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SEC Chair Clayton Targets Disclosure Overload & Materiality

In his remarks today at the Economic Club of New York, among other things, SEC Chair Jay Clayton reiterated his concerns about the shrinking public capital markets - highlighting in particular the cumulative adverse effect on companies' determinations of whether to go and remain public resulting from disclosure mandates that extend beyond "materiality" and other regulatory burdens. Here is a key excerpt:

D.  Principle #4: Regulatory actions drive change, and change can have lasting effects.

Incremental regulatory changes may not seem individually significant, but, in the aggregate, they can dramatically affect the markets.  For example, our public company disclosure and trading system is an incredibly powerful, efficient, and reliable means of making investment opportunities available to the general public.  In fact, this disclosure-based regime has worked so well that we — not just the SEC, but lawmakers and other regulators — have slowly but significantly expanded the scope of required disclosures beyond the core concept of materiality.  Those actions have been justified by regulators and lawmakers alike, often based on discrete, direct and indirect benefits to specific shareholders or other constituencies.  And it has often been concluded that these benefits outweigh the marginal costs that are spread over a broad shareholder base. 

But the roughly 50% decline in the total number of U.S.-listed public companies over the last two decades forces us to question whether our analysis should be cumulative as well as incremental.  I believe it should be.  As a data point, over this period, studies show the median word-count for SEC filings has more than doubled, yet readability of those documents is at an all-time low. 

While there are many factors that drive the decision of whether to be a public company, increased disclosure and other burdens may render alternatives for raising capital, such as the private markets, increasingly attractive to companies that only a decade ago would have been all but certain candidates for the public markets.  And, fewer small and medium-sized public companies may mean less liquid trading markets for those that remain public.  Regardless of the cause, the reduction in the number of U.S.-listed public companies is a serious issue for our markets and the country more generally.  To the extent companies are eschewing our public markets, the vast majority of Main Street investors will be unable to participate in their growth.  The potential lasting effects of such an outcome to the economy and society are, in two words, not good.

Chair Clayton's remarks also specifically noted and quoted in part (see FN #6) the Supreme Court's decision in TSC Industries, Inc. v. Northway, Inc.,  426 U.S. 438, 449 (1976), with reference also to Basic Inc. v. Levinson, 485 U.S. 224 (1988), in advocating  the SEC's historic approach to materiality-based disclosure. His remarks are read-worthy in their entirely. 

What's Next for Dodd-Frank Reform?

K&L Gates notes that, in lieu of the CHOICE Act, the Senate is likely to develop for consideration its own bipartisan-backed financial regulatory reform bill that will be informed, at least in part, by suggestions submitted to the Senate Banking Committee in response to its March 20th request for legislative proposals to increase economic growth, which the Society participated in here. The firm further predicts that incremental reforms to various provisions of Dodd-Frank will occur over a period of years, and advises interested parties to continue to advocate for their specific policy objectives to influence the dialogue.  

Treasury Targets Tax Regulations for Repeal or Modification

In response to President Trump's Executive Order 13789 aimed at reducing tax regulatory burdens, the Treasury Department issued this Notice seeking public comment on the potential rescission or modification of eight enumerated tax regulations issued since January 1, 2016, including one specifically targeting so-called "earnings stripping," which is commonly used by multinational companies in conjunction with corporate inversions. Comments, which may be submitted electronically via the following e-mail address: Notice.Comments@irscounsel.treas.gov, are due by August 7th, and a responsive report from the Treasury Secretary to the President is due September 18th.  

Whistleblower Enforcement: SEC Reiterates Focus on Employment Agreements

In this new memo, Orrick reports on SEC Office of the Whistleblower Jane Norberg's remarks at the PLI's recent event: "Corporate Whistleblowing in 2017." Notably, Norberg reiterated the Office's continued focus on alleged employee retaliation and companies' severance and other employment agreements that the agency deems violative of the Dodd-Frank whistleblower rules due to their potential to impede (see § 240.21F-17) reporting of securities violations to the SEC, and indicated that non-US employment agreements may also be covered by the rules. 

