It’s no secret that certain folks at the SEC have been particularly focused on auditor independence as of late. Acting Chief Accountant Paul Munter has issued a couple of statements on the topic, and the Division of Enforcement is casting a net for gatekeeper wrongdoing. One thing that would seem to pretty obviously undercut auditor independence would be to have your independent auditor participate in the CFO interview process, but the SEC brought an enforcement action just a few weeks ago that alleges that an audit partner did this…which would be problematic, if true.
Meanwhile, the Center for Audit Quality has been sharing a series of videos & analyses on the value of auditor independence – including this post in support of the current model of auditor independence, which stems from the Sarbanes-Oxley Act and related reforms.
The CAQ says that criticisms of the current model fail to consider vital regulatory & voluntary components that safeguard auditor independence. One of these factors is the role of the audit committee. Here’s an excerpt:
In addition to the many safeguards that auditors must follow, the Sarbanes-Oxley Act had the wisdom to reinforce the role of public company boards of directors and their audit committee. SOX requires that the audit committee, not the CEO or CFO, maintain sole responsibility for the hiring, firing, compensation of, and oversight of the external auditor. Audit committee oversight is an important ingredient of auditor independence; external auditors are not reporting to the employees whose work they are reviewing but instead to a committee with fiduciary responsibilities to the company and its investors.
With 20 years of SOX under our belts, it is sometimes easy to be lulled into complacency and forget how critical it is to closely monitor the independence of the audit committee. This CAQ post is a reminder of why it matters – and the SEC’s current enforcement focus shows that now is not the time to let down your guard on this topic.
In a new 15-minute episode of our “Women Governance Trailblazers” podcast, Courtney Kamlet & I interviewed Sara Jensen, who is Assistant Corporate Secretary for Co-Op Solutions, which is the largest credit union-owned interbank network in the US. I very much enjoyed hearing Sara’s unique perspectives on supporting the board of a cooperative, and how she has made a career in corporate governance coming from a non-lawyer background.
In response to the SEC’s newly effective “universal proxy card” rules, some companies have been tightening up their bylaws (as explained in this 12-minute podcast that John taped with Hunton Andrews Kurth’s Steve Haas). We also discussed the need for bylaw amendments at our recent “Proxy Disclosure Conference” with Davis Polk’s Ning Chiu, Okapi Partners’ Bruce Goldfarb, SGP’s Rob Main and Wachtell’s Sabastian Niles – the consensus there was that bylaw amendments aren’t necessary for every company at this time, but many companies are using this as an opportunity to conduct a review.
A new case shows the risk in being too aggressive. In late October, an activist hedge fund sued a company in the Delaware Court of Chancery over a series of allegedly “draconian” advance bylaw amendments – which require an activist to provide extra disclosures about the hedge fund’s holdings as well as the fund’s limited partners’ holdings. The activist is asking the court to invalidate those provisions, which would reveal the identity of investors that are supporting activists. We don’t know the outcome yet of this case, and it will be worth watching.
Michael Levin at The Activist Investor shared this analysis of the provisions from an activist’s perspective – along with other examples that may go too far, such as requiring activist-appointed directors to resign from the board if they violate a company policy. He lays out activist-perspective concerns with how these provisions could be applied:
Also, we’re talking about duly-elected directors here. We can accept (but don’t like) that a director agrees to these terms as part of a settlement of a proxy contest, or otherwise accepts an invitation to join a BoD. These terms become part of the negotiation between the company and an activist.
Consider a director that wins an election, though. A company with these bylaw terms can pretty much remove directors at its will. It would approve a new policy that the director would violate, then accept the resignation that it required as a condition to even stand for election.
Sure, unnecessary and intrusive disclosure is an expensive hassle. We find limits on what a duly-elected director can do to represent shareholder interests, including automatic enforcement at the discretion of company leadership, much worse.
Lawrence has been blogging on PracticalESG.com about “greenwashing” investigations and consumer lawsuits. This “D&O Diary” blog from RT ProExec’s Kevin LaCroix highlights another flavor of litigation that (not surprisingly) is becoming more common: securities class action lawsuits that allege that company’s have misrepresented their ESG progress.
Kevin describes a recent case that came about after a short report targeted a company that positioned itself as an ESG leader. Here are thoughts from Kevin:
All of these examples (and many others I have previously documented on this site) underscore a point I have made many times, which is that it is not the ESG laggards that are attracting D&O claims. The companies getting hit with ESG-related claims are in fact companies that have taken the ESG initiative. All of this is inconsistent with the D&O insurance industry’s current operating premise about ESG, which is that companies that are supposedly “good” on ESG are better D&O risks and therefore entitled to some (usually unspecified) underwriting advantage or break. All of the available data suggests that this premise is at a minimum incomplete and arguably misguided. The fact is that ESG as a D&O risk is a much more nuanced and multilayered issue than the D&O marketplace have been assuming.
