It’s finally happened. Yesterday, the SEC announced that it’s adopted final rules to implement the “Fast Act” disclosure simplifications – which were proposed about a year & a half ago. We’ll be posting memos in our “Fast Act” Practice Area. Here are some highlights from the 251-page adopting release – and except as noted below, the rules become effective 30 days after their publication in the Federal Register:
– Item 303 and Form 20-F will allow companies to exclude discussion of the earliest of three years in the MD&A if they’ve already included the discussion in a prior filing
– Item 601(b)(2) and (10) will allow companies to omit confidential information in exhibits without submitting a CTR, so long as the information is (i) not material and (ii) would likely cause competitive harm to the company if publicly disclosed (this part of the rule is a change in procedure only, and is effective upon the rule’s publication in the Federal Register)
– Item 601(b)(10) will require only newly-reporting companies to file material contracts that were entered into within two years of the registration statement or report
– Item 601(a)(5) will no longer require companies to file attachments to material agreements, if the attachments don’t contain material information and aren’t otherwise disclosed
– Item 102 will require disclosure about physical properties only to the extent they’re material to the company
– Forms 8-K, 10-Q, 10-K, 20-F & 40-F will require companies to disclose on the cover page the national exchange or principal US market for their securities, the trading symbol, and the title of each class of securities
– “Incorporation by Reference” rules will no longer require companies to file as an exhibit any document or part thereof that’s incorporated by reference in a filing – but instead will require them to provide links to documents incorporated by reference
– Forms 10-K, 10-Q, 8-K, 20-F & 40-F will require Inline XBRL tags on the cover page (this part of the rule has a three-year phase-in)
– Form 10-K will no longer have a checkbox to show delinquent Section 16 filers, the Item 405 heading to be used within the proxy is now “Delinquent Section 16(a) Reports,” and the heading should be excluded altogether when there are no delinquencies to report
– Item 503 (risk factors) will become new Item 105 – and the list of example risk factors is being eliminated from the rule in order to emphasize that it’s principles-based
Business Development Companies: SEC Proposes Offering Reforms
Yesterday, the SEC proposed Securities Act amendments to streamline the offering process for business development companies and registered closed-end funds – by expanding the “WKSI” definition, among other things. Here’s the 361-page proposing release – we’ll be posting memos in our “Business Development Companies” Practice Area.
NYSE’s “eGovDirect” Decommissioned
According to a notice sent to listed companies, the NYSE is planning to decommission “eGovDirect” at the end of next week. Everything will be migrated to the exchange’s “Listing Manager” system. The “Listing Manager” will also be enhanced to allow submission of press releases and supplemental listing applications. Here’s more detail:
Current users of eGov, who do not have accounts on Listing Manager, will need to work with their Listing Manager administrator to obtain access to the new reporting platform. Alternatively, users can contact the NYSE at ListingManager@nyse.com or 212-656-4651 to request access – or to discuss any questions or concerns. Please note that eGov login credentials will not work on the new Listing Manager website.
HOW WILL THIS IMPACT ME?
– If you have an interim written affirmation record in progress, you will have to complete the submission in eGov no later than a) the affirmation’s due date or b) by 5:00PM EST on March 29th (whichever is earlier)
– If you have an annual written affirmation record in progress, this will be migrated to Listing Manager as an open record. You will have the chance to complete your submission online once you obtain access to the website
– If you recently submitted your shareholder meeting dates in eGov, you do not have to re-enter the information in Listing Manager
– Previously completed written affirmations in eGov will not be available in Listing Manager, but a copy can be provided by an NYSE representative
– CAM Basics – a high-level overview of the required “CAM language” that will be added to auditors’ reports, and the quality review & documentation requirements for CAMs
– Determination of CAMs – FAQs on how to identify CAMs, e.g. how they differ from the company’s critical accounting estimates
– Review of Audit Methodologies – observations based on a review of audit firms’ “dry run” CAM methodologies, training materials & practice aids
The guidance is based on the PCAOB’s discussions with audit firms that collectively audit 85% of large accelerated filers, as well as other outreach efforts. All three documents emphasize the company-specific nature of CAMs and related reporting, the broad scope of information that auditors will look at to identify and address CAMs, and the role of the auditor versus the audit committee & management. Here’s a few nuggets:
– CAMs are drawn from matters required to be communicated to the audit committee — even if not actually communicated — and matters actually communicated — even if not required. The standard does not exclude any required audit committee communications from the source of CAMs.
