Join us today at 2pm Eastern for the webcast, “SEC Clawback Rules: What To Do Now.” We’ll be hearing practical guidance from Cooley’s Ariane Andrade, Hunton Andrews Kurth’s Tony Eppert, Orrick’s JT Ho, Pay Governance’s Mike Kesner, and Kirkland’s Abigail Lane about what to do to prepare for the SEC’s new Dodd-Frank clawback rules that go into effect next month. Among other topics, this program will cover:

– Overview of rules
– Differences from existing requirements & practices
– Specific action items
– Compliance timeframe
– State law issues
– Interplay between ISS guidelines, institutional investor expectations and DOJ enforcement policies
– Enforcement of clawbacks
– Disclosure implications

We’re also continuing to post memos on this topic in our “Clawbacks” Practice Area. As a member of CompensationStandards.com, you get access to the live webcast, plus the on-demand archive & transcript, and all of the other resources on this topic – which we’ll be continuing to update as the compliance date nears.

– John Jenkins

Yesterday, Corp Fin issued 7 Non-GAAP Financial Measures CDIs. Several of these CDIs update or replace the language of existing CDIs, while the remainder are new. Hanukkah and Christmas are just around the corner, so as a gift I’m going to do what the Staff doesn’t & provide a markup showing the changes. Additions are in bold, while deletions are presented as strikethroughs:

Question 100.01

Question: Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?

Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. Whether or not an adjustment results in a misleading non-GAAP measure depends on a company’s individual facts and circumstances.

Presenting a non-GAAP performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business is one example of a measure that could be misleading.

When evaluating what is a normal, operating expense, the staff considers the nature and effect of the non-GAAP adjustment and how it relates to the company’s operations, revenue generating activities, business strategy, industry and regulatory environment.

The staff would view an operating expense that occurs repeatedly or occasionally, including at irregular intervals, as recurring. [December 13, 2022]

Question 100.04

Question: A registrant presents a non-GAAP performance measure that is adjusted to accelerate revenue recognized ratably over time in accordance with GAAP as though it earned revenue when customers are billed. Can this measure be presented in documents filed or furnished with the Commission or provided elsewhere, such as on company websites? Can a non-GAAP measure violate Rule 100(b) of Regulation G if the recognition and measurement principles used to calculate the measure are inconsistent with GAAP?

Answer: No. Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP could violate Rule 100(b) of Regulation G. Other measures that use individually tailored recognition and measurement methods for financial statement line items other than revenue may also violate Rule 100(b) of Regulation G. [May 17, 2016].  Yes. By definition, a non-GAAP measure excludes or includes amounts from the most directly comparable GAAP measure. However, non-GAAP adjustments that have the effect of changing the recognition and measurement principles required to be applied in accordance with GAAP would be considered individually tailored and may cause the presentation of a non-GAAP measure to be misleading. Examples the staff may consider to be misleading include, but are not limited to:

– changing the pattern of recognition, such as including an adjustment in a non-GAAP performance measure to accelerate revenue recognized ratably over time in accordance with GAAP as though revenue was earned when customers were billed;

– presenting a non-GAAP measure of revenue that deducts transaction costs as if the company acted as an agent in the transaction, when gross presentation as a principal is required by GAAP, or the inverse,

– presenting a measure of revenue on a gross basis when net presentation is required by GAAP; and

– changing the basis of accounting for revenue or expenses in a non-GAAP performance measure from an accrual basis in accordance with GAAP to a cash basis. [December 13, 2022]

Question 100.05

Question: Can a non-GAAP measure be misleading if it, and/or any adjustment made to the GAAP measure, is not appropriately labeled and clearly described?

Answer: Yes. Non-GAAP measures are not always consistent across, or comparable with, non-GAAP measures disclosed by other companies. Without an appropriate label and clear description, a non-GAAP measure and/or any adjustment made to arrive at that measure could be misleading to investors. The following examples would violate Rule 100(b) of Regulation G:

• Failure to identify and describe a measure as non-GAAP.
• Presenting a non-GAAP measure with a label that does not reflect the nature of the non-GAAP measure, such as:

– a contribution margin that is calculated as GAAP revenue less certain expenses, labeled “net revenue”;
– non-GAAP measure labeled the same as a GAAP line item or subtotal even though it is calculated differently than the similarly labeled GAAP measure, such as “Gross Profit” or “Sales”; and
– non-GAAP measure labeled “pro forma” that is not calculated in a manner consistent with the pro forma requirements in Article 11 of Regulation S-X. [December 13, 2022]

Question 100.06

Question: Can a non-GAAP measure be misleading, and violate Rule 100(b) of Regulation G, even if it is accompanied by disclosure about the nature and effect of each adjustment made to the most directly comparable GAAP measure?

