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

In the closely watch area of shareholder proposals, Apple is seeking to exclude a shareholder proposal  regarding the establishment of a Human Rights Committee because it involves  the company’s ordinary business operations under Rule 14a-8(i)(7).  Apple is relying on newly issued Staff Legal Bulleting 14I.  Apple states SLB 14I provides  that whether a policy issue is of sufficient significance to a particular company to warrant exclusion of a proposal that touches upon that issue may involve a “difficult judgment call” which the company’s board of directors “is generally in a better position to determine,” at least in the first instance. A well-informed board, according to Apple analyzing the SEC’s views, exercising its fiduciary duty to oversee management and the strategic direction of the company, “is well situated to analyze, determine and explain whether a particular issue is sufficiently significant because the matter transcends ordinary business and would be appropriate for a shareholder vote.”

Exactly what a board or a committee need to do to avail itself of SLB 14I has been a hotly debated area.  Apple appears to be taking the “been there, done that approach.”  According to Apple:

 “The Board recognized that it had already considered the issues raised by the Proposal when setting the strategic direction of the Company and performing its duties as a Board.  Additionally, the Board determined that senior executives’ focus on reviewing, improving, and  implementing policies designed to promote human rights make these matters an integral part of  the ordinary business operations of the Company, and the issues presented in the Proposal as a whole fit squarely within the Company’s ordinary business mission to safeguard and uphold human rights wherever it does business. The Board also considered the Company’s existing policies, practices, and disclosures and concluded that the Proposal, even if submitted to shareholders and approved, would not call for the Company to consider facts, issues or policies that the Company does not regularly consider in the course of its day-to-day operations, and therefore does not transcend the Company’s ordinary business The Board considered the fact that it, along with management, is regularly and actively involved in the consideration, oversight and re-assessment of the Company’s human rights policies.”

The House Financial Services Committee has announced it intends to meet to consider mark-ups of bills to repeal the conflicts minerals disclosures (H.R. 4248) and mine safety disclosures (H.R. 4289) on November 14, 2017.

I’m guessing both will pass, but I recommend that anyone working on conflicts minerals to continue to work. Bills passed by the Financial Services Committee have a relatively poor track record of being enacted into law, at least over the short term. Similar provisions were included in the Financial Choice Act 2.0 which has not been enacted.

On November 9, 2017, the U.S. House of Representatives passed the Micro Offering Safe Harbor Act.  The vote was largely along party lines, with Rep. Walter Jones from North Carolina’s third district casting the lone Republican dissenting vote.  The Act, as we previously reported here, resurrected a failed bill introduced by Rep. Tom Emmer (R-MN) in early 2016.

The Act seeks to create a new category of exempt transactions under Section 4(a) of the Securities Act of 1933 (the “’33 Act”).  New Section 4(a)(8) would create an issuer exemption for what the bill deems “micro offerings.”  Under the exemption, a “micro offering” would be limited to offerings where:

  1. all purchasers have a substantive pre-existing relationship with an officer, director or 10% or greater shareholder of the issuer;
  2. there are no more than, or the issuer reasonably believes there are no more than, 35 purchasers of the securities sold in reliance on the exemption during the 12-month period preceding the offering; and
  3. the aggregate amount of securities sold in reliance on the exemption during the 12-month period preceding the offering does not exceed $500,000.

Importantly, the Act would also exempt micro offerings from most forms of state regulation pursuant Section 18 of the ’33 Act. Commensurate with state regulation of exempt offerings pursuant to Regulation D, states would be able to require issuer to file notices and pay fees for micro offerings.  Likewise, state (and federal) anti-fraud regulation would still apply to micro offerings.

The exemption provided by the Act would also be subject to the “bad actor” disqualifications found in Rule 506(d) (17 C.F.R. 230.506).

The Act now faces an uphill battle in a closely divided U.S. Senate.

Read the full text of the bill here.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 13 cities, including Minneapolis, Mankato and St. Cloud, MN; Kansas City, St. Louis and Jefferson City, MO; Phoenix, AZ.; Denver, CO; Washington, D.C.; Decatur, IL; Wichita, KS; Omaha, NE; and Bismarck, ND.

