Since 2002, the Nasdaq & NYSE definitions of “Family Member” have differed – and that’s caused more than a few headaches for anyone who has to prepare or complete a D&O questionnaire or analyze director independence. According to this notice published yesterday by the SEC, the discrepancies are all due to an oversight when Nasdaq paraphrased its definition 17 years ago – and now the exchange is proposing changes to Rule 5605(a)(2) that would essentially revert back to the old formulation.
If the revisions are approved, the Nasdaq definition will no longer include step-children – and there will also be a carve-out for domestic employees who share a director’s home. Of course, the board still has to make an affirmative determination that no relationship exists that would interfere with a director’s ability to exercise independent judgment, and those relationships can be considered as relevant factors. Comments are due in mid July.
On Monday, the SEC also published this notice of an immediately-effective Nasdaq rule change that adds a definition of “Derivative Securities” to the Rule 5615 corporate governance & IM-5620 annual meeting exemptions – and modifies & adds exemptions for issuers of only non-voting preferred securities & debt securities. Nasdaq noted that the proposed changes would substantially conform to the existing rules of NYSE Arca.
Board Leadership Structure: Governance Impact
Investors remain mixed in their view of whether companies should have an independent chair. In this “CLS Blue Sky Blog”, ISS Analytics examines the gap between board leadership practices in the US and the rest of the world – and the possible consequences. Here’s an excerpt:
In relation to board composition, board refreshment and gender diversity improve as independent leadership on the board increases. In addition, shareholder rights and responsiveness to shareholders also improve with increased board leadership.
On the compensation front, companies that lack board leadership tend to pay their CEO at a higher multiple compared to the CEOs of peer companies. However, pay equity within the C-Suite mainly correlates with whether the roles of Chair and CEO are combined. Combined CEO-Chairs tend to get paid more relative to the rest of their executive team regardless of whether there is a Lead Director on the board.
One of the next logical questions is, “Do these consequences ultimately impact company performance?” As you might expect from an academic paper entitled “Irrelevance of Governance Structure,” a couple of researchers say that “shareholder rights” might not matter.
Based on comparing “real world” outcomes to a constructed model of an efficient universe, they conclude that “the relationship between the allocation of control rights and firm performance is more complex than just holding conflicted managers accountable.” In the model, the governance structure was irrelevant when other factors were at play – e.g. shareholders having imperfect information or market power, and managers having meaningful career concerns.
Boards Around The World
Spencer Stuart has taken data from its well known “Board Indexes” (here’s the US version) and created this interactive tool to compare “average” board practices around the world. Topics include board composition, diversity, director pay and board assessments.
Recently, ISS ESG (the “responsible investment” arm of ISS) announced its annual ratings of ESG performance for companies across the globe. At first glance, things look good:
This year’s report finds the share of companies covered by ISS’ Corporate Rating and assessed as “good” or “excellent” (both assessments lead to Prime status) now stands at 20.4 percent, up from just over 17 percent in the previous year. This year’s report also shows that the group rated with medium or excellent performance (on a four-category scale of poor, medium, good or excellent) now includes more than 67.5 percent of covered companies in developed markets. This represents an all-time high over the 11-year history of the report. Similar patterns can be observed among companies in emerging markets, the report finds, albeit at a considerably lower level.
But the jury’s still out on whether companies are following through on the sustainability strategies that they’re touting. We’ve blogged that CSR statements might serve as the basis for plaintiffs’ claims – and the ISS ESG analysis confirms that these types of disputes are on the rise. Here’s an excerpt:
Meanwhile, Norm-Based Research, which identifies significant allegations against companies linked to the breach of established standards for responsible business conduct, saw a more than 40 percent rise in the number of reported controversies across all ESG topics. This exemplifies a growing misalignment of corporate practices with stakeholder expectations that are grounded in UN Global Compact and the OECD Guidelines for Multinational Enterprises.
At the close of 2018, failures to respect human rights and labour rights together accounted for the majority (56 percent) of significant controversies assessed under ISS ESG’s Norm-Based Research. Industries that are most exposed to controversies in the environmental area are Materials, Energy, and Utilities. On social matters, Materials is also leading, similarly followed by Energy and Capital Goods. The governance area sees most controversies within Banks, Capital Goods, and Pharmaceuticals & Biotechnology.
