Securities Regulation and Corporate Governance

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ISS Releases Survey for 2015 Policy Updates

Institutional Shareholder Services Inc. (“ISS”), the most influential proxy advisory firm, today launched its 10th annual global policy survey.  Each year, ISS solicits comments in connection with its review of its proxy voting policies. At the end of this process, in November 2014, ISS will announce its updated proxy voting policies applicable to 2015 shareholders’ meetings. 

Results from the policy survey that ISS posted on its website today will be used by ISS to inform its voting policy review.  The survey includes questions on a variety of topics involving Say-on-Pay and equity plan approvals, voting recommendations on directors and the selection of auditors, and other governance topics, including the following:

  • What relationship should exist between setting performance-based compensation goals and the value of performance-based compensation awards?
  • Is there is an absolute magnitude of CEO compensation that causes concern regardless of company performance, and if so, how should that pay magnitude be determined?
  • How should disclosures regarding changes made to a company’s current or future compensation program be considered in ISS’s pay-for-performance evaluation, which examines a company’s compensation program based on compensation paid in the prior fiscal year?
  • When is it appropriate for companies to use quantitative environmental and social performance goals, and what alternatives might be acceptable?
  • In the context of ISS’s stated intention to implement a “balanced scorecard” for evaluating equity plans, how should ISS weigh factors such as plan cost, plan features, and company practices?  What other factors should be considered?
  • How and under what circumstances should directors be held accountable for adopting bylaw amendments that restrict shareholder rights without obtaining shareholder approval of the amendments?
  • How do investors consider gender diversity when evaluating boards?
  • What factors should be considered when evaluating a board’s role in risk oversight?
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House Financial Services Committee Approves Eight Bills Affecting Securities Regulation

Earlier this summer, on May 22, 2014, the Financial Services Committee of the House of Representatives approved eight bills relating to issuer disclosures, public and private capital raising, the liquidity of restricted securities and SEC regulations generally.  These bills, if enacted into law, would incrementally ease the many burdens imposed by the current securities regulatory regime.

The Disclosure Modernization and Simplification Act and the Small Business Investment Company Advisers Relief Act were both unanimously approved, while the other bills were generally approved by fairly narrow margins.

No corresponding bills are currently scheduled to be taken up in the Senate Banking Committee.

Disclosure

The Disclosure Modernization and Simplification Act (H.R. 4569) would require the SEC to:

  • permit issuers to include a summary page in their annual reports on Form 10-K;
  • revise Regulation S-K to further scale back or eliminate disclosure requirements for smaller issuers, including emerging growth companies, accelerated filers and smaller reporting companies; and
  • eliminate duplicative, overlapping, outdated and unnecessary requirements. 

In addition, the bill would require the SEC to conduct another study of Regulation S-K, to issue a report of its findings and recommendations to Congress and to propose rules to implement its recommendations.  The study would be required to determine how to modernize and simplify Regulation S-K to reduce the costs and burdens of compliance on issuers, eliminate boilerplate language and static requirements, evaluate methods of information delivery and presentation, and explore methods to discourage repetition and the disclosure of immaterial information. 

H.R. 4569 directs the SEC to ensure that all material information continues to be provided to investors, and to preserve the completeness and comparability of information across registrants.  The Committee approved the bill by a vote of 56-0.

Advisers to Small Business Investment Companies

The Small Business Investment Company (SBIC) Advisers Relief Act (H.R. 4200) would ensure that an investment adviser that relies on either the venture capital fund adviser exemption or the private fund adviser exemption from registration under Section 203A of the Investment Adviser’s Act of 1940 will not be required to register if it also acts as an investment adviser to one or more SBICs.  The bill would also preempt any state registration require...Read More

PCAOB Adopts Auditing Standards Governing Related Parties, Significant Unusual Transactions And Financial Relationships With Executive Officers

The Public Company Accounting Oversight Board (“PCAOB”) yesterday adopted new and amended auditing standards that expand audit procedures required to be performed with respect to three important areas:  (1) related party transactions; (2) significant unusual transactions; and (3) a company’s financial relationships and transactions with its executive officers.  The standards also expand the required communications that an auditor must make to the audit committee related to these three areas.  They also amend the standard governing representations that the auditor is required to periodically obtain from management.