I find this lawsuit interesting to contemplate in the context of a financial marketplace environment where companies are under pressure to demonstrate their ESG credentials. Activist investors, institutional investors, and, yes, D&O insurance underwriters, are creating an environment where companies are motivated to wrap themselves in the ESG flag. The danger is that companies eager to demonstrate their ESG virtues may be vulnerable to allegations of exaggeration, or execution error, or failure to follow through. All of these concerns may, as this case show, translate into D&O claims risk. For that reason, as I have said, even if the ESG laggards may be vulnerable to D&O claims, the companies taking the ESG initiative also may face D&O claims risk, perhaps even more so than the ESG laggards.
The uptick in greenwashing allegations shows that ESG disclosure controls are not a “nice to have” – they are necessary from a risk perspective. We discussed ESG litigation & investigation risks at our 1st Annual Practical ESG Conference a couple of weeks ago, with guidance delivered by Morrison Foerster’s Jina Choi, Beveridge & Diamond’s John Cruden, Ecolumix’s Doug Parker and Baker Mckenzie’s Peter Tomczak. The on-demand video archive & transcript of that conference is still available for purchase by emailing sales@ccrcorp.com. Members of PracticalESG.com can also take advantage of the practical checklists and other resources on that site, which walk through how to verify data, as well as give tips for how to deliver on your claims.
As you face down the new Item 402(v) disclosure requirements for your 2023 proxy statement, join us tomorrow on CompensationStandards.com for a 3-hour special session, “Tackling Your Pay Vs. Performance Disclosures.” This is a 3-part, 3-hour special session that will cover:
1. Navigating Interpretive Issues – we are already getting lots of questions in our Q&A forum about how to apply the new rules, and we know that new issues are arising daily. Hear practitioner guidance and any SEC updates that you need to know – from Sidley’s Sonia Barros, Compensia’s Mark Borges, WilmerHale’s Meredith Cross, EY’s Mark Kronforst, and Morrison Foerster’s Dave Lynn – including what you’ll need to tell your board and executives.
2. Big Picture Impact – how will the disclosure mandate affect say-on-pay models and shareholder engagements? This session will provide context and pointers for bolstering executive compensation & compensation committee support during proxy season – featuring ISS Corporate Solutions’ Jun Frank, Morrison Foerster’s Dave Lynn, and SGP’s Rob Main.
3. Key Learnings From Our Sample – attendees of this event will get first access to our sample disclosures, prepared by Mark Borges and Dave Lynn. Hear “lessons learned” from their drafting effort that will guide you through your own process and jump start your disclosures. Mark & Dave will be joined by Gibson Dunn’s Ron Mueller and Fenwick’s Liz Gartland for this discussion.
If you’ve signed up to access this event, you’ll access the video stream tomorrow by clicking through where indicated on the event page and entering the email address that you used to register. If you have any questions, please email our Event Manager, Victoria Newton, at vnewton@ccrcorp.com.
This event is available at a reduced rate of only $295 for anyone who is already a CompensationStandards.com member or who registered for the live or on-demand version of our “Proxy Disclosure & 19th Annual Executive Compensation Conferences.” You can still register online today for the “special session” and get the CompensationStandards.com member rate. Beginning tonight, you can register by emailing sales@ccrcorp.com, up until 12:30 pm Eastern tomorrow.
For non-members, the cost to attend is $595. You can register online if you sign up before 4pm Eastern today (after that, email sales@ccrcorp.com… you can sign up as late as 12:30 pm Eastern tomorrow).
If you’re not yet a member, try a no-risk trial now. We’ll be continuing to add practical guidance on this topic to CompensationStandards.com as disclosure hurdles & consequences come to light – such as this great podcast that Dave already taped with Gibson Dunn’s Ron Mueller about “first impressions” of the rule, emerging interpretive issues, possible pitfalls, and more.
All that to say, a CompensationStandards.com membership be an essential ongoing resource if you are involved with pay vs. performance. Plus, our “100-Day Promise” guarantees that during the first 100 days as an activated member, you may cancel for any reason and receive a full refund. Register for the “special session” here if you are a non-member and didn’t attend our Conference.
As a bonus, you also can still get the discounted special session rate if you sign up for on-demand access to the Conference archives, which you can do by emailing sales@ccrcorp.com. The practical guidance that was provided at these events will help you navigate shareholder activism, executive compensation, ESG disclosures, compensation committee responsibilities, and more in 2023.
Snow is in the forecast here this week, which is a reminder that annual report season will soon be upon us – and it’s time to start assessing whether you need to update your risk factors. This 14-page memo from White & Case gives color on 10 macro developments that may affect your risk factors this year:
1. Market Conditions
2. Inflation & Interest Rates
3. Covid-19 Impact
4. ESG Issues
5. Ukraine Conflict
6. Cybersecurity
7. Supply Chain Disruptions
8. Human Capital & Labor Issues
9. Regulatory Developments (e.g., the Inflation Reduction Act)
10. Trade Sanctions
The memo goes on to give 4 important drafting reminders – e.g., avoiding hypotheticals. For additional practical tips on that front, see our article from the January-February 2018 issue of The Corporate Counsel newsletter on “Best Practices for Drafting Your Risk Factors” – and our “Risk Factors Disclosure” Handbook. Also see the memos we’ve posted on “Risk Trends” in our “Risk Management” Practice Area. If you don’t already have access to these resources, email sales@ccrcorp.com.