Pay Ratio Disclosure: Preparation & Next Steps

Most companies responding to our recent Society member-requested Pay Ratio Rule Preparedness Quick Survey have performed trial calculations of their CEO/median employee pay ratio (58.18%), but fewer than 13% have begun drafting and vetting internally a draft proxy disclosure.

Additional survey findings include:

• Most companies (60%) are not considering making supplemental disclosures - beyond what is required by the rule - to their investors, employees, customers or other constituencies.
• Just over 40% have thus far worked closely with outside advisors such as HR service providers, compensation consultants or lawyers in preparing to determine and disclose their pay ratio. Of those, companies have worked most closely with their compensation consultants.
• Of those that haven't yet begun preparing to comply with the rule, 40% are concerned with the difficulties in compliance assuming a 2018 proxy disclosure obligation.

Of the 55 respondents, 42% were Russell 3000 companies (see the respondent demographics in Q8).

Next steps: As announced at the Society's Securities Law Committee (SLC) meeting at our recent Annual Conference in San Francisco, be on the watch for an invitation to attend the next SLC-hosted Pay Ratio rule preparation teleconference, where all of your questions will be answered - coming soon!

NYSE Companies: Annual Director Independence Review

According to our recent NYSE company member-requested Quick Survey on the board's annual director independence review, as it relates to non-charitable payments to/from the company, most respondents either: (i) use a categorical standard (47.69%), or (ii) primarily rely on the director’s responses to their D&O questionnaire (36.92%), although over 9% reported management's use of discretion to screen out immaterial transactions before going to the board in conjunction with the absence of categorical standards.

As a brief reminder, in addition to the five enumerated objective independence criteria that automatically disqualify a determination of independence, boards are required under the NYSE standards to make an affirmative determination that each director has no material relationship with the company, which the NYSE Commentary advises should be relevant facts-and-circumstances-based. However, boards are permitted to (and frequently do) adopt categorical transaction, relationship or arrangement standards to define independence for their directors and make the appropriate disclosure under Reg. S-K Item 407(a), provided that the standards can't be less stringent than the enumerated objective (i.e., per se non-independence) standards. Either way - whether via categorical standards or not - the board (not management) is charged with determining each director's independence.   

Board Committee Meeting Scheduling and Member Rotation Practices

A recent member-requested Quick Survey on key committee meetings and membership revealed practices generally consistent with those identified in our recently-released Society/Deloitte 2016 Board Practices Report, including: 

• Key board committee meetings are most often run consecutively (i.e., separately, as opposed to concurrently) (54.55%), followed in predominance by a mix of concurrent and separate meetings depending on member and/or management attendee overlap (33.33%). 
• The vast majority of companies (84.62%) don't have a policy to rotate key committee members. 
• For those companies without a key committee member rotation policy, committee rotation most often (76.56%) occurs organically depending on new director appointments and retirements/resignations, and interests of directors in committee membership.  

AICPA Cybersecurity Reporting Framework: Consider These Upsides

Deloitte's new "Cybersecurity risk management oversight and reporting" discusses the implications of the new American Institute of Certified Public Accountants (AICPA) cybersecurity attestation reporting framework (which we recently reported on here - see "AICPA Releases Cybersecurity Reporting Resource for CPAs," and here) and, specifically, how companies can benefit from voluntarily adopting the framework in the context of increasing scrutiny and pressure from investors, customers, regulators and others concerning corporate cybersecurity practices.  

The report makes a good case for the multiple benefits potentially attainable from utilizing the framework, including greater transparency, independent and objective reporting (which provides a greater degree of assurance to investors and others), and operational efficiencies resulting from the use of one reporting mechanism that is responsive to multiple stakeholder interests including boards, the media, investors and analysts, regulators/federal agencies, vendors and business partners, and existing and prospective clients/customers.

