A couple weeks ago, Broc blogged about some confusion around the Inline XBRL requirements that will be required for Form 10-Q filings by large accelerated filers this quarter. And with the 10-Q deadline looming for those with a June 30th quarter-end (tomorrow!), the dialogue has continued in our “Q&A Forum” (see #9960). Yesterday, Bass Berry also shared this blog about how to handle the iXBRL requirements. Here’s an excerpt about Form 10-Q – as well as Form 8-K (and see this Gibson Dunn blog for even more pointers):
Form 10-Q Question: As a large accelerated filer, should our 10-Q exhibit list include a separate reference to Exhibit 104?
Based on our discussions with SEC Staff within the SEC’s Division of Corporation Finance, we understand the position of the Staff in Corp Fin’s Office of Chief Counsel is that a registrant should explicitly reference an Exhibit 104 in the list of exhibits. And because the recent EDGAR Filer Manual makes clear that a registrant meets its obligation under Exhibit 104 by providing the cover page interactive data file using an Inline XBRL document set with Exhibit 101, the registrant should simply cross-reference to Exhibit 101.
For example, Exhibit 104 could include a cross-reference as follows: “104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).”
We also remind large accelerated filers that the recent instructions to Item 601(b)(101) of Regulation S-K were amended to require that for interactive data files, the Exhibit Index must include the word “Inline” within the title description for any XBRL-related exhibits. See Instruction 1 to Paragraphs (b)(101)(i) and (ii) of Regulation S-K.
Form 8-K Question: In a Form 8-K, are you required to explicitly reference Exhibit 104 in the Exhibit Index?
Answer: In discussions with SEC Staff within the SEC’s Division of Corporation Finance, we received the following guidance related to a registrant’s Exhibit 104 reference obligation in 8-Ks:
– If the 8-K does NOT otherwise have an exhibit being filed or furnished under Item 9.01(d), then the company does not need to include Item 9.01(d) in the 8-K solely for the Exhibit 104 reference. (The cover page tagging is still required in the background, but there is no standalone Exhibit 104 reference in an Item 9.01.)
– In contrast, if the 8-K does have another exhibit being filed or furnished under Item 9.01(d) (e.g., there is a material contract), then the company should include a reference to Exhibit 104 in the Item 9.01(d) disclosure because there is already disclosure being provided under this Item. For example, the reference could be as follows: “104 Cover Page Interactive Data File (embedded within the Inline XBRL document)”
– The principle behind this position is that Item 9.01 is intended to have an informational component to it, and if an Exhibit 104 reference is required in every 8-K then the informational benefit of item 9.01 is weakened.
Fast Act: SEC Issues “Technical Corrections”
A couple weeks ago, Broc noted in his Inline XBRL blog that an incorrect eCFR of the Item 601(a) table was causing some confusion about iXBRL requirements. The SEC has now issued this 18-page release, which corrects the exhibit table and a few other items from the original Fast Act amendments. The technical corrections to the final rules do the following:
– Reinstate certain item headings in registration statement forms under the Securities Act of 1933 that were inadvertently changed
– Relocate certain amendments to the correct item numbers in these forms and reinstates text that was inadvertently removed
– Correct a portion of the exhibit table in Item 601(a) of Regulation S-K to make it consistent with the regulatory text of the amendments
– Correct certain typographical errors and a cross-reference in the regulatory text of the amendments
Today’s Open Commission Meeting: Cancelled
The SEC has cancelled the open meeting that it had previously scheduled for today to consider whether to propose additional Regulation S-K disclosure reforms. No word on rescheduling yet.
Next Wednesday: SEC’s “Small Business Forum”
The SEC will hold its 38th annual “Small Business Forum” next Wednesday – August 14th – in Omaha, Nebraska (and if you’re like me, you now have this ‘Counting Crows’ song stuck in your head). The SEC’s announcement summarizes what topics will be covered and explains how to access the meeting (you need to register by tomorrow if you want to attend or listen in on any of the breakout sessions):
As in past years, the format of the Forum will include a live webcast informational morning session followed by an afternoon working session where participants will formulate specific policy recommendations in groups. The morning panels will cover capital formation (“success stories from the Silicon Prairie”) and efforts to harmonize the offering framework, based on the SEC’s June concept release.
The afternoon breakout group sessions will not be webcast but will be accessible by teleconference for those not attending in person. Anyone wishing to participate in a breakout group either in person or by teleconference must register online by August 9.
Also, about a month ago, the SEC posted its final report from last year’s Forum – which included recommendations about modernizing disclosure requirements and harmonizing private offering exemptions.
Here’s something from Dan Goelzer’s latest newsletter: A challenge faced by a company under non-public SEC investigation is whether to publicly disclose the investigation before the company knows whether it will result in any charges. There are no firm rules on whether investigations must be disclosed. The decision is inherently a judgment call and depends on an assessment of materiality after considering the costs and consequences of the investigation, the issues underlying the inquiry, the likelihood and potential impact of any eventual SEC enforcement proceeding, and other factors. It is frequently assumed that transparency is the more conservative approach and that, in the long run, the market rewards candor.
