SEC Proposes Claw-Back Rules 

The SEC announced the issuance today of proposed clawback rules under Section 954 of the Dodd-Frank Act. Highlights of the proposed rules, which will be effected via exchange listing standards, include:

• Recovery from current and former "executive officers" who received incentive-based compensation during the 3 fiscal years preceding the date on which the company is required to prepare a restatement to correct a material error.
• The definition of "executive officer" would be based on the definition of "officer" under Section 16.   
• Incentive-based compensation that is granted, earned or vested based on the attainment of any "financial reporting measure" would be subject to recovery.
• Recovery would be required on a no-fault basis, without regard to whether any misconduct occurred or an executive officer's responsibility for the erroneous financial statements.
• Companies would be required to recover the amount of incentive-based compensation received in excess of the amount the officer would have received had the compensation been determined based on the restatement. 
• Companies would have discretion not to pursue recovery if the direct expense of enforcing recovery would exceed the amount to be recovered
• Companies would be required to file their clawback policies as an annual report exhibit
• If a restatement requires clawback, companies would be required to disclose in annual reports/proxies (wherever executive compensation disclosure is otherwise required) instances in which executives did not repay promptly or the company exercised its limited discretion not to pursue recovery.
• Proposed rules apply to all listed companies except certain registered investment companies. 

Commissioner Piwowar, along with Commissioner Gallagher, opposed the proposal. Reflecting on the unintended consequences of Section 162(m), Piwowar remarked: 

A recovery policy would introduce uncertainty in the amount of incentive-based compensation that executives will ultimately retain. Prior research and experience suggests that this uncertainty will increase total executive compensation. In particular, corporate executives may lower the value that they attach to the incentive-based component of their pay and demand an offset to bear the increased uncertainty.  

See also these open meeting statements from Chair White and Commissioners Aguilar, Stein and Gallagher. 

SEC Issues Audit Committee Disclosure Concept Release

The SEC released today the expected concept release on audit committee disclosure, focusing on the committee's oversight of independent auditors. The Commission seeks information about the audit committee/auditor relationship and whether improvements can be made to enhance the information provided to investors about the audit committee's responsibilities and activities. In addition to seeking views about audit committee disclosures, the concept release invites comment on whether disclosure requirements should be refined to provide more insight into the information the audit committee uses and factors it considers in its oversight, including considerations related to the process for appointing or retaining the auditor and the qualifications of the auditor and certain members of the engagement team. The public comment period will remain open for 60 days following publication of the concept release in the Federal Register.

Yesterday, the SEC's Division of Economic and Risk Analysis posted this memo extending its previously published analysis of the potential effects on the accuracy of the proposed pay ratio rule calculation of excluding different percentages of certain categories of employees. As previously reported, comments on the proposed rule and analysis are due by July 6.  Despite this late breaking development, there is no indication that the comment period is being extended.

PCAOB Seeks Comment on Engagement Partner Disclosure Proposal

Yesterday, the PCAOB issued this supplemental request for comment on its 2013 proposal on whether to require audit firms to file a new form with the PCAOB to make public the name of the audit engagement partner and information about certain other audit participants. The proposed new PCAOB Form AP (see Appendix 1 of the release), which would be posted and made searchable on the PCAOB's website, is purportedly responsive to concerns raised by firms and other stakeholders about liability risks associated with disclosure of such information in the auditor's report, as was initially proposed. See also PCAOB James Doty's and other board members' statements from the Open Meeting, and this Fact Sheet. Comments on the proposal are due August 31, 2015.

PCAOB Issues Concept Release on Audit Quality Indicators

The PCAOB announced yesterday the issuance of a concept release on audit quality indicators (AQI) which, together with qualitative information, are intended to provide new insights into audit quality for the benefit of audit committees and others involved in the financial reporting process. The concept release will seek comment on 28 potential AQIs covering these three categories:

• Audit Professionals - measures dealing with the availability, competence, and focus of those performing the audit.
• Audit Process - measures concerning an audit firm's tone at the top and leadership, incentives, independence, investment in infrastructure needed to support quality auditing, and monitoring and remediation activities.
• Audit Results - measures relating to financial statements (such as the number and impact of restatements, and measures of financial reporting quality), internal control over financial reporting, going concern reporting, communications between auditors and audit committees, and enforcement and litigation.

