Yesterday, the SEC issued two controversial rule proposals that, if adopted, would significantly modify the proxy disclosure & solicitation process. There’s a lot to cover, so I’m going to do these one at a time. First, the SEC announced a rule proposal that would impose disclosure & other obligations on proxy advisors. The proposed rules would:
– Amend Exchange Act Rule 14a-1(l), which defines the terms “solicit” and “solicitation,” to specify the circumstances when a person who furnishes proxy voting advice will be deemed to be engaged in a solicitation subject to the proxy rules.
– Revise Rule 14a-2(b) to condition certain exemptions relied upon by proxy advisors on their compliance with three new requirements. In order to avoid complying with the full range of rules applicable to proxy solicitations, proxy advisors would have to disclose material conflicts of interest in their proxy voting advice, provide the company with an opportunity to review and comment on their advice before it is issued; and, if requested by the company, include in their voting advice a hyperlink directing the recipient of the advice to a written statement that sets forth the company’s position on the advice.
– Modify Rule 14a-9 to include examples of when failing to disclose certain information in the proxy voting advice could be considered misleading within the meaning of the rule.
The SEC was sharply divided on this proposal & its companion – both of which were approved by a 3-2 vote. Commissioner Jackson issued a statement on his decision to dissent from the proposal, which he characterized as limiting the ability of investors to “hold corporate insiders accountable.” Fellow Democratic Commissioner Allison Herren Lee issued a statement in which she said that both proposals would “suppress the exercise of shareholder rights.”
In contrast, Republican Commissioner Eliad Roisman issued his own statement in support of the proposal, which he said would help fiduciaries “receive more accurate, transparent, and complete information when they make their voting decisions.”
When Caesar crossed the Rubicon with his legions in 49 BC, he knew that he was taking a fateful step and reportedly exclaimed “Alea iacta est!” – “The die is cast!” Maybe I’m being a little dramatic, but it sure feels like there’s an element of that sentiment in the SEC’s action. While Commissioner Clayton issued a statement in which he stressed that the proposal is just that – a proposal – it seems inevitable that the regulatory ground is about to shift in a significant way.
But Wait! There’s More! SEC Proposes to Tighten Shareholder Proposal Thresholds
Because one highly controversial proposal wasn’t enough, the SEC also announced a rule proposal yesterday that would make it more difficult for shareholders to submit & resubmit proposals for inclusion in a company’s proxy statement. The rule proposal would, among other things:
– Amend Rule 14a-8(b) to replace the current $2,000/1% ownership for at least 1 year threshold with 3 alternative thresholds for submission: continuous ownership of at least $2,000 of the company’s securities for at least 3 years; at least $15,000 of the company’s securities for at least 2 years; or at least $25,000 of the company’s securities for at least 1 year.
– Amend Rule 14a-8(c) to apply the one-proposal rule to “each person” rather than “each shareholder,” which would effectively prohibit a shareholder-proponent from submitting one proposal in their own name and simultaneously submit another proposal in a representative capacity. Representatives would also be prohibited from submitting multiple proposals, even if the representative were to submit each proposal on behalf of different shareholders.
– Amend Rule 14a-8(i) to increase the current thresholds of 3%, 6% and 10% for resubmission of matters voted on once, twice or three or more times in the last five years to 5%, 15% and 25%, respectively. A new provision would also be added permitting exclusion of a proposal that’s received 25% approval on its most recent submission if it has been voted on 3 times in the last 5 years and both received less than 50% of the votes cast and experienced at least a 10% decline in support.
Other proposed changes to Rule 14a-8(b) would subject shareholders using representatives to enhanced documentation requirements with respect to the authority of those agents, and require shareholder-proponents to express a willingness to meet with the company and provide contact & availability information.
I’ve already noted the reaction of individual SEC commissioners to these two proposals, but outside commenters had plenty to say as well. For instance, the CII decried the proposals as apparently “intended to limit shareholders’ voice at public companies in which they invest,” while the U.S. Chamber of Commerce hailed them for ensuring that “investors will have access to transparent and unconflicted proxy advice as well as improv[ing] the proxy submission process.”
Audit Reports: New CAM Disclosure Req’t Shines Light on Material Weakness
Check out this recent “FEI Daily” commentary on the impact of the new CAM disclosure requirement on one company:
In a stark example of how the new “critical audit matters” (CAM) rule is training a spotlight on companies’ internal controls, Stitch Fix Inc. is expanding its internal information-technology controls after identifying weaknesses in how the online service reported financial performance. The issue, related to outsourced information-technology service providers, was flagged by the San Francisco company’s independent auditor in October. The Public Company Accounting Oversight Board began requiring independent auditors to disclose significant challenges in reviewing public companies’ financial statements under the CAM rule this year.
