E-Minders August 2020
In This Issue:
E-Minders is our monthly e-mail newsletter containing the latest developments and practical guidance for corporate & securities law practitioners.
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At an open meeting, the SEC adopted amendments to its proxy solicitation rules, which are intended to give companies a more meaningful opportunity to review and respond to proxy advisors' voting recommendations, ensure that proxy advisor clients have access to those responses prior to the meeting, and require the advisory firms to disclose potential conflicts of interest. The rules were adopted by a 3-1 vote, with Commissioner Allison Herren Lee issuing this dissenting statement. CII also issued a statement expressing disappointment with the rules.
Here are the high points, which are explained in more detail in the SEC's Fact Sheet (also see Mike Melbinger's blog and this blog from Cooley's Cydney Posner - and we're posting memos in our "Proxy Advisors" Practice Area).
- "Solicitation" Includes Proxy Advice for a Fee: Consistent with the Commission's longstanding view, the changes amend the definition of "solicitation" in Exchange Act Rule 14a-1(l) to specify that it includes proxy voting advice, with certain exceptions.
- New Conditions for Exempt Solicitations: Under amendments to Rules 14a-2(b)(1) & 14a-2(b)(3), in order for proxy voting advice businesses to rely on the exemptions from information and filing requirements (which are essential for them to be able to carry out their business), they must satisfy the conditions of new Rule 14a-2(b)(9), including disclosure of conflicts of interest and adoption & disclosure of policies that allow for companies to review & respond to the voting recommendations. New Rule 14a-2(b)(9) also establishes non-exclusive safe harbors that will allow proxy advisors to meet the conditions.
- Application of Antifraud Rule to Proxy Advice: The amendments modify Rule 14a-9 to include examples of when the failure to disclose certain material information in proxy voting advice could, depending upon the particular facts and circumstances, be considered misleading within the meaning of the rule. These examples include material information about the proxy voting advice business's methodology, sources of information, or conflicts of interest.
It is worth noting that the "registrant review" provisions of the final rule are less demanding that those that were originally proposed. That original proposal would have obligated advisors to provide companies with a copy of their advice in order to permit them to identify errors or other problems with the analysis in advance of their release, and would have also required proxy advisors to provide the company with a final report no later than two business days prior to its dissemination to their clients.
The amendments will be effective 60 days after publication in the Federal Register, but affected proxy voting advice businesses subject to the final rules are not required to comply with the Rule 14a-2(b)(9) amendments until December 1, 2021. At least that's the plan - ISS has a pending lawsuit against the SEC challenging the agency's ability to regulate it. The parties agreed to stay the lawsuit until the SEC adopted final rules. Now that the rules are in place, the real fight may be just beginning.
The SEC also supplemented its 2019 guidance to investment advisers about their proxy voting responsibilities, and the steps they could take to demonstrate that
they're making voting decisions in a client's best interest. As noted
in Cydney Posner's blog, that guidance:
The supplemental guidance addresses how investment advisers should consider company responses to proxy advisor voting recommendations. This includes circumstances in which the investment adviser utilizes a proxy advisory firm's electronic vote management system that "pre-populates" the adviser's ballots with suggested voting recommendations or for voting execution services (so-called "robo-voting"). It also addresses their disclosure obligations and client consent requirements when using automated voting services. Here's an excerpt:
An investment adviser should consider, for example, whether its policies and procedures address circumstances where the investment adviser has become aware that an issuer intends to file or has filed additional soliciting materials with the Commission after the investment adviser has received the proxy advisory firm's voting recommendation but before the submission deadline. In such cases, if an issuer files such additional information sufficiently in advance of the submission deadline and such information would reasonably be expected to affect the investment adviser's voting determination, the investment adviser would likely need to consider such information prior to exercising voting authority in order to demonstrate that it is voting in its client's best interest.
