We have many interesting topics on the agenda for our “Proxy Disclosure & 21st Annual Executive Compensation Conferences” next week – including color commentary about updated disclosure requirements that will apply for 2025, and what you need to do now to prepare. This Covington memo summarizes what will be new next year for calendar-year companies. At a very high level:
– File your insider trading policies and procedures as exhibits to Form 10-K
– Discuss your insider trading policies and procedures in your Form 10-K (or incorporated proxy)
– Provide narrative and tabular disclosure about the timing of stock options and option-like instruments in close proximity to disclosures of MNPI
The memo also recaps the many changes that became effective during 2024 – which of course we’ll need to continue to comply with going forward – as well as guidance on cyber incident reporting, universal proxy rules, pay-versus-performance, and XBRL tagging.
In case you forgot, the SEC’s climate disclosure rules were also adopted – and stayed – earlier this year. The memo recommends that companies keep thinking about how their disclosure controls and procedures may need to change if the rules do go into effect.
Yesterday, the SEC posted notice of an NYSE proposal that, if approved, would make it harder for penny stocks to linger around as listed companies. Here’s what the change would look like if adopted:
Notwithstanding the foregoing, if a company’s security fails to meet the Price Criteria and the company (i) has effected a reverse stock split over the prior one-year period or (ii) has effected one or more reverse stock splits over the prior two-year period with a cumulative ratio of 200 shares or more to one, then the company shall not be eligible for any compliance period specified in this Section 802.01C and the Exchange will immediately commence suspension and delisting procedures with respect to such security in accordance with Section 804.00.
Furthermore, a listed company may not effectuate a reverse stock split if the effectuation of such reverse stock split results in the company’s security falling below the continued listing requirements of Section 802.01A.
The proposed rule would apply to a company even if the company was in compliance with the Price Criteria at the time of its prior reverse stock split. The NYSE’s rationale for the proposal isn’t too surprising:
As described above, many companies seek to cure their noncompliance with the Price Criteria or seek to increase their stock price for other reasons by effectuating a reverse stock split. However, the Exchange has observed that some companies, typically those in financial distress or experiencing a prolonged operational downturn, engage in a pattern of repeated reverse stock splits. The Exchange believes that such behavior is often indicative of deep financial or operational distress within such companies rendering them inappropriate for trading on the Exchange for investor protection reasons. In these situations, the Exchange has observed that the challenges facing such companies, generally, are not temporary and may be so severe that the company is not likely to maintain or regain compliance on a sustained basis.
If this proposal looks familiar, it’s because Nasdaq has also been looking to rein in the use of reverse splits as a compliance strategy. As Meredith noted a few months ago, this type of rule change, if approved, would make it more important to strike the right balance in calculating a reverse split.
In addition to this proposal about reverse splits, the NYSE is shaking its fist at delinquents. The Exchange also proposed a rule change to say that it would not review a compliance plan submitted by a listed company that is below compliance with a continued listing standard if the company owes any unpaid fees to the Exchange. Under this proposal, the NYSE would immediately commence suspension & delisting procedures if the fees aren’t paid in full by the plan submission deadline or at the time of any required periodic review. Here’s the SEC notice for that one.
Earlier this week, the US Government Accountability Office released its annual report on the effectiveness of the SEC’s conflict mineral rule in promoting peace & security in the DRC and adjoining countries. This year, the GAO did not bury the lede, naming the report: “Peace and Security in Democratic Republic of the Congo Have Not Improved with SEC Disclosure Rule.” In fact, according to the GAO, the data shows that the rule has actually contributed to the spread of violence at some mines. Here’s an excerpt from the 1-page highlights:
GAO found no empirical evidence that the rule has decreased the occurrence or level of violence in the eastern DRC, where many mines and armed groups are located. GAO also found the rule was associated with a spread of violence, particularly around informal, small-scale gold mining sites. This may be partly because armed groups have increasingly fought for control of gold mines since gold is more portable and less traceable than the other three minerals. Further, GAO found that the number of violent events in the adjoining countries did not change in response to the SEC rule.
