On June 1, 2017, the Public Company Accounting Oversight Board (“PCAOB”) announced the adoption of a new auditor reporting standard, subject to SEC approval. Although the standard maintains the current pass/fail opinion in auditor reports it does make substantial changes to the report. Most significantly, the new standard requires the auditor to communicate any critical audit matters that arose during the audit.
On March 22, 2017, the U.S. Securities and Exchange Commission (SEC) announced the unanimous passage of an amendment to Rule 15c6-1(a), shortening the standard settlement cycle for most broker-dealer securities transactions from three business days (T+3) to two business days (T+2). The new T+2 settlement cycle will apply to the same securities transactions covered by T+3, including transactions for stocks, bonds, municipal securities, exchange-traded funds, certain mutual funds traded through a broker, and limited partnerships that are not listed on an exchange; provided, however, parties still retain the right to expressly agree to a longer settlement cycle pursuant to the “override provision” of Rule 15c6-1(a). Sales of securities exempt from the T+2 settlement cycle are exempted securities, government securities, municipal securities, commercial paper, banker’s acceptances and commercial bills.
The amendment also does not apply to contracts for the sale of securities for cash that are priced after 4:30 p.m. Eastern time on the date of pricing of the securities that are either (i) sold pursuant to a firm commitment underwritten offerings registered under the Securities Act of 1933 by the issuer to an underwriter or (ii) sold to an initial purchaser by a broker-dealer participating in such offering. Such firm commitment offerings remain outside of the settlement cycle pursuant to Rule 15c6-1(c) and (d) as long as the alternative settlement date is expressly agreed to by the managing underwriter and issuer for all securities sold in the offering at the time of the transaction.
The SEC states that this amendment aligns with the SEC’s desire that regulations reflect the technology of modern times. Shortening the settlement cycle is aimed to increase efficiency and reduce risk for market participants, including the risk of a counterparty defaulting.
Compliance by broker-dealers with the T+2 amendment is not required until September 5, 2017, consistent with the Industry Steering Committee’s target implementation date. In order to assist compliance preparation, inquiries regarding the amendment may be submitted to the SEC staff at T2settlement@sec.gov.
The SEC press release announcing the amendment and the release adopting the change to Rule 15c6-1(a) are available at https://www.sec.gov/news/press-release/2017-68-0 and https://www.sec.gov/rules/final/2017/34-80295.pdf, respectively.
On August 5, 2015, the Securities and Exchange Commission (“SEC”) adopted rule amendments to implement Section 953(b) of the Dodd-Frank Act, requiring that public companies disclose the “pay ratio” between its CEO’s annual total compensation and the median annual total compensation of all other employees of the company. The new rule, located in Item 402(u) of Regulation S-K, is effective in the first full fiscal year commencing on or after January 1, 2017, and the initial pay ratio disclosure will be required in the company’s first annual meeting proxy statement following the conclusion of such year.
Below is a short guide that will assist companies in preparing for pay ratio disclosure.
Does pay ratio apply to my company?
Pay ratio applies to all companies required to provide summary compensation table disclosure pursuant to Item 402(c) of Regulation S-K. Smaller reporting companies, emerging growth companies, foreign private issuers, multijurisdictional disclosure system filers and registered investment companies are exempt.
What is the required disclosure?
Companies must disclose (1) the annual total compensation, but not the identity, of the employee whose compensation falls at the mathematical median of compensation for all employees of the company (except the CEO), (2) the annual total compensation of the CEO and (3) the ratio of (1) to (2) (the “pay ratio”). The total compensation may be calculated consistent with Item 402(c)(2)(x) of Regulation S-K or the company can use its own methodology provided the disclosure contains the material assumptions, estimates, adjustments and exclusions (including relating to cost-of-living, non-U.S. employees, business combinations and acquisitions) used in the identification of the median employee and the calculation of that employee’s annual total compensation.
How is the ratio presented?
The Ratio must be presented as either:
- a ratio in which the median compensation equals one; or
- a narrative in terms of the multiple that the CEO compensation bears to the median compensation.
