Monthly Archives: October 2014

October 17, 2014

Our New “Rule 10b5-1 Trading Plans Handbook”

Spanking brand new. By popular demand, this comprehensive “Rule 10b5-1 Trading Plans Handbook” covers a topic that many have requested. This one is a real gem – 72 pages of guidance.

DOJ Staffer Provides Fresh Guidance on Effective Compliance Programs

As noted in this Morrison & Foerster memo, Marshall Miller, the Criminal Division’s Principal Deputy Assistant Attorney General in the DOJ, recently gave remarks about when a compliance program can help stave off indictment – or at least secure it more lenient treatment from the DOJ. Here’s a blog from Jeff Kaplan with more info…

Podcast: Canadian Shareholder Activism

In this podcast, Amy Freedman of Kingsdale Shareholder Services discusses her firm’s new report on Canadian shareholder activism-related developments & trends, including:

– Can you describe the level of proxy contest activity in 2014 relative to prior years, and reasons it may be declining or leveling off?
– Based on 2014 takeover activity, what is the BC Securities Commission position on poison pills, and what’s the best guidance for companies?
– What are the current levels & scope of activism in M&A transactions?
– Can you describe the trends in shareholder engagement?
– What activism-related developments & trends do you anticipate going forward, and how should companies prepare?

– Broc Romanek

October 16, 2014

ISS: New Draft Approaches to Equity Plan & Independent Board Chair Proposals

Yesterday, ISS released a group of draft policy changes for comment – two of them relating to the US: a new “scorecard” approach to evaluating equity compensation plan proposals and independent board chair proposals. Here’s what Ron Mueller & Beth Ising of Gibson Dunn have blogged about them:

Today, proxy advisory firm Institutional Shareholder Services Inc. (“ISS”) provided additional information on its plans to implement a new “scorecard” approach to evaluating equity compensation plan proposals at U.S. shareholder meetings and requested comments on its proposed policy change. This is one of two significant proposals ISS announced today that would impact U.S. companies for the 2015 proxy season, with the other proposed policy change relating to voting recommendations on independent chair proposals (which we discuss here). Companies considering seeking shareholder approval of equity plans at shareholder meetings in 2015 should consider these proposed changes now to the extent they want ISS to recommend votes “For” the equity plan.

Current ISS Approach to Equity Plan Proposals

ISS’s current approach uses a series of “pass/fail” tests. Specifically, ISS will recommend votes “Against” an equity plan if the total cost of the company’s equity plans including the proposed new plan is “unreasonable,” if the company’s three-year burn-rate exceeds the applicable burn rate cap determined by ISS, if the company has a pay-for-performance “misalignment” or if the plan includes certain disfavored features (e.g., if the plan permits repricing or includes a liberal change of control definition).

Companies seeking shareholder approval of a new equity plan or an amendment to an existing plan can often independently determine compliance with each of these factors except for cost. ISS evaluates the cost of a company’s plans using its proprietary shareholder value transfer (SVT) measure. ISS describes SVT as assessing “the amount of shareholders’ equity flowing out of the company to employees and directors.” ISS considers the SVT for a company’s plans to be reasonable if it falls below the company-specific allowable cap as determined by ISS using benchmark SVT levels for each industry. Thus, companies often engage the consulting side of ISS to determine the SVT of their plans and the number of additional shares that ISS would support for the new or amended equity plan.

New ISS Approach to Equity Plan Proposals

ISS previously announced its intention to implement a new “scorecard” approach to evaluating equity plan proposals at U.S. shareholder meetings. Today ISS provided more insights with the publication of its proposed new Equity Plans policy, which details ISS’s new Equity Plan Scorecard (“EPSC”). Under the proposed EPSC, ISS will determine its voting recommendations on equity plan proposals by determining an EPSC score for a company based on three broad categories of factors: (1) the total potential cost of the company’s equity plans relative to its peers; (2) the proposed plan’s features; and (3) the company’s equity grant practices. ISS has indicated that these scorecard factors and their relative weightings would be keyed to company size and status, with different weightings applicable to companies in the following categories: S&P 500, Russell 3000 (excluding the S&P500), Non-Russell 3000, and Recent IPOs or Bankruptcy Emergent companies.

