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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 highincome 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 EquityBenoît 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] 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] 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 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)Allison Balick – Los Angeles (213-229-7685; abalick@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.

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.  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.  "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]  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.  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. 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 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)   © 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: 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. “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. 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. 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. 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. 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) © 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 19, 2016 |
SEC Updates Guidance on Non-GAAP Financial Measures

On May 17, 2016, the Division of Corporation Finance of the Securities and Exchange Commission (the "Staff") issued new Compliance and Disclosure Interpretations (C&DIs) regarding the use of non-GAAP financial measures and revised existing C&DIs on the same topic.  These interpretations come on the heels of numerous speeches by SEC Commissioners and the Staff indicating that the SEC is increasing its scrutiny of companies’ use of non-GAAP financial measures in light of the increasing use of such measures by companies, analysts and the press.  The Staff has also intensified its focus on non-GAAP financial measures in the review and comment process.  The C&DIs related to non-GAAP financial measures are available here, and a redline comparing the Staff’s non-GAAP C&DIs to its prior interpretations is availablehere.  The new and revised interpretations will significantly impact companies’ use of non-GAAP financial measures and will require many companies to revise their current earnings release presentations.  Whereas the Staff in recent years was viewed as encouraging companies to include in their SEC filings any non-GAAP financial measures contained in analyst presentations, the new interpretations represent a dramatic swing of the pendulum in the Staff’s views on non-GAAP disclosures, and may lead companies to reconsider including such measures in earnings releases and filed documents. The new guidance addresses two primary issues: the "equal or greater prominence" requirement for certain non-GAAP presentations and presentations of non-GAAP financial measures that the Staff views as improper.  These interpretations carry out the recent statement by the Chief Accountant of the Division of Corporation Finance that the Staff intended to "crack down" on a variety of non-GAAP disclosure practices.  1.      Equal or Greater Prominence Requirement.  As stated in the C&DI, any document filed with the Commission and any earnings release furnished under Item 2.02 of Form 8-K that contains a non-GAAP financial measure must present the most directly comparable GAAP measure "with equal or greater prominence."  The Staff’s new interpretations read "equal" prominence to mean that the GAAP measure generally must precede any non-GAAP measure, and make clear that the Staff reads "prominence" to refer not simply to the location or ordering of GAAP and non-GAAP numbers, but also to apply to the manner in which GAAP and non-GAAP numbers are discussed and characterized.  Specifically, while acknowledging that "prominence" generally depends on the facts and circumstances under which a disclosure is made, C&DI 102.10 states that the Staff would consider the following situations to be examples of impermissibly presenting a non-GAAP measure as more prominent:  Presenting a non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption), or omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures; Providing tabular disclosure of non-GAAP financial measures without preceding it with an equally prominent tabular disclosure of the comparable GAAP measures or including the comparable GAAP measures in the same table; Presenting a non-GAAP measure using a style (e.g., bold, larger font) that emphasizes the non-GAAP measure over the comparable GAAP measure; Describing a non-GAAP measure as, for example, "record performance" or "exceptional" without at least an equally prominent descriptive characterization of the comparable GAAP measure; and Providing discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence. In the context of providing forward-looking statements (such as guidance or outlook) using non-GAAP measures, the same C&DI interprets the "equal or greater prominence" requirement to create a new disclosure obligation.  Specifically, the non-GAAP disclosure rules require that any forward-looking non-GAAP financial measure be accompanied by a quantitative reconciliation to the most directly comparable GAAP measure, "to the extent available without unreasonable efforts."  C&DI 102.10 states that when a company relies on the "unreasonable efforts" exception, the equal or greater prominence rule requires the company to disclose "in a location of equal or greater prominence" the fact that the company is relying on the exception and to identify the information that is unavailable and its probable significance.  Finally, the Staff reflected its long-standing disapproval of non-GAAP income statements through the equal or greater prominence rule, stating that a full income statement of non-GAAP measures presented alongside a GAAP income statement or presented when reconciling non-GAAP measures to the most directly comparable GAAP measures fails to satisfy the "equal or greater prominence" requirement.  2.      Problematic Presentations of Non-GAAP Financial Measures.  Rule 100(b) of Regulation G prohibits the use of a non-GAAP financial measure that is misleading when viewed in context with the information accompanying that measure and any other accompanying discussion of that measure.  Four of the new interpretations address practices that, in the Staff’s view, can result in a non-GAAP financial measure that is misleading.  These are: Presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading. Varying non-GAAP financial measures from period to period by adjusting for a particular charge or gain in the current period when "other, similar charges or gains" were not also adjusted in prior periods, unless the change between periods is disclosed and the reasons for it explained.  The Staff noted that, in addition, it may be necessary to recast prior measures to conform to the current presentation. For companies that present non-GAAP financial measures that are adjusted only for non-recurring charges, failing to adjust that non-GAAP financial measure for non-recurring gains that occurred during the same period. Presenting a non-GAAP performance measure that is adjusted to accelerate revenue recognized over time under GAAP as though the company earned revenue when customers were billed or using other individually tailored revenue recognition and measurement methods. Notably, the Staff guidance does not address whether accompanying disclosures that highlight the nature of non-GAAP adjustments would, in the Staff’s view, be sufficient to overcome the concern that a non-GAAP measure would be misleading.  Instead, these interpretations reflect practices that may draw SEC scrutiny regardless of the context.  For example, the Deputy Chief Accountant of the Division of Corporation Finance recently stated that, if a company presents an adjusted revenue measure, the company "will likely get a comment" from the Staff questioning the measure, and that companies should "expect the staff to look closely, and skeptically, at the explanation as to why the revenue adjustment is appropriate." See Remarks Wesley R. Bricker, Deputy Chief Accountant of the Division of Corporation Finance, before the 2016 Baruch College Financial Reporting Conference, available here.   As well, other interpretations reflect a more proactive stance by the Staff in reviewing and questioning certain non-GAAP disclosures:  Per Share Liquidity Measures.  The Staff’s interpretations, for example, reflect a more prescriptive position under which "non-GAAP liquidity measures that measure cash generated must not be presented on a per share basis."  As stated in interpretation 102.05, the Staff will apply the prohibition on the use of per share data to any non-GAAP financial measure that can be used as a liquidity measure, even if management characterizes it solely as a performance measure.  The Staff also revised existing C&DIs to make clear that free cash flow, EBIT and EBITDA may not be presented on a per share basis.  Adjustments for Tax.  The Staff also has focused on how income tax assumptions related to adjustments are calculated and presented when presenting a non-GAAP financial measure.  The new interpretations touch upon this issue, stating that the nature of income tax effects reflected in non-GAAP financial measures depends on the nature of the measures.  If a measure is a liquidity measure that includes income taxes, the Staff states that it might be acceptable to adjust GAAP taxes to show taxes paid in cash.  If, however, a measure is a performance measure, companies should include current and deferred income tax expense "commensurate with the non-GAAP measure of profitability."  In addition, when setting forth reconciliations between GAAP and non-GAAP measures, adjustments to arrive at the non-GAAP measure should not be presented "net of tax," but instead income taxes should be shown as a separate adjustment and clearly explained.  Based on speeches and comments by several SEC Commissioners and the Staff, these interpretations should be viewed as an early step, but not the last word, in the SEC’s re-examination of non-GAAP presentations.  Indeed, the Staff has indicated that they are more actively reviewing SEC filings, including earnings releases furnished under Item 2.02 of Form 8-K and investor materials presented on company websites, and commenting on non-GAAP financial measures.  In addition to the topics addressed in the Staff’s C&DIs, the Staff also has focused on the requirement that companies disclose the reasons why management believes that presentation of a non-GAAP financial measure provides useful information to investors, and has expressed concern that company disclosures in this area are often comprised of boilerplate explanations that do little to explain to investors the significance of non-GAAP financial measures.  The new and revised non-GAAP C&DIs reflect a new stance by the SEC on the use of non-GAAP financial measures.  While many companies, analysts and investors find non-GAAP presentations helpful, the SEC is reacting to abuses it has seen in non-GAAP measures.  Companies should, in advance of their next earnings release, review their non-GAAP presentations, including descriptions of and language accompanying the non-GAAP financial measures, in light of the C&DIs, and consider whether their non-GAAP presentations should be modified, further elaborated on, or dropped entirely.  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 practice leaders and members: Brian J. Lane - Washington, D.C. (202-887-3646, blane@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)Michael J. Scanlon - Washington, D.C. (202-887-3668, mscanlon@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)Michael A. Titera - Orange County, CA (949-451-4365, mtitera@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 18, 2016 |
PCAOB Again Issues Proposal to Change Audit Report

The Public Company Accounting Oversight Board ("PCAOB") recently re-proposed an audit standard to amend the form and content requirements for the independent auditor’s report on financial statements.  The new proposal retains the pass/fail model present in the existing audit report but also requires the auditor to include new disclosures in the audit report about "critical audit matters" that are identified during the course of the audit.  The re-proposal also requires new disclosures about the length of the auditor’s tenure and the applicable auditor independence requirements.  The re-proposal is the latest chapter in a standard-setting project that dates back to 2011, when the PCAOB issued a concept release on potential changes to the audit report, and that evolved in 2013, when the PCAOB issued its original proposal on this topic.  The PCAOB’s re-proposal narrows in some respects the scope of the disclosure requirements for critical audit matters that appear in the audit report, and also drops the component of the original proposal that would have required the auditor to review and report on matters outside the financial statements.  But the re-proposal still represents an important development for the financial reporting landscape that issuers and their audit committees should review and consider in detail, including as described below under "Steps to Consider." The PCAOB’s new proposal can be found here.  The deadline for commenting on the PCAOB’s proposal is August 15, 2016. What are CAMs? — Required Disclosures in the Audit Report about Critical Audit Matters Under the re-proposal, a critical audit matter ("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 proposed 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 not narrow, with AS 1301 containing more than fifteen topics and several dozen related paragraphs that specify what 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 proposed 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 proposed definition provides that a CAM must have involved an "especially challenging, subjective, or complex auditor judgment."  The proposal seeks to inject some objective criteria to help guide this test by laying out several 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 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; 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; and the nature of audit evidence obtained regarding the matter. The new proposal 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. The CAM definition offered in the original proposal was more expansive because it did not specifically relate back to disclosure of matters that were communicated to the audit committee.  By incorporating the concept of matters required to be communicated to the audit committee, the re-proposal draws on existing AS 1301 to provide some guideposts for determining which matters may be treated as CAMs.  However, given the lengthy list of required communications in AS 1301 and that the re-proposal 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."  The new proposal specifies that CAMs would not have to be disclosed in audit reports issued in connection with audits of brokers and dealers; investment companies other than business development companies; or employee stock purchase, savings, and similar plans. Additional New Disclosures in the Audit Report Auditor Tenure.  The re-proposal requires the auditor to include in its report "[a] statement containing the year the auditor began serving consecutively as the company’s auditor."  Under the proposed requirement, the auditor tenure would include 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 approved the issuance of the proposal, several Board members indicated they were not certain this disclosure is needed.  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 re-proposal 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 re-proposal, 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 and the release accompanying the re-proposal says 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. Steps to Consider With this re-proposal, the PCAOB appears to be moving closer to requiring changes to the pass/fail model that has served as the basis for an unqualified audit report for many decades.  As a result, issuers and their audit committees would be well served to review in depth the new disclosures contemplated by the proposal – particularly as they are disclosures for which the auditor will have the final say; consider the potential implications and costs associated with the new disclosures, including the questions and potential issues discussed below; and evaluate whether to comment on the proposal.  In considering this topic, issuers and audit committees also may wish to engage with their auditors to understand what types of issues in prior audits may be considered CAMs under the proposal and what corresponding disclosures would have looked like if they had been disclosed in connection with those prior audit reports. Scope of the New CAM definition.  In its re-proposal, the PCAOB made efforts to rein in the breadth of its original concept for critical audit matters, but aspects of the proposed CAM definition still may 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 rather 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 still leaves the auditor with broad discretion to determine whether a matter is a CAM that should be disclosed in the audit report.  Auditor discretion in making this determination of course could cut either way, but issuers and their audit committees may wish to consider whether the degree of uncertainty in how the proposed CAM definition will be applied in practice, given its potential breadth and subjectivity, merits comment.     Auditor Disclosure of Original Information.  In reviewing the original proposal, a number of commenters expressed concern that the proposal 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 PCAOB’s re-proposal responded to this concern by noting that "[s]ince the auditor would be communicating information regarding the audit rather than information directly about the company and its financial statements, the communication of critical audit matters should not diminish the governance role of the audit committee and management’s responsibility for the company’s disclosure of financial information."  Companies and audit committees may wish to consider if this response is sufficient to allay the noted concerns, particularly given the nature of the proposed disclosure topics that have to be addressed once a CAM has been identified – as reflected by the three pages of sample disclosures for a CAM that appear in the proposing release.  The PCAOB’s proposed standard also includes a note intended to address concerns about the auditor becoming the source of original (and potentially confidential) information about the company.  This note says that the auditor will not be expected to provide information about the company that has not been made publicly available by the company "unless such information 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."  Companies and audit committees may wish to consider whether this exception in effect nearly swallows the rule, and if so, what disclosure considerations may be implicated, including whether it would put the auditor in a position of having to make disclosures in the first instance about any number of matters, such as loss contingency considerations or investigations. Uncertainty in Application.  A number of concerns expressed in relation to the original proposal also appear not to have been fully addressed by the re-proposal.  Companies and their audit committees may wish to comment on these issues as well.  For example, because the re-proposal may require disclosure of matters that have been voluntarily reported to the audit committee, some have expressed the view that the approach outlined could lead auditors to hesitate in raising matters to audit committees as it would then trigger potential CAM reporting.  Conversely, some have expressed concern that there will be a tendency to over-disclose the existence of CAMs given the subjectivity in the proposed standard and the potential adverse consequences for the auditor associated with being second guessed in whether a CAM should have been disclosed.  Still others have expressed concern that the range of CAM disclosure practice amongst firms and engagement teams will lead to unhelpful variability across audit reports.  Concerns expressed about the original proposal with respect to the increased strain on audit committee resources and timing issues associated with completing the audit – for example, when financial reporting or audit-related issues that have CAM implications arise at the last moment – also seem relevant in relation to the re-proposal.  Although varied in nature, the common theme underlying these concerns appears to be that uncertainty in application will result from requiring CAM disclosures in the audit report, particularly in light of the subjectivity inherent in the definition and the significance of the changes to the audit reporting model.       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 practice leaders and members: John F. Olson - Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Brian J. Lane - Washington, D.C. (202-887-3646, blane@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)Michael J. Scanlon - Washington, D.C. (202-887-3668, mscanlon@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)Michael A. Titera - Orange County, CA (949-451-4365, mtitera@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.

April 5, 2016 |
French Legal Briefing – French Government Sends Strong Positive Signals to French and Foreign Businesses

The Paris office of Gibson, Dunn & Crutcher LLP is pleased to provide this French legal briefing covering France for the first quarter of 2016. The French government elected in 2012 initially took a very adverse stand against financial and international businesses in general.  As you are likely aware, this translated into higher taxes, numerous regulations affecting foreign investments into France, and a general attitude perceived as hostile to multinational corporations and reducing France’s attractiveness to foreign investors.  This has evolved substantially since the early part of 2015, notably following a change of the minister of economy.  A more liberal approach of the business world has been advertised.  In line with this new direction and a stated desire to reassure investors, substantial legal reforms have been launched.  The purpose of this briefing is to provide a summary of some of the latest examples of these new directions in three areas: Labor Law: An ongoing proposed reform aims at providing more flexibility to a current rigid labor law, notably with respect to the management of working hours. Equity Incentive Plans: The attractiveness of French equity-based incentive plans has been significantly improved, including for foreign issuers, provided that a special resolution has been adopted at a shareholders’ general meeting held on or after August 8, 2015. Contract Law: The French Civil Code is about to be rejuvenated in order to bring French contract law into line with international standards. 1.   French labor laws: What the reform should change The French government is proposing a set of labor law reforms aimed at offering greater flexibility to increase employment and sending a positive signal to foreign investors to implement their businesses in France, which still needs to be discussed in parliament before being enacted. Facilitate dismissals conditions in order to boost hiring The proposed reform would allow companies to dismiss workers on economic grounds based on the financial situation of the companies’ activities in France, irrespective of the situation and financial results of their foreign branches and of their group activities abroad.  This proposal is a strong signal sent to investors who conduct activities in France: any company facing economic difficulties (to be assessed in accordance with legal guidelines) will be able to shed jobs even though the company is financially sound outside of France.  Previous legislation and case law imposed to look at the entire group. The reform would also set new caps on the amount of compensatory damages that can be awarded by labor courts for dismissals without actual and serious grounds.  Capping court-ordered severance would allow costs of workers lay-offs to be more foreseeable.  Under pressure, the government eventually turned these caps into simple guidelines.  The effectiveness of this approach will thus rest with the courts and depend on how judges follow these guidelines. Furthermore, the reform proposes that agreements entered into by employers at the company level to maintain or develop employment may prevail over employment contracts’ inconsistent provisions.  This could apply to compensation and working hours, provided that they do not generate a decrease of the employee’s monthly salary.  If an employee was to reject the company level agreement, the employer could validly terminate his or her contract of employment on that basis. Greater flexibility is sought by increasing the worktime limit (per week up to 46 hours) and partly deregulating overtime. As a derogatory regime from the 35-hour workweek system, the reform sets a weekly worktime limit of 44 hours over a period up to 12 weeks, which can go up to 46 hours.  This may be achieved at the level of each company, without the need to comply with an industry-wide collective agreement as currently required. For greater flexibility, overtime rates and working time over periods of up to 3 years (instead of up to 1 year now) may also be negotiated at the company level. The reform favors collective bargaining and upstream negotiations Majority collective agreements (i.e., agreements entered into with unions having obtained more than 50% of votes during the previous Works Council elections) are generalized.  To circumvent union’s blockage in the negotiations of these types of collective agreements, it is now proposed that minority collective agreements (i.e., entered into with unions gathering at least 30% of votes but less than 50% thereof) can still be validated by an employees’ ballot (such possibility to be opened only for agreements relating to working time, as a first step). The reform also enables employers to set anticipated adjustment agreements or substitution agreements in the event of a legal change in the company (merger, sale etc.).  In other words, employers contemplating corporate restructuring transactions are encouraged to negotiate upstream with unions in order to simplify and favor social measures. Despite the government backing down under unions’ pressure on some significant changes (such as the possibility for employers in companies with less than 50 employees to individually enter into flat rate pay agreements covering days worked outside any collective agreement), the draft bill is viewed as heading in the right direction and is supported by some of the major employers’ unions (including the MEDEF).  However, the proposals developed here above are not yet final and may still evolve. 2.   The Rebirth of Free Share Awards in France The so-called "Macron Law" substantially alleviates the conditions and constraints applicable to free share awards in France, by reducing the minimum legal vesting and holding periods.  Free shares can now vest 1 year after their grant date, provided that the combined vesting and holding periods are at least equal to 2 years (previously, the specific regime was available only for free shares awards subject to a minimum 2-year vesting period and a minimum 2-year holding period, amounting to a minimum aggregate period of 4 years). The Macron Law also significantly improves the tax and social treatment for both the employer and the beneficiaries.  It provides that gains realized through the allocation and sale of free shares can be treated as capital gains, instead of being treated as salary for French tax and social security purposes as before, as shown in the table below.   Previous Regime New "Macron Law" Regime (1) Employer social contribution 30%due upon grant on market value of free shares as of the grant date 20%due upon vesting on the market value of free shares as of the vesting date (2) Employee social contribution 10%+8% social security contributions due on acquisition gain (out of which 5.1% is tax deductible) 15.5% social security contributions due on acquisition gain (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 rate) 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 Total cost for employees(3) 60.7%(+3% or 4% in case special high income contribution applies) 35.8%(if shares held at least for 2 years and less than 8 years after vesting)(+3% or 4% in case special high income contribution applies) (1)      The new regime only applies to free shares the granting of which has been approved by a decision of the extraordinary shareholders’ meeting held on or after August 8, 2015.(2)      The positive effect of this new rule is that the employer social contribution will only be due if and when the beneficiary effectively acquires the free shares. Its correlative drawback is that the cost of the awards for the employer will be uncertain at the date of the grant since the employer social contribution will be assessed based on the market value of the shares upon vesting.(3)      Based on marginal rates. The new French regime of free share awards remains available for free shares awarded by foreign companies to French tax residents. The improved tax and social security treatment is subject to the new awards having been authorized by a resolution of the extraordinary general meeting of the shareholders of the foreign issuer passed on or after August 8, 2015.  Since last summer, a number of domestic and foreign issuers have already taken all necessary steps to take advantage of the new favorable regime for their employees and corporate officers residing in France. 3.   An Upcoming Rewriting of French contractual law reinforcing legal certainty On February 10, 2016, the French Government issued an Ordinance enacting new provisions of the Civil Code which will enter into force on October 1, 2016, subject to Parliament’s ratification.  This reform is generally praised for the quality of its drafting and the improved legal certainty offered to business operators. Improvement of legal certainty and security On top of rejuvenating rules dating back to Napoleonic times, a number of new provisions increase contractual certainty and security which in some cases had been weakened by case law.  As a matter of example, the legal effect of unilateral promises (promesses unilatérales) such as calls and puts are reinforced and the promisor may no longer usefully revoke its promise before acceptance by the beneficiary (Article 1124). Recognition of the concept of significant imbalance in standard contracts The reform also codifies certain provisions aiming at protecting the weaker party in a contract.  For instance, Article 1171 extends the concept of significant imbalance concept for all adherence contracts (i.e., contracts based on "general terms" or "terms of use" which have not been negotiated between the parties), irrespective of the identity and quality of the parties.  Previously, this principle could be invoked in consumer contracts or contracts between traders (commerçants) only.  Its scope will, thus, be much broader and will now encompass loan agreements, distribution agreements, supply contracts, etc. The effect is that any provision creating a significant imbalance between the parties’ rights and obligations is deemed unwritten. Contrary to what exists with respect to contracts between traders, the imbalance may, however, not be assessed based on the price of the contract nor on the main subject matter of the contract.  Another limitation aiming at safeguarding legal certainty resides in the proportionality test that will be carried out by the judge, since only significant imbalance can be sanctioned. To conclude, this reform creates an efficient protection against excessive non-core contractual provisions (such as dispute resolution clauses, termination clauses, non-compete or exclusivity provisions, non-affiliation clauses, etc.) which will be available to all economic operators. The introduction of the "unforeseeability doctrine" under French law Pursuant to new Article 1196, when performance of a contract is rendered excessively onerous for a contracting party due to unforeseeable circumstances, the affected party may ask for the renegotiation of the contract.  If the other party refuses or the renegotiation fails, both parties may jointly ask in Court that the contract be adapted to the new economic and financial situation.  If the matter is not brought in Court, either party may ask for judicial termination. While this renegotiation right constitutes a major change under French law, its impact may be limited.  First, because the contract may provide that a party has accepted to bear a specific risk (such as a significant change in raw material prices), thus depriving this party from its renegotiation right.  Second, because the contract may provide material adverse change clauses or hardship clauses enabling the parties to set in advance what the contractual changes should consist in, thus preventing a Court interference in the contractual relationship. This new framework definitely needs to be taken into account for future contract negotiations, especially in the context of long-term contracts. The following Gibson Dunn lawyers assisted in preparing this client update:  Benoît Fleury, Bernard Grinspan, Ariel Harroch, Patrick Ledoux, Judith Raoul-Bardy and Audrey Obadia-Zerbib.   Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update.  The Paris office of Gibson Dunn brings together lawyers with extensive knowledge of corporate, insolvency, tax and real estate, antitrust, labor and employment law as well as regulatory and public law.  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 EquityBernard Grinspan (bgrinspan@gibsondunn.com)Benoît Fleury (bfleury@gibsondunn.com)  Ariel Harroch (aharroch@gibsondunn.com)Jean-Philippe Robé (jrobe@gibsondunn.com)Patrick Ledoux (pledoux@gibsondunn.com)Judith Raoul-Bardy (jraoulbardy@gibsondunn.com)Audrey Obadia-Zerbib (aobadia-zerbib@gibsondunn.com) Labor and EmploymentBernard Grinspan (bgrinspan@gibsondunn.com)Jean-Philippe Robé (jrobe@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.

March 31, 2016 |
District Court Issues Troubling Decision in Sun Capital Case: Private Equity Funds Formed “Partnership-in-Fact” and Were Engaged in “Trade or Business,” Liable for Withdrawal Liability Obligations of Portfolio Company

On March 28, 2016, in a much-anticipated ruling in the Sun Capital case,[1] the U.S. District Court for the District of Massachusetts held on remand that two private equity funds had formed a “partnership-in-fact” and were engaged in a “trade or business” and, accordingly, were jointly and severally liable for multiemployer pension plan “withdrawal liability” obligations of one of their portfolio companies.  The court apparently reached this result by treating two private equity funds as if they were a single “partnership” even though the two funds had separate investors and separate lifecycles and did not always invest in the same portfolio companies. Background As discussed in more detail in our prior Client Alert, the Sun Capital case was remanded from the First Circuit to the district court in July, 2013.[2]  The First Circuit held that a private equity fund (“Fund IV”) was engaged in a trade or business for purposes of the controlled group liability provisions of the Employee Retirement Income Security Act of 1974 (“ERISA”) and, as such, would be jointly and severally liable for the unfunded pension obligations of one of its portfolio companies, Scott Brass, Inc. (“SBI”), if it were found to be part of the same “controlled group” as SBI under the relevant ERISA provisions.  Under ERISA, entities that are engaged in a “trade or business” are part of the same controlled group if they are under common control.  Common control generally exists where the entities are at least 80%-related by ownership. Although the case was an ERISA case (and was specifically limited to ERISA by the First Circuit), it caught the attention of the tax community because of its analysis of whether a private equity fund was engaged in a trade or business – even though only for ERISA purposes.  In holding that Fund IV was engaged in a trade or business under ERISA, the First Circuit adopted an “investment plus” standard and emphasized (i) the active involvement by Fund IV and/or its affiliates in the management and operation of its portfolio companies and (ii) the receipt by Fund IV of an “economic benefit” beyond that which an ordinary, passive investor would receive due to the fact that management fees owed by Fund IV to its general partner were to be reduced by management fees paid by SBI to the general partner. Ultimately, the First Circuit remanded the case to the district court to determine: (i) whether another private equity fund managed by Sun Capital (“Fund III,”[3] and together with Fund IV, the “Funds”) was engaged in a “trade or business” for purposes of the ERISA controlled group liability provisions (given that the First Circuit was unable to determine whether Fund III had received an economic benefit in the form of an offset of management fees otherwise owed to its general partner) and (ii) whether the Funds and SBI were part of the same “controlled group” for purposes of the ERISA controlled group liability provisions. The District Court’s Decision Trade or Business.  The district court found that Fund III received a reduction in management fees as a result of management fees paid by SBI to Fund III’s general partner, and, therefore, consistent with the First Circuit Court’s “investment plus” standard, the district court found that Fund III was engaged in a trade or business for purposes of the controlled group liability provisions of ERISA.[4] Common Control.  In general terms, because each of the Funds was found to be engaged in a “trade or business,” either Fund would be a member of the same controlled group as SBI if it was 80%-affiliated with SBI.[5] Since Fund III owned 30%, and Fund IV owned 70%, of a limited liability company (the “LLC”) that indirectly owned 100% of SBI, neither fund was 80%-affiliated with SBI.  Thus, according to the district court, “absent some mechanism by which the ownership interests of [the Funds] would be aggregated,” the unfunded pension obligations of SBI would not extend to the Funds.  The district court found, however, that such a mechanism existed.  Although not altogether clear, it appears that the district court relied on general federal income tax principles to find that Fund III and Fund IV formed a “partnership-in-fact sitting atop the LLC.”  Factors the district court relied on to reach such a finding included, among others, (i) the Funds being closely affiliated entities and part of a “larger ecosystem” of Sun Capital entities created and directed by two individuals (who each retained substantial control over both Funds), (ii) the Funds having co-invested in five other companies using the same organizational structure (and the joint activity that took place in order for the two funds to decide to co-invest), and (iii) certain other factors illustrating that the Funds had an “identity of interest and unity of decision making.”  In its analysis, the district court acknowledged that the two funds filed separate partnership tax returns, had separate financial statements and bank accounts, were not parallel funds[6] and had largely non-overlapping sets of limited partners and portfolio companies in which they had invested, and had expressly disclaimed an intent to form a partnership or joint venture in the operating agreement of the LLC.  Moreover, the district court did not explain how treating the Funds as having formed a partnership-in-fact supported its conclusion.  That is, the Funds actually had formed the LLC, and it is not apparent how treating a partnership-in-fact as owning all of the interests in the LLC would support the district court’s ultimate holding. Irrespective of its precise reasoning, the district court held that the Funds were jointly and severally liable for SBI’s unfunded pension obligations.  We expect this holding to be appealed to the First Circuit for review. Conclusion From an ERISA perspective, this case is extremely troubling for private equity funds.  Before the First Circuit’s 2013 Sun Capital decision, most funds were comfortable that they were not engaged in a “trade or business,” so that the first prong of the controlled group test would not be satisfied.  The 2013 Sun Capital decision, as well as a few additional cases decided since 2013, have made that position more difficult to support. In Sun Capital, however, Fund III and Fund IV had different investors, and neither Fund owned 80% of SBI.  For these reasons, the consensus has been that Sun Capital should prevail under the common control prong of the controlled group test.  If the First Circuit upholds the district court’s decision, multiemployer pension funds may well be emboldened to seek to collect withdrawal liability from private equity funds, particularly where the private equity funds are managed by the same sponsor and those funds own in the aggregate 80% or more of the applicable portfolio company.  The controlled group rules applicable to multiemployer plan withdrawal liability also apply to single employer plan terminations with the Pension Benefit Guaranty Corporation (the “PBGC”), so that risk also will apply to liability to the PBGC.  Going forward, private equity sponsors that acquire portfolio companies with multiemployer pension plan obligations or that sponsor single-employer defined benefit pension plans need to take this risk into account and may want to seek outside investors so that the aggregate investments by the sponsor’s funds fall below the 80% threshold.[7] From an income tax standpoint, our prior Client Alert on Sun Capital noted that the court’s trade or business analysis presented potentially troubling issues, including, for example, a possible impact on the determination of whether a foreign person is engaged in a U.S. trade or business.  The recent district court decision does nothing to assuage that concern.  We continue to believe that the “investment plus” analysis ought not to apply to generally treat private equity funds as engaged in a trade or business. The district court’s use of federal income tax principles to reach its conclusion regarding the “partnership-in-fact” conclusion is equally, if not more, troubling.  The IRS or a state taxing authority may view the district court’s decision as an opportunity to treat two or more separate partnerships as a single partnership.  Although tax practitioners have recognized the possibility that parallel funds and alternative investment vehicles could be treated as forming a “partnership-in-fact” with the main fund (or be “collapsed” into the main fund) and often have taken steps to mitigate this risk, such as those taken by Sun Capital, the risk of “partnership-in-fact” has been viewed as modest.  The sweeping language and somewhat opaque reasoning of the Sun Capital decision – if imported into the tax law – could have far reaching implications for investment funds that form parallel funds or alternative investment vehicles to address a range of business and tax sensitivities (including sensitivity to certain types of income, such as effectively connected income and unrelated business taxable income).  Notwithstanding this potential, we do not believe such a result is likely.[8]  While we will continue to watch the Sun Capital cases, we do not believe that they have application outside of ERISA.  Our private equity and other clients should feel free to reach out to the members of our tax department to discuss any concerns they have regarding the implications of this decision.    [1]   Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund, No. 10-10921-DPW (D. Mass. Mar. 28, 2016).    [2]   Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund, 724 F.3d 129 (1st Cir. 2013), cert. denied, 134 S. Ct. 1492 (2014).    [3]   There actually were two funds in the Fund III family that invested in parallel.  Both Sun Capital and the New England Teamsters and Trucking Industry Pension Fund (the “Pension Fund”) treated them as if they were a single fund, and we do the same here.    [4]   Notably, the district court also found that the “partnership-in-fact” (discussed under the heading “Common Control”) was also engaged in a trade or business despite the fact that it received no similar “direct economic benefit.”    [5]   29 C.F.R. § 4001.3(a); Treas. Reg. § 1.414(c)-2(b).    [6]   The district court, similar to the First Circuit Court, specifically noted that it considered the two parallel funds compromising Fund III as one fund for purposes of the opinion and therefore appears to have implicitly aggregated the two vehicles for purposes of the controlled group analysis.    [7]   Multiemployer plans may then try to expand the “partnership-in-fact” analysis of Sun Capital to cover this scenario as well, but we believe that would stretch even the district court’s expansive analysis beyond the breaking point.  There are some other arguments that multiemployer plans could make under ERISA (e.g., under ERISA’s “evade or avoid” rule applicable to withdrawal liability), but those should be unavailing when bona fide outside investors are involved.    [8]   The district court’s decision appears to be results-oriented and fails to address a number of factors in favor of not finding a “partnership-in-fact.” The following Gibson Dunn lawyers assisted in preparing this client alert:  Michael Collins, Sean Feller, Eric Sloan, Benjamin Rippeon, Paul Issler, David Rosenauer, Jeffrey Trinklein, Romina Weiss, Lorna Wilson and Mary Kwon. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments.  For further information or to discuss any concerns you may have regarding the implications of this decision, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the lawyers listed below: Tax Art Pasternak – Co-Chair, Washington, D.C. (+1 202-955-8582, apasternak@gibsondunn.com) Jeffrey M. Trinklein – Co-Chair, London/New York (+44 (0)20 7071 4224 / +1 212-351-2344), jtrinklein@gibsondunn.com) Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@gibsondunn.com) David B. Rosenauer – New York (+1 212-351-3853, drosenauer@gibsondunn.com) Eric B. Sloan – New York (+1 212-351-2340, esloan@gibsondunn.com) Romina Weiss – New York (+1 212-351-3929, rweiss@gibsondunn.com) Benjamin Rippeon – Washington, D.C. (+1 202-955-8265, brippeon@gibsondunn.com) Hatef Behnia – Los Angeles (+1 213-229-7534, hbehnia@gibsondunn.com) Paul S. Issler – Los Angeles (+1 213-229-7763, pissler@gibsondunn.com) Dora Arash – Los Angeles (+1 213-229-7134, darash@gibsondunn.com) Scott Knutson – Orange County (+1 949-451-3961, sknutson@gibsondunn.com) David Sinak – Dallas (+1 214-698-3107, dsinak@gibsondunn.com)    ERISA/Labor and Employment Michael J. Collins – Washington, D.C. (+1202-887-3551, mcollins@gibsondunn.com) Stephen W. Fackler – Palo Alto/New York (+1650-849-5385/+1212-351-2392, sfackler@gibsondunn.com) Sean C. Feller – Los Angeles (+1310-551-8746, sfeller@gibsondunn.com) Private Equity Paul Harter – Dubai (+971 (0)4 318 4621, pharter@gibsondunn.com) Sean P. Griffiths – New York (+1 212-351-3872, sgriffiths@gibsondunn.com) Charlie Geffen – London (+44 (0) 20 7071 4225, cgeffen@gibsondunn.com) Steven R. Shoemate – New York (+1 212-351-3879, sshoemate@gibsondunn.com) Ari Lanin – Los Angeles (+1 310-552-8581, alanin@gibsondunn.com) Business Restructuring and Reorganization Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) Securities Regulation and Corporate Governance Group: James J. Moloney – Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com) Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@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.

October 26, 2015 |
SEC Picks Up The Pace On Financial Reporting Fraud Efforts

​San Francisco partner Marc J. Fagel and Washington D.C. associate Courtney M. Brown are the authors of "SEC Picks Up The Pace On Financial Reporting Fraud Efforts" [PDF] published on October 26, 2015 by Law360.

October 21, 2015 |
U.S. Retirement Plan COLAs Unchanged for 2016

​Earlier today, the IRS released its cost-of-living adjustments (COLAs) applicable to tax-qualified retirement plans for 2016.  The vast majority of these 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 2015 levels because increases in the cost-of-living index did not meet statutory thresholds that would trigger their adjustment. The key 2016 limits are as follows, all of which are unchanged from 2015 limits: Limitation 2016 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.) $18,000 414(v) Limit on "Catch-Up Contributions" for Employees Age 50 and Older (Note:  This is relevant for 401(k), 403(b) and 457 plans.) $6,000 401(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.) $265,000 415(c) Limit on Annual Additions Under a Defined Contribution Plan $53,000 (or, if less, 100% of compensation) 415(b) Limit on Annual Age 65 Annuity Benefits Payable Under a Defined Benefit Plan $210,000 (or, if less, 100% of average "high 3" compensation) 414(q) Dollar Amount for Determining Highly Compensated Employee Status $120,000 416(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.) $170,000 Social Security "Wage Base" for Plans Integrated with Social Security $118,500   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 (650-849-5385 and 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)   © 2015 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 13, 2015 |
Directors’ Duties & Responsibilities in Singapore

​ Being appointed to a company’s board of directors comes with serious duties and responsibilities. In Singapore, the Companies Act, Chapter 50 of Singapore ("Act"), is the main source of directors’ duties. Other sources of regulations include the Listing Manual ("Listing Manual") of the Singapore Exchange Securities Trading Limited and the Singapore Code on Take-Overs and Mergers ("Take-Over Code"). The regulatory climate of directors’ duties is evolving in Singapore. The Companies (Amendment) Act 2014 ("CA Amendments") was recently passed in October 2014. Overall, the changes reflect a commercial approach to directors’ duties in Singapore, recognising the need to liberalise the position in some areas while imposing stricter obligations in others. These changes will be implemented in two phases — the first phase from 1 July 2015 and the second phase from the first quarter of 2016 ("Q1 2016"). The Take-Over Code is also slated to be amended following a consultation paper issued by the Securities Industry Council ("SIC") on its proposed revisions. A detailed overview of directors’ duties and responsibilities in Singapore may be found HERE. This client alert summarises the following significant points in relation to the law on directors’ duties in Singapore as well as the latest regulatory changes:   Summary of directors’ duties and responsibilities Who is a director? The Act defines a "director" broadly to include any person occupying the position of director of a corporation by whatever name called. This would include executive directors, de facto directors, nonexecutive directors as well as independent directors. Alternate or substitute directors are also considered "directors" for which the duties and obligations under the Act would apply. Shadow directors are also likely to fall within the ambit of the Act even though it is not explicitly defined. However, the CA Amendments have since clarified that a director also includes a person in accordance with whose directions or instructions the directors or the majority of the directors of a corporation are accustomed to act. Appointment and qualifications of a director. Under the Act, a director must be a natural person, attain at least 18 years of age and have full legal capacity. In absence of any provision in the Act, the present position is that the company’s articles will provide for the appointment of directors. The CA Amendments will introduce a new provision to allow the appointment of a director by ordinary resolution passed at a general meeting, subject to any contrary provisions in the articles. The age limit of 70 years for directors will also be abolished. These changes will come into effect in Q1 2016. The following categories of persons would commit an offence under the Act if they act as directors: Undischarged bankrupts; Unfit directors of insolvent companies; Persons convicted of certain offences; Persistent default in delivering documents; and Being a director in not less than three companies which were struck off within a five-year period (new disqualification pursuant to the CA Amendments which will take effect in Q1 2016). Remuneration. Under the Act, a company is prohibited from compensating a director for loss of office or retirement unless shareholders’ approval has been sought. The CA Amendments provide an exception to this requirement where payment of compensation for termination of employment is provided in an agreement between the company and the director. These changes came into effect on 1 July 2015. The Governance Code also provides that a company’s board should establish a remuneration committee for the determination of a director’s remuneration. Fiduciary Duties of Directors, Disclosures and Conflicts of Interest. Directors are under a common law duty to act in good faith and in the interests of the company. The Act imposes both civil and criminal sanctions on directors in breach of their duties. Disclosure obligations are also imposed on directors under the Act. Examples under the Act include disclosure at a board meeting of any interest a director has in a transaction or proposed transaction with the company, disclosure of a director’s shareholdings in the company and in any related corporation etc. The Listing Manual and Governance Code also impose additional disclosure obligations on directors. Directors are also prohibited by the Act from engaging in certain transactions that may give rise to a conflict of interest. This includes loans to directors and companies controlled by them, subject to certain exceptions.  The CA Amendments will also extend these restrictions to quasi-loans, credit transactions and related arrangements. Exoneration of Directors. Generally, any attempt by the company to exempt or indemnify directors from any legal liability arising from negligence or breach or duty is void under the Act. In clarifying this restriction further, the CA Amendments will introduce a new provision to allow a company to indemnify a director against third parties’ liability if they do not fall within certain circumstances. These changes will come into effect in Q1 2016. However, the Act permits a company to purchase insurance policies for its directors to insure against any liability incurred by them except where the liability arises out of dishonest or wilful conduct. The Act further grants the court the power to relieve a director from liability for negligence, default, breach of duty or breach of trust. Likewise, shareholders of a company may choose to release a director from liability subject to certain limitations. Shareholders’ Remedies. The Act also provides recourse for disgruntled shareholders. Generally, shareholders may bring an action against the company if there is oppression or unfair discrimination of a shareholder or where a shareholder’s interests are disregarded. The courts had also pronounced in a recent case in Singapore that such a claim need not be based on a corporate wrong. Alternatively, a shareholder may also have recourse to the common law "proper plaintiff" rule which is codified under the Act. Accordingly, a complainant may apply to the court for leave to bring an action on behalf of the company. The CA Amendments expanded this provision to allow courts to grant leave to a complainant to commence arbitration in the name of the company. These changes came into effect on 1 July 2015. Directors’ duties under the Take-Over Code. The Take-Over Code clarifies a director’s duties under a take-over. In particular, the offeree board is prohibited from taking any action without shareholders’ approval that may frustrate a bona fide offer. The proposed amendments to the Take-Over Code seek to clarify this restriction further to provide that the solicitation of a competing offer would not amount to frustrating the original offer. The Take-Over Code also provides safeguards in relation to break fees, where directors are required to provide confirmations on certain matters to the SIC where a break fee is imposed. Other obligations imposed by the Take-Over Code include the need for directors to be provided with all information and relevant documents in connection with an offer, the need to consult the SIC in potential situations of conflict of interest, and the assumption of responsibility by directors for documents issued by the company. Conclusion As noted above, directors are subject to many onerous duties and responsibilities. This is due to the need to protect shareholders and those who deal with the company from the negligence or malfeasance of errant directors who often control the management of the company. Thus, while being a director brings with it a certain amount of prestige, it is not a position to be taken lightly. Instead, such an executive appointment should only be assumed by those with a wealth of experience in business and management in order to run a company competently. Please click below for a detailed overview of directors’ duties and responsibilities in Singapore:      Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work or any of the following:    Robson Lee – Singapore (+65.6507.3684, rlee@gibsondunn.com)Grace Chow – Singapore (+65.6507.3632, gchow@gibsondunn.com)Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com) © 2015 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.