Pending the posting of the concept release, see this detailed Fact Sheet. The PCAOB will convene a public roundtable this fall for further input. Comments on the release are due September 28, 2015. 

In response to the release, the CAQ, which developed a suggested approach and potential AQIs last year, reiterated that AQIs should be tailored to each company's particular facts and circumstances.  

SEC Commissioner Gallagher Speaks on Activism and Proxy Advisors

SEC Commissioner Gallagher shared extensive and noteworthy remarks about shareholder activism, short-termism and the SEC at the 21st Annual Stanford Directors' College last week. Highlights include: 

• Activism. Rather than asking whether activism is good or bad (which is overly simplistic), the focus should be on whether it is aimed at creating long-term shareholder wealth and actually achieves this.
• SEC's Role. The SEC's role regarding activism should be limited to creating a level playing field for investors to make intelligent, informed determinations for themselves. However, the SEC's role/responsibilities have been eroded through its own actions/inactions and its "overzealous implementation of legislative enactments." To illustrate this, Gallagher discussed the SEC's role in the shareholder proposal regime; Section 13 reporting compliance; and ensuring the integrity of the process and relationships among activists, institutional investors, proxy advisors, and corporate boards/management. On proxy advisors specifically, he said:
  

  Now we come to proxy advisory firms, another perennial favorite of mine. Many forms of activism entail shareholder voting, and proxy advisory firms like to tell investors how to vote. Unfortunately, as I mentioned earlier, too many institutional investors uncritically vote the proxy advisory firm recommendations. And proxy advisory firms in turn seem to have done little to address the factors that have given rise to poor research, erroneous recommendations, and conflicted advice.  

   

  I had hoped that Staff Legal Bulletin No. 20, which was issued a year ago, would have been the catalyst for improvement. But so far it appears like many market participants have taken a "business as usual" approach. That is unfortunate, because these are critical issues. Fortunately, there is still significant attention being given to this issue, including on Capitol Hill. And a lack of progress under the SLB 20 regime could, and probably should, result in more stringent regulation - for example, (1) formal withdrawal of the no-action letters that led advisers to believe they could rotely rely on proxy advisory firm recommendations, (2) a federal registration, inspection, and oversight regime for proxy advisory firms, or even (3) reconsideration of the proxy solicitor exemptions that have been seen as applying to proxy advisory firms. 

SEC Publishes Small Entity Guidance and C&DIs on Reg. A+ 

Further to its recent adoption of Reg A+, the SEC published this Small Entity Compliance Guide summarizing and explaining the rules, including relevant bad actor disqualification provisions and transition issues. The SEC also published a number of Compliance and Disclosure Interpretations, which Gibson Dunn summarizes in this post. See also Gunster's Securities Edge blog discussing the availability of Reg. A+ for M&A transactions that meet the rule's criteria, as affirmed in C&DI Question 182.07. 

Commissioner Aguilar on Cybersecurity: SEC Should Ensure Better Disclosure  

In his remarks last week before the SINET Innovation Summit, SEC Commissioner Aguilar discussed the ways in which the SEC has been addressing cybersecurity threats, and areas where additional work and collaboration among all stakeholders would be beneficial. As to public companies specifically, he observed that the SEC needs to ensure better disclosure and consider updating its 2011 guidance:  

[T]he SEC needs to ensure that public companies provide better and more timely information about the particular cyberattack risks they face, and to be more consistent in disclosing cybersecurity incidents. One 2014 study noted that the Commission's 2011 guidance on cyber risk disclosures "has resulted in a series of disclosures that rarely provide differentiated or actionable information for investors." This view was shared by some participants at the SEC's cybersecurity roundtable, as well. Public companies need to tailor their risk disclosures to provide more useful information about the precise nature of the risks their specific business models present. In this regard, SEC staff may wish to consider updating its 2011 guidance regarding public companies' cyber risk disclosures.  

