Securities Mosaic® Blogwatch
August 26, 2016
The 2016 Proxy Season: Proxy Access Proposals
by Avrohom Kess, Karen Kelley, Yafit Cohn, Simpson Thacher
Editor's Note:

Yafit Cohn is an associate at Simpson Thacher & Bartlett LLP. The following post is based on a Simpson Thacher publication authored by Ms. Cohn, Karen Hsu Kelley, and Avrohom J. Kess. Related research from the Program on Corporate Governance includes The Case for Shareholder Access to the Ballot by Lucian Bebchuk; and Private Ordering and the Proxy Access Debate by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

For the second year in a row, the most prevalent governance-related shareholder proposals in 2016 were those that sought to implement proxy access, a mechanism allowing shareholders to nominate directors and have those nominees listed in the company’s proxy statement and on the company’s proxy card. While the continuing momentum of proxy access proposals is due in part to the submission of 72 such proposals by New York City Comptroller Scott Stringer on behalf of the New York City pension funds he oversees, this year was marked by a meaningful increase in proxy access proposals submitted by individuals as well. Consistent with last year, the overwhelming majority of proxy access shareholder proposals called for the right of shareholders owning three percent of the company’s outstanding shares for at least three years to nominate directors in the company’s proxy materials. This year’s proposals, however, have gotten somewhat more sophisticated. More than half of the proxy access shareholder proposals reaching a vote at Russell 3000 companies capped proxy access nominees at the greater of 25 percent of the board or two directors, as opposed to simply 25 percent, which was almost universal last year. And, unlike last year, in which most shareholders proposals were silent on aggregation limits, most proxy access proposals submitted to a vote in 2016 specified that an unrestricted number of shareholders may be aggregated to reach the shareholding threshold.

As of July 15, 2016, 78 proxy access shareholder proposals have been submitted to a vote at Russell 3000 companies during the 2016 proxy season, compared to 87 in 2015. Of the 78 proposals that have been voted on thus far this year, 41 proposals (or 52.6%) passed, while 37 proposals (or 47.4%) failed, with the primary factor determining the vote often being whether the company had previously adopted proxy access. So far this year, shareholder proposals submitted to a vote at Russell 3000 companies received average shareholder support of 51.1%, though average shareholder support rose to 64.2% among companies that had not yet adopted proxy access and dropped to 37.9% among companies that had already adopted some form of proxy access.

I. Notable Developments A. Staff Legal Bulletin 14H

In advance of the 2016 proxy season, the Division of Corporation Finance (the “Division”) of the Securities and Exchange Commission (“SEC”) issued Staff Legal Bulletin 14H (“SLB 14H”), alleviating the uncertainty that permeated last year’s proxy season as a result of the Division’s unexpected mid-season announcement that it would not express any views that season with regard to the application of Rule 14a-8(i)(9). Rule 14a-8(i)(9) permits public companies to exclude a shareholder proposal “[i]f the proposal directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting.” SLB 14H clarifies the Division’s interpretation of this provision in a manner that differs significantly from that which the SEC applied before the 2015 proxy season.

While no-action responses issued prior to 2015 on the basis of Rule 14a-8(i)(9) focused on the potential for inconsistent and ambiguous results and shareholder confusion, the Division’s new approach centers “more specifically on the nature of the conflict between a management and shareholder proposal.” In particular, under the Division’s new approach, any assessment of whether a proposal is excludable under Rule 14a-8(i)(9) assesses “whether there is a direct conflict between the management and shareholder proposals.” As explained by the Division, “a direct conflict would exist if a reasonable shareholder could not logically vote in favor of both proposals, i.e., a vote for one proposal is tantamount to a vote against the other proposal.” Thus, if the two proposals are “in essence, mutually exclusive,” the shareholder proposal is excludable; if, however, a reasonable shareholder could logically vote in favor of both proposals—although possibly preferring one proposal over the other—the shareholder proposal is required to be included in the company’s proxy statement.

Illustrating the application of its new guidance, the Division specifically noted that a shareholder and management proposal, each of which seeks the adoption of proxy access but with different eligibility thresholds, are not “directly conflicting.”

B. Expansion of the Comptroller’s Proxy Access Initiative

Last year’s influx of proxy access shareholder proposals was due, in large part, to New York City Comptroller Scott Stringer’s “2015 Boardroom Accountability Project”—an initiative in which the Comptroller submitted 75 precatory shareholder proposals on proxy access to companies in diverse industries and with various market capitalizations on behalf of the New York City pension funds he oversees. In January of 2016, the Comptroller’s office issued a press release announcing the expansion of the Comptroller’s proxy access initiative, pursuant to which it submitted 72 proposals to public companies this proxy season calling for the adoption of “meaningful proxy access bylaws.”

Like last year, the Comptroller’s 2016 proposal seeks the right for shareholders owning three percent of the company’s outstanding shares for at least three years to nominate up to 25 percent of the board in the company’s proxy materials. And like last year, the vast majority of the issuers targeted by the Comptroller’s office in 2016 were companies with purportedly weak track records on the issues of board diversity, climate change or say-on-pay.

Interestingly, half of the 72 companies that received the Comptroller’s proxy access proposal this year had also received his proposal last year, but, according to the Comptroller, had “not yet enacted, or agreed to enact, a 3% bylaw with viable terms” as of the time he submitted his 2016 proposal. Notably, this group of issuers includes companies that had enacted so-called “unworkable bylaws requiring 5% ownership, some of which received binding proposals to amend their bylaw.”

The 36 companies that received the Comptroller’s proposal for the second year in a row can be broken down as follows:

Of the 72 shareholder proposals that the Comptroller’s office submitted to public companies this year, 50 (or 69.4%) were withdrawn pursuant to negotiations with the proponent. The high rate at which companies have been willing to implement proxy access at the 3% / three-year thresholds in response to the Comptroller’s proposal seems to reflect a recognition that, in its sustained pursuit of a global standard of proxy access across public companies, the Comptroller’s office is likely to continue to target these companies in subsequent years if they do not adopt proxy access at the Comptroller’s preferred thresholds. It also may indicate an acknowledgment that, at companies that have not yet adopted proxy access, a shareholder proposal on the issue is significantly more likely to garner majority support.

II. SEC No-Action Letters

Thus far this year, the staff of the SEC’s Division of Corporation Finance issued responses to 51 no-action requests pertaining to proxy access shareholder proposals, 42 of them on substantive grounds. Of those, 40 responses were based on Rule 14a-8(i)(10), which permits the exclusion of a shareholder proposal where “the company has already substantially implemented the proposal.”

A. Substantial Implementation Under Rule 14a-8(i)(10)

With its suggestion in SLB 14H that Rule 14a-8(i)(9) will no longer be available in most cases to issuers seeking to exclude proxy access shareholder proposals from their proxy materials, more companies turned to Rule 14a-8(i)(10) as a basis for exclusion this proxy season. Rule 14a-8(i)(10) was particularly ripe for use in the proxy access context this year, as an unprecedented number of companies adopted proxy access in 2015 and 2016. This exclusionary rule, however, had seldom been applied to proxy access prior to this proxy season, given the relatively new phenomenon of proxy access proposals and adoptions.

During the 2016 proxy season, the SEC Staff concurred with 36 companies that the proxy access shareholder proposals they had received may be excluded from their proxy materials pursuant to Rule 14a-8(i)(10). The Staff denied relief, however, in three instances where the company’s proxy access bylaw provisions contained a higher eligibility threshold than that requested in the shareholder proposal, as well as one case in which the shareholder proposal explicitly requested specific revisions to the company’s proxy access bylaw.

In all 36 cases in which the Staff granted no-action relief, the shareholder proposal requested, in relevant part, that the company adopt proxy access with the following provisions:

  • Ownership threshold and holding period. The proposal requested proxy access for holders of three percent of the company’s outstanding common stock for at least three consecutive years. The proposal specifically noted that “recallable loaned stock” should be counted toward the three-percent ownership.
  • No Aggregation Limit. The proposal provided that an “unrestricted number of shareholders” should be permitted to form a group for purposes of satisfying the ownership threshold.
  • Cap on Shareholder Nominees. The proposal requested that the number of shareholder-nominated candidates appearing in the company’s proxy materials not exceed the greater of two directors or 25 percent of the board.
  • Information Requirements. The proposal sought to require the nominating shareholder (or group of shareholders) to provide the company with information required by the company’s bylaws and any SEC rules regarding “(i) the nominee, including consent to being named in proxy materials and to serving as director if elected; and (ii) the Nominator, including proof it owns the required shares.”
  • Required Shareholder Certifications. The proposal sought to require the nominating shareholder (or group of shareholders) to certify that “(i) it will assume liability stemming from any legal or regulatory violation arising out of the Nominator’s communications with the Company shareholders … (ii) it will comply with all applicable laws and regulations if it uses soliciting material other than the Company’s proxy materials; and (iii) to the best of its knowledge, the required shares were acquired in the ordinary course of business, not to change or influence control at the Company.”
  • “No Additional Restrictions.” The proposal added: “No additional restrictions that do not apply to other board nominees should be placed on these nominations or re-nominations.”

In all 36 cases, the proxy access bylaw adopted by the company granted proxy access for holders of three percent of the company’s outstanding stock for at least three years and explicitly included loaned shares in the ownership calculation, provided that the lending shareholder has the power to recall the shares within a specified period (and, in some cases, that the shareholder does indeed recall them). Most of the companies’ bylaws, however, differed from the proposal in one or more of the following respects:

  • Aggregation Limit. In 33 cases, the company’s bylaws limited the number of shareholders who could be aggregated for purposes of reaching the ownership threshold. (In all but one of these cases, the group limit was set at 20 shareholders; in the remaining case, the group limit was set at 25 shareholders).
  • Cap on Shareholder Nominees. The bylaws of 30 companies included a lower cap on the number of candidates who may be nominated pursuant to proxy access. These bylaws limited the number of shareholder nominees to either:
    • the greater of the two directors or 20 percent of the board, or
    • 20 percent of the board (rounded down to the nearest whole number).
  • Whether or not a company’s bylaws contained a lower cap on shareholder nominees than that requested by the proposal, the bylaws sometimes specified additional categories of individuals who would be deemed shareholder nominees for purposes of calculating the cap (e.g., individuals nominated pursuant to the company’s advance bylaw provision, incumbent director candidates previously nominated through the proxy access mechanism until they have served a specified number of terms, any shareholder nominee whose nomination is subsequently withdrawn or who becomes ineligible).
  • Information and Certification Requirements. While the bylaws of each of the companies that obtained no-action relief required all of the disclosures and certifications outlined in the proposal, they also often required additional disclosures and/or certifications from the nominating shareholder (e.g., a representation that the nominating shareholder intends to continue to own the requisite shares through the date of the annual meeting and/or for at least one year following the date of the annual meeting (subject to limited exceptions), a representation that the nominating shareholder will not distribute any form of proxy for the annual meeting other than the form distributed by the company, a representation that the nominating shareholder will indemnify the company and its directors and officers against specified losses arising from nominations submitted by the shareholder).
  • Additional Restrictions. While noting that it is not entirely clear what “additional restrictions” the proposal referred to, many of the no-action request letters acknowledged that the company’s bylaws impose certain requirements on shareholder-nominated candidates that do not expressly apply to the board’s nominees. Examples include requirements that:
    • the shareholder-nominated candidate be independent according to applicable listing standards and/or the company’s governance guidelines;
    • the election of the shareholder-nominated candidate not cause the company to violate its governing documents, applicable listing rules or other applicable laws, rules or regulations;
    • the shareholder-nominated candidate not be an officer or director of a competitor; and
    • the shareholder-nominated candidate not be the subject of certain criminal proceedings or be a “bad actor” under SEC rules.

Many companies took the position that the practical effect of imposing such “additional restrictions on proxy access nominees is to place proxy access candidates and [b]oard nominated candidates on an equal footing,” because the board “does not have the opportunity to follow the same vetting process for shareholder-nominated proxy access candidates.”

Despite these differences, the Staff granted no-action relief to these companies, specifically noting in each case the company’s “representation that the board has adopted a proxy access bylaw that addresses the proposal’s essential objective.”

Three companies, however, which had received a substantially similar shareholder proposal as those companies that received no-action relief, were unsuccessful in obtaining relief in reliance on Rule 14a-8(i)(10). These companies had each adopted proxy access for owners of at least five percent of the company’s outstanding common stock, while the shareholder proposals they received called for proxy access at a three-percent ownership threshold. In each of these cases, the Staff concluded that, based on the information presented by the company in its no-action request, “it appears that [the company’s] policies, practices and procedures do not compare favorably with the guidelines of the proposal and that [the company] has not, therefore, substantially implemented the proposal.” (In one of these cases, the company’s board later amended the company’s proxy access bylaw to reduce the minimum ownership requirement from five percent to three percent of the company’s outstanding common stock and was able to obtain no-action relief from the Staff pursuant to Rule 14a-8(i)(10).)

One additional company—H&R Block, Inc.—was unsuccessful in its substantial implementation argument, though with regard to a proxy access shareholder proposal that was phrased as a request that the company’s board adopt and present for shareholder approval specific revisions to the company’s existing proxy access bylaw. H&R Block’s proxy access bylaw, which it had adopted last year, permits a shareholder or a group of up to 20 shareholders owning three percent or more of the company’s outstanding common stock continuously for at least three years to nominate and include in the company’s proxy materials director nominees constituting up to 20 percent of the board. The shareholder proposal submitted to H&R Block requested that the company’s bylaws be revised to “ensure the following:

  1. The number of shareholder-nominated candidates eligible to appear in proxy materials should be one quarter of the directors then serving or two, whichever is greater.
  2. Loaned securities should be counted toward the ownership threshold if the nominating shareholder or group represents that it has the legal right to recall those securities for voting purposes, will vote the securities at the annual meeting, and will hold those securities through the date of that meeting.
  3. There should be no limitations on the number of shareholders that can aggregate their shares to achieve the required 3% ownership to be an ‘Eligible Shareholder.’
  4. There should be no limitation on the renomination of shareholder nominees based on the number of percentage votes received in any election.”

Citing the group of no-action letters issued earlier this year with regard to proxy access proposals under Rule 14a-8(i)(10), H&R Block asserted that “[t]he Staff has concluded that proposals calling for a shareholder proxy access bylaw could be excluded as substantially implemented where the company had adopted a bylaw with the same stock ownership amount and length of ownership called for by the proposal, even though the company’s bylaw included certain procedural limitations or restrictions that were inconsistent with or not contemplated by the proposal.” The company took the position that, under this standard, it too has substantially implemented the proposal. The proponent, on the other hand, argued, among other things, that the no-action letters issued by the Staff earlier this year with regard to proxy access proposals under Rule 14a-8(i)(10) “provide no evidence why 3% of shares is considered an essential element to proxy access but having no cap on the number allowed to form a group is not. There is a world of difference between a group of twenty … and an unlimited group.” Perhaps more importantly, the proponent drew a distinction between proposals seeking the adoption of proxy access bylaws and those seeking “revisions to existing proxy access bylaws,” arguing that “once bylaws have been adopted, shareholders must be able to recommend substantive changes.” The Staff ultimately denied H&R Block no-action relief, noting that the Staff was “unable to conclude that H&R Block’s proxy access bylaw compares favorably with the guidelines of the proposal.”

B. Violation of Proxy Rules Under Rule 14a-8(i)(3)

While the vast majority of substantive no-action requests regarding proxy access proposals were based on Rule 14a-8(i)(10), two letters sought no-action relief pursuant to Rule 14a-8(i)(3). Rule 14a-8(i)(3) permits the exclusion of a shareholder proposal “[i]f the proposal or supporting statement is contrary to the Commission’s proxy rules, including Rule 14a-9, which prohibits materially false or misleading statements in [a company’s] proxy soliciting materials.” Both The Interpublic Group of Companies, Inc. and Amphenol Corporation took the position that the proxy access proposals they received—which were substantially identical to those at issue in the no-action requests premised on Rule 14a-8(i)(10)—were “impermissibly vague and indefinite so as to be inherently misleading.”

The Interpublic Group asserted that the shareholder proposal was “vague, indefinite and misleading in at least the following respects”:

  • The provision in the proposal that provides that “[n]o additional restrictions that do not apply to other board nominees should be placed on these nominations or re-nominations” is susceptible to multiple interpretations, and “neither the shareholders when voting on the Proposal nor the Board when fashioning the requested bylaw would know what terms or provisions of the requested bylaw would constitute ‘additional restrictions.’”
  • The term “beneficial ownership” has many definitions, such as those “found in the securities laws and a vast variety of commercial and governance settings,” and yet this term is undefined in the proposal, rendering the proposal vague, indefinite and misleading. Additionally, the board “is called upon by the Proposal to provide a useful and workable definition [of ‘beneficial ownership’], but in light of the No Additional Restrictions Provision it is not clear” how the board would know that its definition does not violate the “no additional restrictions” provision.
  • The proposal’s request that to cap shareholder nominees at “one-quarter of the directors then serving or two, whichever is greater” is vague, because the proposal does not clarify how the board must treat a circumstance in which 25 percent of the board results in a fractional number, and any resolution devised by the board may contravene the “no additional restrictions” provision.
  • The meaning and scope of the proposal’s provision that the nominating shareholder certify that it will “assume liability stemming from any legal or regulatory violation arising out of the Nominator’s communications with the Company shareholders” is ambiguous, “nor is it clear how the Board can clarify this language without violating the No Additional Restrictions Provision.”
  • The proposal’s language regarding continuous ownership of the requisite amount of stock for three years “is open to multiple definitions and interpretations,” since it “specifies a continuous holding period of three years ‘before’ submitting the nomination, which would potentially allow any prior three-year period of continuous ownership to enable a Nominator to submit a nominee, not just the three years leading up to and including the day of submission.” If the board were to clarify, when adopting its bylaw, that the shares must have been held continuously for at least three years as of the date of submission, the board would not know whether it had violated the “no additional restrictions” provision.

Amphenol Corporation similarly took the position that there were “multiple ways” in which the company and its shareholders could interpret the proposal, but focused on the fact that the proposal did not “provide any clarity as to what steps the Proponent expects the Company and its stockholders to take in order to implement the Proposal.” Specifically, Amphenol Corporation noted that it was unclear whether, upon passage of the shareholder proposal, the shareholder proponent expected the board to:

  • “adopt a resolution setting forth the amendment proposed, declaring its advisability, and either calling a special meeting for consideration of the amendment or directing that the amendment be considered at the next annual meeting of shareholders”;
  • approve the proposed bylaw and call on the shareholders to approve the proposal at the next annual meeting, though the bylaw would remain effective regardless of the outcome of the shareholder vote;
  • approve the proposed bylaw and call on the shareholders to approve the proposal at the next annual meeting, and if the shareholders reject the bylaw, it would be repealed; or
  • “present the proposed bylaw for approval by stockholders in the manner set forth in the Company’s bylaws, without any special actions by the Board prior to such vote.”

The Staff denied both of the requests for no-action relief under Rule 14a-8(i)(3), noting: “We are unable to conclude that the proposal is so inherently vague or indefinite that neither the shareholders voting on the proposal, nor the company in implementing the proposal, would be able to determine with any reasonable certainty exactly what actions or measures the proposal requires.”

Shortly after receiving the denial of no-action relief, Amphenol Corporation revised its bylaws to adopt proxy access at the 3% / 3-year thresholds and returned to the SEC with a request for no-action relief on the basis of substantial implementation, which the Staff granted.

III. Positions of the Proxy Advisory Firms A. Institutional Shareholder Services, Inc. (“ISS”)

1. Policy

ISS’s voting policy with regard to proxy access proposals remains unchanged from last year.

Unlike the case-by-case approach it used in evaluating these proposals prior to 2015, ISS’s current policy provides that it will generally recommend a vote in favor of management and shareholder proxy access proposals with the following features:

  • A maximum ownership threshold of three percent of the voting power;
  • A maximum duration requirement of three years of continuous ownership for each member of the nominating group;
  • “[M]inimal or no limits on the number of shareholders permitted to form a nominating group”;

and

  • A cap on shareholder nominees generally set at 25% of the board.

ISS will also “[r]eview for reasonableness any other restrictions on the right of proxy access” and will “[g]enerally recommend a vote against proposals that are more restrictive than these guidelines.”

This proxy season, ISS also issued a new Frequently Asked Question (“FAQ”) regarding proxy access, which delved into how ISS will evaluate a board’s implementation of proxy access in response to a majority supported shareholder proposal. The FAQ provides that, in assessing a board’s response to a majority supported shareholder proposal seeking proxy access, ISS will examine “whether the major points of the shareholder proposal are being implemented” and whether additional provisions that were not included in the shareholder proposal “unnecessarily restrict the use of a proxy access right.” ISS’s assessment will inform its vote recommendation with regard to individual directors, nominating/governance committee members or the entire board, as appropriate.

The FAQ further specifies that ISS may issue adverse vote recommendations “if a proxy access policy implemented or proposed by management contains material restrictions more stringent than those included” in the shareholder proposal with respect to the following features, “at a minimum”:

  • An ownership threshold above three percent;
  • Ownership duration longer than three years;
  • A limit on the number of shareholders who may be aggregated to form a group set at below 20 shareholders; and
  • A cap on proxy access nominees below 20 percent of the board.

According to ISS, where an aggregation limit or cap differs from that provided in the shareholder proposal, “lack of disclosure by the company regarding shareholder outreach efforts and engagement may also warrant negative vote recommendations.”

Turning to the addition of provisions in the company’s proxy access policy or management proposal beyond those included in the shareholder proposal, ISS indicated that it will review “restrictions or conditions on proxy access nominees” on a case-by-case basis. The restrictions ISS deems problematic, “especially when used in combination include, but are not limited to:

  • Prohibitions on resubmissions of failed nominees in subsequent years;
  • Restrictions on third-party compensation of proxy access nominees;
  • Restrictions on the use of proxy access and proxy contest procedures for the same meeting;
  • How long and under what terms an elected shareholder nominee will count toward the maximum number of proxy access nominees; and
  • When the right will be fully implemented and accessible to qualifying shareholders.” In addition, the two types of restrictions that ISS considers “especially problematic” are:
  • “Counting individual funds within a mutual fund family as separate shareholders for purposes of an aggregation limit; and
  • The imposition of post-meeting shareholding requirements for nominating shareholders.”
2. Practice

This proxy season:

  • ISS recommended a vote “For” all but one of the 83 proxy access shareholder proposals submitted to Russell 3000 companies for which it has published a report (including those proposals that were subsequently withdrawn). The sole shareholder proposal to receive a negative ISS vote recommendation this proxy season was submitted to Peoples Financial Services Corp. and, unlike every other shareholder proposal submitted this year, sought proxy access for those owning 1.5% of the company’s outstanding stock for at least two years.
  • ISS recommended a vote “For” 18 of the 21 proxy access proposals submitted by management for which it published a report. In the three cases in which ISS recommended a vote “Against” a management-sponsored proposal on proxy access, ISS voiced concerns about various provisions it deemed “overly restrictive”—most notably, a five-percent ownership threshold and/or an aggregation limit of 10 shareholders.
B. Glass Lewis 1. Policy

Glass Lewis’s policy, which remains unchanged from last year, provides that the proxy advisory firm “will consider supporting reasonable proposals requesting shareholders’ ability to nominate director candidates to management’s proxy” and will review such proposals on a case-by-case basis, considering the following factors:

  • company size;
  • board independence and diversity of skills, experience, background and tenure;
  • the shareholder proponent and its rationale for submitting the proposal;
  • the proposal’s ownership threshold and holding period requirement;
  • shareholder base in both percentage of ownership and type of shareholder;
  • responsiveness of board and management to shareholders evidenced by progressive shareholder rights policies (e.g., majority voting, declassified boards) and reaction to shareholder proposals;
  • company performance and steps taken to improve poor performance;
  • existence of anti-takeover protections; and
  • opportunities for shareholder action (e.g., ability to act by written consent, right to call a special meeting).

Given the SEC’s recent release of SLB 14H, which leaves open the option for issuers to submit a shareholder proposal alongside a management proposal on the same issue, Glass Lewis added a policy to its proxy voting guidelines this year that articulates its approach to analyzing dueling proposals. In reviewing dueling proposals, Glass Lewis will consider the following factors:

  • “The nature of the underlying issue;
  • The benefit to shareholders from implementation of the proposal;
  • The materiality of the differences between the terms of the shareholder proposal and management proposal;
  • The appropriateness of the provisions in the context of a company’s shareholder base, corporate structure and other relevant circumstances; and
  • A company’s overall governance profile and, specifically, its responsiveness to shareholders as evidenced by a company’s response to previous shareholder proposals and its adoption of progressive shareholder rights provisions.”

2. Practice

Glass Lewis generally recommends voting “For” proxy access shareholder proposals. Notably, in the three instances this year in which a company submitted competing shareholder and management proposals to a vote, each of which included a three-percent shareholding threshold, Glass Lewis recommended voting “Against” the shareholder proposal while supporting the management proposal.

Glass Lewis recommended a vote “For” 19 of the 21 proxy access proposals submitted by management this year. In the two cases in which Glass Lewis recommended a vote “Against” the management-sponsored proposal, the proposal included a five-percent shareholding threshold.

IV. Positions of Large Institutional Shareholders

At present, there is no consensus among the major institutional shareholders on the issue of proxy access. BlackRock and State Street Global Advisors, for example, currently consider proxy access proposals on a case-by-case basis. BlackRock’s present policy, which remains unchanged from last year, reflects its belief that “long-term shareholders should have the opportunity, when necessary and under reasonable conditions, to nominate individuals to stand for election to the boards of the companies they own and to have those nominees included on the company’s proxy card,” provided that the proxy access mechanism will “provide assurances that the mechanism will not be subject to abuse by short-term investors, investors without a substantial investment in the company, or investors seeking to take control of the board.” State Street Global Advisors supports shareholder proposals on proxy access “that set parameters to empower long-term shareholders while providing management the flexibility to design a process that is appropriate for the company’s circumstances.” In deciding how to vote, State Street will take into account considerations such as “the ownership thresholds and holding duration proposed in the resolution, the binding nature of the proposal, the number of directors that shareholders may be able to nominate each year, company governance structure, shareholder rights, and board performance.”

The Vanguard Group also currently considers proxy access proposals on a case-by-case basis, but generally supports proxy access provisions that provide a shareholder (or group of shareholders) holding three percent of a company’s outstanding shares for at least three years with the right to nominate up to 20% of the board’s directors. The Vanguard Group may, however, “support different thresholds based on a company’s other governance provisions, as well as other relevant factors.” This policy represents a change from last year, in which Vanguard supported provisions that sought proxy access for holders of five percent of the company’s outstanding shares.

Finally, Fidelity Management & Research is currently opposed to proxy access, generally voting against management and shareholder proposals seeking to implement proxy access.

V. Proxy Access Proposal Trends A. Overall Trends
  • For the second year in a row, proxy access shareholder proposals were the most popular of the governance-related proposals. A total of 78 shareholder proposals have gone to a vote thus far among Russell 3000 companies (with two proposals pending as of July 15, 2016), as compared to 87 proposals that have gone to a vote in 2015. In contrast, between 12 and 17 proxy access shareholder proposals were submitted to a vote in each of the previous three years.
  • Shareholder proponents continue to converge on the 3% / 3-year thresholds. All but one proposal submitted to a vote at Russell 3000 companies called for proxy access at the thresholds of three percent and three years. As noted earlier, only one proposal broke with this trend, seeking proxy access for holders of 1.5% of the company’s outstanding stock for at least two consecutive years. This continues the trend observed last year, in which all 87 proposals submitted to a vote at Russell 3000 companies called for proxy access at the 3% / three-year thresholds. In contrast, of the 17 shareholder proposals submitted to a vote in 2014, only ten contained the 3% / three-year thresholds.
  • More than half of this year’s shareholder proposals capped proxy access nominees at the greater of 25% of the board or 2 directors. Forty-three of the 78 proposals that were submitted to a vote (or 55%) capped proxy access nominees at the greater of 25% of the board or 2 directors, while the remaining 35 proposals (or 45%) sought a cap of 25% of the board. This reflects the somewhat increased sophistication of shareholder proposals this proxy season as compared with last year’s proposals, 98% of which capped proxy access nominees at 25% of the board (while the remaining two percent capped shareholder nominees at 20% of the board).
  • Most of this year’s shareholder proposals explicitly provided that an unrestricted number of shareholders may be aggregated to reach the shareholding threshold. Forty-seven of the 78 proposals that reached a vote at Russell 3000 companies this year (or 60%) requested that there be no group limit for purposes of reaching the requisite ownership threshold, while the remaining 31 proposals (or 40%) were silent on the issue of group size limitations. This represents a meaningful change from last year, in which the overwhelming majority of shareholder proposals were silent with respect to limits on the number of shareholders that can be aggregated to form a group.

  • While the New York City Comptroller’s office submitted many proxy access proposals this year, the majority of proposals that reached a vote were submitted by individuals. At least 40 of the 78 shareholder proposals that reached a vote this year at Russell 3000 companies (or 41.3%) were submitted by individuals. Only 18 of the 78 proposals that reached a vote among the Russell 3000 (or 23.1%) were submitted by the New York City Comptroller’s office, primarily due to the high rate of successful negotiations between issuers and the Comptroller’s office this year. Across all indices, 20 of the 72 shareholder proposals sponsored by the New York City Comptroller’s office (or 27.8%) reached a vote this year, in contrast to 66 of the 75 proposals (or 88%) submitted by the Comptroller’s office in 2015.

  • Vote results have been decidedly mixed. Of the proposals that have been voted on at Russell 3000 companies so far this season, 41 shareholder proposals (or 52.6%) have passed, while 37 shareholder proposals (or 47.4%) have failed. Two proposals remain pending as of July 15. In contrast, in 2015, 53 of 87 shareholder proposals (or 60.9%) passed, while 34 proposals (or 39.1%) failed.

  • The major factor determining the vote results this year appears to be whether the company has already adopted proxy access. There were 19 cases this year in which companies that had already adopted proxy access at the 3% / 3-year thresholds nonetheless received and submitted to a vote a shareholder proposal on proxy access. In each of these cases, the shareholder proposal failed. Shareholder proposals submitted to companies that neither adopted proxy access nor were submitting a dueling management-sponsored proposal to a vote fared significantly better. Thirty-eight of the 49 shareholders’ proposals in this category (or 77.6%) garnered majority support, while the remaining 11 proposals (or 22.4%) failed.

  • Average shareholder support for proxy access shareholder proposals decreased slightly from last year, though shareholder support varied meaningfully depending on whether a company had already adopted proxy access. Proxy access shareholder proposals among Russell 3000 companies received average support of 51.1%% thus far in 2016, compared to 55% average support in 2015. While significantly higher than the 30.9% average shareholder support these proposals received in 2014, this year’s average shareholder support is roughly consistent with the 53.4% average support for proposals with 3% / three-year thresholds in 2014. Notably, at companies that had not already adopted a proxy access bylaw, average shareholder support of shareholder proposals with 3% / 3-year thresholds rose to 64.2%. Conversely, at companies that had already adopted some form of proxy access, average shareholder support was only 37.9%.

B. Management Responses to Proxy Access Shareholder Proposals

Putting aside cases in which management negotiated successfully with the shareholder proponent for exclusion of the proposal, companies chose to pursue different options in response to proxy access shareholder proposals. While the vast majority of companies submitting a proxy access shareholder proposal to a vote opposed the proposal, others determined to include the proposal alongside a competing management proposal, supported the shareholder proposal or did not provide any board recommendation with regard to the shareholder proposal.

C. Trends Among Companies Submitting Dueling Proposals

Vote results for shareholder proposals that were submitted in conjunction with a competing management proposal were mixed. In two of the five cases of dueling proposals, the shareholder proposal passed, while the management proposal failed. In both of these cases, the management proposal sought proxy access at the five percent shareholding threshold. In the three cases in which the shareholder proposal and the management proposal both sought proxy access for holders of three percent of the company’s stock, however, the shareholder proposal failed, while the competing management proposal passed by a significant margin.

* In these cases, the management-sponsored proposal sought proxy access at the 5% threshold. In addition, both of these companies submitted dueling proposals last year, and the vote results were significantly closer then. At Chipotle, both proposals failed last year, with the shareholder proposal garnering 49.9% support and the management proposal receiving 34.5% support. At SBA, the management proposal passed last year, receiving 51.7% support, while the shareholder proposal received 46.3% support.

VI. Proxy Access Adoption Trends

This year, there has been a steep increase in the number of companies that had adopted proxy access. Last year, 119 companies adopted proxy access, compared to a total of 12 companies that had adopted proxy access before then. This trend has accelerated in 2016, with an increasing number of companies adopting proxy access pre-emptively.

As of June 30, 2016, approximately 38% of companies in the S&P 500 index and approximately 73% of companies in the Dow 30 index have adopted proxy access thus far. In contrast, by June 30, 2015, only 3.8% of the S&P 500 and 6.7% of the Dow 30 had adopted proxy access.

While there is variation in the proxy access bylaws adopted by public companies, their most significant provisions are generally consistent.

* An additional two companies have aggregation limits that are subject to change. In one instance, the company’s limit of 20 shareholders increases to 25 shareholders if the company’s revenues for the prior fiscal year exceeds a certain threshold. In another case, the company’s chosen limit of 10 shareholders increases to 25 shareholders if the company’s market cap for the prior fiscal year exceeds $1 billion.

VII. Takeaways

As evidenced this season, a key factor influencing the vote results is whether a particular company had already adopted proxy access. Given this observation—and in light of the SEC Staff’s clarification that the adoption of proxy access at the 3% / 3-year thresholds substantially implements a proposal with the same thresholds, despite other differences between the shareholder and management proposals—more companies have adopted proxy access in the first six months of this year than in all of 2015. This trend is likely to continue, particularly as more companies appreciate that the Comptroller’s office and other shareholder proponents are likely to continue submitting proxy access proposals and that, especially for larger companies, receiving such a proposal is a question of when, not if.

Since the “private ordering” of proxy access at the 3% / 3-year thresholds is very likely to continue, issuers that have not yet adopted proxy access should consider how they will approach proxy access in the coming months. In preparation for the 2017 proxy season, issuers that have not yet adopted proxy access and their in-house counsel should consider taking the following actions:

  • Educate the Board. The board of directors should be informed of the trends that have developed during the 2016 proxy season, as well as the advantages and disadvantages of pre-emptively adopting proxy access.
  • Evaluate the Company’s Shareholder Base and Engage with Shareholders. As noted above, there is no consensus among the large institutional shareholders on the issue of proxy access. Issuers considering the adoption of a proxy access bylaw should analyze their shareholder base and their shareholders’ policies on proxy access and should begin to engage their largest shareholders.
  • Consider the Proxy Access Structure, If Any, Appropriate for the Company. To the extent a company is open to voluntarily adopting a proxy access bylaw, it should consider which thresholds and which “bells and whistles” it might want to include in the provision.
August 26, 2016
A Plea for a Better Response to a Failed Say on Pay Vote
by Christoph Van der Elst

The 2010 Dodd-Frank Act provided shareholders of U.S. public corporations the right to vote on chief executive officers’ compensation, at least every three years. The so–called say on pay vote is advisory but was designed to curb overly generous executive pay packages.

Since 2011, the financial press, consultants and academic scholars have considered how shareholders make use of this right. According to the latest results of Semler Brossy[1], 93 percent of the Russell 3000 companies received say on pay support of more than 70% in 2016, and the failure rate dropped to 1.7 percent, the lowest level since 2011. Meanwhile, academic studies suggest that American companies are not cutting back on executive pay in this say on pay era.

They are, however, paying attention to say on pay votes, typically restructuring compensation packages of executives in the years the votes occur.[2] Also, the likelihood of being dismissed as a CEO has increased since say on pay was adopted, and average CEO compensation has increased as a result.[3] In my study[4], I look at whether advisory say on pay votes can reduce generous executive pay and how the mechanism could be improved.

To date, little is known about how non-U.S. companies react to failed say on pay votes and whether they adjust their executive remuneration packages. For comparative reasons, we turned to Europe to study this feature of corporate executive compensation behavior. In an earlier post on Columbia’s Blue Sky Blog[5], Vanderbilt Law School Professor Randall Thomas and I reported that the UK and Belgium, representing a common law and a civil law country, respectively, both introduced a similar, mandatory but advisory vote for the remuneration report.[6]

As in the U.S., the average opposition rate for say on pay is higher than for other voting items and ranges every year between 5 percent and 10 percent of the total votes both in the UK and in Belgium. In both countries a handful of companies — relatively even fewer than in the US — failed the remuneration report vote. We can also confirm that lowering the absolute amounts of remuneration is not a key feature of the adjustment measures, if any, companies are considering after a failed vote. The failed vote signals discontent with the structure of the pay package, and in particular the unsatisfactory incentive mechanisms, more than it does with the amount of compensation.

However, the say on pay vote is certainly not superfluous and should be further strengthened. We found that UK boards are discussing with their major shareholders what in particular upset them about the pay package. In many cases, the chairman of the board’s remuneration committee reports the reasons the corporation identified for the dissent and the subsequent report provides details of the measures to align the remuneration practices with the interests of the shareholders. It is an important step in the improvement of shareholder communication.

Belgian companies are less transparent. Some companies do not disclose any reason why shareholders disapproved of the remuneration report, and one company even blamed its shareholders for following what it viewed as the misguided recommendations of proxy advisors. Consequently, the support for remuneration reports that follow failed say on pay votes is significantly lower in Belgium than in the UK.

We recommend several ways to improve say on pay. Shareholders are currently allowed only to approve or disapprove a remuneration report once it is complete. They could, however, disclose how they plan to cast their votes either before or during annual meetings, giving the board the chance to take their opinions into account. What’s more, after the votes have been cast, only the UK requires the corporation to identify the reasons for the dissenting votes and the actions it plans to take. The Belgian reports, by contrast, are vague and uninformative.

We also make a plea for an adjustment of the say on pay system. Boards are currently not required to do anything after a losing vote. That’s the nature of an advisory ballot, and it’s at odds with the traditional legal framework of both countries The results of the ballot of other agenda items of the general meeting of shareholders bind the board of directors. A failed vote means that the board must refrain from taking action. To the contrary, we found that one Belgian corporation’s remuneration report failed two consecutive votes, but the company did not adjust its remuneration practices, and shareholders did not express the reasons for their disapproval. According to Semler Brossy, 30 American companies failed a say on pay vote twice – and one even failed in five consecutive years.[7] Other boards merely make superficial changes to their remuneration practices.

One solution would be to make legally binding any say on pay vote that occurs after a failed vote and, in the event of yet another failed vote, to require the board to amend the remuneration practices in accordance with the views of the shareholders.

This responsibility should be shared with the shareholders. Shareholders that continue to be dissatisfied with the remuneration practices have an obligation to explain their reasons for voting down the subsequent report. This rule resembles the Australian two-strike rule. When the remuneration report of an Australian corporation receives opposition of more than 25 percent in two separate votes, a "spill" resolution will determine whether the boards of directors must stand for re-election.[8] Our proposal does not require a resolution to determine whether the board must stand for re-election. Neither does it set the threshold at 25 percent; a majority is required. However, the Australian rule offers one way to structure the process. The combination of an advisory and a binding vote might avoid repeated rejections of CEO pay.

This procedure can also discourage shareholders from voicing their discontent with remuneration practices by voting no on other agenda items. In a study with Lafarre[9], we found that when shareholders of a Dutch corporation disagreed with a proposed CEO bonus (one of the say on pay voting items in the Netherlands), they refused to discharge the supervisory board. The company received negative press. Only when the board promised not to provide this kind of bonus in the future did the shareholders approve the discharge of the board members in the next general meeting.

ENDNOTES

[1] http://www.semlerbrossy.com/wp-content/uploads/SBCG-2016-SOP-Report-07-27-2016.pdf

[2] Kronlund, M. and Sandy, S., Does Shareholder Scrutiny Affect Executive Compensation?, November 20, 2015. Available at SSRN: http://ssrn.com/abstract=2358696.

[3] Iliev, P. and Vitanovy, S., The Effect of the Say-on-Pay in the U.S., February 1, 2015, Available at SSRN: http://ssrn.com/abstract=2235064.

[4] Van der Elst, C., Anwering the Say for No Pay, August 1, 2016, Available at SSRN: http://ssrn.com/abstract=2818502

[5] http://clsbluesky.law.columbia.edu/2013/08/26/the-scope-of-international-say-on-pay/

[6] In the meantime the UK also introduced a mandatory, binding vote of the remuneration policy.

[7] http://www.semlerbrossy.com/wp-content/uploads/SBCG-2015-Year-End-Say-on-Pay-Report.pdf

[8] See R. Thomas and C. Van der Elst, "Say on Pay around the World", Washington University Law Review 2015, vol. 92, nr. 3, 670-673.

[9] Van der Elst, C. and Lafarre, A., "Shareholder Voice on Executive Pay: A Decade of Dutch Say on Pay", European Business Organization Law Review, 2016/17, to be published.

This post comes to us from Professor Christoph Van der Elst at Tilburg Law School in the Netherlands. It is based on his article, "Answering the Say for No Pay," which is available here.


August 26, 2016
Capitalizing on Capitol Hill: Informed Trading by Hedge Fund Managers
by Jiekun Huang, Meng Gao
Editor's Note:

Jiekun Huang is an Assistant Professor of Finance at the College of Business at the University of Illinois Urbana-Champaign. This post is based on a forthcoming article by Professor Huang and Meng Gao, doctoral candidate in finance at the College of Business at the University of Illinois Urbana-Champaign.

Governments play an increasingly prominent role in influencing firms and stock prices. According to a Duke University/CFO Magazine Business Outlook Survey in 2013, federal government policies rank second only to consumer demand among the top three external concerns corporations face. The profound effects of political decisions on corporate performance and stock prices are evidenced by recent government policies and actions such as the bailouts of AIG and Bear Stearns, the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the Affordable Care Act. As a result, information regarding political decisions is of considerable interest to financial market participants. Yet, little is known about the dissemination and incorporation of political information or its value to financial market participants. In our paper, Capitalizing on Capitol Hill: Informed Trading by Hedge Fund Managers, we test the hypothesis that hedge fund managers obtain and trade on political information through their connections with lobbyists.

Lobbyists have access to political information because they routinely exchange information with legislators and many are themselves former legislators. A Wall Street Journal (2006) article reports that hedge funds find Washington to be a “gold mine of market-moving information.”[1] By hiring lobbyists, hedge fund managers can gain access to information about ongoing or impending government actions. As an example, consider the case of USG Corp., a building-material company facing an estimated $5.5 billion in asbestos-related lawsuits. On November 15, 2005, the company’s stock was traded at 200% of its normal trading volume and delivered an abnormal return of almost 5%, yet no company-specific news was released on that day. On the following day, the Senate Majority Leader announced a plan to create a $140 billion bailout fund to relieve companies such as USG Corp. of their asbestos liabilities. It appears that the market reacted before the public announcement, which led the financial press to speculate that some investors traded ahead of the news, guided by consultants on “political intelligence” (Business Week, 2005).[2]

The practice of lobbyists passing on material nonpublic political information obtained from within Congress to hedge funds has raised concerns among regulators, because it can compromise the integrity of the political process. The fact that members and employees of Congress were able to use confidential information acquired as a result of holding public office for personal gain could undermine the public trust placed in them; more disturbing is the possibility that it may lead to legislative decisions that would maximize private gain to lawmakers rather than serve the public interest. Before 2012, trading by hedge funds on private political information obtained from within Congress did not violate insider trading laws because, first, neither the tippers (members of Congress and their staffers) nor the tippees (hedge funds) owed fiduciary duties to the issuers of the securities in which the hedge funds trade, and second, it was commonly believed that the tippers did not owe a duty of trust and confidence to the source of information. The Stop Trading on Congressional Knowledge (STOCK) Act, signed into law in April 2012, imposes a duty of trust and confidence on government officials, thus exposing hedge funds that trade on private political information to potential insider trading liability. Nevertheless, the opaque nature of the political intelligence industry and enforcement challenges associated with the law have sparked an ongoing debate about whether it is necessary to institute a new law to specifically govern the transfer of political information in financial markets.

Our research provides evidence on how hedge funds benefit from access to political information. We make use of a large data set on long-equity holdings of hedge funds from 1999 through 2012 as well as a database of federal lobbying expenditures in the U.S. to identify potential information transfers from lobbyists to hedge funds. If hedge funds gain an informational advantage through their connections with lobbyists, connected hedge funds should trade more actively in stocks that are sensitive to political decisions than non-connected funds. Connected hedge funds should also outperform non-connected hedge funds on their politically sensitive holdings. We refer to this as the information transfer hypothesis.

We find evidence that connected funds trade more actively in politically sensitive stocks. On average, connected funds’ trading volume (inferred from quarterly holdings) in political stocks accounts for 24.44% of their total trading volume, compared with 18.67% for non-connected funds; the difference remains after controlling for various fund characteristics. Moreover, connected funds tilt their portfolio holdings more heavily towards political stocks than non-connected funds. These findings are consistent with our information transfer hypothesis.

We then examine whether the political holdings of connected funds outperform passive benchmarks. We construct calendar-time portfolios that mimic the aggregated portfolio allocations of connected and non-connected hedge funds by assigning stocks in each hedge fund portfolio to one of the two-by-two matrix of portfolios based on whether the hedge fund is connected and whether the stock is politically sensitive. We find that connected hedge funds earn higher returns on their political holdings. A strategy of buying a mimicking portfolio of political holdings by connected funds delivers an abnormal return of 56 to 93 basis points per month, suggesting that connected funds possess an informational advantage in trading politically sensitive stocks. Furthermore, we construct a spread portfolio in the spirit of a difference-in-differences analysis. The tests show that connected funds, compared with non-connected ones, yield a monthly abnormal return of 69 to 89 basis points higher on their political positions than on non-political ones. This evidence suggests that the outperformance of connected funds on political holdings is not driven by the generally superior stock-picking abilities of connected fund managers or by political stocks in general delivering superior returns.

Understanding the flow of political information and the extent to which political information has value to certain financial market participants like hedge funds carries important implications. From a policy perspective, understanding the channels through which political information gets incorporated into stock prices is important for the design of the legal arrangements governing the flow of political information. Also, from a political science perspective, the flow of political information can engender rent seeking by politicians. Since political information is of significant value to stock market participants, elected officials may use such information to derive personal benefits (e.g., in the form of campaign funds and revolving doors). Also, since elected officials possess valuable information about their own actions, there is a possibility that they may have an incentive to intervene excessively in economic activities or to institute temporary policy measures that have to be revisited time and again (e.g., federal tax code provisions set to expire in a few years) in order to create a demand for the information. Our findings indicate that the flow of political information, if left unregulated, may contribute to the problem of political corruption.

The full article is available for download here.

Endnotes:

[1] Wall Street Journal, 2006. Hedge funds hire lobbyists to gather tips in Washington, December 8.
(go back)

[2] Business Week, 2005. Washington whispers to Wall Street. December 26.
(go back)

August 26, 2016
This Week In Securities Litigation (Week ending August 26, 2016)
by Tom Gorman

Numbers were the focus this week as the Commission filed 81 administrative proceedings (must be near fiscal year end) and two civil injunctive actions. Seventy-one of the actions involved municipal issuers who self-reported under the Municipalities disclosure initiative. Another ten focused on investment advisers who negligently relied on certain information furnished by another adviser regarding the performance of an index recommended to clients. And, two other proceedings were brought against immigration attorneys involved in EB-5 programs for acting as unregistered brokers, an increasing trend in this area.

Jacob Alexander, at one time the CEO of Converse Technology, pleaded guilty to securities fraud based on option backdating. Mr. Alexander has been on the run for 10 years. He was remanded to jail pending sentencing. Finally, the PCAOB entered into a cooperation agreement with a German regulator.

SEC

Disclosure: The Commission announced that it is seeking comment on Disclosure Requirements Relating to Management, Security Holders and Corporate Governance Matters. Currently the requirements are in Subpart 400 of Regulation S-K (here).

Investment advisers: The Commission announced the adoption of Rules to Enhance Information Reported by Investment Advisers. The Rules focus on disclosures relating to separately managed accounts. They also require additional record keeping (here).

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 2 civil injunctive action and 85 administrative proceeding, excluding 12j and tag-along proceedings.

Misstatements: In the Matter of Schneider Downs Wealth Management Advisers, Adm. Proc. File No. 3-17493 (August 25, 2016) is a proceeding which names as a Respondent the registered investment adviser. The Order alleges that the adviser made misstatements to certain advisory clients, including those with separately managed accounts, invested in F-Squared Investments, Inc. index. The adviser was negligent in relying on F-Squared’s materially inflated, hypothetical and back-tested performance track record that F-Squared had misrepresented. This resulted in violations of Advisers Act Sections 204(a) and 206(4). The proceeding was resolved with the entry by consent to a cease and desist order based on the Sections cited in the Order, and the payment of a penalty of $100,000. See also In the Matter of Banyan Partners, LLC, Adm. Proc. File No. 3-17495 (August 25, 2016)(same); In the Matter of Shamrock Asset Management, LLC, Adm. Proc. File No. 3-17492 (August 25, 2016)(same); In the Matter of J.J.B. Hilliard, W.L. Lyons, LLC, Adm. Proc. File No. 3-17498 (August 25, 2016)(same); In the Matter of AssetMark, Inc., Adm. Proc. File No. 3-17504 (August 25 2016)(same); In the Matter of Congress Wealth Management LLC, Adm. Proc. File No. 3-17503 (August 25, 2016); In the Matter of BB&T Securities, LLC, Adm. Proc. File No. 3-17502 (August 25, 2016); In the Matter of Constellation Wealth Advisors LLC, Adm. Proc. File No. 3-17501 (August 25, 2016); In the Matter of Executive Monetary Management, LLC, Adm. Proc. File No. 3-17499 (August 25, 2016); In the Matter of Ladenburg Thalmann Asset Management Inc., Adm. Proc. File No 3-17497 (August 25, 2016).

Order: In the Matter of Orinda Asset Management, LLC, Adm. Proc. File No. 3-17506 (August 25 2016) is a proceeding which names the registered investment adviser as a Respondent. The firm applied in 2011 for an exemptive order which would have provided relief from the requirement to obtain shareholder approval to enter or materially amend sub-advisory agreements and certain disclosures. Investment Management told the firm it would not approve a provision providing for termination payments should the firm recommend the sub-adviser’s termination for something other than cause. The adviser and Advisors Series Trust agreed to remove the provisions and filed an amended application. In the interim, the adviser and AST agreed to waive the ability to terminate the sub-adviser. Neither Orinda nor ATS told IM of the revised side agreement. IM then granted the exemptive order. The advisory agreements with each AST fund advised by Orinda incorrectly stated that the sub-advisory agreements could be terminated at any time and did not disclose the side agreement. The Order alleges violations of Investment Company Act Section 34(b). To resolve the case Orinda consented to the entry of a cease and desist order based on the Section cited in the Order, to a censure and agreed to pay a penalty of $75,000.

