Occasionally, there’s an debate about whether directors should attend senior management meetings. Some think it’s a bad idea because directors might cross the line into operations. This “Stanford Rock Center” article presents the counterargument – by using Netflix as a case-study. At Netflix, directors regularly observe senior management meetings to get an unfiltered understanding of issues & strategies.
Of course, another benefit is that it’s an opportunity for directors to build relationships outside of the C-suite – and it gives them the ability to evaluate senior managers, which can eventually help with CEO succession planning. For more, see our “Checklist: Board Access to Management” – and our “Board Access” Practice Area.
Poll: Should Directors Attend Management Meetings?
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Director Viewpoints: Anxious About Technology
The main finding from the annual “What Directors Think” survey – by NYSE Governance/Spencer Stuart – is that many directors share an “overwhelming concern” of being ill-equipped to keep up with cyber threats & disruptive technology. Here are five other takeaways:
1. Boards’ main strengths continue to center around strategy & finance – only 12% of directors list IT as a skill
2. Cybersecurity, disruptive innovations & succession planning are the main issues for which directors would seek outside advice
3. Directors are changing their tune about cybersecurity regulations – 60% now think they’re a good idea (compared to 22% last year)
4. Nearly 75% support board diversity efforts
5. 57% of directors say an enhanced brand image and reputation – and a greater ability to attract & retain employees – are big benefits of corporate social responsibility programs…but ESG initiatives are at the bottom of their priorities
Here’s something that I blogged yesterday on our “Proxy Season Blog”: The National Association of Manufacturers (NAM) and other conservative-leaning organizations have launched a new campaign, the “Main Street Investors Coalition” – with a multi-million dollar budget – to limit the influence of large asset managers that they feel wield too much power on ESG initiatives. As we’ve previously blogged, more support from Vanguard is one factor that has led to higher approval rates for ESG proposals – and, as noted in this blog, BlackRock has also urged companies to develop a long-term strategy that accounts for their societal impact.
This Axios article says that the group’s first focus will be writing studies & op-eds backing up their positions – which is interesting in light of recent DOL guidance that restricts ERISA fiduciaries from pursuing ESG initiatives in the absence of data showing that the initiatives will lead to higher returns. It’s not clear yet whether this group will also pursue the tactic of submitting its own shareholder proposals, in order to beat ESG activists to the punch.
The Axios article notes that this campaign comes at a time when “shareholder advocacy” has been producing more social change among companies than legislation. And here’s an excerpt from an op-ed by Bloomberg’s Matt Levine:
The interesting development will be if this (pro-corporate, anti-environmentalist, etc.) group makes common cause with the more left-ish critics of institutional investors who worry that they create antitrust problems. Having most of corporate America controlled by a handful of giant institutions: It makes a lot of people nervous.
Deloitte Fined $500k for Faulty Audit
Yesterday, as noted in this article, the PCAOB levied a hefty $500k upon Deloitte for missing material accounting errors in three consecutive audits of a client…
Memorial Day Weekend
May we have lasting gratitude and memories of those who’ve sacrificed for our country.
Some companies decide to ban reporters from their annual meetings. The risk in doing this is that it backfires and draws even more negative publicity. Here’s one example of negative press due to a ban – and this MarketWatch article looks at another recent uproar. Nell Minow is quoted:
It’s not unusual for companies to say that meetings are for shareholders only. But I think that it’s best practice for them to allow press in so that shareholders who can’t be there in person can learn about the sole opportunity shareholders have to see the board and executives in person – how they present themselves when they control the process, and how they respond to questions when they do not. If the answer is cutting off access to the press, the obvious question is, what are they trying to hide?
Our “Checklist: Annual Meetings – Dealing with the Press” outlines logistics to think about if you want media coverage at your meeting – or if you don’t. It also considers the possibility of using rules of conduct to limit the type of coverage – e.g. a ban on recording devices. But this article shows that those types of restrictions should also be handled carefully.
