ISS Releases 2013 Updates to Proxy Voting Guidelines

On November 16, 2012, the ISS released its final 2013 Updates to its U.S. Corporate Governance Policy. ISS also will release a FAQ document in December 2012 for further guidance. The Updates will be effective for meetings on or after February 1, 2013.

Highlights of the 2013 Updates include:

• Stock Pledges/Hedges: In response to comments, ISS will be taking a case-by-case approach in determining whether pledging of company shares rises to a level of serious concern for shareholders. Also in response to comments, ISS is including significant pledging of company stock as a failure of risk oversight and thus considered a governance failure for which directors should be held accountable (rather than communicating concern through a say-on-pay recommendation as originally proposed). However, hedging of company stock, through covered call, collar or other derivative transactions, will be considered a problematic practice warranting a negative voting recommendation on the election of directors.

• Failure to Act on Shareholder Proposals: ISS will keep its current policy in effect for 2013, with some modifications: ISS will recommend a negative vote for individual directors, committee members or the entire board, if the board failed to act on a shareholder proposal that received the support of either (i) a majority of the outstanding shares or (ii) a majority of the votes cast in the last year and one of the two previous years. Beginning in 2014, ISS will recommend a vote negative vote if the board failed to act on a shareholder proposal that received the support of a majority of shares cast in the previous year. Under the Update, the ISS now has the flexibility to recommend a negative vote on members of the board as deemed appropriate, not necessarily the full board. The ISS also has included more guidance on the case-by-case examination of the sufficiency of a company’s action in response to a majority-supported shareholder proposal.

• Peer Groups: The new methodology incorporates information from companies’ self-selected pay benchmarking peer groups in order to identify and prioritize Global Industry Classification Standard (GICS) industry groups beyond the subject company’s own GICS classification. The methodology draws peers from the subject company’s GICS group as well as from GICS groups represented in the company’s peer group, while maintaining the approximate proportions of these industries in the final peer group where possible. The methodology additionally focuses initially at an 8-digit GICS resolution to identify peers that are more closely related in terms of industry. Finally, when selecting peers, the methodology prioritizes peers that maintain the company near the median of the peer group, are in the subject company’s peer group, and that have chosen the subject company as a peer. The peer group methodology maintains its focus on identifying companies that are reasonably similar to the subject company in terms of industry profile, size, and market capitalization. Other changes to the peer group methodology include using slightly relaxed size requirements, especially at very small and very large companies, and using revenue instead of assets for certain financial companies.

• Realizable Pay: Realizable pay is being added to the research report for large capitalization companies. Realizable pay will consist of the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured, based on equity award values for actual earned awards, or target values for ongoing awards, calculated using the stock price at the end of the performance measurement period. Stock options or stock appreciation rights will be revalued using the remaining term and updated assumptions, as of the performance period, using the Black-Scholes Option Pricing model. The realizable pay consideration may mitigate or exacerbate the CEO’s pay for performance concerns.

• Voting on “Say on Golden Parachute” Proposals: The Update will (i) include existing change-in-control arrangements maintained with named executive officers rather than focusing only on new or extended arrangements and (ii) place further scrutiny on multiple legacy problematic features (e.g. single trigger equity, tax gross –ups, etc.) in change in control agreements.

ISS Releases Proposed Updates to Proxy Voting Guidelines for Comment

The ISS recently released its 2013 proposed updates to their proxy voting guidelines. Five proposals would affect US based companies, of which one was directed at shareholder proposals and four focused on executive compensation, as follows:
• ISS would recommend a vote AGAINST or WITHHOLD from the entire board if the board failed to act on a shareholder proposal that received the support of a majority of shares cast in the previous year. Currently, ISS would make such a recommendation only if the proposal received the support of either (i) a majority of the outstanding shares or (ii) a majority of the votes cast in the last year and one of the two previous years.
• A revision in the methodology for selecting peer groups for executive compensation comparisons in say-on-pay proposals.
• The use of a comparison of realizable pay to grant date pay as part of the evaluation of pay-for-performance alignment.
• Adding the pledging of company shares by directors and officers as a factor that may lead to negative recommendations under the existing problematic pay practices evaluation.
• A change on say-on-golden parachute proposals to (i) include existing change-in-control arrangements maintained with named executive officers rather than focusing only on new or extended arrangements and (ii) to place further scrutiny on multiple legacy problematic features (e.g. single trigger equity, tax gross –ups, etc.) in change in control agreements.
The full proposals are available at http://www.issgovernance.com/policycomment2013. The comment period expires on October 31, 2012.