– Excluded Shareholder Proposals. Some of the most notable policy changes respond to the SEC’s recent guidance on the shareholder proposal no-action process. Glass Lewis now says that if the SEC declines to state a view on whether a shareholder proposal should be excluded, then it will likely recommend that shareholders vote against the members of the governance committee unless that proposal appears in the proxy statement.
If the SEC verbally permits a company to exclude a proposal and doesn’t provide a written record, Glass Lewis says that the company will have to provide some disclosure about the no-action position. Companies that don’t provide this disclosure will also face a negative recommendation on the members of their governance committee.
– Committee Performance & Disclosure. Several revisions relate to the codification of circumstances under which Glass Lewis will recommend against chairs of the audit, governance, and comp committees. Audit committee chairs will earn a thumbs down if fees paid to the company’s external auditor aren’t disclosed.
Governance committee chairs will get dinged when either director attendance information isn’t disclosed or when a director attended less than 75% of board and committee meetings and the proxy doesn’t provide enough details as to why. Comp committee chairs will earn Glass Lewis’s wrath if they adopt a time period for holding a “say-on-pay” vote that differs from the one approved by shareholders.
– Exclusive Forum Bylaws & Supermajority Provisions. Glass Lewis has tweaked its guidelines to clarify that it may not recommend against the governance committee chair in situations where it determines that an exclusive forum bylaw has been “narrowly crafted to suit the unique circumstances facing the company.” Glass Lewis has also codified its position that it will recommend voting against proposals to eliminate supermajority provisions at controlled companies, because these protect minority shareholders.
– Gender Pay Equity. Glass Lewis clarified that it will review on a case-by-case basis proposals that request that companies disclose their median gender pay ratios. It will generally vote against those proposals if the company has provided sufficient information concerning its diversity initiatives & concerning how it is ensuring that women and men are paid equally for equal work.
Other changes include defining situations where Glass Lewis reports on post-fiscal year end compensation decisions & setting expectations for disclosure of mid-year adjustments to short-term incentive plans. Glass Lewis also says that it has “enhanced” its discussion of excessively broad “change in control” provisions in employment agreements.
Whistleblowers: SEC Enforcement Says Protections Aren’t Just for Employees
Typically, when we think about whistleblowers, most of us probably picture disgruntled current or former company employees. Yesterday, the SEC’s Division of Enforcement provided a reminder that while that’s often the case, others can qualify as whistleblowers too. As this excerpt from the SEC’s press release announcing enforcement proceedings against Collector’s Café & its CEO demonstrates, investors are also eligible for protection as whistleblowers:
The Securities and Exchange Commission today filed an amended complaint against online auction portal Collectors Café and its CEO Mykalai Kontilai to add allegations that they unlawfully sought to prohibit their investors from reporting misconduct to the SEC and other governmental agencies. The SEC previously charged Collectors Café and Kontilai with a fraudulent $23 million securities offering based on false statements to investors, and alleged that Kontilai misappropriated over $6 million of investor proceeds.
The SEC had previously brought securities fraud charges against the defendants, and its amended complaint alleges that the defendants tried to resolve investor allegations of wrongdoing by conditioning the return of their money on agreements barring investors from dropping a dime on them to law enforcement, including the SEC.
The SEC’s complaint alleges that this conduct violated the SEC’s whistleblower protection rules – and just to make absolutely certain that they waived a red flag in front of the SEC bull, the complaint alleges that these defendants sued two investors that it believed breached one of these agreements.
Non-GAAP: Is It a Non-GAAP Number or Something Else?
Here’s a really helpful SEC Institute blog that reviews the sometimes murky distinction between non-GAAP financial measures subject to Reg G’s requirements & operating measures that are outside the scope of the rule. It also provides some guidance as to how to go about determining what category a particular metric falls into.
The SCOTUS’s 2017 Kokesh decision limited the SEC’s ability to use one of its favorite enforcement remedies when the Court unanimously held that SEC disgorgement claims were subject to a 5-year statute of limitations. Now, this Reuters article says that the SCOTUS has agreed to hear a new case that could remove disgorgement entirely from the SEC’s arsenal. Here’s an excerpt:
The U.S. Supreme Court on Friday agreed to hear a challenge to the ability of the Securities and Exchange Commission to recover ill-gotten profits obtained through misconduct in a case from California that could weaken the agency’s enforcement power.
