Exchange Act Filings

Recent Commission Comments on Business Activities in Certain Countries Designated As State Sponsors of Terrorism

by Vanessa Schoenthaler on December 12, 2011

SEC Comment LettersThe Financial Times ran a piece yesterday noting the the Securities and Exchange Commission’s Division of Corporation Finance has been increasingly focusing on disclosure regarding business activities in and with Cuba, Iran, North Korea, Sudan, Syria and other countries designated by the U.S. as state sponsors of terrorism.

Below are some of the recurring comments that the Commission has been issuing*:

  • Please describe your current, past and anticipated operations in and contacts with [Cuba, Iran, North Korea, Sudan and Syria], if any, including through subsidiaries, affiliates and other direct and indirect arrangements. Include a discussion of direct and indirect contacts with the governments of these countries and entities controlled by them.
  • Discuss the materiality to you of the operations and contacts described in your response to the foregoing comment, in light of the related countries’ status as state sponsors of terrorism. Please also discuss whether the operations or contacts constitute a material investment risk to your security holders.
  • Your materiality analysis should address materiality in quantitative terms, including the approximate dollar amount of revenues, assets and liabilities associated with [Cuba, Iran, North Korea, Sudan and Syria], individually and in the aggregate. Please also address materiality in terms of qualitative factors that a reasonable investor would deem important in making an investment decision, including the potential impact of corporate activities upon your reputation and share value.
  • Your qualitative materiality analysis also should address whether, and the extent to which, the governments of [Cuba, Iran, North Korea, Sudan and Syria], or entities controlled by them, receive cash or act as intermediaries in connection with your operations or other direct or indirect contacts with those countries.
  • Please also address the impact of your regulatory compliance programs which cover operations and contacts associated with these countries, and any internal risk assessment undertaken in connection with business in these countries.
  • Please address the applicability to your Iran-related activities, including any direct or indirect payments to the Iranian government, of Section 5(b) of the Iran Sanction Act of 1996, as modified by the Iran Freedom Support Act on September 30, 2006.

The FT also notes that the Commission is considering requiring companies to disclose any dealings with countries designated as state sponsors of terrorism, not just those that are material.
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* Remember, comment letters are released no earlier than 20 business days after the Commission has completed its review.

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The SEC Issues Disclosure Guidance on Cybersecurity

by Vanessa Schoenthaler on October 14, 2011

Yesterday the Division of Corporation Finance issued informal disclosure guidance detailing the staff’s views on disclosure obligations related to cybersecurity risks and cyber incidents.

This, the Division’s second issuance of such informal disclosure guidance, is most likely in response to a letter that Senator Rockefeller penned to Chairman Schapiro back in May. The Senator specifically requested that the Commission issue interpretive guidance on cybersecurity disclosures, and, in her response letter, Chairman Shapiro promised to seriously consider it.

Perhaps coincidentally, the guidance also coincides with President Obama’s proclamation of October 2011 as National Cybersecurity Awareness Month.

Cyber Incidents and Their Effects

Beginning with a general discussion of cyber incidents, the guidance notes that there has been an increase in focus on incidents that include:

  • gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data and causing operational disruptions (e.g., the recent cyber attacks on EMC Corp.’s RSA unit, which cost the company $66 million in Q2); and
  • denial of service-type attacks (e.g., the Visa and MasterCard denial of services attacks that took place last year).

Among other things, cyber incidents like these have caused companies to incur:

  • remediation costs, including, for example, costs associated with liability for misappropriated assets or information, and costs related to incentives offered to maintain customer or partner relationships;
  • increased cybersecurity costs;
  • revenue losses;
  • litigation costs; and
  • reputational damage.

The Disclosure Guidance

The guidance notes that when assessing whether and to what extent cybersecurity risk and cyber incident disclosures are required, a company should consider both the materiality of the information and the applicability of the antifraud provisions of the federal securities laws.

It then goes on to review existing disclosure requirements that may trigger cybersecurity risk and cyber incident disclosures. It covers risk factors, financial statements and management’s discussion and analysis of financial conditions and results of operations the most extensively, but also touches on disclosure controls and procedures, a company’s description of business and legal proceeding disclosures.

Risk Factors

Beginning with risk factors the guidance reiterates the requirements of Item 503 of Regulation S-K and notes that disclosure of cybersecurity risk is required if cyber incidents are “among the most significant factors that make an investment in the company speculative or risky.” In making such a determination a company should take into consideration all relevant information, including:

  • the occurrence of prior cyber incidents;
  • their severity and frequency;
  • the probability of future cyber incidents;
  • the qualitative and quantitative magnitude of the risk, including, for example, the potential costs and other consequences of misappropriated assets or information, data corruption or operational disruptions; and
  • the adequacy of preventative measures taken to reduce cybersecurity risks in the context of the industry in which the company operates, and any risks to those preventative measures, including threatened attacks.