In mid-July, the SEC proposed amendments to Form 13F for institutional investment managers. If adopted, the primary proposed change would raise the Form 13F reporting threshold for investment managers - from the current $100 million to $3.5 billion - and as stated in the SEC's press release, would thereby provide relief for smaller managers who are currently subject to Form 13F reporting. Other proposed changes include:
The proposed changes also would direct the staff to review the Form 13F reporting threshold every five years and recommend an appropriate adjustment, if any, to the Commission. Additionally, the proposal would eliminate the ability of managers to omit certain small positions, thereby increasing the overall holdings information required from larger managers. The proposal also would require managers to report additional numerical identifiers to enhance the usability of the information provided on the form, and amend the instructions relating to requests for confidential treatment of Form 13F information.
The proposed reporting threshold change from $100 million to $3.5 billion is a big increase but as the announcement points out, the threshold hasn't been updated since the Commission adopted the form over 40 years ago! In the time since the form was adopted, the announcement says the overall value of U.S. public corporate equities has grown over 30 times (from $1.1 trillion to $35.6 trillion).
Even though the press release notes that the Commission has received recommendations to revisit the Form 13F reporting thresholds over the years, not all are in agreement with the proposed changes. Commissioner Allison Lee issued a dissenting statement saying the proposal decreases transparency and that it lacks sufficient analysis. The National Investor Relations Institute (NIRI) tweeted its disagreement and said it "shared Commissioner's Lee's concerns about the ill-advised proposal." NIRI also referenced its position paper on 13F reforms, which is dated just last fall and among other things, advocates for shortening the 13F reporting deadline.
Just a couple of years ago, media reports suggested that the SEC's universal proxy rule proposal was an "ex-parrot." But this Davis Polk blog says that latest edition of the agency's Reg Flex Agenda includes the proposal on the short list, together with proxy plumbing. Here's an excerpt:
Worth noting is that the potential rulemaking related to universal proxies, proxy process amendments (a.k.a. "proxy plumbing") and mandated electronic filings have moved up to the short-term agenda; formerly these were on the 2019 fall long-term agenda. The universal proxy is a proxy voting method meant to simplify the proxy process in a contested election and increase, as much as possible, the voting flexibility that is currently only afforded to shareholders who attend the meeting. Shareholders attending a meeting can select a director regardless of the slate the director's name comes from, either the company's or activist's. The universal proxy card gives shareholders, who vote by proxy, the same flexibility.
The proxy process topic is a very large-complicated topic that involves voting mechanics and technology, including issues such as those associated with the complex system of share ownership and intermediaries. As customary, the Reg Flex Agenda provides no details; however, given the complexity of the issues, it is most likely that "low hanging fruit" will be addressed. Some of these were identified by the SEC Investor Advisory Committee Recommendation issued in September 2019, which included the use of universal proxies and were previously discussed in our blog.
The Reg Flex Agenda targets an October 2020 date for the finalization of the rule. However, the blog points out that an agency is not required to consider or act on any agenda item, and that SEC Reg Flex Agenda reflects solely the priorities of the Chairman and does not necessarily reflect the position of any other Commissioner.
On June 30th, the SEC held a roundtable on 2nd quarter reporting & Covid-19 disclosure. The panelists included a bunch of big shots from private equity firms and asset managers. This Mayer Brown blog summarizes the panel's recommendations on Q2 & Covid-19 disclosure. Many of these recommendations focused on liquidity & human capital-related issues. Here are some of them:
- Provide specific and forward-looking guidance on the company's liquidity position, including its expected cash burn and upcoming capital expenditures. Companies should consider including a best, middle and worst case liquidity scenario.
- Separately disclose the company's short-term and long-term liquidity plans. Identify the company's primary use of cash during the second quarter as compared to prior quarters.
- Specify, in a standardized format, the amount of liquidity that is currently available under the company's existing financing facilities and if financial covenants prevent the company from accessing or drawing down from a disclosed financing source. Identify the time period that the company can expect to continue to operate with limited or no cash revenue.
