Proxy and Form 10-K Preparation for 2014

January 27, 2014

While this year’s proxy and Form 10-K season brings no new major disclosure obligations to contend with, the previously adopted compensation committee member and advisor independence provisions, ISS policy changes, and say-on-pay developments will play a continuing role in your proxy statement preparation this year. On the other hand, social media concerns, changes to NYSE quorum requirements and a new Nasdaq compliance certification obligation will also require your attention during the annual meeting process. Fortunately, however, the few remaining disclosure mandates under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) will not affect disclosures before next year.

Independence of Compensation Committee Members and Advisors; Conflicts of Interest

In January 2013, the SEC approved the revised listing standards adopted by the New York Stock Exchange (NYSE) and The NASDAQ Stock Market (Nasdaq), which largely track the SEC’s rules requiring the exchanges to revise their listing standards as mandated by Dodd-Frank. As required by SEC Rule 10C-1, these revised listing standards were to address (i) enhanced independence requirements for compensation committee members; (ii) the authority and responsibility for the selection, compensation and oversight of advisors to the compensation committee; and (iii) factors to be considered in evaluating the independence of advisors to the compensation committee.

Nasdaq then further amended its listing standards to more closely align its compensation committee member independence and advisor conflict of interest requirements with the NYSE’s standards. Previously, Nasdaq’s bright-line test for independence prohibited compensation committee members from accepting directly or indirectly any consulting, advisory or other compensatory fees from the company or any subsidiary, other than board or committee fees. Now, Nasdaq’s listing rule is consistent with the mandate of Rule 10C-1, which merely requires consideration of, but does not necessarily exclude from service on the compensation committee directors who receive compensatory fees from the company.

Committee Member Independence. As a threshold matter, companies with exchange-listed equity securities were required to comply with the revised listing standards relating to the authority of the compensation committee to retain advisors and a review the independence of any advisors beginning in July 2013. The revised listing standards regarding the enhanced independence of compensation committee members must be met by the earlier of a company’s first annual meeting after January 15, 2014, or October 31, 2014. Moreover, no later than 30 days after this compliance deadline, Nasdaq-listed companies must furnish Nasdaq with a specific compliance certificate covering the revised listing standards as discussed below.

The NYSE and Nasdaq compensation committee independence rules generally provide that, in addition to the existing director independence general requirements, a board of directors must affirmatively consider all factors specifically relevant to determining whether a director who will serve on the compensation committee 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. These factors should include, but are not limited to: (A) the source of compensation of such director, including any consulting, advisory or other compensatory fee paid by the company to such director; and (B) whether such director is affiliated with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.

As such, a board must consider, based on the company’s and the director’s unique circumstances, whether the receipt of any fees, even if below the caps, would impair the director’s ability to make independent judgments about the company’s executive compensation. In this regard, exchange-listed companies should review the status of their compensation committee members to ensure that they satisfy the enhanced compensation committee independence standards. If any changes to committee composition are needed, such changes must occur by the deadline noted above.

Compensation Advisor Independence. The revised listing rules also specify the rights and responsibilities of the compensation committee with respect to compensation advisors, which rights and responsibilities must be addressed in the compensation committee charter. These provisions give the compensation committee the sole discretion to retain or obtain the advice of a compensation consultant, independent legal counsel or other advisor, and the company must fund payment of reasonable compensation to an advisor retained by the compensation committee.

The compensation committee of a listed issuer may select a compensation consultant, legal counsel or other advisor only after taking into consideration the following six Rule 10C-1 factors: (i) the provision of other services to the company by the person that employs the compensation advisor; (ii) the amount of fees received from the company by the person that employs the compensation advisor, as a percentage of that person’s total revenue; (iii) the policies and procedures of the person that employs the compensation advisor that are designed to prevent conflicts of interest; (iv) any business or personal relationship of the compensation advisor with a member of the company’s compensation committee; (v) any stock of the company owned by the compensation advisor; and (vi) any business or personal relationship of the compensation advisor or the person employing the advisor with an executive officer of the company. After considering these independence factors, the compensation committee may select or receive advice from any compensation advisor it prefers, even ones that are not independent.

According to the SEC’s order approving the amended listing standards, the SEC “anticipates that compensation committees will conduct such an independence assessment at least annually.” Also, unlike the NYSE standard which requires consideration of “all relevant factors,” Nasdaq only requires consideration of the six enumerated factors above, without any requirement to consider any additional relevant factors.