SEC Issues Letter to New Investment Advisers Regarding Presence Exams

On October 9, 2012, the Office of Compliance Inspections and Examinations (OCIE) of the SEC issued a letter directed to senior officers of newly registered investment advisers that manage private equity funds introducing them to the National Exam Program (NEP). The letter explains that the NEP is launching an initiative to conduct Presence Exams, which are focused, risk-based examinations of investment advisers to private funds.  In the letter, the SEC explains that the Presence Exams initiative will take place over the next two years and will be comprised of three phases: engagement, examination and reporting. 

Engagement Phase.  The NEP is currently engaged in an outreach program to inform newly registered investment advisers about their obligations under the Advisers Act.  As part of such outreach, the NEP has published various materials, including staff letters, risk alerts, special studies and speeches.  The letter contains a list of some of these resources and their reference links. 

Examination Phase.  The letter states that the NEP staff will contact advisers separately if and when they are selected for an examination.  If an adviser is selected for examination, the NEP staff will review one or more of the following higher risk areas: marketing, portfolio management, conflicts of interest, safety of client assets and valuation.   Upon completion of an on-site examination, the NEP staff may send the investment adviser a letter (i) indicating that the exam has concluded without findings, or (ii) describing the deficiencies identified and asking the firm to take corrective action.  Serious deficiencies may be referred to the Division of Enforcement of the SEC or other regulators.

Reporting Phase.  Upon completion of the examination phase, the NEP will report its observations, such as common practices and industry trends, to the SEC and the public.

NASDAQ Has Proposed Changes to Its Compensation Committee Rules. What Should We Do Now?

If you work for a Nasdaq-listed company, you should pay close attention to Nasdaq’s proposal related to compensation committees rules.  The proposal was issued last week in response to the SEC’s Rule 10C-1 and Section 952 of the Dodd-Frank Act that required the SEC to direct the national securities exchanges to prohibit the listing of any equity security of an issuer, subject to certain exemptions, that does not comply with the Act’s requirements relating to compensation committees and compensation advisers. 

 Summary of Nasdaq’s Proposal

 Generally, Nasdaq has proposed the following changes to its compensation committee rules:

  •  companies must have a compensation committee consisting of at least two members, each of whom must be an independent director as defined in Nasdaq’s current listing rules;
  • compensation committee members must not accept directly or indirectly any consulting, advisory or other compensatory fee, other than for board service, from a company or any subsidiary thereof;
  • in determining whether a director is eligible to serve on a compensation committee, a company’s board of directors must consider whether the director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company; and
  •  companies must adopt a formal, written compensation committee charter that must specify, among other matters, the compensation committee responsibilities and authority as set forth in Rule 10C-1 relating to the: (i) authority to retain compensation consultants, independent legal counsel and other compensation advisers; (ii) authority to fund such advisers; and (iii) responsibility to consider certain independence factors before selecting such advisers, other than in-house legal counsel.

 Effective Dates

 Proposed Nasdaq Listing Rule 5605(d)(3), which requires compensation committees to have the specific responsibilities and authority relating to compensation consultants, independent legal counsel and other compensation advisers, will be effective immediately upon the SEC’s approval of the Nasdaq’s proposal. 

 Nasdaq-listed companies must comply with the remaining amended listing rules described aboveby the earlier of: (1) their second annual meeting held after the date of approval of the proposed rules; or (2) December 31, 2014.  A company must certify to Nasdaq, no later than 30 days after the implementation deadline applicable to it, that it complied with the amended listing rules on compensation committees (Nasdaq will provide a form for this certification).

 What Should We Do Now?

 Please see below a list of suggested action items in connection with such proposals:

  1.  If you do not have a compensation committee and a majority of independent directors is making, or recommending to the board, compensation decisions related to executive officers of the company, start evaluating potential candidates for compensation committee membership.
  2. If you have a compensation committee consisting of one director, start evaluating potential candidates to expand the compensation committee to two members, as suggested by the SEC, or even to three members in order to avoid giving each director a veto power.
  3. Consider whether existing members of the compensation committee or potential members of the compensation committee are getting any compensatory fees from the company or any of its subsidiaries or are affiliated with the company or a subsidiary of the company or an affiliate of a subsidiary of the company.  Evaluate whether any changes to the current composition of the compensation committee are necessary.
  4. Implement new responsibilities and authority applicable to compensation committees, or independent directors involved in compensation decisions, relating to: (i) authority to retain compensation consultants, independent legal counsel and other compensation advisers; (ii) authority to fund such advisers; and (iii) responsibility to consider certain independence factors before selecting such advisers through a charter amendment or board resolution.
  5. Draft a new, or revise an existing, compensation committee charter.

