Lest you think that the SEC’s focus on the use of non-GAAP financial metrics is so, well, 2018, think again.  On December 26, the SEC issued a cease-and-desist order against a company based entirely on the company’s use of non-GAAP metrics without giving “equal or greater prominence [to] the most directly comparable financial measure or measures calculated and presented in accordance with GAAP…”, as required by Item 10(e)(1)(i)(A) of Regulation S-K.

According to the SEC order, the company in question – ADT, the security company based in Boca Raton, Florida – issued earnings releases for fiscal 2017 and the first quarter of fiscal 2018 that prominently included such non-GAAP metrics as adjusted EBITDA, adjusted net income, and free cash flow before special items, without giving equal or greater prominence to the comparable GAAP data.  For example, the order states:
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Following a tweet from the President last August, the SEC has begun the process of reviewing the existing quarterly reporting regime and will be further exploring possible changes that may ease administrative and other burdens on public companies. Specifically, the President “asked the SEC to study!” whether less frequent reporting for publicly traded companies would “allow greater flexibility and save money.” This is not a new issue on the SEC’s radar screen, but it has recently regained traction– the SEC issued a concept release in 2016 soliciting public comments more specifically on reporting frequency and the current quarterly reporting process.

The request for comments, which can be viewed here, asks for public input on several questions related to the existing reporting regime. One of the more interesting questions on which the SEC is seeking input is whether the practice of public companies issuing forward earnings guidance places undue pressure and focus on short-term results and negatively impacts long-term results. Several commentators have expressed concern on this issue over the years and believe management teams with a longer-term view would be better stewards of investor capital. Many of the other specific questions asked by the SEC in its request for comments relate directly to the current reporting process and whether changes could be made that balance the interests of investors while making the reporting process more efficient, including, among other things:
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As we approach the end of 2018, it’s only natural to look back on some of the year’s events – and some non-events.  For my money, one of the most significant non-events was the inauguration of CEO pay ratio disclosure, one of the evil spawn of Dodd-Frank.

In the interest of brevity, I’ll skip the background of the disclosure requirement, except to say that it seemed intended to shame CEOs – or, more accurately, their boards – into at least slowing the rate of growth in CEO pay.  Some idealists may have actually thought that it would lead to reductions in CEO pay.  Poor things; they failed to realize not only that all legislative and regulatory attempts to reduce CEO pay have failed, but also that such attempts have in every single instance been followed by increases in CEO pay.

So the 2018 proxy season, and with it pay ratio disclosures, came and went.  Sure, there were media outcries about some of the ratios, but they failed to generate any traction.  Companies may have incurred significant monetary and other costs to develop the data needed to prepare the disclosures, but their concerns about peasants storming the corporate gates with torches and pitchforks proved needless.  Few, if any, investors – and certainly no mainstream investors – seemed to care about the pay ratios.  Employees making less than the “median” employee didn’t rise up in anger.  Even the proxy advisory firms seemed to yawn in unison.

So that’s that.  Or so you’d think.


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A while back – March 2017, to be exact – I posted a piece entitled “Beware when the legislature is in session”, citing a 19th Century New York Surrogate’s statement that “no man’s life, liberty or property are safe while the legislature is in session.”

It may be time to amend that statement, for Washington seems to be at it regardless of whether the legislature is in session.  A very rough count suggests that there are more than 20 pending bills dealing with securities laws, our capital markets, corporate governance and related matters.  And that does not include other initiatives, such as the President’s August 17 tweet that he had directed the SEC to study whether public companies should report their results on a semi-annual, rather than a quarterly, basis.

Problems with the Approach

I’m not saying that all of the ideas being floated are awful, or even bad.  (One good thing is that our legislators seem to have decided that trying to give every statute a name that can serve as a nifty acronym isn’t worth the effort.)  In fact, some of the ideas merit consideration.  However (you knew there would be a “however”), I have problems with the way in which these bills deal with the topics in question.  (I have problems with some of the ideas, as well, but more on that later.)

  • First, in my experience, far too many legislators do not understand what our securities laws are all about, and some do not want to understand or do not care. I will not cite particular instances of this, but I’ve been surprised several times with the level of ignorance or worse (i.e., cynicism) demonstrated by legislators and their staffs about the matters their proposals address.  At the risk of hearing you say “duh”, this does not lead to good legislation.
  • Second, these bills represent a slapdash approach when what is needed is a comprehensive, holistic one. Even the best of the pending bills and proposals is a band-aid that will create another complication in an already overcrowded field of increasingly counterintuitive and/or contradictory regulations, interpretations, and court decisions.

Problems with the Proposals

As promised (threatened), I also have concerns about a number of the proposals being bruited about, but for the moment I’ll focus on two of them – eliminating quarterly reporting and Senator Warren’s “Accountable Capitalism Act”.
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Since the beginning of this month (July 2018), the SEC has brought two enforcement cases involving perquisites disclosure – one involving Dow Chemical, and one involving Energy XXI.  As my estimable friend Broc Romanek noted in a recent posting, over the past dozen years, the SEC has brought an average of one such case per year.  It’s not clear why the SEC is doubling down on these actions, but regardless of the reasons, it makes sense to pay attention.