ESG Ratings: Making Sure They’re Accurate
This 19-page DFin paper points out that it’s increasingly important to understand your ESG ratings and correct any errors, because investors are using them to evaluate non-financial performance and compare your company to other investment alternatives (e.g. this blog says that the universe of “sustainable funds” grew by 50% last year – also see this WSJ article). In addition to outlining the issues that factor into ratings, DFin gives seven steps to ensure accurate scoring:
1. Learn about existing ESG ratings frameworks
2. Know your ESG scores
3. Compare yourself to your peers
4. Understand how the various ratings standards compare to one another
5. Attend to the raw data your company provides – the data comes from SEC filings, your website, blogs, social media, etc.
6. Supply information proactively
7. Sharpen your communications
ESG: Advantages for Small & Mid-Cap Companies
We’ve blogged (sometimes more than we’d like) about the growing interest in ESG topics – among institutional as well as retail shareholders, and even credit rating agencies. While most large cap companies are now publishing sustainability reports and incorporating ESG metrics into business decisions, many smaller companies are just beginning that journey.
This blog from Next Level Investor Relations explains how even thinly-staffed small & mid-cap companies can identify strategic & disclosure-based ESG improvements that can improve their business, make important customers happy, and enhance their access capital. Here’s an excerpt (also see this blog from the Governance & Accountability Institute addressing ROI for sustainability efforts):
As highlighted in recent Gartner supply chain research, “ESG has emerged as a source of growth & innovation strategy for supply chains, spurring better performance & mitigating supply chain risks.” So why develop the widget (or ESG disclosure) that nobody wants? What are your customers (and competitors) focusing on in their ESG/Sustainability disclosure and supplier questionnaires?
AlphaSense search on ‘ESG Sustainability AND Profitability’ for the latest 12 months found 56 small and mid-cap companies across 10 sectors, with related disclosure including supply chain policies, expectations and supplier audit practices across the cap range, from $266mm market cap Natural Grocers by Vitamin Cottage [$NGVC] to Tetra Tech [$TTEK] and Goodyear [$GT], market cap $3.3bn and $4.2bn, respectively.
Last December, Broc blogged about the second-ever attempt at using proxy access – via a Schedule 14N filed for “The Joint Corp.” This Form 8-K reports that the nominee was elected – along with all of the incumbents that the company nominated. It doesn’t look like the company put up much of a fight (at least not publicly). The filings indicate that the proxy access nominee was added to the slate in lieu of one of the prior-year directors, who wasn’t renominated.
Our “Proxy Disclosure Conference”: Reduced Rates End This Friday
– The SEC All-Stars: A Frank Conversation
– Hedging Disclosures & More
– Section 162(m) Deductibility (Is There Really Any Grandfathering)
– Comp Issues: How to Handle PR & Employee Fallout
– The Top Compensation Consultants Speak
– Navigating ISS & Glass Lewis
– Clawbacks: #MeToo & More
– Director Pay Disclosures
– Proxy Disclosures: 20 Things You’ve Overlooked
– How to Handle Negative Proxy Advisor Recommendations
– Dealing with the Complexities of Perks
– The SEC All-Stars: The Bleeding Edge
– The Big Kahuna: Your Burning Questions Answered
– Hot Topics: 50 Practical Nuggets in 60 Minutes
Reduced Rates – act by June 14th: Proxy disclosures are in the cross-hairs like never before. With Congress, the SEC Staff, investors and the media scrutinizing disclosures, it is critical to have the best possible guidance. This pair of full-day Conferences will provide the latest essential—and practical—implementation guidance that you need. So register by June 14th to take advantage of the discount.
Tomorrow’s Webcast: “Proxy Season Post-Mortem – The Latest Compensation Disclosures”
Tune in tomorrow for the webcast – “Proxy Season Post-Mortem: The Latest Compensation Disclosures” – to hear Mark Borges of Compensia, Dave Lynn of CompensationStandards.com and Morrison & Foerster and Ron Mueller of Gibson Dunn analyze what was (and what was not) disclosed this proxy season.
– Liz Dunshee
At a recent meeting of the Twin Cities Chapter of the Society for Corporate Governance, Dorsey’s Bob Cattanach shared details on California’s Consumer Privacy Act – or as he called it, “the single most difficult cyber development in the US over the last decade.”
With the legislation set to become effective next January, Bob & other litigators are predicting a surge in class actions for companies that do business in that state. That’s because the provision that allows consumers to recover up to $750 in damages per incident makes it much easier to show that the breach caused injury (and as this Womble Bond Dickinson chart says, a pending amendment may even allow consumers to sue for violations other than data breaches). So plaintiffs’ firms are lining up – and there’s reason to think twice about automatically treating any cyber incident as a “breach,” before you’re certain that breach notification & disclosure requirements have been triggered.