Lease Accounting Standard Remains Backstage to Revenue Recognition

A May 2017 survey of more than 600 finance/accounting executives and management (65% public companies and 91% US GAAP reporters) conducted by PwC/CBRE revealed slow progress on companies' evaluation and implementation of the new lease accounting standard (FASB ASC 842) - a not unexpected status report in light of the equally demanding revenue recognition standard and associated significant transition efforts still underway by most companies to meet that standard's earlier reporting deadline (recently reported on here). Just 3% of respondents expect to early-adopt the leasing standard, while 11% are undecided.

Noteworthy findings include:

• 66% have formed an internal working group to assist in assessing and/or adopting the new standard.
• Most respondents (52%) are in the process of assessing the impact of the new standard; 23% haven't started adoption efforts, and 24% are in the process of implementing.
• The top three most difficult implementation considerations are data collection, systems, and resources.
• 43% are implementing a new lease system to track leases and lease accounting.
• 70% of respondents are primarily collecting the relevant lease data manually "in house."
• 25% reported the level of effort required to date in assessing or implementing the new standard to be greater than expected; 17% haven't started yet, so were unable to judge.
• 72% are leveraging existing internal resources to implement the new standard; 23% are hiring consultants; 6% are hiring additional internal resources; and 16% are undecided (multiple answers permitted).
• 13% expect the new standard to require a renegotiation of existing debt covenants, and 36% are unsure.

EY also released results of a lease accounting standard survey conducted in March 2017 of 300 US-HQ'd public companies ($1 billion to >$10 billion annual revenues), which touched on some similar and different aspects of the implementation process than the PwC/CBRE survey, but revealed similarly slow progress. Just 27% of respondents expressed confidence that their companies were on track to meet critical compliance milestones. Top challenges cited by respondents to meeting the standard's reporting deadlines were systems, difficulty collecting the required data, insufficient allocation of people resources, and challenges interpreting the standard’s technical requirements. 68% of respondents reportedly plan systems changes - with 40% of those reporting at least nine months to implement.

Leasing Standard: Nearly 20% of Fortune 500 Report Material Impact

Relatedly, PwC summarized (page 2) via this graph below the potential impact of adoption of the new revenue recognition, leasing, and credit losses accounting standards as reported by the Fortune 500 in their SEC filings between April 1, 2017 and May 26, 2017:

Newly-Appointed Women Directors More Apt to Have Prior Board Experience

Based on its study of 105,000 directorships, ISS Analytics reportedly determined that newly-appointed women directors are far more likely to have prior board experience (32%) than newly-appointed male directors (23%), believed to be largely attributable to boards' continued reliance on fellow directors' recommendations for new board members, as reflected in PwC's 2016 Annual Corporate Directors Survey. That 884 public company director respondent survey revealed that board member recommendations were the #1 source of new directors (87% of boards) - far outweighing other sources, including search firms (60%), and management (52%) and investor (18%) recommendations.

Among the consequences: women directors tend to serve on a number of boards, with some serving on more than six boards concurrently. As noted in the article and previously on numerous occasions (see, e.g., "Consider This 5-Step Board Diversity Strategy" in Company News here, "Board Gender Diversity Progress: Here’s How," and "State Street to Boards: Here's How to Increase Your Gender Diversity"), broadening the candidate pool beyond the traditional acting or retired CEO/CFO criteria has repeatedly been identified as a key strategy to changing this dynamic and increasing board gender diversity. Furthermore, to the extent prior board experience is preferred for candidate sourcing, it appears male and female candidates are being considered differently.