As with other risk factors, any cybersecurity risk factors should be specifically tailored to the company, detailing the nature of the risk and how it might impact the company. In other words avoid generic or boiler plate disclosure. Among other things such risk factors might include:

  • a discussion of attributes of the company’s business or operations that give rise to material cybersecurity risks;
  • the potential costs and consequences of cybersecurity risks;
  • if a company has outsourced operations and they have material cybersecurity risks, a discussion of those risks and how the company is addressing them;
  • a discussion of any cyber incidents experienced by the company that are individually or in the aggregate material, and a description of the potential costs and other consequences of those incidents;
  • a discussion of risks related to cyber incidents that may remain undetected for an extended period of time; and
  • a description of any relevant insurance coverage.

A company may have to explicitly disclose known or threatened cyber incidents and their potential costs and other consequences to place a discussion of its cybersecurity risks into context. However, the guidance notes that the Division is mindful of concerns that detailed disclosures may compromise security efforts by, among other things, providing would-be attackers with a “road map” through the company’s security system, and emphasizes that disclosure at that level of specificity is not required under the federal securities laws.

Financial Statements

With respect to a company’s financial statements the guidance notes that, based on the nature and severity of an actual or potential cyber incident, disclosure may be required in a number of different areas, for example:

  • prior to a cyber incident costs associated with preventative measures may have to be disclosed, such as cost related to internal use software (ASC 350-40, Internal-Use Software);
  • remediation costs associated with the occurrence of cyber incident may also have to be disclosed, such as incentives offered to maintain customer or partner relationships (ASC 605-50, Customer Payments and Incentives);
  • a cyber incident may also require disclosure of loss contingencies for asserted and unasserted claims, such as claims related to warranties, breach of contract, product recalls and replacements, and indemnification of counterparty losses (ASC 450-20, Loss Contingencies);
  • a cyber incident may result in a company having diminished future cash flows, requiring consideration of impairments to assets, such as goodwill, customer-related intangible assets, trademarks, patents, capitalized software or other long-lived assets associated with software or hardware, and inventory;
  • the impact of a cyber incident may not be immediately known, requiring a company to develop estimates to account for future financial implications, such as estimates of warranty liability, allowances for product returns, capitalized software costs, inventory, litigation and deferred revenue (ASC 275-10, Risks and Uncertainties); and
  • where a cyber incident is discovered after the balance sheet date, a company should consider whether disclosure of  a subsequent event is necessary (ASC 855-10, Subsequent Events).

Management’s Discussion & Analysis (MD&A)

MD&A disclosure may be warranted if the costs or other consequences of a known or potential cyber incident represent a material event, trend or uncertainty that is reasonably likely to have  a material effect on a company’s results of operations, liquidity or financial condition, or would cause the company’s financial information not to be necessarily indicative of future operating results or financial conditions.

Disclosure Controls and Procedures

If a cyber incident poses a risk to a company’s ability to record, process, summarize and report the information required to be disclosed in its filings, the company should consider whether there are deficiencies in its disclosure controls and procedures rendering them ineffective.

Description of Business

Disclosure in a company’s “Description of Business” section may be warranted if a cyber incident materially affect the company’s products, services, customer or supplier relationships, or competitive conditions.

Legal Proceedings

“Legal Proceedings” disclosure may be warranted if a company is party to a material pending legal proceeding that involves a cyber incident.

Current Reports and Road Maps

Finally, the securities laws are designed to “elicit disclosure of timely, comprehensive and accurate information about risks and events that a reasonable investor would consider important to an investment decision.” Accordingly, the guidance notes that a company with an effective shelf registration statement on file should consider whether it needs to disclose a material cyber incident on a Form 8-K (or Form 6-K) in order to maintain the accuracy and completeness of its disclosure information.

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Recent Commission Comments on the Tax Implications of Overseas Earnings and Offshore Cash Holdings

by Vanessa Schoenthaler on September 21, 2011

SEC Comment LettersThe Financial Times ran a piece on Monday noting the the Securities and Exchange Commission’s Division of Corporation Finance has been increasingly focusing on disclosure regarding the tax implications of overseas earnings and offshore cash holdings in accounting and regulatory reviews of company filings.

Below are some of the recurring comments that the Commission has been issuing*:

  1. Please disclose the amount of cash, cash equivalents and investments held outside the U.S. Please also describe any potential income tax consequences or other limitations that may impact your ability to repatriate cash, cash equivalents and investments held outside of the U.S.
  2. Please tell us what consideration you gave to providing a discussion of the need to repatriate undistributed earnings of foreign subsidiaries and the associated potential tax impact.
  3. Please tell us how you considered providing disclosures that explain how having earnings in countries where you have different statutory tax rates impacts your effective income tax rates and obligations. In this regard, you should consider explaining the relationship between the foreign and domestic effective tax rates in greater detail as it appears as though separately discussing the foreign effective income tax rates may be important information necessary to understanding your results of operations. To the extent that certain countries have had a more significant impact on your effective tax rate, then tell us how you considered disclosing this information and including a discussion regarding how potential changes in such countries’ operations may impact your results of operations.

Most of the above also refer back to Item 303(a)(1) of Regulation S-K, addressing liquidity in MD&A disclosure, and Sections III.B and IV of Interpretive Release 33-8350, addressing the Commission’s guidance on MD&A content and focus, and on liquidity and capital resources disclosure. Both of which you may want to revisit as we approach the quarter’s end.

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*Remember, comment letters are released no earlier than 20 business days after the Commission has completed its review.

