Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

For those who want to start preparing for the 2018 proxy season, our preliminary list of important considerations is set forth below:

Directors’ and Officers’ Questionnaires

We are not aware of any regulatory changes that would require directors’ and officers’ questionnaires to be updated.

Say-on-Pay Frequency Vote

Rule 14a-21(b) requires a say-on-pay frequency vote every six years. Many issuers included a frequency vote in their 2017 proxy because they were subject to the initial rules when they became effective for shareholders’ meetings occurring on or after January 21, 2011. However, “smaller reporting companies” as of January 21, 2011, and new smaller reporting companies after that date, were not required to hold a frequency vote until the first meeting occurring on or after January 21, 2013. Thus, for many smaller reporting companies the outside date for the next say-on-pay frequency vote may be pushed out until the 2019 proxy season.  However, each issuer should review its own facts and circumstances.

Issuers that formerly qualified as “emerging growth companies” (EGCs) under the JOBS Act should also remain mindful of say-on-pay requirements as issuers that no longer qualify as EGCs lose their exemption from the requirements under Exchange Act Sections 14A(a) and (b). Such former EGCs are required to begin providing say-on-pay votes within one year of losing EGC status (or no later than three years after selling securities under an effective registration statement if an issuer was an EGC for less than two years).  Typically, such companies will also hold say-on-pay frequency votes when they hold their first say-on-pay vote as a non-EGC.

And if you hold a frequency vote, do not forget the requirement to amend your Form 8-K that discloses voting results to “disclose the company’s decision in light of such vote as to how frequently the company will include a shareholder vote on the compensation of executives in its proxy materials until the next required vote on the frequency of shareholder votes on the compensation of executives.” The amendment must be made within 150 calendar days after the end of the meeting at which the say-on-pay frequency vote was held.

Pay Ratio Disclosure

In February 2017, then acting Chairman Michael S. Piwowar announced his intention to conduct a review of the Dodd-Frank pay ratio rule. The Financial CHOICE Act, introduced and passed in the House in June 2017, would repeal the pay ratio disclosure rule, but the legislation has not progressed to the Senate. There has been no subsequent indication that implementation of the rule will be delayed, so the pay ratio rule will be effective for the upcoming proxy season.  The rule requires a public company to disclose the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer. The disclosure is required for proxy statements that include information about a fiscal year that begins after January 1, 2017.  A new public company will have to disclose a pay ratio for the first fiscal year after the year it becomes a reporting company. The SEC’s FAQs are a good source of further detailed information regarding implementation and calculation of the ratios as well.

ISS Proxy Voting Policies

ISS is in the process of formulating changes to its voting recommendation policies and has released its 2018 policy survey. The survey generally foreshadows changes to policies for the upcoming proxy season.  This year’s survey demonstrates an increased focus on gender diversity in board composition, shareholder authorization for share issuances and buybacks, implications of virtual/hybrid shareholder meetings, and disclosure of pay ratios.  We recommend that issuers monitor ISS’ new and updated policies, including ISS’s official proxy voting guidelines, which are typically issued in December for the upcoming proxy season.

Hyperlinking of Exhibits

The SEC has adopted rules which will require public companies to include a hyperlink to each exhibit identified in an exhibit index. This includes Form 10-K.  The final rules will take effect on September 1, 2017.  The rule is applicable to smaller reporting companies unless they make EDGAR filings using the ASCII format. ASCII filers have an additional year to comply with the rule. If a public company becomes aware of an inaccurate hyperlink, the link must generally be corrected in a manner specified in the rules.

Form 10-K Cover Page

The SEC revised the cover page of Form 10-K when adopting rules to incorporate certain provisions of the JOBS Act. Broadly speaking the cover page has been revised to include a “check the box” item to indicate that the person filing the report is an “emerging growth company” and an additional box to check as follows:  “If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.”

Inflation-adjusted threshold for EGCs

The SEC also revised the definition of “emerging growth company” to provide an inflation-adjusted threshold for the annual gross revenue amount that determines EGC status. Until further revised by the SEC in five years (as required per the statutory language of the JOBS Act), the maximum inflation-adjusted EGC revenue threshold is $1,070,000,000.

Resource Extraction Rules

The resource extraction rules, which would have required disclosures from companies engaged in the oil, natural gas, and mineral extraction industries to disclose payments made by the companies to governments beginning in 2019, were eliminated by Congressional action under the Congressional Review Act in February 2017.

Conflict Minerals Rules

The SEC staff issued no-action guidance which stated the staff would not recommend enforcement if a Company did not report under Item 1.01(c) of Form SD to describe the results of due diligence conducted on its supply chain to determine origination of conflict minerals used in its products. This survey suggests many issuers continued to respond to Item 1.01(c) notwithstanding the staff guidance.

Providing Paper Copies of Annual Reports to the SEC

Exchange Act Rule 14a-3(c) and Rule 14c-3(b) require registrants to mail seven copies of the annual report sent to security holders to the Commission “solely for its information.” A similar provision in Form 10-K requires certain Section 15(d) registrants to furnish to the Commission “for its information” four copies of any annual report to security holders. The SEC staff advised in a Compliance and Disclosure Interpretation that it will not object if a company posts an electronic version of its annual report to its corporate web site by the dates specified in Rule 14a-3(c), Rule 14c-3(b) and Form 10-K respectively, in lieu of mailing paper copies or submitting it on EDGAR. If the report remains accessible for at least one year after posting, the staff will consider it available for its information.

Inline XBRL

The SEC has proposed rules that would require financial statements to be provided in the Inline XBRL format. Final rules have not been issued. Inline XBRL allows filers to embed XBRL data directly into an HTML document, eliminating the need to tag a copy of the information in a separate XBRL exhibit. Inline XBRL would be both human-readable and machine-readable for purposes of validation, aggregation and analysis.  However, the SEC has not enacted final rules requiring the use of Inline XBRL.  While the SEC permits the use of Inline XBRL, we suggest checking with your auditor first as to any sensitivity to providing information in this manner.

PCAOB’s Changes to Audit Report

The Public Company Accounting Oversight Board adopted a new auditor reporting standard that will require audit reports to include additional information about the audit. Specifically, auditors will be required to describe “Critical Accounting Matters” encountered during the audit and the auditor’s response to them, or state that no Critical Accounting Matters were encountered.  Generally speaking, Critical Accounting Matters are matters that require especially challenging, subjective, or complex auditor judgment.

In addition to Critical Accounting Matters, the new standard makes the following changes:

  • Independence—a statement that the auditor is required to be independent;
  • Addressee—the auditor’s report will be addressed to the company’s shareholders and board of directors or equivalents (additional addressees are also permitted);
  • Enhancements to basic elements—certain standardized language in the auditor’s report has been changed, including adding the phrase whether due to error or fraud, when describing the auditor’s responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements; and
  • Standardized form of the auditor’s report—the opinion will appear in the first section of the auditor’s report and section titles have been added to guide the reader.

The new standard will not apply to public companies unless/until it receives SEC approval. To date, the SEC has published the PCAOB standard for comment but final rules have not been adopted. The PCAOB standard provides that all provisions other than those related to critical audit matters will take effect for audits of fiscal years ending on or after December 15, 2017.  Provisions related to critical audit matters will take effect for audits of fiscal years ending on or after June 30, 2019, for large accelerated filers; and for fiscal years ending on or after December 15, 2020, for all other companies to which the requirements apply. In other words, if the SEC approves the PCAOB standard late in 2017 or early in 2018, the components other than the Critical Accounting Matters will apply to annual reports for 2017.  Auditors may elect to comply before the effective date, at any point after SEC approval of the final standard.

Communication of Critical Audit Matters is not required for audits of brokers and dealers reporting under the Exchange Act Rule 17a-5; investment companies other than business development companies; employee stock purchase, savings, and similar plans; and EGCs. Auditors of these entities may choose to include critical audit matters in the auditor’s report voluntarily.

Revenue Recognition and Lease Accounting

For the 2017 Form 10-K, Staff Accounting Bulletin No. 74 requires companies to provide transition disclosures of the impact that a recently-issued accounting standard will have on its financial statements when that standard is adopted in a future period. Public companies will need to address the new revenue recognition standard and the new lease accounting standard.  Public companies will apply the new revenue standard to annual reporting periods beginning after December 15, 2017.  Public companies will apply the new lease accounting standard for fiscal years beginning after December 15, 2018.

While public companies generally have their hands full planning for proxy season and preparing for shareholders meetings, we recommend significant thought be given to preparing for the first quarter 10-Q when the new revenue recognition standard will be adopted. We have set forth our thoughts on the initial MD&A and reviewed disclosures made by some of the early revenue recognition adopters.

In addition, public companies that adopt the new revenue recognition standard using the full retrospective method may encounter difficulties if a Form S-3 is filed after the first quarter of 2018. Item 11(b)(ii) of Form S-3 requires restated financial statements to be filed if there has been a change in accounting principles that requires a material retroactive restatement of financial statements.  This would require filing of restated financial statements for 2015, 2016 and 2017 significantly in advance of the 2018 Form 10-K, and restated 2015 financial statements would not otherwise be required.  This can be avoided if the Form S-3 is filed during the first quarter of 2018.   Form S-8 does not include an identical provision but General Instruction G.2 of Form S-8 requires that “material changes in the registrant’s affairs” be disclosed in the registration statement.

T+2 Settlement

The SEC has adopted new rules requiring settlement of securities transactions on a T+2 basis, as opposed to the existing T+3 basis. The new rule is effective September 5, 2017.  One effect of the new rules is that the ex-dividend date will be just one trading day prior to the record date.  References to the ex-dividend date should be adjusted accordingly in announcement of dividends.

NYSE Dividend Notification Requirements

The SEC has approved a change to the NYSE’s rules which requires listed companies to provide dividend notifications to the Exchange at least 10 minutes prior to disseminating them publicly when the notification is made outside of Exchange trading hours of 7:00 a.m. ET and the end of the NYSE trading session (4:00 p.m. ET). No change is being made to the NYSE’s rules with respect to dividends between 7:00 a.m. ET and the end of the NYSE trading session.

Following SEC approval of the revised rule, the NYSE filed a further proposed rule change to delay implementation of the rule. According to the NYSE, the delay is necessary to provide listed companies with additional time to prepare to comply with the new requirements and for the NYSE to provide the necessary support to its staff in reviewing notifications. The NYSE plans to provide reasonable advance notice of the new implementation date to listed companies by emailing a notice to them that will also be posted on The new implementation date will be no later than February 1, 2018.

Rule 14a-8: Shareholder Proposals

Companies should be mindful in the upcoming proxy season of the potential for the typical shareholder proponents and other activist shareholders to submit shareholder proposals under SEC Rule 14a-8 seeking to further shareholders’ ability to nominate directors, which is referred to as proxy access. Shareholder proposals focused on proxy access were the most common type of shareholder proposal in the 2017 proxy season and all signs suggest this trend will continue.  As a result, companies that have not yet adopted proxy access should be prepared to receive shareholder proposals recommending adoption of such a provision.  Companies that have already adopted a proxy access provision should be prepared to receive shareholder proposals focused on broadening applicable thresholds for shareholder nomination of directors such as eliminating limits on shareholder aggregation.

Other popular topics for shareholder proposals in 2018 are expected to address independent board chairs, board diversity and social, environmental and political proposals.

Rule 14a-8 has not been amended to limit shareholder proposals and provisions of the Financial Choice Act seeking to do so have not advanced to the Senate for consideration. In addition, absent some unanticipated action by the SEC under new Chairman Jay Clayton, the SEC’s interpretation of Rule 14a-8 as embodied in the no-action letter process to exclude proposals is not expected to change in 2018.

Other Regulatory Initiatives

Proposed rules have been issued on the following topics, but final rules have not been adopted: