Yesterday at an open meeting, the SEC adopted amendments to parts of Regulation S-K – specifically relating to Item 101 (business description), Item 103 (legal proceedings) & Item 105 (risk factors). As anticipated, the amendments include increased focus on human capital.
These are the first significant amendments to these disclosure items in 30 years – and the updates have been many years in the making, as they’re part of the “disclosure effectiveness initiative” that emerged with the SEC’s 2016 concept release and continued up through last year’s proposal. These go beyond the “cleaning out the garage” amendments of a couple years ago and are intended to simplify the substantive disclosure requirements while also improving the readability of disclosure documents. The amendments shift away from prescriptive disclosures to a more principles-based disclosure framework. Here’s an excerpt from the SEC’s press release with highlights:
– Amend Item 101(a) by:
making it largely principles-based, requiring disclosure of information material to an understanding of the general development of the business;
replacing the previously prescribed five-year timeframe with a materiality framework; and
permitting a registrant, in filings made after a registrant’s initial filing, to provide only an update of the general development of the business focused on material developments that have occurred since its most recent full discussion of the development of its business, which will be incorporated by reference;
– Amend Item 101(c) by:
clarifying and expanding its principles-based approach, with a non-exclusive list of disclosure topic examples drawn in part from topics currently contained in Item 101(c);
including, as a disclosure topic, a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business; and
refocusing the regulatory compliance disclosure requirement by including as a topic all material government regulations, not just environmental laws;
– Amend Item 103 by:
expressly stating that the required information may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document to avoid duplicative disclosure; and
implementing a modified disclosure threshold for certain governmental environmental proceedings resulting in monetary sanctions that increases the existing quantitative threshold for disclosure of those proceedings from $100,000 to $300,000, but that also affords a registrant some flexibility by allowing the registrant, at its election, to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or one percent of the current assets of the registrant; and
– Amend Item 105 by:
requiring summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages;
refining the principles-based approach of Item 105 by requiring disclosure of “material” risk factors; and
requiring risk factors to be organized under relevant headings in addition to the subcaptions currently required, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.
The Commission adopted the amendments by a 3-2 vote – Commissioners Allison Herren Lee and Caroline Crenshaw dissented. Some may have hoped for more prescriptive human capital disclosure requirements and the two dissenting statements each express concern with the principles-based nature of the rule. In Commissioner Lee’s dissenting statement, she said she would have supported the final rule “if it had included even minimal expansion on the topic of human capital to include simple, commonly kept metrics such as part time vs. full time workers, workforce expenses, turnover, and diversity.” Commissioner Lee also cited the rule’s “ill-advised omissions” of diversity and climate change. Commissioner Crenshaw’s dissenting statement says the rule fails to deal adequately with climate change risk and human capital and suggests the Commission form an external ESG Advisory Committee to help the Commission respond to ESG trends.
One aspect of the amendments some companies likely aren’t thrilled with is the new requirement to include summary risk factor disclosure when risk factor disclosure exceeds 15 pages. Commissioner Hester Peirce’s statement says she views this change as a “bit of an experiment” and wonders whether the “penalty” of needing to prepare a summary will overcome the fear of litigation that leads companies to produce voluminous risk factor disclosures.
The rules will be effective 30 days after publication in the Federal Register and we’ll be posting the avalanche of memos in our “Reg S-K” Practice Area. We’ll also be updating our Handbooks on these topics.
There’s More! SEC Amends Definition of “Accredited Investor” & QIBs
Before yesterday’s meeting even began, the SEC also adopted amendments to the definition of “accredited investor” in Reg D and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act. The new “accredited investor” definition expands the number of investors eligible for this status – by allowing individuals to qualify based on their professional knowledge, experience or certifications while also expanding the list of entities that may qualify. In determining whether an individual would qualify as an accredited investor based on a particular certifications or credentials, under the amended definition, the SEC will consider, among other things, whether the certification, designation or credential arises out of an examination designed to reliably and validly demonstrate an individual’s comprehension and sophistication in the areas of securities and investing – examples being a Series 7, 65 or 82 license.
The SEC’s amendments to the definition of “qualified institutional buyer” broaden it by including LLCs, RBICs and any institutional accredited investor not already listed in Rule 144A when they meet the existing threshold of $100 million in securities owned and invested.
Although the SEC’s Press Release says the “SEC Modernizes the Accredited Investor Definition”, Commissioners Allison Herren Lee and Caroline Crenshaw issued a joint dissenting statement on the “Failure to Modernize the Accredited Investor Definition” that says despite support for indexing the accredited investor wealth thresholds to inflation, the amended definition fails to do so while also putting vulnerable investors at risk. And Commissioner Hester Peirce tweeted about her statement that the rule didn’t go far enough.
The new rules will be effective 60 days after publication in the Federal Register – and we’ll be posting memos in our “Accredited Investor” and “Rule 144A” Practice Areas. We’ll also be updating our “Regulation D Handbook”.