 

NYSE Amends its Compensation Committee and Committee Adviser Independence Proposed Rules

Yesterday the NYSE filed an amendment to its proposed compensation committee and committee adviser independence rules.  According to the rule filing, the amendment corrects an error in the rule text under the heading “Transition Periods for Compensation Committee Requirements.”  According to the amended rule text, listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new director independence standards with respect to compensation committees.  The other proposed rules, including those related to compensation committee advisers, will become effective on July 1, 2013.

NYSE Proposes New Rules Related to Compensation Committee and Committee Adviser Independence

Earlier this week, the NYSE filed proposed rule changes with the SEC related to compensation committee independence and the hiring of compensation advisers.  The NYSE proposed such rules to comply with Exchange Act Rule 10C-1 adopted in June.  Rule 10C-1 requires national securities exchanges to adopt listing standards which effectuate the compensation committee and committee adviser independence requirements of Section 952 of the Dodd-Frank Act.   The NYSE’s proposed rules do not expand upon or vary much from the SEC rules.  The NYSE proposed to have its new listing standards effective on July 1, 2013; however, companies would have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the such new standards.  Set forth below is a summary of the NYSE’s proposed rules:

 Compensation Committee Independence

The NYSE proposed rules do not establish any new bright line standards specific to compensation committee independence.  Instead, the NYSE proposed rules require that, in affirmatively determining the independence of any director who will serve on a compensation committee, a listed company’s board “consider all  factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to, the two factors explicitly enumerated in Rule 10C-1(b)(ii)”:

  • the source of the director’s compensation, including any consulting, advisory or other compensatory fee paid by the listed company to such director; and
  • whether the director has an affiliate relationship with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.

The proposing release specifically provides that the NYSE does not believe that board compensation should be considered as part of the independence determination.  Further, commentary to the proposed NYSE rules provides that “the board should consider whether the director receives compensation from any person or entity that would impair his ability to make independent judgments about the listed company’s executive compensation. Similarly, when considering any affiliate relationship a director has with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company, in determining his independence for purposes of compensation committee service,. . . the board should consider whether the affiliate relationship places the director under the direct or indirect control of the listed company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair his ability to make independent judgments about the listed company’s executive compensation.”

 Compensation Committee Adviser Independence

The NYSE proposed rules related to compensation committee advisers provide that prior to hiring a compensation adviser, the compensation committee must consider the six factors set forth in Rule 10C-1(b)(4).  The NYSE proposed rules do not add any factors for a compensation committee to consider prior to hiring an adviser, as the “Exchange believes that the list included in Rule 10C-1(b)(4) is very comprehensive and the proposed listing standard would also require the compensation committee to consider any other factors that would be relevant to the adviser’s independence from management.”

The NYSE’s proposed new rules are subject to SEC review and comment.  We believe it is unlikely that the SEC will have many objections to the proposed rules, as they essentially mirror the SEC’s rules.  In light of the NYSE proposed rules, NYSE listed companies should be reviewing their compensation committee charters, the composition of the compensation committee and their relationships with the compensation advisers in order to identify whether any modifications or changes may be in order to comply with the coming NYSE standards.

Last Minute Summer Reading Alert! SEC Adopts Rules Regarding Conflict Minerals and Resource Extraction Payments

           If you were concerned that you had finished all your summer reading with time to spare, worry no more.  The SEC has adopted a total of 588 pages of final rules regarding disclosures of the use of conflict minerals and payments by resource extraction issuers.

          The new rules were adopted on August 22, 2012.   Both rules were mandated by the Dodd-Frank Act and apply to all reporting companies (including foreign issuers and smaller reporting companies).  Congress enacted the conflict minerals requirement out of concerns that the exploitation and trade of “conflict minerals” by armed groups was helping to finance conflict in the Democratic Republic of the Congo (DRC) and adjoining countries.  Congress enacted the resource extraction payments disclosure to increase the transparency of payments made by oil, natural gas and mining companies to foreign governments so that, in theory, the citizens of those countries could hold their governments accountable for the wealth generated by those resources.

            The conflict minerals rule will require reporting companies that use certain minerals, including gold, tin, tungsten and tantalum, that are “necessary to the functionality or production” of a product manufactured or contracted to be manufactured by the company, to make disclosures on new Form SD (rather than as an exhibit to Form 10-K as originally proposed).  The rule requires that the company make a reasonable inquiry to determine whether any of the conflict minerals originated in the DRC or an adjourning country and, based on the results of that inquiry, make disclosures including, in some cases, a Conflict Minerals Report that will require an independent private sector audit.  There is no de minimis standard in the rule.   All issuers are required to use the same reporting period, the calendar year, regardless of fiscal year.  The first report is due on or before May 31, 2014 for the 2013 calendar year and no later than May 31st every year thereafter.