For example, if the Median Compensation is $100 and the CEO compensation is $1,000, the ratio can be presented as: (1) 10 to 1, (2) 10:1 or (3) “The CEO compensation is ten times the median compensation.”
How do I determine who the median employee is?
The median employee may be identified:
- using the company’s entire employee population or by means of statistical sampling and/or other reasonable methods;
- once every three years, assuming no significant changes in either (a) the median employee’s circumstances or (b) the company’s compensation levels or employee composition;
- using any date within the last three months of the last completed fiscal year;
- using annual total compensation or any consistently applied compensation measure;
- by making cost-of-living adjustments for employees in jurisdictions other than the jurisdiction in which the CEO resides.
In determining who the median employee is, companies must include all full-time, part-time, seasonal, temporary and non-U.S. employees of the company and its consolidated subsidiaries. Independent contractors and “leased” workers providing services to the company are excluded from the definition as long as they are employed by an unaffiliated third party and their compensation is determined by such party. Companies may exclude:
- employees employed in a foreign jurisdiction in which the laws or regulations governing data privacy are such that, despite reasonable efforts to obtain or process the necessary information, the company is unable to do so without violating such data privacy laws or regulations
- a de minimis number of non-U.S. employees (up to five percent of the company’s global workforce, including any employees excluded under the foreign data privacy law exemption)
What reports require the pay ratio disclosure?
Companies must include disclosure in any annual report on Form 10-K, proxy or information statement or registration statement that requires executive compensation disclosure pursuant to Item 402 of Regulation S-K.
What pay ratio disclosure is required if my company files a registration statement before filing its proxy?
A company does not need to update its pay ratio disclosure until it files its annual report on Form 10-K or, if later, its proxy statement or information statement for its next annual meeting of shareholders.
How does my company comply with the rule if it transitions from being a smaller reporting company or an emerging growth company after January 1, 2017?
Companies that cease to be smaller reporting companies or emerging growth companies are not required to provide the pay ratio disclosure until they file a report for the first fiscal year after they cease to be a smaller reporting company or emerging growth company.
How does my company comply with the rule if it acquires new employees through a business combination during any part of the fiscal year?
The rule permits companies that engage in a business combination or acquisition to omit the employees of a newly-acquired entity from their pay ratio calculation for the first fiscal year in which their business combination or acquisition occurs.
Should my company begin providing pay ratio disclosures before the first reporting period in which such disclosures are required?
You may if you choose to do so. A number of companies began voluntarily providing pay ration disclosures in their 2016 proxy statements. By going through the disclosure process before the pay ratio reporting period begins, companies are able to address a number of key issues that require management consideration well in advance of the reporting period. Additionally, companies that voluntarily report ahead of the reporting period get the benefit of SEC Staff review of their pay ratio disclosures before the disclosures are mandated. At the very least, companies should start thinking about issues that will go into developing the pay ratio disclosures. First, what method will the company adopt in determining the median employee? Second, how will annual compensation be determined? If the company will not follow Item 402 of Regulation S-K in determining annual compensation, what methodology will the company use and what material assumptions, estimates, or adjustments are required? What accompanying disclosures are needed in the pay ratio disclosure to provide the appropriate context needed to make the disclosure helpful to investors? We believe it is prudent for all companies to begin implementing and testing their procedures to support these disclosures now, if they have not already done so, regardless of whether the company plans to elect early compliance. This will allow any unforeseen difficulties that arise in the company’s implementation process to be addressed in a deliberate manner, without the pressure of looming disclosure deadlines.
On July 1, 2015, the Securities and Exchange Commission published a Concept Release on Possible Revisions to Audit Committee Disclosures. This comes on the heels of a PCAOB request for comments regarding whether public accounting firms are required to release the name of audit engagement partners and certain participants in audits. While not strictly related, these new possible rules highlight regulators’ renewed concern for audit disclosures. At this time, the SEC is seeking comments regarding (1) the idea of revisions to the existing requirements in general, and (2) specific areas of possible disclosure. The SEC cites some shareholders expressing the view that the existing “rules do not provide investors with sufficient useful information regarding the role and responsibilities carried out by the audit committee in public companies.” The SEC is particularly careful to point out that many companies “voluntarily provide information beyond the disclosures required by [the SEC’s] current rules.” The areas of possible disclosure seem to cover a wide array of issues, indicating that the SEC may be strongly influenced by the input from comments.
