The Business Roundtable’s “Statement on the Purpose of a Corporation” has been a frequent conversation and blog topic. Interesting to see that the Governance & Accountability Institute recently analyzed and reported on the reporting practices of the companies whose CEOs signed the BRT statement.
Of the stats included in G&A’s report, 85% of the signatory companies publish a sustainability/ESG report. Of the signatory companies that publish a sustainability report, 58% have adopted one or more Sustainable Development Goals – with the most common SDG being climate action and the next being decent work and economic growth.
To hear more about shareholder primacy and the corporate purpose, be sure to tune-in for our January 21 webcast, “Deciphering ‘Corporate Purpose’.” We’ll talk with John Wilcox of Morrow Soldali, Pam Marcogliese of Freshfields Brruckhaus and Tricia Vella of Morris Nichols to understand what the debate is all about and what it means for directors’ fiduciary duties and company disclosure.
Divestment: Another Investor Approach to Social Issues?
Last summer, Liz wondered whether shareholders would show renewed interest in “firearms responsibility” during the 2020 proxy season. In December, the Connecticut Treasurer announced a “responsible gun policy” that goes past engagement and right on to divestment. We’ve blogged about how the NY Comptroller is considering divestment as part of its “decarbonization” plan as well – but of course it’s too early to tell whether divestment will become a real threat on these types of “social” issues.
As State Treasurer, the costs and risks of gun violence are a matter of significant financial concern, and the business of guns is becoming an increasingly risky proposition. Under Connecticut statute, the State Treasurer is empowered to consider the social, economic and environmental implications of specific investments. The Treasurer will propose amendments to the current Investment Policy Statement, with appropriate public notice prior to consideration and approval by the Investment Advisory Council.Following amendment of the Investment Policy Statement, fund managers will be instructed to reallocate investments into comparable substitutes in a similar industry that have the same risk and return characteristics as civilian gun manufacturing companies.
The Connecticut Retirement Plans and Trust Funds (CRPTF) currently hold $30 million of equity investments in 5 companies involved in the manufacture of ammunition for the civilian market (Northrop Grumman, Olin Corp., Daicel Corp., Clarus Corp., and Vista Outdoor). These investments represent .08% of the CRPTF’s portfolio.
While the CRPTF currently does not own investments in Sturm, Ruger & Company, a publicly traded civilian firearms manufacturer headquartered in Southport, CT, the Responsible Gun Policy will prohibit consideration of future investments with this company unless they move to advance smart gun technology. Other manufacturers, such as Colt (based in West Hartford, CT), are privately-held and would not be impacted by divestment.
The CRPTF is currently invested in Northrop Grumman, a multi-billion dollar global security company which wholly-owns Adaptive Optics Associates Xinetics (AOX) in East Hartford. Since Northrop Grumman is also in the civilian firearms ammunition manufacturing market, its securities would be subject to the Responsible Gun Policy and as such, $28 million currently invested in Northrop Grumman would be reallocated to an economically equivalent substitute.
Besides prohibiting Connecticut’s pension funds from investing in such companies, the policy will also require banks and other financial institutions that want to work with the state to disclose their policies on guns. When making decisions to contract with a bank or financial institution, the state will consider the institution’s gun policies as one factor in its decision making process.
10-K Considerations to Keep in Mind
With calendar year Form 10-K filings coming up, Gibson Dunn issued a memo that walks through substantive and technical considerations when preparing 2019 10-Ks. The memo discusses SEC disclosure amendments in the last year and SEC enforcement actions that may impact this year’s disclosures. Here are some of the considerations, check out the complete 12-page memo for more:
– As of year end, of the 91 S&P 500 companies that filed a Form 10-K since the MD&A changes went into effect last April, 57% discussed 3 years of financial information rather than omitting discussion of the earliest of the 3 years from the MD&A
– Whether discussing 3 years or only 2 in the MD&A, companies should remember to review discussion of the earlier years to determine whether anything has come to light since the time of the original disclosure that would now make the original disclosure incomplete or inaccurate to an extent that it would be material – the memo provides examples of how or when this could occur
– Given SEC enforcement actions last year dealing with risk factor statements that phrased an event or contingency as a hypothetical, risk factors should be regularly revisited and treated as “living” as much as the rest of the filing – it may be preferable to refer to consequences of a risk that arises from time to time as a material contingency instead of as a hypothetical contingency
This Allianz report highlights 5 “mega trends” likely to impact boards and officers – and the D&O insurance market – in 2020 (also see this annual Protiviti memo that identifies emerging risk themes involving talent & culture and technology & innovation). The “mega trends” identified in the Allianz report include:
1. Litigation Risks: The report highlights the growing risk of “event driven” litigation – e.g. cyber security breaches, environmental disasters, product problems – as well as continued high levels of securities class actions & shareholder activist suits.
