Dear clients and friends,
We present our traditional year-end issue of Snell & Wilmer’s Corporate Communicator to help you prepare for the upcoming annual report and proxy season. This issue highlights SEC reporting and corporate governance considerations that will be important this annual meeting season as well as in the upcoming year.
During 2018, members of our Corporate & Securities Group will continue to publish the Corporate Communicator, host business presentations, participate in seminars that address key issues of concern to our clients, and sponsor conferences and other key events. First on the calendar is our Tenth Annual Proxy Season Update, which will be held in our Phoenix office on January 11, 2018. Finally, we are pleased to present our 2017 Tombstone, which highlights selected deals that Snell & Wilmer’s Corporate & Securities group helped clients close during the year.
As always, we appreciate your relationship with Snell & Wilmer, and we look forward to helping you make 2018 a successful year.
Very truly yours,
Snell & Wilmer
Corporate & Securities Group
SEC, NYSE & NASDAQ UPDATE
Pay Ratio Disclosure
Status: Pay ratio disclosure requirements go into effect for 2018 proxy statements; SEC issued interpretive guidance; Division of Corporate Finance issued additional guidance and revised Compliance & Disclosure Interpretations (C&DIs); Financial CHOICE Act was passed by House in June 2017, but no action in Senate to date.
Summary: With the Financial CHOICE Act, which sought to repeal or modify pay ratio disclosure, along with other Dodd-Frank Act laws stalled in the Senate, barring any last-minute, surprise developments, most public companies will need to disclose the ratio of their principal executive officer’s compensation to the median employee’s compensation in their 2018 proxy statements. To assist companies with this requirement, the SEC issued interpretive guidance on calculating the pay ratio disclosure, including how to use reasonable estimates, assumptions and methodologies, statistical samplings, and internal records, as well as when to use widely recognized tests to determine independent contractor status. Concurrently, Corporate Finance staff provided additional guidance on how to use statistical sampling and other reasonable methods to identify the median employee’s compensation and revised its previously issued C&DIs on pay ratio disclosure.
Other SEC Rulemaking, Including Dodd-Frank
Status: Dodd-Frank executive compensation-related proposals, as well as many other proposed rules, removed from SEC regulatory agenda for the next 12 months; effectively stalled.
Summary: With the SEC’s removal from its regulatory agenda to the SEC’s long-term agenda (which are items that the SEC does not expect to resolve within the next 12 months) of a number of Dodd-Frank Act rules, including rules on clawbacks, pay versus performance disclosure, and hedging disclosure, along with other rules relating to universal proxy and security-based swaps, these rules are on hold indefinitely.
Status: Conflict minerals rule still in limbo; Corporate Finance staff issues no-action guidance.
Summary: The Corporate Finance staff issued a public statement in April 2017 indicating that it would not recommend enforcement action to the Commission if a company does not file disclosure under Item 1.01(c) of Form SD after the District of Columbia Circuit Court of Appeals issued a final judgment on April 3, 2017 reaffirming its prior holding that a portion of the conflict minerals rule violates the First Amendment and remanding the rule back to the SEC.
FAST Act Modernization and Simplification of Regulation S-K Proposed Rules
Status: Proposed rules issued October 2017; comment period expires January 2, 2018.
Summary: The proposed rules implement a mandate under the Fixing America’s Surface Transportation (FAST) Act to modernize and simplify certain disclosure requirements in Regulation S-K and related rules and forms. The amendments proposed seek to update, streamline, or otherwise improve the disclosure framework and include, among others, proposed changes to:
implement a materiality threshold for description of property disclosure (Item 102);
allow for flexibility in discussing historical periods in Management’s Discussion and Analysis (Item 303);
eliminate the requirement that reporting persons furnish Section 16 reports to registrant and allow registrants to rely on electronically filed Section 16 reports (Item 405);
eliminate certain undertakings in registration statements that are duplicative of other rules or that have become unnecessary over time (Item 512); and
ease exhibit filing requirements for material agreements and the necessity of preparing confidential treatment requests for sensitive information in material agreements (Item 601).