The nine justices agreed to hear an appeal by California couple Charles Liu and Xin Wang contesting a 2016 civil action brought against them by the SEC. The SEC won a court ruling in 2017 requiring Liu and Wang to disgorge almost $27 million, the same amount they raised from foreign investors to build a never-completed cancer treatment center.
Part of the SEC’s civil enforcement arsenal, disgorgement requires defendants to hand over to the U.S. government money obtained from a fraudulent scheme. The SEC has said it generally passes on disgorged funds to the original investors although it was not required to do so in this particular instance. In fiscal year 2018, the agency returned $794 million to harmed investors.
Whether the SEC actually has the ability to seek disgorgement is an issue that the Kokesh Court specifically raised in footnote 3 of Justice Sotomayor’s opinion:
Nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context. The sole question presented in this case is whether disgorgement, as applied in SEC enforcement actions, is subject to § 2462’s limitations period.
It looks like the SCOTUS’s invitation to litigate this issue has been accepted. Here’s the cert petition & the Court’s order granting it. A decision in the case is expected by June 2020.
Boardroom Diversity: Where Do African-Americans Stand?
Efforts to enhance board diversity in recent years have focused primarily on increasing the number of women who serve as directors. Those efforts have slowly paid off and women now are represented on every S&P 500 board. But this Black Enterprise article says that African-Americans still have a long way to go when it comes to boardroom representation:
There are 322 black corporate directors at 307 companies versus 308 at 316 corporations last year. Our editorial research team also discovered that 187 S&P 500 companies or 37%, did not have a single black board member in 2019—a 2 percentage point improvement from 2018.
Boardroom Diversity: Progress on Racial Diversity Impeded by Slow Turnover
The news isn’t all bad when it comes to the inclusion of African-American & other minority board members. Spencer-Stuart’s 2019 Board Index says that progress on racial & ethnic diversity is being made – but that slow turnover is impeding that progress. Here’s an excerpt:
Boards are also focused on racial/ethnic diversity. Just under one in four new S&P 500 directors (23%) are minorities (defined as African-American/Black, Asian or Hispanic/Latino). Minority women represent 10% of the incoming class, up slightly from 9% last year. Minority men represent 13% of the new directors, an increase from 10% last year but still down from 14% two years ago.
While women and minority men constitute more than half of the new directors, continued low boardroom turnover remains a persistent impediment to meaningful year-over-year change in the overall composition of S&P 500 boards. As a result, in spite of the record number of female directors, representation of women increased incrementally to 26% of all directors, up from 24% in 2018 and 16% in 2009.
The report says that “slight” progress is being made in minority representation at the top 200 S&P 500 companies. Today, 19% of all directors of the top 200 companies are male or female minorities, up from 17% last year and 15% in 2009.
Section 404 of the Sarbanes-Oxley Act requires companies to review their internal control over financial reporting and report whether or not it is effective. Non-accelerated filers are required to provide management’s assessment of the effectiveness of their ICFR, while larger companies are required to accompany that assessment with an attestation from their outside auditors.
As it does every year, Audit Analytics took a look at the most recent round of negative auditor attestations & management-only assessments of ICFR. This recent blog reviews the results of the past 15 years of experience under SOX 404, and makes several interesting observations:
– Negative auditor attestations bottomed out in 2010 at 3.5% of filings. They rose fairly steadily and peaked at 6.7% in 2016. After declining to 5.2% in 2017, they rose again last year to 6.0% of filings.
– Negative management-only assessments peaked at a whopping 40.9% of filings in 2014, and have remained at or slightly below the 40% level since that time. In 2018, they declined slightly to 39.6% of filings.
The top reasons for negative audit attestations in 2018 were material or numerous year-end adjustments, shortcomings in accounting personnel, IT & security issues, inadequate segregation of duties and inadequate disclosure controls. Many of these same issues resulted in negative management-only assessments, although accounting personnel issues topped the list here. One item that made the top five reasons for negative management-only assessments that didn’t make the audit attestation list was an ineffective, understaffed, or non-existent audit committee.
Canada Heading for Mandatory “Say-on-Pay-Eh”?
Okay, that title is a very lame Canadian joke, but if you were made to look like a fool on a hockey rink by your Canadian pals as frequently as I am, you’d be looking for a little payback too. Anyway, according to this Blakes memo, recent amendments to the Canada Business Corporation Act may result in a mandatory “say-on-pay” regime for federally chartered Canadian public companies.