Bob noted that practicing mock breach scenarios under your “incident response plan” is now all the more important. With so much more soon to be at stake, you will need to anticipate the challenges of assessing your many overlapping disclosure obligations, and the likely lack of sufficient & reliable information necessary to make decisions under increasingly shortened time periods, in advance.
For more details on California’s law – and similar legislation that is cropping up in other states – check out the memos in our “Cybersecurity” Practice Area…
Cyber Breach Disclosure: 90% of Incidents Aren’t “Material”?
One of the many things that makes cyber breach disclosure a tricky issue is that the market can get info from notices that are required by state law, even if a company doesn’t disclose the incident in a press release or 8-K. Last summer, I blogged that SEC Commissioner Rob Jackson was concerned that this creates an opportunity for “arbitrage” – and market overreactions.
Disclosure of cyber incidents seems to be trending up, but it’s still rare. That’s according to this WSJ article, which says that Rob is still focused on the issue – and that he thinks companies might benefit from a bright-line disclosure rule. According to his latest research, 10% of known cyber incidents were disclosed in SEC filings in 2018. That compares to 3% in 2017, before the SEC issued its disclosure guidance.
Consistent with those findings, this Audit Analytics blog reports that 121 breaches were disclosed in SEC filings last year – compared to the thousands of breaches & “incidents” identified in Verizon’s latest “Data Breach Investigations Report.” Audit Analytics also found that it takes companies a little over a month to discover a breach and another 4-6 weeks to report it – i.e. 2-5 months between the time of the initial breach and the time of disclosure – and companies vary widely in the level of detail they disclose about the breach.
Meanwhile, this blog says that the SEC’s Enforcement Division remains focused on cybersecurity controls & inadequate disclosure. Relevant factors for investigations include “how the information was accessed, whether there were sufficient walls in place, when the company knew about the intrusion, what the company did in response to the intrusion, and when the company came forward.”
Cybersecurity: When the Threat Comes From Inside
A significant number of cybersecurity incidents & breaches are the result of “privilege misuse” by employees and independent contractors, according to Verizon’s 11th annual “Data Breach Investigations Report.” It also says that “miscellaneous errors” are the second-most common cause of breaches! Hacks can happen if an employee or director is using a personal email account to send confidential documents, or faxing information to an unconfirmed number.
This “Insider Threat Report” – also from Verizon – suggests ways to minimize these internal risks through internal controls. The report’s sample fact patterns could serve as “table top exercises” to help you simulate all of the issues that arise when a data breach happens – including the need to make disclosure & insider trading decisions. Note that Verizon recommends limiting employee access to sensitive data (pg. 9), which is a step some companies are also taking to prevent insider trading. Also see this blog about how law firms can help clients address the risk of internal threats.
Yesterday, the SEC posted this Sunshine Act notice of an open Commission meeting next Thursday – May 9th – to consider whether to propose amendments to the “accelerated filer” & “large accelerated filer” definitions and related transition thresholds (the Commission will also be discussing the cross-border application of rules for security-based swaps). The agenda says that any proposed amendments would be intended to promote capital formation for smaller reporting companies that are currently included in the larger filer categories.
When the SEC adopted the higher $250 million definition for “smaller reporting company” last year, the definitions of “accelerated filer” and “large accelerated filer” didn’t change. As a result, companies with $75 million or more of public float that qualify as SRCs are still subject to the requirements that apply to accelerated filers, including the timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting – and I blogged that that was a point of contention among the Commissioners.
We’ve blogged a few times since then about SEC Chair Jay Clayton’s desire to promote capital formation – and his view that the SOX 404(b) thresholds play into that. So a proposal to amend the definitions wouldn’t come as a surprise.
Audit Committee Independence: Still Important
We get a pretty regular stream of questions on our “Q&A Forum” to the effect of, “Is it really *that* important for our audit committee members to avoid any potentially conflicting relationships with the company?” And we know our members aren’t just making up these questions for fun – let’s just say, the enhanced independence requirements aren’t always front of mind for every director. If I had a dime for every time one of my clients discovered a consulting agreement that had some sort of tie to an audit committee member…well, anyway:
In remarks yesterday, SEC Chief Accountant Wes Bricker called out independence of committee members as one of the main drivers of audit committee effectiveness – along with time, information quality and training & experience.