Korn Ferry & Gibson Dunn recently published this survey of board evaluation practices in the S&P 500, based on public disclosures. Anthony Goodman, who leads Korn Ferry’s Board Effectiveness Practice, shared these highlights from the 440 companies that provided details in their proxy statements:
– 60% are evaluating individual directors, not just the board or its committees
– 53% are using interviews as part of the process, rather than relying purely on surveys
– 32% use a third party evaluator either annually or periodically
While individual director evaluations appear to be getting more common, Anthony notes that it’s rare for them to yield constructive feedback for directors. Using independent evaluators to conduct interviews can help overcome that challenge – and make it more likely that the board & individuals receive candid, nuanced & actionable feedback.
Right now, the survey concludes that the lack of feedback could be hampering the usefulness of board evaluations: only 23% of companies disclosed that they made changes as a result of the evaluation.
That seems low, but it’s important to keep in mind that there are a variety of reasons why companies might not spell out changes that resulted from the evaluation process – so a lack of disclosure doesn’t necessarily prove that changes aren’t happening. Yet, there are ways to make the board’s efforts at “continuous improvement” more transparent. Anthony suggests describing:
– An overview of the process
– Key takeaways
– Updates on the key takeaways from prior year evaluations
As outlined in this Cozen O’Connor memo, the Fifth Circuit heard oral arguments in late August for the lawsuit that challenges the SEC’s approval of Nasdaq’s board diversity rule, which we’ve blogged about a few times. While we await the outcome of that case, Nasdaq has also filed notice that it is extending its program to provide eligible companies with complimentary board recruiting services – and the updated terms for this service are immediately effective. Here’s more detail:
Nasdaq is proposing to extend its program, described in IM-5900-9, providing Eligible Companies (as defined in IM-5900-9) with complimentary board recruiting services. The rule currently requires Eligible Companies to request services by December 1, 2022; as revised that deadline would be extended to December 1, 2023. Nasdaq also proposes to make clarifying changes to reflect the approval of Rule 5605(f).
Under Nasdaq Rule 5605(f)(7), the earliest that a Nasdaq listed company will need to explain why it does not have at least one Diverse director (as defined in Nasdaq Rule 5605(f)(1)) is August 6, 2023; and the earliest it will have to explain why it does not have at least two Diverse directors is August 6, 2025.
Earlier this fall, John blogged that the Division of Enforcement had gotten something it has coveted for quite some time – an insider trading case involving senior executives allegedly misusing a Rule 10b5-1 plan. Bloomberg reported last week that the SEC is looking to add to that tally, using data analytics. Here’s an excerpt:
The Justice Department and Securities and Exchange Commission are using computer algorithms in a sweeping examination of preplanned equity sales by C-suite officials, according to people familiar with the matter. Investigators are concerned that some people are manipulating the stock-sale programs, which are intended to shield executives from misconduct allegations by letting them schedule transactions in advance and on preset dates.
The article says that the agencies are preparing to bring “multiple cases,” following information requests that were made earlier this year, and that at least one company has disclosed that it received subpoenas about a former executive’s trading activity under a Rule 10b5-1 plan.
If the SEC successfully uncovers violations, it may use those findings to refine & support final rules that restrict the use of prearranged trading plans, as proposed last year. The securities law community has expressed concern that, as proposed, the rules would be a departure from insider trading law and should be targeted more closely to address demonstrable abuses. If the investigations come up empty, the Commission may still adopt the rules using data it has already relied on – and may also keep looking for violations.
Insider trading is just one of the many topics that the SEC’s Enforcement Division is focused on right now, according to a PLI speech last week from SEC Chair Gary Gensler. He noted that all of this activity has added up to massive fines & penalties:
In the fiscal year that just ended on September 30, 2022, we filed more than 700 actions. We obtained judgments and orders totaling $6.4 billion, including $4 billion in civil penalties.
This Reuters article says that’s a record level of collections for the agency. Gensler also had a message for securities lawyers:
You also have a role as gatekeepers in upholding the law.
For instance, today’s event takes place in the State of New York, where the state courts describe the role of attorney as a position of duty, trust, and authority, conferred by governmental authority for a public purpose.
We want you to succeed in meeting these standards of rectitude.
When lawyers—or other gatekeepers, like auditors and underwriters—breach their positions of trust and violate the securities laws, we will not hesitate to take action.
During the recent fiscal year, for example, we charged an attorney for his role in an unregistered, fraudulent securities offering, and we suspended him from practicing before the SEC as an attorney.
We also are litigating an action against an attorney for his alleged role in a would-be pump-and-dump scheme. In addition to other remedies, we seek an injunction to prohibit him from providing legal services regarding securities offers or sales.
These examples may be just a couple of bad apples, but they serve as a reminder to “Just Say No” to any sketchy propositions. Chair Gensler also noted that the SEC has been pursuing auditors and underwriters, in some of the largest and/or first actions of their kind.
