Cleary Gottlieb is out with its “Selected Issues for Boards of Directors in 2022” – this year’s edition covers 16 topics over the course of 83 pages. One item that I found particularly useful was the summary of how Delaware courts are analyzing director independence & disinterest (pg. 28), which is almost always an important issue in derivative suits and any other challenges to potentially conflicted transactions.
The Cleary team notes that recent Delaware cases – United Food & Commercial Workers Union v. Zuckerberg and others – are showing that judges are closely analyzing both economic conflicts and personal relationships. Here are the takeaways:
– The independence analysis under Delaware law is distinct from, and more nuanced, than under stock exchange rules. While the Delaware courts have noted that independence for purposes of stock exchange rules is one factor they consider, the Delaware law analysis is more holistic and fact-specific and considers, in addition to the traditional financial factors, such things as personal friendships or other relationships of a “bias-producing nature.
– Independence of directors is critical under Delaware law in a number of situations, including when the board is sued in a shareholder derivative action or when the board is asked to consider a related-party transaction. The Delaware courts have developed doctrines, including the demand futility test announced in Zuckerberg and the “MFW test” – which requires the approval of an independent special committee of directors for obtaining business judgment review of controlling stockholder squeeze-outs and other conflicted controlling stockholder transactions – that place a premium on the independence of directors in managing litigation risk.
– In evaluating director independence, Delaware courts have not hesitated to scrutinize closely personal relationships, taking into account facts such as co-ownership of unique assets, personal admiration, longstanding and overlapping business network ties, and shared philanthropic contributions. Boards should give serious consideration to these factors when selecting new directors or constituting special committees for the purposes of potentially conflicted transactions. It is advisable to stay aware of potential independence issues raised by interconnected personal relationships as Delaware courts continue to focus on this issue.
A recent SEC order serves as a reminder that the Commission is paying attention to disclosures about director relationships. This Stinson blog explains:
The SEC announced settled charges against formerly publicly-traded Leaf Group Ltd. for failing to adequately evaluate and disclose in its annual proxy statement the lack of independence of a director and a board committee as well as an “interlocking” board-of-directors relationship between that director and Leaf’s Chief Executive Officer.
According to the SEC’s order, Leaf made material misstatements in 2020 concerning the independence of a director and the existence of an interlocking relationship between that director and Leaf’s CEO. The order finds that Leaf materially misstated that the director was independent even though he served as Chief Financial Officer of another company, for which Leaf’s CEO served as a director and whose compensation committee Leaf’s CEO chaired. The order further finds that this “compensation committee interlock” disqualified the Leaf director as independent under the listing standards of the securities exchange on which Leaf’s stock traded and also required specific disclosure, under the SEC’s Regulation S-K, in Leaf’s proxy statement.
According to the order, Leaf further materially misstated the independence of a special committee that it had established to explore strategic alternatives, including a possible sale of Leaf, and also failed to maintain, during the 2019-20 period, disclosure controls concerning director independence and interlocks.
The blog points out several other interesting points from the order – and says that the company paid a penalty of $325,000 to settle the charges. As you head into proxy season, our “Director Independence” Handbook is an essential resource to help navigate the tricky world of interlocks and independence standards.
The guidance notes that S&P 500 boards averaged more than 9 formal meetings during 2021 – a 25% increase over 2020 – in light of intensifying challenges & oversight expectations. This means that it’s more important than ever for boards to manage their directors’ time commitments. SSGA has updated its overboarding guidelines to emphasize that Nominating Committees are in the best position to establish, enforce & disclose corporate policies that support director effectiveness.
