As I wrote in the November-December 2022 issue of The Corporate Counsel, the Say-on-Frequency vote is the “Halley’s Comet” of the securities laws. Per the Dodd-Frank Act, the Say-on-Frequency vote only comes around once every six years, which means that we really don’t retain the “muscle memory” from including it in past proxy statements. As a result, this year we are busy revisiting decisions made in long ago proxy seasons for those issuers who were first required to conduct a Say-on-Frequency vote in 2011, after the Dodd-Frank Act was enacted. I thought it might be helpful to review some of the common questions that come up every time the Say-on-Frequency vote rolls around.
Do I have to include the Say-on-Frequency Vote if the issuer conducts annual Say-on-Pay votes and the issuer has never changed the frequency of Say-on-Pay Votes?
Yes. Exchange Act Rule 14a-21(b) requires that companies provide a separate shareholder advisory vote in proxy statements for annual meetings to determine whether the vote on the compensation of executives required by Section 14A(a)(1) of the Exchange Act “will occur every 1, 2, or 3 years,” and this advisory vote must occur “no later than the annual or other meeting of shareholders held in the sixth calendar year after the immediately preceding vote.” The Say-on-Frequency vote must occur even if the company does not intend to change the frequency with which it seeks to conduct its Say-on-Pay votes.
Is there a specific form of resolution that issuers must use for the Say-on-Frequency vote?
No. Rule 14a-21(b) does not require that issuers use a specific form of resolution for the Say-on-Frequency vote. Unlike the Say-on-Pay vote requirement in Rule 14a-21(a), the rule does not specify a nonexclusive example of a Say-on-Frequency resolution. Exchange Act Rules Compliance and Disclosure Interpretations Question 169.04 indicates the Staff’s view that the Say-on-Frequency vote need not be set forth as a resolution. Separately, the Staff has informally cautioned that the Say-on-Frequency vote must be clearly stated, in that it must be clear that shareholders can vote on the options of every one, two or three years (or abstain from voting), rather than solely following management’s recommendation as to the frequency, if one is provided.
Companies have relied on this Staff guidance to provide Say-on-Frequency votes in a “proposal” format, such as by simply referencing the four choices that are available on the proxy card, rather than using a “resolution” approach. The Staff indicates in Exchange Act Rules Compliance and Disclosure Interpretations Question 169.06 that it is permissible for the Say-on-Frequency vote to include the words “every year, every other year, or every three years, or abstain” in lieu of “every 1, 2, or 3 years, or abstain.”
Does the inclusion of a Say-on-Frequency vote proposal require the filing of a preliminary proxy statement?
No. The inclusion of a Say-on-Frequency vote proposal does not necessitate the filing of a preliminary proxy statement under Exchange Act Rule 14a-6.
Does the board of directors have to make a recommendation to shareholders on the Say-on-Frequency vote?
No. Rule 14a-21(b) does not require that the board of directors make a recommendation as to the frequency of Say-on-Pay votes, but the SEC has noted that uninstructed proxy cards may be voted in accordance with management’s recommendation only if the company follows the requirements of Rule 14a-4, which include specifying how proxies will be voted (i.e., in accordance with management’s recommendations) in the absence of an instruction from the shareholder. Historically, most companies have provided shareholders with a recommendation as to the frequency of Say-on-Pay votes, and that recommendation has usually been to conduct a Say-on-Pay vote annually.
How do I determine which frequency “wins” the vote?
The Say-on-Frequency proposal is unusual because the issuer is not asking the shareholders to “approve” a specific proposal or resolution. Instead, shareholders are being to select one of three frequency options or abstain from voting. In footnote 121 of the adopting release from 2011, the Commission stated: “Because the shareholder vote on the frequency of voting on executive compensation is advisory, we do not believe that it is necessary to prescribe a standard for determining which frequency has been ‘adopted’ by the shareholders.”
Item 5.07 of Form 8-K requires that an issuer must disclose its decision as to how frequently the company will conduct Say-on-Pay votes following each Say-on-Frequency vote (the Say-on-Frequency vote is advisory, so the company must ultimately decide the frequency of future Say-on-Pay votes). To comply with this requirement, a company must disclose the determination in the original Form 8-K or file an amendment to its original Form 8-K filing (or filings) that disclosed the preliminary and final results of the Say-on-Frequency vote.
The Form 8-K amendment is due no later than 150 calendar days after the date of the end of the annual meeting in which the Say-on-Frequency vote occurred, but in no event later than 60 calendar days prior to the deadline for the submission of shareholder proposals as disclosed in the proxy materials for the meeting at which the Say-on-Frequency vote occurred. Specifically with respect to Say-on-Frequency votes, an issuer must disclose the number of votes cast for each of the choices (every one, two or three years), as well as the number of abstentions in Item 5.07 of Form 8-K.
