s next revision—with a color illustration—mostly passed muster: The device is designed to grow more-natural cell cultures. But Ms. Long remained concerned by language saying the device was “sponsored” or “managed” by the National Aeronautics and Space Administration. “As currently drafted, the disclosure suggests that NASA is actively involved in the process of making the cosmetics,” she wrote in January 2013. The company now says in its filings that the device was “developed and patented” by NASA and a private firm. John Stickler, vice president at Technology Applications, said the company expected some back and forth with the SEC over its share registration, though the extent came as a bit of a surprise. “The process got a little old after a while when you kept reiterating this is how it works, this is how it works,” said Mr. Stickler.

Most of Corp Fin’s inquiries tackle tougher topics. But simplifying language to be better understood by investors is also a serious goal. Former SEC Chairman Arthur Levitt made clarity a career mission, prompting the agency in 1998 to publish an 83-page “Plain English Handbook” that still circulates today. “What we are getting to is clear and concise disclosure that people can understand,” said Shelley Parratt, Corp Fin’s deputy director for disclosure operations. One pitfall for corporate filers: forgetting that filings are primarily legal documents, not marketing material. Restaurant chain Zoe’s Kitchen Inc., which blends Southern and Greek dining, bills itself as providing “flavorful, Mediterranean, naturally healthful meals prepared fresh each day.”

Similar language didn’t fly when Zoe’s registered shares for sale to the public. “We note that 17% of your total cost of sales was chicken; 7%, beef; and 4%, feta cheese and that your menu includes soft drinks and potato chips. Do you believe this is a reflection of traditional Mediterranean cuisine a 100 years ago?We suggest revising your descriptions,” wrote Max Webb, then assistant director of Corp Fin for transportation and leisure and a law-school lecturer. “Are the potato chips prepared from scratch daily? The soft drinks?” Zoe’s replied: “The Company respectfully advises the staff that chicken, beef and feta are significant contributors to the Company’s cost of sales, and the Company’s traditional Mediterranean menu includes a majority of ingredients that reflect cuisine from 100 years ago.”

Mr. Webb also highlighted redundancies. “We note…that on pages 1 and 2 you mention that your food is ‘fresh’ five times. The same two pages inform the reader that your offerings are prepared ‘from scratch’ four times,” he wrote. “In the four sentence paragraph under Overview on page 56 you use ‘fresh’ and/or ‘freshly-prepared’ three times.” Zoe’s agreed to most of the requested changes, although references to “traditional Mediterranean cuisine” made it into the final prospectus. The company’s shares have roughly doubled since their April 11 initial public offering.

Conflict Minerals: NAM Argues Against En Banc Rehearing 

Here’s a blog from Steve Quinlivan (and here’s a related one from Ning Chiu):

Earlier, the United States Court of Appeals for the District of Columbia Circuit ordered the appellants in the conflict minerals case, NAM et al, to file a response to the SEC’s and Amnesty International’s petition for an en banc rehearing.

The response has now been filed. NAM says there is no need for a rehearing. According to NAM the standard for a rehearing isn’t met because the case presents no conflict in the DC Circuit’s decisions or with decisions of the Supreme Court or other Courts of Appeals.

Maybe it’s not surprising so far because the court essentially ruled in favor of NAM. Then NAM says what it really wants – the appellate panel should amend its decision in light of the American Meat case to clarify that the compelled statement is not eligible for Zauderer rational basis review. The reason Zauderer doesn’t apply is the conflict minerals disclosure does not constitute “purely factual and uncontroversial information.”

According to NAM, doing anything else would break dangerous new ground: “Appellants are aware of no case permitting the government to require a company to adopt an ideological slogan written by the government that attacks the company and its products, and neither the SEC nor Amnesty has cited any such case. If such requirements were deemed permissible, the temptation for Congress and state legislatures to require similar self-shaming measures across a range of controversial issues could be irresistible.”

