Alert - November 2, 2016

Weekly newsletter covering timely corporate governance developments.

Legislative & Regulatory | Company News & Resources | Proxy Season Related | Huddle

Legislative & Regulatory News

November 2, 2016

This Week's Alert
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Proposed Universal Proxy Rule Impacts All Director Elections

Further to our report in last week's Society Alert and corresponding Rants to Riches post, the SEC issued a proposed Universal Proxy rule that encompasses not only a universal proxy, but also changes to director election voting options and disclosure in all (including uncontested) elections, as noted in this Goodwin memo:

The proposed rules would require, in all director elections (contested and uncontested), the following:

“Against” and “abstain” voting options for the election of directors, in lieu of a “withhold” option, when applicable state law gives legal effect to a vote against a nominee;

Elimination of the current ability to provide a “withhold” voting option when an “against” vote has legal effect under applicable state law;

An “abstain” voting option in a director election governed by a majority voting standard; and

Disclosure about the treatment and effect of a “withhold” vote in director elections.

In addition, the SEC specifically requests comment on elimination of a “withhold” option where plurality voting standards apply, replacing this with an “abstain” option so that shareholders are aware that such votes do not legally affect the outcome of the director election.

We are posting numerous additional memos and other resources relating to the proposal on our Universal Proxy topical page.

The Society plans to submit a comment letter on this proposal. If you are interested in participating in the Society's comment letter, please contact Corporate Practices Committee chair Rachel Lee at Rachel.Lee@dell.com. The proposal will be open for comment for 60 days after publication in the Federal Register.

Comment Periods Close on SEC Releases

The comment period on the SEC's Disclosure Update and Simplification proposed rule closes today. Comments posted to date are here. See our prior reports on the proposal here and here.
The comment period on the SEC's Exhibit Hyperlinks and HTML Format proposed rule closed October 27th. Comments submitted on the proposal are here. Our prior report on the proposal is here.
The comment period on the SEC's request for comment on Reg. S-K's Item 400 series corporate governance disclosures (Subpart 400 of Reg. S-K Disclosure Requirements Relating to Management, Certain Security Holders and Corporate Governance Matters) closed October 31st. Comments submitted and posted on the proposal to date are here. See our prior reports on the proposal here and here.

PCAOB Developments

Investor Advisory Group - As anticipated, the PCAOB's IAG discussed non-GAAP financial measures (NGFM) and the auditor's reporting model (i.e., expanded auditor's report proposal) at its meeting last week (webcast here). Among the NGFM working group recommendations discussed: requiring disclosure and presentation of NGFM in financial statements to ensure they are consistently calculated and audited, and mandating inclusion of NGFM in supplementary information and making them subject to AS 17, Auditing Supplementary Information Accompanying Audited Financial Statements. As to the auditor's reporting model, the IAG indicated support for the PCAOB's proposal, but requested that it further encourage (but not require) auditors to include in their reports "informative, company-specific findings related to each CAM as a best practice in auditor reporting." The IAG's comment letter on that proposal is here. See also this Cooley post.
Audit Committees - In his remarks before the Association of Audit Committee Members, Inc. last week, PCAOB Board member Jay Hanson acknowledged corporate concerns about auditors going overboard on their review of, and requests for documentation relating to, internal controls (which he identified as potentially responsive to the PCAOB's frequent ICFR audit inspection findings) - assuring attendees that the PCAOB and SEC would continue to work on finding an appropriate balance between audit quality and burdens on the financial reporting process. He also reiterated that the Board was not likely to mandate audit quality indicators in the near term, but rather would continue to gather information.
CPAs - PCAOB Board member Steven Harris discussed renewed concerns about auditor independence in his speech last week before the New York State Society of Certified Public Accountants, purportedly prompted by PCAOB's ongoing review of "emerging threats" to independence - including increasing consulting and advisory services and continuing auditor independence violations. Also notable was his apparent attempt to "sell" the PCAOB's expanded auditor's report proposal to the US CPA audience by recounting remarks made by a UK Big 4 audit partner to the effect that - in the context of the UK's still-newish extended auditor's report requirement - auditors there are now "inspired" by the fact that the "key matters" they address in their auditing work are now "directly described" in their public report (as part of their client companies' financial reporting) - presumably not a very appealing thought to US corporates, who remain concerned about their auditors potentially serving as an original source of information about the company in their financial reporting.

See the PCAOB's Strategic Plan, its current Standard-Setting Agenda, its just-released 2015 annual report, and numerous additional resources on our PCAOB, Auditing & Audit Firms, Audit Committees, and Financial Reporting topical pages.