- Explain management's rationale for implementing announced executive compensation or staff reductions. Disclose changes to the company's work force and expected impact on the company's operations.
- Disclose the impact of the pandemic on the company's human capital. Explain if the company's employees will be able to work remotely and disclose the company-specific challenges. Estimate costs if the company expects to spend significantly on personal protective equipment in order to safely reopen.
The panelists said that investors also want to see qualitative disclosures addressing a company's operational challenges & resiliency, as well as forward-looking disclosures & trend guidance, particularly around capital raising activities. In addition, investors are looking for companies to address the effect of recent social unrest on their business & employees, along with standardized disclosure about their racial and gender diversity, including a description of applicable hiring practices.
This FEI report on ICFR addresses the potential implications of the Covid-19 crisis on the assessment of whether material weaknesses in internal controls exist. Not surprisingly, this excerpt suggests that we're likely to see more conclusions that material weaknesses exist than we have in recent years:
We'll definitely see an increase in delayed filings and we'll likely see an increase in material weakness disclosures. If remote work arrangements, facility closures or unavailability of key personnel due to illness result in an inability to apply or test control procedures, management may be forced to conclude that one or more material weaknesses in internal control exist, unless compensating preventive or detective controls are in place and able to be tested.
Satisfying the external auditors with sufficient evidence that controls are performing as intended could also be challenging in this environment. For example, people working remotely may not have access to typical work tools such as printers and scanners, making it difficult to evidence control performance.
The article also cautions that pandemic-related declines in earnings, revenues & other materiality benchmarks could also result in the inclusion of some items in the scope of this year's internal control assessment that were excluded in prior years.
Earlier this year, we blogged about the practice of presenting "EBITDAC"- type disclosures that adjust for Covid-19's impact. A more recent blog from Liz suggests that this practice is growing in popularity. Clearly, disclosures about the effects of Covid-19 are very important, but non-GAAP disclosures that include estimates of lost revenue from the pandemic aren't likely to make you many friends at the SEC.
Unfortunately, the quantitative disclosures about Covid-19 that can raise compliance issues aren't limited to EBITDAC, and guidance about where to draw the line has been hard to come by. That's why this Cleary Gottlieb memo about disclosures quantifying Covid-19's impact is a very helpful resource. This excerpt addresses potential concerns about the accuracy & verifiability of Covid-19 adjustments:
Not all adjustments are created equal. Adjustments stemming from fairly objective charges, such as COVID-related contract terminations or purchases of personal protective equipment, are easier to isolate, quantify and support than charges related to supply chain interruptions and operational inefficiencies, which may reflect drivers beyond COVID-19. The more judgment calls that are needed in a company's assessment of an adjustment, the more the company should consider its assumptions.
The SEC may be more likely to question the accuracy of the disclosure during its normal-course review of the company's periodic filings, and there is also litigation risk surrounding COVID-impact disclosure that contains a misstatement or is otherwise inaccurate or unsupportable. In addition, it may be difficult for auditors to comfort such an adjustment in an underwritten offering. such as COVID-related contract terminations or purchases of personal protective equipment, are easier to isolate.
Through a user-friendly format that incorporates Q&As and concrete examples, the memo also provides insight on determining whether or not a particular disclosure involves a non-GAAP financial measure, whether the disclosure is permissible or potentially misleading, and other matters.
Companies looking into using non-GAAP financial measures to address the impact of Covid-19 should also check out this Deloitte memo on the topic.
