Warren Buffett’s annual letter to Berkshire Hathaway shareholders came out last Saturday. It attracted the usual avalanche of media attention, but I recommend that you check out Kevin LaCroix’s particularly good write-up about it over on the “D&O Diary.” The letter contained its customary mix of insight & folksy charm, but it also once again featured a lot of griping about the Oracle of Omaha’s favorite hobby-horse, generally accepted accounting principles – specifically ASC Topic 321.
The fact that ASC 321 requires Berkshire Hathaway to mark many of its minority investments to market really frosts Buffett. He’s spilled a lot of ink on the topic – and its impact on the company’s bottom line – in each of his last 3 annual letters. Here’s an excerpt from the latest:
The adoption of the rule by the accounting profession, in fact, was a monumental shift in its own thinking. Before 2018, GAAP insisted – with an exception for companies whose business was to trade securities – that unrealized gains within a portfolio of stocks were never to be included in earnings and unrealized losses were to be included only if they were deemed “other than temporary.” Now, Berkshire must enshrine in each quarter’s bottom line – a key item of news for many investors, analysts and commentators – every up and down movement of the stocks it owns, however capricious those fluctuations may be.
Berkshire’s 2018 and 2019 years glaringly illustrate the argument we have with the new rule. In 2018, a down year for the stock market, our net unrealized gains decreased by $20.6 billion, and we therefore reported GAAP earnings of only $4 billion. In 2019, rising stock prices increased net unrealized gains by the aforementioned $53.7 billion, pushing GAAP earnings to the $81.4 billion reported at the beginning of this letter. Those market gyrations led to a crazy 1,900% increase in GAAP earnings!
Buffett’s position is that Berkshire’s a buy & hold investor, and he doesn’t think fluctuations in the value of its enormous stakes in Apple, Coca-Cola and other companies should run through its income statement. He says that just doesn’t reflect business reality for a company like his.
If GAAP Doesn’t Reflect Reality, Then Why You Mad, Bro?
It’s easy to understand Buffett’s beef with GAAP, because mark-to-market fluctuations in Berkshire’s investments add a huge amount of volatility to its bottom line. But here’s the thing – Berkshire made a business decision to take multi-billion dollar minority stakes in enormous companies. What if it had to sell one or more of those positions? That’s what ASC 321 is getting at – it shows users of the financial statements what that would look like.
That fire-sale mentality reflects GAAP’s conservative bias, and yes, it doesn’t necessarily reflect current business reality for a company sitting on a pile of cash that could fund the federal deficit, but Buffett’s allowed to tell people that – and he does, constantly. The fact that Buffett points this out doesn’t bother me, but the fact that he trashes GAAP to do it kind of does.
Of course, GAAP has its limitations, but GAAP disclosures usually provide insights into a business that shouldn’t be ignored. I’ve been practicing law long enough to know that when people constantly harp on the dirty deeds that GAAP’s doing to their company’s financial statements, it’s usually a sign that those financials are highlighting something that makes them uncomfortable.
In Buffett’s case, that “something” is likely the magnitude of the investments that Berkshire’s size compels it to make in order to move the needle – as well as the magnitude of the market risks to which those investments expose it. ASC 321 gives Berkshire no place to hide on this issue & highlights an even more fundamental question: does the Berkshire Hathaway conglomerate make sense anymore?
Restatements: A Quick Reference
When you’re as old as I am, you really develop a fondness for anything that you can quickly grab to remind you of all the things you’ve forgotten about stuff that any corporate lawyer should know. That’s why I really like this 12-page BDO guide on the fundamentals of restatements. There’s definitely enough in there on accounting changes, error corrections & reclassifications to let you fake your way through a conference call or two. Check it out!
If you’re a trend chaser, forget about canned booze or intermittent fasting – all the cool kids are now getting their own stock exchange. This Axios article discusses The Members Exchange, or MEMX, which is backed by the likes of Goldman Sachs, BofA & Morgan Stanley. It’s expected to go live this summer & compete with the NYSE and Nasdaq based on lower fees.
Meanwhile, not to be outdone by Wall Street’s brahmins, Silicon Valley bigwigs are backing the Long Term Stock Exchange, or LTSE. We’ve blogged about this one before, but according to this Marker article, the LTSE’s backers include Andreessen Horowitz, Peter Thiel’s Founders Fund, LinkedIn co-founder Reid Hoffman, & AOL founder Steve Case. CEO Eric Ries & his backers have big ambitions for the exchange:
When it launches — sometime late in the first quarter of this year, Ries hopes — the LTSE will be the 14th U.S. exchange registered for trading securities, but only the third active exchange that is approved for both trading and listing of public companies. That means, instead of IPO’ing on the NYSE or Nasdaq, companies will now have the option of listing shares, aka “going public,” on the LTSE.
