As we enter the 2019 proxy season, we want to bring your attention to a few topics that are likely to play a prominent role in the coming months.
In our first alert, we discussed changes in the voting policies of ISS, the SEC's continued focus on non-GAAP measures and the SEC's proxy plumbing roundtable. In our second alert, we took a deeper dive into issues directly impacting the 2019 proxy season to discuss changes in the voting policies of Glass Lewis, virtual-only shareholder meetings, issues regarding board refreshment, composition and diversity, say-on-pay, CEO pay ratio and director compensation arrangements. Our third alert discussed some issues beyond proxy-related matters that are likely to impact public companies in general, including the new SEC hedging rules, changes to the independent auditor's report, changes to the Form 10-K cover pages and exhibit hyperlinks. And our fourth alert looked at the SEC staff's latest C&DIs on diversity disclosure and executive compensation issues.
In this – our final alert for the 2019 proxy season – we are taking a holistic look at some important issues that affect all registrants, starting with some trends we have observed based on our review of SEC comment letters. We then explore some ideas regarding using a proxy statement as a strategic, investor-focused engagement tool.
We are excited about our new format for this series and invite you to call the authors of this alert or your DLA Piper contact if you have any questions or would like to discuss any of the issues reviewed in the series.
1. SEC COMMENT LETTER TRENDS
Overall, the number of comment letters issued by the SEC staff continues to decline. It is important, however, to monitor trends in the SEC comment letters in order to anticipate and stay ahead of SEC comments as much as possible.
The table and graph below show the most common comment areas for Form 10-K, Form 10-Q and Form 8-K filings during the 12-month period from October 1, 2017 through September 30, 2018. During this period, Management's Discussion and Analysis was the most frequent comment area, slightly ahead of revenue recognition and non-GAAP financial measures.
*Based on an Audit Analytics analysis of SEC comment letters issued from October 1, 2017 through September 30, 2018. Some comment letters were counted in multiple topics if the comment letter included comments with respect to multiple areas.
The chart below shows the most commonly occurring comment topics within management's discussion and analysis.
Selected areas of focus within comment topics – pointers and key takeaways
- Management's Discussion and Analysis
- Staff comments emphasized disclosure of the key performance indicators (financial and non-financial) that are used by management and the adequacy of the discussion of how the metric is calculated and used, limits on the usefulness of the metric, disaggregated presentation and the relationship between changes in the metric and operating results.
- Appropriate context should be provided so that the use of metrics is not misleading.
- Disclosures of critical accounting estimates should provide detailed analysis and not be overly general.
- Revenue recognition
- Comment letters issued to early adopters of the new revenue standard indicate that the SEC staff is focusing on matters of management judgement. Some representative comments on this topic include:
- Requests for information about how the registrant identifies its performance obligations in customer contracts and, if the registrant determines that certain goods and services are not separately identifiable obligations, how the registrant supports that conclusion.
- Requests for disclosure that the method used to recognize revenue provides a faithful depiction of the transfer of goods or services, as required by ASC 606.
- Requests for information about disaggregated revenue disclosures and how management determined the categories for disaggregation (sometimes based on the SEC's review of publicly available information).
- Non-GAAP financial measures
- SEC comments in this regard were generally consistent with prior year comments.
- Be prepared to explain how the use of non-GAAP financial measures complies with the May 2016 CD&Is.
- Comments also posed questions about presentation, including the inclusion of all the same items in periods presented, reconciliations, the prominence of non-GAAP vs. GAAP measures and the labeling of adjustments to GAAP. See our first alert, in which we discussed SEC's continued focus on non-GAAP measures.
- Fair value measures
- Some comments focused on the quality of disclosure regarding valuation techniques and third party resources.
- Some registrants received specific comments and questions related to the specific inputs to the applicable fair value measurement and requests for a description of processes by which registrants validate fair value measurements and conclude that they are reliable.
In the upcoming year, we expect the SEC staff to continue focusing on accounting under the new revenue recognition accounting standard, as well as new accounting standards on leases and credit impairment, cybersecurity disclosures and accounting for the impact of tax reform.
DLA Piper action items
- New accounting revenue recognition standard
- Be prepared to help the SEC staff understand the judgments being made by management in applying the new standard. Consider preparing and maintaining internal records to document these judgments for this purpose.
- New accounting lease and credit impairment standards
- Ensure that disclosure complies with Staff Accounting Bulletin Topic 11.M (SAB 74) and the SEC's 2016 announcement regarding its expectations for disclosure with respect to these items for affected registrants.
- Filings should include a description of the process used to assess the effect of the new standard, provide the status of the implementation process and disclose which matters are still to be addressed and what additional steps are to be taken.
- Note that disclosure related to these matters should evolve in annual and quarterly filings as the registrant makes progress in implementing the new standards.
- The SEC Chairman has asked the Division of Corporation Finance to monitor cybersecurity disclosures carefully.
- Review cybersecurity disclosures and update as necessary.
- Review the SEC's 2018 cybersecurity release, in particular the list of disclosure items provided therein for registrants to consider and the materials about policies and procedures on cybersecurity.
- Accounting for the impact of federal income tax reform
- The SEC has emphasized that SAB 118 (which provided a 1-year accommodation period for registrants unable to complete accounting for the effect of income tax reform in the period including December 22, 2017) does not provide a deferral.
- Evaluate any necessary changes to provisional amounts recorded in the period of enactment, and be prepared to provide supplemental information to support the timing of any adjustments.
2. PROXY PRESENTATION – SHAREHOLDER ENGAGEMENT
As institutional investors and proxy advisors continue to pressure boards to justify their governance practices and adopt new ones, companies are increasingly looking at the proxy statement as a strategic shareholder engagement tool, particularly because it provides a direct, efficient and effective way to communicate a registrant's overall governance philosophy and its approach to discrete governance issues.
Investor interest and shareholder activism remained intense during 2018, and we believe that the trend will continue during 2019. The momentum is facilitated in part by institutional investors, whose influence has grown in recent years amidst waning voter response from retail investors since the advent of notice-only proxy delivery in 2007.1
Environmental and social issues dominated the shareholder proposal landscape this past year, with nearly half of all shareholder proposals falling into one of those categories. Overall voter support of these proposals increased as well, with numerous proposals receiving support above 30 percent. Proposals related to climate change and environmental sustainability reporting remained popular, as did lobbying and political contribution disclosures, board diversity, social reporting, gender related matters and newer topics such as gun safety and violence, content management and "fake news" at social media companies. A trend that we are following closely is the popularity of proposals seeking to expand shareholder rights, which made up 35.6 percent of all shareholder proposals among Equilar 500 companies in 2018.2 Meanwhile, success rates for no-action requests have fallen by approximately 12 percent. In our view, the combination of rising activism from investors and diminishing insulation from SEC no-action letters, continues to underscore a strong need for improved shareholder engagement.3
In response to these pressures, an increasing number of companies are including shareholder engagement-related disclosure into their annual meeting proxy statements. A survey of 2018 proxy disclosures of 100 prominent companies4 revealed the following:
- 82 percent were found to contain some form of shareholder engagement-related disclosure.
- 58.6 percent disclosed the process of how they engage shareholders rather than merely stating that shareholder engagement occurs, a 24.7 percent increase from 2017.
- Many include voluntary disclosure of specific topics not required to be disclosed by the SEC but of growing interest to shareholders, including as follows:
- 62.7 percent voluntarily mentioned or disclosed their board evaluation processes, and the portion that disclose the process has nearly tripled since 2014
- 55 percent voluntarily disclosed information regarding the registrant's environmental and sustainability practices and
- 49 percent voluntarily disclosure information about management succession planning.
- Over 55 percent presented information on board gender diversity and ethnic diversity.
- 79 percent included director photos, 65 percent disclosed director tenure and 26 percent disclosed average age of directors.
- Over 80 percent included a proxy statement summary, corporate governance highlights section, executive compensation highlights section, or some combination of these.
- 26 percent included a letter from the CEO, while a smaller percentage included a letter from the board chair or lead independent director.
In addition to voluntary disclosures such as those listed above, the Council of Institutional Investors (CII) identifies the following shareholder engagement disclosures as best practices found in "exemplary" proxy statements:
- Detailed information about the processes employed to facilitate shareholder engagement.
- Registrant email contact information and instructions for shareholders wishing to engage with the registrant.
- Emphasis on the board's role in the engagement process.
- A statement that shareholder engagement is primarily management's responsibility.
- A quantification of shareholder engagement activities (such as the number of meetings held during the year and the percentage of the registrant's shareholder base that the registrant engaged).
- Any changes to governance practices the registrant has made in response to shareholder feedback.5
A final key data point from 2018 is that, although investor interest remains intense and focused, the number of shareholder proposals among Equilar 500 companies was nearly 10 percent lower than in 2016, including a decrease in environmental, social and governance proposals. This decrease coincides with an increase in negotiated withdrawals of submitted proposals, indicating that as companies become increasingly proactive in their shareholder engagement activities, they may find common ground with shareholders on new actions and disclosures while avoiding public votes on proposals that otherwise may pit shareholders against management.
The growing trend toward shareholder engagement via proxy statement disclosure is a proactive practice we highly recommend. The annual proxy statement is no longer a primarily SEC-focused compliance document. Instead, it can be used as a strategic, investor-focused engagement tool that can be used to communicate important concepts and actions to the marketplace.
DLA Piper action items
- Conduct a holistic review of the registrant's existing shareholder engagement initiatives in tandem with the company's overall strategic objectives.
- Identify areas where increased proxy disclosure could enhance or facilitate the registrant's ability to fulfill its strategic goals.
- Examine shareholder engagement activities of recognized governance-leading companies and the registrant's peer group and consider adopting appropriate adaptations of such initiatives.
- Work with internal and external advisors to implement proxy statement disclosure tailored to the interests and concerns of the registrant's shareholders.
Find out more by contacting any of the authors of this series: Sanjay M. Shirodkar, Jason Harmon, Jared Jensen, Rita Patel, Brooke Goodlett, Cisco Palao-Ricketts and Sarah Ritter, and see the entire 2019 Proxy Season Hot Topics Series here.
1 See Choosnik Lee and Matthew E. Souther, Proxy Delivery Methods Show How Managers Rely on the Retail Shareholder Vote, The CLS Blue Sky Blog (May 29, 2017): http://clsbluesky.law.columbia.edu/2017/05/29/proxy-delivery-methods-show-how-managers-rely-on-the-retail-shareholder-vote.
2 See Corporate Governance Outlook 2019, Equilar (December 2018).
3 See "The Debriefing, 2018 Fall Engagement Guide," D.F. King, available at http://www.dfking.com/2018EngagementGuide/DFKingTheDebriefing2018FallEngagementGuide_2018-10-04_19-29-13.html
4 See Stephen T. Giove, Kyungwon (Won) Lee, Lona Nallengara and Zacharty Aries, Shareholder Engagement: Using Proxy Statements and Corporate Websites: https://www.lexology.com/library/detail.aspx?g=57aa05e1-3e84-40a0-b955-87372d4be244.
5 See Best Disclosure: Company-Shareholder Engagement, Council of Institutional Investors (December 2015): https://www.cii.org/files/about_us/press_releases/2015/12_2_15_best_disclosure_shareholder_engagement.pdf.