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.
Here’s something I blogged yesterday on CompensationStandards.com: When the SEC adopted the pay ratio rule four years ago, it repeatedly stressed that company-to-company comparisons would be meaningless. The adopting release said:
As we noted in the Proposing Release, we do not believe that precise conformity or comparability of the pay ratio across companies is necessarily achievable given the variety of factors that could cause the ratio to differ. Factors that could cause pay ratio to differ from one company to the next include differences in business type, variations in the way the workforces are organized to accomplish similar tasks, differences in the geographical distribution of employees, reliance on outsourced workers, and the variations in methodology for calculating the median worker. Consequently, we believe the primary benefit of the pay ratio disclosure is to provide shareholders with a company-specific metric that they can use to evaluate the PEO’s compensation within the context of their company.
That message stuck: most people seemed to understand that the ratio would be company-specific, and there was a pretty “ho-hum” reaction to the first year of pay ratio disclosure. But, you might say, “What about tracking changes to a particular company’s ratio over time, to monitor how CEO pay increases compare to everyone else’s? Won’t that be useful?” More than a few people predict that pay ratio will garner more attention going forward, because shareholders & others will compare a company’s current year number to prior years.
The problem with that, as this WSJ article points out, is that the same factors that make comparisons among different companies meaningless are also things that can change from one year to the next at a single company. And as I’m sure you can guess, those changes cause big swings in the ratio. So for many companies, pay ratio doesn’t even provide meaningful year-over-year info (at least, about the relationship between CEO & employee pay). Here’s a couple of examples from the article:
Median pay at Jefferies Financial jumped to $150,000 last year from $44,584 in 2017 after the holding company sold most of its stake in its National Beef meat-processing unit in June 2018, cutting its workforce to about 4,600 from 12,600. The 2017 median employee at the company, formerly called Leucadia National, was an hourly line worker at National Beef, while last year’s was a senior research associate in the company’s Jefferies LLC financial-services operation.
Coca-Cola slashed its median pay figure by two-thirds after it finished shifting North American bottling operations to franchisees and acquired a controlling interest in African operations. The 2017 median worker was an hourly full-timer in the U.S. making $47,312, while last year’s made $16,440 as an hourly full-timer in South Africa. In its proxy statement, Coca-Cola said it intends to shed the African operation again after making improvements and offered an alternative median employee excluding that unit: an hourly full-timer in the U.S. making $35,878, about 25% less than his or her 2017 counterpart.
I will say, companies are making the most of what they have to work with (thanks in large part to the flexibility the SEC incorporated into the rule). And for better or worse, the “median employee” data point might illustrate to people how company policies & strategies play out in the workforce. But a single data point can’t tell the whole story – and the pay ratio itself remains pretty useless.
Internal Auditors Worry Boards Aren’t Using Them Enough
This survey of chief audit executives & directors, compiled by the Institute of Internal Auditors, suggests that enhancing internal audit’s role could help directors identify & mitigate emerging risks. Here’s a few of their recommendations (also see this and this CFO.com article and this Cooley blog):
– While cyber and IT issues have grown to represent nearly 20% of the average audit plan, CAOs still think there’s a shortage in the resources and skills that would allow them to protect the company from significant cyber incidents. Audit committees should ask about obstacles to internal audit’s performance in this area.
– At about 60% of companies, internal audit either never reviews board materials, or does so only for unusual situations. Copying the CAO on board materials would allow them to provide negative assurance on its accuracy, completeness, timeliness, transparency, and reliability. According to this WSJ article, the lack of corroboration worries auditors, who feel that audit committees aren’t exercising “professional skepticism,” and aren’t ensuring that necessary controls are in place.
– Organizational monitoring of third-party relationships is viewed by nearly half of CAOs as ad hoc or weak. CAOs must elevate concerns about weak controls on third-party risks to the audit committee. These relationships require the same level of risk management as any that affect the organization directly.
– 75% of CAOs report to the CFO – which is concerning because they may focus disproportionately on financial risks and overlook areas such as reputational & cyber risk. Internal audit can take on a greater role in oversight of emerging risks by monitoring “key risk indicators” for the company.
– Variances in audit committee structure and responsibility create the real possibility that in some organizations internal audit is not involved with committees that handle critical issues, such as cybersecurity and overall risk governance. For example, in many organizations, risk and IT committees, not audit committees, are tasked with overseeing cybersecurity and cyber preparedness. Such conditions could handicap internal audit’s ability to deliver perspectives about those vital risk domains. CAOs should be present and able to share information at these committee meetings.