  • Related party transactions.  The new standard for related parties, Auditing Standard No. 18, supersedes AU sec. 334, Related Parties, which had not been substantively updated since it was issued in 1983.  While AU sec. 334 included limited direction for obtaining an understanding of the company’s relationships and transactions with its related parties, the new standard requires the auditor to perform specific procedures to obtain an understanding of the nature of the relationships and of the terms and business purposes (or the lack thereof) of related party transactions identified by management.  For example, the auditor should inquire of management and other company personnel regarding: (1) background information on the related parties; (2) the business purpose for entering into a transaction with a related party; and (3) if a transaction was not approved in accordance with the company’s established policies or procedures, the reasons for granting the exception.  The auditor also must undertake additional procedures to evaluate whether the company has properly identified all of its related parties and transactions with such parties, and in cases where an undisclosed transaction is identified further steps are required.  While the prior standard focused on the adequacy of disclosure of identified related party transactions, the PCAOB says the goal of the new standard is to focus the auditor not only on the disclosure aspects of related party transactions, but also the appropriate accounting for such transactions.  In view of this expansion of procedures, companies should focus on ensuring that appropriate authorizations and approvals are in place and documented for related party transactions.
  • Significant unusual transactions.  The PCAOB amended AU sec. 316, Consideration of Fraud in a Financial Statement Audit, to require the auditor to perform specific procedures to identify and evaluate significant unusual transactions.  It indicated that, particularly when such transactions are entered into on or around period ends, their purpose in some instances is to engage in fraudulent financial reporting rather than legitimate business purposes.  The amended standard states that, f...Read More
SEC Issues Guidance on the Use of Social Media and the Intrastate Offering Exemption

Solicitations using Social Media

During a webcast earlier this year, our partner Jim Moloney, who formerly worked in the SEC’s Office of Mergers & Acquisitions (“OM&A”), spoke with the current Chief of OM&A, Michele Anderson.  On that webcast, Ms. Anderson acknowledged that “social media is here to stay,” noting that the Commission was “trying to find a way to make it work.”  Following the webcast, the SEC’s Division of Corporation Finance (“Corp Fin”) posted a new round of Securities Act Compliance and Disclosure Interpretations (“C&DIs”) that approved hyperlinking to legends or required statements in satisfaction of the requirements of Rules 134, 165 and 433 in certain situations.  Under three new interpretations, Corp Fin clarified that an electronic communication containing a hyperlink to a legend (or a required statement in the Rule 134 context) would be acceptable so long as: 

(1)  the electronic communication is spread using a platform that limits the number of characters allowed in the communication (such as Twitter);

(2)  including the entire legend (or required statement in the Rule 134 context) would result in a communication that exceeds the platform’s character limit (such as Twitter’s 140 character limit); and

(3)  the electronic communication contains a working hyperlink to the legend (or required statement in the Rule 134 context) along with language explaining that important or required information resides at the other end of the hyperlink.

(Question 110.01; Question 164.02; Question 232.15)  The new guidance also makes clear that an issuer hyperlinking in satisfaction of the requirements under Rules 134 and 433 would not be liable for any re-transmission by a third party of the original electronic communication containing the hyperlink, so long as the third party is not participating in the offering or acting on the issuer’s behalf.  (Question 110.02; Question 232.16)  The new guidance, however, does not address uses of social media in other contexts such as earning...Read More

PCAOB Public Meeting on Proposed Changes to the Auditor’s Reporting Model

Last week, the Public Company Accounting Oversight Board (the “PCAOB”) convened a series of ten panels as part of a two-day public meeting regarding proposed changes to the auditor’s reporting model.  The proposed changes have elicited a range of opinions from various stakeholders and commentators, a majority of which have been critical of the proposals.  Individuals invited to appear as panelists at last week’s meeting, however, were generally supportive of the proposed changes and offered various recommendations for ways in which the PCAOB could modify its proposals in order to move forward. 

The proposed changes to the auditor’s reporting model are included in two proposals:

 

  • The Auditor’s Report on an Audit of Financial Statements would expand the auditor’s report to include additional disclosures relating both to the auditor and the audit itself, including the disclosure of critical audit matters (“CAM”), defined as those audit-specific matters that involved the most difficult, subjective, and complex auditor judgments; posed the most difficulty to the auditor in obtaining audit evidence; or posed the most difficulty to the auditor in forming an opinion regarding the financial statements.

 

  • The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report would require the auditor to read and evaluate “other information” included in the annual report, including the MD&A, exhibits and other information incorporated by reference, in order to determine whether the other information contains a material misstatement of fact or a material inconsistency with the audited financial statements included in the annual report, with the auditor’s conclusion reflected in the audit report.

More information on the proposed changes is available at http://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=210.

