Preparing for the 2024 Proxy and Annual Reporting Season

For the upcoming 2024 Proxy and Annual Reporting season, companies should be aware of certain regulatory and advisory developments in preparing annual reports and proxy statements. Below are some of the recent regulatory and advisory developments from the Securities and Exchange Commission (“SEC”), New York Stock Exchange (“NYSE”), and Nasdaq Stock Market LLC (“Nasdaq”) in addition to voting guidelines from proxy advisory firms Institutional Shareholder Services Inc. (“ISS”) and Glass, Lewis & Co. (“GL”) to consider this reporting season.

Regulatory Developments Affecting Annual Reports and Proxy Statements

Cybersecurity Disclosure

Companies will be required to make specific cyber-related disclosure in a new section of Form 10-K, beginning with fiscal years ending on or after December 15, 2023. The new rules require a company to disclose its processes for assessing, identifying and managing material risks that arise from cybersecurity threats. If companies have not already included risk factor disclosure about cybersecurity threats (potential or realized), the new rules will likely trigger that disclosure in this Form 10-K. Following the trend of recent SEC rules, companies must also provide an overview of the board of directors’ oversight of risks from cybersecurity threats and management’s role in assessing those risks and managing them. Additional information regarding the new cybersecurity disclosure rules can be found in our LEGALcurrents, Public Companies Beware: SEC Introduces Yet Another Data Breach Notification Deadline and Other Cybersecurity Requirements.

Executive Compensation Clawback Policies

This year, public companies must include their executive compensation clawback policy as an exhibit to their Form 10-Ks. This policy, which companies listed on NYSE and Nasdaq were required to adopt by December 1, 2023, requires a company that is restating its financial statements to recover erroneously awarded incentive-based compensation from executives if that compensation was received during the three years before the restatement. NYSE-listed companies should have submitted the Recovery Policy Affirmation via NYSE’s Listing Manager by December 31, 2023 to confirm adoption of a clawback policy or reliance on an exemption. 

Related changes to the Form 10-K and proxy statement include two new checkboxes on the form’s cover page, plus new disclosure under “Executive Compensation” (in the Form 10-K or the proxy statement) if the company was required to restate its financial statements. If the company restated its financial statements, it must report either (1) that no recovery of erroneously award compensation was required under its clawback policy, with a brief explanation of that conclusion; or (2) details about the restatement, the amount of erroneously awarded compensation due to the restatement, how that amount was calculated, and the status of the company’s effort to recover the compensation. This disclosure must be XBRL-tagged. A detailed discussion of the final clawback rules can be found in our LEGALcurrents, Final SEC Rules on Executive Compensation Clawbacks.

Rule 10b5-1 Changes and Related Disclosure

In late 2022, the SEC amended Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and related disclosure requirements. For calendar year-end companies, the Form 10-K filed in 2024 will be the first with the disclosure under Regulation S-K Item 408 in Item 9B “Other Information.” Item 408 requires quarterly disclosure of whether (1) an officer or director or (2) the company adopted or terminated a Rule 10b5-1 trading plan or any similar trading arrangement during the quarter. If so, the company must include details of that arrangement. Regardless of filer status, all companies must provide this disclosure for the first full fiscal period beginning on or after October 1, 2023. This disclosure must be XBRL-tagged. See our LEGALcurrents, SEC Adopts Amendments to Rule 10b5-1 and New Disclosure Requirements, for more information.

In 2025, companies will be required to disclose whether they have adopted a policy designed to promote compliance with insider trading laws (and if not, why not). This disclosure must be XBRL-tagged. A company must also file its insider trading policy as an exhibit to its Form 10-K. These requirements apply beginning for fiscal years ending on or after December 31, 2024.

Finally, also in 2025, companies will be required to add disclosure under Item 402(x) (Executive Compensation). First, a company must include a narrative description of its policies governing the timing of awarding stock options, including whether (and if so, how) the board or compensation committee takes material nonpublic information (“MNPI”) into account when awarding stock options. If the company awarded options to a named executive officer between four business days before and one business day after publicly releasing MNPI, it must include tabular disclosure of the details of the awards and the percentage change in market price for its securities from before and after the MNPI was released. This disclosure must be XBRL-tagged. For calendar year-end companies, this will first apply in the Form 10-K or proxy statement filed in 2025.

Pay versus Performance

In 2024, companies that first provided pay versus performance disclosure in 2023 must add a year to that disclosure. For example, if a company disclosed three years in its pay versus performance tables last year, it will likely need to disclose four years this year. Smaller reporting companies will be required to disclose three years of pay versus performance disclosure in 2024. Companies should verify their filer status early in the year-end process to ensure they are ready for this disclosure in 2024.

The SEC updated its guidance in Fall 2023 and clarified some elements of the compensation actually paid calculation in the pay versus performance table. For an employee that becomes retirement eligible during the year, the employee’s equity awards should be treated as vesting if the equity awards have no other substantive vesting conditions.

Keep in mind that the “total shareholder return” element of the pay versus performance disclosure can tie back to the stock performance graph included in the Form 10-K and keep internal teams aligned on those separate disclosures. Additional information on pay versus performance disclosure can be found in our LEGALcurrents, SEC Adopts Final Pay Versus Performance Disclosure Rules and Practical Approach to Pay Versus Performance.

Share Repurchase Disclosure

The effective date of the new share repurchase disclosure rules, originally set for the fourth quarter of 2023, has been indefinitely paused. The Fifth Circuit Court of Appeals ruled to vacate the new share repurchase disclosure rules after finding the rules were arbitrary and capricious under the Administrative Procedure Act. Unless the SEC successfully appeals this decision, the rules cannot become effective in their adopted form. For 2024 Exchange Act reports, companies should plan to comply with the former rules for share repurchase disclosure. These rules required quarterly disclosure of repurchases with data aggregated monthly.

Upcoming Change: Climate-Related Disclosure

In March 2022, the SEC proposed rules that would require public companies to include certain climate-related disclosure in their public filings. Originally, we expected final rules in this area in the first half of 2023. Under the SEC’s most recent regulatory agenda, the SEC is expected to adopt final rules in April 2024. However, this is merely a goal for the agency, not a deadline. In addition, even if final rules are adopted, there is a high likelihood that the rules will be challenged. In the absence of federal regulation, some states have begun taking action. For example, California has passed two laws that would, starting in 2026, require companies of a certain size that do business in California to disclose Scope 1, 2 and 3 emissions and submit climate-related financial risk reports.

Voting Policy Updates

Institutional Shareholder Services (“ISS”) and Glass Lewis (“GL”) have updated their proxy voting policies for 2024. Other than updates to its equity compensation plan and policy guidance, the voting policy updates from ISS were limited for 2024. GL clarified its recommendation criteria for recently adopted voting policy guidelines, focusing on the hot topics of cybersecurity risks, clawback policies, and board diversity.

2024 ISS Updates

Compensation Policy

Under ISS’s 2024 guidance on how a company’s compensation policies impact the voting recommendation in an ISS research report, ISS highlighted the importance of explaining the board’s rationale for using non-GAAP measures (and the adjustments from GAAP measures approved by the board) when those non-GAAP measures materially increase incentive payouts. ISS expects a description explaining the nature of the adjustments to GAAP, the quantitative impact on incentive payouts, and the board’s rationale for the adjustments and use of the non-GAAP measure. ISS noted that including the reconciliation table to GAAP in the proxy statement is a best practice. Keep this disclosure in mind when compiling the Pay versus Performance table, as ISS will be looking for this disclosure for companies where pay for executives is not aligned with performance and non-GAAP measures are used to determine payouts.

For new executive agreements, ISS clarified that it distinguishes between problematic severance upon a change in control (“CIC”) and an incentive award payable upon a CIC transaction. ISS will evaluate the disclosure of the CIC provision and the award structure and rationale to determine whether a bonus linked to a CIC transaction is problematic single-trigger severance or an incentive award.

If a company receives a negative voting recommendation in an ISS research report, the company may publicly disclose actions taken to address pay-related concerns noted in the ISS report. Then, ISS may issue a proxy alert to update its analysis and may even change its voting recommendation. In its compensation policy guidance, ISS clarified that it typically cannot change its voting recommendation if the public disclosure is made five or fewer business days before the meeting date. ISS noted that the mitigating weight of the actions taken increases as the disclosure is more specific about addressing the pay-related concerns. In its illustrative list of examples, ISS indicated that the strongest mitigating factor would be modifying existing awards to strengthen the link between pay and performance.

Equity Compensation Plan FAQs

ISS evaluates equity compensation plans with its equity plan scorecard (“EPSC”) when a company is seeking stockholder approval of a new equity compensation plan or an amendment to an existing stockholder-approved plan. Using the EPSC, ISS makes a voting recommendation for or against stockholder approval of the new plan or plan amendment. ISS weighs factors under three pillars in its equity plan scorecard: (1) Plan Cost; (2) Plan Features; and (3) Grant Practices. ISS uses these factors to analyze how a new plan or plan amendment may be viewed by ISS before submitting the plan for stockholder approval.

In 2024, ISS will weigh the three pillars differently than prior years. For S&P 500 and Russell 3000 companies, the shareholder value transfer element of the Plan Cost pillar will have less weight. The benchmarks used for the burn rate calculation in the Plan Cost pillar have been adjusted for 2024 for all company categories. For S&P 500, Russell 3000, and non-Russell 3000 companies, the Plan Features pillar will have more weight while the Grant Practices pillar will have less weight in the scorecard calculation. In addition, the threshold passing score for S&P 500 companies increased by two points (from 57 to 59).

ISS also clarified its position on how a company’s clawback policy impacts the Grant Practices pillar. To receive points for its clawback policy, a company’s policy must allow for the recovery of performance-vesting and time-vesting equity awards. If a company’s policy includes the minimum required by the SEC’s rules in this area, it will not receive Grant Practices points for having a clawback policy.

2024 Glass Lewis Updates

Material Weaknesses

GL may recommend a vote against all members of a company’s audit committee when a material weakness is reported and the company has not disclosed a remediation plan, or when a material weakness has existed for more than one year and the company has not disclosed an updated remediation plan that clearly outlines the company’s progress toward remediating the material weakness. GL’s recommendation will apply to all members of the audit committee who served on the committee when the material weakness was identified.

