Earlier this month, the Federal Reserve proposed changes to its guidance on corporate governance for banking organizations.  The proposals suggest a new approach to corporate governance that could extend beyond the banking industry; among other things, they suggest that boards should spend more time on more important matters, such as strategy and risk tolerance, than on compliance box-ticking. However, taken as a whole, the proposals strike me as being something of a mixed bag.  And some of the positive aspects of the proposals are already being subjected to attacks.

The Good News

The good news is that the Fed seems to be acknowledging that the board’s role is that of oversight and that boards are spending far too much time micro-managing compliance and should focus on big picture items such as strategy and risk.  Those of us who speak with board members know that this has been a significant concern since the enactment of Dodd-Frank.

Continue Reading Federal Reserve governance guidance: the pendulum swings back (?)

In late July, S&P Dow Jones and FTSE Russell announced that they were changing or proposing to change the standards that govern whether a company is included in their indices.  Although their approaches differ, the changes would effectively bar most companies with differential voting rights from their indices, as follows:

  • In its July 31 announcement, S&P Dow Jones said that companies with multiple share classes will no longer be included in the indices comprising the S&P Composite 1500 – which includes the S&P 500, S&P MidCap 400 and S&P SmallCap 600. There are some exceptions; companies currently in these indices will be grandfathered, as will any newly public company spun off from a company currently included in any of the indices.
  • Five days earlier, FTSE Russell proposed to require more than 5% of a company’s voting rights – across all equity securities, whether or not listed or traded – to be held by “free float” holders to be eligible for inclusion in the FTSE Russell indices.

Continue Reading Class Acts: Stock Indices Bar Differential Voting Rights

Some of you may remember Christopher Cox, who served as SEC Chair from 2005 to early 2009, when he was succeeded by Mary Schapiro.  His name doesn’t come up often, perhaps because his legacy was a weakened Commission tarnished by, among other things, the financial crisis and the Madoff scandal.

While Chairman Cox may not have been responsible for either of those debacles, he did leave another unpleasant legacy – XBRL.  He was among the biggest cheerleaders for XBRL, claiming that it would enable investors to compare companies within and across industries and would perform various other miracles.  Suffice it to say it hasn’t done that.  Aside from the fact that it’s time-consuming, it has failed to provide the benefits of comparability.  As a client recently said,

“[E]ven if two companies use the same taxonomy/tagging for Cost of Sales, they probably are not consistent in the underlying details that go into Cost of Sales.  One company might classify certain components as G&A instead.  There are many other examples.  Consistency is very important for one company’s reporting from period to period, however comparisons of competitors’ financials will always be approximations at best.”

Continue Reading RIP XBRL?

The young ones among you may not be familiar with Harvey Pitt, but he is an incredibly smart man and a gifted attorney who chaired the SEC some years back.  He made some political gaffes in that role, but that doesn’t diminish his understanding of the securities laws and how disclosure works.

A few weeks ago, he was quoted in The Wall Street Journal on the subject of disclosure (“Harvey Pitt Envisions a New Form of Corporate Disclosure”).  Specifically, he points out that “[d]isclosure is supposed to be for the purpose of informing…but…it’s become for the purpose of providing a defense”.  He also says “…when you have proxy statements that run hundreds of pages…it’s impossible to expect any normal individual to put in the time to read all of those pages”.  As I said, he’s an incredibly smart man.

So what is his solution?  He suggests a “summary disclosure document the way disclosure used to be” – say five or six pages – and that more detailed information be available by hyperlink for the investors who want to dig deep.  At the same time, companies could track how many people actually make that deep dive and make judgments as to eliminating information that no one seems interested in.

Continue Reading On the subject of effective disclosure…

Photo by Martin Fisch
Photo by Martin Fisch

When you think of corporations, you think “maximize profits for shareholders”. This notion is being turned on its head as a growing sustainable business movement asks: “Can we look to factors in addition to profit to measure a company’s success?” More than thirty U.S. states and the District of Columbia have answered “yes” by authorizing a benefit corporation, or “B Corp” – a for-profit corporate entity, but one that seeks to positively impact society, the community, or the environment, in addition to generating profit. The concept is catching on internationally as well, with Italy the first country outside the U.S. to pass benefit corporation legislation.

Tell me more

Benefit corporations fundamentally alter how a company is allowed to act. While the laws on benefit corporations differ around the country, model legislation is available. B Corps not only seek to create shareholder value, but also must balance social purpose, transparency, and accountability. A B Corp’s purpose is also to create general public benefit — for instance, a material positive impact on society or the environment. B Corps must publish annual benefit reports, made against an independent third-party standard, of their social and environmental performance, and often must file these reports with the Secretary of State. The benefit report includes a description of how the company pursed its benefit, hindrances faced in pursuing such benefit, and the reasons for choosing the specific third-party standard. For example, a company with an environmental purpose may choose to report against the standards set forth by the Global Reporting Initiative. Additionally, shareholders have a private right of action known as a benefit enforcement proceeding, in which they can seek to enforce the company’s mission.

