2013 Annual Meeting Season
Dear clients and friends,
We present to you 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. In this issue, we are including our customary articles on recent SEC, NYSE/Nasdaq and other corporate law developments. ISS, Glass Lewis and other proxy advisory firms continue to have increasing influence on public companies’ corporate governance policies, executive pay and the related disclosures about these matters and we have devoted special attention in this issue to policy updates that will take effect in the 2013 proxy season.
Jeff Beck’s Quarterly Tidbit of Interest:
Quote from Robert Khuzami, Director of the SEC’s Division of Enforcement (November 16, 2012):
“That is why we work every day to find evidence of wrongdoing and to pursue such wrongdoing whenever and wherever it occurs. Indeed, in the last two years the SEC has brought the two highest number of enforcement actions in the agency’s history.”
During 2013, members of our Business & Finance 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 Fifth Annual Public Company Proxy Season Update, which will be held in our Phoenix office on January 10, 2013. Finally, we are pleased to present our 2012 Tombstone, which highlights selected deals that Snell & Wilmer’s Business & Finance Group helped our clients close during the year. As always, we appreciate your relationship with Snell & Wilmer and we look forward to helping you make 2013 a successful year.
Very truly yours,
Snell & Wilmer L.L.P.
Business & Finance Group
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Dealing with ISS and Other Proxy Advisory Firms this Proxy Season
Set forth below are summaries of key ISS and Glass Lewis policy updates that will take effect for the 2013 proxy season.
ISS Policy Updates
- Revised Peer Group Methodology. ISS modified its peer group methodology to consider a public company’s self-selected peer group, recognizing that the peer groups historically used by ISS sometimes omitted competitors of the subject company and/or included companies that were not appropriate for pay-related comparisons. ISS also “slightly relaxed” its size requirements (primarily affecting very small and very large companies), although the firm stressed that it will continue to emphasize similarities in industry profile, size and market capitalization when formulating peer groups for purposes of its pay-for-performance quantitative analyses.
- Analysis of “Realizable” Pay. In 2012, ISS observed more companies disclosing “realizable” total compensation in addition to the “grant date fair value” amounts required under SEC rules. In providing such additional disclosure, public companies attempt to show not only the Compensation Committee’s intent when it makes executive compensation decisions, but also how that compensation is subsequently affected by gains or losses in the company’s stock price. Beginning in 2013, ISS will include “realizable pay” in its qualitative analysis for large capitalization companies. Such pay will consist of the sum of cash and equity awards for the applicable performance period, with equity awards (whether actually earned or based on target future achievement) being valued using the stock price at the end of the performance period. Stock options and stock appreciation rights (SARs) will be valued using a Black Scholes model. ISS noted that its consideration of “realizable pay” could mitigate—or exacerbate—an individual company’s pay-for-performance concerns arising from the preliminary quantitative analysis.
“Majority-Supported” Shareholder Proposals
- Historical Standard; Investor Feedback. Historically, ISS recommended a vote against the full board of directors if it failed to act on a shareholder proposal that received the support of a majority of the shares outstanding in the last year, or a majority of the shares cast in the last year and one of the two previous years. In a 2012 survey of institutional investors, ISS observed that 86 percent of respondents would expect a public company’s board to implement a shareholder proposal approved by a majority of the votes cast at the previous annual meeting (even if less than a majority of the shares issued and outstanding).
- 2013 Transition Rule. In response to that feedback, and to provide for more flexibility in its recommendations, pursuant to a transition policy effective for the 2013 proxy season, ISS will recommend a vote against individual directors, committee members or the full board (as appropriate) if the board failed to act on a shareholder proposal that received the support of (i) a majority of the shares outstanding the previous year or (ii) a majority of the shares cast in the last year and one of the previous two years.
- 2014 Proxy Season and Beyond. In the 2014 and future proxy seasons, ISS will recommend a vote against individual directors, committee members or the full board (as appropriate) if the board failed to act on a shareholder proposal that received the support of a majority of the shares cast in the previous year.
- Case-by-Case Application; FAQ. ISS noted that the policy will be applied on a case-by-case basis.
Pledging and Hedging
- Pledging “Significantly” Problematic. In 2012 surveys conducted by ISS, 49 percent of institutional investors and 45 percent of public company respondents indicated that they view pledging of shares by directors and executives as significantly problematic. Nevertheless, ISS’ proposal to consider pledging a “problematic pay practice” for purposes of a public company’s say-on-pay proposal was met with criticism from both audiences.
- ISS Approach; Focus on Risk Oversight. Taking into account the criticism, ISS decided to take a case-by-case approach to determining whether share pledging represents a significant concern for shareholders. If it does, ISS will consider the share pledging to be a failure of risk oversight for which the board is accountable (i.e., instead of recommending a vote against the company’s say-on-pay proposal, ISS might decide to recommend a vote against the full board or individual directors).
Glass Lewis Policy Updates
Board Responsiveness to Negative Shareholder Votes
For the 2013 proxy season, Glass Lewis formalized its historical policy of scrutinizing a board’s response to a shareholder vote of at least 25 percent (excluding abstentions and broker non-votes) in opposition to management’s recommendation on any proposal. Previously, the written policy applied only to say-on-pay votes. Any such negative shareholder vote will trigger a detailed analysis of the issues giving rise to the vote and the board’s response, including through Glass Lewis’ review of the proxy statement and other public disclosures explaining the response. Ultimately, Glass Lewis will consider whether it believes the board’s response was proper and use that judgment as a factor in determining its voting recommendations with respect to the directors standing for election at the annual meeting.
Equity Compensation Plans (Share-Counting)
Glass Lewis has added “inverse full-value award multipliers” to the list of “overarching principles” that it uses when evaluating equity compensation plans. In other words, according to Glass Lewis’ principles, “plans should not count shares in ways that understate the potential dilution, or cost, to common shareholders,” for example, by counting options as less than one share granted for purposes of determining how many shares remain available for additional awards under an equity compensation plan. Currently, few public companies use that approach to share-counting, so the new policy is not expected to have a significant practical impact on future proposals relating to equity compensation plans.
Role of Committee Chair
Glass Lewis generally holds the chair of each committee primarily responsible for the committee’s actions. Accordingly, in connection with adverse committee-specific recommendations, Glass Lewis’ policy is to recommend a vote against the committee chair (rather than all members of the committee). If there is no committee chair, or if the committee chair is not standing for re-election as a director at the annual meeting, the policy is to recommend a vote against the senior member of the committee. Previously, if committee seniority could not be determined, the “no” vote recommendation applied to the longest-serving director who was a member of the committee. For 2013, that policy has been changed, such that Glass Lewis will now recommend a vote against all committee members in the absence of a chair if seniority cannot be determined.