– When identifying CAMs, AS 3101 requires auditors to consider the six factors in the standard as well as other factors specific to the audit
– Descriptions of CAMs – and how they were addressed – are required to be specific to the circumstances – i.e. auditors can’t just restate that they identified “a matter involving especially challenging, subjective or complex auditor judgment,” or generically say they tested internal controls to address the CAM
– Auditors aren’t expected to provide non-public information in their report unless it’s “necessary to describe the principal considerations that led the auditor to determine that a matter is a CAM or how the matter was addressed in the audit” – and “public information” includes press releases, etc. – not just financials
– Although audit committees are entitled to a draft of the auditor’s report and a dialogue about CAMs (and any sensitive information) is expected, CAMs are the responsibility of the auditor, not the audit committee
Auditor Ratification: Tenure Not a Factor for ISS?
This memo from EY/Tapestry Networks summarizes a meeting among audit committee chairs & ISS to discuss potential changes to the factors considered by the proxy advisor for its voting recommendations on auditor committee matters, including auditor ratification. While ISS isn’t making immediate policy changes, it’s trying to understand whether financial reporting shortcomings share red flags that signal a relationship should be reconsidered. Audit chairs cautioned against a more formulaic approach. On the topic of tenure, this dialogue occurred:
While audit firm tenure is one possible factor in evaluating auditor independence, members were cautious about proxy advisory firms using this metric as well. Several members noted that auditor tenure is an ineffective data point that further limits competition and a company’s ability to select the best firm. Others emphasized the difficulty of changing audit firms: “There’s turmoil when you change auditors; these are massive projects.” On the issue of partner tenure, members generally agreed that the current five-year rotation requirement in the United States should make this a non-issue.
Mr. Goldstein agreed on both auditor and partner tenure: “We don’t expect to use tenure in our guidelines. Partner rotation already exists.” Mr. Goldstein sought to reassure the audit chairs by describing the factors ISS considered in making a recommendation against the ratification of KPMG as GE’s external auditor. “Long tenure as GE’s auditor was not a reason for our recommendation,” said Mr. Goldstein. “KPMG had given GE a clean bill of health for many years, and then there was a surprising large write-off related to their legacy long-term care insurance business, followed by an SEC investigation. There were other concerns and enough questions for us to take what, for us, was a radical position.” Mr. Goldstein elaborated that part of ISS’s concerns in the GE case stemmed from the criticism of KPMG’s work as the auditor of Carillion. Members again cautioned that ISS be careful before connecting a firm’s performance on one audit in a particular country with its work on another audit in another country.
Transcript: “How to Use Cryptocurrency as Compensation”
We’ve posted the transcript for the recent CompensationStandards.com webcast: “How to Use Cryptocurrency as Compensation.” The agenda included:
1. Defining “Cryptocurrency”
2. Securities Implications
3. Tax Implications
4. Accounting Implications
5. Other Applicable Regulations
6. Why Digital Assets Are Attractive To Entrepreneurs
7. Types of Crypto Compensation Structures
8. Drafting Issues For Plans & Awards
9. Token Plan Administration
10. When Using Crypto Doesn’t Make Sense
It’s no surprise that the uncertainty surrounding Brexit continues to impact business – I blogged last month that it might be one of this year’s “top risks.” And in December, I wrote that the SEC is monitoring disclosure.
In remarks late last week, Corp Fin Director Bill Hinman reiterated that the UK’s withdrawal from the European Union may be material not just to UK- and EU-headquartered companies – but to any company with extensive international operations – and explained how companies should be applying the SEC’s “principles-based” disclosure rules to Brexit’s evolving business risks (he also touched on sustainability disclosure, as noted in this blog from Stinson Leonard Street).
Bill shared six topics for companies to consider as a starting point when assessing & drafting tailored Brexit disclosures. This Cooley blog highlights that these are the types of questions Corp Fin will be asking during their disclosure reviews. And this “D&O Diary” blog provides further analysis, along with an abbreviated “cheat sheet”:
1. Is the business exposed to new regulatory risk given the uncertainty of which set of laws and regulations will apply and whether transition agreements will be in place?
2. Are there significant supply chain risks due to the potential disruption to the U.K.’s access to free trade agreements with other nations and any resulting changes in tariffs to exports or imports?
3. Does the company face a material risk of losing customers, a decrease in sales or revenues or an increase in costs due to tariffs or other factors? Is the demand for the company’s product especially sensitive to exchange rates or changes in tariffs?
4. Does the company have exposure to currency devaluation, foreign currency exchange rate risk or other market risk?
5. What is the company’s exposure to contractual risk in the face of Brexit? Has the company undertaken a review of its existing contracts with counterparties in the U.K. or the EU to determine whether renegotiation or termination is necessary in light of contractual obligations?
