SEC Commissioner Stein Suggests SEC Develop Investor-Specific Disclosure Scheme

In recent remarks before the Consumer Federation of America, SEC Commissioner Kara Stein
suggested using the SEC's current disclosure effectiveness project as an opportunity to consider varying financial disclosure based on investor type - in recognition of the fact that different types of investors have "different levels of knowledge, desires for information and analytical skills." Specifically, Stein supports "layers" of disclosure for different types of investors.

She suggested the SEC engage in investor testing to understand how different investors absorb disclosures. "We would benefit from testing that lets us understand how the ordinary investor in Peoria, Illinois or Portland, Oregon, absorbs corporate disclosures.  And does this change depending on the age of the investor?  Do Millenials absorb information differently than Boomers?  We should formulate a plan to incorporate thorough investor testing into as many of our projects as possible." While acknowledging the SEC's efforts to vary disclosure in some instances, she indicated that "we still generally take a 'one-size-fits-all' approach to disclosure as investor protection. I think we can should think about whether we can do better."

House Passes Disclosure Modernization & Simplification Act 

Last week, the House passed and referred to the Senate the Disclosure and Simplification Act of 2014. The bill directs the SEC to:

• Issue regulations permitting companies to submit a summary page to the Form 10-K that page cross-references material contained in 10-K,
• Revise Regulation S-K to reduce the burden on smaller issuers, including emerging growth companies, accelerated filers, and smaller reporting companies, and
• Eliminate duplicative, overlapping, outdated, or unnecessary provisions in Regulation S-K.

The bill also directs the SEC to study ways to: (1) modernize and simplify the requirements in regulation S-K, (2) improve the readability and navigability of disclosure documents, and (3) discourage repetition and disclosure of immaterial information. 

See also this Cooley blog. 

SEC Sanctions Eight Firms for Auditor Independence Violations 

Earlier this week, the SEC sanctioned eight audit firms for auditor independence violations. The firms used data provided by their broker-dealer clients to prepare their clients' financial statements, effectively putting themselves in the position of auditing their own work. "To ensure the integrity of our financial reporting system, firms cannot play the roles of auditor and preparer at the same time," said Stephen L. Cohen, Associate Director of the SEC's Division of Enforcement.  "Auditors must vigilantly safeguard their independence and stay current on the applicable requirements under the rules." 

See also this PCAOB release announcing auditor independence enforcement actions against 7 companies under comparable circumstances.

SEC Accounting Staff Addresses "Scope Creep," Revenue Recognition & ICFR Issues

In the context of recurring auditor independence issues, SEC Deputy Chief Accountant Brian Croteau reiterated at this week's AICPA Conference the importance of companies having policies and procedures to evaluate their independent auditor's provision of non-audit services. Specifically, he noted that policies should accommodate evaluating services for "scope creep," which happens when an initially permissible service morphs into an impermissible service - thus triggering an auditor independence violation. His speech also reminds us that, regardless of whether a particular type of service is permissible, the auditor independence principles set forth in Rule 2-01 of Regulation S-X govern.  Even a permissible service can't be provided if the nature of the service or manner in which it is provided is inconsistent with other aspects of the rule.

Croteau also reiterated prior concerns about whether companies are properly identifying, evaluating and disclosing material weaknesses based - in part - on the fact that identification of a material weakness in the absence of a material misstatement is "surprisingly rare." Senior Associate Chief Accountant Kevin Stout supplemented Croteau's remarks in this speech, where he discussed management's identification and consideration of financial reporting risks in their annual ICFR evaluations, and specific concerns about how the nature of deficiencies are described and evaluated.

Also noteworthy is SEC Chief Accountant James Schnurr's discussion at the conference about implementation efforts and issues associated with the new revenue recognition standard. His remarks are captured well in this FEI blog. See also this Compliance Week article discussing the three issues FASB is focused on to evaluate the need for a delay of the standard's effective date.