Answer: Yes. It is the staff’s view that a non-GAAP measure could mislead investors to such a degree that even extensive, detailed disclosure about the nature and effect of each adjustment would not prevent the non-GAAP measure from being materially misleading. [December 13, 2022]

Question 102.10

Question 102.10(a): Item 10(e)(1)(i)(A) of Regulation S-K requires that when a registrant presents a non-GAAP measure it must present the most directly comparable GAAP measure with equal or greater prominence. This requirement applies to non-GAAP measures presented in documents filed with the Commission and also earnings releases furnished under Item 2.02 of Form 8-K. Are there examples of disclosures that would cause a non-GAAP measure to be more prominent?

Answer: Yes. Although whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances in which the disclosure is made, the staff would consider the following examples of disclosure of non-GAAP measures as more prominent:  Yes. This requirement applies to the presentation of, and any related discussion and analysis of, a non-GAAP measure. Whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances in which the disclosure is made. The staff would consider the following to be examples of non-GAAP measures that are more prominent than the comparable GAAP measures:

• Presenting a full income statement of non-GAAP measures or presenting a full non-GAAP income statement when reconciling non-GAAP measures to the most directly comparable GAAP measures; Presenting an income statement of non-GAAP measures. See Question 102.10(c).
• Omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures; Presenting a non-GAAP measure before the most directly comparable GAAP measure or omitting the comparable GAAP measure altogether, including in an earnings release headline or caption that includes a non-GAAP measure.
• Presenting a ratio where a non-GAAP financial measure is the numerator and/or denominator without also presenting the ratio calculated using the most directly comparable GAAP measure(s) with equal or greater prominence.
• Presenting a non-GAAP measure using a style of presentation (e.g., bold, larger font, etc.) that emphasizes the non-GAAP measure over the comparable GAAP measure.
• A non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption); Describing a non-GAAP measure as, for example, “record performance” or “exceptional” without at least an equally prominent descriptive characterization of the comparable GAAP measure.
• Presenting charts, tables or graphs of a non-GAAP financial measures without presenting charts, tables or graphs of the comparable GAAP measures with equal or greater prominence, or omitting the comparable GAAP measures altogether.
• Providing discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence. [December 13, 2022]

 

Question 102.10(b): Are there examples of disclosures that would cause the non-GAAP reconciliation required by Item 10(e)(1)(i)(B) of Regulation S-K to give undue prominence to a non-GAAP measure?

Answer: Yes. The staff would consider the following examples of disclosure of non-GAAP measures as more prominent than the comparable GAAP measures:

• Starting the reconciliation with a non-GAAP measure.
• Presenting a non-GAAP income statement when reconciling non-GAAP measures to the most directly comparable GAAP measures. See Question 102.10(c).
• When presenting a forward-looking non-GAAP measure, a registrant may exclude the quantitative reconciliation if it is relying on the exception provided by Item 10(e)(1)(i)(B) of Regulation S-K. A measure would be considered more prominent than the comparable GAAP measure if it is presented without disclosing reliance upon the exception, identifying the information that is unavailable, and its probable significance in a location of equal or greater prominence. [December 13, 2022]

 

Question 102.10(c): The staff considers the presentation of a non-GAAP income statement, alone or as part of the required non-GAAP reconciliation, as giving undue prominence to non-GAAP measures. What is considered to be a non-GAAP income statement?

Answer: The staff considers a non-GAAP income statement to be one that is comprised of non-GAAP measures and includes all or most of the line items and subtotals found in a GAAP income statement. [December 13, 2022]

I’d have to check with Broc to be sure, but I think this may be the longest blog in the history of this blog.  Anyway, Happy Holidays!

– John Jenkins

Yesterday, the SCOTUS granted Slack Technologies’ cert petition in a case raising the issue of whether Section 11 and Section 12(a)(2) of the 1933 Act require a plaintiff to be able to trace their shares to those sold in the registered offering at issue.  Slack asserted this tracing requirement – which has been recognized by several circuit courts – as a defense to Section 11 claims arising out if its 2019 direct listing.

That defense was rejected by a California federal court and by the 9th Circuit, but now Slack will get another bite of the apple in the Supreme Court. The stakes are very high here – if the tracing requirement survives, then the high-profile companies for which a direct listing is a viable alternative will have significant advantages over those that take the traditional IPO route. If it doesn’t survive, then we may see a lot more Section 11 litigation involving follow-on offerings by public companies.