Dan goes on to say that a recent paper by David H. Solomon, of Boston College’s Carroll School of Management, and Eugene Soltes, of Harvard Business School, casts doubt on these assumptions. Professors Solomon and Soltes conclude:
– Even if no charges are ultimately filed, companies that voluntarily disclose an SEC financial fraud investigation have “significant negative returns, underperforming non-sanctioned firms that stayed silent by 12.7% for a year after the investigation begins.”
– Disclosing in a “more prominent manner” (e.g., in a press release as distinguished from an SEC filing) is associated with worse returns.
– A CEO whose company discloses an investigation is 14 percent more likely to “experience turnover” within two years than a CEO whose company opts to remain silent, regardless of the outcome of the SEC investigation.
These findings won’t come as a surprise to anyone who’s been involved in responding to fraud allegations. Even if the SEC ultimately drops their inquiry, a years-long investigation can tear apart the company and make it pretty hard for management to stay focused on their day jobs. But in his newsletter, Dan notes that:
The circumstances which lead to SEC financial fraud investigations vary widely, as do the pros and cons of voluntary disclosure. The Solomon and Soltes research, while intriguing, should not be a factor in deciding whether to disclose an investigation. The paper does, however, underscore how seriously the markets are likely to take news of a financial fraud investigation. The audit committee needs to treat such a matter equally seriously.
Securities Class Actions: M&A Filings Down, But Plaintiffs Still Loving Disclosure Fraud
Last week, Cornerstone Research published its midyear assessment of securities class action filings. Here’s a few takeaways from the press release:
– Plaintiffs filed 126 “core” class actions (excluding M&A claims) – that’s just one shy of the record set in the first half of 2017 – due to delayed market volatility in late 2018 and an uptick in filings against consumer-focused and tech companies
– Plaintiffs have filed more than 1,000 securities class actions in the last 2.5 years – accounting for more than 20% of the total number of filings since 1997
– M&A-related filings declined more than 20% since last year – to 72 – and dropped below 90 for the first time since the second half of 2016
– Six mega-dollar disclosure loss (DDL) filings (at least $5 billion) and 11 mega maximum dollar loss (MDL) filings (at least $10 billion) propelled aggregate market capitalization losses to the highest and fourth-highest levels on record, respectively
– Due to the Supreme Court’s 2018 Cyan decision, plaintiffs continue to shift securities fraud claims against IPOs from federal to state court – 61 new 1933 Act filings have appeared post-Cyan, which consists of 23 parallel filings, 12 filings in federal courts only, and 26 filings in state courts only
’33 Act Class Actions: NY State May Not Be So Plaintiff-Friendly After All
People have been predicting that SCOTUS’s 2018 Cyan decision – which held that class actions alleging claims under the Securities Act of 1933 may be heard in state court – would be a boon for the plaintiffs’ bar…and a big problem for IPO companies & their D&O carriers. Cornerstone’s midyear assessment of securities class action filings certainly suggests that plaintiffs have found the decision encouraging.
But this D&O Diary blog points to a glimmer of hope in New York – where many post-Cyan suits are being filed because the state’s pleading standards are less onerous than at the federal level. The blog explains that a New York State trial judge recently dismissed a case brought against an IPO company & its underwriters under Sections 11 and 12(a)(2) of the Securities Act. Here’s an excerpt (and here’s a call for reform):
To the extent that the plaintiffs’ lawyers were motivated to file in state court based on perceived advantages at the motion to dismiss stage, Judge Borrok’s decision represents something of a reality check. Judge Borrok’s opinion is thorough, sure-handed, and shows no discomfort in working with the federal securities laws and relevant case law. (In that regard, Judge Borrok’s reliance on the Omnicare decision underscores the importance of that ruling in opinion cases.) The state court pleading standard does not seem to have been a factor in the ruling. And no one would mistake Judge Borrok’s opinion as plaintiff friendly.
The decision in the Netshoes case is of course just one ruling by one trial court judge. It has no precedential value and may have only limited value as an indicator of how New York state courts generally may deal with the new influx of securities cases. Moreover, Judge Borrok’s dismissal of the Netshoes case was without prejudice; the plaintiffs will have an opportunity to try to cure the shortcomings Judge Borrok noted in his decision. For all we know, the plaintiffs might well succeed in amending their complaint and in surviving the next round of dismissal motions.
However, one can hope that Judge Borrok’s ruling may help send a message that the plaintiffs may need to reconsider whatever perceived advantages they may think they have in proceeding in state court rather than federal court.
Back in December, Stinson’s Steve Quinlivan spotted the first CAM. Now we owe him another hat tip for finding the first few CAMs in audits issued by the “Big 4” accounting firms – see page 93 of Microsoft’s Form 10-K and page 107 of Open Text’s Form 10-K. Both companies had a CAM relating to revenue recognition. Steve noted in his blog (also see his follow-up entry):
The CAM is straightforward and does not reflect negatively on the company or its audit committee or cast doubt on its financial reporting. If anything, it most likely reflects an attitude by the auditor that “we have to find something to protect us in the case of a PCAOB inspection.” I think revenue recognition CAMs are going to become somewhat boiler plate and not likely to attract a lot of attention absent special circumstances.