Open Meetings for SEC Investor Advisory, Small & Emerging Companies Committees 

• The SEC Advisory Committee on Small & Emerging Companies will hold an open, public telephone meeting on Wednesday, July 15, 2015, beginning at 1:00 p.m. EDT. Members of the public may attend the meeting by webcast. The agenda for the meeting includes a continuation of discussions started at the Committee's meeting on June 3rd, including regarding public company disclosure effectiveness.
• The SEC Investor Advisory Committee will hold a public meeting on Thursday, July 16, 2015 from 9:30 a.m. to 3:30 p.m. EDT in the Multi-Purpose Room LL-006 at the Commission's headquarters in Washington, DC. The meeting will be webcast. The agenda for the meeting includes a discussion of the DOL's fiduciary rule proposal and a shareholder rights update panel.
  

House & Senate Appropriations Funding Bills Would Halt DOL Fiduciary Proposal 

Both the Senate and House Appropriations Committees approved funding bills for Labor, Health and Human Services last week that prohibit funding for the DOL's fiduciary standard proposal. As previously reported, concerns about the proposal have been expressed by lawmakers and financial trade and business groups. In related news, the Chamber's CCMC has invited small businesses to sign onto this letter to Congress opposing the DOL's proposal.  

House Bill Blocks IRS Rulemaking on Political Activity for Non-Profits 

The House Appropriations Committee's 2016 Financial Services and General Government Appropriations bill would prohibit the IRS from moving forward with proposed rules defining political activity for nonprofits (see Sec. 129). As previously reported, the bill also prohibits the SEC from requiring corporate political spending disclosure for public companies. This release summarizes the bill.  

Delaware Fee-Shifting and Forum Selection Amendments Signed into Law 

Delaware Senate Bill No. 75 was signed last week by Governor Jack Markell. As reported previously, among other things, the legislation prohibits adoption of fee-shifting provisions and validates forum selection provisions in corporate charters and bylaws. As noted in this Richards Layton & Finger memo, the amendments also clarify the procedures for boards to authorize issuances of stock and stock options such that they needn't separately authorize each issuance.

The amendments do not address proposals that had been approved by the Delaware Bar Association's Corporation Law Section to address concerns of abuse of Delaware's appraisal statute (reported on here). At the Society's conference last week, Former Chief Justice Myron Steele noted that this topic needed more work.

See also this Columbia Law School blog, discussing the continued applicability of fee-shifting provisions to federal securities class actions such that the legislation's prohibition leaves many fee-shifting bylaws largely intact.

ISS Peer Group Submission Open for Annual Meetings From 9/16/15 to 1/31/16  

ISS is offering companies with annual meetings between September 16, 2015 and January 31, 2016 an opportunity to provide changes to company self-selected peer groups. This form allows you to submit your peer group to ISS. The peer group provided should be the peer group used for benchmarking CEO pay for the fiscal year ending prior to your next annual meeting. Feedback and confirmation letters must be submitted no later than 8PM EDT on Friday, July 10, 2015.
 

ISS will conduct a separate peer submission process in late 2015 for companies with annual meetings after February 1, 2016. For more information on ISS' peer selection methodology, see these FAQs. 

Chamber Suggests Principles-Based Approach on Pay-for-Performance

The Chamber's CCMC submitted this comment letter to the SEC yesterday on the proposed Pay Versus Performance (P4P) rule. The letter supports a P4P disclosure conceptually, but not as proposed. Specifically, the letter expresses concerns that the current proposal will increase the complexity of disclosures, fails to provide investors with decision-useful information on compensation or performance, and may incentivize short-termism. The CCMC further:

• Recommends that the rule take a principles-based approach
• Suggests exempting smaller reporting companies
• Suggests the SEC consider how proxy advisors should consider the proposal in light of SLB 20

Business Roundtable CEOs Identify Major Regulations/Issues of Concern

The Business Roundtable just published this list of approximately 50 existing, pending or proposed regulations or policies identified by its member CEOs that may impose significant economic costs and unnecessary burdens on business. Major regulations/issues of concern include the conflict minerals rule, PCAOB rulemaking, CEO Pay Ratio proposal, proxy access and the Pay vs. Performance proposal.