Below are some of the areas that the SEC is considering for additional disclosures:
- the audit committee’s oversight of the auditor, including: communications between the committee and auditor (which would provide information about actions taken in the most recent fiscal year); meetings between the auditor and audit committee; committee review of the auditing firm’s internal controls; and how the committee reviews the auditor’s objectivity and professional skepticism;
- the audit committee’s process for appointing and retaining the auditor, including assessments, proposals, and shareholder input;
- qualifications of the audit firm, such as the engagement team and number of years the firm has audited the company;
- whether the audit committee disclosures should be included in IPO and other registration statements; and
- requirements for smaller and emerging growth companies.
While some of these disclosures appear to be less difficult than others, such as how long an auditor has audited a company, others appear to be more in depth, such as requiring disclosure of the committee’s review of the auditor’s internal controls, or others that could be hard to explain, such as why ABC Co. chose KPMG over PWC. It is unclear from the SEC’s release how these disclosures will help the average investor make wise investment decisions. Arguably the process would be more transparent, but the flip-side is that it becomes more burdensome on companies to disclose more and more, and may overload investors with information. However, the SEC is seeking comment, and issuers may be able to influence the direction and scope of the rules by submitting comments.
It is clear from the SEC’s broad request for comments that the necessity, demand, and scope of the rules is not yet clear, which is good reason for reporting companies to take advantage of the request for comments. Companies should consider the effect this may have on small versus large companies, as well as the possible disclosures regarding justification – and what burden that might entail. Additionally, there are also forthcoming PCAOB regulations requiring public disclosures that might make some of these rules redundant, and perhaps the SEC rules would be better created after the scope of the PCAOB regulations is determined. If companies wish to submit comments to the SEC, Husch Blackwell LLP is here to help.
Alex Gross, a summer associate at the firm, assisted in the preparation of this post.
On July 1, 2015, the Securities Exchange Commission (“SEC”) took action to fulfill the final executive compensation rulemaking mandate of Section 954 of the Dodd-Frank Act. The SEC proposed a rule that directs national securities exchanges and associations to establish listing standards that would require companies to develop and implement executive compensation clawback policies. Under the proposed rule, if a company is required to prepare an accounting restatement due to a material noncompliance with any financial reporting requirement, executive officers—defined in the proposed rule to include the same “officers” subject to Section 16 short-swing trading disclosures under SEC Rule 16a-1(f)—must relinquish the compensation they received in excess of what would have been received based on the restated financial results. Proposed Rule 10D-1 would apply to incentive-based compensation that current and former executives received for any of the three completed fiscal years preceding the date the company is required to prepare a covered restatement.
The driving principle behind the rule is that “executive officers should not be permitted to retain incentive-based compensation that they should not have received in the first instance, but did receive because of material errors in their companies’ publicly reported financial statements,” as SEC Chair Mary Jo White stated. Executives will be prevented from keeping “erroneously awarded” compensation without any regard to fault, misconduct, or an executive’s responsibility for the financial statements that prompted the accounting restatement, which is not required by the Dodd-Frank Act. Ms. White and other supporters hope the rule will “result in increased accountability and greater focus on the quality of financial reporting, which will benefit investors and the market.” SEC Commissioner Luis A. Aguilar commented that the proposed rule rests on the perceived foundational idea that “Americans believe you should earn your money” and that “if you did not earn your compensation, you should not keep it.”
Not all incentive-based compensation will fall under the proposed rule’s scrutiny and be subject to recovery. As proposed, the rule defines incentive-based compensation as “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure.” Financial reporting measures may include three pieces of information: accounting-related metrics used to prepare a company’s financial statements, stock price, or total shareholder return. For example, compensation that could be subject to a clawback policy includes stock options, non-equity incentive plans, bonuses paid from a bonus pool, and other compensation that was earned or granted based wholly or in part on satisfying a performance goal tied to a financial reporting measure. Excluded from the proposed rule’s contemplated umbrella of incentive-based compensation are salaries, discretionary and time-vested awards that don’t depend on financial reporting metrics, and incentive compensation awarded based on the occurrence of a non-financial event, such as consummating a merger, opening a certain number of stores, or obtaining regulatory approval of a product. However, the clawback requirement would apply to all incentive-based compensation that is “received” for any portion of the covered three-year period – which would include compensation paid out after the end of such period based on the achievement of any specified financial reporting measure during the period in question.
Proposed Rule 10D-1 would also require all listed companies—except certain registered investment companies to whom the rule would not apply—to file their clawback policy as an exhibit to their annual reports and disclose actions they’ve taken pursuant to their policy. Significantly, this means that companies which happen to list only debt securities—and previously have not been required to identify which of their executives are “officers” for purposes of equity-based Section 16 compliance—will need to do so to comply with this new rule. Additionally, companies will have to disclose, in any proxy statement that requires executive compensation disclosure, whether during the most recent fiscal year the company completed an accounting restatement that required recovery of erroneously paid excess compensation, and whether there was an outstanding unrecovered balance of excess incentive-based compensation from the application of the company’s clawback policy to a prior restatement. Companies that fail to adopt any compensation recovery policy, fail to disclose such policy in accordance with the rule, or fail to comply with their clawback policy could face delisting.
One of the distinctive characteristics of the proposed rule is that boards of directors will be able to exercise discretion not to recover any excess incentive-based compensation only if: (1) recovery would violate the home-country laws of a foreign private company; or (2) the expense of enforcing recovery would be expected to exceed the amount of incentive-based compensation that would be recovered. Commenters noted in response to a preliminary SEC proposal that boards should have this discretion because the costs of recovering excess incentive-based compensation may outweigh the benefits of obtaining it. The proposed rule recognizes this fact, but also notes that allowing boards to exercise too much discretion could undermine the entire purpose of the rule—to bar an executive officer from retaining incentive-based compensation that he or she did not earn.
On the other hand, some commenters argue that allowing a board to forego the costs of recovering erroneous compensation based on the impracticality of pursuing the compensation would align with investors’ interests. But as SEC Commissioner Piwowar noted, the breadth of the proposal—requiring companies to pursue a clawback unless it would be “impracticable” to do so—may end up unnecessarily committing more shareholder resources to clawbacks. Under the proposed rule, the only criteria that would factor into a determination of “impracticability” are those related to whether the recovery would be cost effective. Thus, before a company can conclude the costs of recovering excess incentive-based compensation impractically outweigh the benefits, they may need to first make a reasonable attempt to recover the incentive-based compensation, and then determine it would not be cost-effective. By engaging in this process, companies may still end up expending more shareholder resources than the excess compensation would justify.
Concerning the exercise of Board discretion, the SEC is seeking comment on a variety of topics, including: (1) whether this discretionary provision will hinder effectuation of the rule’s purpose; (2) whether the provision grants companies a substantial loophole to avoid compliance; (3) whether the standard for exercising discretion not to recover should be limited to situations in which it is impracticable; and (4) whether other circumstances exist in which companies should be allowed not to pursue recovery.
Opponents of Proposed Rule 10D-1 argue the rule as proposed could have the unintended effect of increasing the overall compensation of executive officers. In opposing the rule, SEC Commissioner Michael Piwowar pointed to the fact that the rule will breed uncertainty in executive compensation. Due to the threat that some of their compensation may ultimately be subject to a “clawback” triggered by a financial restatement even in the absence of any misconduct, executives are likely to demand higher salaries or insist that a smaller portion of their compensation come from incentive-based awards. These consequences could potentially defeat the purpose of the increased emphasis on pay-for-performance in designing executive compensation.
The method for calculating certain types of compensation subject to recovery constitutes another source of uncertainty. Unlike incentive-based compensation that bears a clear relationship to the financial reporting measure that triggered the payment, erroneously-awarded compensation that is based on stock price or total shareholder return cannot be recalculated with mathematical precision from the new information in an accounting restatement. In recognition of this difficulty, the rule proposes to allow companies to use a reasonable estimate of the effect of the accounting restatement on the stock price or total shareholder return on which the erroneous compensation was based. Companies would have to document their methodology in determining such a reasonable estimate and provide the information to their national securities exchange. We expect a number of comments to question whether this is feasible or would require too many assumptions, or result in additional, unnecessary expense to shareholders as companies engage third party experts to provide support for their estimates.
Others who have spoken out against the proposed rule criticize its scope. Tom Quaadman, the Vice President of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness has called the plan “extremely prescriptive” in that it includes more executive officials than the statute contemplated. The rule has expanded on the Sarbanes-Oxley Act’s clawback provisions, which only apply to CEOs and CFOs, by applying to any president, principal financial officer, principal accounting officer, vice president in charge of a principal business unit, division, or function, or any other person who performs a similar policy-making function at the company. Some have argued that the rule’s aggressive “no fault” clawback policy should apply to a smaller group of executives who are responsible for the preparation of the financial statements. Alternatively, some argue the proposed rule could apply to a larger group of executives, but the application of the rule should be limited to only those who had a hand in causing the financial misstatement.
The proposed rule also raises certain questions concerning how the clawback amount will be treated for tax purposes. For instance, while the proposed rule would allow “erroneously awarded” compensation to be recovered over time from an executive’s future salary or other incentive awards, companies should be careful to ensure that any amounts recovered through an offset against future awards of deferred compensation do not result in an impermissible acceleration of deferred compensation payments that could trigger tax penalties under Section 409A of the Internal Revenue Code. Additionally, the clawback is calculated on a pre-tax basis, but the officers would be returning the compensation with after-tax money, requiring them to seek to recover any resulting overpayment of income tax from the IRS.
Under the SEC’s clawback proposal, each exchange will have 90 days after the date the SEC adopts Rule 10D-1 in definitive form to file its proposed listing standards to implement the new rule, and its rules must become effective no later than one year following the publication date of the exchange’s proposed rules. Listed companies would be required to have a clawback policy in place that complies with such rules no later than 60 days after the date on which their exchange’s rules become effective. Accordingly, while these rules are not likely to be applicable until early 2017, listed companies of all sizes should begin now to proactively evaluate the impact they may ultimately have on existing company policies and on the design of their executive compensation programs.
Madison Benedict, a summer associate at the firm, assisted in the preparation of this post.
The SEC staff recently conducted a preliminary review of the disclosure requirements under Regulation S-K, which was the initial step in a plan to conduct a comprehensive review of the regulation to address reporting requirements and presentation and delivery issues for public companies. The SEC has launched a website dedicated to gathering information from companies, investors and other market participants on what information is important to investors, how disclosure enhancements can be made, how disclosure can be simplified and how technology can play a role in these items.
In an April 2014 speech to the American Bar Association Business Law Section, Keith M. Higgins, Director of the SEC’s Division of Corporate Finance, expanded on this SEC effort to eliminate duplication and reduce disclosure burdens for public companies, while continuing to provide material information to investors. In addition, Mr. Higgins recommended companies not to wait for any comprehensive updates to Regulation S-K, but made several suggestions that public companies and their counsel can begin now to make disclosure more effective, including the following:
- Reduce repetition – Mr. Higgins encouraged companies, for example, to reconsider whether including a verbatim disclosure from the footnotes in MD&A is necessary.
- Focus disclosure – Mr. Higgins cautioned companies that more is not always better, but that a company should consider whether something is truly applicable to the company, and not include just because it is a “hot button” issue for the staff or all of the company’s peers appear to include it.
- Eliminate outdated information – Lastly, Mr. Higgins encouraged companies to allow their disclosure to evolve over time and eliminate disclosure once no longer material, even if it was originally included as a response to a SEC staff comment.