SEC Calendars Open Meeting: Amendments to Whistleblower Rules on the Agenda
Yesterday, the SEC also scheduled another open meeting – it’s scheduled for this coming Wednesday, September 2nd. The Sunshine Act notice says that the Commission will consider whether to adopt amendments to rules relating to the SEC’s whistleblower program – it’s not clear whether they’ll move forward on some of the controversial amendments that were under consideration last year. Here’s an excerpt from the notice:
The amendments would enhance claim processing efficiency, and clarify and bring greater transparency to the framework used by the Commission in exercising its discretion in determining award amounts, as well as otherwise address specific issues that have developed during the whistleblower program’s history. The Commission will also consider whether to adopt interpretive guidance concerning the term “independent analysis” in the Commission’s rules implementing its whistleblower program.
Last week, the NYT DealBook column said that shipping giant, A.P. Moller-Maersk, not only reinstated full-year financial guidance but also pegged it higher than pre-pandemic levels. If your company is on the fence about what to do, you’re not alone as companies seem to be all over the map.
A recent AlphaSense Analyst blog analyzed trends in companies providing or withdrawing quarterly or annual earnings guidance and says recent data shows continued uncertainty. Recapping Q1, the blog notes there was an unprecedented number of companies that withdrew guidance due to market turbulence that resulted from Covid-19. After reviewing Q2 updates, the blog says some companies have begun reinstating previously withdrawn guidance, while others maintained their ambiguous position and declined to provide guidance – in other words, companies are still sitting amid uncertainty, although some sectors lean more one direction than the other. Here’s some takeaways:
– Since the huge spike in guidance withdrawals this Spring, companies have taken different approaches to providing guidance Q2 earnings, with a near even split between companies providing guidance and those declining to do so
– Consumer Discretionary companies declined to provide guidance most often, accounting for 19% of companies not providing guidance this quarter
– Information Technology companies account for 17% of companies declining to provide guidance and 24% of companies sharing guidance this quarter, showing a split in confidence across the sector
ESG Disclosure Trends: SEC Filings Increasingly Highlight Disclosures on Company Websites
A recent White & Case report summarizes ESG disclosure trends of the top 50 of Fortune 100 companies by revenue. It’s a good look at where disclosure is headed as all of the information was pulled from SEC filings and it’s notable how much human capital and environmental disclosure was included in the filings. When comparing 2020 data to 2019, it’s important to note the effect of the Covid-19 pandemic and the current social climate and how that has placed focus on companies’ management of ESG issues. Here’s some of the report’s highlights:
– In 2020, every company surveyed increased its ESG disclosures in at least one category in their proxy statements compared to 2019
– The largest increase in ESG disclosures came in human capital management, in fact 90% of the companies surveyed included some form of HCM disclosure in their 2020 Form 10-K or proxy statement, increasing 8% from 2019
– 29% of the 2020 filings increased their environmental disclosure from 2019, with a significant increase in the amount of quantitative disclosures, such as information on greenhouse gas emissions reductions and renewable energy use
– Other ESG categories on the rise in 2020 include company culture, ethical business practices, board oversight of E&S issues, social impact/community and E&S issues in shareholder engagement
The report provides a few things for companies to think about that includes beefing up disclosure on human capital management, environmental, and board oversight of E&S issues – if companies haven’t already done so. One tricky issue for companies is deciding where to include ESG disclosures – in SEC filings or on company websites. The report says 84% of the companies surveyed referred readers to disclosure on the company’s website from their 10-K or proxy statement with an increasing number using their SEC filings to high-light for investors that enhanced ESG reporting is available on the company website.
Bloomberg Joins Mix with Proprietary ESG Score
We’ve blogged before about the various ESG ratings – here’s an entry about Morningstar and Sustainalytics joining up and now we can add Bloomberg to the mix. Earlier this month, ThinkAdvisor reported that Bloomberg launched its own proprietary ESG score, available to Bloomberg Terminal subscribers. Initially, the score will cover E&S for over 250 companies in the oil and gas sector and it will also include board composition scores for over 4300 companies. For board composition, here’s an excerpt from Bloomberg’s press release:
The Board Composition scores enable investors to assess how well a board is positioned to provide diverse perspectives and supervision of management, as well as to assess potential risks in the current board structure. The quantitative model is designed by Bloomberg governance specialists and utilizes Bloomberg’s management and board level data. The scores rank the relative performance of companies across four key focus areas of diversity, tenure, overboarding and independence.
Wilson Sonsini recently came out with its risk factor trends report among Silicon Valley’s 150 largest public companies. One item the report delves into is the potential impact of SEC proposed rulemaking relating to risk factors that the Commission is slated to consider at its meeting tomorrow. Some may recall that the proposed amendments to Item 105 of Reg S-K would require summary risk factor disclosure if the risk factor section is greater than 15 pages and that companies organize risk factors with headings.