DFS: New York’s New Regulatory King Kong?
Armed with the formidable Martin Act, the NY Attorney General’s office has long been one the most powerful state regulators in the country – but this WilmerHale memo says that if legislation introduced by NY Gov. Andrew Cuomo is enacted, the AG won’t be The Empire State’s only regulatory colossus:
In legislative language accompanying his proposed budget, New York Governor Andrew M. Cuomo proposes to significantly expand the powers of the New York Department of Financial Services (DFS), the state’s banking and insurance regulator. The Governor’s proposal would enlarge the department’s mission beyond banking and insurance oversight, transforming DFS into perhaps the most powerful state regulator in the nation, with new and broad jurisdiction and substantial enforcement powers over consumer products and services, business to business arrangements, and securities and investment advice.
Though significant in its scope, the Cuomo proposal is in many respects unsurprising. The Governor created DFS in 2011 upon merging the state’s Banking Department and Insurance Department; he initially sought to give DFS powers under the Martin Act, the state’s broad “blue sky” securities statute, but the Legislature declined to do so. Governor Cuomo has, however, expanded DFS’s jurisdiction in other ways in the years since its creation, including by granting it powers to police the state’s student loan servicing industry.
Among other things, the proposal would amend New York’s Financial Services Law to add securities to the definition of “financial product or service” and give DFS the power to regulate the provision of investment advice. As a result, the memo says that the proposal would effectively make DFS another securities regulator. There are a number of other provisions that would enhance DFS’s power to protect consumers, and would also grant DFS jurisdiction over fraud or misconduct in business-to-business transactions.
Lease Accounting Impact: Holy Cow!
We’ve blogged several times in recent years about the implementation of the new FASB lease accounting standard. Now that the standard’s in place for public companies, a recent article from “Accounting Today” says that the balance sheet impact has been staggering:
The new lease accounting standard caused lease liabilities for the average company to increase a whopping 1,475%, skyrocketing from $4.4 million before the transition to $68.9 million post transition, as operating leases were recorded on the balance sheet for the first time, according to a new study.
The study, from the lease accounting software provider LeaseQuery, analyzed more than 400 companies in its customer base and found that the increase was particularly striking in certain industries, such as financial services, where the amount of the average lease liability increased 6,070%. Similarly, in the health care industry, average lease liability liabilities went up 1,817 %, in the restaurant industry 1,743%, in the energy industry 1,542%, in retail 1,012%, and in manufacturing 495%.
Not surprisingly, the article says that companies found the transition to the new standard more difficult and more time consuming than they initially thought. Feedback from public companies prompted FASB to delay the new standard’s application to private companies in order to give them an extra year to get their act together.
With everybody’s 401(k) plan smarting from the stock market’s belated realization that the coronavirus epidemic was actually a thing, this Nelson Mullins memo seems particularly timely. It takes a deep dive into the potential disclosure issues that the ongoing outbreak may raise for public companies. As this excerpt demonstrates, the memo is a great resource for issue spotting:
The impact of CV may have repercussions on a number of disclosure areas, including liquidity and capital resources, sources and uses of funds, gross and net revenues in the short, medium and long term, and other economic and noneconomic, personal and ESG considerations. Enhanced or additional risk factor disclosure related to CV pursuant to Regulation S-K Item 105 may be needed if it is or becomes one of the most significant factors that make an investment in the company or any offering speculative or risky.
Since SEC disclosure is increasingly principles-based, even if there is not a rule specifically dealing with a situation that a company may find itself in related to CV, the principles of full and fair disclosure apply. Companies should be mindful that their planning for uncertainties that may arise as a result of CV and their response to events as they unfold may be material to an investment decision, and should plan accordingly.
Consider other situations where disclosure of material nonpublic information may be necessary, such as if senior management or boards become impaired and are unable to serve or whether a “material adverse change” in “prospects” has occurred or is reasonably likely to occur. Business interruption insurance policies may be triggered. “Act of God” provisions may be applicable. Contract disputes may occur over CV related matters. Professionals should review and update insider trading policies, blackout periods and trading activity monitoring in light of new information related to CV.