Companies are encouraged to carefully consider the disclosures included in their periodic reports, and may want to ask themselves some of the following questions as they draft: Are you including certain disclosure because it is truly material to a description of your company or required by the regulations? Is there disclosure you could eliminate that is only included because it has always been included, but is no longer relevant to the total mix information that investors need? Taking a fresh look at the disclosure may be the best first step in beginning to improve the disclosure process.
Rule 165 of the Securities Act of 1933 permits the offeror of securities in a business combination transaction to make public statements related to or in connection with the transaction, both before and after the filing of a registration statement related to the transaction, as long as the statement contains a legend:
- urging investors to read the relevant documents containing important information filed or to be filed with the Securities & Exchange Commission (the “SEC”);
- explaining that investors can obtain those documents for free from the SEC; and
- describing which of those documents can be obtained from the offeror free of charge.
As social media outlets have become widely used, the SEC has issued guidance for companies wishing to use social media to make these and other public disclosures. Because the required legend must accompany the social media post, questions arose regarding how such public statements could be made in compliance with Rule 165 on social media websites, like Twitter, that limit the number of characters in a single post.
On April 22, the SEC issued a new Compliance Discussion & Interpretation (“CDI”) to provide guidance on this issue, which also applies to legends required by Rules 14a-12 (proxy solicitations before furnishing a proxy statement), 13e-4(c), 14d-2(b) and 14d-9(a) (tender offer communications) of the Securities Exchange Act of 1934, but the CDI has raised more questions than it answers.
Commonly, when Twitter users want to tweet more information than would be permitted by the 140 character limit, they add a link to the tweet to separate websites containing additional text, articles and photos. The hyperlinks themselves take up approximately 10 of the 140 permitted characters.
The SEC has taken the position that a tweet can link to a separate page that contains the required legend, but the tweet must include language conveying that the hyperlink contains important information. Additionally, where a social media platform allows the offeror sufficient characters to include the legend in the post in its entirety, the offeror may not use the hyperlink method to meet the legend requirement.
Including both the hyperlink and the additional language conveying that the hyperlink is important eats up valuable “tweet-estate.” Since each character in a tweet, including hyperlinks, must be carefully chosen to stay within the 140 character limit, presumably, a hyperlink would not be included in a tweet if it were not important and intended to be clicked by the reader.
Questions remain regarding whether each tweet in a series of tweets that, together, constitute a single statement must include both the hyperlink and language conveying the importance of the hyperlink or whether their inclusion in the initial tweet will suffice.
Time will tell whether the SEC will relax its position on required legends in social media. In the meantime, companies should take a conservative approach and include both the hyperlink and language conveying its importance in each tweet or series of tweets that constitutes a public statement related to or in connection with a business combination transaction.
On September 18, 2013, the Securities and Exchange Commission (the “SEC”) issued proposed rules to implement the pay-ratio disclosure requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The proposed rules would compel public companies to disclose how the compensation of the chief executive officer compares with that of employees.
As proposed, covered companies would be required to disclose (i) the median annual total compensation of all employees (excluding the principal executive officer, referred to here as the CEO), (ii) the annual total compensation of the CEO, and (iii) the ratio of the two totals. The ratio must be expressed as a multiple of one – for example, 1 to 268 or the CEO’s “annual total compensation is 268 times that of the median of the annual total compensation” of all other employees. The information must appear in any annual report, proxy, information statement or registration statement requiring executive compensation disclosure under Item 402 of Regulation S-K. Further discussion of the specifics of the proposed rules can be found here.
The question some are asking in response to this proposal is “what information will investors truly glean from such disclosure?” Disclosures of the compensation of the CEO have long been required of public companies. Will the strategy of investors change when they see a ratio of the pay of the median employee to the CEO in writing in a proxy statement? Is it worth the cost and time that companies are going to have to expend to determine these numbers? Why were part-time, seasonal and foreign employees included? Will the use of sampling and reasonable estimations help limit the costs and burden on companies having to make this disclosure? Will we really learn anything new at all or will this disclosure be used to embarrass CEOs?