Allianz has seen double-digit growth in the number of claims it has received in the last five years and expects that increased claims activity to continue. According to Cornerstone Research, plaintiffs filed lawsuits in 82% of public mergers valued over $100 million. And event driven litigation often triggers claims under multiple policies – e.g. D&O and cyber.
2. Expectation that Boards Focus on ESG: As Liz blogged recently, D&O underwriters are paying attention to a company’s “social media temperature” as a factor in assessing reputational & brand risks
3. Slowing Economic Growth & Political Uncertainty: Allianz expects to see increased insolvencies, which have been rising for the last 3 years and lead to D&O claims
4. Litigation Funding: This fuels the other mega trends and is forecast to continue growing internationally
What does all this mean for your insurance? Here’s an excerpt from the report’s parting remarks:
According to Aon, D&O rates per million of limit covered were up 17.1% in Q2 2019,compared to the same period in 2018, with the overall price change for primary policies renewing with the same limit and deductible up almost 7%. Primary policies renewing with the same limit were at 93.5% in Q2 2019, but only 70.6% renewed with the same deductible and 66% at the same limit and deductible, suggesting tightening terms and conditions. Still, over 92% of primary policies renewed with the same carrier.
From an insurance-purchasing perspective AGCS sees customers that are unable to purchase the same limits at expiration are also looking to purchase additional Side A only limits and also to use captives or alternative risk transfer (ART) solutions for the entity portion of D&O Insurance (Side C). Higher retentions, co-insurance and captive-use indicate a clear trend of customers considering retaining more risk in current conditions.
Sustainability Disclosure Trends: Small & Mid-Caps
This new memo courtesy of White & Case is unique in showing sustainability reporting trends for small & mid-cap companies by number of years since IPO – and by whether a company is controlled/dual class versus widely held. Here are six key nuggets (for even more info on small & mid-cap perspectives on sustainability, also check out our recent webcast transcript):
1. Overall, more than 33% of surveyed companies include some form of website sustainability disclosure – either via a “sustainability” page or a standalone report
2. Sustainability disclosures are more prevalent among surveyed companies that have been public for longer periods
3. Surveyed companies with higher market caps are more likely to report on sustainability – but even among companies with a market cap below $1 billion, 25% are providing some form of disclosure
4. Among controlled or dual-class surveyed companies, 26% provide some sustainability disclosure – that compares to 35% of other companies who may be receiving pressure from significant institutional shareholders
5. Energy companies are the most likely to provide some form of sustainability reporting
6. The most common topics covered are: environmental impact & risk management (including waste reduction), human capital management (including diversity & inclusion and community engagement) and health & safety
MD&A: Corp Fin Wants More Info on Supplier-Finance Arrangements
In recent remarks at an AICPA conference, Corp Fin’s Deputy Chief Accountant Lindsay McCord said companies need to do a better job discussing the financial implications of supplier-finance arrangements on liquidity & cash flows in the MD&A. That’s according to this memo from Moody’s, which explains that supplier-finance arrangements – also known as “reverse factoring” – are arrangements where a bank or other finance company serves as an intermediary between a company and its suppliers. The bank agrees to pay the company’s invoices to the supplier in exchange for interest.
But, GAAP guidance doesn’t say whether supplier-finance arrangements should be classified as debt or accounts payable, or how the arrangement should be disclosed in financial statements. Usually the only evidence of supplier-finance arrangements in the financial statements is an increase in the accounts payable balance. So, improved disclosure would help shareholders & analysts identify financing arrangements that are otherwise embedded within working capital.