With respect to the three categories that factor into a company’s EPSC score:

– Cost will continue to be evaluated on the basis of SVT in relation to peers. However, SVT will now be calculated for both (a) new shares requested, plus shares remaining for future grants, plus outstanding unvested and/or unexercised grants, and (b) only on new shares requested plus shares remaining for future grants.

– Plan features that will be evaluated under the EPSC include automatic single-triggered award vesting upon a change-in-control, discretionary vesting authority, liberal share recycling on various award types (which will no longer be a component of SVT), and minimum vesting periods for grants made under the plan, in each case as specified in the plan document itself rather than in practice through award agreements.

– With respect to company grant practices, ISS’s proposed EPSC will consider a company’s three-year burn rate relative to its peers (which will eliminate company “burn rate commitments” going forward), vesting requirements in the most recent CEO equity grants, the estimated duration of the plan (calculated based on the sum of shares remaining available and the new shares requested under the plan, divided by the average annual shares granted under the plan in the prior three years), the proportion of the CEO’s most recent equity awards subject to performance vesting (as opposed to strictly time-based vesting), whether the company maintains a clawback policy, and whether the company has established post-exercise/vesting holding requirements.

Although ISS has stated that certain highly egregious plan features (such as the ability to reprice options without shareholder approval) will continue to result in an automatic negative voting recommendation regardless of other factors, overall the EPSC will result in voting recommendations based on a combination of the above factors. This means that ISS may recommend votes “For” an equity plan proposal where costs are nominally higher than a company’s allowable cap when sufficient other positive plan features and company grant practices are present. Likewise, ISS may recommend votes “Against” an equity plan proposal even where costs are lower than a company’s allowable cap if sufficient other negative plan features and company grant practices are present.

Next Steps

ISS has invited comments on its proposed policy, and has specifically asked for feedback on: (1) whether any factors outlined above should be more heavily weighted when evaluating equity plan proposals; and (2) whether stakeholders see any unintended consequences from shifting to a scorecard approach. Comments may be submitted on or before October 29, 2014 via email to For more information, here’s the ISS release discussing the proposed revisions.

We expect that corporate commenters will focus on the nature and extent of flexibility in the EPSC approach around plan features and past grant practices. For example, we understand that under the proposed scorecard, a plan will gain credit if it contains minimum vesting provision (for example, a minimum three year pro-rata vesting requirement), although companies may want flexibility to grant some awards free of any such restrictions. Thus, companies may wish to provide input to ISS on situations in which such grant practices may be warranted and should not result in negative weighting under the scorecard.

With respect to the proposed EPSC’s factors that take into account past grant practices, companies often propose new equity plans so that they can implement new grant practices in the future that were not feasible under their existing plans (for example, a company may wish to be able to implement a performance stock unit program, or increase the percentage of shares granted under such awards and correspondingly decrease its use of stock options). In those cases, overemphasis on past grant practices may be inappropriate. Thus, in order that ISS may consider such situations as it develops its EPSC methodology, companies may wish to provide comments to ISS regarding situations in which they have sought shareholder approval of a new plan so that they could implement new grant practices, as well as other situations in which past grant practices may not be indicative of future equity programs.

Companies that are developing new equity plans that they intend to submit for shareholder approval at their 2015 annual meetings may need to scramble to reflect ISS’s EPSC factors in their proposed plan if they want ISS to recommend votes “For” the plan. For example, even if a company’s SVT would not have exceeded ISS’s limits under its current voting policy, a “liberal share counting provision” under which shares retained to pay taxes again become available for grant under the plan may now contribute to a negative ISS voting recommendation on the plan. Likewise, the proposed EPSC methodology will contribute to more plans containing restrictions on how quickly equity awards are permitted to vest. It is worth noting, however, as ISS observes in its request for comments, that even though ISS historically has recommended votes “Against” approximately 30% of equity plan proposals each year under existing its policy, no more than 10 plan proposals have actually failed in any recent year. Nevertheless, ISS’s policies are based in part on feedback from its institutional shareholder clients, and thus companies will want to carefully consider the extent to which factors considered under the EPSC reflect emerging trends and shareholder-favored practices.