Auditor Attestations: No Shortage of Comments on SEC Proposal
The comment letters have been rolling in on the SEC’s proposed amendments to the “accelerated filer” definition – which would make fewer companies subject to the auditor attestation requirement. Predictably, accounting firms aren’t in favor of the change and say that it would weaken the quality of financial reporting (here’s EY’s letter as an example). CII has also joined that camp – its letter argues that the amendment may cause investors to lose confidence in the integrity of financial statements.
CII also takes issue with the SEC’s economic analysis of the proposal – by citing to another recent comment letter from four B-School profs. That letter adds data to the assertion that some companies can’t be trusted to report material weaknesses when left to their own devices (as does this blog about Canada’s experience with a similar rule). Here’s an excerpt from this WSJ article about the letter and its underlying study:
More than 100 companies that could get relief have reported restatements that altered combined net income by $295 million from 2014 through 2018, according to a comment letter from researchers at Stanford University, the University of Pennsylvania, the University of North Carolina and Indiana University. Eleven of the restatements occurred in 2018 and wiped out about $294 million in market value, the researchers wrote.
One company in the group is Insys Therapeutics Inc., said Prof. Taylor, who co-wrote the letter. Insys, an opioid manufacturer whose market value peaked at $3.2 billion in 2015, sought bankruptcy protection in June after pleading guilty to bribing doctors to boost use of its spray version of fentanyl, a synthetic opioid. It agreed to pay $225 million in fines and forfeiture.
Insys effectively failed the internal-controls audits in 2015 and 2016, according to securities filings. The company later restated results for several quarters in 2015 and 2016. The company said at the time that neither fraud nor misconduct caused the errors. Auditors in 2017 and 2018 reported its internal controls were free from material weaknesses.
The comment letter emphasizes that the analysis in the SEC proposal quantifies the cost of internal control audits – but not the potentialbenefits. Of course, there are two sides to this heated debate – and the WSJ article also emphasizes the high cost of compliance for smaller companies, and that investing that money in the core business rather than compliance could improve returns for shareholders…there are letters supporting the proposal from Nasdaq, the Chamber, Proskauer and a score of life science companies, among others.
Sarbanes-Oxley Compliance: Still a Lot of Work, But Automated Controls Might Help
There was a slight decrease in Sarbanes-Oxley compliance costs last year – according to Protiviti’s annual survey on the topic – but spending remains significant ($1.3 million on average among large accelerated filers – and that excludes external audit fees). In addition, hours & control counts continue to increase. Protiviti predicts that new technologies – along with a desire to strengthen controls and (finally) lower costs – will usher in “SOX Compliance 2.0.” Here’s an excerpt:
A growing number of SOX executives recognize that more dramatic improvements, fueled by a new mindset and advanced technologies, are required. To illustrate, our results reveal that the use of analytics has jumped significantly and that a broader range of compliance activities are being subjected to advanced technology — with even more plans to do so in the future. It also appears many organizations are huddling with their external auditors to figure out how the auditor’s use of advanced automation can deliver greater compliance effectiveness.
Protiviti also found that the use of automated controls testing is increasing, more companies are using outside providers for Sarbanes-Oxley compliance, and cybersecurity is substantially increasing compliance hours. Nearly half of companies said they were now required to issue a “cybersecurity disclosure” based on guidance from the SEC & Corp Fin.
The SEC announced that it’s holding an open Commission meeting this Thursday – August 8th – to consider whether to propose rule amendments to modernize these Regulation S-K disclosure requirements:
1. Business Description
2. Legal Proceedings
3. Risk Factors
I’ll admit that my first reaction to this news was, “Didn’t they already do this (twice) last year?” But then I remembered that the 341-page Reg S-K concept release from 2016 went well beyond the Fast Act and Disclosure Update & Simplification amendments. We don’t know yet whether a proposal coming out of this meeting – if any – will address any of those ideas (the agenda just says that any proposal would be intended to update these rules to account for developments since their adoption or last amendment, to improve these disclosures for investors, and to simplify compliance efforts for companies). We’ll keep you updated in any event.
By the way, we’ve overhauled about 4000 pages of our “Handbooks” to reflect the latest disclosure requirements, accommodations and best practices – including all of the Fast Act and Disclosure Update & Simplification amendments. They’re a great resource for making sure that your forms & disclosures are up to date.
Board Diversity: S&P 500 No Longer Has Any All-Male Boards
A couple weeks ago, the WSJ reported that all S&P 500 boards now include at least one female director – a pretty significant milestone, given that one in eight boards in that index were all male as recently as 2012. The “Thirty Percent Coalition” – which coincidentally was formed by investors in 2012 with the goal of improving female representation – also announced that 85 companies appointed a woman to their board for the first time during the last year and that more company boards include a woman now than at any other time since the campaign launched.