“Changes in Accounting Estimates” Linked to Low-Quality Financial Reporting
Accounting isn’t as “black & white” as people sometimes think. This Audit Analytics blog highlights the tendency for people to overlook the significant judgment calls that are involved in financial reporting – and it takes a look at what it can mean when those judgments change. Here’s an excerpt:
Changes in Accounting Estimates (CAEs) are a normal part of periodic reviews of both current and future benefits and obligations. These estimates are recorded as new information appears. From an accounting perspective, the disclosure is governed by ASC 250, which requires all material changes in estimates to be disclosed.
The PCAOB proposed amendments to ASC 250 a couple of years ago, because it views this area as one of the riskiest parts of an audit. The blog walks through three studies that lend support to the PCAOB’s belief – and encourages auditors to be very skeptical of CAEs. Here’s the conclusion:
All three working papers found evidence that CAEs can lead to lower quality of financial reporting. Whether it may be from opinion shopping, managerial opportunism or an unintentional misstatement, these CAEs have been positively associated to subsequent restatements. This can lead to poorer financial quality which, in turn, can impede the assessment of earnings quality making it harder to accurately assess a company’s performance.
We’ve blogged about how some companies have adopted a “Rooney Rule” in an effort to improve board diversity. Now, it might be easier to include diverse candidates for vacancies – because Heidrick & Struggles has announced that each year, half of their cumulative slate of board candidates presented to clients will be diverse.
Heidrick has reason to be confident they’ll meet that goal. In 2018, 52% of their North American board placements were diverse candidates. Hopefully, starting with change at the beginning of the recruitment process will result in real change – but the proof is in the pudding…
This WaPo article reports on Goldman Sachs’ efforts to improve gender diversity for both entry level & senior employee positions, which came about because the bank wants to improve its gender pay ratio (which is required to be reported in Britain).
Board Diversity: Illinois Considering Quotas
Recently, the Illinois House of Representatives passed “House Bill 3394” – which would amend the state’s Business Corporation Act to require public companies headquartered in the “Land of Lincoln” to have at least one female director and one African-American director on their boards by the end of next year. Companies that don’t comply would face fines of $100,000 (first-time offenders) or $300,000 (repeat offenders).
After a heated debate, the bill advanced to the Illinois Senate by a vote of 61-27. If it becomes law, companies can increase the size of their boards to comply. Illinois is home to some pretty well-known companies – e.g. Walgreens, Boeing, McDonald’s, Archer Daniels Midland – but I’m guessing that smaller companies will be more affected. UCLA’s Stephen Bainbridge is among those criticizing the bill. But there’s a reputational risk for companies that challenge the low bar that the legislation would establish.
Board Diversity Mandates: What’s the Impact?
It was pretty big news when California passed its board gender diversity law last year. And Illinois isn’t the only state that’s considering similar legislation. Earlier this year, Broc blogged about a bill in New Jersey, and this Bloomberg article reports on proposed legislation in Massachusetts and non-binding guidelines in other states. But if these types of statutes catch on in the US, how much will they move the needle? This Cooley blog analyzes Bloomberg’s findings – here’s an excerpt:
The Bloomberg analysis showed that the new law could mean that 692 more board seats open up for women. In addition, reports Bloomberg, if every state were to adopt a comparable law, “U.S. companies in the Russell 3000 would need to open up 3,732 board seats for women within a few years.” Meaning the number of women on boards nationwide would rise by almost 75 percent.
Currently, among the Russell 3000, men hold 21,424 board seats, while women hold 5,088 seats. And 99 percent of boards are majority male. Board seats are often filled by current or retired executives, who are most often men. In addition, when director slots open, they are often filled through personal connections, likewise most often male. Those are just two of the reasons why women make up only one-fifth of U.S. board directors.
As Bloomberg reports, without some kind of change, “it could take another two generations before the boardroom matches the workforce, which is about half female. The glacial rate of progress inspired the California law, which had wide support in the state legislature.” And, as discussed in this article in the WSJ, companies will need to “revamp the way they recruit female directors.” According to the chair of the NACD, the “‘system produces white male candidates unless board leaders deliberately do something different.’”