ISS’s final 2015 proxy voting policies are expected to be released in November and typically apply to shareholder meetings held on or after February 1. We expect that ISS will soon offer a new consulting product to help companies and their advisors analyze equity plans under the proposed new EPSC.

Fee-Shifting Bylaws: Will The SEC Get Involved?

In her blog, Cooley’s Cydney Posner notes how Professors John Coffee and Larry Hamermesh recently testified at the SEC’s recent Investor Advisory Committee meeting about whether the SEC should get involved in the debate over fee-shifting bylaws. Here’s an excerpt from Cydney’s blog (and here’s a blog from John himself about it):

What is Coffee’s prescription for the SEC? Coffee suggests, unless the provision at issue expressly precluded application in cases involving the federal securities laws, that the SEC file amicus briefs in litigation arguing that these provisions are contrary to public policy as expressed in the federal securities laws and therefore any state law permitting them is preempted.

Meanwhile, Keith Bishop weighs in with a blog entitled “Why The SEC Should Stay Out Of The Fee-Shifting Charter Debate.” In addition, MoFo’s Bradley Berman blogs about how the SEC’s Investor Advisory Committee recommended that the definition of “accredited investor” in Rule 501(a) undergo some significant changes…

IPO Trends: “Loser Pays” Fee Shifting?

In this article, Alison Frankel of Reuters identifies this:

You’d better hope that the stock price is as solidly based as it seems, because if Alibaba’s officers and directors are engaged in fraud, shareholders will have a very tough time suing for their losses. That’s certainly what the company intends. On the very last page of its 38-page articles of association, Alibaba includes a provision stating that any shareholder who initiates or assists in a claim against the company must pay the company’s defense fees and costs unless shareholders win a judgment on the merits. This sort of “loser pays” fee-shifting is an exception to the general rule in the United States that each side bears its own costs of litigating – and it effectively precludes shareholder class actions suits because investors and their law firms don’t want to risk paying defendants’ legal fees.

– Broc Romanek

October 15, 2014

Whistleblowers: How to Evaluate Hotline Providers

With whistleblowing such a hot topic, it’s a good time to gain an in-house perspective on how to evaluate the many firms that assist companies to process whistleblower tips (we maintain a list of hotline providers in our “Whistleblowers” Practice Area). In this podcast, Joe Kolomyjec of Lionbridge Technologies addresses how to evaluate and select whistleblower hotline providers, including:

– Who within the company is involved with evaluating & selecting a hotline provider?
– What are the main factors that you initially considered important in evaluating hotline providers for Lionbridge?
– Did those factors change during the vetting process?
– How many hotline providers did you initially consider? How did you learn of providers to consider?
– How many vendors did you interview? Were all of the interviews telephonic?
– Were there any surprises during the process?

As noted in this Akin Gump blog, the Supreme Court declined last week to review the 11th Circuit’s decision in U.S. v. Esquenazi, leaving standing the appellate court’s expansive definition of “foreign official” under the FCPA.

Whistleblowers: Is New York’s AG a Better Alternative Than The SEC?

I would think “no” given that the SEC just blessed a $30 million payout to a whistleblower. But this Bloomberg article notes that some whistleblowers become frustrated with the SEC and turn to the New York Attorney General to report suspected violations.

Whistleblowers: Impact on SEC Enforcement & DOJ Cases

This study examines the impact of whistleblowers on the outcomes of SEC and DOJ enforcement actions for financial misrepresentation and found significant increases in penalties against firms and individuals when a whistleblower is involved. This suggests that whistleblowers are valuable to the SEC and DOJ – perhaps explaining why the SEC is willing to pay out $30 million to a single whistleblower! Here are some of the observations:

– 145 of the 1,133 enforcement actions (12.8%) during 1978-2012 have some form of whistleblower involvement.
– Average total monetary penalties assessed against firms in the 145 enforcement actions associated with whistleblower complaints was $143.9mm compared to $33.29mm for the 988 enforcement actions without a whistleblower.
– Average total monetary penalties assed against individual respondents in the 145 enforcement actions associated with whistleblower complaints was $63.6mm compared to $16.7mm for individual respondents in the 988 enforcement actions without a whistleblower.
– Average prison term of convicted respondents was 39.4 months in the 145 enforcement actions associated with whistleblower complaints compared to 17.9 months for the 988 enforcement actions without a whistleblower.
– Presence of a whistleblower increases the length of time needed to complete the enforcement action by 10% (approximately 10 months).
– Likelihood of an enforcement action given the filing of a whistleblower complaint increases to 20.5% compared to 4.3% without. This represents a 4.8x increase in the risk of an enforcement action for firms that have a whistleblower complaint filed against them.
– Estimated increase in total penalties associated with whistleblower involvement is $21.27 billion or 30.3% of the total $70.13 billion total penalties assessed in all 1,133 enforcement actions.

Take a moment to participate in our “Quick Survey on Whistleblower Policies & Procedures” and our “Quick Survey on Earnings Releases & Earnings Calls.”

– Broc Romanek

October 14, 2014

Survey Results: Ending Blackout Periods

I have posted the results of our survey regarding ending blackout periods, repeated below (compare results of our prior blackout surveys):

1. Which factor is most important in allowing a blackout period to end one day after an earnings release:
– Filer status being large accelerated filer and a WKSI – 18%
– Number of analysts providing coverage on company – 20%
– Average daily trading volume for the company – 18%
– None of the above is important – 44%

2. How many analysts covering the company is considered sufficient to allow blackout period to end one day after an earnings release:
– 1-5 – 6%
– 6-10 – 25%
– 11-15 – 8%
– 16 or more – 4%
– None of the above is important – 57%

3. What average daily trading volume is considered sufficient to allow blackout period to end one day after an earnings release:
– 1% of its outstanding common stock – 17%
– $5 million or more in average daily trading volume (daily trading volume x stock price) – 4%
– $10 million or more in average daily trading volume (daily trading volume x stock price) – 6%
– $25 million or more in average daily trading volume (daily trading volume x stock price) – 10%
– None of the above is important – 63%

Take a moment to participate in our “Quick Survey on Whistleblower Policies & Procedures” and our “Quick Survey on Earnings Releases & Earnings Calls.”

SEC Could Lose Ability to Bring Enforcement Actions Before Administrative Law Judges

In this blog, Allen Matkins’ Keith Bishop notes that the SEC has considerable latitude in choosing whether to pursue enforcement actions in an administrative setting or in a true Article III court. He notes that the status of administrative law judges is under attack in Stillwell v. SEC, U.S. Dist. Ct. S.D. N.Y. Case No. 14 CV 7931…

Note that “Alan Dye’s Section 16 Hands-On Training Workshop” on January 9th is sold out. If this was something that you wished to attend, email me as we may schedule another session on a date in mid-’15 if there is enough interest…

Webcast: “Private Company Trading Markets: The Latest”

Tune in tomorrow for the webcast — “Private Company Trading Markets: The Latest” — to hear NASDAQ Private Market’s Greg Brogger, SecondMarket’s Annemarie Tierney, ACE Portal’s Peter Williams and our own Dave Lynn of Morrison & Foerster discuss how the private company trading exchanges are evolving as the Nasdaq and NYSE have recently got into the game.

– Broc Romanek

October 13, 2014

SEC Staff Goes After “Unregistered Securities” Brokers

As noted in this blog by Steve Quinlivan, the SEC Staff announced two items last week that will make it harder to sell unregistered securities. The Division of Trading & Markets issued this set of FAQs – and OCIE issued this Risk Alert – to remind brokers of their obligations when they sell unregistered securities on behalf of clients, such as when founders and employees sell their initial stakes in companies that have gone public or when investors sell securities in public companies that were acquired in private placements. This twin sets of Staff guidance was accompanied by the announcement of an enforcement action against E*Trade for improperly selling billions of shares of penny stocks through such unregistered offerings. Stan Keller notes that while this doesn’t deal with lawyers and no registration opinions, including resales, the guidance has relevance for lawyers…

Asset-Backed Securities: Corp Fin’s New Draft Registration Review Process

Last week, Corp Fin posted this announcement that asset-backed issuers can request staff review of draft registration statements starting next week – on October 20th. This project is to help facilitate compliance with new ABS rules that become effective on November 23rd, 2015. Per the announcement, Corp Fin will select at least two issuers per asset class on a first-come, first-served basis (and perhaps select other issuers) to participate in this draft filing review program.