Nasdaq Annual Meeting Proposal Rejected

Last week we reported on Nasdaq's rule change proposal that would have provided limited staff discretion to allow companies additional time to solicit proxies and hold their meeting in compliance with Rule 5620, rather than requiring delisting as is currently the case. We have since learned that this proposal has been rejected. Please let us know if you have any additional information about the basis for the rejection and/or potential for a re-proposal.

Costco Director Tenure Shareholder Proposal Will Go to a Vote  

Costco is putting a Chevedden-sponsored shareholder proposal on director tenure to a vote at its annual meeting on January 29. The proposal seeks board adoption of a bylaw that would require at least two-thirds of the board to have less than 15 years tenure. According to the proposal, eight of 14 (or eight of 13 taking into account an impending departure, as noted in this article) of Costco's directors have more than 15 years tenure.  

Costco's board recommends a vote against the proposal, indicating that imposing mandatory limits on director tenure would "arbitrarily deprive Costco of qualified, experienced and effective directors." The board further notes in its response that experienced directors support Costco's long-term approach to creating shareholder value and that board processes adequately consider tenure.  

In his blog, Jim McRitchie characterizes the proposal as "overgenerous." He further states, "I'll be looking to introduce something similar at any company in my portfolio where more than two-thirds of the directors have served for 10 years or longer and the board shows other signs of stagnation or entrenchment."  

Stay tuned.  

In other shareholder proposal news, this is a reminder that the Society has begun to receive members' shareholder proposals and we encourage any of you who would like access to the database to submit your own. We have about 50 so far. Please submit your proposals to twebb@governanceprofessionals.org. The database is for those who wish to connect with others who have received similar proposals.
 

SEC Comment Letters (Still) Focused on MD&A

Deloitte just published its latest annual report on SEC comment letter trends. As in prior years, the MD&A is the leading source of SEC Staff comments. Deloitte notes, "Comments often focus on enhancing the executive overview to provide an investor with a balanced summary of key drivers, challenges, and risks that affect the registrant's liquidity and results of operations. In results of operations, the staff has continued to focus on encouraging registrants to disclose known trends or uncertainties, quantify components of overall changes in financial statement line items, and enhance their analysis of the underlying factors that cause such changes."

Other areas of frequent comment include segment reporting, revenue recognition, income taxes, internal control over financial reporting and comments on the cash flow statement. In addition, industry-specific comments have reportedly been substantial.

See also Deloitte's article on comment letter topics and areas of expected future focus.

UK Corporate Secretaries Survey Provides Boardroom Insights

A new "Boardroom Bellwether" report - reflecting the views of company secretaries of the UK FTSE 350 - reveals noteworthy boardroom insights, and could press new expectations in the U.S.  

Findings include:

• Gender diversity - 69% of respondents believe that their boards are diverse or very diverse in terms of gender - up from 51% last year. 53% expect that their company will meet Lord Davies' target of 25% of women on boards by 2015. For those companies not expecting to hit the target, reasons ranged from the quality of candidates and adequacy of the pool, to the ability to retain them.
• Board succession planning - Only 51% of respondents reported a written succession plan for their board, the majority of which are reviewed annually. This is up from 44% in July . The Financial Reporting Council reportedly plans to publish a discussion document on board succession planning in Spring 2015.
• Shareholder engagement - Virtually all companies now have a shareholder engagement plan - whether communicating via e-mail, mail or scheduled meetings - up from 60% last year.
• Risk management - 76% of boards receive regular updates from the company's chief risk officer or equivalent. 35% of companies have a risk committee as a formal committee of the board.
• Proxy advisers - The perception of the influence of proxy advisers is far more negative than positive - with only 4% seeing them as a positive influence, and just under half of respondents perceiving their influence on company/shareholder engagement as negative.

Thoughts for Boards of Directors in 2015

In this recent memo, Wachtell Lipton discusses significant issues and trends directors should keep in mind as they plan their 2015 agendas - including shareholder activism, risk management oversight, and board evaluations and composition - and relevant ISS and Glass Lewis policies on each of these topics.

