2016 Navigating the Annual Report and Proxy Season

Transcription

1 2016 Navigating the Annual Report and Proxy Season

2 2016 Governance Hot Topics

3 Look Ahead to Board composition issues: Tenure/refreshment Diversity 0 Companies not worried about proxy access 1 Dodd-Frank rules adopted in final form in 2015: Pay-Ratio 6 Shareholder engagement topics: Board structure and composition CEO performance (and succession) Executive compensation program and disclosure Shareholder rights Strategic direction and risk oversight Sustainability practices and reporting 3

4 Governance Updates

5 2015 Shareholder Proposal Recap Environmental & Social Governance Compensation Labor and human rights Proxy access Severance payments and accelerated vesting Climate change and sustainability Independent board chair (change in ISS policy led to more for recommendations) Clawback policies Political spending Board declassification Stock retention Board diversity Majority voting Selection of performance objectives (ex: tie to environmental goals) 5

6 Shareholder Activism in 2015 Fewer proxy contests went to a vote Increased willingness of companies to settle (about 24% went to a vote) When contest went to a vote, incumbents won more seats than they lost Company win rate of approximately 60%+ Effective vote no campaigns Any company can be a target, regardless of size or company performance DuPont Companies should have 48-hour response plans in place 6

7 ISS/GL Policy Changes Overboarded Directors ISS and GL: not more than five public company boards (previously six) For CEOs: GL: not more than two public company boards, including their own board (previously three) ISS: no change from current policy (will still permit three boards own board plus two others), but will monitor the issue, including service on boards of subsidiaries and affiliates of the CEO s own company Changes effective for meetings in 2017 to allow transition 7

8 Glass Lewis Additional Policy Changes Environmental and Social Risk Oversight May recommend against directors for lapses in environmental and social risk management Nominating Committee Performance May recommend against nominating committee chair where board failed to have relevant experience that contributes to company s poor performance One-time and Transitional Awards (including make-whole awards) Expects clear disclosure of the payments and how amounts were determined Equity Compensation Plans Listing of additional quantitative and qualitative factors 8

9 Year Two of ISS Equity Plan Scorecard CIC Equity Vesting: Time-based awards: Full points: no acceleration or only for awards not assumed/substituted No points for automatic acceleration Half points for anything else Performance-based awards: Full points: forfeiture/termination or payout at target/pro-rated basis No points for payout above target Half points for anything else Post-vesting holding period: Full points: 36 (up from 12) months (or termination of employment) Half points: 12 months (or until ownership guidelines are met) 9

10 Proxy Access in 2015 Proxy access represents the right of shareholders to include one or more alternate nominees for director in the company s proxy statement Viewed as fundamental shareholder right by many investors Proxy access proposals - over 100 companies Average support of 54% Prior 14a-11 structure: 3% of stock 3 year holding requirement 25% of the board Numerous companies have voluntarily adopted proxy access 10

11 Representative Advisory Firm and Investor Views Firm Voting Guideline Recommendations in 2015 ISS Generally recommend FOR FOR all but one management proposal with a 3% threshold AGAINST all management proposals with a 5% threshold FOR all shareholder proposals Glass Lewis Case-by-case FOR all management proposals with 3% requirement AGAINST all management proposals with a 5% threshold FOR 92% of shareholder proposals Active Proponent Supports Opposes NY Comptroller TIAA-CREF CalPERS CalSTRS BlackRock State Street T. Rowe Vanguard (at 5%) JP Morgan (at 5%, but has supported 3%) Fidelity Northern Trust (voted against) Wellington (voted against) 11

12 Proxy Access SEC Developments January 2015: SEC withdraws 14a-8(i)(9) no-action letters Companies not able to adopt their own proxy access bylaw as a way to exclude shareholder proposal March 2015: GE No-Action Letter addressing 14a-(i)(10) SEC grants no-action relief to exclude shareholder proposal calling for proxy access where GE proposal includes limit of 20 on shareholders aggregating ownership and other procedural matters October 2015: SEC issues SLB 14H addressing 14a-8(i)(9) Shareholder proposal will not be considered to directly conflict with company proposal if a reasonable shareholder, although possibly preferring one proposal over the other, could logically vote for both 12