So yes, it’s still important to at least one influential person, even as we debate whether the overall trend of “supermajority” director independence is worthwhile. Wes also suggested that the auditor’s understanding of the company’s business & audit risks should be something the audit committee considers when evaluating their performance. And he implied that the idea of mandatory auditor rotation remains pretty dead in the US, despite some European regulators requiring it:
As relevant information for the audit committees’ oversight, I believe it is also essential for the committee members to familiarize themselves with relevant research evidence. For example, existing academic research has not been conclusive on the relationship between an auditor’s tenure and either audit quality or auditor independence. Some studies document that mandated rotation may worsen an auditor’s efforts to be skeptical and may mask company “opinion shopping.” There is also some evidence suggesting that professional skepticism can, in some cases, benefit from a long-term auditor-client relationship.
ESG Ratings: The Field Gets More Crowded
There’s some consensus that ESG ratings are impacting investment decisions – but it’s getting very difficult to keep up with all the offerings. S&P recently jumped into the mix with this “ESG Ratings Tool,” which allows companies to participate in the ratings process from start to finish. Assessments are conducted at the request of & in consultation with a company, and the company can then also decide whether & how to disclose the rating.
Meanwhile, State Street Global Advisors is fed up with the ESG ratings free-for-all and is now applying its own scoring system – “R-Factor.” This Davis Polk blog has the details:
An April 2019 SSGA article provides further insight into which resources SSGA is actually using to generate its R-Factor score for any company. For environmental and social scoring, R-Factor leverages the Sustainability Accounting Standards Board (or SASB) Materiality Map as the key framework for materiality.
SSGA writes that, “The R-Factor scoring model is powered by multiple best-in-class ESG data providers — Sustainalytics, Vigeo EIRIS, Institutional Shareholder Services (ISS) Governance and ISS Oekom — as well as SASB meta-data for categorizing and weighting.” SSGA uses another in-house proprietary tool for governance scoring that takes into account region- or country-specific norms. State Street has stated in other publications that it utilizes the Task Force on Climate-related Financial Disclosures Framework (known as TCFD) and that CDP’s (formally the Carbon Disclosure Project) Framework is another possibility.
It’s a safe bet that the SEC still takes social media more seriously than Elon Musk – whose recent Twitter bio was “Meme Necromancer.” But last week they called a truce in their ongoing battle by filing an amended settlement for court approval (although this WSJ article says that SEC Commissioner Rob Jackson wasn’t happy with the deal). The earlier version required a Tesla lawyer to give advance approval for any tweets that “contain, or reasonably could contain, information material to the company or its shareholders.”
I wrote about how the original settlement didn’t work out so well in practice, when Elon tweeted production numbers without getting pre-approval and the two sides couldn’t agree on whether those numbers were “material.” So, page 3 of the amended settlement attempts to be more specific – it says pre-approval is required for communications that contain information on any of the following topics:
– the Company’s financial condition, statements, or results, including earnings or guidance;
– production numbers or sales or delivery numbers (whether actual, forecasted, or projected) that have not been previously published via pre-approved written communications issued by the Company (“Official Company Guidance”) or deviate from previously published Official Company Guidance;
– new or proposed business lines that are unrelated to then-existing business lines (presently includes vehicles, transportation, and sustainable energy products);
– projection, forecast, or estimate numbers regarding the Company’s business that have not been previously published in Official Company Guidance or deviate from previously published Official Company Guidance;
– events regarding the Company’s securities (including Musk’s acquisition or disposition of the Company’s securities), credit facilities, or financing or lending arrangements;
– nonpublic legal or regulatory findings or decisions;
– any event requiring the filing of a Form 8-K by the Company with the Securities and Exchange Commission, including:
A. a change in control; or
B. a change in the Company’s directors; any principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer, or any person performing similar functions, or any named executive officer; or
– such other topics as the Company or the majority of the independent members of its Board of Directors may request, if it or they believe pre-approval of communications regarding such additional topics would protect the interests of the Company’s shareholders
To anyone involved with insider trading, disclosure, Reg FD or social media compliance, this list looks similar to the materiality examples that those policies typically provide – i.e. info that’s not to be selectively shared, or publicly announced unless it’s fully-vetted. Hopefully there are controls to make sure those policies are followed!
