Earlier this month, in In re Investors Bancorp, Inc. Stockholders Litigation, the Delaware Court of Chancery reiterated its view that placing a meaningful limit on director equity awards to be granted under a stockholder approved equity plan allows the court to determine whether director equity awards are excessive under the more lenient business judgment rule. Continue Reading Another Reminder that Director Limits set forth in Equity Plans Allow Director Compensation to be Reviewed under the more Lenient Business Judgment Rule
Pamela B. Greene focuses her practice on securities compliance, executive compensation, and corporate governance matters. She advises public companies on compliance with the Securities Act of 1933, the Securities Exchange Act of 1934, stock exchange requirements, the Sarbanes-Oxley Act of 2002, and the Dodd-Frank Act of 2010. Pam works with management teams, boards, and compensation committees to develop and design appropriate executive compensation programs. She also advises public and private companies and individuals on executive compensation matters and provides executive compensation and securities counsel to clients in merger and acquisition transactions.
SEC Acting Chairman Michael S. Piwowar issued a public statement on February 6, 2017 requesting input on any unexpected challenges that companies have experienced as they prepare for compliance with the CEO pay ratio rule, which will become required disclosure in public company 2018 proxy statements. Piwowar also directed SEC staff to “reconsider the implementation of the rule” based on comments submitted.
This public statement and request for comments is a first step in considering changes to the rule, as part of the Republican Party’s effort to modify or roll back certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd Frank). Any SEC modifications to the CEO pay ratio rule would take time to implement and may be challenged. The easiest route to prevent its implementation would be for Congress to repeal this provision of Dodd Frank.
On August 5, by a vote of 3-to-2 with the SEC Commissioners voting along party lines, the SEC approved the final rule to implement the requirements of Section 953(b) of the Dodd-Frank Act, which instructed the SEC to amend existing rules under Item 402 of Regulation S-K to require public companies to disclose the ratio of their CEO’s annual total compensation to that of the median annual total compensation of all company employees. All public companies will be subject to this new disclosure requirement, with the exception of emerging growth companies, smaller reporting companies and foreign private issuers.
The rule requires companies to disclose:
(a) The median of the annual total compensation of all company employees, excluding the CEO;
(b) The annual total compensation of the company’s CEO; and
(c) The ratio of (a) to (b).
Companies will be required to provide disclosure of this ratio commencing with their first fiscal year beginning on or after January 1, 2017, which information will be disclosed in the Executive Compensation section of a company’s Form 10-K (or proxy statement). Thus, disclosure will begin in the 2018 proxy season. In addition to the ratio itself, disclosure describing the methodology used to identify the median employee, determine total compensation and any material assumptions, adjustments (including allowable cost-of-living adjustments) or estimates used to identify the median employee or to determine annual total compensation will also be required. As described in the proposed rule, when identifying the median employee, the final rule requires companies to include all employees, including full-time, part-time, temporary, seasonal, and foreign employees employed by the company or any of its subsidiaries and to annualize the compensation of permanent employees who were not employed for the entire year, such as new hires. Companies may not, however, annualize the compensation of part-time, temporary, or seasonal employees. Consultants and other advisors who are not employees and individuals who are employed by unaffiliated third parties are not to be included in the calculation.
Despite the attempt by the State of Montana’s securities division to stay the rule, Regulation A+ is effective as of today, June 19, 2015.
Regulation A+ allows companies organized in the U.S. and Canada to raise money from investors, even those that are not accredited investors, under a less burdensome regime than traditional going public transactions and through the use of general solicitation, even to unaccredited investors, which is not allowed under current private placement rules. Regulation A+ replaces and expands the seldom used Regulation A by increasing the offering limit under the rule from $5 million to up to $20 million for “Tier 1 Offerings” and up to $50 million for “Tier 2 Offerings.” The regulation also preempts state law review for Tier 2 Offerings, for which the disclosure documents will instead be reviewed by the SEC.
