Securities Exchange Act

The SEC Issues New Exchange Act C&DIs: Business Activities Related to Iran

by Vanessa Schoenthaler on December 6, 2012

The Iran Threat Reduction and Syria Human Rights Act of 2012 (the “Act”), which was enacted on August 10, 2012, amended the Securities Exchange Act of 1934 to add new Section 13(r), requiring reporting companies to disclose certain business activities related to Iran in periodic reports filed with the Securities and Exchange Commission after February 6, 2013.

Yesterday the Division of Corporation Finance issued seven new Compliance and Disclosure Interpretations related to Section 13(r). In summary:

  • If an issuer’s annual report is required to be filed after the Act’s February 6, 2013 effective date, the report must include disclosure of Iran-related business activities pursuant to Section 13(r) even if the issuer files the report early (on or before the February 6, 2013 effective date).
  • If an issuer’s annual report is required to be filed after the Act’s February 6, 2013 effective date, the report must include disclosure of Iran-related business activities pursuant to Section 13(r) that occurred during the entire fiscal year covered by the report, including the period prior to enactment of the Act. For example in the case of an issuer that files an annual report for the fiscal year ending December 31, 2012, that issuer is required to disclose any Iran-related business activities specified in Section 13(r) for the period from January 1, 2012 through December 31, 2012.
  • The term “affiliate” as used in the Act has the meaning set forth in Exchange Act Rule 12b-2.
  • Disclosure is only required in a periodic report if an issuer or any of its affiliates engaged in any Iran-related business activities specified in Section 13(r) for the period covered by the report; it is not necessary to include a statement to the effect that the issuer and its affiliates have not engaged in any Iran-related business activities specified in Section 13(r).
  • A transaction or dealing with any person or entity identified under 31 CFR § 560.304 must be disclosed unless it was specifically authorized by a U.S. federal department or agency. If a disclosable transaction was specifically authorized by a foreign governmental authority, an issuer may disclose that fact in addition to the other information specified in Section 13(r) to provide appropriate context.
  • Both general and specific licenses constitute specific authorization by the Office of Foreign Assets Control (OFAC) of the U.S. Department of the Treasury to engage in a transaction, provided all conditions of the applicable license are strictly observed.
  • Any disclosures included in a periodic report in response to Section 13(r) will automatically become publicly available upon filing through the EDGAR system.

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D.C. Circuit Court of Appeal’s Order Vacating Proxy Access Rule 14a-11

by Vanessa Schoenthaler on July 22, 2011

The U.S. Court of Appeals for the D.C. Circuit handed down its decision in the Business Roundtable and Chamber of Commerce’s challenge to proxy access today.

The Court vacated Exchange Act Rule 14a-11, finding that the Commission acted arbitrarily and capriciously when promulgating the rule, because: (1) “it neglected its statutory responsibility to determine the [Rule's] likely economic consequences … and to connect those consequences to efficiency, competition, and capital formation … [and (2) of its] decision to apply Rule 14a-11 to investment companies … .” The Court did not address the petitioner’s First Amendment challenge.

Judge Ginsburg penned a scathing opinion for the Court, and as Broc Romanek and Brian Breheny note, other than appealing the decision en banc, the Commission generally has three options going forward: revise and reapprove Rule 14a-11 now, allow Rule 14a-8 to go effective now and revise and reapprove the Rule 14a-11 later, or do nothing.

(Download File)

Update: 4:30 PM

Each of the parties has now made their obligatory public statement:

The Business Roundtable and U.S. Chamber of Commerce issuing a joint statement applauding the decision as a “big win for America’s job creators and investors …” and the SEC a brief statement expressing disappointment, noting that it is exploring its options and reminding us that Rule 14a-8  remains unaffected by the decision.

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Proposed Rules Requiring Proposed Listing Standards About Compensation Committees

by Vanessa Schoenthaler on March 31, 2011

Proposed Rules on Compensation Committees and Compensation ConsultantsSection 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act amends the Securities Exchange Act of 1934 by adding new Section 10C, requiring the Securities and Exchange Commission to adopt rules directing the national securities exchanges* to prohibit the listing of the equity securities of a company that does not comply with certain compensation committee and compensation advisor requirements. Yesterday the Commission released a set of proposed rules and amendments that are designed to implement Section 952.

