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.
In recent years, as SEC rulemaking has stalled on topics like proxy access and political spending disclosure, “private ordering” has become the catalyst for ESG changes (see Broc’s earlier blog about how that’s faring). This may have been due partly to Department of Labor interpretive bulletins from 2015 and 2016 which assured ERISA fiduciaries – i.e. pension plans – that they could consider ESG factors in making investment decisions.
1. Fiduciaries must avoid too readily treating ESG issues as being economically relevant to any particular investment choice
2. Fiduciaries may not incur significant plan expenses to (i) pay for the costs of shareholder resolutions or special shareholder meetings, or (ii) initiate or actively sponsor proxy fights on environmental or social issues
As noted in a CII alert, the most significant impact of the guidance likely will be on shareholder engagement. Earlier guidance – the bulletin says – didn’t suggest that it’s always appropriate for plans to engage with the board or management of companies in their portfolios. The guidance “was not meant to imply that plan fiduciaries, including appointed investment managers, should routinely incur significant plan expenses” to fund advocacy or campaigns on shareholder resolutions or proxy fights on environmental or social issues at portfolio companies. It appears that this new field assistance bulletin shifts the burden to pension funds to prove there are tangible activism benefits in every case. This creates a negative presumption that most ESG factors are not economically significant.
The change in tone will undoubtedly elicit angst among governance & sustainability advocates. It’s the latest in a long history of back-and-forth: the DOL’s 2015 & 2016 bulletins were issued in response to a 2008 bulletin, which walked back 1994 guidance. Also see this Davis Polk blog entitled “Are the Reports that the DOL Guidance Will Lead to the Demise of ESG-Focused Plans Greatly Exaggerated?”…
Sustainalytics’ ESG Ratings Now on Yahoo! Finance
Here’s the intro from this blog by Davis Polk’s Ning Chiu:
Some companies may not be aware that since February, their Yahoo Finance web page includes a separate tab with the ESG scores from Sustainalytics. The Sustainalytics quote page shows a company’s numerical rating for three categories, environment, social and governance, along with the overall ESG score. Scores range from 1 to 100.
There is also a graphic representation of the score that, according to the Sustainalytics press release, will be tracked against the average in each category and plotted over time. The graph, currently reflecting data from 2014 to now, is intended to display trends of how a company ranks against industry peers.
Our May Eminders is Posted!
We’ve posted the May issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
Every few years, we survey the practices relating to blackout & window periods (we’ve conducted over a dozen surveys in this area). Here’s the results from our latest one:
1. Does your company ever impose a “blanket blackout period” for all or a large group of employees?
– Regularly before, at, and right after the end of each quarter – 78%
– Only in rare circumstances – 15%
– Never – 7%
2. Does your company allow employees (that are subject to blackout) to gift stock to a charitable, educational or similar institution during a blackout period?
– Yes, but they must preclear the gift first – 47%
– Yes, and they don’t need to preclear the gift – 16%
– No – 30%
– Not sure, it hasn’t come up and it’s not addressed in our insider trading policy – 7%
3. Does your company allow employees (that are subject to blackout) to gift stock to a family member during a blackout period?
– Yes, but they must preclear the gift first – 37%
– Yes, and they don’t need to preclear the gift – 14%
– No – 38%
– Not sure, it hasn’t come up and it’s not addressed in our insider trading policy – 11%
4. Are your company’s outside directors covered by blackout or window periods and preclearance requirements?
– Yes – 100%
– No – 0%
5. Our company’s insider trading policy defines those employees subject to a blackout period by roughly:
– Stating that all Section 16 officers are subject to blackout – 3%
– Stating that all Section 16 officers “and those employees privy to financial information” are subject to blackout – 4%
– Stating that all Section 16 officers “and others as designated by the company” are subject to blackout – 38%
– Stating that all Section 16 officers “and those employees privy to financial information and others as designated by the company” are subject to blackout – 35%
– All employees – 16%
– Some other definition – 4%
– Our company doesn’t have an insider trading policy- 0%
Please take a moment to participate anonymously in these surveys:
This “Harvard Law” blog claims that companies that use the word “stockholder” hold the sinister view that investors are passive and powerless book-entries:
Today, the term “stockholder” gives off a whiff of a Mad Men-era world where investors were bystanders. Nearly all institutional investors have junked “stockholder” for “shareholder” when referring to themselves. They see their roles not as passive holders of electronic notations but as parties sharing responsibilities for performance when they invest in a company.
That’s why Blackrock CEO Larry Fink recently wrote to corporate boards referring to investors conspicuously as “owners”— the word “stockholder” is nowhere to be found.