13 Proxy Access ISS Policy Developments Policy on board implementation of proxy access in response to majority-supported shareholder proposal Minimum expectations: 3%, 3 years, no less than 20% of board, aggregation limit no less than 20 shareholders Differences from proposal must be explained by reference to shareholder engagement Assess restrictions or conditions Policy on evaluation of proxy access nominees Nominators rationale and critique of management/incumbent directors Nominee s qualifications, independence and overall fitness for service Company-specific factors Election-specific factors 13

14 Proxy Access Glass Lewis Policy Developments Glass Lewis policy on conflicting management and shareholder proposals Nature of the issue Benefit to shareholders of implementation of the proposal Materiality of the differences between the proposals Consideration of shareholder base, corporate structure, etc. Company s overall governance profile and responsiveness to shareholders 14

15 Proxy Access Educate the Board and Management Engage with Shareholders Voluntary Adoption Decide the Terms Receive Shareholder Proposal May still get shareholder proposal with different terms Oppose proposal Support proposal Offer competing proposal Seek to negotiate withdrawal Seek exclusion under 14a-8(i)(10) Put to a vote Shareholder proposal likely wins Shareholder proposal wins Company proposal wins Disclose deadline for proxy access nominees in proxy statement Adopt bylaw after vote

16 Potentially Controversial Proxy Access Provisions Limitations on resubmissions of failed nominees in subsequent years Restrictions on third-party compensation of proxy access nominees Restrictions on the use of proxy access and proxy contests at same meeting How long and under what circumstances an elected shareholder nominee will count toward the maximum number of proxy access nominees When the right to proxy access is fully implemented and accessible to shareholders 16

17 CyberGovernance Assess appropriate leadership (CISO) and lines of reporting Identify board/committee ownership At least annual reporting to full board Quarterly reporting to a committee (often the audit committee) Identify director responsible for interim events Periodic auditing by outside consulting firm with report to the board Review areas of greatest risk, incidents and incident response plans Evaluate responses to incidents and remediation plans Document in minutes and report to shareholders in proxy statement Analyze and review insurance coverage 17

18 Disclosure of Voting Standards CII initiative highlighting that company disclosure in proxy statements regarding voting standards was often confusing Example proxy disclosure refers to votes Against a director nominee, but proxy card does not have Against vote choice SEC reviewed filings of top 150 of Russell 3000 and identified several instances of imprecise descriptions 18

19 Fiscal 2015 SEC Enforcement Report SEC filed 807 actions: 507 independent enforcement actions 168 follow-on actions 132 actions for delinquent filings Up only slightly from FY2014 (when SEC filed 755 enforcement actions) SEC imposed $4.19 billion in monetary penalties and disgorgements Financial reporting and audit fraud actions doubled in insider trading cases SEC awarded 8 whistleblowers a total of $38 million SEC continues to demand admissions of wrongdoing in important cases 19

20 Related Party Transactions

21 Related Party Transactions Item 404 of Reg. S-K, Transactions with Related Persons ASC 850, Related Party Disclosures Auditing Standard No. 18, Related Parties Best Practices for Ensuring Compliance with RPT Policies & Procedures Interplay Between Related Party Transactions, Director Independence, and Conflicts of Interest

22 Item 404(a) of Reg. S-K: Definition of Related Person Transactions Any transaction since beginning of last FY or any currently proposed transaction Company was or is to be a participant Amount involved exceeds $120,000 Any related person had or will have a direct or indirect material interest Related person is (i) any director or executive officer, (ii) any nominee for director, (iii) 5%+ security holders, and (iv) any immediate family member of the foregoing Immediate family member is any child, stepchild, parent, stepparent, spouse, sibling, in-law (mother, father, son, daughter, brother, or sister), and any person sharing the household of the related person (other than tenant or employee)

23 Item 404(b) of Reg. S-K: Disclosure of RPT Policies and Procedures Direct or Indirect Material Interest Instruction 6 to Item 404(a) contains safe harbor for certain interests that are deemed not material Materiality depends on the significance of the information to investors in light of all circumstances Must be substantial likelihood that reasonable investors would have viewed disclosure of the fact omitted as having significantly altered the total mix of information Factors to consider: Relationship of related persons to transaction Relationship of related persons to the company Importance of the interest to the person having the interest Amount involved