Annual Meetings: Be Consistent With Your Admission Policies
It’s always smart to be consistent when restricting shareholder attendance at your annual meeting. Some companies require beneficial holders to show proof of ownership in order to gain admittance. But if you’re going to use that as a means to prohibit people from being admitted, it can be risky to make exceptions in exchange for a vow of silence.
This article highlights that risk – here’s an excerpt:
After the attorneys summoned security guards to physically block Danhof from the meeting room – and threatened to call the police – Danhof gave up and opted to file a complaint with the SEC. He had begun to suspect that the situation involved more than a simple miscommunication when the company offered to let him attend if he didn’t make any comments or attempt to address the meeting.
“That leads me to believe that they did some quick research, they figured out I was there, that I was an activist investor, that I ask tough questions and put CEOs on the spot, and they wanted to do whatever they could to make sure their CEO didn’t have to answer the question,” he said.
Recently, CII responded to MSCI’s proposal to weight companies in its indexes based on whether they have unequal voting structures – i.e. “dual class” companies. Since CII wants alignment between economic & voting rights, it’s not surprising that they support the proposal. But – consistent with these letters that CII recently sent to two IPO candidates – they suggest exemptive relief for companies that adopt a 7-year sunset provision.
CII also thinks that it would be reasonable for a sunset structure to be renewable for additional 7-year terms if approved by a majority of the shares with inferior voting rights – and that existing index constituents should have 3 years to adopt a sunset provision before getting dinged by MSCI’s weighting feature. CII’s response differs from BlackRock’s. As I recently described on “The Mentor Blog,” BlackRock wants indexes to reflect the entire investable marketplace.
Sustainability: More Talk Than Action?
This Ceres report finds that few companies are taking a “systemic approach” to sustainability. Sure, lots of proxy statements make reference to sustainability as a board responsibility, but just 13% of large companies have formalized that in committee charters and/or disclosed board-management engagement – and 83% of boards don’t have a director with sustainability expertise. Similarly, a third say they link executive pay to sustainability – but most don’t describe the specific goals that are incentivized.
Ceres found that companies that are more precise in these areas are at least twice as likely to have strong sustainability commitments. On each topic, the report highlights disclosure from companies with leading practices – a good starting point if you’re looking to bolster your own systems.
Ceres & “The B Team” also released this “Climate Smart Primer” to help directors understand the potential material impact of sustainability issues…
“Bipartisan Banking Act” Will Soon Become Law
Here’s a nice infographic from Davis Polk about the “Bipartisan Banking Act” – which the House passed yesterday – that makes big changes to the regulation of banking organizations. It’s expected to be signed by the President shortly. Also see this MoFo memo…
Here’s something that I blogged yesterday on CompensationStandards.com: A member of Congress is now using pay ratio data to examine income inequality. This study from Rep. Keith Ellison’s staff (D-Minn) looked at pay ratios from 225 large companies that were responsible for employing more than 14 million workers. When it comes to “extreme gaps,” it “names names” – and it also seems to assume that companies that excluded portions of their workforce were doing so to keep their ratio down.
This article describes the findings – here are the main ones:
1. Pay ratios ranged from 2:1 to 5000:1. The average was 339:1 – compared to 20:1 in 1965
2. 188 companies had a ratio of more than 100:1 – so the CEO’s pay could be used to pay the yearly wage for more than 100 workers
3. Median employees in all but 6 companies would need to work at least one 45-year career to earn what their CEO makes in a single year
4. The consumer discretionary industry had the highest average pay ratio – 977:1
I think it’s easy to become numb to high CEO pay when you work with it all the time and you’re focused on the mechanics of programs and disclosures. This study is a reminder that no matter how useless pay ratio seems to companies, people outside of this field are paying attention – and they’re synthesizing the data not just to compare companies, but to show that outsized executive pay is a pervasive issue that interests many.
Pay Ratio: Customer Fallout?