While it’s not a bad idea to cross-check your own policies against this list, if you work with a limit-testing exec, you also might need to remind them it’s a baseline deriving from a (heavily) negotiated settlement – not an exhaustive list. So a principles-based approach remains best for most companies. As this article points out, it’s even hard to determine whether the tweet that caused this scuffle would require pre-approval, since Musk’s lawyers argued that the info was consistent with what was previously published in the company’s Form 10-K. This saga will likely continue.
Still More on “10-K/10-Q/8-K ‘Cover Page’ Changes: Courtesy of the Fast Act”
Yesterday, I blogged that the SEC had (very promptly) posted updated cover pages for Forms 10-K, 10-Q and 8-K – which companies now need to use due to the “Fast Act” rules being effective – and pondered why the Form 10-K cover page seemed to require companies to make redundant disclosure about the title & class of securities registered under Section 12(b). Now the SEC has moved the new “trading symbol” disclosure to a more logical location. The zombie Item 405 checkbox remains, for the time being…
More on “Human Capital: Investor Coalition Sends 45-Page Survey”
Last summer, I blogged about a lengthy survey sent to 500 companies by a 120-member investor coalition called the “ShareAction Workforce Disclosure Initiative.” The initiative stems from the UN’s Sustainable Development Goals and aims to get companies to disclose comparable workforce information. Now the coalition is reporting the results.
First off, 90 companies responded to the survey – which is honestly more than I expected – and apparently more companies plan to report human capital information to WDI in future years. But in most cases, the info they shared wasn’t as specific or transparent as WDI wanted. For example, here’s what the investors say about governance descriptions that were shared in the survey:
Although almost all (98%) companies reported extensively on their governance of workforce issues, the quality of these responses was highly varied and often missing key information. For example, while all companies named an individual or committee responsible for workforce issues, only 40% referred to specific areas of oversight – some companies referred to the credentials of individual board members or the composition of a committee rather than what they were tasked with delivering, while others did not even mention workers in their response. 10% of companies disclosed information on the regularity of oversight mechanisms and internal review of workforce issues (including Lloyds Banking Group).
There were significant weaknesses in the reporting of governance related to the workforce. Around half reported how overall responsibility for workforce issues is filtered down from the board to the rest of the organisation (including AIA Group, BAE Systems, Enel, Pearson, SSE, and Svenska Handelsbanken), and less than half provided specific examples of workforce-related performance indicators (including BHP, Cranswick, Inditex, Intel, Pearson, Veolia, and VW). Most companies only discussed corporate responsibility in general terms rather than linking workforce issues with performance-related remuneration.
The 13-page report summarizes five primary findings. WDI plans to post more analysis – and recommended disclosure & workforce practices – on its website in coming months.
The SEC’s “Fast Act” rules go effective tomorrow – which means you need to start using new cover pages for Form 10-K, Form 10-Q and Form 8-K. I blogged last month about our Word versions – and we’ve updated those to match the format that the SEC has now posted.
Also note that the way the trading symbol disclosure is set up for Form 10-K, companies will now need to identify the title(s) & class(es) of Section 12(b) securities twice on the cover page. That seems a little odd since page 82 of the adopting release acknowledged that the Form 10-K cover page already required that info and implied that the new rules would just add the trading symbol. Some of our members are speculating that this was done to facilitate tagging requirements and others think it was an oversight. Drop me a line if you know!
Fast Act: More FAQs on Expanded Hyperlinking Requirement
With the effective date looming for the Fast Act changes, we’ve been fielding tons of questions in our “Q&A Forum” about the new exhibit and hyperlink requirements. Here’s one (#9868):
Do the recently-adopted FAST Act disclosure simplification rules require registrants to include hyperlinks for the reports that are incorporated by reference into Part II, Item 3 of Form S-8? The adopting release does not mention Form S-8, but the amendments to Rule 411 could impact Form S-8 through general application of Regulation C (per Instruction B.1). Arguably, Item 3 should not be subject to the hyperlinking requirement, because the incorporation by reference required by Item 3 serves a different purpose than the incorporation by reference permitted under Rule 411, and because Item 3 also contemplates forward incorporation by reference (as to which hyperlinking is, obviously, impossible), but I haven’t seen any guidance on this.
John answered:
I think in the absence of guidance from the Corp Fin Staff to the contrary, people should assume that the hyperlink requirement does apply to S-8s, for the reasons you suggest. People raised the issue about forward incorporation by reference for other registration statements during the comment process, but the SEC wasn’t persuaded. See the discussion on pg. 77 of the adopting release.