So, the blog concludes that the move to “shareholder” was caused by greater attention to investor rights and long-term stewardship. Maybe it’s just me – but I think we’re reading too much into this terminology. I interned for a Delaware Justice – we always used “stockholder” since that’s the word used in the DGCL. But I use “shareholder” for companies incorporated in states that follow the Model Business Corporation Act or otherwise use that terminology in their statute. On this site, we almost always use “shareholder” – but we do that because it’s easier, not as a statement on investor rights. This blog might’ve eliminated my last hope that actions matter more than words.
On the other hand, maybe there’s something to it. Keith Bishop pointed out that even though the blog focuses on the “shareholder v. stockholder” distinction – the nomenclature it’s really trying to argue for is “shareowner.” Here’s his note:
It is my understanding that shareholder activists have adopted the term “shareowner” as a way of signaling that they are more than passive investors (i.e., they are owners, not mere holders). CalPERS, for example, refers to itself as a “shareowner”. I haven’t run across any corporate statutes that have adopted the term, however. As for Delaware, the DGCL uses the term “stockholder”. Incongruously, however, Rule 23.1 of the Delaware Court of Chancery Rules refers to “shareholder”.
Poll: “Shareholder” v. “Stockholder”?
Please take our anonymous poll about your views on investor terminology:
We haven’t heard much about auditor rotation since the PCAOB’s concept release about that topic in 2011. That concept release didn’t go too far due to controversy. But at GE, proxy advisors appear to be taking a closer look at the company’s longstanding relationship with its auditor. Here’s the intro from Cydney Posner’s blog (also see this WSJ article):
It’s certainly a rare event, but both ISS and Glass Lewis have recommended voting against a proposal to ratify the appointment of GE’s auditor, KPMG at the GE annual shareholders meeting. Most often, the issue of auditor ratification is not very controversial—in fact, it’s usually so tame that it’s one of the few matters at annual shareholders meetings considered “routine” (for purposes of allowing brokers to vote without instructions from the beneficial owners of the shares). Are we witnessing the beginning of a new trend?
In its analysis justifying its negative recommendation, ISS observed that the SEC is currently investigating GE’s revenue recognition practices and internal controls related to long-term service agreements, as well as a $9.5 billion increase in future policy benefit reserves for the GE’s insurance operations. ISS also cites commentators who suggested that GE and its auditors “must have or should have been aware of the issues—particularly the increasing insurance liabilities—for years.” These accounting issues, together with KPMG’s issuance of unqualified reports on the financial statements, were the basis of the recommendation by ISS against ratification of the auditors. Not to mention that KPMG has been GE’s auditor for a long time—by a “long time,” I mean 109 years! And notwithstanding major changes in the management team, ISS observed, the board, stressing the benefits of auditor tenure, still reappointed KPMG.
In addition, ISS also saw no discussion in the proxy statement regarding how or whether the board took into account KPMG’s role in GE’s two accounting problems or any other regulatory issues involving KPMG, including auditor independence allegations (which both ISS and GL indicate were alleged to involve GE) that KPMG settled with the SEC in 2014 or the indictments in 2018 of KPMG employees.
Glass Lewis also indicated that it usually supports management’s choice of auditor except when GL believes the auditor’s “independence or audit integrity has been compromised.” In its analysis, GL raised the same concerns as ISS regarding the SEC investigation of GE and problems at KPMG, noting in particular the large increase in fees to KPMG in the prior year, as well as its long tenure as GE’s auditor, which has “thrown KPMG’s effectiveness and relationship with the Company into question.”
Also note this article which highlights how the new changes to the audit report include disclosure of the length of an auditor’s tenure at that company. The article notes: “At the time of writing, 21 of the Dow 30 companies had released their annual reports (those with Dec. 31 year-ends). The average auditor tenure at those companies was 66 years.”
1. Why have audit regulators such as the PCAOB – which has now been in business for 15+ years – been unable to improve the quality of audits to high-quality?
2. Why is the goal to have 71% of audits comply with professional standards? Do investors really have to pay for audits when 29% are found to be defective?
3. Does this system even work? The regulators very rarely fine an auditor for deficient work. And auditors have a conflict of interest since they’re paid by the company being audited.
4. How can the IFIAR manage and inspect for quality – when their report says they’re having a difficult time figuring out how to measure it? Perhaps that’s the reason over one in every four audits is deficient.
The inconsistency among IFIAR member findings is also concerning. Those who conducted fewer inspections were much more likely to find a significant failure to satisfy audit standard requirements. There was a 62% finding rate for members inspecting 20 or fewer audits – a 46% finding rate for members inspecting 21-40 – and a 30% finding rate for members inspecting 41 or more.