New Director Attributes: Fortune 500 Director Class of 2016

According to Heidrick & Struggles recently-released annual Board Monitor: "Board Diversity at an Impasse?", new female directorships among the Fortune 500 declined 2% in 2016 compared to the prior year, ending a 7-year rise and triggering a change in projections to the year 2032 (based on this year's report stats) from 2026 (based on last year's report) for women to reach parity with men on boards. Additional noteworthy findings regarding Fortune 500 new director attributes in 2016, as previously reported on Rants to Riches include:

• Companies filled 421 vacant or newly created board seats with independent directors—the highest number of such appointments since tracking the data began 8 years ago. However, the total number of board seats shrank slightly from 4,698 in 2015 to 4,609 in 2016.
• Board turnover rate increased to 9% in 2016 from 8.5% in 2015 and 6.8% in 2014.
• Current and former CEOs & CFOs together represented almost 66% of new director appointments - down from an 8-year high of 73% in 2015.
• Almost 75% of new directors have had prior board experience.
• Almost 60% of Hispanic directors were appointed to Consumer sector boards; almost 41% of Asian and Asian-American directors were appointed to Tech boards; and about 33% of African-American directors were appointed to Industrial sector boards.

Crisis Management: Board Oversight Guidance

PwC's new "How Your Board Can Be Ready for a Crisis" identifies the primary building blocks and associated practical "to do's" that will fulfill the board's crisis management (risk) oversight responsibility, inclusive of this user-friendly infographic overview of each of the key board action items, which are elaborated upon in the memo:

The memo also includes a checklist of the key elements of effective crisis management plans and relevant statistics from PwC's 2016 Annual Corporate Directors Survey, which is among the many surveys posted on our Board/Governance Practices topical page, and which we previously reported on here.   

Changing the Conversation: Using the Proxy Process to Direct Your Story

As reported Monday on Rants to Riches, in this recent post: "What's New in Shareholder Engagement: Telling Your Own Story," Nasdaq shares proxy process best practices observed and utilized to effect a "compelling corporate story," including:

- Engage with shareholders proactively. Remember that engagement is a two-way dialogue - not just an opportunity for the company to present and garner support for its positions.
- Bring the proxy process in-house. Read about how Nasdaq created a "look book" to facilitate its in-house efforts.
- Enhance disclosure and transparency. Be sure to tout your great governance practices that are otherwise likely invisible to the investor community.
- Transform the proxy into a communication tool. Recognize that retail and institutional investors read and use proxies differently. Your presentation should cater to these different needs and preferences.
- Launch an interactive digital proxy. The post identifies a number of interactive proxies that have been filed recently that are worth checking out. Read about Nasdaq's interactive proxy in this prior Rants to Riches post: "Proxy Disclosure Reform: Here's How." 

The post's reference to the Mad Men quote:  "If you don't like what's being said, change the conversation" (or words to that effect) is certainly apropos. The proxy process is the ideal opportunity for the company to direct the dialogue and related perceptions. 

Shareholder Proposals: Do's & Don'ts

As reported yesterday on Rants to Riches, Hogan Lovells Partner and Society member Alex Bahn prepared and shared at the Society's recent Securities Law Meeting at our conference in San Francisco these practical takeaways from the SEC's recent invitation-only Rule 14a-8 Stakeholder Meeting:

• Proxy card descriptions of proposals: The staff has continued to pay attention to how companies describe shareholder proposals on their proxy cards following CDI 301.01 under Rule 14a-4. While the staff has observed progress, it is clear there are still examples of deficiencies. Companies and counsel should make sure to keep this on their proxy review checklists going forward. 
• Timing of correspondence: The staff reiterated that they appreciate being apprised of developments following the submission of a no-action request (such as letting them know of an intention to respond to correspondence from the other side, whether the proposal is being negotiated for a likely withdrawal, etc.). In some cases, the staff has seen correspondence from proponents or their representatives that expresses an intention to respond to a no-action request in a certain period of time. If the staff views that period of time as too long they will reach out to the proponent and ask for a faster response. 
• What to include in no-action submissions: In cases where a company sends a proponent a deficiency notice after receipt of the proposal, often the no-action request submitted to the SEC attaches a copy of the deficiency notice (as relevant correspondence). The staff has observed that many issuers include as attachments to the deficiency notices, in addition to the required copy of Rule 14a-8, copies of the staff’s SLBs on Rule 14a-8. The staff stated that when submitting no-action requests to the SEC, if a copy of the deficiency notice is included, there is no need to also attach the copy of Rule 14a-8 or the SLBs. Rather, if the no-action request contains  an argument to which the deficiency notice is relevant, companies can simply make clear in the no-action request that the copy of the Rule and the SLBs were provided (noting which SLBs in particular).

Proxy Advisors Discuss "Ideal" Director

At a proxy advisor roundtable that included ISS and Glass Lewis among its 50 participant firms, which was recently convened by The Conference Board, proxy advisors reportedly agreed on the importance of board diversity and in-person shareholder engagement (i.e., inclusive of non-employee directors), but disagreed on means to attain board refreshment. While proposed fixes to the latter apparently ranged from term limits and mandatory retirement ages to improved board evaluations and succession planning, GE was reportedly touted as a board refreshment "model. This excerpt from GE's 2017 Proxy (see "How We Refresh the Board") is excerpted from The Conference Board's roundtable report:  

Shareholders Continue to Strongly Prefer Annual Votes on Say-on-Pay

Recent reports on say-on-pay (SoP) frequency voting statistics reportedly reveal most shareholders continuing to overwhelmingly express a preference for annual SoP.

Hunton & Williams' recent memo notes these statistics:

• Going into this proxy season, a Willis Towers Watson review of 2,848 Russell 3000 companies showed that 81% of companies were holding annual SoP votes; 1% had biennial votes; and 18% had triennial votes.
• ISS reported that, of 1,121 Russell 3000 companies that had reported 2017 proxy results through May 31, 2017, shareholders expressed a preference for annual SoP at 92% of them.
• A Compensation Advisory Partners report on the S&P 500 revealed that shareholders supported annual SoP at 96% of companies, and triennial votes at 4% of companies (none supported biennial votes).

On a positive note, the memo observes that the shareholder approval rate for executive compensation (SoP proposal) remains strong. 

Investor Views on Financial CHOICE Act Reform Vary

IR Magazine and Corporate Secretary reported on a Rivel Research Group survey of 75 institutional investors globally that revealed differences of opinion among asset manager respondents on the desirability of corporate governance and other reforms encompassed in the House-passed Financial CHOICE Act. Overall, 43% reportedly oppose the proposed reforms; 39% are unsure; and 18% support them. Generally, larger institutions tended to oppose reform efforts at a much higher level than smaller ones. 

Noteworthy findings are depicted here:

Do you support of oppose efforts to pare back Dodd-Frank? (by assets under management)

Source: Rivel Research Group

Notably, Rivel Research Managing Director Brendan Sheehan reportedly remarked: "‘Many of the large institutional investors are saying that if you marginalize the smaller investors, they will be forced to take up the mantle. It’s much easier as a public issuer to dismiss a proposal from a small investor than it is from a State Street or a BlackRock.’"

The reports identify these top five Financial CHOICE Act governance reform concerns among survey respondents:

• 81% oppose any repeal of board diversity disclosure mandates
• 79% oppose any repeal of political spending disclosure mandates
• 74% oppose any repeal of a separation of chair/CEO disclosure rules
• 68% oppose limiting say-on-pay votes to material changes only
• 66% oppose any repeal of CEO pay ratio disclosure requirements.

As previously reported, the Financial CHOICE Act, which includes proposed shareholder proposal (14a-8) reforms, is unlikely to garner sufficient Democratic support to pass in the Senate; however, various provisions, including modest shareholder proposal reforms (see page 15), may have an opportunity to advance with adequate bipartisan support on a stand-alone or other basis outside of the Act. 

Investors File Workforce Disclosure Rulemaking Petition with SEC

The Human Capital Management Coalition, led by the UAW Retiree Medical Benefits Trust and including 25 asset owners (including, e.g., CalPERS, CalSTRS, Calvert, CtW, Legal & General, NYC Comptroller, Teamsters), filed this rulemaking petition with the SEC on July 6th calling for new rules or rule amendments mandating  a mix of specific line item rules-based and open-ended principles-based, and  quantitative and qualitative, disclosure by issuers about their human capital management policies, practices and performance.