Starting in March 2022, for non-NEO directors who hold what SSGA deems to be “excessive commitments,” the stewardship team may consider waiving the typical policy to vote “against” the overboarded director. SSGA will consider voting in support of the director if the company publicly discloses its overboarding policy (which may be in corporate governance guidelines, the proxy statement, or on the company website) – and the policy includes:
– A numerical limit on public company board seats a director can serve on (which cannot exceed SSGA’s policy by more than one seat)
– Consideration of public company board leadership positions (e.g., Committee Chair)
– Affirmation that all directors are currently compliant with the company policy
– Description of an annual policy review process undertaken by the Nominating Committee to evaluate outside director time commitments
As a reminder, SSGA’s “standard” policy is to vote against:
– Non-executive board chairs or lead independent directors who sit on more than 3 public company boards
– Director nominees who sit on more than 4 public company boards
– NEOs of a public company who sit on more than 2 public company boards
The new disclosure waiver policy applies only to the first two categories – i.e., directors who are not NEOs. If you want to utilize the waiver, the SSGA team asks companies to share their publicly disclosed director commitment policy (including primary source materials), or intention to establish such a policy in 2022 with our team via email at GovernanceTeam@SSGA.com. If a director is imminently leaving a board and the departure is disclosed in a written, time-bound and publicly available manner, SSGA may also consider waiving its withhold vote.
SSGA also points out that in addition to service on mutual fund boards and UK investment trusts not counting towards the overboarding total, service on a SPAC board won’t be considered when evaluating directors for excessive commitments. However, SSGA does expect these roles to be considered by Nominating Committees when evaluating director time commitments.
On Friday, Vanguard posted its 2022 proxy voting policies for US portfolio companies – which go into effect March 1st. Like SSGA, Vanguard’s updates also address governance & disclosure practices around director overboarding. Here’s an excerpt:
For 2022, the Vanguard funds will also look for portfolio companies to adopt good governance practices regarding director commitments, including the adoption of an overboarding policy and disclosure of how the board oversees policy implementation.
Here are Vanguard’s thresholds for overboarding:
– Non-NEO Directors: Vanguard will generally vote against directors who serve on 5 or more public company boards – at each company except the one where they serve as board chair or lead independent director.
– Directors Who Are NEOs: Vanguard will generally vote against a director who is a current NEO at a public company and sits on more than 2 public company boards (which the new policy clarifies could be either the NEO’s “home board plus one outside board, or two outside boards if the NEO doesn’t serve on their home board). A fund will typically vote against the nominee at each company where they serve as a non-executive director.
In addition, Vanguard’s new voting policy steps up expectations for board diversity and related disclosures, by saying:
Boards can inform shareholders of the board’s current composition and related strategy by disclosing at least the following:
– Statements from the nominating committee (or other relevant directors) on the board’s intended composition strategy, including expectations for year-over-year progress
– Policies related to promoting progress toward increased board diversity
– Current attributes of the board’s composition
Board diversity disclosure should at least include the genders, races, ethnicities, tenures, skills, and experience that are represented on the board. Disclosure of personal characteristics (such as race and ethnicity) should be on a self-identified basis and may occur at an aggregate level or at the director level. Disclosure of tenure, skills, and experience at the director level is expected (see details on “skills matrix” formats below)
New this year, Vanguard will vote against the nominating and/or governance committee chair (or other director if needed) if a company’s board is making “insufficient progress” in its diversity composition and/or in addressing its board diversity-related disclosures. Vanguard will consider applicable market regulations & expectations, company-specific context, diversity of personal characteristics (gender, race, ethnicity, tenure, skills, experience), and believes that boards should reflect a composition that is appropriately representative given their markets and strategies.
Vanguard’s approach to shareholder proposals that call for skills matrix disclosures and board diversity policies is unchanged from last year.
Vanguard’s new voting policies also address factors that funds will consider when assessing climate risk oversight failures (pg. 7) and shareholder proposals calling for “hybrid” or “virtual-only” meetings (pg. 18).
Tune in at 2pm Eastern tomorrow for the webcast – “The Latest: Your Upcoming Proxy Disclosures” – to hear Mark Borges of Compensia, Alan Dye of Hogan Lovells and Section16.net, Dave Lynn of Morrison & Foerster and TheCorporateCounsel.net, and Ron Mueller of Gibson Dunn discuss all the latest issues to consider as you prepare your upcoming proxy disclosures – including say-on-pay trends, shareholder proposals, ESG metrics, clawbacks, director compensation disclosure, pay ratio considerations and more. We are making this CompensationStandards.com webcast available on TheCorporateCounsel.net as a bonus to members – it will air on both sites.