Wilson Sonsini’s report covers risk factor disclosures from Form 10-Ks filed from early 2019 through March 2020 and includes information of disclosure practices overall of the SV150. Given the timing of the disclosures that were reviewed, the report doesn’t indicate trends in Covid-19 risk factor disclosure but it does illustrate how Covid-19 related disclosures impacted the overall length of risk factor disclosures. Here’s an excerpt:
Wilson Sonsini’s report says that 74% of SV150 companies include at least one heading for risk factors, with most including only one to three headings. And, all companies that went public in the last five years include at least one heading in their risk factors – whereas companies that went public over 20 years ago only 39% include at least one heading in their risk factors.
As far as inclusion of summary risk factor disclosure, the report says none of the SV150 companies include an explicit summary risk factor disclosure in their 10-K filings. So although this practice is rare, the report references Walmart’s Form 10-K filed in March of this year as a notable example of a titled summary risk factor disclosure (see page 5).
Other trends noted in the report include the number of pages of risk factors decreases as more time elapses since a company’s IPO – companies that went public in the last five years average about 27 pages of risk factors compared to companies that went public at least 20 years ago that average about 15 pages of risk factors.
As annual sales increase, the average total number of pages of risk factors also decreases.
Companies in the technology industry average the highest total number of pages of risk factors disclosure – approximately 23 pages.
Mandatory D&O Insurer Rotation: Solution for Mitigating Governance Risks?
That’s what one law prof suggests. A recent entry on the Columbia Law School Blog asserts that mandatory rotation of D&O insurers could help control corporate governance risks. Professor Andrew Verstein of UCLA School of Law grounds that assertion on his 66-page academic study in which he concludes that mandatory rotation of D&O insurers would leave insurers with only a few years to recoup any losses thus leading the insurers to serve as governance gatekeepers to limit those losses.
Like many academic studies, the study is thought-provoking as the author suggests D&O insurance itself contributes to governance problems and that the way D&O insurance is bought and sold harms governance. The gist of the author’s argument in favor of mandatory rotation is based on a theory that companies rarely switch D&O insurers, leading insurers to be passive and not monitor risk because they can recoup losses over future years from their loyal customers. By time-limiting the client-insurer relationship, the author says insurers would need to evaluate and price risks in real time rather than recouping any losses for years into the future. Here’s an excerpt summarizing the author’s reasoning:
Insurers should be permitted no more than five years with a given client, at which time they must take their underwriting elsewhere. Mandatory rotation renders the passive insurance model impractical. Insurers can never hope to insure passively and then recoup their losses down the line. Every insurer will have to actively vet insureds for risks pending over the next few years, to monitor for abrupt changes during that period, and to take steps to limit a corporation’s slide toward increase risk; the result is that corporations and their managers will be more likely to internalize the expected cost of their harmful behaviors and, thus, take those harms more seriously.
Through 66 pages, the author acknowledges the complexity of the D&O insurance model. For a thorough critique of the study, Kevin LaCroix walks through a thoughtful series of observations about the author’s assumptions – and reasons for disagreement. Up front, Kevin notes D&O insurers and their policyholders would be surprised to hear of the perceived loyalty between companies and their insurers since the D&O insurance environment can at times be “prickly.” Among other things, Kevin also discusses how much chaos mandatory rotation of D&O insurers would cause.
Without getting into the weeds about the author’s assertion and assumptions, some might wonder how mandatory D&O insurer rotation would be enforced and one way the author suggests is for the SEC to require it. As the author notes, this would require Congressional action because there is no colorable basis for the SEC to impose such a requirement on companies – I don’t think I’m going too far out on a limb in saying it’s unlikely this is coming along anytime soon.
SRCs: Scaled Disclosures & Tools to Help Determine Filer Status
With recent economic volatility, some companies might find themselves evaluating whether they qualify as “smaller reporting companies.” Of course, companies qualifying as “smaller reporting companies” can take advantage of scaled disclosure requirements that are outlined in this BDO memo – it provides a quick summary for those able to take advantage of SRC filing status. For more on determining filer status, which can be confusing, check out our “Disclosure Deadlines Handbook” and our “Smaller Reporting Companies – Entering Status” and “Smaller Reporting Companies – Existing Status” checklists available to members on TheCorporateCounsel.net.
Late Friday afternoon, the SEC issued proposed amendments under Regulation S-T aimed at promoting reliability and integrity of EDGAR submissions. If adopted, the amendments could mark the end of an era for “fake SEC filings” that we enjoy blogging about so much. But there’s still cause for celebration. In addition to aiming to curtail fake filings, the proposal is also intended to improve administration of EDGAR – for example, filing delays arising in connection with EDGAR outages (which have been a problem lately). The proposed rule specifies the Commission can take the following actions to facilitate resolution of issues that arise in connection with EDGAR submissions:
– redact, remove, or prevent dissemination of sensitive personally identifiable information that if released may result in financial or personal harm;
– prevent submissions that pose a cybersecurity threat;
– correct system or Commission staff errors;
– remove or prevent dissemination of submissions made under an incorrect EDGAR identifier;
– prevent the ability to make submissions when there are disputes over the authority to use EDGAR access codes;
– prevent acceptance or dissemination of an attempted submission that it has reason to believe may be misleading or manipulative while evaluating the circumstances surrounding the submission; and allow acceptance or dissemination if its concerns are satisfactorily addressed;
– prevent an unauthorized submission or otherwise remove related access; and
– remedy similar administrative issues relating to submissions.
