Spencer Stuart recently published its 2022 S&P 500 Board Diversity Snapshot, which notes some progress with increasing the diversity of boards of directors at the largest companies. The Snapshot notes that 72% of the incoming S&P 500 class of directors come from historically underrepresented groups — defined as individuals who self-identify in one or more of the following categories: women, underrepresented racial/ethnic group or the LGBTQ+ community. The Snapshots notes that year-over-year percentages grew only modestly from 2021, when 30% of directors were women and 21% were from underrepresented racial and ethnic groups. In 2022, 32% of all S&P 500 directors are women and 22% come from historically underrepresented racial and ethnic groups — defined as Black or African American, Asian, Hispanic or Latino/a, two or more races/ethnicities, American Indian/Alaska Native, and Native Hawaiian or other Pacific Islander.
Spencer Stuart’s Snapshot notes that 50% of S&P 500 boards have adopted a policy like the Rooney Rule to include individuals from underrepresented groups in the candidate pool when recruiting directors, up from 39% last year. The Snapshot also notes disclosure about board diversity continues to improve, with 93% of S&P 500 companies disclosing their racial/ethnic composition, with 41% of those companies identifying directors from underrepresented racial and ethnic groups by name for those who volunteered to self-identify.
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One topic that often comes up when discussing board refreshment and board diversity is the existence of classified boards. With a classified, or staggered, board, the directors are divided into roughly equal classes and are typically elected for three year terms, so that only the directors in each class are up for re-election at the annual meeting, rather than the full board. Critics say that classified boards are not in the interests of shareholders because the anti-takeover effect of a classified board can entrench management and discourage attractive takeover offers, while also discouraging accountability for the actions of directors.
Despite years of negative perceptions about classified boards, they still have not gone the way of the dinosaur. The prevalence of classified boards has waned among the largest companies, with only 12% of S&P 500 companies having classified boards today, as compared with 60% in 2000. In the broader market, however, classified boards are more common, with 43% of Russell 3000 companies have classified boards today.
What keeps the classified board in place at so many companies, despite the persistent investor dissatisfaction with classified boards? A classified board remains one of the strongest defenses against shareholder activism, and that makes the practice one of the last “problematic” governance practices that companies want to give up. With a classified board, an activist investor can only replace a majority of the directors serving on the board if it is able to wage a successful proxy fight over the course of multiple annual meetings. In contrast, where there is no classified board, an activist investor can replace all of the directors by launching a proxy contest at one annual meeting.
Further, despite the fact that institutional investors largely look askance at classified boards, their approach to classified boards is generally “transactional.” If a company or shareholder puts forth a proposal to eliminate the classified board, many institutional investors (and the proxy advisors) will vote in favor of that proposal, and those proposals generally receive very strong shareholder support. With that said, these same investors are unlikely to submit shareholder proposals seeking to dislodge the classified board or take other “aggressive” action, despite the negative perception of the practice. One institutional investor, Invesco, will generally vote against the incumbent governance committee chair or lead independent director if a company has a classified board that is not being phased out, but that more active approach to expressing dissatisfaction with a classified board tends to be an outlier.
Considering the removal of a classified board provision requires a careful consideration of the pros and cons by the board, with the full recognition that once the classified board is eliminated, it is unlikely to ever be reinstated. The board should carefully assess the company’s anti-takeover profile and the sentiment of the company’s key investors when weighing whether to phase-out a classified board, while also considering the overall market environment and the company’s rationale for retaining the classified board. Some feel strongly that classified boards promote stability and continuity on the board and promote a long-term strategic outlook, and even some institutional investors (such as BlackRock) may be open to considering the board’s rationale for retaining the classified board if the topic shows up on the company’s ballot. Ultimately, the board should periodically evaluate the classified board structure in the context of an overall evaluation of the company’s governance practices and in light of evolving “best practices” for similar companies.
I look forward to joining many colleagues and friends at our rapidly approaching Conferences, which will occur virtually this year on October 11–14.