24 Item 404(b) of Reg. S-K: Disclosure of RPT Policies and Procedures Company s policies and procedures for review, approval, or ratification of any transaction qualifying under Item 404(a) must be disclosed in proxy statements Disclosure must include material features, such as: Types of transactions covered Standards applied Persons responsible for applying policies and procedures Whether policies and procedures are in writing and, if not, how they are evidenced Must also disclose any transaction required to be reported under 404(a) where such policies and procedures did not require review, approval, or ratification, or where such policies and procedures were not followed

25 ASC 850: Definition of Related Parties Under ASC 850, related parties include: Affiliates of the company Entities for which investments in their equity securities would be required, absent the election of the fair value option, to be accounted for by the equity method Trusts for the benefit of employees Principal owners (10%) of the company and members of their immediate families Management of the company and members of their immediate families Other parties with which the company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests Immediate family means family members who might control or influence a principal owner or a member of management, or who might be controlled or influenced by a principal owner or a member of management, because of the family relationship

26 ASC 850: Related Party Disclosures Financial statements must disclose material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business Related party disclosures must include: Nature of the relationship(s) involved Description of the transactions and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements Dollar amount of transactions and effects of any change in the method of establishing the terms from that used in the preceding period Amounts due from or to related parties and terms or manner of settlement Certain tax information for entities with separately issued financial statements that are members of a consolidated tax return

27 Auditing Standard No. 18 What s New? PCAOB adopted AS 18, Related Parties, in 2014, effective for fiscal years beginning on or after 12/15/14 AS 18 requires specific audit procedures for the auditor s evaluation of a company s identification of, accounting for, and disclosure of transactions and relationships between a company and its related parties Auditors are taking different views about what kind of additional procedures they need to do in response to AS 18 and those procedures are still evolving

28 Auditing Standard No. 18 What Does it Mean? Some auditors are taking the view that they need to get, in some format, a list of the following types of information from directors and officers: List of entities such director or officer controls or can exert significant influence over List of immediate family members and any of their affiliations in which they control or significantly influence an entity Immediate family members as defined in ASC 850, which hinges on control and influence Information is likely to come from D&O questionnaires and/or quarterly updates Concern is how respondents will interpret and apply vague concepts of control and influence Bottom line is that each company will need to come up with a plan for AS 18 acceptable to its auditors

29 Best Practices Ensuring Compliance Education Communicate scope of disclosure requirements to directors, director nominees, and executive officers so all relevant transactions are identified and brought to the attention of appropriate persons These related persons need to understand that they have an affirmative obligation to identify and disclose such potential transactions and relationships on a real-time basis Information Collection and Tracking Systems D&O questionnaire should reflect RPT disclosure requirements Consider implementing additional procedures to assist in identifying relevant transactions on a real-time basis during the year Run list of immediate family members of related persons and their affiliated entities through A/P and A/R databases to identify transactions Review Schedule 13D and 13G filings on a real-time basis as part of RPT procedures to identify greater than 5% holders

30 RPTs, Director Independence, and Conflicts of Interest RPTs Director Independence Conflicts of Interest Authority 1. Item 404(a) 2. Company s RPT Policy 1. Stock exchange on which company s stock is listed 2. Committee member requirements (audit committee and compensation committees) 1. State corporate statutes and common law 2. Company s conflict of interest policy or code of conduct Standard 1. Any transaction with which company was involved (or will be involved) that exceeds $120k and any related person had (or will have) material direct or indirect interest 2. Company s policy, which may cast wider net than Item 404(a) NYSE: director qualifies as independent if the director has no material relationship with the company (based on a broad consideration of all relevant facts and circumstances) and meets other requirements NASDAQ: director qualifies as independent if the director is not an executive officer or employee of the company or any other individual having a relationship which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director and meets other requirements 1. Varies by state -implicates duty of loyalty (best interest of company and no personal gain) -may require recusal 2. Company s policy / code, which may outline: -types of relationships / transactions that create conflicts or even appearances of conflicts -policies for disclosure and approval of certain relationships / transactions Notes Company s RPT Policy must be described and disclosed in accordance with Item 404(b) Company must identify all independent directors under Item 407(a), which requires disclosure of any transactions or relationships not disclosed under 404(a) that were considered in evaluating independence Many states have safe harbor statutes for self-dealing transactions, making certain transactions not voidable (fair to corporation or approval by informed or disinterested directors)