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Corp Fin Updates Its Compliance and Disclosure Interpretations; Issues a Statement on WKSI Waivers

by Vanessa Schoenthaler on July 9, 2011

The Division of Corporation Finance added eight new Compliance and Disclosure Interpretations (C&DIs) to the Commission’s website yesterday, addressing four main areas of disclosure:

Notification of Late Filings (Question 107.02)

The first notes that if a company is filing a Notification of Late Filing on Form 12b-25, but doesn’t believe that it will be able to file the required report by the extended deadline, then it shouldn’t check the box in Part II of Form 12b-25 indicating that it will.

This seems obvious enough, but what happens if a company doesn’t check the box and somehow manages to file the required report by the extended deadline? Not to worry, if the deadline is met then the Commission will consider the report to have been timely filed, regardless of the checking of the box.

Notification of Late Filing

Compensation Related Disclosures (Questions 108.01, 117.07, 118.08 and 119.28)

The next three C&DIs address compensation related disclosures:

The first reiterates that Regulation G and Item 10(e) of Regulation S-K apply to any non-GAAP financial disclosures, other than target level disclosures, that are included in a company’s proxy statement. With regard to pay-related non-GAAP disclosures, the Commission notes that it will not object if a company includes the requisite GAAP reconciliations in a prominently cross-referenced annex or by incorporation by reference to the relevant pages of the company’s annual report containing the requisite GAAP reconciliations.

The second specifies that a company may omit disclosure regarding disability plans (as with group life, health, hospitalization, or medical reimbursement plans) that do not discriminate in scope, terms or operation, in favor of its executive officers or directors, and that are available generally to all of its salaried employees.

The third is a little counterintuitive (at least it was at first for me). It notes that the grant date fair value for stock and option awards that are subject to performance conditions must be reported based on the probable outcome of the performance conditions as of the grant date, even if the actual outcome is known as of the disclosure date. (For clarity’s sake you may want to take a look the fact pattern posed by question 119.28)

Disclosure Regarding Departing Directors (Question 116.10)

The next CD&I represents a change in position from question 116.08, which was withdrawn as of yesterday.

Basically it states that if a company incorporates by reference into its annual report disclosure from its proxy statement regarding the identification and business experience of its directors, and the definitive proxy statement is filed within 120 days of the company’s fiscal year-end, then the company may omit from both the proxy statement and annual report disclosure regarding any director whose term will not continue after its annual shareholder meeting.

If, however, a company directly discloses information regarding the identification and business experience of its directors in its annual report (rather than incorporating by reference), it cannot omit disclosure regarding any director whose term will not continue after the company’s annual shareholder meeting.

Disclosures Related to Say on Frequency (Questions 121A.03 and 121A.04)

The final two CD&Is address disclosures related to shareholder advisory votes on the frequency of advisory votes on executive compensation (say on frequency votes):

The first notes that, with respect to the say on frequency vote, a company is not required to disclose the number of broker non-votes; only the number of votes cast for each of the one, two and three-year frequency options and the number of abstentions.

The second notes that a company may disclose the initial voting results from its shareholder meeting in an annual or quarterly report, rather than in a Form 8-K, provided the report is filed within the requisite disclosure period. Thereafter, a company may choose to disclose its board’s decision as to how frequently it will hold the shareholder advisory vote on executive compensation in a new Form 8-K, rather than by amending the annual or quarterly report in which the initial voting results were disclosed. If, however, the initial voting results are disclosed in a Form 8-K the board’s subsequent decision as to how frequently the shareholder advisory vote on executive compensation will be held must be disclosed in an amendment to the original Form 8-K, as opposed to a new Form 8-K.

Statement on Well-Known Seasoned Issuer (WKSI) Waivers

In addition to the new C&DIs, the Division of Corporation Finance also released a statement outlining the framework that it will use when determining whether to grant an “ineligible issuer” waiver to a company that has lost its status as well-known seasoned issuer for having violated the anti-fraud provisions of the federal securities laws. The statement is very brief and if you’re a WKSI worth the quick read.

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Should Companies be Required to Disclose Cyber Attacks?

by Vanessa Schoenthaler on June 8, 2011

With more and more of our data moving to the cloud network security is becoming an increasingly mainstream issue. But, for all of the media attention that material network breaches have garnered as of late, there hasn’t been much in the way of disclosure. That may be about to change.

A Little Legislative Background

According to the National Conference of State Legislatures 46 states as well as the District of Columbia, Puerto Rico and the Virgin Islands have legislation in place requiring that companies notify affected individuals of security breaches involving their personal data.

In May the White House introduced a legislative proposal which, if enacted, would largely displace these state law requirements with a federal cybersecurity act.

As proposed the federal legislation would require a company that participates in interstate commerce and “uses, accesses, transmits, stores, disposes of or collects sensitive personally identifiable information about more than 10,000 individuals during any 12-month period” to notify affected individuals following a security breach. The proposed legislation contains a safe harbor which would exempt a company from this notification requirement if, following a risk assessment, it concludes that there is no reasonable risk that the security breach has or will result in harm to the affected individuals and if it notifies the Federal Trade Commission of its risk assessment and safe harbor election.