A recent 12-page Moody's report says that the Covid-19 pandemic has increased the likelihood that ESG will affect credit ratings over the long term - i.e., beyond 12-18 months from now. The report puts these trends into three buckets: risk preparedness for global risks, social considerations related to healthcare access & economic inequality, and a shift from shareholder primacy to stakeholder needs. Specifically, it predicts that in addition to the "usual suspects" of governments, companies in the healthcare industry and carbon-intensive companies, all sectors have the potential for greater scrutiny of these areas:
- Risk management practices
According to a recent study cited in this "Institutional Investor" article, companies that implement social responsibility plans are twice as likely to enter activist hedge funds crosshairs as firms that are not addressing these issues:
The study, evaluating data on U.S.-based activist campaigns from 2000 to 2016, found that hedge funds are significantly more likely to target companies that have a strong performance record in corporate social responsibility. In fact, the likelihood of a company being targeted increased from 3% to 5% if their CSR scores rose by two standard deviations above the average. If companies are trying to do the right thing in industries that have historically not addressed environmental, social, or governance issues, they're even more likely to be in the sight lines of activists, according to the study.
Ain't that a kick in the head? According to Prof. Rodolphe Durand, one of the study's authors, activists believe that these initiatives are a waste of money & distract management from efforts to maximize profits.
Prof. Durand says that if you want to prioritize ESG without attracting the attention of activists, forget the greenwashing & go all-in: "management teams that clearly articulate their operational and financial strategies for impact and ESG initiatives have a better chance of escaping an activist campaign than those who are vague about their plans."
The Government Accountability Office has issued a 62-page report on ESG disclosures - why investors want them, what public companies are doing, and the advantages & disadvantage of voluntary vs. mandatory disclosure regimes. The report itself doesn't give much info that people in this space don't already know - investors want ESG info, companies are working hard to provide it, there are gaps & inconsistencies in company disclosures due to the lack of standardized and prescriptive disclosure rules, and competing disclosure regimes pose important trade-offs.
One interesting tidbit - which may become relevant as investors & companies increase their focus on equity and resiliency going forward - is that companies seem to have come around to at least providing narrative cybersecurity information after the SEC's emphasis on that issue for many years, but data about human rights and health & safety is harder to come by:
As shown in figure 2, we identified disclosures on six or more of the eight ESG factors for 30 of the 32 companies in our sample and identified 19 companies that disclosed information on all eight factors. All selected companies disclosed at least some information on factors related to board accountability and resource management. In contrast, we identified the fewest companies disclosing on human rights and occupational health and safety factors.
With regard to the 33 more-specific ESG topic disclosures we examined, 23 of 32 companies disclosed on more than half of them. The topics companies disclosed most frequently were related to governance of the board of directors and addressing data security risks. Conversely, based on disclosures we identified, we found that companies less frequently reported information on topics related to the number of self-identified human rights violations and the number of data security incidents.
In addition, we found that companies most frequently disclosed information on narrative topics and less frequently disclosed information on quantitative topics. There are several reasons why a company may not have disclosed information on a specific ESG topic, including that the topic is not relevant to its business operations or material.
Senator Mark Warner (D-VA), who had requested this report back in 2018, is now calling on the SEC to establish an ESG task force to consider requiring disclosure of "quantifiable and comparable" metrics. He seized on the GAO's finding that even quantifiable metrics like carbon dioxide emissions are reported differently from company to company. As Lynn blogged recently - and as noted in this Wachtell Lipton memo - some standard-setters are starting to collaborate, which may help clarify reporting frameworks for companies & investors alike.
Last year, Liz blogged about calls for standardized sustainability disclosure and the "alphabet soup" of reporting frameworks, which haven't diminished with time. But now, in an effort to help companies and investors, the SASB and GRI announced a "collaborative work plan." Each organization issued an announcement - here's the SASB announcement and GRI's. The collaboration sounds promising, an Accounting Today article helps explain what this means:
The collaboration aims to demonstrate how some companies have used both sets of standards together and the lessons that can be shared. SASB and the GRI also hope to help the consumers of sustainability data, such as investors and financial analysts, understand the similarities and differences in the information created from these standards.
The collaboration will initially focus on delivering communication materials to help stakeholders better understand how the standards can be used together. GRI and SASB also plan to develop examples based on real-world reports to demonstrate how the standards can be employed concurrently. These resources are expected to be delivered before the end of this year.