Beginning next year, CalPERS will likely vote “against” compensation committee members in the same year that the compensation plan fails its pay-for-performance quantitative model. That’s according to recommendations in a recent staff report to the pension fund’s Investment Committee. Here’s more detail on the executive compensation initiative that’s underway:
– Move from a 3-year to a 5-year quantitative model (developed in collaboration with Equilar) to assess pay-for-performance, and vote “against” bottom quartile of universe
– Vote “against” Compensation Committee members in the same year the compensation plan fails the pay-for-performance quantitative model (effective 2020 proxy season)
– Additional qualitative components will continue to be used to assess compensation plans – e.g. insufficient disclosure of goals, lack of clawback policy
– For this year, CalPERS expects its say-on-pay voting outcomes to be similar to 2018, where CalPERS voted against 43% of pay programs
The report also summarizes the status of CalPERS’ voting & engagement efforts with Climate Action 100+, and its push for board quality, board diversity and majority voting in director elections. Here’s the staff’s recommended enhancements for overboarding and refreshment:
– Vote “against” non-executive directors who sit on more than 4 boards. The current practice is to vote “against” non-executive directors who sit on more than 5 boards
– Vote “against” Nominating/Governance Committee members if the Board has more than 1/3 of directors with greater than 12-year tenure AND less than 1/3 of directors were appointed in the last 6 years
More on “SEC Chair Talks About ‘Human Capital’ Disclosure”
In February, I summed up then-recent remarks from SEC Chair Jay Clayton on the topic of human capital disclosure by saying:
Companies should focus on providing material information that a reasonable investor needs to make informed investment & voting decisions – Jay is wary of mandating rigid disclosure standards or metrics.
In remarks a couple of weeks ago to the SEC Investor Advisory Committee, it was pretty clear that Chair Clayton’s views still stand. Here’s an excerpt:
Disclosure should focus on the material information that a reasonable investor needs to make informed investment and voting decisions; yet, applying this and the other principles I mentioned to human capital in the way businesses assess and disclose, and investors evaluate, for example, revenue or costs of goods sold, is not a simple task. That said, the historical approach of disclosing only the costs of compensation and benefits often is not enough to fully understand the value and impact of human capital on the performance and future prospects of an organization.
With that as context, my view is that to move our framework forward we should not attempt to impose rigid standards or metrics for human capital on all public companies. Rather, I think investors would be better served by understanding the lens through which each company looks at its human capital. In this regard, I ask: what questions do boards ask their management teams about human capital and what questions do investors—those who are making investment decisions—ask about human capital?
These remarks came in response to an IAC subcommittee recommending that the SEC adopt additional disclosure requirements on the topic of human capital management. Here’s an excerpt (also see this Cooley blog, which summarizes several HCM rulemaking petitions & initiatives, and this Willis Towers Watson memo about the IAC recommendations):
There are a wide range of potentially material HCM disclosures and ways to integrate that information into current reporting. At the most basic, issuers could be required to comply with a principles-based disclosure requirement asking them to detail their HCM policies and strategies for competitive advantage and comment on their progress in meeting their corporate objectives. This would essentially augment existing principles-based requirements with explicit discussions of HCM.
The fact that board and managers routinely rely on a number of similar metrics suggests that they can add value for investors, at least within a given sector, similar to the “view from management” approach to MD&A disclosure. We offer a few examples here of disclosure that – based on research findings in the studies cited above — could be considered. They could be considered in rule-making or as part of routine disclosure reviews by Commission staff. At a minimum, application of existing SEC guidance on non-GAAP accounting, including efforts to prevent issuers from providing inconsistent or otherwise misleading HCM disclosures over time, could be specifically applied to HCM metrics.
In the category of “leading by example,” SEC Chair Jay Clayton structured his remarks at yesterday’s “SEC Speaks” Conference in the form of an MD&A. Here’s an excerpt that shows the importance of “human capital” at the SEC:
Employee pay and benefits was our largest expenditure in fiscal years 2018 and 2013. This is not surprising given that our human capital is by far our most important asset. Technology expenditures have increased in total dollars and as a percentage of the total budget over the last five years. This is a direct result of our commitment to maintaining and upgrading our information technology systems and enhancing the agency’s cybersecurity and risk management.
For fiscal year 2019, our current fiscal year, employee pay and benefits is expected to continue to account for a significant portion of our appropriation. As a result of a hiring freeze, Commission staffing is down more than 400 authorized positions compared to fiscal year 2016. To ensure we can continue to meet our mission objectives, the resources Congress provided the agency for fiscal year 2019 will allow us to lift the hiring freeze and add 100 much-needed positions. This would put our staffing level on par with where we were five years ago.
A few weeks ago, the SEC adopted rules to implement the “Fast Act” – and when the rules go effective next month, they’ll make the following changes to the cover pages for Form 10-K, Form 10-Q and Form 8-K:
– Forms 8-K and 10-Q will require disclosure of the national exchange or principal US market for their securities, the trading symbol, and the title of each class of securities
– Form 10-K will have a new field for disclosure of the trading symbol for any securities listed on an exchange
– Form 10-K will no longer have a checkbox to show delinquent Section 16 filers
To reflect these changes, we’ve updated the Word version of the Form 10-K cover page in our “Form 10-K” Practice Area, as well as the Word version of the Form 10-Q cover page in our “Form 10-Q Practice” Area, and the Word version of the Form 8-K cover page in our “Form 8-K” Practice Area. Note that the adopting release contains the new cover page captions starting on page 216 – but doesn’t indicate exactly where the new text will be added to Form 8-K and Form 10-Q. So we’ve made an educated guess of where this new language will appear. The rules are effective May 2nd – but it typically takes the Staff a few weeks or months to incorporate these types of updates to the PDF cover pages published on the SEC’s website.