Of course, there are plenty of companies outside of the S&P 500 that haven’t diversified – and as this Korn Ferry blog points out, business benefits are best realized when 20-30% of the board is “diverse.” The Thirty Percent Coalition’s investors will be asking companies to undertake the following:
1. Disclosure in the Proxy of board composition inclusive of gender, race, and ethnicity
2. Language committing to diversity in Governance charter
3. Disclosure of future plans to make progress on board diversity
4. Adaptation of the “Rooney Rule” for board candidates and senior leadership (investors want each company to commit to include women & people of color in every pool from which Board nominees are chosen and to state this in their Board Refreshment Policies and/or Nominating & Corporate Governance Committee Charter)
5. Consideration of candidates outside of CEOs for board positions.
Tomorrow’s Webcast: “Joint Ventures – Practice Pointers (Part II)”
Tune in tomorrow for the DealLawyers.com webcast – “Joint Ventures: Practice Pointers (Part II)” – to hear Troutman Sanders’ Robert Friedman, Proskauer’s Ben Orlanski, Cooley’s Marya Postner and Aon’s Chuck Yen provide an encore to our popular June webcast with even more practical advice on navigating your next joint venture. The topics include:
1. Joint Ventures vs. Contractual Collaboration
2. IP Issues: JVs Based on An Owner’s Platform Technology
3. Negotiating “Divorce” Up Front
4. Consider Piloting a JV Before Full Commitment
5. Majority/Minority Dynamics
6. Acting By Written Consent
7. Clarifying JV’s Purpose
8. Pay Principles: Benchmarking & Long-Term Incentives
9. How Key Pay Decisions Are Made
Every proxy season, Corp Fin responds to somewhere between 200-400 no-action requests about shareholder proposals. Earlier this year, we blogged several times about how the government shutdown upended the process. And even though the Staff got back to “business as usual” when the shutdown ended, they had to be even more efficient given the time constraints – and that experience might have contributed to Corp Fin considering whether to rethink their approach to Rule 14a-8 no-action requests.
As you can hear at the 29-minute mark of this taping of a Chamber event a few days ago, SEC Chair Clayton & Corp Fin Director Hinman commented that they’re considering changing some aspects of their “referee” role (my word, not theirs) – so that, like other types of no-action requests, Corp Fin wouldn’t respond to every Rule 14a-8 submission. Rather, they’d focus on requests that involve “novel” issues and encourage companies & proponents to work things out themselves. Bill says they’re seeking input from the community on how they might change their approach.
As I blogged during the shutdown, companies continue to be very cautious about excluding proposals without first obtaining Staff no-action relief. Some speculate that we’ll see more litigation if Corp Fin does change their role and isn’t as involved – especially on matters that involve tough judgment calls. Any changes in Corp Fin’s role is bound to have a variety of views as this area is always contentious when change is considered, particularly if the SEC’s role might change.
How Asset Managers Feel About “Activists”
John’s blogged on DealLawyers.com that activist hedge funds don’t actually do much to improve company performance. But according to this SquareWell Partners survey (download required), the perception – at least among “active” asset managers – is that these funds are a useful market force, even if they have a short-term, selfish interest.
For that reason, it’s becoming more common for asset managers to align with activists on proxy fights and proposals if they agree with the substance of the activist’s argument – especially on governance & strategic matters. Here’s some interesting takeaways that can help you form alliances when you need them (this was also a topic covered earlier this week in our DealLawyers.com webcast – “How to Handle Hostile Attacks” – stay tuned for the transcript):
– 81% of investors expect companies to engage after they’ve analyzed the analyst’s arguments & formed a strategic response – i.e. don’t rush into a “PR War” – but also know that investors will engage with an activist even before the campaign is public
– 64% of active managers expect to engage with independent directors
– Investors consider a number of factors when assessing a targeted company – the top ones are company performance versus peers, management & board quality, and engagement history – they also look to broker reports, proxy advisors, media outlets & social media
– Investors are mixed on whether poor TSR is a dealbreaker – they’ll also consider ratios that show profitability, efficiency, debt & liquidity
– In addition to capital allocation decisions, active managers are most attuned to governance issues such as collective board expertise, board independence, chair quality and executive pay
Convertible Debt: Still a Good Way to Raise a Buck (or a Million)
This Fenwick survey looks at the terms of 100 convertible debt deals last year – for first-money and early- and late-stage bridge deals. Here’s some key findings:
– Year over year, deal sizes have continued to increase. The median overall deal size this year is up 14%, from $1.4 million to $1.6 million
– Conversion discounts are increasingly common, even in later-stage debt issuances, as is the practice of pairing the discount with a valuation cap
– In change-of-control situations, such as the sale of a company, most deals provide for a premium payout that is a multiple on top of the repayment of the principal balance. The number of deals giving a premium, as well as the median premium amount has remained steady year over year; however, this year the low end of the premium spectrum dropped from 25% to 10%
– Only 11% of deals used a valuation cap as a standalone provision in the absence of a conversion discount
At the recent Society conference, shareholder proposals – in particular, exclusions based on “micromanagement” – were a hot topic. I’ve blogged that last year’s Staff Legal Bulletin No. 14J revived that prong of Rule 14a-8(i)(7)’s “ordinary business” test.