Failure to provide the required disclosure under Item 5.07 could impact an issuer’s ability to use Form S-3 and maintain WKSI status, therefore it is important to remember to include the necessary disclosure about the determination as to the frequency of future Say-on-Pay votes, even if there is no change from past practice. Back in 2011 when the first Say-on-Frequency vote was conducted, many issuers failed to timely disclose the board’s decision on the frequency of future Say-on-Pay votes, which resulted in a significant number of late Form 8-K filings. The Staff granted Form S-3 eligibility waivers fairly liberally at that time, but then became much less accommodating on this issue over time.
Most companies now opt for including the determination language in the original Form 8-K, rather than filing the amendment at a later date. To accomplish this, it is often necessary to ask the board of directors to approve the frequency of Say-on-Pay votes after the votes from shareholders are tallied.
The vast majority of issuers adopted an annual frequency for Say-on-Pay votes back in 2011, based on pressure from the proxy advisory firms and institutional investors, and not much has changed since that time.
We are unlikely to see issuers make any changes in the frequency of Say-on-Pay votes this proxy season or in the future, because Say-on-Pay has become such a fixture of the engagement process between issuers and investors over the past dozen years. As a result, the Say-on-Frequency vote has become essentially a historical relic that we trot out every six years simply because the rule requires us to do so, and we must go through the motions to provide shareholder feedback to the board of directors that is of little use to them in making their decision as to frequency of Say-on-Pay votes.
The SEC’s Reg Flex Agenda has recently listed a rulemaking in the proposed rule phase identified as “Regulation D and Form D Improvements.” Last month, I speculated in the blog about what that rulemaking could involve, because to date we have not received much indication of what the Commission may be considering in terms of rule amendments.
Earlier this week at the Northwestern Pritzker School of Law’s Securities Regulation Institute, SEC Commissioner Caroline Crenshaw delivered the Alan B. Levenson Keynote Address and provided some important insights into the issues that the Commission may now be considering. Focusing on Rule 506 of Regulation D, Commissioner Crenshaw noted several areas of concern with the ubiquitous private offering exemption and the rise of unicorns that utilize the private offering exemption, including those related to investor protection, inflated valuations, corporate governance and the impact on small businesses. Concluding that Regulation D is not serving its intended purpose, Commissioner Crenshaw suggested the following potential areas for reform:
Form D. Commissioner Crenshaw suggests that Form D could be required to be filed prior to the time any solicitation under Regulation D is made, and failure to file a Form D could have actual consequences, such as the inability to rely on Regulation D in future offerings. She notes that the form itself could include useful, substantive information about a private company and could be required to be signed and certified by an executive officer.
A Two Tiered Exemption Like Regulation A. Commissioner Crenshaw suggests that the Commission could import a two-tiered framework, similar to that under Regulation A, which would impose heightened obligations on the larger private issuers and issuances. At a minimum, she suggests that large private issuers could bear heightened disclosure obligations at the time of the offering and on an ongoing basis. For example, large private issuers could be required to engage independent auditors and would have to provide prospective and committed investors with financial statements audited in accordance with GAAS, along with auditor opinion letters, confirming the adequacy of the company’s internal controls over financial reporting.
In conclusion, Commissioner Crenshaw noted:
To my mind, this is a tailored solution that helps us fulfill our mandates. First it imposes heightened obligations on larger private companies. In so doing we would both acknowledge Reg D’s purpose in allowing reprieve to smaller businesses, and also help eliminate the benefit and effective subsidy being given to large private issuers on the backs of these same small businesses. Second, it provides broader disclosure to investors, which acknowledges again that, even among a set of accredited and sophisticated investors, private market investors are entitled to a certain basic set of information.
These proposals could substantially change the way issuers utilize Regulation D, which is by far the most widely used exempt offering alternative.
Earlier this week, the SEC’s Small Business Capital Formation Advisory Committeeannounced the agenda for its meeting to be held next Tuesday. The Committee will discuss alternative approaches to private company financing, the Commission’s February 2022 proposal regarding private fund advisers, and the role of equity research for smaller public companies and investors. The meeting will be open to the public via webcast on www.sec.gov. The announcement notes:
The Committee, which provides advice and recommendations to the Commission on rules, regulations, and policy matters relating to small businesses, will start the morning session by exploring revenue-based financing and other alternatives to traditional bank or venture capital funding for smaller private companies. The Committee will finish the morning session by discussing the Commission’s proposed new rules and amendments related to the regulation of private fund advisors and hear from invited panelists about how the proposal may impact early-stage venture capital funds.