As if that wasn’t enough, the memo also addresses a variety of other legal issues that may arise as a result of the outbreak, including potential labor and employment law, privacy, and even cybersecurity considerations.
Coronavirus: Implications for Contracts
It really is difficult to get your arms around the sweeping legal & business implications of the coronavirus epidemic. This Cleary Gottlieb memo picks up on one of the topics alluded to in the Nelson Mullins memo – the potential inability of companies to perform their contractual obligations due to the impact of the epidemic on supply chains. This excerpt addresses the potential availability of the “force majeure” clause to provide relief from contractual liability:
Force majeure clauses seek to define circumstances beyond the parties’ control which can render performance of a contract substantially more onerous or impossible, and which may suspend, defer or release the duty to perform without liability. They can take a variety of forms but most list a number of specific events (as well as more general ‘catchall’ wording to make clear the preceding list is not exhaustive) which may constitute a “Force Majeure Event” and excuse or delay performance, or permit the cancellation of the contract.
Matters such as war, riots, invasion, famine, civil commotion, extreme weather, floods, strikes, fire, and government action (i.e. serious intervening events that are outside the control of ordinary commercial counterparties) are typically included within the scope of Force Majeure Events.
The memo reviews how courts in the U.K., the U.S. & France have interpreted these clauses, and also discusses how common law doctrines of frustration and impossibility of performance may come into play in situations involving U.K. or U.S. contracts. It also touches on the right of parties to contracts entered into after October 1, 2016 under French civil law right to renegotiate those contracts based on a change in circumstances.
EU Blacklists The Cayman Islands & My Wife’s Book Club Gets Skunked
All this coronavirus stuff has made this morning’s blog pretty depressing, so I want to close on a lighter note. My wife is part of a neighborhood book club. Last week, it was hosted by a woman who lives across the street. At one point in the evening, she let one of the family dogs – “Hank” – outside. Hank is a very good boy, but he’s about as smart as you’d think a dog named Hank might be. So, he quickly ended up on the losing end of an encounter with a skunk.
Being a dog, Hank promptly retreated back into the house, whereupon he shared his “Eau de Pepe le Pew” with all the book club members in attendance. Regrettably, all of those women, including my beloved, returned home to their spouses reeking of skunk. As the neighborhood Facebook page lit up with late night tips on how to launder skunk out of clothing, it dawned on me that I live in a sitcom.
It’s at times like these when I fantasize of escaping from my suburban Ohio sitcom life – this week’s episode written & directed by Larry David – to an exotic location like The Cayman Islands. So, it kind of bummed me out to learn that according to this Debevoise memo, the EU just added my fantasy island to its “tax blacklist.” The memo discusses the implications of this action, which are most relevant for investment funds.
Okay, so that’s probably not real relevant to most of you, but I was just looking for an excuse to tell you about the skunking of the Wyndgate Farms book club. Have a good day, everybody!
Well, it didn’t take long for the Division of Enforcement to focus everybody’s attention on the SEC’s recent guidance on the use of key performance indicators in MD&A, did it? This Fried Frank memo focuses on how that guidance may influence the use of ESG metrics in MD&A. While the guidance itself only references ESG metrics in a footnote, this excerpt says that what it had to say about them is consistent with recommendations of some well-known sustainability frameworks:
Although the Metrics Guidance is largely silent with respect to ESG metrics as a specific category, it does note that some companies “voluntarily disclose environmental metrics, including metrics regarding the observed effect of prior events on their operations.” In a footnote, the Metrics Guidance provides examples of metrics to which the guidance is intended to apply, which include a number of ESG metrics, such as total energy consumed, percentage breakdown of workforce, voluntary and/or involuntary employee turnover rate and data security breaches.
While the Metrics Guidance addresses ESG metrics only via footnote, it is consistent with the recommendations in certain voluntary sustainability frameworks that require both qualitative and quantitative disclosure associated with ESG metrics. For example, SASB’s Conceptual Framework notes that sustainability metrics should be accompanied by “a narrative description of any material factors necessary to ensure completeness, accuracy, and comparability of the data reported.”
In addition, the TCFD recommendations note that reporting companies should provide metrics on climate-related risks for historical periods to allow for trend analysis and, where not apparent, should provide a description of the methodologies used to calculate the climate metrics. Similarly, both SASB and TCFD emphasize the importance of having effective disclosure controls and governance, as well as verifying ESG data (by third-party auditors, if possible).