Drew Kuettel is a member of the firm’s corporate finance group.

The staff’s release of Staff Legal Bulletin No. 14I (“SLB 14I”) ahead of the upcoming proxy season appears to reflect several issuer-friendly modifications to the staff’s processing of no-action letters seeking exclusion of shareholder proposals under Rule 14a-8 of the Exchange Act.  In particular, SLB 14I addresses the following aspects of the shareholder proposal submission process under Rule 14a-8 that could be viewed as favorable to issuers:

  • Deference to issuers’ analyses of significant policy issues under Rule 14a-8(i)(7)’s “ordinary business” exception;
  • Expansion of the “economic relevance” exception under Rule 14a-8(i)(5);
  • Additional eligibility requirements for proposals “by proxy” under Rule 14a-8(b); and
  • Application of Rule 14a-8(d) to the use of images in shareholder proposals and supporting statements and encouraged reliance on Rule 14a-8(i)(3)’s “false and misleading” standard for exclusion.

Ordinary Business Exception – Rule 14a-8(i)(7)

The ordinary business exception provides a basis for exclusion under Rule 14a-8(i)(7) if a shareholder proposal deals with matters “so fundamental to management’s ability to run a company on a day-to-day basis that they could not, as a practical matter, be subject to direct shareholder oversight.”  An exception to this exclusion, however, applies to proposals that “focus on policy issues that are sufficiently significant because they transcend ordinary business” that they may not be excluded.  The staff has traditionally conducted a painstaking, multi-faceted analysis to determine whether an issue may rise to the level of significant policy issue warranting a no-action letter denial.

The staff’s guidance expresses the view that the board of directors is generally in a better position to determine the significance of a shareholder proposal. As such, SLB 14I indicates that the staff will now be looking to an issuer’s boards of directors to provide a discussion that reflects the board’s analysis of the particular policy issue raised and its significance including “the specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned.” In this respect, SLB 14I appears to the lay the groundwork for the staff to defer to the board’s analysis on the “the difficult judgment call” of determining the significance of a shareholder proposal under Rule 14a-8(i)(7).

Economic Relevance Exception – Rule 14a-8(i)(5)

The infrequently relied upon “economic relevance” exception under Rule 14a-8(i)(5 permits a company to exclude a proposal that “relates to operations which account for less than 5 percent of the company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business.” The staff has historically narrowly applied the Rule 14a-8(i)(5) and, as such, has infrequently granted no-action relief under this basis over the years.

SLB14I notes the Division of Corporation Finance’s belief that the existing application of Rule 14a-8(i)(5) has unduly limited the exclusion’s availability because it has not fully considered whether the proposal “deals with a matter that is not significantly related to the issuer’s business.” and is therefore excludable. Under the staff’s guidance, the Division’s analysis of Rule 14a-8(i)(5) requests going forward will focus on a proposal’s significance to the company’s business irrespective of whether it raises broad issues of social or ethical significance. SLB 14I provides that the analysis will now be dependent on the particular circumstances of the company to which the proposal is submitted.  For example, SLB14I highlights that a proposal may be excludable under Rule 14a-8(i)(5) where a proponent fails to demonstrate that a proposal “may have a significant impact on other segments of the issuer’s business or subject the issuer to significant contingent liabilities.”  Furthermore, similar to its guidance on Rule 14a-8(i)(7), SLB 14I suggests that the staff will defer to an issuer’s board as to whether a particular proposal is “otherwise significantly related to the company’s business.”

“Proposals by proxy” – Rule 14a-8(b)

SLB14I discusses the common practice of shareholder submission of proposals through a representative, or “proposal by proxy” – a tactic frequently relied upon by serial shareholder proponents such as John Chevedden. Although the staff’s guidance confirms the propriety of such submissions under the spirit of Rule 14a-8, SLB14I appears to raise the bar for proposal submissions by proxy by increasing the type of documentation that must be provided to prove eligibility under Rule 14a-8.