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Final Rules on Compensation Committee Listing Standards
On June 20, 2012, the Securities and Exchange Commission (SEC) adopted Exchange Act Rule 10C-1 implementing listing standard requirements pursuant to Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) which, among other things, imposes new independence requirements for compensation committees of publicly traded companies. Rule 10C-1 directs U.S. stock exchanges (e.g., NYSE, NASDAQ, etc.) to prohibit the listing of any equity security of a company that does not comply with the new listing standards. On September 25, 2012, NYSE and NASDAQ proposed new listing standards pursuant to Rule 10C-1. Rule 10C-1 became effective on July 27, 2012. Each exchange must implement final rules that comply with the new listing standards approved by the SEC no later than June 27, 2013.
The new listing standards apply to any committee of the board that performs functions typically performed by a compensation committee, including the oversight of executive compensation, whether or not such committee also performs other functions or is formally designated as a compensation committee. Rule 10C-1 also applies, with limited exceptions, to members of the board who oversee executive compensation in the absence of a board committee. Rule 10C-1 contains rules regarding committee independence and the use of compensation advisers as well as the independence of those advisers. Each is discussed in turn below.
Committee Independence Requirements
Section 952 of Dodd-Frank requires the SEC to direct the U.S. stock exchanges to adopt rules that prohibit the listing of companies that do not have an “independent” compensation committee. Rule 10C-1 requires that each member of a company’s compensation committee be a member of the company’s board of directors and provides that the stock exchanges must take the following two factors into account when developing their own definitions of “independence:”
- a director’s source of compensation, including any consulting, advisory or compensatory fee paid by the company; and
- whether a director is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.
Although the exchanges must consider affiliate relationships when establishing a definition of compensation committee independence applicable to compensation committee members, unlike the similar audit committee rules governing audit committee independence, Rule 10C-1 does not require the exchanges to prohibit any specific affiliate relationships based on significant stock ownership or any other relationship—nor does the rule separately define “affiliate” for compensation committee independence purposes. Rule 10C-1 is intentionally flexible, allowing the exchanges to craft their own definitions around the two considerations required by the rule.
The independence requirements of the new listing standards do not apply to controlled companies or smaller reporting companies (as defined in Exchange Act Rule 12b-2). Rule 10C-1 also exempts limited partnerships, companies in bankruptcy proceedings, open-end management investment companies and foreign private companies that disclose in their annual reports the reasons why they do not have an independent compensation committee.
Compensation Adviser Requirements
Dodd-Frank requires that each compensation committee have the authority to retain or obtain advice from compensation consultants, legal counsel and other advisers, (collectively, but excluding in-house legal counsel, “Compensation Advisers”). Rule 10C-1 provides that compensation committees must take into account the following independence factors before selecting, or receiving advice from, Compensation Advisers:
- whether the employer of the Compensation Adviser provides other services to the registrant;
- the amount of fees received from the registrant by the employer firm of the Compensation Adviser as a percentage of such firm’s total revenue;
the policies and procedures of the Compensation Adviser’s employer that are designed to prevent conflicts of interest;
- any business or personal relationship of the Compensation Adviser with a member of the compensation committee;
- whether the Compensation Adviser owns any stock of the registrant; and
- any business or personal relationship between the executive officers of the registrant and the Compensation Adviser or the employer of the Compensation Adviser.
The compensation committee is required to be directly responsible for the appointment, compensation and oversight of Compensation Advisers. Additionally, each company must provide its compensation committee with appropriate funding for the payment of “reasonable compensation” to Compensation Advisers.
Although a compensation committee must consider Compensation Adviser independence, Rule 10C-1 clarifies that the rule does not require a compensation committee to follow the recommendations of Compensation Advisers the committee engages or otherwise impact the responsibility of a compensation committee to exercise its own independent judgment in the exercise of its duties.
Opportunity to Cure
The national securities exchanges must provide listed companies with a reasonable opportunity to cure any defects that would prohibit the listing of the company’s securities as a result of its failure to satisfy the listing standards described above. For example, if a member of the compensation committee ceases to be independent, the member may remain on the compensation committee until the earlier of the next annual shareholders meeting or one year from the occurrence of the event that caused the member to be no longer independent.
What to Do Now?
The exchanges’ proposed transition periods will provide companies with time to comply with the new independence requirements and, if necessary, restructure their board committees. Most of the provisions of NASDAQ’s proposed rules would not, with one exception discussed below, require compliance until the earlier of (i) the registrant’s first annual meeting after January 14, 2014, or (ii) October 31, 2014. The NYSE’s proposed rules would not become operative until July 1, 2013 and set the same compliance deadlines as NASDAQ’s proposed rules. Although listed companies cannot be certain as to the final content of the exchanges’ proposed rules, we anticipate that the final rules will be substantially similar to the proposed rules, and, accordingly, companies may want to take steps now to prepare.
Review the Proposed Rules of NYSE, NASDAQ, etc.
The following chart sets forth the proposed compensation committee member and advisers’ independence standards and considerations for NASDAQ and NYSE.
Compensation Committee Independencea
Although not required by Rule 10C-1, proposed Rule 5605(d)(2)(A) requires that each company have a standing compensation committee comprised entirely of independent directors.
A member of the compensation committee cannot accept directly or indirectly any consulting, advisory or other compensatory fee from the company or any of its subsidiaries. The board must also consider whether the director has an affiliate relationship with the company, a subsidiary or an affiliate of a subsidiary that would impair the director’s judgment as a member of the compensation committee.
Compensation: The proposed rule clarifies that (i) fees relating to membership on the compensation committee, the board of directors or any other board committee, or (ii) compensation under a retirement plan (under limited circumstances), are not considered “compensatory fees.”
Affiliates: The proposed commentary provides that stock ownership, even of a controlling interest, does not automatically preclude independence.
NASDAQ’s proposed rules also provide a limited exception from the independence standards in “exceptional and limited circumstances” where a director’s membership on the compensation committee is in the best interests of the company and its stockholders. However, a director appointed under such circumstances cannot serve on the compensation committee for more than two years.b
a Directors must also satisfy the exchanges’ existing director independence standards.
b NASDAQ proposed Rule 5605(d)(2)(B).
The NYSE already requires a standing compensation committee of independent directors.
In addition, proposed Rule 303A.02(a)(ii) requires the board to 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 enumerated in Rule 10C-1 (as set forth above).
Compensation: The proposed commentary provides that the board should consider whether the director receives any compensation that would impair his ability to make independent judgments about the listed company’s executive compensation.
Affiliates: The proposed commentary provides that the board should consider whether the relationship places the director under 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.
