This year’s PLI Securities Regulation Institute was a source for a lot of useful information and interesting perspectives. Panelists discussed a variety of topics, including climate disclosure (although no one shared any insights into the timing of the SEC’s final rules), proxy season issues, accounting issues, ESG and anti-ESG, and some of the most recent SEC rulemakings, such as pay versus performance, cybersecurity, buybacks and 10b5-1 plans. Some of the panels focused on these recent rulemakings echoed concerns expressed last year about the difficulty and complexity of implementation of these new rules, only this time, we also heard a few panelists questioning the rationale and effectiveness of these new mandates. What was the purpose of all this complication? Was it addressing real problems or just theoretical ones? Are investors really taking the disclosure into account? Is it all for naught? Pay versus performance, for example, was described as “a lot of work,” but, according to one of the program co-chairs, in terms of its impact, a “nothingburger.” (Was “nothingburger” the word of the week?) Aside from the agita over the need to implement the volume of complex rules, a key theme seemed to be the importance of controls and process—the need to have them, follow them and document that you followed them—as well as an intensified focus on cross-functional teams and avoiding silos. In addition, geopolitical uncertainty seems to be affecting just about everything. (For Commissioner Mark Uyeda’s perspective on the rulemaking process presented in his remarks before the Institute, see this PubCo post.) Below are just some of the takeaways, in no particular order.
[Based on my notes and limited by my imperfect attendance, so standard caveats apply.]
- The panelist from DF King reported that, this season, more proposals appeared on the ballot, although support generally declined across the board, driven primarily by environmental and social proposals. That was the case even after excluding anti-ESG proposals, which generally receive very low support. The decline in support has been attributed to the prescriptive quality of the proposals. Less than 5% of environmental proposals received majority support, although proposals relating to climate change lobbying disclosures gained support.
- The panelist from the NYC Comptroller’s office described anti-ESG proposals as trojan horses—the proponents aren’t necessarily interested in the topic of the proposal, but really wanted the air time. She advocated disclosing the proponents and saying more about the nature of the company’s engagement with the proponent.
- The panelist from DF King reported that neither proxy advisors nor institutional investors have incorporated the pay-versus-performance disclosure into their decision-making on voting.
- To enhance engagement, companies should ask their proxy solicitors for a list, identifying the “rabble rousers.” One reason to engage with and cultivate index investors: even if they can’t sell the shares, they can vote against directors and for shareholder proposals. It’s important to build up trust.
- There was a fear that universal proxy would precipitate many board contests, but that didn’t materialize. Instead, actions were taken to solidify the bylaw requirements for nominations, and there were increases in shareholder proposals relating to “fair elections,” that is, proposals requesting that shareholder approval be required for advance notice provisions.
- Avoid grade inflation—that is, presenting each board member as having all skills and capabilities; instead, it’s better to be selective and tie qualifications to strategy.
- Pay attention to the process for review of D&O questionnaires, especially if you prepopulate them. You may need to have conversations with the director or officer to be sure you understand the details, especially for Item 404 related-person transactions and perks. There have been a number of Enforcement cases in the last few years that identified serious problems related to D&O questionnaires and omitted perks. (See, e.g., this PubCo post and this PubCo post; here’s a PubCo post involving independence questionnaires.)
Corp Fin speaks
- Corp Fin Director Erik Gerding reported that they have received a number of requests for guidance on AI; they do expect to provide guidance, but in the meantime, he observed that, much like with other issues, issuers need to have a basis for their claims and particularize risk factors.
- The impact of inflation should be considered in MD&A and risk factors; in addition, focus has increased on Item 305 in connection with interest rate risk and liquidity risk.
- Expect more CDIs on Pay Versus Performance. The staff have noted a number of problematic omissions: narrative providing clear descriptions of the relationship between comp actually paid and the financial performance measures in the PVP table; identity of the peer group; how a non-GAAP company-selected financial measure was calculated (and not by cross-reference to the 10-K); and the assumptions made regarding CAP if the valuation assumptions differ materially from those previously disclosed, identifying if they are changed or just supplemental. With regard to the tabular list of the most important financial performance measures, they expect consistency with the CD&A.
- Corp Fin Deputy Director for Legal and Regulatory Policy Mellissa Campbell Duru observed that, with regard to determining materiality under the new cybersecurity rules, traditional rules apply, taking into account the nature, scope and impact of the incident; outreach to law enforcement does not necessarily mean that the incident is material. Avoid boilerplate in discussing cybersecurity governance infrastructure.
- On the climate proposal, they are carefully considering the 16,000 comments and taking into account the many developments that have occurred. Sound familiar?
- Corp Fin Chief Counsel Michael Seaman advised that there would not be a new staff legal bulletin for this proxy season, but there will be a new shareholder proposal no-action request intake system. (See this PubCo post.) He noted that more no-action relief was granted last year. This year they expect to see proposals on AI.