            The resource extraction payment rule will require reporting companies that are engaged in the commercial development of oil, natural gas or minerals to disclose certain payments (including taxes, royalties, fees, bonuses, dividends and costs of infrastructure improvements) made to foreign governments (including foreign local governments) or the U.S. government.  Payments (including a series of related payments) of less than $100,000 are considered de minimis under the rule and need not be disclosed.

            As with the conflict minerals rules, disclosure will be made on Form SD, but are required to be filed within 150 days after the end of the issuer’s fiscal year.  Issuers are required to comply with the new rules for fiscal years ending after September 30, 2013. For the first report, most resource extraction issuers may provide a partial report disclosing only those payments made after September 30, 2013.

            Both rules provide that the disclosures will be deemed “filed” and not “furnished” (as had originally been proposed), thereby imposing potential liability under the Securities Exchange Act, but no separate CEO and CFO certifications will be required.

SEC to hold Sunshine Act Meeting

The SEC announced yesterday that on August 22, 2012 at 10:00 a.m. it will hold an open meeting to consider:

  • whether to adopt rules regarding disclosure and reporting obligations with respect to the use of conflict minerals;
  • whether to adopt rules regarding disclosure and reporting obligations with respect to payments to governments made by resource extraction issuers; and
  • rules to eliminate the prohibition against general solicitation and general advertising in securities offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933, as amended and Rule 144A promulgated thereunder.

What has changed in compensation committee requirements and disclosures after the issuance of the new SEC release last week? What should we do now?

Due to the SEC’s adoption of a new Rule 10C-1, Listing Standards Relating to Compensation Committees, we are one step closer to having the mandate of Section 952 of the Dodd-Frank Act fully implemented and to securities exchanges adopting listing standards relating to the independence of the compensation committee members, the committee’s authority to retain compensation advisers, and the committee’s responsibility for the appointment, compensation and oversight of the work of a compensation adviser. Each national securities exchange must provide to the SEC proposed rules that comply with Rule 10C-1 no later than September 25, 2012 and must have final rules that comply with Rule 10C-1 no later than June 27, 2013.

Public companies will also have to comply with a new disclosure requirement related to the conflicts of interest of compensation consultants in any proxy statement for a meeting of shareholders at which directors will be elected occurring on or after January 1, 2013.  Pursuant to this new requirement under Item 407(e)(3)(iv) of Regulation S-K,  public companies will have to disclose the nature of the conflict of interest, if any, related to the compensation consultant’s work on executive and director compensation and how the conflict is being addressed. 

In addition to monitoring the rulemaking of national securities exchanges related to the implementation of Rule 10C-1 directives, public companies should consider taking the following actions in connection with the required analysis of the conflicts of interest related to the work of a compensation consultant:

  • establish procedures for obtaining information about (i) all services provided to the company by the compensation consultant and the entity that employs the consultant during the last completed fiscal year, (ii) the amount of fees received from the company by the entity that employs the compensation consultant as a percentage of the total revenue of such entity, and (iii) any stock of the company owned by the compensation consultant;
  • request and review the policies and procedures of the entity that employs the compensation consultant that are designed to prevent conflicts of interest; and
  • update directors’ and officers’ questionnaires to include questions related to the business or personal relationships of (i) the compensation consultant with a member of the compensation committee; and (ii) the compensation consultant, or the entity employing the compensation consultant, with an executive officer of the company.

SEC Extends Compliance Date for Third-Party Solicitor Provisions of Advisers Act Pay-to-Play Rule

On June 8, 2012, the SEC extended the compliance date for the third-party solicitor provisions of Rule 206(4)-5 of the Advisers Act (the “Pay-to -Play Rule”). The Pay-to-Play Rule, among other things, prohibits an adviser from providing or agreeing to provide, directly or indirectly, compensation to any person to solicit a government entity for investment advisory services on behalf of such adviser unless the person is an executive officer, general partner, managing member or employee of the adviser, or such person is a registered investment adviser, a registered broker-dealer, or a registered municipal adviser. 

The SEC extended the compliance date for the third-party solicitor provisions of the Pay-to-Play Rule until nine months after the compliance date of a final rule adopted by the SEC related to the registration of municipal advisor firms. Once the final rule regarding the registration of municipal advisor firms is adopted, the SEC will issue the new compliance date for the ban on third-party solicitations.