While Regulation A+ has critics on both sides of the table – that it doesn’t go far enough in providing flexibility, or that it goes too far and does not adequately protect unsophisticated investors – it should be a welcome avenue for smaller companies who believe their companies have significant value to test the appetite of investors, raise capital publicly at a lower cost, and become accustomed to the public disclosure regime by preparing less burdensome ongoing disclosure. It remains to be seen how companies take advantage of these new rules and whether investors are at the ready.
Section 162(m) of the Internal Revenue Code precludes the deduction by public companies for compensation paid to certain covered employees in excess of $1,000,000 in any taxable year. This limitation on deduction does not apply to performance-based compensation. Such performance-based compensation is deductible so long as the following requirements are met:
- the compensation is paid solely on account of the attainment of one or more pre-established, objective performance goals,
- the performance goals must be established by a compensation committee comprised solely two or more outside directors,
- the material terms of performance goals under which the compensation is to be paid must be disclosed to and approved by the shareholders, and
- prior to payment of the performance-based compensation, the compensation committee must certify in writing that the performance goals have been attained.
Under the existing regulations, compensation attributable to stock options or stock appreciation rights are deemed to satisfy the performance-goal so long as, among other requirements, the plan under which the option or right is granted states the maximum number of shares with respect to which the option or right may be granted to any employee during any specified period and that cap is preapproved by the public company shareholders.
On March 31, the IRS issued final regulations clarifying the satisfaction of the performance-goal and shareholder approval requirement with respect to stock options and stock appreciation rights. Specifically, the IRS clarified that the performance-goal requirement is satisfied if the plan states the maximum number of shares with respect to which options or rights may be granted during a specified period to any individual employee. Further, the IRS clarified that the plan will satisfy this per employee limitation even if the plan provides the aggregate maximum number of shares with respect to which any equity-based award may be granted to any individual employee, such as restricted stock units and restricted stock. The IRS noted that this is not meant to be a substantive change in the regulations but only a clarification regarding satisfaction of the per employee limitation requirement.
The final regulations clarifying the per employee limitation requirement apply to compensation attributable to stock options or stock appreciation rights granted on or after June 24, 2011.
The final regulations also clarified the applicability of the transition rules for compensation payable pursuant to a restricted stock unit by companies that become publicly held after the grant. Generally, when a company becomes publicly held, the compensation deduction limitation under Section 162(m) does not apply to any compensation paid pursuant to a plan existing during the period prior to the company becoming public, and the company may rely on this transition relief provision until the earliest of:
- the expiration of the plan,
- a material modification of the plan,
- the issuance of all employer stock that has been allocated under the plan, and
- the first meeting of the shareholders at which directors are to be elected that occurs after the close of the third calendar year following the calendar year in which the IPO occurs or, in the case of a company that did not have an IPO, the first calendar year following the calendar year in which the company becomes publicly held.
This transition relief applies to any compensation received pursuant to the exercise of a stock option or stock appreciation right, or vesting of restricted stock (even though the compensation from time based restricted stock grants would not generally be exempt as a performance-based grant after the transition period), granted under a plan that would be eligible for the transition relief so long as the grant is before any of the above events. Under the final regulations, the IRS clarified that restricted stock units are eligible for the transition relief only if the compensation attributable to the restricted stock unit is paid (i.e. the shares underlying the award are delivered) before the first to occur of the above events, not merely granted.
The final regulations regarding the transition relief provisions apply to remuneration resulting from a stock option, stock appreciation right, restricted stock or restricted stock unit that is granted on or after April 1, 2015.
While the IRS does not deem these regulations to be significant, they do provide needed clarification to compensation committees and practitioners tasked with ensuring that compensation payable under equity and bonus plans is deductible by the companies. Moreover, private companies that become public are now on notice that the transition relief is limited for restricted stock units that vest after the transition period has terminated.