Specifically, in order to meet the eligibility requirements under Rule 14a-8(b), a proponent seeking to submit a proposal by proxy must now provide documentation describing the shareholder’s delegation of authority to the proxy including the following:

  • the identity of shareholder-proponent and the person or entity selected as proxy;
  • the identity of the company to which the proposal is directed;
  • the annual or special meeting for which the proposal is submitted;
  • the specific proposal to be submitted (e.g., proposal to lower the threshold for calling a special meeting from 25% to 10%); and
  • a copy executed by the shareholder.

Although a failure to provide such documentation upon initial submission may not be fatal to a proposal by proxy (since an issuer is required to provide a notice of deficiency to the proponent with an additional 14-calendar day period to provide required information), it is clear that SLB 14I reflects the staff’s intent to place an additional procedural obstacle in front of shareholder proponents who are viewed by some as unfairly monopolizing the Rule 14a-8 shareholder submission process.

Use of Images – Rule 14a-8(d)

Rule 14a-8(d) is a procedural bases for exclusion that provides that a “proposal, including any accompanying supporting statement, may not exceed 500 words.”

SLB14I provides the Division of Corporation Finance’s view that, consistent with recent no-action letter precedent, the use of images or graphs in shareholder proposals is appropriate. However, SLB14I simultaneously invites issuers to seek exclusion of graphs and/or images under Rule 14a-8(i)(3) where they:

  • make the proposal materially false or misleading;
  • render the proposal inherently vague or indefinite;
  • directly or indirectly impugn character or make charges of improper, illegal, or immoral conduct, without factual foundation; or
  • are irrelevant to a consideration of the subject matter of the proposal.

SLB14I also notes that exclusion would also be appropriate under Rule 14a-8(d) if the total number of words in a proposal, including words in the graphics, exceeds 500.

The SEC issued a warning to celebrities and others that endorse initial coin offerings and other investments. The SEC noted:

Any celebrity or other individual who promotes a virtual token or coin that is a security must disclose the nature, scope, and amount of compensation received in exchange for the promotion. A failure to disclose this information is a violation of the anti-touting provisions of the federal securities laws.  Persons making these endorsements may also be liable for potential violations of the anti-fraud provisions of the federal securities laws, for participating in an unregistered offer and sale of securities, and for acting as unregistered brokers.  The SEC will continue to focus on these types of promotions to protect investors and to ensure compliance with the securities laws.

One anti-touting provision is included in Section 17(b) of the Securities Act. That section provides:

It shall be unlawful for any person, by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails, to publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof.

 

Cboe Global Markets, Inc. (f/k/a CBOE Holdings, Inc.) recently received comments on its Form 10-Q related to FASB’s new revenue recognition standard. The SEC comments were:

  •  Please explain to us how you determined that rebates paid to customers in accordance with published fee schedules should not be accounted for as a reduction of the transaction price. Refer to ASC 606-10-32-25 to 32-27.
  • We note your disclosure that you recognize revenue for certain services over time. Please tell us how you considered the requirements in ASC 606-10-50-13 to 50-15 to disclose information about remaining performance obligation or application of optional exemptions.

I outlined another comment letter received by an issuer here. There are no common threads between the two letters, except both asked questions about recognizing revenue over time.

ISS has made available for public comment certain proposed changes to ISS’ benchmark voting policies for 2018 that could generally become effective for the upcoming proxy season. In the U.S., ISS is proposing three changes:

  • Gender Pay Gap Shareholder Proposals: ISS is proposing specific factors to consider when making a recommendation with respect to gender pay gap shareholder proposals, including a company’s current diversity and inclusion policies and related disclosure, whether the company has been the subject of recent controversy or litigation related to gender pay gap issues and whether the company’s reporting regarding gender pay gap policies or initiatives is lagging its peers.
  • Non-Employee Director Compensation: The policy will focus on excessive non-employee director pay without a compelling rationale or other mitigating factors. There would be no impact on vote recommendations in 2018 for directors as a result of this proposed policy.
  • Poison Pills:  ISS is proposing to recommend against all board nominees, every year, at companies who maintain a long-term poison pill that has not been approved by shareholders.