Authority and Responsibilities
Authority and Responsibilities: Proposed Rule 5605(d)(3), requires listed companies to grant compensation committees specific responsibilities and authority necessary to comply with sections of Rule 10C-1 relating to (i) the authority to retain Compensation Advisers, (ii) the authority to find such advisers, and (iii) the responsibility to consider certain independence factors before selecting such advisers.
If the company does not yet have a compensation committee, this rule would apply to the independent directors who either determine or make recommendations to the board regarding the compensation of the CEO and all other executive officers of the company.c
Committee Charter: Proposed rule 5605(d)(1) also requires that a company certify that it has adopted a formal written compensation committee charter and that the charter will be reassessed each year. The proposed rule requires that the compensation committee charter specify the following:d
- the scope of the committee’s responsibilities, and how it carries out those responsibilities, including structure, processes and membership requirements;
- the committee’s responsibility for determining or recommending to the board the compensation of the CEO and all other executive officers;
- that the CEO may not be present during voting or deliberations on his compensation; and
- the specific committee responsibilities and authority to comply with Rule 10C-1 relating to Compensation Advisers.
c NASDAQ proposed Rule 5605(d)(6).
d NASDAQ proposed Rule 5605(d)(1), (3).
Authority and Responsibilities: Proposed rule 303A.05(c) sets for the authority and responsibilities of the compensation committee, which tracks the language of Rule 10C-1 relating to Compensation Advisers almost verbatim. The proposed rule would also delete the existing commentary relating to Compensation Advisers, as it would be superseded by the proposed rule.
Committee Charter: Although the NYSE’s existing rules already require companies to have a compensation committee charter setting forth the committee’s authority and responsibilities, proposed Rule 303A.05(b)(iii) would require that the charter set forth the additional authority and responsibilities of compensation committees relating to Compensation Advisers set forth in proposed Rule 303A.05(c) (discussed above).
Compensation Adviser Independence
Proposed Rule 5605(d)(3) provides that the compensation committee must consider the six factors set forth in Rule 10C-1 (discussed above) before selecting, or receiving advice from, Compensation Advisers. In contrast to the NYSE proposed rule, the proposed NASDAQ rule would not require the compensation committee to consider any other factors, as NASDAQ believes those factors elicit “broad and sufficient” information to determine whether Compensation Advisers are independent.
As discussed above, proposed Rule 303A.05(c) tracks the language of Rule 10C-1 (discussed above) almost verbatim in requiring that compensation committees consider the same six factors as those set forth in Rule 10C-1 when selecting Compensation Advisers. However, in contrast to the proposed NASDAQ rule, the NYSE’s proposed rule frames the six factors as a non-exhaustive list, providing that compensation committees must consider “all factors relevant” to that person’s independence from management.
Proposed Rule 5605(d)(4) provides that if a compensation committee member ceases to meet the proposed independence standards for reasons outside his reasonable control, he would be permitted to remain a member of the compensation committee until the earlier of (i) the next annual meeting or (ii) one year from the date when the member ceased to be independent.
The proposed rule also provides that companies have a minimum of 180 days to cure noncompliance.
Proposed Rule 303A.00 provides that if a compensation committee member ceases to meet the proposed independence standards for reasons outside his reasonable control, he would be permitted to remain a member of the compensation committee until the earlier of (i) the next annual meeting or (ii) one year from date when the member ceased to be independent.
The proposed rule limits the cure provision to situations where a majority of the compensation committee remains independent.
Smaller Reporting Companies
Proposed Rule 5605(d)(5) generally exempts smaller reporting companies from the proposed listing standards, except for the following:
- the company must have, and certify to having, a compensation committee of at least two members, each of whom must be an independent director;
- the company may rely on the proposed “limited and exceptional circumstances” exception (discussed above) to the proposed independence standards;
- the company may rely on the proposed cure period; and
- the company must certify to having adopted a formal written charter or board resolutions that specifies the same authority and responsibilities, except for those set forth in Rule 10C-1 relating to Compensation Advisers.
Proposed Rule 303A.00 exempts smaller reporting companies from the following:
- proposed rule 303A.02(a)(ii) relating to the additional compensation committee member independence standards; and
- proposed rule 303A.05(c)(iv) relating to the independence considerations for Compensation Advisers.
Transition Schedule/Effective Dates
Proposed Rule 5605(d)(6) would, with one exception, require compliance by the earlier of (i) the listed company’s first annual meeting after January 15, 2014 or (ii) October 31, 2014.
Once approved by the SEC, proposed Rule 5605(d)(3) would become effective on July 1, 2013. This rule relates to providing compensation committees with the authority and responsibilities summarized in the “Authority and Responsibilities” section of this table.
Proposed Rule 303A.00 provides that it would not become operative until July 1, 2013 and would require compliance by the earlier of (i) the listed Company’s first annual meeting after January 15, 2014, or (ii) October 31, 2014.
Provide Authority Regarding Compensation Advisors (NASDAQ Companies Only)
NASDAQ proposed Rule 5605(d)(3) would, upon approval by the SEC, become effective on July 1, 2013. The proposed rule would require listed companies to grant compensation committees specific responsibilities and authority necessary to comply with sections of Rule 10C-1 relating to (i) the authority to retain Compensation Advisers, (ii) the authority to find such advisers, and (iii) the responsibility to consider certain independence factors before selecting such advisers. Where a company does not yet have a compensation committee, this rule would apply to the independent directors who either determine or make recommendations to the board regarding the compensation of the CEO and all other executive officers of the company. This proposed rule does not require that the company immediately adopt a compensation committee charter granting such responsibility and authority by July 1, 2013, rather companies may implement a charter according to the transition schedule. The proposed requirements of such a charter are discussed below. Reviewing applicable state law to determine the best method for granting such responsibility and authority may also be appropriate.
Review Director Independence Questionnaires
Both the NYSE- and NASDAQ-proposed rules relating to compensation committees incorporate the independence standards of their existing rules, but add language specific to compensation committee members per Rule 10C-1 to consider (i) sources of the director’s compensation and (ii) existing affiliations with the company. Companies may want to review, and revise if necessary, their director independence questionnaire to include questions broadly soliciting information regarding any relationship between the director or a family member and the company or its directors or executive officers, or its affiliates or their directors or executive officers, including any commercial, industrial, banking, consulting, legal, accounting, charitable, family or passive investments. Similarly, companies may want to review and revise their existing questionnaire to solicit information regarding the sources of director or family member compensation. In many cases, a company’s director independence questionnaire may already cover most of the relevant questions for compensation committee independence that are already covered by the traditional audit committee independence questions, although subtle differences may exist and may want to be considered.