In addition, John blogged last week about informal Staff guidance that suggests a link isn’t required if you’re incorporating by reference from one item to another within the same filing. Now, Bass Berry’s Jay Knight has followed up with thoughts on another common situation:
Question: How does this new hyperlinking requirement apply when the registrant cross-references the reader to other information that is contained either within the same filing or in a prior filing, without explicitly incorporating the information by reference?
For example, is a hyperlink required if the registrant in the legal proceedings item in Form 10-Q says that no material updates have occurred since the last Form 10-K and cross-references the reader to such prior disclosure, without explicitly incorporating the information by reference?
Here’s Jay’s answer:
Answer: Based on a review of the rules as well as the SEC’s adopting release, we believe it is reasonable to conclude that a “cross-reference” to other information, whether in the same or prior filing, should not be treated the same as the disclosure by a registrant that such other information is “incorporated by reference.” We believe this view is supported by the language in the new rules where incorporation by reference and cross-referencing are mentioned separately.
For example, new Rule 12b-23(b) states, “In the financial statements, incorporating by reference, or cross-referencing to, information outside of the financial statements is not permitted unless otherwise specifically permitted or required by the Commission’s rules or by U.S. Generally Accepted Accounting Principles or International Financial Reporting Standards as issued by the International Accounting Standards Board, whichever is applicable.” (emphasis added) We believe the phrase “or cross-referencing to” demonstrates that the SEC views incorporating by reference and cross-referencing differently.
In contrast, Rule 12b-23(d), which is the operative rule related to hyperlinking in the Form 10-Q context, omits any reference to cross-referencing. Rule 12b-23(d) states, “You must include an active hyperlink to information incorporated into a registration statement or report by reference if such information is publicly available on the Commission’s Electronic Data Gathering, Analysis and Retrieval System (“EDGAR”) at the time the registration statement or form is filed.”
Therefore, unless the registrant specifically incorporates by reference the information (perhaps even using that language explicitly), we believe it is reasonable to conclude that a hyperlink is not required by the new rules.
Our May Eminders is Posted!
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Following up on John’s blog about whether “non-IPOs” will become the new IPOs, on Friday, Slack Technologies filed a Form S-1 for its anticipated direct listing on the NYSE. Slack is the second big company to go this route (the first being Spotify). There are no lock-ups and no new shares being issued – but will this fundamentally change how IPOs get done? After delving into the unique parts of Slack’s “Plan of Distribution,” Bloomberg’s Matt Levine notes:
There is a sense of a sort of shadow-bookbuilding process: Slack’s banks are not underwriting an IPO, they’re not marketing stock to potential investors on behalf of Slack and its existing investors. But they are having chats with the existing private investors in Slack to see what their interest is in selling, and they’re having chats with potential public investors to see what their interest is in buying, and at what price, and those chats are all being relayed to the designated market maker, who will … just take binding bids and offers for the stock and set a price that clears the market? That last part seems pretty mechanical, which makes it not entirely clear why you need the first part, but I guess it is hard to let go of the IPO process entirely.
At any rate, there seems to be no shortage right now of “unicorn IPOs” – in one form or another. Yesterday, The We Company (otherwise known as “WeWork”) announced that it’s confidentially submitted an amended draft Form S-1. The WSJ reported that the filing was made without the assistance of bankers, but that doesn’t mean they won’t be hired eventually. If you’re a cynic, you’re not alone…
More on “Regulation G: Coming to a CD&A Near You?”
A couple weeks ago, John blogged that SEC Commissioner Rob Jackson wants the SEC to require explanations & reconciliations when non-GAAP numbers are used in the CD&A. Yesterday, the Council of Institutional Investors announced that it agrees with that suggestion – and it’s filed this petition with the SEC to recommend rule changes. Specifically, the petition requests that the SEC:
1. Amend Item 402(b) of Reg S-K to eliminate Instruction 5 (which says that disclosure of target levels that are non-GAAP financial measures won’t be subject to Reg G and Item 10(e))
2. Revise the Non-GAAP CDIs to provide that all non-GAAP financial measures presented in the CD&A are subject to Reg G and Item 10(e) – and that the required reconciliation must be included within the proxy statement or through a link in the CD&A
CII says it isn’t seeking a ban on using non-GAAP measures in compensation plans. However, it says that its members are concerned about the complexity in executive pay structures – and the challenges in understanding the link between pay & performance.