Corp Fin Staffers have explained that proposals may be excludable due to “micromanagement” if they unduly limit management’s discretion – e.g. by advocating for specific methods or policies rather than deferring to the company to determine how to address a topic. They’ve also said that the complexity of the underlying subject matter doesn’t impact the analysis. And this 46-page Sullivan & Cromwell memo about trends in shareholder proposals looks at how “micromanagement” has been applied in some recent no-action letters.
Not everyone agrees with how things are playing out. For example, the Council of Institutional Investors recently submitted a comment letter to Corp Fin that frames the Staff’s approach as an arbitrary “too complex for shareholders” test – and requests that the Staff again revisit its approach to the rule. Specifically, CII takes issue with the Staff’s no-action relief for proposals relating to the use of non-GAAP adjustments in incentive plans (the topic of a rulemaking petition that CII filed with the SEC in April) – as well as requests for companies to report on greenhouse gas emissions. Here’s an excerpt:
With regard to the each of the Devon and Exxon proposals, the Staff said that, “by imposing this requirement, the Proposal would micromanage the Company by seeking to impose specific methods for implementing complex policies in place of the ongoing judgments of management as overseen by its board of directors.” [6] The Staff used the word “impose” twice in this sentence, but that doubling-down does not obviate the fact that the precatory recommendation would not impose anything on the company, other than for management to place the item on its proxy card and include the proposal and supporting statement in the proxy statement. These are requests to the boards on a major public policy issue, not directives.
Nor, for that matter, do the proposals require “specific methods.” The proposals thread the needle between vagueness and recommending overly specific policies. They do not suggest specific goals or a timetable, but rather frame a general structure, well understood by investors, for disclosure of goals.
Mandatory ESG Disclosure: Coming to an SEC Filing Near You?
Last week, the House Financial Services Committee debated five draft bills that would require companies to disclose information about climate change risk, political contributions and other ESG topics (you can also watch this week’s committee markup). This Davis Polk blog summarizes the hearing:
The committee memorandum prepared by the majority staff prior to the hearing stated that “investors have increasingly been demanding more and better disclosure of ESG information from public companies.” The target for improving this disclosure has been the SEC, which received an October 2018 petition from a coalition of investment managers, public pension funds and non-profit organizations requesting that the agency develop a robust ESG disclosure framework. Representative Juan Vargas (D-CA) noted in his remarks that this petition was the impetus for his draft legislation, ESG Disclosure Simplification Act of 2019, one of the bills considered at the hearing.
Several committee members on both sides of the aisle noted that, as interest in ESG disclosure rises, some public companies have responded by voluntarily adding these types of issues to their reporting efforts. However, debate ensued when considering that the draft bills would mandate this type of disclosure for all public companies. Issues raised during the question and answer period included:
– Whether mandated disclosure is necessary given current voluntary disclosure practices;
– The potential increased regulatory burden of these disclosures, which could negatively impact U.S. IPO markets; and
– Whether ESG issues qualify as material information for investors.
This column from Bloomberg’s Matt Levine points out that advice to quantify & disclose climate change risks might be something that companies hear from management gurus – and certainly some of their investors. But that has a different ring than an SEC mandate – especially if the underlying goal is to “solve climate change through the mechanism of corporate disclosure.” If regulating through securities laws ends up being our best hope to solve big problems, yikes – but at least we have a lot of thoughtful people in the field. And some even think a uniform ESG disclosure framework would help companies.
More on “California Reports on Mandatory Women Directors”
Last week, Broc blogged about discrepancies in the first “board diversity” report that the California Secretary of State published under new Section 301.3(c) of the California Corporations Code. A Secretary staffer later spoke with Cooley’s Cydney Posner to explain why the report looks the way it does – here’s an excerpt from her blog:
First, in the methodology, the Secretary acknowledges that there are gaps in available data because of the various filing deadlines: Forms 10-K are due, generally depending on the size of the company’s public float, 60, 75 or 90 days after the end of the company’s fiscal year, and the deadline for filing the California Statement is 150 days after the end of the company’s fiscal year. Accordingly, in some cases, the representative indicated, companies that may have their principal executive offices in California may not have filed their 10-Ks or California Statements during the designated review period and, as a result, their data was not included. (But there still appeared to be some unexplained omissions from the lists.)
Second, according to the representative, because of the language in the statute defining “female” as “an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth,” the Secretary is not reviewing 10-Ks or proxy statements to determine whether a company is compliant with the new board composition requirement. Rather, the Secretary is determining compliance based only on the California Statement, which, since March, has included a specific inquiry regarding the number of “female” directors.
Third, the California Statement is required to be filed by both foreign and domestic corporations and, if a company replied to the question regarding the number of female directors, even if it indicated that its principal executive offices were not located in California, the Secretary included that company on the compliant list; i.e., foreign corporations were not screened out. For the March update, the Secretary plans to provide a separate list of companies that report compliance but do not have principal executive offices located in California.