- Deficiency notices from issuers to proponents are sometimes too obscure; issuers need to be clear in telling proponents how to fix the problem.
- One optimistic panelist suggested that, while it appears that we have a plethora of different rules from the SEC, the EU, California and the voluntary ISSB, in her view, we have moved from fragmented to harmonized. Why? Because most of these rules have as their bases the GHG protocol and the TCFD. (She didn’t mention double materiality—the backbone of the CSRD.)
- One panelist noted that while the SEC’s proposal would require information related to scenario analyses if they were performed, it may be that California’s rules, relying on the TCFD, might ultimately require that they be performed.
- Panelists discussed the need for internal and disclosure controls (which were expected to be “high maintenance” because of the anticipated volume of changes, but definitely necessary for “reasonable assurance”), and disclosure committee review for accuracy and consistency of disclosure across different formats and contexts.
- One panelist noted that the SEC wanted to see specific numbers in responses to comments on climate disclosure. He also observed some skepticism on the part of the SEC to some responses. For example, if a company responded that it had determined that something was not material, the SEC pursued that further by asking the company what it saw that it did not think was material.
- One panelist attempted to describe the calculation of GHG emissions: It’s just inputs (e.g., hauling products or using lighting) multiplied by emissions factors; however, there might be hundreds of thousands of inputs and the emissions factors were very complex.
- One panelist, on a different panel, advised that companies should be sure that their voluntary sustainability reports and mandatory SEC disclosures are aligned. The SEC does look at disclosures outside of periodic reports. (See this PubCo post regarding the SEC’s case against Vale S.A., a publicly traded (NYSE) Brazilian mining company, mentioned during the panels.)
Cross-currents in ESG.
- Of the S&P 500, 494 companies disclosed some ESG information. The moderator of this panel noted that the debate surrounding ESG is part of the larger discussion of the role of the corporation in society. Now, some resistance has emerged and is reflected in actions by politicians (including state AGs) and conservative policy organizations through legislation, litigation and shareholder proposals.
- What’s behind anti-ESG? The panelist from The Conference Board said that, in some cases, it’s just healthy skepticism, sometimes philosophical opposition (i.e., the company should just stick to its knitting), and in some cases, “rank opportunism.” He believes that there is a lot of fear driving this trend—fear of job loss, fear of the implications of diversity and fear of the implications of a move away from fossil fuels.
- Most companies have not yet experienced a lot of backlash; currently, it appears to be mostly confined to funds, asset managers and proxy advisors, where anti-ESG groups want to prohibit the use of ESG factors in decision-making and investing.
- In 2023, there were 165 anti-ESG pieces of legislation in 35 states.
- There have been a number of anti-ESG shareholder proposals, although support has been low—around 2.2%. But they do get press. According to panelists, the proponents are typically not interested in engagement or negotiation. Instead, companies can simply submit their no-action requests and fine-tune their messages.
- A number of companies have taken to “green-hushing”—doing the work but keeping quiet about it. (See this PubCo post.) A panelist advised companies not to cede the field, but instead, to step back and consider the company, its strategy and history—that being good neighbors and good employers that employees want to work for is in the long-term best interest of the company. One company with a long history responded that “sustainability” is just what they’ve been doing successfully for 200 years. One recommendation was to tie actions related to ESG to the company’s business strategy. A panelist recommended substituting the word “sustainability” for ESG, which some find more palatable. Another recommendation was to describe environmental issues in more human terms—clean air, clean water. Another was to involve marketing to help craft a message that has an emotionally positive resonance that will combat the fear. Panelists advised to create a cross-functional ESG group, including marketing, litigation and labor law, document your process and tailor your disclosure. (See this PubCo post and this PubCo post.)
- In deciding whether to express a view on controversial issues, panelists said, companies should have clear criteria to help guide the decision and the right people in the room to make it. Instead of looking only to values (which may differ among employees), consider factors such as the relevance of the issue to the business, standing, ability to follow through. Make sure the board is aware of the criteria— and perhaps advise employees also. Criteria are often difficult to apply and may require a tabletop exercise. Decision-making processes that are now in place may be useful in making these decisions too. In some cases, it may not be possible to stay silent. For example, a panelist reported that there were 20 shareholder proposals on abortion care last year. (See this PubCo post.)
- One panelist described a recent survey of 3,000 customers asking what factors might influence them to buy or not buy a product. Respondents cited as top factors decent working conditions, equal pay and community impact.
- One panelist suggested the following questions, among others, to help assess materiality: did you have a cyber incident? Is there harm to reputation or customer or vendor relationships? Is it contained? What happened to the data? Has the system been restored? Is it industry specific?