Review Compensation Committee Composition
Companies may want to begin to review their current compensation committee composition and evaluate whether the composition of those committees may want to be adjusted. NASDAQ companies that do not yet have compensation committees may want to consider whether to implement one in conjunction with the proposed rule requiring companies to provide compensation committees with the necessary authority and responsibilities to act and the option of doing so through early adoption of a compensation committee charter.
Draft/Revise Compensation Committee Charter
Under the proposed rules, both NYSE and NASDAQ companies would need to provide for the proposed authority and responsibilities set forth in the table above. NYSE companies are already required to have charters in place. Under the proposed rules, however, NASDAQ would be required to certify to the adoption of a formal written charter and that the charter will be reassessed each year. Although NYSE companies have, and a number NASDAQ companies may already have, charters in place, all listed companies may want to carefully review the new charter requirements relating to the authority and responsibilities of the compensation committee as they prepare to draft new charters or to revise their existing charters. As discussed, companies will be able to implement the charter requirements according to the transition schedule. However, NASDAQ companies may consider drafting and adopting a charter much sooner as a means of providing the compensation committee with the authority and responsibilities companies would be required to provide by July 1, 2013, subject to approval of the proposed rules by the SEC.
Prepare Compensation Adviser Independence Questionnaire
Under the proposed SEC rules, including the conflicts-of-interest disclosure rules discussed below, and the corresponding rules proposed by the exchanges, companies may want to consider preparing a Compensation Adviser questionnaire soliciting the information required to consider the six factors set forth in Rule 10C-1, as well as any other factors that an NYSE-listed company may consider relevant to the Compensation Adviser’s independence from the management of the company.
Review Disclosure of Compensation Adviser Conflicts of Interest
Listed companies are already required to disclose in their proxy statements whether its compensation committee retained or obtained the advice of a Compensation Adviser and whether the work of the compensation adviser raised a conflict of interest. If a Compensation Adviser’s work raised a conflict of interest, the company must disclose the nature of the conflict and how the conflict is being addressed. However, in conjunction with Rule 10C-1, the SEC amended Item 407 of Regulation S-K to clarify this disclosure requirement applies when a Compensation Adviser plays “any role in determining or recommending the form or amount of executive and director compensation.” The “any role” disclosure trigger is intentionally broader than the “obtained or retained the advice” trigger included in Section 10C.
Thus, the amendment will apply to any compensation consultation whose work must be disclosed under Item 407(e)(3)(iii), regardless of whether the Compensation Adviser was retained by management or the compensation committee or any other board committee.
As discussed above, the new rule, as well as the corresponding rules proposed by the exchanges, applies to an issuer’s compensation committee with respect to any compensation consultant, legal counsel or other adviser that provides advice to the compensation committee. The rule does not apply to in-house counsel, who, as employees, are not considered independent. Importantly, the rule does not prohibit the compensation committee from receiving advice from Compensation Advisers who are not independent.
Listing companies must comply with these new disclosure rules for any proxy or information statement for an annual meeting of shareholders at which directors will be elected occurring on or after January 1, 2013. Although not required by the new rule’s broader disclosure trigger, at least one company has provided a “negative disclosure” in response to the new rule.
Conflict Minerals – You Need to Prepare Now
In August 2012, the SEC adopted its final rules for implementing the “conflict minerals” disclosure requirements enacted under Dodd-Frank. Affected companies will be required to file the new Form SD by May 31, 2014. While this implementation date may seem a long way off, the first covered calendar year under the new regulatory and reporting regime is 2013, which is now upon us. Despite this fact, a recent survey by the CorporateCounsel.net indicated that 85 percent of respondents were either “in denial” or had only begun to analyze their products, but had not yet begun implementing compliance systems. Other commentators have sounded an alarm that echoes these results conveying the message that companies are benchmarking their progress against the public company universe that is, as a whole, behind in the implementation process. Thus, being “at or near the median” in the implementation process may not be much of an accomplishment.
Under the new rules, which apply to all public companies, if conflict minerals are necessary to the functionality of a product manufactured, or contracted to be manufactured, by your company, your company will be required to file a report on new Form SD disclosing whether such conflict minerals originated in a “conflict country,” based on a “reasonable country of origin” inquiry.
If a company meets the first criterion (i.e., if conflict minerals are necessary to the functionality of a product manufactured or contracted to be manufactured by the company), it is required to disclose that determination and the reasonable country of origin inquiry conducted in reaching the determination of whether or not the conflict minerals originated in a conflict country. If the conflict minerals did not originate in a conflict country (or originated from scrap/recycled sources), the disclosures on Form SD will be relatively short. But, if the conclusion is either that the conflict minerals originated in a conflict country or, during the first two years of the rules, the origin is “undeterminable,” the company will need to conduct due diligence on the source and chain of custody of its conflict minerals supply chain and file a more detailed Conflict Minerals Report on Form SD.
Following is a summary of key aspects of the new conflict minerals rules.
- Conflict Countries. Defined as Democratic Republic Congo and the adjoining countries of Angola, Burundi, Central African Republic, the Republic of Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia (collectively, DRC).
- Conflict Minerals. Defined as coltan (ore from which tantalum is extracted), cassiterite (tin), wolframite (tungsten) and gold.
- Meaning of Manufactured or Contracted for Manufacture. Unfortunately, the rules do not define these concepts. Generally, the determination of whether a product is manufactured or contracted for manufacture will turn on the degree of influence exercised by the company over the product. The SEC stated in its adopting release that the concept of “contracted for manufacture” is intended to capture companies that have some actual influence over the manufacturing of their products. For example, merely affixing a company’s brand, logo or label to a generic product manufactured by a third party should not be considered as “contracting for the manufacture” of that product.
- Meaning of Necessary for the Functionality or Production of a Product. Here too, the rules do not define these concepts. The new rules apply where conflict minerals are necessary for the functionality or production of a product, even if very small amounts of the covered minerals are actually used (even trace amounts). The SEC’s adopting release suggests that companies may want to consider the following in making their determination: whether a conflict mineral is contained in, or intentionally added to, the product or production process vs. being a naturally-occurring by-product; whether a conflict mineral is necessary to the product’s generally expected function, use or purpose; and if the conflict material is added for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration (e.g., gold in a gold necklace).
- Meaning of Product. Similar to above, the SEC’s adopting release does not provide a lot of guidance about the meaning of “product.” Depending on the size of a company and the industry in which it operates, it is easy to see a blurred line between what is product and what is service. For example, an airline flying an airplane containing conflict minerals is probably considered to be selling a service (air travel) vs. a product. But, the line is harder to determine for a cable TV company that sells cable TV converter boxes containing conflict minerals. Is the box a product, or is the company selling a “service” (cable TV)? Packaging of products also creates difficult questions. For example, chicken soup is a product, but what if that soup is sold in a can containing conflict minerals? Is the product soup, or soup in a can? Important Note: There is no de minimus exception to the rules. So, even if 99 percent of a company’s revenues are generated through the sale of services, if 1 percent of its revenues are generated through the sale of products, the new rules apply with respect to the products comprising that 1 percent.