Conflicts of Interest. When it adopted Rule 10C-1, the SEC also revised Item 407(e) of Regulation S-K to require disclosure of compensation advisor conflicts of interest. In this regard, Item 407(e)(3)(iii) already requires a company to disclose the role of any compensation advisors in determining or recommending the amount or form of executive and director compensation, including the advisor’s name, who retained them, the nature and scope of the assignment and, in certain circumstances, the aggregate fees paid to the advisor. As revised last year, Item 407(e)(iv) requires that, for any compensation advisor identified under Item 407(e)(3)(iii) that has a conflict of interest, the company must disclose the nature of such conflict and how the conflict is being addressed, regardless of whether the compensation committee, management or any other board committee retained the consultant. In determining whether a conflict of interest exists for disclosure purposes, companies must consider the same six factors that Rule 10C-1 requires compensation committees to consider when hiring compensation advisors. Disclosure is only required if a compensation advisor has an actual conflict of interest; no disclosure is required as to potential conflicts of interest or of an appearance of a conflict of interest.

New Nasdaq Compensation Compliance Certificate. As noted above, Nasdaq-listed companies subject to the compensation committee listing rules will need to file a one-time Compensation Committee Certification with Nasdaq within 30 days after the earlier of the company's first annual meeting after January 15, 2014, or October 31, 2014. Each listed company must certify to Nasdaq that it has complied with the amended listing rules. A copy of the short Compensation Committee Certification is currently available on the NasdaqOMX Listing Center website. The annual NYSE certification continues to be required within 30 days after the company’s annual meeting.

Robert B. Murphy
Washington, D.C Office

Say on Pay and Compensation-Related Litigation

The year 2013 marked the third annual meeting season of mandatory say-on-pay (“SOP”) and, for the third year in a row, about 97% of issuers saw their proposals approved, most by a large margin. The biggest proxy advisory firms, ISS and Glass Lewis, continue to wield significant influence on these votes and continue to adjust their metrics and voting guidelines in response to various criticisms by issuers. Our 2013 proxy alert [] and 2012 alert [] each included a brief synopsis of prior developments and results in this area. During the last year, the most noteworthy developments have been in connection with the litigation being brought against issuers relating to SOP and other compensation-related proxy statement proposals.

The first two years of mandatory SOP after the enactment of Dodd-Frank resulted in nearly two dozen lawsuits. This first wave of claims consisted of shareholder derivative actions filed against companies whose SOP proposals were defeated. The central claim in these cases was that the board had breached its fiduciary duties by adopting the compensation programs that shareholders later voted against. These cases were almost always defeated at an early stage, as courts noted that the Dodd-Frank provision contained language intended to refute the claim that the SOP vote advisory outcome changed the board’s fiduciary duties. More recently, a California appellate court affirmed the trial court’s dismissal of the claim against Jacobs Engineering, further discrediting these claims.

As the first wave of cases died out in late 2012, a new wave of cases began. Borrowing a tactic from merger-related litigation, these cases have been brought as putative shareholder class actions after the proxy statement is filed but before the annual meeting (and before the vote occurs). These suits typically claim no damages, but instead seek to enjoin the annual meeting until the company has remedied inadequate disclosure in the proxy statement relating to the SOP proposal and, in many instances, to proposals to approve or add shares to a stock compensation plan or to reapprove the performance measures in a stock incentive plan for purposes of the performance-based compensation exception to the million dollar cap on compensation deductions in Section 162(m) of the Internal Revenue Code. Usually these suits claim that certain information considered by the compensation committee, such as compensation consultant reports, ISS analyses and other details not specifically required to be disclosed by SEC rules are material facts that should be disclosed. Other so-called shortcomings include insufficient detail on items such as peer group data, the rationale for the mix of long term vs. short term compensation, how the compensation consultants were chosen and how much they were paid. In cases challenging proposals to approve IRC Section 162(m) performance measures, the allegations often involve claims that the disclosure regarding which compensation will and will not be tax deductible is misleading or insufficient and may also include breach of fiduciary duty claims based on a waste of assets for paying compensation that is not tax deductible.

Even in the absence of a damage claim, these lawsuits can put a lot of pressure on companies to settle and comply with the disclosure demand to avoid disrupting their annual meeting schedule as well as the associated cost, inconvenience and potentially negative publicity. As in merger-related strike suits, settlements involving additional disclosure provide the plaintiff’s law firm grounds to claim it is entitled to substantial legal fees for the so-called “improvements” to the related proxy statement. Although many issuers have chosen to settle these claims for various reasons, several companies have accepted the challenge to fight these claims in court and most who have fought the claims have succeeded in having them dismissed.

There does not seem to be any way of predicting who will be targeted by these lawsuits, as it seems that the claims are made regardless of the quality and quantity of the proxy statement disclosure. But as public companies look ahead to preparing their 2014 proxy statements, there are several things they can do to prepare for potential litigation in the latest wave.