31 SEC and Disclosure Updates

32 Summary of Proposed SEC Rules Rulemaking Hedging Disclosure Requires disclosure of whether companies prohibit hedging by directors, officers and employees Pay-for-Performance Disclosure Requires disclosure of the relationship between compensation actually paid and company TSR, as well as TSR relative to peers Clawback Requirement Requires adoption of a policy requiring executive officers to pay back incentive compensation that was erroneously paid upon certain financial restatements Status SEC proposed rule Feb 2015 Comments under review SEC proposed rule April 2015 Comments under review SEC proposed rule July 2015 Comments under review Further stock exchange rulemaking required 32

33 Audit Committee Concept Release Background: Center for Audit Quality Call to Action in 2013 Carpenters Union issues shareholder proposals calling for enhanced disclosure and reports on company progress SEC Concept Release potential disclosure requirements: Audit committee s oversight of the auditor Committee process for appointing or retaining the auditor Qualifications of audit firm and members of engagement team Location of audit committee disclosures in SEC filings 33

34 Center for Audit Quality 2015 Transparency Report Disclosure Topic % of S&P 500 Length of time audit firm was engaged 54% Statements that audit committee is involved in the selection of the audit engagement partner Disclosure that audit engagement partner rotates every five years Enhanced discussion of audit committee s considerations in appointing an audit firm Detailed discussions about criteria used by the audit committee in evaluating the audit firm Disclosure of audit committee s responsibility for the audit firm s compensation 31% 26% 25% 24% 16% 34

35 Material Weaknesses SEC officials expressed concern that companies are not properly identifying and disclosing material weaknesses Currently, most material weaknesses are disclosed at the time there is a restatement, which seems too late Auditors are now requiring more control deficiencies to be characterized as material weaknesses even if there is no restatement Disclosure of a material weakness, without a restatement, is often uneventful for investors Study suggests, however, that companies disclosing material weaknesses in advance of restatement may face greater penalties if a restatement related to that weakness arises later Auditors have significant leverage in classifying control deficiency 35

36 NYSE Update and Reminder Premarket notification to NYSE: Notify NYSE at least 10 minutes prior to releasing material news between 7 am and 4 pm ET (previously, 9 am to 4 pm ET) Release of material news at close of market: Wait until publication of official closing price or 15 minutes after trading Release of material news verbally: Release of material news on earnings call or at investor presentation satisfies Regulation FD Also requires notice to NYSE under Timely Alert Policy Reminder to publicly disclose scheduling of quarterly earnings release and any changes to the schedule 36

37 Nasdaq Update and Reminder Pre-notification to Nasdaq: Notify Nasdaq through electronic disclosure submission if information released between 7 am and 8 pm ET Release of material news at close of market: Wait until at least 4:01 and preferably 4:05 pm ET Remember to publicly disclose changes to earnings release, dividend record and dividend payment dates Use a Reg FD compliant method Notify Nasdaq in advance 37

38 2016 Conflict Minerals Reports Year 3 Form SDs due Tuesday, May 31, 2016 Transition period ends (except for SRCs) cannot classify products as undeterminable Pending litigation challenging whether conflict mineral rules violate First Amendment D.C. Circuit Court of Appeals found that rules violated First Amendment SEC s Director Higgins indicated that, in the meantime, companies would not be required to identify products using the labels in the rules ( DRC conflict free and not been found to be DRC conflict free ) Any voluntary disclosure as DRC conflict free will require an IPSA SEC has until February 2016 to seek review by the US Supreme Court Director Higgins has indicated that prior guidance will continue to apply in the meantime 38