6. Do Brexit-related issues affect financial statement recognition, measurement or disclosure items, such as inventory write-downs, impairments, collectability of receivables, assumptions underlying valuations, foreign currency matters, hedge accounting, or income taxes?
Glass Lewis announced that it will pilot a new Report Feedback Statement (RFS) service to a limited number of U.S. public companies and shareholder proponents during the 2019 proxy season. According to Glass Lewis, the purpose of the RFS service is to allow companies and shareholder proponents to “more fully and directly express their views on any differences of opinion they may have with Glass Lewis’ research.”
The RFS service is to be used to report on differences of opinion — not factual errors, which companies should continue to communicate to Glass Lewis. Companies and shareholder proponents may submit statements noting their differences of opinion with Glass Lewis’ analysis of their proposals to Glass Lewis’ research and engagement team. That team will then distribute the statements, without editing or modifying the content, directly to Glass Lewis’ 3,000+ investor clients along with Glass Lewis’ response to the RFS.
Participants may submit a request to subscribe to the RFS service; Glass Lewis will accept requests on a first-come-first-served basis. The maximum number of pilot participants will be 12 companies and/or shareholder proponents per week between March and May 2019 (subject to decrease if the statements received in any week are particularly long or complex).
Free CLE for In-House Lawyers
I recently noticed on LinkedIn that some of my in-house connections have been panelists for a new CLE provider -“In-House Focus.” IHF is focusing on including case studies from current in-house lawyers, and has committed to using diverse faculty. And according to this announcement, they’re offering nine free video programs as part of their launch. Topics include legal operations, privacy, IPOs and government investigations.
After Broc blogged last week about GE’s “Letter to Shareholders,” a few loyal readers reached out to gush about the proxy statement that was recently filed by Regions Financial. One person said it was “unreal – totally changes expectations around proxy disclosures.” And this comment explains why:
It’s like a proxy statement, proxy advisory data report on governance practices, consolidated sustainability report and review of every shareholder hot topic rolled into one. It’s worth checking out if you’re looking for sample proxy disclosure on virtually any topic – it was even cited by CII in its recent report on best practices for board evaluation disclosure.
This is not to comment on the merits of any of their programs or practices, which I haven’t reviewed, just the scope of disclosure. I do note they have enjoyed strong voting support, but clearly they aren’t resting on their laurels in that respect. And that’s a good lesson for every company, even if you don’t have the resources to prepare a proxy like Regions’.
Sustainability: How to Talk So Investors Will Listen
This PwC memo says the “safe zone” of ESG reports & communications is quickly disappearing as investors get more aligned in the type of info they’re looking for – and continue to integrate ESG criteria into decision-making by investment officers & PMs, rather than just the stewardship team.
You’re likely familiar with the “safe zone” – it’s sustainability reporting that calls out a ton of company accomplishments…but it doesn’t quantify their impact on the bottom line, and there’s no convincing link to business strategy. From an investor’s view, it’s a start – but it’s not going to ensure the company avoids the biggest global risks that are coming down the pike, or that it’s positioned to capture a competitive advantage. A recent 40-page report from Ceres offers some strategies to improve your positioning – and engagement – on this topic. Here’s one takeaway, as summarized in this Cooley blog:
Use language that investors understand and value. One goal of the IR team should be to “communicate the company’s values and strategies using language that investors understand” — including, where appropriate, financial terms such as margin and EPS, as well as business concepts such as risk mitigation, cost avoidance, revenue growth and competitive differentiation — thus positioning sustainability in the context of business performance.
To permit investors to incorporate sustainability into their valuations, companies should discuss sustainability investments, risks and benefits “through the prism of [practical business concerns such as] supply chain resilience, stranded asset avoidance, cost savings and efficiency, improved product performance, consumer acquisition and increased employee retention.” Notably, some asset managers do not position their questions as “sustainability” questions per se, but may instead frame them strictly as financial issues, such as supply chain stability.
According to Ceres, one “constant refrain” heard from investors is that “if a company is not talking about its sustainability strategy and performance, they may conclude the company does not have a story to tell or, even worse, it’s hiding something.”