International Convergence

Interestingly, the meeting showed a heavy focus on international reporting with three panels dedicated to this perspective.  Board members often referenced seemingly positive results in the UK and the EU when addressing panelists, particularly panelists who warned about potential negative consequences of the proposals, such as the increased use of boilerplate or greater investor confusion.  Some Board members also expressed concern about potential risks to the United States capital markets if disclosure standards for audi...Read More

SEC Issues Second Set of FAQs on Conflict Minerals Rules

On April 7, 2014 the SEC’s Division of Corporation Finance issued a second set of Frequently Asked Questions (“FAQs”) on its conflict minerals rules (Exchange Act Section 13(p), Rule 13p-1 and Item 1.01 of Form SD).  The full set of FAQs, including the nine new FAQs and the 12 FAQs issued in May 2013, is available at http://www.sec.gov/divisions/corpfin/guidance/conflictminerals-faq.htm.  For more information about the conflict minerals rules, please see our client alert available at http://www.gibsondunn.com/publications/pages/ConflictMinerals-UnderstandingFinalSECRules.aspx, and for a discussion of the first set of FAQs, please see our client alert available at http://www.gibsondunn.com/publications/pages/SEC-Issues-FAQs-On-Conflict-Minerals.aspx.   

The nine new FAQs focus primarily on the requirement under the conflict minerals rules to obtain an independent private sector audit (“IPSA”) of the conflict minerals report.  While many interpretive questions under the rules are still outstanding, the FAQs provide helpful guidance to companies as they seek to comply with the rules and prepare their first annual disclosures covering the 2013 calendar year, which are due on Monday, June 2, 2014.  Set forth below are several highlights from the new FAQs:

  • IPSA Trigger During Temporary Phase-In Period.  FAQ #14 clarifies that if any of a company’s products are “DRC conflict undeterminable,” an IPSA of the company’s conflict minerals is not required during a two-year transition period (or a four-year transition period for smaller reporting companies).  If, for example, a company’s conflict minerals report covers products that qualify as “DRC conflict undeterminable” under the rules as well as products believed to be “DRC conflict free,” no IPSA of the report is required.  However, FAQ #15 states that, in this case, the company’s conflict minerals report may not describe as “DRC conflict free” any otherwise qualifying products because a company may use this designation only after conducting due diligence, which the rules define as including an IPSA.
  • Scope of IPSA Requirement.  FAQ #17 confirms that the scope of the IPSA is limited to the IPSA objective set forth in the conflict minerals rules and does not include any other matters, su...Read More
The Council of Institutional Investors Presses SEC Staff for Guidance on Interim Vote Tallies

Last May, Broadridge Financial Solutions, Inc., the provider of proxy services for over 90% of public companies and mutual funds in North America (“Broadridge”), decided to end its established practice of providing interim vote tallies (sometimes referred to as “preliminary voting results”) to proponents of shareholder proposals.  Following this change in practice, the Council of Institutional Investors (“CII”) sent a letter to the SEC asking the Commission to reverse Broadridge’s change in practice.  Later in July, Broadridge reviewed its decision, promising to “continue to monitor developments on th[e] issue” and noting that it is contractually obligated to follow client directions regarding release of interim vote tallies. 

In response, shareholder proponents like John Chevedden submitted a number of proposals seeking to restrict issuer access to interim vote tallies.  Thus far, the SEC has permitted exclusion of these proposals for a number of issuers, including Amazon, Home DepotIntel and Southern Company

In early February of this year Broadridge addressed a similar interim tally issue when it announced that each party engaged in a non-exempt contested solicitation would only receive tallies with respect to votes cast on its own proxy card...Read More

Corp Fin Issues Revised Statement on WKSI Waivers

On March 12, 2014, the SEC’s Division of Corporation Finance (Corp Fin) issued a Revised Statement on Well-Known Seasoned Issuer Waivers (the Revised Statement). 

Well-Known Seasoned Issuers, or WKSIs, benefit from a number of communications and registration rules that are significantly more flexible than the rules that apply to non-WKSIs, including most notably the ability to file a shelf registration statement that becomes effective automatically upon filing.  An issuer that has violated (or is subject to certain orders or decrees relating to) the anti-fraud provisions of the federal securities laws or that is subject to certain criminal convictions, however, will be deemed an “ineligible issuer” and will lose its WKSI status (though not necessarily its ability to file a non-“automatic” shelf registration statement).  Corp Fin’s Director has the authority to waive an issuer’s ineligible status “upon a showing of good cause, that it is not necessary under the circumstances that the issuer be considered an ineligible issuer.”  Such waivers are commonly referred to as “WKSI waivers.” 

Corp Fin previously issued a Statement on Well-Known Seasoned Issuer Waivers on July 8, 2011 (the Original Statement).  The Original Statement provided guidance on what may constitute a “showing of good cause” when analyzing an ineligible issuer’s WKSI waiver request, and outlined the general analytical framework that Corp Fin can be expected to follow when considering whether to grant a WKSI waiver request.  The Revised Statement updates and further refines the Original Statement.

