2016 Navigating the Annual Report and Proxy Season 2016 Governance - - PowerPoint PPT Presentation

2016 Navigating the Annual Report and Proxy Season

2016 Governance Hot Topics

Doug Wright

Look Ahead to 2016

2 – 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

Governance Updates

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

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

• bjectives (ex: tie to

environmental goals)

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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

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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

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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

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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)

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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

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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

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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)

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”

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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

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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

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Proxy Access – Educate the Board and Management Engage with Shareholders

Voluntary Adoption— Decide the Terms

Seek to negotiate withdrawal Put to a vote Seek exclusion under 14a-8(i)(10)

Disclose deadline for proxy access nominees in proxy statement Adopt bylaw after vote

Company proposal wins

May still get shareholder proposal with different terms Receive Shareholder Proposal Offer competing proposal Support proposal Oppose proposal

Shareholder proposal likely wins Shareholder proposal wins

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

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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

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Investigations

Michael MacPhail

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 2015 ►87 insider trading cases ►SEC awarded 8 whistleblowers a total of $38 million ►SEC continues to demand admissions of wrongdoing in important

cases

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Investigations Top 10 List

10. Develop an investigation plan immediately (who should participate, who should oversee, scope of investigation) that focuses on three primary goals—efficiency, effectiveness, and

• bjectivity

9. Determine whether you should involve outside or independent counsel or outside forensic accountants 8. Move immediately to protect and preserve data 7. Determine early the potential that issue may need to be reported (to insurers, lenders, SEC, etc.) 6. Limit employees aware of investigation (keep things on need-to- know basis)

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Investigations Top 10 List

5. Keep your auditors apprised of the scope and findings of the investigation 4. Understand what is and is not privileged, and how to keep privileged information privileged 3. Act quickly, but don’t sacrifice completeness 2. Prepare final report with appropriate level of detail (setting forth the who, what, when, why, and how, and who knew or should have known of the reported activity) 1. Implement appropriate remedial actions (terminations, reprimands, training, etc.)

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The Yates Memo: What You Need to Know

►What is it?

Memo from Deputy AG Sally Yates regarding individual accountability for corporate wrongdoing, with measures DOJ/US Attorneys’ Offices should take in investigating corporate misconduct Six key steps identified

►To qualify for cooperation credit, corporation must provide DOJ all relevant

facts relating to individuals responsible for misconduct

►Investigations to focus on individuals from outset ►Criminal and civil attorneys to routinely communicate about investigations ►No release of culpable individuals absent extraordinary circumstances ►DOJ attorneys must have clear plan to resolve individual cases ►Ability to pay not relevant to whether to bring suit against individuals

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The Yates Memo: What You Need to Know

►What does it mean for you?

Not yet completely certain For example, where there are mandatory disclosure requirements (as with Federal Acquisition Regulation), will companies have to identify culpable individuals?

►What does it mean for any investigations you may conduct?

Cooperation credit requires disclosure of all facts about individuals involved in wrongdoing But, with Yates Memo in play, will executives or other individuals being investigated lawyer up and refuse to cooperate?

►What should you do now?

Check limits on your D&O insurance

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BREAK

SEC and Disclosure Updates

Jeff Sherman

Summary of Proposed SEC Rules

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

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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

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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 31% Disclosure that audit engagement partner rotates every five years 26% Enhanced discussion of audit committee’s considerations in appointing an audit firm 25% Detailed discussions about criteria used by the audit committee in evaluating the audit firm 24% Disclosure of audit committee’s responsibility for the audit firm’s compensation 16%

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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

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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

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

• ver

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

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

• bligation to identify and disclose such potential transactions and relationships
• n 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

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

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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

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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

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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!

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Compensation and Pay Ratio Disclosures

Amy Seidel

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?

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SEC Rulemaking: Pay-Ratio Disclosure Rule

►Final rule adopted August 5th

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

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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)

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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%

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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%

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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

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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

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Who Cares?

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

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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

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Thanks for Coming!

Good luck with proxy season!