The comment period will run through 5:00 p.m. ET on November 9, 2017. ISS expects to announce its final 2018 benchmark policy changes during the second half of November.

Gender Pay Gap Shareholder Proposals

To date, ISS has applied its global “case-by-case” approach on social/environmental issues when analyzing gender pay gap proposals. The proposed new policy provides more specificity but is not a major shift in ISS’ current policy approach.

In the proposed new policy ISS’s policy will be to recommend votes on a case-by-case basis on requests for reports on a company’s pay data by gender, or a report on a company’s policies and goals to reduce any gender pay gap, taking into account:

  • The company’s current policies and disclosure related to both its diversity and inclusion policies and practices and its compensation philosophy and fair and equitable compensation practices;
  • Whether the company has been the subject of recent controversy or litigation related to gender pay gap issues ; and
  • Whether the company’s reporting regarding gender pay gap policies or initiatives is lagging its peers.

ISS believes the proposed policy provides more clarity regarding ISS’ approach as the subject seems to be one that is going to continue and potentially grow in terms of the number of shareholder proposals filed in the short to medium term. ISS does not expect the proposed policy to have a significant impact on vote recommendations.

Non-Employee Director Compensation

Although non-employee director compensation, which ISS refers to as NED, varies by company size and industry, ISS believes it has identified some extreme pay outliers at which excessive compensation is sometimes not clearly explained. Currently, NED compensation is broadly addressed under ISS’ five Compensation Global Principles. The fifth principle states that companies should avoid inappropriate pay for non-employee directors.

The proposed new policy would explicitly provide for adverse vote recommendations for board committee members who are responsible for approving/setting NED compensation when there is a pattern (i.e. two or more consecutive years) of excessive NED pay magnitude without a compelling rationale or other mitigating factors.

There would be no impact on vote recommendations in 2018 for directors as a result of this proposed policy. Going forward, negative recommendations would be triggered only after a pattern of excessive NED pay is identified in consecutive years. ISS expects a minimal impact for boards as the policy is focused on extreme director pay outliers.

Poison Pills

The current policy with respect to poison pills is as follows:

  • Recommend against the full slate of directors for companies that maintain a pill that has a “deadhand” or “slowhand” feature.
  • For long term pills, or those with a term in excess of one year, whether ISS makes an adverse recommendation depends on whether the board is annually-elected or classified. ISS recommends against all nominees every year if the board is classified, but, if the board is annually elected, only once every 3 years. Companies who had newly adopted a pill could be exempt from adverse vote recommendations by making a commitment to put the pill to a binding shareholder vote at the next year’s annual meeting.
  • ISS’ current policy was put into place on Nov 19, 2009. Boards that adopted pills prior to that date were grandfathered from the policy and do not receive adverse vote recommendations.
  • The adoption (but not the renewal) of a short-term pill is considered on a case-by-case basis and generally does not cause an against recommendation on the board if there was a compelling rationale for its adoption and the company has a generally good governance track record.

ISS is proposing to update the policies outlined above, and recommend against all board nominees, every year, at companies who maintain a long-term poison pill that has not been approved by shareholders. Therefore annually-elected boards would receive adverse recommendations on an annual basis, rather than every 3 years. Commitments to put a long-term pill to a vote the following year would no longer be considered a mitigating factor. The boards with the 10-year pills currently grandfathered from 2009 would no longer be exempt and would receive against recommendations. With the proposed removal of grandfathering, there will also be no need to have an explicit policy regarding deadhand or slowhand features, as the few remaining deadhand/slowhand pills are not approved by shareholders and would be covered under the proposed policy.

Short-term pill adoptions would continue to be assessed on a case-by-case basis, but the proposed policy update would focus more on the rationale for their adoption than on the company’s governance and track record. Renewals or extensions though, as with the current policy, will not receive the case-by-case assessment.