The proposed rule provides that in certain circumstances, such as a threat to EDGAR, the Commission may take corrective action without first communicating with the filer. In such instances, the proposed rule sets forth a process for the Commission to notify filers and other relevant persons of actions it takes as soon as reasonably practicable.
Filers still need to ensure the accuracy and completeness of information in their EDGAR submissions and in most cases, address any errors by submitting a filer corrective disclosure. The proposed rule will be subject to a 30-day comment period after publication in the Federal Register.
SEC Comment Letters Continue Downward Trend
SEC comment letters are still around and haven’t completely disappeared but if it seems like you don’t hear as much about them, it’s because they’re declining in number. As reported in a recent Audit Analytics blog, SEC comment letters on Forms 10-K, 10-Q and 8-K continued a downward trend in 2019, a trend spanning the last nine years. The decline in 2019 seems like quite a drop-off, although much of the decline is attributed to the government shutdown in early 2019. Between 2018 and 2019, the blog says the number of comment letters fell by 30% and this was after a 32% decline between 2017 and 2018. The blog also reports that the number of conversations declined and that most reviews were resolved after one round of comments. For something to watch, the blog notes ASC 842 – the lease accounting standard – became effective in 2019 for companies with calendar year-ends so keep an eye out for any comment letter trends relating to that.
July-August Issue of “The Corporate Executive”
The July-August issue of The Corporate Executive was just posted – & also sent to the printer. It’s available now electronically to members of TheCorporateCounsel.net who also subscribe to the print newsletter at each of their locations (try a no-risk trial). This issue includes articles on:
– SEC Adopts Rules to Regulate Proxy Advisory Firm Recommendations: Where Do We Go from Here?
The Unique Role of Proxy Advisory Firms
The SEC’s First Shot Across the Bow: The 2019 Interpretive Release
ISS Responds: See You in Court!
This Means War: The SEC’s Rule Proposal
The Final Rules: Proxy Advisory Firm Regulation is Born—After a Decade in Labor!
Dissent
Next Steps
Supplemental Guidance for Investment Advisers
Status of the ISS Lawsuit
What Now?
– Considerations for the Use of Private Air Travel During the COVID-19 Pandemic
Late yesterday evening, the Senate confirmed the nominations of Hester Peirce and Caroline Crenshaw to serve as SEC Commissioners by a voice vote. SEC Chair Jay Clayton and Commissioners Elad Roisman and Allison Lee issued a statement of congratulations and news was first reported in ThinkAdvisor. Commissioner Peirce was first sworn in on January 11, 2018 and her new term will end on June 5, 2025, while Commissioner Crenshaw’s term will end on June 5, 2024.
CPRA: California 2020 Ballot Initiative Means Potential Changes to CCPA
Back in May, I blogged on the Mentor Blog about California’s ballot initiative – the California Privacy Rights Act (CPRA). And, earlier this summer, I also blogged about the release of final CCPA regulations as California’s Attorney General began enforcement of the regulations July 1. Now, as has been widely reported, the CPRA initiative has qualified to be on California ballots in November. This Sidley blog says the initiative has a strong chance of passing and provides an overview of what this might mean:
In the short term, the CPRA will help businesses by preserving through 2022 the employee and business-to-business exemptions that are otherwise scheduled to sunset on December 31, 2020. Some of the potential changes, among others, relate to new duties imposed on businesses that collect personal information and their service providers, new rights for sensitive personal information and expansion of data breach liability to include email addresses with passwords.
The blog notes that the CPRA would create a requirement for annual cybersecurity audits and regular risk assessments for high risk data processors – Businesses whose processing of consumers’ personal information “presents a significant risk to consumers’ privacy or security” would be required to perform annual cybersecurity audits and submit to the new California data protection agency, “on a regular basis,” risk assessments weighing the benefits of processing personal information to the business, the consumer, other stakeholders, and the public, against the potential risks to the consumer.
Presuming the initiative passes, Sidley’s blog suggests company compliance efforts begin soon thereafter – while most of the CPRA would not go into effect until January 2023, obligations of businesses with respect to the personal information covered by the amended CCPA would relate to personal information collected beginning in January 2022.