Lease Accounting: Compliance Still Costing a Pretty Penny
Late last year, “Accounting Today” reported that companies expected to spend $1-5 million to implement the new lease accounting standard, ASC 842. And a recent Deloitte poll is showing that, for many companies, compliance efforts will continue to require time & money for the rest of this year. Here’s the intro from Deloitte’s press release:
Nearly half of public company executives see no slowdown ahead in the time and effort to be spent on compliance with the new lease accounting standards issued by the Financial Accounting Standards Board and the International Accounting Standards Board, according to a new Deloitte poll conducted in February 2019. In fact, after they file Q1 2019 earnings, one-quarter (25 percent) expect to spend the same amount of time and effort on lease implementation related activities and nearly as many (23.9 percent) plan to spend more.
It’s no wonder that people are working so hard to get implementation right – Audit Analytics predicts that the standard will have a material balance sheet impact on 80% of companies.
It’s no secret that a small group of giant institutional investors exercise significant voting control over almost all large companies. One suggestion that’s been floated to “re-democratize” the proxy process – including in this research paper and in this WSJ op-ed from Vanguard’s founder John Bogle – is for funds to give up some voting power.
Last week, Vanguard announced that it’s doing just that. Starting later this year, the external firms who make investment decisions for 27 Vanguard funds – representing about 9% of its total assets – will also be making voting decisions for those funds. The practical takeaway is that you’ll now need to look more closely at which Vanguard funds own your shares – and you may need to familiarize yourself with the voting policies of these 25 firms. This WSJ article discusses the background & impact of the change:
Wellington Management Co., a Boston firm that serves as Vanguard’s biggest external manager, will gain the most voting power from the shift. Wellington oversees roughly $230 billion of the roughly $470 billion affected by the move. Twenty-four other outside firms control votes on the remaining amount.
“We are passing the baton to give active managers direct control over voting the shares of companies in which they invest,” said Glenn Booraem, who heads investment stewardship at Vanguard. “It’s to integrate their voting and engagement processes with their investment decisions.”
Wellington, in a rare public rebuke this year, said it opposed Bristol-Myers Squibb Co.’s deal to buy Celgene Corp. Wellington, however, wasn’t able to cast votes for all shares it managed. Vanguard retained control over a chunk of votes. Wellington had voting control over roughly 28 million shares of its some 126 million shares earlier this year. Shareholders ultimately approved the Bristol-Myers deal. Vanguard voted most of its shares in favor of the deal, said a person familiar with the matter.
The first Vanguard fund where an outside active manager has the power to vote shares will be launched in late May to early June. The fund will target companies with strong environmental, social and governance practices, and Wellington will manage it.
CEO Succession: Trends
Recently, Spencer Stuart released its annual report on CEO transitions in the S&P 500. Here’s the key takeaways:
– In 2018, the number of CEO transitions fell slightly, to 55 from 59 in 2017
– 69% of CEOs retired or stepped down; 22% of CEOs resigned under pressure, 5% left for health reasons, 2% left as a result of a company acquisition/merger and another 2% for other reasons
– 73% of new CEOs were promoted from inside the company, compared to 69% in 2017 and 90% in 2016
– Of the 12% of CEOs to resign under pressure, only 42% of candidates who took the role were internal promotions
– 1 of the 55 new CEOs is a woman and 20% had prior public company CEO experience
– 15% of new CEOs were also named board chair, compared to 7% in 2017 – and 35% of outgoing CEOs stayed on to serve as board chair, compared to 51% in 2017
CEO Succession: Why Boards (Not CEOs) Should Own the Process
CEO succession is a collaborative process involving the board, CEO, senior management and outside advisors. Although the CEO should be a productive partner in the process, the board – not the CEO – should drive the process, and clearly define and manage all participants’ roles& expectations.
This WSJ article gives a bunch of reasons why that’s the case. Here’s an excerpt (also see this Korn Ferry memo about the benefits of continuous “CEO progression” planning):
CEOs might not have the right perspective to evaluate successors. At the end of a long career, many CEOs are concerned about their legacy. This can bias them toward favoring candidates who will guide the company in the same direction—and in the same manner—that they themselves led it. Research bears this out: When powerful CEOs play a role in the succession process, they steer the choice toward someone with similar characteristics to themselves. However, the future is rarely like the past, and if the company’s success going forward requires a change in strategy or a different mix of skills, duplicating the old CEO—even a very successful one—can be a costly mistake.