As per usual, the Commission is soliciting public comments on the proposed rules and amendments, which are due on or before April 29, 2011.

Updated April 29, 2011:

On April 29, 2011, in response to a request from the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, the Commission has extended the comment period through May 19, 2011.

Who do the proposed rules and amendments apply to?

Proposed Rule 10C-1

Proposed Exchange Act Rule 10C-1 requires that the rules of the national securities exchanges prohibit the initial or continued listing of any equity security of a company that does not comply with certain compensation committee and compensation advisor requirements.

As proposed Rule 10C-1 only applies to companies with exchange-listed equity securities, excluding security future products and standardized options. The Commission estimates that there are approximately 76 companies that fall outside of the scope of Rule 10C-1 by virtue of having only exchange-listed debt securities, and is specifically seeking comment on whether these companies should be made to comply with the final rule.

Additionally, by definition, companies with securities quoted through inter-dealer quotation systems in an over the counter market, such as the OTC Bulletin Board or the OTC Markets Group (formerly the Pink Sheets), are excluded from Rule 10C-1, unless, of course, they also have a class of equity securities listed on a national securities exchange.

Proposed Amendments to Item 407 of Regulation S-K

The proposed amendments to Item 407 of Regulation S-K broaden the scope of existing disclosure requirements with respect to compensation advisor and conflict of interest disclosures.

As proposed the amendments apply to all Exchange Act reporting companies that are subject to the proxy rules, this includes companies with securities quoted in an over the counter market, such as the OTC Bulletin Board or the OTC Markets Group, and controlled companies, but excludes foreign private issuers, which are not subject to the proxy rules, and registered investment companies, but only because they are not subject to the disclosure requirements of Item 407 of Regulation S-K.

What does proposed Rule 10C-1 require regarding compensation committees?

Proposed Rule 10C-1 requires that if a company has a compensation committee, or a committee performing the function of a compensation committee (i.e., one that oversees executive compensation), each committee member must also be a member of the company’s board of directors and must be independent. The national securities exchanges are themselves tasked with defining independence in the context of compensation committee membership, but must take into consideration factors such as:

  • sources of compensation paid to a board member, including consulting, advisory and other fees paid by the company; and
  • whether a board member is affiliated with the company or a subsidiary of the company.

Notably, as proposed Rule 10C-1 does not direct the national securities exchanges to adopt listing standards that would require a company to have a compensation committee, or to apply the compensation committee independence standards to the independent members of a board of directors that oversee executive compensation when there is no committee. The Commission is also specifically seeking comment on whether the final rule should instead direct the national securities exchanges to adopt listing standards that simply require compensation committees.

What does proposed Rule 10C-1 require regarding compensation advisors?

Proposed Rule 10C-1 requires that a compensation committee have the discretion and reasonable funds available to retain compensation consultants, independent legal counsel and other advisors, and that the committee be responsible for appointing, compensating and overseeing the work of such advisors, but not be required to follow the their advice or recommendations.

When choosing advisors, proposed Rule 10C-1 does not require that they also be independent, only that the compensation committee, in its selection process, consider:

  • whether the advisor provides other services to the company;
  • the amount of fees the advisor receives from the company as a percentage of the advisor’s total revenues;
  • what policies and procedures the advisor has in place to prevent conflicts of interest;
  • whether the advisor has a business or personal relationship with any member of the compensation committee; and
  • whether the advisor owns any company stock.

In addition to the foregoing, the national securities exchanges may adopt other relevant factors for consideration in their respective listing standards.

Are there any exemptions?

Exchange Act Section 10C exempts five categories of companies from the the compensation committee independence requirements:

  • controlled companies;
  • limited partnerships;
  • companies in bankruptcy proceedings;
  • open-ended management companies; and
  • foreign private issuers that disclose in their annual report the reason they do not have an independent compensation committee.

Proposed Rule 10C-1 also authorizes the national securities exchanges to adopt listing standards that exempt:

  • certain relationships from the compensation committee independence requirements; and
  • entire categories of companies from all of the Section 10C requirements, taking into consideration the potential impact that the requirements may have on smaller reporting companies.