I am particularly looking forward to our 1st Annual PracticalESG Conference, which will kick things off on October 11 with an action-packed agenda full of practical guidance on the most important ESG issues that companies are facing. I will be speaking with Corp Fin Director Renee Jones at our two-day 2022 Proxy Disclosure Conference, and participating in panels that you do not want to miss – “The SEC All-Stars: Proxy Season Insights” and “ESG Disclosures: Staying Out of Hot Water.”
I also look forward to our 19th Annual Executive Compensation Conference, where I will be joined by the SEC All-Stars to discuss your favorite executive compensation nuggets. With all that is going on today at the SEC and in the world, you do not want to miss the valuable and timely guidance that we will provide at this year’s Conferences.
The time is right for you to sign up for the Conferences today!
Last week the SEC re-proposed rule amendments originally proposed in 2015 to narrow an exemption from the requirement to be a FINRA member that is applicable to certain proprietary trading firms.
Exchange Act Rule 15b9-1 provides an exemption under which certain SEC-registered dealers can engage in unlimited proprietary trading of securities on any national securities exchange of which they are not a member or in the over-the-counter market without triggering the requirement to be a FINRA member. The SEC adopted this exemption over forty years ago to facilitate limited proprietary trading by regional specialists and floor brokers conducted off their home exchange. The trading world has changed quite a bit in the ensuing four decades, moving from floor-based to mostly electronic. During that time, SEC-registered dealers have emerged which engage in significant, proprietary trading of off-member-exchange securities, including in the U.S. Treasury securities market, and these dealers are not FINRA members in reliance on Rule 15b9-1.
Under the re-proposal, an SEC-registered broker or dealer would be required to join FINRA if it effects securities transactions other than on an exchange of which it is a member unless:
It is a member of a national securities exchange;
It carries no customer accounts; and
Such transactions (i) result solely from orders that are routed by a national securities exchange of which the broker or dealer is a member to comply with Rule 611 of Regulation NMS or the Options Order Protection and Locked/Crossed Market Plan; or (ii) are solely for the purpose of executing the stock leg of a stock-option order.
Over the past few weeks, we have seen a number of reflections on the impact of the Sarbanes-Oxley Act on its twentieth anniversary. Last week, Liz noted the remarks of Chair Gensler at a program hosted by the Center for Audit Quality, and I noted a program that I had the honor of moderating for the SEC Historical Society. Last week, the Council of Institutional Investors hosted PCAOB Chair Erica Williams for remarks on the twentieth anniversary of SOX and the establishment of the PCAOB.
After recounting the events that led up to the enactment of SOX, Chair Williams noted the many accomplishments of the PCAOB and the overall impact of the auditing regulator on the quality of audits. Going forward, Chair Williams outlined the three key areas that the PCAOB is addressing: (i) modernizing standards; (ii) enhancing inspections, and (iii) strengthening enforcement. On the standard-setting front, Chair Williams noted:
When the PCAOB was first getting off the ground in 2003, it adopted existing standards that had been set by the auditing profession on what was intended to be an interim basis.
Twenty years later, far too many of those interim standards remain unchanged.
The world has changed since 2003. And our standards must adapt to keep up with developments in auditing and the capital markets.
Our current short-term and mid-term projects will address more than half of the remaining interim standards from 2003.
And we don’t intend to stop there.
Chair Williams went on to discuss the PCAOB’s ambitious standard-setting agenda, as well as efforts to enhance inspections. Chair Williams also addressed an aggressive enforcement approach, noting “[w]e intend to use every tool in our enforcement toolbox and impose significant sanctions, including substantial penalties, to ensure there will be consequences for putting investors at risk.”
When participating in the SEC Historical Society’s SOX anniversary program a few weeks ago, I was struck by one topic in particular – the changes to the SEC review process that SOX brought about. Section 408 of the Sarbanes-Oxley Act required that the SEC review every public company no less frequently than once of every three years, and that directive resulted in a significant expansion of Corp Fin and reinvention of the work of the Division in a way that lives with us to this day.
The events that led up to the enactment of the Sarbanes-Oxley Act principally involved accounting fraud, so Corp Fin inevitably became a very accounting-focused Division, with the review of public company filings becoming particularly focused on the financial statements and related disclosure. It was very interesting to hear Shelley Parratt and Alan Beller recount the Herculean efforts that were necessary to actually hire the right people to build out a reconstituted Corp Fin and to quickly stand up a review program that could meet the SOX directive.