A Request for Interpretive Guidance

Just prior to the White House’s release of its proposed cyber security legislation Senator Jay Rockefeller, Chairman of the Senate Committee on Commerce, Science and Transportation, who has previously introduced his own cybersecurity legislation, penned a letter to Chairman Schapiro requesting that the Securities and Exchange Commission issue interpretive guidance addressing when companies need to make information security disclosures regarding:

  • material information security risks and actions taken to reduce those risks; and
  • material network breaches.

(Download File)

Disclosure Regarding Material Information Security Risks

When does a company need to make disclosures regarding material information security risks?

While there are no disclosure obligations that specifically address information security risks, disclosure may still be appropriate under one or all of the following existing disclosure requirements:

  • Risk Factors – Item 503(c) of Regulation S-K requires disclosure of the most significant factors that make an investment in a company speculative or risky. Risk factor disclosure should clearly state the risk and specify how the particular risk affects the company. The following are a sample of risk factors related to information security that have been culled from recent annual report filings:

If we experience significant service interruptions, which could require significant resources to resolve, it could result in a loss of customers or impair our ability to attract new customers, which in turn could have a material adverse effect on our business, results of operations and financial condition.

In addition, with the growth of wireless data services, enterprise data interfaces and Internet-based or Internet Protocol-enabled applications, wireless networks and devices are exposed to a greater degree to third-party data or applications over which we have less direct control. As a result, the network infrastructure and information systems on which we rely, as well as our customers’ wireless devices, may be subject to a wider array of potential security risks, including viruses and other types of computer-based attacks, which could cause lapses in our service or adversely affect the ability of our customers to access our service. Such lapses could have a material adverse effect on our business and our results of operations.

We may experience outages and disruptions of our online services if we fail to maintain adequate operational services and supporting infrastructure.

As we increase our online products and services, we expect to continue to invest in technology services, hardware and software — including data centers, network services, storage and database technologies — to support existing services and to introduce new products and services including websites, e-commerce capabilities and online communities. Creating the appropriate support for online business initiatives is expensive and complex, and could result in inefficiencies or operational failures, and increased vulnerability to cyber attacks, which could diminish the quality of our products, services, and user experience. Such failures could result in damage to our reputation and loss of current and potential users, subscribers and advertisers which could harm our business. In addition, we could be adversely impacted by outages and disruptions in the online platforms of our key business partners, who offer our products and services.

If we are unable to protect our information systems against data corruption, cyber-based attacks or network security breaches, or if we are unable to provide adequate security in the electronic transmission of sensitive data, it could have a material adverse effect on our business, financial condition and results of operations.

We are highly dependent on information technology networks and systems, including the Internet, to securely process, transmit and store electronic information. In particular, we depend on our information technology infrastructure for business-to-business and business-to-consumer electronic commerce. Security breaches of this infrastructure, including physical or electronic break-ins, computer viruses, attacks by hackers and similar breaches, can create system disruptions, shutdowns or unauthorized disclosure of confidential information. If we are unable to prevent such security or privacy breaches, our operations could be disrupted, or we may suffer loss of reputation, financial loss and other regulatory penalties because of lost or misappropriated information, including sensitive consumer data.

  • Management’s Discussion and Analysis – Item 303 of Regulation S-K requires a broad range of disclosures necessary for an understanding of a company’s financial condition, changes in financial condition and results of operations.

Are there any known trends, events, demands, commitments or uncertainties related to network security that are reasonably likely to have a material effect on your liquidity, capital resources or financial condition? How might a network security breach impact your business? What are the costs associated with protecting personally identifiable information about your customers? What actions have you taken to mitigate the risks associated with a network breach? Do you have adequate network security in place? Do you carry insurance against cyber attacks? As the Commission has noted in its guidance on MD&A, disclosure of a trend, event, demand, commitment or uncertainty is required unless a company is able to conclude that it is not reasonably likely to come to fruition or that a material effect on the company’s liquidity, capital resources or results of operations is not reasonably likely to occur.

  • Legal Proceedings – Item 103 of Regulation S-K requires disclosure of any material legal proceeding, other than ordinary routine litigation incidental to a company’s business.

Disclosures Regarding Material Network Breaches

One of the more prominent media examples of a material network breach is that of Sony Corporation, which has fallen victim to at least three different breaches in recent months, the first in late April, the second shortly thereafter in early May, and the most recent just last week. At least twenty-five lawsuits have been filed against Sony since its second network breach, one of which alleges that the company was aware of the possibility of a security breach, but failed to adequately warn consumers.

Sony is a foreign private issuer, however, and not the best example for purposes of our disclosure discussion because its reporting obligations are primarily governed by Japanese law. Some notable examples of domestic companies that have made headlines for material network breaches include:

  • Lockheed Martin – which disclosed a May 21, 2011 network breach in a press release issued on May 28th and available on the company’s website. The release states, in relevant part, that “no customer, program or employee personal data” had been compromised in the attack.
  • Google – which disclosed a mid-December 2010 network breach in a post on its official blog and in a Form 8-K, on January 12, 2010 (there are estimates that over 200 companies were similarly targeted in the Google cyber attack). The most recent cyber attack concerning Google Gmail users did not involve a network breach but rather, as disclosed in a post on Google’s official blog on June 1, 2011, targeted users  in a campaign to collect passwords through scams such as phishing.
  • Nasdaq OMX Group – which confirmed its discovery of a network breach in October 2010 following a February 2011 Wall Street Journal report.