More on “The Mentor Blog”
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply entering their email address on the left side of that blog. Here are some of the latest entries:
– IPOs: Company-Friendly Directed Share Programs
– Considerations for Mitigating ESG Disclosure Risk
– Main Street Lending Program: Updated Fed Guidance
In this third 30-minute podcast tribute to his friend & “Radio Show” co-host Marty Dunn, who died on June 15, 2020, Dave Lynn welcomes Marty’s colleagues from Corp Fin, private practice and the conference circuit to share their memories of Marty. Highlights include:
– The art of being subtle
– Marty’s fondness for the ‘Original Ledos’
– Marty’s humble leadership
– Crazy, cool new projects Marty couldn’t resist
– Work on the 2007 Reg D Proposing Release as Marty prepared to leave the SEC for private practice
– Marty’s reaction when seeing himself on the “big screen” at conferences
– Marty’s personable, friendly nature
Secure FTP for Supplemental Materials & Rule 83 CTRs
Earlier this week, in response to continued health and safety concerns from Covid-19, Corp Fin issued a statement providing a temporary secure file transfer process for submission of supplemental materials pursuant to Securities Act Rule 418 and Exchange Act Rule 12b-4 and information subject to Rule 83 confidential treatment requests.
Supplemental Materials: Securities Act Rule 418 and Exchange Act Rule 12b-4 permit the Commission or its staff to request certain supplemental materials. The secure file transfer process allows for electronic submission to the Division of supplemental materials submitted pursuant to Rules 418 and 12b-4 during this temporary accommodation, including supplemental materials subject to a Rule 83 confidential treatment request.
Rule 83 Confidential Treatment Requests: The Commission’s Rule 83 provides a procedure by which persons submitting information may request confidential treatment for portions of that information where no other confidential treatment process applies. Information subject to a Rule 83 confidential treatment request must be, to the extent practicable, submitted separately from information for which confidential treatment is not requested, appropriately marked as confidential, and accompanied by a separate written request in paper format for confidential treatment. Although Rule 83 requires that confidential treatment requests be submitted in paper format, the rule also permits the designation of alternative procedures. The secure file transfer process allows for electronic submission to the Division of Rule 83 requests for confidential treatment together with the confidential information during this temporary accommodation. A copy of the request for confidential treatment (but not the confidential information itself) must also be submitted to the Commission’s Office of FOIA Services.
Anyone wishing to submit information using FTP should contact the staff member associated with the matter to request the initiation of FTP. The statement also advises not to send supplemental information or Rule 83 CTRs through email. Supplemental information and information subject to Rule 83 CTR can still be sent to the SEC mailroom, however, the statement says there will be delays in processing the documents.
This Gibson Dunn memo reviews SEC enforcement activity during the first half of 2020. The memo includes discussion of the SEC’s Enforcement Division priorities in light of the Covid-19 pandemic as well as several enforcement actions against parties that allegedly sought to take advantage of the pandemic. In terms of public company cases, here’s an excerpt about financial reporting enforcement actions:
In February, the SEC instituted a settled action against a financial institution for allegedly misleading representations concerning the success of its cross-selling business strategy. According to the settled order, the cross-sell metric reflected accounts and services that were unused and unauthorized by customers, and that had been opened through sales practices inconsistent with the company’s disclosure of a needs-based selling model. Without admitting or denying the allegations, the firm agreed to cease and desist from future violations and to pay a civil penalty of $500 million for distribution to investors. The settlement was part of a broader resolution with the Department of Justice.
Also in February, the SEC filed an action against a parent company, two of its former executives, and its energy subsidiary for allegedly making misleading statements about the subsidiary’s nuclear power plant expansion. According to the complaint, which was filed in federal court in South Carolina, the defendants represented that the company was on track in its plan to build two plants and receive nearly $1 billion in tax credits, even though they knew the company was behind schedule and the plan was eventually abandoned.
Commissioner Roisman recently shared his thoughts on ESG and asked what the term means to “You and Me”. Such keynote speeches are often meant to be provocative, and reasonable minds can differ. Given my experience advising both corporate and investor representatives, this is what ESG means to me:
(1) ESG is a three-syllable acronym that has come to be associated with significant issues that impact the long-term sustainability of companies, our capital markets, capital formation and society. You can find different articles about its origin, but that’s not really the point. Environmental, Social and Governance issues vary in importance across companies and industries, and they appropriately evolve over time. It is important that management teams and boards think about whether and how these issues are financially material to their companies over different time horizons, generally acknowledging that they need to get their “G” right in order to get their “E” and “S” issues right.
(2) It is well established that “financial materiality” under our federal securities laws is what a reasonable investor would consider important in making investment or voting decisions. Nevertheless, I still see some confusion as to which ESG disclosures belong in SEC-filed documents. Many reasonable investors have decided that both filed and unfiled ESG information is material to their investment and voting decisions, which is supported by research (see note 10) linking positive financially material ESG indicators to superior financial results. These investors want to find this information in the public domain, and want the information to be accurate, relevant and comparable, which I believe necessitates explicit disclosure requirements.
The SEC has considered mandated disclosures in the past (see notes 37-39) as a way to provide relevant and comparable data, as opposed to the inconsistent “private ordering” of ESG disclosures championed by Commissioner Roisman. In the meantime, manyinvestors are urging their portfolio companies to disclose information pursuant to the Sustainability Accounting Standards Board (SASB) standards and the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). Both of these frameworks use the SEC definition of financial materiality. The SASB identifies financially material issues using their research, back-testing and feedback from shareholders, companies and other financial market participants.
