E-Minders December 2018
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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In late November, the SEC posted this notice of an open Commission meeting this Wednesday — December 5th — to consider a "request for comment" on the nature & content of quarterly reports and earnings releases. As we've blogged several times, the request is bound to seek comment on the reduction (and even elimination) of quarterly reporting — as tweeted by President Trump.
Here's an excerpt from this WSJ article that John is quoted in:
One question the SEC may ask in its release, up for a vote next Wednesday, is whether quarterly guidance about expected earnings from companies unnecessarily drives expectations for investors, and whether that guidance could be pared back. Earnings guidance is voluntary and isn't required by the government. Among possible changes, the SEC could also reduce the number of disclosures required in quarterly reports, which some companies view as excessive in an age when company information is readily available to the public.
"Do we really need the 'thou shalts' from the SEC in an age when we have so much more information at our fingertips?" said John Jenkins, partner at Calfee, Halter & Griswold LLP and an editor of TheCorporateCounsel.net.
Federal securities rules have required quarterly reporting since 1970, when the SEC required it as part of a formalization of stock-exchange practices that preceded the agency’s creation in 1934. The SEC's planned meeting isn’t the start of a formal rule-making process and is intended to solicit feedback on how the quarterly reporting system is functioning and what improvements could be made, a step that could in the future lead to regulatory changes.
We just calendared a webcast — "Shareholder Proposals: Corp Fin Speaks" — with Corp Fin's Matt McNair, who has headed the Division's "Shareholder Proposal Task Force" for the past five years. Tune in to learn the experiences with implementing Staff Legal Bulletin 14I this past proxy season — and learn the intricacies of new SLB 14J. Also see this blog by Cydney Posner about some no-action positions taken on “ordinary business” since SLB 14J came out last month...
One of the top priorities for SEC Chair Jay Clayton — and Corp Fin Director Bill Hinman — has been the easing of the burdens of being a public company, with the ultimate goal of convincing more companies to go public. This theme has been mentioned many times over the past few years — including raising the threshold for the definition of "smaller reporting company" earlier this year.
So it's no surprise that the SEC published a larger list than usual to be reviewed in mid-November as part of the SEC's annual exercise — as required under the Regulatory Flexibility Act — to review how the agency's rules are faring for smaller reporting companies. This year's list boasts 43 rules (compare that to 2004; only 7 rules). Like in prior years, the rules listed for review aren't limited to rules that affect small companies. Notably, the list doesn't include the elimination of quarterly reports entirely for smaller companies — which we think will eventually be proposed based upon comments made by Bill at the ABA meeting a few weeks ago.
Although some of the listed rules don't apply to public operating companies (ie. apply to mutual funds, etc. instead), some do apply to our community including:
1. Executive pay & related-party disclosures (this is the "biggie" on
pages 5-6; rethinking the 2006 rule amendments)
Although this list is open for public comment, the annual list typically results in only an average of one comment per year, as noted in this statement by then-Commissioner Piwowar in '16...
In early November, Corp Fin updated 4 CDIs to address the implications of the SEC's adoption of rule amendments increasing the number of "smaller reporting companies" (SRCs) eligible to provide scaled disclosure. The updated CDIs reflect the impact of changes in the size thresholds for SRC status on prior interpretive guidance.
Corp Fin also withdrew 4 CDIs addressing transition issues for SRCs, as well 2 obsolete CDIs relating to old Reg S-B and a misstatement in the original SRC adopting release concerning when SRCs would have to provide audit committee financial expert disclosure. Here's the tally of CDIs that were updated or withdrawn:
1. Exchange Act Rules CDIs — Section 130. Rule 12b-2:
3. Section 110. Item 303 — Management's Discussion and Analysis of Financial Condition and Results of Operations:
4. Section 133. Item 407 — Corporate Governance:
5. Exchange Act Forms CDIs — Section 104. Form 10-K:
Check out this Cydney Posner blog for a more detailed analysis of the updated CDIs. And also see Cydney's blog about how the NYSE has proposed changes to Section 303A.00 of the Listed Company Manual related to the exemption from the compensation committee requirements applicable to SRCs due to the SEC's recent changes to the SRC definition.
In mid-November, ISS announced the 2019 updates to its proxy voting policies. We're posting memos in our "Proxy Advisors" Practice Area (also see this blog from Exequity's Ed Hauder — and this Davis Polk blog). Here's the highlights for US companies — except as otherwise noted, the policies apply to meetings held on or after February 1st:
1. Board Diversity: Beginning in 2020 for Russell 3000 and S&P 1500 companies, the chair of the nominating committee (or other directors on a case-by-case basis) will receive an "against" recommendation when there are no women on the company's board. Mitigating factors include a firm commitment in the proxy statement to appoint at least one female director in the near term, the presence of a female on the board at the preceding annual meeting, or other relevant factors.