GRI and SASB both provide compatible standards for sustainability reporting, but the groups pointed out that they're designed to fulfill different purposes and are based on different approaches to materiality. The two groups noted that independence is important to both the GRI and SASB standard-setting processes, and they plan to maintain their independence. This collaborative work plan may identify opportunities to consider how the SASB and GRI standards may be developed in the future. Decisions about standard setting, content of standards, and their interpretation are the sole responsibility of the independent standards-setting functions, which rest with the Global Sustainability Standards Board on behalf of GRI, and of the SASB Standards Board.
Board diversity has been an area of focus for investors for a while now but with recent social unrest, board diversity is being scrutinized even more. With attention on diversity, a pair of recent shareholder derivative suits have been launched against two tech companies over diversity concerns. First, this D&O Diary blog reports that an activist investor has launched a suit against Oracle's directors alleging the directors breached their fiduciary duties by failing to diversify the company's board and failing to address diversity and equality issues.
Separately, a Law360 blog describes a suit targeting Mark Zuckerberg and several other Facebook directors with claims of breach of fiduciary duty, abuse of control and unjust enrichment for allegedly deceiving "stockholders and the market by repeatedly making false assertions about the company's commitment to diversity."
As noted in the D&O Diary blog, these lawsuits show how concerns raised in the wake of current social unrest can indirectly lead to claims against corporate boards - saying activists are likely to bring further lawsuits against corporate boards as they seek to advance diversity objectives, introducing a potential new area of D&O litigation. Both complaints seek several forms of relief, including:
That at a certain number of directors resign prior to their next annual meeting, and the companies should include Black or minority nominees as replacements; that the defendants should return all of their 2020 compensation; that the companies should require their board receive annual diversity training. In Oracle's case, the shareholder also requests that the company set specific goals on the number of Black individuals and minorities to hire over the next five years; and that the company publish an annual Diversity Report. In Facebook's case, the shareholder also requests Zuckerberg be replaced as company chairman, the company create a $1 billion fund to hire Blacks and other minorities and maintain a mentorship program, tie executive pay to achievement of diversity goals and replace Facebook's auditor.
When the BRT made the shift last year from "shareholder primacy," many wondered what type of action the signatories would take to demonstrate a commitment to stakeholders. Earlier this year, Lynn blogged that 85% of those signatories published a sustainability report - and over half had adopted one or more sustainable development goals.
But this 67-page analysis, from two profs at the London School of Economics & Columbia Business School, suggests the "stakeholder" cynics might be right. Not only did the BRT statement have little impact on signatories' stock prices at the time it was announced, the data that the professors reviewed showed that relative to industry peers, signatories to last year's BRT statement:
- Commit environmental and labor-related compliance violations more often (and pay more in compliance penalties)
- Have higher market shares (and thus may face more scrutiny in future M&A transactions)
- Spend more on lobbying policymakers
- Report lower stock returns alphas and worse operating margins
- Have higher paid CEOs
The professors also looked at stocks in the largest ESG ETF and ESG mutual fund and found found "barely any correlation" between the included companies and federal environmental & labor compliance violations. That's despite large asset managers emphasizing that ESG and sustainability issues are used by them in screening or otherwise evaluating investments, or affect their voting. The professors also question whether ESG scores from third-party vendors accurately reflect ESG behavior.
The professors do acknowledge that their data is not very demonstrative of "governance" factors and is more focused on "E&S" - and one might wonder whether the size of the signatories had an outsized impact on some of these findings. But the results are sobering and suggest that investors who are focused on these issues likely need to do more of their own verification. As if you didn't have enough surveys already...