Other Miscellaneous SEC-related Reminders
The following are brief reminders relating to other miscellaneous SEC developments that will affect companies in 2018:
must now hyperlink exhibits;
addition of checkbox for emerging growth company (EGC) language on cover page of several forms (e.g., Forms 10-K, 10-Q, 8-K);
threshold to qualify as EGC adjusted for inflation to $1,070,000,000; and
maximum amount allowed to be sold under Regulation Crowdfunding adjusted for inflation up to $1,070,000.
NYSE & Nasdaq Updates
The NYSE amended its rules to require that listed companies provide notice to the NYSE at least 10 minutes before making any public announcement with respect to a dividend or stock distribution when the notice is given outside of trading hours (in addition to during trading hours, which was already the case prior to this amendment). Though approved by the SEC, the amendment’s effectiveness is delayed until February 1, 2018 or such earlier date that the NYSE notifies listed companies that the new rule will go into effect.
On December 4, 2017, the SEC approved a proposed amendment from the NYSE that prohibits the issuance by listed companies of material news after market close until the earlier of five minutes after the official closing of trading or the publication of a company’s official closing price, except when necessary to comply with Regulation FD following a non-intentional disclosure.
In July 2017, Nasdaq issued a solicitation for comments regarding proposed changes to its 20% rule in relation to a private offering. The proposed changes relate to the price at which stock is sold in a private offering and the approval requirements for a private offering. The comment period has ended but no changes have been effected.
ANNUAL MEETING AND PROXY CONSIDERATIONS
2017 Proxy Season Review
Below is a summary of notable developments and trends relating to the 2017 U.S. annual meeting proxy season:
Continued decrease in overall number of shareholder proposals. Shareholder proposals that went to a vote decreased significantly in 2017 compared to 2016, reflecting a trend of fewer shareholder proposals being submitted since 2015. In addition, the number of SEC no-action requests to exclude shareholder proposals increased from 245 in 2016 to 288 in 2017. The SEC ultimately granted 78% of the 2017 no-action requests that were not withdrawn, which was the highest level in at least four years.
Higher success rate and stronger support for proxy access adoption proposals. In 2017, there were fewer proposals relating to the initial adoption of proxy access provisions submitted and voted on compared to 2016. This is primarily due to the increased number of companies that have already adopted proxy access in recent years. However, of the proposals that were voted on in 2017, the average support and percentage that received majority votes were higher than in 2016. In contrast, none of the “fix-it” proposals, which are designed to amend previously adopted proxy access provisions, passed in 2017.
Board diversity proposals gaining traction. Board diversity continues to remain an important high-profile topic, and some institutional investors are seeking to improve gender and racial diversity on boards. While the number of board diversity proposals submitted in 2017 only increased slightly from 2016, the average support for those that reached a vote increased by approximately 3%. Furthermore, of the record number of proposals submitted in 2017, many were withdrawn after the companies agreed to improve diversity efforts.
Increased focus on environmental proposals. The number of environmental proposals submitted in 2017 increased over the prior year and reflected an increase in average support in 2017. The most common environmental proposal topic pertained to climate change, with three climate change proposals having obtained majority votes for the first time. These particular proposals dealt with the business impact of the Paris Agreement’s two degree Celsius limit on global warming, which generally saw a significant increase in average support compared to 2016.
Support for “say-on-pay” proposals remained strong with an overwhelming trend towards annual voting. Say-on-pay proposals continued to demonstrate strong support shown in prior years with average support in excess of 90%. In addition, 2017 marked the six-year anniversary of the first “say-on-frequency” advisory vote held in 2011. The vast majority of companies holding their second say-on-frequency vote recommended holding annual say-on-pay votes, which were overwhelmingly approved by shareholders.
Virtual annual meeting-related proposals omitted from ballots. With an increasing number of companies choosing to hold exclusively virtual annual shareholder meetings, some shareholders have continued to criticize such virtual meetings as limiting their ability to directly engage and communicate with boards and management. In 2017, there were a few shareholder proposals (compared to none in 2015 and 2016) requesting that companies holding virtual-only annual meetings adopt a corporate governance policy to reinstate in-person annual meetings. All of these proposals were excluded based on ordinary business or technical grounds.