Preparing for “CEO Activism”
There’s a perception that CEOs have become more willing in recent years to speak out on controversial social & political issues. It’s still pretty rare, but that doesn’t mean you shouldn’t prepare for the day when your company’s leader wants to take a stand. We’ve blogged about the public and investor reactions to this double-edged sword – and we’ve been posting even more resources in our “Crisis Management” Practice Area. In this WSJ article, two B-School profs offer tips on when CEOs should take a stand – and how to speak out effectively. Here’s the takeaways:
CEOs should take a stand when:
1. The nudge comes from their employees
2. Their corporate or personal values – and corporate practices – align with the issue at hand
3. The issue is “live”
CEOs who speak out should:
1. Set up a rapid response team
2. Anticipate backlash
3. Work with the communications team
I love that we have a lot of avid readers in our community. Here’s a “Best Books of 2018″ list from Bob Lamm. And when it comes to reading goals, Nina Flax of Mayer Brown has it covered with her latest “list” installment (here’s the last one):
Now that we’re well into the new year, I’m sure we are all making progress on our resolutions. Some of my lofty ideas include watching less mind-numbing TV, increasing my practice of “single-tasking”, actually exercising ever, eating more healthy food, etc. One also includes reading more books for pleasure.
This is actually a hard one for me, because it seems so accomplishable and yet… On the one hand, I love to read books. On the other hand, I read so much for work my eyes are tired. In between the two ends of my reading spectrum thoughts, if I find a book I like, I read and read and read – and will stay awake sometimes all night (literally), which leads to more tired eyes, not wanting to read… I completely appreciate this is a silly problem. And so, I am trying to break through the cycle and focus on reading in a more mindful way, by both picking up AND putting down a book more often. Plus, if I accomplish this goal, by sheer lack of time I will also likely accomplish my watching less mind-numbing TV goal. Yay for my one stone!
So, for my first list of the year, I have created simply a list of non-work books I would like to read in 2019.
Bad Blood
The Girl Who Smiled Beads: A Story of War and What Comes After
Here’s Looking at Euclid: From Counting Ants to Games of Chance – An Awe-Inspiring Journey Through the World of Numbers
Tubes: A Journey to the Center of the Internet
Ghost Fleet: A Novel of the Next World War
On Being Blue: A Philosophical Inquiry
What a Fish Knows: The Inner Lives of Our Underwater Cousins
Mapping the Heavens: The Radical Scientific Ideas That Reveal the Cosmos
The Path Between the Seas: The Creation of the Panama Canal, 1870-1914
Tigana
The Sword of Shannara (which will inevitably lead to the other two)
The Queen’s Poisoner (which will inevitably lead to the other five, but not the prequels)
I also have on my list re-reading a few books – Siddhartha, Peony and Animal Farm. I must admit that I purposely wrote this so that I will feel like you all are holding me accountable and I may actually accomplish this goal! To leave you all with a quote from someone I knew as a child, “Each year you should take a long walk, make a new friend and read a good book.” Here’s to 2019 being great.
Audits: Radical Change on the Horizon?
This article from a Harvard Law School Fellow analogizes problems with the “independent auditor” framework to climate change – there are issues that may well bring down the entire system, but we’re lacking a short-term incentive to fix them. Here’s what he identifies as destabilizing trends that audit committees need to watch:
1. Big 4 Breakup – The UK is continuing to discuss a breakup in light of the Enron-like failure of Carillion – and audit chairs may want to watch these developments carefully when they consider whether to retain or replace current auditors. Not surprisingly, auditors are opposed to spinning off non-audit services – but say they’re open to a market share cap. This blog argues that the break-up proposals are impractical.
2. Obsolete Measures – More stakeholders are asking whether boards in general, and audit committees in particular, are accessories to a process that is growing obsolete by looking at wrong or incomplete indicators – e.g. ignoring the value of intangible assets and metrics that measure long-term performance
3. Changes to Reporting – As enhanced audit reports (CAMs) and integrated reporting spread, board audit committees may find value in monitoring how pace-setting companies handle the new disclosure techniques. They may even urge their companies and auditors to run tests to see how they might be adapted. Advantages could come in the form of higher confidence among investors, with the prospect of a lower cost of capital, and better internal management of multiplying risks that fall outside the bounds of conventional accounting standards. See this 5-minute CAQ video on how audit chairs are approaching CAM disclosures…
Our March Eminders is Posted!
We have posted the March issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
Note from Broc: One last casualty of the shutdown: PLI’s “SEC Spleaks” got moved to April from its traditional February date because they were afraid of a possible second shutdown and they would have no speakers. The ASECA dinner was moved too.
In Morrow Sodali’s latest institutional investor survey, 85% of respondents said that climate change was their most important engagement topic (up 31% from last year) – although when it comes to disclosure, they’re more focused on getting human capital details. Maybe this result isn’t too surprising given that the 46 global survey participants are all signatories to the UN’s Principles for Responsible Investment – but their combined $33 trillion of assets under management is nothing to sneeze at (and yes, the “Big 4” US institutional investors – BlackRock, Vanguard, State Street & Fidelity – are all PRI signatories).