In Florida, a B Corp’s articles of incorporation must state that the corporation is a benefit corporation to incorporate as such. Further, an existing corporation may amend its articles of incorporation to become a benefit corporation. Likewise, a corporation may terminate its benefit status via amendment of its articles of incorporation by a two-thirds vote of shareholders. The law is similar for social purpose corporations (discussed later). B Corp status may provide more options on the sale of the company: (1) buyer competition increased based on the company’s commitment to public benefit, as compared to other potential targets without such a reputational distinction; (2) the seller can consider other factors besides price; and (3) the buyer or seller can keep/remove benefit corporation status immediately before/after sale based on the new owner’s perspective regarding the benefits of B Corp status.

“To ‘B’ or Not To ‘B’?”

There is growing demand for B Corps from: (1) consumers wanting to buy responsibly; (2) employees seeking meaningful jobs; and (3) communities dealing with corporate misconduct. While these Continue Reading Don’t stop B-lievin’: A “Journey” into benefit corporations

PCAOB creates yet another dumpster fire  (Photo by Toms River FD)
PCAOB creates yet another dumpster fire
(Photo by Toms River FD)

Earlier this month, after seven years of threats, the PCAOB adopted rules to drastically change the standard auditor’s report. In adopting the rules, the PCAOB noted that the standard auditor’s report had largely remained unchanged since the 1940s. I believe there was good reason for this: the current auditor’s report works well (or at least well enough). It is simple and, therefore, easy to interpret. Either a company receives an unqualified opinion or it doesn’t. The current report is generally referred to as a pass/fail model. But, the simple and straightforward approach is about to change.

Enter the CAMs

The PCAOB has introduced a new acronym for us to learn, CAM, which stands for Critical Audit Matter. Under the new rules, a CAM is any matter communicated or required to be communicated to the audit committee that: (i) relates to material accounts or disclosures that are material to the financial statements and (ii) involves especially challenging, subjective, or complex auditor judgment. Each and every CAM, as determined by an issuer’s auditor, will then be identified and described in the audit report and the auditor will explain how the CAMs were addressed in the audit. Simple enough, right? Don’t worry, if you are confused – the rules contain a flow chart!

The whole idea behind the CAMs concept is that it is designed to reduce the information asymmetry that exists between investors and auditors. The PCAOB is concerned that investors are unable to adequately assess the risk that underlies the estimates and judgments made by management in preparing the financial statements. That’s probably a fair assessment, but changing the auditor’s report won’t address information asymmetry. And here’s why:

First, critical audit matters are already identified in the MD&A and the financial statements. The PCAOB claims that the auditor should not be limited to discussing the estimates that management discloses. While that may be a good point, most sophisticated users of financial statements should be able to identify the significant estimates an issuer would make. Generally, these estimates are consistent from company to company based on their industry. Is it a revelation that a commercial bank’s most significant estimate is its allowance for loan losses? Or that the valuation of inventory would be important to an issuer with a large inventory balance (especially if the inventory can quickly become obsolete)?

Second, the PCAOB notes that if there aren’t any identified CAMs then the auditor will need to state that fact. What’s the likelihood that any of the larger accounting firms will go on record to state that there was very little judgment used in compiling a set of financial statements? I think the likelihood is next to zero. Also, what is the likelihood that each auditor will craft a custom disclosure each year Continue Reading The CAMs are coming and other enlightened enhancements courtesy of the PCAOB

monkey-557586_1920A few weeks ago, The Wall Street Journal reported that two former directors of Theranos – the embattled blood testing company – “did not follow up on public allegations that…the firm was relying on standard technology rather than its much-hyped proprietary device for most tests”.

The report states that the two board members in question – a former admiral and Secretary of State, respectively – were on the Theranos board when concerns about the company’s device were aired publicly.  However, they seem to have believed that it wasn’t their job to ask questions, at least not in the absence of some sort of proof that the concerns were valid.  The former admiral said he “did not have the information that would tell me that it’s true or not true”; the former Secretary of State said that “it didn’t occur to” him to ask questions, adding “[s]ince I didn’t know, I didn’t have anything to look into”. Continue Reading Ducks and monkeys

back-to-school-954572_1280My last post was a re-posting of Adam Epstein’s great piece on the importance of the proxy statement.  I promised that I would follow up on Adam’s thoughts with some recommendations of my own.  Here goes.