The response also includes predictable references to the “scarlet letter,” issuers with “blood on their hands” and like rhetoric that has become familiar in this case.

House Passes JOBS Act-Related Bill 

As noted by MoFo’s Anna Pinedo in this blog: The House of Representatives voted 320 to 102 to pass H.R. 5405 (Promoting Job Creation and Reducing Small Business Burdens Act) that contains a number of JOBS Act related measures that previously were the subject of individual bill proposals. For example, the bill addresses the JOBS Act inadvertent failure to address the Exchange Act threshold as to savings and loan holding companies; a pilot tick-size pilot program for emerging growth companies; a grace period for transitioning from EGC status; and an exemption from xBRL requirements for EGCs.

- Broc Romanek

September 17, 2014

PCAOB Staff Practice Alert: Revenue Auditing

Recently, the PCAOB issued “Staff Audit Practice Alert No. 12” about auditing revenue, including revenue recognition, presentation and disclosure. The Alert cited “frequently observed significant audit deficiencies” regarding revenues during auditor inspections of audit firms – and focuses on these areas:

- Testing the recognition of revenue from contractual arrangements
- Evaluating the presentation of revenue—gross versus net revenue
- Testing whether revenue was recognized in the correct period
- Evaluating whether the financial statements include the required disclosures regarding revenue
- Responding to risks of material misstatement due to fraud associated with revenue
- Testing and evaluating controls over revenue
- Applying audit sampling procedures to test revenue
- Performing substantive analytical procedures to test revenue
- Testing revenue in companies with multiple locations

Here’s more from the FEI Daily.

In our “Audit Committee” Practice Area, we have numerous resources – including a bunch of sample documents (eg. Memo to Audit Committee: What Certification Procedures Are).

PCAOB Inspection: E&Y’s 49% Audit Deficiency Rate!

As highlighted in this WSJ article, the most recent inspection of E&Y’s audits by the PCAOB found a 49% deficiency rate. 49%! I’m speechless…

Craig Eastland has blogged a 3-part series about restatements, including statistics and a flow chart. Check it out!

Mailed: September-October Issue of The Corporate Executive

The September-October issue of The Corporate Executive was recently mailed to subscribers. This issue includes important practical guidance on:

- Company Postpones its Annual Meeting Due to Lawsuit Over Stock Plan and Disclosures
- Lawsuits Against Non-Employee Directors Over Their Own Compensation Increase—And Why They Are Easier to Bring
- Formal Relief from Section 457A for Stock Options and Stock SARs
- Section 409B—Worse Than 409A?

Act Now: Get the “Rest of 2014 for Free” when you try a ’15 No-Risk Trial now.

- Broc Romanek

September 16, 2014

Poll Results: How Are You Responding to Your SDX Shareholder Engagement Letter?

Last month, I ran a poll in this blog to address the query about how companies were responding to the SDX engagement letter. Here are the results:

- Responded indicating have adopted shareholder-director engagement policy – 0%
- Responded indicating will consider adopting shareholder-director engagement policy – 0%
- Responded saying ‘thanks for the letter’ – 17%
- Decided not to respond at all – 32%
- Undecided; intend to discuss at board meeting what to do – 26%
- Undecided; might not even share with the board – 25%

Please take a moment to participate on this “Quick Survey on Earnings Releases and Earnings Calls” – and this “Quick Survey on Whistleblower Policies & Procedures.”

SEC’s First Ombudsman: Retail Investors Get a Complaint Department

Recently, the SEC hired its 1st Ombudsman – Tracey McNeil – who will report to the head of the Office of the Investor Advocate. Dodd-Frank created this position as the ombudsman will act as a confidential liaison in resolving problems that retail investors may have with the SEC or self-regulatory organizations.