CEOs can also distort the process through their behavior. Because they generally control top talent development in their companies, they control the flow of information that the board receives about how internal candidates are progressing, as well as shaping the board’s assessment of that information. In addition, they control access—the opportunity for directors to meet face-to-face with the people they will be evaluating. Subtle actions can serve to block a disfavored candidate or promote a favored one, biasing the board’s understanding of the candidates’ strengths and weaknesses, skewing the evaluation process, and ultimately leading to the incorrect choice.
Last week the market inched closer to peak “Unicorn” frenzy when – after what felt like a decade of speculation – Uber filed the Form S-1 for its IPO. Reuters reported that it’s seeking to raise $10 billion, which would be the largest offering since Alibaba went public in 2014. John will give his take on the prospectus tomorrow. For today, we’re looking back on IPO trends leading up to this enormous deal.
As Proskaur’s 6th Annual IPO Study shows, Uber’s IPO would build on trends from last year. Nearly half of the 94 IPOs in the study were conducted by companies with a market cap of at least $1 billion – with many of those deals coming from tech & health care behemoths. The 168-page study looks at a subset of IPOs that had an initial base price of $50 million or more. It offers all kinds of data points – and analyzes trends over the last six years. Here’s a few takeaways (also see this “D&O Diary” blog and Proskauer’s press release):
– 46% of analyzed deals were in the $100-250 million range, 48% of companies had a $1 billion+ market cap at pricing, 86% were EGCs
– 82% of IPOs priced in or above range, and the over-allotment was at least partially exercised in 77% of deals
– 99% of companies used the confidential submission process
– Average number of days from initial filing to pricing was 139, up slightly from the year before
– Average number of first-round SEC comments was down to 20 – and the study looks at the prevalence of “hot-button” comment topics, comments by sector, etc.
– 26% of companies included “flash results” for a recently-completed period – that number jumped to 50% for companies that priced within 45 days of quarter-end
– 47% of companies issued stock in a private placement within a year of going public
– 46% of companies disclosed a material weakness and 22% had a going concern qualification
– 15% of companies had multiple classes of stock – mostly in the tech sector – and 92% had a classified board
– 88% of US IPO issuers were incorporated in Delaware, 16% of IPOs came from Chinese companies
Unicorn IPOs: The More The Merrier
With companies staying private much longer these days than they did even five years ago, there’s a lot of pent up demand for “Unicorns” – venture capital-backed companies valued at $1 billion or more before going public (in Uber’s case, 90-100x more). The reason investors are itching to buy stock is because the companies are considered “high growth.” That’s bank-speak for “losing money” – one study even showed that the less profitable unicorns are, the more people like them! And that’s just one way these offerings can differ from those conducted by “regular” companies.
This “Unicorn IPO Report” from Intelligize takes a look at last year’s trends in this space, concluding that these “wild & independent creatures” actually demonstrate a “herd mentality” on some data points – not just on pricing, which is something that’s been written about a lot in the last few weeks & months – but also on things like (lack of) board diversity and the speed of their IPO process. Here are a few takeaways from this Mayer Brown blog (also see Intelligize’s press release):
– There were 20 unicorn IPOs last year, compared to 13 the year before
– A 7% underwriting fee remained the norm – despite concerns of an SEC Commissioner and legislators that smaller and medium-sized companies are paying higher fees
– About 30% of unicorns had multi-class share structures
– Other than Dropbox, all 2018 unicorns went public as EGCs – and took advantage of those scaled disclosure accommodations
– Excluding one outlier, the average time from draft registration statement filing to IPO was 132 days (shortest was 61 days) – about 140 days was spent between filing the draft and the Form S-1, with 28 days from S-1 to effectiveness (for the broader market, the average time from filing the S-1 to trading was 49 days)
Audit Committees: Auditor Assessment Template
Is your audit committee asking the right questions when it reengages your independent auditor each year? As detailed in this Cooley blog, the CAQ recently announced an updated version of its “External Auditor Assessment Tool” – with sample questions that are organized by category:
– Quality of services and sufficiency of resources provided by the engagement team
– Quality of services and sufficiency of resources provided by the audit firm;
– Communication and interaction with the external auditor; and
– Auditor independence, objectivity, and professional skepticism
The tool also includes a sample form and rating scale for obtaining input from company personnel about the external auditor, as well as resources for additional reading.
