About 20 comment letters have been submitted to the SEC so far in connection with Corp Fin’s Disclosure Effectiveness project. Common themes include strong investor interest in mandatory disclosure of sustainability/ESG information, and a desire among issuers to eliminate requirements and processes that elicit redundant and outdated disclosures.
The Society of Corporate Secretaries recommends elimination of obsolete and duplicative disclosures (citing specific examples in both categories), and provides other suggestions for enhanced disclosure including elimination of the “glossy” annual report and prior period results in the MD&A; institution of a formal post-adoption review process for significant new disclosure requirements to evaluate the continuing need for such disclosures in light of evolved economic, business and regulatory conditions; and allowing for sustainability disclosure to be effectively communicated outside of ‘34 Act reports.
The Center for Capital Markets Competitiveness also offers concrete suggestions – including what it characterizes as near-term improvements to Regulation S-K that the SEC can enact expeditiously with the widespread support of multiple stakeholders (e.g., eliminating specifically identified redundant and outdated disclosure requirements), and longer-term projects that reflect more fundamental change such as the CD&A and MD&A.
Near-Term Actions to Enhance Disclosures
In this recent memo, Deloitte summarizes Corp Fin’s views and recommendations about steps companies can take now to improve their disclosures pending formal reforms resulting from Corp Fin’s Disclosure Effectiveness project. The memo includes a table in the Appendix that identifies specific types of disclosures (e.g., critical accounting estimates in MD&A, risk factors) and suggestions for improvements.
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:
– Exclusive Forum Bylaws: California State Court Follows Delaware – Whistleblowers: SEC Receives Two Rulemaking Petitions – Are the Securities Laws a “First Amendment Free” Zone? – Why Ralph Whitworth May Be America’s Best Board Member – Compliance: SEC Expectations vs. Current Stats
Stephen Bainbridge recently shared his comments opposing ISS’s proposed revised policy on independent board chair shareholder proposals. The proposal (issued in connection with draft policy changes) adds new factors that ISS would consider in determining whether to support an independent chair proposal and – unlike the current policy – provides that ISS would consider all of the factors holistically, rather than require that each factor be satisfied for ISS to recommend against a proposal.
Although this holistic evaluation would afford companies greater flexibility in that a failure to satisfy any particular factor wouldn’t necessarily be determinative, the proposed new policy inherently contains additional judgments about what constitutes good or subpar governance. Additional factors ISS would consider include the absence/presence of an executive chair, recent board & executive leadership transitions, and director/CEO tenure – governance practices that vary widely among companies. Also, as noted in this Weil Gotshal article, it’s not clear how these new factors would play into ISS’s analysis. For example, what about director/CEO tenure – i.e., what precisely would ISS take into account, and how will that be weighted relative to the other criteria? And how does that factor relate to the effectiveness of any particular form of independent board leadership?
In support of his position, Bainbridge identifies studies and other information that demonstrate the absence of a link between an independent chair structure and company performance. In addition to those cited in his blog, this 2013 study is relevant and noteworthy. After evaluating all germane (almost 50) studies on “CEO duality” (i.e., combined CEO/chair vs. alternative structures) over the past 20 years and discussing relevant findings, the authors conclude as follows:
More than at any other time since Finkelstein and D’Aveni (1994) published their foundational study on CEO duality, board leadership is in flux. Large firms are increasingly opting for a separate and independent chairman of the board (Lublin, 2012). This shift has garnered praise from governance advisors and institutional investors (Monks & Minow, 2008), but has also introduced new problems, such as the very public disagreement between the CEO and the independent chairman at insurer AIG (Lublin & Ng, 2010). That conflict ultimately ended with the chairman resigning, raising questions about the integrity of CEO non-duality. At the same time, policy makers are weighing whether to mandate a separate chairman at all U.S. firms. We believe such action would be misguided, not because the issue of CEO duality is praise unimportant, but because it is too important and too idiosyncratic for all firms to adopt the same structure under the guise of “best practice.” The most consistent finding in the CEO duality literature is that separating the CEO and board chair positions does not, on its own, improve firm performance. Given that the performance implications of CEO duality are contingent on an array of factors (Boyd, 1995; Krause & Semadeni, 2013), only some of which are known, boards should be left free to adopt the structure they deem to be strategically beneficial for their firms.