For companies that are required to submit Interactive Data Files in Inline XBRL format under Reg S-T, the Fast Act rules also require every data point on the cover pages to be presented with Inline XBRL tags. Some of the “Cover Page Interactive Data File” can be embedded – and the remainder should be attached as an exhibit under Reg S-K’s new Item 601(b)(104). The phase-in for this requirement matches the phase-in for mandatory Inline XBRL compliance. So for large accelerated filers, that means this will first be required in reports for periods ending on or after June 15th. Accelerated filers have until next year – and everyone else has until 2021. We’ve updated our “Form 10-K Cover Page Requirements Checklist” for all of the Fast Act rules – and will be updating all of our Handbooks as well.
Unsurprisingly, BlackRock is now using a technology solution, provided by CorpAxe, to coordinate governance engagement requests. There was an announcement last year that BlackRock had selected CorpAxe as their “corporate access and research management solution,” but since it didn’t mention governance activities per se, it didn’t move onto my radar until BlackRock started redirecting companies that had reached out via email to request engagement. There is also a notice on their stewardship website that you should submit engagement requests through CorpAxe.
Podcast: “Legislation to Study Rule 10b5-1 Plans”
We blogged a few months ago about proposed legislation that flew through the House and would require the SEC to study – and potentially restrict – Rule 10b5-1 trading plans. In this 19-minute podcast, Scott McKinney of Hunton Andrews Kurth discusses the bill in more detail, as it awaits consideration by the Senate. Topics include:
– What is the status of the legislation?
– What are the concerns about Rule 10b5-1 plans the legislation is intended to address?
– What specific issues would the legislation require the SEC to consider?
– What should companies do now?
On Wednesday, the SEC approved changes to the price requirements that companies must meet to qualify for exceptions under the NYSE’s shareholder approval rules. Broc blogged about the proposal last fall – noting that it would make NYSE rules more similar to previously-approved Nasdaq updates. Maybe that’s why the SEC received zero comments in five months. Among other things, the amendments:
– Change the definition of “market value,” for purposes of determining whether exceptions to the shareholder approval requirements under NYSE Sections 312.03(b) and (c) are met, by proposing to use the lower of the official closing price or five-day average closing price and, as a result, also remove the prohibition on an average price over a period of time being used as a measure of market value for purposes of Section 312.03
– Eliminate the requirement for shareholder approval under Sections 312.03(b) and (c) at a price that is less than book value but at least as great as market value
Shareholder Engagement: Tips for Director Involvement
In this 10-page memo, DLA Piper suggests ways to use your proxy statement as a shareholder engagement tool – as well as best practices for disclosing your shareholder engagement efforts. It notes that this type of disclosure is becoming a lot more common. That’s not too surprising since according to this “Director-Shareholder Engagement Guidebook” from Kingsdale Advisors, the vast majority of large companies are now involving directors in regular shareholder engagement – and of course they want to get credit for that.
The Guidebook highlights the benefits of involving directors in engagement efforts and responds to some common objections. And whether your directors already have relationships with shareholders or you’re still evaluating the pros & cons of a direct dialogue, it provides some tips to get the most “bang for your buck.” Here’s an excerpt:
Director-level engagement has to be convenient, otherwise boards and shareholders aren’t going to keep up with the expectations that have been set. Engaging shareholders does not necessarily mean traveling and sitting down for an hour or two. Ideally boards engage face-to-face annually, perhaps on the back of board meetings or institutional investor days, but follow-up may occur over the phone or in video-conferencing.
One of the most convenient set ups we have seen (for directors) is to invite shareholders in the day after a board meeting, when the directors are already prepared and gathered for a series of back-to-back meetings. We recommend invitations to shareholders for director-level meetings come from the corporate secretary, not the IRO. This will signal shareholder engagement is a board-level priority and the meeting will not cover the same topics that may have been previously covered with management.
Engagement should take place well before proxy season, not simply because there is time, but because you will have plenty of runway to address any governance issues that come up.
Transcript: “Earnouts – Nuts & Bolts”
We have posted the transcript for the recent DealLawyers.com webcast: “Earnouts – Nuts & Bolts.”