Meanwhile, the SEC created a new “Office of Risk Assessment” within Risk Fin – the new office will coordinate the data-driven risk assessment tools across the agency, like the ones that recently supported Enforcement’s Section 16 initiative…

Cap’n Cashbags: The “Real” ALS Ice Bucket Challenge

Cap’n Cashbags – a CEO – doesn’t try to avoid the ALS Ice Bucket Challenge in this trailer for the full feature film (here’s his 1st attempt):

- Broc Romanek

September 15, 2014

Webcast: “Cybersecurity – Working the Calm Before the Storm”

Tune in tomorrow for the webcast — “Cybersecurity: Working the Calm Before the Storm“— to hear Weil Gotshal’s Paul Ferrillo, Hogan Lovells’ Harriet Pearson and Dave Lynn of TheCorporateCounsel.net and Morrison & Foerster analyze a host of issues that you need to consider now — before you have a security breach.

Then come back and join us next Monday, September 22nd for the webcast — “Cybersecurity Role-Play: What to Do & Who Does What, When” – to hear the FBI’s Leo Taddeo and Cleary Gottlieb’s Louise Parent, Craig Brod, Richard Kreindler, Pam Marcogliese and Jonathan Kolodner role-play a variety of possible cybersecurity scenarios that could happen to you.

Study: 52% of Banks Don’t Disclose Cyber Risk Factors

Given what I’ve read recently about attempted – and successful – cybersecurity breaches at banks, I was surprised to see this study from LogixData that analyzed the disclosures of 575 banks and found that 303 (52%) of them had absolutely no mention of anything related to cyber security. Here’s a report with the 56 largest banks that had the risk factors.

The Rise of Foreign Issuer IPOs

In this blog, Ze’-ev Eiger of Morrison & Foerster explains the reasons for a comeback in IPOs in the United States by foreign issuers…

- Broc Romanek

September 12, 2014

CII: Investors Seek Proxy Disclosure of Board Evaluation Process

As noted in this blog by Davis Polk’s Ning Chiu, CII has issued this report about “Best Disclosures of Board Evaluation Process.” Based on a survey of CII members, investors want disclosure of the board evaluation process (but not the actual evaluation results themselves).

Exemplars of disclosure about the mechanics of the evaluation process include Potash, Agrium and General Electric – while the report points to BHP Billiton, Dunelm and Randstad Holding (all non-US companies) for “particularly effective” disclosures of the most recent board evaluations.

Shareholder Proposals: Different Outcomes for Political Contribution Proposals

Last week, I narrowly missed the hubbub outside the SEC’s DC headquarters as protestors gathered in support of the petition asking the SEC to require political contribution disclosures (I was down there for other reasons) – the group now has a website: “SECDisclose.org.” It’s still a hot topic. The protest celebrated the 2011 rulemaking petition that now has over 1 million supporters. Wow!

Here’s news from this blog by Davis Polk’s Ning Chiu:

The SEC staff recently disagreed with Procter & Gamble’s no-action letter, which sought to exclude a shareholder proposal on ordinary business grounds, although a similar proposal sent to Johnson & Johnson was allowed to be kept out of its proxy statement this past February.

Both proposals requested reports to shareholders explaining the congruency between the companies’ stated “corporate values” and the company’s political contributions, with “justifications for…exceptions” for those contributions which may appear to be misaligned with the values. While the SEC staff did not explain their reasoning in the P&G decision, the different results seem to lie in the focus of the examples used to demonstrate the alleged incongruency.

The J&J proposal questioned the company’s public commitment to the Patient Protection and Affordable Care Act (ACA), since, according to the proponent, 30% of the company’s political contributions were directed at legislators who voted against ACA and related regulations, or to politicians who favored legislation to prohibit the enforcement of ACA. In that case, the SEC staff stated that the proposal was directed toward specific political contributions that relate to the operation of the business, not general political activities, and therefore permitted the company to exclude the proposal.