– John Jenkins

When Audit Analytics last looked at the universe of going concern opinions, it found that they reached an all-time low in 2020, but according to the firm’s latest report, 2021 was a very different story. Here’s an excerpt with the highlights:

The number of companies that received a going concern opinion during fiscal year (FY) 2021 increased to1,674, around the number of going concerns last seen in FY2016. The percentage of companies that received a going concern opinion during FY2021 was 21.3%, higher than the 18.4% seen in FY2020. Going concern opinions have been declining since they peaked during FY2008 with 2,853 – during the height of the financial crisis. FY2008 also saw a high of 28.3% of companies that received a going concern opinion.

The report says that the percentage of non-accelerated filers reporting a going concern qualification rose by 3.9%, while the percentage of large accelerated filers included in this group increased by 0.7%. Those were the largest increases experienced by those groups of companies in more than a decade. In contrast, going concern qualifications among accelerated filers declined by 5.6% – which was the biggest decline among the members of that group in 15 years.

The report’s most jarring statistic is that while the number of newly public companies increased by 54% last year, the number of going concern opinions issued to those companies increased by 148% over the prior year and was the driving force behind the overall increase in the number of going concern opinions.

– John Jenkins

Over on “The D&O Diary”, Kevin LaCroix recently flagged this Jones Day whitepaper on lessons US companies can learn from European climate change litigation. Kevin points out that litigation has been a component of climate change activists’ strategy in Europe for several years, and that they’ve targeted not just companies, but also “decision-makers in government and in business.” This excerpt from the whitepaper provides the key takeaways from this litigation:

For claimants, the objective is not only to win at trial: NGOs and activists are pursuing novel and inventive litigation strategies. Many of the routes to liability are far from straightforward and difficult to bring successfully. But success at trial often is not the point. Litigation is being used to attract publicity, obtain disclosure of documentation and information, and pressure businesses to change corporate behavior. And not just the behavior of the defendant, but the behavior of other businesses and decision-makers observing the risk of litigation and the direction of judicial travel.

Mind the gap between aspiration and execution: Any gap between a company’s aspirations and its actions creates litigation risk. It is not enough for an organization to make aspirational commitments, however well intentioned. In order to mitigate litigation risks, commitments should be backed up by action—whether that is a credible plan for achieving net-zero pledges, or proper oversight of a subsidiary’s activities to ensure group policies are being adhered to in practice—and adequate justification needs to be made available to the public in order to demonstrate the accuracy of the company’s communications and the seriousness of its plans.

The importance of robust, credible, and scientifically verifiable evidence: Companies making “green” claims about their products or services will need to ensure they can justify those claims by reference to robust, verifiable evidence based on recognized scientific methodologies. Statements that give only part of the story have been found to be misleading, so care needs to be taken to ensure that environmental claims reflect, for example, the full life cycle of a product, or the overall impact of an organization’s activities on the environment or climate (rather than just one of its business lines).

Supporting decision-makers: Evidencing board decision-making is good practice in any event, but directors and other decision-makers within a business will be particularly keen to ensure proper records are kept that they have complied with all relevant obligations when making decisions with potential environmental impact.

Diligence, diligence, diligence: When it comes to ESG and climate change, lines between corporate entities are increasingly blurred. Financial institutions find themselves having to rely on data disclosures provided by corporate issuers to meet their own ESG-related reporting requirements. Supply chain due diligence legislation codifies what was in any event a growing responsibility on parent companies to be alert to the activities not just of their subsidiaries but of those with whom they do business. Robust processes to diligence information and business practices and to audit compliance are essential.

European regulators and businesses have taken the lead on ESG regulation and in corporate commitments to addressing climate change.  That’s created an environment where litigation surrounding those commitments has flourished.  As the US catches up, activists and others may increasingly use litigation as a key component of their own strategies.

– John Jenkins

For some reason, I’ve got a real weakness for articles about best practices for keeping board minutes – which is kind of strange because of all the routine tasks I did as a corporate lawyer, this was the one I disliked most. Anyway, whatever bizarre neurosis may be the cause, I’m always very interested in pieces like this recent Skadden memo, which has plenty of good advice about board minutes.