2. Economic Value Added Data: During 2019, ISS research reports will feature Economic Value Added data as a supplement to GAAP-based measures that measure the alignment between CEO pay & company performance. Moving into 2020, ISS will consider the inclusion of EVA-based measurements as part of its Financial Performance Assessment methodology.
3. Board Meeting Attendance: ISS is codifying its case-by-case approach to chronic poor attendance without reasonable justification. In addition to voting against the director(s) with poor attendance, it will recommend voting against other directors. After three years of poor attendance, the policy applies to the chair of the nominating or governance committee; after four years, the full committee; and after five years, all nominees.
4. Management Proposals to Ratify Existing Charter or Bylaw Provisions: Similar to Glass Lewis's new policy on conflicting & excluded proposals, ISS is codifying its policy to vote against individual directors, members of the governance committee, or the full board, where boards ask shareholders to ratify existing charter or bylaw provisions — taking into account factors such as the presence of a shareholder proposal addressing the same issue, the board's rationale for seeking ratification, the actions to be taken by the board should the ratification proposal fail, whether the current provision was adopted in response to the shareholder proposal, previous use of ratification proposals to exclude shareholder proposals, the company's ownership structure, etc.
5. Board Responsiveness to Ratification Proposals: ISS's existing responsiveness policy is updated to reflect that failure to act on a failed "ratification" proposal will trigger a board responsiveness analysis at the next annual meeting.
6. Director Performance Evaluations: When identifying companies that have long-term underperformance, ISS will look at three- and five-year TSR during the initial screen — rather than using five-year TSR as part of a secondary step in the evaluation.
7. Reverse Stock Splits: ISS broadened its policy to allow analysts to take a case-by-case approach for companies that are not listed on major stock exchange and may have a legitimate need to carry out a reverse stock split. ISS is also broadening the factors it will consider for all companies — exchange listed and non-exchange listed, where substantial risks exist.
8. E&S Proposals: ISS is codifying its case-by-case approach to E&S proposals — to make more explicit that significant controversies, fines, penalties or litigation are considered.
In mid-November, as noted in this Steve Quinlivan blog, ISS released five "preliminary" compensation FAQs, which includes a one-year deferral of its controversial policy over excessive director pay. There are no changes to the quantitative pay-for-performance screens nor changes to the passing scores for Equity Plan Scorecard (EPSC) evaluations of stock plan proposals (but there are new EPSC ‘overriding' factors and a change to the change-in-control vesting factor). "Final" FAQs are expected in a few weeks...
In mid-November, Liz blogged about what it was like to attend the SEC's "Proxy Process Roundtable" — you can also check out Cydney Posner's blog for more details on the substantive discussions. One thing that Liz noted was that there were many people on each panel. The SEC invited a lot of speakers in an effort to get a wide range of views. But since time was limited, not everyone got to delve into their specific recommendations — so at many points, people made reference to the written comments that they'd submitted.
During the ABA meeting the following day, Corp Fin Director Bill Hinman noted that over 80% of the comments came in during the last week — and the Staff thinks they've been very constructive. Here are some of the many submissions, from panelists and others:
In mid-November, Liz blogged: Since I was in Washington DC for the Fall Meeting of the ABA Business Law Section, I thought I'd arrive a day early to attend the SEC's "Proxy Process Roundtable." Broc encouraged me to share the "look & feel" of the experience for those that have never visited the Mothership. So here's eight interesting things that I noticed:
1. Lots of Speakers on Panels — There were three panels for the roundtable — each scheduled for 90 minutes. One panel had 10 speakers, another had 11 — and one had 14! That one ended up running over two hours — and one of the panelists didn't even get to introduce himself till the very end. For comparison, we're setting the agendas right now for next year's "Women's 100" events — and we have 9 speakers for all of our panels for an entire day.
In some cases, it was hard to get a good feel for a speaker's views & ideas because their speaking time was limited (but some panelists definitely didn't let that stop them!) — and as a listener it was hard sometimes to stay focused for such a long discussion, with no audience interaction. This is what a 14-speaker panel looks like — a total of 21 people up on the dais with all the SEC officials...
2. Short Opening Remarks — Chair Clayton limited his opening remarks to allow more time for the panelists to share their views. Remarks from Commissioner Stein, as well as Commissioner Roisman and Corp Fin Director Bill Hinman, were also very brief. In fact, the first panel started about 30 minutes early! Bill did take a moment to pay tribute to Evelyn Y. Davis, though.
3. Surprising In-Person Turnout — Broc warned me that the roundtable might be lightly attended. He said that in the old days, the SEC's open Commission meetings & roundtables were well-attended. But now that they are webcast, people understandably watch online. So it was surprising to see that more than a hundred people were there in person, despite DC having the worst November snowstorm in 29 years. Here's a picture of what the audience looked like.