39 Five Last Reminders In re Harman International Industries Inc. Securities Litigation Cautionary language in forward-looking statement safe harbor must be tailored to the forward-looking statement that it accompanies Stratte-McClure v Morgan Stanley Disclose known trends or uncertainties in MD&A SEC Broken Windows Section 16 and Item 405 Compliance Get filing certifications and report any late/missed filings AS 61 (PCAOB Rule 3200T) AS 16 AS 1301 Don t use rule citations in your governance documents or filings unless necessary ( applicable Public Company Accounting Oversight Board standards ) Don t overuse the SEC s website! 39

40 Compensation and Pay Ratio Disclosures

41 Executive Compensation Hot Topics Disclosure reform initiative SEC expected to solicit comments on compensation disclosures Director compensation litigation Need to ensure that director compensation is set through process that would meet entire fairness standard Compensation disclosure litigation Need to remain vigilant about accuracy and completeness Selection of performance metrics and rigor of goals Investor focus on metrics and whether they are sufficiently rigorous Impact of share repurchases on performance metrics Can executives use company money to buy themselves a bonus? 41

42 SEC Rulemaking: Pay-Ratio Disclosure Rule Final rule adopted August 5 th Effective for fiscal years commencing on or after January 1, 2017 Proxy statements filed in 2018 SRCs, EGCs and FPIs are exempt Disclosure requirement part of Item 402 disclosures: Median of the annual total compensation of all employees, excluding CEO Annual total compensation of the CEO Ratio of the two numbers above Narrative explanation of certain methodologies and assumptions 42

43 Who Are Employees? Anyone employed on measurement date May annualize for permanent employees who came/left during year Includes full-time, part-time, temporary and seasonal workers Cannot make full-time equivalent adjustments Includes employees of consolidated subsidiaries Does not include: Employees of unaffiliated third parties Independent contractors (unless company employs them or determines their compensation) 43

44 Which Employees Can Be Excluded? Violation of foreign data privacy laws May exclude non-us employees where compliance would violate privacy laws Must use reasonable efforts to comply, including seeking an exemption Must obtain a legal opinion from counsel on inability to comply De minimis exemption May exclude non-us employees consisting of up to 5% of total employees Must exclude all employees from the specific jurisdiction Non-US employees excluded for data privacy reasons count toward 5% 44

45 Example of Excluded Employees Entitled to exclude 7% of employees under data privacy exemption May not use de minimis exemption at all Entitled to exclude 4% of employees under data privacy exemption Wish to exclude employees in Guatemala, who represent 1.5% of employees In order to exclude one employee in Guatemala, you must exclude all of them Accordingly, you may not exclude any of them since you would exceed 5% 45

46 Who is the Median Employee? Identify median employee once every three years Unless material changes in employee base or compensation If median employee employees leaves, you can use a similarly situated employee Select a measurement date within last three months of FY Select a compensation methodology to determine the median employee Total compensation or any consistent compensation measure (base salary, taxable income, annual cash compensation) Can use statistical sampling May apply cost-of-living adjustment 46

47 How to Calculate Total Compensation? Calculate total annual compensation of median employee Same calculation as for Summary Compensation Table Base salary = wages plus overtime May use estimates for change in pension plan value May include perquisites, even if under $10,000, but then must include for CEO Must also disclose without cost-of-living adjustment Must recalculate annual compensation each year Calculate total annual compensation of CEO Consistent with Summary Compensation Table (or explain differences) If CEO changes during the year: Calculate for each and then add them together Annualize the compensation of the CEO on the measurement date 47

48 Who Cares? Employees (especially those paid below the median employee) Unions Labor-minded investors Compensation committee and Board Competitors? Other shareholders? Proxy advisory firms? 48

49 What Should We Do Now? Establish cross-functional internal working group Prepare T&R schedule for working group Work on preliminary calculation of ratio Report to Comp Committee on preliminary calculation Assess likely impact of disclosure on employee morale and any mitigating steps Refine calculation and assessment; report to Board Run calculation with F 17 comp numbers Spring 2018 First proxy statement filed with pay ratio for F 17 comp 49

50 Thanks for Coming! Good luck with proxy season!