If you attend the live version of this 60-minute program, CLE credit will be available. You just need to fill out this form to submit your state and license number and complete the prompts during the program.
Members of TheCorporateCounsel.net are able to attend this critical webcast at no charge. The webcast cost for non-members is $595. If you’re not yet a member, subscribe now by emailing sales@ccrcorp.com – or call us at 800.737.1271.
Having just finished grading 19 final exams for the course I co-teach at the Georgetown University Law Center, I can certainly recognize the difficulty in coming up with one letter grade to mark a long semester of work. That challenge doesn’t slow down the Institute for Internal Auditors and the Neel Corporate Governance Center at the University of Tennessee Knoxville, which come up with an annual grade for the state of corporate governance in the United States, which they call the American Corporate Governance Index (ACGI). The ACGI is described as follows:
The ACGI gauges the extent to which companies are effectively achieving each of the Guiding Principles from the perspectives of Chief Audit Executives (CAEs). CAEs are uniquely positioned to provide an independent and objective enterprise-wide perspective of the organization. The index goes beyond the publicly observable aspects of corporate governance to provide an internal perspective on the effectiveness of corporate governance throughout the organization. In forming the survey questions that support the ACGI, it is assumed that corporate governance does not allow for a one-size-fits-all approach and that companies will need to find their own best practices based on the company’s age, size, complexity, extent of international operations, etc.
The 2021 overall ACGI score for corporate governance health in the U.S. is a B- (81), down from an 82 in 2020. The report indicates that this year’s score suggests “that improvements in governance quality may be stymied as companies deal with the ongoing uncertainty of a global pandemic and the complexity of its fallout on supply chains, talent management, economic and political volatility, and more.”
Data from the 2021 ACGI survey signal a number of areas where governance improvements retreated: (i) companies earning “A” grades in governance dropped to 14% from 19% in 2020; (ii) potential declines in important employee-related governance measures were noted, such as providing adequate training and compensating in a way that promotes ethical decisions; and (iii) despite increased activism related to social and environmental issues, companies are slow to address the needs of a broad range of stakeholders in their business decisions.
One of the many interesting topics that came up during our webcast “Rule 10b5-1 & Buybacks: Practical Impacts of SEC’s Proposals” earlier this week (a replay is now available and a transcript will be coming soon) was whether companies should review and update their insider trading policies now given the SEC’s proposed disclosure requirement in Item 408(b) of Regulation S-K. Proposed Item 408(b) of Regulation S-K would require companies to disclose whether the company has adopted insider trading policies and procedures governing the purchase, sale, and other dispositions of the company’s securities by directors, officers, and employees or the company itself that are “reasonably designed to promote compliance with insider trading laws, rules, and regulations, and any listing standards applicable to the issuer.” If a company has not adopted such insider trading policies and procedures, the company must explain why it has not done so, and if the company has adopted insider trading policies and procedures, it must disclose such policies and procedures.
I note that yesterday the SEC took the unusual step of posting a new version of the Rule 10b5-1 and Insider Trading proposing release and removing the prior version from the website. There is no indication of why the old version was replaced. The original version of releases that are posted on the SEC’s website are sometimes replaced with corrected versions to conform to the Federal Register version, but that does not appear to be the case in this instance because the website does not indicate that the proposing release has been published in the Federal Register.
As we discussed during the webcast, there are a few areas that companies may want to revisit now in their insider trading policies:
The treatment of bona fide gifts – in the proposing release, the SEC says the disclosure “could address not only policies and procedures that apply to the purchase and sale of the registrant’s securities, but also other dispositions of the issuer’s securities where material nonpublic information could be misused such as, for example, through gifts of such securities.”
The approach to monitoring material nonpublic information – in the proposing release, the SEC mentions as a potential disclosure item “information on the issuer’s process for analyzing whether directors, officers, employees, or the issuer itself when conducting an open-market share repurchase have material nonpublic information.”
