Preparing for the 2020 Reporting Season

Wilson Sonsini Goodrich & Rosati
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Wilson Sonsini Goodrich & Rosati

With the 2020 reporting season just around the corner, there are several compliance “musts” to focus on, as well as items that can be addressed in the remainder of 2019 to make 2020 a little easier.

Several broader themes from prior years will continue into the 2020 proxy season, together with some new areas of focus and new rules that will be applicable for Annual Reports on Form 10-K and proxy statements filed in 2020. Several themes that have emerged over the past several reporting cycles—including an increased focus on effective disclosure and analysis in the Form 10-K and proxy statement, as well as the ongoing need for effective shareholder engagement—will continue into 2020.

Shareholder Engagement

Shareholder engagement continues to increase in importance. Many large institutional investors and global asset managers have internal investment stewardship and governance groups that actively engage with portfolio companies on matters relating to corporate governance, including environmental, social, and governance (ESG) issues, board composition and effectiveness, risk management and oversight, executive compensation, and increasingly, human capital issues. The scope of engagement by these groups varies, from letter writing campaigns, to in-person meetings with management or directors, to submission of shareholder proposals for inclusion in the company’s proxy statement. Every company should understand the investment stewardship policies of its major institutional investors. In addition, developing relationships with the relevant stewardship and governance groups, in addition to the analysts and portfolio managers, is important. Below are some thoughts on best practices for shareholder engagement going into 2020:

  • Review Shareholder Engagement Efforts and Plan for 2020. Conduct an “after-action review” of shareholder engagement efforts in 2019, with a particular focus on the feedback from shareholders related to corporate governance and executive compensation practices, as well as any feedback received from proxy advisory firms, such as Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis), if those advisory firms are followed by your shareholders. Changes in voting patterns at your 2019 annual meeting compared with those at the 2018 and 2017 annual meetings (for example, a meaningful increase in votes against the election of one or more directors, or a multi-year pattern of declining support for directors) also can be informative. Synthesize this information for the board and any relevant committees to provide them with an unvarnished view of shareholder perspectives. With shareholder engagement now a year-round priority, inform the board of the shareholder engagement plan—including a timeline—for 2020. As part of this plan, consider how to most effectively use “off season” engagement. Meetings with investment stewardship and governance groups are often most effective in the “off season,” as investors tend to be more available during this time. Any feedback can be considered and, if appropriate, implemented in advance of the 2021 proxy statement.
  • Prepare “What We Heard, What We Did” Charts and Summaries. A continuing best practice is to include “what we heard, what we did” charts and summaries in the proxy statement. These charts and summaries describe the nature of shareholder feedback received over the course of the year and detail how the company responded to that feedback. Even if this disclosure ultimately is not included in the proxy statement, it can be very helpful for framing discussion with the board and its committees about shareholder concerns. In some cases, discussion of a company’s response to shareholder feedback may be expected. For example, if the company received a lower vote on say-on-pay or had a shareholder proposal that passed or received a meaningful “For” vote, discussion of the company’s response in the proxy statement will be expected by proxy advisory firms and many institutional investors. As a reminder, ISS generally will recommend votes against (or withhold votes from) some or all directors if the board fails to act on a shareholder proposal that received majority support the prior year.
  • Consider Any Appropriate Responses to Shareholder Feedback. Thoughtfully considering and, if appropriate, implementing responses to shareholder feedback takes time and should be started as early as possible. Sufficient time should be allocated to consider alternatives. In addition, input from key shareholders may be required, as well as approvals from the nominating committee, the compensation committee, and the board. It is always important to keep in mind that what some consider a “best practice” from a governance perspective may not be the right practice for your company; in which case, be prepared to explain to the board and shareholders why the practice is not appropriate and was not adopted, particularly if it was recommended by shareholders.

Form 10-K Drafting

Changes to Form 10-K Cover Page

Three changes to the Form 10-K cover page are required as a result of rulemaking by the Securities and Exchange Commission (SEC) in 2019:

  • The SEC eliminated the checkbox where a company indicated whether disclosure of delinquent filers under Item 405 of Regulation S-K was included in the Form 10-K or the proxy statement.
  • As with Forms 10-Q and 8-K, disclosure of the trading symbol for each class of the company’s registered securities is required, in addition to the previously existing requirement to disclose the title of each class of securities and each exchange on which such securities are listed.
  • All information on the cover page must be tagged using Inline XBRL (iXBRL) format, subject to phased compliance dates. Large accelerated filers are already required to comply with this requirement, while accelerated filers must comply beginning with reports for fiscal periods ending on or after June 15, 2020, and all other filers must comply beginning with reports for fiscal periods ending on or after June 15, 2021. As a reminder, companies must also comply with these cover page tagging requirements for Forms 10-Q and 8-K using the same phased compliance dates.

Disclosure Modernization and Simplification

In March 2019, the SEC adopted new rules to modernize and simplify disclosure requirements in Regulation S-K. These new rules included, among other things, the following changes applicable for Form 10-K: 

  • Exhibits.
    • New Exhibit Requirement: Description of Securities. The new rules require companies to file a “brief” description of their registered securities as an exhibit to their Form 10-K. A company may incorporate by reference and hyperlink to a prior exhibit containing the required disclosure if the information is unchanged. Previously, this disclosure was required only in registration statements. 
    • Elimination of Two-Year Look Back for Material Contracts. Before the new rules, companies were required to file as exhibits all material contracts not made in the ordinary course of business if the contract 1) was entered into within the two years before the filing or 2) was to be performed, in full or in part, in the future. Except for “newly reporting registrants,” a new term defined in Instruction 1 to Item 601(b)(10) of Regulation S-K, companies will no longer be subject to the two-year look back period. Accordingly, companies are no longer required to file material contracts that have been fully performed or are otherwise no longer in effect. Such contracts can also be removed on future exhibit indexes, even if filed previously.
    • Omission of Confidential Information and New Confidential Treatment Process. The new rules significantly simplify the process for omitting confidential information from material contracts and acquisition agreements. Rather than pursuing the often-cumbersome confidential treatment request (CTR) process, a company may now redact confidential information in material contracts and certain other exhibits if the company determines that the information 1) is not material and 2) would likely cause competitive harm to the company if publicly disclosed. When filing a redacted exhibit, companies must: 1) mark the exhibit index to indicate that portions of the exhibit or exhibits have been omitted; 2) include a prominent statement on the first page of the redacted exhibit that certain identified information has been excluded from the exhibit because it is both not material and would be competitively harmful if publicly disclosed; and 3) indicate with brackets where the information has been omitted from the filed version of the exhibit. The SEC will continue a selective review of exhibit filings and may request (separate from the regular comment process) that a company provide supplemental materials similar to those currently required in a CTR to explain its materiality and competitive harm analyses. Accordingly, companies should consider documenting the bases for their redactions to be prepared for any SEC inquiry.
    • Omission of Personally Identifiable Information. The new rules allow companies to redact personally identifiable information, such as bank account numbers, home addresses, and social security numbers, from exhibits without submitting a CTR. 
    • Omission of Exhibit Attachments. Companies are no longer required to file schedules, appendices, or similar attachments to exhibits if such attachments 1) do not contain material information and 2) were not otherwise disclosed in the exhibit or filing. If attachments are omitted from an exhibit, the exhibit must contain a list briefly identifying the contents of the omitted attachments, unless such information is already included within the exhibit in a manner that conveys the subject matter of the omitted attachments (for example, in a table of contents). In addition, companies must provide a copy of omitted attachments to the SEC upon request.
  • MD&A. Item 303(a) of Regulation S-K requires companies to discuss their financial condition, changes in financial condition, and results of operations. Prior to the new rules, Instruction 1 to Item 303(a) provided that the discussion should generally cover the three-year period covered by the financial statements. Among other things, amended Instruction 1 now provides that, in a filing containing financial statements covering three years, a company may omit a discussion about the earliest of the three years if the company previously included in its MD&A a discussion of the earliest year in a prior filing. The company must, however, identify the location in the previous filing of where the omitted discussion may be found. When determining whether to omit the earliest year, a company must still assess the materiality of the discussion.
  • Description of Properties. Previously, Item 102 of Regulation S-K required disclosure of the location and general character of a company’s “principal plants, mines, and other materially important physical properties.” Item 102 was amended to clarify that companies need only disclose those principal physical properties that are material. In addition, disclosure can be provided on a collective basis when appropriate.
  • Executive Officer Disclosure. Item 401 of Regulation S-K requires companies to include disclosure about the identity and background information of their directors, executive officers, and significant employees. Form 10-K allows companies to incorporate this information by reference to their definitive proxy or information statement. As an alternative, companies can include this information in Part I of Form 10-K under an appropriate caption. The amendments clarify that if a company includes executive officer disclosure in Part I of Form 10-K, the company need not repeat that information in its definitive proxy or information statement. Additionally, the required caption for this disclosure if it is included in Part I of Form 10-K is now “Information about our Executive Officers” instead of “Executive officers of the registrant.”
  • Incorporation by Reference.
    • Hyperlinks. Previously, any information that was incorporated by reference into a Form 10-K (or other filing), other than the Part III information that is forward incorporated by reference from the proxy statement, generally had to be filed as an exhibit to the Form 10-K. As a result of the new rules, if this incorporated information is already available on EDGAR, then it is no longer required to be filed as an exhibit to the Form 10-K. Rather, companies are now required to include a hyperlink in HTML format to the information that is being incorporated by reference. When utilizing hyperlinks to incorporate information by reference in a Form 10-K, ensure that you include the hyperlink itself together with an express statement clearly identifying the document where the incorporated information was originally filed or submitted and the location of the information within that document.
    • Five-Year Limitation. Item 10(d) of Regulation S-K previously prevented companies from incorporating documents by reference that had been on file with the SEC for more than five years and did not fall within one of the exceptions provided in the rule. The new rules eliminated this limitation. 
    • Financial statements.Companies may no longer have financial statements cross-reference to, or incorporate by reference, information outside of the financial statements unless permitted by the SEC or certain accounting principles.
  • Risk Factors. The new rules relocate Item 503(c)—which required disclosure of the most significant factors that make an offering speculative or risky—to a new Item 105. Item 105 also requires disclosure of risk factors that make an investment in the company speculative or risky.

iXBRL Requirements

In August 2019, the SEC’s Division of Corporation Finance posted new Compliance and Disclosure Interpretations (CDIs) relating to iXBRL matters. Among other things, these new CDIs provided that 1) companies should identify any Cover Page Interactive Data File as exhibit 104 in the exhibit index, except that no such exhibit reference is required for a Form 8-K if the only exhibit identified in the exhibit index would be exhibit 104; 2) exhibit 104 should cross-reference to the Interactive Data Files submitted under exhibit 101; and 3) when an interactive data file is submitted using iXBRL, then the exhibit index must include the word “Inline” in the title description for any such exhibit.  Ensure that your exhibit index is updated if you are using iXBRL.

In addition, the SEC’s Division of Economic and Risk Analysis recently announced some issues associated with data tagging in some company filings, including 1) inconsistent public float values reported in the HTML filing versus in the XBRL file and 2) tagging revenue disclosures under old accounting standards. Accounting teams should ensure that XBRL or iXBRL tagging, as the case may be, is up-to-date and accurate.

Critical Audit Matters

In 2017, the Public Company Accounting Oversight Board (PCAOB) adopted a new auditor reporting standard that requires the auditor to provide more information about the audit, including critical audit matters (CAMs). The new standard was applicable for large accelerated filers for audits of fiscal years ending on or after June 30, 2019, and will be applicable for accelerated filers, non-accelerated filers, and smaller reporting companies for audits of fiscal years ending on or after December 15, 2020. This standard is not applicable for emerging growth companies. A critical audit matter is “any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: 1) relates to accounts or disclosures that are material to the financial statements and 2) involved especially challenging, subjective, or complex auditor judgment.” For those issuers not yet subject to this requirement, continued monitoring of the implementation of this new standard and discussion with your independent auditor and the audit committee is appropriate.

Review and Update Risk Factor and Related Disclosures

Take a fresh look at risk factors and risk management and oversight disclosures, particularly around some of the key areas of SEC focus, including the United Kingdom’s potential exit from the European Union (Brexit), the transition away from the London Interbank Offered Rate (LIBOR), and cybersecurity.1

  • Brexit. With actions relating to Brexit delayed until 2020, review, add, and/or update, as needed, Brexit disclosures and risk factors, focusing on the impact that Brexit may have on the company and its operations as well as the disclosure principles and non-exhaustive list of questions posed by William Hinman, director of the SEC’s Division of Corporation Finance, regarding Brexit-related disclosures in company filings.2
  • LIBOR Transition. The SEC’s Division of Corporation Finance, Division of Investment Management, Division of Trading and Markets, and Office of the Chief Accountant issued a joint public statement in July 2019, stating that the SEC “is actively monitoring the extent to which market participants are identifying and addressing” risks related to the transition away from LIBOR, and provided guidance to companies in determining what disclosures may be relevant and appropriate.3 For companies that may be impacted by the transition away from LIBOR, which is expected to occur by the end of 2021, review and update, as needed, risks relating to this transition, and consider whether disclosures should be included in other sections of the Form 10-K, including in management’s discussion and analysis, board risk oversight, and notes to the financial statements.
  • Cybersecurity. In February 2018, the SEC published interpretive guidance for preparing disclosures about cybersecurity risks and incidents. In light of this guidance, continue to review related disclosure and disclosure controls around potential incidents. In addition, in October 2018, the SEC also issued an investigative report regarding certain cyber-related fraud and internal accounting controls requirements. The investigation and report considered whether companies that had suffered certain cyber-related incidents had sufficient internal controls under the securities laws. Although no enforcement actions were pursued and the SEC was clear that not every company that suffered a cyber-related fraud incident was in violation of the internal controls requirements, the report emphasized that internal controls around cyber-related fraud are important for enterprise risk management and should be included in the design and evaluation of a registrant’s system of internal controls.

Review SEC Comment Letter Trends and Related Disclosures

Based on a review of SEC comment letters for the 12 months ended June 30, 2019, the top three areas of focus for SEC comments were the following: revenue recognition, in particular the application of ASC 606, Revenue From Contracts With Customers; non-GAAP financial measures, in particular, relating to compliance with the SEC’s CDIs issued in May 2016 and the use, or rather misuse of, tailored accounting principles; and management’s discussion and analysis, including, results of operations, critical accounting policies and estimates, liquidity matters, business overview, and contractual obligations.4 Review these trends together with related disclosures as drafting of the Form 10-K gets underway.  

Proxy Statement Drafting and Related Matters

2019 Key Takeaways

There are several key takeaways from the 2019 proxy season that are informative for ongoing shareholder engagement and proxy statement disclosure considerations. 

  • Board Diversity. Women are joining public company boards in greater percentages than at any time in the past 10 years, comprising 45 percent of all new directors in the Russell 3000 Index (up from 33 percent in 2018 and 11 percent in 2009), and 46 percent of all new directors in the S&P 500 Index (up from 38 percent in 2018 and 14 percent in 2009).5 From State Street’s “Fearless Girl” campaign commenced in early 2017, to BlackRock’s 2018 voting guidelines setting an expectation that companies should have at least two women directors on their boards, to California’s mandatory board diversity law signed into law in late 2018, many different stakeholders have made gender diversity on public company boards a priority. In addition, in recent surveys, public company directors overwhelmingly agree on the benefits of board gender diversity. In PwC’s 2019 Annual Corporate Directors Survey (PwC Survey), 94 percent of the directors surveyed said that board diversity brings unique perspectives to the board and 87 percent said that it enhances board performance.
  • Director Elections. Overall shareholder support for directors remained fairly constant year-over-year, but the number of directors failing to receive majority support continued to increase to 478 directors in 2019, up from 416 in 2018 and 345 in 2015.6 In addition, the number of directors failing to receive more than 70 percent of the vote increased to 1,726 directors in 2019, up from 1,408 in 2018 and 1,185 in 2015.7 The foregoing may be attributable to continued and increased focus by proxy advisory firms and many institutional investors on director overboarding, board effectiveness, board composition, tenure, and other related matters.  
  • Shareholder Proposals.
    • Corporate Governance Proposals. Continuing its downward trend from prior years, there were 332 corporate governance proposals submitted in 2019, down from 351 in 2018 and 462 in 2015, and there were 236 corporate governance proposals voted on in 2019, down from 266 in 2018 and 333 in 2015. Of the proposals voted on in 2019, 33 percent were board-related proposals, followed by proposals relating to executive compensation (14 percent), shareholders’ right to act by written consent (14 percent), proxy access (11 percent), shareholders’ right to call special meetings (11 percent), elimination or reduction of supermajority voting (8 percent), and elimination of dual class stock (3 percent), with the remaining proposals falling in an “other” category. Average support for these proposals, measured in terms of votes cast, varied. The highest average levels of shareholder support were for proposals seeking to declassify the board (78.3 percent), eliminate or reduce supermajority voting (63.9 percent), implement majority voting for directors (57.4 percent), and enact proxy access (52.4 percent). Although independent board chair proposals comprised more than 70 percent of the “board-related” proposals voted on in 2019, those proposals only garnered average support of 29.1 percent.8
    • Environmental and Social Proposals. Also continuing its downward trend from prior years, the number of environmental and social proposals declined to 386 in 2019 from 399 in 2018; however, the number of proposals voted on increased slightly to 160 in 2019 from 150 in 2018. Not surprisingly given the current political climate and upcoming presidential election in 2020, 40 percent of the proposals voted on were related to lobbying and political contributions garnering average support of 33 percent, the highest across all environmental and social proposal types. Other environmental and social proposals reaching a vote in 2019 included proposals relating to board diversity, employment diversity, gender pay gap, climate change and sustainability, public health (for example, opioids and gun safety), human rights, and sexual harassment.9
  • Say-On-Pay. Support for say-on-pay proposals continues to be strong, garnering average shareholder support, based on votes cast, of approximately 91 percent among each of S&P 500 and S&P 1500 companies.10 However, while failure rates for S&P 1500 companies fell slightly from 2.5 percent in 2018 to 2.1 percent in 2019, those companies receiving problematic support levels, meaning between 50 percent and 70 percent support, increased from 5 percent in 2018 to 5.8 percent in 2019 for S&P 1500 companies and increased from 4.8 percent in 2018 to 5.5 percent in 2019 for S&P 500 companies.

New Hedging Disclosures

In December 2018, the SEC adopted hedging disclosure rules requiring a company to describe any practices or policies that it has adopted regarding the ability of its officers, directors, or employees to engage in transactions that hedge or otherwise offset any decrease in the value of the company’s equity securities granted to the officer, director, or employee by the company as compensation or otherwise held, directly or indirectly, by the officer, director, or employee. If a company does not have such a practice or policy, then the new rules require it to disclose that fact or state that these types of transactions are generally permitted. For large accelerated filers and for accelerated filers that are not also emerging growth companies and/or smaller reporting companies, these new rules are supplemental to the existing requirements for disclosures in the CD&A about a company’s hedging policies and practices applicable to a company’s named executive officers. For smaller reporting companies and emerging growth companies, disclosure pursuant to these rules is required in proxy statements with respect to the election of directors during fiscal years beginning on or after July 1, 2020. Although the new rules do not require the adoption of hedging practices or policies, or changes to any existing practices or policies, consider a review of hedging practices and policies in light of these new rules and the practices of peers.

Evaluate the Impact of ISS and Glass Lewis 2020 Voting Policies

ISS published its updated proxy voting guidelines, effective for meetings on or after February 1, 2020. These proxy voting guidelines included updates to ISS’s voting policies relating to, among other things, problematic governance structures and problematic capital structures (that is, dual-class stock), shareholder proposals requiring an independent board chair, board and committee meeting attendance, board diversity, restrictions on shareholders’ ability to amend company bylaws, share repurchase programs, equity plan proposals, and reports on a company’s pay data. For more detailed information on ISS’s updated proxy voting guidelines, please see our Client Alert. Glass Lewis also published its updated proxy voting guidelines, effective for the 2020 proxy season. These proxy voting guidelines included updates to Glass Lewis’s voting policies relating to, among other things, the SEC’s recent policy announcement on responses to no-action requests (discussed below), vote recommendations for committee members, forum selection clauses, shareholder proposals on supermajority vote requirements and gender pay equity, and say-on-pay considerations. For more detailed information on Glass Lewis’s proxy voting guidelines, see our Client Alert. Keep these policies and updates in mind and evaluate whether they may have an impact on the company’s proxy proposals, particularly if the company’s large institutional holders follow these guidelines.

Continue to Enhance Board Composition and Diversity Disclosure

Board composition and diversity continues to be a hot topic in corporate governance. In February 2019, the SEC issued two new CDIs relating to board diversity. CDI Questions 116.11 and 133.13 provide guidance on the disclosures required to be made under Item 401 and 407 of Regulation S-K in circumstances where a director or director nominee provides self-identified diversity characteristics (race, gender, ethnicity, religion, nationality, disability, sexual orientation, or cultural background) for inclusion in the company’s proxy statement. If the board or nominating committee considered self-identified characteristics in determining the specific experience, qualifications, attributes, or skills of an individual for board membership and that individual has consented to the disclosure of those self-identified characteristics, then ensure that these characteristics are identified and describe how they were considered by the board or nominating committee. In addition, any discussion of board diversity policies should include a description of how the board considers self-identified diversity characteristics of nominees. If appropriate, revise D&O questionnaires to gather this information and provide appropriate consent to disclosure. 

In the last couple of years, proxy advisory firms and large institutional shareholders have instituted voting policies on board diversity matters. ISS will generally recommend votes against (or withhold votes from) the chair of the nominating committee (and other directors on a case-by-case basis) at companies where there is no woman on the board.11 Glass Lewis will generally recommend votes against (or withhold votes from) the chair of the nominating committee, and possibly other nominating committee members, if there are no female board members, and takes a stronger position against California-headquartered companies that do not have at least one female director or have not published a plan on how they intend to address the issue.12 In addition, companies should be aware of the voting policies of their significant shareholders, as many of them have instituted voting policies related to board composition and diversity. For example, CalPERS will withhold votes from nominating committee members, board chairs, or long-tenured directors, on a case-by-case basis and where engagement has been unsuccessful, on boards that lack diversity and do not make firm commitments to improve diversity in the near term.13 As another example, starting in 2020, State Street will vote against all nominating committee members at companies where it had concerns about gender diversity for four consecutive years and was unable to engage with the company in productive dialogue on this issue.14

States are also taking an interest in board diversity. Publicly-held companies with principal executive offices in California (regardless of their jurisdiction of incorporation) must have at least one female director no later than December 31, 2019, and must have at least two female directors (if they have five directors) or three female directors (if they have six or more directors) by December 31, 2021.15 Companies that are not in compliance face fines and public disclosure of their non-compliance. Publicly-held companies with principal executive offices in Illinois (regardless of jurisdiction of incorporation) must disclose in Illinois state filings the racial, ethnic, and gender diversity of their boards as soon as practical and no later than January 1, 2021.16 In addition, in legislation that was signed into law earlier this year, companies doing business in Maryland were urged by the state legislature to have a minimum of 30 percent of women directors by December 31, 2022 and are required to disclose the number of women on their boards in their annual personal property tax filings.17 

In addition, Scott Stringer, the New York City Comptroller who manages the New York City Retirement Systems fund, recently announced the third phase of the Boardroom Accountability Project, which is focused on board and management diversity. More specifically, Stringer 1) sent letters to the boards of 56 S&P 500 companies asking them to adopt a policy similar to the National Football League’s “Rooney Rule,” which would require that women and minority candidates be considered for every open board seat and every open chief executive officer position; and 2) announced that he will file shareholder proposals at companies that lack racial diversity in senior management.

Be Mindful of Director Overboarding

An area of increasing concern by investors and proxy advisory firms is the number of public company boards on which directors serve, often referred to as director overboarding. Both ISS and Glass Lewis have director overboarding policies. In addition, many large investors have also implemented voting policies regarding overboarded directors. A sampling of some of these policies is set forth below. The numbers in the table below correlate to the maximum number of boards on which the individual may serve before risking being considered overboarded.

Firm Name

Independent Directors   

CEO (including own board)

ISS18

5

3

Glass Lewis19

5

2*

Vanguard20

4

2*

State Street21

6

3

BlackRock22

4

2

J.P. Morgan Asset Management23

4

3

CalPERS24

4

2*

* Applies to named executive officers (Vanguard) or executive officers generally (Glass Lewis, CalPERS), not just CEOs.

Some companies have director overboarding policies included in their corporate governance guidelines. Those policies should be reviewed, particularly in light of any voting policies that have been adopted by significant stockholders. In addition, board members serving on more than four or five public company boards (or more than two public company boards in the case of CEOs) should be cautioned that they will likely receive substantially lower shareholder support than the other nominees up for election.  

Highlight Board Evaluations

Annual board self-evaluations are required by New York Stock Exchange listing rules, are best practice for public companies, and are an expected board practice by many investors and proxy advisory firms. Nearly all of the S&P 500 report undertaking annual board evaluations, with the prevalence of individual director evaluations (rather than just board and committee-level evaluations) increasing to 44 percent of S&P 500 companies in 2019, up from 38 percent in 2018 and 22 percent in 2009.25 Proxy statement disclosures relating to board and committee self-evaluations are one way to demonstrate efforts at improving the effectiveness of the board. Disclosure should include, at a minimum, that an annual evaluation has, in fact, been done, at both the board and committee level (and individual director level, if applicable). In addition, disclosures regarding the format used (for example, questionnaires or individual interviews), the process followed (for example, use of a third-party facilitator), and any actions taken in response to the self-evaluations, should also be considered.  

ESG Disclosures

Many institutional investors view ESG and sustainability disclosure as a way to gain insight into a board’s approach to risk management and have been increasingly vocal about their expectations for transparency and reporting on these issues. BlackRock’s 2019 shareholder engagement priorities included board composition and effectiveness, environmental risks and opportunities, and human capital management, and BlackRock recently indicated that it may support shareholder proposals on environmental and social issues if a company fails to demonstrate that it is handling these issues appropriately. Similarly, State Street’s investment stewardship report for 2018 and the first half of 2019 noted, that “[i]n addition to issues related to long-term strategy and board composition, we also incorporate material [ESG] concerns into our engagement efforts.”26 Further, Vanguard announced last year its intention to take more public positions on select governance topics, including climate risk and gender diversity.

The SEC has not proposed or adopted disclosure requirements or guidelines on ESG, and there is no single consensus on what key metrics or other reporting should look like. However, there are several resources focused on ESG issues. Recently, the U.S. Chamber of Commerce released a report on ESG reporting best practices, available here. In addition, the Sustainability Accounting Standards Board develops sustainability accounting standards to help companies disclose sustainability information to investors. It also provides education and resources that may provide helpful guidance with respect to sustainability disclosures.

As with governance generally, a one-size-fits-all approach to ESG disclosure is likely not the preferred outcome. Companies should engage with shareholders to understand their priorities. In addition, consider proxy or other publicly available disclosure enhancements regarding the actions already being taken. An articulate and well-reasoned discussion of the company’s approach to ESG and sustainability—even if the conclusion is that these issues have no material impact on the company—can provide significant comfort to investors that the board is appropriately discharging its obligation to manage all types of risk.

For full “credit” regarding ESG and sustainability initiatives, some discussion should be included in the proxy statement. Website disclosure alone can be hard to find and easy to overlook. Consider ways that the proxy statement can be used to highlight, cross-reference, and explain the company’s ESG and sustainability initiatives.

Responding to Shareholder Proposals

In September 2019, the Division announced 1) that it may respond orally instead of in writing to no-action requests and 2) that where it declines to state a view on a no-action request, this should not be interpreted as requiring that the shareholder proposal be included in the company’s proxy statement. When responding “orally,” Division staff will email or call the company and shareholder-proponent to let them know that a decision has been made and that it will soon be posted on the SEC website. The SEC’s decision will be included in a new chart on the SEC website, which is accessible here. The chart includes, among other things, the company’s regulatory bases for exclusion as well as, in cases where the staff concurs with the company’s no-action request, the basis upon which the staff concurs.

Excluding Shareholder Proposals

In October 2019, the Division staff published Staff Legal Bulletin (SLB) No. 14K providing guidance on the “ordinary business” exception and the proof of ownership requirements, in each case, under Rule 14a-8 of the Securities Exchange Act of 1934. Where a company seeks to use the “ordinary business” exception to exclude a shareholder proposal from its proxy statement, a careful review of the guidance provided in new SLB No. 14K, as well as prior Staff Legal Bulletins, is warranted. In addition, given this latest guidance, arguing that a shareholder proposal should be excluded from the proxy statement based on an overly technical reading of the ownership requirements in Rule 14a-8 is unlikely to be persuasive to the Division staff. For more detailed information on SLB No. 14K, please see our Client Alert.

Clean-Up Changes to Proxy Statement

As part of the new rules to modernize and simplify disclosure requirements in Regulation S-K (discussed above), the SEC adopted some clean-up changes for proxy statements, including the following:

  • The caption required by Item 405 was changed from “Section 16(a) Beneficial Ownership Reporting Compliance” to “Delinquent Section 16(a) Reports.” An instruction was also added to encourage companies to omit the caption if there are no disclosures to be made.
  • The outdated auditing standard reference in Item 407(d)(3)(i)(B) for purposes of the audit committee report in the proxy statement has been updated. The audit committee is now required to state that it has “discussed with the independent auditors the matters required to be discussed by the applicable requirements of the” PCAOB (emphasis added).

Consider Proxy Statement Enhancements

Review your proxy statement to see if there are areas for readability improvements. In particular, focus on areas where pictures, charts, and graphs could tell the story more easily or more convincingly than text. Also take a fresh look at how you are describing your voting standards to be sure that it aligns with your organizational documents and other applicable voting requirements (such as relevant tax law or stock exchange requirements), as this continues to be an area of focus for the SEC.

Many companies include an “executive summary” at the start of their proxy statements and in the beginning of their compensation discussion and analysis section (CD&A). Institutional investors often say that a tailored summary—that appropriately focuses on the key metrics, particularly around executive compensation—greatly enhances their ability to review a proxy statement.

Additional Proxy-Related Items to Consider 

  • Preliminary Proxy Statements. Start thinking about the matters that will be submitted for a vote at the annual shareholder meeting, particularly if those matters will require the filing of a preliminary proxy statement.
  • Review Disclosures Carefully. While accounting teams should tick and tie many of the numbers in the proxy statement, double check and review your disclosures carefully, including disclosures of late Section 16 filings.

Emerging Growth Company Considerations

Transition from Emerging Growth Company Status27

If a company’s status as an emerging growth company will terminate as of the end of its current fiscal year, the next year’s proxy statement will require several enhancements, including compensation disclosure that is not limited to the principal executive officer and the two highest paid other executive officers and a full CD&A section. Further, a company is required to hold a say-when-on-pay vote the first year in which it is no longer an emerging growth company. It is recommended that the first say-on-pay vote be held at the same time, even if the company can take advantage of a longer transition period (due to being an emerging growth company for less than two years). In addition, pay ratio disclosure will apply for the first full fiscal year that a company ceases to be an emerging growth company. For example, if a calendar-year company ceases to be an emerging growth company at the end of 2019, pay ratio disclosure will be required in 2021 with respect to fiscal year 2020.

Compensation Considerations

Review Pay Ratio Disclosure

Review the process used and assumptions made for preparing the pay ratio disclosure to see if any updates are necessary or improvements could be made. In addition, review the disclosure of peers and governance leaders to see if any improvements could be made in your disclosure, including enhancements that may explain why your ratios may differ materially from your peers. As a reminder, it is recommended that the pay ratio disclosure appear outside of the CD&A, as it was not part of the executive compensation program.

Begin Preparing the 2020 CD&A Section

Prepare key business milestones to support executive compensation decisions and payouts and for possible inclusion in an executive summary for the CD&A. As compensation decisions are made in the next few months for many companies, consider how they will be described and explained in the 2020 CD&A section and begin preparing draft disclosure.

Review 2020 Peer Group Selection

With the compensation committee, review your compensation peer group for appropriateness and any changes (including as the result of acquisitions and bankruptcies). Consider using any views expressed by proxy advisory firms as to the appropriateness of your current peer group as one input in setting the 2020 peer group.

Review 162(m) Disclosure

The Tax Cuts and Jobs Act eliminated the performance-based exception under Section 162(m) and somewhat expanded the number of officers subject to the $1 million-per-year cap in tax deductibility of compensation. As a result, annual compensation in excess of $1 million paid to any individual covered by 162(m) will not be tax deductible. CD&A and proxy statement proposals for equity need to reflect this change. 

Equity Plan Checkup

Ensure that:

  • There are sufficient shares in your equity plans for planned grants in 2020.
  • Your equity plans are not expiring soon.
  • All necessary equity plan shares have been registered on a Form S-8 registration statement and appropriate filings have been made with the applicable stock exchange.
  • All forms of award agreements have been filed.

Additional Compensation-Related Items to Consider

Given the litigation environment surrounding director pay, consider whether to have shareholders approve director pay. Previously, companies typically did this by including meaningful limits in a compensation plan that shareholders were asked to approve. Based on recent litigation in Delaware, director pay will likely be subject to an entire fairness standard of review unless shareholders approve actual director compensation or a hardwired formula by which director compensation will be paid. However, to date, only a small number of companies have followed these more protective approaches.

For several years, many companies have received demand letters from plaintiffs claiming that share withholding or net settlement is not exempt from being matched as a disposition under the Section 16 short swing profit rules. The theory on which the demand is based is weak, but there are prophylactic measures that you can take to ensure that you are in the clear if you receive one of these demands.


[1] See “SEC Rulemaking Over the Past Year, the Road Ahead and Challenges Posed by Brexit, LIBOR Transition and Cybersecurity Risks,” Speech by Chairman Jay Clayton, New York, N.Y., Dec. 6, 2018, located at https://www.sec.gov/news/speech/speech-clayton-120618 (last accessed on Dec. 4, 2019).

[2] See “Applying a Principles-Based Approach to Disclosing Complex, Uncertain and Evolving Risks,” Remarks at the 18th Annual Institute on Securities Regulation in Europe by William Hinman, Director of Division of Corporation Finance, London, England, March 15, 2019, located at https://www.sec.gov/news/speech/hinman-applying-principles-based-approach-disclosure-031519 (last accessed on Dec. 4, 2019).

[3] See Staff Statement on LIBOR Transition, Division of Corporation Finance, Division of Investment Management, Division of Trading and Markets, and Office of the Chief Accountant, July 12, 2019, located at https://www.sec.gov/news/public-statement/libor-transition (last accessed on Dec. 4, 2019).

[4] See SEC Comments and Trends, An analysis of current reporting issues, Ernst & Young, September 2019, located at https://www.ey.com/publication/vwluassetsdld/seccommentstrends_06976-191us_18september2019/$file/seccommentstrends_06976-191us_18september2019.pdf?OpenElement (last accessed on Dec. 4, 2019).

[5] See U.S. Board Diversity Trends in 2019, ISS Analytics, June 18, 2019, located at https://corpgov.law.harvard.edu/2019/06/18/u-s-board-diversity-trends-in-2019/ (last accessed on Dec. 4, 2019).

[6] See 2019 Proxy Season Review, a Broadridge + PwC Initiative, located at https://www.pwc.com/us/en/governance-insights-center/publications/assets/pwc-broadridge-proxypulse-2019-proxy-season-review.pdf (last accessed on Dec. 4, 2019).

[7] Id.

[8] See 2019 Annual Corporate Governance Review, Georgeson in partnership with Proxy Insight Ltd.

[9] Id.

[10] See 2019 Annual Corporate Governance Review, Georgeson in partnership with Proxy Insight Ltd.

[11] See United States Proxy Voting Guidelines Benchmark Policy Recommendations, Effective for Meetings on or after February 1, 2020, published November 18, 2019, p.11, located at https://www.issgovernance.com/file/policy/latest/americas/US-Voting-Guidelines.pdf (last accessed on Dec. 4, 2019). ISS will consider the following as mitigating factors: 1) until February 1, 2021, a firm commitment in the proxy statement to add at least one woman to the board within a year and 2) the presence of a woman on the board at the preceding meeting and a firm commitment to appoint at least one woman to the board within a year.

[12] See 2020 Proxy Paper Guidelines An Overview of the Glass Lewis Approach to Proxy Advice United States, p. 24, located at https://www.glasslewis.com/wp-content/uploads/2016/11/Guidelines_US.pdf (last accessed on Dec. 4, 2019). Glass Lewis may refrain from recommending a vote against or withhold from directors of companies outside of the Russell 3000 index, or if companies have provided sufficient rationale for not having any female board members, for example, a disclosed timetable to add female directors, a plan to address the issue, or any restrictions regarding board composition.

[13] See CalPERS Proxy Voting Guidelines, September 2019, p. 2, located at: https://www.calpers.ca.gov/docs/proxy-voting-guidelines.pdf (last accessed on Dec. 4, 2019).

[14] See State Street Global Advisors Stewardship Report, 2018-19, located at https://www.ssga.com/investment-topics/environmental-social-governance/2019/09/annual-asset-stewardship-report-2018.pdf (last accessed on Dec. 4, 2019).

[15] Senate Bill No. 826, signed into law on September 30, 2018, located at https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201720180SB826 (last accessed on Dec. 4, 2019).

[16] Pub. Act 101-0589, effective August 27, 2019, located at http://www.ilga.gov/legislation/publicacts/fulltext.asp?Name=101-0589 (last accessed on Dec. 4, 2019).

[17] HB1116, cross-filed with SB0911, Gender Diversity in the Boardroom – Annual Report, effective October 1, 2019, located at http://mgaleg.maryland.gov/2019RS/Chapters_noln/CH_513_hb1116e.pdf (last accessed on Dec. 4, 2019).

[18] See United States Proxy Voting Guidelines Benchmark Policy Recommendations, Effective for Meetings on or after February 1, 2020, published November 18, 2019, p.11, located at https://www.issgovernance.com/file/policy/latest/americas/US-Voting-Guidelines.pdf (last accessed on Dec. 4, 2019).

[19] See 2020 Proxy Paper Guidelines An Overview of the Glass Lewis Approach to Proxy Advice United States, p. 17, located at https://www.glasslewis.com/wp-content/uploads/2016/11/Guidelines_US.pdf (last accessed on Dec. 4, 2019).

[20] See Vanguard funds, Proxy voting guidelines for U.S. portfolio companies, effective April 1, 2019, p. 4, located at https://about.vanguard.com/investment-stewardship/portfolio-company-resources/proxy_voting_guidelines.pdf (last accessed on Dec. 4, 2019).

[21] See 2019 Proxy Voting and Engagement Guidelines: North America, March 27, 2019, located at https://corpgov.law.harvard.edu/2019/03/27/2019-proxy-voting-and-engagement-guidelines-north-america/#1b (last accessed on Dec. 4, 2019).

[22] See BlackRock, Proxy voting guidelines for U.S. securities, January 2019, p. 3, located at https://www.blackrock.com/corporate/literature/fact-sheet/blk-responsible-investment-guidelines-us.pdf (last accessed on Dec. 4, 2019).

[23] See Global Proxy Voting Procedures and Guidelines, North America, Europe, Middle East, Africa, Central America, South America, and Asia, April 1, 2019, p. 10, located at https://am.jpmorgan.com/blob-gim/1383433248923/83456/2019_Global%20Procedures%20and%20Guidelines_FINAL.pdf (last accessed on Dec. 4, 2019).

[24] See CalPERS Proxy Voting Guidelines, September 2019, p. 2, located at: https://www.calpers.ca.gov/docs/proxy-voting-guidelines.pdf (last accessed on Dec. 4, 2019).

[25] See 2019 U.S. Spencer Stuart Board Index, located at https://www.spencerstuart.com/-/media/2019/ssbi-2019/us_board_index_2019.pdf (last accessed on Dec. 4, 2019).

[26] State Street Global Advisors Stewardship Report, 2018-19, located at https://www.ssga.com/investment-topics/environmental-social-governance/2019/09/annual-asset-stewardship-report-2018.pdf (last accessed on Dec. 4, 2019).

[27] Emerging growth company status terminates on the earliest of: 1) the last day of the first fiscal year in which the company’s annual gross revenues exceed $1.07 billion; 2) the date on which the company is deemed to be a large accelerated filer; 3) the date on which the company has, during the previous three-year period, issued more than $1 billion in non-convertible debt; and 4) the last day of the fiscal year in which the fifth anniversary of the company’s first sale of equity securities pursuant to an effective registration statement occurs.

A company becomes a large accelerated filer as of the end of the first fiscal year when it 1) has an aggregate market value of voting and non-voting common equity held by non-affiliates of $700 million or more as of the last business day of the company’s most recently completed second fiscal quarter; 2) has been a public reporting company for a period of at least 12 calendar months; and 3) has filed at least one annual report on Form 10-K.

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