When it comes to voting, the survey says that governance policies & practices are by far the most important factor. Also, some investors are more willing these days to nuance their voting decisions based on information gained in engagements, but some continue to rigidly adhere to stated policies. So you just have to know who you’re dealing with. And be aware that the cost to nuanced decision-making is a greater demand for transparency and director involvement in engagements (87% said that director involvement helps their evaluation of a company’s culture, purpose & reputational risks). Here’s a few other hot topics that will continue to impact board meetings, engagements and disclosure (also see this “Harvard Law” blog):
– Board composition & competence – skills & qualifications are the most important factor in evaluating directors, with diversity lagging behind
– Executive pay – pay-for-performance, rigor of performance targets and the inclusion of long-term performance targets are all important, and investors are beginning to engage collectively on this topic
– Human capital management and corporate culture – including succession planning to prepare for the risk of abrupt executive departures that could result from a scandal
Audit Committees: Tech’s Impact on Financial Reporting
Tech disruption is coming to an audit near you. Whether it’s turning to tech firms for the “data gathering” phase of the audit, or ensuring that automated financial record-keeping and reporting is accurate – which are both increasingly common according to this WSJ article – audit committees need to oversee the related financial reporting risks. Fortunately, the “Center for Audit Quality” has released a tool for audit committees that explains the impact of emerging technologies on the oversight framework. In addition to identifying other helpful resources, the CAQ’s tool contains suggested questions for a number of key tasks.
Large-Cap Directors: Bad News for Small-Caps?
If the director recruitment industry is any indication, experienced large-cap directors are in high demand. And for good reason – they’ve likely had first-hand involvement with a variety of board, management & shareholder situations. But since small-caps tend to have more retail shareholders, fewer resources and different types of business issues, that large company experience could be a double-edged sword.
In this blog, Adam Epstein covers six potential “negatives” – and makes it clear that impressive credentials don’t negate the need to find the right fit and remain attuned to director & board performance. Here’s an excerpt:
– Form over substance: If a large-cap company is akin to an aircraft carrier, many small-caps are more like speedboats. The former takes dozens of people and extended periods of time to change speed or course, while the latter can take one or two people and happen in a matter of seconds. When you try and operate a speedboat the same way as an aircraft carrier, it’s pretty easy to hit other stuff… or sink. Every small-cap investor has a story about a portfolio company that sunk – or came needlessly close to it – because a newly-appointed board member from the large-cap world unconsciously redirected the board’s attention away from key existential threats to never-ending boardroom box-checking.
– Misplaced emphasis on proxy advisors: Large-cap companies are typically more than 80 percent owned by large institutional investors. Those investors, in turn, can place a high degree of emphasis upon third-party advisors that educate institutional investors how they should consider voting on various annual proxy proposals. These so-called proxy advisors (e.g., ISS, Glass Lewis, etc.), can be highly impactful on board appointments and director compensation, among other things, and large-cap board members can get transfixed upon remaining within the good graces of ISS, et al. Regrettably, many large-cap emigres assume that their small-cap colleagues should be equally concerned about proxy advisors, despite the fact that many small-caps are majority owned and traded by retail (i.e., nonprofessional) investors who don’t care one iota about what any proxy advisor says… about anything. The result isn’t pretty, because when small-cap boards lose primary focus on strategy, innovation, culture, and capital formation, and instead become enamored with proxy advisors, bad things tend to happen.
– Corporate finance disasters: Large-cap companies rarely need to access the equity capital markets, and when they do it’s almost always from a position of strength and leverage – strong balance sheets and extremely liquid stocks. On the other hand, many small-caps are serial capital raisers, and often transact financings from positions of weakness and vulnerability – everyone knows they are running out of money and their stock is illiquid. Here’s the rub: when I was an institutional investor, many of our portfolio companies either waited too long to raise “must have” capital, or they turned down “market terms” all because a large-cap board member noisily applied big company corporate finance sensibilities to a marketplace they didn’t understand – at all. This problem is exacerbated by the fact that “other” board members are often overly deferential to the new board member who operated, governed or advised famous companies. Just because someone works on an Indy 500 pit crew, doesn’t mean they are the best person to change the brakes on your Lexus.