Vanguard to Seek Board "Shareholder Liaison Committees"

Further to our report of Vanguard's interest in "shareholder liaison committees" last month, this Financial Times article reports that Vanguard is planning to send letters to company boards asking them to create "shareholder liaison committees" composed of independent directors. Vanguard CEO Bill McNabb wants to promote engagement on long-term issues. "Meetings with shareholder liaison committees would allow investors to express their opinions on how a company's strategy compared with its competitors, or to suggest questions that independent directors should be asking of management." He added that he "hope[s] it leads to . . . not a lot of short-termism but discussion about important long-term issues." The letter campaign will reportedly start in 2015 with U.S. companies.

Wal-Mart Held to Have Improperly Excluded Proposal Despite SEC No-Action Relief

The U.S. District Court for the District of Delaware recently held that Wal-Mart improperly excluded a shareholder proposal from its proxy statement for which it had previously been granted no-action relief by the SEC under Rule 14a-8(i)(7)'s ordinary business exclusion.

The proposal, submitted by Trinity Wall St. for Wal-Mart's 2014 annual meeting, sought to amend Wal-Mart's Nominating/Governance Committee charter to provide for oversight concerning the formulation and implementation of policies that would determine whether the company should sell a product (including certain guns) that (i) especially endangers public safety and well-being; (ii) has the substantial potential to impair the company's reputation; and/or (iii) would reasonably be considered offensive to the family and community values integral to the company's brand.

Earlier this year, Wal-Mart sought and obtained an SEC no-action letter to exclude the proposal since it "relates[d] to the products and services offered for sale by the company." Wal-Mart excluded the proposal and Trinity sued, resulting in the court's ruling that the proposal was improperly excluded, and requiring Wal-Mart to include the proposal in its 2015 proxy materials if a similar proposal is submitted. 

The district court distinguished Trinity's proposal from one that would excludable under ordinary business grounds based on the proposal's focus on board oversight of policy development on a "significant social policy issue." The court further found the proposal suitable for inclusion because it didn't involve any intricate details or impose any time-frames or methods - i.e., it didn't seek to "micro-manage" the company.

The court also reiterated that the U.S. District Court, rather than the SEC, is the final arbiter of whether shareholder proposals are excludable - as the SEC itself has made clear.

After quoting from the SEC's 1998 Release on Shareholder Proposals setting forth the policy underlying the ordinary business exclusion, the court reasoned:

The guidance provided by the SEC in its 1998 Release strongly supports the Court's conclusions. Trinity's Proposal does not undermine the "policy underlying the ordinary business exclusion."  The Proposal does not, for instance, take a "task[] ... so fundamental to management's ability to run a company on a day-to-day basis" and, impractically, subject it to "direct shareholder oversight." Id. That might be the case if the Proposal attempted, through a shareholder vote, to dictate to management specific products that Wal-Mart could or could not sell . . . .  It is not the case here, however, where the "task" is the formulation and implementation of policy, which are tasks the Board's Committee, "subject to direct shareholder oversight," can and already does perform. Trinity's Proposal leaves development of policy to the Board Committee, which in tum is free to delegate responsibility for the day-to-day aspects of implementation of any such policy to the Company's officers and employees.

 

Moreover, to the extent the Proposal "relat[es] to such matters" as which products WalMart may sell, the Proposal nonetheless ''focus[es] on sufficiently significant social policy issues" as to not be excludable, because the Proposal "transcend[s] the day-to-day business matters and raise[s] policy issues so significant that it would be appropriate for a shareholder vote." (Id.) (emphasis added) The significant social policy issues on which the Proposal focuses include the social and community effects of sales of high capacity firearms at the world's largest retailer and the impact this could have on Wal-Mart's reputation, particularly if such a product sold at Wal-Mart is misused and people are injured or killed as a result. In this way, the Proposal implicates significant policy issues that are appropriate for a shareholder vote. (citations omitted)

See also this PLC write-up.