As highlighted in Rep. Keith Ellison’s study, the consumer discretionary industry is shaping up to have the highest average pay ratios – 977:1 among the S&P 500. That compares to a supposedly ideal ratio among consumers of 7:1, according to this study. And while the high numbers aren’t surprising given the workforce for most of those companies, this WSJ article says it could impact their bottom line. Here’s the high points:
A recent study found that consumers are significantly less likely to buy from companies with high CEO pay ratios. First, it found that sales declined for Swiss companies when their high pay ratios were publicized.
In a follow-up experiment, people had the chance to win a gift card to one of two retailers. In the absence of pay-ratio information, 68% of people chose one retailer’s card and 32% chose the other. But when participants were informed that the first of those retailers had a 705:1 pay ratio and the second had a 3:1 ratio, just 44% of people chose gift cards from the first retailer while 56% chose the second.
It’ll be interesting to see whether this holds true in “real life,” where customers probably aren’t looking at pay ratios at the same time they’re making a purchase – and may not have the option to buy from a company with a 3:1 ratio. The lowest ratios I’ve seen for that industry are around 100:1.
By the way, here’s this CNBC piece entitled “Companies with Closer CEO Pay Ratios May Generate Higher Profit Per Worker.”
Last week, two Parliament committees issued their final report on the collapse of Carillion – which had been the UK’s second-largest construction group. The situation has been called the British “Enron” and could lead to sweeping reform. As described in this ”Financial Times” article, the report comes down hard on the Big Four auditors – and also blames the implosion on the board and lax regulations. It includes these findings:
– Carillion’s directors elected to increase its dividend every year, come what may. Even as the company very publicly began to unravel, the board was concerned with increasing and protecting generous executive bonuses.
– Government should refer the statutory audit market to the Competition and Markets Authority. Possible outcomes considered should include breaking up the audit arms of the Big Four, or splitting audit functions from non-audit services. The lack of competition in the audit market “creates conflicts of interest at every turn.”
– In its failure to question Carillion’s financial judgements and information, KMPG was “complicit” in the company’s “questionable” accounting practices, “complacently signing off its directors’ increasingly fantastical figures” over its 19 year tenure as Carilion’s auditor.
– The regulators are wholly ineffective – they only started investigating after the company collapsed and are more interested in apportioning blame than in proactively challenging companies and averting avoidable failures.
– The regulators’ mandate should be changed to ensure that all directors who exert influence over financial statements can be investigated and punished.
Also, the British have a way with words. Here are comments from one MP:
“Same old story. Same old greed. A board of directors too busy stuffing their mouths with gold to show any concern for the welfare of their workforce or their pensioners. This is a disgraceful example of how much of our capitalism is allowed to operate, waved through by a cozy club of auditors, conflicted at every turn. Government urgently needs to come to Parliament with radical reforms to our creaking system of corporate accountability. British industry is too important to be left in the hands of the likes of the shysters at the top of Carillion.”
Some advocates have been pushing companies to put together “integrated reports.” To illustrate how easy they think it is to do so, a couple of researchers recently prepared this 40-page mock “Integrated Report” for ExxonMobil (starts at page 18). As they describe in this Forbes article, they used publicly-available info – the 10-K, proxy statement, citizenship report, annual report, etc. – and said it took them about 40 hours to edit & organize it into the framework.
Some might say that the 40-hour estimate to draft an integrated report isn’t realistic. Perhaps their effort overlooks the amount of time associated with ensuring the various components of an integrated report work together appropriately – and all the layers of review that a company (who has real potential liability for the end product) must go through.
By the way, according to this announcement, the next step for these researchers is to create an “Integrated Report Generator Tool” – which will “provide stakeholders with a way to create integrated reports.”
Poll: Challenges of Drafting Integrated Reports
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Bank Examiners Can’t Override Privilege: 7-Firm Memo
This “7-Firm Memo” asserts that bank examiners aren’t entitled to privileged material from financial institutions – and shouldn’t condition favorable examination results & relationships upon “voluntary” waivers. The analysis relies heavily on recognition of the attorney-client privilege by the SEC & DOJ. Both agencies have said they don’t require privilege waivers in order to deem a company “cooperative.”