Transcript: “Cybersecurity: Working the Calm Before the Storm”

We have posted the transcript for the recent webcast: “Cybersecurity: Working the Calm Before the Storm.”

– Broc Romanek

October 10, 2014

PCAOB Prompts Audit Fee Increases

According to this article, finance executives attributed a 4.5% year-over-year increase in 2013 audit fees to review of manual controls resulting from PCAOB inspections and other PCAOB-related issues. The findings are based on this year’s FERF (FEI)/Audit Analytics Audit Fee Survey (paid publication), and include:

  • Public companies paid an average of $7.1 million in audit fees in 2013 – an increase of 4.5% over audit fees paid in 2012
  • 60% of respondents were required to change their controls, and 80% changed their control documents as a result of the PCAOB’s requirements or inspection feedback
  • Public company audits required an average of 17,525 hours in 2013, at an estimated average cost of $249 per hour
  • Average audit fees of companies with centralized operations – both public and private – were found to be significantly less than those with decentralized operations. On average, public companies with centralized operations paid $3.9 million for their annual financial statement audits, while those with decentralized operations paid an average of $9 million
  • Public companies have used their audit firm for an average of 23 years
  • 57% of public company respondents indicated an increase in internal cost of compliance with SOX within the past 3 years. However, many financial executives stated they believe they now have improved internal controls, making it worth the additional overall expense.
  • 92% of public company respondents stated their boards annually assess their audit firm’s performance and independence qualifications

See also this FEI articlePrior audit fee studies are available in our “Audit Fees” Practice Area.

Podcast: Investor Views on Forward-Looking Information

In this podcast, Sandy Peters addresses a new report from the CFA Institute about investor perspectives on the use of forward-looking information in financial reporting, including:

– What historical developments prompted obtaining investors’ views about the use of forward-looking information?
– What are the report’s key findings?
– What does the CFA Institute plan to do with the findings, and what are the ultimate objectives?
– What should companies take away from this report?

More on “The Mentor Blog”

We continue to post new items daily on our blog – “The Mentor Blog” – for 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:

– Optimizing the Value of Internal Audit
– Why You Shouldn’t Decide Anything Important at Your Board Meeting
– Study: CEO Succession Planning
– A Section 5 Case: Memories of Law School
– SEC Bars Bad-Faith Conduct Whistleblower From Any Awards Eligibility (Common Sense Prevails!)


– by Randi Val Morrison

October 9, 2014

SEC Chair White: Board Gender Diversity

As has been widely reported, SEC Chair White recently delivered this speech about gender diversity on boards. In her speech, Chair White identified studies demonstrating the positive impacts on company performance associated with women on boards, and regulatory and investor-driven efforts to increase gender diversity. She also expressed her own views about how to effect and accelerate change.

Among the points I found particularly noteworthy were her observation of investor and other stakeholder disappointment in board diversity disclosures in proxy statements and how they should affirmatively react, and her express disagreement with – and response to – those who indicate that the lack of gender diversity on boards reflects the lack of suitable women candidates.

As to the former, she noted the SEC’s board diversity disclosure requirements in Item 407 of Regulation S-K, and then stated:

I do recognize, however, that there is also disappointment about the quality of some of the disclosures that companies provide.  This is a shared responsibility.  Shareholders and interested stakeholders have a responsibility to make it known that this is an issue that is important, that they want more information on what is being done to promote diversity, and, if not enough is being done, what actions they expect to be taken.  There are a number of different avenues to make these views known – from direct engagement with public companies to shareholder proposals asking a company to establish more specific policies and commitments – and I encourage you to use all of them.

As to the dearth of women on boards, she indicated:

It is also important for companies to work harder to identify qualified women to serve on boards.  Some defenders of the status quo still say that there are not enough qualified women to fill board vacancies at higher rates.  I disagree.  There is no shortage of highly qualified candidates.  And if that is the view of any company, its nominating and governance committees should broaden their searches.  The challenge is not a lack of suitable candidates.  There is adequate supply, but, the challenge is creating real and committed demand.