(3) ESG is part of Enterprise Risk Management (ERM). ERM oversight is a core board responsibility. Companies generally consider ESG as part of their long-term ERM, to understand, monitor and address risks to, and opportunities for, them and their businesses. Contrary to Commissioner Roisman’s statements, this is not a feel-good company exercise about “doing its part” in the world. Effective board understanding and oversight of ERM are relevant to investors and the long-term viability of their portfolio company investments. The SEC has recognized the importance of this board role by requiring that companies explain the board’s risk oversight to their investors in their annual proxy statements.
(4) Investors want and use ESG data to analyze and protect their financial interests and those of their clients or beneficiaries, not – again in Commissioner Roisman’s words — because they are “thinly veiled political operatives pushing their own agendas”, nor are they “grandstanding” or “conflat[ing] greater societal debates” and “blur[ing] their personal views” with what should be required disclosures. The U.S. Government Accountability Office (GAO) recently published a report, confirming that investors want corporate ESG disclosures to better understand and compare their investment risks, as well as to inform their decisions on voting and buy/sell actions.
Investors and other stakeholders may share their ESG concerns with companies, but these concerns are not presumptively “demands” and “pressure”. Hopefully companies are already monitoring ESG issues that they consider to represent financially material risks and opportunities, as well as making the related capital allocation decisions that benefit their businesses and our capital markets more broadly. Risk management of ESG issues is not a simple corporate responsibility, especially as the issues become more complex and interrelated for companies and our financial markets, communities, and planet.
The G&A Institute has reported that 90% of S&P 500 companies are already publishing voluntary sustainability reports, using many of the sustainability disclosure frameworks as guides. Yet, this voluntary reporting, accompanied by the principles-based approach currently used for disclosure in SEC filings, seems to fall short of providing comparable and reliable information to investors and does not provide a consistent framework to companies, making it difficult for them to discern which information and formats are relevant to investors. Mandated ESG disclosures would more strongly and efficiently support the three-part SEC mission on which Commissioner Roisman is rightly focused.
Comment Letters Pouring in for DOL’s Proposal on ESG Investing
Earlier this summer, Liz blogged on our “Proxy Season Blog” about the Department of Labor’s proposed amendments to the “investment duties” regulations for ERISA plan fiduciaries. The full impact of the proposed rule isn’t exactly known but as this Groom Law Group memo explains, it’s generally viewed as creating significant challenges for ERISA plan fiduciaries considering ESG investing. The proposal had a relatively short comment period, but even so, it’s generated a flurry of comment letters – this DOL web page catalogs over 1000! As the headline for this ThinkAdvisor blog notes, the proposal is drawing quite a bit of criticism – here’s an excerpt:
Opposition to DOL’s proposal to limit ESG-focused investments in 401(k) plans is growing, along with requests for a longer comment period. Morningstar, Heartland Capital Strategies, Principles for Responsible Investment and ISS have written comment letters opposing the proposal along with 41 Democratic members of the House, 13 Democratic members of the Senate and others. In addition, a coalition of trade groups representing financial institutions with business in the defined contribution space requested an extension to the 30-day comment period that ended on July 30. Opposition to the proposal centers on these primary arguments:
– Negative impact on investors: limiting ESG investments could increase risks and costs of plans, threaten performance and discourage plan participation by those who want to match investments to their values
– Inconsistency with other DOL rules: the proposal singles out one type of investment focus when it doesn’t do the same for others
– Burden for plan sponsors: this could have the effect of discouraging their use of ESG-focused investments, causing ‘even worse outcomes for plan participants’ according to Morningstar
– An outdated understanding of the role that ESG factors play in the current investment environment
For more, these letters from American Benefits Council, CII, ISS, Investment Company Institute and Wagner Law Group criticize the rule proposal, with some offering suggestions for modifications. Also, Cyrus Taraporevala, SSGA’s President & CEO, penned an opinion piece in the Financial Times saying the DOL’s proposed rule “misunderstands what matters to performance and should be withdrawn.” In addition to the proposed rule, the DOL Employee Benefits Security Administration is apparently looking into ESG investments – attached is a sample inquiry letter that it has sent to some plan sponsors. It’s not clear if EBSA will treat this as a formal investigation – so stay tuned!
Tomorrow’s Webcast: “ESG Data: Investor Use-Cases and Corporate Adoption”
Tune in tomorrow for the webcast – “ESG Data: Investor Use-Cases and Corporate Adoption” – co-hosted by ISS Corporate Solutions and CCRcorp – to hear to hear Nicole Bouquet of ISS Corporate Solutions, Rhonda Brauer of RLB Governance and Mary Morris of CalSTRS discuss an overview of the ESG landscape and how investors are increasingly using ESG data to make investment decisions.
Following the killing of George Floyd, attention has increased on diversity and inclusion, among other matters. Earlier this summer, Liz blogged on our “Proxy Season” Blog that company “anti-racism” statements could lead to more scrutiny of corporate political spending.
Now, with increased focus on “E&S” as a backdrop, this “Conflicted Consequences“ report from the Center for Political Accountability finds that corporate political spending through non-profit, tax-exempt “527” organizations often doesn’t align with company statements in support of environmental & social issues. The report examines corporate political spending over the last decade and how those funds were used to fund political efforts that have turned out to be contradictory to company public statements. CPA made a bit of a splash with this report, as it received coverage in the NYT and Financial Times the same day of the report’s release. Here’s an excerpt from the Foreword, explaining the concern with “527” political spending:
The intermediate organizations that these companies finance often direct that money in ways that belie companies’ stated commitments to environmental sustainability, racial justice, and the dignity and safety of workers. To take just one of the many instances this report recounts, large donations channeled through these organizations helped North Carolina Republicans take control of the state legislature in 2010. They used that control to institute extreme gerrymanders of both the state legislature and the state’s delegation to Congress, and to pursue a range of divisive and anti-democratic policies, including restrictions on LGBTQ rights and new rules designed to impede the access of black voters to the polls.
Both the NYT and FT cite specific examples of apparent disconnects between company support for issues and ultimate beneficiaries of company “527” donations. Cydney Posner’s blog discusses the report and cites a 2018 CPA report with guidance for companies to address heightened risk of potentially conflicting messages. Among other suggestions, it suggests companies conduct due diligence of risks associated with any donation, including how the funds will be used and with whom the company is being associated by virtue of the donation. If this heightened scrutiny continues as we move into election season and beyond, it could be a big deal for companies, especially in light of the increased focus lately on corporate purpose.
What to do About “Social” Risk
Besides conducting due diligence on risks associated with donations, boards delegate various oversight responsibilities among its committees and social risk is a responsibility likely shared among all committees and the full board. Social risk can be more difficult to get your arms around as it’s not entirely clear when or where an event might arise nor exactly how it will be triggered but it’s one risk that can invite scrutiny from customers, employees, regulators and the general public. A recent article from researchers at Stanford’s Corporate Governance Research Initiative examined social risk, noting that the primary cause of damage is reputational, such as risk from unwanted scrutiny of corporate political spending.
The article provides the following recommendations to help boards prepare for, manage and mitigate social risk:
– Use knowledge of the past to inform future plans: examine social risk events that have impacted peer groups and related industries and evaluate patterns about how risk events have evolved over time
– Conduct scenario planning to identify the highest likelihood risk events: based this analysis on events most likely to manifest given the company’s industry, profile and vulnerabilities and quantify the potential impact by looking at brand, product, suppliers, employees and overall reputation
– Prepare responses and identify the resources necessary to prevent or mitigate the highest likelihood risks: consider both preventative and responsive measures over both short-term and long-term time horizons and develop resources, programs and policies to protect the company going forward
July-August Issue of “The Corporate Counsel”
The July-August issue of “The Corporate Counsel” print newsletter was just posted – and also sent to the printer (try a no-risk trial). The topics include:
– In Memoriam: Marty Dunn
– What’s in a Name? The SEC Amends “Accelerated Filer” and “Large Accelerated Filer” Definitions
– The Curious Case of Public Companies and the PPP
– COVID-19 Disclosure: What Does the SEC Want to See in Your MD&A?
– Covid-19: Chief Accountant’s Statement Emphasizes Financial Reporting Process
– “Going Concern” Rears Its Ugly Head
– SEC Amends Proxy Rules to Address Voting Advice by Proxy Advisors
Audit Analytics recently released its annual report on financial restatement trends – the report looks at trends over the last 19 years. Since 2015, total restatements – reissuance (“Big R”) and revision (“Little R”) – have declined for five consecutive years bringing the total to a 19-year low of 484 restatements in 2019. And, of those, almost 80% were Little R restatements, which is the highest percentage since 2005. Here’s some of the other highlights:
In addition to a decrease in overall number of restatements, Audit Analytics found an indication of low severity in every criterion quantified: (1) the negative impact on net income, (2) the average cumulative impact on net income per restatement, (3) the percentage of restatements with no impact on income statements, (4) the average number of days restated, and (5) the average number of issues identified in the restatements
– Average number of issues implicated in a restatement was approximately 1.5
– Average number of days that were corrected by a financial adjustment decreased from 500 days in 2018, to 451 in 2019 – the lowest number during the 19 years analyzed
– The largest adjustment in 2019 was $276 million and was the lowest during the last 18 years and dramatically lower than the largest adjustments in 2004 ($6.3 billion) and 2005 ($5.2 billion)
– More severe reissuance restatements from U.S. accelerated filers totaled only 32 in 2019, which is the lowest amount since 2005 when the disclosure requirement came into effect
ISS Policy Survey: Covid-19, Climate Change, Board Diversity & More
Summer seems to be flying by and like previous years, ISS opened it’s “Annual Policy Survey.” Similar to last year, ISS is using a single survey with a limited number of questions to help streamline the process. Even though the process is streamlined, it still covers a broad range of topics, including:
COVID-19 related questions on ISS policy guidance in response to the pandemic, AGM formats, and expectations regarding compensation adjustments and adjustments to short-term incentives globally. Additional topics include, among others, a number of global questions related to climate change risk, sustainable development goals, auditors and audit committees, and racial and ethnic diversity on corporate boards, independent board chairs in the U.S.; and executive and director remuneration in pan-European markets.