Every few years, we survey annual meeting practices (we’ve conducted about a dozen surveys on this & related topics). Here’s the results from our latest one:
1. To attend our annual meeting, our company:
– Requires pre-registration by shareholders – 16%
– Encourages pre-registration by shareholders but it’s not required – 8%
– Requires shareholders to bring an entry pass that was included in the proxy materials (along with ID) – 14%
– Encourages shareholders to bring an entry pass but it’s not required – 11%
– Will allow any shareholder to attend if they bring proof of ownership – 76%
– Will allow anyone to attend even if they don’t have proof of ownership – 11%
2. During our annual meeting, our company:
– We hand out rules of conduct that limit each shareholder’s time to no more than 2 minutes – 30%
– We hand out rules of conduct that limit each shareholder’s time to no more than 3 minutes – 35%
– We hand out rules of conduct that limit each shareholder’s time to no more than 5 minutes – 5%
– We announce a policy that limits each shareholder’s time to no more than 2 minutes (but rules are not handed out) – 3%
– We announce a policy that limit each shareholder’s time to no more than 3 minutes (but rules are not handed out) – 0%
– We announce a policy that limit each shareholder’s time to no more than 5 minutes (but rules are not handed out) – 3%
– There is no limit on how long a shareholder can talk (subject to the inherent authority of the Chair to cut off discussion at any time) – 24%
3. For our annual meeting, our company:
– Provides an audio webcast of the physical meeting, including posting an archive – 24%
– Provides an audio webcast of the physical meeting, but does not post an archive – 3%
– Has provided an audio webcast of the physical meeting in the past, but discontinued that practice – 3%
– Is considering providing an audio webcast of the physical meeting but haven’t decided yet – 0%
– Provides a video webcast of the physical meeting (or is considering doing so) – 8%
– Does not provide an audio nor a video webcast of the physical meeting – 62%
4. At our annual meeting, our company:
– Announces the preliminary results of the vote on each matter (unless special circumstances arise such as a very close vote) – 89%
– Doesn’t announce the preliminary results of the vote on each matter – 11%
5. For our annual meeting:
– Our CEO makes a presentation and takes Q&A from the audience – 90%
– Our CEO makes a presentation but no Q&A from the audience – 3%
– We are considering revising next year’s format to eliminate the CEO presentation – 3%
– We are considering revising next year’s format to eliminate the Q&A – 3%
– We are considering revising next year’s format other than the CEO presentation and Q&A but haven’t decided yet – 3%
Also see the transcript for our recent webcast: “Conduct of the “Annual Meeting.”
Board Diversity: Some Progress
This Bloomberg article highlights stories of boards who are achieving some diversity by appointing people who are first-time directors – and who aren’t sitting or retired CEOs. Here’s an excerpt:
Waste management company Republic Services Inc. has been looking for diverse directors since 2011, after a 2008 merger with Allied Waste Industries left it with an all-male board, including one black man. “Change meant bringing people into the waste business who had other experiences,” says CEO Don Slager. “Prior to the merger, frankly, they were just a bunch of garbage men.”
As part of this push, the company enacted some new policies, including a mandatory retirement age of 73 for directors. A variety of experience also was a priority, Slager says. Candidates ideally would bring expertise in areas not already represented, such as logistics and financial reporting. “When you drop a layer below the C-suite, it opens you up to a whole new group of people who are the future leaders of these organizations,” he says.
While the article notes that in 2017, 45% of appointees to S&P 500 boards were novice directors – and a majority of incoming directors were women or minorities – it also states that white men still hold more than 75% of these seats. Not to detract from the companies highlighted as gender diversity success stories in the article – because I do think they’re being thoughtful about this and making progress – but they’ve actually just achieved the “three women” benchmark that Broc’s blogged about…
Age Diversity: Stats on Boards’ “Next Generation”
According to this PwC article, 90% of directors say that age diversity is important – a higher number than gender, race & other forms of diversity. Yet “young directors” – defined as anyone 50 or under – held only 6% of S&P 500 board seats in 2017, and the average age of independent directors increased to 63.