  1. Recognize that whatever the compensation committee looks at could become fodder for a claim that the company should have discussed or summarized it in the proxy statement. In this regard, companies should consider:
    1. Limiting the materials provided to what will actually be discussed by the committee and will be truly necessary to the committee’s ability to make an informed decision.
    2. Giving an oral report to the committee of particular information instead of a detailed written report, especially if the information will be discussed only briefly at the meeting. The oral report and its general message should be mentioned briefly in the minutes as forming part of the informational basis for the committee’s decision but will be more difficult for a plaintiff to analyze and criticize than a written report.
    3. Previewing materials to be sent to the committee for language likely to be seized upon by plaintiff’s lawyers and deleting exaggerations, inaccuracies, over generalizations and the like where possible.
    4. Avoiding references to expected burn rates or grant frequencies as “projections” or to expert advice received as “opinions,” as such terms can have disclosure consequences.
  1. Take special care in drafting compensation committee minutes. Assume the minutes will be read by a plaintiff and used against the company. Memorialize the steps taken by the committee to fulfill its fiduciary duty and the actions taken at the meeting but avoid including a play by play of the discussions or other details that will only be useful to a plaintiff’s lawyer searching for proxy statement omissions or inconsistencies.
  2. Review the committee materials and relevant minutes before drafting the proxy statement compensation discussion and then draft the discussion to be consistent with these materials. Inconsistencies and discrepancies with the committee minutes and materials will otherwise provide an easy target for a plaintiff’s lawyer. To the extent the prior year’s proxy discussion is used as a template, take extra care to scour the discussion for obsolete language or references that need to be removed.
  3. As many commentators have noted, the exercise of drafting the compensation discussion and analysis (CD&A) section of the proxy statement should be more than just checking boxes to comply with the minimum requirements of the SEC rules and satisfy an SEC staff reviewer. Draft the CD&A with shareholders also in mind and include the detail needed to convince shareholders that the compensation committee acted reasonably and thoughtfully. If additional tables or information would help the company better make its case or better explain the committee’s rationale for its decisions, include it in the CD&A even if it is not specifically required.
  4. Review the materials furnished to or discussed by the committee as the basis for its decisions with a view towards determining what information is likely to be important to a reasonable shareholder in determining how to vote (i.e. what is material). If the company is sued and the plaintiff’s disclosure claims are reviewed by a court, the court is likely to evaluate whether any missing information should have been included on the same basis.
  5. Consider unbundling the approval of the performance measures aspect of a new equity plan for purposes of Section 162(m) from the proposal approving the plan itself to remove the potential for a claim that combining them has resulted in misleading

A final note: Companies that adopted a triennial say on pay frequency in 2011 will need to include a SOP vote in their 2014 proxy statement.

Mark A. Metz
Bloomfield Hills Office

ISS Policy Changes

Each year, Institutional Shareholder Services Inc., a leading proxy advisory firm (ISS), tweaks its voting policy guidelines after receiving the results of its annual survey. ISS has released its revised policies to affect voting recommendations for public company shareholder meetings held on or after February 1, 2014.

Board Responsiveness to Shareholder Proposals. One of the changes ISS made for the 2013 proxy season related to recommendations on director elections when the board has failed to act on a shareholder proposal that received significant support from shareholders. Prior to 2013, ISS policy was to make a negative vote recommendation with regard to director elections if a shareholder proposal received a majority of either (a) the votes outstanding or (b) the votes cast in the last year and one of the two previous years, and the board did not implement the proposal as recommended by the shareholders. Now, if the shareholder proposal received a majority of the votes cast at the previous year’s meeting, and the board did not move to implement the proposal before the next annual meeting, ISS may recommend a vote against individual directors, committee members or the whole board.

Also, for the 2014 proxy season, ISS has indicated in its latest guidelines that voting recommendations as to individual directors, committee members or the entire board will be made on a “fact-specific, case-by-case” basis (as opposed to a general “vote against or withhold” basis), if the board failed to fully implement a shareholder proposal that received the support of a majority of the votes cast in the previous year. An important factor to be considered by ISS will be the board’s disclosed rationale for its chosen level of implementation of the majority-supported shareholder proposal. ISS will also consider disclosed shareholder outreach efforts after the majority vote, board actions taken in response to the vote, and the board’s engagement with shareholders.

For issuers that have a majority vote requirement for elections and also have significant institutional shareholders, this change may require directors to choose between authorizing an action that they do not believe is in the company’s best interests and potentially failing to receive the votes necessary to be reelected. The change puts a premium on staying engaged with shareholders and addressing concerns before they become shareholder proposals, and, when proposals are submitted, working hard to exclude them from the proxy through the no-action process or through negotiations with the proponent shareholders.