While both EMC and Google voluntarily disclosed their material network breaches on a Form 8-K filed in conjunction with their public response, most other companies don’t make such disclosures. But should they be required to? And what would trigger such an obligation? Perhaps, along the lines of the proposed federal cybersecurity legislation, a company should only be required to disclose a material network breach to the extent it is required to notify affected consumers?

Updated: June 9, 2011

Chairman Schapiro’s response letter to Senator Jay Rockefeller was made available yesterday:

(Download File)

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Executive Paywatch: A New Site Featuring A CEO Compensation Database and Comparison Tools

by Vanessa Schoenthaler on April 19, 2011

2011 Executive CompensationEarlier today the American Federation of Labor and Congress of Industrial Organizations, better known as the AFL-CIO, the U.S.’s largest federation of labor unions, launched a new website: Executive Paywatch.

The site focuses on the Dodd-Frank Act’s say-on-pay provisions with a particular emphasis on Section 953, which directs the Securities and Exchange Commission to adopt rules requiring disclosure of the:

  • median annual compensation of all of a company’s employees, except for its chief executive officer;
  • total annual compensation of the chief executive officer; and
  • ratio of the median annual compensation of all employees to the total annual compensation of the chief executive officer.

Based on the current Dodd-Frank implementation schedule, the Commission should be proposing rules to address Section 953 some time between August and December 2011 but, as Broc Romanek notes over at The Corporate Counsel, there’s no deadline for implementing Section 953 and the release of proposed rules has already been pushed back once.

Executive Paywatch features a database that includes compensation information for the chief executives of Russell 3,000 companies.

It also includes comparisons of CEO compensation to minimum wage workers, median workers and President Obama, and even allows you to fill out a form to compare your own compensation package (trust me, it’s a pitiful sight, even if you are very well paid).

Executive Paywatch also compares the compensation of chief executives from 299 of the S&P 500′s largest companies, as disclosed in the companies’ most recent proxy materials and compiled by salary.com, with the median salary of workers like nurses, teachers and fire fighters as disclosed in the Bureau of Labor Statistics’ Occupational Employment Statistics estimates.

Source: AFL-CIO analysis of pay data from 299 companies, provided by salary.com

Even though all of this information is publicly available, it’s still utterly jaw dropping when laid out like this.

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An Update on Shareholder Advisory Votes in Graphs

by Vanessa Schoenthaler on February 24, 2011

As of February 22, 2011 250 non-TARP participating companies have filed preliminary or definitive proxy materials containing shareholder advisory votes on executive compensation (Say on Pay) and shareholder advisory votes on the frequency of Say on Pay votes (Say on Frequency).  The following is a brief update on the initial filings and results:

Shareholder Advisory Vote on Executive CompensationShareholder Advisory Vote on the Frequency of Executive CompensationShareholder Advisory Vote on the Frequency of Executive Compensation

Also as of February 22, 2011, 87 companies have disclosed the results of their initial Say on Pay vote and 88 have disclosed the results of their initial Say on Frequency vote (one smaller reporting company voluntarily complied with the Say on Frequency vote, but not the Say on Pay vote, accounting for the difference in the number of reported results).  Of the companies that have disclosed results, 86% have considered their Say on Pay vote successful if approved by a majority of shareholders and 68% have considered the Say on Frequency choice that has received a plurality of votes to be the Say on Frequency choice of their shareholders.

Shareholder Advisory Vote on Executive CompensationShareholder Advisory Vote on Executive Compensation

Of the companies have disclosed the results of their initial Say on Frequency vote 68% have reported that their shareholders have voted to approve either the same Say on Frequency choice as recommended by their board of directors or, where their board of directors has not made a recommendation, an annual, biennial or triennial choice. The remaining 32% have reported that their shareholders have voted to approve an annual Say on Frequency choice as opposed to the biennial or triennial choice recommended by their board of directors.

Shareholder Advisory Vote on Executive Compensation

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The Anatomy of a Shareholder Vote Calculation

by Vanessa Schoenthaler on February 11, 2011

Shareholder Meeting - Tabulating and Calculating Votes

(Note: I’ve since updated this post here)

Counting up the votes from a shareholder meeting is not as easy as one might think.

First off, there are four different sources that dictate how the votes are tabulated: the federal securities laws, the corporate laws of the state in which a company is organized, the rules of the national securities exchanges and a company’s charter documents.

On top of that there are five different categories of votes to consider: votes for and against a proposal, which are self-explanatory, broker non-votes, abstentions and withheld votes (more on these latter three in a second).

Then there’s a quorum requirement to be met, and, finally, the approval threshold for each proposal has to be considered, which can range from a plurality of the votes cast to a super majority of the votes present and entitled to vote, and anything in between.

Broker Non-Votes

A broker non-vote occurs when a broker has not received voting instructions from the beneficial owner of shares held in street name and the broker does not have, or declines to exercise, discretionary authority to vote the shares. Brokers only have discretionary authority to vote uninstructed shares on routine matters, such as the ratification of a company’s auditing firm.

