For the upcoming 2021 proxy season, companies should be aware of certain regulatory and advisory developments in preparing annual reports and proxy statement disclosures in 2021. We have highlighted rule changes and guidance from the Securities and Exchange Commission (“SEC”) and voting guidelines from proxy advisory firms such as Institutional Shareholder Services Inc. (“ISS”) and Glass, Lewis & Co. (“Glass Lewis”). In this LEGALcurrents, we discuss what these recent regulatory and advisory developments mean for companies entering the 2021 proxy season.
SEC Regulatory Developments Affecting Annual Reports and Proxy Statements
COVID-19 Disclosure Guidance. The SEC issued a series of guidance for companies coping with COVID-19 related disruptions. Topic No. 9 provides guidance on disclosure and other securities law obligations that companies should consider during the COVID-19 pandemic and related business and market disruptions. Topic No. 9A supplements Topic 9 by addressing disclosure considerations regarding operations, liquidity, and capital resources. We analyzed the updates from Topic No. 9A in our prior LEGALcurrents, SEC Updates COVID-19 Related Disclosure Guidance. This guidance includes a broad range of questions that companies should consider when updating the disclosure in their Annual Reports on Form 10-K.
MD&A Updates. In November 2020, the SEC announced amendments to Regulation S‑K to modernize, simplify, and enhance certain financial disclosure requirements in Management’s Discussion & Analysis (“MD&A”). As described in our prior LEGALcurrents, SEC Adopts Amendments to Update MD&A, these amendments include, among other changes: eliminating the five-year disclosure of selected financial data under Item 301 of Regulation S-K; amending disclosure requirements for liquidity and capital resources under Item 303 to require disclosure of material cash requirements, including capital expenditures; and eliminating current Item 303(a)(5), which requires registrants to provide a contractual obligations table. Although calendar year-end registrants are not required to comply with these updated requirements in Annual Reports on Form 10-K until 2022, registrants may take advantage of these new requirements after the updated rules become effective, expected to be in early 2021. In early 2020, the SEC also published guidance on the use of financial metrics in MD&A. The guidance provides that such disclosure should be accompanied by a clear definition of the metric and how it is calculated, a statement indicating the reasons for why the metric provides useful information to investors, and a statement by management explaining how management uses the metric in managing or monitoring the performance of the business.
Business, Legal Proceedings, and Risk Factor Disclosures. In August 2020, the SEC adopted amendments to Regulation S-K to modernize business, legal proceedings, and risk factor disclosures. Specifically, the amendments:
- Revise the requirements under Item 101 to discuss the company’s general business development using a largely principles-based approach and eliminating the five-year mandatory timeframe for disclosure.
- Add a new disclosure requirement in Item 101 for human capital resources to the extent material to an understanding of the company’s business.
- Update the legal proceedings disclosure in Item 103 to increase the quantitative threshold for disclosure of environmental proceedings to which a governmental authority is a party, and permitting the hyperlinking or cross-referencing to other discussion of legal proceedings to avoid duplicative disclosure.
- Require a bullet-point summary of risk factors if the company’s risk factor disclosure exceeds 15 pages and the organization of risk factors under relevant headings.
For additional information on these amendments to Regulation S-K, please review our prior LEGALcurrents, SEC Modernizes Business, Litigation, and Risk Factor Disclosure Requirements.
Intellectual Property and Technology Risks. In response to the COVID-19 pandemic, many companies transitioned to remote working arrangements, which may exacerbate the risk of theft of intellectual property and technology through cyberattacks and other security breaches. As a result, companies should revisit the SEC’s guidance published in late 2019 on intellectual property and technology risks associated with international business operations and consider whether any updates are appropriate for their Annual Report on Form 10-K. For additional information on this SEC guidance, please see our prior LEGALcurrents, New SEC Guidance Encourages Disclosure of Risks to Intellectual Property and Technology Assets for Companies with International Business Operations.
Annual Meeting and Proxy Statement Updates
Virtual Meetings. Companies planning to hold virtual-only meetings, especially those that held virtual-only meetings for the first time in 2020 in response to the COVID-19 pandemic, should review SEC guidance and applicable state and local laws regarding virtual meeting formats and limits on in-person gatherings. In the spring of 2020, the SEC published guidance regarding issues associated with the annual meeting of stockholders in light of the COVID-19 pandemic. Companies should continue to monitor whether the SEC further updates the 2020 guidance for any further changes. Additional information on this guidance is available at our prior LEGALcurrents, SEC Releases Guidance on COVID-19 Issues Associated with Annual Meetings of Stockholders, as supplemented by the April updates, available at this link.
Companies should also consider whether any updates to proxy statement disclosure are necessary to account for state law virtual meeting requirements and procedures for shareholder attendance and participation. In addition, companies should also review their by-laws and corporate governance documents to determine if it is necessary to amend those documents to permit virtual shareholder meetings. To the extent companies relied on executive orders or emergency rules to hold virtual meetings in 2020, companies should determine whether those rules are still in effect and prepare for the possibility of in-person meetings.
Perquisite Guidance and Enforcement. In September 2020, the SEC Staff provided guidance on the disclosure of perquisites and other personal benefits (“perks”) provided to executives in the context of the COVID-19 pandemic. The SEC published new issue 219.05 in the Compliance & Disclosure Interpretations to Regulation S-K, which reinforced that companies should use the existing two-step analysis for determining whether something is a perk. Those two steps are: (1) an item is not a perk if it is integrally and directly related to the performance of the executive’s duties; and (2) an item that covers a direct or indirect benefit and that has a personal aspect, even if it may be provided for some business reason, is a perk unless it is generally available to all employees on a non-discriminatory basis. In the guidance, the SEC noted that items provided to allow the executive to perform duties during the COVID-19 pandemic, such as enhanced technology for working at home during stay-at-home orders, may not be a perk. On the other hand, if an executive chooses to use a corporate aircraft instead of flying on a commercial airline because of health and safety concerns during the pandemic, and the company covers the cost of the flight, that cost will likely be a perk unless it is generally available to all employees.
The SEC has continued the trend over the past few years to focus on disclosure of perks. In September 2020, the SEC announced it had settled charges against a company for failing to fully disclose perks provided to executive officers, including personal use of a corporate aircraft and hotel stays. The company settled with the SEC for a $600,000 civil penalty. The SEC’s Division of Enforcement has indicated that it will continue to use risk-based analytics to identify companies that fail to adequately disclose perks, and also noted in its 2020 annual report that it is seeking to reduce the amount of time between discovering the violation and taking enforcement action in order to better protect investors.
Shareholder Proposals. In September 2020, the SEC adopted amendments to Exchange Act Rule 14a-8 that increase the eligibility requirements for a shareholder’s proposal to be included in the proxy statement. Under the revised rules, any shareholder may submit an initial proposal after having held $2,000 of company stock for three years, $15,000 for two years, or $25,000 for one year. The amendments also update the levels of shareholder support required for a proposal to be eligible for resubmission at subsequent shareholder meetings and amend the “one proposal” rule to clarify that a single person may not submit more than one proposal for the same shareholder meeting. These amendments will apply to any proposal submitted for an annual or special shareholder meeting to be held on or after January 1, 2022. Accordingly, these amendments do not apply for the 2021 proxy season. The amendments also include a transition period, allowing shareholders who meet the current submission thresholds to submit 14a-8 proposals for meetings held prior to January 1, 2023, even if they do not meet the amended requirements.
E-Signature. In November 2020, the SEC voted to adopt amendments permitting the use of electronic signatures when executing authentication documents for EDGAR filings. Under the amended rules, these authentication documents may be electronically signed, provided the signatory first manually signs an authorization document and the electronic signature meets certain requirements specified in the EDGAR Filer Manual. These new rules are effective immediately. Please review our previous LEGALcurrents, SEC Adopts Final Rules to Permit Electronic Signatures, for additional detail and a suggested procedure for establishing the use of electronic signatures.
Changes to Filer Status. In March 2020, the SEC amended the “accelerated filer” and “large accelerated filer” definitions and adjusted the transition thresholds for entering and exiting non-accelerated, accelerated, and large accelerated filer status. As described in our prior LEGALcurrents, SEC Amends Definitions of Accelerated and Large Accelerated Filers, the amendments, among other changes, exclude from the definition of accelerated filer issuers that (i) are eligible to be a smaller reporting company (“SRC”) and (ii) had revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available. In addition, the amendments adjust the transition thresholds to (i) $60 million when transitioning from an accelerated filer to a non-accelerated filer and (ii) $560 million when transitioning from a large accelerated filer to an accelerated filer.
Form 10-K Cover Page. As a result of the changes to accelerated filer and large accelerated filer definitions, the Form 10-K cover page will include a new checkbox to indicate whether an auditor’s attestation of internal control over financial reporting is contained within the report. This cover page change excludes SRCs that meet the requirements of the exemption from the definitions of accelerated filer or large accelerated filer.
Inline XBRL. In 2018, the SEC adopted final rules requiring public companies to use interactive data tags into their financial statements directly using a format called Inline eXtensible Business Reporting Language (“XBRL”), which includes page tagging and the new Exhibit 104 requirement. Pursuant to the SEC’s three-year phase-in period, accelerated filers will first need to comply with the Inline XBRL rules in annual reports in their Annual Report on Form 10-K for fiscal 2020. All other filers will be required to use Inline XBRL with their first Form 10-Q for fiscal periods ending on or after June 15, 2021.
Confidential Treatment Orders. In September 2020, the SEC issued updated guidance on seeking extensions of confidential treatment orders (“CTOs”) for material contracts. The new guidance allows companies to extend expiring CTOs by (1) simply refiling the redacted exhibit in accordance with the streamlined rules for filing redacted exhibits under Item 601 of Regulation S-K, (2) if the initial CTO was less than three years old, request an extension of the CTO through the traditional process, or (3) if the initial CTO was more than three years old, submitting a new confidential treatment request. For a flowchart of the options for an expiring CTO and additional information, please refer to our prior LEGALcurrents, SEC Amends Confidential Treatment Extension Guidance.
Voting Policy Updates
2021 ISS Voting Policy Updates
ISS, a proxy advisory firm, released its 2021 benchmark voting policy updates. Unless stated otherwise, these updates take effect for annual meetings on or after February 1, 2021.
Racial and Ethnic Board Diversity. Starting in 2022, ISS will generally recommend voting against or withhold from nominating committee chairs (or other directors who are responsible for the board nomination process) of Russell 3000 or S&P 1500 companies that have no apparent racial and/or ethnic board diversity. ISS will make exceptions if there was racial and/or ethnically diverse members on the board at the prior annual meeting and the board makes a firm commitment to appoint at least one racial and/or ethnic diverse board member within a year. ISS, however, did not provide a formal definition or standards for determining racial or ethnic diversity. For the 2021 proxy season, ISS will identify in its reports boards that lack apparent racial and/or ethnic diversity.
Gender Board Diversity. ISS’s one-year transitional rule for its policy regarding gender diversity on boards has elapsed. Effective February 1, 2021, ISS will generally recommend voting against or withholding from nominating committee chairs (or other directors who are responsible for the board nomination process) at Russell 3000 or S&P 1500 companies where no women serve on the board. The only exception to this policy will be if there was at least one woman on the board at the previous annual meeting and the board makes a firm commitment to add another female director to the board by the following year.
Material E&S Risk Oversight Failures. ISS clarified its policy with respect board oversight failures to explicitly include environmental and social (“E&S”) concerns as an example of risk oversight failures. ISS explains that E&S concerns may constitute material governance failures and, therefore, ISS may recommend voting against the entire board or individual board members.
Board Refreshment (Age/Term Limits). ISS updated its policy from recommending voting against all management and shareholder proposals on director term/tenure limits to a case-by-case approach based on consideration of several factors. In addition to its current policy on voting against age limits, ISS will recommend voting for proposals to remove mandatory age limits.
Shareholder Litigation Rights. ISS will generally recommend voting for federal forum selection provisions in the charter or bylaws that specify all U.S. district courts as the exclusive forum for federal securities law matters and will recommend voting against provisions that restrict the forum to a specific state’s federal district court. In addition, for Delaware companies, ISS will generally recommend voting for charter or bylaw provisions designating Delaware courts as the exclusive forum for state corporate law matters, provided that there are no concerns about corporate governance or board responsiveness to shareholders. For states other than Delaware, ISS will continue to recommend voting on a case-by-case basis for charter or bylaw provisions that designate a specific court as the exclusive forum, taking into consideration several factors, such as the company’s rationale for the provision and the types of lawsuits covered by the provision.
Virtual Shareholder Meetings. In response to the COVID-19 pandemic, ISS adopted a new policy relating to management proposals to allow virtual-only shareholder meetings. ISS will recommend voting on a case-by-case basis for management proposals to allow virtual-only shareholder meetings, as long as the proposal does not preclude in-person meetings.
Advance Notice Requirements. ISS will now recommend voting for advance notice provisions that require shareholders to submit proposals or director nominations no earlier than 120 days prior to the anniversary of the previous year’s annual meeting, with at least a 30-day period for submission (i.e., 90-day to 120-day window). ISS’s previous deadline was no earlier than 60 days prior to the annual meeting. This new policy does not apply to Rule 14a-8 shareholder proposals or director nominations submitted under proxy access provisions.
Poison Pills. ISS revised its policy on poison pill adoption without shareholder approval to recommend voting against or withholding votes for all director nominees (except new nominees on a case-by-case basis) if the company has adopted a poison pill with a deadhand or slowhand feature. ISS also notes that the adoption of a poison pill with a deadhand and slowhand feature constitutes a material governance failure.
The full text of ISS’s 2021 benchmark voting policy updates is available here.
FAQs on Compensation Policy and the COVID-19 pandemic. In October 2020, ISS released FAQs indicating how it may evaluate COVID-19-related pay decisions. After evaluating a company’s executive compensation from a quantitative perspective, ISS may conduct a case-by-case qualitative screen of pay programs and practices in the context of the COVID-19 pandemic and how it has impacted the subject company. ISS made clear that additional disclosure is expected to explain why and how a company adjusted its executive compensation programs due to the impacts of the pandemic. If the targets or payouts of annual incentive programs changed, companies should explain how the new targets and payouts compare to the prior targets and what the payouts under the prior targets would have been. ISS indicated that above-target payouts under adjusted programs will be closely scrutinized. For long-term incentive plans, any changes to cycles in progress will be viewed negatively by ISS, as those programs should be structured to smooth performance over a long-term period. One-time awards will also be closely scrutinized, particularly if they can be interpreted as insulating executives from lower pay. Disclosure of these awards should include the rationale for the amount and structure of the award, with general statements about executive retention generally considered insufficient. If companies made changes to executive compensation policies and programs during 2020 as a result of the impacts of the COVID-19 pandemic, they are encouraged to consult the FAQs when developing their proxy statement disclosure for 2021, which may take more time to draft this year than in prior years.
2021 Glass Lewis Voting Policy Updates
Glass Lewis, a proxy advisory firm, released its 2021 Proxy Voting Policy Guidelines. Unless otherwise stated, these updates take effect for annual meetings on or after January 1, 2021.
Gender Board Diversity. Glass Lewis expanded upon its current policy of generally recommending voting against nominating committee chairs of companies without at least one female director on the board of directors. For the 2021 proxy season, Glass Lewis will note as a concern boards consisting of fewer than two female directors, and, beginning in 2022, Glass Lewis will generally recommend voting against nominating committee chairs of boards with fewer than two female directors. However, for boards with six or fewer total members, Glass Lewis’s existing policy requiring a minimum of one female director will remain in place.
Director Diversity and Skills. Starting in 2021, Glass Lewis’s reports on S&P 500 companies will include an assessment of company disclosure in the proxy statement relating to board diversity, skills, and the director nomination process. Specifically, Glass Lewis’s reports will evaluate how a company’s proxy statement presents (i) the board’s current percentage of racial and ethnic diversity, (ii) whether the board’s definition of diversity includes gender, race, or ethnicity, (iii) whether the board has adopted a policy requiring women and minorities to be included in the initial pool of candidates when selecting director nominees (a/k/a the “Rooney Rule”) and (iv) board skills disclosure. Glass Lewis will not be making voting recommendations in 2021 solely based on this assessment, but noted that the assessment will help form Glass Lewis’s analysis of a company’s overall corporate governance.
Board Refreshment. Starting in 2021, Glass Lewis will note as a concern instances where the average tenure of nonexecutive directors is 10 years or more and no new independent directors have joined the board in the past five years. Although Glass Lewis will not be making voting recommendations solely on this basis in 2021, board refreshment may be a contributing factor in its recommendations when additional concerns have been identified.
E&S Risk Oversight. Glass Lewis updated its guidelines with respect to board-level oversight of E&S issues. Beginning in 2021, Glass Lewis will note as a concern when boards of companies in the S&P 500 do not provide clear disclosure on board-level oversight of E&S issues. Starting in 2022, Glass Lewis will generally recommend voting against governance committee chairs at S&P 500 companies who fail to provide such disclosure.
Virtual Shareholder Meetings. Glass Lewis has rescinded its temporary COVID-19 related policy on virtual shareholder meeting disclosures, which had been in effect for meetings held between March 1 and June 30, 2020. Glass Lewis has now reinstated its standard policy again, which requires companies holding a virtual shareholder meeting to provide disclosure that addresses the ability of shareholders to participate in the meeting. This includes disclosure, among other things, related to the shareholder’s ability to ask questions at the meeting.
The full text of Glass Lewis’s 2021 Proxy Voting Policy Guidelines updates is available here.
What to Do Now
Companies should consider these rule changes, guidance, and voting policies in preparing for the 2021 proxy season. In addition, the COVID-19 pandemic has introduced new disclosure and logistical challenges for proxy statements, Annual Reports on Form 10-K, and annual meetings, which will require even more preparation for the upcoming 2021 proxy season. If you would like more information on how to prepare for the 2021 proxy season, please contact a member of Harter Secrest & Emery LLP’s Securities and Capital Markets group at 716.853.1616 or 585.232.6500.