December 2011

After receiving comments and hosting a roundtable, the PCAOB has reproposed for comment an auditing standard on Communications with Audit Committees by making modifications to its original proposal from March 29, 2010.  Both proposals update existing AU 380.  Comments are due by February 29, 2012, with the new standard anticipated to be effective for audits of fiscal years ending on or after December 15, 2012.

Overall, the proposal as it currently stands covers almost all of the existing topics under AU 380, and in addition contains specific enhancements or new requirements, such as:

• providing the audit engagement letter to the audit committee and determining that the committee has acknowledged and agreed to the terms of the engagement;
• inquiring of the audit committee about matters that might be relevant to the audit, including knowledge of violations or possible violations of laws or regulations or complaints or concerns raised regarding financial reporting matters;
• discussing with the audit committee an overview of the audit strategy, including significant risks identified during the auditor's risk assessment procedures, whether specialists will be needed and the extent to which the auditor plans to use the work of the company's internal audit function or other parties;
• with respect to critical accounting estimates, describing the process that management used to develop those estimates and changes to the process as well as any assumptions used by management that the auditor believes have a high degree of subjectivity;
• informing the audit committee about difficult or contentious matters that triggered consultation outside the engagement team and that the auditor believes are relevant to the audit committee's oversight of the financial reporting process;
• discussing significant transactions that are outside the normal course of business for the company or otherwise appear to be unusual due to their timing, size or nature; and
• communicating matters from the audit that are significant to the oversight of the company's financial reporting process, including concerns regarding accounting or auditing matters that have come to the auditor's attention. 

In addition, the auditor must inform the audit committee of certain matters related to an evaluation of the company's ability to continue as a going concern, and when the auditor expects to modify its opinion or include explanatory language in the auditor's report.   The audit committee communications, which will be required to be conducted prior to the issuance of the report, may continue to be handled either orally or in writing, so long as they are noted in the auditor's work papers.   

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Proxy season 2012 has begun and we’re beginning to see disclosure on the impact of last year’s say on pay voting results.  As of December 16, 2011, 14 large accelerated filer companies have filed proxy statements for the 2012 season.  These proxy statements disclose whether, and to what extent, the companies considered the results of their 2011 management say on pay proposal and how that affected their compensation decisions and practices.  Unsurprisingly, the ten companies with high shareholder approval ratings (83% and higher) have provided simple and unremarkable disclosure.  These companies generally acknowledge their high ratings and cite them as support for continuing their compensation practices.

In contrast, disclosure varied among the four companies with lower shareholder approval ratings.  Mueller Water Products, Inc., who received approximately 78% approval from its shareholders in 2011, kept its disclosure short, indicating that the results were taken into account in determining the amounts of annual cash incentive awards for 2011 and in setting bonus targets for executive officers for 2012.  Johnson Controls, Inc., Jacobs Engineering Group, Inc., and Monsanto, Co., who had 60%, 45%, and 65% approval ratings respectively, all provided lengthy disclosure regarding how say on pay results were considered, and two companies disclosed changes in their compensation practices. 

Johnson Controls and Jacob Engineering both stated that feedback from investors was a factor in their decisions to modify their practices, with Johnson Controls changing annual and long-term incentive performance plan targets and Jacobs Engineering changing the form of awards and adding a performance condition to its long-term equity based incentive program.  In contrast, Monsanto did not alter its compensation practices in light of its results from say on pay.  Monsanto said that discussions with shareholders suggested no common reason for the negative votes and hypothesized that the results stemmed from poor fiscal performance in 2010.  Monsanto said it believes its compensation practices are sound and, based on improved performance in 2011, it thinks it will have improved say on pay results in 2012.

It appears that companies with solid support for their compensation practices are not providing extensive disclosure on the impact of say on pay results, while those who did not fare so well are taking steps to demonstrate they take say on pay seriously—even if they aren’t changing their compensation practices.  This bifurcated approach aligns with what we are hearing in discussions with other companies regarding disclosure for the 2012 proxy season.

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SEC Chairman Schapiro recently made a speech about corporate governance at the Transatlantic Corporate Governance Dialogue which provides some insight into upcoming SEC initiatives in this area.  In her speech, she indicated that the Commission is considering:  

- how to provide guidance on how the federal securities laws should regulate the activities of proxy advisory firms.  It's unclear what the careful choice of words that led to "how to provide guidance on how to regulate" suggests for issuers eager to see greater SEC regulation of these firms;

- how to require participants in the voting process to share information in order to allow for vote confirmation, as currently it is not logistically possible; and

- possible major changes to the beneficial ownership rules, including (a) shortening the Form 13D 10-day filing requirement; (b) changing reporting for use of cash-settled equity swaps and other types of derivatives; and (c) changing the form and information on Forms 13D and 13G.  She discussed the arguments in the debate, and noted that the first step is likely to be through a concept release "given the controversy surrounding some of the issues." 

In addition, she reiterated her support for a mandatory proxy access rule, without mentioning whether the SEC will make another attempt in the near future.  Instead, Chairman Schapiro extolled the type of "private ordering" now available under Rule 14a-8 for proxy access, which she believes could, over time, bring about shareholders' ability to nominate directors at more and more companies. 