Page 13 of the report gives a good overview of the troubled journey of the conflicts mineral disclosure rule and the current Staff and Commission indications about enforcement.
The GAO did find that the rule has encouraged companies to take a closer look at supply chains, and it’s raised awareness about the risks that mineral purchases will benefit armed groups. But the GAO says that minerals are only one factor contributing to conflict in the DRC and adjoining countries, so “transparent sourcing” is both extremely challenging and inadequate on its own to meaningfully improve peace and security.
Many of our friends and readers are preparing for Yom Kippur today. We are sending wishes to everyone for a peaceful year.
In addition to comments from the Corp Fin Staff on cyber-related Form 8-K disclosures that Dave & Meredith previously shared, we’re beginning to see comment letters that the Staff has issued on Form 10-K cybersecurity disclosures. These disclosures were first required this year under Item 106 of Regulation S-K. Here’s a sampling of early comments (some of which I’ve paraphrased):
– We note that leaders from your information security, compliance and legal team oversee cybersecurity risk management. Please revise future filings to provide the relevant expertise of such persons or members in such detail as is necessary to fully describe the nature of the expertise as required by Item 106(c)(2)(i) of Regulation S-K.
– We note statements that you have not currently engaged any third-party service providers to support, manage, or supplement your cybersecurity processes, and that your Audit Committee receives updates from and discusses matters with your third-party IT support specialists. These statements appear inconsistent. Please revise future filings to clarify whether you engage assessors, consultants, auditors or other third parties in connection with your processes for assessing, identifying and managing material risks from cybersecurity threats as required by Item 106(b)(1)(ii) of Regulation S-K.
– We note you do not include Item 1C. Cybersecurity. Please revise or advise us why you do not provide disclosures as applicable under Item 106 of Regulation S-K.
Although comment letters are company-specific, these are the types of comments we’d expect to see out of the Disclosure Review Program as the Staff assesses “Year 1” compliance for this rule. The Corp Fin Staff isn’t looking to “play gotcha.” But if your disclosure has inconsistencies, or if you forgot to include Item 1C – or a specific element – you might be asked to correct that.
Yesterday, the SEC announced that it is monitoring the impact of Hurricane Milton on capital markets – and that it also continues to monitor the impact of Hurricane Helene. We continue to think of all those affected by these back-to-back catastrophic weather events.
The SEC will evaluate relief from filing deadlines as needed. Here’s more detail:
The SEC divisions and offices that oversee companies, accountants, investment advisers, mutual funds, brokerage firms, transfer agents, and other regulated entities and investment professionals will continue to closely track developments. They will evaluate the possibility of granting relief from filing deadlines and other regulatory requirements for those affected by the storms. Entities and investment professionals affected by Hurricane Milton or Hurricane Helene are encouraged to contact SEC staff with questions and concerns:
– Division of Examinations staff in the SEC’s Miami Regional Office can be reached by phone at 305-982-6300 or email at miami@sec.gov
– Division of Examinations staff in the SEC’s Atlanta Regional Office can be reached by phone at 404-842-7600 or email at atlanta@sec.gov
– Division of Corporation Finance staff can be reached by phone at 202-551-3500 or via online submission at www.sec.gov/forms/corp_fin_interpretive
– Division of Investment Management staff can be reached by phone at 202-551-6825 or email at imocc@sec.gov
– Division of Trading and Markets staff can be reached by phone at 202-551-5777 or email at tradingandmarkets@sec.gov
– Office of Municipal Securities staff can be reached by phone at 202-551-5680 or email at munis@sec.gov
Here is something that Meredith blogged earlier this week on our Proxy Season Blog for members:
Bloomberg reports that 22 state AGs announced an inquiry late last week in the form of a joint letter to Nasdaq alleging that the exchange’s board diversity rule may conflict with both State and federal anti-discrimination laws. The letter asks the stock exchange to provide “a summary and specific documentation of Nasdaq’s rules and policies requiring its listed companies to follow federal and State anti-discrimination laws and any legal analysis explaining how those laws comport with Nasdaq’s purportedly aspirational quotas.”
It requests that Nasdaq respond by October 23. In a statement to the WSJ, Nasdaq says it “designed the framework to preserve each company’s decision-making authority over its board composition.”
The signatories to the letter are some of the “usual suspects” in terms of challengers to DEI-related policies. In addition to joining amicus briefs in the pending litigation in the Fifth Circuit challenging Nasdaq’s board diversity rule, they have also challenged the proxy advisors’ DEI proxy voting policies.
As usual, we were inundated with announcements about SEC enforcement activity during the final days of September. I can’t wait to see the full stats. One settlement in particular stood out amidst the FYE crunch – and it’ll probably get your directors’ attention too. The SEC announced charges against a former director who allegedly failed to inform the rest of the board about a “close personal friendship” with a company executive.
In the SEC’s view, that caused the company’s proxy statements to contain materially misleading statements that inaccurately identified the director as “independent” under listing standards and its own governance guidelines. When the company learned of the relationship (which came to light during a CEO succession planning process), it determined that the director was not actually independent under these standards.
The complaint elaborates on the relationship and how it was concealed. Here’s an excerpt:
Around 2017, Craigie began to mentor Executive consistent with his practice of mentoring employees with growth potential. Shortly thereafter, Craigie formed a personal friendship with Executive, who, at this time, was head of a Church & Dwight division. Over the next few years, Craigie and his spouse vacationed internationally with Executive and his spouse six times, traveling to eight countries on five continents. Craigie invited several other couples on these trips and generally paid for all guests’ business class airfare and luxury lodging. Craigie paid over $100,000 for Executive and his spouse to attend these vacations.
Craigie and Executive, along with their spouses, also vacationed together domestically over long weekends, and Executive occasionally stayed at Craigie’s apartment in Miami. Craigie took Executive and his family on boat trips in New York, Connecticut, and Miami.
This blog from Cooley’s Cydney Posner points out that this isn’t the first time Enforcement has brought charges relating to director independence disclosures (here’s my blog about the earlier case). But this current action was more surprising because rather than tripping over one of the line-item independence (or interlock) rules, it turned on the “catch-all” aspect of director independence – i.e., the affirmative determination that there is no material relationship with the company, with broad consideration of all relevant facts and circumstances. Gunster’s Bob Lamm elaborates on the “slippery slope” concern:
There have been many cases over the years in which directors were alleged – often by investors and/or the media – to have lacked independence because they belonged to the same country club, served on the same boards (including boards of charitable organizations), or generally hung out in the same social circles. Some of these cases generated calls for SEC rulemaking that would require disclosure of these informal relationships and thereby disqualify directors in such cases from being described as independent. However, for whatever reason (and I can think of a few), the SEC never took such action.
So, what does “close personal friendship” mean? The SEC appears to have chosen that language carefully – so it’s clearly more than a casual friendship. Although it’s difficult to say where exactly to draw the line, if you encounter a situation in which a director and executive regularly vacation together on a yacht and around the world, you should think hard about whether they’ve crossed it.
Without admitting or denying the SEC’s allegations, the former director agreed to a 5-year D&O bar and a $175k civil penalty. It’s worth sharing this cautionary tale when you circulate your questionnaires next year.
In light of the SEC’s recent trend of tacking on “disclosure controls” violations to charges about non-financial disclosures, I was somewhat heartened to see that the recent “director independence” enforcement action reflected a settlement with the former director, but no action against the company.
It appears the company took standard steps to collect info about director relationships that might affect the “independence” determination:
– Providing a questionnaire with a non-exclusive list of relationships that could affect independence and asking both broad & specific questions to gather information,
– Instructing D&Os to “exercise great care” in providing answers (worth a shot!), and
– Giving the director the opportunity to review and comment on the proxy statement before it was published.
Alas! Although it’s still nice the company wasn’t charged with wrongdoing here, it’s a stretch to rely on this settlement for comfort that these steps will always be adequate. That’s because, in this particular case, it appears the SEC just brought charges relating to proxy disclosures under Exchange Act Section 14(a) and Rule 14a-9 (even though this disclosure had been incorporated into the company’s Form 10-K). If there were no Section 13(a) charges, a disclosure controls charge would be off the table.