- Reasonable Country of Origin Inquiry. This inquiry is required whenever a public company determines that conflict minerals are necessary to the functionality or production of a product manufactured or contracted for manufacture by such company. The inquiry must be one that is reasonably designed to determine whether any of the conflict minerals originated in the DRC or are from recycled/scrap sources. The SEC’s adopting release provides guidance that a reasonable inquiry would be satisfied if a company obtains a reasonably reliable representation indicating the facility at which the conflict minerals were processed and demonstrating that those conflict minerals did not originate in the DRC. Important to this inquiry is that these representations may come directly from the facility or indirectly through the company’s immediate suppliers. Also important, the SEC makes clear that a company does not necessarily need to receive such representations from ALL of its suppliers. The SEC, however, did not set any bright-line standard of what an acceptable coverage level would be (although it is clear that a company cannot ignore warning signs or other circumstances indicating that non-responding suppliers may have used conflict minerals originating in the DRC).
- Disclosure on Form SD Where Conflict Minerals Did NOT Originate in the DRC (or Are from Recycled/Scrap Sources). If a company determines with reasonable certainty, following a reasonable country of origin inquiry, that its conflict minerals did NOT originate in the DRC (or are from recycled/scrap sources), it must disclose its determination and provide a brief description of the country of origin inquiry it undertook and the results of that inquiry.
- Supply Chain Due Diligence. Where a company concludes its products contain conflict minerals and those conflict minerals either (i) originated in the DRC or (ii) the company concludes it is “undeterminable” whether the conflict minerals originated in the DRC, it must undertake due diligence on the source and chain of custody of its conflict minerals supply chain. The due diligence undertaken must conform to a nationally or internationally recognized due diligence framework. Currently, the most cited accepted framework is the due diligence framework promulgated by the Organization for Economic Co-Operation and Development. There are four possible conclusions a company can reach as a result of its supply chain due diligence:
(1) DRC conflict free. Where the conflict minerals did not originate in the DRC or are from scrap/recycled sources.
(2) DRC conflict free. Where conflict minerals originated in the DRC, but did not finance or benefit armed groups.
(3) Not DRC conflict free. Where conflict minerals originated in the DRC but have not been determined to be DRC conflict free. Note: This is the default conclusion where a company CANNOT determine whether its conflict minerals originated in the DRC or are DRC conflict free.
(4) DRC conflict undeterminable. During a temporary two-year phase-in period (four years for smaller reporting companies), if a company is unable to determine whether its conflict minerals originated in the DRC (or are from scrap/recycled sources) or financed or benefited armed groups in those countries, it may conclude that its conflict minerals are “DRC conflict undeterminable.” Important point: DRC conflict undeterminable is only available during the two-year phase-in period. After that time, a finding of DRC conflict undeterminable would equate to a finding that the conflict minerals are NOT DRC conflict free. Our initial impression is that DRC conflict undeterminable will be a common conclusion for public companies during the temporary two-year phase-in period.
- Conflict Minerals Report and Form SD. If a company concludes after conducting its due diligence that its conflict minerals are DRC conflict free because the conflict minerals did not originate in the DRC, or are from scrap/recycled sources (clause (1) above), the company is only required to file the Form SD (but not the Conflict Minerals Report); although it must briefly describe its due diligence and reasonable country of origin inquiry measures taken and the results of that inquiry.
If the company concludes after conducting its diligence that its conflict minerals are DRC conflict free (where conflict minerals originated in the DRC (but are not from scrap/recycled sources) (clause (2) above), the company must file the Form SD with the Conflict Minerals Report describing the measures the company has taken to exercise its due diligence.
If the company’s products have not been determined to be DRC conflict free (clause (3) above), the company must also disclose in its Conflict Minerals Report: a description of the products that are not DRC conflict free; the facilities used to process the conflict minerals in those products; the country of origin of the conflict minerals in those products; and the efforts to determine the mine or location of origin with the greatest possible specificity.
If the company’s products have been determined to be DRC conflict undeterminable (clause (4) above), the company must disclose the following in its Conflict Minerals Report: a description of the products that are DRC conflict undeterminable; the facilities used to process the conflict minerals in those products (if known); the country of origin of the conflict minerals in those products; and the steps it has taken, or will take, to mitigate the risk that its necessary conflict minerals benefit armed groups, including any steps to improve due diligence.
A company required to file a Conflict Minerals Report must obtain an independent audit of its report, certify that it has obtained such an audit, include the audit report as part of its Conflict Minerals Report on Form SD and identify the auditor.
- Content of Conflict Minerals Audit Report. The SEC has clarified that companies required to obtain an audit of their Conflict Minerals Report can engage an auditor using a “performance audit standard” (where a CPA is not required), or an “attestation engagement standard” (where a CPA is required). The audit objective is to express an opinion or conclusion as to whether the design of the company’s due diligence framework as described in its Conflict Minerals Report is in conformity with, in all material respects, the criteria set forth in the nationally or internationally recognized due diligence framework used by the company and whether the company’s description of its due diligence procedures in its Conflict Minerals Report is consistent with the due diligence procedures that the company undertook. The audit does NOT need to express an opinion on the company’s DRC conflict determination.
As indicated above, public companies need to prepare now because the first conflict minerals analysis, determinations and report will cover calendar year 2013, which is upon us. If you have not done so, you may want to consider:
- Evaluate whether your company is subject to the rules (e.g., manufactures or contracts for the manufacture of a product; if so, are conflict minerals necessary for the functionality or production of the product(s)).
- If your company is subject to the rules, it may want to form an implementation team (including representatives with legal, accounting, manufacturing, engineering and procurement expertise) and begin the country of origin inquiry sooner rather than later.
- Companies may want to review their current risk factors to determine whether any enhanced disclosure is necessary in light of the new rules.
For your convenience, here is a link to the flowchart from the SEC’s adopting release that indicates which companies will need to file a Form SD and the contents of that filing.
Dodd-Frank Rulemaking Update
More than two years after Dodd-Frank was signed into law, federal regulatory agencies including the SEC, continue their efforts to implement the almost 400 separate regulations prescribed by the sweeping legislation. Although thousands of pages of new rules have been adopted, much of the work remains to be done; and as of November 2012, the agencies had yet to propose (much less adopt) approximately one-third of the rules mandated by Dodd-Frank. Many expect the coming year to be another eventful one in light of President Obama’s re-election, the adoption of the “Volcker Rule,” and other high-profile regulatory developments anticipated in 2013.