Not surprisingly, the information technology, consumer discretionary & consumer staples industries are the most likely to have at least one director – and technology expertise and active industry knowledge are commonly-cited skills.
Also see this EY report on the traits of first-time directors in 2017.
There’s nothing hotter right now than data analytics. “Big data” can yield some big opportunities – so it would seem that boards would seek this information out when strategizing the big picture. At a minimum, boards should be at least oversee how their companies are using data analytics. This KPMG memo throws out some key questions for boards to consider:
— How is the data being collected and organized within the company and who is involved? Ultimately, who is responsible?
— Can the data be trusted? How is the quality and integrity of the data assessed?
— Does the company have a data ethics policy to protect the brand reputation and reduce legal risk?
— Does the company have the right talent, skills, and resources required to implement/manage its D&A activities?
— Has the company scoped out the near-term and longer-term opportunities for its use of D&A, including financial reporting and predictive analytics?
Trends in Board Cybersecurity Oversight
This recent EY webcast about the board’s cybersecurity oversight role included a poll of director & executive attendees. It appears that most companies aren’t making big changes in response to the SEC’s cybersecurity guidance from earlier this year. Here’s what else they found:
1. Which emerging technology does your board expect to have the greatest impact on the company’s strategy?
– Artificial Intelligence (AI)/Machine Learning and Internet of Things (IoT) – tied at 23%
– Blockchain and Robotic Process automation – tied at 19%
2. As a board member, which of the following do you think is most important to enhance the company’s cyber maturity posture?
– Enhancing data protection and privacy policies – 32%
– Continuously educating and testing the workforce on cybersecurity related matters – 22%
– Improving cyber threat intelligence gathering – 18%
3. How often are your board and management team conducting tabletop exercises and crisis scenario exercises?
– Annually – 31%
– Ad hoc basis/rarely – 30%
– Twice a year or never – tied at 18%
4. Given the recent SEC cybersecurity guidance, do you expect a material change in your disclosure controls process and procedures during your next quarter-end?
– No – 60%
– Yes – 40%
Delaware has amended its data breach law for the first time since enacting it in 2005 (see this Pepper Hamilton memo). To help companies comply with the new requirements, it’s now launched this website with template forms. According to this Morgan Lewis blog, the forms can be used for the required data breach notices to the Delaware Attorney General as well as consumers – and the website also provides a link for consumers to file complaints.
A few years ago, Broc blogged about a VC appointing a robot director. Turns out their announcement was a play on words. But when it comes to director recruitment – the future is now? This paper shows that directors selected using an algorithm would perform better – based on shareholder approval numbers & company profitability – than individuals selected by the company’s board. Here’s an excerpt of the findings from this “Harvard Law” blog:
The differences between the directors suggested by the algorithm and those actually selected by firms allow us to assess the features that are overrated in the director nomination process. Comparing predictably unpopular directors to promising candidates suggested by the algorithm, it appears that firms choose directors who are much more likely to be male, have a large network, have a lot of board experience, currently serve on more boards, and have a finance background.
In a sense, the algorithm is saying exactly what institutional shareholders have been saying for a long time: that directors who are not old friends of management and come from different backgrounds are more likely to monitor management. In addition, less connected directors potentially provide different and potentially more useful opinions about policy. For example, TIAA has had a corporate governance policy aimed in large part to diversify boards of directors since the 1990s for this reason.
An important benefit of algorithms is that they are not prone to the agency conflicts that occur when boards and CEOs together select new directors. Institutional investors are likely to find this attribute particularly appealing and are likely to use their influence to encourage boards to rely on an algorithm such as the one presented here for director selections in the future.
