Companies and their advisors aren’t the only ones struggling to keep pace with SEC Chair Gary Gensler’s “front-loaded” rulemaking agenda – the Staff is also feeling the pressure, according to a recent report from the SEC’s inspector general and a related WSJ article.
This is not very surprising news given everything that is going on, but the report does provide some insight on “how the sausage is made.” And it shows that the Commission is facing challenges that are common across many organizations – for example, collaboration across departments, which is one of the most difficult things anywhere. Here’s an excerpt:
Despite management’s commitment to cross-functional collaboration and communication, personnel we met with (including those from the Division of Economic and Risk Analysis, the Division of Enforcement, and the Office of the General Counsel, among others) identified coordination and communication as a persistent challenge in the rulemaking process, particularly given potential overlaps in jurisdiction and differences in opinion.
We reported on such challenges in a management letter issued in September 2022. Specifically, we reported that, around December 2021, the Office of the Chair modified the process for coordinating internal reviews of draft agency rules, resulting in the Office of the Advocate for Small Business Capital Formation (OASB) and the Office of the Investor Advocate (OIAD) receiving only fatal flaw drafts of proposed rules for a brief period of time. This change was not formally documented or communicated, and the then-directors of OASB and OIAD were not aware of the change until after it took effect.
The report goes on to say that the OASB and OIAD were still able to carry out their responsibilities, but that these types of uncommunicated practices could hinder effective collaboration. You can certainly imagine people getting grumpy over this type of thing! The Staff is also worried that attrition and workload may lead to less time for research & analysis on rulemaking and may increase litigation risks, which are already circulating.
As a “consumer” of SEC rules, it is concerning that the Staff is experiencing these issues. A possible silver lining, as the Staff finalizes rules and thinks about the processes that will be necessary to comply, is that maybe these challenges will create even more empathy amongst the Staff for what companies are going through. I certainly hope that all of the hard-working folks at the SEC get the resources they need – and some appreciation for their efforts.
Yesterday, the DOJ announced that seven directors have resigned from corporate board positions in response to concerns by the Antitrust Division that their roles violated the Clayton Act’s prohibition on interlocking directorates. I blogged last month that inquiries were underway.
The DOJ’s press release identifies five companies – so far – that have lost directors as a result of the alleged interlocks (see this WSJ article for more color). In three instances, a director was serving simultaneously on the boards of two companies that could be deemed competitors. In two instances, investment firms were also implicated – because they had one or more representatives on the boards of potentially competing companies. John warned earlier this year that this Clayton Act issue could be a big problem for private equity, and that appears to be playing out.
The DOJ announcement offers these parting words:
Companies, officers, and board members should expect that enforcement of Section 8 will continue to be a priority for the Antitrust Division. Anyone with information about potential interlocking directorates or any other potential violations of the antitrust laws is encouraged to contact the Antitrust Division’s Citizen Complaint Center at 1-888-647-3258 or antitrust.complaints@usdoj.gov.
Be a hero, not a zero: remember the Clayton Act when you send out your D&O questionnaires, and get out in front of this issue with your directors. Our 95-page “D&O Questionnaire Handbook” includes a sample question to identify relationships that could be problematic, and you can use this enforcement sweep to explain why you’re adding it now.
If you’re already aware of potential interlocks, it would be prudent to address them sooner rather than later. For example, if your company identifies as a competitor in its disclosures a company where one of your directors sits on the board, that could put you in the DOJ’s cross-hairs. You may need to have some difficult conversations, and consider a succession plan if the director wants to stay on the other board.
Here’s a blog I shared this morning on CompensationStandards.com. I’m confident this is also of interest to readers here, because several esteemed members emailed me within minutes of the SEC posting its notice for next week’s open meeting (thanks, y’all)! Make sure to watch CompensationStandards.com for ongoing guidance on the new rules – and what you need to do:
Yesterday, the SEC posted a Sunshine Act Notice for an open meeting of the Commissioners to be held next Wednesday, October 26th. Corp Fin Staff will also be attending – Renee Jones, Erik Gerding, Elizabeth Murphy, Lindsay McCord, and others. After years of anticipation, the agenda includes:
The Commission will consider whether to adopt rules to implement of Section 10D of the Securities Exchange Act, as added by Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
We had a great session at our Executive Compensation Conference last week about what you need to think about when reviewing and updating your clawback policy in light of recent enforcement activity and these expected final rules. If you missed it, you can still get access to the on-demand archives of this session and all of the other practical guidance from our Conferences by emailing sales@ccrcorp.com. Stay tuned for more guidance as we receive and analyze the final rules.
