Category: Corporate Governance
Fifth Circuit hears oral argument on challenge to Nasdaq board diversity rules—will the rules survive?
On Friday, August 6, 2021, the SEC approved a Nasdaq proposal for new listing rules regarding board diversity and disclosure, accompanied by a proposal to provide free access to a board recruiting service. The new listing rules adopted a “comply or explain” mandate for board diversity for most listed companies and required companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards. (See this PubCo post.) As anticipated, a court challenge to these rules didn’t take long to materialize. On Monday, August 9, the Alliance for Fair Board Recruitment filed a slim petition under Section 25(a) of the Exchange Act in the Fifth Circuit Court of Appeals—the Alliance has its principal place of business in Texas—for review of the SEC’s final order approving the Nasdaq rule. (See this PubCo post.) That petition was soon followed by a new petition challenging the rules filed by the National Center for Public Policy Research and subsequently transferred to the Fifth Circuit where the earlier filed petition was pending. (See this PubCo post.) Last week, a three-judge panel of the Fifth Circuit heard oral argument in the case, Alliance for Fair Board Recruitment, National Center for Public Policy Research v. SEC. Did it signal a result?
SEC adopts final pay-versus-performance disclosure rule [updated]
[This post revises and updates my earlier post primarily to reflect in greater detail the contents of the adopting release.]
Last week, without an open meeting, the SEC finally adopted a new rule that will require disclosure of information reflecting the relationship between executive compensation actually paid by a company and the company’s financial performance—a new rule that has been 12 years in the making. In 2010, Dodd-Frank, in Section 953(a), added Section 14(i) to the Exchange Act, mandating that the SEC require so-called pay-versus-performance disclosure in proxy and information statements. The SEC proposed a rule on pay versus performance in 2015 (see this PubCo post and this Cooley Alert), but it fell onto the long-term, maybe-never agenda until, that is, the SEC reopened the comment period in January (see this PubCo post). According to SEC Chair Gary Gensler, the new rule “makes it easier for shareholders to assess a public company’s decision-making with respect to its executive compensation policies. I am pleased that the final rule provides for new, more flexible disclosures that allow companies to describe the performance measures it deems most important when determining what it pays executives. I think that this rule will help investors receive the consistent, comparable, and decision-useful information they need to evaluate executive compensation policies.” In the adopting release, the SEC articulates its belief that the disclosure “will allow investors to assess a registrant’s executive compensation actually paid relative to its financial performance more readily and at a lower cost than under the existing executive compensation disclosure regime.” For the most part, although there is some flexibility in some aspects of the new rule, the approach taken by the SEC in this rulemaking is quite prescriptive; the SEC opted not to take a “wholly principles-based approach because, among other reasons, such a route would limit comparability across issuers and within issuers’ filings over time, as well as increasing the possibility that some issuers would choose to report only the most favorable information.” Commissioners Hester Peirce and Mark Uyeda dissented, and their statements about the rulemaking are discussed below.
Corp Fin issues new CDIs on universal proxy
At the end of last week, Corp Fin issued three new CDIs related to universal proxies under Rule 14a-19. In November 2021, the SEC amended the federal proxy rules to mandate the use of universal proxies in all non-exempt solicitations in connection with contested elections of directors of operating companies. By mandating the use of universal proxies—proxy cards that, when used in a contested election, include a complete list of all candidates for director duly nominated by both management and dissidents—the SEC’s rules now allow a shareholder voting by proxy to choose among director nominees in an election contest in a manner that closely mirrors in-person voting. (See this PubCo post.) The new CDIs address questions that have arisen in connection with notice and proxy statement disclosure. Below are brief summaries.
SEC adopts final pay-versus-performance disclosure rule
It’s been 12 years since Dodd-Frank mandated, in Section 953(a), so-called pay-versus-performance disclosure, and amazingly, no rules had been adopted to implement that mandate…until yesterday, when adoption of the final rule crept in “on little cat feet.” Well, ok, there was a press release, but it was still quite a surprise. Yesterday, without an open meeting, the SEC finally adopted a new rule that would require disclosure of information reflecting the relationship between executive compensation actually paid by a company and the company’s financial performance. The SEC proposed a rule on pay versus performance in 2015 (see this PubCo post and this Cooley Alert), but it fell onto the long-term, maybe-never agenda until, that is, the SEC reopened the comment period in January (see this PubCo post). According to SEC Chair Gary Gensler, “[t]oday’s rule makes it easier for shareholders to assess a public company’s decision-making with respect to its executive compensation policies. I am pleased that the final rule provides for new, more flexible disclosures that allow companies to describe the performance measures it deems most important when determining what it pays executives. I think that this rule will help investors receive the consistent, comparable, and decision-useful information they need to evaluate executive compensation policies.” Commissioners Hester Peirce and Mark Uyeda dissented.
What do the public comments on the SEC’s climate disclosure proposal tell us?
In this July report, Responses to the SEC’s Climate Proposal, KPMG discusses various themes and observations that it gleaned from its review of comment letters on the SEC’s 510-page comprehensive and stunningly detailed climate disclosure proposal issued in March. As you probably recall, the proposal was designed to require disclosure of “consistent, comparable, and reliable—and therefore decision-useful—information to investors to enable them to make informed judgments about the impact of climate-related risks on current and potential investments.” KPMG found that the sentiment about climate standard-setting as a general concept was favorable, with 29% of those commenting very supportive and 50% supportive of the concept. Only 21% had a negative response—12% very unsupportive and 9% generally unsupportive. But that positive attitude toward the general concept did not necessarily translate to support for the specific proposal from the SEC.