Procter & Gamble’s shareholder proposal focused on two different issues. The proposal criticized making donations to politicians who voted to deregulate greenhouse gasses as contrary to the company’s stated goal toward environmental sustainability. In addition, the proposal also questioned the company’s support of candidates who voted against hate crimes legislation or who disfavored same sex marriage, which the proponent claimed is at odds with the company’s stated nondiscrimination policy.

In a letter, the proponent’s attorney distinguished the P&G proposal, noting that in the J&J proposal the focus was on a single issue, the ACA, which was of direct relevance to J&J’s business because the company is a “healthcare industry stakeholder.” According to the attorney, the examples of legislation used in the P&G proposal, however, are “general public policy issues” and not aimed at legislation that directly affected the company.

Chamber: ISS Survey Lacks Empirical Research Linking Policies to Enhanced Shareholder Value

In a letter to ISS – responding to the current ISS policy survey – the Chamber of Commerce disputes the survey results gather by ISS about investment advisors who rely exclusively on ISS voting recommendations. Meanwhile, SEC Commissioner Gallagher has taken the unusual step of writing a report for publication outside the agency’s walls – this report on proxy advisors published by the Washington Legal Foundation…

- Broc Romanek

September 11, 2014

Wow! SEC Launches “Section 16 & Schedule 13D” Enforcement Inititative

Yesterday, as noted in Alan Dye’s blog on Section16.net, the SEC announced a major enforcement initiative in which it has brought enforcement actions against 28 insiders (directors, officers and 10% owners) for failing to file timely Section 16(a) reports and Schedules 13D and 13G. Twenty-seven of the 28 have agreed to settled – and it appears that many (if not all) agreed to pay civil money penalties (totaling $2.6 million!).

In addition, 6 companies settled allegations that they failed to disclose their insiders’ Section 16(a) violations as required by Item 405 of Regulation S-K. As noted in this Reuters article, it’s the 1st time that the SEC has systemically targeted insiders & companies for beneficial ownership reporting violations – Alan will report more in his blog after he reads all of the individual orders.

This could mean a new era of enforcement of beneficial ownership requirements. I read one of the settlements that penalized the company and the SEC said that the company’s employees were negligent in not timely filing the reports for the insiders…

Speaking of Big Fines: $2.8 Million in Attorney Fees!

Over on “The Advisors Blog” on CompensationStandards.com last week, I blogged how Abercrombie recently settled one of the proxy disclosure lawsuits. It’s a “governance by gunpoint” settlement – with a $2.78 million payout in attorneys’ fees…

Just Announced! “Alan Dye’s Section 16 Hands-On Training Workshop”

One of the most frequent requests heard by Alan is “can you recommend a Section 16 training class for beginners?” Until now, the answer is “there is none.” But no more! On January 9th, Alan & I are holding a Section 16 training workshop in DC: “Alan Dye’s Section 16 Hands-On Training Workshop.” Since this is a workshop, there is limited seating – so you should act now if you are among those that need it. The agenda is posted – and includes sessions on these topics:

– The Basics
– Nuts & Bolts: Understanding Forms 3, 4 and 5
– How to Obtain Reporting Guidance & Support
– 10 Most Common Types of Filings
– Overcoming Your Fears of Complex Filings
– Navigating EDGAR & Other Filing Issues
– Establishing Filing Compliance Programs
– Yikes! What to Do If There’s a Filing Error: Corrections & Disclosure
– The In-House Perspective

- Broc Romanek

September 10, 2014

Conflict Minerals: Commerce Department Publishes List (A Year Late)

The excerpts from the two blogs below best describe this year-late list of “all known conflict mineral processing facilities worldwide” from the Commerce Department. The list is required by Dodd-Frank’s Section 1502(d)(3)(C) – but it does “not indicate whether a specific facility processes minerals that are used to finance conflict in the Democratic Republic of the Congo or an adjoining country. We do not have the ability to distinguish such facilities.”