In the meantime, here are some of my latest entries on this topic from our “Advisors’ Blog” on CompensationStandards.com – and more helpful info is available in our “Clawbacks” Practice Area on that site:
John blogged last week about a tech glitch that caused the SEC to reopen the comment period on 11 rulemaking proposals and one request for comment. On Tuesday, the SEC’s order was published in the Federal Register, which began the 14-day clock for the reopened comment periods. The window closes on November 1st.
What does that mean for the timeline for these proposals? We can’t know for sure whether or when they’ll be adopted, but here are the general next steps after November 1st:
– SEC Staff moves forward with making sure all submitted comments are received and reviewing any additional comments that were submitted during the reopened period.
– SEC Staff continues with its process of drafting the final rules & adopting releases for the affected proposals, considering all comments.
– The Commissioners can then consider whether to approve each proposed rule (what they consider will include proposal modifications that are drafted by the Staff in response to public comments).
The SEC’s Acting Chief Accountant Paul Munter published another statement last week to focus on the gatekeeping responsibilities of auditors – this time, in relation to fraud detection. He expressed concern in light of recent developments and conversations that auditors are passing the buck on fraud detection. In his view, that’s not okay, because:
Auditors must plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.
The statement urges auditors not to treat PCAOB Auditing Standard 2401 as an “exhaustive checklist” for fraud risk considerations and related responses. The implication is that maybe that’s been happening.
Mr. Munter identifies “good practices” that presumably go beyond auditors’ current approach to fraud detection. Companies can expect auditors to get nosier about these topics – and possibly others – as auditors work these points into their “New & Improved Fraud Detection Checklist.” His (paraphrased) suggestions include:
– Auditors should consider publicly-available information (including from new sources available during the course of the audit) and objectively evaluate how such information impacts risk assessment and the audit response. For example, auditors should evaluate whether publicly-available information contradicts information received from management.
– Are employees required to annually certify acknowledgement of a code of ethics? That’s a good start, but auditors should also consider whether that is a meaningful demonstration of the company’s commitment to integrity and ethical values. For example, are employees able to anonymously share their views on the company’s tone at the top through, for example, a culture survey? How are the survey results obtained and shared with leadership?
– Is the company’s whistleblower hotline simply a compliance checkbox, or does the issuer have a culture that encourages whistleblowers who see something to actually say something? For example, an auditor may want to discuss with the audit committee the nature of the whistleblower hotline’s operation.
– An auditor should also pay close attention to an issuer’s approach to its own fraud risk assessment as this can provide insight when evaluating the issuer’s control environment.
– Technology plays an increasingly important role in the audit and automated tools and techniques may assist the auditor in applying the fraud lens. Access to granular data and information can increase transparency into underlying transactions, which through the use of technology may provide useful insights to assist with identifying unusual or unexpected relationships or assisting auditors in performing more robust planning analytics.
This is an interesting backdoor nudge from the OCA Staff on corporate culture practices. I guess that as the “bad guys” continue to get more sophisticated, fraud detection has to keep pace – even if it means that code of ethics & whistleblower expectations go beyond what regulations expressly require.
Late last week, Insightia/Diligent released its “Proxy Voting Snapshot” (available for download), which summarizes year-over-year voting trends from the five largest institutional investors – BlackRock, Vanguard, State Street, Fidelity and JPMorgan.
This summary is the preview to Insightia’s deeper dive on voting trends that is coming later this month, based on analysis of annual N-PX filings. Here are the key takeaways:
– The five largest institutional investors decreased their support of environmental and social shareholder proposals by an average 15.1 and 13.5 percentage points, respectively, between the 2021 and 2022 proxy seasons.