Writing minutes is drudgery, but it’s important to get them right – and doing that often requires a lot of judgment calls. One area that requires judgment is how to handle legal advice provided to the board at a meeting. You want the minutes to reflect that the board sought and received legal advice at the meeting, but you also don’t want to do anything to inadvertently waive privilege in the event that you have to produce the minutes through a books and records request or otherwise.  This excerpt from Skadden’s memo highlights a potential pitfall that may arise by the way a lawyer’s advice to the board is characterized in the minutes:

It is important to ensure that the fact that legal advice was given to the board is reflected in the minutes at least at a high level, but boards need to guard against waiving the attorney-client privilege. Although privileged information is typically redacted when minutes are produced to plaintiff stockholders, legal advice may at some point become an issue in litigation if the board asserts that it relied on that advice.

To protect privileged information from disclosure, minutes reflecting legal advice should be characterized as an outside attorney or in-house counsel “providing legal advice” about a matter as opposed to “advising the board” to take a certain action, because advice from a lawyer that is not legal in substance — say, advice on business strategy — potentially may not be protected by the privilege.

The memo’s point about the possibility that legal advice may at some point become an issue in litigation is an important one to keep in mind. That means that when thinking about privilege, you need to think about not only how to protect privilege in board minutes, but also how best to use the minutes to help manage a decision to waive privilege as part of a litigation strategy.

Why might a company do that? Well, one reason is that Delaware courts have made it clear that the advice directors receive from lawyers and other professionals is often central to determining the reasonableness of the board’s actions, and an unwillingness to share the substance of that advice can have significant negative consequences, including a prohibition on asserting the content of the legal advice that the board was provided in the defense of the plaintiffs’ claims. See, e.g., Chesapeake v. Shore (Del. 2/00).

In light of this position, some practitioners suggest referencing the fact that legal advice was given in the minutes, but also providing a summary of the advice in separate privileged minutes. Writing that summary presents challenges of its own, but in appropriate circumstances, that approach may both help avoid inadvertent production and enable the board to provided contemporaneous evidence of the advice provided by counsel if the company determines to waive the privilege.

– John Jenkins

ESG ratings have become an indispensable element of investing and greatly influence how companies manage and market themselves. A myriad of issues exist when relying on and using ESG ratings from a corporate perspective. Tune in to today’s PracticalESG.com webcast, “Improving Your ESG Score” at 10:00 am eastern – to hear from:

Tamara Close, Founder and Managing Partner, Close Group Consulting
Jeremy Davis, Executive Director, ESG & Climate Client Coverage, MSCI
Marie-Josée Privyk, Chief ESG Innovation Officer, Novisto
Huub Savelkouls, Founder and Owner, Scope3Plus Consulting

We’ll be discussing the fundamentals of ESG scores & ratings, exploring ways to improve corporate ratings and considering why you may not want to emphasize ESG ratings improvement at a management level.

If you’re not already a PracticalESG.com member, sign up today to get access to the on-demand replay and transcript from this program, along with access to practical checklists and more, to help you with your corporate ESG program and related disclosures and communications. Sign up on our membership portal or email sales@ccrcorp.com.

– John Jenkins

I know that Liz was incredibly grateful for the outpouring of good wishes that she received when she blogged about her career transition.  You folks were wonderful – and she deserved every bit of the praise you gave her. I told her that if she felt like Sally Field at the Oscars after reading your emails, that’s because she should. I’ve definitely got some very big shoes to fill.

As I read through the messages that Liz shared with us, I got the impression that a lot of people thought that Liz wasn’t going to be around much anymore. That’s decidedly NOT the case. Liz will continue in the blogging rotation, she’ll help organize and moderate some webcasts, and she’ll also be involved in helping me with our Proxy Disclosure and Executive Compensation Conference. So, from our members’ perspective, I don’t think a lot is going to change in terms of Liz’s role here – and we’re as happy about that as you are.

Liz did seem particularly anxious to ensure that she was involved in planning for next year’s Conference, although for the life of me, I don’t know why.  You may not know this because I’m not one to brag, but I was the mastermind behind the1997 Cleveland Securities Law Institute. As I’m sure you know, that epic event has been described as “The Woodstock of flyover state bar association sponsored securities law conferences held in markets too small to get anybody from the SEC to speak.”  People still talk about the set of coasters emblazoned with the Cleveland Bar Association’s logo that we gave away as speaker’s gifts.  Ah, glory days. . .  

I’m also more than a little relieved that Liz will continue to be a part of the team, because frankly, the transition has been a little rocky. First, management shot down what I viewed as an entirely reasonable request to change the title of my new position from “Managing Editor” to “Emperor of the Editors.”  Then, I proposed a couple of much needed reforms to improve the discipline and esprit de corps of the editorial team. Nothing major – just a daily 6:00 am Zoom meeting for calisthenics and a mandatory dress code for working from home. Regrettably, these reform proposals have not been well received.