As always, the policy survey is just the first step as ISS formulates its 2021 voting policies. In addition to the survey, ISS will gather input via regionally-based, topic-specific roundtables and conference calls. From there, interested market participants can comment on the final proposed changes to the policies.
Our August Eminders is Posted!
We have posted the August issue of our complimentary monthly email newsletter. Sign up today to receive it by simply entering your email address!
Earlier this week, the SEC issued a Sunshine Act notice for an open meeting scheduled for this coming Wednesday – July 22nd. Here’s the agenda that lists two items:
The Commission will consider whether to adopt proxy rule amendments to provide investors who use proxy voting advice with more transparent, accurate, and complete information on which to make voting decisions, without imposing undue costs or delays.
The second item on the agenda says the Commission will consider whether to publish supplementary guidance to the Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Release No. IA-5325 (Aug. 21, 2019), 84 FR 47420 (Sept. 10, 2019), regarding how the fiduciary duty and rule 206(4)-6 under the Investment Advisers Act of 1940 relate to an investment adviser’s proxy voting on behalf of clients.
The last time I blogged about the Commission calendaring an open meeting it was cancelled on fairly short notice. The proposed rules on proxy advisors are top of mind for many so hopefully the Commission keeps this meeting – those interested can listen in via audio webcast on the SEC’s website.
And, if rules are adopted, we’ll be covering this and discussing what it means at our upcoming “Proxy Disclosure” & “Executive Pay” Conferences – which will be held entirely virtually over three days – September 21 – 23. We’ve offered a Live Nationwide Video Webcast for our conferences for years – one of the only events to do so – and we’re excited to build on that platform and make your digital experience better than ever. Act now to get an “early bird” discount – here’s the registration information.
Return to Sender: Company Received $250 Million in Relief Funds – But Board Gives it Back
A recent Harvard Business Review article provides a quick read about how one company decided to return $250 million in government relief funds. The funds weren’t part of the PPP rollout fiasco where some companies applied for funds and then returned them as questions mounted about good-faith need certifications. So, with continued economic uncertainty some might question what led a company entitled to funds to give the money back.
As the article explains, the board decided to do what was right and made a unanimous decision to return the money. The article is in the form of a Q&A with the company’s CEO and provides a good case study illustrating board deliberations that considered “stakeholder interests.” The article says the CEO hopes to influence discussions in other boardrooms:
We’re a publicly traded company, and if our decision to return the money helps give other companies a bit of air cover to make the same decision, that’s a good thing. If more companies that aren’t risking their survival decide to return the money, millions will turn into billions of extra funding that can go to those truly in need. Then, hopefully, we emerge stronger as a country. There’s been a decade-long debate about ESG and the role of a company. In my opinion, we’re at a unique time in which CEOs need to act.
Fall Shareholder Engagement: Prep Questions
Here’s something I recently blogged on CompensationStandards.com: Off-season shareholder engagement is always important but this year it may be even more so with attention focused on social issues, company responses to the pandemic and related matters. As proxy seasons seem to be rolling from one right into the next, Teneo recently issued a memo titled “20 Imperatives for Fall 2020 Shareholder Engagement” to help companies prepare for upcoming off-season shareholder engagement and the 2021 proxy season.
The memo lists 20 topics and questions, primarily focused on diversity and executive compensation and suggests companies prepare for Fall engagement by asking themselves those questions. Here are a few:
– Strategy: How are we reassessing and resetting our strategy, business, brand, and reputation to align with the new normal? Over the medium and long term, the new normal may call for a different strategy, brand changes that mitigate inclusiveness concerns, or a reprioritization of business lines. Stakeholders will view the strategy through a new lens and expect companies to do the same.
– Diversity Goals: Should we set and disclose concrete diversity goals? The evolution of sustainability reporting has led to the practice of companies setting and disclosing concrete goals, typically relating to the environment. It is less common for companies to set and disclose any goals relating to social issues. However, the current environment could prompt investor calls for goal setting on this issue as well.
– Consistent Grant Values: How will our year-over-year grant values be perceived by investors? Maintaining year-over-year grant values during periods of extreme stock price volatility poses a unique set of challenges. While lowering annual grant values may raise retention and motivation concerns, proxy advisors and many shareholders expect lower grant date values when the stock price is low, as granting more shares has a dilutive effect. The recent stock market rally has only increased the scrutiny of significant gains from equity awards at the height of the pandemic.