Under the laws of most states broker non-votes are considered present at a meeting, and, as such, are included in the calculation of whether a quorum exists, however, they are not considered entitled to vote, and so have no effect on the outcome of a proposal.

The Dodd-Frank Changes to Broker Non-Votes

Following enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, national securities exchanges were required to adopt rules prohibiting members from voting uninstructed shares on matters related to the election of directors, executive compensation and other significant matters as determined by the rules of the Securities and Exchange Commission.

In September 2010, the Commission approved amendments to New York Stock Exchange Rule 452, and corresponding Section 402.08 of the Listed Company Manual, and Nasdaq Stock Market Rule 2251, to implement the Dodd-Frank Act’s requirements. At present, the Commission anticipates proposing rules to define “other significant matters” sometime between April and July of 2011.

Among other things, the NYSE and Nasdaq Dodd-Frank-imposed rule changes have added uncontested director elections (formerly considered a routine matter), shareholder advisory votes on executive compensation and shareholder advisory votes on the frequency of advisory votes on executive compensation to the category of non-routine matters.

It is also worth noting that these rule changes relate to NYSE and Nasdaq member firms, not to the companies whose securities are listed on the NYSE or Nasdaq markets, so the changes effect all companies, even those with securities quoted in over the counter markets like the OTC Bulletin Board and the reporting tiers of the OTC Pink Markets.

Abstentions

An abstention occurs when a shareholder affirmatively chooses not to vote on a proposal.

Under the laws of most states abstentions are considered present and entitled to vote at a meeting, and, as such, are included in the calculation of whether a quorum exists. However, abstentions are not generally considered votes cast, meaning that where a proposal requires the approval of “a majority of the votes cast” abstentions will have no effect, but, where a proposal requires the approval of “a majority of the votes present” or “a majority of the votes present and entitled to vote” abstentions will have the same effect as votes cast against the proposal.

Withheld Votes

A withheld vote is a category of vote that has come about as a result of the Commission’s proxy rules.

Securities Exchange Act Rule 14a-4 requires that a proxy for the election of directors include an option for shareholders to withhold authority to vote for a director nominee.  The rule does not, however, require that a proxy include an option for shareholders to vote against a director nominee, unless the laws of the state in which the company is organized give effect to such a vote (most don’t).

Under the laws of most states directors are elected by a plurality vote, meaning that the director nominee receiving the highest number of votes, regardless of the number of votes withheld, is elected (i.e., a  director nominee can receive 1 for vote, while 999 votes are withheld, and still be elected).  As a consequence, over the last half dozen or so years, companies have started to amend their charter documents and implement governance policies to give effect to withheld votes.  For example, one approach has been to require a director to tender their resignation, which may or may not be accepted, if they receive a greater number of withheld votes than for votes.  Another approach has been to simply adopt a majority voting standard for the election of directors.

Tallying it All Up

Has the quorum requirement been satisfied?

Before any business can be transacted at a shareholder meeting there must be a quorum present.

By default most states define a quorum as the presence of a majority of the shares entitled to vote in person or by proxy.  A company can modify the default requirement in its charter documents, subject to certain limitations imposed by state law (e.g., in Delaware a quorum cannot be less than one-third of the shares entitled to vote) and by the rules of the exchange on which the company’s securities are listed (e.g., Nasdaq requires a quorum of at least 33.33% of a company’s outstanding common voting stock; NYSE generally requires a quorum of not less than a majority of a company’s outstanding shares).Quorum Requirement - Shareholder MeetingOnce it is established that a quorum exists, the approval thresholds applicable to each proposal have to be considered and the related votes tabulated and counted. Let’s look at this in the context of the shareholder advisory vote on executive compensation and the shareholder advisory vote on the frequency of advisory votes on executive compensation.  Remember these are non-routine matters for which brokers do not have discretionary voting authority, so shares represented by broker non-votes count as present for purposes of establishing a quorum but not as shares entitled to vote on the proposals.

What approval threshold is applicable to the shareholder advisory vote on executive compensation?

There is no approval threshold required for the shareholder advisory vote on executive compensation.  As of this writing, of the companies that have reported results for their advisory votes on executive compensation, most have considered the proposal approved if it received the affirmative vote of a majority of the shares present and entitled to vote, with abstentions having the same effect as a vote cast against the proposal, though in three instances companies have specified that both abstentions and broker non-votes have the same effect as votes cast against the proposal.

Shareholder Meeting Vote

Most of the remaining companies have considered the proposal approved if it received the affirmative vote of a majority of the votes cast, with abstentions having no effect.Shareholder Meeting VoteIn a few cases companies have not disclosed an approval threshold at all, though in each a majority of the shares present and entitled to vote did approve the proposal.

What approval threshold is applicable to the shareholder advisory vote on the frequency of advisory votes on executive compensation?

There is no approval threshold required for the shareholder advisory vote on the frequency of advisory votes on executive compensation. However, if a company wishes to exclude certain shareholder proposals that seek advisory votes on executive compensation or that relate to the frequency of advisory votes on executive compensation, then its shareholders must approve a single frequency choice by a majority of the votes cast, with abstentions having no effect, and the company must adopt a policy that is consistent with that shareholder choice.