I’m not advocating any particular form of board leadership; as GC, I experienced both independent chair and independent lead director structures, and each was suitable under the circumstances. Rather, particularly in view of the absence of a link between a particular structure and company performance, I’m advocating tolerance of multiple views and alternative structures based on what the board believes to be optimal under the circumstances.
See also my previous blog noting declining or flattening shareholder support for independent chair proposals over the past four years – as various forms of independent board leadership have trended up.
Survey: Investors Weigh In on Boards
Not surprisingly perhaps, most investors want boards to consider/discuss all of their governance policies that PwC identified in its new investor survey; However, policies on majority voting, board diversity, and overboarding clearly stand out – each garnishing 94% of investor support. In contrast, less than 65% of investors thought that the board should be revisiting their policies on separating the CEO/chair, director term limits and mandatory retirement.
On diversity, 85% of investors believe that the board will need to address these impediments to increased diversity in connection with revisiting their policy:
Q: What impedes increasing gender or other aspects of diversity on US corporate boards (gender %/other aspects %)?
Directors don’t want to change their current board composition – 55%/52%
Board leadership is not invested in recruiting diverse directors – 52%52%
Directors don’t know many qualified diverse candidates – 52%/55%
Directors don’t view adding diversity as important – 52%48%
No perceived impediments – 15%/15%
Insufficient numbers of qualified diverse candidates – 3%/3%
Note that only 3% of investors cite an insufficient number of qualified diverse candidates as an impediment to increasing board diversity; however, 55% of investors believe that directors’ lack of awareness of many qualified diverse candidates is an impediment. Consistently, of those directors responding to PwC’s recent director survey who believe there are impediments to increased diversity, the top factor cited was a lack of awareness of qualified diverse candidates.
– What is the purpose of the Board Risk Score?
– What factors does the score take into account, and why did Alliance Advisors select those factors?
– Which companies are scored? And how often or when are companies scored?
– What information does a company’s score reveal?
– What should a company do with the information?
– How does a company get its score?
Spanking brand new. By popular demand, this comprehensive “SEC Enforcement Handbook” covers a topic that many have requested – what to do if your company – or someone working there – is investigated by the SEC. This one is a real gem – 31 pages of guidance. For example, the first section is entitled “First Steps for Responding to an Enforcement Investigation.” There is also a section about disclosure obligations relating to SEC enforcement actions…
SEC Commissioners: “Bad Actor” Waiver Battle Grows With Deadlock
With Chair White recused, it appears that the SEC Commissioners are stuck in a 2-to-2 deadlock over the latest in the “bad actor” waiver drama, this one over the ability of BofA to continue certain activities. Here’s a WSJ article – and a Bloomberg article. Here’s an excerpt from the Bloomberg article:
At the SEC, there are three main penalties that banks seek waivers for when they settle cases, with the harshest a ban on managing mutual funds. Another prevents banks from raising money for private companies. The third, and most minor, takes away a privilege that allows a firm to issue its own shares or bonds without SEC approval.
For Bank of America, the biggest hold-up is over the waiver that will allow the bank to continue seeking investors for private firms, such as technology companies that haven’t yet gone public and hedge funds, the people said. “It seems to me it would be important for them to have that waiver,” said Richard A. Kline, a law partner at Goodwin Procter LLP in Menlo Park, California. When fast-growing companies are seeking to raise money from institutions, “there are often banks that will lead some of those private placements,” he said.