The Securities and Exchange Commission adopted yesterday a new set of regulations entitled Regulation “A+,” designed to provide a more streamlined approach for small and mid-sized companies to offer securities to the public. These rules will become final 60 days after publication by the SEC in the Federal Register. We will be preparing a detailed client advisory analyzing these new rules for our friends and clients.
Regulation A+ was initially proposed by the SEC in December 2013 as an amendment to little-used current Regulation A. The purpose of this new rule is to implement Section 401 of the Jumpstart Our Business Startups Act (the JOBS Act) which directed the SEC to adopt rules exempting offerings of up to $50 million of securities annually from the registration requirements of the Securities Act of 1933, as amended. Regulation A+ as adopted yesterday provides for 2 tiers of offerings with differing requirements. Tier 1 is for offerings of securities of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer; and Tier 2 is for offerings of securities of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer. Both tiers are subject to certain basic requirements, while Tier 2 offerings are also subject to additional disclosure and ongoing reporting requirements, such as filing an offering circular with the SEC which will be reviewed by the SEC before qualifying the offering, audited financial statements, and annual reports. Additionally, the amount of securities a non-accredited investor may purchase in an offering will be capped when buying securities not listed on a national exchange.
These rules also provide for the preemption of state securities law registration and qualification requirements for securities offered or sold to “qualified purchasers” in Tier 2 offerings. Tier 1 offerings will be subject to federal and state registration and qualification requirements; however, companies may take advantage of the coordinated review program recently developed by the North American Securities Administrators Association (NASAA), the association of state regulators, that is expected to reduce the compliance costs for small businesses seeking to receive state approval for these offerings.
However, as with many of the rules recently proposed or adopted by the SEC, this one is not free from criticism, as NASAA yesterday released the following statement:
“We appreciate that all five Commissioners recognize the efforts of state securities regulators and NASAA to successfully implement a modernized and streamlined Coordinated Review program for Regulation A offerings to help small and emerging businesses raise investment capital. The program has been lauded for effectively streamlining the state review process that promotes efficiency by providing centralized filing, unified comments, and a definitive timeline for review.
However, it appears that the SEC has adopted a rule that fails to fully recognize the significant benefits of this program to issuers and investors alike. We continue to have concerns that the rule does not maintain the important investor protection role of state securities regulators and must look more closely at the final rule as we evaluate our options.”
The SEC hopes that Regulation A+ will fare better than the current Regulation A and become a more practical way for smaller issuers to access the public markets. Only time will tell if these new offering requirements will lead to easier access to capital.
On Monday, the Securities and Exchange Commission (the “SEC”) proposed rules requiring disclosure of companies’ policies with respect to hedging transactions, in order to implement Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The rules do not prohibit hedging transactions or require companies to adopt policies with respect to hedging, but would instead require companies to disclose whether any corporate hedging policies exist and whether they permit directors, officers or other employees who receive equity securities as part of their compensation, or otherwise hold equity securities of the issuer, whether directly or indirectly, to hedge or offset any declines in the market value of those equity securities.
Many companies already prohibit hedging transactions as part of their corporate governance policies, or at the least require pre-approval by a policy administrator before such transactions can be entered into. Hedging by company personnel is generally frowned upon as a means of reducing the economic risks of share ownership.
Currently, Item 402(b) of Regulation S-K requires certain disclosures related to hedging policies, but only with respect to named executive officers of an issuer. Furthermore, Item 402(b) does not apply to smaller reporting companies, emerging growth companies or registered investment companies.
The rules proposed on Monday would add new paragraph (i) to Item 407 of Regulation S-K, and would require companies to disclose, in annual meeting proxy and information statements, whether they permit employees and directors to hedge their companies’ securities. Unlike existing requirements, the rules would not exempt smaller reporting companies, emerging growth companies, or closed-end investment companies that have shares listed on a national securities exchange, and would instead apply to all companies subject to the federal proxy rules.