The Revised Statement takes a somewhat more nuanced approach to the WKSI waiver analysis than did the Original Statement.  Whereas the Original Statement set forth two “threshold factors” that would often be dispositive of a WKSI waiver request – including whether the anti-fraud violation related to the issuer’s own disclosures about itself (for example, in its periodic reports) and whether the violation was scienter-based – under the Revised Statement, these considerations are viewed as important factors in Corp Fin’s analysis but they are not necessarily dispositive.  The Revised Statement also clarifies various other factors the Division will consider in determining whether to grant a WKSI waiver.

In addition, the Revised Statement affirmatively establishes that the burden falls on the issuer to demonstrate that a WKSI waiver request should be granted.  It also expands the scope of Corp Fin’s analytical framework to include WKSI waiver requests wh...Read More

ISS To Revise QuickScore
On January 8, 2014, Institutional Shareholder Services, Inc. (“ISS”) announced that it will launch a new version of QuickScore (“QuickScore 2.0”) on February 18, 2014.  QuickScore benchmarks a company’s governance risk against other companies in the Russell 3000 Index based on a number of weighted governance factors.  QuickScore 2.0 will use a different method to score companies’ governance risk and will automatically reflect changes in companies’ governance structures based on publicly disclosed information.    
  • First, QuickScore 2.0 will add seven new governance factors (unspecified) and modify the weightings assigned to the governance factors in its scoring methodology.  According to ISS, the new factors and weightings are intended to draw more distinctions between companies and align scores with ISS voting policies and company performance.  Companies will continue to be scored on an overall basis and across four categories: Board, Compensation, Shareholder Rights, and Audit.  Companies also will continue to be scored relative to other companies in the Russell 3000 Index. 
     
  • Second, QuickScore 2.0 will automatically update companies’ governance data and QuickScores based on publicly available information that discloses changes in companies’ governance structures.   
ISS will release more detailed information on QuickScore 2.0 on January 27, 2014.

Companies are encouraged to verify their governance data through the ISS Governance Analytics website before the launch of QuickScore 2.0. 

  • Until January 27, 2014, companies can view their governance data currently used in QuickScore. 

  • From 9:00 a.m. EST on January 27, 2014 until 8:00 p.m. EST on February 7, 2014, companies will be able to preview their updated QuickScore 2.0 governance data and submit requests for changes to ISS.  ISS indicates that it will review and respond to each of these requests. 

  • After the launch of QuickScore 2.0 on February 18, 2014, companies will be able to verify their governance data on an ongoing basis.
U.S. Court of Appeals Hears Argument on SEC’s Conflict Minerals Rules

Yesterday the U.S. Court of Appeals for the D.C. Circuit heard oral argument in a suit challenging the SEC’s conflict minerals rules, which were mandated under the Dodd-Frank Act and issued by the SEC on August 22, 2012.  The case came to the D.C. Circuit on appeal from a July 2013 district court decision upholding the SEC’s rules.  The rules had been challenged by the National Association of Manufacturers, the U.S. Chamber of Commerce and the Business Roundtable (the “Appellants”).

D.C. Circuit Judges David Sentelle, A. Raymond Randolph and Sri Srinivasan heard oral argument.  The Appellants argued that the SEC erroneously and arbitrarily refused to create a de minimis exception, misinterpreted the statute’s “did originate” requirement, extended the rules to non-manufacturers contrary to the statute, and designed an arbitrary and capricious phase-in period.  They also argued that the rules compel speech in violation of the First Amendment.  During oral argument, the topics that received the most attention from the parties and the Court were (1) the requirement to make disclosures if a company has reason to believe that its conflict minerals “may have originated” in the DRC region, rather than if its conflict minerals “did originate” in the DRC region, as the Dodd-Frank Act provides, and (2) whether certain aspects of the conflict minerals disclosure requirements—specifically, the requirement to designate a company’s products as “not found to be DRC Conflict Free” in reports filed with the SEC and posted on the company’s website—are compelled speech in violation of the First Amendment.  

The first reports under the conflict minerals rules are required to be filed on or before June 2, 2014, and the Court’s decision is expected before then.


For additional information about the conflict minerals rules, please see our client alert discussing the rules, available at http://www.gibsondunn.com/publications/pages/ConflictMinerals-UnderstandingFinalSECRules.aspx, and our client alert on the SEC’s Frequently Asked Questions about the conflict minerals rules, available at http://www.gibsondunn.com/publications/pages/SEC-Issues-FAQs-On-Conflict-Minerals.aspx.   

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