Here are results from our recent survey on board fees for CEO searches (the sample size was small, FYI):
1. During our most recent CEO search, we paid a search-related fee to the directors who led the search:
– Yes – 7%
– No – 57%
– We haven’t conducted a CEO search – 36%
2. For those paid the search-related fee, the total amount paid to each director was:
– $25,000 or more – 0%
– $15,000-$25,000 – 50%
– $5,000-$15,000 – 0%
– Less than $5,000 – 50%
3. For those paid the search-related fee, the fee was structured as:
– Per-meeting & per-interview fee – 0%
– Periodic additional retainer – 0%
– Additional “committee” fee – 100%
4. For those paid the search-related fee, the fee was based on:
– Compensation consultant survey & recommendation – 50%
– Informal estimate of extra time commitment – 50%
Please take a moment to participate anonymously in these surveys:
This 28-page survey from Allen & Overy and Willis Towers Watson summarizes the most common D&O concerns – not too surprising that cyber threats now top the list, but less expected is the fact that health & safety is now in the top five – as well as the coverage issues that are most important to directors and officers. These are their top policy priorities:
1. D&O policy and/or company indemnification is able to respond to claims in all jurisdictions
2. How claims against D&Os will be controlled and settled
3. Broad definition of who is insured
4. Clear and easy-to-follow policy terms
5. Whether there is cover for the cost of advice at the early stages of an investigation
Cyber Insurance: Standalone Policies Gain Steam
This PartnerRe/Advisen survey of cyber insurance trends reports that for the last couple years, companies have been shifting from endorsements to standalone policies – in order to get higher dedicated limits and expanded business interruption coverage. In fact, as also noted in this Allianz survey, “BI” coverage was the most sought-after type of protection – displacing data breach from its long-standing spot at the top of cyber-protection priority lists. It’s also helpful to know that many more small- and mid-sized companies are hopping on the cyber insurance bandwagon.
Here we go again. Elon Musk can’t quit Twitter – which means the SEC can’t quit Elon. It was only last October that the Tesla CEO settled with the SEC on allegations of securities fraud, after a series of surprising “going private” tweets. Part of the settlement required Musk to get internal pre-approval of tweets that could contain material info about the company. But, as Broc and others predicted, it was a pretty tall order to think a mere mortal could stand between Elon and his social media.
Last week, Elon tweeted some production stats without getting that internal pre-approval. The SEC responded yesterday with this motion – asking the federal district court in Manhattan to hold Musk in contempt for violating the court-approved settlement. The motion is worth reading – it includes Tesla’s “Senior Executives Communications Policy” as well as a look into how the policy was being applied, and an excerpt from Musk’s December interview with “60 Minutes” Lesley Stahl in which Musk essentially thumbed his nose at the SEC.
It is not surprising that the SEC felt compelled to ask for Musk to be found in contempt, said Charles Elson of the University of Delaware. “They have to react. From an agency standpoint, if you show outright contempt towards the agency and they do nothing, how are they ever going to enforce the law?,” he said.
The SEC could ask the judge to increase the $20 million fine Musk has already paid or move to punish the company’s board if they don’t rein him in, said Adam Epstein, a corporate-governance advisor. But SEC is not likely to ask that Musk be removed from the company altogether, as it initially did last year, he said. “He has a pattern and practice of tweeting in an inflammatory fashion for years,” Epstein said. “He probably knows that the government is not going from Defcon 5 to Defcon 1 to remove him from the company, because that would be the worst possible outcome for investors. He’s clearly created more value than he’s hurt shareholders by his tweeting.”
As this ‘Journal of Accountancy’ article explains, Corp Fin clarified in 2016 that non-GAAP measures that substitute individually-tailored recognition & measurement methods for those of GAAP could violate Rule 100(b) of Regulation G (see CDI 100.04). Head scratching ensued – even at the Big 4 – because nobody knew the meaning of “individually tailored.” But the article reports that at the most recent AICPA conference, Patrick Gilmore (a Corp Fin Deputy Chief Accountant) provided these questions to guide the assessment:
– Does the adjustment shift GAAP from an accrual basis of accounting to a cash or modified basis of accounting? For example, Gilmore said using cash receipts or billings as a proxy for revenue for a subscription-based business that recognizes revenue over time would provide a profitability measure that would be determined on a mixed basis of accounting and would be an individually tailored accounting principle.
– Does the adjustment add in transactions that are also reportable in the company’s financial statements? As an example, Gilmore said adjusting from the guidance for determining whether a company is a principal or an agent could result in presenting transactions that don’t qualify as your own under GAAP and may be an individually tailored accounting principle.