Congress, as part of the Dodd-Frank Act, mandated the proposed rules to provide shareholders with information regarding whether employees or directors are permitted to engage in transactions that “avoid the incentive alignment associated with equity ownership.” The proposed rules are the second of four sets of rules required to be adopted by the SEC under the Dodd-Frank Act relating to executive compensation, each of which is intended to provide investors with additional information about the governance practices of the companies in which they invest. The first set of these rules, pertaining to the ratio of the CEO’s compensation to that of a company’s median employee, have remained in proposal form since September 2013.
The SEC will collect public comments on the rule for 60 days following publication in the Federal Register. We’ll provide additional information as to the rules when they are finalized.
Investors that own more than 5% of a public company’s securities and file under the exempt category (which includes most venture capital firms and other similar investors) are required to file their beneficial ownership reports within 45 days after the close of the calendar year (i.e., on February 14). Investors have a few extra days to file this year, as Valentine’s Day falls on a Saturday, followed by a Monday holiday. Therefore Schedule 13Gs will be due on Tuesday, February 17, 2015.
Don’t Forget Those Filings for Newly Public Companies
Investors in companies that went public in 2014 who either acquired all of their securities prior to the IPO or, if they acquired shares after the IPO, all post-IPO acquisitions plus all other acquisitions of stock during the preceding 12 months did not exceed 2% of the company’s outstanding common stock, are deemed to be exempt investors and are required to file an initial Schedule 13G by February 17, 2015 to report their holdings as of December 31, 2014.
Need a primer on this reporting obligation? To learn more about the rules and the timing of filing Schedule 13Ds and Schedule 13Gs in other circumstances, click here for a detailed memorandum.
Can merely late filing of “routine” forms get you in trouble with the SEC? Yes, at least if it happens too often. On Wednesday the SEC announced charges and financial penalties totaling $2.6 million against 28 officers, directors, and major shareholders for repeated late filing of SEC forms reporting holdings and transactions in company stock, and six publicly traded companies for contributing to filing failures by insiders or failing to report their insiders’ filing delinquencies.
Notably, these cases did not involve allegations of intentional wrongdoing or short-swing trading; the late filings appear to have been merely inadvertent violations of certain reporting requirements under the securities laws for which the SEC sought to hold the respondents strictly liable. Thus these cases seem to reflect the SEC’s “broken windows” approach to enforcement under Commissioner Mary Jo White, which seeks to prosecute even the smallest infractions.
Interestingly, the SEC also said that it had used “quantitative data sources and ranking algorithms to identify these insiders as repeatedly filing late.” This enforcement initiative evidences the SEC’s increasing use of data analytics to identify potential violations of the securities laws since the Enforcement Division’s establishment of its Center for Risk and Quantitative Analytics in July 2013.
Over the past few years, as plaintiffs have found it increasingly harder to succeed in “say-on-pay” litigation, another type of litigation over proxy disclosures has been on the rise. These cases are generally brought as class action lawsuits alleging that boards of directors breached their fiduciary duties by approving purportedly deficient proxy statement disclosures and claiming that shareholders need more information in order to cast an informed vote, typically with respect to equity compensation plan approvals.
In these suits, plaintiffs typically seek an injunction against the upcoming annual meeting until sufficient disclosure is provided in the proxy statement in order for shareholders to make an informed decision. The significant threat of an enjoined annual meeting has pushed many of these companies that have been sued into providing additional disclosures, thereby justifying a fee award to plaintiffs’ counsel. While plaintiffs have not had great results with these lawsuits, they did encounter some early success in these types of cases (an example of which can be found here), and have already filed cases this proxy season. For example, see Masters v. Avanair Pharm., Inc., 2014 U.S. Dist. LEXIS 19408 (S.D. Cal. Feb. 12, 2014).
To learn some strategies designed to prevent this type of litigation, and how to handle litigation if it occurs, please click below.