BY PAMELA PARK, SENIOR ATTORNEY EDITOR, BUSINESS LAW EDITORIAL FOR PRACTITIONER INSIGHTS ON WESTLAWNEXT
The past year saw an increased focus on corporate governance matters, with shareholders and regulators seeking changes in corporate policies, leadership and compensation practices. Activist shareholders were more vocal than ever looking for a role in the business decisions of their portfolio companies and seeking greater disclosure on corporate matters.
Since the financial crisis of 2008, shareholder discontent over lackluster corporate performance and increased regulation targeting corporate greed and corruption have dominated the corporate world. Directors are no longer free to make decisions behind closed boardroom doors. Rather, shareholders and regulators are keeping a close watch on their actions to ensure that the oversight failures and corrupt behaviors that led to the financial crisis are not repeated.
This Top Ten examines ten key issues that should be at the top of directors' minds as we enter 2014 and the upcoming proxy season.
1. Need for shareholder engagement
With shareholder activists taking a larger role in corporate governance, the need for shareholder engagement is more important than ever. The best defense against a long, costly proxy battle is to engage in discussions with investors before any issues escalate. More often, shareholders are demanding direct communication with management and boards of directors. Shareholder engagement can also inform directors as to the reasons for failed proposals, such as say-on-pay. That knowledge allows the board to consider possible reformation of the company's policies and procedures to better meet shareholders' desires.
2. Establish a more diverse board
The importance of a diverse board of directors, particularly in terms of gender, has become a hot issue for many shareholders, commentators and some legislators. Several companies received shareholder proposals in 2013 requesting that the board of directors adopt a policy to ensure that women are routinely sought when choosing board nominees.
Directors should not only reevaluate the board's composition to meet shareholders' demands, but because it may impact the company's bottom line. Studies have found that companies with mixed gender boards outperformed companies with boards comprised solely of men, indicating that including women in the boardroom can be a wise business decision.
3. Consider enhanced political spending disclosures
Boards may consider reviewing their policies on political spending and lobbying disclosures in 2014. The most common shareholder proposals in 2013 related to the disclosure of companies' political spending and lobbying efforts, with more than 100 companies receiving such proposals. It is likely that the issue will again be a concern of shareholders in 2014.
In deciding whether to revise or enhance corporate political spending and lobbying disclosures and policies, boards of directors will need to balance the desire of shareholders for greater transparency with the cost and time of disclosure, as well as the need to keep strategic information - such as lobbying strategies - confidential.
4. Ensure compliance with new exchange listing standards for compensation committees
To ensure compliance with the latest securities exchange listing standards, directors should be aware of new rules regarding the independence of compensation committee members and their advisors.
Both the NYSE's and Nasdaq's listing standards require that all of a listed company's compensation committee members be independent directors. In determining independence, the new rules require a board of directors to consider "all factors specifically relevant to determining whether a director has a relationship" to the listed company that is "material to the director's ability to be independent from management."
Companies listed on Nasdaq or the NYSE are required to comply with the independence standards by the earlier of their first annual meeting after Jan. 15, 2014, or Oct. 31, 2014.
5. Be prepared to implement proposed pay ratio disclosure
A number of executive compensation-related mandates of the Dodd-Frank Act remain outstanding for rulemaking by the SEC. Directors should be aware of these mandates, as action by the SEC may be forthcoming this year.
In the case of the pay ratio disclosure mandate, the SEC has issued proposed rules and will likely finalize those rules in 2014 after the commission evaluates the extensive public comments it received in response to its proposal. The proposed pay ratio disclosure rule requires companies to disclose: (i) the median of the annual total compensation of all their employees except the CEO; (ii) the annual total compensation of their CEO; and (iii) the ratio of the two amounts.