4. NAM/Chamber's Campaign Encouraged Attendance — Recently, the National Association of Manufacturers & the US Chamber have been running ads against proxy advisors — including full-page spreads in the WSJ and Washington Post. They've spent six figures on their media campaign! Here's what the ads looked like. As part of this campaign, the groups operate ProxyReforms.com — a site that had been encouraging folks to attend the last panel of the day (the one about proxy advisors).
5. Minor Infotainment (for a Conference) — Although not as riveting perhaps as "Bodyguard" (new Netflix series that Broc recommends; I haven't seen it), the panels tended to be more entertaining than a typical conference panel. There were speakers on all sides of the issues & sparks flew on more than one occasion.
Chair Clayton, the Commissioners & Corp Fin Staff emphasized throughout the day that they were hoping to get some specific recommendations. A surprising number of panelists thought the shareholder proposal rules and proxy advisor framework is okay 'as-is.'
This wasn't everyone's view (tended to be people who could be disadvantaged if the rules change, though not in every case) — and there were calls for targeted improvements like giving all companies some time to respond to voting reports before they're public and some tweaks to the proposal submission thresholds. But when it came to proxy plumbing, there were more calls for change — maybe even a total overhaul. Even speakers that weren't on that panel said they thought that's where the SEC should focus its time & resources.
6. A Tweet War? — Recently, John blogged about "Tweet Fight! Nell Minow v. Main Street Investors Coalition." For this roundtable, there was some live tweeting from the audience under #proxyroundtable — with most of the tweets coming from opposite ends of the spectrum: Main Street Investors Coalition v. ValueEdge Advisors (for whom Nell Minow is a part of) — as well as Minerva Analytics and others.
7. Going Through Security — Broc also shared stories about the old days & how visitors to the SEC used to be able to go upstairs and deliver packages, etc. without even checking in. Now, he warned me to go early, because you need to get a badge & go through a metal detector. They were efficient — but with the large attendance, I'm pretty sure it took me longer than airport security! In the morning line, I happened to befriend a fellow Minnesotan. And it was in the after-lunch line that I learned of the Main Street Investors Coalition's ad campaign. So it wasn't time wasted.
8. DC is Magical? — The night before the roundtable, Broc picked me up at the airport and we grabbed dinner at "The Wonderland Ballroom." We soon met Frank Namin — who saddled up next to us and seemed to be this establishment's resident magician. We had close-up seats as he fashioned a rose from a cocktail napkin — then levitated it (seriously, it levitated one foot away from us — just stayed floating in the air!) — along with many other illusions. Free entertainment! And nearly as exciting as that "Proxy Advisors" panel...
In late October, the SEC adopted rules to update how mining companies disclose their "property" — including how they disclose mineral resources & reserves — so that the SEC's requirements are closer to what is required globally from mining companies. Here's the SEC's press release — and the 453-page adopting release.
The old rules — including the now-obsolete Guide 7 — permitted the disclosure of non-reserve estimates only in limited circumstances. But that will now change. There is a two-year transition period so that mining companies won't need to comply with the new rules until its first fiscal year beginning on or after January 1, 2021. We are posting memos in our "Mining Companies" Practice Area.
Nearly 30% of companies highlight quantitative information at the top of their earnings release — and after writing my fair share of headlines, we can understand why! Numbers are succinct, eye-catching, and (presumably) accurate. But a recent study shows that this practice may lead to some pretty big swings in stock price — and might foreshadow lower earnings over the long-term. This article summarizes the findings — here's an excerpt:
The study of more than 17,000 earnings releases over an 11-year period finds that increasing headline salience (for example, when earnings exceed forecasts, headlining by how much), gives a hefty lift to a firm's stock price beyond the rise that is normally occasioned by good news. On average, adding one strong performance number to a headline increases a results-inspired boost by an extra one third in the three-day period around the announcement.
Citing psychology research, the professors see this extra boost as due to the effectiveness of headline numbers in attracting investor attention. In addition, "an initial favorable impression can lead investors to underweight contradictory information elsewhere in the report."
But investors beware: after a quick stock-price lift, salience likely portends a considerable reversal over the 60 days following the earnings announcement, a reversal greater than the initial boost that the salience bestowed. In other words, as the professors write, "investors not only undo their initial reaction due to salient headlines but even revise their beliefs in the opposite direction in the subsequent period." In sum, "headlining quantitative information incites investor overreaction to the earnings news at the time of the earnings announcement...This suggests that headline salience misleads investors."