State legislation targets company policies on ESG—how will it affect the corporate balancing act?
Over the past several years of political discord, many CEOs have felt the need to voice their views on important political, environmental and social issues. For example, after the murder of George Floyd and resulting national protests, many of the country’s largest corporations expressed solidarity and pledged support for racial justice. After January 6, a number of companies announced that their corporate PACs had suspended—temporarily or permanently—their contributions to one or both political parties or to lawmakers who objected to certification of the presidential election. Historically, companies have faced reputational risk for taking—or not taking—positions on some political, environmental or social issues, which can certainly impair a company’s social capital and, in some cases, its performance. These types of risks can be more nebulous and unpredictable than traditional operating or financial risks—and the extent of potential damage may be more difficult to gauge. As if it weren’t hard enough for companies to figure out whether and how to respond to social crises, now, another potent ingredient has been stirred into the mix: the actions of state and local governments—wielding the levers of government—to enact legislation or take executive action that targets companies that express public positions on sociopolitical issues or conduct their businesses in a manner disfavored by the government in power. As described by Bloomberg, while “companies usually faced mainly reputational damage for their social actions, politicians are increasingly eager to craft legislation that can be used as a cudgel against businesses that don’t share their social views.” And many of these actions are aimed, not just at expressed political positions, but rather at environmental and social measures that companies may view as strictly responsive to investor or employee concerns, shareholder proposals, current or anticipated governmental regulation, identified business risks or even business opportunities. How will these legislative trends affect the difficult corporate balancing act?
SEC approves new PCAOB requirements for lead auditor’s use of other auditors
At the end of last week, the SEC approved the PCAOB’s updated standards for audits that involve multiple auditing firms. SEC Chair Gary Gensler said that the amended standards “will strengthen the requirements for lead auditors who supervise other auditors in an audit, helping to enhance audit quality and protect investors.” Why were these updates necessary? According to Gensler, the globalization and increasing complexity of public company operations has meant that auditors must increasingly “rely on other auditors—working across different firms, countries, and even languages—in completing an audit. Last year,” he said, “26 percent of all issuer audit engagements used multiple auditors, and more than half of large accelerated filer audits used multiple auditors. Given the challenges that such multi-firm audits present, it is important that there be robust standards for how lead auditors supervise, communicate with, and coordinate with other auditors on the audit engagement.” Gensler noted that the updates enhance the standards “across two broad areas. First, the amended standards specify certain procedures for lead auditors to perform when supervising other auditors. Second, they require lead auditors to prioritize their supervisory activities around higher-risk areas in the audit.” PCAOB Chair Erica Williams observed that companies “continue to increase their global presence. As a result, the use of other auditors has become more prevalent in the conduct of an audit, which can create additional challenges for the lead auditor. Adding other auditors into the process requires careful consideration and clear communications between all auditors involved in the audit. And when miscommunication occurs or when there are misunderstandings about the nature, timing, and extent of the other auditor’s procedures, audit quality will likely suffer.” It’s worth noting that some aspects of the new amendments will affect communications with the audit committee. The amendments will be effective for audits of financial statements for fiscal years ending on or after December 15, 2024.
ESG metrics in compensation plans—a growing trend
Consultant Semler Brossy’s new report, ESG+Incentives, examines the prevalence of various ESG metrics as part of incentive compensation structures among companies in the S&P 500. Although some view ESG targets as just too nebulous to measure—how do you measure company culture?—and too amenable to “architecting” to ensure executive payouts, the use of ESG metrics as part of executive compensation plans appears to be a growing trend. The report concludes that the majority of companies in the S&P 500 now include ESG metrics, largely reflecting increased stakeholder interest in human capital and environmental issues. In 2022, “there was a nearly 23% increase in the proportion of S&P 500 companies applying ESG metrics in incentive plans, at 70% prevalence compared to 57% prevalence a year ago”—that’s a 13 percentage point increase year over year. Metrics related to human capital management were included most often as part of comp plans—used by 65% of all companies in the S&P 500, meaning that almost all companies that included any ESG metrics included HCM metrics. And, while environmental metrics still remained scarce at only 23%, that percentage reflects a 64% increase over the 14% reported last year. The report indicates that the predominant metric overall was diversity and inclusion (46% of companies in the S&P 500); carbon-footprint metrics predominate in the environmental category, having increased by over 300% from last year.
Board refreshment: are evaluations preferable to retirement policies?
A new report from The Conference Board (together with ESG data analytics firm ESGAUGE) , Board Refreshment and Evaluations, indicates that, in pursuit of board diversity—in skills, professional experience, gender, race/ethnicity, demography or other background characteristic—companies must overcome one key impediment: relatively low board turnover. One approach is just to increase the size of the board; another is through “board refreshment.” To that end, the report observes, companies are relying less on director retirement policies based on tenure or age—which may sometimes be viewed as misguided and arbitrary—and looking instead to comprehensive board evaluations, sometimes conducted by a facilitator, as a way to achieve board refreshment. The Conference Board advocates that companies foster a “culture of board refreshment” that removes any stigma that could otherwise attach to an early departure from the board. In any event, The Conference Board cautions that “companies should expect continued investor scrutiny in this area. Indeed, while institutional investors may defer to the board on whether to adopt mandatory retirement policies, many are keeping a close eye on average board tenure and the balance of tenures among directors and will generally vote against directors who serve on too many boards.”
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