6. Consider disclosing the link between executive pay and corporate performance
In addition to the disclosure of pay ratios, the Dodd-Frank Act mandates that the SEC issue rulemaking requiring every public company to disclose in its annual proxy statement "information that shows the relationship between executive compensation that is actually paid and the financial performance of the issuer." Although the SEC has not yet issued a proposed pay-for-performance disclosure rule, more than a quarter of public companies provided such disclosures in 2013.
In its rulemaking, the SEC will need to clarify a number of ambiguities in the Dodd-Frank Act's mandate. For example, should pay be quantified based on realized pay or realizable pay? And what metric should be used to measure a company's performance?
With these questions still outstanding, boards will need to consider whether or not to include the additional disclosure in their proxy statements. If they decide to include pay-for-performance disclosures, boards should carefully consider which metrics to use to provide the best correlation between executive pay and corporate performance.
7. Review clawback policies
Section 954 of the Dodd-Frank Act requires the SEC to direct national securities exchanges to change their listing standards to require that listed companies adopt policies that would claw back overpaid performance-based compensation in the event the company restates its financial statements. Although the SEC has not yet issued rules regarding clawbacks, over 90 percent of companies in the Fortune 100 have publicly disclosed such policies.
Companies that have not already done so may be faced with pressure from investors to broaden their clawback policies and increase the disclosure of such policies. A beginning step for companies looking to revise their executive compensation recoupment policies is to expand existing policies to more closely align with Section 954.
8. Use social media cautiously and continue to disseminate material information through typical means
With more companies, directors and executives using social media, the SEC's guidance on the use of such means to disseminate corporate information in April was welcomed by many. The commission's guidance clarified that companies may use social media platforms to announce key information, provided that they first alert investors to the specific sites they will use to disseminate the information.
While helpful in clarifying that companies may use social media, the SEC's guidance left questions as to how that use will be scrutinized by the commission. The guidance noted that every case will be evaluated on its own facts. Given that there is no precedent as to how the SEC will enforce this new guidance, directors are faced with ambiguity as to exactly what facts the SEC will consider.
Although a number of companies have filed 8-Ks announcing that they may use various social media sites that may reveal corporate information, most companies are not using the Internet as the sole means of disclosure. With uncertainty remaining on the use of social media, directors should consider taking a conservative approach to the SEC's guidance and continue to disseminate material information through securities filings.
9. Consider adopting a forum selection bylaw
In June, the Delaware Court of Chancery held that unilaterally board-adopted forum selection bylaws are statutorily and contractually valid. Since that decision, numerous companies have adopted bylaws selecting the courts of the company's state of incorporation as the exclusive forum for any derivative actions.
The adoption of bylaws designating an exclusive forum for shareholder litigation can reduce the cost, time commitment and procedural hurdles of multi-forum litigation. Although the court's decision made clear that such bylaw provisions will be upheld by the Delaware courts, it remains to be seen whether courts in other jurisdictions will recognize the provisions as valid. As such, boards of public companies considering adopting a forum selection bylaw should consider such uncertainty and the fact that the provisions may be viewed negatively by shareholders.
10. Become aware of cyber threats and establish policies and procedures to reduce risk
As technology advances and becomes an integral part of business operations, directors are finding that the burden of ensuring their companies are "cyber secure" no longer falls just on the tech department. Threats to companies' information technology systems have become a top priority as part of the board's oversight function.
Directors should be updated regularly on the company's technology risks and policies to prevent cyber attacks, as well the procedures to follow in the event of a threat to the company's technology. Boards should also consider whether cyber insurance policies are needed or if existing coverage is appropriate.
While the entire board is tasked with overseeing the company's technology risks, it can also delegate these responsibilities to the audit committee or a separate risk committee.
Conclusion
With a number of new Dodd-Frank mandated SEC rules on the horizon and new securities exchange rules, directors will need to ensure that their companies are in compliance with disclosure obligations and independence standards in 2014 and beyond. In addition, directors should take the opportunity to engage with shareholders to avoid public criticism and proxy battles as shareholder activism is likely to continue to strengthen in 2014.