We should expect that some timing issues will continue to affect the March 1, 2020 update report. Notably, given the process the Secretary is following, current information from the California Statement regarding compliance for 2019 may not be available for the 2020 update report for companies with calendar-year FYEs, among others. For example, companies with calendar-year FYEs will have filed their California Statements in the first half of 2019, but if they do not add a female director and become compliant until, say, the third quarter of 2019, they will not have reported that compliance on their California Statements in time for the March 1, 2020 update (unless they were to file early). As of now, the Secretary does not intend to develop a new separate filing for purposes of soliciting the relevant information on board gender diversity on a more timely basis, but it can’t be ruled out. However, the Secretary does contemplate some revisions to the California Statement, currently expected to be in place by the beginning of 2020. Keep in mind also, that, no fines should be imposed until the Secretary adopts appropriate regulations, and my understanding is that the process of developing regulations has not yet begun.
California won’t be the only state requiring reports on board diversity – the Illinois General Assembly recently passed its own “Diversity Disclosure Bill,” which will require companies headquartered in that state to include diversity info in annual reports filed with the Secretary of State. However, as this Vedder Price memo explains, the version of the statute that ultimately passed in the “Land of Lincoln” doesn’t mandate the inclusion of women or minorities on boards or fine companies that fail to achieve a statutory target, which had been part of the original bill. At the federal level, the House Financial Services Committee has also passed a couple bills on the topic…
This isn’t news to those of you who experienced it – and unfortunately, plenty of people I’ve talked to have. But this PJT Camberview memo highlights the unusually low votes that some directors are getting this year (in the 70th percentile range) – as a result of new overboarding policies at some institutional investors (especially those that were announced once proxy season was already underway, since at that point it was really too late to do anything about it). Here’s an excerpt:
In a sign of growing investor assertiveness, significant opposition to directors of Russell 3000 companies this year increased to its highest level since 2011 despite a year-over-year decrease in negative proxy advisor recommendations, according to a June ISS Analytics report. A contributor to this decline was new or stricter overboarding policies put in place by leading institutional investors such as Vanguard, BlackRock and Boston Partners. Active public company executives sitting on more than two boards were particularly hard hit, and a number of directors saw their support drop 25 or more percentage points on a year-over-year basis.
Investors’ stated concern with ‘overboarded’ directors is that they may not have sufficient time to dedicate to their roles, particularly when an activism, M&A or crisis event hits one or more of the companies on which they serve. Tighter overboarding policies may become more prevalent in the coming years, with direct implications for board diversity, succession planning and the way that directors and companies manage and track their board commitments.
Auditor Ratification: This Year’s Biggest (Almost) Losers
Each year, auditors at a handful of companies manage to irritate shareholders enough to motivate a notable “against” vote on the auditor ratification proposal. This “Audit Analytics” blog says that last year, there were 21 companies with more than 20% of votes “against” ratification. And according to the blog, 2018’s biggest (almost) losers were:
– Dynasil – 44% against
– Amber Road – 40% against
– MusclePharm – 37% against
If you think today’s headline is catchy, that’s because I stole it from John’s blog last year. He observed that most companies go on to reappoint their auditor despite shareholder objections – and that remains true…
EGC Transitions: Interplay With Revenue Recognition
Earlier this year, the Center for Audit Quality published notes from a spring meeting between its “SEC Regulations Committee” and the Corp Fin Staff. The Staff is considering the impact of the new leasing standard on the contractual obligations table – and has “pointed views” about the leasing standard’s impact on EBITDA disclosures (see this “Compliance Week” article). It also clarifies that an Item 2.01 Form 8-K is required to report an acquisition, even if the Staff grants a Rule 3-13 waiver that allows a company not to file acquired entity financials. The Staff also covered EGC transition issues, including:
Question: If an EGC loses status after it submits a draft registration statement or publicly files a registration statement, then it will continue to be treated as an EGC until the earlier of the date on which the issuer consummates its initial public offering (IPO) or the end of the one-year period beginning on the date the company ceased to be an EGC. If the EGC had elected private company transition for new accounting standards in the IPO, how and when is it required to transition to the new accounting standards for filings subsequent to its consummation of the IPO assuming that was the earliest date?
Answer: FRM 10230.1 states if an EGC loses its status after it would have had to adopt a standard absent the extended transition; generally,the issuer should adopt the standard in its next filing after losing status. EGCs that take advantage of an extended transition period provision are encouraged to review their plans to adopt accounting standards upon losing EGC status and to discuss with the staff any issues they foresee in being able to timely comply with new accounting standards already effective for public business entities in the next filing.
Question: When is quarterly information under Item 302 of Regulation S-K required to be revised under ASC 606 for a registrant that loses its EGC status?
Answer: FRM 10230.1 states if an EGC loses its status after it would have had to adopt a standard absent the extended transition; generally, the issuer should adopt the standard in its next filing after losing status. For example, a registrant that has elected the private company transition and loses its EGC status on December 31, 2019 would be required to reflect the adoption of ASC 606 in its December 31, 2019 annual report on Form 10-K. Since the issuer is not an EGC as of December 31, 2019 it is not provided the accommodation for Item 302 quarterly information, in FRM 11110.2, in that Form 10-K. That is, for the example provided, the issuer would reflect the adoption of ASC 606 in its 2019 quarterly financial information in its December 31, 2019 annual report on Form 10-K.