In the afternoon session, the Committee will examine the current availability of public company investment research prepared by broker-dealer firms, including what impact its availability has on liquidity for smaller public companies, how the analysis reaches investors, and the value of that research for investors. Panelists will share market data and insights with the Committee.
If you are interested in the work of the Small Business Capital Formation Advisory Committee, the period for nominations is now open. Last month, the SEC announced that it is seeking candidates for appointment to the Committee. To be considered timely, submissions must be received by February 17, 2023. The SEC notes that relevant experience may include: (i) representing emerging companies engaging in private and limited securities offerings or considering an initial public offering (IPO), professional advisors of such companies, and investors in such companies; (ii) service as an officer or director of minority-owned small businesses or women-owned small businesses; (iii) representing smaller public companies, the professional advisors of such companies, and the pre-IPO and post-IPO investors in such companies; and (iv) representing participants in the marketplace for the securities of emerging companies and smaller public companies.
During a panel yesterday featuring the Corp Fin Senior Staff, Erik Gerding, who has been named Director of Corp Fin effective February 3rd, noted that the Staff is planning to issue Compliance and Disclosure Interpretations on the pay versus performance disclosure requirements soon. While any Staff guidance will certainly be welcome on the new rules, the timing of the guidance may require many issuers to revisit disclosures that they have already drafted.
What types of topics might this guidance address? It is difficult to predict which topics ultimately may be addressed by the Staff in the CDIs, but some of the possibilities include:
– The potential use of the CD&A peer group for the TSR comparison, as I covered in the blog recently;
– How to determine which named executive officers are included in the average calculations, including “voluntary” named executive officers;
– Valuation approaches for options and performance-based equity awards when calculating compensation actually paid;
– Addressing equity awards that fail to vest but remain outstanding and situations where an executive departs and forfeits equity awards;
– Addressing modified equity awards in the compensation actually paid calculation;
– Applying the market capitalization weighting requirement when calculating peer group TSR;
– Addressing changes in peer groups over time;
– Dealing with unusual situations such as IPOs, spin-offs, mergers and acquisitions and bankruptcy when calculating peer group TSR;
– The time periods addressed by the required footnotes to the pay versus performance table;
– Disclosure required regarding assumptions for the pay versus performance table;
– Various issues with selecting measures for the tabular list and the Company Selected Measure;
– Presentation issues for newly public companies, merged companies and spun off companies; and
– Issues with presenting supplemental measures.
We understand that the Staff has been collecting a lot of questions on the pay versus performance disclosure requirements, so the Staff will no doubt have to be selective in which issues are ultimately addressed. Given the uncertainty as to when this guidance might be provided, it is advisable for issuers to keep moving forward with preparing the pay versus performance disclosure and then consider what adjustments may be necessary once the guidance is available.
At this year’s Securities Regulation Institute, I served as a moderator for a panel that focused on three areas of SEC rulemaking – the cybersecurity rule proposal, the share repurchase rule proposal and the new Rule 10b5-1 and insider trading disclosure rules. In talking about how to get ready for the adoption of the proposed cybersecurity disclosure rules – which the SEC has said could occur between now and April of this year – there are a number of things that companies can do now in anticipation of the new rules. Here is my list:
1. The SEC’s cybersecurity proposals are somewhat unique in that at least part of the proposed rules contemplate codifying existing interpretive guidance regarding real-time Form 8-K reporting of material cybersecurity incidents, so many companies often have a process already in place as part of their disclosure controls and procedures for escalating cybersecurity incidents within the organization so that disclosure decisions can be made.
2. As a result, companies can now look at those controls and procedures and evaluate how they might change when the SEC adopts the proposed rules. For example, companies often are focused on disclosure of single-time material cybersecurity events, while the final rules may require disclosure about a series of previously undisclosed individually immaterial cybersecurity incidents that become material in the aggregate.
3. An important tool for being able to make rapid judgments about whether a Form 8-K must be filed to disclose a material cybersecurity event is having a framework in place for how materiality will be evaluated, so companies should consider establishing that framework if they have not already done so. When significant cybersecurity events occur, they often do not neatly fit into specific categories and the ultimate impact of the events may be very hard to judge, so the framework is a way of articulating the specific factors that management will use when making the materiality determination.
4. It is also important to integrate the disclosures controls and procedures for disclosing material cybersecurity incidents with the company’s overall incident response plan, so that processes do not get “siloed” which could result in incidents being missed.
5. It is possible to work now on developing a workplan to obtain the information that will need to be disclosed in periodic reports.