Directors should not, however, feel pressured by this ISS policy update to fully implement a shareholder proposal. As part of exercising their fiduciary duties, directors should evaluate the merits of any shareholder proposal and determine whether full, partial or no implementation is in the best interest of the company and its shareholders, and should then be prepared to engage with shareholders over their decision and provide proxy statement disclosure of their decision and rationale.

Pay-for-Performance Changes. ISS is also changing its methodology for calculating the relative degree of alignment (RDA) pay-for-performance measure it will use to evaluate say-on-pay votes. The RDA measure examines the difference between the company’s total shareholder return (TSR) rank and the CEO’s total pay rank within an ISS-established peer group. In place of the previous weighted average of one-year and three-year RDA measures, the new methodology will include one annualized, three-year RDA measurement period. The TSR for each year in the RDA measurement period will be weighted equally and calculated to produce the annualized TSR for that period. As applicable, ISS will address relevant performance and pay for particular years during the qualitative (rather than quantitative) phase of its review of executive pay. Because the prior RDA methodology placed greater emphasis on the most recent year, companies with volatile year-over-year TSR may find the new methodology to be a favorable change.

Jeanne Marie Whalen
Bloomfield Hills Office

NYSE Amends Its Listing Standards to Eliminate a Quorum Requirement

The SEC approved a change in the NYSE’s listing standards to modify the vote required whenever shareholder approval was required to list additional shares, such as in connection with the adoption of equity compensation plans, and the issuance of securities in certain transactions in excess of a specified threshold or in connection with a change in control. Prior to the amendment, Under the old standard, approval for purposes of the NYSE rule required that (1) a majority of votes cast must have approved the matter, and (2) that the total votes cast represented a majority in interest of all securities entitled to vote.  The rule change eliminates the second, or “quorum,” prong of the requirement.

The separate quorum requirement has made it more difficult for some companies to satisfy the shareholder approval requirement. Since listed companies are already subject to quorum requirements under applicable state law, and acknowledging that a separate NYSE quorum requirement with respect to a limited category of proposals is confusing to companies and their shareholders, NYSE now believes the separate quorum requirement is unnecessary.

As a practical matter, this amendment will simplify proxy statement disclosure for NYSE companies relating to proposals driven by the NYSE shareholder approval requirement, and will also eliminate undue complexity when determining whether the NYSE shareholder approval requirement has been satisfied. More importantly, by eliminating the separate quorum requirement, the listing amendment may make it easier for NYSE listed companies to obtain shareholder approval on matters, particularly in instances where broker non-votes on the proposal are significant.

Abimbola A. Obisesan
Bloomfield Hills Office

Social Media, Disclosure and the SEC

In view of the ever-increasing use of social networking sites as a form of general communication, such as Facebook and Twitter, the SEC recently forewarned public companies that corporate communications policies and procedures need to encompass disclosures that may occur in the social media realm. According to the SEC, these kinds of communications must be monitored for compliance with Regulation FD’s restrictions on the disclosure of material non-public information.

A company’s social media policy should address, among other things, who is authorized to use the company’s social media channels, whether company communications on social media channels are required to be preapproved by persons from the legal and/or communication departments, any guidelines that could impact the personal use of social media by company employees and whether material nonpublic information about the company will first appear on company social media channels. The SEC has stated that a company may satisfy its Regulation FD public disclosure requirement through any method of disclosure that is reasonably designed to provide broad, non-exclusionary distribution of the information to the public. Whether social media channels qualify as a broad, non-exclusionary distribution of information to the public is critical to assessing Regulation FD compliance.

Companies should also take care not to use social media or other written communications in a manner that could be viewed as the solicitation of a proxy. As defined in the SEC proxy rules, a “solicitation” includes, among other things, the furnishing of a communication to shareholders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy. In an era in which shareholder communications and increased disclosure and transparency are encouraged, companies should choose their means of communicating, as well as the timing and content of their communications, with care in light of this broad definition. For example, a tweet or other communication from the CEO discussing the current economic climate and its impact on the company’s business, would not ordinarily be a solicitation. On the other hand, a communication urging shareholders to support an anticipated company-sponsored proposal could be a solicitation because it seeks to influence the outcome of an anticipated vote.