The preclearance process – in the proposing release, the SEC mentions as a potential disclosure item “the issuer’s process for documenting such analyses and approving requests to purchase or sell its securities.”
The policy’s compliance mechanisms – in the proposing release, the SEC mentions as a potential disclosure item “how the issuer enforces compliance with any such policies and procedures it may have.”
One of the perennial challenges with updating insider trading policies is trying to benchmark a company’s policies against those of other companies, because only some companies voluntarily choose to post their insider trading policies on their website. Over the years, we have often conducted surveys about practices around things like trading restrictions and to whom within the organization the various aspects of the policy apply, as well as other areas of common interest, but it is usually impossible to get a picture of the entire landscape from the voluntary disclosures and survey results. As a result, if Item 408(b) were adopted, it would probably go a long way to helping companies get a handle on what their peers are doing in their insider trading policies.
If you are a securities law nerd and you feel like now might be a good time to take part in the Great Resignation, take a look at the SEC’s recent job postings for the Division of Corporation Finance. Corp Fin is now hiring for the job of Chief Counsel, which I held in Corp Fin from 2003 to 2007. I always say that my time as Chief Counsel was the best job I ever had a securities lawyer, because every day you get to “drink from the firehose” of securities law issues. It is also a great opportunity to work with the very talented Staff in the Office of Chief Counsel, in Corp Fin and in the other Offices and Divisions at the SEC. If you have any questions about what it is like to serve in Corp Fin or the job of Chief Counsel in particular, always feel free to reach out to me.
The National Association of Corporate Directors recently published its 2022 Governance Outlook, which is designed to give corporate directors and senior executives a comprehensive overview of major business and governance issues that are likely to demand board focus over the coming year.
The topics addressed in the NACD Governance Outlook include:
Board Agendas Must Change to Meet 2022 Director Priorities
Embracing Greater Investor Interest in ESG Practices
The Role of the Board in Overseeing ESG
How Purpose is Changing the Board M&A Oversight Role: What Directors Are Saying
Board Responsibilities in Mitigating Ransomware Risk in 2022
The Role of Boards in Assessing DE&I Practices with Advanced Data Analytics
Directors and Officers Liability Threat and Insurance 2022 Outlook
State Street Global Advisors released its annual letter to board members of portfolio companies outlining the engagement issues that SSGA will prioritize this year. The letter indicates that SSGA’s main focus for 2022 “will be to support the acceleration of the systemic transformations underway in climate change and the diversity of boards and workforces.”
On the climate change front, SSGA states that, for the 2022 proxy season, it will expect companies in major indices in the US, Canada, UK, Europe, and Australia to align with climate-related disclosures requested by TCFD, including whether the company discloses: (1) board oversight of climate-related risks and opportunities; (2) total direct and indirect GHG emissions (Scope 1 and Scope 2 emissions); and (3) targets for reducing GHG emissions. SSGA will take voting action against directors if companies do not meet SSGA’s specific disclosure expectations. Further, SSGA will launch a targeted engagement campaign with “the most significant emitters” in its portfolio to encourage disclosure aligned with SSGA’s disclosure expectations for climate transition plans, and in 2023 SSGA will hold companies and directors accountable for failing to meet those disclosure expectations.
On diversity, SSGA has enhanced its diversity policy to provide that, beginning in the 2022 proxy season, SSGA will expect all of its portfolio companies to have at least one woman on their boards. Additionally, beginning in the 2023 proxy season, SSGA will expect boards to be comprised of at least 30% women directors for companies in major indices in the US, Canada, UK, Europe, and Australia. In each instance, SSGA will vote against the Chair of the board’s Nominating Committee or the board leader should a company fail to meet these expectations.
The letter also notes that SSGA has expanded its focus on diversity to include race and ethnicity, and for the 2022 proxy season SSGA will take voting action against responsible directors if: (1) companies in the S&P 500 and FTSE 100 do not have a person of color on their board; (2) companies in the S&P 500 and FTSE 100 do not disclose the racial and ethnic diversity of their boards; and (3) companies in the S&P 500 do not disclose their EEO-1 reports.