As the memo also points out, many companies have been criticized by stakeholders for using ESG metrics that aren’t “easily comparable, decision-useful, and verifiable.” The new guidance on MD&A key performance indicators heightens the stakes for these ESG disclosures, and companies that don’t respond appropriately may face a bigger downside than complaints about “greenwashing.”
ESG: Building Value Through Good Disclosure
This Latham memo says that companies have an opportunity to build value through their ESG initiatives & disclosure. The memo says that clear and transparent ESG disclosures can “build trust and demonstrate the company’s thoughtful management of ESG risks and opportunities.” This excerpt offers some specific suggestions for preparing ESG disclosures:
– Companies should take steps to ensure the consistency of disclosures in financial and sustainability reports.
– Even if information is included in the sustainability report, ESG information should be included in financial reports if material and called for by the regulations underpinning the disclosure documents.
– Information disclosed in sustainability reports is subject to the antifraud provisions of the securities laws even if not filed with the SEC. The information in companies’ sustainability reports should be scrutinized and verified to ensure its accuracy and completeness as if it were filed with the SEC.
– Companies should explain the importance of the ESG factors in their disclosures to help the reader to understand why the information is meaningful to the company and how it fits within the company’s strategy.
In today’s environment, I don’t think companies that want to address their ESG performance have any alternative to real transparency. The audience for ESG disclosures is increasingly sophisticated & extremely skeptical, so the historically preferred alternative of having the marketing department “put lipstick on the pig” when it comes to describing corporate ESG performance is likely to get you clobbered.
Transcript: “Conflict Minerals – Tackling Your Next Form SD”
We have posted the transcript for our recent webcast: “Conflict Minerals – Tackling Your Next Form SD.”
Last month, I blogged about the first 10-K filing to include a coronavirus risk factor. As concerns about the virus’s economic impact have continued to grow, a total of 26 companies have included a risk factor or, in some cases, MD&A disclosure about the virus in their 10-K filings. This Audit Analytics blog reviews those disclosures. Here’s an excerpt:
While the economic effects of the Wuhan coronavirus are still unknown, it makes sense that the majority of references to the disease have been included in the Risk Factors section of a company’s 10-K. Most of the language seen thus far discusses the uncertainty of the disease’s effects on global macroeconomic conditions, production capabilities, and decreases in international travel; this is similar language used surrounding other risk factors such as political unrest, natural disasters, and terrorism.
However, some companies have discussed the impact of the coronavirus in the Management’s Discussion & Analysis (MD&A) section of the 10-K, indicating that some companies expect to experience significant effects. For example, Carnival Corp [CCL] disclosed in their MD&A that the travel restrictions as a result of the outbreak could have a material impact on financial performance:
Fiscal Year 2020 Coronavirus Risk
In response to the ongoing coronavirus outbreak, China has implemented travel restrictions. As a result, we have suspended cruise operations from Chinese ports between January 25th and February 4th, canceling nine cruises. We also expect that travel restrictions will result in cancellations from Chinese fly-cruise guests booked on cruises embarking in ports outside China… If the travel restrictions in China continue until the end of February, we estimate that this will further impact our financial performance by an additional $0.05 to $0.06 per share… If these travel restrictions continue for an extended period of time, they could have a material impact on our financial performance.
Other companies that have mentioned coronavirus in the MD&A section include Mondelez International, Inc. [MDLZ], Mettler-Toledo International, Inc. [MTD], and Las Vegas Sands Corp. [LVS].
If you’re looking for disclosure precedent (who isn’t?), the blog names all 26 companies that have included 10-K disclosure about the coronavirus to date. And to demonstrate that there’s nothing new under the sun, the blog also includes a chart with the number of companies that included 10-K disclosure about other recent international public health emergencies.
Board Recruitment: Want Diverse Candidates? Climb Down the Org Chart
This Bloomberg BusinessWeek article says that companies looking to enhance the gender diversity of their boards would be wise to look further down the org chart than has traditionally been the case when looking for potential directors. That’s because while many big companies are reining in CEO participation in outside boards, some are actively encouraging less senior execs to obtain board positions:
Outside corporate board gigs are a classic perk of being a chief executive officer. The side jobs offer extra pay, as well as a way to network—perhaps for the next big job. But all those top bosses filling up directors’ seats has a predictable effect. Since CEOs are an overwhelmingly white, male bunch, they tend to reinforce the lack of diversity on corporate boards.