More specifically, the Petition identifies this laundry list of topics as "fundamental to human capital analysis" and thus disclosure-worthy at some to-be-determined level (with non-exhaustive examples in parentheses):

1. Workforce demographics (number of full-time and part-time workers, number of contingent workers, policies on and use of subcontracting and outsourcing)
2. Workforce stability (turnover (voluntary and involuntary), internal hire rate)
3. Workforce composition (diversity,111 pay equity policies/audits/ratios)
4. Workforce skills and capabilities (training, alignment with business strategy, skills gaps)
5. Workforce culture and empowerment (employee engagement, union representation, work-life initiatives)
6. Workforce health and safety (work-related injuries and fatalities, lost day rate)
7. Workforce productivity (return on cost of workforce, profit/revenue per full-time employee)
8. Human rights commitments and their implementation (principles used to evaluate risk, constituency consultation processes, supplier due diligence)
9. Workforce compensation and incentives (bonus metrics used for employees below the named executive officer level, measures to counterbalance risks created by incentives)

Investors Push for Global Workforce Data & Disclosure

Somewhat relatedly topically, a 79-member institutional investor coalition representing the ShareAction-developed and coordinated Workforce Disclosure Initiative, reportedly backed a global human capital/workforce management survey sent last week to 50 of the largest FTSE-listed companies plus an additional 25 global mega-cap companies listed on seven other stock exchanges, including Nasdaq and the NYSE (see survey methodology and the 75 recipient companies here). Respondent companies are being asked to provide information about their governance of workforce issues, global workforce composition and stability, personnel training and development, and worker engagement, in both developed and developing economies where they have operations and supply chains.

This initial survey blast purportedly represents a pilot that is intended to be expanded to additional companies in future years after the pilot year process is evaluated. 

• Rep. Wagner Drafts Bill to Kill DOL Fiduciary Rule, Replace it with Best-Interest Standard, Investment News, July 11, 2017
• 'Sea Change' in Enforcement Shows Regulatory Ease, Possible Rise in Individual Prosecutions, Reuters, July 11, 2017
• Silence is Golden When Partners Leave for Top SEC Posts, American Lawyer, July 11, 2017
• Do High CEO Pay Ratios Harm Company Value?, CFO, July 11, 2017
• Senate Confirms Trump's 'Regulatory Czar', The Hill, July 10, 2017
• Fiduciary-Rule Review Zeroes In on Industry Costs, Liabilities, WSJ, July 10, 2017
• Trump Regulation 'Czar' Cleared by Senate, WSJ, July 10, 2017
• Trump to Nominate Randal Quarles as Fed Bank Regulator, WSJ, July 10, 2017
• G-20 Leaders Find Trade Compromises, But are Split on Climate, WSJ, July 8, 2017
• Revamped UK Governance Code Will Have a New Focus on Culture, Board Agenda, July 7, 2017
• SEC Lets More Companies Ignore Shareholder Proposals in 2017, WSJ, July 7, 2017
• Confidential IPO Filing Work, If They Stay Confidential, NYT, July 7, 2017
• U.S. Treasury targets Eight Tax Regulations for Possible Changes, WSJ, July 7, 2017
• After Election, U.K. Sees Possible Signs of Softer Brexit, WSJ, July 7, 2017
• Forget an IPO, Coin Offerings are New Road to Startup Riches, WSJ, July 7, 2017
• SEC's Piwowar Eyes Proxy Adviser Registration, Corporate Secretary, July 6, 2017
• More Companies Cite Activism as a Risk in Financial Disclosures, Bloomberg, July 6, 2017
• Another Shareholder Proposal? McDonald's Deserves a Break Today, WSJ, July 6, 2017
• Finance Firms Need Freedom to Choose Location After Brexit, Reuters, July 6, 2017

See other recently posted Articles of Interest.