Study Shows Steady Increase Since 2007 of S&P 1500 Director Age & Tenure

This recent study by Equilar reveals that S&P 1500 company director age and tenure have steadily increased since 2007. Equilar attributes the gradual increase in average director age to older directors being appointed to open positions and longer tenures. Specific findings include:

• Average age of directors has increased to 64 from around 61 since 2007.
• Median age of newly appointed directors has increased from <56 in 2007 to 57 in 2014.
• Median director tenure has increased by about one year since 2007 to a median of about 8 years.
• Smaller companies have longer tenured directors than larger companies.

Industry variations include tech companies having the youngest directors, and financial sector companies having the oldest and longest tenured directors.

Annual Meeting Results

Proxy Access

• Stockholder proposals to adopt proxy access were reportedly approved at Equity Residential and Cheniere Energy.
• Stockholder proposals to adopt proxy access were reportedly not approved at DaVita HealthCare Partners and Regeneron Pharmaceuticals.
• Management's proposed amendments to bylaws to implement proxy access reportedly were not approved by Abercrombie & Fitch shareholders. Approval in this instance required 75% support by Class A stockholders.
• Unrelated to its annual meeting, which is usually held in September, H&R Block announced its adoption of a 3%/3 years/20% proxy access bylaw.

Other Proposals

• Stockholder proposals regarding accelerated vesting of equity awards upon a change of control were not approved at Abercombie & Fitch and Allegiant Travel.

Proxy Access: The 2015 Proxy Season and Beyond

This new Skadden memo summarizes 2015 proxy season company responses to - and voting results on - shareholder proxy access proposals, and suggests going forward considerations. Key takeways include:

• Approximately half of companies opposed the proposals.
• Approximately 15% either adopted a 3% proxy access bylaw, announced an intention to do so, or agreed with the proponent to submit a 3% management proposal to shareholders.
• Approximately 15% either adopted a 5% proxy access bylaw, announced an intention to do so, or agreed with the proponent to submit a 3% management proposal to shareholders.

Approximately 10% opposed the proposal, but expressed a willingness to continue to engage with shareholders to determine appropriate terms.

Vanguard Chair/CEO Advises Companies to Think Like Activists

In his keynote address last week at Lazard's 2015 Director Event, "Shareholder Expectations: The New Paradigm for Directors," Vanguard Chair & CEO F. William McNabb III emphasized Vanguard's focus on the long-term, and characterized engagement as a "touchstone" for all of Vanguard's other core governance principles. He advised companies to engage with investors on board composition and on other areas of business oversight and strategy where a company may be an outlier or be perceived as an outlier. His practical suggestions for enhancing engagement on board composition (see page 3) are particularly noteworthy.

He also advised boards to obtain information from sources in addition to management, and to think like activists "in the very best sense" by asking themselves these specific questions:

• Where should we be pushing harder or taking costs out? What are the management team's blind spots?
• What are the board's blind spots?
• And how do we correct that? Some boards bring in sell-side analysts that have a "sell" on the company to tell them what they're missing.

Reiterating a previously expressed theme, McNabb advocated creation of a board-level Shareholder Relations/Liaison Committee to solicit Vanguard's and other investors' views. He also referenced the SDX Shareholder-Director Exchange Protocol as a source of guidance for establishing an engagement program.

Pension Fund Activism Negatively Correlated with Share Value

This Proxy Monitor report examines the impact on target company share value resulting from shareholder proposal activism by the five largest state and municipal public pension plans including NYC Retirement Systems, CalPERS and CalSTRS. Section I of the report outlines the funds' activism activity since 2006 by volume, proposal topic and voting results. Section II of the report addresses stock price reactions to the activism activity - evidencing a negative relationship between the funds' shareholder proposals and subsequent stock prices for targeted companies. The degree of negativity varies by proposal type, with executive compensation-related proposals displaying the greatest underperformance relative to the S&P 500.