As of this writing, of the companies that have reported results for their advisory votes on the frequency of votes on executive compensation, most have considered the frequency receiving a plurality of the votes cast as the frequency approved by shareholders.  Though, there have been a handful of companies that have considered the frequency receiving a majority of the votes cast as the frequency approved by shareholders. If companies in this latter group then adopt policies that are consistent with their shareholders’ vote, they may exclude future shareholder proposals related to advisory votes on executive compensation or the frequency of advisory votes on executive compensation.

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The Proposed Amendments to the Definition of Accredited Investor and Other Odds and Ends

by Vanessa Schoenthaler on February 1, 2011

Last week the Securities and Exchange Commission issued proposed amendments to conform the definition of accredited investor to the requirements of Section 413(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. As amended, the definition would read:

Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of purchase, exceeds $1,000,000, excluding the value of the primary residence of such natural person, calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property.

An interesting tidbit from the footnotes of the proposing release: in fiscal year 2010 the Commission received 17,593 initial Form D filings, of those 16,856, or 96%, claimed an exemption that relies on the definition of an accredited investor.

The Commission is soliciting comments on a number of aspects of the new definition, which are due on or before March 11, 2011. Of particular note, at the Commission’s January 25, 2011 open meeting, both Commissioners Casey and Paredes expressed interested in hearing comments on whether the amended definition should “grandfather” existing investors who were accredited at the time of their initial investment, but who may no longer be accredited under the new definition, to allow those investors to make follow-on investments.

An Extension of Comment Periods

On Friday the Commission announced that it was extending the comment period for its proposed rules on disclosures related to conflict minerals, mine safety and payments made in connection with resource extractions through March 2, 2011. The original comment period was set to expire on January 31, 2011. The extension is being issued in response to several requests for additional time to “allow for the collection of information and improve the quality of responses” by interested persons. Each of the extending releases, available here, here and here, references a representative sample of letters that have made a request for additional time.

The Cost of Implementing Dodd-Frank

Also on Friday Representatives Randy Neugebauer, Chairman of the Subcommittee on Oversight and Investigations, and Spencer Bachus, Chairman of the House Financial Services Committee, issued a joint letter to the Commission, and several other federal agencies, seeking information regarding the estimated costs associated with implementing and executing the Dodd-Frank Act. The Commission has until February 10, 2011 to respond.

(Download File)

The Commission continues to suffer from budgetary constraints and is currently operating on the basis of a continuing resolution that temporarily extends its fiscal year 2010 budget through March 4, 2011. As a result, the Commission has been forced to scale back or delay a number of Dodd-Frank initiatives, among other things.

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Shareholder Advisory Votes on Executive Compensation: What’s in the Final Rules

by Vanessa Schoenthaler on January 26, 2011

Say on Pay, Say on Frequency and Say on Golden ParachutesYesterday, in an open meeting, the Securities and Exchange Commission voted by a margin 3-2 to adopt final rules and amendments to implement Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which addresses shareholder advisory votes on executive compensation (“Say on Pay”), the frequency of shareholder advisory votes on executive compensation (“Say on Frequency”) and shareholder advisory votes on golden parachute compensation (“Say on Golden Parachute”). Chairman Schapiro and Commissioners Walter and Aguilar voted in favor of adopting the rules and amendments, and Commissioners Casey and Paredes voted against adopting them.

The Effective Date

The new rules and amendments take effect on April 4, 2011, however, the Dodd-Frank Act requires that any company holding a shareholder meeting on or after January 21, 2011 include in their proxy solicitation materials separate Say on Pay and Say on Frequency votes.

One notable departure from the rules and amendments as initially proposed is the temporary exemption for smaller reporting companies from Say on Pay and Say on Frequency votes until their first annual or other shareholder meeting occurring on or after January 21, 2013.

The following is a summary of the most widely applicable provisions of the new rules and amendments:

Say on Pay Votes

New Exchange Act Rule 14a-21(a) requires that a company hold a separate Say on Pay vote in its first annual or other shareholder meeting occurring on or after January 21, 2011 (or, in the case of a smaller reporting company, on or after January 21, 2013) and, thereafter, at least once every three calendar years. A Say on Pay vote is only required with respect to an annual or other shareholder meeting at which proxies will be solicited for the election of directors.

The Say on Pay vote must relate to all executive compensation disclosed pursuant to Item 402 of Regulation S-K, however, compensation policies and practices related to risk management and risk-taking incentives, as required to be disclosed by Item 402, are only subject to the Say on Pay vote to the extent they are a material part of a company’s compensation policies or decisions for named executive officers, as opposed to compensation policies or decisions for all employees generally.

In the instructions to new Rule 14a-21(a) the Commission gives the following example of a Say on Pay resolution that would satisfy the requirements of Exchange Act Section 14A(a)(1) and Rule 14a-21(a):

RESOLVED, that the compensation paid to the company’s named executive officers, as disclosed pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis, compensation tables and narrative discussion is hereby APPROVED.

This is a non-exclusive example (and in the case of a smaller reporting company would have to be revised to reflect applicable scaled disclosure requirements, rather than a Compensation Disclosure and Analysis (“CD&A”)). Rule 14a-21(a) does not require a company to use any specific language or form of shareholder resolution.