Details are in the memo, but what’s more interesting to me is that the memo points out that say-on-pay has already become pretty widespread in Canada among larger cap companies on a purely voluntary basis:
Shareholder Say-on-Pay advisory votes on the compensation practices of public companies in Canada started in 2010 when the major Canadian banks gave their shareholders an advisory Say-on-Pay vote. By 2011, 71 reporting issuers in Canada had adopted Say-on-Pay advisory votes, representing approximately 7% of Canadian listed issuers by number, excluding structured-product issuers and non-listed issuers.
That number has steadily grown each year, such that a total of 220 companies in Canada have now adopted an annual Say-on-Pay advisory vote, including more than 71% of companies in the TSX Composite Index and 52 of the TSX60 Index companies. The adoption of this practice has been completely voluntary thus far, in many cases in response to pressure from institutional investor groups, such as the Canadian Coalition for Good Governance (CCGG), or non-binding votes on shareholder proposals.
Board Elections Less Cozy? Yeah, But Let’s Not Get Carried Away . . .
A recent WSJ headline breathlessly announced that 478 directors failed to get a majority vote this year – and that’s up 39% since 2015. Okay, fair enough – but this Hunton Andrews Kurth memo analyzing the study upon which the WSJ article was based notes that it’s still exceedingly rare for a director to get less than a majority of the votes cast:
How often do directors fail to receive majority support when they stand for reelection? The answer is not often. According to a recent report, however, director “against/withhold” votes are on the rise even though they remain rare. In 2019, 478 directors failed to receive majority support—a small number, but up 38% from 2015. Likewise, the number of directors failing to receive at least 70% support for reelection increased 45% from 2015 to 2019. Overall average shareholder support for directors last year was 95% (votes cast).
The memo breaks down some of the study’s data, and notes that it’s rare for directors to receive less than 70% support – but that data indicates that institutional investors have become more willing to withhold votes from directors in uncontested elections.
– Rule 14a-8(i)(7)’s “ordinary business” exclusion, the role that the board’s analyses of why the policy issues involved in a proposal are not significant plays in the Staff’s consideration of a no-action request, and the board analyses that the Staff has found – and not found – to be persuasive.
– The factors considered in determining whether a proposal may be excluded under Rule 14a-8(i)(7) on the basis that it would involve “micromanagement” of the company, including circumstances that may result in even precatory proposals being deemed to raise micromanagement issues.
In addition, the SLB sets forth the Staff’s view that companies should refrain from an “overly technical” reading of proof of ownership letters in a effort to avoid including a proposal. In particular, the SLB points out that the Staff has not required proponents to adhere strictly to the suggested format for those letters contained in Staff Legal Bulletin 14F in order to avoid having their proposals excluded under Rule 14a-8(b).
Hey, remember those whistleblower proposals I blogged about yesterday? The SEC also announced that it has scheduled an open meeting on October 23rd to consider adopting the proposed amendments. Based on the SEC’s recent track record when it comes to cancelling open meetings, I sure wouldn’t recommend buying non-refundable tickets if you’re planning to head in to DC to attend.
Naming Audit Partners: No Audit Quality Impact?
Several years ago, the PCAOB adopted a rule requiring the public identification of the audit firm’s engagement partner on each public company audit. This rule went into effect for audit reports issued after January 31, 2017. It was intended to promote improved audit quality by enhancing auditor accountability. But according to this MarketWatch.com article, so far, there’s no evidence that it’s moved the needle on that front, but there’s at least some evidence that investors are using the information as a screening tool. Here’s an excerpt:
One of those new studies found that despite slightly positive trends in audit quality, the improvement is not yet convincingly attributable to the adoption of the audit partner-naming rule. That research, entitled “What’s in a Name? Initial Evidence of U.S. Audit Partner Identification Using Difference-in-Differences Analyses,” by Lauren M. Cunningham of the University of Tennessee, Chan Li of the University of Kansas, Sarah E. Stein of Virginia Tech, and Nicole S. Wright of James Madison University, is in the current issue of The Accounting Review, a peer-reviewed journal of the American Accounting Association.
The study by Cunningham and her colleagues also cites another ongoing study that finds investors are less likely to invest in a company when the partner is linked to another client with a restatement. Another working paper finds no evidence of significant trading activity in the days surrounding PCAOB Form AP disclosure, even in cases of a change in audit partner in the second year of mandatory disclosure.
Director Onboarding: Board Governance Guidebook
Clients frequently ask for resources to help new directors get up to speed on governance during the onboarding process – and this 12-page “Guidebook to Boardroom Governance Issues” that Wilson Sonsini has put together seems to fit the bill nicely. It covers a lot of ground in a concise & informative way. Check it out!
