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 2019 proxy season, our preliminary list of important considerations is set forth below:

Review 162(m) Disclosures in Proxy Statements

We recommend issuers review their Section 162(m) disclosures in proxy statements. As noted on our Benefits Notes blog, on August 21, 2018, the IRS issued its initial guidance on the amendments to Section 162(m) made by the Tax Cuts and Jobs Act, in the form of Notice 2018-68. The guidance is fairly limited and does not completely address some of the questions it takes on. Notably, the guidance on what compensation will not be subject to the amended Section 162(m) under the grandfather rule may be very restrictive with respect to performance-based compensation that is subject to negative discretion, depending on the extent to which that discretion may be exercised under applicable law.

Directors’ and Officers’ Questionnaires

We are not aware of any corporate governance changes that would require directors’ and officers’ questionnaires to be updated.  As a result of the changes to Section 162(m) noted above, questions arise as to whether questions in directors’ and officers’ questionnaires related to §162(m) for compensation committee members can be eliminated. Potentially that is possible if it is clear the compensation committee is not required to administer any compensation arrangements under the grandfather rule.  We urge caution in that regard, and Notice 2018-68 referred to above should be reviewed before making any changes to the questionnaire.

Determine Your Status as an Issuer

The SEC has adopted final rules, effective September 10, 2018, to expand the availability of scaled disclosure requirements for a company qualifying as a smaller reporting company, or SRC, by allowing companies with a public float of less than $250 million to qualify as an SRC, as compared to the $75 million threshold under the prior definition.  In addition, companies that either do not have a public float or have a public float of less than $700 million are now permitted to provide scaled disclosures if annual revenues are less than $100 million, as compared to the prior threshold of less than $50 million in annual revenues.  Some smaller reporting companies may not be required to transition as a result of the more generous rules, and others who did not previously qualify as a smaller reporting company may wish to avail themselves of the scaled disclosure option.

A reporting company will determine whether it qualifies as a SRC annually as of the last business day of its second fiscal quarter. If it qualifies as a SRC on that date, it may elect to reflect that determination and use the SRC scaled disclosure accommodations in its subsequent filings, beginning with its second quarter Form 10-Q. As in prior years, issuers should verify whether or not they are transitioning from status as a non-accelerated filer, accelerated filer or large accelerated filer.

In the release revising the thresholds for SRC eligibility, the SEC did not did not raise the accelerated filer public float threshold or otherwise modify the Section 404(b) requirements (which include mandatory auditor attestation of internal controls) for registrants with a public float between $75 million and $250 million.

Issuers that rely on emerging growth company status, or EGCs, should also determine if they remain eligible as an EGC. Among other tests, an issuer is only allowed to retain EGC status for five years after its IPO, and the five-year window is closing for some.

Say-on-Pay Frequency Vote

Rule 14a-21(b) requires a say-on-pay frequency vote every six years. Issuers should review their own particular facts and circumstances to determine if they are required to hold a say-on-pay frequency vote.  We note that issuers that formerly qualified as EGCs 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.

Inline XBRL

The SEC also adopted final rules to require the use of Inline XBRL. Currently, data in XBRL format is attached as an exhibit to SEC filings. Inline XBRL allows filers to embed XBRL data directly into the body of the SEC filing, eliminating most of the need to tag a copy of the information in a separate XBRL exhibit.  Inline XBRL will still require exhibits to be used to provide contextual information about the XBRL tags embedded in the filing.

The use of Inline XBRL will not be required in Form 10-Ks for the calendar year ended December 31, 2018. Large accelerated filers will be required to use Inline XBRL beginning with their first Form 10-Q filing for a fiscal period ending on or after June 15, 2019.

Changes to Form 10-K Cover Page

The adoption of rules related to expanded SRC status and Inline XBRL will require changes to the applicable selection boxes on the cover page of Form 10-K.  Changes related to SRC status are effective as of September 10, 2018.  Changes related to Inline XBRL are effective September 17, 2018.

Disclosure Simplification

The SEC’s new rules implementing disclosure simplification mostly address accounting matters in Regulation S-X, but provide some modest relief for Form 10-Ks.  Among other things, certain previously-required disclosures are eliminated from the required business description, and issuers are no longer required to provide a history of stock prices and dividend history in their Form 10-K.

Form 10-K – Selected Financial Date

The SEC has confirmed in its Financial Reporting Manual (paragraph 11110.1) that issuers that adopt the new revenue recognition standard using the full retrospective method do not need to apply the new revenue standard when reporting selected financial data (S-K Item 301) for periods prior to those presented in its retroactively-adjusted financial statements. However, such issuers must provide the information required by Instruction 2 to S-K Item 301 regarding comparability of the data presented. Instruction 2 requires issuers to briefly describe, or cross-reference to, a discussion thereof, factors such as accounting changes, business combinations or dispositions of business operations, that materially affect the comparability of the information reflected in selected financial data.

Pay Ratio Disclosure

Pay ratio disclosure appears to be here to stay. In general, the “pay ratio” rule requires public companies to disclose the median of the annual total compensation of all employees of a registrant (excluding the chief executive officer), the annual total compensation of that registrant’s chief executive officer, and the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer.