According to Deloitte’s highlights from the conference, Corp Fin has observed a lack of disclosure of the use, and sometimes, the existence of the arrangements in the MD&A. Key points Corp Fin expects companies to consider disclosing in the MD&A include:
– Material terms, general benefits and risk that are introduced
– Any guarantees provided by subsidiaries or the parent
– Any plan to further extend programs to suppliers
– Factors that may limit further expansion
– Trends and uncertainties, including interperiod variations related to the programs
Yesterday, Corp Fin added to its “CF Disclosure Guidance Topic” series with two new topics. “Topic No. 8: Intellectual Property & Technology Risks Associated with International Business Operations” explains the Staff’s views on what companies should consider disclosing about their reliance on technology & intangible assets if they conduct business in places that don’t have robust IP laws – and where that disclosure would appear. Here’s an excerpt:
Although there is no specific line-item requirement under the federal securities laws to disclose information related to the compromise (or potential compromise) of technology, data or intellectual property, the Commission has made clear that its disclosure requirements apply to a broad range of evolving business risks in the absence of specific requirements. In addition, a number of existing rules or regulations could require disclosure regarding the actual theft or compromise of technology, data or intellectual property if it pertains to assets or intangibles that are material to a company’s business prospects. For example, disclosure may be necessary in management’s discussion and analysis, the business section, legal proceedings, disclosure controls and procedures, and/or financial statements.
The guidance includes examples of risks that might arise from business relationships – e.g. idiosyncratic license terms that favor the other party or compromise the company’s control over proprietary info, regulatory requirements that require companies to store data locally or use local services or technology. It also includes a laundry list of questions companies should ask themselves to assess risks. We’ll be posting memos in our “Cybersecurity” Practice Area.
Corp Fin’s New “Disclosure Guidance”: Confidential Treatment Requests
RIP, Staff Legal Bulletins No. 1 and 1A. Yesterday’s new “CF Disclosure Guidance Topic No. 7: Confidential Treatment Applications Under Rules 406 & 24b-2” supersedes that guidance. It addresses how and what to provide when submitting a “traditional” confidential treatment request – i.e. outside of the accommodations from earlier this year that now allow companies to simply redact immaterial confidential information from exhibits. The new disclosure guidance also applies to filings where traditional CTRs remain the only available method to protect private information – e.g. Schedule 13D or exhibits required by Item 1016 of Reg M-A.
After filing the exhibit on Edgar with redactions that show where confidential info is omitted, here’s what companies now need to do for written applications (we’ll be posting memos in our “Confidential Treatment Requests” Practice Area):
1. Provide one unredacted copy of the contract required to be filed with the Commission with the confidential portions of the document identified;
2. Identify the Freedom of Information Act[6] exemption it is relying on to object to the public release of the information and provide an analysis of how that exemption applies to the omitted information. Often, this is the exemption provided by Section 552(b)(4)[7] of the FOIA, which protects “commercial or financial information obtained from a person and privileged or confidential.” If this is the case, the Supreme Court’s decision in Food Marketing Institute v. Argus Leader Media, 139 S.Ct. 2356 (2019) addresses the definition of confidential and may be helpful in providing this analysis;
3. Justify the time period for which confidential treatment is sought;
4. Explain, in detail, why, based on the applicant’s specific facts and circumstances, disclosure of the information is unnecessary for the protection of investors. This generally is encompassed in a materiality discussion, addressed below;
5. Provide written consent to the furnishing of the confidential information to other government agencies, offices or bodies and to the Congress;
6. Identify each exchange, if any, with which the material is filed (required in applications under Rule 24b-2 relating to Exchange Act filings only); and
7. Provide the name, address and telephone number of the person with whom the Division should communicate and direct all issued notices and orders.
What’s the Deal with “CF Disclosure Guidance”?
A while back, Corp Fin was on a roll with this format for guidance – issuing six topics from 2011 to 2013 (here’s Broc’s blog from when this format first debuted). But yesterday’s new topics were the first in over six years.
They’ve always included a “Supplementary Information” disclaimer at the beginning to emphasize that the guidance isn’t a rule and hasn’t been approved by the Commission. Of course, lately there’s been even more back & forth about the role of “guidance” versus rules – and as Broc blogged last month, a recent executive order severely restricted most federal agencies’ ability to practice “regulation by guidance.” So to be extra clear that these publications aren’t rules, the disclaimer for yesterday’s two topics includes this new sentence:
This guidance, like all staff guidance, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.