6. With respect to governance and risk management around cybersecurity, it is not too early before the rules are adopted to consider potential changes to these matters. In many ways, the SEC’s disclosure rules around these topics seem to articulate expectations that the SEC has about the governance approach.
7. When working on a policy for escalating cybersecurity incidents for disclosure purposes, it is also appropriate to consider developing a policy for when cybersecurity incidents should be escalated to the board or a committee of the board, even when those cybersecurity incidents may not ultimately need to be disclosed in SEC filings.
8. It is not too early to think about disclosure regarding cybersecurity expertise and what current and potential board members bring to the board on this particular topic, so that the company can provide the disclosure that may be required by the new rules.
9. These rules will require a great deal of cooperation among different departments and individuals within the organization, so now is a good time to establish or strengthen those relationships.
1. The changes to Rule 10b5-1 adopted by the SEC are significant enough that companies now need to step back and consider how insiders should use Rule 10b5-1 going forward:
– Are Rule 10b5-1 plans with long cooling off periods and restrictions on overlapping plans too restrictive to be useful for some or all of the transactions that insiders regularly engage in?
– How will the brokers that insiders use for executing Rule 10b5-1 plans implement these rules, and will they allow the use of non-Rule 10b5-1 trading plans in some instances?
– If you have a policy that says all insider transactions must be conducted through Rule 10b5-1 plans, should you now revisit that policy given how Rule 10b5-1 has become more restrictive?
– Should the company encourage insiders to engage in transactions in the window period, rather than rely on Rule 10b5-1 transactions?
– Should you revise who are your Section 16 insiders in light of the increased transparency around Rule 10b5-1 plans?
2. Given the increased transparency around insider trading policies, it makes sense to review and update your insider trading policies now to make sure it is ready for “prime time.”
– Are your window periods appropriate, or are they too aggressive and might subject your company to scrutiny when they are made public?
– Are your preclearance procedures appropriate?
– Is the group that you subject to preclearance and window period procedures the right group?
– Do you need to revisit your approach to gifts of securities, in light of the SEC’s interpretive guidance indicating that gifts could, under certain circumstances, be treated as a trade or sale?
– What actually constitutes your policies and procedures relating to insider trading and are you comfortable with filings those materials as an exhibit to the Form 10-K?
3. Should you now consider putting in place a policy around the company’s repurchase of its own securities and dealing with material nonpublic information in light of the requirement to discuss whether such a policy exists?
4. The new disclosure required in Item 402 of Regulation S-K regarding the grant of options in an around the time of release of material nonpublic information is obviously disclosure that companies want to avoid. As a result, do you need to adopt or amend equity grant policies to ensure that you won’t have situations going forward where this disclosure would be required?
5. With respect to the SEC’s share repurchase disclosure rule proposal, a lot depends on how rapidly the SEC ends up requiring the disclosure of share repurchases.
– A one day reporting requirement would obviously create logistical difficulties, so it would make sense to try to “automate” the process as much as possible.
– A whole new series of disclosures controls and procedures will be necessary to ensure that accurate reporting is done in a timely manner.
– The decision will have to be made internally as to who “owns” this disclosure requirement, Legal or Treasury?
– Once the disclosure is required, there will need to be a coordinated effort because these disclosures could be potentially closely watched, and Treasury, Investor Relations and Legal will need to be prepared to respond to inquiries regarding the company’s share repurchase patterns.
The Corp Fin Staff published the latest update to the Division of Corporation Finance’s Financial Reporting Manual (affectionately known as the “FRM”), which is dated as of December 31, 2022. The FRM is the “go to” resource for so many things related to the presentation of financial statements and financial information, so it is always exciting to see the FRM get an extensive refresh.
The updated FRM has been revised to:
– Reflect amendments to Rules 3-10 and 3-16 and addition of new Rules 13-01 and 13-02 of Regulation S-X;
– Clarify the implementation date of ASU 2018-12, Financial Services – Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts for certain registration statements;
– Update the contact information for Corp Fin’s Office of Chief Accountant;
– Update the EGC revenue threshold based on the inflation-related adjustment announced in September 2022; and
– Remove certain outdated information, such as guidance on the adoption of ASC 606.
As the Staff notes in its disclaimer for the FRM, the manual was originally prepared by the Corp Fin Staff to serve as internal guidance, and in 2008, in an effort to increase transparency of informal Staff interpretations, Corp Fin posted a version of the FRM to its website. I can still remember carrying around my original hard copy FRM, which we always called the “Training Manual” back in the day. It was easily identifiable by the bright orange cover, which the PDF version retains to this day. The FRM includes critical interpretive nuggets and explanations that are always useful in your day-to-day practice.