Nasdaq has filed an immediately effective rule change with the SEC to reflect a corporate branding change to Nasdaq’s name. Specifically, current references in Nasdaq’s governing documents and rules will be changed as follows:

  • References to “NASDAQ” will be changed to “Nasdaq”
  • References to “The NASDAQ Stock Market LLC” or “NASDAQ Stock Market LLC” will be changed to “The Nasdaq Stock Market LLC”
  • References to “NASDAQ PHLX LLC” or “NASDAQ PHLX” will be changed to “Nasdaq PHLX LLC” or “Nasdaq PHLX”
  • References to “NASDAQ BX, Inc.” or “NASDAQ BX” will be changed to “Nasdaq BX, Inc.” or “Nasdaq BX”
  • References to “NASDAQ OMX PSX” or “NASDAQ PSX” will be changed to “Nasdaq PSX”
  • References to “The NASDAQ OMX Group, Inc.” or “NASDAQ OMX Group, Inc.” will be changed to “Nasdaq, Inc”
  • In addition to the preceding changes, all references to “OMX” will be removed from the rulebook.
  • References to “NASDAQ Options Market LLC” will be replaced with “The Nasdaq Options Market LLC”
  • References to “NASDAQ Execution Services, LLC” will be changed to “Nasdaq Execution Services, LLC”
  • In all instances where the word “the” should have been capitalized, (e.g., Rule 4758(b)(1)), the Exchange will make the appropriate correction.

The SEC has approved the Public Company Accounting Oversight Board’s (“PCAOB”) new standard for audit reports on public company financial statements. The new auditor reporting standard will require more information about the audit with the stated intention of making the auditor’s report more informative and relevant to investors.

The standard includes the communication of critical audit matters, referred to as CAMs, which will provide information about matters arising from the audit that required especially challenging, subjective, or complex auditor judgment, and how the auditor responded to those matters.

Communication of CAMs is not required for audits of emerging growth companies; brokers and dealers; investment companies other than business development companies; and employee stock purchase, savings, and similar plans.

The new standard also makes other changes to the audit report with respect to disclosures regarding auditor tenure, independence, addressees and other enhancements.

CAMs will be required to be included in audit reports for large accelerated files for fiscal years ending on or after June 30, 2019. CAMs will be required to be included in audit reports for other issuers for fiscal years ending on or after December 15, 2020. Auditors may elect to comply with the standard before the effective date.  All provisions other than those related to critical audit matters will take effect for audits for fiscal years ending on or after December 15, 2017.

Public companies may want to take the following steps now that the PCAOB standard has been approved by the SEC:

  • Ascertain wither the auditors intend to disclose CAMs in audit reports prior to the required effective time.
  • Become familiar with the changes to the audit report that will be effective during the upcoming reporting season.

Critical Audit Matters

The new standard requires the auditor to communicate in the auditor’s report any critical audit matters arising from the current period’s audit of the financial statements, or state that the auditor determined that there were no critical audit matters.

A CAM is defined as a matter that was communicated or required to be communicated to the audit committee that:

  • Relates to accounts or disclosures that are material to the financial statements, and,
  • Involved especially challenging, subjective, or complex auditor judgment.

When determining whether a matter involved especially challenging, subjective, or complex auditor judgment, the auditor takes into account certain factors, including the auditor’s assessment of the risks of material misstatement, the degree of auditor judgment applied, and the nature and timing of unusual transactions.

The communication of each CAM in the auditor’s report includes:

  • identification of the CAM;
  • description of the principal considerations that led the auditor to determine that the matter was a CAM;
  • description of how the CAM was addressed in the audit; and,
  • reference to the relevant financial statement accounts or disclosures.