Cap’n Cashbags: Time to Grant Stock Options
In this 20-second video, Cap’n Cashbags – a CEO – is hoping to get his mega-grant of stock options soon:
For those practicing long enough, you will recall that the commencement of the SEC’s foray into modern corporate governance kicked off a few years before Sarbanes-Oxley – then-Chair Arthur Levitt focused on audit committees in the late ’90s. This focus culminated in a Blue Ribbon Commission on Audit Committee Effectiveness established in ’98 by the NYSE & NASD, whose report led to a reform pushed by the SEC. It now looks like the audit committee will again be the focus of the SEC, building on work that the PCAOB has been doing for a while (here’s a new speech by the PCAOB’s Jay Hanson about audit committees).
Chair Mary Jo White, speaking before the Investor Advisory Group of the PCAOB, said that the SEC plans to issue a concept release in early 2015 “exploring possible avenues for elevating the work of public company audit committees.” The release is expected to address many of the issues that the PCAOB is examining, particularly those relating to the relationship between the audit committee and the independent auditors. White emphasized that she “’can’t overstate the importance of the audit committee functioning at the highest possible level.’”
SEC Approves PCAOB’s Related Party Transaction Changes
As noted in this Gibson Dunn blog, the SEC issued this order last week approving the PCAOB’s new related-party transaction standards. Notably, the SEC retained the PCAOB’s proposed effective date – so the new standards will become effective for audits for fiscal years beginning on and after December 15, 2014. In our “Related Party Transactions” Practice Area, we have posted memos regarding these new standards.
CFO Sues Former Employer for Defamation Over Earnings Forecast Error
In this Chicago Tribune article, it’s reported that a former Walgreens CFO has sued the company for blaming him for an earnings forecast error – a $1 billion error for which he was terminated.
Companies will have from November 3rd to November 14th to verify the underlying raw data and submit updates and corrections through ISS’s data review and verification site. As always, ratings are updated based on a company’s public disclosures during the calendar year.
Board Diversity Disclosures: Diversity Definition Often Hinges on Experience
As noted in this DealBook article and Fortune article, most of the S&P 100 are interpreting diversity as having a varied background or experiences, instead of gender, race or age. According to research by Professor Dhir for an upcoming book, in each of the past 4 years, about 50% described diversity as meaning gender, race or ethnicity – but more than 80% consistently cited a variety of experience or backgrounds. The article notes that Corp Fin has rarely issued comments in this topic area during the past two years.
Board Gender Diversity: CalSTRS & The Thirty Percent Coalition’s New Campaign
As noted in this press release, institutional investors representing more than $3 trillion in assets along with some of the nation’s leading women’s organizations – aka “The Thirty Percent Coalition” – recently sent letters to 100 companies that lack women on their boards. The letter also affirms the importance of racial diversity. Here’s a sample letter. Prior letter writing campaigns has led to appointment of women to 17 boards. The Coalition has set a goal of women holding 30% of board seats across public companies by the end of 2015, up from the 17% current ratio…
More on “Corp Fin Comment Letters: Insiders Selling Ahead of Their Public Availability?”
Last month, I blogged about a 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. After my blog, Gretchen Morgenson wrote this NY Times column touting the study.
Personally, I continue to doubt the credibility of the study – and here is some of the community feedback that I have received:
– Must be nice to be an academic. One of the dumbest studies I have ever heard of. I can only imagine it’s just happenstance.
– From the poorly written article, it did not seem like much of a bombshell, but the reporter lost all credibility in my eyes when he said repeatedly that “companies” are required to issue and publish comment letters. Is there any profession that has fallen more than business reporting in intelligence, sophistication and plain old effort (would not have been hard to get this right)? Maybe if I read the actual study, I would be more alarmed.
– Wow! That’s INSANE! At first I thought this had to be anomalous but after glancing at the report, maybe not! My second thought is that maybe management puts too much emphasis on the correlation to long term stock price depression and SEC Comments. Honestly not sure what to make of this (except for the fact that the author got the comment letter process wrong!).
Cybersecurity: Verizon Data Breach Investigations Report
With cybersecurity the hot topic – I have held two webcasts on the topic over the past month – it is worth taking a look at this 60-page Verizon Data Breach Investigations Report that was released last month. The Verizon report contains a host of useful information as it relies on over 63,000 incidents from 50 organizations for it’s analysis. Also check out our checklists related to incident response planning, disclosure practices and risk management – as well as a chart of state laws related to security breaches…
Meanwhile, Kevin LaCroix blogs that a closely watched cybersecurity derivative suit against against Wyndham Worldwide Corporation’s board has been dismissed…
Last week, the SEC released the stats for the activities of its Enforcement Division for the agency’s 2014 fiscal year, noting a “record” number of enforcement actions in 2014 involving a “wide range of misconduct” and including a “number of first-ever cases.” As Kevin LaCroix blogs, important lessons can be learned. Here’s an excerpt from Kevin’s blog:
During FY 2014, the SEC filed 755 enforcement actions, which represented a 10% increase over the 686 enforcement actions filed in FY 2013. In FY 2014, the agency also obtained orders totaling $4.16 billion, compared to $3.4 billion in 2013. By way of comparison to the statistics for FY 2013 and FY 2014, in FY 2012 the agency filed 734 enforcement actions and obtained orders totaling $3.1 billion in disgorgement and penalties.
The agency identified at least two significant factors driving the increase in enforcement actions. The first was the agency’s use of “new investigative approaches and the innovative use of data and analytic tools” and the second was the agency’s expansion into a number of new areas based on “first time cases.”
With respect to the use of data and analysis, the press release quotes SEC Chair Mary Jo White as saying that “the innovative use of technology – enhanced use of data and quantitative analysis – was instrumental in detecting misconduct and contributed to the Enforcement Division’s success in bringing quality actions.”
The kinds of “first-ever cases” identified in the press release included “actions involving the market access rule, the ‘pay-to-play’ rule for investment advisers, an emergency action to halt a municipal bond offering, and an action for whistleblower retaliation.”
The press release also quotes SEC Chair White as saying that “aggressive enforcement” will remain a “top priority” and quotes the head of the SEC Enforcement Division as saying that he expects “another year filled with high-impact enforcement actions.” Going forward, the SEC Enforcement head said, the agency will “continue to bring its resources to bear across the entire spectrum of the financial industry.” Ominously, for the clients of the readers of this blog, he noted that among other things the agency will focus on bringing “cases against gatekeepers.”
SEC Commissioner Piwowar Doesn’t Like “Broken Windows” Enforcement Policy
In this speech, SEC Commissioner Piwowar analyzes the agency’s enforcement efforts – including noting that he’s not in favor of the Commission’s recent “broken windows” initiative including this quote: “If every rule is a priority, then no rule is a priority.”
The DealBook column is interesting – covering a panel consisting of the SEC’s Enforcement Director Andrew Ceresney and five of his predecessors. And this “Naked Capitalism” blog is entitled “Private Equity as the Latest Example of SEC Enforcement Cowardice?”…
Shareholder Returns of Hostile Takeover Targets: Counterpoint to ISS’s “The IRR of ‘No’”
Here’s something that I just blogged on the DealLawyers.com Blog by Wachtell Lipton’s Eric Robinson and Sabastian Niles:
This morning, Institutional Shareholder Services (ISS) issued a note to clients entitled “The IRR of ‘No’.” The note argues that shareholders of companies that have resisted hostile takeover bids all the way through a proxy fight at a shareholder meeting have incurred “profoundly negative” returns following those shareholder meetings, compared to alternative investments. ISS identified seven cases in the last five years where bidders have pursued a combined takeover bid and proxy fight through a target shareholder meeting, and measured the mean and median total shareholder returns from the dates of the contested shareholder meeting through October 20, 2014, compared to target shareholders having sold at the closing price the day before the contested meeting and reinvesting in the S&P 500 index or a peer group.
A close look at the ISS report shows that it has at least two critical methodological and analytical flaws that completely undermine its conclusions:
– ISS’s analysis refers to Terra Industries as one of the seven cases in the last five years where a target had resisted a hostile bid through a shareholder vote on a bidder’s nominees, but the analysis then excludes Terra from its data analysis, by limiting it to targets that ultimately remained standalone. Terra is one of the great success stories of companies that have staunchly resisted inadequate hostile takeover bids, even after the bidder succeeded in electing three nominees to its board, and ultimately achieved an outstanding result for shareholders. As ISS notes, if the pre-tax cash proceeds of the final cash-and-stock offer for Terra had been reinvested in shares of the bidder, Terra shareholders would have seen a total return of 271% from the date of the initial shareholder meeting through October 20, 2014, significantly beating the S&P 500 Index and the median of peers by 181 and 211 percentage points, respectively. Had ISS properly included Terra in its analysis of “The IRR of ‘No’”, the mean return of the seven companies would have beaten the S&P index by 18.4 percentage points (compared to a shortfall of 8.7 percentage points when Terra was excluded) and beaten the ISS peer groups by 10.0 percent (compared to a shortfall of 23.6 percentage points excluding Terra).
– Of the seven cases discussed in the analysis, one was a micro-cap company with a market cap of $250 million (Pulse Electronics) and one was a nano-cap company with a market cap of $36 million (Onvia). The other five companies, including Terra, had market caps between approximately $2 billion – $8 billion, yet ISS treats them all equally. A market-cap weighted analysis would have had dramatically different results. Excluding the micro-cap and nano-cap companies from the analysis, the mean and median returns for the five companies (including Terra) exceeded the S&P Index by 65.4 percentage points and 1.4 percentage points, respectively, and exceeded the respective peer groups by 57.6 percentage points and 20.8 percentage points, respectively.
More broadly, the real world of corporate takeover practice demonstrates that prudent use of structural protections and “defensive” strategies provides boards – and shareholders – with the benefits of substantial negotiating leverage and enhanced opportunity to demonstrate that the company’s stand-alone strategy can deliver superior value.
Last month, I co-hosted a “Usable Proxy Workshop” with Addison in NYC for a group of in-house folks. The panels were video-taped (thanks to the host of our location, Simpson Thacher!) – and I have now posted those video archives in our “Usable Disclosure” Practice Area. So you can check out those panels (which include speakers from the companies leading the charge for more usable disclosure, such as GE, Coca-Cola, Pru, Western Union, etc.), as well as the related course materials at your leisure.
The panel topics include:
– “What Investors Really Want to See In Your Proxy”
– “Information Design 101: Beyond Fonts & Colors”
– “Bold Thinking in the Digital Age”
– “Video as a Disclosure Tool”
– “How to Use Customized Graphics to Enhance Your Message”
– “How to Best Work With Design Firms”
Checklist: How to Best Work With Design Firms
Recently, I posted this checklist about how to work with design firms that specialize in usable proxies. The checklist is filled with practice pointers from three in-house folks that have led the way making their proxy statements more usable. In addition, I just posted these two other related checklists:
Recently, I received an email from Rich Andrews of EZOnlineDocuments reminding me of the growing use of “tiles” for online proxies to facilitate navigation in a growing mobile world. Tiles is a big boost to usability because if you open a PDF on a tablet or smart phone, there is no option to full-text search, etc. Probably the best way to explain “tiles” is to just show you. Here are examples from this year:
As companies are staffing & gearing up for the FASB/IASB’s new revenue recognition rules, it dawned on me that folks in the accounting world might not be aware of the upcoming Dodd-Frank rulemaking on clawbacks. And those folks that live and breathe compensation might not be aware of the revenue recognition accounting changes that were adopted a few months back (but won’t be effective until fiscal years beginning after 12/15/16).
The implementation of the new revenue recognition rules will create all sorts of opportunities to get it wrong – and it looks like they will coincide with mandatory no-fault clawbacks that have to be applied to a broader range of executives for a longer period of time for any restatement. Section 954 of Dodd-Frank is quite prescriptive so I don’t know how the SEC will have much flexibility. Maybe in the implementation and grandfathering provisions. This convergence of forces may well make for a dandy of a sleeper in Dodd-Frank, years after it was enacted!
The upshot is that we may be living in a world where senior managers will be trying to persuade compensation committees to either have less performance-based compensation that is susceptible to a restatement – or to use metrics that are less susceptible. Stepping back from performance-based pay is not what shareholders want to see – so this likely will cause tension between companies and their shareholders.
It’s ironic that a new accounting standard that will cause more opportunities for restatements will apparently come on board near in time with the Dodd-Frank “super-charged” clawbacks. These newer clawbacks will be super-charged because you don’t need misconduct like under the Sarbanes-Oxley standard.
And the kicker to watch out for right now is that as more companies move to multi-year performance metric setting, there could be companies that are setting performance goals now for years that will be subject to both the new revenue recognition rules (no matter how they wind up getting interpreted) and the Dodd-Frank clawbacks.
The bottom line is that the new clawbacks will certainly up the ante in discussions among auditors, audit committees and management as to whether errors discovered in previously filed financials are material. As with any area of uncertainty, step with caution. Thanks to Steve Bochner of Wilson Sonsini for pointing this out!
Q&A With Bob Monks & Nell Minow
I’m always curious as to what Bob and Nell think about the issues of the day – here’s a USA Today interview that provides the latest from them…
Webcast: “Anatomy of a Proxy Contest: Process, Tactics & Strategies”
Tune in tomorrow for the DealLawyers.com webcast – “Anatomy of a Proxy Contest: Process, Tactics & Strategies” – during which experts with different perspectives on proxy contests will catch us up on all the latest: ISS’ Chris Cernich, Joele Frank’s Dan Katcher, Greenberg Traurig’s Cliff Neimeth and MacKenzie Partner’s Paul Schulman.
About a decade ago, I blogged: “Personally, I am always amazed that there have not been any reported hacks of the EDGAR system – as that has to be one of the most popular targets of the hacking community, even for the youngsters for whom it’s just a sport. It is easy to imagine the harm that could be caused by someone that hacked EDGAR (e.g. post a fake 8-K with some drastic news that is a market-mover).”
I imagine that if EDGAR had been hacked, the SEC would make an announcement – or at least the SEC’s Inspector General would eventually mention it in one of their reports about the SEC’s security systems. And of course, the company (or companies) impacted by a hacking episode would tell the investor community of the problem. Falsified numbers in financials filed on EDGAR would truly undermine confidence in the markets. So I’m glad that there hasn’t been any cybersecurity incidents of this nature so far…
The SEC’s Long History of Laptop Security Issues
As picked up by this Fortune article, the SEC’s Inspector General recently issued a report that over 200 of the agency’s laptops could be missing. The SEC has 5525 laptops in total, with about half in DC. Here’s an excerpt from the article:
The SEC’s Office of Inspector General said it reviewed a statistical sample of 488 laptops assigned to the agency’s headquarters and three regional offices to determine laptop accountability. Of those devices, 24 laptops couldn’t be accounted for, while incorrect user information was listed for about 22% of the laptops and incorrect location information was found for 17% of the sample size.
This type of thing is not new news for the SEC. Problems with laptops dates back at least to this GAO report in 2005 through this SEC Inspector General report in 2012, as highlighted by this report about the federal government’s sketchy track record with cybersecurity safeguards for critical infrastructure by Senator Tom Coburn…
Friday Night Spamming by the SEC
And here’s something more light-hearted. After accidentally pumping out dozens of unnecessary alerts on Friday night, the SEC sent out this email:
Subject: Inadvertent email notifications
Last night, you may have received multiple email notifications inadvertently triggered by system enhancements that were installed after midnight. The notifications do not contain new information or changes. The problem was resolved this morning.
As Latham’s Steve Wink noted to me, it was the SEC’s own version of the Knight Capital glitch. If you want to sign up for updates from the SEC directly, here’s their sign-up page…