– Combined, the top five investors voted the dissident card 25 times out of 83 (30.1%) in proxy contests held during the 2022 proxy season, compared to 14 times out of 58 (24.1%) one season prior.
– The top five’s alignment with Institutional Shareholder Services (ISS) and Glass Lewis recommendations declined by an average of 4.1 and 3.2 percentage points, respectively, between the 2021 and 2022 proxy seasons.
– Support for advisory “say on pay” proposals from the top five investors decreased by an average of 1.4 percentage points between the 2021 and 2022 proxy seasons.
Stewardship teams have gotten out in front of the narrative on ESG proposals, signaling for months that support for these proposals would be lower this year because many of the “asks” were too prescriptive. So, that data point is not too surprising. Plus, because proponents are likely to adapt their proposals to this feedback as we look to the 2023 proxy season – and because SEC no-action relief remains scarce – it’s unlikely that these support levels will dampen proponent enthusiasm or make proxy season any easier for companies.
In fact, the data points here suggest that proxy season could keep getting more difficult, because investor voting behavior is becoming less predictable and doesn’t reliably align with management. Here are two examples from Insightia that support that conclusion:
– The influence of ISS and Glass Lewis appears to be waning – at least with the Big 5.
– Although activists won fewer board seats this year, the Big 5 supported more dissidents, especially at smaller companies. They were in a “swing vote” position with several high-profile proxy contests, but ended up siding with management.
In other words, directors aren’t getting a free pass to reelection these days. Luckily, since you’re reading this blog, you’ll be prepared! Start thinking now about your solicitation strategies for spring – including your budget & team.
The SEC announced yesterday that the compliance date for electronic Form 144 filing requirements will be April 13, 2023. As I blogged a few weeks ago, EDGAR is already set up to accept these filings.
If you haven’t already confirmed EDGAR accounts for all of your reporting insiders, now is the time to get the ball rolling! You’ll also likely need to discuss the new Form 144 process with the brokers that handle insiders’ transactions. According to the informal “Quick Poll” that I ran a few weeks ago, most people want the brokers to keep handling this compliance step.
As we make our way through a complicated earnings season, this WSJ article says that some companies may be looking at ways to expand the range for guidance – or implement more nimble forecasting processes. One thing that companies probably won’t do – at least for now – is back away entirely from the practice of giving guidance, which serves a Reg FD purpose in addition to generally managing expectations. This CLS Blue Sky blog explains:
Headlines during earnings season often focus on the forward-looking guidance corporate managers provide. Yet, questions remain about managers’ perceptions of the guidance process and the tradeoffs they face in deciding whether and what to guide. To gain greater insight, we surveyed 357 managers at publicly listed corporations and conducted nine in-depth interviews.
Our survey sheds light on the critical role guidance plays during earnings season. Because analysts and investors dislike surprises, our respondents said guidance provides an effective channel to manage expectations. Around earnings announcements, corporate managers commonly meet privately with analysts and investors after conference calls. Our respondents said that providing guidance allows for more open and forthcoming discussions about the future in one-on-one meetings, with less concern that the conversation will run afoul of disclosure regulation (Reg FD).
Our study also highlights some downsides of issuing guidance. We find that reporting results that fall short of guidance is a primary concern because it signals a failure to understand the business or a lack of control of the company’s operating environment. The anticipated consequences of missing guidance include reduced credibility of future guidance, increased scrutiny from sell-side analysts and the board of directors, and stock price declines.
The managers said that widespread economic uncertainty would be the only circumstance that would cause them to stop providing guidance entirely. Yet, that may also be when these Reg FD-compliant private calls will be most valuable. It will be interesting to see whether there’s a drop-off in the practice of providing guidance as recession murmurs grow louder.