If you’re a public company director looking to put a real crimp in your future career prospects, it looks like adopting a poison pill is a pretty good way to do it. In a recent Business Law Prof blog, Akron U’s Stefan Padfield flagged a new study that says directors who vote to adopt a poison pill pay a significant price. Here’s the abstract:
We examine the labor market consequences for directors who adopt poison pills. Directors who become associated with pill adoption experience significant decreases in vote margins and increases in termination rates across all their directorships. They also experience a decrease in the likelihood of new board appointments. Firms have positive abnormal stock price reactions when pill-associated directors die or depart their boards, compared to zero abnormal returns for other directors.
Further tests indicate that these adverse consequences accrue primarily to directors involved in the adoption of pills at seasoned firms and not at young firms. We conclude that directors who become associated with poison pill adoption suffer a decrease in the value of their services, and that the director labor market thus plays an important role in firms’ governance.
The study suggests that the absence of any adverse effect on directors who put pills in place at emerging companies may reflect the market’s perception that takeover defenses are positive for young firms and negative for more seasoned ones.
PCAOB: Board Seat Drama Culminates in SEC Shake-Up
Last month, Broc blogged about the controversy over Kathleen Hamm’s seat on the board of the PCAOB. To make a long story short, Hamm wanted to be reappointed to the Board, but according to this article by MarketWatch.com’s Francine McKenna, the SEC seemed to have other ideas. Last week, the CII sent a letter to the SEC citing Francine’s article & endorsing Hamm’s reappointment.
The plot thickened late Friday afternoon when the SEC issued a press release announcing that Hamm would leave the PCAOB board when her current term expires. That was followed by another release announcing that White House staffer Rebekah Goshorn Jurata would take Hamm’s place on the board.
If the replacement of the reportedly “Democrat-aligned” Hamm with a Trump Administration insider wasn’t enough to raise eyebrows, the SEC’s second press release went on to announce that Commissioner Hester Peirce – who is, to say the least, not a fan of Section 404 of the Sarbanes-Oxley Act – would “lead the Commission’s coordination efforts with the Board of the PCAOB.”
Any hopes that releasing the news about the shake-up late on the Friday before a holiday weekend would limit media attention on the PCAOB were likely dashed yesterday when the WSJ published an article detailing a whistleblower’s allegations that the PCAOB’s work has been slowed by “board infighting, multiple senior staff departures, and allegations that the chairman has created a “’sense of fear.'”
Whistleblowers: Big Changes in SEC’s Program On the Way?
According to this recent AP report, the SEC is quietly moving toward adopting some potentially significant changes in its whistleblower program. Here’s an excerpt:
The proposal would give the SEC discretion to set the smallest and largest cash awards to whistleblowers, among other changes. Critics say that change would likely discourage employees from reporting major frauds by lowering the chances of a huge payout. The payment for successful cases is now 10% to 30% of fines or restitution collected by the agency — which means the bigger the fraud, the larger the bounty.
The SEC also wants to impose new requirements for filing a whistleblower complaint. To receive legal protection from the SEC against retaliation — a core concern for people risking their careers and livelihoods — a whistleblower would have to report violations in writing, rather than the oral disclosures now permitted at the SEC and other federal agencies.
Liz blogged about the proposal to amend the whistleblower rules when the SEC initially made it in June 2018, but now that it appears to be close to adoption, it has prompted the usual reaction from the usual suspects. Whistleblower advocates contend the changes would have calamitous results, while the AP story quotes the U.S. Chamber of Commerce as saying that the proposal is a “small but nonetheless important step” toward improvement.
Last week, NYC Comptroller Scott Stringer announced an initiative calling for companies to adopt a corporate version of the NFL’s “Rooney Rule” in order to promote gender & ethnic diversity in the boardroom. Here’s an excerpt from the Comptroller’s press release:
At the annual Bureau of Asset Management (BAM) “Emerging and MWBE Manager” conference, New York City Comptroller Scott M. Stringer today launched the third stage of the groundbreaking Boardroom Accountability Project with a new first-in-the-nation initiative calling on companies to adopt a policy requiring the consideration of both women and people of color for every open board seat and for CEO appointments, a version of the “Rooney Rule” pioneered by the National Football League (NFL). The new initiative is the cornerstone of the Comptroller’s Boardroom Accountability Project, a campaign launched in 2014 which seeks to make boards more diverse, independent, and climate competent.