That makes a push by Marriott International Inc. to get lower-level executives to join boards a bigger deal than it might seem. CEO Arne Sorenson says his aim is to give the hotel company’s rising stars valuable experience. Incidentally, though, of the five who have found board positions, three are women and one is a black man. The same trend is showing up at other large U.S. companies. Among the 10 companies with the most employees serving on other boards, the executives with directorships are overwhelmingly women or people of color, according to data compiled by Bloomberg.
The article points out that while Marriott’s effort to promote board participation doesn’t have a diversity goal, executives who aren’t white males are more in demand for board slots.
Transcript: “Cybersecurity Due Diligence in M&A”
We have posted the transcript for our recent DealLawyers.com webcast: “Cybersecurity Due Diligence in M&A.”
A recent paper from Stanford’s Rock Center notes that while most insider trading policies are designed to prevent violations of law, companies need to ask whether their existing insider trading policies need to cover more ground in order to be consistent with good governance practices. Here’s an excerpt:
Despite procedures designed to ensure compliance with applicable rules, news media and the public tend to be suspicious of large-scale executive stock sales.7 This is particularly the case when a sale occurs prior to significant negative news that drives down the stock price.
Public suspicion is exacerbated by inconsistent and nontransparent corporate practices—such as, lack of communication around why the sale was made, whether the general counsel approved the trade in advance, and whether the trade was the result of a 10b5-1 plan—and differing opinions about what constitutes “material” nonpublic information. Thus, an executive stock sale might pass the legal test but fail the “smell test” employed by the general public. A well-designed ITP lessens the likelihood of such a scenario.
The paper reviews 4 real-life vignettes involving insider transactions that, if not illegal, sure didn’t look very good. It raises a number of governance issues, like why companies don’t always make their insider trading policies public, mandate the use of 10b5-1 plans by senior execs or require pre-approval of all trades by the general counsel?
Shareholder Proposals: Be Careful What You Wish For?
Carl Hagberg, who has probably forgotten more about the proxy voting and annual meeting process than most of us will ever know, recently submitted a comment letter on the SEC’s proposed changes to Rule 14a-8. In addition to some colorful language about the release itself – which he calls “ponderously long, dense and maddeningly-meandering” – he contends that the current system is working reasonably well. He also claims that the proposals don’t address the ability of shareholders to use “proxies” to make proposals on their behalf, which he views as the biggest problem under the current regime.
Your mileage may vary when it comes to Carl’s arguments, but you should definitely read his letter because he knows a lot about this stuff & his letter’s kind of fun. But regardless of whether you agree with his arguments, he raises a good point about the potential unintended consequences of the proposed changes:
My most important takeaway, however, from a “common sense perspective,” is to note yet another tried and true old-saw: “Beware of what you wish for.” I guarantee that higher hurdles, if enacted, will result in institutional investors casting way more Yes-Votes for shareholder proposals than they otherwise would – simply to give proponents a decent shot at a three-year trial-run in the polls.
Quick Poll: Your Take on The 14a-8 Proposals
Carl recognizes that not everybody will agree with his take, so he suggested that we take a poll of our readers. My response was “Why not?” And so, because polls are an easy third blog, here we go – please take part in this anonymous poll.
Well, we thought that the comment process for the SEC’s proposed proxy advisor regulations was going to be a free-for-all, and it hasn’t disappointed. Lynn blogged last week about some investor comments, but representatives of other constituencies also weighed in.
Insightful comments from advocates for the proposed rules include this letter from the Society for Corporate Governance, which, among other things, highlighted the reports of its members concerning the prevalence of errors in proxy advisor reports. Leading pro-regulation advocate Bernard Sharfman also submitted a comment letter analyzing the implications of the “collective action problem” in shareholder voting that he contends is central to understanding the need for proxy advisor regulation.
On the other side of the ledger, Glass Lewis weighed in with concerns about the paperwork burdens associated with both complying with the proposed rules & satisfying the conditions for exemptions from them. This Olshan letter on the rule’s potential implications for proxy contests is also worth checking out.
And if you’re looking for “fair & balanced,” then check out this debate on proxy advisor regulation between U of Chicago B-School Prof. Steven Kaplan & ValueEdge Advisors’ Nell Minow.
And The Ridiculous . . .
On the other hand, there’s also been some commentary on the proposed rules that can most charitably be described as propaganda. Take this video, for example. Among other things, it blames proxy advisory firms for submitting climate change, abortion, gun control & other shareholder proposals on their “ultra left wing political agenda.”