The gist of the rule, as amended, is that if you use a reverse stock split to regain compliance with the minimum bid price requirement, and that causes you to fall below the minimum number of publicly held shares and holders that Nasdaq standards require, you don’t get extra time to cure the new violation. The SEC notice gives more detail – here’s an excerpt (also see this Cooley blog):
Under the proposed rule, such company will not be considered to have regained compliance with the Bid Price Requirement if the company takes an action to achieve compliance and that action results in the company’s security falling below the numeric threshold for another Exchange listing requirement without regard to any compliance periods otherwise available for that other listing requirement. In such event, the company will continue to be considered non-compliant until both: (i) the other deficiency is cured and (ii) thereafter the company meets the bid price standard for a minimum of ten consecutive business days, unless Nasdaq staff exercises its discretion to extend this ten-day period as discussed in Rule 5810(c)(3)(H).
If the company does not demonstrate compliance with (i) and (ii) during the compliance period(s) applicable to the initial bid price deficiency, Nasdaq will issue a Staff Delisting Determination Letter.
This rule is separate from the one I blogged about earlier this week on “accelerated delistings” for penny stocks – although both involve Rule 5810. In fact, this blog has been corrected a couple hours after publication to reflect the distinction. Nasdaq probably had good reasons for making these two separate proposals, but those reasons aren’t clear to me, and I apologize for adding to any confusion in the original blog post!
Spencer Stuart recently published its 2024 Board Index – which always includes valuable data points about board composition and governance practices in the S&P 500. The Index also spotlights trends over the 1-, 5-, and 10-year periods.
One thing that jumped out, which Meredith also discussed in a recent podcast with ESGAUGE’s Paul Hodgson, is the small but noticeable shift away from mandatory director retirement policies. According to Spencer Stuart’s data, 67% of S&P 500 boards still have a retirement policy – but that’s a decrease from 69% last year and 73% in 2014. Moreover, at companies that do have policies in place, the mandatory retirement age has been creeping up (from approximately 72 to approximately 75, with the average being 74). This A&O Shearman memo from late last year articulates why some companies are reconsidering mandatory retirement policies:
Given the challenges described above and the focus on individual directors, it seems certain that boards will feel a sense that the pace of the need for refreshment is accelerating. Traditional models for ensuring reasonable turnover on the board, such as mandatory retirement age and term limits are blunt tools that may not result in the optimum outcomes in terms of board configuration and deliberation, especially at crucial moments in a company’s evolution. Also, these approaches may lead to a loss of experience, leadership or critical skills at an inopportune time.
Boards need to consider whether these methods operate as crutches to avoid difficult interactions about continued service or hobble their plans for refreshment. A flexible approach, where length of service and other factors are considered in the renomination process, may prove more effective, especially if coupled with a board culture that is more accepting of director departures when tenure, skills or other factors call for it, fostered by strong leadership and constant communication about the board’s needs.
Spencer Stuart’s 2024 Board Index shows that the move away from mandatory retirement policies isn’t happening in a vacuum. 28% of boards work with a third party to facilitate the evaluation process (up from 25% last year), and 47% conduct individual director evaluations as part of their process. Additionally, in just 4 years, the percentage of boards that include a director skills matrix in their proxies has almost doubled (from 38% in 2020 to 73% in 2024).
The result of all this work on refreshment? In 2024, boards across the S&P 500 added a total of 406 new independent directors, which is up from last year but down from the 432 directors added in 2019. Average tenure is unchanged from last year – but it’s dropped by 3% over the past 5 years and 7% over the past 10 years. I’m cautious about drawing too many conclusions from high-level stats, when boardroom dynamics are so company specific. But it appears that *maybe* third-party evaluations, investor voting policies, and a shareholder activism environment where “nobody is safe” may be spurring the types of hard conversations that actually affect the refreshment rate.