The Comptroller launched this initiative by sending a letter to 56 S&P 500 companies that do not currently have a Rooney Rule policy requesting them to implement one. The press release indicates that the Comptroller will file shareholder proposals at companies “with lack of apparent racial diversity at the highest levels.”
Since the Comptroller is pressing for a corporate Rooney Rule, I wondered if there was data on how the NFL’s Rooney Rule has played out in terms of promoting diversity. I came across this recent article from “TheUndefeated.com” which says that the results are a mixed bag. Minority candidates are getting more shots at head coaching positions, but the results suggest that they’re put in a position to succeed less frequently than white coaches, and that teams give them the axe more quickly. It’s also worth noting that, despite the Rooney Rule, 7 of the 8 head coaching vacancies in the NFL during the past offseason were filled by white dudes.
I have a problem with the methodology that the article applies to its Rooney Rule analysis. The Cleveland Browns’ hiring & firing of Romeo Crennel & Hue Jackson during the period were included in the sample, which I really think should’ve been limited to professional football teams. Besides, as we Cleveland fans are in the process of finding out once again this season, nobody can question the fact that the Browns are an equal opportunity pit of despair.
Conflict Minerals: GAO Says 2018 Reports Were More of the Same
The GAO recently completed its annual conflict minerals review as required by Dodd Frank. Here’s an excerpt from this GAO report highlighting its results:
Companies’ conflict minerals disclosures filed with the U.S. Securities and Exchange Commission (SEC) in 2018 were, in general, similar in number and content to disclosures filed in the prior 2 years. In 2018, 1,117 companies filed conflict minerals disclosures—about the same number as in 2017 and 2016. The percentage of companies that reported on their efforts to determine the source of minerals in their products through supply chain data collection (country-of-origin inquiries) was also similar to percentages in those 2 prior years.
As a result of the inquiries they conducted, an estimated 56 percent of the companies reported whether the conflict minerals in their products came from the Democratic Republic of the Congo (DRC) or any of the countries adjoining it—similar to the estimated 53 and 49 percent in the prior 2 years. The percentage of companies able to make such a determination significantly increased between 2014 and 2015, and has since leveled off.
Tomorrow’s Webcast: “Sustainability Reporting – Small & Mid-Cap Perspectives”
Tune in tomorrow for the webcast – “Sustainability Reporting: Small & Mid-Cap Perspectives” – to hear White & Case’s Maia Gez, Elm Sustainability Partners’ Lawrence Heim, Ballard Spahr’s Katayun Jaffari and Toro’s Angie Snavely discuss sustainability trends among small & mid-caps – and how companies with limited resources can get a sustainability initiative off the ground.
Yesterday, the SEC announced that it had adopted final rules permitting all companies to gauge market interest in a possible initial public offering or other registered securities offering to “test the waters” by reaching out to certain institutional investors before filing a registration statement. Previously, only EGCs had been able to engage in this activity under applicable provisions of the JOBS Act. Here’s an excerpt from the fact sheet included in the press release summarizing the rule:
Securities Act Rule 163B will permit any issuer, or any person authorized to act on its behalf, to engage in oral or written communications with potential investors that are, or are reasonably believed to be, QIBs or IAIs, either prior to or following the filing of a registration statement, to determine whether such investors might have an interest in a contemplated registered securities offering. The rule is non-exclusive and an issuer may rely on other Securities Act communications rules or exemptions when determining how, when, and what to communicate about a contemplated securities offering.
Under the rule:
– there are no filing or legending requirements;
– the communications are deemed “offers”; and
– issuers subject to Regulation FD will need to consider whether any information in a test-the-waters communication would trigger disclosure obligations under Regulation FD or whether an exemption under Regulation FD would apply.
In a public statement accompanying the announcement of the new rule, SEC Chair Jay Clayton said that it will allow issuers to “better identify information that is important to investors and enhance the ability to conduct a successful registered offering, ultimately providing both Main Street and institutional investors with more opportunities to invest in public companies that, in turn, provide ongoing disclosures to their investors.” The new rule will become effective 60 days after publication in the federal register.
Auditor Independence: Flurry of SEC & PCAOB Enforcement
Earlier this week, the Division of Enforcement announced a settled enforcement proceeding with PwC arising out of alleged violations of the SEC’s independence rules. PwC’s Mexican affiliate was also sanctioned for independence violations by the PCAOB in August. The SEC’s action against PwC comes on the heels of another settled proceeding late last month involving RSM US LLP. Earlier this month, the PCAOB sanctioned another two accounting firms for independence violations.