There are all sorts of agenda-driven shareholder proposals – and not just from the left. One of my beefs about the proxy advisor industry is that it’s set up to cater to the “shareholders good, management bad” worldview of the investors who subscribe to them. But dreaming up lefty shareholder proposals isn’t part of what proxy advisors do.
Proxy advisors are business to make money, and that means giving their customers what they want – and their customers want to have the last word at the companies in which they invest.
How Did Proxy Advisor Regulation Get to Be Left v. Right?
The fundamental sales pitch in the video is that proxy advisor regulation is a political, “liberals v. conservatives” issue. While the video gets a lot wrong, it appears to have that part right. With the exception of a few prominent Republicans associated with activist hedge funds, this really does seem to have devolved into a left v. right issue.
I guess the short answer to the question of why proxy advisor regulation became a political litmus test is that it’s America in 2020 and everything is polarized. But what’s kind of interesting to me is how the sides align in this particular debate. Think about it – how is it “conservative” to restrict how capital providers use their advisors? How is it “liberal” to champion an unfettered free market for capital providers who continue to insist that their interests trump those of other constituencies, like workers?
Maybe I’m just trying to justify my own idiosyncratic position on this issue. I consider myself slightly left-of-center on many issues, but I absolutely agree that proxy advisors should be regulated. I don’t know, but perhaps the cause of the odd “left v. right” split here is the governance paradigm that views corporations as analogous to nation-states, and the presumption among progressive types that since that’s the case, shareholder democracy is a moral imperative. From my perspective, that’s a highly debatable proposition.
My own view is that the separation of ownership from control that characterizes the Berle & Means corporation is a feature, not a bug. I think that control of the world’s largest business enterprises by corporate managers is fundamentally less dangerous to society than putting them in the hands of an ever smaller number of institutions holding an ever increasing share of the world’s wealth. Managers are just greedy, so their agenda is pretty transparent. I don’t feel the same way about the agenda of public pension funds & giant asset managers.
Audit Analytics recently took a look at the audit fees paid by S&P 500 companies – and to say that they vary widely is a huge understatement. The average audit fees paid by S&P 500 companies were $13.0 million in 2018. Median fees were $8.3 million, with the lower quartile cut-off at $4.6 million & the upper quartile cut-off at $14.7 million. But what’s really eye-popping is the fee range – audit fees paid by the S&P 500 ranged from $800,000 to $133.3 million.
That degree of variation in audit fees is interesting, but so is this nugget about non-audit fees:
Roughly 9.5% of S&P 500 companies had non-audit fees greater than 25% of total fees in 2018. While high non-audit fees exclusively are not a red flag, they can serve as an indicator for investors and other users of financial statements to review what factors are contributing to the fees in each disclosed fee category and potentially look closer at services that have been characterized as non-audit work.
As Audit Analytics notes, the size of non-audit fees that auditors receive may raise concerns. Here’s an excerpt from this NYT article on the topic:
Most recently, the Securities and Exchange Commission issued a statement cautioning accounting firms on the provision of consulting services to their auditing clients. The commission, which did not challenge any specific services in its June 15 “interpretive release,” said its purpose was “to reinforce the sensitivity of corporate‐audit committees and corporate managers as well as accounting firms to the need for preserving independent audits.” Apparently, the commission is concerned because it fears that an accounting firm’s interest in keeping — or obtaining — a company as a consulting client may erode the auditor’s independence.
I guess I probably should have mentioned that this NYT article was published in 1979. The rules are tighter now – but after more than 40 years, it seems like the music may have changed but the song remains the same.
Proxy Access: Adopted Widely, Used Only Once
Sidley recently issued a 5-year review of proxy access developments. In addition to tracking the adoption of proxy access bylaws, the review also addresses a variety of other topics, including management & shareholder proxy access proposals, typical proxy access provisions, and proxy advisor policies on proxy access.
While noting that proxy access bylaws have been adopted by 76% of the S&P 500 and a majority of the Russell 1000, the memo also notes that such bylaws have actually been used only once. Here’s an excerpt with the details:
In 2019, for the first and only time, a shareholder included a director nominee in the proxy materials of a U.S. company pursuant to a proxy access right. In December 2018, The Austin Trust dated January 1, 2006 (with Steven Colmar as trustee) with ownership of approximately 3.8% of the common stock of The Joint Corp. filed a Schedule 14N seeking to use proxy access to nominate a director at the company’s 2019 annual meeting.