Proxy Advisors—Voting Guideline Updates
As is the case each year around this time, Institutional Shareholder Services Inc. (“ISS”) and Glass, Lewis & Co. (“Glass Lewis”) both recently updated their proxy voting guidelines for the 2018 proxy season.
UPDATES TO ISS’ PROXY VOTING GUIDELINES
The following is a summary of ISS’ key policy updates applicable to U. S. companies:
Non-Employee Director Pay. Beginning in 2019, ISS will recommend against board or committee members who are responsible for approving or setting non-employee director (“NED”) compensation where there are two or more consecutive years of excessive NED pay compared to their peer companies without mitigating factors.
Poison Pills. ISS will recommend against all board nominees, every year, at companies that maintain a long-term poison pill, which is a poison pill with a term greater than one year that has not been approved by shareholders. With respect to short-term poison pills, ISS will evaluate its recommendations on a case-by-case basis and, under the updated policy, will focus more on the rationale for adopting the poison pill than on the company’s governance track record.
Gender Pay Gap. ISS adopted a new policy relating to shareholder proposals for reports or policies relating to potential gender pay gaps. Under the new policy, proposals will be evaluated on a case-by-case basis on the following factors:
the company’s current policies and disclosures related to both its diversity and inclusion policies and practices;
the company’s compensation philosophy and use of fair and equitable compensation practices;
whether the company has been the subject of recent controversies, litigation or regulatory actions related to gender pay gap issues; and
whether the company’s reporting regarding gender pay gap policies or initiatives lags its peers.
UPDATES TO GLASS LEWIS’S PROXY VOTING GUIDELINES
The following is a summary of Glass Lewis’s key policy updates applicable to U. S. companies:
Board Gender Diversity. Consistent with prior years, Glass Lewis will review board composition and may note as a concern boards that Glass Lewis believes lack representation of diverse director candidates, including if there are no female directors. Beginning in 2019, Glass Lewis will generally recommend voting against the nominating committee chair of a board that has no female directors. Depending on other factors, Glass Lewis may also extend the “vote against” recommendation to all members of the nominating committee. However, in making its recommendations, Glass Lewis will look closely at the disclosures of a company’s diversity considerations and may refrain from a “vote against” recommendation for companies that are (i) outside of the Russell 3000, (ii) have provided sufficient rational for not having any female board members, or (iii) have disclosed a plan to address lack of diversity on the board.
Dual-Class Voting Structures. In its summary of governance positions, Glass Lewis has added a discussion of its view that dual-class voting structures are not typically in the best interests of common shareholders. In connection with newly public companies, Glass Lewis generally believes that newly public companies should be provided sufficient time to fully comply with marketplace listing requirements and meet basic governance standards, but will consider recommending that shareholders vote against members of the governance committee or the directors that served at the time of adoption of governing documents that Glass Lewis believes severely restricted shareholder rights indefinitely. Glass Lewis updated its policy to include the presence of dual-class voting structures as an additional factor in making its determination whether shareholders’ rights were severely restricted indefinitely.
Board Responsiveness. Glass Lewis updated its policy to provide that the board generally has an imperative to respond to shareholder dissent from a proposal at an annual meeting where more than 20% of the votes cast were contrary to management's recommendation (down from 25%).
Virtual Shareholder Meeting. Glass Lewis added discussion of its position that virtual-only meetings have the potential to curb the ability of a company’s shareholders to meaningfully communicate with the company’s management. In 2018, holding a virtual-only meeting will only be a factor in Glass Lewis’s evaluation of a company’s governance profile. Beginning in 2019, Glass Lewis will generally recommend voting against members of the governance committee of a board where the board is planning to hold a virtual-only shareholder meeting and the company does not provide robust disclosure in its proxy statement that assures shareholders that they will be afforded the same rights and opportunities to participate as they would at an in-person meeting.