SEC & Edgar Closed Tuesday & Wednesday
This executive order announces that all federal agencies – including the SEC – will be closed on Tuesday for Christmas Eve (Christmas Day was already designated as a Federal Holiday, so the SEC is closed that day too). The SEC announced that this means Edgar will be closed too – so you’ve got until December 26th to make filings that would be due on Tuesday or Wednesday.
This blog from Alan Dye points out that it isn’t clear whether the 24th is still counted as a “business day” for purposes of calculating filing deadlines that fall later in the week. Based on last year’s precedent, it wouldn’t be considered a “business day” for purposes of calculating filing deadlines – and Alan was told in a phone call with the Staff that they’d take the same position this year.
As anticipated, yesterday the SEC voted to propose amendments to the definition of “accredited investors.” The proposed amendment, issued upon a 3-2 vote, will allow more investors to participate in private offerings by adding more natural persons that will qualify based on their professional knowledge, experience or certifications. Interestingly, the proposal contemplates that these categories could be established by the SEC by order, rather than the rule itself – which would allow the SEC to establish the criteria in the future without notice & comment. Also, the proposed amendments expand the list of entities that may qualify as accredited investors.
During the summer, Liz blogged about the SEC’s concept release that included discussion of the accredited investor definition. As the concept release generated a flurry of comment letters, it’s hard to say whether this proposal will please everyone. As this Cooley blog notes, the statements of dissent from Commissioners Rob Jackson and Allison Lee – compared to the statements of support from Commissioners Hester Peirce and Elad Roisman – highlight the differences in views that exist about the fundamental purposes of the securities laws.
The proposal doesn’t raise the income and wealth thresholds that have existed since 1982 or suggest adjustments for inflation in the future. This WSJ article says that the lack of an inflation adjustment has contributed to the current number of qualifying households rising over time – from 1.3 million in 1983 to 16 million this year. And among the 69 questions that the SEC specifically requests people to comment on is whether the standards should be tied to geographic reasons to account for potentially lower costs of living.
We’ll be posting memos in our “Accredited Investor” Practice Area to help everyone stay up to date with the latest on the proposed changes.
SEC Proposes Expanding QIB Def’n
As mentioned in the press release about the proposed expansion of the “accredited investor” definition, the SEC also proposed expanding the definition of “qualified institutional buyers” under Rule 144A. The expanded definition would add LLCs and RBICs (Rural Business Investment Companies) to the types of entities eligible for QIB status if they meet the securities owned and investment threshold in the definition. There’s also a new ‘catch-all’ category that would permit institutional accredited investors under Rule 501(a), of an entity type not already included in the QIB definition, to qualify as QIBs when they satisfy the $100 million threshold.
Keeping step with the fast-approaching year-end rush, yesterday the SEC also voted to propose rules requiring mining companies to disclose payments made to foreign governments or the U.S. government for the commercial development of oil, natural gas or minerals.
The Commission is statutorily obligated to issue a rule in this area. And, as outlined in the SEC press release about the proposed rules and in Broc’s blog back a couple of years ago, the path to these new proposed rules has been anything but smooth. Here’s an excerpt from the SEC press release:
The Commission first adopted rules in this area in 2012, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). The 2012 rules were vacated by the U.S. District Court for the District of Columbia. The Commission then adopted new rules in 2016, which were disapproved by a joint resolution of Congress pursuant to the Congressional Review Act.
As Liz blogged last week, the NYSE proposal to allow “direct listings” for primary offerings has been revised and is back on the table, and it’s led to a lot of chatter and head-scratching about how exactly this path would work. This 12-page memo from Gibson Dunn is a good up-to-date resource that outlines benefits, issues to consider and current rules that apply. The memo has a nice tabular overview of the various listing standards so that you can compare different alternatives (as Liz also blogged last week, Nasdaq now has a rule that allows secondary direct listings on its Global Select, Global and Capital Markets).
At this point, we still don’t know why the SEC rejected the first NYSE proposal – was it something that the NYSE adequately addressed in its revised proposal, or does the SEC think there’s a fundamental problem with primary direct listings, for investor protection or other reasons? Stay tuned, we’ll be blogging more on this topic as it develops.