When will the new listing standards take effect?

Procedurally, following the public comment period, and once the final rules and amendments are adopted and published in the Federal Register, the national securities exchanges will have 90 days to propose conforming listing standards, which must then be approved by the Commission within one year of the date on which its final rules and amendments were published in the Federal Register.

To the extent that they do not already do so, the listing standards of the national securities exchanges will have to provide companies with a reasonable opportunity to cure any defects that would otherwise cause their securities to be delisted, or ineligible for listing, based on a failure to meet the new standards.

What new disclosures do the proposed amendments to Item 407 of Regulation S-K require?

As proposed, the amendments to Item 407 of Regulation S-K would require a company to make certain expanded disclosures in any proxy or information statement filed in connection with an annual or special meeting at which directors are elected, regarding whether:

  • management or the company’s compensation committee retained or obtained the advice of a compensation advisor during the most recently completed fiscal year; and
  • the work of the compensation advisor raised any conflicts of interest, and, if so, how the conflicts are being addressed.

When do the new disclosure requirements take effect?

The new disclosure requirements will not take effect until the effective date of the final rules and amendments adopted by the Commission.

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* The proposed rules would also apply to a registered national securities association that lists equity securities in an automated inter-dealer quotation system.  At present, the Financial Industry Regulatory Authority (FINRA) is the only registered national securities association, however, FINRA does not list equity securities and, as such, the new rules do not apply to it.

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Insider Information – A Working Definition

by Vanessa Schoenthaler on March 24, 2011

Insider Trading - Insider Information - Expert NetworksIn its ongoing coverage of Galleon Group founder Raj Rajaratnam’s trial for insider trading the Wall Street Journal’s Law Blog brings up a good question: what exactly is insider information?

Before attempting an answer, let’s have a quick look at what exactly insider trading is:

For the most part, the insider trading laws prohibit trading in a company’s securities on the basis of material, nonpublic information in breach of a duty of trust or confidence owed to the company, its shareholders or the source of the information.

There are two general theories of liability for insider trading:

  • the classical theory, under which a traditional insider–such as an officer, director or employee–or a constructive or temporary insider–such as a company’s outside counsel, accountants or bankers–trades in a company’s securities on the basis of material, nonpublic information in breach of a duty of trust or confidence owed to the company or its shareholders; and
  • the misappropriation theory, under which a non-insider trades in a company’s securities on the basis of material, nonpublic information acquired in breach of a duty of trust or confidence owed to the source of the information.

Under either theory a tippee, such as Raj Rajaratnam is alleged to be, may be held liable for trading in a company’s securities on the basis of material, nonpublic information acquired from a tipper, such as Rajiv Goel, formerly of Intel Capital, where the tippee knew or should have known that the information was disclosed in violation of the tipper’s fiduciary duties, and the tipper personally benefited from the disclosure.

Information that is both material and nonpublic, or “insider information”, is a necessary component under each theory of liability.  But, when is information material and when is it nonpublic?

As a general matter, information is material if there is a substantial likelihood that a reasonable investor would consider it important in determining whether to buy, sell or hold a company’s securities, or would view it as altering the total mix of information available. And, information is nonpublic if it has not been disseminated in a manner that makes it available to investors generally.

Note, however, that trading on the basis of information that is nonpublic but also non-material is not illegal insider trading. Rather, piecing bits of non-material information together to uncover material information about a company falls under a legitimate theory of analysis called the mosaic theory, which is often asserted as a defense to allegations of insider trading, as it is in the Galleon case.

Based on trial coverage available in the WSJ and New York Times’ DealBook it appears that, at least so far, Rajaratnam’s defense team is only arguing that the information on which Galleon’s trades were based was publicly available.  I haven’t seen any materiality arguments come up yet, though we’re only two weeks into a potentially 10 week trial. The concept of materiality is a difficult one, especially in retrospect and in the context of the mosaic theory. It’ll be interesting to see what kind of information the prosecution focuses on and what, if anything, it adds to the current understanding of material information.

Now this doesn’t quite answer the question of: what exactly is insider information? But it does give us an operable framework.  Perhaps by the time the jury deliberates we can add on some factual information and come up with a better answer.

