Monday, December 19, 2011

SEC May Provide Guidance on Proxy Advisory Firms, Says Chairman Schapiro, and Will Review Beneficial Ownership Rules

The SEC is considering providing guidance on how the federal securities laws should regulate the activities of proxy advisory firms as a result of comments received on a Concept Release on the US proxy system, said SEC Chair Mary Schapiro. In remarks at the Transatlantic Corporate Governance Dialogue, she also noted that the beneficial ownership reporting rules will be reviewed next year with an eye to modernizing them in light of modern investment strategies and innovative financial products. Chairman Schapiro also examined say-on-pay, proxy access, and beneficial ownership issues.

More broadly, the SEC Chair set a goal of breaking down barriers that may prevent effective engagement, impact investor confidence and, ultimately, diminish financial performance to the detriment of shareholders. Effective corporate governance is an imperfect art, she said, with case-specific rules of engagement that can vary dramatically from company to company, while yielding satisfactory results. Given the diversity of approaches, the focus of the SEC is on variables through which the Commission can have a beneficial impact on engagement, and where it can increase the quality of communication in the board-shareholder dialogue.

Many commenters suggested that proxy advisory firms may interfere with, rather than enhance, the communication at the heart of effective engagement. Companies are frustrated by the influence these firms have, noted Chairman Schapiro, and worry that they may not be accountable for, or even concerned with, the quality of the information on which they make voting recommendations.

And, when boards believe that a recommendation has been based on incorrect information, she reasoned, those recommendations can act as a barrier to boards’ efforts to persuade investors to change their minds. A related fear is that proxy firms’ conflicts of interest may be insufficiently disclosed, preventing shareholders from considering possible conflicts when analyzing those recommendations.

The SEC is also examining uncertainty surrounding vote confirmation. Currently, investors are often not able to receive confirmation that their votes have been cast and accurately counted. This inability to confirm voting information is caused in part because no one individual participant in the voting process, neither issuers, transfer agents, vote tabulators, securities intermediaries, nor third party proxy service providers, possesses all of the information necessary to confirm whether a particular shareholder’s vote has been timely received and accurately recorded.

Thus, the SEC is considering how to require participants in the voting process to share information with each other in order to allow for vote confirmations.
The review of beneficial ownership reporting will consider whether the 10-day initial filing requirement for Schedule 13D filings should be shortened and whether beneficial ownership reporting should be changed with respect to the use of cash-settled equity swaps and other types of derivative instruments. According to Chairman Schapiro, the first step will likely be a concept release given the controversy surrounding some of the issues

The Dodd-Frank Act has provided the Commission with new statutory authority to shorten the 10-day filing deadline for 13D, as well as to regulate beneficial ownership reporting based on the use of security-based swaps. And, earlier this year, the SEC received a petition for rulemaking recommending amendments to Regulation 13D-G.

The petition asks the SEC to broaden the definition of beneficial ownership to include interests held by persons who use derivative instruments. The petition also specifically requests that the time period within which initial beneficial ownership reports must be filed be shortened to one calendar day because technological advances have rendered the 10-day window obsolete.

The SEC Chair noted that many feel that the 10-day window results in secret accumulation of securities and material information being reported to the marketplace in an untimely fashion. They also say that it allows 13D filers to trade ahead of market-moving information and maximize profit, perhaps at the expense of uninformed security holders and derivative counterparties. In response, some argue that tightening the timeframe may reduce the rate of returns to large shareholders, thereby resulting in decreased investments and monitoring of and engagement with management. They also maintain that state law developments, such as the validity of poison pills and staggered boards, have tilted the regulatory balance towards issuers.

While disappointed by the DC Circuit decision striking down the proxy access regulation, Chairman Schapiro believes that, as a matter of fairness and accountability, long-term significant shareholders should have a means of nominating candidates to the boards of the companies that they own. She has great faith in the collective wisdom of shareholders to determine which competing candidates will best fulfill the responsibilities of serving as a director. The critical point is that shareholders have the ability to identify alternatives and for all shareholders to make an informed choice.

She noted that, while the appeals court vacated the proxy access rule, it did not impact Rule 14a-8, which will increase shareholder access to the proxy ballot in key circumstances. Shareholders will be able to submit proposals for proxy access at their individual companies, she emphasized, a process known as private ordering.
Rule 14a-8 provides an opportunity for shareholders owning a relatively small amount of a company’s securities to have their proposal placed alongside management’s proposals in the proxy materials.

There are several procedural requirements that a shareholder must satisfy to have a proposal included in the company’s proxy materials, including ownership of at least $2,000 or 1 percent of the company’s securities entitled to be voted for at least one year. Within the parameters of Rule 14a-8, said the Chair, shareholders will now have the chance to ask their fellow shareholders to support a proxy access system at their companies.

Finally, Chairman Schapiro reported that it appears that say-on-pay regulations put in place through Dodd-Frank are leading to improvements in communication in both directions. It has given shareholders a clear channel to communicate to the boards their satisfaction or lack of satisfaction with executive compensation practices. And it is giving boards a powerful incentive to clarify disclosure to shareholders, and to make a coherent case for the compensation plans they have approved.

The regulations require companies to provide shareholders with an advisory vote on executive compensation at least once every three years and an advisory vote on the frequency of say-on-pay votes at least once every six years. In addition, companies must provide a separate advisory vote regarding certain golden parachute arrangements in connection with a merger, acquisition, or other disposition of all or substantially all, assets.

While the outcomes of these votes are not binding on the company, noted the SEC Chair, the advisory vote does let boards know what shareholders think of compensation arrangements. Also, companies are required to quickly report on Form 8-K the results of these votes, she emphasized, and there is tremendous interest in the outcome of these votes.

In addition, companies have to report the decision on the frequency of say-on-pay votes. And, going forward, companies will have to disclose in proxy statements, in the year following the vote, how they have responded to the most recent say-on-pay vote. Chairman Schapiro is heartened that the SEC is beginning to see companies filing proxy statements following say-on-pay votes that are, in fact, responding to these issues.