Supplemental Briefs Filed in Conflict Minerals Case

Earlier this week, the SEC, intervenor Amnesty International and amici Global Witness and Free Speech for People filed their supplemental briefs in support of upholding the conflict minerals disclosure requirement. As we previously reported, the DC Circuit Court of Appeals directed the parties to brief three specific questions related to the First Amendment issue in connection with the rehearing.

Congratulations to Society Member and Past Chair Lydia Beebe

Congratulations to past Society Chair Lydia Beebe, who earlier this week was named to the board of HCC Insurance Holdings, Inc. (NYSE:HCC):

We are very pleased to have Lydia join our Board. With over 35 years of experience in corporate governance and tax, including extensive experience managing a corporate governance function, Lydia brings a new perspective to our Board that we believe will be very valuable as HCC continues to grow," said Christopher J.B. Williams, HCC's Chief Executive Officer.  

Deloitte LLP/Society Board Practices Report and Webcast

The Society/Deloitte LLP 2014 Board Practices Report: Perspectives from the Boardroom will be sent to members next week. We believe this report is unique in its focus on practitioner questions. It provides useful trend information from questions posed in earlier surveys, and covers newer topics such as CEO succession, board composition and refreshment, and activism.
 

Deloitte will also host a webcast featuring data from the Report on December 16 from 2:00 pm - 3:00 pm Eastern time titled: Boardroom Agenda 2015: A Look at Hot Topics and Board Practices. Click here to register.

Study Suggests Diverse Board Candidates Still Need Some Common Characteristics with Fellow Directors

Based on 12 years of research data on Fortune 500 boards, the W.P Carey School of Business concluded that new diverse (i.e., women and minority) directors can measurably impact board decision-making - but are more likely to be effective if they share some characteristics with existing directors. Based in social psychology, researchers determined that having traits such as educational background, industry expertise, job function, etc., in common serves to integrate otherwise dissimilar (from the traditional director point of view) directors into the group - increasing their chances of success.

More specifically, the research showed that demographically different directors who shared attributes with incumbent directors were more likely to win re-election to the board, gain positions on important board committees and influence board behavior. Conversely, the absence of shared traits resulted in diverse directors who are "more likely to be marginalized in their roles..."

The full study is available for purchase.  

Audit Partner Rotation Provides the Intended "Fresh Look" to Audit Engagement

This new paper provides evidence that audit partner rotation (not audit firm rotation), which is required every five years, serves its intended purpose - i.e., brings a "fresh look" to the audit engagement in furtherance of auditor independence, while supporting firm continuity and overall audit quality.

Based on 220 primarily mandatory audit partner rotations of 205 public companies from 2006 to 2013, the authors find that audit partner rotation results in enhanced audit quality as measured by substantial increases in material restatements and write-downs of impaired assets. The authors determine that the increases in restatements and write-downs "suggest that new partners may help address the complacence of the former audit partner by bringing a renewed sense of skepticism as well as additional insights and expertise."

This week's highlighted question from the Huddle is:

Does anyone have a response plan that you would put into place if your board is approached by an activist shareholder (e.g., draft press release, key roles (including board, PR firm, etc.)? If so, would you be willing to share a redacted version?  

This question generated a lot of activity and many excellent answers (too many to note here) including:

It's also important to note that every potentially threatening situation is likely to need a "Special Team" of subject-matter experts...like product safety experts, legal experts, your investment banker, expert "proxy advisors and 'fighters' etc...depending on the situation...And, in any crisis, your expert communications teams (IR, PR, Community Relations staff. and maybe others) will be extremely important to involve from the get-go. So the sooner the 'Team Captains' can identify, and bring the right experts into the loop, the better...

Satisfying Shareholders and Proxy Advisers

On This Week in the Boardroom, Laura Finn sits down with Zach Oleksiuk, Americas Head, Corporate Governance and Responsible Investment, BlackRock, to talk about the most critical issues for shareholders today and how companies can better shareholder engagement efforts.

BE A SOCIETY ADVOCATE! Tap into your smartphone or Rolodex to spread the word about the importance and value of Society membership!

The Society is a member of Corporate Secretaries International Association.