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The Consequences of a Late Filing

by Vanessa Schoenthaler on March 4, 2011

Exchange Act Report Filing DeadlinesNobody likes a late filer, especially not if the filing is a quarterly report and the reason its late is because of an accounting issue.

A recent academic study, out of the University of Southern California and New York University, examines the Capital Market Consequences of Filing Late 10-Qs and 10-Ks and finds, as you might have guessed, that capital markets react negatively when a company files a late quarterly or annual report. In addition, and perhaps less intuitively, the study finds that capital markets react more negatively in response to the filing of late quarterly reports than to the filing of late annual reports, and even more so when accounting issues are cited as the reason for the delay. The authors postulate that this is because quarterly reports require less disclosure and are unaudited, and so markets perceive accounting issues associated with the filing of late quarterly reports as more significant than accounting issues associated with the filing of late annual reports.

The study uses change in share price to measure market reaction and observes late filers for a period of eight months following their notice of late filing. In the short term, companies experience an immediate negative reaction when they announce a late filing and a significantly more negative reaction if they miss the Securities Exchange Act Rule 12b-25 filing grace period. Interestingly, companies continue to experience share price declines for several months following a late filing, except when accounting issues are the reason for the delay, because, the authors suggest, investors are better able to interpret and immediately react to accounting-related information.

Beyond the capital market consequences of a late filing, there are a host of other issues to consider:

Filing Deadlines

By way of review, a public company is required to file its quarterly and annual reports with the Securities and Exchange Commission within a certain number of days following a fiscal period’s end:

Quarterly (Form 10-Q) and Annual (Form 10-K) Report Filing DeadlinesNote: these deadlines only apply to domestic companies, foreign private issuers are subject to a different set of filing requirements. For example, they currently have to file annual reports (on a Form 20-F) within 6 months following a fiscal year’s end. However, beginning with fiscal years ending on or after December 11, 2011, this deadline will be pushed up to within 4 months following a fiscal year’s end. Foreign private issuers also have an obligation to file current reports (on a Form 6-K) “promptly” after certain information is made public in accordance with the laws of their own jurisdictions.

Securities Law Consequences of a Late Filing

Exchange Act Rule 12b-25 provides that if a company cannot timely file all, or any portion, of a quarterly or annual report then within one business day after the report’s due date the company must file a Notification of Late Filing (on a Form 12b-25) stating the reason why.*

Rule 12b-25 also provides that if the report could not have been filed by its due date without unreasonable effort or expense, then it may still be deemed to have been timely filed if the company:

  • timely files its Notification of Late filing; and
  • files the late report within the applicable grace period (no later than 5 calendar days in the case of a quarterly report, and no later than 15 calendar days in the case of an annual report, regardless of the company’s filer status).

This is an important detail because if a company has not timely filed all of its Exchange Act filings (with the exception of certain filings required to be made on a Form 8-K) it will lose the ability to file a short form registration statement on Form S-3 (or Form F-3 in the case of a foreign private issuer) for at least a period of 12 months. This will in turn limit the company’s ability to conduct certain types of registered securities offerings.

In addition, until the late report is filed the company will also lose its ability to file a Form S-8 registration statement and its Rule 144 eligibility. Form S-8 is a short form registration statement used for offering securities under an employee benefit plan, and Rule 144 covers unregistered public resales of restricted and control securities. These are temporary consequences, however, because neither Form S-8 nor Rule 144 require that a company’s reports be timely filed, only that they are filed.

As for any currently effective registration statement, a company’s ability continue to rely on that registration statement prior to filing a late report will depend on whether the prospectus and anti-fraud provision of the Securities Act are satisfied, the late filing notwithstanding.

Securities Exchange Consequences of a Late Filing

Where a company’s securities are listed or quoted will also effect what happens when a filing is late.

In the case of a NYSE-listed company, the NYSE Listed Company Manual (Section 802.01E) sets forth a series of procedures that are triggered if a company files a late annual report.

In the case of an AMEX or Nasdaq-listed company, both the AMEX Company Guide (in Section 1101) and Nasdaq Stock Market Rules (in Rule 5250(c)(1)) require that a company file with the exchange copies of reports filed with the Commission on or before their filing deadline. Late filings will result in a company’s receipt of a notice of failure to meet the exchange’s continued listing requirements, which must be disclosed on a Form 8-K, and will require a company to submit a plan for regaining compliance with those requirements. In each case, if a company fails to regain compliance with the exchange’s continued listing requirements, its securities may be suspended from trading or delisted.

In the case of a company with securities quoted in an over the counter market, like the OTC Bulletin Board, there are no listing requirements. However broker-dealers participating in the OTC Bulletin Board markets are members, and governed by the rules, of the Financial Industry Regulatory Authority (FINRA).  FINRA Rule 6530(e) prohibits members from quoting the securities of a company that has failed to timely file a required report three times in any 2-year period, or that has had its securities removed from the OTC Bulletin Board quotation service twice in a 2-year period for failing to file a required report within 30 days of the filing deadline. Once a company’s securities are prohibited from being quoted on the OTC Bulletin Board the company must timely file all required reports for a period of one year before it can regain eligibility.

Other Consequences of a Late Filing

Late filings occur for all kinds of reasons and under certain circumstances may simply be unavoidable. In addition to these general capital market, securities law and securities exchange consequences, late filers also need to be aware of and consider company-specific consequences, such as whether a late filing will trigger an event of default or violate any other contractual covenants.

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* In gathering and investigating data for their Capital Market’s study, the authors communicated with Wayne Carnall, Chief Accountant of  the Commission’s Division of Corporation Finance, regarding discrepancies in the number of reported late filings that appeared in different data sources.  The authors noted that Mr. Carnall “suggested that it is very rare for late filers not to file [a Form 12b-25], and that he would be very interested in knowing of any … ” non-filers they were able to identify.

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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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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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ProxyMonitor: A New Shareholder Proposal Monitoring Tool

by Vanessa Schoenthaler on January 20, 2011

Shareholder Proposal Monitoring The Manhattan Institute for Policy Research’s Center for Legal Policy, a conservative, market-orientated think tank, launched a new proxy monitoring resource earlier this week: ProxyMonitor.org.  A searchable database of shareholder proposals submitted to the 100 largest U.S. companies over the past three years.  You can sort through the data by company, industry, proponent and proposal type.

Even though the data set is a bit limited at this point (the Center intends to expand it over time), the site is straightforward and aggregates some pretty useful proxy information, providing quick insight into shareholder proposal tends, plus it allows you to easily dig deeper.  For example, in three mouse clicks you can see that there were 32 shareholder proposals on executive compensation submitted to companies in the health care industry between 2008 and 2010:

Shareholder Proposals

The table columns are sortable, you can export the data into a spreadsheet, which I think is a wonderful and often overlooked option, and there’s a link to take you straight to the company filing or you can just print the proposal:

Shareholder Proposal

ProxyMonitor definitely makes for a useful resource for anyone interested in shareholder proposals, and will become more so over time as data is added, especially if the Securities and Exchange Commission prevails in its current battle for proxy access.

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The SOX 404(b) Compliance Study: A Comment Letter Audit

by Vanessa Schoenthaler on January 11, 2011

Internal Controls Over Financial ReportingWhen President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on July 21, 2010 it immediately amended the Sarbanes-Oxley Act of 2002 by permanently exempting non-accelerated filers from the Section 404(b) requirement that they obtain an auditors’ attestation on management’s assessment of the effectiveness of internal controls over financial reporting.

The Dodd-Frank Act also requires that the Securities and Exchange Commission study how the burden of Section 404(b) compliance might be reduced for companies with market capitalizations of between $75 million and $250 million while still maintaining investor protections, and whether a reduction in or exemption from Section 404(b) compliance would encourage companies to list their initial public offerings in the United States.  The Commission has until April 21, 2011 to submit the study to Congress.

This is the second cost-benefit analysis of Section 404(b) that the Commission will undertake.

The First SOX 404(b) Compliance Study (2009)

Section 404 of the Sarbanes-Oxley Act, as originally adopted, was made up of two subsections:

  • 404(a) requiring that a report on management’s assessment of the effectiveness of internal controls over financial reporting be included in a company’s annual report; and
  • 404(b) requiring a company’s auditors to attest to, and report on, management’s assessment of the effectiveness of its internal controls over financial reporting.

Shortly after Section 404 took effect it became apparent that it was far more costly for companies to comply with the new requirements than had originally been anticipated, particularly with Section 404(b).  To address this issue, in 2007, the Commission released interpretive guidance to assist management in its assessment of internal controls over financial reporting.  That same year the Commission also approved the Public Company Accounting Oversight Board’s (PCAOB’s) new Auditing Standard No. 5–addressing an auditor’s attestation of, and report on, management’s assessment under Section 404(b)–which replaced the more conservative Auditing Standard No. 2.

Thereafter the Commission undertook a survey of companies experienced with Section 404(b) compliance to determine whether, and to what extent, the 2007 reforms affected their compliance costs. The results, published in September 2009, found the reforms were effective in reducing the overall cost of compliance.  The survey also found costs varied by:

  • company size–with larger companies experiencing greater total costs, but smaller companies experiencing greater costs as a percentage of assets;
  • whether a company was complying with Section 404(a) alone, or with both Sections 404(a) and 404(b); and
  • the amount of time a company had been complying with Section 404(b).

Comments on the Current SOX 404(b) Compliance Study

In October 2010 the Commission issued a request for public comment on the Dodd-Frank-mandated Section 404(b) compliance study.  To date it has received 12 comment letters, 2 coming from organizations representing companies with market capitalizations of between $75 million and $250 million, 6 from accounting firms and organizations representing the accounting and investment industries, and the remaining 4 from individuals.

Comments from Organizations Representing Companies

Comment letters from the Independent Community Bankers of America and Biotechnology Industry Organization (BIO) both favor extending the Section 404(b) exemption for non-accelerated filers to companies with market capitalizations of between $75 million and $250 million, mainly on the basis of the costs of compliance outweighing the perceived benefits.  BIO also points out in its comment letter that in a capital-intensive, research and development-oriented  industry, such as biotechnology, it is not uncommon for a company to have a large market cap, in excess of $75 million, but little or no revenue, further compounding the cost of compliance issue.

Comments from Accounting Firms and Organizations Representing the Accounting and Investment Industries

The Center for Audit Quality’s (CAQ’s) comment letter (representative of most of the other accounting firm and organizational comment letters) argues against extending the Section 404(b) exemption for non-accelerated filers to companies with market capitalizations of between $75 million and $250 million, maintaining that:

  • an auditor’s attestation of, and report on, management’s assessment under Section 404(b) encourages accountability on the part of management, which in turn enhances financial statement quality;
  • the cost of implementing Section 404(b) has declined since the Commission’s 2007 reforms and with the development and availability of additional resources (such as publications by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission and CAQ itself); and
  • such companies are already complying with Section 404(b) and therefore have the most expensive implementation costs, the startup costs, behind them.

As a means of possibly reducing the compliance burden on such companies CAQ recommends that the PCAOB issue “best practices” for a Section 404(b) audit, the Commission and PCAOB conduct a series of forums to discuss best practices and common issues with the companies and their auditors and that the Commission participate in a COSO project to update its internal control framework guidance.

In its comment letter, the CFA Institute recommends that the Commission amend Forms 10-k and 10-Q to require Section 404(b) exempt companies: (i) check a box on the front page of each report disclosing their exempt status, and (ii) include substantive disclosure in each report regarding:

  • the reasons why they have taken advantage of the exemption;
  • a description of the internal controls they have in place to prevent faulty or fraudulent financial reports; and
  • why management believes such controls are sufficient (or not).

Comments from Interested Individuals

Finally we have a comment letter from Mr. Georg Merkl, a Swiss resident and frequent commenter on Commission rules related to internal controls over financial reporting.  Like the CFA Institute, Mr. Merkl also suggests that the Commission require Section 404(b) exempt companies to disclose their exempt status and include additional substantive disclosures regarding their internal controls over financial reporting in annual and quarterly reports.  Mr. Merkl also suggests that the Commission issue additional guidance regarding management’s obligations when an audit adjustment or restatement due to fraud or error occurs.