SIFMA’s Report to Help More Companies Go & Stay Public
In this recent report, SIFMA (“Securities Industry & Financial Markets Association”) – which represents brokers, banks & asset managers – gives its two cents about what’s behind the declining number of public companies, why this is bad, and how to fix it. Not surprisingly, they suggested reducing the compliance burden (as opposed to SEC Commissioner Rob Jackson’s recent suggestion that underwriters need to reduce their fees). This Gibson Dunn memo summarizes the many recommendations:
1. Expand & lengthen the EGC exemptions under the JOBS Act
2. Encourage more research coverage of EGCs and other small public companies by allowing investment banks & analysts to jointly attend pitch meetings and relaxing restrictions on communications during an offering
3. Reduce the “administrative burden” of public reporting and the influence of activist shareholders & proxy advisory firms
4. Allow all companies to use Form S-3 – and allow underwriters to communicate on behalf of WKSIs before filing a registration statement
5. Implement a revenue-only test for smaller reporting companies, and raise the cap so that more companies would qualify
6. Tailor the equity market structure for small public companies, by allowing smaller tick sizes and limiting their shares to fewer exchanges (however, smaller exchanges are arguing this would be anti-competitive)
And see this “Radical Compliance” blog for another hypothesis on declining IPOs: the real issue isn’t that companies are afraid of going public because of fees or compliance, the issue is that it’s easy to stay private because there’s loads of money in that space…
ISS Launches a New “Help Center”
ISS has migrated its communications to a new portal – the “ISS Help Center.” This Weil blog has more details:
The ISS Help Center may be used by companies, law firms, consultants, and other third-parties who register. It includes FAQs & allows you to connect with ISS about research reports, engagement, peer groups, and equity plan verification – among other matters.
ISS will no longer take questions via email to the Global Research Help Desk and is eliminating various other legacy global e-mail addresses that were previously used to submit inquiries to ISS.
SEC Commissioner Mike Piwowar – whose term expires in early June & who served briefly as Acting SEC Chair last year – will leave the SEC by early July, after serving nearly five years. Here’s an excerpt from the WSJ article:
Mr. Piwowar’s departure would leave the agency with four commissioners, meaning some votes could be deadlocked if the SEC’s two Democrats oppose measures favored by Chair Jay Clayton, a Trump administration appointee. That could slow Mr. Clayton’s progress on his priorities, which include stricter rules for brokers advising retail investors and lightening the regulatory burdens on public companies.
In theory, the White House and Senate could move quickly and nominate replacements for both Mr. Piwowar and Democratic SEC Commissioner Kara Stein, whose term ended last year. The Senate usually considers candidates for commissioners in pairs – one Republican and one Democrat.
Supplemental Pay Ratios: Not So Many (So Far)
Here’s something that I blogged last week on CompensationStandards.com: One of the big unknowns for the first year of mandatory pay ratio was whether companies would include supplemental ratios using a different methodology from the required rules. What situations would justify that extra effort? This Pearl Meyer blog notes that of the first 1039 companies to file proxies this year, only 99 have included a supplemental ratio. That’s less than 10%. Here’s what else they found:
– Most of the supplemental ratios were significantly lower than the required pay ratio.
– The desire to smooth out the impact of one-time or multi-year grants to a CEO was the most commonly occurring reason to provide a supplemental ratio.
– The most profound decrease from the required ratio occurred when companies provided a supplemental ratio that excluded part-time and seasonal employees.
– 14 companies provided a supplemental ratio that was greater than the required ratio, mostly likely to avoid a drastic increased ratio in 2019.
It’s possible that supplemental ratios will become more common in the future, as companies try to explain year-over-year pay ratio changes…
SEC’s Information Security Program: Not “Effective”
Recently, the SEC’s Inspector General released its audit results for the SEC’s information security program – as required by the “Federal Information Security Modernization Act.” Although the SEC’s program has improved, it didn’t meet the criteria to be deemed “effective” as of September 30, 2017. The SEC is supposed to submit a corrective action plan by mid-May that covers the audit’s 20 recommendations.
And in recent testimony before the House Appropriations Financial Services Subcommittee, SEC Chair Jay Clayton discussed the SEC’s new Chief Risk Officer position, its incident response procedures, and its ongoing internal investigation of last fall’s high-profile Edgar hack.