DOL Issues FAQs on New Fiduciary Rule

Last Thursday, the DOL published reportedly the first of several releases of FAQs on the new fiduciary duty conflict of interest rule based on input provided by the financial services industry and others. The 34 questions cover basics pertinent to the rule's Best Interest Contract and Principal Transactions Exemptions, such as how the DOL will approach implementation of the new rule and exemptions during the compliance transition period, and when firms and their advisers are required to comply with the exemption conditions. See these articles from ThinkAdvisor and InvestmentNews, this memo from Ropes & Gray, and our most recent prior reports on the rule here and here.

Company News & Resources

CEO Succession Practices

Among the many notable key findings from The Conference Board's annual review and analysis of S&P 500 CEO succession practices revealed in this recent Harvard Law post are:

The appointment of an interim CEO is emerging as a more common practice for managing a CEO succession event. In 2015, approximately 10% of the 56 total S&P 500 CEO succession events involved an interim appointment with lengths of service for interim CEOs ranging from two to 10 months (with one interim CEO ultimately being offering the permanent position).
Appointing outsiders to the CEO role is becoming much less common as companies continue to invest in leadership development or choose the experience of an independent director. In 2014, 85.7% of incoming CEOs were “insiders” promoted to the CEO position after at least one year with the company; the remaining 14.3% were “outsiders” - with less than one year with the company.
With shareholders and proxy advisors increasingly scrutinizing CEO/chair combinations, the immediate appointment of the incoming CEO as board chair is relatively rare. Only 10.7% of the 2015 successions involved a concurrent chair appointment - stabilizing around the 10% rate that The Conference Board had identified in the prior two years.
The largest financial companies have the highest rate of CEO succession planning disclosure. Across industries and size groups, less than half of non-financial companies include information on succession planning in their proxy - compared to 83.3% of financial companies with assets valued at $10 billion.
There is a trend toward providing advance notice of a CEO succession event, with just under 70% of 2015 succession announcements made before the succession effective date.

See also this new Equilar post: "CEO Turnover and Board Changes at S&P 500 Companies," and this article from The Washington Post.

Voluntary Disclosure Increases: Audit Committee Oversight of External Auditor

This joint CAQ/Audit Analytics just-released 3rd annual Audit Committee Transparency Barometer shows a continued rise in voluntary proxy statement disclosure by S&P Composite 1500 companies (composed of the S&P 500,S&P Mid-Cap 400, and S&P Small-Cap 600) of information about the audit committee's oversight of the external auditor.

Key findings for 2016 include:

Audit Firm Selection/Ratification - 31% of the S&P 500 include enhanced discussion of the audit committee’s considerations in recommending the audit firm's appointment - up from 13% in 2014. 22% of Mid-Cap companies (up from 10% in 2014) show enhanced discussion, compared to 17% of S&P Small-Cap companies (up from 8% in 2014).
Audit Firm Compensation - 17% of the S&P 500 explicitly stated the role audit committees play in negotiating audit fees - up from just 8% in 2014. About 1/3 of each of the Large-, Mid-, and Small-Cap companies provided an explanation of a change in fees paid to the audit firm.
Audit Firm Evaluation/Supervision - 34% of the S&P 500 disclosed criteria considered when evaluating the audit firm - up from just 8% in 2014. 26% and 25% of Mid-Cap and Small-Cap companies, respectively, made such disclosure.
Audit Partner Selection - 43% of the S&P 500 stated that the audit committee is involved in audit partner selection, compared to just 13% in 2014.

The report includes helpful, illustrative examples of each type of disclosure. See the CAQ's release, and additional resources on our Disclosure Reform and Audit Committees topical pages.

Executive Compensation Program & Payout Considerations

This new memo from Pay Governance: "Ensuring the Executive Pay Program is on a Strong Foundation" serves as a good checklist of considerations and perspectives relative to: (i) selecting and applying peer groups for pay benchmarking purposes; (ii) selecting incentive plan performance measures and goals; and (iii) ensuring alignment of pay with performance across multiple dimensions (e.g., market, realizable, realized, executive tenure) and consistent with the company's strategy. Each of the three components is accompanied by a user-friendly grid of relevant considerations, insights, and objectives.

Selecting & Disclosing Appropriate Business Performance Metrics

Latham & Watkins' "Key Metrics: Thoughts for Directors" suggests questions boards should consider raising with management about the various financial and operating metrics used by the company to understand and measure the performance of the business both on a stand-alone basis and relative to the market, as well as to determine executive compensation. The memo identifies relevant considerations in a user-friendly checklist format on metric selection, definition, calculation, disclosure and - where pertinent - the relationship to compensation.

