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November 8, 2017 |
Potential Changes in Taxation of Executive Compensation and Employee Benefits Under the Proposed House Tax Legislation

On November 2, 2017, House Republicans released their much-anticipated tax reform proposal, entitled the Tax Cuts and Jobs Act (the "Act").  We provided a summary of the Act here, which noted that there is significant uncertainty as to whether some or all of the provisions in the Act will take effect, and, if they do, in what form.  If enacted, certain provisions of the Act would have a major impact on executive compensation and various employee benefits, including qualified retirement plans and fringe benefits.  We summarize the provisions of the Act relating to executive compensation and employee benefits below.

Effective Elimination of Unfunded Non-Qualified Deferred Compensation

As an offset to lower individual tax rates, the Act substantially limits amounts on which taxes can be deferred by individuals as nonqualified deferred compensation.  The basic principle is that an individual would be taxed on compensation as soon as that compensation is no longer subject to an obligation to perform future substantial services.  Other types of restrictions, such as bona fide performance goals, that under current law delay taxation until if and when they are achieved, would not defer taxation.[1]  The proposed tax legislation takes the form of introducing a new Code section—Section 409B.  The existing elaborate rules governing the taxation of nonqualified deferred compensation under Section 409A would be repealed in their entirety. Section 409B would effectively eliminate long-term nonqualified deferred compensation as a means of delaying income taxation for years into the future by virtue of taxing compensation once any service requirement has been fulfilled.  Unlike Section 409A, there would be no penalties in the form of additional income taxes, interest and penalty taxes imposed under Section 409B. Certain concepts under Section 409A will or should remain.  First, the concept of payment on or before 2 ½ months after the end of a tax year in which the right to compensation vests (the so-called "short-term deferral rule") would remain in effect.  Second, transfers of property in connection with the performance of services, which are taxed under Section 83, would not be covered under Section 409B.  Third, since Section 422 would not be repealed under the Act, incentive stock options should remain in effect.  The proposed legislation gives the Treasury Department broad authority to exempt various forms of compensation from Section 409B, so we would expect (as is the case in the Section 409A regulations) that if this legislation were enacted in its present form, the Section 409B regulations would expressly exempt incentive stock options. Options generally, however, receive unusually unfavorable treatment under Section 409B.  Both options and stock appreciation rights would become taxable when any service-based requirements are satisfied, regardless of whether or not the option is exercised, the underlying stock is publicly traded, or the option is then still subject to other restrictions such as performance goals that have not yet then been achieved.   We expect this provision in particular to draw much comment and criticism.  At least one member of Congress has already proposed allowing deferral of taxation of options until five years after vesting (or, if earlier, when the option is exercised). Deferred compensation plans sponsored by tax-exempt organizations (other than state and local governments) under Section 457 would be eliminated.  Section 457A (which covers deferred compensation paid by partnerships and certain foreign corporations) would also be repealed, presumably because the standard for taxation that is established for those arrangements is the same as has been proposed under Section 409B. These provisions would become generally effective for compensation attributable to services performed on or after January 1, 2018.  Deferred compensation accrued prior to 2018 is not entirely grandfathered, rather it must be taxed (generally upon actual payment) no later than December 31, 2025.  Note that this requirement includes even deferred compensation accrued prior to 2005, the year in which Section 409A originally became effective.

Expansion of Non-deductibility of "Excessive" Executive Compensation under Section 162(m)

The Act would substantially expand the scope of non-deductible executive compensation above $1 million in a single fiscal year for public companies.  It does so by making a number of important changes to Code Section 162(m).
  • The current exemption for "performance-based compensation" (which covers cash incentive bonuses and a number of different types of equity compensation, such as options and performance shares) would be eliminated.  The exemption for commission payments would also be repealed.
  • The scope of those executives whose compensation is covered by Section 162(m) would be expanded in two ways.  First, the Act conforms the definition of "covered employee" to the current definition of "named executive officer" applicable to proxy disclosure for public companies under federal securities law.  This has the effect of covering Chief Financial Officers, whose compensation has not been covered under current Section 162(m) in recent years.  It also results in covering any person who serves as a company's principal executive officer or principal financial officer at any time.  Second, while under current law the group of covered employees is determined at the end of a public company's fiscal year and applies only to compensation paid in that fiscal year, under the Act once an executive becomes a covered employee, that status is retained for the remainder of that executive's life and therefore covers all compensation paid to the executive for the remainder of his or her life.  There is even a special rule to pick up compensation paid to beneficiaries after the death of a covered employee.
  • The Act broadens the scope of companies treated as "publicly held corporations" subject to this law, including not only companies that have registered their stock or other equity securities with the Securities & Exchange Commission, but also certain other companies that file reports with the SEC (such as companies only filing reports relating to their debt securities).  This latter extension could be problematic since many of these additional companies are not currently required under securities laws to identify their named executive officers in SEC filings.
These changes to Section 162(m) would be effective for tax years beginning after December 31, 2017.

Changes Affecting Tax-Qualified Retirement Plans

The Act also includes several changes directed at tax-qualified retirement plans.  Unlike the executive compensation provisions discussed in this client alert, none of these changes should be controversial, and we think it is likely that some or all of these changes will be enacted (either as part of the Act or in other legislation). During the drafting of the Act, there were rumblings that the Act could make a number of unpopular changes, such as significantly reducing the limit on employee "401(k)" contributions and characterizing all employee contributions as "Roth" after-tax contributions.  However, none of those provisions were included in the current version of the Act. The changes in the Act that would impact tax-qualified plans are:
  • IRA Conversions.  Under current law, individuals are permitted to recharacterize contributions to "traditional" IRAs as contributions to "Roth" IRAs, and vice versa.  Under the Act, this will no longer be permitted after December 31, 2017.   Thus, individuals would be stuck with the initial tax treatment they choose for their IRAs.
  • Reduction in Age for Permissible In-Service Distributions.  Currently, individuals who continue working generally cannot take distributions from defined benefit pension plans and money purchase pension plans until age 62.  Commencing with plan years beginning after December 31, 2017, the Act would allow plans to permit in-service distributions commencing at age 59-1/2, similar to the rules for 401(k) plans.
  • Hardship Distributions.  Beginning in 2018, the Act would modify the rules applicable to hardship distributions from 401(k) plans.  First, the Act would eliminate the rule that participants must be suspended from making employee contributions for six months following a hardship withdrawal.  Second, the Act would repeal the requirement to take a plan loan before a hardship withdrawal is permitted.  Third, the types of contributions that may be withdrawn would be expanded to include qualified nonelective contributions, qualified matching contributions and post-1988 earnings.
  • More Flexibility to Repay Plan Loans.  Under current law, a plan loan generally goes into default (triggering a deemed distribution and, in many cases, a 10% excise tax) unless the loan is repaid in full within 60 days following termination of employment.  The Act would extend that deadline to the individual's due date (including extensions) for filing his or her individual tax return for the year of termination of employment.
  • Closed Plan Nondiscrimination Testing.  In recent years, many employers have closed defined benefit pension plan participation to new employees, so that only previous hires continue to accrue benefits.  As the "grandfathered" group ages and becomes more highly-compensated relative to the rest of the workforce, that can result in the plan's failure to satisfy various IRS nondiscrimination rules.  Subject to various requirements, the Act would provide relief to these plans, as well as to defined contribution plans where enhanced contributions are made for a "grandfathered" group who stopped accruing benefits under a pension plan in connection with a "freeze" of that plan.

Repeal or Limitation of Certain Exclusions Relating to Fringe Benefits

In the name of "simplification", the Act also repeals or limits a number of exclusions or exemptions relating to employer-provided fringe benefits from an employees' taxable income.  The fringe benefits affected include the following:
  • Dependent Care Assistance Programs.  The Act eliminates dependent care flexible spending accounts (dependent care FSAs) by repealing Code Section 129.  Currently, an employee can contribute up to $5,000 on a pre-tax basis to fund child care costs or expenses related to care for a disabled spouse or other dependent or an elderly or disable parent.  Contributions to dependent care FSAs would no longer be excluded from income under the Act.  The Act would not have any impact on health FSAs that allow for contributions on a pre-tax basis up to $2,500 to cover health care expenses not covered by insurance.
  • Adoption Assistance Programs.  The Act eliminates adoption assistance programs by repealing Code Section 137.  Under the Act, employers would no longer be permitted to exclude from income amounts paid or expenses incurred by the employer for qualified adoption expenses under an adoption assistance program.
  • Educational Assistance Programs.  The Act eliminates educational assistance programs by repealing Code Section 127, which provides for an exclusion from taxable income of up to $5,250 of employer-provided educational assistance.
  • Employer-Provided Lodging.  Currently, Code Section 119 excludes from an employee's taxable income the value of certain employer-provided lodging where an employee is required to accept lodging on the employer's business premises as a condition of employment.  The Act would add a new subsection (e) to Section 119 that would limit the aggregate amount that could be excluded from income in any one year to $50,000, which limit would be further reduced for certain highly compensated employees and 5% owners.
  • Employee Achievement Awards.  The Act repeals Code Section 74(c) (and related provisions), which provides that certain employee achievement awards are not included in an employee's taxable income (and are therefore not deductible by the employer).
Gibson, Dunn & Crutcher is focused on the Act and how it would affect our clients, and we will continue to provide updates as more information about the Act or tax reform in general becomes available.
   [1]   Although presumably the presence of these vesting conditions should affect the valuation of the compensation to be paid.

The following Gibson Dunn lawyers assisted in preparing this client update: Steve Fackler, Michael Collins, Sean Feller and Arsineh Ananian.

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, or the following:

Stephen W. Fackler - Palo Alto and New York (+1 650-849-5385 and 212-351-2392, sfackler@gibsondunn.com) Michael J. Collins - Washington, D.C. (+1 202-887-3551, mcollins@gibsondunn.com) Sean C. Feller - Los Angeles (+1 310-551-8746, sfeller@gibsondunn.com)
© 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 19, 2017 |
IRS Updates U.S. Retirement Plan COLAs for 2018

On October 19, 2017, the IRS released its cost-of-living adjustments applicable to tax-qualified retirement plans for 2018.  In contrast to recent years where many limits had remained unchanged, a number of the key limitations for 2018 will increase as follows:

Limitation

2018 Limit

402(g) Limit on Employee Elective Deferrals (Note:  This is relevant for 401(k), 403(b) and 457 plans, and for certain limited purposes under Code Section 409A.)

$18,500 ($18,000 for 2017)

414(v) Limit on "Catch-Up Contributions" for Employees Age 50 and Older (Note:  This is relevant for 401(k), 403(b) and 457 plans.)

$6,000 (unchanged)

401(a)(17) Limit on Includible Compensation (Note:  This applies to compensation taken into account in determining contributions or benefits under qualified plans.  It also impacts the "two times/two years" exclusion from Code Section 409A coverage of payments made solely in connection with involuntary terminations of employment.)

$275,000 ($270,000 for 2017)

415(c) Limit on Annual Additions Under a Defined Contribution Plan

$55,000 (or, if less, 100% of compensation) ($54,000 for 2017)

415(b) Limit on Annual Age 65 Annuity Benefits Payable Under a Defined Benefit Plan

$220,000 (or, if less, 100% of average "high 3" compensation) ($215,000 for 2017)

414(q) Dollar Amount for Determining Highly Compensated Employee Status

$120,000 (unchanged)

416(i) Officer Compensation Amount for "Top-Heavy" Determination (Note:  Because Code Section 409A defines "specified employees" of public companies by reference to this provision, this amount also affects the specified employee determination, and thus, the group subject to the six-month delay under Code Section 409A.)

$175,000 (unchanged)

Social Security "Wage Base" for Plans Integrated with Social Security

$128,700 ($127,200 for 2017)


Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, or any of the following:

Stephen W. Fackler - Palo Alto/New York (650-849-5385/212-351-2392, sfackler@gibsondunn.com) Michael J. Collins - Washington, D.C. (202-887-3551, mcollins@gibsondunn.com) Sean C. Feller - Los Angeles (310-551-8746, sfeller@gibsondunn.com) Krista Hanvey - Dallas (214-698-3425; khanvey@gibsondunn.com)

  


© 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 13, 2017 |
SEC Proposes Amendments to Securities Regulations to Modernize and Simplify Disclosure

On October 11, 2017, the Securities and Exchange Commission (SEC) unanimously voted to propose amendments to modernize and simplify disclosure requirements for public companies, as well as investment advisers and investment companies.  The rule proposals, available here, represent a significant first step by the SEC toward implementing Congress' mandate under the Fixing America's Surface Transportation (FAST) Act to reduce compliance costs and burdens on companies while continuing to provide all material information to investors.

Chairman Jay Clayton said the proposals will reduce the burdens on issuers while providing investors with the information they need to make informed decisions.  This viewpoint is consistent with the guiding principles Chairman Clayton outlined at the start of his tenure, available here.  Chairman Clayton stated that "[t]he proposed amendments are intended to improve the quality and accessibility of disclosure in filings by simplifying and modernizing our requirements.… The proposed amendments also clarify ambiguous disclosure requirements, remove redundancies and further optimize the use of technology."

Background

In December 2015, Congress passed the FAST Act, available here.  The FAST Act required the SEC to conduct a study on Regulation S-K, the primary disclosure regulation, and eventually to enact related rules, to "(1) determine how best to modernize and simplify such requirements in a manner that reduces the costs and burdens on issuers while still providing all material information; (2) emphasize a company-by-company approach that allows relevant and material information to be disseminated to investors without boilerplate language or static requirements…; [and] (3) evaluate methods of information delivery and presentation and explore methods for discouraging repetition and the disclosure of immaterial information." The SEC submitted its report on this study – the FAST Act Report – on November 23, 2016, available here.  The FAST Act further required the SEC to propose amendments implementing recommendations from the report within 360 days of the report date.  At the open Commission meeting, Chairman Clayton and Division of Corporation Finance Director William Hinman indicated the proposed amendments are a result of recommendations in the FAST Act Report and cover all areas of improvement previously identified by the SEC staff.

Summary of Proposed Amendments

Several of the proposed amendments are discussed in further detail below. Management's Discussion and Analysis (MD&A) – Item 303 of Regulation S-K Under the proposed amendment to Item 303, registrants that provide financial statements covering three years in their filings would not be required to include in MD&A a discussion of the earliest year if (i) discussion of the earliest year is not material to understanding the registrant's financial condition, and (ii) the registrant has filed its prior year Form 10-K containing MD&A of the earliest of these three years.  For example, under the proposed amendment, if a registrant files its 2017 Form 10-K that includes financial statements for fiscal years 2015, 2016, and 2017, the registrant would be able to eliminate the discussion comparing fiscal year 2016 to 2015 in its 2017 Form 10-K, and instead address 2016 solely in the context of the discussion comparing 2017 to 2016, if a discussion about 2015 is not material to an understanding of the registrant's current financial condition and the registrant included this information in its 2016 Form 10-K. One of the priorities of this proposed amendment is to encourage registrants to take a "fresh look" at their MD&A to determine whether such disclosures remain material.  Omission of the information that is no longer material is intended to reduce repetition in filings.  As such, the proposed amendment does not include the FAST Act Report's recommendation requiring a hyperlink to the prior year's annual report for the earlier year-to-year comparison. The proposed amendment would also eliminate the reference to trends related to five-year selected financial data in Instruction 1 to Item 303(a) because disclosure requirements for liquidity, capital resources, and results of operations already require trend disclosure. Exhibits – Item 601 of Regulation S-K Omission of Information From Material Contracts Without Confidential Treatment Request Under the proposed amendments, registrants would be allowed to omit confidential information from material contracts filed pursuant to Item 601(b)(10) where such redacted information is both (i) not material and (ii) competitively harmful if publicly disclosed, without requesting confidential treatment from the SEC.  As is the current practice, registrants would still be required to (i) mark the exhibit index to indicate portions of the exhibit have been omitted, (ii) include a prominent statement on the first page of the redacted exhibit indicating certain information has been omitted, and (iii) indicate with brackets where such information has been omitted within the exhibit. Although registrants would not be required to file confidential treatment requests, it would remain the responsibility of these registrants to ensure all material information is disclosed and the redactions are limited to those portions necessary to prevent competitive harm.  The SEC staff would continue to selectively review registrant filings and assess whether registrants have satisfied their disclosure responsibility with respect to these omissions.  Upon request, registrants would be required to provide supplemental materials similar to those currently required in confidential treatment requests.  Registrants could request confidential treatment pursuant to Rule 83 for these supplemental materials.  If the supplemental materials do no support the redactions, the SEC staff may instruct registrants to file an amendment disclosing some, or all, of the previously redacted information. Omission of Schedules and Attachments to Exhibits Under the proposed amendments, registrants would be permitted to omit entire schedules and similar attachments to exhibits, unless these schedules or attachments contain material information that is not otherwise disclosed in the exhibit or SEC filing.  This proposed amendment would extend the existing accommodation in Item 601(b)(2) for plans of acquisition, reorganization, arrangement, liquidation, or succession to all exhibits, including credit agreements and purchase agreements.  As with Item 601(b)(2), registrants would be required to provide, on a supplemental basis, a copy of any omitted schedules or attachments to the SEC staff upon request. Omission of Personally Identifiable Information (PII) The proposed amendments would permit registrants to omit PII (such as bank account numbers, social security numbers and home addresses) from all exhibits without submitting a confidential treatment request.  Additionally, registrants would not be required to provide an analysis in order to redact PII from exhibits.  This is consistent with the SEC staff's current practice of not objecting when registrants seek confidential treatment and omission of PII. Two-Year Look Back Period for Material Contracts Under the proposed amendments, with the exception of "newly reporting registrants," registrants would no longer be subject to the two-year look back period under Item 601(b)(10)(i).  The two-year look back period currently requires all registrants to include all material exhibits entered into during its last two years in their Form 10-K.  Under the proposed amendment, registrants would only file exhibits that are still material at the time of the filing. Legal Entity Identifiers (LEIs) LEIs are 20-character, globally-recognized alpha-numeric codes that allow for unique identification of entities engaged in financial transactions.  Under the proposed amendment to Item 601(b)(21)(i), all registrants and subsidiaries that have LEIs would be required to disclose each of these LEIs in this exhibit on the theory that this additional information could allow investors to better understand the registrant's corporate structure and certain transactional risks at minimal additional cost to registrants.  While Commissioner Kara Stein voted to approve the proposed amendments, she expressed concern that the proposed amendments do not go far enough in this area because they would not require registrants and subsidiaries to obtain LEIs if they do not currently have them. Description of Securities The proposed amendments to Item 601(b)(4) would require registrants provide a brief description of all securities registered under Section 12 of the Exchange Act (i.e., the information required by Item 202(a)-(d) and (f)) as an exhibit to their Form 10-K.  Currently, such disclosure is only required in registration statements.  The SEC noted that requiring Item 202 disclosure as an exhibit to annual reports would improve investors' access to information about their rights as security holders, thereby facilitating more informed investment and voting decisions. Description of Property – Item 102 of Regulation S-K Under the proposed amendment to Item 102, registrants would only be required to disclose physical properties to the extent such properties are material to the registrant's business, which contrasts with the current requirement to disclose "principal" plants, mines, and other "materially important" physical properties.  However, given the significance of the disclosure of properties for registrants' operating in the mining, real estate, and oil and gas industries, the SEC does not propose to modify the instructions to Item 102 specific to these industries and they remain subject to their existing industry guides. Other Proposed Technical Amendments
  • Changes to Clarify Unclear Instructions or Terms.  The proposed amendments to Item 401 (Directors, Executive Officers, Promoters, and Control Persons), Item 405 (Compliance with Section 16(a) of the Exchange Act), Item 407 (Corporate Governance), Item 501(b) (Outside Front Cover Page of the Prospectus), and Item 508 (Plan of Distribution) would help clarify unclear instructions or terms within these specific Items.
  • Relocation of Certain Requirements.  The proposed amendments to Item 503(c) (Risk Factors) would relocate Item 503(c) from Subpart 500 to Subpart 100 to reflect the application of risk factor disclosure requirements to registration statements on Form 10 and periodic reports.
  • Elimination of Obsolete Undertakings.  The proposed amendments to Item 512 (Undertakings) would eliminate those undertakings that have become obsolete.
  • Changes to Improve Access to Information.  The SEC proposes to incorporate technology to improve access to information by requiring data tagging for items on the cover page of certain filings and the use of hyperlinks for information that is incorporated by reference and available on EDGAR.
  • Ticker Symbol.  The proposed amendments would require disclosure of a registrant's stock ticker symbol on the cover page of certain filings.

Considerations for Companies and Commenters

The comment period for the proposed rules will expire 60 days after the proposed rules are published in the Federal Register. Chairman Clayton's statement during the open meeting proposing rules to modernize and simplify disclosure requirements is available here, Commissioner Stein's statement is available here, and Commissioner Michael Piwowar's statement is available here.  In her remarks, Commissioner Stein specifically asked for comments regarding whether the release goes as far as it can with respect to LEI requirements, as well as for comments on MD&A disclosure and redactions of sensitive information in exhibits. The proposed amendments are generally consistent with the FAST Act Report, so they do not present any great surprises.  Registrants will welcome the opportunity for less redundancy in their disclosure. However, a number of technical issues are presented by the proposals.  For example, registrants may have to revise the format of their MD&A so that the discussion of current year to prior year results addresses material aspects of both years.  As well, there are uncertainties related to the elimination of the confidential treatment request process, including, but not limited to: the treatment and expiration of current confidential treatment orders; whether companies will need to revise their exhibits as time passes to ensure that previous redactions remain limited to those portions necessary to prevent competitive harm; and whether companies conducting initial public offerings will be able to go effective if the SEC staff decides to review a redacted exhibit during its review process. Regardless of whether or when the proposed amendments are adopted, this release provides registrants with a good reason to take a fresh look at the disclosure in their Exchange Act reports.  Registrants will want to evaluate how their reports and registration statements can be revised to improve readability and navigability and eliminate repetitive or immaterial disclosure. Registrants should evaluate, together with their legal counsel and other advisors, how the proposed amendments may impact their future compliance costs and burdens and the content of their future disclosures.  Based on those reviews, registrants may wish to submit comments on the proposed amendments.

Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm's Securities Regulation and Corporate Governance and Capital Markets practice groups, or any of the following practice leaders and members

Securities Regulation and Corporate Governance Group: Elizabeth Ising - Co-Chair, Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney - Co-Chair, Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com) Brian J. Lane - Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com) Ronald O. Mueller - Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) John F. Olson - Washington, D.C. (+1 202-955-8522, jolson@gibsondunn.com) Michael J. Scanlon - Washington, D.C. (+1 202-887-3668, mscanlon@gibsondunn.com) Lori Zyskowski - New York (+1 212-351-2309, lzyskowski@gibsondunn.com) Gillian McPhee - Washington, D.C. (+1 202-955-8201, gmcphee@gibsondunn.com) Michael A. Titera - Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)

Capital Markets Group: Stewart L. McDowell - Co-Chair, San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) Peter W. Wardle - Co-Chair, Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com) Andrew L. Fabens - Co-Chair, New York (+1 212-351-4034, afabens@gibsondunn.com) Glenn R. Pollner - New York (+1 212-351-2333, gpollner@gibsondunn.com) Hillary H. Holmes - Houston (+1 346-718-6602, hholmes@gibsondunn.com)


© 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 26, 2017 |
SEC Issues Significant Guidance on Pay Ratio Rules

On September 21, 2017, the U.S. Securities and Exchange Commission (the "SEC") and the Division of Corporation Finance (the "Division") issued new interpretive guidance addressing significant issues under the pay ratio disclosure rule mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act").  The guidance provides a number of helpful clarifications and examples that will assist companies in their efforts to comply with the disclosure rules and, as stated by SEC Chairman Clayton, "encourages companies to use the flexibility incorporated in [the SEC's] prior rulemaking to reduce costs of compliance."[1] 

The guidance consists of an interpretive release by the SEC available here, guidance by the Division available here, and new and revised Compliance & Disclosure Interpretations ("C&DIs") available here.  As discussed below, the Division also withdrew an earlier C&DI that had created uncertainty over when independent contractors and other workers would be viewed as company employees for purposes of the rule.

As we previously discussed in this alert, Item 402(u) of Regulation S-K implements the pay ratio disclosure mandate of the Dodd-Frank Act.  The rule requires disclosure of: (i) the median of the annual total compensation of all employees of the registrant other than the CEO; (ii) the annual total compensation of the CEO; and (iii) the ratio of these two amounts.  Under Item 402(u), companies are generally required to report the pay ratio disclosure based on compensation for their first fiscal year beginning on or after January 1, 2017.  For a calendar-year company, the disclosure generally will be required in the company's 2018 proxy statement, filed next year.

This new guidance reiterates and clarifies important statements and concepts from the SEC's release adopting Item 402(u) (the "Adopting Release").  In particular, the new guidance emphasizes that the SEC provided companies significant flexibility when it designed the pay ratio rule "to allow shareholders to better understand and assess a particular registrant's compensation practices … rather than to facilitate a comparison of this information from one registrant to another."  Consistent with this approach, the guidance addresses a number of contexts in which, to mitigate the costs of compliance, the pay ratio rule generally allows companies to rely on existing internal records and use reasonable estimates, assumptions, and methodologies to identify the median-compensated employee and calculate that employee's annual total compensation:

  • Employees Covered by the Rule and the Treatment of Independent Contractors:  Item 402(u) defines an "employee" for purposes of the rule as "an individual employed by the registrant or any of its consolidated subsidiaries, whether as a full-time, part-time, seasonal, or temporary worker" and expressly excludes individuals "who are employed, and whose compensation is determined, by an unaffiliated third party but who provide services to the registrant or its consolidated subsidiaries as independent contractors or 'leased' workers."  The SEC's new guidance affirmatively states that this exclusion is not the exclusive basis for determining whether a worker is an "employee" for purposes of the rule, and confirms that companies may use tests from other areas of law (e.g., tests under employment or tax law) to determine who is an employee.  Accordingly, companies generally will not be required to count independent contractors or workers employed by unaffiliated third parties as company "employees" for purposes of the pay ratio rule. 

    Consistent with the SEC's new guidance, the Division withdrew one of its prior interpretations (C&DI 128C.05, originally issued in October 2016).  The withdrawn C&DI had suggested that companies had to count workers who were employed by unaffiliated third parties as company employees under the rule if the company determined their compensation, regardless of whether the worker was considered an "employee" for tax or employment law purposes.  The withdrawn C&DI, by going beyond the language of the rule itself and addressing "workers" generally, had significantly increased compliance costs and concerns as companies tried to determine whether workers employed by third parties might be deemed their "employees" for purposes of the pay ratio rule and, if so, how to obtain compensation information on such workers.  By reiterating that Item 402(u)'s definition of "'employee' is an individual employed by the registrant," and confirming that companies generally can apply a "widely recognized test under another area of law to determine whether its workers are employees" for purposes of Item 402(u), the SEC's guidance will greatly simplify compliance for many companies.
  • Using a Consistently Applied Compensation Measure to Identify the Median Employee:  The SEC confirmed that companies can rely on existing internal records (such as tax and payroll records) that reasonably reflect annual compensation when utilizing a consistently applied compensation measure to identify the median employee, even if those records do not include every element of compensation such as equity awards.  This guidance is helpful because many companies administer their equity compensation through a separate reporting system and valuing equity compensation can be problematic.  In particular, this guidance will reduce compliance costs for companies seeking to rely on salary and cash bonus information or similar "base pay" information as the basis for identifying their median employee when the companies are able to conclude that such measures provide a reasonable alternative to annual total compensation for identifying their median employee.   

    Consistent with the SEC's new guidance, the Division modified one of its prior interpretations (C&DI 128C.01, originally issued in October 2016) to omit language indicating that total cash compensation would not be an acceptable consistently applied compensation measure if annual equity awards were widely distributed among employees and that social security taxes withheld would not be an appropriate consistently applied compensation measure unless all employees earned less than the social security wage base.  The omitted language had drawn criticism as it failed to take into account the wide variety of equity compensation practices across companies, and (in contrast to the Adopting Release) seemed to focus on the pay structure of a company's entire workforce, instead of addressing the relative impact of compensation elements paid to employees whose compensation is likely to be at or near the median. 
  • Reliance upon Internal Records, Reasonable Estimates, Assumptions, and Methodologies: The new guidance reaffirms concepts from the Adopting Release allowing companies to rely upon reasonable estimates, assumptions, and methodologies, including statistical sampling, to comply with the rule.  For example, in its interpretive release, the Division identified a variety of situations where reasonable estimates may be used under the rule, including to:
    • analyze the composition of the workforce;
    • characterize the statistical distribution of compensation of employees;
    • calculate annual total compensation or another consistently applied compensation measure;
    • evaluate the likelihood of significant changes in employee compensation from year to year;
    • identify the median employee;
    • identify other employees around the middle of the compensation spectrum; and
    • use the mid-point of a compensation range to estimate compensation
    The Division confirms that the pay ratio rule allows companies to use a combination of reasonable estimates, statistical sampling, and other reasonable methodologies.  In addition, by citing a variety of different statistical sampling approaches that can be applied under the rule, the Division has reaffirmed its flexibility and deference to companies to determine which reasonable and appropriate sampling methods may work best for their organization.  Other examples of reasonable methodologies identified by the Division include: 
    • making one or more distributional assumptions, such as assuming a lognormal or another distribution provided that the company has determined that the use of the assumption is appropriate given its own compensation distributions;
    • reasonable methods of imputing or correcting missing values; and
    • reasonable methods of addressing extreme observations, such as outliers.
    As noted above, the guidance also confirms that companies may use existing internal records, such as tax or payroll records, in determining and disclosing the median employee's compensation.  For example, Item 402(u) allows companies to exclude non-U.S. employees who constitute up to five percent of the company's total workforce when identifying the median compensated employee.  In the new guidance, the SEC expressly affirms that a company can rely on internal records such as tax or payroll records in applying this five percent test. 
  • Important Implications and the Role of Disclosure: Importantly, the SEC acknowledges that, in light of the use of estimates, assumptions, adjustments, and reasonable methodologies allowed under the rule, "pay ratio disclosures may involve a degree of imprecision."  The new guidance addresses a number of implications of this aspect of the rule. 
    • Good Faith Standard: Acknowledging the inherent imprecision in these estimates, assumptions, and methodologies, the SEC stated that "if a registrant uses reasonable estimates, assumptions or methodologies, the pay ratio and related disclosure that results from such use would not provide the basis for Commission enforcement action unless the disclosure was made or reaffirmed without a reasonable basis or was provided other than in good faith."
    • Anomalous Results: The SEC acknowledges that the use of a consistently applied compensation measure based on internal records may identify a median employee whose annual total compensation has anomalous characteristics.  The SEC's guidance reaffirms that in such a situation, a company may substitute another employee with substantially similar compensation to the originally identified median employee.  We believe this same approach is generally appropriate when a company identifies more than one employee with the same median compensation based on its consistently applied compensation measure and that it would be consistent with this guidance for such a company to assess the annual total compensation of those employees and select the most representative case as its median employee. 
    • Disclosure as Reasonable Estimate:  Consistent with the SEC's new guidance, the Division issued a new interpretation (C&DI 128C.06, issued Sept. 21, 2017) stating that the Division would not object if a company states that its disclosed pay ratio is a reasonable estimate calculated in a manner consistent with Item 402(u)

Finally, consistent with the SEC's traditional focus on disclosure, the new guidance notes in a number of contexts the disclosure requirements under the pay ratio rule.  For example, the SEC's guidance notes that if a company substitutes a different median employee to address anomalous results, the company should disclose the substitution as part of its brief description of the methodology it used to identify the median employee.  Similarly, the SEC notes that factors relevant to identifying a company's employees who are covered by the rule may involve material assumptions that should be described as part of the company's methodology for calculating and disclosing its pay ratio. 

Overall, the new guidance reiterates the company-specific facts-and-circumstances nature of pay ratio determinations and further outlines the variety of estimates, methods, and options that a company has at its disposal in determining its employee population, identifying its median employee, and calculating its pay ratio.  What is appropriate for one company may not work for another, and companies will need to determine how best to comply with Item 402(u) in light of their size, geographic scope, and business operations.  Companies also should carefully evaluate how to briefly describe material estimates, assumptions, and methodologies they employ, to place their pay ratio disclosure in context and reflect the unique nature of the disclosure.


   [1]   See SEC, Press Release, SEC Adopts Interpretive Guidance on Pay Ratio Rule, Sept. 21, 2017, available here.


The following Gibson Dunn lawyers assisted in the preparation of this client update: Ronald O. Mueller, Elizabeth Ising, Maia Gez and Krista Hanvey.

Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following lawyers in the firm's Securities Regulation and Corporate Governance practice group:

Brian J. Lane - Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com)
Ronald O. Mueller - Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
James J. Moloney - Orange County (+1 949-451-4343, jmoloney@gibsondunn.com)
Elizabeth Ising - Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Sean C. Feller - Los Angeles (+1 310-551-8746, sfeller@gibsondunn.com)
Lori Zyskowski - New York (+1 212-351-2309, lzyskowski@gibsondunn.com)
Gillian McPhee - Washington, D.C. (+1 202-955-8201, gmcphee@gibsondunn.com)
Maia Gez - New York (+1 212-351-2612, mgez@gibsondunn.com)
Krista Hanvey - Dallas (+1 214-698-3425, khanvey@gibsondunn.com)
Julia Lapitskaya - New York (+1 212-351-2354, jlapitskaya@gibsondunn.com)


© 2017 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 5, 2017 |
Internal Revenue Service Announces Relief for Southeast Texas Due to Hurricane Harvey

The Internal Revenue Service (the "IRS") has announced relief from certain time sensitive deadlines for taxpayers affected by Hurricane Harvey (https://www.irs.gov/newsroom/tax-relief-for-victims-of-hurricane-harvey-in-texas). Pursuant to the announcement, affected Taxpayers (described below) may defer certain time-sensitive actions otherwise to be made on or after August 23, 2017 and before January 31, 2018 (the "Postponement Period") to January 31, 2018. The IRS also reminded taxpayers of their ability to report deductions for casualty losses unreimbursed by insurance for Harvey in 2016 or 2017 and provided guidance on how to get expedited refund processing for 2016. In addition, the IRS has announced relief intended to ease the process whereby employer-sponsored retirement plans, such as 401(k) plans, may extend loans and make hardship distributions to individuals impacted by Hurricane Harvey and their family members (https://www.irs.gov/pub/irs-drop/a-17-11.pdf) (the "Relief Announcement").

Actions Postponed

Tax Reporting and Payment Deadlines. Affected Taxpayers may postpone payment and filing deadlines for federal income taxes (e.g., individual, corporate and partnership tax return filings, estimated tax payments otherwise due September 15, 2017 and January 15, 2018) that would have been due during the Postponement Period until January 31, 2018. Payroll and certain excise tax reporting is postponed but not payment of employment and excise tax deposits (although penalties on deposits due on or after August 23, 2017 and before September 7, 2017 will be abated if paid by September 7, 2017). Employee plan reporting on Form 5500 due during the Postponement Period is included in the relief. Like-Kind Exchange Reporting Deadlines. The last day of the 45-day identification period and the 180 day exchange period and applicable reverse like kind exchange periods are postponed for Affected Taxpayers to the end of the Postponement Period and possibly up to 120 days thereafter. This rule also applies for some non-Affected Taxpayers in certain cases where the property at issue, a counterparty, a titleholder, or material documents are in the affected areas or lender or title insurance issues arise due to Hurricane Harvey.

Affected Taxpayers

Residence or Place of Business. Individuals with a principal residence in an affected area and business entities or sole proprietorships whose principal place of business is in an affected area
Relief Workers. An individual relief worker affiliated with a recognized government or philanthropic organization and who is assisting in an affected area
Location of Tax Records. Individuals, business entities, sole proprietorships, estates and trusts if such taxpayer has tax records necessary to meet a deadline and those records are maintained in an affected area
Spouses and Traveling Victims. Spouses of an affected taxpayer (with respect to a joint return) and individuals visiting the affected area but are killed or injured as a result of the disaster

Texas Counties Treated as Disaster Areas*

Aransas

Gonzales

Newton

Austin

Hardin

Nueces

Bastrop

Harris

Orange

Bee

Jackson

Polk

Brazoria

Jasper

Refugio

Calhoun

Jefferson

Sabine

Chambers

Karnes

San Jacinto

Colorado

Kleberg

San Patricio

DeWitt

Lavaca

Tyler

Fayette

Lee

Victoria

Fort Bend

Liberty

Walker

Galveston

Matagorda

Waller

Goliad

Montgomery

Wharton

*As of September 5, 2017

Casualty Losses

In the announcement, the IRS reminds taxpayers that they may opt to deduct unreimbursed casualty losses from a federally declared disaster area in the year of the disaster or in the preceding taxable year. See IRS Publication 547 here: (https://www.irs.gov/publications/p547/ar02.html#en_US_2016_publink1000225399). Note casualty loss deductions are subject to other limitations, such as a floor of $100 and 10% of adjusted gross income, each discussed in IRS Publication 547. Affected taxpayers declaring the deduction on their 2016 return should put the disaster designation "Texas, Hurricane Harvey" at the top of Form 4684 (https://www.irs.gov/forms-pubs/form-4684-casualties-and-thefts) to expedite their refund claim.

Benefit Plans

This Relief Announcement extends to 401(k), 403(b) and 457(b) plans, IRAs, and qualified defined benefit pension plans with stand-alone accounts that hold employee contributions and rollover amounts.  Employees and close family members (e.g., spouse, children, grandchildren, parents, grandparents and other dependents) who live or work in areas affected by Hurricane Harvey and designated for individual assistance by the Federal Emergency Management Agency (FEMA) are eligible for relief under the Relief Announcement.[1] The Relief Announcement provides the following forms of relief:
  • A plan will not be treated as failing to satisfy any requirement under the Internal Revenue Code ("Code") merely because the plan makes a loan, or a hardship distribution for a need arising from Hurricane Harvey.
  • When determining whether to make a hardship distribution, plan administrators may rely upon representations from the employee or former employee as to the need for and amount of a hardship distribution (unless the plan administrator has actual knowledge to the contrary).
  • The relief applies to any hardship of the employee, not just the types enumerated under the Code.
  • The six-month ban on 401(k) and 403(b) contributions that normally affects employees who take hardship distributions will not apply.
  • Plans will be allowed to make loans or hardship distributions before the plan is formally amended to provide for such features.  However, the plan must be amended to allow for plan loans and/or hardship distributions no later than the end of the first plan year beginning after December 31, 2017 (i.e., on or before December 31, 2018 for calendar year plans).
  • Even in a situation where a plan administrator has not assembled all of the documentation required for a loan or distribution, loans and distributions may be made so long as the plan administrator makes a good-faith diligent effort under the circumstances to comply with those requirements.  As soon as practicable, the plan administrator (or financial institution in the case of IRAs) must make a reasonable attempt to assemble any forgone documentation.
The relief provided under the Relief Announcement only applies to loans and hardship distributions made on or prior to January 31, 2018.  It is important to note that the tax treatment of loans and distributions remains unchanged. Thus, any distribution (not including amounts already taxed) made pursuant to the relief provided in the Relief Announcement will be includible in gross income and generally subject to the 10-percent additional tax imposed under Code section 72(t).
   [1]   Parts of Texas are currently eligible for individual assistance. A complete list of eligible counties is available at https://www.fema.gov/disasters.  If additional areas in Texas or other states are identified by FEMA for individual assistance because of damage related to Hurricane Harvey, the relief provided in the Relief Announcement will also apply from the date specified by FEMA as the beginning of the incident period.

Gibson Dunn's lawyers are available to assist in addressing any questions you may have regarding these and other tax- or benefits-related developments.  If you have any questions, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Tax or Executive Compensation and Employee Benefits practice groups, or the authors:

James Chenoweth - Houston (+1 346-718-6718, jchenoweth@gibsondunn.com) Michael J. Collins - Washington, D.C. (+1 202-887-3551, mcollins@gibsondunn.com) Sean C. Feller - Los Angeles (+1 310-551-8746, sfeller@gibsondunn.com) Krista Hanvey - Dallas (+1 214-698-3425,khanvey@gibsondunn.com) David Sinak - Dallas (+1 214-698-3107, dsinak@gibsondunn.com) Michael Q. Cannon - Dallas (+1 214-698-3232, mcannon@gibsondunn.com)


© 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 29, 2017 |
Shareholder Proposal Developments During the 2017 Proxy Season

This client alert provides an overview of shareholder proposals submitted to public companies for 2017 shareholder meetings, including statistics and notable decisions from the staff (the "Staff") of the Securities and Exchange Commission (the "SEC") on no-action requests.[1]

I.    Shareholder Proposal Statistics and Voting Results[2]

        A.    Shareholder Proposals Submitted

        1.    Overview

For 2017 shareholder meetings, shareholders have submitted approximately 827 proposals, which is significantly less than the 916 proposals submitted for 2016 shareholder meetings and the 943 proposals submitted for 2015 shareholder meetings.

For 2017, across four broad categories of shareholder proposals—governance and shareholder rights; environmental and social issues; executive compensation; and corporate civic engagement[3]—the most frequently submitted were environmental and social proposals (with approximately 345 proposals submitted).

The number of social proposals submitted to companies increased to approximately 201 proposals during the 2017 proxy season (up from 160 in 2016).  Thirty-five social proposals submitted in 2017 focused on board diversity (up from 28 in 2016), 34 proposals focused on discrimination or diversity-related issues (up from 16 in 2016), and 19 proposals focused on the gender pay gap (up from 13 in 2016).

Environmental proposals were also popular during the 2017 proxy season, with 144 proposals submitted (up from 139 in 2016).  Furthermore, there was an unprecedented level of shareholder support for environmental proposals this proxy season, with three climate change proposals receiving majority support and climate change proposals averaging support of 32.6% of votes cast.  This compares to one climate change proposal receiving majority support in 2016 and climate change proposals averaging support of 24.2% of votes cast.  As further discussed below, the success of these proposals is at least in part due to the shift in approach towards environmental proposals by certain institutional investors, including BlackRock, Vanguard and Fidelity. 

        2.    Types of Shareholder Proposals

The most common types[4] of shareholder proposals in 2017, along with the approximate numbers of proposals submitted, were:

  • social (201 proposals);
  • environmental (144 proposals, including 69 climate change proposals);
  • proxy access (112 proposals); and
  • political contributions and lobbying disclosure (87 proposals).

By way of comparison, the most common types of shareholder proposals in 2016 were:

  • proxy access (201 proposals);
  • social (160 proposals);
  • environmental (139 proposals, including 63 climate change proposals); and
  • political contributions and lobbying disclosure (91 proposals).

        3.    Proponents

As is typically the case, John Chevedden and shareholders associated with him (including James McRitchie, Kenneth and William Steiner, and Myra Young) submitted by far the highest number of shareholder proposals for 2017 shareholder meetings—approximately 203, which is 24.5% of all shareholder proposals submitted to date in 2017.   Other proponents reported to have submitted or co-filed at least 20 proposals each include: As You Sow Foundation (48, largely focused on environmental matters); Trillium Asset Management (42, largely focused on environmental matters); the New York City Comptroller (39, largely focused on governance/shareholder rights and environmental matters); Walden Asset Management (23, largely focused on environmental and political matters); Mercy Investment Services (21, largely focused on environmental and social matters); the New York State Common Retirement Fund (25, largely focused on political matters); and NorthStar Asset Management (20, largely focused on social matters).

        B.    Shareholder Proposal No-Action Requests

        1.    Overview

During the 2017 proxy season, companies submitted 288 no-action requests to the Staff as compared to approximately 245 during the 2016 proxy season.  In 2017, the percentage of no-action requests that were granted by the Staff increased to 78%, the highest level in at least four years. The following table summarizes the responses to no-action requests that the Staff issued during the 2017 and 2016 proxy seasons:

 

2017

2016

Total no-action requests submitted

288

245

Total Staff responses issued[5]

283

239

          No-action requests withdrawn

41

28

          Responses granting or denying exclusion

242

211

                     Exclusions granted

189 (78.0%)

143 (67.8%)

                     Exclusions denied

53 (22.0%)

68 (32.2%)

        2.    Reasons for Exclusion in 2017

Based on a review of no-action letters issued during the 2017 proxy season, the Staff concurred that shareholder proposals could be excluded for the following principal reasons:[6]

  • 37.6% based on ordinary business arguments;
  • 32.8% because the company had substantially implemented the proposal; and
  • 17.5% based on procedural arguments, such as timeliness or defects in the proponent's proof of ownership.

Of the shareholder proposals for which no-action relief was denied, 47.2% were challenged as being related to the company's ordinary business operations under Rule 14a-8(i)(7), making ordinary business the most common basis for denial as well as success for a no-action request. Other frequently unsuccessful arguments included that the proposal was vague or false and misleading (45.3% of denials), that the company had substantially implemented the proposal (30.2% of denials), and that there was a procedural defect in the submission of the proposal (17.0% of denials).

Three aspects of the foregoing data are worth noting:

  • The success during 2017 of ordinary business arguments, with 37.6% of no-action requests granted on that basis, up from 32.2% in 2016.
  • The continued success of substantial implementation arguments. This marks the second straight year in which approximately one-third of all no-action requests were granted because the Staff concurred that the company had substantially implemented the proposal.  During the 2017 proxy season, 32.8% of such no-action requests were granted, down slightly from 34.3% in 2016 but up from 21.0% in 2015.
  • The continued decrease in exclusions based on procedural arguments, with 17.5% of no-action requests granted on that basis in 2017, down from 23.1% in 2016 and 35.0% in 2015.

                            a)    Increase in Exclusions Based on Ordinary Business

Several new types of shareholder proposals were excluded based on ordinary business arguments during the 2017 proxy season, including proposals relating to (i) requests for reports on human lead exposure; (ii) a new version of minimum wage reform proposals; (iii) a new type of pharmaceutical pricing proposals; and (iv) a report on certain religious freedom principles.  In addition, the Staff agreed that certain environmental and social proposals were excludable on ordinary business grounds because the proposals sought to "micromanage" the company, as further described below.

                                          i.    Requests for Reports on Human Lead Exposure

During the 2017 proxy season, at least two companies received what appears to be a new type of environmental proposal.  Specifically, The Home Depot, Inc. and Lowe's Companies, Inc. each received a shareholder proposal asking them to "issue a report, at reasonable expense and excluding proprietary and privileged information, on the risks and opportunities that the issue of human lead exposures from unsafe practices poses to the company, its employees, contractors, and customers."  The supporting statement mentioned that companies should consider improving their lead safety practices through "consumer education on lead-safe practices, free or discounted lead testing products, and dedicated lead safety personnel." 

While proposals that focus on the adverse effects on the environment and/or public health are typically not excludable, both companies submitted no-action requests to the Staff arguing that this particular proposal was excludable because (1) the supporting statements made it clear that it related to ordinary business matters, namely, the products and services that these companies offer to their customers, and (2) the proposal did not otherwise focus on a significant policy issue.[7] 

Ultimately, the proposal submitted to The Home Depot, Inc. was withdrawn, and the Staff granted the no‑action request submitted by Lowe's Companies, Inc. While the Staff did not provide any additional insight into its decision, the Lowe's decision confirms the well-established principle that proposals relating to both ordinary business matters and social policy issues may be excludable.

                                          ii.    Minimum Wage Shareholder Proposals

This proposal, which asks companies to adopt principles for minimum wage reform, is similar to the proposals submitted by Trillium Asset Management and several religious orders in 2016, with one important distinction described below.

Specifically, last year, five of the six submitted proposals were successfully challenged under Rule 14a-8(i)(7) as relating to the companies' ordinary business operations (specifically, general compensation matters).[8] Seeking to avoid exclusion on ordinary business grounds this year, the proponents (Trillium Asset Management and Zevin Asset Management) revised the proposal to include a specific disclaimer regarding general compensation matters by stating that the proposal did not "seek to address the [c]ompany's internal approach to compensation, general employee compensation matters, or implementation of its principles for minimum wage reform" and giving the board discretion to determine the appropriate timing for publishing the principles.

Five companies that received the proposal this year (including The TJX Companies, Inc. and Chipotle Mexican Grill, Inc., both of which received a minimum wage proposal last year as well) submitted no-action requests to the Staff arguing, among other things, that the proposals were excludable on ordinary business grounds (as relating to general compensation matters) with some letters explicitly noting that the issue of minimum wage is not a significant policy issue and that the Staff has never viewed it as such.[9] The no-action requests also maintained that, in spite of the proponent's disclaimer, the supporting statement still addressed the wage practices (i.e., general compensation matters) of each company that received the proposal.

The Staff agreed that the proposal could be excluded on ordinary business grounds, noting that the proposal "relates to general compensation matters, and does not otherwise transcend day-to-day business matters."[10]

                                          iii.   Pharmaceutical Pricing Proposals

This season saw the return of a shareholder proposal campaign targeting how pharmaceutical companies determine the price of their products.  At least ten pharmaceutical companies received proposals requesting that the board "issue a report listing the rates of price increases year-to-year of the company's top ten selling branded prescription drugs between 2010 and 2016, including the rationale and criteria used for these price increases, and an assessment of the legislative, regulatory, reputational and financial risks they represent for the company."  The last campaign that similarly focused on the pricing of pharmaceutical products asked companies during the 2015 proxy season to prepare reports "on the risks to [the companies] from rising pressure to contain U.S. specialty drug prices."  Those proposals were found to be not excludable under Rule 14a-8(i)(7) by the Staff because they focused on "fundamental business strategy with respect to . . . [companies'] pricing policies for pharmaceutical products."[11]

During the 2017 proxy season, the 10 companies that received this new drug pricing-related proposal sought no‑action relief under Rule 14a-8(i)(7), with many arguing that this proposal was different from the 2015 adverse precedents because in those instances, the proposals "focused on the company's fundamental business strategy with respect to its pricing policies for pharmaceutical products rather than on how and why the company makes specific pricing decisions regarding certain of those products."  The companies also argued that "[u]nlike the requests in [2015], the primary focus of the [current proposals] . . . is on obtaining explanation and justification for product-specific and time period-specific price increases."  Most of the proponents, on the other hand, cited those same 2015 letters and argued that they stood for the proposition that "[i]t is abundantly clear that the pricing of their drugs . . . is a significant policy concern for drug manufacturers."  The Staff concurred that the proposals were excludable on ordinary business grounds because they related "to the rationale and criteria for price increases of the company's top ten selling branded prescription drugs in the last six years."[12]

                                       iv.    Report on Certain Religious Freedom Principles

During the 2017 proxy season, the National Center for Public Policy Research and its leaders submitted a new type of proposal to at least eight companies asking them to produce a report (1) detailing risks and costs associated with pressure campaigns to oppose religious freedom laws, public accommodation laws, freedom of conscience laws and campaigns against candidates from Title IX exempt institutions, (2) detailing risks and costs associated with pressure campaigns supporting discrimination against religious individuals and those with deeply held beliefs, and (3) detailing strategies that they may deploy to defend their employees and their families against discrimination and harassment that is encouraged or enabled by such efforts.  

While the proposals were framed as asking for a "[r]eport on certain non-discrimination principles," eight companies sought no-action relief on ordinary business grounds as relating to management of workforce and/or public relations.  The Staff concurred in the exclusion of five of these proposals under Rule 14a-8(i)(7), as relating to companies' ordinary business operations.[13]  These no-action letters demonstrate that merely labeling a proposal as implicating discrimination issues is not sufficient to avoid evaluation of whether a proposal seeks to address ordinary business operations.

                                    v.    Micromanagement Exclusions

During the 2017 proxy season, some companies were also able to exclude proposals on ordinary business grounds because they impermissibly sought to "micromanage" the company.  These letters are notable because the Staff has rarely concurred with no-action requests based on the micromanagement prong of the ordinary business exception.  For example, Deere & Co. and another company were able to exclude on ordinary business grounds a proposal requesting that the company "generate a feasible plan for the company to reach a net-zero GHG emissions status by the year 2030 . . . and report the plan to shareholders" because, according to the Staff, the proposal sought to "micromanage the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment."[14]

                            b)    Continued Success in Exclusions Based on Substantial Implementation

While substantial implementation continued to be a popular basis for exclusion during the 2017 proxy season, 54.8% of the no-action requests granted on this basis concerned "amend proxy access" proposals, as further discussed below.  Overall, approximately 34 companies were able to exclude "amend proxy access" proposals based on arguments that the existing terms of their proxy access bylaws substantially implemented the proposal.[15]  As further discussed below, an additional 13 companies were able to exclude "adopt proxy access" proposals on the basis of substantial implementation arguments because of their adoption of a proxy access bylaw prior to their annual meetings.

                            c)    Decrease in Exclusions Based on Procedural Arguments

As noted above, the number of exclusions based on procedural arguments continued to decrease in 2017, with 17.5%[16] of no-action requests (or 33 of 189) granted on that basis in 2017, down from 23.2% in 2016 (or 33 of 142) and 35.0% in 2015 (or 46 of 133).  The most common procedural argument that failed to obtain no-action relief in 2017 was based on the one-proposal limitation.  Under Rule 14a-8(c), each shareholder may submit no more than one proposal to a company for a particular shareholders' meeting. All seven no-action requests asserting that a submission violated the one-proposal rule did not prevail on this argument

        C.    Shareholder Proposal Voting Results[17]

Based on the 331 shareholder proposals for which ISS provided voting results in 2017, proposals averaged support of 29.0% of votes cast, slightly down from average support of 29.8% of votes cast in 2016.  The proposal topics that received high shareholder support, including four categories of proposals that averaged majority support, were:

  • Board Declassification: Three proposals voted on averaged support of 70.2% of votes cast in 2017, compared to three proposals with average support of 64.5% in 2016;
  • Elimination of Supermajority Voting Requirements: Seven proposals voted on averaged support of 64.3% of votes cast, compared to 13 proposals with average support of 59.6% in 2016;
  • Adopt Proxy Access:  Eighteen adopt proxy access proposals voted on averaged support of 62.1% of votes cast. In 2016, average support for proxy access proposals where the company had not previously adopted some form of proxy access was 56.0%.
  • Majority Voting in Uncontested Director Elections: Seven proposals voted on averaged support of 62.3% of votes cast, compared to 10 proposals with average support of 74.2% in 2016;
  • Written Consent: Twelve proposals voted on averaged support of 45.6% of votes cast, compared to 13 proposals with average support of 43.4% in 2016;
  • Shareholder Ability to Call Special Meetings: Fifteen proposals voted on averaged support of 42.9% of votes cast, compared to 16 proposals with average support of 39.6% in 2016; and
  • Climate Change: Twenty-eight proposals voted on averaged support of 32.6% of votes cast, compared to 37 proposals with average support of 24.2% in 2016.

Overall, approximately 10.9% of shareholder proposals that were voted on at 2017 shareholder meetings received support from a majority of votes cast, compared to 14.5% of proposals in 2016.  The table below shows the principal topics addressed in proposals that received majority support:

Proposal

2017 Majority Votes

2016 Majority Votes

Adopt proxy access

13

27

Elimination of supermajority vote requirements

6

8

Majority voting in uncontested director elections

4

8

Climate change

  3[18]

1

Shareholder written consent

3

1

Board diversity

2

1

Board declassification

2

2

Shareholders' ability to call special meetings

2

2

Report on sustainability

1

1

Political contributions disclosure

0

2

II.    Key Shareholder Proposal Topics and Trends During the 2017 Proxy Season

        A.    Environmental Proposals

The total number of environmental proposals increased in 2017, with shareholders submitting approximately 144 environmental proposals for 2017 meetings compared to 139 in 2016. Overall, the 55 environmental proposals voted on received average support of 28.9% of the votes cast, compared to 71 that received average support of 25.1% of votes cast in 2016.

The largest group of environmental proposals related to climate change, with 69 such proposals submitted in 2017 compared to 63 in 2016.  The 28 climate change proposals voted on in 2017 averaged support of 32.6% of votes cast.[19]  Three climate change proposals received a majority of the votes cast, as further discussed below.  Climate change proposals were submitted not just to oil and gas companies, but also to companies in the financial services and technology industries.  ISS recommended that shareholders vote "for" 23 of the 28 proposals (or 82.1%) voted on in 2017 and "for" 27 of the 37 proposals (or 73.0%) of the proposals voted on in 2016.

In addition to climate change proposals, environmental proposals submitted in 2017 included:

  • 28 proposals related to environmental impacts on the community or supply chains, including impacts of deforestation and pesticides (with 11 such proposals voted on averaging 23.6% support);
  • 24 proposals calling for reports on sustainability (with nine such proposals voted on averaging 30.0% support);
  • 12 proposals focusing on renewable energy (with four such proposals voted on averaging 18.3% support); and
  • Nine proposals focusing on recycling (with three such proposals voted on averaging 24.3% support).

        1.    Three Climate Change Proposals Receive Majority Support and Pass in 2017

As mentioned above, three climate change proposals received majority support.  Various factors may have contributed to the success of these proposals.  Most notably, in March, BlackRock announced in its 2017-2018 engagement priorities that it expects boards to have "demonstrable fluency in how climate risk affects the business and management's approach to adapting and mitigating the risk," and that where it has concerns that a board is not "dealing with a material risk appropriately," it may signal that concern through its vote.[20]  Vanguard also updated its proxy voting guidelines in 2017 to state that it would evaluate each environmental proposal on the merits and may support those with a demonstrable link to long term shareholder value.[21]

The three climate change proposals that passed specifically called for a report on the impact of climate change policies, including an analysis of the impacts of commitments to limit global temperature change to two degrees Celsius.  The three companies where this proposal passed were the following:

  • Occidental Petroleum Corp. received the proposal from Wespath Investment Management, the Nathan Cummings Foundation and other investors, including the California Public Employees' Retirement System ("CalPERS"), and it received support of 67.3% of votes cast by the company's shareholders, including BlackRock, a 7.8% owner. In an unprecedented move, BlackRock issued a press release announcing that it had supported the shareholder proposal.[22]
  • PPL Corp., a utility holding company, received the proposal from the New York State Common Retirement Fund, and it received support of 56.8% of votes cast by the company's shareholders, including CalPERS and other pension funds.
  • Exxon Mobil received the proposal from the New York State Common Retirement Fund, and it received support from about 62.1% of votes cast by the company's shareholders.

These votes reflect the new willingness of institutional investors to support environmental proposals and the effect of increased pressure from their clients to influence companies on environmental issues.  In addition, the same proposal was submitted to 18 other companies and voted on at ten companies, where it averaged 45.6% of votes cast.

        B.    Board Diversity Proposals

Board diversity continues to remain at the forefront of corporate governance discussions as investors and shareholder activists are increasingly pushing for gender diversity on the boards of U.S. public companies.  Most recently, BlackRock and State Street Global Advisors announced plans to drive greater gender diversity on boards through active dialogue with companies.  These institutional investors have indicated that, if progress is not made within a reasonable time frame, they plan to use their proxy voting power to influence change by voting against certain directors, such as members of nominating and governance committees.[23]

As such, perhaps unsurprisingly, in 2017 the number of board diversity proposals reached an all-time high.  Thirty-five proposals calling for the adoption of a policy on board diversity or a report on steps to increase board diversity were submitted in 2017 as compared to 28 proposals submitted in 2016.  As in 2016, a substantial number of board diversity proposals were withdrawn, likely due to commitments made by companies to the proponents of these proposals, such as adopting board recruitment policies inclusive of race and/or gender.[24]

Of the 35 proposals submitted in 2017, eight proposals have been voted on and received, on average, 28.3% of votes cast, as compared to six proposals in 2016, which received, on average, 19.1% of votes cast.  ISS recommended that shareholders vote "for" all but two of the proposals voted on in 2017 and "for" all but one of the proposals voted on in 2016.

Two board diversity proposals submitted in 2017 received majority support, as compared to one in 2016.  One of the successful proposals was submitted by the City of Philadelphia Public Employees Retirement System to Cognex Corp. requesting that the company's board adopt a policy for "improving board diversity [by] requiring that the initial list of candidates from which new management-supported director nominees are chosen . . . by the Nominating and Corporate Governance Committee should include (but need not be limited to) qualified women and minority candidates."  Cognex Corp. had no women on its board of directors.  The proposal received 62.8% of votes cast. The second proposal asked a different company to prepare a report (at a reasonable expense and omitting proprietary information) on steps the company is taking to foster greater diversity on its board.  The proposal received the support of 84.8% of votes cast.

These results, along with the continued investor focus on board composition and board diversity, mean that board diversity will continue to be raised in shareholder engagements, and that shareholder proponents likely will continue to use the Rule 14a-8 shareholder proposals process as a way to push for greater board diversity.

        C.    Other Diversity-Related Proposals

Approximately 34 proposals submitted to companies in 2017 related to discrimination and diversity concerns, compared to 16 such proposals in 2016.  These proposals included 20 proposals calling for the preparation of a diversity report, eight proposals calling for policy amendments to prohibit discrimination based on sexual orientation and gender, and six proposals calling for a report on company non-discrimination policies.  On average, the eight proposals related to discrimination and diversity concerns that were voted on in 2017 received support from 24.2% of the votes cast. ISS recommended that shareholders vote "for" all but three of these proposals voted on in 2017 and "for" all but two of these proposals voted on in 2016.

        D.    Gender Pay Gap

Approximately 19 proposals submitted in 2017 concerned the gender pay gap, compared to approximately 13 such proposals submitted for 2016 meetings.  Among the 19 proposals were 17 proposals requesting reports on the gender pay gap (two of which also requested a report on any race or ethnicity pay gaps), one proposal requesting evidence that no gender pay gap exists, and one proposal requesting disclosure of the number of women at each compensation percentile.  The proposals calling for a report on the gender pay gap include seven proposals submitted to financial institutions and credit card companies requesting a report on whether the company has a "gender pay gap," the size of the gap, and its policies and goals to reduce the gap.  On average, the eight gender pay gap proposals that were voted on received support from 18.8% of the votes cast.  ISS recommended that shareholders vote "against" all eight of these proposals in 2017 but "for" three out of the five proposals voted on in 2016.

        E.    Pay Disparity

Approximately 14 proposals regarding pay disparity were submitted in 2017, as compared with nine in 2016.  Among these proposals were two general types: proposals related to employee wages (eight proposals) and proposals requesting a report on the ratio between compensation paid to senior management and the median employee (six proposals).  On average, the three pay disparity proposals that were voted on in 2017 received the support of only 5.3% of the votes cast.  ISS recommended that shareholders vote "against" all three of these proposals voted on in 2017 and "against" both of these proposals voted on in 2016.

Among the proposals related to employee wages were six proposals requesting that companies adopt principles for minimum wage and/or guaranteeing a living wage (five of which were submitted by either, or both of, Trillium Asset Management and Zevin Asset Management) and two proposals requesting a report on incentive risks for low-paid employees.

Although the six pay ratio proposals represent a three-fold increase over the two pay ratio proposals submitted for 2016 meetings, the number remained well below the 15 pay ratio proposals submitted in 2015.  Pay ratio is likely to become a focus in upcoming months for companies and the investors eager to obtain this information, as under current SEC regulations, the pay ratio rule will generally require companies to disclose a pay ratio in their 2018 proxy statements.  Assuming no change in current regulations, the impact of this 2018 pay ratio disclosure on shareholder proposals may become apparent during the subsequent proxy season (i.e., in 2019).

        F.    Virtual Annual Meeting-Related Proposals

In recent years, an increasing number of companies have opted to hold exclusively virtual annual shareholder meetings.  These annual meetings are commonly referred to as "virtual-only annual meetings."[25]

After not submitting shareholder proposals on this topic during the 2015 and 2016 proxy seasons, some proponents submitted proposals in 2017 requesting that companies that previously held virtual-only annual meetings adopt a corporate governance policy to initiate or restore in-person annual meetings.[26]  Notably, none of these proposals have gone to a vote. 

Instead, in a decision critical for companies that currently hold or are contemplating switching to virtual-only annual meetings, the Staff issued a no-action letter for the 2017 proxy season permitting HP Inc. to exclude a shareholder proposal submitted by John Chevedden and Bart Naylor that objected to virtual-only annual meetings.  The Staff concurred that the proposal could be excluded under Rule 14a-8(i)(7) on the grounds that the "determination of whether to hold annual meetings in person" is related to the company's ordinary business operations.[27]

Since then, investors (including the New York City Comptroller, Walden Asset Management, the Interfaith Center on Corporate Responsibility, CalPERS, and the Council of Institutional Investors ("CII")) have continued to advocate against virtual-only meetings through their own policy pronouncements and direct communications with companies holding virtual-only meetings.  For instance, in the spring of 2017, the New York City Comptroller sent letters to more than a dozen S&P 500 companies that held virtual-only meetings in the prior year (or had announced that they would do so in the future) urging them to host in-person annual meetings instead, but noting that it welcomed and encouraged the use of new technologies to expand shareholder participation (i.e., in the context of "hybrid" annual meetings that allow both live and on-line participation).  Furthermore, under its updated proxy voting guidelines, the New York City Comptroller, on behalf of four New York City pension funds,[28] has indicated that the pension funds "may oppose all incumbent directors of a nominating committee subject to election at a 'virtual-only' annual meeting."[29] 

        G.    Proxy Access Proposals

Although proxy access was the second most common shareholder proposal topic in 2017, the spotlight has waned on this issue as proxy access has become the majority practice in the S&P 500 (over 60% have adopted as of the end of the 2017 proxy season).  Proxy access refers to the right of shareholders under a company's bylaws to nominate candidates for election to the board and have the shareholder nominees included in a company's proxy materials.

After two years of growing pains, proxy access has become the latest widely-accepted governance change among large-cap companies, following in the footsteps of previous shareholder-advocated governance changes, such as the replacement of plurality with majority voting in uncontested director elections and the declassification of boards.  Likewise, the core provisions in proxy access bylaws are now settled (i.e., ownership of 3% of a company's shares for at least three years, and the right to nominate up to 20% of the board by a shareholder or group of up to 20 shareholders).

Approximately 112 proxy access proposals were submitted for 2017 meetings, representing significantly fewer than the 201 proposals submitted for 2016 meetings and only slightly more than the 108 proposals submitted for 2015 meetings.  Of the 112 proxy access proposals, 59 proposals requested the adoption of a proxy access bylaw ("adopt proxy access proposals") and 53 proposals requested amendments to an existing proxy access bylaw ("amend proxy access proposals").  Thirty-four of the adopt proxy access proposals and nearly all of the amend proxy access proposals were submitted by John Chevedden (in his own capacity and on behalf of others), while an additional 18 adopt proxy access proposals were submitted by the New York City Comptroller.

The 18 adopt proxy access proposals voted on received average support of 63.1% of votes cast, while the 20 amend proxy access proposals voted on received average support of 28.5% of votes cast.  A total of 13 proxy access proposals (all adopt proxy access proposals) received a majority of votes cast.  ISS recommended that shareholders vote "for" all of the proxy access proposals voted on in 2017 and "for" all but one of the proxy access proposals voted on in 2016.

The main proxy access development in 2017 related to proposals seeking to amend an existing proxy access bylaw to increase the number of shareholders permitted to constitute a nominating group.  The Staff generally agreed with companies that they could exclude these proposals as substantially implemented, provided that the no-action request demonstrated how the existing aggregation limit achieved the proposal's goal of providing a meaningful proxy access right.[30]

As in 2016, a number of companies also obtained no-action letters concurring that a proposal seeking adoption of proxy access had been substantially implemented when the companies responded to the receipt of an adopt proxy access proposal by adopting a proxy access bylaw prior to their annual meetings, even though the companies' bylaws varied in certain respects from the proxy access terms requested in the proposals.[31]

III.    Potential Reform of Shareholder Proposal Rule

There have been growing calls over the last decade to amend Rule 14a-8, the SEC's shareholder proposal rule, to update various thresholds in the rule and to address some of the ways in which the rule has been abused.  For example, in 2014, the U.S. Chamber of Commerce, along with eight other business organizations, petitioned the SEC to raise the existing threshold for the excludability from company proxy materials of shareholder proposals previously submitted to shareholders that did not elicit meaningful shareholder support.  The petition requested that the SEC reconsider its resubmission rule by conducting a thorough cost-benefit analysis of the current rule and creating new threshold percentages based on the conclusions gleaned from its cost-benefit analysis.[32]

More recently, the House Republicans' proposal for financial regulation reform, the CHOICE Act, tackled the issue.  The legislation, which passed the House by a 233-186 vote in early June, would amend the shareholder proposal rule to (1) increase the holding period for the shareholder proponent from one year to three years; (2) require that a shareholder hold 1% of a company's outstanding stock (and eliminate the option to satisfy this requirement by holding $2,000 in stock) for the holding period; (3) prohibit the submission of proposals other than by the shareholder (so-called "proposals by proxy"); and (4) increase the percentage of support that a proposal must have received the last time it was voted on in order to be resubmitted.  The proposed resubmission thresholds would exclude proposals that previously were voted on in the past five years and most recently received less than 6% (currently 3%) if voted on once, 15% (currently 6%) if voted on twice, and 30% (currently 10%) if voted on three times.[33]

The CHOICE Act has faced strong opposition from institutional investors, including CII, which sent a letter to House members urging them to oppose the bill.[34] While the legislation's prospects in the U.S. Senate are uncertain, the SEC may consider Rule 14a-8 amendments (although that is more likely to occur once the two vacancies on the Commission are filled).

IV.    Top Take-Aways for 2017 Season

Based on the results of the 2017 proxy season, there are several key take-aways to consider:

  • First, 2017 was the year for both environmental and social proposals to take center stage, and the spotlight on these issues is likely to continue to shine brightly in 2018.

    • Over 40% of shareholder proposals submitted in 2017 dealt with environmental and social issues, making this the largest category of shareholder proposals for the first time since 2014.
    • The key environmental proposals in 2017 were climate change proposals (69 in 2017, with those voted on averaging 33.8% support); environmental impacts on communities or supply chains (28 in 2017, with those voted on averaging 23.6% support), and reports on sustainability (24 in 2017, with those voted on averaging 30.0% support).  The key social proposals to watch are board diversity proposals (35 in 2017, with those voted on averaging 28.3% support); diversity-related proposals (34 in 2017, with those voted on averaging 24.2% support); and gender pay gap proposals (19 in 2017, with those voted on averaging 18.8% support).
    • With the Administration's decision to withdraw from the Paris Climate Accord and decrease federal support for environmental initiatives, the focus on private sector environmental initiatives has increased, including through the submission of shareholder proposals. In this context, engagement on climate-related matters has become more important, as several institutional investors have indicated that company engagement and responsiveness on these issues can sway their votes.
    • With several institutional investors increasingly willing to support environmental proposals, companies should consider whether to take additional actions with respect to their sustainability practices and how these efforts are communicated to investors.  
  • Second, in the area of virtual-only annual meetings, the stage is set for increased debate over this hot-button issue.
    • Companies now have solid no-action request precedent to exclude these shareholder proposals.  That being said, certain investors are very vocal about their opposition to virtual-only meetings. Their activism (both leading up to and during the meeting) may discourage some companies from making a move to virtual-only meetings.
    • Companies that are currently holding virtual-only annual meetings may face increasing pressure to either hold hybrid annual meetings or to enhance virtual-only meetings to make them as interactive as possible (i.e., as close to a physical annual meeting as possible).  This would include live audio and/or video participation for all shareholder participants, which is something most companies that hold virtual-only annual meetings currently do not accommodate.
  • Third, although the spotlight on proxy access has waned, this has become the latest standard governance practice.
    • Companies that have not yet adopted proxy access are likely to continue to face shareholder proposals on this topic in the coming years, and these proposals are likely to continue to receive significant support—in 2017, adopt proxy access proposals voted on received average support of 63.2% of votes cast.
    • Accordingly, companies that have not yet adopted proxy access may consider whether to do so—and this may arise either in response to a shareholder proposal or due to the desire to align with majority practice among S&P 500 companies.  Likewise, companies that previously adopted proxy access, particularly those that were early adopters of proxy access, may want to revisit their bylaws and consider whether their provisions align with the terms adopted by the majority of adopters.
  • Lastly, the momentum to amend Rule 14a-8 is growing, albeit slowly.
    • There is increasing support for amendments to the shareholder proposal rule to update various thresholds in the rule and address some of the ways in which the rule has been abused.  Rule 14a-8 was last amended in 2010 to no longer permit the exclusion of proxy access shareholder proposals.  However, there have been calls for some time to address other aspects of the rule.  Top items on the reform list for Rule 14a-8 include increasing the holding period and ownership requirements for shareholder proponents and increasing the resubmission thresholds for proposals that were voted on in prior years.  
    • The CHOICE Act takes a comprehensive approach to amending the rule and aims to address these "top items" on the reform list as well as to prohibit submission of so-called "proposal by proxy" (i.e., ability of a proponent to act as a designee for an actual shareholder with respect to a proposal).  Given the scope of the reforms in the CHOICE Act, and with a new Administration and growing support for deregulation, changes to Rule 14a-8 may finally happen.  Even without Congressional action, the SEC could take action on its own to amend Rule 14a-8 with its rulemaking authority.

   [1]   Gibson, Dunn & Crutcher LLP assisted companies in submitting the shareholder proposal no-action requests discussed in this alert that are marked with an asterisk (*).

   [2]   For the purposes of reporting in this alert statistics regarding no-action requests, references to the "2017 proxy season" refer to the period between October 1, 2016 and June 1, 2017. Data regarding no-action letter requests as well as no-action letters was derived from the information available on the SEC's website. Unless otherwise noted, all data in this alert on shareholder proposals submitted, withdrawn, and voted on is derived from the Institutional Shareholder Services ("ISS") publications and the ISS shareholder proposals and voting analytics databases, and includes proposals submitted and reported on in these ISS databases at any time prior to June 1, 2017 for annual meetings of shareholders at Russell 3000 companies held at any time in 2017 ("2017 meetings"). References in this alert to proposals "submitted" include those shareholder proposals voted on or that were withdrawn by the proponent. Voting results are reported on a votes cast basis (votes for or against) and do not address the impact of abstentions. Where statistics are provided for prior years, the data is for a comparable period in those years.

   [3]   Corporate civic engagement includes proposals regarding support for political, lobbying, or charitable organizations.

   [4]   Shareholder proposals are categorized based on the subject matter of various proposals.

Social proposals cover a wide range of issues and include proposals relating to (i) board diversity; (ii) discrimination and other diversity-related issues; (iii) the gender pay gap; (iv) establishing a board committee on human rights; (v) requiring a director nominee with social and environmental qualifications; and (vi) providing a report on drug pricing increases.

Environmental proposals include proposals addressing (i) a report on climate change; (ii) a report on or the adoption of greenhouse gas emissions goals; (iii) actions to address risks in light of climate change; (iv) reviewing public policy advocacy on climate change; (v) recycling; (vi) renewable energy; (vii) hydraulic fracturing; and (viii) a report on sustainability.

Climate change proposals include proposals addressing (i) a report on climate change; (ii) a report on or the adoption of greenhouse gas emissions goals; (iii) actions to address risks in light of climate change; and (iv) reviewing public policy advocacy on climate change.

Proxy access proposals are proposals calling on a company to adopt a proxy access right or to revise an existing proxy access bylaw.

Political contributions disclosure proposals call on a company to provide information regarding political contributions, while lobbying disclosure proposals request information on a company's lobbying policies and practices.

   [5]   Includes Staff-issued responses either granting or denying exclusion of a proposal, or following withdrawal of a no-action request, usually in response to a proponent's withdrawal of a proposal.

   [6]   All percentages are based on the number of no-action requests for which relief was granted.

   [7]   Lowe's Companies, Inc. also argued that the proposal was excludable because it had already been substantially implemented (Rule 14a-8(i)(10)) and because it related to operations that did not meet the five percent threshold and were not otherwise significantly related to the company's business (Rule 14a-8(i)(5)). The Staff did not address these arguments.  See Lowe's Companies, Inc. (avail. Mar. 8, 2017).

   [8]   See, e.g., The TJX Companies, Inc. (avail. Mar. 8, 2016)*.  One proposal was withdrawn (Panera Bread Co.).

   [9]   See, e.g., CVS Health Corp. (avail. Mar. 1, 2017).

[10]   See id.; see also Amazon.com, Inc. (avail. Mar. 1, 2017)*;  The Home Depot, Inc. (avail. Mar. 1, 2017)*; and The TJX Companies, Inc. (avail. Mar. 1, 2017)*.  One proposal was withdrawn (Chipotle Mexican Grill, Inc.).

[11]   See Celgene Corp. (avail. Mar. 19, 2015); Vertex Pharmaceuticals, Inc. (avail. Feb. 25, 2015); Gilead Sciences, Inc. (avail. Feb. 23, 2015).

[12]   See, e.g., Amgen Inc. (avail. Feb. 10, 2017); Eli Lilly & Co. (avail. Feb. 10, 2017).

[13]   See, e.g., Johnson & Johnson (avail. Feb. 23, 2017)*.  The proposal was excluded on procedural grounds at two companies and was withdrawn at a third company.

[14]   See Deere & Co. (avail. Dec. 5, 2016).  Deere argued that the proposal sought to micromanage the company by replacing the judgment of management with specific quantitative measures and timelines provided by shareholders, who, as a group, would not be in a position to make an informed judgment. The Staff also concurred that SeaWorld Entertainment, Inc. could exclude a shareholder proposal for the same reason (the proposal "seeks to micromanage the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment"). See SeaWorld Entertainment, Inc. (avail. Mar. 30, 2017).

[15]   As further discussed below, the Staff generally agreed with companies that they could exclude as substantially implemented "amend proxy access" proposals that only requested an increase in the number of shareholders permitted to constitute a nominating group, provided that the no-action requests included specified share ownership information demonstrating that the aggregation limit in the company's bylaw compared favorably to the limit in the shareholder proposal. See, e.g., Amazon.com, Inc. (avail. Mar. 7, 2017)*; Anthem, Inc. (avail. Mar. 2, 2017)*; and General Dynamics Corp. (avail. Feb. 10, 2017).

[16]   Based on the number of no-action requests for which relief was granted.

[17]   Voting results are reported on a votes cast basis (votes for or against) and do not address the impact of abstentions.

[18]   The information in this alert regarding the three climate change proposals that received majority support includes the Exxon Mobil Corp. shareholder vote on May 31, 2017, which ISS voting results data did not yet report as of June 1, 2017.  Apart from this information, the data in this alert regarding climate change proposals is based on ISS data as of June 1, 2017, and, therefore, excludes this proposal. 

[19]   Climate change proposals submitted in 2017 included 35 proposals calling for a report on climate change (including the three that received majority support); 29 proposals calling for a report on, or adoption of, greenhouse gas emissions goals; three proposals requesting the company to take action to address risks in light of climate change; and two proposals related to the review of public policy advocacy on climate change.  

[20]   BlackRock, Our Engagement Priorities for 2017-2018, available at: https://www.blackrock.com/corporate/en-us/about-us/investment-stewardship/engagement-priorities.

[21]   Vanguard, Vanguard's Proxy Voting Guidelines, available at: https://about.vanguard.com/investment-stewardship/voting-guidelines/. Furthermore, Fidelity updated its proxy voting guidelines to state that "[i]n certain cases…Fidelity may support shareholder proposals that request additional disclosures from companies regarding environmental or social issues, where it believes that the proposed disclosures could provide meaningful information to the investment management process without unduly burdening the company." See Fidelity, Fidelity Funds' Proxy Voting Guidelines, available at: https://www.fidelity.com/about-fidelity/fidelity-by-numbers/fmr/proxy-voting-overview.     

[22]   See BlackRock Press Release, available at: https://www.blackrock.com/corporate/en-us/literature/publication/blk-vote-bulletin-occidental-may-2017.pdf (specifically noting that "when we do not see progress despite ongoing engagement, or companies are insufficiently responsive to our efforts to protect the long-term economic interests of our clients, we will not hesitate to exercise our right to vote against management recommendations. Climate-related risks and opportunities are issues we have become increasingly focused on at BlackRock as our understanding of the related investment implications evolves").

[23]   BlackRock, Our Engagement Priorities for 2017-2018, available at: https://www.blackrock.com/corporate/en-us/about-us/investment-stewardship/engagement-priorities; State Street Global Advisors, SSGA's Guidance on Enhancing Gender Diversity on Boards, available at: https://www.ssga.com/investment-topics/environmental-social-governance/2017/guidance-on-enhancing-gender-diversity-on-boards.pdf.

[24]   For instance, in 2017, NorthStar Asset Management filed eight board diversity proposals.  Six of these proposals were withdrawn because companies agreed to make certain commitments with respect to seeking greater board diversity. See, e.g., Jeff Green and Emily Chasan, Investors Push Corporate Boards to Add Women, People of Color, Bloomberg, available at: https://www.bloomberg.com/news/articles/2017-03-02/shareholders-target-pale-male-and-stale-corporate-boards.

[25]   According to Broadridge, in 2016, 187 companies held virtual annual meetings (including virtual-only meetings and hybrid meetings that are both virtual and physical).  Of those, 83% (155) were virtual-only meetings, as compared to 67% in 2015.  In addition, of these 155 virtual-only meetings, six were conducted with live video, while the vast majority (149) used only live audio. Moreover, of the 44 companies that held a hybrid annual meeting in 2015, 12 of them switched to virtual-only meetings in 2016.

[26]   ISS data includes information about three such proposals. Two of these proposals were excluded after receiving no-action relief as described further below, and one proposal was excluded based on procedural grounds. 

[27]   See HP Inc. (avail. Dec. 28, 2016)*.  In permitting HP to exclude the proposal, the Staff reaffirmed its position on this subject from more than 14 years ago.

[28]   These four funds are the New York City Employees' Retirement System, the New York City Police Pension Fund, the New York City Fire Department Pension Fund and the Board of Education Retirement System of the City of New York. The guidelines for these four funds indicate that a fifth New York City pension fund, the New York City Teachers' Retirement System, has the same policy. See The Office of the New York City Comptroller, Corporate Governance Principles and Proxy Voting Guidelines (last amended Apr. 2017), available at: https://comptroller.nyc.gov/wp-content/uploads/documents/NYCRS-Corporate-Governance-Principles-and-Proxy-Voting-Guidelines_April-2016-Revised-April-2017.pdf.

[29]   The revised policy applies to S&P 500 companies starting in 2017 and will expand to cover all U.S. portfolio companies in 2018. Nominating committee members can avoid negative votes during 2017 if their companies agree to hold in-person or hybrid annual meetings beginning in 2018.

[30]   See, e.g., Leidos Holdings, Inc. (avail. Mar. 27, 2017); Quest Diagnostics Inc. (avail. Mar. 23, 2017); ITT Inc. (avail. Mar. 16, 2017).

[31]   See, e.g., Marriott International, Inc. (avail. Feb. 27, 2017)*; OGE Energy Corp. (avail. Feb. 24, 2017); Comcast Corp. (avail. Feb. 15, 2017).

[32]   U.S. Chamber of Commerce, Petition for Rulemaking Regarding Resubmission of Shareholder Proposals Failing to Elicit Meaningful Shareholder Support (Apr. 9, 2014), available at: https://www.sec.gov/rules/petitions/2014/petn4-675.pdfSee also Business Roundtable, Principles of Corporate Governance 2016, available at: https://businessroundtable.org/sites/default/files/Principles-of-Corporate-Governance-2016.pdf.

[33]   This would raise the thresholds to the same percentages that were proposed but not adopted by the SEC in 1998.  See Release No. 40018, available at: https://www.sec.gov/rules/final/34-40018.htm. ("We had proposed to raise the percentage thresholds respectively to 6%, 15%, and 30%. Many commenters from the shareholder community expressed serious concerns about this proposal. We have decided not to adopt the proposal, and to leave the thresholds at their current levels."). 

[34]   Council of Institutional Investors, Institutional Investors Oppose Key Provisions of the Financial CHOICE Act, available at: http://www.cii.org/choice_act_press_release. Public pension funds backing the CII letter include the CalPERS, Colorado Public Employees' Retirement Association and the New York State Teachers' Retirement System.

 


The following Gibson Dunn lawyers assisted in the preparation of this client update: Ronald O. Mueller, Elizabeth Ising, Lori Zyskowski, Gillian McPhee, Maia Gez, Julia Lapitskaya, Lauren Assaf, Kevin Hill, Victor Twu, and Geoffrey Walter.

Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following lawyers in the firm's Securities Regulation and Corporate Governance practice group:

Ronald O. Mueller - Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Elizabeth Ising - Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Lori Zyskowski - New York (+1 212-351-2309, lzyskowski@gibsondunn.com)
Gillian McPhee - Washington, D.C. (+1 202-955-8201, gmcphee@gibsondunn.com)
Maia Gez - New York (+1 212-351-2612, mgez@gibsondunn.com)
Michael Titera - Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)
Julia Lapitskaya - New York (+1 212-351-2354, jlapitskaya@gibsondunn.com)

 


© 2017 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 2, 2017 |
PCAOB Adopts New Model for Audit Reports

On June 1, 2017, the Public Company Accounting Oversight Board ("PCAOB" or "Board") moved ahead and adopted perhaps its most significant new standard since the Board's inception, setting requirements for significant additional disclosures in the auditor's report on an issuer's financial statements.  These new disclosure requirements, if adopted by the SEC, will drastically alter the audit reporting model that has been in place for the past seventy years. Specifically, the new standard, available here, retains the pass/fail model present in the existing audit report, but goes well beyond this test and requires the auditor to include new disclosures in the audit report about critical audit matters ("CAMs") that the auditor identifies during the course of the audit.  As discussed below, CAMs represent a new concept in audit reporting, and the degree to which this new concept will impact various aspects of the audit process – including on the relationship between audit committees, auditors and management – remains uncertain. The standard also requires new disclosures in the audit report about the length of the auditor's tenure and a statement about the applicable auditor independence requirements. 

The Board's new standard will be submitted to the SEC for consideration and notice and comment.  If the SEC approves the Board's standard, the requirements for additional disclosure about auditor tenure and independence will be effective for all filers beginning in fiscal years ending on or after December 15, 2017.  The CAM reporting requirements will be effective for large accelerated filers beginning in fiscal years ending on or after June 30, 2019, and for all other filers beginning in fiscal years ending on or after December 15, 2020.

The PCAOB has been considering this standard-setting initiative since 2011, when the PCAOB issued a concept release on potential changes to the audit report; that process evolved in 2013, when the PCAOB issued its original proposal on this topic.  In 2016, the PCAOB issued a re-proposal that narrowed in some respects the scope of the disclosure requirements for critical audit matters that appear in the audit report, and also dropped a component of the original proposal that would have required the auditor to review and report on matters outside the financial statements.  The adopted standard is substantially the same as the 2016 re-proposal, but clarifies some items which had been left unsettled in the re-proposal, including the applicability of the standard to emerging growth companies. 

The adoption of the new standard represents an important development in the financial reporting landscape.  Issuers and their audit committees should review and consider the Board's new standard in detail, including as described below under "Steps to Consider."

What are CAMs? — New Required Disclosures in the Audit Report about Critical Audit Matters

Under the new standard, a CAM is defined as "any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment." 

The definition thus has three component pieces.  First, a CAM must be a matter that was voluntarily communicated to the audit committee or that was required to be communicated to the audit committee under Auditing Standard 1301 (formerly AS No. 16), Communications with Audit Committees.  As issuers and audit committees are well aware, the scope of these required communications is broad, with AS 1301 containing more than fifteen topics and several dozen related paragraphs that specify the topics that must be communicated to the audit committee.  Second, a CAM must relate to an account or disclosure that is "material" to the financial statements.  Notably, the definition does not require the communication itself to involve a material issue, but rather that the communication must be about an account or disclosure that is material to the financial statements.  And third, the definition provides that a CAM must have involved an "especially challenging, subjective, or complex auditor judgment."  The standard seeks to inject some objective criteria to help guide this test by laying out a non-exhaustive list of factors that an auditor should take into account in determining whether a matter involved such judgments, specifically: 

  • the auditor's assessment of the risks of material misstatement, including significant risks;
  • the degree of auditor judgment related to areas in the financial statements that involved the application of significant judgment or estimation by management, including estimates with significant measurement uncertainty;
  • the nature and timing of significant unusual transactions and the extent of audit effort and judgment related to these transactions;
  • the degree of auditor subjectivity in determining or applying audit procedures to address the matter or in evaluating the results of those procedures;
  • the nature and extent of audit effort required to address the matter, including the extent of specialized skill or knowledge needed or the nature of consultations outside the engagement team regarding the matter; and
  • the nature of audit evidence obtained regarding the matter.

The new standard provides that if the auditor determines that a CAM exists, the auditor must include disclosure in the audit report that:  identifies the CAM; describes the principal considerations that led the auditor to determine that the matter is a CAM; describes how the CAM was addressed in the audit; and identifies the relevant financial statement accounts and/or disclosures that relate to the CAM.  Disclosure satisfying these criteria is required for each CAM identified in the audit.  Where no CAM is identified, the auditor must include disclosure stating as much.

By incorporating the concept of matters required to be communicated to the audit committee, the standard draws on existing AS 1301 to provide some guideposts for determining those matters that may be treated as CAMs.  However, given the lengthy list of required communications in AS 1301 and given that the standard includes both required communications and those that are voluntarily communicated to the audit committee, the range of matters that could be CAMs remains quite broad and could lead to significant new disclosures in the audit report, as discussed in more detail below under "Steps to Consider." 

Additional New Disclosures in the Audit Report

Auditor Tenure.  The standard requires the auditor to include in its report "[a] statement containing the year the auditor began serving consecutively as the company's auditor."  Under this requirement, auditor tenure includes the years the auditor served as the company's auditor both before and after the company became subject to SEC reporting obligations.  Although the Board unanimously adopted the standard, several Board members indicated they were not certain that auditor tenure disclosure is useful to investors.  These sentiments were expressed in part because many issuers have voluntarily included enhanced audit committee-related disclosures in their proxy statements and such disclosures often include information about the length of service by the auditor.

Independence.  The standard also requires a statement in the audit report that the auditor "is a public accounting firm registered with the PCAOB (United States) and is required to be independent with respect to the company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the SEC and the PCAOB." 

Clarification of Auditor Responsibilities.  Under the standard, the auditor also has to include in its audit report the phrase "whether due to error or fraud," when describing the auditor's responsibilities under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements.  This phrase is not included in the existing auditor's report.  When inclusion of the phrase was proposed as part of the 2016 re‑proposal, the PCAOB said that the phrase is added to clarify that the auditor is responsible for detecting material misstatements, whether such misstatements are due to error or fraud.

Applicability to Filers

The standard specifies that CAMs would not have to be disclosed in audit reports issued in connection with audits of emerging growth companies; brokers and dealers; investment companies other than business development companies; or employee stock purchase, savings, and similar plans.  It notes that auditors of these entities may consider voluntarily including communication of CAMs as described in the standard. 

Steps to Consider

With this new standard, the PCAOB is requiring changes to the pass/fail model that has served as the basis for audit reports for many decades.  As a result, even though the new standard still has to go through the SEC notice-and-comment process and its ultimate adoption thus hinges on SEC approval, issuers and their audit committees would be well served to review in depth the new disclosures mandated by the standard—particularly as they are disclosures for which the auditor will have the final say; and consider the potential implications of the new standard, including the issues discussed below. 

  • Scope of the New CAM Definition.  During the standard-setting process, the PCAOB made efforts to reign in the breadth of its original concept for CAMs, but aspects of the final CAM definition still present concern.  The audit standard governing communications that the auditor is required to make to the audit committee is itself expansive, as noted above.  The definition also includes any communication made to the audit committee outside of the required communications.  It also appears that CAMs may not be limited to communication about material issues, but also could include disclosure of an issue that may not itself be material but that may involve a material account or disclosure.  And, the question of whether an issue was "especially challenging, subjective, or complex auditor judgment" by its terms will be a subjective matter for audit teams.  Discretion in making this determination of course could cut either way, but issuers and their audit committees should understand there will likely be a fair degree of variability in how the CAM definition may be applied, at least at the outset, given its potential breadth and subjectivity.    
  • Auditor Disclosure of Original Information.  In reviewing the PCAOB's original proposal and 2016 re-proposal, a number of commenters expressed concern that the standard would place the auditor in the position of being the source of disclosure of original information about a company—in other words, having to make disclosures before a company itself has made the disclosure or, in effect, forcing a company's hand to make disclosures.  The Board's final standard appears to give little heed to this concern.  The final adopting release acknowledges the tension, and observes that an auditor will not be obligated to provide original information about a CAM identified in the audit report "unless it is necessary to describe the principal considerations that led the auditor to determine that a matter is a critical audit matter or how the matter was addressed in the audit."  But disclosure of the CAM itself could result in disclosure of original information; and it would seem that auditors will not infrequently determine that disclosure is needed to describe the considerations that led to the determination that the matter is a CAM and how the matter was addressed, each of which could result in disclosure of original information.  On this point, the Board observed that it believes it is in the public interest for auditors generally to disclose information that is necessary to describe the principal considerations that led the auditor to determine that a matter is a CAM and how the CAM is addressed in the audit, even if such information would not otherwise be disclosed by the issuer.  Thus, issuers and audit committees will want to consider possible scenarios where the new standard might put the auditor in a position of having to make disclosures in the first instance, and prepare in advance for how to address these situations.  
  • Uncertainty in Application.  A number of other concerns expressed during the standard-setting process appear not to have been fully addressed in the final standard.  For example, because the standard may require disclosure of matters that have been voluntarily reported to the audit committee, some expressed the view that the standard could lead auditors to hesitate in raising matters to audit committees as it would then trigger potential CAM reporting.  Conversely, some expressed concern that there will be a tendency to over-disclose the existence of CAMs given the subjectivity in the standard and the potential adverse consequences for the auditor associated with being second-guessed in whether a CAM should have been disclosed.  Still others expressed concern that the range of CAM disclosure practice among firms and engagement teams will lead to unhelpful variability across audit reports.  Additionally, some have expressed concern about the increased strain on audit committee resources, as well as concerns about the impact of the new disclosures on timing for completing the audit – for example, when financial reporting or audit-related issues that have CAM implications arise at the last moment.  

In considering these issues, issuers and audit committees should engage with their auditors now to gain insights into the anticipated impacts on the audit process for their particular audit, including what the new standard might mean for the timing of audit completion and when and how the issuer and audit committee will have the opportunity to review proposed CAM audit reports.  In doing so, audit committees and issuers also may consider asking the auditor what types of issues in prior audits may be considered CAMs under the standard and what corresponding disclosures would have looked like if they had been disclosed in connection with those prior audit reports.

Given the numerous questions that arise from the dramatic shift in the auditor reporting model in light of the Board's new standards, issuers and audit committees may wish to consider submitting comments to the SEC on the new standard.

 


Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm's Securities Regulation and Corporate Governance practice group, or any of the following:

Elizabeth Ising - Co-Chair, Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
James J. Moloney - Co-Chair, Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com)
Brian J. Lane - Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com)
Ronald O. Mueller - Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Michael J. Scanlon - Washington, D.C. (202-887-3668, mscanlon@gibsondunn.com)
Lori Zyskowski - New York (+1 212-351-2309, lzyskowski@gibsondunn.com)
Gillian McPhee - Washington, D.C. (+1 202-955-8201, gmcphee@gibsondunn.com)
Michael A. Titera - Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)


© 2017 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

February 21, 2017 |
French Legal Briefing – France Continues to Adopt the Highest International Standards to Attract Investors

Despite a net fall in the global M&A activity in 2016 (the total deal value amounted last year to US$ 3.7tn, down 16 % compared to 2015[1]), French M&A market has been supported by a few domestic deals while the level of in-bound investments has dramatically dropped. Another distinctive feature of the 2016 M&A market, both globally and in France, has been an exceptional activity during the last quarter suggesting that French M&A market may be poised to accelerate and gain a new momentum in 2017.

Several significant factors of uncertainty do remain, including in relation to the Brexit and Trump's victory. In addition, the as-of-now unpredictable outcome of major elections to come later this year in the Netherlands, France and Germany may trigger political and economic disturbances. Combined, they may hamper 2017 perspectives for the EU and France.

In this uncertain environment, businesses will need to be stronger and over-performing. Recent surveys[2] show that companies are, thus, likely, first, to refocus on their core businesses (leading to an increase of divestitures). Second, they will be required to remain alert to potential technology shifts. As in 2016, digital and technology will remain in fashion and should surge as top strategic drivers of M&A activity this year.

In this context, France has continued to adopt in 2016 the highest legal international standards whether it be in terms of governance, by enacting the say-on-pay, or fight against corruption by modernizing and strengthening its judicial arsenal which will now have an extra-territorial reach. It has also chosen to be at the forefront of the protection regarding personal data.

To assist French and foreign investors navigating through these important recent changes, the Paris office of Gibson, Dunn & Crutcher LLP is pleased to provide this French legal briefing.

Executive Summary:

  • Anti-corruption Compliance. The "Sapin 2 Law" adopted on December 9, 2016, broadly inspired by the US and UK regimes, intends to bring France to the highest standards in the areas of transparency and anti-corruption, setting up, among other things, new obligations for companies to establish adequate procedures to prevent and detect corruption and influence peddling.
  • Corporate Governance / Directors' Compensation: One of the other key provisions of the "Sapin 2 Law" provides for a binding say-on-pay for French listed companies, which will have an impact as from this year's annual general meetings.
  • Equity Incentive Plans: The tax and social regime of French equity-based incentive plans has gone through its 3rd reform since 2012, in a less favorable direction this time, including for foreign issuers. However, the negative effects of this reform may not be felt immediately as future grants may still benefit from the previous regime set up by the Macron Law provided that they are made pursuant to an authorization granted by a shareholders' resolution adopted prior to January 1, 2017.
  • Data Protection: The Law for a Digital Republic adopted on October 7, 2016 intends to strengthen the protection of personal data and anticipate the forthcoming entry into force of the European Union Regulation 2016/679 adopted on April 27, 2016.

______________________________________

1.   Anti-corruption Compliance: The announcement of a more robust era in French anti-corruption enforcement and compliance expectations.

On December 9, 2016, a new major statute on transparency, the fight against corruption and the modernization of the economy (better known as the "Sapin 2 Law") was enacted. The Sapin 2 Law, mainly inspired by the US and UK regimes, intends to bring France to the highest standards in the areas of transparency and anti-corruption. 

Creation of a French Anti-Corruption Agency. The French Anti-Corruption Agency will replace the Central Service for the prevention of corruption which did not have any investigation or sanction powers. The new agency is the result of the French government's aspiration to set up an independent and fully effective body (somewhat equivalent to the French financial markets authority (the Autorité des Marchés Financiers) or the French authority for the supervision of prudential insurance and reinsurance (the Autorité de Contrôle Prudentiel et de Résolution)). The Agency will include an Enforcement Commission ("commission des sanctions") vested with disciplinary powers and the ability to fine non-compliances (which are in addition to the existing criminal sanctions). One of the initial priorities of the Agency will be to assist French corporations in implementing the new arsenal by releasing recommendations.

Obligation to establish adequate procedures to prevent and detect corruption and influence peddling.

Which corporations are concerned? French companies with at least 500 employees and an annual turnover exceeding €100 million (such threshold being assessed on a consolidated basis with respect to group of companies the parent company of which is headquartered in France). Anti-corruption measures will have to be implemented in such companies and in their subsidiaries (even located outside France).

What key measures will be implemented? Besides the introduction of a full set of anti-corruption procedures such as codes of conduct, training program for employees, accounting control systems or clients risk-based assessment procedures, the Sapin 2 Law also introduces two innovative measures:

  • A risk mapping of external solicitations for corruption purposes to which the company may be exposed: this risk mapping will be key. It will need to be adapted to the industries and countries in which the corporation operates as well as to its clients, suppliers and intermediaries. It will need to be regularly monitored to take into account changes in business and risks. Therefore, corporations will be likely required to (a) identify actual and potential risks, (b) assess the risks, (c) elaborate appropriate measures to prevent and eradicate the identified risks and finally (d) implement those specific measures;
  • Appropriate internal control procedures will need to be applied. These will likely require implementation of three types of processes (i) controlling operations, (ii) risks monitoring and managing and (iii) documenting internal controls to ensure compliance traceability.

    Failure to implement the corruption prevention plan may entail the liability of both the corporations and their legal representatives. Corporations may be fined up to EUR 1 million and individuals up to EUR 200,000. The Sapin 2 Law is somewhat similar to the United Kingdom Bribery Act (and also the Swiss regime) pursuant to which corporations may be sanctioned if they have not taken sufficient measures to prevent bribery (failure of commercial organizations to prevent bribery).

Reinforcement of whistleblowing protection. The new statute strengthens the protection offered to whistleblowers by guaranteeing their confidentiality and offering an increased safeguard against retaliation. It extends whistleblowing protection to situations where the whistleblower has reported "a serious threat or damage to the public interest" and not only a violation of applicable laws. However, despite what was first enacted by the Sapin 2 Law, no financial assistance to the whistleblower to cover his/her proceedings costs will be provided as the French Constitutional Council considered this provision as unconstitutional.

New extraterritorial reach of French anticorruption laws. The Sapin 2 Law considerably extends the jurisdiction of French criminal courts. It enables them to prosecute acts of corruption committed abroad by anyone who "carries on its business or a part of its business in France". This will need to be taken into account by foreign companies which conduct even part only of their business in France.

Adoption of a judicial agreement process. The Sapin 2 Law introduces a new legal agreement mechanism, named public interest judicial agreement (convention judiciaire d'intérêt public) and resembling the DPA process in the United States. Under such mechanism, so long as prosecution has not been set in motion, the Public Prosecutor may offer companies accused of corruption, influence peddling or laundering of tax fraud proceeds to enter into a judicial agreement imposing payment of a financial penalty up to a maximum of 30% of the company's average turnover over the past three years and/or the implementation of a three-year maximum anti-corruption compliance program supervised by the French Anti-corruption Agency. In addition, the agreement shall provide for indemnification of identified victims. If validated by the court following a public hearing, the judicial agreement is published on the French Anti-corruption Agency website. However, there is no recognition of guilt from the companies concerned and the judicial agreement is not recorded in the companies' criminal record.

In anticipation of the French Anti-Corruption Agency's expectations, companies will have to implement adequate procedures (particularly internal control and risk-mapping) which will be broadly inspired by the US and UK regimes, as well as the best risk management practices already implemented by French insurance and banking institutions.

2.   Corporate Governance / Directors' compensation: A new French binding say-on-pay

Scope of the say on pay

The say-on-pay process will concern compensation granted to the chairman of the board of directors, CEO or deputy CEO, members of the executive board ("Directoire") or members of the supervisory board ("Conseil de Surveillance") of a French société anonyme listed on a regulated market (Euronext). Surprisingly, the new scheme does not apply to the members of the board of directors ("Conseil d'administration") but this is likely due to the fact that the determination of the amount of attendance fees to be received by board members already lies within the power of the shareholders. No say-on-pay process is required with respect to the compensation received by the managers pursuant to an employment agreement.

Two votes by the shareholders

  • Prior vote. The principles and criteria for fixing, allocating and awarding the total compensation (including fixed, variable or exceptional compensation) to be paid to the managers shall be approved by the shareholders at each annual general meeting. A new vote is required (i) in case of any modification of such compensation policy and (ii) at each renewal of the managers' office. In case of a negative vote of the shareholders, the principles and criteria approved for the preceding fiscal year shall continue to apply. If no principle or criteria was previously approved or in the absence of prior compensation paid to the managers, compensation shall be determined "in accordance with the existing practices of the company". Compensation committees of French listed companies will need to adopt such practices as soon as possible in view of the next ordinary general meeting of 2017, in the absence thereof.
  • Subsequent vote. The shareholders will subsequently have to approve the total amount of compensation granted to the executive for the preceding year. In case of a negative vote of the shareholders, the fixed portion of the compensation will not be at risk but the variable and exceptional remunerations could not be paid. One should note that a subsequent vote is not required for the members of the supervisory board (except for its chairman).

Practical considerations

The provisions regarding the prior vote will apply from the annual general meeting for the first fiscal year ended after the promulgation of the law (December 9, 2016). Regarding the subsequent vote, the rule will apply from the end of the fiscal year following the first fiscal year ended after the promulgation of the law.

In other words, companies which ended their fiscal year on December 31, 2016 will have to make a prior vote from their ordinary general meeting of 2017 and a subsequent vote in 2018.

This new statute intends to reassure investors in French companies by preventing the allocation of abnormal compensation. However, this new statute could lead to emphasis being placed on fixed compensation (guaranteed by the prior vote) rather than variable compensation. This would go against established corporate governance principles which recommend to index officers' compensation on the company's financial performance by using variable and exceptional remunerations. It is likely that companies will have, during the next annual general meeting, to determine a level of fixed remuneration that will ensure the presence of the officers for the next years.   

Depending on the level of constraint imposed by the shareholders when implementing this new say-on-pay process, the management of listed companies may also be keen to find out ways to circumvent it. To this end, they may try to use foreign companies to compensate their group officers. If that happened, this would obviously not improve transparency.

The conditions of this new binding say-on-pay will be soon specified in a decree. However, listed companies should already take into consideration the "Sapin 2 Law" while organizing their new strategy and financial communication.

3.   Equity Incentive Plans: Free shares allocation - a step backwards the negative effects of which may be delayed.

On December 29, 2016, the French Parliament adopted the Finance Act for 2017 (the "Finance Act"), which partially amends the legal and tax regimes of free shares allocation. The free shares allocation legal framework had been substantially improved by the so-called "Macron Law" enacted on August 6, 2015, with a view to improve the attractiveness of French equity-based incentive plans for employees.

The new regime resulting from the Finance Act will apply to awards authorized by a resolution of the extraordinary general meeting of the shareholders passed on or after January 1, 2017 only. Consequently, new awards of free shares that have been authorized by a shareholders' resolution passed between August 8, 2015 and December 31, 2016 (included) will still benefit from the favorable regime provided by the Macron Law, regardless of the date on which such awards will effectively be granted. Therefore, the negative effects of the reform may be delayed for issuers using multiannual stock inventive plans, as is commonly the case for foreign issuers, so long as they have been adopted prior to or on December 31, 2016 (but as from August 8, 2015).

Vesting and holding periods

The provisions related to the vesting and holding periods remain unchanged. Therefore, free shares can still vest 1 year after their grant date, provided that the aggregate vesting and holding periods are at least equal to 2 years.

Increase of employers' social security contribution

Under the Finance Act, the employer social security contribution rate is increased from 20% to 30%, bringing it back to the former rate into force before passing of the Macron Law. The contribution remains due within the month following the date of the effective acquisition of the shares by the beneficiary. The employer contribution applying to small and medium-sized companies that have not distributed any dividend in the past five years shall remain unchanged at the rate of 20%.

An increased taxation for the portion of the acquisition gain exceeding EUR 300,000

Contrary to the Macron Law, which provided for the taxation of all of the acquisition gain realized by the beneficiary as a capital gain, the 2017 Finance Act states that only the portion of such profit not exceeding EUR 300,000 per year will be treated as capital gain. The fraction of the acquisition gain exceeding EUR 300,000 per year will be taxed as employment income, losing the benefit of the 50% tax base reduction when the shares are held for at least 2 years and the 65% tax base reduction when the shares are held for more than 8 years.

Accordingly, the 8% social security contribution applicable to activities income will apply to the portion of the annual acquisition profit in excess of EUR 300,000, instead of the 15.5% rate applicable to capital gains. The 15.5% social security withholding remains however applicable to any acquisition profit (or portion thereof) up to EUR 300,000.

The 10% employee social security contribution that had been fully abolished by the Macron Law is partially reinstated for the part of the annual acquisition gain in excess of EUR 300,000.

Summary table of the major changes to the free shares allocation legal and tax regimes

 

Previous regime

Macron Law Regime

Finance Act Regime

Concerned free shares

Awards authorized by an extraordinary shareholders' resolution passed on or before August 7, 2015

Awards authorized by an extraordinary shareholders' resolution passed between August 8, 2015 and December 31, 2016 (included)

Awards authorized by an extraordinary shareholders' resolution passed on or after January 1, 2017

Employer social contribution

30%
due upon grant on market value of the free shares on the grant date

20%
due upon vesting on the market value of the free shares as of such date

30%
due upon vesting on the market value of the free shares as of such date

Employee social contributions

10%
+
8% social security contributions due on acquisition profit (out of which 5.1% is tax deductible)

15.5% social security contributions due on acquisition profit (out of which 5.1% is tax deductible)

Part of the annual acquisition gain up to EUR 300,000:
15.5% social security contributions due on acquisition profit (out of which 5.1% is tax deductible)

 

 

 

Part of the annual acquisition gain exceeding EUR 300,000:
10%
+
8% social security contributions due on acquisition profit (out of which 5.1% is tax deductible)

Employee Income tax

Acquisition profit subject to income tax (impôt sur le revenu) (at rates of up to 45%)

Acquisition profit subject to income tax (at the applicable progressive rates) with a 50% tax base reduction when the shares are held for at least 2 years and a 65% tax base reduction when the shares are held for more than 8 years

Part of the annual acquisition gain up to EUR 300,000: Acquisition profit subject to income tax (at the applicable progressive rates) with a 50% tax base reduction when the shares are held for at least 2 years and a 65% tax base reduction when the shares are held for more than 8 years

Part of the annual acquisition gain exceeding EUR 300,000: Acquisition profit subject to income tax (impôt sur le revenu) (at rates of up to 45%)

Total cost for employees(1)

60.7%
(+3% or 4% in case special high
income contribution applies)

36.8%(2)
(+3% or 4% in case special high income contribution applies)

Illustrative examples: For an annual acquisition gain of up to EUR 300,000: 36.8%(2)

For an annual acquisition gain of EUR 600,000: 48.75%(2)

(plus, in each case, 3% or 4% in case special high income contribution applies)

(1) Based on marginal rates.
(2) if shares held at least for 2 years and less than 8 years after vesting

4.   Data Protection – The Law for a Digital Republic: anticipating the EU Regulation on data protection?

The French Data Protection Act adopted on January 6, 1978 (the "French Data Protection Act") was amended twice in 2016. First, on October 7, 2016, when the French Parliament adopted the Law for a Digital Republic with the aim to create new rights for citizens in the digital environment. Amongst other rights, the Law for a Digital Republic intends to strengthen the protection of personal data.

Secondly, on October 12, 2016 with the adoption of the Law for the modernization of justice.

Interestingly, some provisions of these pieces of legislation anticipate the European Union Regulation 2016/679 adopted on April 27, 2016 relating to the protection of personal data and which will be applicable only as of May 25, 2018.

Reinforcement of data subjects' rights

First of all, the Law for a Digital Republic creates specific provisions in the French Data Protection Act extending the right to be forgotten for minors. Indeed, the general right for data subjects to have their data deleted applies only where the data is "inaccurate, incomplete, equivocal, outdated or which processing is forbidden." According to the new provisions arising out of the Law for a Digital Republic, any individual can ask for the deletion of his/her data where such data was collected when he/she was still minor without having to demonstrate that he/she has a legitimate interest. Companies receiving such requests would be due to delete the data without undue delay.

If the right mentioned above should have limited impact on our clients' direct obligations, two other provisions of the Law for a Digital Republic should be considered closely as they need to be taken into account directly in companies' data protection compliance measures.

Companies are indeed expected to enable data subjects to exercise their rights directly online wherever possible. In practice, this means that all companies should create a specific email address dedicated to the handling of data subjects' requests but also need to make sure that it creates a mechanism to ensure that such requests are actually handled.

With always the idea to enable data subjects to master the use of their personal data, the French legislator also provides for additional obligations of information for companies processing personal data. As a result of this provision, companies are now expected to inform data subjects about (i) the data retention period of the data collected and processed and (ii) the right of data subjects to give instructions in relation to the processing of their personal data after their death. Such information shall be provided as part of the information notice which companies were already required to provide under the French Data Protection Act.

Therefore, companies shall make sure that their existing and future information notices are compliant with these new provisions.

The Law for a Digital Republic also granted data subjects with the right to data portability (i.e. the right to recover for free all the personal data and files). At this stage, companies shall therefore anticipate this new obligation by starting to consider the procedure they should implement to ensure that this right of portability is actually applied and what would be the consequences from a business point of view. However, this should be only initial thoughts since a decree shall further detail this upcoming obligations for companies.

Finally, the Law for the modernization of justice has extended the right to class action in particular regarding the right for data subjects to bring a class action in case of data breach. Data protection litigation may therefore increase considerably – this will need to be taken into consideration by companies in their risks assessment.

Strengthening of the CNIL enforcement authority

According to the Law for a Digital Republic, the French data protection authority (the "CNIL") can now impose to companies a maximum fine of 3 million euros while it was previously limited to 150,000 euros. The amount of the penalty should be proportionate to the seriousness of the breach committed and the CNIL will take into consideration notably the intentional nature of the infringement, the measures taken by the data controller to mitigate the damage suffered by the data subjects and the degree of cooperation with the Commission to remedy the infringement.

The Law for a Digital Republic shall therefore be considered by companies as a first step toward the EU Regulation 2016/679 which reinforces even further companies' obligations and on which we will comment in future alerts.


[1]      Source: Thomson Reuters.

[2]      Notably, Deloitte's M&A trends report 2016.


The following Gibson Dunn lawyers assisted in preparing this client update:  Ahmed Baladi, Benoît Fleury, Ariel Harroch, Judith Raoul-Bardy and Clarisse Bouchetemble.

Gibson Dunn's lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update.  TheParis office of Gibson Dunn brings together lawyers with extensive knowledge of all aspects of business law, covering corporate transactions, restructuring/insolvency, litigation, compliance, public law and regulatory, as well as tax and real estate.  The Paris office is comprised of a dynamic team of lawyers who are either dual or triple-qualified, having trained in both France and abroad.  Our French lawyers work closely with the firm's practice groups in other jurisdictions to provide cutting-edge legal advice and guidance in the most complex transactions and legal matters.  For further information, please contact the Gibson Dunn lawyer with whom you usually work or any of the following members of the Paris office by phone (+33 1 56 43 13 00) or by email (see below): 

Corporate/M&A/Private Equity
Benoît Fleury (bfleury@gibsondunn.com)  
Bernard Grinspan (bgrinspan@gibsondunn.com)
Ariel Harroch (aharroch@gibsondunn.com)
Patrick Ledoux (pledoux@gibsondunn.com)
Judith Raoul-Bardy (jraoulbardy@gibsondunn.com)
Jean-Philippe Robé (jrobe@gibsondunn.com)
Audrey Obadia-Zerbib (aobadia-zerbib@gibsondunn.com)

IT/ Data Protection
Ahmed Baladi (abaladi@gibsondunn.com)
Bernard Grinspan (bgrinspan@gibsondunn.com)
Vera Lukic (vlukic@gibsondunn.com)
Audrey Obadia-Zerbib (aobadia-zerbib@gibsondunn.com)

Compliance
Benoît Fleury (bfleury@gibsondunn.com
Bernard Grinspan (bgrinspan@gibsondunn.com)

Ariel Harroch (aharroch@gibsondunn.com)
Judith Raoul-Bardy (jraoulbardy@gibsondunn.com)


© 2017 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 26, 2017 |
Webcast: Key Legal Issues in Compensation and Benefits in M&A Transactions

​Employees are a key component to most business combinations. Without their cooperation, and preferably motivated enthusiasm, the transaction will not be as successful as it could be. In addition, employees are a big investment, and buyers need to understand how the current employer has structured those costs. Buyers also often take on large potential liabilities – assumed equity compensation awards, accrued vacation, historical compliance problems, pensions, retiree medical benefits, union retirement plans, and others. A thorough understanding of the company's overall "human resources" (meaning the people, the costs, the programs and the level of compliance) is the foundation on which the task of addressing the key issues is built. In this webcast, Gibson Dunn experts walk you through the key legal considerations involved in facing these business issues. Topics discussed include:

  • Keeping and motivating key employees
    • Handling of existing incentive awards: both equity and cash
    • Granting of new incentives
    • Integration of existing benefit programs
    • Negotiation of new agreements
  • Effectively transitioning excess employees
    • Handling of existing severance programs (both formal and informal)
    • Handling of transitional employees
    • Obtaining desired releases and restrictive covenants
  • Managing existing liabilities (including any existing problem areas)
    • Pension plans and retiree medical benefits
    • Multiemployer plans and other union benefits issues
    • Successor liabilities
  • Different Issues when Going Global
    • Regional differences
  • Possible Changes with a New Incoming US Administration
Who Should View This Program: General Counsels, HR personnel, in-house employment and benefits counsel, HR consultants View Slides [PDF]
https://player.vimeo.com/video/201596242
PANELISTS: Michael Collins is a partner in our Washington, DC office. He is Co-Chair of the Executive Compensation and Employee Benefits Practice Group. For four consecutive years, he has been ranked by Chambers & Partners USA as a leading lawyer in the area of Employee Benefits and Executive Compensation in the District of Columbia. He is also listed in 2016 edition of The Best Lawyers in America® under the category of Employee Benefits (ERISA) Law. His practice focuses on all aspects employee benefits and executive compensation. He represents both executives and companies in drafting and negotiating employment arrangements. Stephen Fackler is a partner in the firm's Palo Alto and New York offices and Co-Chair of Gibson Dunn's Executive Compensation and Employee Benefits Practice Group. He has extensive experience nationwide advising public and private companies, private equity funds and boards of directors on compensation and benefits matters. He also regularly advises senior executives on their employment and severance arrangements, and directors in connection with compensation and indemnification arrangements. Mr. Fackler has been selected by Chambers and Partners as a Leading Employee Benefits Lawyer each year since 2006 in its publication "America's Leading Business Lawyers" and as a 'Leading US Employee Benefits and Executive Compensation Lawyer' by The Legal 500 in its inaugural 2007 and subsequent editions. He was named among the Top 20 Most Powerful Lawyers for Employee Benefits and ERISA in Human Resource Executive magazine and Lawdragon in 2012, 2013, 2014, 2015 and 2016. Sean Feller is a partner in our Century City office. He is a member of the firm's Executive Compensation and Employee Benefits Practice Group. His practice focuses on all aspects executive compensation and employee benefits. His practice encompasses tax, ERISA, accounting, corporate, and securities law aspects of equity and other incentive compensation plans; qualified and nonqualified retirement and deferred compensation plans and executive employment and severance arrangements. He has been recognized by his peers as one of The Best Lawyers in America in the area of Employee Benefits (ERISA) Law. In 2016, he was ranked by Chambers USA as a Leading Lawyer in California in the area of Employee Benefits and Executive Compensation. MODERATOR: Jeffrey Chapman is Co-Chair of the firm's Global Mergers and Acquisitions Practice Group. He maintains an active M&A practice representing private equity firms and public and private companies in diverse cross-border and domestic transactions in a broad range of industries. Chambers Global ranks him as one of the top 50 M&A lawyers in the United States. Law360 named him one of the nation's top five Private Equity lawyers in 2015. Recognized for many years by Chambers USA in its most elite "Band 1" category as one of a handful of the leading corporate lawyers in Texas, Chambers singled him out in 2013 and elevated him to "Star Individual." Mr. Chapman remains the only corporate lawyer in Texas history ever to be so designated. BTI Consulting named him to its 2016 BTI Client Service All-Stars list, one of only 37 M&A lawyers in the United States "singled out by general counsels as the best of the best, separating themselves from the pack with the ability to guide any deal and assemble the perfect teams" and "considered the cream of the crop when it came to their client service." D CEO magazine and the Association of Corporate Growth named him the 2016 Dallas Dealmaker of the Year.

January 24, 2017 |
Webcast: Antitrust Agencies Issue Guidance for Human Resource Professionals on Employee Hiring and Compensation

​Antitrust authorities around the world are increasingly taking an interest in companies' hiring practices and compensation decisions. On October 20, 2016, the Antitrust Division of the Department of Justice and the Federal Trade Commission jointly issued guidance for human resource ("HR") professionals regarding the application of the federal antitrust laws in this area. The guidance focuses on HR professionals as gatekeepers, explaining that they "often are in the best position to ensure that their companies' hiring practices comply with the antitrust laws." The guidance also states that companies and individual HR professionals may be held criminally liable for antitrust violations in this area. Join Gibson Dunn for a one-hour discussion of the guidance, as well as how authorities in Europe would deal with these issues. Participants can also earn MCLE credit. View Slides [PDF]


https://player.vimeo.com/video/201968874
PANELISTS: Daniel G. Swanson is a partner in Gibson, Dunn & Crutcher LLP, with offices in Los Angeles and Brussels. Mr. Swanson has been a trial and appellate litigator for over 30 years, and has Co-Chaired Gibson Dunn's highly-regarded Antitrust and Competition Practice Group since 1996. His practice focuses on U.S., U.K., EU and international antitrust and competition law, including trial and appellate litigation, class actions, criminal investigations and cartel defense, merger review and government civil investigations, regulatory and competition policy matters, and antitrust counseling. Rod J. Stone is a partner in the Los Angeles office of Gibson, Dunn & Crutcher LLP. He is a member of the firm's Litigation Department and has extensive experience in antitrust, government investigations, unfair competition and competitive business practices litigation, including class actions. Mr. Stone's antitrust litigation practice has encompassed a broad range of antitrust issues under the Sherman Act, the Clayton Act, the Robinson-Patman Act, the FTC Act, and state antitrust and unfair competition laws. He has litigated claims of alleged monopolization, tying, exclusive dealing, price fixing, group boycott, refusal to deal and price discrimination, among others, in civil litigation and government investigations throughout the country. Jessica Brown is a partner in the Denver office of Gibson Dunn and a member of the firm's Labor and Employment, Class Action, and Electronic Discovery Practice Groups. She has been ranked by Chambers USA for twelve consecutive years as one of "America's Leading Lawyers for Labor and Employment." She also has been listed in The Best Lawyers in America®. The Denver Business Journal named Ms. Brown winner of the 2015 Outstanding Women in Business Award for the Law category. She was previously named one of Denver's "Forty Under 40." Ali Nikpay is a partner at Gibson Dunn & Crutcher and head of its competition practice group in London. He has more than 20 years of merger control, antitrust and litigation experience in both the private and public sectors. He has served in important positions at both the European Commission's DG for Competition (DG COMP) and the UK competition authority. He has particular expertise in global cartel investigations and matters that are complex from an economic perspective. He has counseled clients such as UBS, Gala Coral, Schlumberger, Facebook, Marriott Hotels, and Debenhams plc. Clients he has advised prior to joining Gibson Dunn include GE, NTT DoCoMo, KKR, and CVC.

December 5, 2016 |
A DOJ Crackdown on Employee Recruiting and Compensation

​Los Angeles partner Daniel Swanson, Washington, D.C. partner Jason Schwartz, Los Angeles partner Rod Stone and San Francisco associate Caeli Higney are the authors of "A DOJ Crackdown on Employee Recruiting and Compensation" [PDF] published by Law360 on December 5, 2016.

November 22, 2016 |
Proxy Advisory Firm Updates and Action Items for 2017 Annual Meetings

The two most influential proxy advisory firms--Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis)--recently released their updated proxy voting guidelines for 2017.  The key changes to the ISS and Glass Lewis policies are described below along with some suggestions for actions public companies should take now in light of these policy changes and other proxy advisory firm developments.  The 2017 ISS policy updates are available here.  The 2017 Glass Lewis Guidelines are available here.   

ISS 2017 Proxy Voting Policy Updates 

On November 21, 2016, ISS released updated proxy voting policies for shareholder meetings held on or after February 1, 2017.  These policies are used by ISS in making voting recommendations on director elections and company and shareholder proposals at U.S. companies.  The changes in the 2017 proxy voting guidelines are described below. 

ISS also indicated that it plans to issue updated FAQs on equity plan proposals (discussed below) and other matters in mid-December, and that it plans to issue updated voting policies on shareholder proposals anticipated for 2017 annual meetings in January 2017.   

1.      Director Elections 

Overboarded Directors 

As announced in the ISS 2016 Proxy Voting Policy Updates, ISS will begin recommending votes "against" directors who sit on more than five public company boards.  Prior to this announcement and during the 2016 transition period, the maximum number of boards a director could sit on without receiving a negative ISS voting recommendation was six.  The recommendations for public company CEOs remain unchanged:  ISS will continue to recommend votes "against" public company CEOs who sit on the boards of more than two public companies besides their own (but only at those companies where the CEO is a director, not on the CEO's own board). 

Restrictions on Shareholders' Ability to Amend Bylaws

ISS now will recommend votes "against" members of the governance committee if a company's charter places "undue" restrictions on shareholders' right to amend the company's bylaws.  Undue restrictions include, but are not limited to, prohibitions on the submission of binding shareholder proposals or ownership requirements in excess of those imposed by Rule 14a-8.  ISS will continue to issue negative voting recommendations each year that these restrictions remain in place.  Prior to this update, ISS did not have a stated position on this issue. 

Unilateral Bylaw/Charter Amendments and Multi-Class Capital Structures at IPO Companies

ISS now will generally recommend votes "against" all directors other than new nominees if a company completes an IPO with a multi-class capital structure in which the classes do not have equal voting rights.  Prior to this update, ISS recommended votes "against" directors of IPO companies if the company had provisions in its charter or bylaws that were "materially adverse" to shareholder rights, and ISS provided a list of factors that could change the presumption of a negative voting recommendation, including a public commitment to put the adverse provision to a shareholder vote within three years of the date of the IPO. 

Under the new guidance, if, prior to the IPO, the company or its board adopted charter or bylaw provisions materially adverse to shareholder rights, or implemented a multi-class capital structure in which the classes have unequal voting rights, ISS will recommend a vote "against" all directors except new nominees, unless there is a reasonable sunset provision (i.e., a commitment to hold a shareholder vote within three years will no longer be sufficient).  In addition to the sunset provision, as under its current policy, ISS will continue to consider a list of factors in making its final voting recommendation.  In addition, unless the adverse provision and/or problematic capital structure is reversed or removed, ISS will recommend votes case by case on director nominees in subsequent years. 

2.      Capital 

Stock Distributions:  Splits and Dividends

ISS has a voting policy that specifically addresses common stock authorizations in connection with a stock split or stock dividend, and it has clarified this policy for 2017.  In connection with a planned stock split or stock dividend, a company may need to increase the number of authorized shares of its common stock, which would require shareholder approval.  The company may seek approval for a total number of shares that exceeds the number it anticipates distributing in connection with the stock split or stock dividend.  As updated, the ISS policy now makes clear that ISS will generally vote "for" these proposals as long as the "effective" increase in authorized shares satisfies ISS's common stock authorization policy.  As we understand it, this clarification means that, in evaluating the impact of the increase on a company's authorized share capital, ISS will continue to consider only the number of excess shares--that is, shares over and above those to be issued as a planned stock split or stock dividend.   

3.      Executive Compensation 

Equity-Based Incentive Plans

ISS has changed aspects of its "Equity Plan Scorecard," which is part of its proxy voting policy for equity-based incentive plans.   Specifically, ISS has added a factor to the Equity Plan Scorecard that considers whether dividends or dividend equivalents related to an equity award can be payable prior to vesting of the award.  Under the new factor, equity plans that explicitly prohibit the payment of all dividends or dividend equivalents before the vesting of the underlying equity award will receive full credit, while companies will receive no credit if the prohibition is "absent or incomplete" (that is, it does not apply to all types of awards).  A company's general practice to withhold dividends during the vesting period is insufficient to receive credit under the Equity Plan Scorecard if the policy is not made explicit in the equity plan document.  A provision that allows the accrual of dividends/dividend equivalents payable upon vesting is sufficient as long as dividends are withheld during the vesting period. 

In addition to adding the new factor, ISS has also changed the factor in the Equity Plan Scorecard related to minimum vesting periods.  Under the updated factor, in order to receive full credit, an equity plan must specify a minimum vesting period of at least one year that applies to all award types and that cannot be overridden in individual award agreements.  This is a change from the prior version of the factor, which only required that the minimum vesting period apply to one type of award and was silent with respect to individual award agreements. 

Amendments to Cash and Equity Incentive Plans

ISS clarified how it will evaluate proposals to amend cash or equity incentive plans by more clearly differentiating the framework it will apply to various types of amendments.  ISS's recommendation on amendments to all plans (whether cash, stock, or a combination of the two) that only seek shareholder approval of performance metrics for Section 162(m) purposes (other than in connection with the first such approval following an IPO) will depend on whether the board committee administering the plan consists entirely of independent directors.  Note that for these purposes ISS applies its definition of "independence", not the applicable New York Stock Exchange or NASDAQ definition.  All other cash and equity plan amendments will receive recommendations on a case-by-case basis.  The amendments do not substantively change the ISS policy; they merely clarify its application.

Pay-for-Performance Updates

Separately, ISS also recently announced that it would incorporate an additional proprietary financial performance metric into the pay-for-performance analysis it uses in evaluating a company's executive compensation and say-on-pay proposal.  When evaluating executive compensation, ISS currently applies a quantitative screen that uses three metrics: (a) the degree of alignment between the company's annualized total shareholder return (TSR) and the CEO's annualized total awarded compensation, each measured on a relative basis within a peer group and over a three-year period; (b) the degree of absolute alignment between the trend in CEO pay and the company's TSR over the prior five fiscal years; and (c) the multiple of the CEO's total awarded compensation relative to the peer group median CEO total compensation. This quantitative screen is intended to flag companies where a potentially significant misalignment of pay and performance may exist and therefore where further assessment is warranted in the form of a qualitative pay-for-performance analysis. 

Based on feedback obtained through its 2016 policy survey, ISS has announced that it will incorporate an additional pay-for-performance metric into its analysis beginning in 2017.  Specifically, ISS has developed a new metric that compares the relative degree of alignment between the CEO's annualized total awarded compensation and the company's performance as calculated by ISS based on six financial metrics, with both compensation and financial performance being measured relative to an ISS-selected peer group over a three-year period.  The six financial performance metrics that will be used in this analysis are (a) return on invested capital, (b) return on assets, (c) return on equity, (d) revenue growth, (e) EBITDA growth, and (f) growth in cash flow from operations.  The weight that ISS places on each of these six metrics will vary by industry for purposes of producing the new numerical weighted financial performance metric.  Beginning in 2017, ISS's voting recommendation reports will present this information in a new standardized table that sets forth the company's three-year performance based on TSR and on these six financial metrics relative to the company's ISS selected peer group, compares performance on these metrics with relative compensation levels (in each case, relative to the ISS selected peer group), and presents the overall weighted financial performance metric.  Companies that subscribe to ISS's executive compensation services will be able to view online projections of their relative financial performance evaluation under these new measures.  

For 2017, ISS stated that it may use the relative financial performance information in the qualitative aspect of its pay-for-performance analysis.  Thus, no changes are being made for 2017 to ISS's quantitative pay-for-performance analysis, although ISS is leaving the door open for changes in 2018 and beyond.  As with any standardized measure, some companies may object that the new financial performance measures utilized by ISS do not accurately portray their performance, and may object to the manner in which ISS weights the various financial performance measures.  The extent of these objections, and the extent to which shareholders embrace the ISS presentations, may well depend on the extent of transparency that ISS provides into its proprietary financial performance calculations and to the weight it assigns to each.   

4.      Director Compensation 

Shareholder Ratification of Director Compensation Programs

ISS has added a new policy for evaluating company proposals seeking ratification of non-employee director compensation.  ISS will vote case by case on these proposals, based on a list of factors.  The list of factors includes director compensation at comparable companies, the presence of "problematic" pay practices relating to director compensation, director stock ownership guidelines and holding requirements, equity award vesting schedules, the mix of cash and equity-based compensation, "meaningful" limits on director compensation, the availability of retirement benefits, and the quality of disclosure surrounding director compensation.  ISS will also consider whether or not the equity plan under which non-employee director grants are made warrants support, if that plan is up for shareholder approval.  This policy is being implemented in reaction to shareholder litigation over director compensation and the ensuing shareholder ratification proposals put forth by companies.   

Equity Plans for Non-Employee Directors

ISS modified the factors considered when it evaluates equity compensation plans that apply solely to non-employee directors.  ISS will continue to evaluate plans on a case by case basis based on the estimated cost of the plan relative to peer companies, the company's three-year burn rate relative to peer companies, and plan features.  In cases where director stock plans exceed ISS plan cost or burn rate benchmarks, in making its recommendation, ISS will continue to consider various factors relating to director compensation in formulating its voting recommendation.  However, rather than requiring that a company's director compensation program meet certain enumerated criteria, which is the approach under ISS's current policy, ISS will "look holistically" at all of the factors.  In addition, ISS has updated and expanded these factors so they are the same factors used in ISS's new policy for evaluating company proposals seeking shareholder ratification of director compensation programs.   

Glass Lewis 2017 Proxy Voting Policy Updates 

On November 18, 2016, Glass Lewis released their updated proxy voting policy guidelines for 2017 in the United States and for shareholder proposals.  These guidelines are a detailed overview of the key policies Glass Lewis applies when making voting recommendations on proposals at U.S. companies and on shareholder proposals.  The four key changes in these 2017 guidelines are summarized below.   

1.      Overboarded Directors 

As previously announced, beginning in 2017 Glass Lewis will generally recommend voting "against" a director who serves as an executive officer of any public company while serving on a total of more than two (instead of three) public company boards (including their own) and any other director who serves on a total of more than five public company boards.  However, Glass Lewis has introduced some flexibility in how it will apply this standard:

  • When determining whether a director's service on an excessive number of boards may limit the director's ability to devote sufficient time to board duties, Glass Lewis may consider relevant factors such as the size and location of the other companies where the director serves on the board, the director's board duties at the companies in question, whether the director serves on the boards of any large privately held companies, the director's tenure on the boards in question, and the director's attendance record at all companies.
  • Glass Lewis may also refrain from recommending voting "against" certain directors if the company provides sufficient rationale in the proxy statement for their continued board service.  Glass Lewis believes that this rationale "should allow shareholders to evaluate the scope of the directors' other commitments as well as their contributions to the board including specialized knowledge of the company's industry, strategy or key markets, the diversity of skills, perspective and background they provide, and other relevant factors."
  • If directors are overboarded, Glass Lewis will not recommend that shareholders vote "against" overcommitted directors at the companies where they serve as an executive.  

2.      Board Evaluation and Refreshment 

Glass Lewis clarified its approach to board evaluation, succession planning and refreshment.  Generally speaking, Glass Lewis believes a robust board evaluation process--one focused on the assessment and alignment of director skills with company strategy--is more effective than solely relying on age or tenure limits.  This discussion appears in a newly captioned section entitled "Board Evaluation and Refreshment" in the U.S. Guidelines and reflects a shift in focus from a similar discussion that previously appeared under the heading "Mandatory Director Term and Age Limits."   

3.      Governance Following an IPO or Spin-Off 

Glass Lewis clarified how it approaches corporate governance at newly public entities. While it generally believes that such companies should be allowed adequate time to fully comply with marketplace listing requirements and meet basic governance standards, Glass Lewis will also review the terms of the company's governing documents in order to determine whether shareholder rights are being severely restricted from the outset.  If Glass Lewis believes the board has approved governing documents that significantly restrict the ability of shareholders to effect change, it will consider recommending that shareholders vote "against" members of the governance committee or the directors that served at the time of the governing documents' adoption, depending on the severity of the concern.  The new guidelines outline the specific areas of governance Glass Lewis will review (for example, antitakeover provisions, supermajority vote requirements, and general shareholder rights, such as the ability of shareholders to remove directors and call special meetings).  

4.       Gender Pay Equity Shareholder Proposals   

Glass Lewis codified its policy concerning shareholder proposals requesting that companies provide increased disclosure concerning efforts taken to ensure gender pay equity.  Glass Lewis will review these proposals on a case by case basis and will consider (a) the company's industry; (b) the company's current policies, efforts and disclosure with regard to gender pay equity; (c) the practices and disclosure of company peers; and (d) any relevant legal and regulatory actions at the company. Glass Lewis will consider recommending votes in favor of "well-crafted shareholder resolutions requesting more disclosure on the issue of gender pay equity in instances where the company has not adequately addressed the issue and there is credible evidence that such inattention presents a risk to the company's operations and/or shareholders."

Actions Public Companies Should Take Now

  • Evaluate your company's practices in light of the revised ISS and Glass Lewis proxy voting guidelines:  Companies should consider whether their policies and practices, or proposals expected to be submitted to a shareholder vote in 2017, are impacted by any of the changes to the ISS and Glass Lewis proxy voting policies.  For example, companies should consider whether any directors or director nominees would be considered "overboarded" under the updated policies. 
  • Update ISS on your compensation peer group:  ISS is inviting companies to notify it of changes companies have made to the peer companies they use for determining compensation where the company's next annual meeting will be held between February 1, 2017, and September 15, 2017.  ISS factors the company-selected peer companies into its peer group construction process as part of its compensation-related voting recommendations.  Companies do not need to submit an update if the peer group has not changed since the last proxy statement.  ISS will automatically use the peers disclosed in a company's last proxy statement if no updates are submitted.  The ISS peer submission window will be open for these U.S. companies from 9:00 AM EST on Monday, November 28, 2016 until 8:00 PM EST on Friday, December 9, 2016.   Companies can submit the updates by logging onto the ISS Corporate Solutions website at https://login.isscorporatesolutions.com.  
  • Check your ISS QualityScore Scores:  In late October, ISS announced QualityScore, a rebranded and revised version of its corporate governance ratings system.  Following a data verification period, ISS released on November 21, 2016, the new QualityScore ratings for companies.  These scores will be publicly available on Yahoo! Finance and included in the ISS reports containing proxy voting recommendations for shareholder meetings.  However, a company cannot update its QualityScore data once it files the proxy statement.  Thus, companies are encouraged to review in advance the new QualityScore scores and confirm the accuracy of the raw data that ISS is using.  QualityScore information can be accessed on the ISS Corporate Solutions website at https://login.isscorporatesolutions.com.  
  • Enroll in the Glass Lewis 2017 Issuer Data Report (IDR) program:  Glass Lewis has opened enrollment for its 2017 Issuer Data Report (IDR) program.  The IDR program enables public companies to access (for free!) a data-only version of the Glass Lewis Proxy Paper report prior to Glass Lewis completing its analysis and recommendations relating to public company annual meetings.  Glass Lewis does not provide drafts of its voting recommendations report to issuers it reviews, so the IDR is the only way for companies to confirm the accuracy of the data before Glass Lewis's voting recommendations are distributed to its clients.  Moreover, unlike ISS, Glass Lewis does not provide each company with complimentary access to the final voting recommendations for the company's annual meeting.  IDRs feature key data points used in Glass Lewis's corporate governance analysis, such as information on directors, auditors and their fees, summary compensation data and equity plans, among others.  The IDR is not a preview of the final Glass Lewis analysis as no voting recommendations are included.  Each participating public company receives its IDR approximately three weeks prior to its annual meeting and generally has 48 hours to review the IDR for accuracy and provide corrections, including supporting public documents, to Glass Lewis.  Participation is limited to a specified number of companies, and enrollment is on a first-come, first-served basis.  Enrollment closes on January 6, 2017, or as soon as the annual limit is reached.  To learn more about the IDR program and sign up to receive a copy of the 2017 IDR for your company, go to https://www.meetyl.com/issuer_data_report.   

The following Gibson Dunn lawyers assisted in the preparation of this client alert:  Elizabeth Ising, Lori Zyskowski, Ronald Mueller, Sean Feller, Gillian McPhee and Matt Haskell.

Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm's Securities Regulation and Corporate Governance and Executive Compensation and Employee Benefits practice groups, or any of the following:

Securities Regulation and Corporate Governance Group:
Elizabeth Ising - Co-Chair, Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
James J. Moloney -
Co-Chair, Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com)
Brian J. Lane - Washington, D.C. (
+1202-887-3646, blane@gibsondunn.com)
Ronald O. Mueller - Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
John F. Olson - Washington, D.C. (+1 202-955-8522, jolson@gibsondunn.com)
Lori Zyskowski - New York (+1 212-351-2309, lzyskowski@gibsondunn.com)
Gillian McPhee - Washington, D.C. (+1 202-955-8201, gmcphee@gibsondunn.com)
Julia Lapitskaya - New York (+1 212-351-2354, jlapitskaya@gibsondunn.com)
Sarah E. Fortt - Washington, D.C. (+1 202-887-3501, sfortt@gibsondunn.com)
Kasey L. Robinson - Washington, D.C. (+1 202-887-3587, krobinson@gibsondunn.com)

Executive Compensation and Employee Benefits Group:
Stephen W. Fackler - Co-Chair, Palo Alto/New York (+1 650-849-5385/+1 212-351-2392, sfackler@gibsondunn.com)
Michael J. Collins - Co-Chair, Washington, D.C. (+1 202-887-3551, mcollins@gibsondunn.com)
Sean C. Feller - Los Angeles (+1 310-551-8746, sfeller@gibsondunn.com)


© 2016 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 16, 2016 |
Planning for Your Annual Shareholder Meeting: Selected Considerations for a Virtual-Only Meeting

In recent years, an increasing number of companies have opted to hold annual shareholder meetings exclusively online--i.e., a virtual meeting without a corresponding physical meeting--rather than a virtual meeting in tandem with a physical meeting (the so-called "hybrid" approach).  While hybrid approaches are generally welcome or not opposed by investors and activist shareholders, some have criticized companies holding virtual-only annual meetings, asserting that virtual meetings limit the opportunity for shareholder participation in the meeting as well as engagement with management and the board.  In spite of these criticisms, just as corporate use of the internet and social media to communicate with stakeholders is growing, virtual meetings are on the rise.

In 2001, Inforte Corporation was the first company to hold a virtual-only meeting, following Delaware's 2000 amendment to its General Corporation Law permitting such meetings.[1]  Though virtual meetings are still very much a minority of total annual shareholder meetings, more and more companies have been holding virtual meetings over the last few years:  27 virtual meetings in 2012, 35 in 2013, 53 in 2014 and 90 in 2015.[2]  Broadridge Financial Solutions, an investor communications firm and a provider of a virtual meeting platform, reported 136 virtual meetings held in 2016 to date,[3] with particular popularity with recently-publicly listed companies and technology companies.  These include companies, large and small, such as Intel, HP Inc., Hewlett Packard Enterprise, Fitbit, Yelp, NVIDIA, Sprint, Lululemon, Graco, GoPro, Rambus, El Pollo Loco and Herman Miller.

Considerations for a Virtual Meeting

Benefits of Virtual Meetings

Virtual meetings present many potential advantages for companies and their shareholders.  Advocates suggest that virtual meetings will increase shareholder participation as compared to physical-only meetings because of improved access--shareholders who cannot attend in person due to location or other reasons can attend virtually and do not have to incur the time and costs of travel to a physical meeting.  As an example, one company had only three shareholders attend its last physical meeting in 2008, while 186 shareholders attended its virtual meeting in 2009.[4]  In addition, considering that thousands of annual shareholder meetings are held within a few weeks of each other, shareholders can participate in more virtual meetings than physical meetings.[5]

Similarly, companies may find virtual meetings appealing in their potential to reach as many shareholders as possible.  Companies can also choose among different approaches to handling shareholder questions,[6] some of which allow companies to preview and prioritize important questions, eliminate duplicative items and prepare more substantive or complete responses.  Moreover, for some companies, the use of technology for the conduct of a shareholder meeting may be consistent with promoting the technology business of the company or enable a company to project a tech-savvy image.

A benefit to both shareholders and companies is the reduced cost of the annual meeting--a virtual meeting avoids the time, effort and expense of organizing a physical meeting, including reserving a large venue and arranging for appropriate personnel and materials.  With companies and investors becoming increasingly global, virtual meetings can trim travel time and costs for shareholders, avoid traffic and other logistical delays and be easier to schedule amidst competing time demands.  A virtual meeting may also be less disruptive to the company's daily routine, allowing management and other employees to return to their work more quickly.  In the current atmosphere where physical safety is always a concern, it is relatively easy to maintain security and control for a virtual meeting as compared to a live one.  Lastly, holding the annual meeting virtually can reduce environmental impact, because there would be less travel and fewer printed materials regardless of the number of participants.

Challenges Presented by Virtual Meetings

Despite the potential advantages, some perceived challenges raised by virtual meetings cause certain institutional investors, such as the California Public Employees' Retirement System (CalPERS), the largest U.S. public pension fund, and shareholder groups, such as the Council of Institutional Investors (CII), to oppose virtual meetings.[7]  These investors assert that virtual meetings reduce the effectiveness of shareholder participation by eliminating shareholders' ability to meet with directors and express their concerns face-to-face.  There is also concern that companies will manipulate shareholder questions to reduce any negative impact or redirect focus, by filtering, grouping, rephrasing or even ignoring questions so that companies can manage questions and their responses to advance the company viewpoints.  By selecting questions ahead of time, companies could choose not to answer hard questions that would be more difficult to avoid in person.  In effect, virtual meetings could potentially allow companies to limit the influence of corporate governance activists.

Companies may fear that virtual meetings lack the personal connection with shareholders and communities that in-person meetings can convey.  Virtual meetings may create more uncertainty in shareholder votes because shareholders can more easily attend virtual meetings than physical meetings and thus electronically vote or change votes at the last moment while attending a virtual meeting.  Especially in contested elections, the certainty of proxies received in advance of physical meetings provides more comfort for companies about the projected outcome of votes.  Shareholders who can attend a meeting virtually may be less inclined to vote by proxy in advance, making voting results less predictable and making it harder for companies to gauge whether their solicitation methods are effective or need to be adjusted.  In proxy contests, parties could continue solicitation efforts via e-mail up to the time of the virtual meeting, though a company's last-minute announcements or statements may similarly be more likely to affect votes.  Some companies may avoid virtual meetings because of their reluctance to make their shareholder lists available online, as required by many states for virtual meetings.  Moreover, without the personal touch present when face-to-face, virtual meetings may diminish companies' ability to resolve hostile or otherwise challenging questions as effectively as in physical meetings.  Finally, to the extent that a virtual meeting broadcasts shareholder questions on a real-time basis, it could be more difficult for companies to manage disruptive participants than in a physical meeting.

Some prominent activist shareholders also oppose virtual meetings.  For the 2017 proxy season, John Chevedden has submitted shareholder proposals to various companies requesting that the companies' board of directors adopt a governance policy to initiate or restore in-person annual meetings and publicize this policy to investors.[8]  Mr. Chevedden has argued that in-person meetings serve an important function by enabling shareholders to better judge management's performance and plans.[9]  Similarly, James McRitchie has written on his website about the negative impact of holding virtual annual meetings and advocated for shareholder proposals requiring physical meetings.[10]

Both CalPERS and CII believe that companies "should hold shareowner meetings by remote communication (so-called 'virtual' meetings) only as a supplement to traditional in-person shareowner meetings, not as a substitute" and that "a virtual option, if used, should facilitate the opportunity for remote attendees to participate in the meeting to the same degree as in-person attendees."[11]  California State Teachers' Retirement System (CalSTRS) has also expressed a preference for a hybrid meeting, though it acknowledged that "the technology is moving."[12]  At this time, most other major institutional investors have not taken a public stance regarding virtual meetings.

Neither Institutional Shareholder Services (ISS) nor Glass Lewis have directly opposed virtual meetings in their guidelines, although ISS has indicated that it may make adverse recommendations where a company is using virtual-meeting technology to impede shareholder discussions or proposals.

Best practices for virtual meetings are continuing to evolve as more companies hold virtual meetings, so it may be difficult to predict investor response to specific practices.

Initial Considerations in Deciding Whether to Hold a Virtual Meeting

Governing Law and Documents

If a company desires to hold its meeting virtually, it first must confirm that the law of its state of incorporation permits virtual annual meetings and the requirements applicable to such meetings.  Almost half of the U.S. states, including Delaware, permit virtual meetings.[13]  However, some of these 22 states include conditions that, practically speaking, mean that virtual meetings likely would not be used--for example, California permits virtual meetings but only with the consent of each shareholder participating remotely.[14]  Seventeen states and the District of Columbia do not permit virtual meetings but do permit hybrid meetings, and 11 states require a physical location for the shareholders' meeting while permitting remote participation.[15]

A Delaware corporation can hold its annual meeting virtually if it complies with certain statutory requirements.  The company must "implement reasonable measures" to confirm that each person voting is a shareholder or proxyholder and to provide such persons with "a reasonable opportunity to participate in the meeting and to vote," including the ability to read or hear the meeting proceedings on a substantially concurrent basis.[16]  The company must also maintain records of votes or other actions taken by the shareholder or proxyholder.[17]

After confirming that virtual meetings are allowed under the state law applicable to the company, the company should make note of any statutory conditions, such as disclosure or shareholder consent requirements or objection rights.  For example, as noted above, a company may also be required to make its shareholder list electronically available during the meeting.[18]  A company must also confirm that its governing documents permit virtual meetings; for example, a company's bylaws often state where annual meetings are to be held and may need amendment to provide for virtual meetings.  Notably, federal securities laws do not impose restrictions on how shareholder meetings are held.  Similarly, while stock exchanges like the NYSE and NASDAQ require listed companies to hold shareholder meetings, they also do not prohibit nor impose restrictions on virtual meetings.

Factors Influencing the Decision to Hold a Virtual Meeting

A company should assess typical shareholder attendance at its annual meeting and the interest of senior management and directors in holding the annual meeting virtually who may have concerns about investor reaction to a virtual meeting announcement or who may want the company to demonstrate its embrace of current technology.  A company should also compare the costs and logistical efforts necessary for a physical meeting against those needed for a virtual meeting, which will include fees for the virtual meeting platform and may still include travel expenses for certain directors and management team members.  Other factors include whether any shareholder proposals are pending and the level of shareholder dissent, such as with respect to the company's performance or governance.  The company should evaluate the risk of triggering shareholder activism if it announces an intent to hold its annual meeting virtually.  There may be reasons why a physical meeting may be preferable, such as where director elections are contested or a significant business transaction or controversial proposal will be put to a shareholder vote.  To date, no virtual meetings involving proxy contests have been held.

Planning for a Virtual Meeting

In 2012, a group of "interested constituencies, comprised of retail and institutional investors, public company representatives, as well as proxy and legal service providers" published guidelines for virtual meetings.[19]  Chaired by a representative of CalSTRS and including members from the National Association of Corporate Directors, the Society for Corporate Governance (formerly known as the Society of Corporate Secretaries & Governance Professionals), AFL-CIO and NASDAQ and others, this "Best Practices Working Group for Online Shareholder Participation in Annual Meetings" set forth the following principles for online shareholder participation in annual meetings:[20]

  • Companies should "employ safeguards and mechanisms to protect [shareholder interests] and to ensure that companies are not using technology to avoid opportunities for dialogue that would otherwise be available at an in-person shareholder meeting."[21]  Companies should adopt safeguards for shareholders' online participation by adopting policies and procedures that offer a similar level of transparency and interaction as a physical meeting.  The policies and procedures should also address validation of attendees (to confirm that they are shareholders and proxyholders) and enable online voting.
  • Companies should "maximize the use of technology" to make the meeting accessible to all shareholders.  Steps to be considered include offering telephone or videoconferencing access "so that shareholders can call in to ask questions during the meeting," ensuring accessible technology "by utilizing a platform that accommodates most, if not all, shareholders," "providing a technical support line for shareholders," and "opening web lines and telephone lines in advance" for pre-meeting testing access.[22]

If a company decides to hold its annual meeting virtually, it may wish to proactively discuss the proposed change with key shareholders and explain the rationale for it.  The company must also determine how it would handle shareholder questions--for example, whether all questions would be posted and establishing what happens to questions received during the meeting that are not answered during the meeting.

A company has several options for hosting a virtual meeting (audio, video, telephone, web, etc.), and a company's choice among those options will be guided by state legal requirements.  Providers offer virtual meeting platforms on which companies can host their annual meetings and shareholders can attend and vote online.  These commercial platforms can help companies comply with statutory requirements, such as Delaware's requirement to maintain records of votes and other shareholder actions.  If possible, the company should leverage technology to allow attendees with different levels of technological savvy or resources to attend.

Conclusion

Though some originally thought that only small companies would use virtual meetings because larger, more well-known companies would want to use the annual meeting as a public relations opportunity and to avoid backlash from shareholder groups, large companies have now started holding virtual meetings.  In deciding whether to hold a virtual meeting, companies should weigh the relative advantages and disadvantages applicable to their situations, which may include potential negative sentiment from investors.  With technological advances that enable the meetings to be more similar to physical meetings, the potential cost and time savings of virtual meetings may appeal to more companies.


   [1]   See Eric Bomkamp, Virtual-Only Shareholder Meetings: Inevitable Advance or Unwelcome Development?, BNA's Corporate Counsel Weekly (February 23, 2011); Virtual Shareholder Meetings, TheCorporateCounsel.net, http://www.thecorporatecounsel.net/member/LawFaqs/ElectronicStockholder.htm#a (last visited Oct. 11, 2016).

   [2]   See TheCorporateCounsel.net, supra note 1; Broadridge Financial Services, Inc., 2016 Proxy Season Key Statistics & Performance Rating (based on shareholder meetings (i.e., proxy "jobs") mailed between March 1, 2016 and June 17, 2016), http://media.broadridge.com/documents/Key-Statistics-and-Performance-Ratings-for-the-2016-Proxy-Season-new.pdf (last visited October 20, 2016); Richard Daly, Unless You're Warren Buffet, Your Next Shareholder Meeting Should be Online, Forbes.com (Apr. 28, 2016) http://www.forbes.com/sites/richdaly/2016/04/28/unless-youre-warren-buffett-your-next-shareholder-meeting-should-be-online/#75ebdf7d42d2; Tom Braithwaite, US companies embrace virtual annual meetings, FT.com (Mar. 11, 2016), https://www.ft.com/content/874879c0-e664-11e5-bc31-138df2ae9ee6.

   [3]   See Broadridge, supra note 2.

   [4]   See Daly, supra note 2.

   [5]   See id.

   [6]   For example, Broadridge offers companies three primary options for handling the question & answer segment of a virtual meeting:  live questions submitted from shareholders via online text box, with only the company able to view incoming questions; telephone questions from shareholders during the meeting; pre-meeting questions submitted by shareholders via a separate online portal.  See TheCorporateCounsel.net, Virtual Only Meetings: Nuts and Bolts (Oct. 18, 2016), available at https://www.thecorporatecounsel.net/Webcast/2016/10_18/.

   [7]   See Braithwaite, supra note 2.

   [8]   At least one shareholder proposal prohibiting virtual-only meetings was excluded under Rule 14a-8(i)(7) as relating to a company's ordinary business operations.  See EMC Corp., SEC Staff No-Action Letter (Mar. 7, 2002), available at https://www.sec.gov/Archives/edgar/vprr/0202/02029901.pdf.

   [9]   See Ross Kerber, HP Moves Annual Meeting Online-Only as CEO Face Time Fades, Reuters (Feb. 12, 2015), available at http://www.reuters.com/article/hp-meeting-internet-idUSL1N0VM1XM20150212.

[10]   See James McRitchie, Virtual Meetings: Can Shareholder Proposals Stem the Tide?, Corporate Governance (May 11, 2016), available at http://www.corpgov.net/2016/05/virtual-meetings-can-shareholder-proposals-stem-tide/.

[11]   See Council of Institutional Investors, Corporate Governance Policies 11 (updated Apr. 1, 2015), available at http://www.cii.org/files/committees/policies/2015/04_01_15_corp_gov_policies.pdf; CalPERS, Global Governance Principals 63 (Mar. 16, 2015), available at https://www.calpers.ca.gov/docs/forms-publications/global-principles-corporate-governance.pdf.

[12]   See Kerber, supra note 8.

[13]   See The Best Practices Working Group for Online Shareholder Participation in Annual Meetings, Guidelines for Protecting and Enhancing Online Shareholder Participation in Annual Meetings (June 2012), http://www.calstrs.com/CorporateGovernance/shareholder_participation_annual_meetings.pdf; see also Del. Code. Ann. tit. 8, § 211.

[14]   See The Best Practices Working Group for Online Shareholder Participation in Annual Meetings, supra note 13; Cal. Corp. Code §§ 20(b), 600(a).

[15]   See The Best Practices Working Group for Online Shareholder Participation in Annual Meetings, supra note 13.

[16]   See Del. Code. Ann. tit. 8, § 211(a)(2).

[17]   See id.

[18]   See The Best Practices Working Group for Online Shareholder Participation in Annual Meetings, supra note 13.

[19]   See id..

[20]   See id.

[21]   Id.

[22]   Id.


The following Gibson Dunn lawyers assisted in the preparation of this client alert:  Lisa Fontenot and Linda Dang.

Gibson Dunn's lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm's Securities Regulation and Corporate Governance practice group, or any of the following:

Elizabeth Ising - Co-Chair, Washington, D.C. (202-955-8287, eising@gibsondunn.com)
James J. Moloney -
Co-Chair, Orange County, CA (949-451-4343, jmoloney@gibsondunn.com)
Lisa A. Fontenot - Palo Alto (650-849-5327, lfontenot@gibsondunn.com)
Ronald O. Mueller - Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)
John F. Olson - Washington, D.C. (202-955-8522, jolson@gibsondunn.com)
Lori Zyskowski - New York (212-351-2309, lzyskowski@gibsondunn.com)
Gillian McPhee - Washington, D.C. (202-955-8201, gmcphee@gibsondunn.com)


© 2016 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 1, 2016 |
IRS Updates U.S. Retirement Plan COLAs for 2017

On October 27, 2016, the IRS released its cost-of-living adjustments applicable to tax-qualified retirement plans for 2017.  For the second consecutive year, many of the key limitations, including the elective deferral and catch-up contribution limits for employees who participate in 401(k), 403(b) and 457 tax-qualified retirement plans, remain unchanged from current levels because increases in the cost-of-living index did not meet statutory thresholds that would trigger their adjustment.  This is despite the fact that there will be an increase of almost $9,000 in the Social Security wage base for 2017.

The key 2017 limits are as follows:

Limitation

2017 Limit

402(g) Limit on Employee Elective Deferrals (Note:  This is relevant for 401(k), 403(b) and 457 plans, and for certain limited purposes under Code Section 409A.)

$18,000 (unchanged)

414(v) Limit on "Catch-Up Contributions" for Employees Age 50 and Older (Note:  This is relevant for 401(k), 403(b) and 457 plans.)

$6,000 (unchanged)

401(a)(17) Limit on Includible Compensation (Note:  This applies to compensation taken into account in determining contributions or benefits under qualified plans.  It also impacts the "two times/two years" exclusion from Code Section 409A coverage of payments made solely in connection with involuntary terminations of employment.)

$270,000 ($265,000 for 2016)

415(c) Limit on Annual Additions Under a Defined Contribution Plan

$54,000 (or, if less, 100% of compensation) ($53,000 for 2016)

415(b) Limit on Annual Age 65 Annuity Benefits Payable Under a Defined Benefit Plan

$215,000 (or, if less, 100% of average "high 3" compensation) ($210,000 for 2016)

414(q) Dollar Amount for Determining Highly Compensated Employee Status

$120,000 (unchanged)

416(i) Officer Compensation Amount for "Top-Heavy" Determination (Note:  Because Code Section 409A defines "specified employees" of public companies by reference to this provision, this amount also affects the specified employee determination, and thus, the group subject to the six-month delay under Code Section 409A.)

$175,000 ($170,000 for 2016)

Social Security "Wage Base" for Plans Integrated with Social Security

$127,200 ($118,500 for 2016)

 


Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have regarding these issuesPlease contact the Gibson Dunn lawyer with whom you usually work, or any of the following:

Stephen W. Fackler - Palo Alto/New York (650-849-5385/212-351-2392, sfackler@gibsondunn.com)
Michael J. Collins - Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)
Sean C. Feller - Los Angeles (310-551-8746, sfeller@gibsondunn.com)
Krista Hanvey - Dallas (214-698-3425, khanvey@gibsondunn.com)
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© 2016 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 4, 2016 |
Final NASDAQ Rule on Disclosure of Third-Party Compensation for Directors and Nominees Includes Important Clarifications and Highlights Related Considerations for All Public Companies

On August 1, 2016, the new rule on disclosure of third-party compensation for directors and nominees adopted by The NASDAQ Stock Market LLC ("NASDAQ") took effect.  Disclosure will be required in connection with annual shareholder meetings after August 1.  Accordingly, for NASDAQ companies with a calendar-year end, no action is immediately required, but they should have the rule on their radar screens as they begin preparations for the next annual meeting season.  In addition, we anticipate that third-party compensation will continue to be a focal point for both NASDAQ and New York Stock Exchange (NYSE) companies due to current levels of shareholder activism and as public companies continue to adopt proxy access bylaws, which typically address these arrangements. 

The final rule includes a number of welcome clarifications to NASDAQ's proposal that address important aspects of the rule, including the timing of required disclosures and the rule's application to directors designated by private equity firms, hedge funds and similar firms.  The final rule also includes a new section of commentary that supplements the rule text.  A copy of the final rule, which has been added as Rule 5250(b)(3), and the commentary, which is found in Interpretive Material (IM)-5250-2, appears at the end of this alert.  NASDAQ filed several versions of the rule proposal with the Securities and Exchange Commission (SEC), and the SEC release approving the final proposal is available here

Overview of the Final NASDAQ Rule

New NASDAQ Rule 5250(b)(3) requires companies to disclose "the material terms of all agreements and arrangements between any director or nominee for director, and any person or entity other than the Company (the "Third Party"), relating to compensation or other payment in connection with such person's candidacy or service as a director of the Company."  Disclosure must be made no later than the date on which the company files its definitive proxy statement for the next shareholder meeting at which directors are to be elected.  The disclosure must be made in the proxy statement or via the company's website. 

Companies need not disclose:

  • reimbursement of expenses in connection with serving as a nominee; and
  • compensation paid to employees of private equity funds, hedge funds and other investment firms who routinely serve on the boards of portfolio companies as part of their job duties, if the compensation predates their appointment to a company's board and the relationship with the firm has been publicly disclosed.  Disclosure is required if an individual's compensation is "materially increased" specifically in connection with the person's candidacy or service as a director of a NASDAQ company, and in that situation, the difference between the new and previous level of compensation must be disclosed. 

Consistent with the proposed rule, the required disclosure must be made until the earlier of the director's resignation from the board or one year after termination of the agreement or arrangement.  The final rule also incorporates a "safe harbor" that protects companies if third-party compensation is not disclosed because a company is not aware of it.  Companies would not be in violation of the rule if: (a) they make "reasonable efforts" to identify third-party compensation, including asking each director or nominee in a manner designed to allow timely disclosure; and (b) they disclose any compensation promptly upon discovering it "by filing a Form 8-K . . . where required by SEC rules, or by issuing a press release." 

Important Clarifications in the Final NASDAQ Rule

The final rule includes a number of clarifications that were made over the course of several months during which the proposed rule was revised and subject to public comment. 

  1. Timing of required disclosures.  The final rule provides clarity on several aspects of the timing for disclosure.  Specifically: 
    • Under the proposed rule, there was some question about the timing of the initial disclosure, and in particular, whether companies could wait until the next proxy statement to disclose third-party compensation arrangements where the board appointed a director during the year.  The final NASDAQ rule clarifies that it does not separately require disclosure of new arrangements at the time they are entered into.  Disclosure is required at least annually, no later than the filing of the company's definitive proxy statement for the next shareholder meeting at which directors are to be elected.  The disclosure can be included in the proxy statement or (as discussed below) made via the company's website.  This timing is intended "to provide shareholders with information and sufficient time to help them make meaningful voting decisions," according to IM-5250-2.
    • However, under SEC rules, for directors appointed outside of a shareholder meeting, Item 5.02(d)(2) of Form 8-K requires disclosure of "any arrangement or understanding between [a] new director and any other persons, naming such persons, pursuant to which such director was selected as a director."  Where a company provides the 8-K disclosure, Rule 5250(b)(3)(A) states that separate additional disclosure "in the current fiscal year" is not necessary under the rule.  This provides companies with one-time relief from the requirement to provide proxy disclosure, for the fiscal year in which an Item 5.02(d) 8-K announcing the appointment of a new director is filed, if the third-party compensation arrangement was disclosed in the Form 8-K.  However, this relief may prove to be largely technical.  In this regard, it seems likely that companies would repeat the information in the proxy statement because of the likelihood that shareholders would view it as relevant to the director's election.  Moreover, disclosure would be required in future years because the NASDAQ rule imposes an annual disclosure obligation thereafter.
    • The final rule contains a similar, one-time disclosure exemption for third-party compensation disclosed during the course of a proxy contest.  That is, if a compensation arrangement has already been disclosed "in the current fiscal year" under Item 5(b) of Schedule 14A in the proxy materials distributed by the parties running the proxy contest, the NASDAQ company need not disclose the arrangement in its own proxy materials filed in that fiscal year.  Company disclosure would be required the following year if the director is elected to the board and renominated because the disclosure requirement applies for one year after termination of any arrangement.  If the compensation arrangement is ongoing, it would be subject to annual disclosure in subsequent years when the director is renominated. 
  2. "Material terms" of compensation arrangements.  The text of final Rule 5250(b)(3) explicitly limits the disclosure requirement to the "material terms" of third-party compensation or "other payment."  IM-5250-2 states that "[t]he terms 'compensation' and 'other payments' . . .  are not limited to cash payments and are intended to be construed broadly."  In this regard, the rule applies to any "agreements and arrangements that provide for non-cash compensation and other payment obligations, such as health insurance premiums or indemnification, made in connection with a person's candidacy or service as a director," as NASDAQ clarified in its final rule proposal filed with the SEC.[1] 
  3. Application to directors designated by private equity firms, hedge funds and similar firms.  In response to comments asking that NASDAQ clarify the application of the rule to directors designated by investment firms, in part because of the complex arrangements that can exist between these firms and individuals appointed to portfolio company boards, the final rule contains some helpful language clarifications.  First, it clarifies that disclosure of arrangements that existed prior to a nominee's candidacy need not be disclosed if "the nominee's relationship with the Third Party" (emphasis added) has been publicly disclosed in a proxy statement or annual report (for example, in the individual's biography).  Thus, details of an individual's employment compensation with an investment firm need not be disclosed in order for this exemption to be available.  Second, IM-5250-2 clarifies that disclosure is only required if an individual's compensation is materially increased "specifically in connection with" candidacy or service as a director of the NASDAQ company.  In that case, only the difference between the new and previous level of compensation or other payment obligation needs to be disclosed.  Despite the clarification (noted above) that the rule covers indemnification, it is unlikely this will lead to significant disclosure about indemnification arrangements provided by investment firms.  Many investment firms grant their director appointees indemnification as an additional layer of protection beyond the indemnification in place at the portfolio company level.  However, these arrangements would be part of an appointee's pre-existing relationship with an investment firm and it is unlikely they would be materially increased in connection with appointment to a specific board. 
  4. Website disclosure.  The final rule clarifies the timing and substance of disclosure about third-party compensation arrangements if companies choose to make these disclosures via their websites.  To the extent disclosure is not required in a company's proxy statement under SEC rules, Rule 5250(b)(3) permits website disclosure, as long as the disclosure is posted no later than the date on which a company files its definitive proxy statement in connection with the relevant shareholder meeting at which directors are to be elected.  Companies can provide disclosure on their own website or by hyperlinking to another website.  The disclosure must be continuously accessible.  If the website hosting the disclosure becomes inaccessible or the hyperlink becomes inoperable, the company must promptly restore it or make other disclosure in accordance with the rule.  The one instance in which the rule does not appear to permit website disclosure is where a company must make remedial disclosure after becoming aware of third-party compensation that it should have disclosed but did not.  As noted above and discussed in Rule 5250(b)(3)(C), that disclosure must be made through a Form 8-K "where required by SEC rules" or by issuing a press release.
  5. Foreign private issuers. Existing NASDAQ rules permit a foreign private issuer to follow its home country practices, in lieu of NASDAQ's corporate governance requirements, if the foreign private issuer fulfills certain conditions in the rules.  These include providing disclosure about each NASDAQ requirement a foreign private issuer does not follow and briefly describing the home country practice it follows instead.  This approach will also apply to Rule 5250(b)(3). 

Relationship to SEC Rules

The overlap between new Rule 5250(b)(3) was discussed at some length by the SEC in its release approving the rule,[2] by NASDAQ and by those who commented on the rule proposal.  Both the SEC and NASDAQ noted that there may be some overlap with existing SEC disclosure requirements.  These requirements include:

  • Regulation S-K Item 401(a) (requiring disclosure identifying directors, and arrangements or understandings with any other person (naming the person) pursuant to which they were selected as a director or nominee));
  • Regulation S-K Item 402(k) (requiring disclosure of all compensation paid to directors "by any person" for all services rendered in all capacities for the company's last fiscal year);
  • Item 5(b) of Schedule 14A (discussed above, and requiring proxy disclosure, in contested solicitations, of "any substantial interest, direct or indirect, by security holding or otherwise," of certain persons, including each director nominee and each other participant in the solicitation); and
  • Item 5.02(d)(2) of Form 8-K (requiring, as discussed above, disclosure of "any arrangement or understanding between [a] new director and any other persons, naming such persons, pursuant to which such director was selected as a director" for a director appointed outside of a shareholder meeting).

In spite of this overlap, in a July 1 letter to the SEC,[3] NASDAQ noted that the "nature, scope and timing of these required disclosures may not in all cases be the same" as the disclosure that would be required by NASDAQ Rule 5250(b)(3).  The SEC, in its release approving Rule 5250(b)(3), observed that it is "not unusual" for national securities exchanges to adopt disclosure requirements that supplement or overlap with those applicable under the federal securities laws, and that "it is within the purview of a national securities exchange to impose heightened governance requirements."  The SEC also observed that Rule 5250(b)(3) does not require separate disclosure when a company has made NASDAQ-compliant disclosure in its proxy statement under SEC rules. 

Relationship to Director Independence

During the period when proposed Rule 5250(b)(3) was under consideration, NASDAQ also conducted a survey and sought feedback on whether to propose additional rules on various aspects of third-party compensation arrangements, including how they may impact independence.  NASDAQ officials have since indicated that the exchange has no current plans to proceed with additional rulemaking in this area.  However, in the rule proposal, NASDAQ reminded companies about its definition of "independence" for directors, noting that the definition excludes any director with any relationship that, in the opinion of the board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.  Accordingly, boards that are not already doing so should be sure to consider any third-party compensation arrangements in assessing the independence of directors and director candidates.  NASDAQ's rule on compensation committee independence (found in Rule 5605(d)(2)(A)) also specifically requires that boards consider this compensation in assessing whether directors meet the heightened independence criteria applicable to service on the compensation committee.

Conclusion

For NASDAQ companies, preparations for the next annual shareholder meeting will need to include consideration of how Rule 5250(b)(3) may be relevant for them and their directors.  It remains to be seen whether the NYSE will follow NASDAQ's lead and adopt its own rule on third-party director compensation arrangements.  However, of relevance to all public companies, in the release approving the NASDAQ rule, the SEC observed that, in addition to certain line-item disclosure requirements of the federal securities laws that may apply (as listed above), the anti-fraud provisions of the proxy rules and Rule 10b-5 under the Securities Exchange Act of 1934 may mandate disclosure of third-party compensation in order to make statements included an SEC filing not misleading in light of the circumstances in which they were made.  

In light of the new NASDAQ rule and the cautionary language in the SEC's release, public companies should review their D&O questionnaires to confirm that the questions are appropriately drafted to obtain potentially relevant information required under both SEC rules and, for NASDAQ companies, new Rule 5250(b)(3).  This includes non-cash arrangements and items such as indemnification.  In addition, both NYSE and NASDAQ companies that have adopted proxy access, or that have advance notice bylaws or other bylaw provisions addressing third-party compensation, will want to confirm that their D&O questionnaires cover any information addressed in these bylaws.   


NASDAQ Rule 5250(b)(3)

Changes are operative on August 1, 2016

5250. Obligations for Companies Listed on The Nasdaq Stock Market

* * * * * *

(b) Obligation to Make Public Disclosure

* * * * * *

(3) Disclosure of Third Party Director and Nominee Compensation

Companies must disclose all agreements and arrangements in accordance with this rule by no later than the date on which the Company files or furnishes a proxy or information statement subject to Regulation 14A or 14C under the Act in connection with the Company's next shareholders' meeting at which directors are elected (or, if they do not file proxy or information statements, no later than when the Company files its next Form 10-K or Form 20-F).

(A) A Company shall disclose either on or through the Company's website or in the proxy or information statement for the next shareholders' meeting at which directors are elected (or, if the Company does not file proxy or information statements, in its Form 10-K or 20-F), the material terms of all agreements and arrangements between any director or nominee for director, and any person or entity other than the Company (the "Third Party"), relating to compensation or other payment in connection with such person's candidacy or service as a director of the Company. A Company need not disclose pursuant to this rule agreements and arrangements that: (i) relate only to reimbursement of expenses in connection with candidacy as a director; (ii) existed prior to the nominee's candidacy (including as an employee of the other person or entity) and the nominee's relationship with the Third Party has been publicly disclosed in a proxy or information statement or annual report (such as in the director or nominee's biography); or (iii) have been disclosed under Item 5(b) of Schedule 14A of the Act or Item 5.02(d)(2) of Form 8-K in the current fiscal year. Disclosure pursuant to Commission rule shall not relieve a Company of its annual obligation to make disclosure under subparagraph (B).

(B) A Company must make the disclosure required in subparagraph (A) at least annually until the earlier of the resignation of the director or one year following the termination of the agreement or arrangement.

(C) If a Company discovers an agreement or arrangement that should have been disclosed pursuant to subparagraph (A) but was not, the Company must promptly make the required disclosure by filing a Form 8-K or 6-K, where required by SEC rules, or by issuing a press release. Remedial disclosure under this subparagraph, regardless of its timing, does not satisfy the annual disclosure requirements under subparagraph (B).

(D) A Company shall not be considered deficient with respect to this paragraph for purposes of Rule 5810 if the Company has undertaken reasonable efforts to identify all such agreements or arrangements, including asking each director or nominee in a manner designed to allow timely disclosure, and makes the disclosure required by subparagraph (C) promptly upon discovery of the agreement or arrangement. In all other cases, the Company must submit a plan sufficient to satisfy Nasdaq staff that the Company has adopted processes and procedures designed to identify and disclose relevant agreements or arrangements.

(E) A Foreign Private Issuer may follow its home country practice in lieu of the requirements of Rule 5250(b)(3) by utilizing the process described in Rule 5615(a)(3).

IM-5250-2. Disclosure of Third Party Director and Nominee Compensation

Rule 5250(b)(3) requires listed companies to publicly disclose the material terms of all agreements and arrangements between any director or nominee and any person or entity (other than the Company) relating to compensation or other payment in connection with that person's candidacy or service as a director. The terms "compensation" and "other payment" as used in this rule are not limited to cash payments and are intended to be construed broadly.

Subject to exceptions provided in the rule, the disclosure must be made on or through the Company's website or in the proxy or information statement for the next shareholders' meeting at which directors are elected in order to provide shareholders with information and sufficient time to help them make meaningful voting decisions. A Company posting the requisite disclosure on or through its website must make it publicly available no later than the date on which the Company files a proxy or information statement in connection with such shareholders' meeting (or, if they do not file proxy or information statements, no later than when the Company files its next Form 10-K or Form 20-F). Disclosure made available on the Company's website or through it by hyperlinking to another website, must be continuously accessible. If the website hosting the disclosure subsequently becomes inaccessible or that hyperlink inoperable, the company must promptly restore it or make other disclosure in accordance with this rule.

Rule 5250(b)(3) does not separately require the initial disclosure of newly entered into agreements or arrangements, provided that disclosure is made pursuant to this rule for the next shareholders' meeting at which directors are elected. In addition, for publicly disclosed agreements and arrangements that existed prior to the nominee's candidacy and thus not required to be disclosed in accordance with Rule 5250(b)(3)(A)(ii) but where the director or nominee's remuneration is thereafter materially increased specifically in connection with such person's candidacy or service as a director of the Company, only the difference between the new and previous level of compensation or other payment obligation needs be disclosed.

All references in this rule to proxy or information statements are to the definitive versions thereof.

Adopted July 1, 2016 (SR-NASDAQ-2016-013), operative Aug. 1, 2016.


[1] See File No. SR-NASDAQ-2016-013, Amendment No. 2 (June 30, 2016), available at http://nasdaq.cchwallstreet.com/NASDAQ/Filings/

[2]  See SEC Release No. 34-78223, 81 Fed. Reg. 44400 (July 7, 2016), available here.

[3] See July 1, 2016 Letter from A. David Strandberg III of NASDAQ to Brent J. Fields of the SEC, available at https://www.sec.gov/comments/sr-nasdaq-2016-013/nasdaq2016013-12.pdf


Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm's Securities Regulation and Corporate Governance practice group, or any of the following practice leaders and members:

Ronald O. Mueller - Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)
James J. Moloney - Orange County, CA (949-451-4343, jmoloney@gibsondunn.com)
Elizabeth Ising - Washington, D.C. (202-955-8287, eising@gibsondunn.com)
Lori Zyskowski - New York (212-351-2309, lzyskowski@gibsondunn.com)
Gillian McPhee - Washington, D.C. (202-955-8201, gmcphee@gibsondunn.com)
Dennis Friedman - New York (212-351-3900, dfriedman@gibsondunn.com)
John F. Olson - Washington, D.C. (202-955-8522, jolson@gibsondunn.com)


© 2016 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 21, 2016 |
“Commonsense Principles of Corporate Governance” Released

Today a group of 13 executives at leading companies and institutional investors released "Commonsense Principles of Corporate Governance" for public companies, their boards of directors and their shareholders.  The Principles are described as being intended "to provide a basic framework for sound, long-term-oriented governance" and to "promote further conversation on corporate governance."  An open letter accompanying the Principles describes them as "conducive to good corporate governance, healthy public companies and the continued strength of our public markets."  Full-page ads summarizing key parts of the Principles were published in national and international newspapers.

The Principles, which are the product of meetings that have been reported on for several months, acknowledge that not every Principle will work for every company or be applied in the same manner given the many differences among public companies.  Institutional investor signatories include representatives of Berkshire Hathaway, BlackRock, Capital Group, J.P. Morgan Asset Management, State Street, T. Rowe Price and Vanguard.  The signatories also include the chief executive officers at General Electric, General Motors Co., JPMorgan Chase and Verizon.  The chief executive officers of hedge fund ValueAct Capital and the Canada Pension Plan Investment Board, a public pension fund, also are signatories. 

The Principles are organized into eight areas:  (1) Board of Directors – Composition and Internal Governance; (2) Board of Directors' Responsibilities; (3) Shareholder Rights; (4) Public Reporting; (5) Board Leadership (including the lead independent director's role); (6) Management Succession Planning; (7) Compensation of Management; and (8) Asset Managers' Role in Corporate Governance.  Some of the Principles address matters that are already required by state law, the corporate governance requirements in listing standards or the Securities Exchange Commission rules. 

Recent high-profile public company governance issues and other matters that are addressed include:

  • Proxy access:  The Principles report on the terms generally adopted by most companies, but do not advocate the adoption of proxy access or the adoption of specific terms.
  • Board leadership:  "The board's independent directors should decide, based upon the circumstances at the time, whether it is appropriate for the company to have separate or combined chair and CEO roles."  When the CEO/chair roles are combined, the board should have a "strong designated lead independent director and governance structure."  The Principles also include a list of possible duties for the lead independent director. 
  • Non-GAAP numbers:  The Principles state that non-GAAP numbers "should be sensible and should not be used to obscure GAAP results."  The Principles also note "that all compensation, including equity compensation, is plainly a cost of doing business and should be reflected in any non-GAAP measurement of earnings in precisely the same manner it is reflected in GAAP earnings."
  • Earnings guidance:  The Principles state that companies "should not feel obligated to provide earnings guidance – and should determine whether providing earnings guidance for the company's shareholders does more harm than good."
  • Board diversity:  The Principles state that "[d]irectors should have complementary and diverse skill sets, backgrounds and experiences.  Diversity along multiple dimensions is critical to a high-functioning board.  Director candidates should be drawn from a rigorously diverse pool."
  • Director election voting standard:  The Principles state that directors should be elected using majority voting.  They do not mention specifics such as whether majority voting should only be used in uncontested elections or advocate the adoption of companion director resignation policies. 
  • Board tenure:  Instead of adopting a bright-line view on board tenure, the Principles emphasize the need for considering board refreshment and tempering "fresh thinking and new perspectives" with "age and experience" on the board. 
  • Term limits/retirement ages:  Consistent with the approach on board tenure, the Principles do not recommend the adoption of retirement ages or term limits but instead state that, to the extent a board permits an exception to any such policy, the board explain the reasons for the exception. 
  • Director effectiveness:  The Principles state that boards "should have a robust process to evaluate themselves on a regular basis" and "the fortitude to replace ineffective directors."
  • Industry experience:  The Principles state that a "subset" of directors should "have professional experiences directly related to the company's business" and that the board should be "continually educated" on the company's industry.
  • Ability of shareholders to act by written consent and call special meetings:  The Principles state that the ability of shareholders to act by written consent and call special meetings "can be important mechanisms for shareholder action" but, when adopted, should require "a reasonable minimum amount of outstanding shares . . . [to act] in order to prevent a small minority of shareholders from being able to abuse the rights or waste corporate time and resources."
  • Director engagement with shareholders:  The Principles encourage boards to engage in robust communication of the board's thinking to shareholders.  They note that there are many ways to do so, including designating certain directors "in coordination with management" to "communicate directly with shareholders on governance and key shareholder issues."
  • Audit committee review of financial statements:  The Principles state that audit committees "should focus on whether the company's financial statements would be prepared or disclosed in a materially different manner if the external auditor itself were solely responsible for their preparation."  This Principle was recommended during a 2002 Securities and Exchange Commission roundtable by Warren Buffett, a signatory to the Principles and at the time a member of the Coca-Cola Audit Committee, as one of several questions audit committees should be asking auditors.  
  • Access to management:  The Principles state that "directors should have unfettered access to management, including those below the CEO's direct reports."
  • Director compensation:  The Principles recommend that companies consider both paying "a substantial portion" of director compensation in equity and requiring directors "to retain a significant portion of their equity compensation during their tenure" on the board.
  • Executive compensation
    • Executive compensation plans should "ensure alignment with long-term performance" and "have both a current component and a long-term component." 
    • "Benchmarks and performance measurements ordinarily should be disclosed to enable shareholders to evaluate the rigor of the company's goals and the goal-setting process."
    • "Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of compensation for senior management in the form of stock, performance stock units or similar equity-like instruments."

The Principles do not explicitly mention some prominent governance issues, such as classified boards, supermajority voting requirements, poison pills or sustainability.

The Principles also address the role of asset managers in corporate governance.  The Principles state that "[a]sset managers should exercise their voting rights thoughtfully and act in what they believe to be the long-term economic interests of their clients."  They also note that when voting on matters, asset managers "should give due consideration to the company's rationale for its positions" on those matters and vote based on "independent application of their own voting guidelines and policies."  The Principles also encourage asset managers to evaluate the performance of the boards at the companies in which they invest. 

Public companies – especially those whose institutional investor base includes significant holdings by the institutional investors who signed the Principles – should consider promptly distributing the Principles to their boards and/or governance committees.  Public companies also should consider ways to enhance their shareholder communications – including proxy materials – to emphasize the Principles that the companies follow.  Finally, directors may find it useful to review a summary of or discuss how the company's governance practices compare to the Principles and, where they are different, the reasons why. 

The Principles (click on link) and theopen letter (click on link) from the signatories are available at http://www.governanceprinciples.org/


Gibson Dunn's lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm's Securities Regulation and Corporate Governance practice group, or any of the following:

John F. Olson - Washington, D.C. (202-955-8522, jolson@gibsondunn.com)
Ronald O. Mueller - Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)
Elizabeth Ising - Washington, D.C. (202-955-8287, eising@gibsondunn.com)
Lori Zyskowski - New York (212-351-2309, lzyskowski@gibsondunn.com)
Gillian McPhee - Washington, D.C. (202-955-8201, gmcphee@gibsondunn.com)


© 2016 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 5, 2016 |
IRS Releases Additional Guidance on Changes to Determination Letter Program for Qualified Retirement Plans

On June 29, 2016, the United States Internal Revenue Service released Revenue Procedure 2016-37 (available here) providing additional guidance on when an individually designed tax-qualified retirement plan must be amended for changes in law and when such a plan may request a determination letter from the IRS as to its tax-qualified status.  As we previously discussed in this publication, in July 2015 the IRS announced that beginning on January 1, 2017, it would be eliminating the staggered five-year remedial amendment cycle system for individually designed plans.  The IRS noted at that time that additional details on the program changes would be forthcoming. 

Previously, plan sponsors were required to amend their plan each year for required legal updates and then make conforming changes every five years during their "remedial amendment cycle" during which they could submit their plan to the IRS for a determination letter.  This system allowed plan sponsors to apply for a determination letter every five years.

Under the new guidance, on October 1st of each year the IRS will publish an annual "Required Amendment List" or "RA List," which sets forth all amendments an individually designed plan must adopt to retain its tax qualified status.  Although required to operationally comply with any changes in law from the effective date of such changes, plan sponsors will now generally be required to adopt any applicable amendments from the RA List by the end of the second calendar year following the year in which the RA List was published (unless otherwise provided).  For example, an amendment included on the 2016 RA List would need to be adopted by December 31, 2018.  The IRS has indicated that generally items will not be placed on the RA List until guidance with respect to the change (including any model amendments) has been published in the Internal Revenue Bulletin.  The first RA List will include required amendments first effective during the 2016 calendar year.

The IRS has also stated that it intends to annually provide an "Operational Compliance List" that identifies changes in qualification requirements that have become effective during a calendar year in order to assist plan sponsors in ensuring operational compliance with applicable qualification requirements.

Discretionary plan amendments (those not specifically required by changes in law) will still need to be adopted by the end of the plan year in which the amendment is to become effective (or, where there is a reduction in benefits or an adverse change in a plan's optional features, before the amendment becomes effective).

Under this new program, individually designed qualified plans may request a determination letter for initial plan qualification or in connection with a plan termination.  The IRS will also annually consider whether exceptions should be made allowing for consideration of determination letter applications as a result of special circumstances such as significant law changes, new approaches to plan design, or the inability of certain types of plans to convert to pre-approved (generally prototype) plan documents.  If the agency determines to accept determination letter applications as a result of such circumstances, it will publish guidance to that effect.


Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have regarding these issuesPlease contact the Gibson Dunn lawyer with whom you usually work, or any of the following:

Stephen W. Fackler - Palo Alto/New York (650-849-5385/212-351-2392, sfackler@gibsondunn.com)
Michael J. Collins - Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)
Sean C. Feller - Los Angeles (310-551-8746, sfeller@gibsondunn.com)
Krista Hanvey - Dallas (214-698-3425, khanvey@gibsondunn.com)

 

© 2016 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 24, 2016 |
IRS Issues Proposed Regulations Addressing Application of Section 409A to Nonqualified Deferred Compensation Plans

On June 21, 2016, the Internal Revenue Service ("IRS") issued proposed regulations clarifying or modifying a number of provisions of the final regulations under Internal Revenue Code ("Code") section 409A.  The IRS also withdrew one provision from previous proposed regulations regarding the calculation of amounts includible in income under section 409A(a)(1) and replaced it with revised proposed regulations.  The proposed regulations do not have any specific focus, but rather address various concerns raised by taxpayers over interpretive issues since the current regulations were finalized in 2007. 

Background

Section 409A was added to the Code in 2004 and addresses the taxation of amounts deferred under nonqualified deferred compensation plans ("NQDC plans").  The Treasury Department and the IRS issued final regulations under section 409A in 2007, addressing section 409A issues and setting forth the requirements for deferral elections and for the time and form of payments under NQDC plans.  The Treasury Department and the IRS then issued additional proposed regulations in 2008, providing guidance on the calculation of amounts includible in income under section 409A(a)(1) and the additional taxes imposed by section 409A regarding service providers participating in certain NQDC plans and other arrangements that do not comply with section 409A(a).  It has been rumored for years that the proposed regulations will be issued in final form "soon".

Overview of Provisions

Some of the key clarifications and modifications under the proposed rules include:

  • Clarifying that Code section 409A's rules apply to NQDC plans separately and in addition to the rules under Code section 457A.  Code section 457A provides that compensation deferred under a nonqualified entity's NQDC plan is includible in gross income when there is no substantial risk of forfeiture of the rights to the compensation.  Nonqualified entities include (i) certain foreign corporations and (ii) partnerships where substantially all income is allocated to non-taxpayers.  The Treasury Department is expected to issue proposed regulations under section 457A of the Code relatively soon.
  • Modifying the definition of "eligible issuer of service recipient stock" to include a corporation or entity for which a person is reasonably expected to begin, and actually begins, providing services within 12 months after the grant date of a stock right.  This addresses complaints that the current definition hinders employment negotiations by preventing service recipients from granting stock rights (i.e., stock options and stock appreciation rights) to prospective service providers before they actually commence employment.
  • Clarifying that a service provider who ceases providing services as an employee and begins providing services as an independent contractor is treated as having a separation from service if, at the time of the employment status change, the level of services reasonably anticipated to be provided after the change would result in a separation from service under the rules applicable to employees.  The final regulations provide various presumptions in this regard (e.g., if the person is expected to work at a level below 20% of the average level over the prior 36 months, there is a presumption a separation from service has occurred).
  • Providing a rule that is generally applicable to determine when a "payment" has been made for purposes of section 409A.  Under the proposed regulations, a payment is made or occurs when any taxable benefit is actually or constructively received.  The proposed regulations include examples of payments (e.g., a transfer of cash or a transfer of property includible in income under section 83) and when payments are made (e.g., upon the transfer or reduction of an amount of deferred compensation in exchange for benefits under a welfare plan). 
  • Modifying the rules applicable to amounts payable following death.  The proposed regulations clarify that the rules applicable to amounts payable upon the death of a service provider also apply to amounts payable upon the death of a beneficiary, and provide guidelines on when such payments are treated as timely paid. 
  • Clarifying rules permitting accelerated payments in connection with the termination and liquidation of a NQDC plan.  The proposed regulations clarify that the acceleration of payments is permitted only if the service recipient terminates and liquidates all plans of the same category that the service recipient sponsors and not just those in which the service provider actually participates.
  • Clarifying and modifying the anti-abuse provisions under the proposed income inclusion regulations regarding the treatment of deferred amounts subject to a substantial risk of forfeiture for purposes of calculating the amount includible in income where section 409A is violated.  There was some concern that taxpayers could intentionally create noncompliant NQDC plans for additional flexibility and then "fix" them at a later date.

The proposed regulations will become final 90 days after publication of the final regulations in the Federal Register.  However, taxpayers may rely on the proposed regulations until that time. 


Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have regarding these issues.  Please contact the Gibson Dunn lawyer with whom you usually work, or any of the following:

Stephen W. Fackler - Palo Alto/New York (650-849-5385/212-351-2392, sfackler@gibsondunn.com)
Michael J. Collins - Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)
Sean C. Feller - Los Angeles (310-551-8746, sfeller@gibsondunn.com)


© 2016 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 31, 2016 |
Equal Employment Opportunity Commission Issues Final Wellness Plan Regulations

On May 16, 2016, the Equal Employment Opportunity Commission (EEOC) released final regulations applying the requirements of the Americans with Disabilities Act (ADA) and the Genetic Information Nondiscrimination Act (GINA) to employer "wellness" programs.  The regulations, which largely mirror proposed regulations issued in 2015, are effective for plan years beginning on or after January 1, 2017.  With open enrollment for 2017 only a few months away, employers need to ensure that their wellness programs comply with the new rules and that their employee communications are consistent with these rules.

Background and Application

A wellness program generally includes any health promotion and disease prevention program offered to employees either as part of a group health plan or as a separate employee benefit.  Common examples include "health risk assessments" and biometric screenings for health risk factors, such as high blood pressure or cholesterol.  Wellness programs also can include benefits such as nutrition classes, weight loss programs, smoking cessation programs, and onsite exercise facilities.

The ADA generally prohibits employers from discriminating against employees on the basis of disability.  It also generally restricts employers from obtaining medical information from employees except in certain circumstances.  One exception is data collection as part of a "voluntary" employee health program, such as many wellness programs.  In addition, the ADA requires that wellness programs must be made available to all employees, that the employer provide reasonable accommodations to employees with disabilities, and that the employer keep all medical information confidential.  The reasonable accommodation standard is intended to "enable employees with disabilities to earn whatever financial incentive an employer" offers to non-disabled employees under its wellness program.

GINA prohibits discrimination in employment on the basis of genetic information.  Among other things, it prohibits employers from using genetic information in making decisions about employment and restricts employers from requesting, requiring, or purchasing genetic information.

The Health Insurance Portability and Accountability Act, as amended by the Patient Protection and Affordable Care Act, also includes rules governing wellness programs.  Final regulations were issued in 2013, and the new EEOC and GINA regulations generally are consistent with those rules.

A key requirement under the final regulations is that a wellness program must be "reasonably designed to promote health or prevent disease."  In order to meet this standard, the program cannot require an overly burdensome amount of time for participation, involve unreasonably intrusive procedures, be a subterfuge for violating the ADA, GINA or other laws prohibiting employment discrimination, or require employees to incur significant costs for medical examinations.  Examples of programs that are reasonably designed to promote health or prevent disease include biometric screening or other procedures to alert employees to health risks.  However, a program that provides no feedback to employees or is used merely to shift costs from employers to employees would not so qualify.

"Voluntary" Wellness Programs

The final regulations permit employers to inquire regarding disabilities and genetic information-related matters in connection with "voluntary" wellness programs.  A wellness program is considered voluntary only if the employer:

  • Does not require any employee to participate;
  • Does not deny any employee who does not participate in the program access to health coverage or prohibit the employee from choosing any particular plan;
  • Does not take any other adverse action or retaliate against the employee; and
  • Provides employee notices that clearly explain what medical information will be obtained, how it will be used, who will receive it, and the restrictions on disclosure.

A voluntary wellness program may offer "incentives" to employees to participate.  In general, the incentive is limited to 30 percent of the total cost of self-only coverage under the health plan, with similar rules applicable to programs not tied to the employer's health plan.  For example, a wellness program could reduce employees' out-of-pocket health plan costs if the employee undergoes a biometric health screening or attends nutrition classes. 

There are special rules for smoking cessation programs.  If the program requires testing of employees in order to receive the incentive, the 30 percent limit applies.  However, if it permits employees to self-certify, the incentive can be up to 50 percent of the cost of self-only coverage.

Confidentiality Rules

ADA rules already in effect generally prohibit disclosure of an employee's medical information, and the final wellness program regulations make clear these rules apply to wellness programs.  In addition, the regulations add two other conditions, providing that the employer:

  • May only receive information collected by a wellness program in aggregate form that does not disclose, and is not reasonably likely to disclose, the identity of specific individuals except as necessary to administer the plan; and
  • May not require an employee to agree to the sale, exchange, transfer, or other disclosure of medical information or to waive confidentiality protections under the ADA in exchange for an incentive or as a condition for participating in a wellness program, except to the extent permitted by the ADA to carry out specific activities related to the wellness program.

Conclusion

There are few surprises in the final rules, since they closely mirror the 2015 proposed regulations and are consistent with EEOC enforcement actions in the past several years.  However, employers should carefully review their wellness programs to determine whether any changes are needed.  They also should ensure that required confidentiality protections are in place and that employee communications during open enrollment later this year for the 2017 plan year satisfy all applicable requirements.


Gibson, Dunn & Crutcher's lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm's Labor and Employment or Executive Compensation and Employee Benefits practice groups, or the authors:

Michael J. Collins - Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)
Jason C. Schwartz - Washington, D.C. (202-955-8242, jschwartz@gibsondunn.com)

Please also feel free to contact any of the following practice leaders and members:   

Labor and Employment Group:
Catherine A. Conway - Los Angeles (213-229-7822, cconway@gibsondunn.com)
Eugene Scalia - Washington, D.C. (202-955-8206, escalia@gibsondunn.com)
Jason C. Schwartz - Washington, D.C. (202-955-8242, jschwartz@gibsondunn.com)

Executive Compensation and Employee Benefits Group:
Michael J. Collins - Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)
Stephen W. Fackler - Palo Alto/New York (650-849-5385/212-351-2392, sfackler@gibsondunn.com)
Sean C. Feller - Los Angeles (310-551-8746, sfeller@gibsondunn.com)


© 2016 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 25, 2016 |
Board Evaluations – Getting the Most from the Evaluation Process

Click for PDF More than ten years have passed since the New York Stock Exchange (NYSE) began requiring annual evaluations for boards of directors and "key" committees (audit, compensation, nominating/governance), and many Nasdaq companies also conduct these evaluations annually as a matter of good governance.[1]  With boards now firmly in the routine of doing annual evaluations, one challenge (as with any recurring activity) is to keep the process  fresh and productive so that it continues to provide the board with valuable insights.  In addition, companies are increasingly providing, and institutional shareholders are increasingly seeking, more information about the board's evaluation process.  Boards that have implemented a substantive, effective evaluation process will want information about their work in this area to be communicated to shareholders and potential investors.  This can be done in a variety of ways, including in the annual proxy statement, in the governance or investor information section on the corporate website, and/or as part of shareholder engagement outreach. To assist companies and their boards in maximizing the effectiveness of the evaluation process and related disclosures, this alert provides an overview of several frequently used methods for conducting evaluations of the full board, board committees and individual directors.  It is our experience that using a variety of methods, with some variation from year to year, results in more substantive and useful evaluations.  This alert also discusses trends and considerations relating to disclosures about board evaluations.  We close with some practical tips for boards to consider as they look ahead to their next annual evaluation cycle. Common Methods of Board Evaluation As a threshold matter, it is important to note that there is no one "right" way to conduct board evaluations.  There is room for flexibility, and the boards and committees we work with use a variety of methods.  We believe it is good practice to "change up" the board evaluation process every few years by using a different format in order to keep the process fresh.  Boards have increasingly found that year-after-year use of a written questionnaire, with the results compiled and summarized by a board leader or the corporate secretary for consideration by the board, becomes a routine exercise that produces few new insights as the years go by.  This has been the most common practice, and it does respond to the NYSE requirement, but it may not bring as much useful information to the board as some other methods. Doing something different from time to time can bring new perspectives and insights, enhancing the effectiveness of the process and the value it provides to the board.  The evaluation process should be dynamic, changing from time to time as the board identifies practices that work well and those that it finds less effective, and as the board deals with changing expectations for how to meet its oversight duties.  As an example, over the last decade there have been increasing expectations that boards will be proactive in oversight of compliance issues and risk (including cyber risk) identification and management issues. Three of the most common methods for conducting a board or committee evaluation are: (1) written questionnaires; (2) discussions; and (3) interviews.  Some of the approaches outlined below reflect a combination of these methods.  A company's nominating/governance committee typically oversees the evaluation process since it has primary responsibility for overseeing governance matters on behalf of the board.             1.      Questionnaires The most common method for conducting board evaluations has been through written responses to questionnaires that elicit information about the board's effectiveness.  The questionnaires may be prepared with the assistance of outside counsel or an outside advisor with expertise in governance matters.  A well-designed questionnaire often will address a combination of substantive topics and topics relating to the board's operations.  For example, the questionnaire could touch on major subject matter areas that fall under the board's oversight responsibility, such as views on whether the board's oversight of critical areas like risk, compliance and crisis preparedness are effective, including whether there is appropriate and timely information flow to the board on these issues.  Questionnaires typically also inquire about whether board refreshment mechanisms and board succession planning are effective, and whether the board is comfortable with the senior management succession plan.  With respect to board operations, a questionnaire could inquire about matters such as the number and frequency of meetings, quality and timeliness of meeting materials, and allocation of meeting time between presentation and discussion.  Some boards also consider their efforts to increase board diversity as part of the annual evaluation process. Many boards review their questionnaires annually and update them as appropriate to address new, relevant topics or to emphasize particular areas.  For example, if the board recently changed its leadership structure or reallocated responsibility for a major subject matter area among its committees, or the company acquired or started a new line of business or experienced recent issues related to operations, legal compliance or a breach of security, the questionnaire should be updated to request feedback on how the board has handled these developments.  Generally, each director completes the questionnaire, the results of the questionnaires are consolidated, and a written or verbal summary of the results is then shared with the board. Written questionnaires offer the advantage of anonymity because responses generally are summarized or reported back to the full board without attribution.  As a result, directors may be more candid in their responses than they would be using another evaluation format, such as a face-to-face discussion.  A potential disadvantage of written questionnaires is that they may become rote, particularly after several years of using the same or substantially similar questionnaires.  Further, the final product the board receives may be a summary that does not pick up the nuances or tone of the views of individual directors. In our experience, increasingly, at least once every few years, boards that use questionnaires are retaining a third party, such as outside counsel or another experienced facilitator, to compile the questionnaire responses, prepare a summary and moderate a discussion based on the questionnaire responses.  The desirability of using an outside party for this purpose depends on a number of factors.  These include the culture of the board and, specifically, whether the boardroom environment is one in which directors are comfortable expressing their views candidly.  In addition, using counsel (inside or outside) may help preserve any argument that the evaluation process and related materials are privileged communications if, during the process, counsel is providing legal advice to the board. In lieu of asking directors to complete written questionnaires, a questionnaire could be distributed to stimulate and guide discussion at an interactive full board evaluation discussion.             2.      Group Discussions Setting aside board time for a structured, in-person conversation is another common method for conducting board evaluations.  The discussion can be led by one of several individuals, including: (a) the chairman of the board; (b) an independent director, such as the lead director or the chair of the nominating/governance committee; or (c) an outside facilitator, such as a lawyer or consultant with expertise in governance matters.  Using a discussion format can help to "change up" the evaluation process in situations where written questionnaires are no longer providing useful, new information.  It may also work well if there are particular concerns about creating a written record. Boards that use a discussion format often circulate a list of discussion items or topics for directors to consider in advance of the meeting at which the discussion will occur.  This helps to focus the conversation and make the best use of the time available.  It also provides an opportunity to develop a set of topics that is tailored to the company, its business and issues it has faced and is facing.  Another approach to determining discussion topics is to elicit directors' views on what should be covered as part of the annual evaluation.  For example, the nominating/governance could ask that each director select a handful of possible topics for discussion at the board evaluation session and then place the most commonly cited topics on the agenda for the evaluation. A discussion format can be a useful tool for facilitating a candid exchange of views among directors and promoting meaningful dialogue, which can be valuable in assessing effectiveness and identifying areas for improvement.  Discussions allow directors to elaborate on their views in ways that may not be feasible with a written questionnaire and to respond in real time to views expressed by their colleagues on the board.  On the other hand, they do not provide an opportunity for anonymity.  In our experience, this approach works best in boards with a high degree of collegiality and a tradition of candor.             3.      Interviews Another method of conducting board evaluations that is becoming more common is interviews with individual directors, done in-person or over the phone.  A set of questions is often distributed in advance to help guide the discussion.  Interviews can be done by: (a) an outside party such as a lawyer or consultant; (b) an independent director, such as the lead director or the chair of the nominating/governance committee; or (c) the corporate secretary or inside counsel, if directors are comfortable with that.  The party conducting the interviews generally summarizes the information obtained in the interview process and may facilitate a discussion of the information obtained with the board. In our experience, boards that have used interviews to conduct their annual evaluation process generally have found them very productive.  Directors have observed that the interviews yielded rich feedback about the board's performance and effectiveness.  Relative to other types of evaluations, interviews are more labor-intensive because they can be time-consuming, particularly for larger boards.  They also can be expensive, particularly if the board retains an outside party to conduct the interviews.  For these reasons, the interview format generally is not one that is used every year.  However, we do see a growing number of boards taking this path as a "refresher"--every three to five years--after periods of using a written questionnaire, or after a major event, such as a corporate crisis of some kind, when the board wants to do an in-depth "lessons learned" analysis as part of its self-evaluation.  Interviews also offer an opportunity to develop a targeted list of questions that focuses on issues and themes that are specific to the board and company in question, which can contribute further to the value derived from the interview process. For nominating/governance committees considering the use of an interview format, one key question is who will conduct the interviews.  In our experience, the most common approach is to retain an outside party (such as a lawyer or consultant) to conduct and summarize interviews.  An outside party can enhance the effectiveness of the process because directors may be more forthcoming in their responses than they would if another director or a member of management were involved. Individual Director Evaluations Another practice that some boards have incorporated into their evaluation process is formal evaluations of individual directors.  In our experience, these are not yet widespread but are becoming more common.  At companies where the nominating/governance committee has a robust process for assessing the contributions of individual directors each year in deciding whether to recommend them for renomination to the board, the committee and the board may conclude that a formal evaluation every year is unnecessary.  Historically, some boards have been hesitant to conduct individual director evaluations because of concerns about the impact on board collegiality and dynamics.  However, if done thoughtfully, a structured process for evaluating the performance of each director can result in valuable insights that can strengthen the performance of individual directors and the board as a whole. As with board and committee evaluations, no single "best practice" has emerged for conducting individual director evaluations, and the methods described above can be adapted for this purpose.  In addition, these evaluations may involve directors either evaluating their own performance (self-evaluations), or evaluating their fellow directors individually and as a group (peer evaluations).  Directors may be more willing to evaluate their own performance than that of their colleagues, and the utility of self-evaluations can be enhanced by having an independent director, such as the chairman of the board or lead director, or the chair of the nominating/governance committee, provide feedback to each director after the director evaluates his or her own performance.  On the other hand, peer evaluations can provide directors with valuable, constructive comments.  Here, too, each director's evaluation results typically would be presented only to that director by the chairman of the board or lead director, or the chair of the nominating/governance committee.  Ultimately, whether and how to conduct individual director evaluations will depend on a variety of factors, including board culture. Disclosures about Board Evaluations Many companies discuss the board evaluation process in their corporate governance guidelines.[2]  In addition, many companies now provide disclosure about the evaluation process in the proxy statement, as one element of increasingly robust proxy disclosures about their corporate governance practices.  According to the 2015 Spencer Stuart Board Index, all but 2% of S&P 500 companies disclose in their proxy statements, at a minimum, that they conduct some form of annual board evaluation. In addition, institutional shareholders increasingly are expressing an interest in knowing more about the evaluation process at companies where they invest.  In particular, they want to understand whether the board's process is a meaningful one, with actionable items emerging from the evaluation process, and not a "check the box" exercise.  In the United Kingdom, companies must report annually on their processes for evaluating the performance of the board, its committees and individual directors under the UK Corporate Governance Code.  As part of the code's "comply or explain approach," the largest companies are expected to use an external facilitator at least every three years (or explain why they have not done so) and to disclose the identity of the facilitator and whether he or she has any other connection to the company. In September 2014, the Council of Institutional Investors issued a report entitled Best Disclosure: Board Evaluation (available here), as part of a series of reports aimed at providing investors and companies with approaches to and examples of disclosures that CII considers exemplary.  The report recommended two possible approaches to enhanced disclosure about board evaluations, identified through an informal survey of CII members, and included examples of disclosures illustrating each approach.  As a threshold matter, CII acknowledged in the report that shareholders generally do not expect details about evaluations of individual directors.  Rather, shareholders "want to understand the process by which the board goes about regularly improving itself."  According to CII, detailed disclosure about the board evaluation process can give shareholders a "window" into the boardroom and the board's capacity for change. The first approach in the CII report focuses on the "nuts and bolts" of how the board conducts the evaluation process and analyzes the results.  Under this approach, a company's disclosures would address: (1) who evaluates whom; (2) how often the evaluations are done; (3) who reviews the results; and (4) how the board decides to address the results.  Disclosures under this approach do not address feedback from specific evaluations, either individually or more generally, or conclusions that the board has drawn from recent self-evaluations.  As a result, according to CII, this approach can take the form of "evergreen" proxy disclosure that remains similar from year to year, unless the evaluation process itself changes. The second approach focuses more on the board's most recent evaluation.  Under this approach, in addition to addressing the evaluation process, a company's disclosures would provide information about "big-picture, board-wide findings and any steps for tackling areas identified for improvement" during the board's last evaluation.  The disclosures would identify: (1) key takeaways from the board's review of its own performance, including both areas where the board believes it functions effectively and where it could improve; and (2) a "plan of action" to address areas for improvement over the coming year.  According to CII, this type of disclosure is more common in the United Kingdom and other non-U.S. jurisdictions. Also reflecting a greater emphasis on disclosure about board evaluations, proxy advisory firm Institutional Shareholder Services Inc. ("ISS") added this subject to the factors it uses in evaluating companies' governance practices when it released an updated version of "QuickScore," its corporate governance benchmarking tool, in Fall 2014.  QuickScore views a company as having a "robust" board evaluation policy where the board discloses that it conducts an annual performance evaluation, including evaluations of individual directors, and that it uses an external evaluator at least every three years (consistent with the approach taken in the UK Corporate Governance Code).  For individual director evaluations, it appears that companies can receive QuickScore "credit" in this regard where the nominating/governance committee assesses director performance in connection with the renomination process. What Companies Should Do Now As noted above, there is no "one size fits all" approach to board evaluations, but the process should be viewed as an opportunity to enhance board, committee and director performance.  In this regard, a company's nominating/governance committee and board should periodically assess the evaluation process itself to determine whether it is resulting in meaningful takeaways, and whether changes are appropriate.  This includes considering whether the board would benefit from trying new approaches to the evaluation process every few years. Factors to consider in deciding what evaluation format to use include any specific objectives the board seeks to achieve through the evaluation process, aspects of the current evaluation process that have worked well, the board's culture, and any concerns directors may have about confidentiality.  And, we believe that every board should carefully consider "changing up" the evaluation process used from time to time so that the exercise does not become rote.  What will be the most beneficial in any given year will depend on a variety of factors specific to the board and the company.  For the board, this includes considerations of board refreshment and tenure, and developments the board may be facing, such as changes in board or committee leadership.  Factors relevant to the company include where the company is in its lifecycle, whether the company is in a period of relative stability, challenge or transformation, whether there has been a significant change in the company's business or a senior management change, whether there is activist interest in the company and whether the company has recently gone through or is going through a crisis of some kind.  Specific items that nominating/governance committees could consider as part of maintaining an effective evaluation process include:

  1. Revisit the content and focus of written questionnaires.  Evaluation questionnaires should be updated each time they are used in order to reflect significant new developments, both in the external environment and internal to the board.
  2. "Change it up."  If the board has been using the same written questionnaire, or the same evaluation format, for several years, consider trying something new for an upcoming annual evaluation.  This can bring renewed vigor to the process, reengage the participants, and result in more meaningful feedback.
  3. Consider whether to bring in an external facilitator.  Boards that have not previously used an outside party to assist in their evaluations should consider whether this would enhance the candor and overall effectiveness of the process.
  4. Engage in a meaningful discussion of the evaluation results.  Unless the board does its evaluation using a discussion format, there should be time on the board's agenda to discuss the evaluation results so that all directors have an opportunity to hear and discuss the feedback from the evaluation.
  5. Incorporate follow-up into the process.  Regardless of the evaluation method used, it is critical to follow up on issues and concerns that emerge from the evaluation process.  The process should include identifying concrete takeaways and formulating action items to address any concerns or areas for improvement that emerge from the evaluation.  Senior management can be a valuable partner in this endeavor, and should be briefed as appropriate on conclusions reached as a result of the evaluation and related action items.  The board also should consider its progress in addressing these items.
  6. Revisit disclosures.  Working with management, the nominating/governance committee and the board should discuss whether the company's proxy disclosures, investor and governance website information and other communications to shareholders and potential investors contain meaningful, current information about the board evaluation process.

[1] See NYSE Rule 303A.09, which requires listed companies to adopt and disclose a set of corporate governance guidelines that must address an annual performance evaluation of the board.  The rule goes on to state that "[t]he board should conduct a self-evaluation at least annually to determine whether it and its committees are functioning effectively."  See also NYSE Rules 303A.07(b)(ii), 303A.05(b)(ii) and 303A.04(b)(ii) (requiring annual evaluations of the audit, compensation, and nominating/governance committees, respectively). [2] In addition, as discussed in the previous note, NYSE companies are required to address an annual evaluation of the board in their corporate governance guidelines.

Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm's Securities Regulation and Corporate Governance practice group, or any of the following practice leaders and members:

John F. Olson - Washington, D.C. (202-955-8522, jolson@gibsondunn.com) Dennis Friedman - New York (212-351-3900, dfriedman@gibsondunn.com) Ronald O. Mueller - Washington, D.C. (202-955-8671, rmueller@gibsondunn.com) James J. Moloney - Orange County, CA (949-451-4343, jmoloney@gibsondunn.com) Elizabeth Ising - Washington, D.C. (202-955-8287, eising@gibsondunn.com) Lori Zyskowski - New York (212-351-2309, lzyskowski@gibsondunn.com) Gillian McPhee - Washington, D.C. (202-955-8201, gmcphee@gibsondunn.com)


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