Practical Considerations. Disclosure on designated social media outlets should be coordinated as part of a company’s overall investor communication strategy. Companies should consider the following, among other issues, in connection with the recent guidance of the SEC in this regard:

  • Companies should consider whether disclosure in addition to or instead of conventional means (such as a press release or Form 8-K) would be advantageous to them and then develop a policy establishing one or more social media outlets through which it would disclose material nonpublic information, who would be responsible for posting information, how the information would be posted and indicating that disclosure of material nonpublic information relating to the company in other social media outlets is prohibited.
  • If a company determines to use one or more social media outlets instead of conventional means for disclosing material nonpublic information, it should identify these social media outlets and the means for accessing them in the company’s periodic reports, press releases and on the company’s website in order to alert investors to watch those social media outlets for important news and information about the company.
  • Any social medium used must disseminate the information in a manner that provides unfettered access by the public to the information by subscribing to, joining, registering with or monitoring the social medium.
  • Companies utilizing social media for corporate communications should implement controls to ensure that all social media communications on behalf of the company are true and complete and that the company controls the timing to comply with Regulation FD and to avoid premature disclosure.

The central focus of the SEC’s guidance in this area is whether the public company has made investors, the market, and the media aware of the channels of distribution it expects to use with respect to the dissemination of material information about the company, so that these parties know where to look for this information or what channels to monitor for announcements and developments.

Robert B. Murphy
Washington, D.C Office

Refreshing and Renewing E-Proxy—Beyond a Notification Tool For Shareholder Voting

The SEC adopted its E-Proxy Rules in 2007 permitting public companies to make proxy materials available via the Internet in lieu of mailing a paper copy. The E-Proxy Rules outlined two permitted methods of delivering proxy materials—(1) the “notice and access option” and (2) the “full set delivery option”- but also contemplate a hybrid delivery method. This update provides a brief overview of the E-Proxy Rules and offers some insight on how the E-Proxy Rules can be used by companies to potentially influence shareholder voting patterns.

Notice and Access Option. Instead of mailing a full set of printed materials to shareholders, this option allows companies to post their proxy material on a “cookie free” website that may not track or gather any information about shareholders. To do this, a company must mail shareholders a “Notice of Internet Availability” to inform them how to access the appropriate website at least forty days prior to the annual meeting. Shareholders can then go to the website, authenticate themselves, review the proxy materials and execute a form of proxy. Nevertheless, companies are still required to mail printed proxy materials if requested by a shareholder.

Full Set Delivery Option. While the full set delivery option is the same traditional paper model that companies followed prior to adoption of the E-Proxy Rules, there are several additional requirements. In addition to delivering proxy materials in a printed format, companies must also post all proxy materials to a cookie free website and send shareholders the information required in a Notice of Internet Availability. The Notice of Internet Availability does not need to be sent ahead of proxy materials under this option unlike the forty day notice period required under the notice and access option.

Hybrid Option. The notice and access and full set delivery options are not exclusive. Many companies elect to use the notice and access option for some shareholders and the full set delivery option for other shareholders. In this way, companies can stratify the delivery method utilized and, for example, send paper copies to their largest shareholders and use notice and delivery for the rest, or could send paper copies to their record holders and use notice and access for beneficial owners

Delivery Choice and E-Proxy Rules as a Vote Driver. Since the E-Proxy Rules have gone into effect, the notice and access option has been shown to lead to a significant decrease in the number of shares that are voted at the meeting. Companies with a large base of retail shareholders have experienced a decline in shares present for quorum purposes and higher levels of non-voting shares. Many companies may decide that they still want to deliver paper to boost the level of votes to ensure a quorum or because they think their shareholders value receiving the glossy annual report and proxy statement via “snail mail.”

Nevertheless, the use of e-delivery of proxy materials increased in 2013 due to the significant cost savings it provided for many companies. One proxy delivery company reported that its clients who used e-delivery methods saved approximately $280 million. Furthermore, some companies that have utilized e-delivery methods in the past reported increased shareholder participation and response rates compared to prior years. This may indicate that shareholders are becoming more familiar and comfortable with the e-proxy delivery method, and are becoming more willing to participate.

After several years of experience complying with the rules, companies should consider reassessing whether to use the notice and access methodology and whether their current use is optimal by considering:

  • If your company uses notice and access, how has your shareholder participation rate been affected?
  • Is a certain shareholder demographic, such as large or smaller shareholders, less likely to vote if notice and access is used?
  • If your company uses notice and access, how much money is being saved?
  • What is the cost-benefit analysis to improving voter participation?
  • If your company uses notice and access, has it received any recent bids from financial printers to determine the current cost of printing proxy and annual report materials in greater quantities?

With e-proxy trends differing from company to company, a company may be able to better determine which delivery option is best for it by knowing the answers to such questions. A company may even be able to improve support for a close vote by using the hybrid delivery option. For example, if a company believes that a proposal may be met with shareholder opposition from a certain class or demographic of shareholders, and the results from past elections indicate a higher vote response when paper copies are sent, the board may decide to send paper copies to the shareholder demographics most likely to support its proposal or to all shareholders. Thus, after several years of e-proxy delivery, companies should reassess their use or non-use of the notice and access methodology permitted by the E-Proxy Rules. .

