For the upcoming 2022 proxy season, companies should be aware of certain regulatory and advisory developments in preparing annual reports and proxy statement disclosures in 2022. This LEGALcurrents highlights rule changes and guidance from the Securities and Exchange Commission (“SEC”), the New York Stock Exchange (“NYSE”) and Nasdaq Stock Market LLC (“Nasdaq”) as well as voting guidelines from proxy advisory firms such as Institutional Shareholder Services Inc. (“ISS”) and Glass, Lewis & Co. (“Glass Lewis” or “GL”), and discusses what these recent regulatory and advisory developments mean for companies entering the 2022 proxy season.
SEC Regulatory Developments Affecting Annual Reports and Proxy Statements
MD&A Updates. The SEC’s amendments to Regulation S‑K to modernize, simplify, and enhance certain financial disclosure requirements in Management’s Discussion & Analysis (“MD&A”) are effective for periodic reports filed in 2022, meaning that many companies will be complying with these new rules for the first time in their Annual Reports on Form 10-K for fiscal 2021. As described in our prior LEGALcurrents, SEC Adopts Amendments to Update MD&A, these amendments include the following changes:
- Focusing on trends, events, or uncertainties that are reasonably likely to impact the company instead of those that are known material trends or expected to impact the company. This change in the scope of MD&A, combined with the principles-based changes to these rules, underscores the SEC’s guidance that MD&A should allow investors to view the company from management’s perspective.
- Codifying the SEC’s guidance on critical accounting estimates. Companies are now required to provide disclosure necessary for investors to understand the uncertainty in critical accounting estimates and how those estimates may impact the company’s financial condition or results of operations, from both a qualitative and quantitative perspective.
- Eliminating the selected financial data table, or the five-year disclosure of selected financial data under Item 301 of Regulation S-K, that appeared in Item 6 of Form 10-K. Companies should consider including any information on trends that would have appeared in this table in MD&A instead.
- Eliminating the contractual obligations table that was previously required by Item 303(a)(5) and often appeared both in MD&A and in the notes to the financial statements. While the requirement to present this disclosure in tabular format was eliminated, companies are required to disclose material cash requirements, including capital expenditures and known contractual obligations. Companies should consider whether a different tabular disclosure or narrative disclosure in the discussion of liquidity and capital resources should be added to address this change.
- Eliminating the separate caption for off-balance sheet arrangements. While the separate caption is no longer required, a company must discuss commitments or obligations with unconsolidated entities that are reasonably likely to have a material effect on the company, such as a guarantee or a variable interest in an unconsolidated entity.
- For interim periods, companies are now permitted to compare the most recently completed quarter with the immediately preceding quarter instead of the corresponding quarter of the last fiscal year. If a company chooses to change its method for reporting interim results, it is required to explain why it changed its presentation and include both methods in the first filing with the new presentation.
Companies should consider updating MD&A on an accelerated timeline as compared to prior years to leave adequate time for internal and external advisors to confirm they comply with these updated requirements in their periodic reports in 2022.
Risk Factor Disclosure. A deep-dive review of the risk factors in a company’s Form 10-K is a critical element of preparing year-end disclosure. While hard to believe, risk factors developed at the start of the COVID-19 pandemic (or even at the beginning of the delta variant surge) are likely already stale. In an effort to keep risk factors updated, consider the following questions:
- Have the economic effects related to the COVID-19 pandemic, such as supply chain disruptions or labor shortages, impacted or are reasonably likely to impact the company’s financial results? The SEC’s disclosure guidance on the pandemic (in Topic No. 9 and Topic No. 9A) is helpful in identifying and considering how to describe those risks.
- What business, financial, or regulatory risks does the company face related to climate change? Consider reviewing the SEC’s sample comment letter focusing specifically on public companies’ climate-related disclosure and our prior LEGALcurrents, SEC Focuses Attention on Climate Change Disclosure, to help determine whether this disclosure should be expanded this year.
- Does the company have risk factors addressing the specific risks the company faces regarding cybersecurity failures and data breaches? Consider revisiting the SEC’s guidance from 2018 on cybersecurity disclosure as a tool for refreshing disclosure of these risks.
- Does the company face risks from inflation? Does a current risk factor referencing inflation need to be updated to better reflect current conditions?
- Will the transition away from the London Interbank Offered Rate (“LIBOR”) as a benchmark rate impact the company?
- Do any risk factors describe a hypothetical risk that the company has realized after the risk factor was written? A company should not describe an event as hypothetical if it has, in fact, experienced the risk.
As a reminder, after the August 2020 modernization of Regulation S-K, risk factors should discuss the material factors (previously the most significant factors) that make an investment in the company speculative or risky. The risk factors should be grouped under headings, with a heading for “General Risk Factors” that could apply generically to any company or offering. If the risk factors section exceeds 15 pages, the company must include a summary of the risk factors of no more than two pages at the front of the annual report.
ESG Disclosure. Demand for environmental, social, and governance (“ESG”) disclosure has grown dramatically in recent years and some companies have chosen to include ESG information in their annual reports, proxy statements, and supplemental reports that are not yet required by the SEC. Companies should ensure that all ESG-related reporting is subject to the same disclosure controls and procedures as other disclosure while keeping in mind that the disclosure should be consistent, whether it appears in a formal filing or an investor-focused report or presentation. Companies should expect the SEC to issue proposed rules in this space during this administration and should remain focused on keeping ESG disclosure current and reliable.
Holding Foreign Companies Accountable Act Disclosure. In December 2021, the SEC adopted amendments to finalize rules to implement the submission and disclosure requirements of the Holding Foreign Companies Accountable Act, which may eventually impose prohibitions on trading in a company’s securities. The amendments add a new Item 9C to Form 10-K. The new item applies to foreign issuers that have been identified by the SEC as having retained, for the preparation of the audit report on their financial statements, an accounting firm that the Public Company Accounting Oversight Board is unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction in which the accounting firm’s office or branch is located. The earliest a company could be identified is after its Form 10-K for fiscal 2021 is filed. Accordingly, companies must include this new heading in the Form 10-K this year, but may indicate that it is not applicable.
NYSE and Related Party Transactions. The NYSE amended Section 314 of its Listed Company Manual to require audit committees to conduct reasonable prior review and oversight of all related party transactions. The key change to the rule defined “related party transaction” as a transaction required to be disclosed pursuant to Item 404 of Regulation S-K, a helpful clarification for NYSE-listed companies. The review and approval requirement only applies to transactions required to be disclosed after considering the transaction value and materiality thresholds set forth in Item 404 of Regulation S-K. NYSE-listed companies should review and, if needed, update their approval processes for related party transactions to comply with these requirements and ensure their proxy statements reflect any revised approval procedures.
Annual Meeting and Proxy Statement Updates
Board Diversity Disclosure Requirements. In August 2021, the SEC approved a new Nasdaq rule requiring prescribed diversity-related disclosure about its board of directors and, eventually, a “comply or explain” disclosure requirement for a company to report the diversity statistics of its board of directors or explain why it does not meet the Nasdaq standard. Starting this year, Nasdaq-listed companies are required to disclose director diversity statistics on a standardized matrix template, unless they are exempt (a Special Purpose Acquisition Company (“SPAC”) prior to its business combination, is exempt). In contrast, the “comply or explain” part of the new rule is subject to a longer phase-in period. When fully phased-in, the diversity standard will require a Nasdaq-listed company to either (i) have two diverse directors consisting of at least one female director and at least one director who is an underrepresented minority or LGBTQ+ individual or (ii) explain why it does not have these two diverse directors.
The question of a director’s diversity status is based on self-identification by the director, is self-reported, and is meant to be voluntary. If a director chooses to not report their gender and demographic information, a company cannot rely on that director for the purposes of the rule. Thus, while a company may technically meet the diversity standard, if it is unable to disclose its board member diversity statistics, it will have to explain why it does not meet the diversity standard. Companies can disclose their diversity matrix online or in their proxy materials. Accordingly, it is critical for this proxy season that companies think ahead about the diversity matrix and solicit this information from directors in a tailored self-reporting questionnaire. Additional information on this guidance is available in our prior LEGALcurrents, Nasdaq’s New Board Diversity Disclosure Requirements.
While this rule is only applicable to Nasdaq-listed companies, NYSE-listed companies should consider whether their investors will expect this type of disclosure or whether this fits into their other ESG-related disclosure.
Virtual Meetings. Companies planning to hold virtual meetings in 2022 should plan early in order to secure the date, time, and service provider they prefer for their meetings, given the sharp rise in popularity of virtual meetings due to the COVID-19 pandemic. If a company has not yet done so, it should review its governing documents to determine whether amendments are necessary to permit virtual meetings. For companies incorporated in New York in particular, given the recent change to permanently allow virtual meetings, an amendment may be advisable to more closely follow the final text of the law. More information about the New York law is available in our LEGALcurrents, A Welcome Change Resulting from the COVID-19 Pandemic.
Shareholder Proposals — Change in SEC Staff Position. As described in our LEGALcurrents, SEC Guidance Gives Green Light to Shareholder Proposals, the issuance of CF Staff Legal Bulletin No. 14L and rescission of the SEC Staff’s prior three bulletins will likely have the practical effect of requiring public companies to include more ESG shareholder proposals in their proxy statements under the process in Exchange Act Rule 14a-8.
Shareholder Proposals — Submission Thresholds. 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. These rules are effective for this upcoming proxy season and apply to any proposal submitted for an annual or special shareholder meeting held after January 1, 2022. 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. The amendments include a transition period, allowing shareholders who meet the prior submission thresholds to submit 14a-8 proposals for meetings held prior to January 1, 2023, even if they do not meet the amended requirements.
NYSE Amendment of “Votes Cast” Standard. In November 2021, the SEC approved an amendment to NYSE Listed Company Manual Section 312.07 to amend the NYSE’s standard for determining the minimum vote that constitutes shareholder approval for listing new or additional securities on the NYSE. This requirement is the majority of “votes cast” on the matter. Previously, the NYSE treated abstentions as “votes cast,” meaning that an abstention would have the same effect as a vote against the proposal. Instead of using this presumption, now, the NYSE manual indicates that a company should calculate the votes needed to approve a proposal in accordance with its governing documents and any applicable state law. Accordingly, if permitted by its governing documents and state law, a NYSE-listed company may disregard abstentions in determining the number of votes cast for a proposal and may be more likely to have its proposals approved.
Enforcement of Required Perquisite Disclosure. The SEC remains focused on the disclosure of perquisites and other personal benefits (“perks”) provided to public company executives. For example, in August 2021, the SEC settled charges against National Beverage Corp. for violating proxy disclosure rules by failing to disclose the cost of flights taken by the company’s CEO on a corporate aircraft that were not “integrally and directly related to the CEO’s job duties.” In that case, the company understated the CEO’s compensation by over $700,000 during the applicable period. In the settlement with the SEC, the company was ordered to pay a penalty of just under $500,000. More recently, in November 2021, the SEC settled charges against ProPetro Holding Corp. and its former CEO for similar violations. In that case, the CEO had caused the company to incur personal and travel expenses unrelated to the performance of his duties as CEO, and the company later underreported those perks in its public filings. In addition, the CEO failed to disclose that he had pledged his stock in the company in real estate transactions, which resulted in the company not reporting that required disclosure in its public filings. Given the SEC’s continued focus in this area, companies should closely scrutinize any personal benefits received by executives to ensure they are properly reported.
Universal Proxy Cards in Contested Director Elections. In November 2021, the SEC adopted final rules requiring public companies and shareholder proponents in contested elections to use universal proxy cards that include all director nominees for election, as well as requiring enhanced disclosure of voting options in all elections. While the final rules will be effective January 31, 2022, compliance with the rules related to universal proxy cards and enhanced disclosure will be required for any director election held after August 31, 2022. Calendar year-end companies should understand and make plans to comply with the rule changes for their 2023 annual meetings. For additional information on these rule changes, please see our LEGALcurrents, SEC Adopts New Rules for Universal Proxy Cards in Contested Director Elections.
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.
Inline XBRL. In 2018, the SEC adopted final rules requiring public companies to embed 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. The SEC’s three-year phase-in period ended June 15, 2021, and now all reporters will need to comply with the Inline XBRL rules in annual reports in their Annual Report on Form 10-K for fiscal 2021 and other future reports.
Voting Policy Updates
2022 ISS Voting Policy Updates
ISS, a proxy advisory firm, released its 2022 benchmark voting policy updates. Unless stated otherwise, these updates take effect for meetings on or after February 1, 2022. Overall, issues relating to climate change, board diversity, and distributing voting power more evenly among shareholders continue to be hot topics for ISS.
Environment and Climate Change
ISS will recommend a vote against or to withhold votes from the incumbent chair of the responsible committee or other directors of a company that is a significant greenhouse gas (“GHG”) emitter through its operations and supply chain if ISS determines the company is not taking the minimum steps necessary to understand, assess, and mitigate climate-related risks to itself and the broader economy. ISS indicated that in 2022, a company would need to disclose (1) appropriate GHG emissions reduction targets and (2) climate-related risks, using a framework like the Task Force on Climate-related Financial Disclosures (“TCFD”). ISS expects the “minimum steps necessary” will increase over time.
Say on Climate Proposals
ISS has added new policies for Say on Climate proposals. ISS will recommend voting on a case-by-case basis for management and shareholder Say on Climate proposals, taking into account a number of factors outlined in the policy guidelines. Notably, those factors include some elements promoted by shareholder proponents in past proxy seasons, including:
- alignment of disclosure with recommendations from the TCFD;
- disclosure of the company’s operational and supply chain GHG emissions, targets for reducing those GHGs, and actual GHG emissions performance;
- whether the company has committed to have “net zero” emissions by 2050;
- disclosure of how its lobbying activities and capital expenditures align with its climate-related strategies; and
- whether the climate data it presents has received third-party assurance.
Any company considering a management Say on Climate proposal or facing the proposal from a shareholder proponent should review the ISS guidelines in detail while drafting its proxy statement to ensure it includes disclosure for each factor it is already addressing.
For the upcoming proxy season for companies in the Russell 3000 or S&P 1500 indices, ISS will generally recommend a vote against or to withhold votes from the chair of the nominating committee or other directors of companies where the board has no apparent racially or ethnically diverse directors. For all other companies, this policy will apply for meetings on or after February 1, 2023.
For the upcoming proxy season for companies in the Russell 3000 or S&P 1500 indices, ISS will generally recommend a vote against or to withhold votes from the chair of the nominating committee or other directors of companies where the board has no female directors. For all other companies, this policy will apply for meetings on or after February 1, 2023.
Change to Burn Rate Calculation for Equity Compensation Proposals
For meetings held on or after February 1, 2023, ISS will use a Value-Adjusted Burn Rate calculation for evaluating equity-based compensation plan proposals instead of its current method of using a volatility-based adjusted burn rate. The Value-Adjusted Burn Rate method will use the company’s stock price for full value awards and the Black-Scholes value for options. For 2022 meetings, the Value-Adjusted Burn Rate will be displayed for informational purposes only as part of the equity plan scorecard. ISS intends on issuing more guidance on this change after the 2022 proxy season.
Increasing Authorized Common or Preferred Stock
ISS modified its recommendation policies for proposals seeking to increase the number of shares of authorized common or preferred stock. ISS emphasized the difference between general and specific authorization requests, with ISS more likely to recommend voting for specific authorization requests. The modified policy includes a list of factors that ISS considers problematic and may outweigh a company’s need for authorized shares, including if the class proposed to be increased has superior voting rights or if the company has a non-shareholder approved poison pill. ISS indicates that it will recommend votes against all nominees if a company is incorporated in a state that does not require shareholder approval of increasing authorized capital and it does not receive shareholder approval, or if the increase in capital does not conform to ISS’s stated policies. A company seeking to increase its authorized capital should review the ISS policy in detail while structuring the proposed increase to seek a solution that works for the company and may conform to this policy.
Unequal Voting Rights
Starting February 1, 2023, ISS will recommend votes against or to withhold votes from directors, committee members, or the entire board if the company has a common stock structure with unequal voting rights among the classes of common stock. There is an exception for newly public companies that have a sunset provision for these unequal voting rights within seven years of going public.
2022 Glass Lewis Voting Policy Updates
GL, a proxy advisory firm, released its 2022 benchmark voting policy updates. Unless stated otherwise, these updates take effect for annual meetings on or after January 1, 2022. Similar to ISS, GL remains focused on board diversity and ESG oversight.
Environmental and Social Risk Oversight
GL has updated its policies for board-level oversight of environmental and social issues. Starting in this proxy season, if a company in the S&P 500 index fails to provide explicit disclosure about the board’s role in overseeing environmental and social risks, GL will recommend voting against the governance committee chair. These risks include risks related to climate change, diversity, health and safety, human capital management and stakeholder relations. For companies in the Russell 1000 index, GL will review the company’s overall governance practices. Accordingly, companies should consider evaluating the updated GL policy on this area of risk oversight while drafting its proxy statement to ensure that the proxy statement reflects how the board oversees risks.
Board Composition and Diversity
Building on its progress from 2021, GL expanded its policy on board gender diversity. Beginning in 2022, for companies in the Russell 3000 index, GL will recommend voting against (1) the chair of the nominating committee if the board has less than two gender diverse directors or (2) each member of the nominating committee if the board has no gender diverse directors. For boards with six or fewer directors, or companies outside the Russell 3000, the required minimum will remain at one gender diverse director. If state law conflicts with the GL policy, GL will not recommend votes against these directors if the company’s policy follows the applicable state law.
Beginning with meetings held after January 1, 2023, GL indicated that its policy will change again. Instead of a fixed number of directors, its policy will be based on a percentage of total directors. For companies in the Russell 3000, GL will generally recommend voting against the nominating committee chair of a board that is not at least 30% gender diverse.
Underrepresented Community Diversity
GL has updated its policy to indicate that it will generally make voting recommendations in line with applicable state laws regarding representation by members of underrepresented communities on boards of directors.
GL revised its policy on company disclosure of director diversity and skills in proxy statements. This year, for companies in the S&P 500 index that do not provide disclosure of individual or aggregate racial or ethnic minority demographic information, GL may recommend voting against the chair of the nominating or governance committees. Next year, GL will recommend voting against the chair of the governance committee of these companies.
For annual meetings held after August 8, 2022, for Nasdaq-listed companies, GL will recommend voting against the chair of the governance committee when a company does not provide the new disclosure required by Nasdaq. See “Board Diversity Disclosure Requirements” above.
Unequal Voting Rights
GL will recommend voting against the chair of the governance committee at companies with a multi-class share structure and unequal voting rights without a reasonable sunset of the multi-class share structure. GL prefers unequal voting rights to sunset within seven years.
Governance Following a Business Combination with a SPAC
GL will generally recommend a vote against all members of the board who served at the time of the SPAC IPO if the board did not submit what GL considers overly restrictive governing documents for the advisory approval of its shareholders after the business combination transaction. What GL considers overly restrictive governing documents in this case is consistent with its other policies for public companies.
What to Do Now
Companies should consider these rule changes, guidance, and voting policies when preparing for the 2022 proxy season. In addition, the ongoing COVID-19 pandemic and increased scrutiny on ESG issues has introduced new disclosure challenges for proxy statements, Annual Reports on Form 10-K, and annual meetings, which will require even more preparation for the upcoming 2022 proxy season.
If you would like more information on how to prepare for the 2022 proxy season, please contact a member of Harter Secrest & Emery’s Securities and Capital Markets group at 716.853.1616 or 585.232.6500.