New SEC rules relating to compensation committee independence and conflict minerals are described elsewhere in this issue of the Corporate Communicator. The following is a brief summary of certain other final rules that were recently adopted, as well as the current status of additional rules prescribed by Dodd-Frank that have yet to be proposed or adopted.
- Payment Disclosures by Resource Extraction Issuers. In August 2012, the SEC adopted rules requiring “resource extraction issuers” (i.e., public companies engaged in the commercial development of oil, natural gas or minerals) to disclose information about certain payments made to the U.S. government or any foreign government. Disclosure will be required with respect to tax, royalty, license, bonus, dividend and other payments that are “not de minimis” (i.e., single payments or related payments equaling or exceeding $100,000 during the fiscal year). The SEC is implementing a new form (Form SD, which will be subject to XBRL tagging) to facilitate the required disclosure, which will take effect for fiscal years ending after September 30, 2013. The report will be due no later than 150 days after the end of each fiscal year.
In October 2012, the American Petroleum Institute, Chamber of Commerce, Independent Petroleum Association of America and National Trade Counsel filed a petition for review in the U.S. Court of Appeals for the D.C. Circuit and requested that the SEC stay the final rules pending resolution of its complaint. The SEC denied that request in November 2012.
- Corporate Governance and Executive Compensation Disclosures. In July 2012, the SEC further delayed rulemaking with respect to the following Dodd-Frank provisions:
- Disclosure of pay-for-performance and pay disparity ratios
- Disclosure of hedging of company stock by directors and employees
- Recovery (“clawback”) of executive compensation
Previously, the SEC’s rulemaking calendar called for these rules to be proposed in December 2011 and adopted in the first half of 2012. In light of more urgent rulemaking priorities (including under the Jumpstart Our Business Startups (JOBS) Act), the issuance of proposed rules was postponed indefinitely and is now shown simply as “pending action” on the SEC’s website. It now appears that the rules will not take effect until the 2014 proxy season (at the earliest). As one commentator observed, “the SEC is conceding it has no idea when it will finish the rules.”
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Other NYSE/NASDAQ Developments
Non-Executive Employment of Family Members No Longer Precludes Nomination of Non-Independent Directors under “Exceptional and Limited Circumstances”
Until recently, a director of a NASDAQ-listed company could serve as an independent member of the audit, compensation or nomination committee even if a family member of that director was a non-executive employee of the issuer, yet, at the same time, be precluded by the family member’s employment relationship from serving as a non-independent member of any of those committees under the exceptional-and-limited-circumstances exception (the “Exception”) to the NASDAQ committee composition rules.
On July 19, 2012, the SEC approved a proposal by NASDAQ to amend Rule 5605 to allow a director who is a family member of a non-executive employee of a listed company to serve on any of these committees under the Exception, provided the company’s board concludes that the director’s membership on the relevant committee is required by the best interest of the company and its shareholders.
NASDAQ proposed the amendment because it believed that the same family relationship should not preclude eligibility to use the Exception if it does not otherwise preclude independence, citing the distinction in the prior rule as being “incongruous.” The proposed rules regarding compensation committee member independence make no substantive changes to the Exception.
The Exception still requires that companies comply with the requirements set forth in the table below in order to use the Exception:
Compensation and Nomination Committees
- the director meets the criteria set forth in Section 10A(m)(3) under the Exchange Act and the rules thereunder;
- the director is not an executive officere of the company;
- the director is not an employee of the company;
- the director is not a family member of an executive officer;
- the board of directors made an affirmative determination that the appointment is in the best interests of the company and its shareholders;
- the director does not serve longer than two years;
- the director does not serve as the chair of the audit committee; and
- the company makes the disclosures required by Instruction 1 to Item 407(d)(2) of Regulation S-K.f
e The definition of Executive Officer in the amended rule means “those officers covered in Rule 16a-1(f)” under the Securities Exchange Act of 1934.
f The foreign private issuer relying on the Exception must disclose in its next annual report (e.g., Form 20-F or 40-F) the nature of the relationship that makes the director not independent and the reasons for the determination.
- the committee has at least three members;
- the director is not an executive officer of the company;
- the director is not an employee of the company;
- the director is not a family member of an executive officer;
- the board of directors made an affirmative determination that the appointment is in the best interests of the company and its shareholders;
- the director does not serve longer than two years;
- the company discloses the nature of the relationship and the reasons for the determination either on or through the company’s website or in the next proxy statement; and
- the company makes the disclosures required by Instruction 1 to Item 407(a) of Regulation S-K.
Enhanced Disclosure for NASDAQ Delisting Notices
On December 3, 2012, the SEC approved NASDAQ’s enhanced delisting disclosure rules. The SEC noted in its approval that the new rules preserve the ability of investors to make informed trading decisions based on adequate disclosure to the public of listing deficiencies. Under the prior rules, companies were able to avoid this purpose through minimal disclosure.
In general, Rule 5810(b) requires that a company make a public announcement by filing a Form 8-K, where required by the SEC, or by issuing a press release, as promptly as possible, but not more than four business days following the receipt of the staff deficiency determination. Should a company fail to make the announcement in the allotted time, or include the enhanced disclosures, trading of its securities will be halted and NASDAQ will make a public announcement. If a company’s failure to make a public announcement is the only reason for halting trading, NASDAQ will ordinarily resume trading after it makes the public announcement.
Although a company is required to more fully disclose each concern identified a staff deficiency determination, it may want to take advantage of the opportunity the new rule affords the company to provide its own positions on the deficiencies raised. This opportunity for the company to tell its story to investors may help preserve shareholder confidence in the company. At the same time, the SEC warned that a company may not want to use this optional disclosure as a way to debate the issues through public announcements. Should a company’s disclosure be deemed by NASDAQ to be inaccurate or misleading, NASDAQ may issue a clarifying public announcement.
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Delaware Law Update—Delaware Court Applies Heightened Scrutiny to Director Compensation
In an era of intense investor scrutiny and SEC rulemaking regarding executive compensation, a recent decision by the Delaware Court of Chancery raises questions as to the protections afforded to directors when granting themselves equity incentive awards under stockholder-approved incentive plans. In the case, Seinfeld v. Slager, the Court reaffirmed the application of the business judgment rule in the context of a stockholder derivative claim challenging numerous compensation-related decisions as wasteful; however, for one claim the Court refused to apply the business judgment rule to a board’s decision to award equity bonuses to directors under a stockholder-approved incentive plan and, instead, ruled that the awards in question may want to be evaluated under the entire fairness standard.