Commissioner Aguilar similarly emphasized the board’s responsibility to actively seek diverse (women and ethnic minority) candidates in his 2010 speech on board diversity.

Chair White also mentioned that, based on survey data, there would be more opportunity in coming years to nominate women candidates due to increasing vacancies resulting from board term and age limit policies and the associated statistics (e.g., EY’s 2013 study indicating that 20% of S&P 1500 board seats are held by directors nearing or exceeding the common board retirement age of 72).

She concluded by noting that to effect real transformative change, investors and other stakeholders would need to seek change from companies, “and those who support this effort need to recognize those companies that are doing things right, and not just those that are not doing enough.”

See also this interesting new Paul Hastings study, which explores the role and influence that stock exchanges globally currently have – and could potentially have – on improving board gender diversity.

Directors Survey: Perceived Impediments to Gender Diversity

In contrast with Chair White’s view – as expressed in her recent speech – that there is no shortage of highly qualified women board candidates, a majority of directors in PWC’s latest annual directors survey indicated that there are no perceived impediments to increasing gender diversity, the balance cited lack of awareness of qualified women candidates as the top impediment to increased board diversity:

In general, what impedes a board’s ability to increase diversity?:*

  • Directors are unaware of many qualified diverse candidates
  • Directors don’t want to change the current board composition to create a position for a diverse candidate
  • There are insufficient numbers of qualified diverse candidates
  • Directors don’t view adding diversity as important
  • Board leadership is not invested in recruiting diverse directors


*Results shown from greatest impediment to least impediment

Also noteworthy is the fact that 61% of female directors described gender diversity as very important – compared to only 32% of male directors.

However, note that ISS’s just-released gender diversity report reveals measurable progress – particularly among S&P 500 companies, with women filling nearly 3 of every 10 vacancies so far in 2014, almost double the rate compared with 2008.

More on “The Mentor Blog”

We continue to post new items daily on our blog – “The Mentor Blog” – for 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:

– It’s Time to Fix the Very Pale, Very Male Boardroom
– The Risks of Too Much Risk Assessment
– Survey: Challenges with Complying with Internal Control Requirements
– No Link Between Interim CEO Appointment & Company Performance
– Surveys Show Need for Continued Focus on Effective Compliance Programs


– by Randi Val Morrison

October 8, 2014

New Corp Fin CDI: Using IP Addresses to Control Intrastate Offerings

As Steve Quinlivan notes in this blog, a new Corp Fin CDI 141.05 (Securities Act Rules) indicates that companies may use IP addresses to effectively limit their offers to particular states or territories to qualify for Rule 147’s intrastate offering exemption:

In a new CDI, the SEC indicates it may be possible to use IP addresses to control internet communications so that offers are made only in one state and qualify for the intrastate exemption under Rule 147.  In Securities Act Rules CDI 141.05, Corp Fin states:

“Issuers could implement technological measures to limit communications that are offers only to those persons whose Internet Protocol, or IP, address originates from a particular state or territory and prevent any offers to be made to persons whose IP address originates in other states or territories. Offers should include disclaimers and restrictive legends making it clear that the offering is limited to residents of the relevant state under applicable law. Issuers must comply with all other conditions of Rule 147, including that sales may only be made to residents of the same state as the issuer.”

See also this Cooley blog, which addresses the practical implications of this CDI – i.e., the alleged difficulty in implementing these technological measures such that they serve as a reliable control.

SEC Charges Company With Accounting Fraud & Uses SOX Clawback

As described in this recent press release, the SEC charged Saba Software and two of its former VPs for an accounting fraud where management directed its Indian subsidiary’s consultants to falsify timesheets so that the company could hit its quarterly financial targets. Both the company and VPs agreed to settle the charges.

The SEC also used Sarbanes-Oxley’s Section 304 to claw back $2.5 million in incentive compensation and stock profits from the CEO, who was not charged with misconduct.

See also this Reuters article discussing the clawback, and noting SEC Enforcement Chief’s Andrew Ceresney’s remarks about the case, including the fact that it reflects “the SEC’s increased focus on financial reporting fraud” and underscores “the need for companies with offshore operations to have effective internal controls.”