Cyber Risk Oversight

In 2024, following the adoption of the SEC’s cybersecurity rules, GL may recommend against directors when a company has been materially impacted by a cyber-attack and the board’s oversight, response or disclosure concerning cybersecurity-related issues was insufficient or absent. If a company has not experienced a material cybersecurity incident, GL will generally not make a voting recommendation based on cybersecurity disclosure.

Clawback Policies

GL expects, in addition to meeting listing requirements of the NYSE and Nasdaq, effective clawback policies will provide companies with the power to recoup incentive compensation from an executive when there is evidence of problematic decisions or actions, such as material misconduct, a material reputational failure, material risk management failure, or a material operational failure (“misconduct”), the consequences of which have not already been reflected in incentive payments and where recovery is warranted. If a company does not recoup compensation despite misconduct, GL expects that the rationale for not clawing back the compensation should be disclosed along with any alternative measures used or considered by the company to take action after discovering the misconduct, such as the exercise of negative discretion on future payments.

Executive Ownership Guidelines

GL updated its guidelines to explicitly set forth its approach to executive ownership guidelines. GL expects companies to adopt and enforce minimum share ownership rules for their named executive officers. GL notes that companies should provide clear disclosure of their executive share ownership requirements and how outstanding equity awards are treated when determining an executive’s level of ownership in the Compensation Discussion and Analysis section of the proxy statement. GL disfavors including unearned performance-based full value awards or unexercised stock options as part of an executive’s ownership unless their inclusion is adequately explained by the company.

NOL Poison Pills

GL may recommend shareholders vote against a management-proposed net operating loss (“NOL”) poison pill when the NOL pill includes an expansive acting-in-concert definition. GL will also consider whether the pill is implemented following the filing of a Schedule 13D by a shareholder or there is evidence of hostile activity or shareholder activism when making its voting recommendation. GL’s view is that companies may be disguising conventional poison pills in the packaging of an NOL pill, given that NOL pills have evolved to include the features that may disempower shareholders and insulate the board and management typically associated with non-NOL poison pills.

Board Oversight of Environmental and Social Issues

GL clarified its position regarding the board’s role in overseeing environmental or social issues. For companies in the Russell 3000 index, GL will examine a company’s committee charters and governing documents to determine if the company has codified a meaningful level of oversight of and accountability for a company’s material environmental and social impacts. In addition, GL may recommend voting against the governance committee chair of a company in the Russell 1000 index that fails to explicitly disclose the board’s role in this area.

Board Accountability for Climate-Related Issues

GL updated its policy regarding board accountability for climate-related issues to include companies in the S&P 500 index operating in industries where the Sustainability Accounting Standards Board (“SASB”) has determined that the companies’ greenhouse gas emissions represent a financially material risk, as well as if GL believes emissions or climate impacts, or stakeholder scrutiny thereof, represent an outsized, financially material risk.

GL clarified that it will assess whether the disclosure is in line with the recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”) or whether these companies have disclosed explicit and clearly defined board-level oversight responsibilities for climate-related issues. GL may recommend voting against responsible directors if it finds these disclosures to be absent or significantly lacking.

Gender Diversity

For companies within the Russell 3000 index, GL’s approach to board gender diversity is percentage-based, recommending against the chair of the nominating committee of a board that is not at least 30 percent gender diverse, or against all members of the nominating committee of a board with no gender diverse directors. Furthermore, for companies outside the Russell 3000 index, GL’s approach to board gender diversity is numbers-based, requiring at least one gender diverse director.

For 2024, GL clarified its policy on board gender diversity to emphasize that when recommending a vote for or against the chair of the board’s nominating committee or all members of the nominating committee, GL will carefully review a company’s disclosure of its diversity considerations and may refrain from recommending that shareholders vote against directors when the company has provided a sufficient rationale or plan to address the lack of diversity on the board, including a timeline of when the board intends to appoint additional gender diverse directors.

Underrepresented Community Diversity

For companies within the Russell 1000 index, GL’s approach to board underrepresented community diversity is numbers-based, recommending against the chair of the nominating committee if the board has fewer than one underrepresented community director.

For 2024, GL clarified its policy on underrepresented community diversity to emphasize that when recommending a vote for or against the chair of the board’s nominating committee, GL will carefully review a company’s disclosure of its diversity considerations and may refrain from recommending that shareholders vote against directors when the company has provided a sufficient rationale or plan to address the lack of diversity on the board, including a timeline of when the board intends to appoint additional directors from an underrepresented community. GL also revised part of its definition of “underrepresented community director” from an individual who self-identifies as gay, lesbian, bisexual, or transgender to an individual who self-identifies as a member of the LGBTQIA+ community.

What to Do Now

Companies should consider these rule changes, guidance, and voting policies updates when preparing for the 2024 proxy season.

If you have any questions, please contact a member of Harter Secrest & Emery’s Securities and Capital Markets or Employee Benefits and Executive Compensation groups for the latest insights and industry response to these developments.

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