LIBOR is going away in 2021 – and the SEC Staff is reiterating that companies should prepare – and adequately disclose the associated risks. Last week, Corp Fin issued a joint statement with the Division of Investment Management, Division of Trading & Markets and Office of the Chief Accountant to say that companies should identify their exposure under contracts that extend past 2021 and consider whether future contracts should use an alternative rate. Corp Fin’s portion of the statement also says:
As companies consider the questions in the section above entitled “Managing the Transition from LIBOR” and address the risks presented by LIBOR’s expected discontinuation, it is important to keep investors informed about the progress toward risk identification and mitigation, and the anticipated impact on the company, if material. In deciding what disclosures are relevant and appropriate, CF encourages companies to consider the following guidance.
– The evaluation and mitigation of risks related to the expected discontinuation of LIBOR may span several reporting periods. Consider disclosing the status of company efforts to date and the significant matters yet to be addressed.
– When a company has identified a material exposure to LIBOR but does not yet know or cannot yet reasonably estimate the expected impact, consider disclosing that fact.
– Disclosures that allow investors to see this issue through the eyes of management are likely to be the most useful for investors. This may entail sharing information used by management and the board in assessing and monitoring how transitioning from LIBOR to an alternative reference rate may affect the company. This could include qualitative disclosures and, when material, quantitative disclosures, such as the notional value of contracts referencing LIBOR and extending past 2021.
At this stage in the transition away from LIBOR, we note that companies most frequently providing LIBOR transition disclosure are in the real estate, banking, and insurance industries. We also note that, based on our reviews to date, the larger the company, the more likely it is to disclose risks related to LIBOR’s expected discontinuation. However, for every contract held by one of these companies providing disclosure, there is a counterparty that may not yet be aware of the risks it faces or the actions needed to mitigate those risks. We therefore encourage every company, if it has not already done so, to begin planning for this important transition.
Buybacks: Rulemaking Petition Wants to “Repeal & Replace” Rule 10b-18
A few weeks ago, the AFL-CIO and 18 other organizations submitted this rulemaking petition to call for more comprehensive rules around stock buybacks. Here’s an excerpt from this Wachtell Lipton memo (also see this Cooley blog):
The petition contends that the current rule has “failed to prevent executives from using repurchases to boost a company’s stock price or meet other performance goals at the expense of investing in its workers,” and that the existing disclosure requirements are inadequate. The petitioners cite evidence that corporations devote substantial capital to buybacks, noting the recent uptick following the enactment of the Tax Cuts and Jobs Act, and argue that the funds would be better spent on “wages, training, hiring” and other capital investments. The petitioners request that the SEC develop a “more comprehensive framework” to deter manipulation and protect workers, and propose that the SEC consider certain suggestions made in prior rulemaking processes (including additional disclosure requirements and tighter trading limits) and consider adopting regulatory features imposed in certain other countries (such as shareholder approval requirements and prohibitions on executive trading).
The History of Stock Buybacks
This WSJ article posits that “Share buybacks are as American as mom, apple pie and hot dogs on the Fourth of July.” They’ve been around since the 1800s – and were often mandatory back then, in order to keep management from pocketing extra profits. Bloomberg’s Matt Levine suggests that maybe the changing sentiment about this practice has more to do with our modern expectations for “corporate purpose” than with the supposed unfairness of profits going to shareholders rather than workers:
In the olden days, you’d start a company and call it like Pennsylvania Tin Folding Ltd., and its purpose would be to fold tin in Pennsylvania, and it would never occur to you to fold tin in Ohio, or to fold nickel, or to twist tin, or to do anything else not in the name. You’d raise money from investors for a purpose, and do the purpose, and if it was profitable you’d give the money to the investors; you’d stay in your lane.
In modern times, you start a company and call it like Alphabet Inc., and its purpose is be to sell online advertisements against search results, and when that turns out to be an extraordinarily lucrative business it will get into other businesses like email and self-driving cars and human immortality. And no one thinks this is the least bit weird; everyone says “well of course who should end the tyranny of death if not the search-ad guys?” And this becomes the normal way of thinking, so that any profitable mobile-phone or social-networking or whatever company that doesn’t plow its profits back into grandiose moonshot projects is somehow failing in its duty to humanity. How are we going to fund our most ambitious collective goals, if not by social-media startup founders making whimsical decisions about what to do with their retained earnings?
Every 2-3 months this year, the PCAOB has been publishing resources to explain the “critical audit matters” disclosure that’ll appear in upcoming audit reports (here’s our blog about their May guidance). The latest two pieces came out last week – one is directed to investors and the other is directed to audit committees – in addition, the CAQ also published this primer on CAMs for investor relations teams.
Here’s a couple responses to “frequently asked questions” that the PCAOB has gotten from audit committees about CAMs (also see pg. 6 for a list of questions that audit committees should ask auditors):
1. Will the new requirement of the auditor to communicate CAMs change required audit committee communications?
Other than a new requirement for the auditor to provide and discuss with the audit committee a draft of the auditor’s report, the PCAOB’s requirements for audit committeecommunications remain the same. Any matter that will be communicated as a CAM should have already been discussed with the audit committee and, therefore, the information should not be new.