The SEC’s complaint in the Dow Chemical case is an important read, as it summarizes the requirements for perquisites disclosure.  Among other things, it’s worth noting the following:

  • While SEC rules require disclosure of “perquisites and other personal benefits”, they do not define or provide any clarification as to what constitutes a “perquisite or other personal benefit.” Instead, the SEC addressed the subject in the adopting release for the current executive compensation disclosure rules, and it has also been covered in numerous speeches and other statements over the years by members of the SEC staff.
  • For those of you who prefer a principles-based approach to rulemaking, you win. Specifically, the adopting release stated as follows:

“Among the factors to be considered in determining whether an item is a perquisite or other personal benefit are the following:

  1. An item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive’s duties.
  2. Otherwise, an item is a perquisite or personal benefit if it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees.”

The SEC has also noted on several occasions that if an item is not integrally and directly related to the performance of the executive’s duties, it’s still a “perk”, even if it may be provided for some business reason or for the convenience of the company.


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No, this is not a riff on Hamlet’s soliloquy.  It’s about the current kerfuffle (one of my favorite words) about stock buybacks.  In case you’ve not heard, some (but not all) of the concerns about stock buybacks are as follows:

  • Plowing all that cash into buying back stock means that it’s not going into plant and equipment, R&D or other things that facilitate longer-term growth and job creation.
  • Companies are using the windfall from the 2017 tax act to buy shares back rather than to make investments that will create jobs and longer-term growth.
  • Stock buybacks artificially inflate stock prices and earnings per share, which contributes to or results in additional (i.e., excessive) executive compensation.
  • By reducing the number of shares outstanding, buybacks mask the dilutive effects of equity grants to senior management.

And now there’s another concern.  Specifically, in a recent speech, new SEC Commissioner Jackson announced that stock buybacks are being used by executives to dispose of the shares they receive in the equity grants referred to above.  And one of his proposed solutions is that compensation committees engage in more active oversight – or, rather, that compensation committees should be required to engage in more active oversight – of insider trades “linked” to buybacks.


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If you find the title of this posting confusing, let me explain:  On June 28, the SEC announced revisions to the definition of “smaller reporting company”that will significantly expand the number of companies that fit within that category (i.e., “smaller gets bigger”).  As a result, more public companies will be able to reduce the disclosure they are required to provide under SEC rules (i.e., “which means less”).  The new definition will go into effect 60 days after publication in the Federal Register.

Background

The SEC adopted the reduced disclosure requirements applicable to smaller reporting companies, or SRCs, in 2007. These reduced requirements were intended to ease the costs and other burdens of disclosure for small companies.  The reduced requirements enabled SRCs, among other things, to:

  • present only two (rather than three) years of financial statements and the related management’s discussion and analysis;
  • provide executive compensation for only three (rather than five) “named executive officers”;
  • omit the compensation discussion and analysis in its entirety;
  • present only two (vs. three) years of information in the summary compensation table; and
  • omit other compensation tables, pay ratio disclosure, and narrative descriptions of various compensation matters.

In addition, SRCs that are not “accelerated filers” (companies that must file their Exchange Act reports on an accelerated basis) need not provide an audit attestation of management’s assessment of internal controls, required by the Sarbanes-Oxley Act.  More on this below.
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A few weeks ago, I attended the “spring” meeting of the Council of Institutional Investors in Washington (the quotation marks signifying that it didn’t feel like spring – in fact, it snowed one evening).  These meetings are always interesting, in part because over the 15+ years that I’ve been attending CII meetings, their tone has changed from general hostility towards the issuer community to a more selective approach and a general appreciation of engagement.

So what’s on the mind of our institutional owners?  First, an overriding concern with capital structures that limit or eliminate voting rights of “common” shareholders.  CII’s official position is that such structures should be subject to mandatory sunset provisions; that position strikes me as reasonable (particularly as opposed to seeking their outright ban), but it’s too soon to tell whether it will gain traction.


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It may be nice to be your own boss, but setting your own compensation – and, at least arguably, giving yourself excessive pay – may get you in trouble.  A number of boards of directors have found that out, as courts have given them judicial whacks upside the head for paying themselves too much.  Not surprisingly, shareholders have gotten on the bandwagon as well.

Executive compensation – at least for public companies – has to be scrutinized and blessed by independent directors and, since the advent of Say on Pay, approved by shareholders (albeit on a non-binding basis).  In contrast, directors have long set their own pay, with little or no scrutiny and no requirement for independent review, much less approval.  (Director plans generally must get shareholder approval if they provide for equity grants, but neither the overall director compensation program nor specific awards have to be approved.)
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Yes, it’s that time of year again.  Turkey, Black Friday, decking the halls, office parties, and the annual issuance of ISS’s voting policies for the coming year.

To make sure I’m on Santa’s good list, I need to be honest – and, to be honest, the 2018 changes seem rather benign.  In fact, as noted below, ISS hasn’t gone as far as some of its mainstream members in terms of encouraging board diversity and sustainability initiatives.

Here’s a quick rundown on the key changes for 2018:

  • Director Compensation: Director compensation – or at least excessive director compensation – has been looming ever larger as a hot topic in governance.  ISS continues the trend by determining that a two-consecutive-year pattern of excessive director pay will result in an against or withhold vote for directors absent a “compelling” rationale.  Since the policy contemplates a two-year pattern, there will be no negative voting recommendations on this matter until 2019.


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