The two areas with the highest rate & greatest number of findings were:
– Accounting Estimates: most findings related to failure to assess the reasonableness of assumptions
– Internal Control Testing: most commonly, auditors failed to obtain sufficient persuasive evidence to support reliance on manual controls. The next most common finding was that auditors failed to sufficiently test controls over – or the accuracy & completeness of – data or reports produced by management
“You Get What You Pay For”: Audit Fee Pressure Lowers Audit Quality?
There’s some concern among audit firms that they’re being required to “do more with less.” Rigorous work is required to comply with Sarbanes-Oxley and other regulations – but clients are looking for ways to reduce or maintain fee levels. As a consequence, 80% of firms have seen a reduction in the profitability of audit services.
Studies are starting to show that this fee pressure is negatively impacting audit quality. This latest white paper finds that there’s a higher rate of misstatements among firms that are shifting their focus to more profitable non-audit services. Interestingly, the analysis also shows that the decline in audit quality is more common at large audit offices than small ones.
Some people in our community are wondering whether this information will affect auditor regulations and shareholder ratification votes. I’m not holding my breath – this study just confirms what many people have been observing for decades, and shareholders seem to ignore audit fee info.
Yesterday, Corp Fin issued two new CDIs about non-GAAP financial measures that are used in connection with business combinations. They’re a follow-on to CDI 101.01 – which we blogged about last fall. This Wachtell Lipton memo provides an overview (also see this Cooley blog):
While CDI 101.01 helped address the recent spate of frivolous litigation claiming that projections disclosed to explain the assumptions underlying a financial advisor’s fairness analyses require GAAP reconciliation, plaintiffs’ lawyers subsequently seized on the fact that the CDI did not explicitly clarify whether the GAAP reconciliation requirements apply to projections shared with bidders or the board and opportunistically continued to pursue weak disclosure claims.
The underlying logic of the initial CDI plainly applies to these circumstances too: disclosure of internal forecasts to bidders or the board is not intended to communicate performance expectations to investors, and reconciling them to GAAP is neither useful nor required. Corp Fin has now helpfully confirmed that the same considerations animating the initial CDI extend to these additional factual circumstances.
SEC Impersonators: “This Is What Fraud Sounds Like”
Scammers impersonating the SEC aren’t something new (here’s a blog about one such scam). Yesterday, the SEC issued a warning – along with a one-minute audio recording – about SEC impersonators who are pretending to execute trades in an attempt to dupe people into giving them money or account info. Crazy stuff. Here’s an excerpt:
“The audio recording is what fraud sounds like,” said Lori Schock, Director of the SEC’s Office of Investor Education and Advocacy. “We included the recording in our Investor Alert so investors can hear the lies and high pressure tactics imposters use to cheat potential victims out of their money.”
Transcript: “Conduct of the Annual Meeting”
We’ve posted the transcript for our recent webcast: “Conduct of the Annual Meeting.”
Following up on Broc’s blog about the passing of Julie Yip-Williams, there will be a memorial service for Julie on Saturday, May 5th at 5:30 pm, at St. Ann & Holy Trinity Church (157 Montague St, Brooklyn). In lieu of flowers, her family requests that memorial contributions be made to the “Colorectal Cancer Alliance” in Julie’s name.
This “Prosperity Report” from Allstate looks novel. It’s an 11-page document that is positioned before the proxy statement. The full document is: Prosperity Report, Letter from Independent Directors, Proxy Statement, Financial Report – the whole Allstate story under one hood. The “Prosperity Report” focuses on the company’s long-term goals, purpose & role in society.
The thing feels like “BlackRock Catnip.” It’s basically a human capital sustainability report (which is a priority for BlackRock, as noted in this blog) – and yes, BlackRock is the company’s largest holder. Another way to look at it perhaps is as an innovative expansion of the CEO’s “Letter to Shareholders” that typically kicks off the glossy annual report. Whatever your view, you have to admit that Allstate doesn’t slack on its proxy materials. You might recall Broc’s blog from last year, claiming that their proxy statement was one of the best…
Transcript: “The SEC’s New Cybersecurity Guidance”
We’ve posted the transcript for our recent popular webcast: “The SEC’s New Cybersecurity Guidance.”
Last Call for Early Bird Registration! Our “Pay Ratio & Proxy Disclosure Conference”
Early Bird Rates – Act by April 13th: Huge changes are afoot for executive compensation practices with pay ratio disclosures on the horizon. We are doing our part to help you address all these changes – and avoid costly pitfalls – by offering a special early bird discount rate to help you attend these critical conferences (both of the Conferences are bundled together with a single price). So register by April 13th to take advantage of the 20% discount.
Over the years, Broc has blogged about mistakes made in filings (here is one such blog). Members are kind enough to send us good stories about mistakes they’ve seen in SEC filings. Here are a few new ones (please send your own stories – we’ll keep them confidential unless you tell us otherwise):
I live in fear of internal notes making it into filings – always do a “ctrl+F” search for brackets, all team member names and NSFW words before giving the go-ahead!