The director equity awards at issue were granted under the company’s stockholder-approved compensation plan, which gave the directors authority to grant stock options to themselves subject to certain plan-wide limits on the number of shares that could be granted and annual caps on grants to eligible recipients. In its decision, the Court distinguished a similar case, In re 3COM Corp. Shareholders Litigation, in which the Court had granted business judgment protection to a board’s decision to grant itself equity awards under a stockholder-approved incentive plan. The Court noted that in 3COM, the board’s discretion was limited by a stockholder-approved incentive plan that placed specific limits on the number of shares that could be granted in various contexts. In Seinfeld, however, the Court held that application of the business judgment rule was not appropriate because there was essentially “no effective limits on the total amount of pay that can be awarded.” Instead, the Court held that decisions in this context are to be evaluated for entire fairness to the company of both the decision-making process and the decision itself.
In the near term, the Seinfeld case raises several questions and provides few answers. While it is clear that a board’s decision to grant equity awards to itself under a broad-based equity compensation plan, with only plan-wide limitations on the number of shares that can be granted, will be subject to the entire fairness standard, it is not clear how specific the restrictions on director equity grants must be in a plan to afford the board the benefit of the business judgment rule. Although precise limits and standards for director equity grants will act as insurance against shareholder litigation relying on the entire fairness standard, they will limit a company’s ability to adapt to company-specific needs and evolving director compensation models in the broader market. Going forward, companies may need to carefully consider and balance their need for flexibility in director compensation with the need to minimize the potential for shareholder litigation by establishing meaningful limits on the board’s discretion to compensate its directors.
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Disclosures Under the Iran Threat Reduction and Syria Human Rights Act of 2012
In August 2012, the Iran Threat Reduction and Syria Human Rights Act of 2012 (ITR) was signed into law. ITR is part of a broad sanctions strategy designed to deter the pursuit of nuclear weapons and support for terrorism and terrorist groups by the Iranian government. ITR requires issuers that file public reports with the SEC to disclose, among other things, whether they or their affiliates knowingly engaged in various activities that are subject to sanctions under previously enacted Iranian sanction programs. These disclosure obligations will apply to reports that are required to be filed with the SEC on or after February 6, 2013.
Section 219 of ITR requires issuers to disclose in their Forms 10-K and 10-Q whether the issuer or its affiliates knowingly:
- engaged in activities subject to sections under the Iran Sanctions Act of 1996 or the Comprehensive Iran Sanctions, Accountability and Divestment Act of 2010. Such activities include, among other things, those involving:
- investments in Iran’s petroleum industry, exportation of refined products to Iran and certain other transactions involving Iran’s petroleum industry;
transactions facilitating Iran’s development of weapons of mass destruction and certain other weapons capabilities;
- transferring goods, technologies or services that are likely to be used by the Iranian government to commit human rights abuses, including transferring technology that is to be used to restrict the free flow of unbiased information in Iran or to disrupt, monitor or otherwise restrict speech of the Iranian people; and
- transactions involving U.S. financial institutions providing financial services for Iran’s Revolutionary Guard Corps or facilitating money laundering by the Central Bank of Iran or other Iranian financial institutions;
- conducted transactions with persons whose assets are blocked pursuant to certain executive orders relating to terrorism and the proliferation of weapons of mass destruction; or
- conducted transactions with the Iranian government without the specific authorization of a U.S. federal department or agency.
Issuers engaging in any reportable activity must disclose (i) the nature and extent of the activity, (ii) the gross revenues and net profits, if any, attributable to such activity, and (iii) whether the issuer or any affiliate of the issuer intends to continue the activity. If an issuer reports any of these activities in its periodic reports, it must also file a separate notice with the SEC advising the SEC that it has reported Iran-related activities in its periodic reports. The SEC is required to send these separate notices to the United States president and certain congressional committees, and to make these separate notices available on its website. After receiving the separate notice, the president is required to commence an investigation into the potential imposition of sanctions.
Issuers may want to consider reviewing their activities and those of their affiliates to assess whether they have engaged in any reportable transactions under the ITR. Corresponding with and gathering information from affiliates can be difficult and time consuming. Issuers may want to assess their internal controls to ensure they are able to monitor and identify future transactions that might be reportable under the ITR and work with their affiliates to establish detection and reporting programs to facilitate compliance with the ITR.
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Lessons Learned in 2012
As one calendar year ends and the next begins, it is natural to look back to take an inventory of lessons learned and to look forward in an attempt to implement such lessons. The year 2012 certainly had its fair share of wisdom to absorb. Throughout this Corporate Communicator, we touched on a number of such topics, but below we discuss three areas noted during interactions with our clients this year.
SEC Comment Letter Process
Receiving a comment letter from the SEC is often old-hat for a CFO and GC of a public company. The SEC began publicly releasing correspondence between it and public registrants in 2005. In issuing comments to a registrant, the SEC staff may request that the company provide additional supplemental information so the staff can better understand the company’s disclosure, revise disclosure in a document on file with the SEC, provide additional disclosure in a document on file with the SEC, or provide additional or different disclosure in a future filing with the SEC. As any seasoned CFO or GC understands, there may be several rounds of letters from the SEC staff and responses from the filer until the issues identified in the staff review are resolved. Set forth below are some short tips regarding the review process:
- Public companies may want to consider implementing an official process and procedure related to the receipt of an SEC comment letter.
- This process may contemplate immediate distribution of the comment letter to both internal and external working group members (e.g., accounting and legal departments, auditors and outside legal counsel) upon receipt from the SEC staff. Consideration may be given to identifying consistent points of contact for external parties.
- Any comments that are unclear or not understood by the company can be clarified with the SEC staff.
- Companies may want to ensure they meet designated response deadlines set forth in the comment letter (generally 10 business days) or to reach out to the SEC staff for an extension request if the response deadline is not feasible.
- Responses should be concisely drafted and specifically address each area of inquiry.
- While the SEC staff has clarified that comment letters (1) are not an official expression of SEC views and (2) are limited to the specific facts of the filing in question and do not apply to other filings, many registrants and their outside legal counsel and accountants comb through SEC comment letters to get a sense of trends and SEC positions on specific topics. More often than not, your competitors and peers have received a similar comment from the SEC and there is often a compelling argument to not “reinvent the wheel” when crafting a response to a comment the SEC has made in prior comment letters.
- A registrant should not necessarily assume that the SEC understands the company’s disclosure as well as the registrant. While seemingly an obvious point, this concept bleeds into various areas. For instance, if the SEC has commented on immaterial disclosure, or has made a comment that is misguided, the registrant may want to offer a detailed and cogent response that clarifies why this disclosure is immaterial or the staff’s comment is misguided. There may be a tendency of management to take the path of least resistance, which may not be the best course in the long run for the registrant. Like most disclosure issues, management must reach a balanced approach on such matters.