Like many businesses, my law firm's offices have been operating on a restricted schedule for the past several months, and even though we're in the process of transitioning to a full reopening, we suspect that many of our lawyers will continue to spend a lot of time working from home. Our guess is that many other companies will have similar experiences. This Deloitte memo on the CLO's role in reopenings highlights some of the cybersecurity challenges facing companies that will continue to have a large remote workforce. These include:
- Increases in socially engineered cyberattacks targeting financial and personally identifiable information (PII) data
In addition to reviewing cybersecurity insurance policies for potential coverage gaps associated with remote work, the memo recommends additional cybersecurity training to employees, communicating new and emerging threats as they arise, providing remote workers with the tools and instructions necessary to protect data and maintain data privacy protocols.
The memo also recommends that companies prioritize the preservation of the attorney-client privilege by taking actions such as reminding employees not to forward documents to personal email accounts or use other unsecure methods to transfer files or communicate with clients.
Some of our most vivid memories of our nights as young lawyers involve watching bulge bracket investment bankers & their lawyers sit in a Bowne or R.R. Donelley conference room in the wee small hours & obsess over a prospectus' compliance with the terms of the bank's style guide.
These style guides were sometimes elaborate documents with detailed instructions about proper fonts, spacing, logos, front & back cover page & underwriting section language, together with a bunch of other formatting details for every kind of offering document imaginable. Sometimes, they even specified the color of ink to be used ("Morgan Stanley blue" anyone?).
And woe to you if your document departed from the style guide! Punishment was swift and merciless (or so it was said). We remember one poor soul literally sweating as he meticulously measured & remeasured the distance between lines on the back cover page of the prospectus, and then turned his attention to the front cover, to ensure that the red herring language aligned perfectly with the top and bottom lines of the page. You'd have thought the guy was about to cut a 20 karat diamond.
That kind of obsessiveness is why the news that Goldman Sachs has come up with a new font that's free to use, but comes with an interesting catch, doesn't surprise us in the least. What's the catch? This Verge article explains:
Investment bank Goldman Sachs has released its very own typeface: an inoffensive set of sans-serif fonts dubbed Goldman Sans. But in the spirit of bankers everywhere, these fonts come with a catch in the contract. As their license states, you're free to use Goldman Sans for just about anything you like so long as you don't use it to criticize Goldman Sachs.
According to the article, the license prohibits the user from using the licensed font software to "disparage or suggest any affiliation with or endorsement by Goldman Sachs." It looks like Goldman's PR folks got wind of the negative media attention, however, because the license agreement no longer contains the anti-disparagement language.
We're guessing some people saw this as overreach by a firm that's long been a magnet for criticism, but anyone who has worked with an investment banker totally gets why they originally included the language in the license. For a Goldman Sachs lifer, there could be no greater affront than to have an element of the firm's sacred style guide weaponized against it!
A recent Harvard Business Review article provides a quick read about how one company decided to return $250 million in government relief funds. The funds weren't part of the PPP rollout fiasco where some companies applied for funds and then returned them as questions mounted about good-faith need certifications. So, with continued economic uncertainty some might question what led a company entitled to funds to give the money back.
As the article explains, the board decided to do what was right and made a unanimous decision to return the money. The article is in the form of a Q&A with the company's CEO and provides a good case study illustrating board deliberations that considered "stakeholder interests." The article says the CEO hopes to influence discussions in other boardrooms:
We're a publicly traded company, and if our decision to return the money helps give other companies a bit of air cover to make the same decision, that's a good thing. If more companies that aren't risking their survival decide to return the money, millions will turn into billions of extra funding that can go to those truly in need. Then, hopefully, we emerge stronger as a country. There's been a decade-long debate about ESG and the role of a company. In my opinion, we're at a unique time in which CEOs need to act.
We recently posted & sent to the printer the July-August issue of the "The Corporate Counsel" Print Newsletter (try a no-risk trial) - articles include:
- In Memoriam: Marty Dunn
We recently posted & sent to the printer the July-August issue of the "Deal Lawyers" Print Newsletter (try a no-risk trial) - articles include:
- M&A Transactions & PPP Eligibility and Forgiveness Considerations
Among other new additions, we have posted:
The following memos & insights:
Memos: SEC's Form 13F Proposal
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