Best Pay Ratio Disclosure to Date!
Hilarious item on the NASPP blog yesterday from McLagan’s Ryan Gildner – here’s an excerpt:
The newly formed Data on Ratio Comparison Society (D.O.R.C.S) is pleased to announce preliminary results from a groundbreaking ongoing study of CEO pay ratio disclosures. According to Ryan Gildner, president of the Society, “This is the first study of its kind and uses an unprecedented innovative approach to evaluate the content of CEO pay ratio disclosures. We hope our data will provide a new perspective on this controversial disclosure and lead to a more complete understanding of its value.”
Using a proprietary 16-point qualitative analysis, the Society has identified the following disclosure to be the best disclosure to date:
As required by Item 402(fu) of Regulation S-K, we are providing the following information:
For fiscal 2017, our last completed fiscal year:
– The number of words comprising the CEO Pay Ratio Regulation (Item 402(u) of Regulation S-K) is 2,933.
– The number of words comprising the Compensation Discussion and Analysis Regulation (Item 402(b) of Regulation S-K) is 1,282.
Our April Eminders is Posted!
We have posted the April issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
Here’s the intro from this blog by Cooley’s Cydney Posner:
Is it just me? Am I the only one that finds having to decipher a load of graphics in a proxy statement to be somewhat daunting on occasion? Inclusion of graphics in lieu of copious text has been almost de rigueur in proxy statements for several seasons now as a way to facilitate comprehension of sometimes complex data. And most often, those graphics are relatively effective for that purpose. As we head into the 2018 proxy season, however, this piece on CFO.com suggests that some forms of visual presentation may be, well, a lot more useful than others.
According to the article, featuring some graphics does make sense because research has shown that people “process visual information faster than verbal information. And we do it with a part of the brain that requires less energy.” That’s especially true with line and bar charts. Where things get trickier, the article suggests, is with pie charts: “a pie chart often makes it hard to figure out the exact magnitude of a data point (a slice) and uses a lot of text to display very little data. It also forces readers to rapidly move their eyes back and forth between the legend and the graphic to interpret the data. A simple table can be a lot more elegant, experts say.”
And more sophisticated tools, such as “exploding 3-D pie charts” can compound the problem, according to one academic. He also took issue with “stacked bar charts,” according to the article, “’because they make estimating the values of the variables on the top of the bars difficult.’”
Tomorrow’s Webcast: “Handling the Proxy Season – The In-House Perspective”
Tune in tomorrow for the webcast – “Handling the Proxy Season: The In-House Perspective” – to hear Intuit’s Betsy McBride, Juniper Networks’ Shahzia Rahman and Oracle’s Renee Strandness discuss how to prepare for the proxy season from the in-house perspective…
Here’s the results from our recent survey on Regulation FD policies & practices (here’s other Reg FD surveys conducted over the years):
1. Our company has a written policy addressing Regulation FD practices:
– Yes, and it is publicly available on our website – 5%
– Yes, but it is not publicly available on our website – 64%
– No, but we are in the process of drafting such a policy – 7%
– No, and we do not intend to adopt such a policy in the near future – 24%
2. For Regulation FD purposes, our company believes:
– Our website is a “recognized channel of distribution” – 29%
– We are still studying whether our website is a “recognized channel of distribution” – 17%
– Our website is not a “recognized channel of distribution” – 52%
– I don’t even know what this question means – 2%
3. Compared to our insider trading policy, our Regulation FD policy:
– Has the exact same parameters – 34%
– Our Regulation FD policy imposes a quiet period that starts earlier than our insider trading policy – 6%
– Our Regulation FD policy imposes a quiet period that starts later than our insider trading policy – 25%
– Our Regulation FD policy imposes a quiet period that lasts longer than our insider trading policy – 6%
– Our Regulation FD policy imposes a quiet period that lasts shorter than our insider trading policy – 28%
– We don’t have a Regulation FD policy – 26%
I found it interesting that Japan just introduced its own version of Reg FD. Better late than never…
Equifax: Special Committee Finds Insiders Properly Pre-Cleared Trades
Back when I blogged about the Equifax cybersecurity breach – and the question arose whether senior executives had pre-cleared trades in the company’s stock – I wrote: “At this point – as the LA Times article notes – we don’t know if these officers were aware of the breach before they made the sales and/or whether the company’s pre-clearance procedures were adequately followed.”
Equifax now has released this special committee report dealing specifically with this pre-clearance of insider trades. And after reviewing 55,000 documents & 62 interviews with the parties involved, it found that the insiders involved did indeed properly pre-clear the trades according to the company’s policy. That certainly is good news.