- In making a materiality assessment, it’s important that the right people be involved—a cross-functional team that includes, not just the cyber team, but also attorneys, accountants, investor relations and the disclosure committee. It would probably be a good idea to include disclosure personnel on the cyber team and cyber personnel on the disclosure committee.
- Be sure to follow process—including disclosure controls and procedures—and document that you have done so. The SEC wants to “see the math.” Have an attorney involved to preserve privilege, including engagement of any outside cybersecurity firm, and be careful in emails not to use the word “material” loosely. Check out the case against SolarWinds and its CISO (see this PubCo post). A cross-functional team should be involved in drafting the disclosure.
- Panelists observed that the new rule led a number of companies to revisit whether to retain these plans as an option for executives; although results were mixed, panelists thought most companies were continuing to use them. Panelists advised that sellers may need to plan well in advance.
- In creating the 10b5-1 rules, the panel wondered, was the SEC responding to an onslaught of Enforcement actions or primarily academic studies?
- Given the limitation on single-trade plans, what if a plan accidentally becomes a single trade plan? Panelists believed that the rule was intended to refer only to plans that are intentionally single-trade plans.
- Plans that don’t meet all the requirements are probably in the category of “non-rule 10b5-1 plans.”
- Companies should consider adding policies about gifts to their insider trading policies. (See this PubCo post.) Mixed views on whether to add provisions to address “shadow trading”; many companies cover customers and suppliers, but not other similar companies. (See this PubCo post and this PubCo post.)
- The panel discussed the recent Fifth Circuit decision that the buyback rules violated the APA because the SEC failed to show that the issue the rule was intended to address was really a problem. The court remanded the case back to the SEC to fix the problem in 30 days. (See this PubCo post.) Panelists questioned whether the SEC would be able to fix the problem in 30 days and noted that there would not be time for notice and comment.
- The rules assume that companies have policies regarding repurchases, but there may not be any policies at this point.
- The panel noted that there had been lots of investigations regarding buybacks, but no Enforcement actions. Implications?
- A capital markets panelist wondered who would even use the buybacks table? Maybe quants, he speculated. The same panel suggested that companies might just announce a “marker” that if the stock falls “x” below book, they intend to repurchase. Apparently that is a practice followed by some companies.
Pay versus performance
- Most companies are using an industry index and usually only financial measures.
- Some have been wondering what to make of comp actually paid as a negative number. (See this PubCo post for a discussion of this point in remarks by Commissioner Mark Uyeda. Apparently, staff data showed that approximately 34% of companies reported a negative amount for the principal executive officer’s CAP in one of the three years in the table.)
- Compliance with the new rule is “a lot of work,” but neither Glass Lewis nor ISS are using the data; one of the co-Chairs called the rule a “nothingburger,” presumably referring to its impact.
- One panelist suggested using PVP to tell your story in CD&A.
- Panelists, including Vice Chancellor Lori Will, discussed several cases, including the recent Disney case, in which VC Will decided against granting the plaintiff’s books-and-records request, concluding that, under the Delaware business judgment rule, the Disney board had considerable discretion in making a business decision with respect to its public statements about the “don’t say gay” bill. (See this PubCo post.)
- The panel also discussed the McDonald’s case in which the court considered what it means to have a system of oversight in place under Caremark. In this case, the court held that, although there were red flags regarding the company’s toxic culture, the board did take notice, did hold meetings to discuss it, as reflected in minutes, and did respond. (See this PubCo post.) A different McDonald’s case held that officers also have Caremark duties of oversight. (See this PubCo post.)
- The panel also discussed the difference between legal risk and business risk, a distinction raised in a different Delaware case in which the plaintiffs brought Caremark claims. VC Will found that the board made unfortunate business decisions, not bad legal decisions, and dismissed the case.
- In controlling shareholder (with benefit) cases, to avoid the entire fairness test, MFW requires both a special committee and a majority minority vote from the outset. One case is pending which addresses the issue of whether meeting just one of the criteria would suffice.
- A recent change allows reverse splits to be authorized with the approval of a majority of votes cast, rather than a majority of shares outstanding.
- On amendments to allow officer exculpation, on 249 votes, all but 39 passed.
- Geopolitical and economic uncertainty, particularly inflation, are having an effect on financial reporting.
- A company facing a potential goodwill impairment should review Section 9510 of the Financial Reporting Manual. That section discusses the need to forewarn of potential future goodwill impairments and identifies disclosures to be considered if the “reporting unit” is in danger of failing step one of the impairment test.
- A panelist observed that non-GAAP financial measures remain the #1 comment, especially equal prominence, descriptions and labeling, e.g., if the term “other” is used, what does it include? Key performance indicators also often draw comment.
- Non-GAAP adjustments to a GAAP measure that have the effect of changing GAAP recognition and measurement principles may be considered “individually tailored” and may cause the presentation of the non-GAAP measure to be misleading under Reg G.