The Joint Corp. had adopted proxy access in August 2018 on standard terms after a shareholder proposal to adopt proxy access submitted by Colmar was approved (with 96% support) at the company’s annual meeting in June 2018. (The board of directors had not made a recommendation for or against the proposal.)
Both the board of directors and ISS ultimately recommended that stockholders vote for the proxy access nominee, and he was elected at the company’s May 2019 annual meeting with more than 99% support.
Tomorrow’s Webcast: Tying ‘ESG’ to Executive Pay”
Join us tomorrow for the CompensationStandards.com webcast – “Tying ‘ESG’ to Executive Pay” – to hear Aon’s Dave Eaton, Mercer’s Peter Schloth, Southern’s James Garvie, and Willis Towers Watson’s Steve Seelig discuss how to handle the growing demands – and challenges – to including ESG metrics in executive compensation plans.
With D&O insurance premiums on the rise & more Section 11 suits being filed in plaintiff-friendly state courts, IPO companies and their directors & officers face an increasingly hostile environment. This Wilson Sonsini memo points out that for some companies, a direct listing may provide a practical solution for avoiding Section 11 liability by making it impossible to satisfy the statutory requirement to trace the shares purchased to those sold in the offering. This excerpt explains why:
In a direct listing, no shares are sold by the company and therefore no capital is raised. Rather, a company files a registration statement solely to provide certain of its existing shareholders, such as early stage investors and employees, the ability to resell their shares directly to the public.
The existing shareholders include both those whose shares are registered pursuant to the company’s registration statement and those whose shares are exempt from the registration requirements of the securities laws. The shareholders have complete discretion about whether to sell their shares and all are equally able to sell shares upon the company’s direct listing – i.e., starting from the moment of the opening bell.
There are no initial allocations: any prospective purchaser can place orders with their broker of choice. Because both registered and unregistered shares are available for sale upon the company’s direct listing and the sales are conducted through anonymizing brokerage transactions, it is not possible for any purchaser to trace the particular shares she bought back to the registration statement covering the direct listing. Accordingly, no purchasers have standing to assert an offering claim under the ’33 Act.
Before we all get too carried away, the memo also points out that this is a fix that only works for those few cash-rich unicorns that don’t need to raise capital in an IPO. But the memo says there’s another potential fix that could work for the rest of the pack – with a little cooperation from their underwriters. How? Just tweak the shareholder lockups to allow some shares to be sold into the market in exempt transactions simultaneously with the IPO. That would also make tracing of shares to the IPO impossible. Well, at least until Blockchain ruins things for everybody. . .
Compliance Officers: NYC Bar Says It’s Time to Turn Down the Heat
As a former junior high school football coaching super-genius, I know I would’ve done things differently in the 4th quarter of the Super Bowl if I were coaching the 49ers instead of Kyle Shanahan. While “Monday Morning QBs” like me are merely obnoxious bores, Matt Kelly recently blogged about an NYC Bar Association report that says our regulatory counterparts cause big problems for corporate compliance officers:
The New York City Bar Association released a report on Tuesday warning that compliance officer liability continues to be a worrisome part of regulatory enforcement, and called for more guidance about when a compliance officer’s conduct can leave him or her in regulators’ crosshairs.
The report focused on compliance officers working in financial services firms, although compliance officers from any industry will appreciate the points raised. Its chief complaint is that compliance officers fear growing personal liability for failures of their firm’s compliance program, when those failures might be more due to insufficient budgets, weakly structured compliance roles, or management that just doesn’t care much about the importance of a strong compliance function.
The report also complained that enforcement actions against compliance officers suffer from hindsight bias. That is, compliance officers are supposed to implement programs “reasonably designed” to prevent violations, but you can’t really assess the quality of that effort until a violation has actually happened — which creates the risk that what seemed reasonable at the time will look unreasonable after something has gone wrong.
The report recommends that regulators take a number of actions designed to provide greater clarity to compliance officers concerning what’s expected of them, and Matt’s blog also notes that some heavy hitters in the financial services industry have endorsed the report’s recommendations.
ESG Investing: It’s a Woman’s World – And It May Stay That Way
This Fortune article says that while men dominate most areas of finance & investing, socially responsible investing is a field where women are clearly in command:
It was the usual setup for panelists at a finance conference talking about making smart investments. They were all the same gender. In this case, all women. That probably wasn’t surprising, considering the event was hosted by the United Nations-backed Principles for Responsible Investment. Still, Karine Hirn, founding partner at East Capital in Hong Kong, watched in admiration. She celebrated on Twitter: “Climate finance is at last opening up perspectives for great talent within the otherwise very unbalanced world of finance.”