Podcast: Shareholder Engagement on Executive Pay

In this podcast, Frank Glassner of Veritas discusses engaging with shareholders on executive pay, including:

– What do you think has caused the increase in shareholder engagement on executive pay issues?
– What are the advantages of engaging with shareholders?
– What are some of the pitfalls of engaging with shareholders?
– Is there a better than average method of engaging with shareholders?
– What would a best practice with shareholder engagement process look like, and what do you think companies should do?


– by Randi Val Morrison

October 7, 2014

Study: CEO’s Age Impacts Company Risk Profile & Performance

I found this recent blog noteworthy because it discusses the influence of a CEO’s age on the company’s strategic direction – a previously inconclusive and undocumented association.

The article cites a new study (purchase required) of the S&P 1000, which demonstrates that older CEOs take fewer risks. Specifically, older CEOs invest less in research and development, make more diversifying acquisitions, manage companies with more diversified operations, and maintain lower operating leverage. Using the company’s stock price volatility as the indicator of risk, older CEOs are associated with less stock price volatility – less risk.  Further, company risk and the riskiness of corporate policies are shown to be lowest when both the CEO and the next most influential executive are older, and highest when both are younger.

As noted in the blog, the author also identified a correlation between the company’s risk profile and its CEO hiring practices – i.e., lower risk profile companies tended to hire older (and presumably more risk-averse) CEOs, as compared to higher risk profile companies that tended to hire younger CEOs.  That’s not to say that lower risk behavior is a better investment strategy. To the contrary – the study apparently determined that the risk-adjusted portfolios of companies managed by younger CEOs outperformed those managed by older CEOs.

The blogger’s bottom line: “Older CEO’s, who tend to make more conservative decisions, can be ideal stewards for firms seeking stability. But younger CEOs’ willingness to take on risky projects can pay off for shareholders in the long run.”

Study: Diverse Boards Are More Risk-Averse

Interestingly, this recent Workplace Diversity article also addresses the correlation between management and the company’s risk profile – but in a different way. It cites a soon-to-be-published study of more than 2,000 public companies that shows that companies with more diverse boards are less prone to taking risks (i.e., are more risk-averse), and more likely to pay dividends and have richer dividend policies.

Board diversity was defined broadly – to include gender, race, age, experience, tenure and expertise. Risk in this case was a function of each company’s capital expenditures, research and development expenses, acquisition spending, stock return volatility and accounting return volatility.  Companies with more diverse boards spent less on cap-ex, R&D and acquisitions; exhibited lower stock price volatility; and were more likely to pay dividends and to pay greater dividends than those with less diverse boards – leading to the authors’ conclusion that, “In general, risk-averse firms are more likely to avoid investment projects with uncertain outcomes and return cash to shareholders in the form of dividends.”

The authors of the study acknowledge that taking risks is part of doing business, but caution that excessive risk-taking can jeopardize a company’s survival.

More on “The Mentor Blog”

We continue to post new items daily on our blog – “The Mentor Blog” – for 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:

– Strategies to Address SEC’s AQM-Triggered Scrutiny of Your Financial Reporting
– Creating a Formal Framework for Accounting Judgments
– How Boards Need to Evolve Over Time
– ISS QuickScore Data Reveals Key Governance Trends
– Director Orientation & Onboarding Considerations


– by Randi Val Morrison

October 6, 2014

Proxy Advisor Insights

Even if you are already familiar with their voting policies and policy-making processes, I found this King & Spalding memo noteworthy for the additional insights ISS and Glass-Lewis provided directly during their participation in a recent joint Lead Director Network/Compensation Committee Leadership Network meeting. Noteworthy points include:

– Involvement in developing customized voting policies

Both ISS and Glass Lewis work with investment managers to develop customized policies. Glass Lewis noted more than 80% of its 900 clients use a custom policy or process for their voting decisions. And ISS indicated: “Our house views are a benchmark, but most of the ballots [cast on the ISS voting platform] are either client-directed or based on a customized policy. Custom policies are a tremendous growth area for ISS.”

– Board tenure/refreshment

Notwithstanding ISS Governance QuickScore 2.0, which reveals ISS’s view that a director’s tenure of more than 9 years is considered to potentially compromise a director’s independence and so is deemed “excessive,” at the recent meeting, ISS noted a lack of investor interest in director term limits. According to the article, ISS indicated that “investors prefer to scrutinize new nominees on a case-by-case basis, e.g., asking why a board with no women just nominated another man.” And Glass-Lewis indicated that they look for evidence of investor concern about board refreshment or diversity – that their clients “‘look for more information on this [than just statistics].”’

– Recommending votes against directors

Director participants criticized – for several reasons – ISS’s and Glass Lewis’s policies to recommend votes against directors based on their committee membership, e.g., recommending votes against governance committee members when the company doesn’t follow certain governance practices. Directors effectively noted that the proxy advisors’ policies are inflexible, whereas companies are dynamic, and can unfairly target directors who were in fact not involved in the decision-making or were part of a full board decision-making process.

Glass Lewis responded by indicating that the alternative to recommending a vote against committee members was to recommend a vote against the entire board which, not surprisingly, didn’t generate a lot of enthusiam among the directors. ISS seemed to suggest that companies’ full disclosure about what they did would resolve the directors’ concerns; however, I think instead there is simply a huge disconnect between proxy advisory firms’ policy positions for recommending votes against directors and what directors believe is reasonable based on what actually transpires in the boardroom.

Board Tenure Considerations

This thoughtful, balanced memo about director tenure addresses some of the common arguments in favor of and against director term limits, and notes other considerations including international trends and results of studies about the impact of director tenure on board effectiveness. Although authored by a Canadian firm, the considerations apply equally to US companies.

The discussion of studies is particularly noteworthy in view of concerns expressed by some investors and proxy advisors that long tenure equates to a lack of independence from management and, thus, reduced oversight effectiveness. Along those lines, here is a excerpt from Wachtell Lipton’s recent article on director tenure, which logically concludes that the academic studies (footnoted in the article) are not conclusive:

Academic Studies

Academic researchers have examined the question of whether there is an optimal length of tenure for outside directors, with varying results. Studies from the 1980s through the 2000s have shown, for example, that longer tenure tends to increase director independence because it fosters camaraderie and improves the ability of directors to evaluate management without risking social isolation. A 2010 study confirmed that companies with high average board tenure (roughly eight or more years) performed better than those companies with lower average board tenure, and that companies with diverse board tenure performed better than those with homogeneity in tenure. A 2011 study, by contrast, examined a sample of S&P 1500 boards and found that long-serving directors (roughly six or more years)—as well as directors who served on many boards, older directors, and outside directors—were more likely to be associated with corporate governance problems at the companies they served.

One 2012 study found that boards with a higher proportion of long-serving outside directors were more effective in fulfilling their monitoring and advising responsibilities, while another 2012 study found that having inside directors increased a board’s effectiveness in monitoring real earnings management and financial reporting behavior, presumably due to their superior firm-specific knowledge and operational sophistication. On the related topic of board turnover, a recent study of S&P 500 companies from 2003 to 2013 found that companies that replaced three or four directors over the three-year period outperformed their peers. The study found further that two-thirds of companies did not experience this optimal turnover and that the worst-performing companies had either no director changes at all or five or more changes during the three-year period.

A 2013 study on director tenure by a professor from the INSEAD Business School has received significant attention. The study hypothesizes that there is a tradeoff between independence and expertise for outside directors—a prejudgment that is widely disputed—and examines the effect of tenure on the monitoring and advising capacities of the board. After review of over 2,000 companies, the author finds that the optimal average tenure for an outside director is between seven and 11 years, though industry- and company-specific factors create substantial variability. He concludes that nine years is generally the optimal point at which a director has accumulated the benefits of firm-specific knowledge but has not yet accumulated the costs of entrenchment. As a policy matter, however, he suggests that in light of the significant variations across industries and company characteristics, regulating director tenure with a single mandatory term limit would not be appropriate.

Taken together, the academic studies show that conclusions about optimal director tenure are elusive. Common sense indicates that a board should use tenure benchmarks not as limits but as opportunities to evaluate the current mix of board composition, diversity, and experience.

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– by Randi Val Morrison