The report suggests various potential reasons for the outcome, including public pension activists' pursuit of "self-interested objectives" (quoting the Washington DC Circuit when it vacated the SEC's proposed proxy access rule in 2011), and notes:

These findings substantially undercut the hypothesis that public pension funds' shareholder-proposal activism adds to share value for the average diversified investor-and suggest such efforts may actually destroy value. Unlike private pension plans, public pension funds are exempt from ERISA and bound only by state-law obligations. Yet these funds collectively hold trillions of dollars in assets, providing for trillions of dollars of pension obligations for workers and retirees, with trillions of dollars of potential taxpayer liabilities: state policymakers should therefore consider adopting appropriate guidelines to mitigate risks.

CII Submits Comment Letter Generally Supportive of P4P Rule Proposal

CII submitted this comment letter to the SEC last week generally supporting the Commission's proposed Pay Versus Performance rule. Here is an excerpt of CII's remarks on the required use of TSR:

We acknowledge that TSR has a number of potential flaws. For example, some critics of TSR have argued, that "it is not necessarily reflective of current incentive compensation design at many companies," it could encourage "possible manipulation of stock price," it could be impacted by forces "that are well beyond the control or influence of the company's executives, including factors such as central bank policies, macroeconomics and global politics," and it could "mask a decline in a company's economic value."

 

Notwithstanding TSR's potential flaws, we generally agree with the Commission that requiring TSR as the performance measure is consistent with the "language in the statute," and has many potential benefits for investors, including that it is "objectively determinable from the share price of the registrant and not open to subjective determinations of performance," and "should increase the comparability of pay-versus-performance disclosure across registrants."

U.S. Supreme Court Declines Review of Reverse Stock-Drop Case

On Monday, the U.S. Supreme Court declined to review a reverse stock-drop case brought by the R.J. Reynolds Tabacoo Co. 401(k) plan fiduciaries. In Tatum v. RJR Pension Investment Committee, the Fourth Circuit reversed the district court's holding that the plan fiduciaries were not liable for a breach of duty because they met their burden of proof that the elimination of employer stock from the 401(k) plan was a decision a prudent fiduciary "could have" made after proper investigation. The Fourth Circuit held that defendants were required to show that a prudent fiduciary "would have" made the same decision. See this Goodwin Procter summary and status of the case leading up to the Supreme Court's denial.

SEC Enforcement: Recommendations on Current Processes and Practices

You are invited to join the U.S. Chamber's Center for Capital Markets Competitiveness (CCMC) on Wednesday, July 15, for SEC Enforcement: Recommendations on Current Processes and Practices. The event will take place from 8:30 a.m. until 12:00 p.m. at the Chamber headquarters in Washington, DC at 1615 H Street, NW. At the event, CCMC will release a study that looks closely at the enforcement practices of the SEC and provide recommendations on how to improve the process. Speakers will discuss how the process is managed, react to the study and recommendations, and suggest ways to improve the enforcement process.

Registration fees are $50 for Chamber members, $75 for non-Chamber members and complimentary for government employees. Register here.

This week's highlighted question from the Huddle is:

Does anyone use a tool (other than email) for scheduling special meetings of the Board? Currently, we email the Board requesting information relating to their availability for various proposed dates and times, wait for responses, and then try to see which date works best but this seems cumbersome. We would appreciate knowing if there is a more efficient process. We use an electronic BOD portal but it does not appear to have a scheduling tool.

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

I use an free online site called Doodle (http://doodle.com/). You enter in some possible dates and times, send out a link to everyone via email, and everyone checks off their availability. It then tabulates the date/time with the most "votes." There are some companies that have a policy to support only software headquartered in the US. In that case, you might also check out TimeBridge, in business since 2005 and acquired by MerchantCircle in 2010. Works similarly to Doodle and integrates well with most calendaring software.  

Check out the Society Huddle.