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On February 26, 2021, the Board of Governors of the Federal Reserve System (Federal Reserve) issued a Supervision and Regulation letter[1] containing its final supervisory guidance (Effectiveness Guidance) on the effectiveness of a banking institution’s board of directors.  The Guidance applies to bank holding companies and savings-and-loan holding companies with total consolidated assets of $100 billion or more, with the exception of intermediate holding companies of foreign banking organizations (IHCs).  A separate Supervision and Regulation letter issued the same day revised twelve prior Supervision and Regulation letters touching on the subject and made nine additional prior Supervision and Regulation letters inactive.[2]

In keeping with recent banking agency views on supervisory “guidance” generally,[3] the Effectiveness Guidance, in its final form, is less prescriptive than in the Federal Reserve’s 2017 proposal (Effectiveness Proposal).[4]  The Federal Reserve states that the Effectiveness Guidance thus reflects the Federal Reserve’s “observ[ations] over time” regarding the attributes of effective boards of directors and seeks to eschew “standardized” expectations.  This said, the Federal Reserve also declares that “[a]s the board effectiveness guidance builds on the principles set forth in the large financial institution ratings framework, the Federal Reserve intends to use the board effectiveness guidance in informing its assessment of the governance and controls at all firms subject to the large financial institution rating system.”[5]

As a result, it is reasonable to conclude that these new principles of board effectiveness, although stated in guidance form, will become an important standard for determining whether, in Federal Reserve assessments, a board of directors of a large financial institution is meeting regulatory expectations with respect to the firm’s governance.

Federal Reserve’s Key Principles of an Effective Board

The Effectiveness Guidance sets forth five principles that it deems important for a board of directors to be effective.  These are:

• Setting a Clear, Aligned and Consistent Direction Regarding Firm Strategy and Risk Appetite
• Directing Senior Management Regarding the Board’s Information Needs
• Overseeing and Hold Senior Management Accountable
• Supporting the Independence and Stature of Independent Risk Management and Internal Audit
• Maintaining a Capable Board Composition and Governance Structure

A. Setting a Clear, Aligned and Consistent Direction Regarding Firm Strategy and Risk Appetite

The Effectiveness Guidance emphasizes the importance of the alignment of a firm’s strategy to its risk appetite.  The Federal Reserve defines “risk appetite” as “the aggregate level and types of risk the board and senior management are willing to assume to achieve the firm’s strategic business objectives, consistent with applicable capital, liquidity, and other requirements and constraints.”  Overseeing such an alignment is a critical board function.

The takeaway on this attribute is that risk management should be an integral part of a firm’s business strategy – the Federal Reserve believes that a business strategy untethered to effective risk management is not a good practice.  This point may be seen in the Federal Reserve’s description of appropriately “clear” business strategies:  such strategies help to “establish and maintain an effective risk management structure, appropriate processes for each . . . risk management function, and an effective risk management and control function.”  So too, when discussing entering into new business lines, the Effectiveness Guidance states that a “clear strategy explains how conducting the business would be consistent with the firm’s risk appetite and changes that would need to be made to the firm’s risk management program and controls.”

An effective board of directors, therefore, regularly evaluates the development of a firm’s business so that risk management keeps up with business goals.  This is in addition to required board reviews of capital planning, recovery and resolution planning, audit plans, enterprise-wide risk management policies, liquidity risk management, compliance risk management, and compensation programs.

B. Directing Senior Management Regarding the Board’s Information Needs

In the aftermath of the Financial Crisis, as board oversight became subject to greater regulatory scrutiny, the information provided to regulated institutions’ boards increased substantially.  The Effectiveness Guidance notes as an attribute of effective boards that such boards direct senior management to provide sufficient, high-quality information in order to make well-informed decisions, including on “potential risks.”

The Effectiveness Guidance does not, however, stop with management reports.  It notes that effective directors actively seek out information in other ways – through special board sessions, outreach to the firm’s chief executive officer and his or her direct reports, and, interestingly, discussions with “Federal Reserve senior supervisors.”

The Effectiveness Guidance also notes that directors of an effective board, “particularly the lead independent director or independent board chair or committee chairs,” take an active role in setting board and committee agendas.  Here again, the concern with risk is paramount:  the Federal Reserve gives as an example if the topic is growth into a new business, “an effective board typically discusses the firm’s risk management and control capabilities that reflect the views of the independent risk management and internal audit function.”

C. Overseeing and Holding Senior Management Accountable

In the Federal Reserve’s view, an effective board of directors is not limited in the ways in which it holds senior management accountable.  There must be sufficient time in board meetings for candid discussion and debate and the hearing of diverse views – particularly around risk.  The Effectiveness Guidance indicates that incomplete information, and identified weaknesses, are to be thoroughly challenged before management recommendations can be approved.  It also indicates that for effective boards, the following areas demand “robust inquiry”:

• drivers, indicators and trends related to current and emerging risks;

• adherence to the board-approved strategy and risk appetite by business lines; and

• material or persistent deficiencies in risk management or control practices.

The Federal Reserve further states that an effective board reviews reports of internal and external complaints, including “whistleblower” reports.

Another key to appropriate management oversight is sufficiently empowered independent directors.  For example, the Federal Reserve notes that where a firm has an executive chair of the board of directors, an effective board may give a lead independent director the power to call board meetings with or without the chair present as a means of counteracting management influence.

For the Federal Reserve, effective boards also carefully consider senior management compensation, including the degree to which management “promot[es] compliance with laws and regulations, including those related to consumer protection.”  Performance objectives include nonfinancial objectives for both business line executives (including the chief executive officer) and the chief risk officer and chief audit executive; in the case of the latter two executives, only nonfinancial objectives are considered.

Once again, risk concerns are paramount to the Federal Reserve:  “[p]erformance management and compensation systems, when combined with business strategies, discourage risk-taking inconsistent with the firm’s strategy and safety and soundness, including compliance with laws, regulations and internal standards, and promote the firm’s risk management goals.”  The Effectiveness Guidance also notes that depending on the size, complexity, and nature of the firm, formalized board succession planning can go beyond planning for the firm’s chief executive officer and include the chief risk officer and chief audit executive, “given the independence of those positions and the control function each serves.”  This is an area where the Effectiveness Guidance reflects supervisory experience that goes beyond legal constraints such as the New York Stock Exchange Rules and their CEO-only requirement.

D. Supporting the Independence and Stature of Independent Risk Management and Internal Audit

The Effectiveness Guidance also describes the attributes of effective risk committees and effective audit committees.  The Federal Reserve states that an effective audit committee engages in “robust inquiry” into, among other things:

• the causes and consequences of material or persistent breaches of the firm’s risk appetite and risk limits;

• the timeliness of remediation of material or persistent internal audit and supervisory findings; and

• the appropriateness of the annual audit plan.

In the Federal Reserve’s view, an effective audit committee also meets directly with the chief audit executive, supports internal audit’s budget, staffing and internal controls, and reviews the status of actions recommended by internal and external auditors to remediate material or persistent deficiencies.

As for an effective risk committee, the Effectiveness Guidance states that it too engages in robust inquiry about the above subjects and further:

• communicates directly with the chief risk officer on material risk management issues;

• oversees the appropriateness of independent risk management’s budget, staffing, and internal control systems;

• coordinates with the compliance function;

• provides independent risk management with direct and unrestricted access to the risk committee; and

• after reviewing the risk management framework relative to the firm’s structure, risk profile, complexity, activities and size, effects changes that align with the firm’s strategy and risk appetite.

Finally, the Federal Reserve indicates that an effective board of directors steps in when internal audit and independent risk management are unduly influenced by business lines, and if the views of internal audit and independent risk management are not taken into account when management decisions are made.

E. Maintaining a Capable Board Composition and Governance Structure

The final attribute of an effective board is maintaining a capable composition and governance structure – including “a process to identify and select potential director nominees with a mix of skills, knowledge, experience and perspectives.”  In an addition from the Effectiveness Proposal, the final Guidance states explicitly that a diverse pool of nominees “includ[es] women and minorities.”  Other aspects that support an effective governance structure are appropriate committees and management-to-committee reporting lines.  Finally, an effective board engages in evaluating on an ongoing basis its own strengths and weaknesses, including the performance of board committees, and, specifically, the audit and risk committees.

Conclusion

For those who have followed developments in bank governance, the Effectiveness Guidance does not contain many surprises.  The Federal Reserve’s view – which holds true with respect to its approach to senior management as well – is that the constraints imposed by general corporate law and stock exchange requirements do not necessarily appropriately balance business goals with prudent risk taking, and therefore other checks on the profit making function are necessary to further safety and soundness.  Although a firm’s independent risk management and internal audit are helpful in this regard, those functions need continual reinforcement from a well-informed board and well-informed board committees that keep all forms of risk at the forefront of their consideration and robustly challenge management.

As a result, although firms subject to the Effectiveness Guidance may be judged somewhat particularly given their size and risk profile in supervisory assessments, those firms should not take individualized examination consideration to mean that they should ignore the principles that the Federal Reserve has articulated.  Indeed, to the extent that particular policies and practices at a covered firm do not take into account and reflect these principles, a firm may wish to consider the reasons for taking a different approach and determine whether its current practices achieve the Federal Reserve’s overall goal of effectively overseeing risk.

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   [1]   Federal Reserve, SR Letter 21-3/CA 21-1: Supervisory Guidance on Board of Directors' Effectiveness (February 26, 2021), available at https://www.federalreserve.gov/supervisionreg/srletters/SR2103.htm.

   [2]   Federal Reserve, SR Letter 21-4/CA 21-2: Inactive or Revised SR Letters Related to the Federal Reserve’s Supervisory Expectations for a Firm’s Boards of Directors (February 26, 2021).  The purpose of the revisions was to align statements made about boards of directors with the Effectiveness Guidance.  The letters rendered inactive were generally described as providing outdated guidance on their subjects.

   [3]   See, e.g., Joint Press Release, “Agencies propose regulation on the role of supervisory guidance” (October 29, 2020).

   [4]   Federal Reserve, “Proposed Guidance on Supervisory Expectation for Board of Directors,” 82 Federal Register 37,219 (August 9, 2017).

   [5]   Such “large financial institutions” include the firms subject to the Effectiveness Guidance, as well as greater than $50 billion asset IHCs.

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The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long and Elizabeth Ising.

Gibson Dunn’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, the authors, or any of the following members of the firm’s Financial Institutions or Securities Regulation and Corporate Governance practice groups:

Financial Institutions Group: Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com) Mylan L. Denerstein – New York (+1 212-351- 3850, mdenerstein@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)

Securities Regulation and Corporate Governance Group: Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com) Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, ctillinghast@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Click for PDF On February 24, 2021, Allison Herren Lee, Acting Chair of the Securities and Exchange Commission (“SEC”), issued a statement titled “Statement on the Review of Climate-Related Disclosure” that “direct[s] the Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings” (the “Climate Change Statement”).[1]  The Climate Change Statement expressly builds on the interpretive guidance that the SEC previously issued in 2010 regarding how the SEC’s existing principles-based disclosure requirements apply to climate change matters (the “2010 Climate Change Guidance”).[2]  This alert reviews the Climate Change Statement, the SEC’s 2010 Climate Change Guidance, and other recent developments regarding climate change disclosures, and it addresses what public companies should consider going forward. Overview of the Climate Change Statement The Climate Change Statement explains that “[n]ow more than ever, investors are considering climate-related issues when making their investment decisions” and that it is the SEC’s “responsibility to ensure that they have access to material information when planning for their financial future.”  To that end, the Climate Change Statement announces that the SEC and its staff will take “immediate steps” to “[e]nsur[e] compliance with the rules on the books, and updat[e] existing guidance” as part of “the path to developing a more comprehensive framework that produces consistent, comparable, and reliable climate-related disclosures.”  Specifically, as part of their “enhanced focus in this area,” the SEC staff “will review the extent to which public companies address the topics identified in the [2010 Climate Change Guidance], assess compliance with disclosure obligations under the federal securities laws, engage with public companies on these issues, and absorb critical lessons on how the market is currently managing climate-related risks.”  The Climate Change Statement also notes that the SEC staff “will use insights from this work to begin updating the [2010 Climate Change Guidance] to take into account developments in the last decade.” Overview of the 2010 Climate Change Guidance The 2010 Climate Change Guidance referenced in the Climate Change Statement is an interpretative release issued by the SEC clarifying how existing SEC disclosure rules[3] may require public companies to describe climate change matters.[4]  The 2010 Climate Change Guidance notes four topics in particular that may trigger climate change disclosure under the SEC’s rules: 1. The impact of climate change legislation and regulation.  The 2010 Climate Change Guidance notes that companies should consider the impact of existing (and in some circumstances, pending) legislation and regulation related to climate change both in the United States and globally. 2. The impact of international climate change accords.  The 2010 Climate Change Guidance advises companies to consider, and disclose under existing SEC rules where material, the impact of international accords relating to climate change. 3. Indirect consequences of climate change regulation or business trends.  The 2010 Climate Change Guidance indicates that companies should consider actual and potential indirect consequences of climate change-related regulation and business trends. 4. The physical impacts of climate change.  The 2010 Climate Change Guidance also states that companies should consider actual or potential impacts of the physical effects of climate change on their business. The 2010 Climate Change Guidance appeared to have dramatically impacted public company disclosures regarding climate change:  the number of S&P 500 companies mentioning climate change and/or greenhouse gas(es) in their Annual Reports on Form 10-K approximately doubled from the one year prior to the one year after the release of the 2010 Climate Change Guidance.[5]  However, the 2010 Climate Change Guidance was not a focus of SEC staff comments in the years that followed.  According to a 2018 Government Accountability Office report (the “GAO Report”), the SEC staff issued a limited number of climate change comments to public companies and often without citing the 2010 Climate Change Guidance.[6]  For example, the GAO Report noted that based on a review of SEC filings by companies in five industries particularly “affected by climate change-related matters” (oil and gas, mining, insurance, electric and gas utilities, and food and beverage), the SEC staff issued only 14 comment letters relating to climate-related disclosures to 14 companies, out of the over 41,000 comment letters issued from January 1, 2014, through August 11, 2017.[7] What Companies Should Do Now In light of Acting Chair Lee’s Climate Change Statement and its emphasis on compliance with existing SEC regulation, including the 2010 Climate Change Guidance, public companies should: 1. As part of the company’s disclosure controls and procedures, review the existing process for assessing the materiality of climate change matters to the company and determine whether any additional climate change disclosures should be included in their SEC filings. The process should include discussions among the company’s securities law counsel, environment/safety/health, sustainability and government relations personnel and members of the company’s disclosure committee.  Companies that will file their Annual Reports on Form 10-K in the coming weeks should in particular review their disclosures in light of the Statement and the 2010 Climate Change Guidance. However, it is important to note that the Statement was released after many large accelerated filers had already filed their 2020 Annual Reports on Form 10-Ks.  That said, the number of S&P 500 companies now mentioning climate change and/or greenhouse gas(es) in their Annual Reports on Form 10-K has approximately doubled when compared to the one year after the release of the 2010 Climate Change Guidance.[8]  In addition, as disclosures become more granular and science-based, it is important to avoid unintentionally including statements that would need to be “expertized” under the Securities Act without following appropriate related procedures. 2. Assess the company’s other public climate change disclosures (e.g., state- and EPA-mandated disclosures, voluntary disclosures in sustainability reports and to third-party organizations like the CDP, and disclosures on websites and in investor presentations). Companies have increased the scope and quantity of voluntary ESG disclosures over the last decade, often in response to stakeholders and in an attempt to address the many surveys and other data requests from entities that rate companies’ ESG practices.  While many of these disclosures may not be material under the federal securities laws, the increasing focus on ESG matters may lead to SEC staff comments regarding their absence from issuers’ SEC filings.[9]  For example, in 2016, the SEC staff issued a comment letter that quoted text from a company’s CDP Report[10] and a different comment letter that referenced disclosures in a company’s sustainability report.[11] 3. Evaluate whether additional disclosure controls are needed around the company’s other public climate change disclosures, particularly with respect to voluntary disclosures. Companies should carefully evaluate their disclosure controls and procedures that are in place for reviewing and approving public disclosures regarding climate change.  This is important both because the SEC staff may now review such disclosures and comment on whether they should be included in SEC filings, but also because—whether presented on an investor relations website or not—it may now be more likely that investors will review and potentially even rely on such statement (or at least that plaintiffs’ lawyers may claim so in hindsight).  Among other things, companies should evaluate whether each of their statements are verifiable, make sure that goals and aspirations are clearly stated as such as opposed to being stated as accomplished facts, and remove any materially misleading statements or omissions.  Companies should consider including forward-looking statement disclaimers with any statement of goals or intentions.[12] 4. Monitor regulatory and legislative developments on greenhouse gas and climate change matters at the international, Federal, state and regional levels, and assess the potential impact of such developments on the company’s business. Public policy responses to climate change are rapidly developing internationally and in the United States.  This is especially the case given recent actions by President Joseph Biden related to the United States rejoining the Paris Agreement (an agreement within the United Nations Framework Convention on Climate Change) and promised additional actions in his January executive orders[13] addressing climate change.[14]  Companies will need to stay informed of these developments and continue to assess their impact on the risks and opportunities presented by climate change. 5. Prepare for additional SEC disclosure requirements related to climate change and ESG matters. In their dissenting statement issued in connection with the adoption of Regulation S-K amendments in November 2020, Acting Chair Lee and the other Democratic Commissioner Caroline Crenshaw noted that “[w]e have an opportunity going forward to address climate, human capital, and other ESG risks, in a comprehensive fashion with new rulemaking specific to these topics,” possibly providing a glimpse of what to expect from a new Democratic-controlled SEC.[15] Commissioners Lee and Crenshaw also suggested an internal task force and ESG Advisory Committee dedicated to building upon the recommendations of leading organizations, such as the Task Force on Climate-Related Financial Disclosures, and to defining a clear plan to address sustainable investing. Recent senior SEC appointments already signal that climate and other ESG matters will be priorities at the SEC during the Biden Administration—including Acting Chairman Lee’s appointment of the SEC’s first-ever senior policy adviser on “climate and ESG” matters earlier this month.[16]  Another recent appointee, Acting Director of the Division of Corporation Finance John Coates, was a member of the SEC’s Investor Advisory Committee when it urged the SEC to update its disclosure requirements to include “material, decision-useful, ESG factors” in May 2020.[17]  More recently, Acting Director Coates told financial industry members at a conference on climate how the SEC can help create “a cost-effective and flexible disclosure system,” adding that “[s]omething like that is clearly increasingly necessary to the capital markets at the center of our global economy to adequately price climate and other ESG risks and opportunities.”[18]  In a recent interview about ESG disclosure and related rulemaking, Acting Director Coates said that, “[i]f I were to pick a single new thing that I’m hoping the SEC can help on, it would be this area.”[19] Public companies should also note that legislation in the U.S. Congress would mandate additional climate change-related disclosures.  For example, the House Financial Services Committee’s Subcommittee on Investor Protection, Entrepreneurship and Capital Markets last week held a hearing[20] on several bills that would require additional climate change disclosures in SEC filings, including:

• the “Climate Risk Disclosure Act of 2021,”[21] which would amend the Exchange Act to require issuers to disclose in SEC filings various climate change-related risks and require the SEC to adopt rules mandating certain other climate change-related disclosures such as “input parameters, assumptions and analytical choices to be used in climate scenario analyses”; and
• the “Paris Climate Agreement Disclosure Act,”[22] which would amend the Exchange Act to require disclosures related to the Paris Climate Agreement, including “[w]hether the issuer has set, or has committed to achieve, targets that are a balance between greenhouse gas emissions and removals, at a pace consistent with limiting global warming to well below 2 degrees Celsius and pursuing efforts to limit it to 1.5 degrees Celsius” (or if it is committed to setting such targets in the future or, if it is not, a statement to that effect and a detailed explanation as to why and whether it supports the Paris Agreement’s temperature goals).

____________________ [1] Allison Herren Lee, Statement on the Review of Climate-Related Disclosure (February 24, 2021), available at https://www.sec.gov/news/public-statement/lee-statement-review-climate-related-disclosure. [2] Securities and Exchange Commission, Commission Guidance Regarding Disclosure Related to Climate Change (17 CFR PARTS 211, 231 and 241; Release Nos. 33-9106; 34-61469; FR-82), available at http://www.sec.gov./rules/interp/2010/33-9106.pdf. [3] The key rules addressed are in Regulation S-K:  Item 101 (Description of Business); Item 103 (Legal Proceedings); Item 303 (Management’s Discussion of Financial Condition and Results of Operations (MD&A)); and Item 503(c) (Risk Factors). [4]  For additional information, see Gibson Dunn, SEC Issues Interpretive Guidance on Climate Change Disclosures (February 4, 2010), available at https://www.gibsondunn.com/sec-issues-interpretive-guidance-on-climate-change-disclosures/. [5]   Based on an Intelligize search of S&P 500 companies’ Forms 10-K filed between February 1, 2009 and February 1, 2010 (82 filings) compared to February 2, 2010 to February 1, 2011 (167 filings). [6]  United States Government Accountability Office, Climate-Related Risks: SEC Has Taken Steps to Clarify Disclosure Requirements (February 2018) (the “GAO Report”), available at https://www.gao.gov/assets/700/690197.pdf. [7]  Id. at 14. [8]  Based on an Intelligize search of S&P 500 companies’ Forms 10-K filed between February 2, 2010 to February 1, 2011 (167 filings) compared to February 1, 2020 to February 1, 2021 (329 filings). [9]  As noted in the GAO Report, one of the challenges the SEC staff faces in reviewing climate change-related and other disclosure in companies’ SEC filings is that the “SEC relies primarily on information that companies determine is material [and] may not have details of the information companies used to support their determination of material climate-related risks.”  GAO Report, supra note 6, at 16. [10] See comment letter to Anadarko Petroleum dated September 16, 2016 stating “Please reconcile this assertion in your proxy statement with your description of the climate change risks from your CDP Report as having a ‘high’ impact on your business and provide your analysis as to why you believe such ‘uncertaint[ies]’ do not constitute ‘known trends or . . . uncertainties’ requiring disclosure pursuant to Item 303(a) of Regulation S-K,’” available at https://www.sec.gov/Archives/edgar/data/773910/000000000016093302/filename1.pdf. [11] See comment letter to Mettler Toledo International dated March 23, 2016 inquiring about operations in Sudan and Syria and noting “[t]he 2014 Sustainability Report posted on your website states that you have largely ceased business in Sudan,” available at https://www.sec.gov/Archives/edgar/data/1037646/000000000016069396/filename1.pdf. [12] For additional information, see Gibson Dunn and the Society for Corporate Governance, ESG Legal Update:  What Corporate Governance and ESG Professionals Need to Know (June 2020), available at https://www.gibsondunn.com/wp-content/uploads/2020/10/Ising-Meltzer-McPhee-Percopo-Assaf-Holmes-ESG-Legal-Update-What-Corporate-Governance-and-ESG-Professionals-Need-to-Know-Society-for-Corporate-Governance-06-2020.pdf [13] The White House, FACT SHEET: President Biden Takes Executive Actions to Tackle the Climate Crisis at Home and Abroad, Create Jobs, and Restore Scientific Integrity Across Federal Government (January 27, 2021), available at https://www.whitehouse.gov/briefing-room/statements-releases/2021/01/27/fact-sheet-president-biden-takes-executive-actions-to-tackle-the-climate-crisis-at-home-and-abroad-create-jobs-and-restore-scientific-integrity-across-federal-government/. [14] For additional information, see Gibson Dunn, President Biden Issues Executive Orders on Climate Change Policy (February 9, 2021) (the “Climate Change Alert), available at https://www.gibsondunn.com/president-biden-issues-executive-orders-on-climate-change-policy/. [15] Allison Herren Lee and Caroline A. Crenshaw, Joint Statement on Amendments to Regulation S-K: Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information (November 19, 2020), available at https://www.sec.gov/news/public-statement/lee-crenshaw-statement-amendments-regulation-s-k. [16] Securities and Exchange Commission, Satyam Khanna Named Senior Policy Advisor for Climate and ESG (February 1, 2021), available at https://www.sec.gov/news/press-release/2021-20. [17] Al Barbarino, SEC To Drill Down On Co[mpanies’] Climate-Related Risk Disclosures (Law360, February 25, 2021), available at https://www.law360.com/articles/1358615/sec-to-drill-down-on-cos-climate-related-risk-disclosures. [18] Bloomberg Law Staff, ESG Reporting Top Priority for SEC Director on Leave From Harvard (February 24, 2021), available at https://news.bloomberglaw.com/environment-and-energy/esg-reporting-top-priority-for-sec-director-on-leave-from-harvard. [19] Id. (quoting Acting Director Coates). [20] U.S. House Committee on Financial Services, Virtual Hearing: Climate Change and Social Responsibility: Helping Corporate Boards and Investors Make Decisions for a Sustainable World, (accessed February 24, 2021), available at https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=407109. [21] See Climate Risk Disclosure Act of 2021 (Discussion Draft) (January 26, 2021), available at https://financialservices.house.gov/uploadedfiles/02.25_bills-1173ih.pdf. [22] See Paris Climate Agreement Disclosure Act (Discussion Draft) (February 17, 2021), available at https://financialservices.house.gov/uploadedfiles/02.25_bills-1176ih.pdf.

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The following Gibson Dunn attorneys assisted in preparing this client update:  Hillary Holmes, Elizabeth A. Ising, Thomas J. Kim, Ronald O. Mueller, Lori Zyskowski, Julia Lapitskaya, and Stefan Koller. Gibson Dunn’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, the authors, or any of the following leaders and members of the firm’s Securities Regulation and Corporate Governance or ESG practice groups. Securities Regulation and Corporate Governance Group: Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney – Orange County, CA (+ 949-451-4343, jmoloney@gibsondunn.com) Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com) Brian J. Lane – Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com) Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com) Michael A. Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com) Environmental, Social and Governance (ESG) Group: Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com) Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Perlette M. Jura – Los Angeles (+1 213-229-7121, pjura@gibsondunn.com) Ronald Kirk – Dallas (+1 214-698-3295, rkirk@gibsondunn.com) Michael K. Murphy – Washington, D.C. (+1 202-955-8238, mmurphy@gibsondunn.com) Selina S. Sagayam – London (+44 (0) 20 7071 4263, ssagayam@gibsondunn.com) Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) © 2021 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Our panelists discuss significant recent developments and forecast what to expect from the new U.S. presidential administration on topics ranging from data privacy and cybersecurity to antitrust, corporate governance, international trade, money laundering, securities fraud, white collar defense and investigations, and more. Our panelists also will provide practical tips for identifying and addressing key compliance risks and strengthening corporate compliance programs. Topics to be discussed include:

• Global Enforcement and Regulatory Developments
• The Biden Administration’s Expected Approach to Enforcement and Regulation
• Practical Recommendations for Improving Corporate Compliance
• DOJ and SEC Priorities, Policies, and Penalties
• Update on Key Governance Issues and Regulatory Requirements

View Slides (PDF)

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MODERATOR: Joseph Warin, a partner in Washington, D.C., is Co-Chair of the firm’s White Collar Defense and Investigations practice and former Assistant U.S. Attorney in Washington, D.C. Mr. Warin is consistently recognized annually in the top-tier by Chambers USA, Chambers Global, and Chambers Latin Americafor his FCPA, fraud and corporate investigations acumen.  In 2018 Mr. Warin was selected by Chambers USAas a “Star” in FCPA, and “a “Leading Lawyer” in the nation in Securities Regulation: Enforcement.  Global Investigations Review reported that Mr. Warin has now advised on more FCPA resolutions than any other lawyer since 2008.  Who’s Who Legal and Global Investigations Review named Mr. Warin to their 2016 list of World’s Ten-Most Highly Regarded Investigations Lawyers based on a survey of clients and peers, noting that he was one of the “most highly nominated practitioners,” and a “’favourite’ of audit and special committees of public companies.”  Mr. Warin has handled cases and investigations in more than 40 states and dozens of countries.  His credibility at DOJ and the SEC is unsurpassed among private practitioners — a reputation based in large part on his experience as the only person ever to serve as a compliance monitor or counsel to the compliance monitor in three separate FCPA monitorships, pursuant to settlements with the SEC and DOJ: Statoil ASA (2007-2009); Siemens AG (2009-2012); and Alliance One International (2011-2013). PANELISTS: Roscoe Jones, a counsel in Washington, D.C., is a member of the firm’s Public Policy, Congressional Investigations, and Crisis Management groups. Mr. Jones formerly served as Chief of Staff to U.S. Representative Abigail Spanberger, Legislative Director to U.S. Senator Dianne Feinstein, and Senior Counsel to U.S. Senator Cory Booker, among other high-level roles on Capitol Hill. Thomas Kim, a partner in Washington, D.C., is a member of the firm’s Securities Regulation and Corporate Governance Practice Group. Mr. Kim focuses his practice on advising companies, underwriters and boards of directors on registered and exempt capital markets transactions, SEC regulatory and reporting issues, and corporate governance, as well as on general corporate and securities matters. Mr. Kim served for six years as the Chief Counsel and Associate Director of the Division of Corporation Finance at the SEC. Kristen Limarzi, a partner in Washington, D.C., focuses on investigations, litigation, and counseling on antitrust merger and conduct matters, as well as appellate and civil litigation. Ms. Limarzi previously served as the Chief of the Appellate Section of the U.S. Department of Justice’s Antitrust Division, where she led a team of more than a dozen professionals litigating appeals in the Division’s civil and criminal enforcement actions and participating as amicus curiae in private antitrust actions. Jason J. Mendro, a partner in Washington, D.C., represents clients in wide-ranging shareholder disputes, including securities class actions, challenges to mergers and acquisitions, and derivative lawsuits alleging breaches of fiduciary duties.  Mr. Mendro also advises boards of directors and special litigation committees in conducting internal investigations and addressing shareholder litigation demands.  He has earned national recognition, being named “Litigator of the Week” by The American Lawyer and a “Rising Star” by Law360 and Super Lawyers. Adam M. Smith, a partner in Washington, D.C., was the Senior Advisor to the Director of the U.S. Treasury Department’s OFAC and the Director for Multilateral Affairs on the National Security Council. His practice focuses on international trade compliance and white collar investigations, including with respect to federal and state economic sanctions enforcement, the FCPA, embargoes, and export controls. He routinely advises multi-national corporations regarding regulatory aspects of international business. Lori Zyskowski, a partner in New York, is Co-Chair of the firm’s Securities Regulation and Corporate Governance practice. She was previously Executive Counsel, Corporate, Securities & Finance at GE.  She advises clients, including public companies and their boards of directors, on a wide variety of corporate governance and securities disclosure issues, and provides a unique perspective gained from over 12 years working in-house at S&P 500 corporations. Lora MacDonald, an associate in Washington, D.C., practices in the firm’s Litigation Department, focusing on white collar criminal defense and internal investigations. Ms. MacDonald has experience conducting internal investigations and advising clients on compliance with the FCPA and other anti-corruption laws. She also assists clients under investigation by the World Bank Integrity Vice Presidency and companies already subject to World Bank sanction.

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As we do each year, we offer our observations on new developments and recommended practices for calendar-year filers to consider in preparing their Form 10-K. In addition to the many challenges of the past year, the U.S. Securities and Exchange Commission (“SEC”) adopted and provided guidance on a number of changes to public company reporting obligations impacting disclosures in the 10-K annual report for 2020. In particular, we discuss the recent amendments to Regulation S-K, disclosure considerations in light of COVID-19, a number of technical considerations that may impact your Form 10-K annual report, and other considerations in light of recent and pending changes in the executive branch and at the SEC.

An index of the topics described in this alert is provided below.

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Table of Contents

I. Amendments to Regulation S-K Requirements

A. Amendments to 100 Series of Regulation S-K Requirements (Part I of Form 10-K)

1. Business (Part I, Item 1 of For 10-K)

a. General Development of Business b. Description of Business c. Spotlight on Human Capital Disclosure.

2. Legal Proceedings (Part I, Item 3 of Form 10-K)

3. Risk Factors (Part I, Item 1A of Form 10-K)

a. Organization of Risk Factors under Headings b. “Materiality” Replaces “Most Significant” Standard c. Risk Factor Summary d. Cautionary Note about Hypothetical Language

B. Amendments to 300 Series of Regulation S-K Requirements (Part II of Form 10-K)

1. Selected Financial Data (Part II, Item 6)

2. Supplementary Financial Data (Part II, Item 8)

3. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Part II, Item 7)

a. New Item 303(a) – Objectives of MD&A. b. Amended Item 303(b) – Full Fiscal Year Presentation c. Amended Item 303(b) – Items no Longer Required d. Amended Item 303(b) – Clarification on Discussion of “Underlying Reasons” for Period-to-Period Changes e. Amended Item 303(b) – A Note on Product Lines f. New Item 303(c) – Interim Period Discussion.

II. COVID-19 Disclosure Considerations

A. Impact on Management’s Discussion and Analysis of Financial Condition and Results of Operations

B. Impact on Risk Factors

C. Impact on Non-GAAP Financial Measures

III.   Other Considerations and Reminders

A. Key Performance Indicators (KPIs)

B. Impact of Changes to Filer Definitions

C. Omitting Third Year of MD&A

D. Exhibit List Reminders

1. Exhibit 4 – Description of registered securities 2. No lookback period for material contracts 3. Omission of schedules to exhibits 4. Omission of information from exhibits without confidential treatment request 5. Exhibit 22 – List of guarantors

E. Extending confidential treatment

F. E-signature Rules

G. Cover Page Changes

H. Critical Accounting Matters

I. Updates to Disclosure Controls and Procedures

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I.   Amendments to Regulation S-K Requirements

A.   Amendments to 100 Series of Regulation S-K Requirements (Part I of Form 10-K)

As discussed in our prior client alert,[1] in August 2020, the SEC adopted amendments to Item 101 (Description of Business), Item 103 (Legal Proceedings) and Item 105 (Risk Factors) designed to result in improved disclosure that is tailored to reflect a company’s particular circumstances (the “Business Disclosure Amendments”).[2] These rules went into effect on November 9, 2020, making the upcoming Form 10-K the first SEC filing for which most calendar-year filers will need to implement these new rules.

1.  Business (Part I, Item 1 of For 10-K)

The recent amendments to Item 101 of Regulation S-K (Description of Business) introduce flexibility by replacing certain prescriptive requirements with a more principles-based approach. The amendments also introduce a new area of focus: human capital management.

a.   General Development of Business

Principles-based approach. Item 101(a) of Regulation S-K focuses on the general development of a company’s business. The Business Disclosure Amendments make the general development of business disclosure more principles-based: first, by providing a non-exclusive list of topics that a company may need to disclose; and second, by requiring disclosure of a topic only to the extent such information is material to an understanding of the general development of a company’s business.

General development disclosure topics. Three of the four disclosure topics in the non-exclusive list should be familiar to companies from the pre-amendment requirements: (1) bankruptcy or similar proceedings; (2) material reclassification or mergers, and (3) acquisitions / dispositions of material amount of assets. The fourth (new) topic relates to material changes to a previously disclosed business strategy. In its final rule, the SEC declined to define “business strategy” in order to allow companies to tailor such disclosure as appropriate for their business. The SEC emphasized that the new principles-based approach to this disclosure should mitigate any disincentives in disclosing a business strategy as companies have the flexibility to determine the appropriate level of detail for such disclosure based on materiality.

No longer required. The Business Disclosure Amendments delete the requirement in Item 101(a) of Regulation S-K to disclose the company’s year and form of organization and any material changes in the mode of conducting business. In addition, the Business Disclosure Amendments eliminate the five-year prescribed timeframe for disclosure of general developments of the business, allowing companies to focus on the aspects of the development of their business they deem material, regardless of when the developments occurred.

Updates only in lieu of full discussion. The Business Disclosure Amendments eliminate the requirement to provide a full discussion of the general developments of the business each time Item 101 disclosure is required. Instead a company can provide “an update to the general development of its business, disclosing all of the material developments that have occurred since the most recent registration statement or report that includes a full discussion of the general development of its business.” If the company provides these updates only, it must also incorporate by reference (including an active hyperlink) the relevant disclosure from such registration statement or report with the latest full discussion of the general development of the business. The SEC staff has explained that it anticipates that this updating method will apply mainly to registration statements.[3] Companies are cautioned that using the updating method in a Form 10-K is likely to cause incorporation issues for registration statements and subsequent Form 10-K filings. Accordingly, including a full description, as opposed to providing an update, is a cleaner, simpler approach that is likely no more burdensome than merely disclosing updates.

b.   Description of Business

Principles-based approach. Continuing with the principles-based approach, Item 101(c) of Regulation S-K was also updated to provide a non-exclusive list of the types of information that a company may need to disclose if material to an understanding of the business. This approach is in lieu of the 12 enumerated disclosure topics, some of which the SEC noted may not be relevant to all companies. Item 101(c) now focuses on seven disclosure topics, and continues to distinguish between topics for which segment disclosure should be the primary focus, and those for which the focus should be on the company’s business taken as a whole. It should be noted that under the principles-based approach, companies would have to provide disclosure about any other topics regarding their business as well if they are material to an understanding of the business and not otherwise disclosed. A discussion of the seven topics is set forth below.

Segment-level disclosure topics. For the following topics, companies should provide this information with a focus on their reporting segments. Note that when describing each segment, only information material to an understanding of the business taken as a whole is required.

1. “Revenue-generating activities, products and/or services, and any dependence on revenue-generating activities, key products, services, product families or customers, including governmental customers.”

This principles-based requirement replaces the prior line-item requirements related to (i) principal products and services and principal markets and methods of distribution, (ii) quantitative disclosure around the percentage of total revenue attributable to a class of product or services, and (iii) disclosure of key customers. Companies should take this opportunity to carefully comb through the disclosures that have historically been included in the Business section to confirm that the information and any metrics provided are still material and to determine whether it would be appropriate to add disclosure regarding any additional revenue-generating activities. Some companies may determine that continued disclosure of the information required by the former prescriptive requirements (e.g., ≥10% customers) is still an appropriate way to communicate the extent to which certain revenue-generating activities are material to an understanding of the business.

2. “Status of development efforts for new or enhanced products, trends in market demand and competitive conditions.”

This principles-based requirement replaces the current line-item requirements related to (i) status of a new product or services and (ii) competitive conditions in the business. Companies should be mindful of the requirement to disclose trends in market demand to the extent material to an understanding of the business. While discussion of such trends has been required under the MD&A rules, this is the first time trend information has been specifically called for in the Business section. Among other things, it may be important for companies to think through broader societal trends (e.g., increased use of social media, increased use of and access to big data, increased focus on environmental, social, and governance issues, etc.) and whether those are a material to an understanding of the business.

3. “Resources material to a [company’s] business, such as: (a) sources and availability of raw materials; and (b) the duration and effect of all patents, trademarks, licenses, franchises, and concessions held.”

This principles-based requirement is more broad than the prior line-item requirements related to raw materials and intellectual property, asking about resources generally and using those specific items as examples. Companies should think through the resources required to run their businesses (e.g., to determine whether any of those merit additional attention). The previous focus on raw materials made sense in the context of manufacturing, but with an increasing number of digitally focused businesses, resources such as information and technology are becoming increasingly important.

4. “A description of any material portion of the business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government.”

This requirement remained unchanged from the prior line-item requirement.

5. “The extent to which the business is or may be seasonal.”

This requirement remained unchanged from the prior line-item requirement.

Company-Level Disclosure Requirements. For the following topics, companies should provide this information to the extent material to an understanding of the business taken as a whole. Note that if the topic is material to a particular segment, then information should be provided with respect to that segment.

6. “The material effects that compliance with government regulations, including environmental regulations, may have upon the capital expenditures, earnings and competitive position of the [company] and its subsidiaries, including the estimated capital expenditures for environmental control facilities for the current fiscal year and any other material subsequent period.”

While all companies are impacted by government regulation to one extent or another, not all companies will determine that their compliance with those regulations materially affects their capital expenditures, earnings, or competitive position, so we expect a portion of companies to not provide any new disclosure in response to this requirement. Even before the Business Disclosure Amendments, it was relatively common for companies, especially those in highly regulated industries, to provide a summary of applicable government regulations. When including a discussion of government regulations for the upcoming Form 10-K filing, companies should consider that the mention of a regulation may suggest that the company views compliance with that regulation as having a material effect on the company. A laundry list of every regulation impacting the company is not required.

7. “A description of the [company’s] human capital resources, including the number of persons employed by the [company], and any human capital measures or objectives that the [company] focuses on in managing the business (such as, depending on the nature of the [company’s] business and workforce, measures or objectives that address the development, attraction and retention of personnel).”

The new disclosure topic regarding human capital received particular attention at the meeting at which the rules were adopted, and we expect this topic and related disclosure will continue to evolve. A discussion of this new topic is set forth below.

c.   Spotlight on Human Capital Disclosure

In addition to retaining the former prescriptive requirement to disclose the number of employees, the Business Disclosure Amendments now impose a principles-based requirement to describe the company’s “human capital resources . . . and any human capital measures or objectives that the [company] focuses on in managing the business.” Although the disclosure is required “to the extent material to an understanding of the business,” it will be rare for a company to conclude such disclosure is not material to the business.

The rules do not include any specific reporting framework or define “human capital” instead leaving it to companies to determine what information about human capital resources is material to an understanding of the business. The new rule emphasizes that disclosure will vary depending on the nature of the company’s business and workforce. The disclosure should not be boilerplate and should be relevant to each company’s facts and circumstances. When preparing your human capital disclosure, reviewing disclosures from companies in the same industry will be the most helpful. Disclosure by a small professional services company headquartered in a major US city will be different than disclosure by a multinational manufacturer of consumer goods that primarily employs low wage workers, because their human capital resources will be vastly different, as will the measures and objectives they employ.

Getting Started. Before putting pen to paper on these human capital disclosures, management should begin the process by reviewing the following:

1. Existing internal and external statements regarding key human capital resources, measures, and objectives (e.g., proxy statement, website, recruiting materials, ESG reports, internal memos, PR videos, employee handbooks);
2. Past and current discussions at the board and executive level regarding human capital topics;
3. Past engagement with and input from shareholders on this topic; and
4. The list of disclosure topics suggested by the SEC. Specifically, depending on the nature of the company’s business and workforce: measures or objectives that address the development, attraction and retention of personnel.

Description of Human Capital Resources. The first requirement is to describe the company’s human capital resources. Who are the people who make the products or provide the services that generate revenues for the company? There are many different ways in which a company can describe its work force, and the description should be relevant to understanding the company’s business as a whole. If, for example, the company has two segments, one of which entails manufacturing products in China and Mexico and the other is providing consulting services to Silicon Valley and Wall Street, then the workforces of these two segments will be very different and may need to be described separately. Companies should also be mindful of what they have said about the composition of their workforce in their CEO pay ratio disclosures.

Examples of Measures and Objectives. While the Business Disclosure Amendments stress the need for each company to consider how to make its human capital disclosure specific to its industry and workforce approach and relevant to its unique facts and circumstances, the proposing release and public comments referred to in the adopting release shed light on potential measures or objectives that might be material and worth discussing, including:

• worker recruitment, employment practices and hiring practices;
• employee benefits and grievance mechanisms;
• employee engagement or investment in employee training;
• strategies and goals related to human capital management;
• legal or regulatory proceedings related to employee management;
• whether employees are covered by collective bargaining agreements;
• employee compensation or incentive structures;
• types of employees, including the number of full-time, part-time, seasonal, and temporary workers;
• measures with respect to the stability of the workforce, such as voluntary and involuntary turnover rates;
• information regarding human capital trends, such as competitive conditions and internal rates of hiring and promotion;
• measures regarding worker productivity;
• measures of employee engagement; and
• workplace health and safety measures.

The amended rule requires disclosure of the number of employees. In addition, companies that run their business through a workforce that includes persons who are not technically employees (e.g., consultants or management services arrangements) should discuss those non-employee workforce arrangements and the management of that human capital.

Companies should also discuss the progress that management has made with respect to any objectives it has set regarding its human capital resources. Former Chairman Clayton commented that he would expect companies to “maintain metric definitions constant from period to period or to disclose prominently any changes to the metrics.”

We have monitored human capital disclosures made by S&P 500 companies since the effective date of the rule through the date of this alert. Based on that benchmarking, common focus areas we have seen addressed include (parenthetical represents the number of companies which included the topic):

• Talent attraction, development and retention (28): Focus on overarching human capital, talent recruitment, retention strategies and goals; talent development; succession planning.
• Diversity (22): Discussion of disclosure and inclusivity programs.
• Workforce statistics (20): Breakdown of employee base by employee classification (full-time, part-time, contractor) and geography; Turnover rates; Diversity representation stats (e.g., % male/female, % minority, etc.). Not all companies include each statistic noted above.
• Employee compensation (19): Compensation/incentive mechanisms; potentially pay equity.
• Health and safety (18): Workplace safety; Employee mental health.
• Culture and engagement (17): How a company monitors its workplace culture; Culture initiatives taken by the company.
• COVID-19 (15): Health and safety of employees in light of COVID-19 and work from home measures.
• Governance (10): Organizational and governance structure through which human capital is managed (C-suite level) and overseen (board level).

Consider Investors and Other Stakeholders. Human capital has rapidly emerged as a growing focus area for stakeholders, which means companies cannot simply consider what is required to comply with SEC rules. In a 2020 survey, 64% of institutional investors said they would focus on human capital management when engaging with boards (second only to climate change, at 91%).[4] BlackRock’s approach to engagement on human capital highlights one reason for this focus: “Most companies BlackRock invests in on behalf of clients have, to varying degrees, articulated in their public disclosures that they are operating in a talent constrained environment, or put differently, are in a war for talent. It is therefore important to investors that companies explain as part of their corporate strategy how they establish themselves as the employer of choice for the workers on whom they depend.”[5]

Expect an Evolution of Disclosures. We expect human capital disclosures to evolve over time and companies should be prepared to develop their disclosure over the course of the next couple 10-Ks. In the initial year, companies may opt for conservative disclosure, adding additional disclosure as appropriate in subsequent years as they observe peer practices or to address regulatory changes. You should not be surprised by a growing group of companies that will disclose granular details about human capital, not necessarily because it is material to the company, but because they might perceive other advantages in doing so. We anticipate that the SEC will be focused on this disclosure as part of the comment letter process. In the first year, the SEC staff likely to go after low-hanging fruit (e.g., companies that omit human capital disclosure altogether), but in subsequent years, as industry practices develop, we may see the SEC staff probe deeper into what information is material and should be disclosed in certain industries. The SEC staff may also issue a report of observations regarding human capital disclosure in the first year.

In addition, the recent change in the administration and shift to a Democrat-controlled SEC, as well as increasing attention placed by institutional investors on ESG matters, may result in additional requirements for companies in this area. In this regard, we note that the two Democrat Commissioners’ dissent from the adoption of the amended rules pushed back on the principles-based approach and noted the lack of specific disclosure requirements concerning ESG matters and prescriptive requirements for metrics on diversity, climate change and human capital. As further evidence of the SEC likely focus on the area, a senior position was added to the Office of the Chairman devoted exclusively to ESG matters.

2.   Legal Proceedings (Part I, Item 3 of Form 10-K)

The Business Disclosure Amendments provided two helpful updates to legal proceedings disclosure. While the requirement of Item 103 of Regulation S-K to disclose any material pending legal proceedings, other than ordinary routine litigation incidental to the company’s business, has not changed, the Business Disclosure Amendments expressly allow a company to provide the information required by Item 103 by hyperlink or cross-reference to disclosure located elsewhere in the document. This approach confirms a common practice by many companies to cross-reference to the duplicate or similar disclosure in the notes to the financial statements.

The second update to Item 103 raised the threshold for disclosure of governmental environmental proceedings. Previously, companies were required to disclose environmental proceedings involving potential monetary sanctions of $100,000 or more. That threshold has been raised to $300,000 to adjust for inflation. However, in line with its principles-based approach to business disclosure, the Business Disclosure Amendments acknowledge that a bright-line threshold may not be indicative of materiality on a company-specific basis and therefore allow a company to establish a different disclosure threshold as high as $1 million (or, if lower, one percent of the current assets of the company). Interpretive guidance may be required to confirm whether disclosure of this alternative threshold for environmental proceedings must be disclosed even when the company has no such proceedings to report, or only when a proceeding involves sanctions exceeding the $300,000 threshold. Disclosing the dollar amount of a company-determined materiality threshold is not currently a common practice.

3.   Risk Factors (Part I, Item 1A of Form 10-K)

Companies are no doubt familiar with the prior Item 105 of Regulation S-K requirement to disclose the most significant factors that make investing in the company speculative or risky. Developments in securities litigation and risk profiles have caused risk factor disclosure to grow over the years. The Business Disclosure Amendments attempt to curb the ever-expanding list of risk factors in three ways.

a.   Organization of Risk Factors under Headings

Companies are required to organize logically their risk factors into groups under headings that adequately describe the type of risk. Many companies already breakdown their risk factors into 3-4 categories, with some companies presenting subcategories. Examples of such categories include “Risks Related to our Business”, “Risks Related to our Assets”, “Legal and Regulatory Risks”, “Financial Risks” and “Market Risks.” With the focus on discouraging lengthy disclosure of generic risk factors, the Business Disclosure Amendments emphasize that the presentation of risks that could apply generically to any company is discouraged; however, to the extent any such risk factors are presented, they must be disclosed at the end of the risk factor section under the caption “General Risk Factors.”

b.   “Materiality” Replaces “Most Significant” Standard

Continuing with the effort to reduce the use of generic risk factors and shorten the risk factor disclosure, the Business Disclosure Amendments change the standard for disclosure from the “most significant” factors to factors that are “material.” The adopting release expresses the view that this will result in risk factor disclosure more tailored to a company’s facts and circumstances, with a focus on the risks to which reasonable investors would attach importance in making investment or voting decisions. For most companies, this is unlikely to result in a major overhaul of their risk factors, but rather a review of current disclosure to confirm it is consistent with the new materiality standard.

c.   Risk Factor Summary

The third update to Item 105 of Regulation S-K added a requirement that, if the risk factor disclosure exceeds 15 pages, the company must provide a series of concise, bulleted or numbered statements that is no more than two pages summarizing the principal factors that make an investment in the company speculative or risky. The adopting release noted that “the requirement to provide a risk factor summary may create an incentive for companies to reduce the length of their risk factor discussion to avoid triggering the summary requirement.” Companies who have already filed their Forms 10-K with risk factor summaries have generally listed the captions or abbreviated versions of the captions of their risk factors. Companies are not required to list all of the risk factors in the bulleted list.

If a risk factor summary is required, it must be included in “the forepart of the … annual report.” There is no clear guidance on what is considered the “forepart” of Form 10-K. Placement of the summary in pages preceding Item 1 (Business) seems most consistent with the spirit of the requirement; however, we have also seen the summary included at the beginning of Item 1A (Risk Factors).

d.   Cautionary Note about Hypothetical Language

As a reminder for companies when reviewing risk factors for the recent changes, two enforcement cases brought by the SEC in 2019 emphasized the need to revisit risk factor disclosure regularly and treat it as “living” as much as the rest of the Form 10-K. Companies should thoroughly review their risk factor disclosures so that the disclosures do not speak about events hypothetically (e.g., “could” or “may”) if those events have occurred or are occurring. If a risk has manifested itself, that factual event should be appropriately reflected in the body of the risk factors. Companies should be careful with how they describe significant events (e.g., material cyber breaches, material events impacting operating results) as well as more routine items (e.g., fluctuations in demand, inventory write-downs, customer reimbursement claims, intellectual property claims, poorly performing investments, and tax audits). If a risk involves a situation that arises from time to time, then it would likely be preferable to refer to the consequences of such situation as a material contingency, instead of referring to the situation as a hypothetical contingency.

B.   Amendments to 300 Series of Regulation S-K Requirements (Part II of Form 10-K)

On November 19, 2020, the SEC announced[6] that it had adopted amendments to Item 301 (Selected Financial Data), Item 302 (Supplementary Financial Information) and Item 303 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of Regulation S-K designed to improve disclosure by enhancing its readability, discouraging repetition and eliminating information that is not material, and to “allow investors to view the [company] from management’s perspective” (the “Financial Disclosure Amendments”).[7]

The Financial Disclosure Amendments will become effective on February 10, 2021, though companies will not be required to comply with the new requirements until their first fiscal year ending on or after August 9, 2021. This means compliance will first be required in the Form 10-K for 2021 for calendar year end companies. Companies are permitted to update their Form 10-K disclosure consistent with the Financial Disclosure Amendments any time after the effective date; provided that, if they choose to apply the amended requirements for one item of Regulation S-K, they must apply all of the provisions of that amended item. As a result, companies filing their Form 10-K prior to February 10, 2021 will be required to comply with the pre-amendment Regulation S-K requirements, but companies filing after February 10, 2021 will have the option of whether to adopt the changes to one, two, or three of the amended items. Companies should exercise caution in early adopting the amendments to any of Items 301, 302 or 303. In light of President Biden’s January 21 Executive Order and the change in acting Chairman at the SEC, there is a possibility that, prior to February 10th, effectiveness of the amendments is delayed 60 days and, once the new Chairman is confirmed, the amendments do not become effective. Of course, any company is entitled to early adopt and apply the amended rules once they are effective on or after February 10th, even if the rules are further amended at a later time.

The discussion below provides a high-level summary of the Financial Disclosure Amendments. We also refer you to our prior post, which contains a summary chart and comparative blackline reflecting the Financial Disclosure Amendments.[8]

1.   Selected Financial Data (Part II, Item 6)

Elimination of Presentation of Past Five Years of Financial Data. The Financial Disclosure Amendments will “[r]emove and reserve” Item 301 of Regulation S-K and Part II, Item 6 of Form 10-K, completely eliminating the requirement to furnish in the Form 10-K selected financial data in comparative tabular form for each of the company’s last five fiscal years. The SEC has not indicated when it plans to update the Form 10-K pdf available on its forms site, but we suspect it will do so shortly after the February 10, 2021 effective date.

The adopting release emphasizes that, despite removal of this requirement, the material trend disclosures that Item 301 was meant to highlight continue to be elicited by the MD&A requirements, and companies should consider whether trend information for periods earlier than those presented in the financial statements may be necessary as part of MD&A’s objective to “provide material information relevant to an assessment of the financial condition and results of operations.” The release also encouraged companies to “consider whether a tabular presentation of relevant financial or other information, as part of an introductory section or overview, including to demonstrate material trends, may help a reader’s understanding of MD&A.”

2.   Supplementary Financial Data (Part II, Item 8)

Elimination of Presentation of Quarterly Financial Data. The Financial Disclosure Amendments also eliminate the requirement to disclose in the Form 10-K and Form 10-Qs selected quarterly financial data of specified operating results and variances in these results from amounts previously reported on a prior Form 10-Q.

Replace with Principles-Based Requirement For Material Retrospective Changes. Under the new rule, if there are retrospective changes to the statements of comprehensive income for any of the quarters within the two most recent fiscal years that are material individually or in the aggregate, a company must (a) explain the reasons for the changes, and (b) for each affected quarterly period and the fourth quarter in the affected year, disclose (i) summarized financial information related to the statements of comprehensive income (net sales, gross profit, income from continuing operations, net income, and net income attributable to the entity), and (ii) earnings per share reflecting the changes. Material retrospective changes might include correction of an error, discontinued operations, reorganization of entities under common control, or change in accounting principle.

To comply with this rule, companies should have in place an annual procedure whereby retrospective changes are identified and then evaluated to determine whether disclosure is required. Such a procedure will likely be similar to what companies use to comply with the requirement in the current rule to provide an explanation whenever the amounts disclosed in the Form 10-K table vary from the amounts previously reported on the Form 10-Q.

3.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Part II, Item 7)

a.   New Item 303(a) – Objectives of MD&A

The Financial Disclosure Amendments add a new first paragraph to Item 303 to emphasize the objective of MD&A for both full fiscal years and interim periods, which incorporates much of the substance of current instructions and codifies the guidance that MD&A should enable investors to view the company from management’s perspective. While many companies may ultimately determine that no changes to their disclosure need to be made in response to this rule, focusing on the objective when preparing and reviewing MD&A is always a worthwhile exercise.

b.   Amended Item 303(b) – Full Fiscal Year Presentation

Amended Item 303(b) focuses on the full fiscal year presentation and lists three main components, (i) liquidity and capital resources, (ii) results of operations, and (iii) critical accounting estimates. The primary updates from the Financial Disclosure Amendments are described below.

Liquidity and Capital Resources. The Financial Disclosure Amendments codify past guidance and require each company to describe its “material cash requirements, including commitments for capital expenditures, as of the end of the latest fiscal period, the anticipated source of funds needed to satisfy such cash requirements and the general purpose of such requirements.” Companies must identify and disclose all known material cash requirements, not just those needed for capital expenditures (e.g., funds necessary to maintain current operations, complete projects underway, and achieve stated objectives or plans). The adopting release notes that “while capital expenditures remain important in many industries, certain expenditures and cash commitments that are not necessarily capital investments in property, plant, and equipment may be increasingly important to companies, especially those for which human capital or intellectual property are key resources.” The adopting release also emphasizes that these changes solicit information that may otherwise be lost with the deletion of the contractual obligations table (discussed below).

Results of Operations. The Financial Disclosure Amendments require a company to disclose events that are reasonably likely to (as opposed to events that “will” or that the company “reasonably expects will”) have a material impact on revenue/income or cause a material change in the relationship between costs and revenues, syncing with the disclosure standard used elsewhere in MD&A. This new phrasing emphasizes that the standard for disclosure of trends in MD&A is not an unreasonably high one where forward-looking disclosure is only required in instances where there is certainty about what will happen.

In addition, the Financial Disclosure Amendments codify past guidance and specify that discussion of changes in price/volume and new products is required whenever there are “material changes” to revenue, rather than simply when there are “material increases” in revenue.

Critical Accounting Estimates. The Financial Disclosure Amendments codify past guidance and require companies to provide qualitative and quantitative disclosure necessary to understand the uncertainty and impact a critical accounting estimate has had or is reasonably likely to have on financial condition or results of operations of the company, including why each estimate is subject to uncertainty. This disclosure is only required to the extent the information is material and reasonably available, and should include “[(i)] how much each estimate and/or assumption has changed over a relevant period, and [(ii)] the sensitivity of the reported amount to the methods, assumptions and estimates underlying its calculation.”

The adopting release clarifies that this disclosure of critical accounting estimates is not a recitation of what is required under U.S. GAAP. For example, there is no general requirement to disclose underlying assumptions for material accounting estimates included in the financial statements, and U.S. GAAP does not require a discussion of material changes in the underlying assumptions over a relevant period. The adopting release notes that “[to] the extent the financial statements include information about specific changes in the estimate or underlying assumptions, the [Financial Disclosure Amendments] include an instruction that specifies that critical accounting estimates should supplement, but not duplicate, the description of accounting policies or other disclosures in the notes to the financial statements.”

c.   Amended Item 303(b) – Items no Longer Required

Inflation and Price Changes. The Financial Disclosure Amendments eliminate the requirement that companies discuss the impact of inflation and price changes on their net sales, revenue, and income from continuing operations. Despite these deletions, companies are still expected to discuss the impact of inflation or changing prices if they are part of a known trend or uncertainty that has had, or the company reasonably expects to have, a material impact.

Off-Balance Sheet Arrangements. The Financial Disclosure Amendments eliminate the requirement to present a separately captioned section discussing off-balance sheet arrangements and instead add a principles-based instruction to discuss certain commitments or obligations (including those formerly disclosed as off-balance sheet arrangements).

Contractual Obligations. The Financial Disclosure Amendments eliminate the requirement to provide a contractual obligations table, as much of the information is included in the notes to the financials under GAAP or elsewhere in MD&A under the new requirements to discuss cash commitments. The Financial Disclosure Amendments add a provision reiterating that material cash requirements from known contractual or other obligations should be discussed in Liquidity and Capital Resources, and also add an instruction that material requirements from known contractual obligations may include, for example, lease obligations, purchase obligations, or other liabilities reflect on the balance sheet. While the Form 10-K and Form 10-Q are no longer required to include a contractual obligations table and material updates, care should be taken that any material cash requirements are discussed elsewhere in the Liquidity and Capital Resources discussion. In addition, a company’s accounting personnel should confirm whether there is any information currently contained in the table that is required by GAAP and, therefore, must be added elsewhere in the notes to the financials.

d.   Amended Item 303(b) – Clarification on Discussion of “Underlying Reasons” for Period-to-Period Changes

The Financial Disclosure Amendments also clarify that, where there are material changes from period-to-period in one or more line items, companies must describe the underlying reasons for such changes in both quantitative and qualitative terms, rather than only the “cause” for such changes. The Financial Disclosure Amendments also amend the language to clarify that companies should discuss material changes within a line item even when such material changes offset each other. These amendments codify what the SEC staff has been asking companies to include via the comment letter process for some time.

Companies should more closely examine the drivers behind changing operating results and how those drivers are described in the Form 10-K. Superficial discussions of, for example, decreased sales volumes or increased compensation expenses may not be sufficient. Evaluating the disclosure required by this rule will likely be done in tandem with the evaluation of whether certain trends should be identified in MD&A.

e.   Amended Item 303(b) – A Note on Product Lines

The Financial Disclosure Amendments add “product lines” as an example of subdivisions of a company’s business that should be discussed where, in the company’s judgment, such a discussion would be necessary to an understanding of the company’s business. The prior rule requested discussion of “segment information and/or of other subdivisions (e.g., geographic areas) of the company’s business.” Similar to the rule change in Item 101 requiring disclosure of “any dependence on … product families,” this rule change should focus companies’ attention on groups of products about which information may be material to investors’ understanding of the business.

f.   New Item 303(c) – Interim Period Discussion

The Financial Disclosure Amendments permit companies to compare the operating results from their most recently completed quarter to the operating results from either the corresponding quarter of the prior year (as is currently required) or to the immediately preceding quarter. If a company changes the comparison from the prior interim period comparison, the company is required to explain the reason for the change and present both comparisons in the filing where the change is announced. Notwithstanding this change, a discussion of any material changes in the company’s results of operations for the most recent the year-to-date period would still need to be compared to the results of operations from the corresponding year-to-date period of the preceding fiscal year.

For companies who choose to adopt new Item 303(c) for their first quarter 2021 Form 10-Q, a new comparison of Q1 2021 to Q4 2020 will be required, as well as the existing comparison of Q1 2021 to Q1 2020 results and an explanation as to the change. Going forward, a comparison of the current quarter to the previous quarter will be sufficient, so long as a comparison of any material changes from the current quarter to the prior year’s corresponding quarter is provided. Given the cyclical nature of many businesses, we expect that many companies will not make any changes as result of this amendment; however, companies whose businesses lend themselves to sequential analysis will probably welcome the change.

II.   COVID-19 Disclosure Considerations

As we round the one-year mark of the COVID-19 pandemic, it is important for companies to evaluate whether their COVID-19 disclosure adequately and accurately reflects the impact of COVID-19. This should continue to be a focus of disclosure controls and procedures and may continue to draw scrutiny from the SEC staff. While many companies have crafted and tailored this disclosure over the past several months, it is helpful to refer back to prior SEC guidance[9] and SEC enforcement actions, a helpful summary of which is included in our prior client alerts.[10] As we look towards the 2020 Form 10-K filing, we reflect on a few important considerations below.

A.   Impact on Management’s Discussion and Analysis of Financial Condition and Results of Operations

As reflected in the new MD&A objectives statement in the Financial Disclosure Amendments, the purpose of MD&A is to provide material information relevant to an assessment of the financial condition and results of operations of the company. The company should aim to allow investors to understand the business results through the eyes of management. New Item 303(a) specifically calls out a focus on material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition. As companies review their MD&A disclosure, they should pay particular attention to how the COVID-19 pandemic, including (i) actions taken by governments, customers, suppliers, and other third-parties, (ii) work from home measures and employee safety, and (iii) impact on the economy or industry in which they operate, has impacted their results of operations or financial condition. Companies should continue to evaluate whether it is necessary to revise their liquidity and capital resources section to reflect the historical and any future impacts to the COVID-19 pandemic. In characterizing the impact of the pandemic, companies should be specific and clarify the time periods involved in the disclosure. It is no longer appropriate to provide only generic statements about the company’s inability to predict the impact of the pandemic, which may have been included in the Form 10-K for 2019.

B.   Impact on Risk Factors

A great number companies have included a COVID-19 risk factor in one of their quarterly reports since the outset of the pandemic. As companies review their risk factor disclosure in light of the Business Disclosure Amendments, it is important that the COVID-19 risk factor disclosure be appropriately tailored to the facts and circumstances of the particular company, whether due to (i) risks that directly impact the company’s business, (ii) risks impacting the company’s suppliers or customers, or (iii) ancillary risks, including a decline in the capital markets, a recession, a decline in employee relations or performance, governmental regulations, an inability to complete transactions, and litigation. The SEC has reiterated that risk factors should not use hypotheticals to address events that are actually impacting the company’s operations and brought enforcement actions against certain companies for portraying realized risks as hypothetical.[11] Accordingly, companies should be specific in providing examples of risks that have already manifested themselves.

C.   Impact on Non-GAAP Financial Measures

When reviewing 2020 operating results and performance, companies may consider presenting non-GAAP financial measures for historical periods impacted by the COVID-19 pandemic that reflect adjustments from the required GAAP measures. If such non-GAAP measures are presented in the Form 10-K, the disclosure should be clear and the rationale for the presentation explained. Management may articulate the position that these adjustments are critical in order for investors to be able to compare the performance of the business period over period.

Companies should be mindful of the rules relating to non-GAAP supplemental measures under Regulation G and Item 10(e) of Regulation S-K. In guidance issued on March 25, 2020, the Division of Corporation Finance reminded companies that “we do not believe it is appropriate for a company to present non-GAAP financial measures or metrics for the sole purpose of presenting a more favorable view of the company.”[12] Additionally, companies should be mindful of Non-GAAP Financial Measures CD&I 100.02, which states that non-GAAP measures can be misleading if presented inconsistently between periods, and CD&I 100.03, which states that non-GAAP measures can be misleading if they exclude charges, but do not exclude any gains. In addition, to the extent a company discloses any key performance metrics and changes have been made to such metrics to exclude items related to the crises or address such items in a different manner, the company should be clear to call out such changes and provide updated comparable prior period information to the extent practicable.

III.   Other Considerations and Reminders

A.   Key Performance Indicators (KPIs)

As mentioned in our prior post,[13] the SEC issued an Interpretative Release[14] in January 2020 providing guidance on key performance indicators and metrics discussed in MD&A. The release was a reminder that companies must disclose key variables and other qualitative and quantitative factors that management uses to manage the business and that would be peculiar and necessary for investors to understand and evaluate the company’s performance, including non-financial and financial metrics.

The guidance instructs companies that, when including metrics in their disclosure, they should consider existing MD&A requirements and the need to include such further material information, if any, as may be necessary in order to make the presentation of the metric, in light of the circumstances under which it is presented, not misleading. The disclosure of such additional metrics, based on the facts and circumstances, should be accompanied by the following disclosures:

• a clear definition of the metric and how it is calculated;
• a statement indicating the reasons why the metric provides useful information to investors;
• a statement indicating how management uses the metric in managing or monitoring the performance of the business; and
• whether the disclosure of any estimates or assumptions underlying such metric or its calculations are necessary to be disclosed for the metric not to be materially misleading.

In addition, if a company changes the method by which it calculates or presents the metric from one period to another or otherwise, the company should disclose, to the extent material, the differences between periods, the reasons for the changes and the effect of the changes. Changes may necessitate recasting the prior period’s presentation to help ensure the comparison is not misleading.

B.   Impact of Changes to Filer Definitions

On March 12, 2020, the SEC announced[15] the adoption of a final rule amending the “accelerated filer” and “large accelerated filer” definitions.[16] The amendments became effective April 27, 2020 and first impacted annual reports on Form 10-K due after the effective date. The amendments exclude from the “accelerated filer” and “large accelerated filer” definitions issuers that are otherwise eligible to be a “smaller reporting company” and that had annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available. The most notable effect of these amendments is that a smaller reporting company with less than $100 million in revenues, while obligated to establish and maintain internal control over financial reporting (“ICFR”) and have management assess the effectiveness of ICFR, will not be subject to the requirements of Section 404(b) of the Sarbanes-Oxley Act, which requires that an issuer’s independent auditor attest to, and report on, management’s assessment of the effectiveness of ICFR (i.e., the so-called auditor attestation report). Note that these smaller companies will continue to be subject to a financial statement audit by an independent auditor, who is required to consider ICFR in the performance of that audit, but will not be required to obtain an auditor attestation report.

The amendments also (i) increase the public float transition threshold for an accelerated and a large accelerated filer becoming a non-accelerated filer from $50 million to $60 million and for existing large accelerated filer status from $500 million to $560 million; and (ii) add the Smaller Reporting Company revenue test to the transition threshold for both accelerated filer and large accelerated filer status. Please see our prior post for more information regarding these amendments.[17]

C.   Omitting Third Year of MD&A

In 2019, the SEC adopted amendments to modernize and simplify various disclosure requirements, which included the option for companies to omit from MD&A a discussion of the earliest of the three years of financials included in the Form 10-K if such discussion was included in a prior filing with the SEC.[1] When a company takes this approach, the location of the omitted discussion must be identified in the current Form 10-K, but that previous disclosure should not be incorporated by reference. On January 24, 2020, the Division of Corporation Finance issued three new Compliance and Disclosure Interpretations (C&DIs)[18] addressing common questions regarding Instruction 1 to Item 303(a). A brief overview of this guidance is discussed below and in more detail in our prior post.[19]

Question 110.03 – May not Omit Earliest Year if Necessary to Understanding of Financial Condition. Provides that a company may not omit a discussion of the earliest of three years from its current MD&A if it believes a discussion of that year is necessary to an understanding of its financial condition, changes in financial condition and results of operations. When determining whether to omit the earliest year discussion, a company should analyze whether the entirety of the discussion of its financial condition and operating results from three years ago (e.g., 2018 for the 2020 10-K), either as previously reported or updated to reflect trends or developments, is necessary to understand its financial condition, changes in financial condition and results of operations. If so, that discussion should be included in the Form 10-K. In our survey of S&P 500 companies that filed a 10-K between the effective date of the revised instruction through the date of our alert on the topic in early 2020, approximately 54% have opted to exclude the earliest year’s discussion in the MD&A.

Question 110.02 – Earliest Year Discussion Not Incorporated Unless Explicitly Stated. Clarifies that when a company omits a discussion of the earliest of three years and includes the required statement that identifies the location of such discussion in a prior filing with the SEC, such discussion is not incorporated by reference into the filing unless the company expressly states that the information is incorporated by reference. According to our survey mentioned above, less than 10% of companies chose to expressly incorporate the prior discussion by reference.

Question 110.04 – Incorporation by Reference in Registration Statements. Given that the Form 10-K operates as the Section 10(a)(3) update to an effective registration statement, once the Form 10-K is filed without an MD&A discussion for the earliest year of financials, the effective registration statement would not include the MD&A discussion for the earliest year. As such, the company will not incur Securities Act liability on such discussion. When filing a new registration statement or commencing an offering, a company should analyze whether the entirety of the discussion of its financial condition and operating results from three years ago, either as previously reported or updated to reflect trends or developments, is necessary to understand its financial condition, changes in financial condition and results of operations. While in many cases such information will not be material to a current investment decision, in those cases when such information (or any other earlier information) is deemed necessary, companies and their counsel should discuss how best to incorporate such information into the offering documents.

Most companies that choose to exclude the earliest year of financials have tended to include the statement identifying the location of the prior disclosure at the beginning of the MD&A, the beginning of the Results of Operation section, or the end of the Results of Operation section before Liquidity and Capital Resources.

D.   Exhibit List Reminders

In 2019, a number of changes were made to the exhibit requirements in Exchange Act reports.[20] While companies may be familiar with these changes in connection with their Form 10-K filing last year, the short summary below serves as a reminder of the key changes to exhibits when preparing the 2020 Form 10-K this year.

1.   Exhibit 4 – Description of registered securities

Companies are required to provide a brief description of all securities registered under Section 12 of the Exchange Act (i.e., the information required by Item 202(a) through (d) and (f) of Regulation S-K) as an exhibit to their Forms 10‑K. The securities covered by this exhibit are the same as those required to be listed on the cover of the Form 10‑K. While many companies prepared this exhibit for their 2019 Form 10-K, the previously filed exhibit should be reviewed for any changes to the information called for by Item 202 of Regulation S-K. If no changes since the prior filing, the company may simply incorporate by reference to the previously filed exhibit.

2.   No lookback period for material contracts.

Companies other than “newly reporting registrants” need only disclose material contracts to be performed in whole or in part at or after the filing of their Forms 10‑K. Previously, there was a two-year lookback period with respect to material contracts for most companies, which often resulted in filing copies of stale / terminated contracts. (See Item 601(b)(10)(i) of Regulation S‑K.)

3.   Omission of schedules to exhibits

Companies may omit entire schedules or similar attachments to exhibits, unless the schedules or attachments contain material information that is not otherwise disclosed in the exhibit or SEC filing. A brief list identifying the contents of the omitted schedules or other attachments must be included in the exhibit, unless the exhibit already includes information that conveys the subject matter of the omitted material. Companies are no longer required to state that they will furnish a copy of the omitted schedules or attachments to the SEC upon request (which was typically done through a notation in the exhibit index); though they must still provide a copy if requested by the SEC. (See Item 601(a)(5) of Regulation S‑K.)

4.   Omission of information from exhibits without confidential treatment request

Companies are permitted to omit confidential information from material contracts filed under Item 601(b)(10) and agreements filed under Item 601(b)(2) without requesting confidential treatment from the SEC where this information is both (i) not material and (ii) would likely cause competitive harm to the company if publicly disclosed. Companies must mark the exhibit index to indicate that portions of the material contract have been omitted; include a prominent statement on the first page of the redacted material contract indicating certain information has been omitted; and indicate with brackets where this information has been omitted within the material contract.

Companies are also allowed to omit personally identifiable information (such as bank account numbers, social security numbers, telephone numbers, home addresses, and similar information) from all exhibits without submitting a confidential treatment request for this information.

Although companies are no longer required to file confidential treatment requests with respect to exhibits filed pursuant to Item 601(b)(10) and Item 601(b)(2), they are still responsible for ensuring all material information is disclosed and limiting redactions to those portions necessary to prevent competitive harm. The SEC staff will continue to selectively review companies’ filings and assess whether companies have satisfied their disclosure responsibility with respect to these redactions.

5.   Exhibit 22 – List of guarantors

In March 2020, the SEC adopted amendments to Rules 3-10 and 3-16 of Regulation S-X, which became effective on January 4, 2021. These amendments relate to the financial disclosure requirements applicable to registered debt offerings and were adopted in an effort to “improve the quality of disclosure and increase the likelihood that issuers will conduct debt offerings on a registered basis.”[21] Please see our prior post for a detailed description of these amendments, which became effective on January 4, 2021.[22] In connection with the amendments, companies with registered debt securities are required to include a new Exhibit 22, which requires a list, as applicable, the company’s subsidiaries and affiliates covered by new Rules 13-01 and 13-02 of Regulation S-X. Specifically the list must include each of the company’s subsidiaries that is a guarantor, issuer, or co-issuer of the guaranteed security and each of the company’s affiliates whose security is pledged as collateral for the company’s security. For each affiliate, the security or securities pledged as collateral must also be identified.

E.   Extending confidential treatment

As discussed in our prior post,[23] on September 9, 2020, the Division of Corporation Finance updated its guidance on confidential treatment requests to provide companies with the ability to transition to the new redaction rules under certain circumstances.[24] When the SEC first amended its exhibit filing requirements to allow redactions without a confidential treatment request in March 2019, companies that had previously submitted confidential treatment requests were not able to simply refile a redacted exhibit, but rather were required to file an extension to their prior request. The updated guidance now provides that:

“[if] it has been more than three years since the initial confidential treatment order was issued, and if the contract continues to be material, companies have the option to transition to compliance with the requirements set out in Regulation S-K Item 601(b)(10) and other parallel rules, referred to here as the redacted exhibit rules. The redacted exhibit rules allow for the filing of redacted exhibits without submitting an explanation or substantiation to the SEC, or providing an unredacted copy of the exhibit, except upon request of the staff.

In order to transition to the redacted exhibits rules in these situations, a company would only be required to refile the material contract in redacted form and comply with the legend and other requirements of the applicable redacted exhibit rule, most commonly Item 601(b)(10)(iv) of Regulation S-K. We anticipate that many, if not most, companies will chose to transition to this process since substantiation of compliance and submission of unredacted materials to the staff is only required upon staff request.”

There are two other options that remain available to companies faced with a soon-to-expire confidential treatment. The first alternative is for the company to simply refile the unredacted exhibit. The second alternative is to apply for an extension to the confidential period pursuant to Rule 406 or Rule 24b-2 prior to the confidential treatment order’s expiration, which can be done by submitting a short-form application (available here) to CTExtensions@sec.gov (if the initial order was issued less than three years ago) or a complete application (if the initial order was issued more than three years ago).

F.   E-signature Rules

On November 17, 2020, the SEC approved amendments to Regulation S-T and the EDGAR Filer Manual relating to the use of electronic signatures for SEC filings, including Form 10-K.[25] The new rules expressly provide for the use of e-signature methods (e.g., “DocuSign” and “AdobeSign”). In general, where a document submitted electronically to the SEC is required to be signed, the signature appearing in the filing must appear in the electronic filing in typed form, not in manual or graphic form. Signatures that are not required in a filing may appear as in manual or graphic form (e.g., the signature in a letter to shareholders included in a Proxy Statement).

Under Rule 302(b) of Regulation S-T, when an SEC filing must be signed, the signatory must either manually sign the actual signature page or electronically sign the signature page or some other document that authenticates, acknowledges or otherwise adopts the signature appearing in the filing. Before allowing a signatory to electronically sign an SEC filing, a company must obtain a manually signed attestation from the signatory agreeing that the signatory’s electronic signature of an SEC filing has the same effect as a manual signature. This attestation must be retained for a minimum period of seven years after the date of the most recent electronically signed authentication document for the applicable signatory. Companies who plan on shifting to electronic signatures may wish to send a form attestation to their board for manual signature when sending the Form 10-K to the board for approval. A form of attestation document is included in our prior post,[26] which also discusses other applicable considerations and requirements associated with the Regulation S-T and EDGAR Filer Manual amendments.

G.   Cover Page Changes

When the SEC adopted amendments to the definitions of “accelerated filer” and “large accelerated filer” back in March 2020, a new check box was added to the cover page of the Form 10-K to indicate whether an auditor attestation report under Section 404(b) of the Sarbanes-Oxley Act is included in the filing. As a reminder, companies that are large accelerated filers or accelerated filers will be required to tag this new cover page check box disclosure in Inline XBRL. All other companies will be required to comply with the new XBRL tagging requirements for fiscal periods ending on or after June 15, 2021.

H.   Critical Accounting Matters

Form 10-Ks for all companies (except emerging growth companies) require a company’s auditor to include disclosures in its audit report about critical audit matters (“CAMs”) that the auditor identifies during the course of the audit. The audit standard, AS 3101,[27] requires that for each CAM communicated in the auditor’s report, the auditor must: (i) identify the CAM; (ii) describe the principal considerations that led the auditor to determine that the matter is a CAM; (iii) describe how the CAM was addressed in the audit; and (iv) refer to the relevant financial statement accounts or disclosures that relate to the CAM. As noted in our previous client alert,[28] companies should consider possible scenarios where this standard might put the auditor in a position of having to make disclosures of original information, and prepare in advance for how to address such situations. Since CAMs will typically address a topic that also is discussed in financial statement footnotes or MD&A, companies should make sure that their language is consistent with the discussion in the CAM.

I.   Updates to Disclosure Controls and Procedures

In light of the substantial number of changes to the Form 10-K requirements and disclosure guidance, it is important for personnel and counsel to consider the manner in which the company’s disclosure controls and procedures are addressing the changes. It is also important that the disclosure committee and audit committee are briefed on the changes and the company’s approach to addressing them.

_____________________

[1] For further discussion on these amendments, please see our prior client alert “SEC Continues to Modernize and Simplify Disclosure Requirements” (March 26, 2019), available at https://www.gibsondunn.com/wp-content/uploads/2019/03/sec-continues-to-modernize-and-simplify-disclosure-requirements.pdf.

[1] Available at https://www.gibsondunn.com/a-double-edged-sword-examining-the-principles-based-framework-of-the-sec-recent-amendments-to-disclosure-requirements/.

[2] See Modernization of Regulation S-K Items 101, 103, and 105, Release No. 33-10825 (August 26, 2020), available at https://www.sec.gov/rules/final/2020/33-10825.pdf.

[3] See Transitional FAQs Regarding Amended Regulation S-K Items 101, 103 and 105 (November 5, 2020), Question 3, available at https://www.sec.gov/corpfin/transitional-faqs-amended-regulation-s-k-items-101-103-105.

[4] See Morrow Sodali 2020 Institutional Investor Survey, available at https://morrowsodali.com/insights/institutional-investor-survey-2020.

[5] See BlackRock’s Commentary, Investment Stewardship’s Approach to Engagement on Human Capital Management, available at https://www.blackrock.com/corporate/literature/publication/blk-commentary-engagement-on-human-capital.pdf.

[6] See “SEC Adopts Amendments to Modernize and Enhance Management’s Discussion and Analysis and other Financial Disclosures” (November 19, 2020), available at https://www.sec.gov/news/press-release/2020-290.

[7] See Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information, Release No. 33-10890 (November 19, 2020), available at https://www.sec.gov/rules/final/2020/33-10890.pdf.

[8] Available at https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=432.

[9] See CF Disclosure Guidance: Topic No. 9 (March 25, 2020), available at https://www.sec.gov/corpfin/coronavirus-covid-19, and CF Disclosure Guidance: Topic No. 9A (June 23, 2020), available at https://www.sec.gov/corpfin/covid-19-disclosure-considerations.

[10] See “Perspectives from One Month into the COVID-19 U.S. Outbreak: Public Company Disclosure Considerations” (April 9, 2020), available at https://www.gibsondunn.com/wp-content/uploads/2020/04/perspectives-from-one-month-into-the-covid-19-u-s-outbreak-public-company-disclosure-considerations.pdf. See “SEC Brings First Enforcement Action Against a Public Company for Misleading Disclosures About the Financial Impacts of the Pandemic” (December 7, 2020), available at https://www.gibsondunn.com/sec-brings-first-enforcement-action-against-a-public-company-for-misleading-disclosures-about-the-financial-impacts-of-the-pandemic/.

[11] See “2019 Year-End Securities Enforcement Update” (January 14, 2020), available at https://www.gibsondunn.com/2019-year-end-securities-enforcement-update/.

[12] See CF Disclosure Guidance: Topic No. 9 (March 25, 2020), available at https://www.sec.gov/corpfin/coronavirus-covid-19.

[13] Available at https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=394.

[14] See Commission Guidance on Management’s Discussion and Analysis of Financial Condition and Results of Operations, Release No. 3310751 (January 30, 2020), available at https://www.sec.gov/rules/interp/2020/33-10751.pdf.

[15] See “SEC Adopts Amendments to Reduce Unnecessary Burdens on Smaller Issuers by More Appropriately Tailoring the Accelerated and Large Accelerated Filer Definitions” (March 12, 2020), available at https://www.sec.gov/news/press-release/2020-58.

[16] See Accelerated Filer and Large Accelerated Filer Definitions, Release No. 34-88365 (March 12, 2020), available at https://www.sec.gov/rules/final/2020/34-88365.pdf.

[17] Available at https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=400.

[18] Available at https://www.sec.gov/divisions/corpfin/guidance/regs-kinterp.htm#110.02.

[19] Available at https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=393.

[20] See FAST Act Modernization and Simplification of Regulation S-K, Release No. 33-10618 (March 20, 2019), available at https://www.sec.gov/rules/final/2019/33-10618.pdf.

[21] See Financial Disclosures about Guarantors and Issuers of Guaranteed Securities and Affiliates Whose Securities Collateralize a Registrant’s Securities, Release No. 33-10762 (March 2, 2020), available at https://www.sec.gov/rules/final/2020/33-10762.pdf.

[22] See “SEC Amends Rules to Encourage Issuers to Conduct Registered Debt Offerings” (March 7, 2020), available at https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=396.

[23] Available at https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=425.

[24] See Confidential Treatment Applications Submitted Pursuant to Rules 406 and 24b-2 (December 19, 2019, Amended September 9, 2020), available at https://www.sec.gov/corpfin/confidential-treatment-applications#options.

[25] See “Electronic Signatures in Regulation S-T Rule 302, Release No. 33-10889 (November 17, 2020), available at https://www.sec.gov/rules/final/2020/33-10889.pdf.

[26] Available at https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=431.

[27] Available at https://pcaobus.org/Standards/Documents/Implementation-of-Critical-Audit-Matters-The-Basics.pdf.

[28] See “PCAOB Adopts New Model for Audit Reports” (June 2, 2017), available at https://www.gibsondunn.com/pcaob-adopts-new-model-for-audit-reports/.

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The following Gibson Dunn attorneys assisted in preparing this client update: Hillary H. Holmes, Elizabeth Ising, Thomas J. Kim, Brian J. Lane, James J. Moloney, Ronald O. Mueller, Michael Scanlon, Michael A. Titera, and Justine Robinson.

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

Securities Regulation and Corporate Governance Group: Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney – Orange County, CA (+ 949-451-4343, jmoloney@gibsondunn.com) Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com) Brian J. Lane – Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com) Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com) Michael A. Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)

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

© 2021 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

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A California federal court issued the first decision in the country in a securities class action arising out of the COVID-19 pandemic, dismissing the case on the ground that the issuer could not have anticipated the extent of the pandemic in early January 2020. The decision, Berg v. Velocity Financial, Inc.,[1] offers some hope for issuers that their public statements made before or in the early days of the pandemic will be protected from suit to the extent they failed to predict the COVID-19 crisis and its impact on the issuer’s business.

COVID-19 Securities Lawsuits

The COVID-19 pandemic and resulting “Coronavirus Crash” brought on a surge of event-driven securities lawsuits. The initial wave of pandemic-related securities lawsuits began in the Spring of 2020 and targeted primarily businesses in the travel and healthcare industries that were directly impacted by the ongoing public health crisis.[2] Several of these lawsuits centered on allegations that the issuer-defendants had downplayed the impact of COVID-19 on their business and/or concealed incidences of COVID-19 outbreaks at their places of business.

Despite a relatively steady stock market recovery through the Summer and Fall of 2020, pandemic-related securities lawsuits continued to be filed,[3] targeting defendants in a wider range of industries that were less directly impacted by COVID-19, including the software,[4] financial services,[5] and energy industries.[6] These cases alleged that companies failed to disclose the impact of COVID-19 on their financial performance and misstated their ability to weather the storm. Pandemic-related securities lawsuits have now become so numerous that the U.S. Chamber Institute for Legal Reform and the Chamber’s Center for Capital Markets Competitiveness filed a petition with the U.S. Securities and Exchange Commission urging the SEC to “act without delay to place reasonable limits on securities litigation arising out of the COVID-19 pandemic.”[7]

Berg v. Velocity Financial, Inc.

Berg involves claims against Velocity Financial, Inc. (“Velocity”), a real estate finance company specializing in lending for small commercial and residential properties. After Velocity went public in January 2020, its shares rapidly declined in value. The plaintiff filed a putative securities class action in July 2020, accusing Velocity of misrepresenting or failing to disclose material facts in its offering materials concerning: (i) the company’s “disciplined” underwriting process; (ii) the growth of non-performing and short-term, interest-only loans in its investment portfolio; (iii) a “substantial and durable” market for real estate investors; and (iv) risks facing its business, including those relating to the pandemic.

On January 25, 2021, the Court granted Velocity’s motion to dismiss, finding that the allegations of fraud were based on information that was either not available at the time of Velocity’s initial public offering or contradicted by Velocity’s offering materials. Regarding COVID-19, specifically, the Court grounded its decision on the fact that Velocity could not have anticipated the extent of the pandemic in early January 2020. Even so, the Court noted that Velocity’s offering materials had cautioned investors that Velocity’s business might be affected by “changes in national, regional or local economic conditions or specific industry segments,” including those caused by “acts of God,” which disclosure the Court found covered the pandemic. Similarly, the Court found that Velocity could not have anticipated that the rate of its nonperforming loans would increase to the extent that it did and, more specifically, that the extent of the increase due to the pandemic was not foreseeable when the company filed its offering materials in January 2020.

Conclusion

The COVID-19 crisis continues to cause disruptions and uncertainty in the economy, and companies can be certain that plaintiffs’ lawyers will continue to monitor securities filings and stock price performance for potential claims—groundless or otherwise. Companies can take some comfort that courts, starting with the Berg decision and possibly more to follow, will take a sensible and pragmatic approach in recognizing the unprecedented nature of the COVID-19 pandemic and dismissing cases premised on a failure early-on to anticipate the extent of the crisis. The Berg decision further shows that seemingly generic risk disclosures that did not call out COVID-19 risks in particular were sufficient in the early days of the COVID-19 pandemic. And public companies will no doubt hope that the decision provides a roadmap for other courts to dismiss similar securities complaints premised on a failure to predict the extent or commercial impact of the COVID-19 crisis.

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   [1]   No. 20 Civ. 6780, 2021 WL 268250 (C.D. Cal. Jan. 25, 2021).

   [2]   See, e.g., Douglas v. Norwegian Cruise Lines, 20-cv-21107 (S.D. Fla. Mar. 12, 2020); Service Lamp Corp. Profit Sharing Plan v. Carnival Corp., 20-cv-22202 (S.D. Fla. May 27, 2020); McDermid v. Inovio Pharm. Inc., 20-1402 (E.D. Pa. Mar. 12, 2020); Yannes v. SCWorx Corp., 20-cv-03349 (S.D.N.Y. Apr. 29, 2020).

   [3]   See, e.g., Tang v. Eastman Kodak Company, No. 20-cv-10462 (D.N.J. Aug. 13, 2020); City of Riviera Beach Gen. Emps. Ret. Sys. v. Royal Caribbean Cruises LTD, No. 20-cv-24111 (S.D. Fla. Oct. 7, 2020).

   [4]   See Arbitrage Fund v. ForescoutTechs., No. 20-cv-03819 (N.D. Cal. June 10, 2020).

   [5]   See SEC v. Wallach, No. 20-cv-06756 (N.D. Cal. Sept. 29, 2020).

   [6]   See Hessel v. Portland Gen. Elec. Co., No. 20-cv-01523 (D. Or. Sept. 3, 2020).

   [7]   Tom Quaadman & Harold Kim, Petition for Rulemaking on COVID-19 Related Litigation, (Oct. 30, 2020), https://instituteforlegalreform.com/petition-for-rulemaking-on-covid-19-related-litigation/.

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The following Gibson Dunn attorneys assisted in preparing this client update: Brian M. Lutz, Jennifer Conn, Avi Weitzman, Michael Nadler, Dillon M. Westfall, Tyler Andrew Hammond, and Maxwell Peck.

Gibson Dunn 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, any member of the Securities Litigation practice group, or the following authors:

Brian M. Lutz – San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com) Jennifer L. Conn – New York (+1 212-351-4086, jconn@gibsondunn.com) Avi Weitzman – New York (+1 212-351-2465, aweitzman@gibsondunn.com)

Securities Litigation Group: Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com) Brian M. Lutz – Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com) Robert F. Serio – Co-Chair, New York (+1 212-351-3917, rserio@gibsondunn.com) Jefferson Bell – New York (+1 212-351-2395, jbell@gibsondunn.com) Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com) Jennifer L. Conn – New York (+1 212-351-4086, jconn@gibsondunn.com) Thad A. Davis – San Francisco (+1 415-393-8251, tadavis@gibsondunn.com) Ethan Dettmer – San Francisco (+1 415-393-8292, edettmer@gibsondunn.com) Mark A. Kirsch – New York (+1 212-351-2662, mkirsch@gibsondunn.com) Jason J. Mendro – Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com) Alex Mircheff – Los Angeles (+1 213-229-7307, amircheff@gibsondunn.com) Craig Varnen – Los Angeles (+1 213-229-7922, cvarnen@gibsondunn.com) Robert C. Walters – Dallas (+1 214-698-3114, rwalters@gibsondunn.com) Avi Weitzman – New York (+1 212-351-2465, aweitzman@gibsondunn.com) Aric H. Wu – New York (+1 212-351-3820, awu@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

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On December 4, 2020, the Securities and Exchange Commission (“SEC”) announced its first enforcement action against a public company for misleading disclosures about the financial effects of the pandemic on the company’s business operations and financial condition. In a settled administrative order, the Commission found that disclosures in two press releases by The Cheesecake Factory Incorporated violated Section 13(a) of the Exchange Act and Rules 13a-11 and 12b-20 thereunder. Without admitting the findings in the order, the company agreed to pay a $125,000 penalty and to cease-and-desist from further violations.[1] In March 2020, the SEC’s Division of Enforcement formed a Coronavirus Steering Committee to oversee the Division’s efforts to actively look for Covid-related misconduct.

The Company’s Form 8-Ks

On March 23, 2020, the company furnished a Form 8-K to the Commission, disclosing, among other things, that it was withdrawing previously-issued financial guidance due to economic conditions caused by Covid-19. As an exhibit to the Form-8-K, the company included a copy of its press release providing a business update regarding the impact of Covid-19. The press release announced that the company was transitioning to an “off-premise” model (i.e., to-go and delivery) that would enable the company to continue to “operate sustainably.” This press release did not elaborate on what “sustainably” meant. The release also disclosed a $90 million draw down on the company’s revolving credit facility, and stated that the company was “evaluating additional measures to further preserve financial flexibility.”

On March 27, 2020, in response to media reports, the company filed another Form 8-K, disclosing that it was not planning to pay rent in April and that it was in discussion with landlords regarding its rent obligations, including abatement and potential deferral. The company also disclosed that as of April 1, it had reduced compensation for executive officers, its Board of Directors, and certain employees, and that it furloughed approximately 41,000 employees.

On April 3, 2020, the company furnished another Form 8-K to the Commission that attached a copy of an April 2, 2020 press release. This press release provided a preliminary Q1 2020 sales update, which reflected the impact of Covid-19. The release stated that “the restaurants are operating sustainably at present under this [off-premise] model.”

The SEC found that the March 23 and April 3 Form 8-Ks – but not the March 27 Form 8-K – were materially misleading.

What the Company Did Not Disclose

The company’s disclosures on March 23 and April 3 did not disclose:

1. a March 18, 2020 letter from the company to its restaurants’ landlords stating that it was not going to pay its rent for April 2020;
2. that the company was losing $6 million in cash per week;
3. that it had only approximately 16 weeks of cash remaining even after the $90 million revolving credit facility borrowing; and
4. that it was excluding expenses attributable to corporate operations from its claim of sustainability.

The SEC’s Findings

The SEC found that the company’s March 23 and April 3, 2020 Forms 8-K were materially false and misleading in violation of Section 13(a) of the Exchange Act and Rules 13a-11 and 12b-20 thereunder. These sections require that every issuer of a security registered pursuant to Section 12 of the Exchange Act file with the Commission accurate and current information on its Form 8-K, including material information necessary to make the required statements made in the reports not misleading.

Observations and Takeaways

Although this is the first enforcement action against a public company based on disclosures about the financial effects of the pandemic, the findings against the company are fairly unusual.

Two observations:

• First, the SEC’s order focuses on two press releases included as exhibits in Form 8-Ks that are deemed to be “furnished,” and not “filed,” under the Exchange Act. Specifically, one was filed under Item 7.01 and the other under Item 2.02. Because these Form 8-Ks are not deemed to be “filed” for purposes of Section 18 of the Exchange Act, there is no private right of action under Section 18 that can arise in connection with these Form 8-Ks. So, although “furnishing” reports results in lower liability exposure, it does not mean that the SEC cannot take enforcement action if it believes the disclosure is misleading.
• Second, the language at issue in the two Form 8-Ks is the word of the moment, “sustainably,” as in “operating sustainably.” It should be noted that, nine months after the disclosures were made, the company remains in business (and did not file for bankruptcy) and, in fact, as of the close of trading on December 4, 2020, its stock price closed near the high of the 52-week range. The concept of sustainability is generally thought to encompass the concept of over the long- or longer term, so it is not self-evident that these disclosures were materially misleading.

Some takeaways:

• In using the word “sustainably” without further qualification or explanation, issuers run the risk of being misunderstood. Sustainably in what sense (as a synonym for liquidity?) or to which degree? Over what period of time? It is not self-evident what sustainability entails.
• Where the subject matter involves the impact of Covid, the Commission’s order certainly demonstrates its willingness to take action even if, at worst, the disclosure at issue is vague or unclear. This was not a case in which the company claimed it had no liquidity issues when, in fact, it was experiencing significant liquidity issues. Put another way, this case raises the question as to whether Covid disclosures are attracting greater scrutiny than other corporate disclosures in the current climate.
• To state the obvious, the Commission brought this action for a reason: to underscore the importance of carefully drafted disclosures with respect to the impact of Covid on issuers’ results of operations, financial condition and liquidity; and to signal its willingness to take action if issuers’ Covid-related disclosures are not carefully drafted. A quote from the SEC Chair in the press release announcing this action is a further indication of the importance the SEC is placing on this area of enforcement.[2]

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  [1]   Order Instituting Cease-and-Desist Proceedings, Securities Exchange Act of 1934 Release No. 90565 at 4 (Dec. 4, 2020).

  [2]   Press Release, Securities and Exchange Commission, SEC Charges The Cheesecake Factory For Misleading COVID-19 Disclosures (Dec. 4, 2020), available at https://www.sec.gov/news/press-release/2020-306.

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

Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com) Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com) Barry R. Goldsmith – New York (+1 212-351-2440, bgoldsmith@gibsondunn.com) Richard W. Grime – Washington, D.C. (+1 202-955-8219, rgrime@gibsondunn.com) Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney – Orange County, CA (+ 949-451-4343, jmoloney@gibsondunn.com) Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Lauren Myers – New York (+1 212-351-3946, lmyers@gibsondunn.com)

Please also feel free to contact the practice group leaders:

Securities Enforcement Practice Group Leaders: Barry R. Goldsmith – New York (+1 212-351-2440, bgoldsmith@gibsondunn.com) Richard W. Grime – Washington, D.C. (+1 202-955-8219, rgrime@gibsondunn.com) Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com)

Securities Regulation and Corporate Governance Group: Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney – Orange County, CA (+ 949-451-4343, jmoloney@gibsondunn.com) Lori Zyskowski – New York, NY (+1 212-351-2309, lzyskowski@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

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On December 1, 2020, The Nasdaq Stock Market LLC (“Nasdaq”) announced that it filed with the U.S. Securities and Exchange Commission (the “SEC”) a proposal to advance board diversity and enhance transparency of board diversity statistics through new listing requirements. This client alert provides a summary of the proposed rules and the rationale for the proposals. In summary, if approved by the SEC, the proposed rules would require certain Nasdaq-listed companies to: (A) annually disclose diversity statistics regarding their directors’ voluntary self-identified characteristics in substantially the format proposed by Nasdaq for the current year and (after the first year of disclosure) the immediately prior year; and (B) include on their boards of directors at least two “Diverse” directors (as defined in the rules) or publicly disclose why their boards do not include such “Diverse” directors.

Nasdaq’s Annual Board Diversity Disclosure Proposal

The proposed rules would require Nasdaq-listed companies, other than “Exempt Entities” (as defined below), to provide statistical information about each director’s self-identified gender, race, and self-identification as LGBTQ+ in substantially the format proposed by Nasdaq under new proposed Rule 5606 (the “Board Diversity Matrix”), which is reproduced as Exhibit A below and is also available at the Nasdaq Listing Center here. Following the first year of disclosure, companies would be required to disclose the current year and immediately prior year diversity statistics using the Board Diversity Matrix or in a substantially similar format.

This statistical information disclosure would be required to be provided (A) in the company’s proxy statement or information statement for its annual meeting of shareholders, or (B) on the company’s website. If the company provides such disclosure on its website, the company must also submit such disclosure and include a URL link to the disclosure through the Nasdaq Listing Center no later than 15 calendar days after the company’s annual shareholders meeting.

The proposed diversity disclosure requirement is limited to the board of directors of the company, and does not require disclosure of diversity metrics for management and staff. Foreign Issuers may elect to satisfy the board composition disclosure requirement through an alternative disclosure matrix template. (See Nasdaq Identification Number 1761).

Include Diverse Directors or Explain

The proposed listing rule would require most Nasdaq-listed companies, other than “Exempt Entities” (as defined below), to:

	(A)	have at least two members of its board of directors who are “Diverse,” which includes:
		(1) at least one director who self-identifies her gender as female, without regard to the individual’s designated sex at birth (“Female”); and (2) at least one director who self-identifies as one or more of the following:
		(i) Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or two or more races or ethnicities (“Underrepresented Minority”); or (ii) as lesbian, gay, bisexual, transgender or a member of the queer community (“LGBTQ+”); or
	(B)	explain why the company does not have at least two directors on its board who self-identify as “Diverse.”

For the purposes of the proposed rule described above, the term “Diverse” means an individual who self-identifies in one or more of the following categories defined above: Female, Underrepresented Minority or LGBTQ+.

Foreign Issuers (including Foreign Private Issuers) and Smaller Reporting Companies would have more flexibility to satisfy the requirement for two Diverse directors by having two Female directors. In the case of a Foreign Issuer, in lieu of the definition above, “Diverse” means an individual who self-identifies as one or more of the following: Female, LGBTQ+, or an underrepresented individual based on national, racial, ethnic, indigenous, cultural, religious or linguistic identity in the company’s home country jurisdiction.

While Nasdaq’s definition of a “Diverse” director is substantially aligned with California’s Board Gender Diversity Mandate, there are some key differences, which are highlighted by Nasdaq here. Also, according to Nasdaq, the proposed rule “would exclude emeritus directors, retired directors and members of an advisory board. The diversity requirements of the proposed rule would only be satisfied by Diverse directors actually sitting on the board of directors of the company.” (See Nasdaq Identification Number 1770).

The definition of “Underrepresented Minority” is consistent with the categories reported to the U.S. Equal Employment Opportunity Commission through the Employer Information Report EEO-1 Form.

Exempt Entities

The following entities are exempt from the requirements described under “Nasdaq’s Annual Board Diversity Disclosure Proposal” and “Include Diverse Directors or Explain” above (the “Exempt Entities”):

• acquisition companies listed under IM-5101-2 (Listing of Companies Whose Business Plan is to Complete One or More Acquisitions);
• asset-backed issuers and other passive issuers (as set forth in Rule 5615(a)(1) (Asset-backed Issuers and Other Passive Issuers));
• cooperatives (as set forth in Rule 5615(a)(2) (Cooperatives));
• limited partnerships (as set forth in Rule 5615(a)(4) (Limited Partnerships));
• management investment companies (as set forth in Rule 5615(a)(5) (Management Investment Companies));
• issuers of nonvoting preferred securities, debt securities and Derivative Securities (as set forth in Rule 5615(a)(6) (Issuers of Non-Voting Preferred Securities, Debt Securities and Derivative Securities)); and
• issuers of securities listed under the Rule 5700 Series (Other Securities).

Compliance Period

Annual Board Diversity Disclosure Proposal

Each Nasdaq-listed company would have one calendar year from the date the SEC approves the Nasdaq rules (the “Approval Date”) to comply with the board diversity disclosure requirement. Each company newly listing on Nasdaq, including any Special Purpose Acquisition Company (“SPAC”) listed or listing in connection with a business combination under Nasdaq’s IM-5101-2, would be require to comply with the board diversity requirement within one year of listing, subject to the conditions further discussed under “Phase-in Period” below.

Board Diversity Rule Proposal

Each Nasdaq-listed company would have two calendar years from the Approval Date to have, or explain why it does not have, at least one Diverse director. Further, Nasdaq proposes for each company to have, or explain why it does not have, two diverse directors no later than: (i) four calendar years after the Approval Date, for companies listed on the Nasdaq Global Select or Nasdaq Global Market; or (ii) five calendar years after the Approval Date, for companies listed on the Nasdaq Capital Market. A company listing after the Approval Date, but prior to the end of the periods set forth in this paragraph, must satisfy the Diverse directors requirements by the latter of the periods set forth in this paragraph or one year from the date of listing. A SPAC “would be exempt from the proposed board diversity and disclosure rules until one year following the completion of [the SPAC’s] business combination.” (See Nasdaq Identification Number 1762).

Phase-in Period

Any company newly listing on Nasdaq will be permitted one year from the date of listing on Nasdaq to satisfy the requirements of Diverse directors, as long as such company was not previously subject to a substantially similar requirement of another national securities exchange, including through an initial public offering, direct listing, transfer from the over-the-counter market or another exchange, or through a merger with an acquisition company listed under Nasdaq’s IM-5101-2. This phase-in period will apply after the end of the transition periods described under “Compliance Period” above.

Cure Period

If a company does not have at least two Diverse directors and fails to provide the required disclosure, the Nasdaq’s Listing Qualifications Department will notify the company that it has until the later of the company’s next annual shareholders meeting or 180 days from the event that caused the deficiency to cure the deficiency.

Rationale

The proposed requirements are an extension of Nasdaq’s (and other securities exchanges’) use of the listing rules to improve listed companies’ corporate governance (e.g., the requirement of independent committees). The proposed disclosure requirements build on the SEC Division of Corporation Finance’s Compliance and Disclosure Interpretations 116.11 and 133.13, issued on February 6, 2019, regarding director and director nominee diversity disclosure under Items 401 and 407 of Regulation S-K, and reflect similar movement in the market (e.g., Goldman Sachs’s new standard requirement to have at least one diverse board member on companies it helps take public in 2020 and two in 2021). However, according to the New York Times, “[o]ver the past six months, Nasdaq found that more than 75 percent of its listed companies did not meet its proposed diversity requirements.”

Nasdaq’s proposal cited studies about the positive correlation of diversity and shareholder value, investor protection, decision making and monitoring management. In connection with the proposed rules, Nasdaq also announced that it “conducted an internal study of the current state of board diversity among Nasdaq-listed companies based on public disclosures, and found that while some companies already have made laudable progress in diversifying their boardrooms, the national market system and the public interest would best be served by an additional regulatory impetus for companies to embrace meaningful and multi-dimensional diversification of their boards.”

Additional Information

Nasdaq has provided additional information through a summary and Frequently Asked Questions available on Nasdaq’s Reference Library Advanced Search, in Identification Numbers 1745 through 1777.

Nasdaq also announced a partnership with Equilar, Inc., a provider of corporate leadership data solutions, to aid Nasdaq-listed companies with board composition planning challenges and allowing Nasdaq-listed companies, through the Equilar BoardEdge platform, to have access to diverse board candidates to amplify director search efforts.

Next Steps

The proposed rules will be published in the Federal Register and subject to public comment. Comments to the proposed rules should be submitted to the SEC within 21 days of their publication in the Federal Register.

The approval period may take as little as 30 calendar days and as long as 240 calendar days from the date of publication of the proposed rules in the Federal Register (as described in further detail below). If approved by the SEC, the “Compliance Period” discussed above would begin.

• Section 19(b)(2)(C)(iii) of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”), provides that the SEC may not approve a proposed rule change earlier than 30 days after the date of publication of the proposed rules in the Federal Register, unless the SEC finds good cause for so doing and publishes the reason for the finding.
• Under Section 19(b)(2)(A)(i) of the Exchange Act, within 45 days of the date of publication of the proposed rules in the Federal Register, the SEC may approve or disapprove the proposed rule change by order or, under Section 19(b)(2)(A)(ii) of the Exchange Act, extend the period by not more than an additional 45 days (to a total of 90 days).
• However, if the SEC does not approve or disapprove the proposed rule change, Section 19(b)(2)(B)(i)(II) of the Exchange Act allows the SEC the opportunity for hearings to be concluded no later than 180 days after the notice of the proposed rule change (which can be extended by not more than 60 days (to a total of 240 days), pursuant to Section under Section 19(b)(2)(B)(ii)(II) of the Exchange Act).

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Exhibit A

Board Disclosure Format

Board Diversity Matrix (As of [DATE])
Board Size:
Total Number of Directors	#
Gender:	Male	Female	Non-Binary	Gender Undisclosed
Number of directors based on gender identity	#	#	#	#
Number of directors who identify in any of the categories below:
African American or Black	#	#	#	#
Alaskan Native or American Indian	#	#	#	#
Asian	#	#	#	#
Hispanic or Latinx	#	#	#	#
Native Hawaiian or Pacific Islander	#	#	#	#
White	#	#	#	#
Two or More Races or Ethnicities	#	#	#	#
LGBTQ+	#
Undisclosed	#

 

Board Diversity Matrix (As of [DATE]) Foreign Issuer under Rule 5605(f)(1)
Country of Incorporation:	[Insert Country Name]
Board Size:
Total Number of Directors	#
Gender:	Male	Female	Non-Binary	Gender Undisclosed
Number of directors based on gender identity	#	#	#	#
Number of directors who identify in any of the categories below:
LGBTQ+	#
Underrepresented Individual in Home Country Jurisdiction	#
Undisclosed	#

 

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Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. For additional information, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm’s Securities Regulation and Corporate Governance and Capital Markets practice groups, or the authors:

Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Ron Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com) Rodrigo Surcan – New York (+1 212-351-5329, rsurcan@gibsondunn.com)

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

Securities Regulation and Corporate Governance Group: Elizabeth Ising – Co-Chair, Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com) Ron Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com) Lori Zyskowski – Co-Chair, New York (+1 212-351-2309, lzyskowski@gibsondunn.com) Aaron Briggs – San Francisco (+1 415-393-8297, abriggs@gibsondunn.com) Courtney Haseley – Washington, D.C. (+1 202-955-8213, chaseley@gibsondunn.com) Julia Lapitskaya – New York (+1 212-351-2354, jlapitskaya@gibsondunn.com) Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, ctillinghast@gibsondunn.com)

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

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

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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 2021. 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 developments. An executive summary of the ISS 2021 policy updates is available here and a more detailed chart showing additional updates to its voting policies and providing explanations for the updates is available here. The 2021 Glass Lewis Guidelines are available here and the 2021 Glass Lewis Guidelines on Environmental, Social & Governance Initiatives are available here.

ISS 2021 Voting Policy Updates On November 12, 2020, ISS released updates to its proxy voting guidelines for shareholder meetings held on or after February 1, 2021. This summary reviews the major policy updates that apply to U.S. companies, which are used by ISS in making voting recommendations on director elections and company and shareholder proposals at U.S. companies. ISS plans to issue a complete set of updated policies on its website in December 2020. ISS also indicated that it plans to issue updated Frequently Asked Questions (“FAQs”) on certain of its policies in December 2020, and it issued a set of preliminary FAQs on the U.S. Compensation Policies and the COVID-19 Pandemic in October 2020, which are available here. In January 2021, ISS will evaluate new U.S. shareholder proposals that are anticipated for 2021 and update its voting guidelines as necessary.

1. Director Elections

Board Racial/Ethnic Diversity While ISS has not previously had a voting policy regarding board racial or ethnic diversity, ISS noted that many investors have shown interest in seeing this type of diversity on public company boards, especially in light of recent activism seeking racial justice. In its annual policy survey administered in the summer of 2020, ISS reported that almost 60% of investors indicated that boards should aim to reflect a company’s customer base and the broader societies in which companies operate by including directors drawn from racial and ethnic minority groups, and 57% of investors responded that they would also consider voting against members of the nominating committee (or other directors) where board racial and ethnic diversity is lacking. Under ISS’s updated policy, at companies in the Russell 3000 or S&P 1500 indices:

• For the 2021 proxy season, the absence of racial/ethnic diversity on a company’s board will not be a factor in ISS’s voting recommendations, but will be highlighted by ISS in its research reports to “help investors identify companies with which they may wish to engage and foster dialogue between investors and companies on this topic.” ISS will only consider aggregate diversity statistics “if specific to racial and/or ethnic diversity.”
• For the 2022 proxy season, ISS will generally recommend votes “against” the chair of the nominating committee (or other directors on a case-by-case basis) where the board has no apparent racially or ethnically diverse members. Mitigating factors include the presence of racial and/or ethnic diversity on the board at the preceding annual meeting and a firm commitment to appoint at least one racially and/or ethnically diverse member within a year.

ISS highlighted several factors in support of its new policy, including obstacles to increasing racial and ethnic diversity on boards (citing studies conducted by Korn Ferry and the “Black Corporate Directors Time Capsule Project”), new California legislation, AB 979, to promote the inclusion of “underrepresented communities” on boards, recent comments by SEC Commissioner Allison Lee in support of strengthened additional guidance on board candidate diversity characteristics, diversity-related disclosure requirements and SEC guidance, and investor initiatives focused on racial/ethnic diversity on corporate boards. Board Gender Diversity ISS announced a policy related to board gender diversity in 2019, and provided a transitional year (2020) for companies that previously had no female directors to make a commitment to add at least one female director by the following year. In its recent policy updates, ISS removed the transition-related language, as the transition period will end soon. After February 1, 2021, ISS will recommend votes “against” the chair of the nominating committee (or other directors on a case-by-case basis) at any company that has no women on its board except in situations where there was at least one woman on the board at the previous annual meeting, and the board commits to “return to a gender-diverse status” by the next annual meeting. Material Environmental & Social Risk Oversight Failures Under extraordinary circumstances, ISS recommends votes “against” directors individually, committee members, or the entire board, in the event of, among other things, material failures of risk oversight. Current ISS policy cites bribery, large or serial fines or sanctions from regulatory bodies, significant adverse legal judgments or settlements, or hedging of company stock as examples of risk oversight failures. The policy updates add “demonstrably poor risk oversight of environmental and social issues, including climate change” as an example of a board’s material failure to oversee risk. ISS previously noted in its proposed policy updates that this policy is intended for directors of companies in “highly impactful sector[s]” that are “not taking steps to reduce environmental and social risks that are likely to have a large negative impact on future company operations” and is “expected to impact a small number of directors each year.” “Deadhand” or “Slowhand” Poison Pills ISS generally recommends votes case-by-case on director nominees who adopted a short-term poison pill with a term of one year or less, depending on the disclosed rationale for the adoption and other relevant factors. Noting that the unilateral adoption of a poison pill with a “deadhand” or “slowhand” feature is a “material governance failure,” ISS will now also generally recommend votes “against” directors at the next annual meeting if a board unilaterally adopts a poison pill with this feature, whether the pill is short-term or long-term and even if the pill itself has expired by the time of that meeting. ISS explains that a deadhand pill provision is “generally phrased as a ‘continuing director (or trustee)’ or ‘disinterested director’ clause and restricts the board’s ability to redeem or terminate the pill” and “can only be redeemed if the board consists of a majority of continuing directors, so even if the board is replaced by shareholders in a proxy fight, the pill cannot be redeemed,” and therefore, “the defunct board prevents [the redemption]” of the pill. Continuing directors are defined as “directors not associated with the acquiring person, and who were directors on the board prior to the adoption of the pill or were nominated by a majority of such directors.” A slowhand pill is “where this redemption restriction applies only for a period of time (generally 180 days).” Classification of Directors as Independent While there are several changes to ISS’s policy, the primary change is to limit the “Executive Director” classification to officers only, excluding other employees. According to ISS, this change will not result in any vote recommendation changes under its proxy voting policy, but may provide additional clarity for institutional holders whose overboarding policies apply to executive officers.

2. Other Board-Related Proposals

Board Refreshment Previously, ISS generally recommended votes “against” proposals to impose director tenure and age limits. Under the updated policy, ISS will now take a case-by-case approach for tenure limit proposals while continuing to recommend votes “against” age-limit proposals. With respect to management proposals for tenure limits, ISS will consider the rationale and other factors such as the robustness of the company’s board evaluation process, whether the limit is of sufficient length to allow for a broad range of director tenures, whether the limit would disadvantage independent directors compared to non-independent directors, and whether the board will impose the limit evenly, and not have the ability to waive it in a discriminatory manner. With respect to shareholder proposals for tenure limits, ISS will consider the scope of the proposal and whether there is evidence of “problematic issues” at the company combined with, or exacerbated by, a lack of board refreshment. ISS noted that the board refreshment is “best implemented through an ongoing program of individual director evaluations, conducted annually, to ensure the evolving needs of the board are met and to bring in fresh perspectives, skills, and diversity as needed,” but it cited the growing attention on board refreshment as a mechanism to achieve board diversity as an impetus for this policy change.

3. Shareholder Rights and Defenses

Exclusive Forum Provisions Exclusive forum provisions in company governing documents historically have required shareholders to go to specified state courts if they want to make fiduciary duty or other intra-corporate claims against the company and its directors. In March 2020, a unanimous Delaware Supreme Court confirmed the validity of so-called “federal forum selection provisions”—provisions that Delaware corporations adopt in their governing documents requiring actions arising under the Securities Act of 1933 (related to securities offerings) to be filed exclusively in federal court. Noting that the benefits of eliminating duplicative litigation and having cases heard by courts that are “well-versed in the applicable law” outweigh the potential inconvenience to plaintiffs, ISS updated its policy to recommend votes “for” provisions in the charter or bylaws (and announced it would not criticize directors who unilaterally adopt similar provisions) that specify “the district courts of the United States” (instead of particular federal district court) as the exclusive forum for federal securities law claims. ISS will oppose federal exclusive forum provisions that designate a particular federal district court. ISS also updated its policy on state exclusive forum provisions. At Delaware companies, ISS will generally support provisions in the charter or bylaws (and will not criticize directors who unilaterally adopt similar provisions) that select Delaware or the Delaware Court of Chancery. For companies incorporated in other states, if the provision designates the state of incorporation, ISS will take a case-by-case approach, considering a series of factors, including disclosure about harm from duplicative shareholder litigation. Advance Notice Requirements ISS recommends votes case-by-case on advance notice proposals, supporting those that allow shareholders to submit proposals/nominations as close to the meeting date as reasonably possible. Previously, to be “reasonable,” the company’s deadline for shareholder notice of a proposal/nomination had to be not more than 60 days prior to the meeting, with a submittal window of at least 30 days prior to the deadline. In its updated policy, ISS now considers a “reasonable” deadline to be no more than 120 days prior to the anniversary of the previous year’s meeting with a submittal window no shorter than 30 days from the beginning of the notice period (also known as a 90-120 day window). ISS notes that this is in line with recent market practice. This policy applies only in limited situations where a company submits an advance notice provision for shareholder approval. Virtual Shareholder Meetings In light of the ongoing COVID-19 pandemic and other rule changes regarding shareholder meeting formats, ISS has added a new policy under which it will generally recommend votes “for” management proposals allowing for the convening of shareholder meetings by electronic means, so long as they do not preclude in-person meetings. Companies are encouraged to disclose the circumstances under which virtual-only meetings would be held, and to allow for comparable rights and opportunities for shareholders to participate electronically as they would have during an in-person meeting. ISS will recommend votes case-by-case on shareholder proposals concerning virtual-only meetings, considering the scope and rationale of the proposal and concerns identified with the company’s prior meeting practices.

4. Social and Environmental Issues

Mandatory Arbitration of Employment Claims The new policy on mandatory arbitration provides that ISS will recommend votes case-by-case on proposals requesting a report on the use of mandatory arbitration on employment-related claims, taking into account the following factors:

• The company’s current policies and practices related to the use of mandatory arbitration agreements on workplace claims;
• Whether the company has been the subject of recent controversy, litigation, or regulatory actions related to the use of mandatory arbitration agreements on workplace claims; and
• The company’s disclosure of its policies and practices related to the use of mandatory arbitration agreements compared to its peers.

ISS added this policy because proposals on mandatory arbitration have received increased support from shareholders, and ISS clients have expressed interest in a specific policy on this topic. Sexual Harassment ISS’s new policy on sexual harassment provides that ISS will recommend votes case-by-case on proposals requesting a report on actions taken by a company to strengthen policies and oversight to prevent workplace sexual harassment, or a report on risks posed by a company’s failure to prevent workplace sexual harassment. ISS will take into account the following factors:

• The company’s current policies, practices, and oversight mechanisms related to preventing workplace sexual harassment;
• Whether the company has been the subject of recent controversy, litigation, or regulatory actions related to workplace sexual harassment issues; and
• The company’s disclosure regarding workplace sexual harassment policies or initiatives compared to its industry peers.

Similar to the new policy on mandatory arbitration discussed above, ISS cited increasing shareholder support for sexual harassment proposals and client demand as reasons for establishing this new policy. Gender, Race/Ethnicity Pay Gap ISS recommends votes case-by-case on proposals requesting reports on a company’s pay data by gender or race/ethnicity, or a report on a company’s policies and goals to reduce any gender or race/ethnicity pay gaps. In its updated policy, ISS adds to the list of factors to be considered in evaluating these proposals “disclosure regarding gender, race, or ethnicity pay gap policies or initiatives compared to its industry peers” and “local laws regarding categorization of race and/or ethnicity and definitions of ethnic and/or racial minorities.” ISS notes that this change is to “highlight that some legal jurisdictions do not allow companies to categorize employees by race and/or ethnicity and that definitions of ethnic and/or racial minorities differ from country to country, so a global racial and/or ethnicity statistic would not necessarily be meaningful or possible to provide.” Glass Lewis 2021 Proxy Voting Policy Updates On November 24, 2020, Glass Lewis released its updated proxy voting guidelines for 2021. This summary reviews the major updates to the U.S. guidelines, which provides a detailed overview of the key policies Glass Lewis applies when making voting recommendations on proposals at U.S. companies and on environmental, social and governance initiatives.

1. Board of Directors

Board Diversity Glass Lewis expanded on its previous policy on board gender diversity, under which it generally recommends votes “against” the chair of the nominating committee of a board that has no female members. Under its expanded policy:

• For the 2021 proxy season, Glass Lewis will note as a concern boards with fewer than two female directors.
• For the 2022 proxy season, Glass Lewis will generally recommend votes “against” the nominating committee chair of a board with fewer than two female directors; however, for boards with six or fewer members, Glass Lewis’s previous policy requiring a minimum of one female director will remain in place. Glass Lewis indicated that, in making its voting recommendations, it will carefully review a company’s disclosure of its diversity considerations and may refrain from recommending that shareholders vote against directors when boards have provided a sufficient rationale or plan to address the lack of diversity on the board.

In addition, Glass Lewis noted that several states have begun to address board diversity through legislation, including California’s legislation requiring female directors and directors from “underrepresented communities” on boards headquartered in the state. Under its updated policy, Glass Lewis will now recommend votes in accordance with board composition requirements set forth in applicable state laws when they come into effect. Disclosure of Director Diversity and Skills Beginning with the 2021 proxy season, Glass Lewis will begin tracking the quality of disclosure regarding a board’s mix of diverse attributes and skills of directors. Specifically, Glass Lewis will reflect how a company’s proxy statement presents: (i) the board’s current percentage of racial/ethnic diversity; (ii) whether the board’s definition of “diversity” explicitly includes gender and/or race/ethnicity; (iii) whether the board has adopted a policy requiring women and minorities to be included in the initial pool of candidates when selecting new director nominees (also known as the “Rooney Rule”); and (iv) board skills disclosure. Glass Lewis reported that it will not be making voting recommendations solely on the basis of this assessment in 2021, but noted that the assessment will “help inform [its] assessment of a company’s overall governance and may be a contributing factor in [its] recommendations when additional board-related concerns have been identified.” Board Refreshment Previously, Glass Lewis articulated in its policy its strong support of mechanisms to promote board refreshment, acknowledging that a director’s experience can be a valuable asset to shareholders, while also noting that, in rare circumstances, a lack of refreshment can contribute to a lack of board responsiveness to poor company performance. In its updated policy, Glass Lewis reiterates its support of periodic board refreshment to foster the sharing of diverse perspectives and new ideas, and adds that, beginning in 2021, it will note as a potential concern instances where the average tenure of non-executive directors is 10 years or more and no new directors have joined the board in the past five years. Glass Lewis indicated that it will not be making voting recommendations strictly on this basis in 2021.

2. Virtual-Only Shareholder Meetings

Glass Lewis has removed its temporary exception to its policy on virtual shareholder meeting disclosure that was in effect for meetings held between March 30, 2020 and June 30, 2020 due to the emergence of COVID-19. Glass Lewis’s standard policy will be in effect, under which Glass Lewis will generally hold the governance committee chair responsible at companies holding virtual-only meetings that do not include robust disclosure in the proxy statement addressing the ability of shareholders to participate, including disclosure regarding shareholders’ ability to ask questions at the meeting, procedures, if any, for posting questions received during the meeting and the company’s answers on its public website, as well as logistical details for meeting access and technical support.

3. Executive Compensation

Short-Term Incentives Glass Lewis has codified additional factors it will consider in assessing a company’s short-term incentive plan, including clearly disclosed justifications to accompany any significant changes to a company’s short-term incentive plan structure, as well as any instances in which performance goals have been lowered from the previous year. Glass Lewis also expanded its description of the application of upward discretion, including lowering goals mid-year and increasing calculated payouts, to also include instances of retroactively prorated performance periods. Long-Term Incentives With respect to long-term incentive plans, under its updated policy Glass Lewis has defined inappropriate performance-based award allocation as a criterion that may, in the presence of other major concerns, contribute to a negative voting recommendation. Glass Lewis will also review as “a regression of best practices” any decision to significantly roll back performance-based award allocation, which may lead to a negative recommendation absent exceptional circumstances. Glass Lewis also clarified that clearly disclosed explanations are expected to accompany long-term incentive equity granting practices, as well as any significant structural program changes or any use of upward discretion.

4. Environmental, Social & Governance Initiatives

Workforce Diversity Reporting Glass Lewis has updated its guidelines to provide that it will generally recommend votes “for” shareholder proposals requesting that companies provide EEO-1 reporting. It also noted that, because issues of human capital management and workforce diversity are material to companies in all industries, Glass Lewis will no longer consider a company’s industry or the nature of its operations when evaluating diversity reporting proposals. Management-Proposed E&S Resolutions Glass Lewis will take a case-by-case approach to management proposals that deal with environmental and social issues, and will consider a variety of factors, including: (i) the request of the management proposals and whether it would materially impact shareholders; (ii) whether there is a competing or corresponding shareholder proposal on the topic; (iii) the company’s general responsiveness to shareholders and to emerging environmental and social issues; (iv) whether the proposal is binding or advisory; and (v) management’s recommendation on how shareholders should vote on the proposal. Climate Change Glass Lewis will no longer consider a company’s industry when reviewing climate reporting proposals, noting that because of the extensive and wide-ranging impacts climate change can have, it is an issue that should be addressed and considered by companies regardless of industry. As a result, under its new policy, Glass Lewis will generally recommend votes “for” shareholder proposals requesting that companies provide enhanced disclosure on climate-related issues, such as requesting that the company undertake a scenario analysis or report that aligns with the recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”). Glass Lewis explained that that while it is generally supportive of these types of proposals, it will closely evaluate them in the context of a company’s unique circumstances and when making vote recommendations will continue to consider: (i) how the company’s operations could be impacted by climate-related issues; (ii) the company’s current policies and the level and evolution of its related disclosure; (iii) whether a company provides board-level oversight of climate-related risks; (iv) the disclosure and oversight afforded to climate change-related issues at peer companies; and (v) if companies in the company’s market and/or industry have provided any disclosure that is aligned with the TCFD recommendations. Glass Lewis’s updated policy also addresses its approach to proposals on climate-related lobbying. When reviewing proposals asking for disclosure on this issue, Glass Lewis will evaluate: (i) whether the requested disclosure would meaningfully benefit shareholders’ understanding of the company’s policies and positions on this issue; (ii) the industry in which the company operates; (iii) the company’s current level of disclosure regarding its direct and indirect lobbying on climate change-related issues; and (iv) any significant controversies related to the company’s management of climate change or its trade association memberships. Under its policy, while Glass Lewis will generally recommend that companies enhance their disclosure on these issues, it will generally recommend votes “against” any proposals that would require the company to suspend its memberships in or otherwise limit a company’s ability to participate fully in the trade associations of which it is a member. Environmental and Social Risk Oversight Glass Lewis has updated its guidelines with respect to board-level oversight of environmental and social issues. Under its existing policy, for large-cap companies and in instances where Glass Lewis identifies material oversight concerns, Glass Lewis will review a company’s overall governance practices and identify which directors or board-level committees have been charged with oversight of environmental and/or social issues. Under its updated policy:

• For the 2021 proxy season, Glass Lewis will note as a concern when boards of companies in the S&P 500 do not provide clear disclosure (in either the company’s proxy statement or governing documents such as committee charters) on board-level oversight of environmental and social issues.
• For the 2022 proxy season, Glass Lewis will generally recommend votes “against” the governance committee chair at S&P 500 companies without explicit disclosure concerning the board’s role in overseeing these issues.Glass Lewis clarified in its updated policy that, while it believes it is important that these issues are overseen at the board level and that shareholders are afforded meaningful disclosure of these oversight responsibilities, it believes that companies should determine the best structure for this oversight (which it noted may be conducted by specific directors, the entire board, a separate committee, or combined with the responsibilities of a key committee).

5. Other Changes

Glass Lewis’s 2021 voting policies also include the following updates:

1. Special Purpose Acquisition Companies (“SPACs”): New to its policy this year is a section detailing Glass Lewis’s approach to common issues associated with SPACs. Under its new policy, Glass Lewis articulates a generally favorable view of proposals seeking to extend business combination deadlines. The new policy also details Glass Lewis’s approach to determining independence of board members at a post-combination entity who previously served as executives of the SPAC, whom Glass Lewis will generally consider to be independent, absent any evidence of an employment relationship or continuing material financial interest in the combined entity.
2. Governance Following an IPO or Spin-Off. Glass Lewis clarified its approach to director recommendations on the basis of post-IPO corporate governance concerns. Glass Lewis generally targets the governance committee members for such concerns; however, if a portion of the governance committee members is not standing for election due to a classified board structure, Glass Lewis will expand its recommendations to additional director nominees, based on who is standing for election. Glass Lewis also clarified its approach to companies that adopt a multi-class share structure with disproportionate voting rights, or other anti-takeover mechanisms, preceding an IPO, noting it will generally recommend voting against all members of the board who served at the time of the IPO if the board: (i) did not also commit to submitting these provisions to a shareholder vote at the company’s first shareholder meeting following the IPO; or (ii) did not provide for a reasonable sunset of these provisions.
3. Board Responsiveness. Glass Lewis did not change its board responsiveness policy, but clarified its approach to assessing significant support for non-binding shareholder resolutions. Specifically, for management resolutions, Glass Lewis will note instances where a resolution received over 20% opposition at the prior year’s meeting and may opine on the board’s response to such opposition; however, in the case of majority-approved shareholder resolutions, Glass Lewis generally believes significant board action is warranted in response.

Recommended Actions for Public Companies

• Submit your company’s peer group information to ISS for the next proxy statement: As part of ISS’s peer group construction process, on a semiannual basis in the U.S., companies may submit their self-selected peer groups for their next proxy disclosure. Although not determinative, companies’ self-selected peer groups are considered in ISS’s peer group construction, and therefore it is highly recommended that companies submit their self-selected peer groups. Certain companies with annual meetings to be held between February 1, 2021 and September 15, 2021 may submit their self-selected peer groups through the Governance Analytics page on the ISS website from November 16, 2020 to December 4, 2020. The peer group should include a complete peer list used for benchmarking CEO pay for the fiscal year ending prior to the next annual meeting. Companies that have made no changes to their previous proxy-disclosed executive compensation benchmarking peers, or companies that do not wish to provide this information in advance, do not need to participate. For companies that do not submit changes, the proxy-disclosed peers from the company’s last proxy filing will automatically be considered in ISS’s peer group construction process.
• Evaluate your company’s practices in light of the updated 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 2021, are impacted by any of the changes to the ISS and Glass Lewis proxy voting policies. For example, companies should consider whether their exclusive forum provisions or poison pills in the charter or bylaws contain any specific feature that would lead to adverse voting recommendations for directors by ISS or Glass Lewis.
• Assess racial/ethnic diversity on your board and consider enhancing related disclosures in the proxy statement: Companies should assess the composition of their board with respect to gender and racial/ethnic diversity, and consider whether any changes are needed to the board’s director recruitment policies and practices. Companies should also consider whether their diversity disclosures in the proxy statements or other public filings are adequate. To facilitate this assessment and support enhanced public disclosures, companies should consider asking their directors to self-identify their diverse traits in their upcoming director and officer questionnaires. As also noted by ISS, investors, too, are increasingly focused on racial/ethnic diversity. California recently passed the new board racial/ethnic diversity bill that expands upon the 2018 gender diversity bill, and the Illinois Treasurer launched a campaign representing a coalition of state treasurers and other investors in October 2020 asking Russell 3000 companies to disclose the race/ethnicity and gender of their directors in their 2021 proxy statements. In August 2020, State Street sent a letter to the board chairs of its U.S. portfolio companies, informing them that starting in 2021, State Street will ask companies to provide “specific communications” to shareholders regarding their diversity strategy and goals, measures of the diversity of the employee base and the board, goals for racial and ethnic representation at the board level and the board’s role in oversight of diversity and inclusion. In addition, earlier this week, Nasdaq filed a proposal with the SEC to adopt new listing rules related to board diversity and disclosure. The proposed rules would require most Nasdaq-listed companies to publicly disclose statistical information in a proposed uniform format on the company’s board of directors related to a director’s self-identified gender, race, and self-identification as LGBTQ+ and would also require such Nasdaq-listed companies “to have, or explain why they do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+.”

• Consider enhancing board oversight and disclosures on environmental and social matters: Although ISS noted that its update related to material environmental and social risk oversight failures is expected to affect a small number of directors in certain high-risk sectors, it is notable that ISS explicitly adds environmental and social risk oversight as an area where it will hold directors accountable. Also, institutional investors continue to focus on these issues in their engagements with companies and voice their concerns at companies that lag behind on this front. For example, BlackRock recently reported that, during the 2020 proxy season, it took actions against 53 companies for their failure to make sufficient progress regarding climate risk disclosure or management, either by voting against director-related items (such as director elections and board discharge proposals) or supporting certain climate-related shareholder proposals. Regardless of sector or industry, companies should evaluate whether their board has a system that properly enables them to oversee how the company manages environmental and social risks and establishes policies aligned with recent developments.

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

Securities Regulation and Corporate Governance Group: Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com) Ron Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com) Lori Zyskowski – New York, NY (+1 212-351-2309, lzyskowski@gibsondunn.com) Aaron Briggs – San Francisco, CA (+1 415-393-8297, abriggs@gibsondunn.com) Courtney Haseley – Washington, D.C. (+1 202-955-8213, chaseley@gibsondunn.com) Julia Lapitskaya – New York, NY (+1 212-351-2354, jlapitskaya@gibsondunn.com) Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, ctillinghast@gibsondunn.com) Executive Compensation and Employee Benefits Group: Stephen W. Fackler – Palo Alto/New York (+1 650-849-5385/+1 212-351-2392, sfackler@gibsondunn.com) Sean C. Feller – Los Angeles (+1 310-551-8746, sfeller@gibsondunn.com) Krista Hanvey – Dallas (+ 214-698-3425, khanvey@gibsondunn.com) © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Gibson, Dunn & Crutcher LLP is pleased to announce that Thomas Kim has joined the firm as a partner in the Washington, D.C. office.  Kim, formerly with Sidley Austin, will continue to practice in the areas of securities disclosure and regulation and corporate governance. “Tom is a terrific addition to the firm,” said Ken Doran, Chairman and Managing Partner of Gibson Dunn.  “He is a well-respected securities and corporate lawyer with impeccable credentials that include high-level experience at the Securities and Exchange Commission.  He is a great addition to the firm’s premier Securities Regulation and Corporate Governance Practice Group.” “We’re thrilled to have Tom on board,” said Beth Ising, Co-Chair of the Securities Regulation and Corporate Governance Practice Group.  “We expect to see continued congressional and regulatory interest in developing further disclosure and governance standards.  Tom’s experience at the SEC’s Division of Corporation Finance combined with his in-house experience will be an attractive combination for our clients and will allow us to further distinguish the depth and sophistication of our firm’s practice.  With his addition, we will strengthen our position as market leaders in the area of securities regulation and corporate governance.” “I look forward to working with my new Gibson Dunn colleagues,” said Kim.  “I’ve admired the quality of the firm’s work for many years, and I’m delighted to further advance my practice at a firm with a stellar reputation in securities regulation and corporate governance and a strong complementary platform in litigation and transactional work.” About Thomas Kim Kim’s practice focuses on a broad range of SEC disclosure and regulatory matters, including capital raising and tender offer transactions and shareholder activist situations, as well as corporate governance and compliance issues.  He also advises clients on SEC enforcement investigations involving disclosure, registration and auditor independence issues.  Kim has extensive experience handling regulatory matters with the SEC, including obtaining no-action and exemptive relief and waivers. Before joining Gibson Dunn, Kim was a partner with Sidley Austin LLP since 2013.  Before that, he worked for seven years at the SEC, where he served as Chief Counsel and Associate Director of the Division of Corporation Finance and as Counsel to the Chairman.  Prior to his tenure at the SEC, Kim served as Corporate and Securities Counsel for General Electric.  He has been named to the National Association of Corporate Directors’ Directorship 100 since 2015 and is a fellow of the American College of Governance Counsel.  Kim is a frequent speaker at national securities law conferences and is currently Chair of the Northwestern Pritzker Law School’s Annual Securities Regulation Institute. Kim received his law degree, magna cum laude, from Harvard Law School in 1995 and was an editor of Harvard Law Review.  He earned his B.A., summa cum laude, from Yale University.

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On October 29, 2020, the 16th amendment to the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung or “AWV”) entered into force. The amendment is the final step of implementing the EU-wide cooperation mechanism introduced by Regulation (EU) 2019/452 of March 19, 2019 establishing a framework for screening of foreign direct investments into the EU (the “EU Screening Regulation”).

New EU-Wide Cooperation Mechanism

The EU Screening Regulation directly applies as of October 11, 2020 which marks the beginning of a coordinated cooperation among EU member states on foreign direct investments (the “FDIs”). This means that, going forward, the German Federal Ministry for Economic Affairs and Energy (the “German Ministry”) will exchange information on FDIs undergoing screening in Germany with the European Commission and fellow EU member states which, in turn, may issue comments or, in case of the European Commission, an opinion. While such comments and/or opinions are non-binding, they need to be given ‘due consideration’ and, thus, may influence the screening decision rendered by the German Ministry. For details on the EU Screening Regulation, see our Client Alert of March 5, 2019.

In order for the German Ministry to be able to consider the potential impact of an FDI on the public order or security of one or more fellow EU member states as well as on projects or programs of EU interest, the grounds for screening under German FDI rules had to be expanded accordingly. For the same reason, the standard under which an FDI may be prohibited or restrictive measures may be imposed has been tightened from “endangering” (Gefährdung) to “likely to affect” (voraussichtliche Beeinträchtigung) the public order or security, as to reflect the EU Screening Regulation. More or less a side effect, this gives the German Ministry more discretion and room to maneuver as it no longer has to determine an “actual and serious threat” (tatsächliche und hinreichend schwere Gefährdung) but now could prohibit a transaction in order to prevent an impairment that has not yet materialized but that is likely to occur as a result of the contemplated FDI.

Recent Changes to German FDI Rules

In light of the implementation of the EU-wide cooperation mechanism, we want to use the opportunity to recap this year’s key changes to the German FDI screening process. We refer to our client alert of May 27, 2020 (available here) for an overview on the overall screening process and a detailed outline of the most relevant amendments (and contemplated changes) to German FDI rules thus far in 2020.

Changes Effective as of October 29, 2020

• Expanding the Grounds for Screening. As described above, the grounds for screening have been expanded to include public order or security of a fellow EU member state as well as effects on projects or programs of EU interest.
• Tightening the Standard. As described above, the standard under which an FDI may be prohibited or restrictive measures may be imposed has been tightened from “endangering” (Gefährdung) to “likely to affect” (voraussichtliche Beeinträchtigung) the public order or security.

Key Changes Effective as of June 3, 2020

• Health-Care Related Additions. As a response to the COVID-19 crisis, the catalog of select industries subject to cross-sector review was expanded to include personal protective equipment, pharmaceuticals that are essential for safeguarding the provision of healthcare to the population as well as medical products and in-vitro-diagnostics used in connection with life-threatening and highly contagious diseases.
• Governmental Communication Infrastructure. Also added to the catalog of select industries subject to cross-sector review, and thus, triggering mandatory notification to the German Ministry, have been FDIs acquiring 10% or more of the voting rights in companies providing services ensuring the interference-free operation and functioning of governmental communication infrastructure.
• Investor-Related Screening Factors. In line with the EU Screening Regulation, the German Ministry may now consider screening factors that focus on the background and activities of the individual investor. In particular, the German Ministry may now take into account whether the foreign investor (i) is directly or indirectly controlled by the government, including state bodies or armed forces, of a third country, including through ownership structure or more than insignificant funding, (ii) has already been involved in activities affecting the public order or security of the Federal Republic of Germany or of a fellow EU member state, or (iii) whether there is a serious risk that the foreign investor, or persons acting on behalf of it, were or are engaged in activities that, in Germany, would be punishable as a certain criminal or administrative offence, such as terrorist financing, money laundering, fraud, corruption, or violations of the foreign trade or war weapon control rules.
• Applicability to Share and Asset Deals. Since June 3, 2020 it has been codified that German FDI control is not limited to the acquisition of shares but equally applies to asset deals.
• Notification Modalities. It was further clarified that FDIs triggering a notification obligation are to be notified immediately after signing of the acquisition agreement. The notification generally has to be submitted by the direct acquirer (even if the acquisition vehicle itself is not “foreign”) but may also be made by the indirect acquirer instead.

Key Changes Effective as of July 17, 2020

• Effects on Consummating Transactions. In addition to transactions subject to sector-specific review (i.e., the defense industry and certain parts of the IT security industry), all transactions falling under cross-sector review that are notifiable (i.e., FDIs of 10% or more of the voting rights in companies active in industries listed in the catalog of select industries) may only be consummated upon conclusion of the screening process (condition precedent). Note that this has a tangible impact on the transaction practice given the broad range of notifiable FDIs in the cross-sector category, which are affected by this change. Foreign investors need to carefully assess if the target company operates in one of the listed industry categories. From a drafting perspective, acquisition agreements regarding notifiable FDIs should include a closing condition that the FDI is (deemed) cleared by the German Ministry. Buyers should further make sure to include a mechanism allowing for the amendment or termination of the acquisition agreement in case the German Ministry imposes (comprehensive) restrictive measures.
• Penalizing the Disclosure of Security-Relevant Information and Certain Consummation Actions Pending Screening. The following actions are now penalized by way of imprisonment of up to five years or fine (in case of willful infringements and attempted infringements) or with a fine of up to EUR 500,000 (in case of negligence):
  • Enabling the investor to, directly or indirectly, exercise voting rights;
  • Granting the investor dividends or any economic equivalent;
  • Providing or otherwise disclosing to the investor information on the German target company with respect to company objects and divisions that are subject to screening on grounds of essential security interests of the Federal Republic of Germany, or of particular importance when screening for effects on public order and security of the Federal Republic of Germany, or that have been declared as ‘significant’ by the German Ministry;
  • Non-compliance with enforceable restrictive measures (vollziehbare Anordnungen) imposed by the German Ministry.

The introduction of criminal liability will lead to even greater focus on whether or not the transaction requires FDI clearing. The seller de facto will be forced to include the clearing by the German Ministry as a closing condition to avoid exposure to criminal liability.

According to the explanatory notes (Gesetzesbegründung), the prohibition to disclose security-sensitive information as described above will usually not apply to purely or other company-related commercial information that is exchanged in the course of a transaction in order to allow the investor to conduct a sound evaluation of the economic opportunities and risks of the FDI. Nonetheless, the seller will need to be cautious when preparing the due diligence process, in particular when populating the virtual data room. Typically, security-sensitive information as described above will not be shared with potential buyers prior to closing of the transaction anyway. Should the need arise, however, the use of a red data room and special disclosure and confidentiality obligations based on a clean team agreement are advisable.

• Time Periods. In view of necessary adjustments to the timeframe of the screening process to integrate the EU-wide cooperation mechanism, the German legislator took the opportunity to overhaul the framework of screening periods altogether. Time periods are now set forth directly in the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz or “AWG”) instead of the AWV. This way, time periods can only be adjusted by way of legislative procedure, i.e. with involvement of the German parliament, and may no longer be changed unilaterally by executive order of the German government.Note the following changes to the timeline of the screening process (which will only apply to FDIs of which the German Ministry became aware of after July 17, 2020):
  • Standardized Time Periods. The same review periods apply to sector-specific (i.e., the defense industry and certain parts of the IT security industry) and to cross-sector (i.e., all industry sectors except for defense/certain IT security) FDIs alike. The German Ministry now has two months from becoming aware of the reviewable FDI – instead of previously three months (sector-specific review) or even four months (cross-sector review) – to decide whether to initiate formal proceedings. Making a mandatory notification or filing for a certificate of non-objection will equally trigger the two-month pre-assessment period. In addition, the formal screening period was standardized and may now take up to four months regardless of the sector.
  • Extension of Time Periods. The German Ministry may extend the four-month screening period by three months if the individual case is particularly difficult in either a factual or a legal manner. A further extension by one month is possible if the Federal Ministry of Defense puts forward that defense interests of Germany are notably affected. Moreover, periods may now be extended with the investor’s approval.
  • Suspension of Time Periods. The screening period is suspended in case the German Ministry later requests further information on the FDI. Previously, the screening period was not set in motion before the German Ministry received all (initially or later) requested information on the FDI. This change most likely is meant to allow for requests of fellow EU member states for additional information on the FDI within the cooperation process under the EU Screening Regulation while, at the same time, keeping the delay in the screening process to a minimum.
  • Resetting of Time Periods. Time periods will reset and start anew in the event that an FDI clearance or certificate of non-objection was revoked or altered (e.g., in case of willful deceit or the subsequent occurrence of facts). Equally, the time period will also reset if a restrictive measure or a contractual provision with the German Ministry is set aside, partly or in full, by a court decision.
• Submission of Information. Being a triggering point for the screening period, the submission of information also was moved from the AWV to the AWG and, therefore, may only be amended by the German parliament.
  • Triggering of Screening Period. Previously, the screening period was only triggered once all information had been submitted to the German Ministry. It is now provided that the four-month screening period starts when all initially requested information has been submitted which includes, as before, all information set forth in the corresponding general ordinance issued by the German Ministry, and, as of now, all information that the German Ministry additionally may request in its decision to initiate formal screening proceedings.
  • Subsequent Request for Additional Information. The German Ministry may, also later in the screening process, request further information from anyone directly or indirectly involved in the acquisition. Although the screening period will be suspended until submission of the requested information, the overall duration of the screening process remains calculable for the investor who can limit the suspension by actively working towards a speedy submission.
• More Effective Monitoring of Compliance with Measures. Investors and target companies are to expect more monitoring activity by the German Ministry which now has a right of information as well as a right to carry out examinations (including access to stored data, respective data processing systems, and business premises, in each case also by use of third-party representatives (Beauftragte)) in order to better monitor the investor’s and/or target company’s compliance with contractually agreed or imposed measures.
• Imposing Restrictive Measures without Consent of the German Government. Previously, restrictive measures regarding FDIs subject to cross-sector review could only be imposed with the consent of the German government. Now, restrictive measures may be imposed in agreement with and/or consultation of certain federal ministries instead. For the sake of clarity, the German Ministry still requires the consent of the German government if it wants to prohibit an FDI that is subject to cross-sector review. This has not changed.

What Is Next?

Further changes to the AWV are announced to follow in the 17^th amendment to the AWV. In particular, the German Ministry plans to expand the catalog of critical industries which are notifiable and subject to cross-sector review from the acquisition of 10% or more of the voting rights. Based on earlier announcements by the German Ministry on this subject, we expect artificial intelligence, robotics, semiconductors, biotechnology and quantum technology to be potentially declared critical industries. The German Ministry stresses that it will take special consideration of feedback provided by the affected industry circles when proposing the expansion of critical industries to the German government.

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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. For further information, please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the team in Frankfurt or Munich, or the following authors:

Markus Nauheim - Munich (+49 89 189 33 122, mnauheim@gibsondunn.com) Wilhelm Reinhardt - Frankfurt (+49 69 247 411 502, wreinhardt@gibsondunn.com) Stefanie Zirkel - Frankfurt (+49 69 247 411 513, szirkel@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

COVID-19 has shone a bright light on the critical role that ESG considerations can play for companies and firms. Questions of corporate purpose and the meaning of “success” have been reprised and are being carefully considered in the context of an active debate around stakeholder capitalism.  Critically, the role and expectations of directors and management in pursuing a sustainability agenda have risen to the top of the agenda for corporates, legislatures and regulators alike. But what constitutes “good governance” in the context of ESG and how do boards and senior managers address the complex web of rules, regulations, standards and frameworks which apply at a national, regional and global level? During this webinar, members of the ESG Practice Group of Gibson Dunn (London) will provide some insights to help navigate the global ESG landscape from a UK perspective, touching on key rules and regulations, forthcoming developments and trends, and practical tips including:

• An overview of the ESG landscape
• How boards are fulfilling their directors’ duties in the wake of the new vision of the “purposeful company” including engagement with stakeholder groups
• Key reporting and disclosure requirements
• Governance structures and features that underpin effective, integrated ESG business models
• Market trends and emerging rules, regulations and policy changes
• Risk mitigation, litigation risk and shareholder pressures
• Practical guidance and examples for boards and managers

View Slides (PDF)

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PANELISTS: Selina Sagayam is a partner in Gibson Dunn’s international corporate team. Her practice focuses on international corporate finance transactional work, including public and private M&A, joint ventures, international equity capital markets offerings and advisory work focused on corporate governance, shareholder activism and securities law advice. Regarded as one of the leading public M&A advisers in the UK, Ms. Sagayam has advised on hostile, competitive and recommended takeovers. Ms. Sagayam is also noted for her expertise in financial services and regulatory advice. She advises boards and senior management of international corporations, exchanges, regulators, investment banks, and financial sponsors (private equity and hedge funds) on such issues. Her experience as a senior secondee at the UK takeover Panel and also as a non-executive director of a FTSE250 company has positioned her uniquely in her practice area. Ms. Sagayam established and co-chairs the firm’s UK ESG Practice Group. Susy Bullock is a partner in Gibson Dunn’s international litigation team.  Ms. Bullock specializes in commercial litigation and investigations, and business and human rights. Previously Ms. Bullock was Head of Litigation for Europe, the Middle East and Africa at UBS and had responsibility for all litigation and contentious regulatory matters in the EMEA region for the bank including commercial and white-collar criminal litigation, as well as certain internal investigations. In a business and human rights context, Ms. Bullock has supported the Thun Group of banks since 2016 and has also participated in various consultations of the UN Office of High Commissioner for Human Rights. Ms. Bullock can advise clients on sustainability and corporate social responsibility matters such as supply chain issues and investigations, non-financial disclosures and Modern Slavery Act 2015 compliance, and disputes.  Ms. Bullock co-chairs the firm’s UK ESG Practice Group. Anna Howell is a partner in Gibson Dunn’s international corporate team, a co-chair of the Oil & Gas practice, and a member of the firm's Energy & Infrastructure, M&A, Private Equity, and UK ESG practice groups.  Ms. Howell advises on complex cross-border transactions and advisory work in the energy sector with a particular focus on alternative energy, renewables, gas and liquefied natural gas (LNG).  Over her 25+ year career she has advised high-profile clients on some of their most prestigious and challenging mandates, including first entries into both mature and emerging markets throughout Europe, Africa, Latin America, Asia Pacific, and the Middle East.  Ms. Howell has advised clients on re-use and repurposing in the context of decommissioning as well as switching to cleaner fuels, energy efficiency, sustainability and emissions trading.   Ms. Howell spent over 11 years practising in Asia and has worked in London, Singapore, Hong Kong and Beijing.

The leading German legal publication JUVE recommended Gibson Dunn’s Frankfurt, Munich and Brussels offices in the 2020/2021 edition of its annual directory.  Gibson Dunn was named among the top 50 law firms in Germany. It was recommended in the Brussels, Frankfurt and Munich regions and recognized in the Antitrust, Compliance and Internal Investigations, Corporate, Dispute Resolution, M&A and Private Equity categories.

German publication Kanzleimonitor 2020/2021 listed Gibson Dunn among the top 50 law firms in Germany recommended by in-house lawyers. In the categories of Stock Corporation and Corporate Governance Law, Munich partner Ferdinand Fromholzer was one of two most recommended lawyers, Munich of counsel Silke Beiter was frequently recommended, and the firm was ranked among the top 10 in Germany. Partners who are also frequently recommended were Frankfurt partners Dirk Oberbracht in Mergers & Acquisitions and Georg Weidenbach in the area of Antitrust Law. Gibson Dunn’s German offices were also recommended among the leading law firms for Compliance, Corporate Law, IP, and Mergers & Acquisitions. The study, based on approximately 5,610 recommendations by 603 in-house legal departments and set up by Deutsches Institut fuer Rechtsabteilungen & Unternehmensjuristen (diruj), was published on October 26, 2020.

New York partner Eduardo Gallardo was elected as a Fellow of the American College of Governance Counsel. The American College of Governance Counsel is a professional, educational, and honorary association of lawyers widely recognized for their achievements in the field of governance. The newly elected fellows were announced in October 2020. Eduardo Gallardo focuses his practice on mergers and acquisitions, shareholder activism defense and corporate governance matters. He has extensive experience representing public and private buyers and sellers in connection with mergers, acquisitions and takeovers, both negotiated and contested. He has also represented public and private companies in connection with proxy contests, leveraged buyouts, spinoffs, divestitures, restructurings, recapitalizations, joint ventures and other complex corporate transactions.

Expert Guides has named 33 Gibson Dunn partners to the 2020 edition of its Banking, Finance and Transactional Guide, which recognizes the top legal practitioners in the industry.  Selection to this guide is determined by a survey of fellow legal practitioners in more than 80 jurisdictions.  The Gibson Dunn partners included in the guide are Frankfurt partner Dirk Oberbracht, Hong Kong partners Albert Cho, John Fadely, Scott Jalowayski, Michael Nicklin, and Patricia Tan Openshaw, Houston partner Hilary Holmes, London partners Christopher Haynes and Steve Thierbach, Los Angeles partners Jennifer Bellah Maguire, Dennis Arnold and Robert Klyman, New York partners Barbara Becker, Andrew Fabens, David Feldman, Dennis Friedman, Sean Griffiths, Shukie Grossman, Michael Rosenthal, Roger Singer, and Edward Sopher, Orange County partners Jonathan Layne and James Moloney, Palo Alto partner Russell Hansen, San Francisco partners Stewart McDowell, Robert Nelson and Douglas Smith, Singapore partner Brad Roach, and Washington, D.C. partners Mark Director, Stephen Glover, Elizabeth Ising, Brian Lane and Ronald Mueller.  The guide was published on September 21, 2020.

On September 23, 2020, the Securities and Exchange Commission (the “Commission”) voted to adopt amendments (the “Amended Rules”) (available here)[1] to key aspects of the Commission’s shareholder proposal rule.  The Amended Rules:

• modestly increase the current stock ownership threshold to submit a shareholder proposal for shareholders who have not held a company’s stock for at least three years;
• expand the procedural requirements on the submission of proposals, including changes to limit abuse of the process when non-shareholders submit a “proposal by proxy;”
• change the rules to apply the one-proposal rule to each person instead of each shareholder, thereby limiting representatives to one proposal per meeting; and
• increase the levels of shareholder support a shareholder proposal must receive in order to be eligible for resubmission at future meetings.

While the Amended Rules will be effective 60 days after publication in the Federal Register, they only apply to shareholder proposals submitted for an annual or special meeting held on or after January 1, 2022, and thus will not affect the upcoming proxy season.

The Amended Rules represent the first substantive amendments to the shareholder proposal resubmission and stock ownership thresholds since 1954 and 1998, respectively. The Amended Rules are substantially the same as the amendments proposed by the Commission in November 2019 (the “Proposed Rules”) (available here), but reflect amendments made in response to concerns raised on the Proposed Rules. Among other changes, the Amended Rules include a transition period ensuring that any shareholder who currently satisfies the ownership eligibility rules may continue to do so and do not include the “momentum requirement,” which would have permitted exclusion of a previously voted on proposal if the level of voting support had declined significantly in the most recent vote.[2]

The Amended Rules were approved by a 3-2 vote, with the majority viewing the Amended Rules as “reasonable and limited”[3] steps to “adjust these rules to reflect our current markets.”[4] As Chairman Jay Clayton explained, the Amended Rules are intended as a “restructuring and recalibrating [of] the current shareholder ownership threshold for initial submissions as well the shareholder support thresholds for resubmissions” in light of “the many changes in our markets over the past 30 plus years, as well as [the Commission’s] experience with the shareholder proposal process under Rule 14a-8.”[5] At the same time, the Amended Rules reflect that shareholder proposals impose costs on companies and their shareholders, and that some shareholder proponents have effectively outsourced their involvement to representatives. As explained by Commissioner Roisman, “The amendments … aim to strike a better balance by ensuring that a shareholder who submits a proposal to a public company has interests that are more likely to be aligned with the other shareholders who bear the expense.” In contrast, Commissioners Crenshaw and Lee expressed concern that the Amended Rules will suppress the rights of shareholders, undermine environmental, social and governance (ESG) initiatives and dial back shareholder oversight of management.

Read More _____________________    [1]   For a comparison of the Amended Rules with the current rules, see Attachment A to this client alert.    [2]   The Proposed Rules included a “momentum requirement” that would have allowed companies to exclude shareholder proposals submitted three or more times in the preceding five years if they received less than 50% of the vote and support declined by 10% or more compared to the immediately preceding shareholder vote on the proposal.    [3]   Commissioner Hester M. Peirce, “Statement at Open Meeting on Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8” (Sept. 23, 2020), available at https://www.sec.gov/news/public-statement/peirce-14a-8-09232020.    [4]   Commissioner Elad L. Roisman, “Statement on Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8” (Sept. 23, 2020), available at https://www.sec.gov/news/public-statement/roisman-14a8-2020-09-23.    [5]   Chairman Jay Clayton, “Statement of Chairman Jay Clayton on Proposals to Enhance the Accuracy, Transparency and Effectiveness of Our Proxy Voting System” (Sept. 23, 2020), available at https://www.sec.gov/news/public-statement/clayton-shareholder-proposal-2020-09-23.

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Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments.  For additional information, 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 the following authors:

Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Brian J. Lane – Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com) Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Michael A. Titera – Orange County (+1 949-451-4365, mtitera@gibsondunn.com) Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com) Aaron Briggs – San Francisco (415-393-8297, abriggs@gibsondunn.com) Courtney Haseley - Washington, D.C. (+1 202-955-8213, chaseley@gibsondunn.com) Geoffrey Walter – Washington, D.C. (+1 202-887-3749, gwalter@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Click for PDF With talk about a second Coronavirus wave gathering pace, the German Ministry of Justice and Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz) is proposing to extend the temporary COVID-19-related legislation of March 2020 significantly simplifying the passing of shareholders’ resolution, including, in particular, the possibility to hold virtual-only shareholders’ meetings. The extension is proposed in unchanged form for another year until the end of 2021. A respective draft regulation has been published at short notice on 18 September 2020 and stakeholders are invited to submit their comments until 25 September 2020. While the legislation of March 2020 was well received in the rise of the COVID-19 crisis the reactions to an extension were mixed so far. Criticism focuses on the significant restrictions of shareholders’ rights by this legislation (e.g. no right to ask questions or to counter-motions in real time, wide discretion of the management with respect to answering submitted questions, only limited appeal right etc.). This was raised not only by shareholders’ activists but also by various parliament members including prominent experts of the ruling coalition. In the reasons of the draft regulation, the ministry strongly emphasizes that companies should only hold virtual-only meetings if actually required in the individual circumstances due to the pandemic. In addition, the ministry encourages the corporations in question to handle the Q&A process as shareholder-friendly as technically possible, including allowing for questions in real- time, if they decide to hold a virtual meeting. The time window to debate the proposal is extremely short. The new shareholders’ meeting season is already approaching quickly, starting as early as in January/February 2021 for companies with business years ending on 30 September 2020. While the Ministry of Justice and Consumer Protection is authorized to extend the period of application of the legislation for another year without any modifications, modifications in substance would require the involvement of parliament and are thus deemed rather unlikely. If the proposal is adopted, it would be up to the corporations themselves to take the ministry's appeal seriously and to make use of the virtual format in a responsible and shareholder-friendly manner.

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The following Gibson Dunn lawyers have prepared this client update: Ferdinand Fromholzer, Silke Beiter, Johanna Hauser.

Gibson Dunn’s lawyers in the two German offices in Munich and Frankfurt are available to assist you in addressing any questions you may have regarding the issues discussed in this update. For further information, please feel free to contact the Gibson Dunn lawyer with whom you usually work, or the three authors: Ferdinand Fromholzer (+49 89 189 33 170, ffromholzer@gibsondunn.com) Silke Beiter (+49 89 189 33 170, sbeiter@gibsondunn.com) Johanna Hauser (+49 89 189 33 170, jhauser@gibsondunn.com) © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

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On August 26, 2020, as part of its continued effort to update and modernize public company disclosure requirements, the U.S. Securities and Exchange Commission (the “Commission”) adopted amendments to Item 101 (“Description of Business”), Item 103 (“Legal Proceedings”) and Item 105 (“Risk Factors”) of Regulation S-K at an open meeting of the Commission.[1] These amendments, which mark the first time that these disclosure requirements have been substantially updated in over 30 years, were designed to result in improved disclosure, tailored to reflect a registrant’s particular circumstances, and reduce disclosure costs and burdens. Many of the amendments reflect the Commission’s “long-standing commitment to a principles-based, registrant-specific approach to disclosure,” which Commission Chairman Jay Clayton referred to at the open meeting as the “envy of the world.”

As discussed in greater detail below, the key changes are:

• Revisions to the rules for the Description of Business to more broadly embrace a principles-based standard identifying a non-exclusive list of topics that may be addressed when material.
• Revisions to the rules for disclosure of Legal Proceedings to confirm the ability to incorporate by reference from other disclosures in the same document and to raise the dollar threshold for disclosing legal proceedings involving environmental protection laws in which the government is a party.
• Revisions to the Risk Factors standards to encourage more concise and company-specific discussions of material factors that make investment in a company or its securities speculative or risky.

In developing the proposed amendments, the Commission stated that it considered input from comment letters received in response to its disclosure modernization efforts, the SEC staff’s experience with Regulation S-K arising from the Division of Corporation Finance’s disclosure review program, and changes in the regulatory and business landscape since the adoption of Regulation S-K. As a recent example, in response to the COVID-19 pandemic, the Division of Corporation Finance closely monitored registrants’ disclosures about how COVID-19 affected their financial condition and results of operations. Division staff observed that the current principles-based disclosure requirements generally elicited detailed discussions of the impact of COVID-19 on registrants’ liquidity position, operational constraints, funding sources, supply chain and distribution challenges, the health and safety of workers and customers, and other registrant- and sector-specific matters. Chairman Clayton stated that “[t]he effectiveness of this framework in providing the public with the information necessary to make informed investment decisions has proven its merit time and time again as markets have evolved when we have faced unanticipated events.”[2] However, this view was not shared by all of the Commissioners, as evidenced by the amendments’ adoption by a 3-2 vote, with the two Democratic Commissioners dissenting.

This client alert begins with a general overview of the amendments adopted by the Commission and their practical impact on existing public company disclosure requirements, as well as the arguments raised by the dissent. A table providing a more detailed review of and observations on the amendments is provided at the end of this alert. For a comparison of the Regulation S-K language from before and after the amendments, please refer to the attached Annex A.

Read More _____________________    [1]   See Modernization of Regulation S-K Items 101, 103, and 105, Exchange Act Release No. 33-10825 (August 26, 2020), available at https://www.sec.gov/rules/final/2020/33-10825.pdf.    [2]   Modernizing the Framework for Business, Legal Proceedings and Risk Factor Disclosures, available at https://www.sec.gov/news/public-statement/clayton-regulation-s-k-2020-08-26.

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Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments.  For additional information, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm’s Securities Regulation and Corporate Governance and Capital Markets practice groups, or the authors:

Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com) Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Brian J. Lane – Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com) Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) James J. Moloney – Orange County (+1 949-451-4343, jmoloney@gibsondunn.com) Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Michael A. Titera – Orange County (+1 949-451-4365, mtitera@gibsondunn.com) Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com) Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com) William Bald – Houston (+1 346-718-6617, wbald@gibsondunn.com) Rodrigo Surcan – New York (+1 212-351-5329, rsurcan@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

This client alert provides an overview of shareholder proposals submitted to public companies during the 2020 proxy season, including statistics and notable decisions from the staff (the “Staff”) of the Securities and Exchange Commission (the “SEC”) on no-action requests.

Top Shareholder Proposal Takeaways from the 2020 Proxy Season

As discussed in further detail below, based on the results of the 2020 proxy season, there are several key takeaways to consider for the coming year:

• Shareholder proposal submissions continue to decline. The number of proposals submitted decreased by 9% from the prior year to 720, which was 11% lower than the five-year average of 809.
• The number of social and environmental proposals significantly decreased, leading to governance proposals being the most common. Social and environmental proposals declined notably, down 21% and 10%, respectively, from 2019. The number of governance proposals remained steady in 2020 compared to 2019 and represented 40% of proposals submitted, the single largest category during 2020. The five most popular proposal topics, representing 37% of all shareholder proposal submissions, were (i) written consent, (ii) climate change, (iii) anti-discrimination and diversity (although board diversity proposals were down more than 51% from 2019 levels), (iv) independent chair, and (v) lobbying spending.
• Overall no-action request success rates held steady, but Staff response letters declined significantly. The overall success rate for no-action requests held steady at 70%, driven primarily by substantial implementation, procedural, and ordinary business arguments. However, recent changes in the Staff’s practices for responding to no-action requests resulted in significantly fewer written explanations, with the Staff providing response letters only 18% of the time. Almost three-fourths of those Staff response letters were issued when the Staff concurred that a proposal was excludable or denied reconsideration.
• Company success rates using board analysis during this proxy season show promise. Although fewer companies included a board analysis during this proxy season (down 24% from 25 in 2019 to 19 this year), companies that included a board analysis had greater success, with the Staff concurring with the exclusion of four proposals during this year based on the company’s use of a board analysis, compared to just one proposal during the 2019 proxy season.
• Negotiated withdrawals decreased significantly. The overall percentage of proposals withdrawn decreased significantly to its lowest number since 2017. Only 14% of shareholder proposals were withdrawn this season, compared to 20% in 2019, due in part to declining withdrawal rates for social and environmental proposals (dropping to 25% from 38% in 2019).
• Overall voting support dipped slightly, including average support for social proposals, although support for environmental proposals continued to gain momentum. Average support for all shareholder proposals voted on was 31.3% of votes cast, down slightly from the 32.8% average in 2019 and 32.5% in 2018. In 2020, support for social (non-environmental) proposals was about 21.5%, down from 23.6% in 2019, whereas support for environmental proposals increased to 30.2% from 23.9% in 2019. Governance proposals continued to receive the highest average support at 35.3%. This year also saw a decrease in the number of shareholder proposals that received majority support (50 in total, down from 62 in 2019), with an increasing number of such proposals focused on issues other than traditional governance topics.
• Continued proliferation of new proponents and co-filers. The number of shareholders using the Rule 14a-8 shareholder proposal process continues to grow, with more than 300 proponents in each of 2020 and 2019 (compared to approximately 200 proponents in 2018). Approximately two-thirds of proposals were submitted by individuals and religious-affiliated organizations. As in prior years, John Chevedden and his associates were the most frequent proponents (filing 31% of all proposals in 2020). This year also saw the continued trend of multiple co-filers submitting proposals—for example, the number of proposals submitted by at least five co-filers has tripled since 2018.
• Proponents continue to use exempt solicitations and litigation. Exempt solicitation filings continued to proliferate, with the number of filings reaching a record high again this year and increasing more than 40% over the last three years. This continues to be an area ripe for abuse—for example, nearly 20% of exempt solicitation filings in 2020 failed to comply with Staff guidance. In addition, for the second consecutive year, a proponent turned to the courts to fight the exclusion of an environmental proposal even before the Staff had issued its response to the related no-action request.
• Shareholder proposal reform remains pending. On November 5, 2019, the SEC proposed amending Rule 14a-8 to address certain eligibility requirements for submitting shareholder proposals and to raise resubmission thresholds. We anticipate that final rules will be adopted in the near term.

Read More

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The following Gibson Dunn lawyers assisted in the preparation of this client update: Elizabeth Ising, Ron Mueller, Lori Zyskowski, Lauren Assaf-Holmes, Chris Connelly, Sherri Deckelboim, Rama Douglas, Courtney Haseley, Scott Kaplan, Darren Kerstien, David Korvin, Zachary Lankford, Candice Lundquist, Michael Mencher, Jean Park, Victor Twu, and Geoffrey Walter.

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, or any of the following lawyers in the firm's Securities Regulation and Corporate Governance practice group:

Elizabeth Ising - Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Ron Mueller - Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Michael Titera - Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com) Lori Zyskowski - New York, NY (+1 212-351-2309, lzyskowski@gibsondunn.com) Aaron Briggs - San Francisco, CA (+1 415-393-8297, abriggs@gibsondunn.com) Courtney Haseley - Washington, D.C. (+1 202-955-8213, chaseley@gibsondunn.com) Julia Lapitskaya - New York, NY (+1 212-351-2354, jlapitskaya@gibsondunn.com) Cassandra Tillinghast - Washington, D.C. (+1 202-887-3524, ctillinghast@gibsondunn.com) Geoffrey Walter - Washington, D.C. (+1 202-887-3749, gwalter@gibsondunn.com) David Korvin - Washington, D.C. (+1 202-887-3679, dkorvin@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.