Men rule that world, except for one key field: the fast-growing arena of what’s known by the shorthand ESG. There’s big money pouring in, and there are big names promoting the idea of applying environmental, social and governance standards to the business of making money.
As more money has been poured in to ESG investments, the field has attracted more men – but women may have a key advantage here: a substantial installed base of talent. Companies are fighting for ESG investing talent, and that battle favors those who’ve been involved for years – many of whom are women.
Yesterday, the SEC voted to propose significant changes to the financial disclosure provisions of Regulation S-K. The changes are intended to eliminate duplicative disclosures & modernize and enhance MD&A disclosures while simplifying compliance efforts. Here’s the 196-page proposing release. This excerpt from the SEC’s press release summarizes the proposed rule changes:
The proposed amendments would eliminate Item 301 (selected financial data) and Item 302 (supplementary financial data), and amend Item 303 (management’s discussion and analysis). The proposed amendments are intended to modernize, simplify, and enhance the financial disclosure requirements by reducing duplicative disclosure and focusing on material information in order to improve these disclosures for investors and simplify compliance efforts for registrants.
Among other things, the proposed amendments to Item 303 would:
– Add a new Item 303(a), Objective, to state the principal objectives of MD&A;
– Replace Item 303(a)(4), Off-balance sheet arrangements, with a principles-based instruction to prompt registrants to discuss off-balance sheet arrangements in the broader context of MD&A;
– Eliminate Item 303(a)(5), Tabular disclosure of contractual obligations given the overlap with information required in the financial statements and to promote the principles-based nature of MD&A;
– Add a new disclosure requirement to Item 303, Critical accounting estimates, to clarify and codify existing Commission guidance in this area; and
– Revise the interim MD&A requirement in Item 303(b) to provide flexibility by allowing companies to compare their most recently completed quarter to either the corresponding quarter of the prior year (as is currently required) or to the immediately preceding quarter.
Yesterday’s vote was another divisive one. Commissioner Allison Herren Lee issued a dissenting statement criticizing the proposal for ignoring “the elephant in the room” – climate change disclosure. She observed that in all of the SEC’s efforts to modernize Reg S-K in recent years, it has not once mentioned climate change or its relevance to these disclosures.
SEC Chair Jay Clayton issued his own lengthy statement in which he addressed, among other things, the SEC’s ongoing efforts to get its arms around climate change & environmental disclosure issues. Meanwhile, the ever-quotable Commissioner Hester Peirce weighed-in with a statement in support of the proposal, in which she warned that due in part to the efforts of “an elite crowd pledging loudly to spend virtuously other people’s money, the concept of materiality is at risk of degradation” through its expansion to ESG & sustainability disclosures.
But Wait! There’s More! SEC Issues Guidance on MD&A Metrics
As if a revamp of S-K’s financial disclosures wasn’t enough, the SEC also issued this 7-page interpretive release providing guidance on disclosure of key performance metrics in MD&A. The guidance says that when companies disclose such metrics, they should also consider whether additional disclosures are necessary and gives examples of such disclosures. The guidance also cites the requirements in Exchange Act Rules 13a-15 and 15d-15 to maintain disclosure controls and procedures and advises companies to consider these requirements when disclosing metrics.
Risk Factors: Wuhan Coronavirus Outbreak
Jay Clayton also addressed the disclosure implications of the coronavirus outbreak in his statement on the S-K financial disclosure rule proposals. He noted the significant uncertainty surrounding the outbreak’s implications for businesses, but also observed that “how issuers plan for that uncertainty and how they choose to respond to events as they unfold can nevertheless be material to an investment decision.”
Speaking of that, Levi-Strauss filed its Form 10-K yesterday and it includes the first 10-K risk factor disclosure addressing the outbreak (see p. 19). Here’s an excerpt:
Disasters occurring at our or our vendors’ facilities also could impact our reputation and our consumers’ perception of our brands. Moreover, these types of events could negatively impact consumer spending in the impacted regions or depending upon the severity, globally, which could adversely impact our operating results. For example, in December 2019, a strain of coronavirus was reported to have surfaced in Wuhan, China, resulting in store closures and a decrease in consumer traffic in China. At this point, the extent to which the coronavirus may impact our results is uncertain.