CEO Pay Ratio. With respect to the CEO Pay Ratio disclosure required beginning in 2018, Glass Lewis will display the pay ratio as a data point in its “Proxy Papers,” as available. At this time, the CEO pay ratio will not be a determinative factor in Glass Lewis’s voting recommendations.
2018 PROXY SEASON PREVIEW
Below is a summary of other notable developments and key items to consider for the 2018 U.S. annual meeting proxy season:
Proxy Access. Proxy access is likely to be another hot issue in the 2018 proxy season. At this point, as more and more companies move towards the market-standard approach of a “3-3-20” model, those companies that have not adopted an access bylaw run a reasonable risk of a negative proxy advisor recommendation or an activist “access” campaign. In addition, even those who have adopted the 3-3-20 market-standard model may receive a “fix-it” proposal to go beyond this market standard.
Governance Concerns. A number of governance issues will also likely be front-and-center in the upcoming proxy season, with off-market or overly restrictive models triggering a higher risk of withhold vote recommendations or “just vote no” campaigns. Governance concerns that would be particularly likely to lead to a negative campaign include:
lack of director independence;
board actions that reduce shareholder rights;
lack of a formal nominating committee;
bylaws that do not permit amendment by shareholders;
failing to respond to shareholder concerns; and
Dual Class Stock. Companies with multi-class capital structures in which the classes have unequal voting rights will continue to come under scrutiny this year. In November, Twenty-First Century Fox Inc. narrowly defeated a shareholder proposal calling for the company to eliminate its dual-class structure. In fact, a majority of the shares not controlled by the Murdoch Family (the controlling shareholder) voted in favor of the proposal, suggesting there is strong public shareholder support to scrap dual class voting structures.
Director Overboarding, Tenure and Diversity. Directors who sit on a large number of boards, boards that lack diversity (race, gender, ethnicity, age, sexual orientation, skills, background and experience), and companies that lack processes to refresh board composition periodically may find themselves in the spotlight this proxy season. Related to that, in September, the New York City Comptroller’s Office announced its “Boardroom Accountability Project 2.0.” With respect to a number of companies in which the New York City Pension Funds own shares, the Comptroller is asking the companies to disclose a director “skills and experience matrix.” The matrix is intended to assist investors evaluate the suitability of candidates and adequacy of the board composition as a whole. The model skills matrix can be found on the Comptroller’s website by clicking here.
Environmental and Social Proposal Trends. The 2017 proxy season saw an uptick in environmental and social shareholder proposals, and that trend is expected to continue through the 2018 proxy season. This trend has been driven by a select few “socially responsible” investors, with climate change, diversity in the workplace, political spending, and pay disparity at the center of many of the campaigns. Proactive shareholder engagement continues to be the best defense to an activist campaign.
Messaging Pay Ratio Disclosures. While the SEC’s pay ratio rules emphasize that the disclosure should be “brief,” effective messaging of the ratio, both internally and externally, is important to minimize potential negative reactions by employees and shareholders. If a company’s ratio is positive (relative to its peers), the messaging is fairly easy. If it is negative, consider adding disclosure highlighting the unique value added by the company’s CEO, and highlighting how CEO compensation is tied to company objectives. It’s also critical to not neglect the fallout from the new disclosure among the company’s workforce. Many companies are considering launching internal campaigns to educate their workforce on their individual compensation model to get ahead of the curve and limit the chances of employees misinterpreting the pay ratio disclosure when it is eventually publicly disclosed.
Equity Compensation Plan Approval Considerations. While a substantial majority of equity compensation plans and amendments were approved in 2017 as in years past, several such plan proposals continue to fail each year and it tends to be harder to receive advisory firm support for equity compensation plan proposals than it is to obtain shareholder approval (in 2017, according to ISS, average equity plan support was 89%, while ISS supported only 70% of equity plan proposals it evaluated). High shareholder value transfer (essentially a measure of plan cost calculated by taking the total value of equity grants divided by market capitalization) continues to be a red flag for investors, and therefore should be assessed carefully by companies before putting a plan to shareholder vote.
RECENT DEVELOPMENTS AND OTHER CONSIDERATIONS
New Revenue Recognition Standard. The Financial Accounting Standards Board’s new revenue recognition standard is now in place and is effective for public companies for fiscal years beginning after December 15, 2017. For calendar year end companies, they must begin applying the new standard on January 1, 2018. The SEC is expecting companies to provide robust transition disclosures in their 2017 annual reports explaining to investors the anticipated effects of the new standard, including the method of adoption, a comparison to the current standard as it pertains to the company’s existing revenue recognition policy and the expected quantitative and qualitative impacts upon adoption.
New Independent Audit Report Standard. In October 2017, the SEC approved the Public Company Accounting Oversight Board’s (PCAOB) new audit report standard. The new standard is intended to make the auditor’s report more informative by requiring new information be provided about “critical audit matters.”
A critical audit matter as defined by the new standard as any matter that arises from the audit of the financial statements that was communicated, or required to be communicated, to the audit committee that (i) relates to accounts or disclosures that are material to the financial statements and (ii) involves especially challenging, subjective or complex judgment. The new standard provides a nonexclusive list of factors the auditor should consider when determining whether a matter involves especially challenging, subjective or complex judgment.
For each critical audit matter identified, the auditor must describe the principal considerations that led the auditor to determine that the matter was a critical audit matter, describe how it was addressed in the audit, and refer to relevant financial accounts and disclosures that related to the critical audit matter. If the auditor determines there are no critical audit matters, that finding must be disclosed in the audit report. It is noted that the PCAOB has indicated that it expects the auditor will determine there is at least one critical audit matter.
In addition to the disclosures about critical audit matters, the new standard requires several other changes to the audit report, including disclosure of the auditor’s tenure with the company. The new audit report standard is effective for audits of fiscal years ending on or after December 15, 2017, except for the provisions relating to disclosures about critical audit matters, which are effective for audits of fiscal years ending on or after June 20, 2019 (for larger accelerated filers) and on or after December 15, 2020 for all other filers.
The End of the SEC’s “Broken Windows” Policy? As we have written about previously, in 2013, then SEC Chair Mary Jo White gave a speech in which she signaled the SEC’s intention to implement the “broken windows” theory of enforcement made famous long ago in New York City by Mayor Rudolph Giuliani. Chair White stated: “The theory is that when a window is broken and someone fixes it – it is a sign that disorder will not be tolerated. But, when a broken window is not fixed, it ‘is a signal that no one cares, and so breaking more windows costs nothing.’” Subsequent to this speech, the SEC brought a series of enforcement actions involving securities law reporting and similar violations that most commentators agreed resulted in little financial harm, if any, to investors. Nevertheless, the SEC publicly advertised that these actions were intended to send a message and get companies, executives and other reporting persons to take compliance seriously. The SEC recently indicated it may be pivoting away from its broken windows policy. In remarks at the October 2017 Enforcement Forum, Co-Director Peikin indicated that the Division of Enforcement is likely to de-emphasize extensive industry-wide sweeps or enforcement actions based on technical violations of the federal securities laws. We believe this change in policy reflects SEC Commissioner Piwowar’s prior public statements criticizing the broken windows policy because “if every rule is a priority, then no rule is a priority.”
SEC Comment Letter Trends. During the 12 months ended June 30, 2017, the most common comment area by the SEC was non-GAAP financial measures. This is not surprising as this period follows almost exactly the 12 months following the SEC’s issuance of new and revised C&DIs covering non-GAAP measures in May 2016. These C&DIs reflect the SEC’s renewed emphasis on scrutinizing the use of non-GAAP financial measures in SEC filings and other investor communications. According to Ernst & Young, other common comment areas include MD&A, fair value measurements, segment reporting and revenue recognition. Moving into 2018, we speculate that the frequency of SEC comments related to non-GAAP financial measures will wane as it appears generally the SEC’s message has been received. Nevertheless, as companies introduce new or modified non-GAAP disclosures, they should remain mindful of the SEC’s guidance as it remains a hot button topic with the SEC Staff. In our experience, we note that comments about segment reporting remain common. We have also observed that the SEC Staff continues to issue comments about the statement of cash flows and related MD&A discussion. Although the statement of cash flows and related MD&A disclosures often take a back seat in the Form 10-K preparation process, companies should be aware that from the perspective of the SEC, and investors for that matter, they are important.
Trend Disclosure in MD&A—Recent Developments. Regulation S-K, Item 303 requires companies to disclose any “known trends or any known demands, commitments, events or uncertainties” that will result or that are “reasonably likely” to impact a company’s liquidity. Similarly, Item 303 calls for disclosure of any known trends or uncertainties that have had or that the company “reasonably expects will have” a material favorable or unfavorable impact on revenue or income.
In June 2017, the SEC brought cease and desist proceedings against the CEO and CFO of UTi Worldwide Inc. (“UTi”) for violating the Securities and Exchange Act of 1934 by failing to adequately include in its MD&A a discussion about liquidity challenges facing UTi. UTi, a freight forwarding logistics company, provided significant cash outlays for transportation costs, customs, duties, taxes and other expenses on behalf of its customers and then subsequently invoiced its customers for reimbursement of such advances. UTi had implemented a new operating system and experienced significant delays in billing customers for its charges as well as the outlays made on customers’ behalf, resulting in higher than usual unbilled receivables. As a result of these billing delays, UTi experienced liquidity problems throughout much of 2013 that necessitated it obtaining waivers for debt covenant violations. After filing its third quarter Form 10-Q on December 13, 2013, UTi disclosed on Form 8-K (in late February 2014) the extent of its liquidity problems, including higher than normal receivables and weaker cash collections. UTi further disclosed on this Form 8-K that (i) it was unlikely to be in compliance with its debt covenants for the fourth quarter (ended January 31, 2014), (ii) it planned to offer $350 million of convertible notes and $175 million of preference shares to address its liquidity concerns and (iii) its auditor had amended the audit opinion to include a statement that there was a significant concern about UTi’s ability to continue as a going concern.
UTi’s Form 10-Q filed on December 13 failed to discuss the higher than normal unbilled receivables and related liquidity problems. The Form 10-Q included brief mention that cash used in operations had increased due to “an increase in trade receivables and other current assets . . .” The SEC, citing its prior interpretative guidance, stated “disclosure of a trend, demand, commitment, event or uncertainty is required unless a company is able to conclude either that it is not reasonably likely that the trend, uncertainty or other event will occur or 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.” The SEC further declared that the “Commission has explained that the ‘reasonably likely’ standard for disclosures mandated by Item 303 is lower than ‘more likely than not.’”
Companies should be mindful of the required trend disclosure requirements not only because of possible criticism from the SEC, but plaintiffs as well. In a May 2017 Southern District Court of New York decision, in a partial denial to dismiss a securities class action lawsuit, the court found that the plaintiffs had adequately pleaded that the defendant company should have disclosed its increased tax liabilities under Regulation S-K Item 303. The defendant company Inovalon derived significant revenues from customers located in New York. As a result of higher city and state tax rates in New York, Inovalon experienced an increase in its effective tax rate from 39% to 43%. Plaintiffs alleged that Inovalon failed to disclose timely the tax increases and related adverse impact on its operating results. Interestingly, the court found that the plaintiffs had adequately pleaded that Inovalon had knowledge of the tax increases (i.e., the “known” trend or uncertainty) as a result of Inovalon merely receiving a “client alert” from its accounting firm Deloitte & Touche about the pending tax rate increases.
 Mary Jo White, Remarks at the Securities Enforcement Forum (Oct. 9, 2013). [back]
 Michael S. Piwowar, Remarks to the Securities Enforcement Forum (Oct. 14, 2014). [back]
 See Ernst & Young LLP, SEC Comments and Trends, An Analysis of Current Reporting Issues (Sept. 2017). [back]
 See Id. [back]
 Securities Act Release No. 80947 (June 15, 2017). [back]
 Id. (citing Release 33-8550 (Dec. 19, 2003) (emphasis in Release)).[back]
 Id. [back]
 Xiang v. Inovalon Holdings, Inc., U.S.D.C. SDNY (May 23, 2017). [back]
 Id. At 15-16. [back]