- Normal, recurring operating expenses cannot be excluded for an NGFM. Two panels noted the number of staff comments questioning the propriety of exclusion of expenses that the SEC considers to be normal and recurring, such as those related to the hiring and transition of new executives. “Normal” refers to something that relates directly to the business. Extensive disclosure does not cure the exclusion. Many companies have just stopped using NGFMs and instead provide explanatory disclosure. Check out the December 2022 CDIs. (See this PubCo post.)
- If a result is characterized in a press release or other document as “record,” that term must be applicable to both the NGFM and the GAAP number.
- Another panelist reported that the staff have asked for NGFMs to be labeled “adjusted” if not calculated in the typical manner.
- A panelist observed that FASB is moving forward with new requirements regarding disaggregation of income statement expenses and segment expenses. These changes would likely also affect MD&A. (See this PubCo post.)
- Currently, auditors consider NOCLAR (noncompliance with laws and regs) only as directly related to the financial statements; the new NOCLAR proposal from the PCAOB would add consideration of other noncompliance that would have an indirect effect on the financial statements. Lots of negative feedback on this. A panelist observed that the existing standard is currently being “robustly enforced.”
- Disclosure under Reg S-K Item 305, quantitative and qualitative disclosures about market risk, has also drawn comment lately in connection with disclosure regarding interest rate risk and liquidity. If a company uses a sensitivity analysis, it should be described.
- Corp Fin Chief Accountant Lindsay McCord advised that, when crafting PVP or clawback disclosure, companies should be sure to involve their accountants given that accountants were heavily involved in the rulemaking.
- She also pointed out that, with regard to the two clawbacks checkboxes on the cover of Form 10-K, the first box is much broader than the second, covering “Big R” and “little r” restatements and any other error corrections in the financial statements included in the filing. It doesn’t cover changes in accounting principle, just errors corrected.
- In light of the current uncertain state of the capital markets (geopolitical concerns?), some companies are conducting employee equity tenders to provide liquidity and attempt to fulfill the “employee social contract.” Similarly, many lockups now allow employees out. (What does that mean for tracing under Slack?)
- Is the volume of new regulation a deterrence to going public? The panel said no, it has not had a major impact; rather, the question is more about whether it is a good time to go out.
- On the question of reforming private offerings to require more disclosure, the panel thought that the pressure was really more in the opposite direction and that more disclosure would be viewed as “contrary to the entrepreneurial spirit.” One of the program co-chairs observed that it was very difficult to make changes related to offerings in the private markets—even making changes to the definition of accredited investor.
- Some questions have arisen in connection with universal proxy regarding overvotes and undervotes: what happens if a shareholder votes for more nominees than there are seats? If the shareholder undervotes, can the company vote the remainder?
- A panelist noted a recent Enforcement sweep related to late 13D/Gs. (See this PubCo post.)
- Geopolitics has led to a decrease in transactions.
- There has also been an uptick in activism. One panelist noted that activists on boards are sometimes affiliated with funds and can turn out to be buyers or try to market the company or to demand a public sale process that can harm the company.
- What makes a company an activist target? Typically underperformance relative to peers, but sometimes, even big companies can be targets if performance is good but not great.
- Because of antitrust issues, many deals are taking longer than usual to complete, which can be a problem in the context of conduct-of-business clauses and can lead to broken deals, which a panelist characterized as a win for Antitrust. One panelist suggested that investigations into M&A deals are sometimes used to investigate the rest of the business, which can then turn into an industry investigation.
A few notes from some of the litigation panels
- There has been a recent Enforcement sweep on impediments to whistleblowers. (See, e.g., this PubCo post.) The panel advised companies to look everywhere there is a confidentiality provision, not just separation agreements, for clauses that could be viewed to impede whistleblowers. “Effort to impede” has been broadly interpreted.
- The defense panel noted that SolarWinds reflected a shift. (See this PubCo post.) In the past, the SEC did not bring cases against companies that were victims of a cyber breach. Not the case with SolarWinds. A panelist advised putting the CISO on the disclosure committee and document actions in response to incidents.
- The defense panel also took issue with the SEC’s case against McDonald’s, arguing that the SEC was reaching for a theory. (See this PubCo post.) The SEC charged that McDonald’s disclosures related to its former CEO’s separation agreement were deficient in failing to disclose that the company exercised discretion in terminating him without cause, allowing him to retain substantial equity comp. A program co-chair observed that companies were in something of a quandary trying to assess what this case meant for disclosure regarding terminated executives.
- In the Slack case (tracing in litigation involving direct listings), the lower court is still considering what needs to be shown to trace shares. (See this PubCo post.) Does probability work? Also, the panel noted that SCOTUS punted on the 12(a)(2) claim, which was also still open for consideration by the lower court. A plaintiff’s attorney on the panel said that direct listings were rare. He described the issue as a “nothingburger.”