Improving Board Oversight of Risk
The board’s role in risk oversight continues to be top of mind – not only for directors, but also for shareholders, legislatures & proxy advisors. If you’re looking for a pretty comprehensive resource, Wachtell recently issued a 24-page memo on the topic. It includes these recommendations:
– Assess whether the company’s strategy is consistent with agreed-upon risk appetite and tolerance for the company
– Review with management whether adequate procedures are in place to ensure that new or materially changed risks are properly and promptly identified, understood and accounted for in the actions of the company
– Review the risk policies and procedures adopted by management, including procedures for reporting matters to the board and appropriate committees and providing updates, to assess whether they are appropriate and comprehensive
– Review with management the quality, type and format of risk-related information provided to directors
– Review with management the primary elements comprising the company’s risk culture, including establishing “a tone from the top” that reflects the company’s core values and the expectation that employees act with integrity and promptly escalate non-compliance in and outside of the organization
Over Confidence about Risk Management?
As reported in a recent Navex blog, a survey from the Institute of Internal Auditors found that boards are over confident about the effectiveness of an organization’s risk management program. According to the survey results, the board “has more faith in the company’s ability to manage risks than the company’s executives do.”
As the blog high-lights, this can present problems when the board believes the company is effectively managing a risk, such as third-party risk, and the board then voices approval for growing the business in an area that relies heavily on effective third-party risk management. As the business expands or grows, a breakdown can occur and then questions will arise about an apparent weakness in risk management, and perhaps whether management was transparent with the board prior to the breakdown.
Navex offers tips for aligning management’s and the board’s views on risk management. Tips for starting a conversation with the board include:
– Discuss whether the board has the right structure and right people
– Evaluate whether the company has good escalation procedures so that the right information gets delivered to the board
– Does management speak in a unified way about risk to help ensure transparency?
– Does the company have a single, trusted source of risk information – starting with the same data set of information is key
Always a high-interest topic, check out Equilar’s blog on GC compensation trends – including a list of the top 10 highest paid general counsel. The info is based on the “Equilar 500” – 500 largest US-headquarter companies by reported revenue that trade on one of the 3 major US stock exchanges. Here are several tidbits from the findings:
– Median general counsel pay was $2.6 million in 2018, a 3.7% increase from 2017
– Although general counsel pay has risen through the years, it lags the rise in CEO compensation, which increased 8% from 2017
– Among the top 10 highest paid general counsel, the technology sector had the highest representation
– Since 2015, male general counsel have earned 11% more on average than female general counsel, and in 2018, this figure grew to over 18%
When the SEC raised the “smaller reporting company” threshold to $250 million last year, one point of contention was that it didn’t make an analogous change to the “accelerated filer” definition. So as confirmed in a set of CDIs from Corp Fin, a company can now be both a “smaller reporting company” and an “accelerated filer.” And although the SEC proposed amendments to both the “accelerated filer” and “large accelerated filer” definitions earlier this year, the proposed rules haven’t been adopted and there would still be some overlap between the filer categories.
Our members have asked a lot of questions about this over the last year. It’s hard to parse through all the rules! I was happy to see that this Ackerman memo lays out a chart for those companies that find themselves navigating this dual status.
For each Item of Reg S-K that applies to periodic reports, the chart compares general disclosure requirements to the rules that apply to smaller reporting companies – and shows whether or not “dual status” companies can take advantage of scaled disclosure accommodations. The memo also highlights that companies holding “dual status” need to comply with accelerated filer filing deadlines – i.e. 75 days after year end for their Form 10-K and 40 days after quarter end for their Form 10-Qs. Don’t forget about our “Disclosure Deadlines” Handbook if you’re looking for more in-depth info.
Audit Fees Keep Rising Due to “New” Standards
Last year, Liz blogged that audit fees had increased due to implementing new revenue recognition and lease standards. Those efforts have continued, so it’s not too surprising that companies are seeing higher fees again this year – according to a recent survey that’s summarized in this “Accounting Today” article. Unfortunately, the article also says that finance teams don’t feel like they’re seeing much in the way of benefits from the extra work & fees:
Over half of finance teams saw substantial audit cost increases over the past two years, primarily due to new accounting rules. The vast majority of companies that have adopted the new revenue recognition standard said that it has had a negative impact on their audit, audit costs increased and the audit required more time to complete – all leading to increased stress and frustration.