From Stinson Leonard Street’s Steve Quinlivan blog:

But the provision of the Dodd-Frank Act that requires this list is entitled “Report on Private Sector Auditing” and it looks like Commerce hasn’t begun to tackle that responsibility. Annually, beginning 30 months after passage of the Dodd-Frank Act, Commerce is required to submit a report to Congressional subcommittees that includes: “An assessment of the accuracy of the independent private sector audits and other due diligence processes described under the conflict minerals provisions. Recommendations for the processes used to carry out such audits, including ways to (i) improve the accuracy of such audits and (ii) establish standards of best practices.”

I know only one or two or a very few issuers submitted private sector audits with the first round of required conflict minerals filing. Perhaps Commerce has concluded it’s not worth the effort to make the evaluations or maybe the evaluation is underway. Since the standards for the audits have been published, Commerce certainty could provide recommendations as to the processes used to carry out the audits and establish standards of best practices.

From Cooley’s Cydney Posner blog:

The disclosure by Commerce may be helpful for issuers in a couple of ways. The list of smelters and refiners produced by Commerce may actually be useful for issuers in their conflict minerals compliance efforts because it compares and reconciles information about smelters and refiners from a number of sources. Moreover, the admission of the challenges faced by Commerce (with all of its resources) highlights and legitimizes the difficulty that issuers have faced in trying to comply with the conflict minerals rules. We can only hope that the acknowledgement by Commerce of its inability to distinguish which facilities are used to finance conflict in the DRC will encourage the SEC to be a bit indulgent in the conduct of whatever type of review-and-comment process it may undertake for conflict minerals reporting and perhaps lead to some constructive and practical guidance or even revisions of the rules, where necessary.

Also check out this piece by Elm Consulting entitled “Conflict Minerals Math: When 1/11 Equals 100%“…

XBRL: Errors Not Caught By Software

This blog from FEI Daily provides some cautionary tales about XBRL and software used to find errors…

Last Chance — Our Pair of Popular Executive Pay Conferences

With just two weeks to go, folks are rushing to join their 2000 other colleagues to be part of our “Annual Proxy Disclosure Conference” on September 29th-30th. Registrations for our popular pair of conferences (combined for one price)—in Las Vegas and via video webcast — are strong and for good reason. Act now!

The full agendas for the Conferences are posted — but the panels include:

- Keith Higgins Speaks: The Latest from the SEC
- Top Compensation Consultants: Survivor Edition
- Preparing for Pay Ratio Disclosures: How to Gather the Data
- Pay Ratio: What the Compensation Committee Needs to Do Now
- Case Studies: How to Draft Pay Ratio Disclosures
- Pay Ratio: Pointers from In-House
- Navigating ISS & Glass Lewis
- How to Improve Pay-for-Performance Disclosure
- Peer Group Disclosures: The In-House Perspective
- Creating Effective Clawbacks (and Disclosures)
- Pledging & Hedging Disclosures
- The Executive Summary
- Dealing with the Complexities of Perks
- The Art of Communication
- The Big Kahuna: Your Burning Questions Answered
- The SEC All-Stars
- Hot Topics: 50 Practical Nuggets in 75 Minutes

- Broc Romanek

September 9, 2014

Which Factors Influence Board Leadership Structure (& How)?

This recently published Korn Ferry/NACD board leadership survey of the S&P 500 and S&P 400 is particularly noteworthy because it delves into a number of important topics aside from merely identifying leadership structure types and trends.

Survey results include:

  • Continued trend toward separation of the CEO and board chair roles – which reflects almost equally increases in independent and non-independent chairs
  • Smaller companies are more likely to separate the CEO/chair roles than larger companies.
  • Larger companies that separate the roles are more likely to later recombine them.
  • About 50% of companies changed their leadership structure upon a succession event (i.e., new CEO or chair).
  • A slight majority of companies experiencing a succession event chose a combined rather than separated structure.
  • With the exception of founders stepping aside, separating the roles is more likely when an unexpected resignation or crisis (as opposed to a planned succession) triggers the succession event.
  • Planned successions involving founders are more likely to result in separating rather than combining the roles.
  • 40% of succession events in 2012 included some sort of transition – such as the former CEO/chair remaining as chair for some time period after the new CEO was in place.
  • Certain industries (some characterized by having more founder-chairs) like IT tend to separate the roles at a much higher rate than other industries.