We have drafted a checklist outlining the disclosure requirements of the pay ratio rule.

Critical Audit Matters

The Public Company Accounting Oversight Board adopted a new auditor reporting standard that will require more information about the audit, including critical audit matters. The new standard has been approved by the SEC. However, it will not be effective for calendar year issuers this year. The new standard will be applicable for large accelerated filers for audits for fiscal years ending on or after June 30, 2019.  As a result, we encourage issuers to continue monitoring implementation of the new auditor reporting standard with their audit committee and auditors.

ISS Proxy Voting Policies

ISS is in the process of formulating changes to its voting recommendation policies and has released its 2019 Governance Principles Survey and the accompanying Policy Application Survey.  The surveys generally foreshadow changes to policies for the upcoming proxy season.  This year’s Governance Principles Survey focuses on auditor ratification, director accountability and track records, gender diversity on boards and the one-share, one-vote principle.  This year’s Policy Application Survey focuses on independent chair shareholder proposals, disclosure of directors’ skills, quantitative pay-for-performance screens, director pay and minimum stock ownership requirements for binding bylaw amendments. 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.

Perq Disclosures

We recommend public companies take steps to ensure that all staff are appropriately trained when compiling compensation disclosures. In a settled enforcement action, the SEC targeted an issuer for using the wrong standard for disclosures of perqs in the summary compensation table.  In addition, the SEC alleged the issuer did not adequately train employees in key roles, including those tasked with drafting the CD&A section of the proxy statement and compiling the executive compensation tables, to ensure that the proper standard was applied for perquisites disclosure.  The SEC also alleged the issuer had inadequate processes and procedures to ensure proper reporting of perquisites. The issuer’s personnel compiled the executive compensation table from a variety of sources without ensuring that the amounts reported were consistent with the Commission’s perquisite disclosure rules.  The issuer, which did not admit or deny the SEC’s findings, agreed to pay a civil money penalty in the amount of $1,750,000.  Among other things, the issuer also agreed to retain at its own expense an independent consultant, not unacceptable to the staff of the Commission, for a period of one year, to conduct a review of the issuer’s policies, procedures, controls, and training relating to the evaluation of whether payments and other expense reimbursements should be disclosed as perquisites under the securities laws, including the Commission’s rules and standards.

Cybersecurity Disclosures

In February 2018, the SEC outlined its views with respect to cybersecurity disclosure requirements under the federal securities laws as they apply to public reporting companies. We have developed a comprehensive checklist based on the SEC’s views.

SEC Issues Compensation Plan C&DIs

The SEC issued a series of Compliance and Disclosure Interpretations, or CD&Is, on proxy statements and proxy solicitations. The CD&Is in general replaced previously issued telephone interpretations. A number of the CD&Is address Item 10 of Schedule 14A, which sets forth disclosure requirements when compensation plans are submitted for shareholder approval. Issuers that will have a compensation plan on their ballot may find these CD&Is to be a useful resource.

Other Regulatory Initiatives

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

Similarly, press reports speculate that the SEC has deferred plans to implement its proposed universal proxy rules.  However, a universal proxy card was first used in 2018 by a U.S.-incorporated company.  If speculation in the press is accurate, it appears that private ordering, and not regulatory action, will be the primary force behind the use of universal proxy cards going forward.

Shareholder Proposals

Observations from the 2018 season:

  • An increase in the number of environmental/social/political (“ESP”) proposals withdrawn suggests that companies may be adopting a strategy of shareholder engagement to address ESP issues.
  • A lower number of governance proposals passed this year than in 2017, reflecting a reduced number of proposals submitted with respect to common governance issues (e.g., proxy access, majority voting, board declassification, supermajority vote).
  • 2018 reflected an increase in the submission of proposals focusing on the thresholds for calling a special meeting, the right to act by written consent, appointing an independent chair, and an increase in the relative level of shareholder support for these matters.
  • Fewer proposals focused on adopting and revising proxy access were submitted in 2018 and few were put to a shareholder vote.
  • Despite the SEC staff’s release of “issuer-friendly” shareholder proposal guidance in the fall of 2017, issuers’ inclusion of the board’s analysis of a proposal’s significance (in relation to the ordinary business and economic relevance bases for exclusion) did not yield overwhelmingly positive results for issuers in no-action requests in 2018. Still, issuers considering this strategy should not be dissuaded, as several of these requests did not fully adhere to the staff’s guidance and the staff’s responses in other requests provided additional clarity on what could make for a successful argument.

Proxy Modifications on the Horizon

Following up on its 2010 Concept Release seeking public comment on the mechanics of communications and voting under the SEC’s proxy rules, the SEC’s Chairman has announced that the staff will host a roundtable this fall to hear from investors, issuers, and other market participants on possible refinement to the SEC’s proxy rules with a focus on the following topics: the proxy voting process, retail shareholder participation, shareholder proposals, and proxy advisory firms.

Time will tell whether any of these discussion points will find their way into future Commission rulemakings in a more substantive manner than in the 2010 concept release.