– Does the adjustment reflect parts, but not all, of an accounting concept? For example, Gilmore said adjusting income tax effects for cash taxes but not for temporary or permanent differences may be an individually tailored accounting principle.
– Does the adjustment render the measure inconsistent with the economics of a transaction or an agreement? As an example, Gilmore cited some companies that earn revenue from operating leases, but also from sales-type leases or financing leases. “They will adjust revenue for the sales-type or financing leases as if they were operating leases, thus ignoring some of the economics of the lease agreements that they have,” he said.
Would Your Investors Support An Activist?
This recent “Trust Barometer” from the Edelman communications firm has lots of intel about what’s driving investment decisions – based on responses from 500 chief investment officers, PMs and buy-side analysts. This CFO.com article recaps the declining level of trust in business and suggests that companies with higher trust levels, gained via accurate & transparent reporting, experience steadier (and better) share prices.
But what most caught my eye were the investors’ views on activism – especially since this WSJ article reports that there were a record number of activist campaigns last year, and Broc recently blogged that mutual funds are increasingly willing to employ activist tactics:
– 87% of investors are more open to taking an activists approach to investing
– 92% will support a “reputable” activist if they believe change is necessary at the company
– 87% think companies are unprepared for activist campaigns
This “Tech IPO Pipeline” from CB Insights shows that the SEC still has some work to do if it wants to make public offerings as attractive as private funding or an M&A deal. Maybe the SEC’s recent “testing the waters” proposal will help…but this article says it may be more of a market issue, with money migrating to private markets at an unusual rate. Here’s a summary of the pipeline report from Mayer Brown’s blog:
In 2013, the median time between first funding and IPO for U.S. VC-backed tech companies was 6.9 years compared to 10.1 years for tech companies that went public in 2018. In 2018, tech companies raised, on average, $239 million before undertaking their IPOs, which is almost 1.4x the amount raised in 2017, and over 3.7x as much as 2012 figures.
The mega-round financing trend, wherein companies raise over $100 million per round, was also prevalent in the tech-sector, with almost 120 mega-round financings completed in 2018. Tech-focused private equity firms continue to acquire majority stakes in tech companies that are nearing liquidity opportunities, whether IPOs or M&A exits. However, M&A exits continue to replace IPOs.
Pre-IPO Governance: Institutional Investor View
In this interview, Bob McCormick of PJT Camberview points out that it’s not just private equity and VC investors who are funding large pre-IPO companies – institutional investors are also involved. He asked Donna Anderson of T. Rowe Price how much they care about pre-IPO governance, and here’s what she said:
Our approach is to be consistent: we have principles we believe in, whether companies are public or private. For example, our public voting policy is to oppose certain key board members for any company that is controlled by means of dual class stock with differentiated voting rights. We accompany these votes with an explanation to the company as to why we have concerns with that structure for the long-term. Any features we oppose on the public side, we would not tend to consent to them on the private side either.
But it’s really not about applying a rules-based framework. These private companies are looking to their early investors to be their partners, and that’s the attitude we take. It’s about helping them along the journey, helping them find a governance structure that might be appropriate for them today vs. five or ten years from now. Our role in this is not to be the cops on the beat – it’s a consultative relationship. We’re helping to prepare them, if going public is in their plans, for what that will look like in the world of public shareholders, proxy advisors, votes and shareholder rights.
Pre-IPO Governance: When Do Changes Happen?
When it comes to the pre-IPO governance journey, this survey from Stanford’s Rock Center for Corporate Governance says that most companies start transitioning to public company “best practices” about 2-3 years before they go public. Here’s seven examples of how corporate governance practices evolve from startup through IPO:
1. Companies typically add their first independent director to the board 3 years prior to IPO. This occurs around the same time the company first becomes serious about developing a corporate governance system.
2. On average, companies add 3 independent directors prior to IPO. This number varies widely across companies.
3. 53% of companies go public with founder-CEOs. Companies who bring in a non-founder CEO do so 5 years before the IPO, on average. But most companies say that those leaders were hired to scale the company, not necessarily take it public.
4. CFOs are more likely than CEOs to be brought on as part of the IPO process – typically 3 years before going public. Many companies also transition from a regional auditor to a Big Four accounting firm.
5. An internal GC is the “least necessary” governance feature – many companies rely on external counsel.
6. Executive compensation doesn’t change as companies approach the IPO – and KPIs are common – but it becomes more formalized with financial targets afterwards.
7. Only 12% of founders & CEOs believe the quality of governance impacts IPO pricing – but most agree that having a high-quality governance system is required by institutional investors and the SEC.
Over the years, Broc has blogged about periodic attempts by shareholder proponents of going to court to compel the inclusion of a proposal and/or seek declaratory relief to enjoin an annual meeting due to shareholder proposal issues. These types of lawsuits typically challenged a company’s decision to exclude a proposal after Corp Fin granted no-action relief. But recently, the NYC Comptroller went one step further – by filing this complaint against TransDigm shortly after it sought no-action relief – and before Corp Fin weighed in.
The lawsuit sought to enjoin TransDigm – which manufactures aerospace components – from soliciting proxies for its meeting without including a climate change proposal submitted by a group of NYC pension funds. TransDigm had argued to Corp Fin that it could exclude the proposal under Rule 14a-8(i)(7) because it related to “ordinary business.” But the funds – which announced a couple of years ago that they might pursue climate change proposals as an initiative and more recently said they’d pursue a “clean energy” investment & divestment strategy – insisted that this was an urgent matter. Cydney Posner’s blog explains what happened next:
Instead of conforming to the usual practice of submitting its own response to the SEC, the NYC Comptroller’s office wrote to the SEC on December 7th that it would not respond to the company’s November request for no-action because the pension funds had separately commenced a lawsuit against the company seeking declaratory and injunctive relief “that would ensure the… shareholder proposal is included in the proxy solicitation materials.” As a result, in light of the pending litigation, the Comptroller requested that the SEC leave the matter to the courts, requesting that, the “staff follow its prior practice and decline to issue any response to TransDigm’s no-action request.”
The company apparently decided that this was not a battle worth fighting. By letter dated December 28, 2018, in the midst of the government shutdown, the company advised Corp Fin that it was withdrawing its request for no-action relief and would be including the proposal in its 2019 proxy materials. The parties filed a stipulation of settlement on January 18 concluding the action.
In its press release announcing the settlement, the Comptroller said that the “need for climate leadership is more urgent than ever. Yet, just when we need to speed up the pace, federal roll-backs are making polluting easier and could cause generations of damage. That’s why as investors, we’re using our voice to pressure companies to step up and address their role in climate change….Reducing greenhouse gas emissions is a moral imperative—and it’s better for business. We’ll continue to fight for shareholders rights and to hold companies like TransDigm to the highest standards for business and our planet.”
We don’t know yet if the NYC funds will adopt – or inspire other proponents to adopt – a litigation strategy against other companies for climate change proposals and/or other topics. Although the complaint was filed before the government shutdown began, the company might’ve felt additional pressure to settle due to Corp Fin’s inability to respond to no-action requests.
SEC Chair Talks About “Human Capital” Disclosure
In remarks a few days ago to the SEC Investor Advisory Committee, SEC Chair Jay Clayton provided some of his views on human capital disclosure. He first noted that since the time the current disclosure requirements in Items 101 & 102 of Regulation S-K were adopted, human capital has evolved into a resource – rather than a cost – for businesses. And, he acknowledged, disclosure requirements should also evolve over time to reflect market changes…but should remain flexible, enforceable, efficient and grounded in materiality.
So the basic idea stands that companies should focus on providing material information that a reasonable investor needs to make informed investment & voting decisions, and he’s wary of mandating rigid disclosure standards or metrics. But it doesn’t sound like he’s closed the door on nudging companies to provide more info. He continued:
Instead, I think investors would be better served by understanding the lens through which each company looks at their human capital. Does management focus on the rate of turnover, the percentage of their workforce with advanced degrees or relevant experience, the ease or difficulty of filling open positions, or some other factors? I have heard this and similar questions on earnings conference calls and in other investor settings. I am interested in hearing from those on the Committee who manage investment capital – what is it that you are looking for as an investor and what questions do you ask the issuers when it comes to human capital?
Here, a note on comparability. In some cases it is possible to identify metrics that provide for reasonable market-wide comparability (for example, U.S. GAAP). In other cases, this is not possible at a market-wide level, and comparability is reasonably possible at an industry level or only at a company level (this is demonstrated by the development of non-GAAP financial measures). For example, for human capital, I believe it is important that the metrics allow for period to period comparability for the company.
This Cooley blog reports that Jay also touched on proxy plumbing in his remarks – and said that new Commissioner Elad Roisman will be taking the lead on efforts to improve the proxy process, including proxy plumbing, for both the short- and long-term.
SEC Lifts Stay on Administrative Proceedings
Last week, the SEC announced that it was lifting the stay on pending administrative proceedings that it had ordered as a result of the lengthy government shutdown. Parties that had filings due last month should either submit the filings or request an extension – either way, by February 13th.