And here are some other interesting takeaways:
— Companies that flaunt strong current results in headlines tend to have lower long-term earnings (beyond the current quarter)
— High salience is strongly correlated with increased insider stock sales in the month following earnings announcements and also with the recent vesting of executives' stock
— Both 3-day stock returns and 60-day reversals increased with greater headline salience, both being higher as the number of headline statistics increased (for example, from zero to one or from one to two).
— While headline salience is effective when earnings exceed analyst forecasts, that is not the case when they do not. In other words, greater salience does not spur investor interest when earnings barely meet or fall short of predictions.
— Headlined earnings numbers have more effect when expressed as percentages than when stated in dollars.
Liz mentioned in a blog last month that there are an estimated 10k publicly-traded microcaps — but most aren't listed on an exchange (h/t to Adam Epstein for that stat). But we might see a decline in those numbers if the secondary market evaporates — and there are signs that it's heading in that direction. Here's the intro from this Forbes op-ed by Richard Levick:
An event that rather significantly affects the financial markets has just occurred without much if any fanfare in the financial press. Bank of America's Merrill Lynch announced that, as of September 30, it will not allow clients to sell microcap stocks, known as penny stocks, without a regulatory review and will outright ban sales of the riskiest ones. The bank had already discontinued purchases in July.
If enough other financial institutions follow suit, the penny stock market could disappear altogether. As of this writing, Morgan Stanley and UBS have not followed Merrill's lead, according to sources cited by CNBC reports, but investors sense a chill wind has begun to blow. Shares from companies valued under $300 million and traded for under $5 on an over-the-counter market are the ones affected — in other words, virtually the entire microcap market.
By the way, catch Richard Levick in our just-finished webcast: "How Boards Should Handle Politics as a Governance Risk"...
Over the years, Broc has blogged many times about Evelyn Y. Davis — one of the more well-known shareholder proponents of all-time. We are sad to say that Evelyn passed away in early November. Here's the press release from her foundation. This CBS News article notes she was a concentration camp survivor. Here's a few of the things that Broc has blogged about EYD over the years.
This "Audit Analytics" blog discusses an intriguing new study that suggests the SEC's decision to make Corp Fin comment letters publicly available may have resulted in improved disclosure by companies on the receiving end of those letters. Here's an excerpt:
It was found that when comment letters are made public, company filings include longer narratives, have a lower chance of restatements, and there were less discretionary accruals in earnings announcements. Those factors provide a more complete picture of the company's position, benefitting the company, the SEC, and investors or firms who are concerned with company performance.
Well, wadda ya know? They're from the government, and they actually did help you. . .
A few months ago, Broc blogged about the dominance of white people in our industry. We heard some nice feedback. But we particularly liked this one from Carl Hagberg because he offered these concrete suggestions:
I agree that boards — and white people in general — are afraid to talk candidly about race and this needs to stop. In response to your request for ideas, here are a few things that enlightened companies can be doing about it:
— A growing number of companies have been demanding that the law firms they use must have a significant percentage of women and minority group members on the teams for every single company project they are awarded. Many law firms are struggling hard with this — which is precisely the point.
— Smart companies are bidding-out a growing percentage of their legal work — and not only demanding the same degree of diversity for the teams assigned to their projects, but awarding extra points in the evaluation of bids for pro-bono work — where it is easy to specify that diversity efforts and pro-bono work with minority groups will receive extra "extra points."
— Companies should also be demanding — and rewarding strong diversity efforts — and actual results — at ALL of their service suppliers — like transfer agents, proxy solicitors and advisors, financial printers. And yes, in the selection of Inspectors of Election too.
I know that is extremely hard to diversify. I know from my own experience how hard it is — and why. Take a look at my article about "The Prevalence of Old White Men at Shareholder Meetings." But if the clients don't push harder for change, nothing WILL change!
And then Jenner & Block's Jolene Negre sent me these common approaches:
— Mansfield Rule — Consider diverse candidates for open leadership positions (including board seats)
— Diversity training to give boards the tools they need to think and talk about race as it relates to their businesses
— Some major companies offer financial incentives to law firms staffing those companies' matters with diverse legal teams (and penalize firms that do not)
Recently, Liz paid a visit to her old firm (Fredrikson & Byron) to interview my former colleague Zach Olson, a partner in the M&A group — about his side gig as a professional wrestler. You may have seen John's blog about Zach's bold adventures on "The Mentor Blog," but Liz wanted to get more info about this unique endeavor — and how a deal lawyer has time (and nerve) for it.
In our 19-minute podcast, Zach confirmed her suspicion that he'll dive into just about anything he thinks is remotely interesting. We also covered:
— How do you think your skills as a lawyer help you in the ring?
We continue to post new items daily on our blog — "Proxy Season 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:
— Math With Broker Non-Votes
— Proxy Advisors: Six Senators Support House Bill
Among other new additions, during the last month we have posted the following:
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