Liz did caution me about not making drastic changes, but gee whiz, I didn’t consider any of this stuff to be drastic, and I admit that I was kind of bummed out by the reaction to my administration’s reforms. But then this morning I thought of something that I can do to celebrate my newly elevated station in life without needing management’s approval or buy-in from my editorial colleagues. When I was in college, one of my history profs shared an anecdote about Bavaria’s legendary “Mad King Ludwig.”  Apparently, in one of his less lucid moments, Ludwig forgot that he was the king.  When his advisors informed him that he was, his response was something like “I am King? Very well, then I shall have noodles for lunch.”

So now, if you’ll excuse me, I’ve got a package of ramen to boil.

– John Jenkins

According to a recent PCAOB Staff Report, public company auditors didn’t have a great year in 2021. The report says that, according to preliminary inspection data, the number of audits with deficiencies is expected to increase.  Here’s an excerpt with some details:

We observed an increase in the percentage of engagements reviewed with at least one “comment form” (the initial communication to audit firms of observed deficiencies from our inspections, which generally result in Part I.A or Part I.B inspection observations). We expect approximately 33% of the audits we reviewed will have one or more deficiencies that will be discussed in Part I.A of the individual audit firm’s inspection reports, up from 29% in 2020.

In addition, we expect that approximately 40% of the audits we reviewed will have one or more deficiencies discussed in Part I.B of the individual firm’s inspection reports, up from 26% in 2020. Some audits have both Part I.A and Part I.B deficiencies, such that we expect that approximately 55% of the engagements we reviewed will have one or more Part I.A and/or Part I.B deficiencies, compared to 44% in 2020.

A lot of these problems aren’t minor foot-faults. If an issue makes its way into Part I.A. of an inspection report, it means that the PCAOB’s Staff concluded that the deficiencies were significant enough that the auditor, at the time it issued its report, did not have sufficient appropriate evidence to support its opinion on the company’s financials or ICFR. Deficiencies identified in Part 1.B. of the report are less significant and include the Staff’s observations concerning instances of noncompliance with PCAOB standards or rules that don’t relate directly to the sufficiency of the evidence supporting the auditor’s opinion.

The report provides specific data on audit areas where deficiencies were found as well as trend data concerning recurring deficiencies for 2019 through 2021. It also discusses common areas where deficiencies were found in 2021 inspections and highlights “good practices” that the Staff observed relating to ICFR, accounting estimates related to business combinations, critical audit matters, auditor independence, supervision of audits and engagement quality review.

– John Jenkins

Here’s something I recently posted on the DealLawyers.com Blog:

In our recent podcast, Hunton Andrews Kurth’s Steve Haas discussed bylaw changes that companies should consider in response to the implementation of the universal proxy rules.  One possible change he suggested was including language in the bylaws reserving the use of the white proxy card to the board.

White is the color that’s traditionally been used by management in proxy contests, and with all parties jockeying for leverage in the new environment, it certainly seemed plausible that dissidents might try to grab the white card to increase the likelihood that investors would return their version of the universal proxy card.  Over the past couple of months, many companies, including heavyweights like Exxon Mobil and Alphabet, have staked their claim via a bylaw amendment. Here’s the relevant language from Alphabet’s bylaws:

2.12 PROXIES.

Each stockholder entitled to vote at a meeting of stockholders may authorize another person or persons to act for such stockholder by proxy, but no such proxy shall be voted or acted upon after three (3) years from its date, unless the proxy provides for a longer period. A stockholder may authorize another person or persons to act for him, her or it as proxy in the manner(s) provided under Section 212(c) of the DGCL or as otherwise provided under Delaware law. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of Section 212 of the DGCL.

Any stockholder directly or indirectly soliciting proxies from other stockholders must use a proxy card color other than white, which shall be reserved for the exclusive use by the Board.

Anyway, it turns out that the concerns about dissidents beating companies to the punch and claiming the white card for their own that have prompted these amendments aren’t just hypothetical.  On Twitter, Andrew Droste pointed out that activist hedge fund Blackwells Capital has launched a proxy contest at Global Net Lease – and grabbed the white card before the company did. So, if any of you have clients that considering the possibility of this kind of amendment, you might want to share Andrew’s tweet with them & suggest that there’s no time like the present.

Gibson Dunn’s Ron Mueller points out that Engine No. 1 snagged the white card in its battle with Exxon Mobil, and that’s what first put this issue on the radar screen for public companies (and likely prompted Exxon Mobil’s bylaw amendment).

– John Jenkins