2. Does the audit committee have a role in determining and ap-proving CAM communications?
No. While the auditor is required to share the draft auditor’s report including any CAMs identified with the audit committee, CAMs are the sole responsibility of the auditor. The standard is designed to elicit more information about the audit directly from the auditor. As the auditor determines how best to comply with the communication requirements, the auditor could discuss with management and the audit committee the treatment of any sensitive information.
COSO’s “ERM” Framework Now Includes “ESG”
This DFin memo summarizes current trends in ESG reporting & oversight. On pages 11-14, it points out that COSO’s enterprise risk management framework was updated last fall to include risk-related ESG controls & analysis. Here’s an excerpt:
As boards are expected to provide oversight of ERM, the COSO framework supplies important considerations for boards in defining and addressing risk oversight responsibilities. The COSO ERM – ESG framework is built on the five pillars of existing ERM reporting.
5. Information, Communication & Reporting for ESG-Related Risks
Tomorrow’s Webcast: “How to Handle Hostile Attacks”
Tune in tomorrow for the DealLawyers.com webcast – “How to Handle Hostile Attacks” – to hear Goldman Sachs’ Ian Foster, Cleary Gottlieb’s Jim Langston & Innisfree’s Scott Winter provide insights into the art of responding to a hostile attack.
Earlier this year, Broc blogged about how Tesla was using the new “Say” platform to allow retail shareholders to submit questions during earnings calls. This memo from Say reports on how many shareholders are participating in this process – and says they’re more likely to ask about products & consumer experience than financial outlook (compare to these questions that one experienced buy-side advisor would ask). How’s that working out for analysts and Tesla’s IR folks? Here’s an excerpt:
Tesla led the Q&A portions of each call with questions from Say users, ahead of analysts. Like Russell’s questions on Tesla’s Q1 2018 call, Say users’ questions received follow up from traditional equity analysts. During Say’s Q1 2019 call with Tesla, Musk revealed the company would enter the auto insurance market while responding to a Say user question about insuring cars. A Morgan Stanley analyst later asked more about insurance, capturing the media’s attention and creating positive press for Tesla. The original retail shareholder question was submitted on our platform by an 18-year-old.
Our Q1 2019 call also included five questions from institutional Tesla investors, Ark Invest and Domini Impact Investments, who both issue ETFs holding Tesla in their portfolios. Together, they represented $185M in Tesla shares. Their questions, reflected in Figure 3, were largely ESG and product-focused and were not answered by the company. Having them filed on Say, however, captured institutional sentiment for Tesla’s IR department as well.
Allison Herren Lee Confirmed as SEC Commissioner
That was fast. Yesterday morning I blogged that the Senate Banking Committee had approved Allison Herren Lee’s nomination as SEC Commissioner. Yesterday afternoon, the SEC congratulated her on a successful Senate confirmation and welcomed her back to the SEC. Allison had previously served on the SEC staff from 2005 to 2018.
Director Compensation: Delaware Reiterates “Entire Fairness” Applies
Here’s something I blogged recently on CompensationStandards.com: This Bracewell memo notes that – in light of the Delaware Supreme Court’s 2017 Investors Bancorp decision – nearly 75% of surveyed LTIPs now include a director-specific limit on the size of annual grants, with many plans also capping total annual compensation for board members.
That trend isn’t likely to die out any time soon. Recently, the Delaware Court of Chancery reaffirmed that the entire fairness standard applies to most decisions that directors make about their own compensation. The opinion – Stein v. Blankfein – says that director pay decisions can be actionable even if the directors held a “good-faith, Stuart-Smalley-like belief” that they were “good enough, smart enough, and doggone it, they were worth twice—or twenty times—the salary of their peers” (bravo to the Vice Chancellor on the SNL reference – and in this case, it’s not much of a stretch to envision the Goldman Sachs directors holding that belief).
This Stinson blog has the details about the case & its implications – here’s an excerpt:
The following courses of action remain available to public company boards in approving director compensation:
– Have specific awards or self-executing guidelines approved by stockholders in advance; or
– Knowing that the entire fairness standard will apply, limit discretion with specific and meaningful limits on awards and approve director compensation with a fully developed record, including where appropriate, incorporating the advice of legal counsel and that of compensation consultants.
It may also be possible to obtain a waiver from stockholders of the right to challenge future self-interested awards made under a compensation plan using the entire fairness standard. To do so, stockholders would have to approve a plan that provides for a standard of review other than entire fairness, such as a good faith standard. In addition stockholders would have to be clearly informed in the proxy statement that director compensation is contemplated to be a self-interested transaction that is ordinarily subject to entire fairness, and that a vote in favor of the plan amounts to a waiver of the right to challenge such transactions, even if unfair, absent bad faith. Note that the Court did not conclude, because it was not required to do so, that such a waiver was even possible.
Culture & Human Capital Management: Buzz on the Board’s Role
In the past couple of months, my inbox has been even more inundated than usual with memos – and even media articles – about corporate culture and human capital management. Of course I’m dutifully posting in our “Corporate Culture” and “ESG” Practice Areas. But for your convenience, here’s a few that stood out:
