As we head into a new proxy season, this SEC order involving settled charges against Leaf Group Ltd. might be a good case to keep in mind. In this case, the SEC charged that Leaf did not adequately identify and analyze—and did not maintain effective disclosure controls and procedures to identify and analyze— whether some of its directors were “independent” and whether there were “interlocking relationships between its directors and executive officers,” which led to “material misstatements and omissions in certain of its public filings,” including its proxy statement. As part of the settlement, Leaf was ordered to pay a civil penalty of $325,000. The company’s alleged failings as outlined in the order might serve to augment your seasonal checklist for examining issues of director independence.
According to the order, Leaf is a digital media and e-commerce company and, prior to its acquisition in June 2021, Leaf’s common stock was traded on the NYSE. As a result, Leaf was subject to the disclosure requirements regarding director independence of the Exchange Act and listing requirements of the NYSE. The NYSE requires that listed companies have a majority of independent directors, as defined by the NYSE. Under Reg S-K Item 407, companies are required to identify in their proxy statements and Forms 10-K each director who is independent under the independence standards of the national securities exchange on which the company’s securities are listed, in this case, the NYSE. In addition, companies are required to describe, under the caption “Compensation Committee Interlocks and Insider Participation,” relationships that exist if an executive officer served, during the last fiscal year, as a member of the comp committee of another entity, one of whose executive officers served as a director of the issuer. The independence standards of the NYSE provide that a director is not independent if the director is, or has been within the last three years, employed as an executive officer of another company where any of the listed company’s present executive officers at the same time serves or served on that company’s compensation committee.
The order alleges that, before its annual shareholder meeting in May 2019, Leaf was facing the possibility of an election contest. To avoid the contest, the company announced that it would explore “strategic alternatives” and appoint a new, independent director to the board with a term expiring in May 2020. Before the proxy statement was filed, Leaf’s board determined that the director to be appointed was “independent” under NYSE listing standards. After the annual meeting, the board appointed the new director to chair a new independent committee to oversee the review of strategic alternatives.
As you probably anticipated from the introduction to this post, in September 2019, as alleged in the order, the new independent director became CFO of a separate public company. And guess who was on that company’s board and comp committee? Leaf’s CEO of course, thus creating a comp committee interlock. As a result, the new “independent” director chairing the “independent” strategic alternatives committee was no longer independent under NYSE listing standards.
In Leaf’s proxy statement for its 2020 annual meeting, the new director was among directors nominated to the board and up for a vote. The 2020 proxy statement, which was incorporated into Leaf’s Form 10-K, described all of Leaf’s directors, other than the CEO, as “independent” and “independent under NYSE listing standards” and described all of Leaf’s standing board committees, including the strategic alternatives committee, as “independent under all applicable NYSE listing standards.” Finally, and not surprisingly, under the caption “Compensation Committee Interlocks and Insider Participation,” the 2020 proxy statement stated that there were no interlocking relationships at any time during fiscal 2019. The order characterizes all of these statements as “material misstatements.”
In May, the order alleges, the company announced that the strategic review had concluded and again misstated that the committee conducting the review was independent. The press release was filed on a Form 8-K. The order indicates that, “[a]lthough Leaf believed that all of the directors on the committee were independent under Delaware law, the May Form 8-K did not reference any alternative definition for ‘independence’ different from the NYSE standards previously referenced in Leaf’s 2020 Proxy Statement and Form 10-K.”
Then, a Form 8-K filed in July disclosed that the new director, who had been appointed to Leaf’s audit committee in May 2020, was now off the committee because he was “unable to serve on the Committee under applicable NYSE rules.” However, the order charges, the Form 8-K failed to disclose that the reason he was “unable to serve” on the audit committee was that he was not “independent” under the NYSE standards, contrary to Leaf’s prior disclosures regarding this director.
As seems to now be routine for the SEC in these types of cases, the SEC also charged that Leaf “did not maintain disclosure controls or procedures to identify and analyze potential director independence and interlock issues for disclosure in its proxy statements, Forms 10-K, and Forms 8-K during 2019 and 2020.” Some of Leaf’s procedures failed, the SEC alleged, resulting in the company’s not collecting the necessary information, such as a failure to
“send and/or collect independence questionnaires from its CEO and the New Director in advance of drafting the 2020 Proxy Statement, even though it had done so in advance of drafting the prior year’s proxy statement. Additionally, Leaf did not have a procedure for complying with its written Code of Business and Ethics, which required Leaf to present director conflicts to its board of directors for potential waiver and disclosure. The New Director and Leaf’s CEO each separately asked Leaf’s counsel, by September 2019, whether the New Director’s CFO position posed an independence problem, but the matter was not presented to Leaf’s board for consideration and potential disclosure as a conflict of interest.”
Similarly, the order alleged, although the 2020 proxy statement stated that the board had determined which of its members were independent under NYSE listing standards, the board “did not consider or pass a resolution determining which of its directors qualified as ‘independent’ under NYSE listing standards until after its 2020 annual meeting.” The order also noted that, when the new director was appointed to Leaf’s audit committee, the board relied on an outdated independence review from 2019; there was no “contemporaneous collection or review of information” in 2020 to determine his independence.
The SEC charged that, as a result of the alleged material misstatements and omissions in various SEC reports and proxy statements, Leaf violated Section 13(a) of the Exchange Act and Rules 13a-1, 13a-11, and 12b-20 thereunder, and Section 14(a) of the Exchange Act and Rules 14a-3 and 14a-9 thereunder. In addition, the SEC charged that Leaf violated the disclosure controls and procedures provisions of Exchange Act Rule 13a-15(a). As noted above, Leaf agreed in settlement to pay a civil penalty of $325,000.