An Example

Public companies are sensitive to disclosures about loss contingencies or possibilities of illegal acts for fear that they will encourage litigation. The final standard provides that each critical audit matter must relate to accounts or disclosures that are material to the financial statements.  According to the PCAOB, a potential loss contingency that was communicated to the audit committee, but that was determined to be remote and was not recorded in the financial statements or otherwise disclosed under the applicable financial reporting framework, would not meet the definition of a critical audit matter; it does not relate to an account or disclosure in the financial statements, even if it involved especially challenging auditor judgment. The same rationale would apply to a potential illegal act if an appropriate determination had been made that no disclosure of it was required in the financial statements; the matter would not relate to an account or disclosure that is material to the financial statements.

Liability Concerns

The PCAOB does not believe the new rule will lead to additional litigation against companies and their auditors. Commenters had expressed concern that communication of CAMs could result in an increase in “meritless claims” under the securities laws against auditors and issuers. While mandating disclosure of critical audit matters will, by design, entail new statements in the auditor’s report, the Board noted that any claim based on these new statements would have to establish all of the elements of the relevant cause of action (for example, when applicable, loss causation and reliance).  The Board also noted that the disclosure of risks and challenges required by CAMs could alternatively be used to combat litigation by effectively providing a defense to securities laws claims against auditors. In addition, the final standard provides that the auditor is not expected to provide information about the company that has not been made publicly available by the company unless such information is necessary to describe the principal considerations that led the auditor to determine that a matter is a critical audit matter or how the matter was addressed in the audit.

Further, any matter that will be communicated as a critical audit matter will already have been discussed with the audit committee, and the auditor will be required to provide a draft of the auditor’s report to the audit committee and discuss the draft with them. In addition, as the auditor determines how best to comply with the communication requirements, the auditor could discuss with management and the audit committee the treatment of any sensitive information.

Other Changes to the Auditor’s Report

The final standard also includes a number of other changes (the PCAOB describes them as “improvements”) to the auditor’s report that are primarily intended to clarify the auditor’s role and responsibilities related to the audit, provide additional information about the auditor, and make the auditor’s report easier to read:

  • Auditor tenure — The auditor’s report will include a statement disclosing the year in which the auditor began serving consecutively as the company’s auditor;
  • Independence — The auditor’s report also will include a statement that the auditor is required to be independent;
  • 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;
  • Standardized form of the auditor’s report — The opinion will appear in the first section of the auditor’s report. Section titles have also been added to guide the reader; and,
  • Addressees — The auditor’s report will be addressed to the company’s shareholders and board of directors or equivalents (additional addressees also are permitted).

Effective Date

Now that the new standard has been approved by the SEC, the final standard and amendments will take effect as follows:

  • All provisions other than those related to critical audit matters will take effect for audits for fiscal years ending on or after December 15, 2017; and,
  • Provisions related to critical audit matters will take effect for audits for 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.

This year ISS conducted two surveys. One was a high-level survey covering a small number of fundamental and high-profile topics.  We reported the results here.  ISS has now announced the results of a second, more expansive and geographically diverse Policy Application survey.  ISS highlighted the following results 2017 Policy Application survey for US issuers:

  • Director Pay in the U.S. Survey respondents were asked which factors should be considered in determining whether a director pay program presents a governance concern with respect to high pay magnitude. Tops for investors was measuring director pay relative to a four-digit Global Industry Classification Standard (GICS) peer group, followed by stock market index peers, and, third, measuring a director pay program relative to all companies. Corporate respondents, meanwhile, deemed the measurement of pay relative to a stock market index most appropriate, followed next by pay measurements relative to a four-digit GICS industry peer group. When asked which factors should be considered in determining whether a pay program presents a governance concern with respect to problematic pay structure, both groups agreed that excessive perquisites was most problematic.
  • Gender Pay Gap. Over the past two years, shareholders have filed proposals asking for a report on gender pay equity at numerous U.S. companies. ISS’ survey asked whether companies should be disclosing their gender pay gap information, with 60 percent of investor respondents answering affirmatively, compared with 17 percent for corporates. Of the just over one-quarter (27 percent) of investor respondents suggesting the need for such disclosures would “depend” on certain considerations, most indicated they would deem it favorable if the practice became an industry norm and/or the company was lagging its peers.