- When applicable (it is typically clear from the staff comment), the registrant may want to make clear that it will include a requested disclosure in future filings. A failure to do so may result in an unnecessary follow-up comment.
- Clearly citing specific rules, regulations or authorities relied upon in responses increases the likelihood of not receiving further staff comments.
- After response letters have been submitted, registrants may want to have a consistent follow-up process.
- After submitting a response, it is acceptable to follow-up with the SEC staff any time after a 10-day business period has lapsed since the registrant’s response.
- Some registrants avoid oral conversations with SEC staff unless absolutely necessary. Other registrants believe that oral conversations before and after response letters have been submitted open up the channels of communication and, if used judiciously, can alert the staff to registrant-specific issues like specific timing issues or matters unique to the registrant.
- In the event the SEC staff indicates orally that the review is complete, the registrant may want to request a letter of confirmation, although we have found the SEC staff is fairly consistent in issuing its customary “no further comment” letters.
Director Compensation Litigation
Executive compensation, with all of its considerations for public companies, continues to be a subject that demands the attention of management and in-house counsel. Pages could be filled with germane executive compensation topics and elsewhere in this Corporate Communicator, we have addressed many of these salient topics such as compensation committee independence, ISS policy updates and Dodd-Frank rule making. In recent years, shareholder litigation related to executive compensation has arisen in the context of failure to obtain approval of Say-on-Pay advisory votes but courts have typically upheld the deference granted directors under the business judgment rule in the context of failed Say-on-Pay votes.
Ultimately, we continue to emphasize the need for “proper process” for boards and management in the context of compensation decisions and the related disclosure thereof. Below are a few take-aways in light of developments in 2012:
- Proper process may want to be used to determine compensation. For instance, boards may want to carefully consider the use of benchmarking and compensation consultants in not only executive compensation decisions but also director compensation decisions. Due diligence, based on guidance from compensation, legal and other experts, has become a must. Hindsight is 20/20 and it is substantially easier to second guess board decisions that were not based on objective criteria used by the company’s peers. Boards may want to take a step back from their deliberations and consider whether their process of decision making and the data used to come to such compensation decisions will look adequate in the glare of hindsight.
- It goes without saying that public companies may want to have a good process in vetting the adequacy of annual proxy disclosures. Careful thought may want to be given to get adequate feedback from within and outside of the company. Shareholder litigation inherently focuses not only on board process but the adequacy and correctness of disclosures.
- Finally, given the overwhelming scrutiny boards of public companies face in the current regulatory and shareholder climate, it is a wonder why so many qualified individuals still want to serve on public company boards. Some public companies are finding it difficult to recruit and retain qualified directors who meet all the criteria public companies desire in this age of specialization, diversity, independence, etc. The upshot is that when a public company finds the correct mix on its board, it is imperative that compensation for directors be set to retain such directors in light of the current demands that such service requires. We believe that the upward trends in director compensation reflect these realities.
Technology in all its forms (be it social media, mobile devices, remote access or its many other iterations), presents multiple challenges for public companies. Below we address two areas of technology concerns that continued to inundate the news in 2012: (1) social media and (2) cyber security.
- Social media (e.g., Twitter, Facebook, LinkedIn, etc.) have become a significantly integrated part of our personal and professional lives in a very short amount of time. Some public companies have embraced the benefits of social media while many have taken a “wait and see” approach. Many commentators are concerned that public companies have not developed sufficient policies and procedures and, possibly more important, risk assessments related to social media concerns. These policies can address simple issues related to employee access to social media in the workplace to more nuanced issues related to how the company intends to utilize social media to its advantage. Management and boards of public companies may want to make social media a recurring part of the dialogue related to technology concerns at their company—not just from a risk perspective but also from a business growth perspective. Late in 2012, the SEC’s Enforcement Staff entered the fray by issuing a Wells Notice to Netflix and its CEO over a Facebook post about the aggregate number of hours people were viewing Netflix content. This action may severely chill the use of social media as a means to provide the investor community material disclosures. This is particularly true since many in the legal community have had reservations regarding the use of social media as a form of disclosure for public companies.
- As public companies continue to evolve with technology, boards are focusing more and more on cyber security. In 2012, boards of multiple notable public companies were forced to address cyber breaches at their companies. These concerns regarding cyber breaches will be more relevant as companies continue to integrate remote access and data sharing technologies.
- The SEC has existing disclosure guidance regarding these risks. While this guidance is ostensibly “advisory” in nature, in 2012, the SEC made disclosures regarding cyber security a point of review in connection with SEC comment letters on public filings and more than a few companies received comments from the SEC on issues related to cyber security. One thing we can count on in future years is increased regulation/attention in this area and increased potential litigation for companies who fall prey to cyber security breaches. Hence, boards may want to continue to make cyber security concerns a focus of oversight, particularly as it relates to contingency plans and adequacy of existing insurance.
- For example, general liability insurance policies may prove to be inadequate in the event of a material cyber-security breach and boards might consider purchasing specific cyber insurance covering the company and third-party exposure, as well as ensuring that the company’s D&O insurance covers cyber-related claims based on allegations of securities fraud, breach of fiduciary duty and alternative theories of liability.
- Like oversight in all significant areas of concern for a public company, board oversight with respect to cyber security is about proper process. Boards may want to discuss issues regarding cyber security on a regular basis at a board level and may rely upon consultants, experts and even management in its role of oversight, paying particular attention to sufficiency of the company’s overall cyber security plans and resources.
 This requirement added Section 10C to the Securities Exchange Act of 1934 (Exchange Act). [back]
 However, smaller reporting companies are not completely exempt from the proposed rules promulgated by the exchanges. More details are provided in the comparative chart below. [back]
 Section 10C(c)(2)(A) of the Exchange Act. [back]
 Reported November 26, 2012. [back]
 Andrew Ackerman, “SEC Gives Up On Web Schedules For Dodd-Frank Rules,” The Wall Street Journal, September 17, 2012. [back]
 See paragraphs (c)(2)(B), (d)(3) and (e)(3) of NASDAQ Rule 5605. [back]
 Whether the grants at issue were entirely fair was not decided and remains a question to be determined at trial. [back]
 “Legal Risks on the Radar,” Corporate Board Member, 2012 Law and the Boardroom Study, August 13, 2012. [back]
 http://www.sec.gov/divisions/corpfin/guidance/cfguidance-topic2.htm [back]
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Snell & Wilmer's Fifth Annual Public Company Proxy Season Update
We invite you to attend Snell & Wilmer's Fifth Annual Public Company Proxy Season Update on Thursday, January 10, 2013. This discussion will address topics of interest for all public companies as they prepare for the 2013 annual report and proxy season. For more information and to RSVP, view the invitation here.
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