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During its 2012 North American Proxy Season review, proxy advisory services firm Glass Lewis looked back to the 2011 proxy season and also gave insights as to what we can expect from them in 2012.  Highlights included:

Say-on-Pay.  Glass Lewis recommended against 17.5% of say-on-pay proposals in 2011.  They use a proprietary model to evaluate companies and come up with "A" to "F" grades.  10% of companies that they reviewed received "F"s in 2011, with the average say-on-pay results at those companies at 73%.  While, like ISS, they cite pay for performance issues as the primary reasons for causing negative recommendations, Glass Lewis also tends to cast an unusual focus on CD&A disclosure that sometimes surprises companies.  According to Glass Lewis, they find it problematic when companies disclose performance measures but not the rationale for the selection or the weighting of the measures, or when they perceive inadequate discussion of a compensation committee's exercise of discretion.  Glass Lewis grades CD&A disclosure as "poor, fair and good," and 5% of companies received "poor" citations in 2011.  They mentioned Amazon as an example of a company that, in their view, both performs and has appropriate executive compensation, but has poor CD&A disclosure.  In terms of evaluating company responses to prior year say-on-pay votes, Glass Lewis will examine those companies that received at least 75% negative votes for whether to recommend against either the chairman of the compensation committee or the entire committee, depending on companies' engagement efforts with shareholders and then the level of responses. 

Shareholder Proposals, Including Proxy Access.  Glass Lewis data shows that there were 443 shareholder proposals in 2011, a decrease from 591 in 2012, mainly attributable to the absence of compensation proposals in light of mandatory say-on-pay.  This year's most popular proposal, given the election year, will likely be on political contributions and related topics.  As for proxy access shareholder proposals, similar to ISS, Glass Lewis will review those on a case-by-case basis before making recommendations, including the percentage ownership requested and holding period requirement.  Their list of factors that they will consider is much longer than the ISS policy, including an analysis of the company's shareholder base in both percentage of ownership and type of shareholders, responsiveness of board and management to shareholders as evidenced by "progressive shareholder rights policies" such as annual elections and majority voting, and company performance and steps taken to improve bad performance. 

Exclusive Forum Provisions.  Glass Lewis discussed the selection of Delaware as an exclusive forum for shareholder derivative suits by 80 companies as of November, adopted either after seeking shareholder approval or by board action alone.  We recently blogged about ISS policies on this matter.  Like ISS, Glass Lewis generally recommends against an exclusive forum provision and a company will need to demonstrate that it has a long history of suffering from frivolous lawsuits to justify the proposal.  But Glass Lewis also takes it a step further and will recommend against the chairman of the governance committee if the company adopts exclusive forum provisions either without shareholder approval or pursuant to a bundled bylaw or charter amendment (where exclusive forum is coupled with other changes).  If a company adopts an exclusive forum provision before a company's IPO, Glass Lewis will recommend against the chairman of the governance committee or the board chairman if there is not a governance committee chairman. 

Talk to Us Now.  Glass Lewis reiterated that they do not engage with companies during the proxy season, long a frustrating policy for companies after they receive negative Glass Lewis reports, but they are available for discussions during the off-season.  At times during the proxy season, they will sponsor "proxy talks" involving a specific company and invited clients. 

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In what would appear to be the first filing of proxy access proposals by an institutional investor, Norges Bank Investment Management (NBIM), manager of the Norwegian Government Pension Fund, has recently filed proxy access shareholder proposals at six U.S. companies. The Norwegian Government Pension Fund held approximately $98 billion in U.S. equities and $63 billion in U.S. bonds as of the end of November.

According to its press release, NBIM filed shareholder proposals at Wells Fargo, Charles Schwab, Western Union, Staples, Pioneer Natural Resources and CME Group, asking each of the companies to establish procedures for shareholders to nominate candidates to the company’s boards of directors.  The NBIM proposal would require that shareholders own a minimum of 1% of the company’s stock for at least one year in order to nominate directors.  Under the proposal, up to 25 percent of the board may be nominated by shareholders. These proposals provide a lower threshold of stock ownership required for nomination than that of  the SEC’s vacated Rule 14a-11, which required ownership of 3% of a company’s shares for a period of three years in order to nominate a director.

All but one of the companies targeted by NBIM has seen a drop in its stock price over the last year.  In its press release, a spokesperson for NBIM said that it “will continue to identify companies with unsatisfactory performance.” According to an article in the Wall Street Journal today, NBIM selected the six targeted companies after a review more than 2000 of the fund’s U.S. holdings.  A spokesperson also said in the article that NBIM is “not planning [on nominating directors] now; we would much rather have a good dialogue with the board.”

ISS has asked that we encourage interested parties to register for its free webinar to discuss its new proxy voting guidelines, which we recently summarized in a client publication.  The session focused on U.S. policies will take place on Wednesday, December 7, at 11:00 a.m. EST and will feature Martha Carter, Head of Governance Research; Carol Bowie, Head of U.S. Compensation Research; and Pat McGurn, Special Counsel. 

Having been on panels with Carol and Pat, both frequent speakers about ISS, it is always helpful to hear them discuss ISS' recent experiences and the background and application of ISS guidelines.  They may explain and further elaborate on some of the seeming complexities of the new pay for performance criteria that will be used to evaluate say-on-pay in 2012, and may provide indications of their upcoming guidance to be issued on the topic, likely in mid-December.  They may also give a sense of the latest status of proxy access proposals.  While many are critical of it, no one disputes the reality of ISS' influence on proxy voting, so this is a welcome opportunity for education as a key step toward being prepared. 

A separate discussion of the European policies will take place a day earlier, and you can find registration for that session on the same site as noted above.   

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