Nikul D. Patel
Chicago Office

Is It Time to Switch to Virtual Shareholder Meetings?

The Delaware General Corporation Law allows companies to hold exclusively virtual shareholder meetings (i.e., no physical location). In this regard, Section 211 provides that a board of directors may, if authorized by the corporation’s charter or bylaws, hold a shareholder meeting by “remote communication.” Similarly, Section 405 of the Michigan Business Corporation Act provides not only for remote shareholder participation at a meeting held in a physical location but also for remote-only shareholder meetings pursuant to which Michigan corporation may hold a meeting solely by electronic means. Delaware, Michigan and many other states require that corporations institute three specific procedures in order to conduct an electronic shareholder meeting such that shareholders can participate, be deemed present, and can vote at the annual meeting:

  • The corporation takes reasonable measures to verify that each person deemed present and permitted to vote at the meeting is a shareholder or proxy holder;
  • The corporation takes reasonable measures to provide shareholders and proxy holders a reasonable opportunity to participate in the meeting and vote on matters submitted to shareholders, including hearing or reading the proceedings as they happen; and
  • The corporation maintains a record of any votes and other actions taken by means of remote communication.

Not all states, however, allow companies to hold exclusively virtual shareholder meetings. Some states, such as California, allow for virtual shareholder meetings, but the restrictions make it difficult for companies to actually do so. Other states, including Florida and Illinois, require a physical location for a shareholder meeting, but allow shareholders to participate in the meeting remotely (a “hybrid meeting”). Finally, some states, including Georgia, New York, and Wisconsin, prohibit virtual shareholder meetings entirely.

Why Hold a Virtual Annual Meeting? Although relatively few companies hold virtual shareholder meetings, the number has been increasing in recent years. There are several reasons a company may choose to hold a virtual shareholder meeting, including:

  • Potential costs savings for the company and attendees.
  • Increased shareholder participation and opportunity for communication with shareholders.
  • Reduced environmental impact.

Why Not? With these potential benefits, why do companies seem reluctant to hold virtual meetings? First, as noted above, state law principles are not well defined as yet, meaning there may be unresolved legal issues regarding the mechanics of holding the meeting and whether certain means are legally sufficient. Second, companies have to deal with technical considerations, including ensuring that shareholders can vote and ask questions during the meeting. These may be costly and difficult to address. Third, shareholders may be concerned that a virtual meeting may limit the shareholders’ ability to interact with each other and with management before, during and after the meeting. Finally, companies are likely to take a “if it ain’t broke, don’t fix it” approach unless there is some impetus to go to a virtual meeting or allow electronic access, preferring to stay with the tried and true in-person meeting.

Practical Considerations. Corporations considering a switch to virtual shareholder meetings should first determine whether applicable state law and their bylaws allow for virtual shareholder meetings and review any requirements that need to be met. They should also consider reaching out to other companies that have held virtual or hybrid meetings and to relevant service providers to determine the practical issues and costs involved. If the company decides to hold a virtual or hybrid shareholder meeting, it should establish a plan for fulfilling its responsibilities under state law and relevant bylaw provisions and should expand its guidelines for participation in the meeting to include considerations relating to remote participation. .

Joseph R. DeHondt
Bloomfield Hills Office

PCAOB Audit Committee Communication Changes

The Public Company Accounting Oversight Board (PCAOB) recently acted to eliminate perceived constraints on communications, and foster constructive two-way discussions, between auditors and audit committees by approving Auditing Standard No. 16, Communications with Audit Committees (AS 16), which was subsequently approved by the SEC. AS 16 retains most of the existing communication requirements, adds a number of new topics that the auditor must discuss with the audit committee and requires that the auditor seek specific responses from the audit committee when discussing certain topics. The changes are based on audit deficiencies that the PCAOB has identified in its inspections of audit firms over a three-year period. In this regard, the PCAOB suggested that audit committees of companies for which audits of internal control are conducted may want to:

  • discuss with their auditors the level of auditing deficiencies in this area identified in their auditors’ internal inspections and PCAOB inspections;
  • request information from their auditors about potential root causes of such findings;
  • ask how they are addressing the matters discussed in the PCAOB’s guidance;
  • inquire about the involvement and focus by senior members of the firm on these matters;
  • inquire of the auditor how the controls to be tested will address the assessed risks of material misstatement for relevant assertions of significant accounts and disclosures; and
  • discuss with the auditor his or her assessment of risks, evaluation of control deficiencies, and whether the auditor has adjusted as necessary the nature, timing, and extent of his or her control testing and substantive audit procedures in response to risks related to identified control deficiencies.