Board Effectiveness: Survey Reveals Significance of Board Chair

Russell Reynolds' report: "Global Board Culture Survey - Understanding the Behaviors that Drive Board Effectiveness" reveals the results of a June/July 2016 worldwide (including the US) survey of 369 large public company directors aimed at understanding the director behaviors that create a high-performing board culture and drive board effectiveness. Notwithstanding cultural differences among the 12 participating countries, directors were remarkably consistent in identifying these five behaviors as the most important - generally in this order: (i) possessing the courage to do the right thing; (ii) willing to constructively challenge management when appropriate; (iii) demonstrating sound business judgment; (iv) asking the right questions; and (v) possessing independent perspective and avoiding "groupthink."

In addition to these behaviors, the most effective boards were differentiated by three characteristics - with having a board chair who is an effective facilitator being by far the most significant. More specifically, effective chairs were characterized by consistently fostering and facilitating high-quality debates, encouraging independence, and actively seeking different points of view - which the report observes "creates a board culture where directors are encouraged to voice their independent perspective, constructively challenge management, and exercise sound judgment." Additional board effectiveness-differentiating behaviors include directors actively cultivating strong relationships with senior management beyond the CEO, and using a 5+ year time frame to evaluate and make decisions about strategic opportunities.

The report recommends actions directors should consider in light of the survey results, including a board evaluation that specifically measures against the behaviors consistently identified as promoting board effectiveness.

See also Spencer Stuart's new memo on board effectiveness assessments, and additional resources on our Board Practices, Compliance & Ethics, Board/Director Evaluations, and Board Leadership topical pages.

Women Increasingly Leading Key Board Committees

According to Equilar, 18.9% of S&P 500 key board committees - compared to 21.3% of directorships overall and 22.2% of committee seats - are chaired by women.

While women still trail men by a significant margin in full board leadership roles such as board chair/lead director, the data shows steady progress in women's assumption of committee leadership roles that Equilar believes is consistent with their steady rise in board representation and related increasing board experience and responsibility.

Board M&A Oversight: Due Diligence

This recent article from Deloitte: "Strengthening the Board's Role in M&A Due Diligence" identifies a series of questions boards should consider addressing with management during the M&A due diligence process to mitigate risks. While the article acknowledges that the extent of appropriate board involvement in any transaction will vary depending on the particularities of the proposed deal, the suggested questions relative to transaction strategy, value, and synergies promote a basic level of board oversight in this area.

Perceived Pressure to Show Shorter-Term Financial Performance Rises

FCLT (Focusing Capital on the Long Term) Global's recently issued report: "Rising to the Challenge of short-termism," which reveals the results of a survey of over 1,000 McKinsey Quarterly panelists (last surveyed in 2013) on their perceptions of short-termism and how it has evolved over time, evidences the continued rise in short-termism-related pressures and associated implications. Key findings include:

Short-term pressure on executives has increased since 2013: 65% of respondents said that the pressure on senior executives to deliver short-term results has increased in the past 5 years and, from 2013-2016, the % of respondents who reported feeling the most pressure to demonstrate strong financial performance w/in 2 years or less increased from 79% to 87%.
Companies have struggled to codify long-term plans and articulate critical elements of their long-term strategies: Respondents reported that their strategic planning horizons are too short relative to their ideal; on the other hand, compared with earlier survey results, management is more likely to believe they should be using a shorter time frame (37% say two years or less, compared to 27% in 2013) - presumably due to short-termism pressures.
Long-term cultures are a boon to financial performance and directly affect the actions executives and their boards expect to take: Among other things, Exhibit 5 of the report illustrates the significant difference in reactions to potential quarterly earnings misses taken by companies with a long-term view vs. others.
The causes of increasing short-termism have evolved over time and come from both secular trends and forces within companies themselves: 51% of respondents - up from 41% in 2013 - cited greater industry-wide competition as the basis for increasing short-termism pressure.

See also FCLT Global's responsive "10 elements of a long-term strategy" on page 13 of the report, and this Manifest post.

Proxy Season-Related Developments & Resources

Business Roundtable Proposes Shareholder Proposal Reforms

The Business Roundtable issued a report this week describing the principal problems with the current shareholder proposal regulatory scheme and how it plays out in practice, and proposing a number of specific reforms, including:

Updating the eligibility requirements for submitting a proposal based on a sliding scale related to a company’s size. (The report notes that, at current market prices and based on current requirements, a shareholder would need to purchase only three shares of Google stock to be proposal-eligible.) For anything other than election of directors, the monetary eligibility standard should be tied solely on percentage of stock ownership based on a sliding scale related to company size - with a requirement to hold at least 0.15% of outstanding stock for proposals submitted to the largest company and up to 1% for proposals submitted to smaller companies.
Increasing the length of the holding requirement to 3 years, which would mirror the standard frequently used for proxy access and encourage a longer-term view
Requiring proponents of shareholder proposals to provide increased disclosure, such as indicating their intentions, economic interests, and holdings in the target company
Raising the resubmission threshold for proposals that have failed in previous years. At a minimum, the thresholds should be updated to implement the increases proposed by the SEC in 1997: 6% on the 1st submission, 15% on the 2nd, and 30% on the 3rd.