For more practical guidance on this topic, make sure to mark your calendar for November 16th, 2-3pm Eastern, for our webcast, “Dissecting the Quarterly Earnings Process” – with Goodwin’s Sean Donahue, O’Melveny’s Shelly Heyduk, and Cooley’s Reid Hooper. Members of this site are able to attend this critical webcast at no charge. If you’re not yet a member, try a no-risk trial now. Our “100-Day Promise” guarantees that during the first 100 days as an activated member, you may cancel for any reason and receive a full refund. The webcast cost for non-members is $595.
I blogged yesterday about the climate-related results of ISS’s recent benchmark policy survey. Another topic that we expect ISS to address in its forthcoming 2023 voting policies is which companies and directors will find themselves facing adverse voting recommendations as a result of multi-class share structures.
The survey results suggest that directors holding super-voting shares and the chair of the governance committee will be in the cross-hairs under the new policy, and that 5% may be the threshold for exceptions to this policy. Here’s more detail:
Already announced in 2021, effective as of Feb. 1, 2023, ISS plans to start recommending votes against certain directors at U.S. companies that maintain a multi-class capital structure with unequal voting rights, including companies that were previously exempted from adverse vote recommendations.
In 2022, we said that we planned to apply exceptions in cases where the capital structure is not deemed to meaningfully disenfranchise public shareholders. When asked what the appropriate threshold for exemption should be, a strong majority of investor respondents agreed that there should be an exception. They were split on exactly what that threshold should be, but “no more than five percent” was the most popular threshold chosen by investor and non-investor respondents. Almost a third of investors responded that there should be no exemptions.
When asked what the appropriate target for an adverse vote recommendation, respondents favored any director who holds super-majority shares and the chair of the governance committee. Twenty-nine percent of non-investor respondents stated that there should not be votes against directors in this situation.
In cases where shareholder do not have the ability to vote against the director who holds super-majority shares, a majority of investor respondents said that shareholders should vote against whatever director was on ballot to protest against the multi-class structure.
When asked to define the most appropriate time for a sunset to begin phasing out problematic governance structures such as a classified board, a plurality of investor respondents chose “between 3 and 7 years.”
When asked whether smaller companies should be exempted from negative vote recommendations for maintaining a classified board or supermajority voting requirement, a strong majority of investor respondents said that should
not. Nearly two-thirds of non-investor respondents, on the other hand, replied that smaller companies should be exempted from either one or both of those provisions.
Both investors and non-investors supported having a supermajority vote requirement of two-thirds of shares outstanding to amend governing documents.
One thing that we can probably all agree on, is that these survey results would be more entertaining if they were unveiled in a “Family Feud” format. We may have to host a game show next year.
The other major topic that ISS asked about in this year’s benchmark policy survey was how to handle shareholder proposals on racial equity audits/civil rights audits. As I noted last month on the Proxy Season Blog, ISS backed 77% of resolutions on this topic during the 2022 proxy season – compared to 22% in 2021. Looking ahead to 2023, here’s the feedback that will be guiding ISS’s policy development:
Discussions with clients and proponents and the survey results lead ISS to conclude that investors are roughly evenly split into two camps on this issue. Approximately 42 percent of investor respondents to the survey said most companies would benefit from an independent racial equity or civil rights audit, while a slightly larger 45 percent responded that whether a company would benefit from an independent racial equity or civil rights audit depends on company-specific factors including outcomes and programs.
A majority of non-investor respondents indicated that they believe company specific criteria are the best determinations of which companies would benefit from a racial equity audit.
When asked what factors were relevant to determine whether a company would benefit from an independent racial equity or civil rights audit, “significant diversity-related controversies” were the most popular choice – being selected by a majority of investor and non-investor respondents. This was followed by whether the company disclosed workforce diversity representation statistics, such as EEO-1 type data, and has undertaken initiatives/efforts aimed at enhancing workforce diversity and inclusion, including training, projects, and pay disclosure.
The least popular choice for investor respondents was whether the company offered products or services and/or made charitable donations with a specific focus on helping create opportunity for people and communities of color.
The question asked this year was the same as the one asked in the 2021 Benchmark Policy Survey to assess any changes in sentiment over time, especially given the strong vote support that many of these proposals received at annual meetings in 2022. The responses for investor and non-investor respondents changed only slightly from last year to this one.