The new standard also requires the auditor to inquire of the audit committee whether the audit committee is aware of matters that are relevant to the audit, including matters such as violations or possible violations of laws or regulations. AS 16 also indicates that communications should be tailored to the circumstances and informative rather than “boilerplate” or standardized.

Robert B. Murphy
Washington, D.C Office

Forum Selection Bylaws

So-called forum selection bylaws provide that shareholders bringing derivative claims or claims alleging breaches of fiduciary duties, or otherwise implicating the internal affairs of the corporation be brought exclusively in a particular state’s court. Such a bylaw allows the company to choose the state whose courts are most likely to have expertise applying the law of the state in which the company is incorporated to hear cases regarding these matters, borrowing a common concept from the realm of contracts.  Also, because most Delaware corporations are headquartered in states other than Delaware, corporations can be subject to duplicative shareholder litigation brought in multiple forums (i.e., the state in which they are headquartered and the state in which they are incorporated). In an effort to reduce the costs associated with multi-forum litigation, publicly-traded companies began adopting forum section bylaws to limit the forums in which certain types of shareholder suits may be brought. On June 25, 2013, the Delaware Court of Chancery found that forum selection bylaws adopted by the Chevron and FedEx boards of directors were facially valid.

There had been some uncertainty regarding whether forum section bylaws are enforceable. In February 2012, twelve complaints were filed against Delaware corporations whose boards had unilaterally adopted forum selection bylaws. Ten of the defendant corporations repealed their forum selection bylaws and the complaints were dismissed. The court consolidated the cases against the two remaining corporations, Chevron and FedEx, into one case.

The boards of directors of Chevron and FedEx, both Delaware corporations, adopted bylaws providing that the forum for litigation related to the internal affairs of the corporation should be brought in Delaware. In bringing suit, the plaintiffs claimed that this forum selection provision was (1) statutorily invalid because the bylaws were beyond the authority granted by Delaware law, and (2) contractually invalid because they were unilaterally adopted by the boards. The Delaware Court of Chancery rejected the plaintiffs’ claims, concluding that forum selection bylaws were statutorily valid under Delaware law. Because the Chevron and FedEx forum selection bylaws govern disputes related to the internal affairs of the corporation, the court found that the bylaws “easily” met the statutory requirements.

Further, the court held that the forum selection bylaws were contractually valid. In this regard, under their certificates of incorporation, the Chevron and FedEx boards of directors had the power to unilaterally amend the bylaws. According to the court, the certificate of incorporation is part of a contract between a Delaware corporation and its shareholders. By buying stock, the shareholders agreed to the certificate of incorporation, including the provision allowing unilateral adoption or modification of bylaws, including a forum selection bylaw. In response to the court’s decision, the plaintiffs initially appealed the case to the Delaware Supreme Court, but subsequently voluntarily dismissed the case.

The corresponding Michigan statutory provision is very similar in design to the Delaware statutory requirements, providing that “the bylaws may contain any provision for the regulation and management of the affairs of the corporation not inconsistent with law or the articles of incorporation.” As such, a court construing Michigan law, in the absence of binding Michigan precedent, would likely follow the Delaware court’s lead and uphold a forum selection bylaw limited to suits by shareholders dealing with the internal affairs of the corporation as valid and enforceable.

Practical Considerations. While this Delaware decision seems to give companies a green light to adopt forum selection bylaws, there are several factors boards should consider before making a decision.

First, it is not clear whether courts construing laws other than Delaware (or Michigan) will give effect to forum selection bylaws. For example, in 2011 a California federal court held that forum selection bylaws were not enforceable; although this decision involved events that gave rise to the litigation which took place prior to the adoption of the forum selection bylaws.

Second, the Delaware court’s decision only states that forum selection bylaws are facially valid on a statutory and contractual basis. Plaintiffs may be successful arguing that (1) as with any forum selection clause, forum selection bylaws should not be enforced because doing so would be unreasonable, or (2) as with any bylaw provision, forum selection bylaws should not be enforced because they are being used for improper purposes inconsistent with the directors’ fiduciary duties.

Third, boards should review the corporation’s investor profile, as forum selection bylaws may draw criticism from shareholders and proxy advisory firms. Although a board typically has the ability to adopt a forum selection bylaw without shareholder approval, receipt of shareholder approval may be sought in some cases as a means of dampening shareholder criticism of the provision. Institution Shareholder Services has indicated that it will review forum selection bylaw proposals on a case-by-case basis, taking into account whether the company has been materially harmed by shareholder litigation outside its jurisdiction of incorporation, based on disclosure in the company’s proxy statement, and whether the company has the following “good governance” features:

  • An annually elected board.
  • A majority vote standard in uncontested director elections.
  • The absence of a poison pill, unless it was approved by shareholders.