General

  • Manage your proxy statement “real estate” to maximize user-friendliness and create an optimal flow: Think about where things go.  For example, if your company is owned largely by institutions (and perhaps even if it’s not), should you lead off with an endless Q&A about the annual meeting and voting, discussing such exciting topics as the difference between record and beneficial ownership and how to change your vote?  Some of it is required, but consider taking out what’s not required and moving what is required to the back of the book.
  • Use executive summaries: Investors like them, and even the SEC has more or less endorsed their use. Think of it this way – whatever you think of ISS, it does a great job of summarizing your key disclosures, albeit not with your company’s best interests in mind.  Why pass up an opportunity to convey your key disclosures with those interests in mind?

Continue Reading Required reading (Part 2)

board-1848717_1280Those of you who know me have probably heard me sing the praises of Adam Epstein.  Adam was trained as a lawyer, has been an investor, and now advises small-cap companies on matters like board composition and disclosure.  IMHO, Adam is brilliant, and his insights need to be read, absorbed and acted on.

Adam has given me permission to copy one of his recent writings here.  It was originally posted on NASDAQ MarketINSITE.  His writing addresses how important it is for small-caps to get their proxy disclosures right.  My only quibble with it is that it’s not only true for small-caps; it’s equally true for any company that seeks to get favorable votes from institutional investors.  On the subject of singing (see above), I’ve been singing this song for a long time to minimal effect, but I’m hopeful that great advocacy from people like Adam will once again prove that justice delayed isn’t always justice denied.  By the way – Adam has written a book on the importance to small companies of getting the right board members.  I don’t often read books of that type, but Adam’s is a gem.

Here’s the posting:

Considering that 78 percent of activist campaigns were waged in companies with market capitalizations below $2 billion in 2016 (according to Activist Insight), it’s incumbent upon small-cap companies to communicate clearly about issues investors care most about. Notwithstanding the fact that proxy statements address many of those issues (e.g., board composition, compensation, etc.), too many small-cap boards outsource responsibility for drafting and refining proxy statements. That’s a mistake.

Consider a few suggestions in this regard from a buy-side perspective.

Board composition. Proxies provide an invaluable opportunity for companies to clearly answer a top-of-mind concern for seasoned investors: does a company have fulsome, objective, value-added governance, or is its board primarily composed of the CEO’s friends (i.e., oversight “lite”)? The most effective proxies set forth how the backgrounds of each board member map to a company’s key strategic imperatives, key enterprise risks, and key stakeholders and customers. An inability to succinctly explain why a company has the right people in the boardroom should serve as a warning to the board that it might be time to refresh its directors.

Compensation. Most small-cap investors aren’t compensation consultants or human resource experts; it’s unwise to draft a Compensation Discussion and Analysis (CD&A) as if they were. Investors principally want to understand how officer and director compensation is aligned with strategic value drivers, particularly for companies that are performing poorly and/or compensating richly when compared to peers. Rather than just repeating last year’s CD&A, boards should spend time each year simplifying and clarifying key investor takeaways.

Storytelling. A proxy statement is a legal document, but great proxies tell a cohesive story about: (1) a company’s values, strategic imperatives and ownership; (2) who the company is run and governed by; and (3) how and why officers and directors are appropriately compensated (among other things). Why would a company expend material time and money perfecting its storytelling to customers, and then outsource a great chance to communicate directly with investors to service providers who can’t possibly know the story as well as those inside the company?

Plain English. When proxy statements are formulaic and lawyerly, savvy small-cap investors often think two things: (1) the company doesn’t value the opportunity to communicate transparently with shareholders; and/or (2) the company is trying to hide something. Most small-cap investors aren’t lawyers, and few captivating tales have ever been written in “legalese.” So if your proxy statement doesn’t tell a compelling story that virtually any investor can understand… consider starting over again.

In addition to selling goods and services, public companies also sell stock. And whether it’s to passive, active, current, or prospective investors, it’s hard to successfully sell stock when investors don’t sufficiently understand what they’re buying.

Thanks, Adam (and NASDAQ MarketINSITE).  I’ll be writing a bit more on this topic in the coming weeks.

 

waldryano
waldryano

I don’t know when Congress decided that every piece of legislation had to have a nifty acronym, but the House Financial Services Committee recently passed (on a partisan basis) what old-fashioned TV ads might have called the new, improved version of the “Financial CHOICE Act”.  The word “choice” is in solid caps because it stands for “Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs”.

Whether and for whom it creates hope, opportunity or something else entirely may depend upon your perspective, but whatever else can be said of the Act, it is long (though at 589 pages, it is slightly more than half as long as Dodd-Frank), and it addresses a very broad swath of issues.  Here’s what it has to say about some key issues in disclosure, governance and capital formation, along with some commentary. Continue Reading The Financial CHOICE Act – everything you’ve ever wanted, and more?