Looking back, the ramped up SEC reviews of periodic reports really changed the relationship between public companies and the SEC, as the prospect for a comment letter significantly increased. At the same time, the enhanced review program and the enhanced disclosures in SOX’s wake meant that the SEC could adopt the Securities Offering Reform changes just a few years later, which I think everyone can agree has made things much easier when larger companies want to raise capital. It is all an important legacy that is useful to remember today now that SOX has turned 20 years old.
Last week, the SEC released a report to Congress that outlined the policy recommendations from the 41st Annual Government-Business Forum on Small Business Capital Formation that took place virtually on April 4-7. The SEC’s report provides a summary of the proceedings, as well as a series of recommendations for changes needed to the capital raising framework that were developed by the Forum participants and recommend by the Commission.
The wide-ranging policy recommendations highlighted in the report include the following:
Ensure capital-raising rules provide equitable access to capital for underrepresented founders and investors.
Support entrepreneurs who lack the technical assistance to understand how to access traditional capital.
Utilize technology and educational resources to help facilitate small business capital markets and decentralize and democratize capital markets.
In considering any changes to the private capital markets, ensure companies have viable pathways to access capital to allow growth and innovation.
Revise Regulation Crowdfunding to permit investment companies to conduct a Regulation Crowdfunding offering.
Expand the accredited investor definition to achieve greater diversity among startup investors and entrepreneurs.
Expand the accredited investor definition to include additional measures of sophistication.
Expand the accredited investor definition to include any person who invests not more than 10% of the greater of his/her annual income or net assets.
In considering changes that raise the wealth thresholds in the accredited investor definition, consider the unintended consequences on access to capital in under-resourced and underrepresented communities.
Finalize the Commission’s finders order.
Create a new private fund exemption to allow states to foster intrastate and regional funds focused on community-based investing that is open to non-accredited investors.
Increase the thresholds (number of investors and cap on fund size) allowed in 3(c)(1) funds to achieve greater diversity among startup investors and entrepreneurs.
Support underrepresented emerging fund managers—specifically minorities and women—building funds that diversify capital allocators, engage sophisticated investors, and challenge pattern-matching trends.
Increase the number of investors allowed in 3(c)(1) funds above 99 investors.
Support underrepresented and emerging fund managers and their investors through targeted resources, in collaboration with other federal agencies.
Modernize Section 17(b) of the Securities Act to warn against pump-and-dump schemes by requiring additional disclosure about paid stock promotion.
Consider the impact of the proposed environmental, social, or governance (ESG) regulations on small and medium-sized companies, including whether such requirements will discourage companies from going public.
Modernize regulation of transfer agents in response to technological and market advancements to increase disclosures made available to broker-dealers to facilitate liquidity for smaller public companies while continuing to protect investors.
Increase transparency around short selling activities and improve short sale data.
Collaborate with NSCC, DTCC, clearing firms, and broker-dealers to improve the clearing and settlement process for small public companies.
In the morning session, the Committee plans to discuss challenges and opportunities for small business capital formation as a result of current economic conditions. In the afternoon session the Committee will address secondary market liquidity issues faced by investors in companies that have raised money using Regulation A and Regulation Crowdfunding and whether there are changes that could facilitate increased secondary market liquidity for these investors. The Committee will also discuss secondary market liquidity challenges affecting smaller publicly-traded companies.
Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse recently published their latest report, Securities Class Action Filings—2022 Midyear Assessment. The report finds that the number of securities class-action filings remains steady in the first half of 2022, with plaintiffs filing 110 new securities class-action lawsuits in federal and state courts in the first half of 2022, which is on par with the 107 cases filed in the second half of 2021.
The report notes that new SPAC cases continue to be a dominant trend, with the 18 SPAC filings in the first half of 2022 indicating a pace that could exceed 2021’s all-time high of 33 filings. Cryptocurrency-related filings are also on pace to reach an all-time high.