Update on the current board issues: January 2014

Issues in brief


Federal appeals court hears challenge to conflict minerals rule

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On January 7 the US Court of Appeals for the District of Columbia Circuit heard arguments in appeal of a district court’s 2013 ruling that upheld the SEC’s conflict minerals disclosure rule.

According to the National Association of Manufacturers (NAM), the lead plaintiff in the appeal, a ruling is expected sometime before public companies have to file initial conflict minerals reports (the date is May 31, 2014). NAM, joined in the litigation by the Business Roundtable and the US Chamber of Commerce, stated that the appeal has been expedited. The rule, mandated by the Dodd-Frank Act, requires public companies to disclose whether they use conflict minerals (tantalum, tin, tungsten, and gold) and whether the minerals originated in the Democratic Republic of the Congo and adjoining countries. The rule responds to concerns that conflict minerals mined in these “covered countries” help finance armed groups that are responsible for violence in the region. [For more information on the conflict minerals rule, read BoardroomDirect June 2013 (Issues in brief: FAQ further clarifies SEC conflict minerals rule).]

During the oral arguments for the appeal, NAM attorneys argued that the SEC incorrectly interpreted the statute, which requires reporting of certain minerals that "did originate" in and around the Democratic Republic of the Congo, to cover minerals that "may have originated" there. They also argued that the SEC failed to recognize and use its power to establish a reasonable de minimis exception for small amounts of minerals, which could provide substantial relief from the burdensome requirements of the rule for thousands of manufacturers.

In his July 23, 2013 opinion, Judge Robert Wilkins of the US District Court for the District of Columbia wrote that he found “no problems with the SEC’s rulemaking” and he disagreed that the conflict minerals disclosure “ran afoul of the First Amendment,” as the plaintiffs alleged.


ISS releases FAQ on corporate bylaws that disqualify director candidates who received compensation from activist shareholders

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Institutional Shareholder Services (ISS) recently released a FAQ in response to new bylaw provisions that have been adopted by more than 24 companies. In general, the bylaws disqualify director candidates who have received bonuses from activist shareholders.

The proxy advisor said it would:

  • Recommend a vote against or withhold vote for directors on boards that adopted such a provision without first putting it to a shareholder vote. However, it would not recommend such a vote if a board adopts a bylaw provision disqualifying those dissident director nominees that fail to disclose third-party compensation.
  • Recommend a vote on a case-by-case basis if a board put such a director qualification bylaw up to a shareholder vote.
  • Recommend a vote on a case-by-case basis for director nominees receiving third party compensation when those nominees names are included on the proxy.

In a weekly newsletter, ISS stated that investors may find the new bylaw provision concerning because it could deter legitimate efforts to seek board representation via a proxy contest, particularly those efforts that include independent board candidates selected for their  relevant industry expertise, and who are generally recruited, but not directly employed, by the dissident shareholder.

So what  can boards to do when faced with such director nominees, which are predominantly recruited by activist hedge funds seeking to influence a board?

In a recent client memo, Martin Lipton, a partner with Wachtell Lipton Rosen & Katz wrote, “At a minimum, all companies should require full disclosure of any third-party arrangements that director candidates may have, which has long been a common practice and does not (at least given ISS’ current position) raise the risk of an ISS withhold recommendation. Companies that do choose to adopt such protective bylaws, with or without a shareholder vote, should consider appropriate shareholder outreach and engagement, focusing on the importance of discouraging third-party incentive compensation arrangements that may lead to board conflicts and divergent incentives.”


CII Petitions the SEC to Adopt Universal Proxy Cards in Contested Elections

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On January 8 the Council of Institutional Investors petitioned the SEC to amend its rules for contested corporate board elections so that shareholders can vote for any combination of management and dissident nominees on a universal proxy card.

Investors who attend shareholder meetings in person can already vote for any combination of board candidates, regardless of whether those candidates are management nominees or dissident nominees. But when investors vote by proxy, their ability to support "mixed" combinations is limited. Neither the management card nor the dissident card provides a complete list of board candidates, and voting with both cards is not permitted.

If the proposed reform is adopted, investors voting by proxy will still have two cards from which to choose, but each card will include the same complete list of board candidates.

"Amending the rules so that each side in a contest can distribute 'universal' proxy cards listing all director nominees would give shareholders freedom of choice to vote for any candidate, regardless of his or her slate," said CII Executive Director Ann Yerger. "It would also ensure a fairer, less confusing and less cumbersome voting process."

[For more information on universal proxy cards, see the recent DavisPolk Briefing and the BoardroomDirect August 2013 (Issues in brief: CII campaigns for majority voting, universal proxy, director voting considerations)].


Implementing the Volcker rule – January 14 revision

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On January 14 five federal agencies made a slight revision to the approved Volcker Rule, which prohibits insured banking entities and companies affiliated with those entities from owning and making short-term proprietary security trades.

Specifically, the revision incorporated an interim rule approved by the SEC, Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, and Commodity Futures Trading Commission. It permits banking entities to retain interests in certain collateralized debt obligations backed by trust preferred securities (TruPS CDOs). The original Volcker Rule would not have allowed banks to own these securities.

Under the interim rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities if the following qualifications are met:

  • the TruPS CDO was established, and the interest was issued, before May 19, 2010;
  • the banking entity reasonably believes that the offering proceeds received by the TruPS CDO were invested primarily in Qualifying TruPS Collateral; and
  • the banking entity’s interest in the TruPS CDO was acquired on or before December 10, 2013, the date the agencies issued final rules implementing the Volcker Rule.

The Volcker rule, which is named after former Federal Reserve Chair Paul Volcker, was part of the Dodd-Frank Act. It also imposes limits on banking entities’ investments in, and other relationships with, hedge funds or private equity funds. The rule provides exemptions for certain activities, including market making, underwriting, hedging, trading in government obligations, insurance company activities, and organizing and offering hedge funds or private equity funds. The final rules also clarify that certain activities are not prohibited, including acting as agent, broker, or custodian.

The compliance requirements under the final rules vary based on the size of the banking entity and the scope of activities conducted.

[For more information on the Volcker rule,  read PwC’s Regulatory brief: Volcker shrugged.]


SEC issues staff report on public company disclosure

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On December 20 the SEC issued The Report on Review of Disclosure Requirements in Regulation S-K. This staff report to Congress, which was mandated by the 2012 JOBS Act, offers an overview of the SEC’s Regulation S-K that governs public company disclosure, as well as the staff’s preliminary conclusions and recommendations.

“This report provides a framework for disclosure reform,” said SEC Chair Mary Jo White. “As a next step, I have directed the staff to develop specific recommendations for updating the rules that dictate what a company must disclose in its filings. We will seek input from companies about how we can make our disclosure rules work better for them and will solicit the views of investors about what type of information they want and how it can be best presented. The ultimate objective is for the Commission to improve the disclosure regime for both companies and investors.”

The last time the SEC made changes to Regulation S-K was in 2009 when it adopted proxy disclosure enhancements about compensation policies and practices that present material risks to the company; stock and option awards of executives and directors; director and nominee qualifications and legal proceedings; board leadership structure; the board’s role in risk oversight; and potential conflicts of interest of compensation consultants that advise companies and their boards of directors.

[For more information about board-related proxy disclosures, read Appendix B of PwC’s Governance for Companies Going Public – What Works BestTM publication.]