Glass Lewis generally recommends that shareholders vote against forum selection bylaw proposals, except that it will consider supporting the adoption of forum selection bylaws if the company provides a compelling argument as to:

  • Why the provision is necessary.
  • How the provision would directly benefit shareholders.
  • Where the company otherwise has a record of good corporate governance practices.

Additionally, if a board unilaterally adopts forum selection bylaws, Glass Lewis will generally recommend voting against the chair of the governance committee.

Joseph R. DeHondt
Bloomfield Hills Office

Conflict Minerals Form SD Filing due June 2, 2014

SEC reporting companies are required to file Form SD by June 2, 2014 if any conflict mineral is necessary to the production or functionality of a product that the reporting company manufactures or contracts with a third party to manufacture. Form SD is technically due May 31, 2014, but because May 31st falls on a Saturday this year, the Form SD is not required to be filed until the next business day on Monday, June 2, 2014. Conflict minerals are tin, tantalum, tungsten and gold.

Most SEC reporting companies with potential conflict mineral issues to report have been actively working with their supply chains for months conducting their country of origin inquiry and related due diligence to determine whether any conflict minerals in their products originate in the Democratic Republic of the Congo or adjoining countries or come from recycled or scrap sources. The contents of the Form SD and possible Conflict Minerals Report will depend on the results of such country of origin inquiry and due diligence.

The Form SD allows for a great deal of flexibility in how a company will make its conflict minerals disclosure. The primary objective from a disclosure standpoint should be to effectively communicate to your key stakeholders your conflict minerals policy and the reasonableness of your country of origin inquiry, due diligence and related determinations. Accordingly, it is strongly recommended that SEC reporting companies prepare a draft Form SD now (and a Conflict Minerals Report if applicable) to assist in developing a company-specific message and disclosure.

The Form SD is signed by an executive officer, and is considered “filed” for SEC reporting and liability purposes. So consider whether the Form SD needs to be included in any internal controls process or back-up certification procedures your company may have in place. A detailed discussion of the conflict minerals rule is outside the scope of this Alert. Click here for our previous Alert containing a detailed discussion of the conflict minerals rule.

D. Richard McDonald
Bloomfield Hills Office

SEC Proposed Pay Ratio Disclosure Rules

In September 2013, the SEC proposed a new rule that would require public companies to disclose the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees. These proposed rules will not be in effect for the 2014 proxy season. Assuming the SEC adopts the final rules in 2014, it is expected that companies with a December 31st fiscal year end would first be required to disclose the pay-ratio information relating to 2015 compensation in their proxy or information statements for their 2016 shareholder meetings. Click here for our previous Alert containing a detailed discussion of the proposed pay-ratio disclosure rules.

Remaining Dodd-Frank Rulemaking Initiatives

There are a number of corporate governance and disclosure provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 that require SEC action but have not been implemented yet.

Pay-for-Performance. Dodd-Frank requires the SEC to adopt rules regarding pay-for performance under which companies will have to disclose material information that shows the relationship between executive compensation actually paid and the financial performance of the company, taking into account any change in the value of the company’s stock and the dividends paid by the company. The SEC has not yet proposed rules for this disclosure requirement and is not currently publishing a target time frame for such a proposal.

Clawbacks. Under Dodd-Frank, the SEC must direct stock exchanges to prohibit listing a company’s securities if it does not develop a policy with respect to the recovery of incentive-based compensation in certain circumstances. Unlike the Sarbanes-Oxley Act clawback provision, which does not require adoption of a policy and is limited in application to the chief executive officer and the chief financial officer, the Dodd-Frank clawback policy will need to cover both current and former executive officers, and will relate to all restatements due to material noncompliance with financial reporting requirements and not merely restatements due to misconduct . The Dodd Frank provision would also calculate the amount to be recouped differently than the Sarbanes-Oxley provision. The SEC has not yet proposed any rules for the exchanges relating to this requirement.

Hedging. The SEC still has not proposed any regulations to implement the Dodd-Frank requirement that companies disclose whether employees and directors are permitted, directly or indirectly, to hedge the market value of securities granted as compensation.

If you have any questions regarding the foregoing matters, please contact your Dykema Corporate Finance attorney, D. Richard McDonald, who leads Dykema’s public company practice group (248-203-0859), or any of the attorneys listed to the left.

As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments are always welcome. © 2014 Dykema Gossett PLLC.

As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments are always welcome. © 2021 Dykema Gossett PLLC.