Based on the findings, the survey reaffirms that there is no “right” board leadership structure; rather, each company needs to determine for itself the most appropriate structure based on its particular facts and circumstances – which evolve over time. See more surveys, memos and other helpful resources in our “Board Leadership” Practice Area.

Enhancing CEO Succession: Directors Mentoring Executives

This recent Heidrick & Struggles article discusses how pairing directors with high-potential internal CEO succession candidates in formal mentoring relationships – well in advance of planned succession events – can reduce risks associated with CEO successsion, and motivate and improve company performance. Mentoring allows directors to gain an in-depth understanding of candidates’ leadership potential – not just past performance, which isn’t sufficient to predict future success.

So-called “soft skills” such as self-awareness and empathy, which are detectable by directors over the course of the mentoring relationship and which most CEO candidates lack, are described as the key differentiators between candidates that can succeed as CEOs vs. those that fail. The article also discusses a form of mentoring program implemented by Frontier Communications (see this 2010 WSJ article), and describes how companies can set up their own program.

This is certainly not the first article to tout the benefits of directors serving as mentors for potential CEO successor candidates. Among others, this report by The Conference Board (discussing the findings of a survey that focused on how well directors know senior executives positioned to succeed to the CEO) recommended that – while CEOs are ultimately responsible for mentoring and developing their direct reports, the board still play an active role by, e.g., serving as informal mentors or advisors, noting:

“It is important for directors to move beyond interacting with executives “when circumstances warrant” (as is commonly reported). Developing true insight into the professional quality and personal character of an executive requires dedicated time and effort.”

Contrary to the recommendation, however, the survey found that only a small percentage (7%) of companies currently assign a director to serve as a mentor for their senior executives.

More on “The Mentor Blog”

We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

- Auditor Engagement Letters: No Company Intervention in Auditor-Directed Work
- PCAOB Roundtable: Mixed Views of Proposed Changes to Auditor’s Report
- Perceived Board Effectiveness Linked to How Board Allocates its Time
- FINRA: Pre-IPO Selling Procedures Need to Be Adequately Supervised
- Board Trends at the S&P 1500

- by Randi Val Morrison

September 8, 2014

Smaller Boards: Bigger Returns

According to this WSJ article, a recent study by GMI Ratings found that – among companies with a market cap of at least $10 billion, those with smaller boards produced substantially better shareholder returns over a 3-year period than companies with the largest boards. According to the reporter, the study isn’t being made publicly available, so it’s difficult to draw conclusions outside the confines of what’s presented there.

However, as noted in a LinkedIn discussion on this topic, other research (for example, see “Higher Market Valuation of Companies with a Small Board of Directors” and “Larger Board Size and Decreasing Firm Value in Small Firms”) has previously identified an association between smaller boards and higher market valuation for companies of all sizes. And those of us who have worked with various boards ranging in size from 7 to 13 or more members can personally speak to the many attributes associated with smaller boards compared to larger ones.

But there are some downsides to smaller boards as well. Here’s an excerpt addressing some of the upsides and downsides of smaller and larger boards from our Board Size checklist posted in our “Board Composition” Practice Area on TheCorporateCounsel.net:

Smaller Board

  • More opportunities for all directors to actively participate and be engaged in board deliberations
  • Greater flexibility and ease in scheduling meetings, setting agendas, distributing materials, communicating on impromptu basis
  • Individual directors more likely to assume responsibility rather than deferring to others – more likely to be a greater sense of ownership & accountability than with a larger board
  • More likely to accommodate detailed materials & discussions
  • Easier and less costly for company personnel to manage, coordinate, facilitate
  • Directors know each other better, increasing likelihood of cohesive board with feeling of common purpose and more productive working relationships
  • Greater workload burden on individual directors may diminish effectiveness – time commitment required may exceed time available on a per person basis
  • May have difficulty effectively staffing committees – particularly with continued additional regulatory-imposed responsibilities that increase committee work load & time commitment
  • More likely lacks diversity of experiences and perspectives characteristic of larger boards
  • Easier to reach consensus
  • Meetings tend to be much more informal

 

Larger Board

  • Can inhibit effective and equal opportunities for participation by individual directors
  • Larger boards tend to exhibit less questioning than smaller boards
  • Can interfere with effective functioning by limiting opportunities for meetings (due to conflicting schedules), necessitating formal procedures for communications, impeding collective input, discussion and consensus, etc.
  • Can more easily accommodate multiple committees effectively staffed
  • Conducive to more board work being delegated to committees (thus enabling active participation by individual directors that may be absent at the board level) – as opposed to remaining at full board level
  • Workload can be better allocated among larger number of directors regardless of committee structure
  • Can accommodate greater diversity in a traditional – as well as a broader – sense, thus allowing for broader range of viewpoints and ideas, which can lead to more thorough and thoughtful consideration of matters
  • More likely that few members will consistently dominate discussion while more reserved members fade into the background (consensus more likely achieved via a herd mentality)
  • At least some individual directors more likely to defer to others – not assume responsibility, accountability
  • Meetings tend to be much more formal out of necessity

Importantly, as noted in the LinkedIn discussion, even if there is an association between board size and shareholder returns, clearly board size is but one of many factors relevant to company performance – so this new study (and any other study) should be viewed in that context.

Study: Academic Directors Yield Better Corporate Governance & Company Performance

This interesting academic paper, “Professors in the Boardroom and Their Impact on Corporate Governance and Firm Performance,” describes the results of a study about the impact of having academic directors on the board. According to the paper, about 40% of the S&P 1,500 had at least one professor on their boards during 1998 – 2011, and for companies with academics on their boards, over 14% of their outside directors are academics. The findings certainly should make boards take a closer look at the academic director candidate pool as one of many great sources for quality candidates.

Noteworthy findings include:

- Companies more likely to have academic directors:

  • Larger companies
  • More research-intensive companies
  • Those situated more closely geographically to universities
  • Larger boards
  • More independent boards
  • Boards with more female directors
  • Boards with older directors
  • Companies where CEO has greater equity stake
  • High-tech and financial companies

 

- Presence and percentage of academic directors on the board positively impacts company performance

  • As measured by Tobin’s Q (market value/book value)
  • As measured by ROA (net income before extraordinary items & discontinued operations/book value of assets)

 

- Academic directors score higher than other outside directors on certain governance indicators:

  • They are more likely to attend board meetings
  • They hold more committee memberships
  • They are more likely to sit on monitoring-related committees (e.g., auditing, corporate governance)

 

- Academic directors strengthen the board’s oversight of management

  • They are associated with significantly lower cash-based CEO compensation, but not equity-based compensation
  • They are associated with a closer relationship between CEO forced turnover and company performance

 

- Academic directors strengthen the board’s advising & monitoring roles

  • Companies are less likely to manage earnings through discretionary accruals
  • Companies are less likely to be the subject of SEC investigations
  • Company stock prices reflect more company-specific information
  • Presence of academic directors is significantly and positively associated with acquisition performance
  • Companies are more innovative as reflected by the number of patents & patent citations

More on “The Mentor Blog”

We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

- PSLRA: Ineffective Motions to Dismiss
- Top Ten List of D&O Coverage Questions for Directors
- Bylaws Mandatory Arbitration Clauses Gaining Ground
- Survey: Board Tenure & Governance
- Weighing Pros & Cons of a Dual-Class Share Structure

- by Randi Val Morrison