So, what’s with this recent spate of enforcement proceedings? It’s hard to say for sure, but this may have been coming for quite some time. Broc blogged last year that Lynn Turner reported that there was “trouble brewing” at the PCAOB & SEC over independence issues. The PCAOB apparently discovered a number of independence issues in its 2016 inspection reports, and noted that many of these were not reported to the audit committee as required under PCAOB rules.
Earlier this year, the PCAOB came out with additional guidance on what the rules require auditors to communicate to audit committees when they identify independence issues, and the failure to comply with independence disclosure requirements is at the heart of both the PCAOB & SEC enforcement proceedings involving PwC.
PCAOB: Board Laying Low in Wake of KPMG Scandal?
Speaking of the PCAOB, according to this article by MarketWatch.com’s Francine McKenna, the PCAOB continues to be in transition in the wake of the KPMG scandal – and its board has apparently decided to keep a very low profile, even if that appears to violate the PCAOB’s bylaws:
The PCAOB board is staying out of the public eye in 2019, in violation of bylaws established by the law that created the PCAOB, the Sarbanes-Oxley Act of 2002. The law requires the PCAOB to hold at least one public meeting of its governing board each calendar quarter. However, the PCAOB board has held no public meetings of its governing board since December 20, 2018.
MarketWatch asked the PCAOB to comment on its apparent lack of compliance with its bylaws regarding open board meetings. A PCAOB spokeswoman told MarketWatch, “Consistent with long-standing practice, the Board holds open meetings to take action on business such as standard-setting or voting on its budget and strategic plan. We expect to hold two open meetings in the coming months to address our 2020 budget and a proposed concept release related to our quality control standards.”
Even by current D.C. standards, the PCAOB’s response leaves much to be desired. It’s not a denial, and it isn’t even a “non-denial denial.” By the way, it isn’t just the board – the article says that the PCAOB’s two outside advisory groups haven’t met in 2019 either.
I have a friend who keeps trying to persuade me to buy a Tesla. He owns one, and I guess there’s some kind of bounty the company pays to Tesla owners who convince other people to pony up for their own E-Z-Go on steroids. I’ve told him he’s barking up the wrong tree. I’ve always driven a beater. My current ride is a 2012 Chevy Equinox with 140,000 miles on it. It goes through 2 quarts of oil a month and I’m still determined to keep it for at least another couple of years.
But I also confess that even if I was in the market for a new car, I just can’t see buying one from Elon Musk. The guy’s antics really rub me the wrong way. So it pains me to have to blog about him again – but I do. This time, Elon and his board have gotten themselves sideways with Tesla shareholders in the Delaware Chancery Court, and the issue isn’t his tweets, it’s his comp.
Last year, the Tesla board – and shareholders – signed-off on a pay deal that would provide Musk with a potentially gargantuan payout if its stock hit some very aggressive market cap & operational goals. How gargantuan? Try more than $50 billion. A shareholder subsequently filed a lawsuit against Musk and the Tesla board alleging that the comp award was a breach of fiduciary duty.
By way of background, the Chancery Court decided last year that Musk was a “controlling shareholder” of Tesla in an unrelated case, despite the fact that he owned only around 20% of the stock. So, for purposes of the motion to dismiss filed in this case, the parties treated him as if he was a controller. That complicates things considerably, because the default standard for reviewing for transactions between a company and its controlling shareholder – even comp decisions – is the demanding “entire fairness” standard and not the deferential business judgment rule.
Delaware has laid out a path to the business judgment rule for these transactions, but in his 40-page opinion denying the defendants’ motion to dismiss, Vice Chancellor Slights found that despite the approval of the comp award by Tesla’s shareholders, the process wasn’t good enough to allow this award to make the cut:
Had the Board ensured from the outset of “substantive economic negotiations” that both of Tesla’s qualified decision makers—an independent, fully functioning Compensation Committee and the minority stockholders—were able to engage in an informed review of the Award, followed by meaningful (i.e., otherwise uncoerced) approval, the Court’s reflexive suspicion of Musk’s coercive influence over the outcome would be abated. Business judgment deference at the pleadings stage would then be justified. Plaintiff has well pled, however, that the Board level review was not divorced from Musk’s influence. Entire fairness, therefore, must abide.
The Vice Chancellor held that the defendants were unable to establish that the award was entirely fair at the pleading stage, so he declined to dismiss the plaintiff’s breach of fiduciary duty & unjust enrichment claims. That probably means I’ll have to blog about Musk again at some point in the not-too-distant future. Lucky me.
SEC Settles Nissan Fraud Charges: Don’t Have the CEO Set Their Own Pay!
It’s been a big week for CEO compensation stories. Here’s something Liz blogged earlier this week on CompensationStandards.com: Wow. Broc & I have blogged a couple of times over the past year about the SEC’s Nissan investigation, which (among other reasons) is of interest because Nissan is a Japanese company, and also because of the bold efforts people took to conceal former CEO Carlos Ghosn’s pay.
Yesterday, the SEC announced that it settled Section 10(b)/Rule 10b-5 fraud charges with Nissan, Ghosn, and a former director/HR exec for omitting $140 worth of Ghosn’s compensation from Japanese securities filings – which were published in the US because the company’s securities trade as ADRs on the OTC – and which required information about executive pay. Allegedly, Ghosn went to all this effort to restructure & hide his pay because he was worried that people would criticize the amounts (pro tip: at least in the US, that’s a hint that you’re probably required to disclose the info).
Nissan is ponying up $15 million – while the individuals are getting off with civil fines of $1 million and $100k. Seems like a pretty good deal for those two, based on the allegations in the SEC’s complaint against them – e.g., Ghosn first brainstormed ways to conceal part of his pay by paying it through Nissan-related entities…when that didn’t work, he started entering into secret contracts with employees and executing backdated letters for LTIP awards, and decided that “postponing” pay (along with creative accounting) would get him around the disclosure obligations.
Initially, one problem here for the company might have been faulty internal controls. But according to the SEC’s complaint against the company, the fatal blow was that because Nissan had specifically delegated to Ghosn the authority to set individual pay arrangements – including his own! – he was acting within the scope of his employment when he intentionally misled investors, and the company was liable under the principles of respondeat superior. We can complain all we want about the burdensome listing rules here, but maybe they’re saving some companies from themselves…
Audit Reports: What Does Auditor Tenure Disclosure Look Like?
This Audit Analytics blog discusses the disclosures that accounting firms are including in their audit reports in response to the relatively new requirement to disclosure their tenure with a particular company. The blog says that although the PCAOB has provided guidance on determining & reporting tenure, “auditors have discretion regarding exactly what and how the information is disclosed, resulting in substantial variation in disclosures.”
Having reviewed the blog, I can assure you that auditors have used their discretion to ensure that all versions of tenure disclosure are extremely boring.
This Stinson blog highlights rule changes that could prompt a few tweaks to D&O questionnaires. Specifically, the blog notes that:
– Companies can now rely on Section 16 filings & written representations to determine whether an insider has delinquencies. As a result, companies may ask whether all required Section 16 reports have been filed on EDGAR instead of asking whether all of those reports have been provided to it.
– If Nasdaq’s proposed changes to the definition of the term “family member” are approved, Nasdaq-listed companies may want tweak the definition contained in their D&O questionnaires to reflect the changes.
The blog also urges companies to be cautious about eliminating references to Section 162(m) in D&O questionnaires for compensation committee members unless it’s clear that the committee isn’t required to administer any compensation arrangements under the transition rule.
Stinson’s blog is a reminder that although it may seem like proxy season just ended, it’s actually right around the corner. And to help you get ready, we’ve already scheduled our “Pat McGurn’s Forecast for 2020 Proxy Season” webcast for January 16th.
Today’s Open Commission Meeting: Cancelled
The SEC has cancelled the open meeting that it had previously scheduled for today to consider, among other things, adopting its “test the waters” for all proposal. No word on rescheduling yet.
I don’t know if this had anything to do with the decision to cancel the meeting, but all 5 Commissioners were grilled for several hours yesterday by the House Financial Services Committee. Committee Chair Maxine Waters (D – Cal.) opened the hearing with a statement that accused the SEC of “not fulfilling its mission as Wall Street’s cop.” No doubt a good time was had by all.
ESG: Investors Want Companies to Align with Paris Climate Goals
According to this Ceres press release, a group of 200 socially conscious institutional investors with more than $6.5 trillion in AUM sent a letter to 47 large public companies asking them to align their climate change lobbying activities with the Paris Agreement’s goal of limiting global temperature increase to less than 2° C and pursue efforts to hold it at 1.5° C.
The group’s letter doesn’t just address the lobbying activities of the individual companies – it also calls upon them to review those of any trade associations to which they belong and engage with the organization if its activities are inconsistent with the Paris Agreement’s goals. If companies are unable to persuade the association to modify its position, then the signatories ask that they “consider taking the steps necessary to disassociate your company from these policies.”