Additional proposed reforms include: (i) prohibiting or setting reasonable limitations on the use of images; (ii) increasing requirements for proposals by proxy; (iii) better defining the criteria for applying the ordinary business exclusion; (iv) reinstating the conflicting proposal exclusion; (v) re-evaluating the standard for excluding proposals that are contrary to proxy rules; and (vi) revising the no-action letter process.

See also the BRT's release, BRT Chair John Hayes' post, and numerous additional resources on our Shareholder Proposals topical page.

ISS: 2017 Policy Consultation Period Launched

As reported last week in Rants to Riches, ISS launched its 2017 benchmark voting policy consultation period, which will solicit comments on these US proposed voting policies for 2017 through 6:00 p.m. ET on November 10th:

- Unilateral Board Actions – Multi Class Capital Structure at IPO
- Restrictions on Binding Shareholder Proposals
- General Share Issuance Mandates for Cross- Market Companies (US-listed, non-US-incorporated companies)
- Executive Pay Assessments (Cross-Market Companies)

Note in particular that the proposed "Restrictions on Binding Shareholder Proposals" policy would entail a vote against or withhold from governance committee members if the company's articles/charter impose "undue restrictions" on shareholders’ ability to amend the bylaws, which are defined to include share ownership requirements or time holding requirements in excess of those set forth in Rule 14a-8.

The Society's Corporate Practices Committee (CPC) is soliciting comment letter participants. If interested, please contact CPC Chair Rachel Lee at Rachel.Lee@dell.com.

Access memos summarizing the proposals here, and our prior reports on the results of ISS's policy survey here and here.

ISS Opens Data Verification Period for Rebranded QuickScore

As noted in these Rants to Riches posts here and here, ISS announced the rebranding and forthcoming new release of QualityScore - formerly known as ISS Governance QuickScore - concurrent with the opening of the data verification period for covered companies. This Gibson Dunn post summarizes the changes for US companies.

The data verification period is open through 8 pm EST on November 11th. If you need an account to log into the Governance Analytics platform, email contactus@isscorporatesolutions.com. If you already have a login, your current login will allow you to participate in Data Verification.

See how this governance rating tool is portrayed to investors here.

Voting Standards Refresher

This new memo: "Voting Standards Are Not That Standard" from Kirkland & Ellis is a welcome resource on a somewhat mundane, but critical, topic that impacts every company's annual or special meeting preparation and proxy statement. The memo discusses the sources of - and common variations among - governing voting standards for three major categories of matters voted upon in the corporate context: (i) director elections, (ii) specified fundamental matters (e.g., mergers, charter amendments), and (iii) everything else, as well as the governing standard's impact on abstentions and broker non-votes, which can be outcome-determinative. Also instructive is the memo's reminder to consider all relevant factors including state law, default standards, charter and/or bylaw variations, etc., when crafting the company's Schedule 14A Item 21 Voting Procedures disclosure.

Access additional resources on our Annual Meeting topical page.

Transfer Agents: Market Share

Courtesy of Audit Analytics, this pie graph shows the top transfer agents by market share based on client numbers as of October 13th - with Computershare/BNY Mellon and American Stock Transfer & Trust encompassing 65% of the total market share:

Computershare/BNY and AST also led last year with a combined market share of 63% - with the other firms following suit closely comparable to this year's results.

Negative Say-on-Pay: Responsive & Preventive Game Plan

According to MacKenzie Partners, over 25% of companies that failed their say-on-pay votes in 2016 received more than 90% support the previous year, suggesting that no company should feel "safe" from a potential negative say-on-pay vote in the context of potentially anomalous circumstances. The post: "Responding to a Negative Say-on-Pay Outcome" does a nice job of suggesting a framework for engaging with/responding to shareholders and proxy advisors - including consideration of a supplemental proxy filing, determining whether to focus on the facts or the "story" (or both), emphasizing the company's compensation "best practices," and one-on-one engagement.

Inside the Huddle

This week's highlighted question from the Huddle is:

Does anyone have a good policy on retention of emails, as opposed to retention of paper business records?

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

We treat all records the same. Retention is based on the subject of the record, not on the medium the record is created/received. So instead of focusing on the medium of the record (paper, e-mail, instant message, etc.), focus on if the emails are records or not. If they are records, your record retention schedule and policy should assist in determining how long to maintain the records no matter the medium.

Check out the Society Huddle.

articles of interest