Also of note, any disclosure of director compensation as required by Item 402 of Regulation S-K is not subject to the Say on Pay vote.

Supplemental Disclosure

In the adopting release, the Commission notes that Rule 14a-21 does not change the scaled disclosure requirements applicable to smaller reporting companies, but that such companies may wish to include additional disclosure in connection with a Say on Pay vote to facilitate shareholder understanding of their compensation arrangements.

The Commission notes that, while not required, the Rule also does not preclude a company from soliciting shareholder approval on specific Say on Pay votes, such as separate votes on cash and other components of compensation.

Say on Frequency Votes

New Exchange Act Rule 14a-21(b) requires that a company hold a separate Say on Frequency vote for the first annual or other shareholder meeting occurring on or after January 21, 2011 (or, in the case of a smaller reporting company, on or after January 21, 2013) and, thereafter, not less than once every six calendar years, to determine whether a Say on Pay vote should be held annually, biennially or triennially. A Say on Frequency vote is only required with respect to an annual or other shareholder meeting at which proxies will be solicited for the election of directors.

Amended Exchange Act Rule 14a-4 requires that proxy cards reflect Say on Frequency choices of 1, 2 or 3 years, or abstain.  A company can vote uninstructed proxies in accordance with management’s recommendation if it follows the existing Rule 14a-4 requirements to include a recommendation for Say on Frequency votes in its proxy materials, permits abstentions and includes language regarding how uninstructed shares will be voted in bold typeface on its proxy cards.

Say on Golden Parachute Votes

New Exchange Act Rule 14a-21(c) requires that a company hold a separate Say on Golden Parachute vote in connection with the solicitation of proxies for approval of an acquisition, merger, consolidation or proposed sale or other disposition of all or substantially all of the company’s assets. Rule 14a-21(c) also offers an exemption from the Say on Golden Parachute vote if a company’s golden parachute compensation has already been disclosed in connection with its annual executive compensation disclosures and has been subject to a prior Say on Pay vote, but only to the extent that the golden parachute compensation arrangements do not change after the Say on Pay vote (other than changes that reflect price movements in a company’s securities or that result in an overall reduction in the value of the total golden parachute compensation).

New Proxy Disclosure Requirements

For Say on Pay and Say on Frequency Votes

New Item 24 has been added to Schedule 14A to require that a company disclose in its proxy solicitation materials that it is providing separate Say on Pay and Say on Frequency votes and explain the general effect of the votes, such as whether they are binding, the current frequency of the Say on Pay vote as determined by the board following the most recent Say on Frequency vote and when the next scheduled Say on Pay vote will occur.

Amendments to Item 402(b) of Regulation S-K require that a company address in its CD&A whether and, if so, how, its compensation policies and decisions have taken into account the results of the most recent Say on Pay vote. A smaller reporting company, which is subject to scaled disclosure requirements under Item 402, rather a CD&A, does not have to make a similar disclosure.

Amendments to Exchange Act Rule 14a-6 add Say on Pay and Say on Frequency votes to the list of items that do not trigger the need to file preliminary proxy materials with the Commission.

For Say on Golden Parachute Votes

New Item 402(t) of Regulation S-K requires that a company  disclose golden parachute compensation arrangements, whether written or unwritten, in both tabular and narrative formats. The new golden parachute compensation table requires quantitative disclosure of individual elements of compensation as well as footnote disclosure regarding amounts of compensation attributable to “single-trigger” and “double-trigger” arrangements.

Golden Parachute Compensation TableSay on Golden Parachute Compensation

Exclusion of Say on Pay and Say on Frequency Shareholder Proposals

An amendment to Exchange Act Rule 14a-8 permits a company to exclude shareholder proposals that would provide for or seek future Say on Pay or Say on Frequency votes if, in the company’s most recent Say on Frequency vote one of the choices (an annual, biennial or triennial frequency) received a majority vote and the company has adopted a policy that is consistent with that choice. Abstentions would not count in the determination of whether a particular Say on Frequency choice has received a majority of votes cast. If, however, no Say on Frequency choice receives a majority of votes cast, then even if a company adopts a policy that is consistent with the choice having received a plurality of votes, it may not be able to exclude shareholder proposals that relate to Say on Pay and Say on Frequency votes.

Disclosing the Results

Amendments to Item 5.07 of Form 8-K require that a company report the results of its Say on Pay and Say on Frequency vote within four business days of the date on which its shareholder meeting ended.  New subsection (d) to Item 5.07 also requires that a company file an amended Form 8-K within 150 days of the date on which its shareholder meeting ended (but in no event later than 60 days before the deadline for submission of shareholder proposals for its next annual meeting) to disclose its decision regarding how frequently to conduct future Say on Pay votes.  A company that fails to file a timely report under Section 5.07 will lose its Form S-3 eligibility.

Smaller Reporting Companies

The new rules temporarily exempt smaller reporting companies from holding Say on Pay and Say on Frequency votes until their first annual or other shareholder meeting occurring on or after January 21, 2013. This temporary exemption does not, however, extend to Say on Golden Parachute votes.

Newly Public Companies

A newly public company is required to include separate resolutions for Say on Pay and Say on Frequency votes in the proxy statement for its first annual shareholder meeting after its initial public offering. 

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