Some of Mr. Merkl’s more interesting suggestions to the Commission include:

  • requiring a company to disclose whether the departure of its chief financial officer, or any key accounting personnel, is due to a disagreement over matters of accounting principle or practice, or financial statement disclosure;
  • extending the Section 404(b) exemption for non-accelerated filers to companies that do not meet certain revenue requirements;
  • less frequent audits for smaller companies (I think this would make for an excellent compromise.  The largest cost component of Section 404(b) compliance is in the auditing fees. By requiring smaller companies to undergo Section 404(b) audits less frequently, say, for example, every three years as opposed to annually, the Commission could substantially reduce the cost of compliance for such companies while still meeting Section 404′s goal of ensuring investor protection); and
  • requiring an audit relying on fewer procedures, such as an audit attesting to, and reporting on, the existence of internal controls over financial reporting rather than their effectiveness (similar to Swiss requirements).

Overall the comments are pretty light compared to just about every other Dodd-Frank initiative underway.  Given the short time frame within which the study must be completed, the Commission’s current workload and continuing budgetary constraints, it’ll be interesting to see what the final study actually consists of.

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The SEC Proposes New Rules on Conflict Minerals … Do You Know What’s In Your Supply Chain?

by Vanessa Schoenthaler on December 16, 2010

Yesterday the Securities and Exchange Commission proposed a series of new rules to implement provisions of the Dodd-Frank Act addressing:

The proposed rules on conflict minerals would add a new Section 13(p) to the Securities Exchange Act of 1934, applicable to all reporting companies (including, as proposed, smaller reporting companies and foreign private issuers) for whom “conflict minerals are ‘necessary to the functionality or production of a product manufactured’ or contracted to be manufactured” by the company.

Conflict minerals include:

  • any derivatives of the above or any other minerals or derivatives designated by the Secretary of State.

If a company falls within this new category of issuer, it would be required to make a reasonable country of origin inquiry to determine whether the conflict minerals it uses originate from the Democratic Republic of the Congo or any country sharing an internationally recognized border with the D.R. Congo (which, at this time, includes: Angola, Tanzania,Rwanda, Uganda, The Republic of Congo, The Central African Republic, The Sudan, Burundi and Zambia).

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If a company finds that its conflict minerals did not originate from the D.R. Congo or a bordering country, it would be required to disclosure that determination, and the reasonable country of origin inquiry used to make the determination, in its annual report and on its website.

If, however, a company finds that its conflict minerals did originate from the D.R. Congo or a bordering country, or if it is unable to find that they did not, then the company would be required to disclose that determination in its annual report, prepare and furnish as an exhibit to its annual report a Conflict Minerals Report and make the Conflict Minerals Report available on its website.

A company’s Conflict Mineral Report would be required to include a description of the:

  • due diligence undertaken on the source and chain of custody of the company’s conflict minerals;
  • products that are not “D.R. Congo conflict free”;
  • country of origin of the conflict minerals,
  • facilities used to process the conflict minerals; and
  • efforts used to determine the mine or location of origin of the conflict minerals.

The company would also be required to obtain an independent audit of the Conflict Minerals Report, to certify the audit report and to furnish a copy of the audit report with its Conflict Minerals Report.

The Commission’s release defines a number of terms used throughout proposed rule, including: “manufacture” and “contract to manufacture”. Comments are due by January 31, 2011.

Summit on the Illegal Exploitation of Natural Resources

Coincidentally (unless yesterday was international conflict minerals day and no one told me), Mail and Globe is reporting that the International Conference on the Great Lakes Region held a Special Summit on the Illegal Exploitation of Natural Resources yesterday, where leaders from 11 African nations signed a pledge to take steps to implement a regional certification system to track conflict minerals from their location of origin to the facilities where they are processed.

Do You Know What’s In Your Supply Chain?

These proposed rules have the potential to affect a large number of companies (the Commission estimates approximately 6,000 issuers will be affected in some way).  Take a look at this report published by The Enough Project (an affiliate project of the Center for American Progress), leaving your political predilections aside for a moment, over the course of two years the group surveyed 21 of the largest electronic companies regarding the conflict status of their supply chains and found none of them to be conflict-free.  If Apple and Intel have conflict minerals in their supply chains, what’s in yours?

SEC Proposed Conflict Mineral Rules

Source: Enough!, Conflict Minerals Company Ranking

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