Unregistered broker: In the Matter of Martin J. Lawler, Adm. Proc. File No. 3-17420 (August 24, 2016) is a proceeding against attorney Lawler who specializes in immigration matters. This action arises out of EB-5 transactions – an immigration program in which a foreign national invests a specified sum – here $500,000 – creating jobs in the U.S in return for a permanent green card. The funds are typically invested in limited partnership shares which are securities. Mr. Lawler is alleged to have effectuated transactions in EB-5 securities, including recommending one or more EB-5 investment officers to his clients and serving as a liaison. He also assisted with documenting the investment funds and was paid transaction based compensation. The Order alleges violations of Exchange Act Section 15(a). To resolve the action Respondent consented to the entry of a cease and desist order based on the Section cited in the Order and agreed to pay disgorgement of $115,000 and prejudgment interest. See also In the Matter of Thomas T. M. Ho, Adm. Proc. File No. 3-17418 (August 24, 2016)(settled proceeding against immigration attorney arising out of EB-5 program as above but where at least part of the fees were paid to an offshore bank although Respondent is based in the U.S.; resolved with a consent to a cease and desist order based on Exchange Act Section 15(a) and the payment of disgorgement of $37,500 and prejudgment interest and a penalty of $30,000).

Municipal bonds: In the Matter of the City of Alameda, Ad. Proc. File No. 3-17421 (August 24, 2016) is one of 71 settled proceedings filed by the Commission under its Municipalities Continuing Disclose Cooperation Initiative. In each instance the Respondents self-reported in return for reduced sanctions. Each action centers on the continuing disclosure obligations of issuers. City of Alameda is typical There the Order alleged that in certain official statements for municipal securities the Respondent affirmatively stated that it had materially complied with prior agreements to provide continuing disclosure when in fact it had not. The Order alleged violations of Securities Act Section 17(a)(2). To resolve the proceeding the City consented to the entry of a cease and desist order based on the Section cited in the Order. It also agreed to comply with certain undertakings which require the City to establish appropriate written policies and procedures, have periodic training regarding its continuing disclosure obligations, update past delinquent filings and certify compliance with the undertakings. Under the Initiative the SEC has now filed 143 settled actions against 144 Respondents.

Offering fraud: SEC v. Secured Income Reserve, Inc., Civil Action No. 9:16-cv-8190 (S.D. Fla. Filed August 24, 2016) is an action which names as defendants the firm, Ilona Mandalbaum, David Zimmerman, Tamda Marketing, Inc. and Mathew Sage. The firm was supposed to extend loans to senior citizens collateralized by their life insurance proceeds. Its majority shareholder is Mr. Mandelbaum who was previously enjoined in a Commission enforcement action. Mr. Zimmerman is the firm’s vice president for investor relations and president of Tamda. He was also enjoined in a prior Commission enforcement action. Defendant Sage is a director, Secretary, Treasurer and COO of Secured. He was also enjoined in a prior Commission enforcement action. The complaint alleges a fraudulent offering of Secured’s shares which continued over five months beginning in February 2013. Investors were defrauded out of about $5 million. The PPM used for the offering failed to disclose the background of the individuals involved or the use of the proceeds, portions of which were taken by Mr. Mandelbaum for other business interests and to partially fund the purchase of a home for his daughter. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). To resolve the actions, Secured, Tamda and Messrs. Mandelbaum, Zimmerman and Sage agreed to the entry of permanent injunctions. The three individual defendants also agreed to the entry of officer/director bars. In addition, Secured will pay disgorgement of $588,242, prejudgment interest and a $775,000 penalty; Mr. Mandelbaum will pay disgorgement of $392,752, prejudgment interest and a penalty of $320,000; Mr. Sage will pay a penalty of $240,000; and Tamda will pay $148,350 in disgorgement, prejudgment interest and a penalty of $148,350. See Lit. Rel. No. 23626 (August 24, 2016).

Disclosure: In the Matter of Apollo Management V, L.P., Adm. Proc. File No. 3-17409 (August 23, 2016). The proceeding centers on inadequately disclosed fees, a failure to fully disclose the terms of a loan agreement and inadequate supervision. Respondents are Apollo Management V, L.P., Apollo Management VI, L.P., Apollo Management VII, L.P. and Apollo Commodities Management, L.P. Each is a private equity fund adviser registered with the Commission as an investment adviser. The parent of each is Apollo Management V. First, Respondents failed to properly disclose how they terminated monitoring fee agreements until after investors had put in their capital and the fees were paid. Second, in June 2008 the general partner to Fund VI, Advisors VI, entered into a loan agreement with Fund VI and four parallel funds and failed to adequately disclose that the accrued interest would be allocated to the capital account of Advisers VI. Finally, from January 2010 through June 2013 a former senior partner of Respondents improperly charged personal items and services to advised funds. After repeated instances and an internal investigation Respondents reported the conduct to the Commission. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). To resolve the proceeding Respondents consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Respondents will pay disgorgement of $37,527,000 and prejudgment interest which will be paid to a disgorgement fund. They will also pay a penalty of $12,500,000 and acknowledge that the amount was limited to that sum based on their cooperation.

Offering fraud: SEC v. Jones, Civil Action No. 1:16-cv-01695 (D.D.C. Filed August 19, 2016). Defendant Michael Jones is currently a uniform salesman. Previously, he was a registered representative at a number of broker-dealers. In 2007 he was barred from association with any FINRA member by the regulator. From April 2010 through July 2013 he was the sole shareholder and director of Green Bash, LLC. During that period he sold convertible promissory notes of the firm to 20 investors in 12 states, raising $706,145. The sales were made on the telephone and using a PPM that contained a series of misrepresentations about the financial prospects of the firm and the size of the offering. Portions of the funds raised were used to pay interest on the notes to some investors. Other portions of the offering proceeds were used by Mr. Jones for his personal expenses. The complaint alleges violations of Securities Act Sections 5 and each subsection of 17(a) and Exchange Act Sections 10(b) and 15(a). Defendant Jones settled with the Commission, consenting to the entry of a permanent injunction based on the Sections cited in the complaint, including an order prohibiting him from participating in the issuance, offer or sale of any security (except for those acquired on a national securities exchange for his own account). In addition, he will pay disgorgement of $709,654, prejudgment interest and a penalty equal to the amount of the disgorgement. He agreed to settle a to be filed administrative proceeding that will bar him from the securities business. See Lit. Rel. No. 23622 (August 22, 2016).

PCAOB

Cooperation agreement: The Board announced an agreement with the German Auditor Oversight Body effective immediately. The Agreement calls for cooperation with respect to joint inspections and the exchange of confidential information. The Board had a similar agreement with the AOB’s predecessor.

Criminal cases

Option backdating: U.S. v. Alexander (E.D.N.Y.) Jacob Alexander, formerly the CEO of Converse Technologies, Inc. pleaded guilty to securities fraud, stemming from his role in backdating stock options at the firm over ten years ago. Mr. Alexander previously fled but was extradited from Namibia earlier this month. He was remanded to jail pending sentencing.

Hong Kong

Manipulation: The Securities and Futures Commission suspended the license of associated person Ku Yuen Leung for eighteen months for engaging in manipulative activities. Specifically, Ku created the false or misleading appearance over a 21 day period in November 2010 with respect to the shares of Agricultural Bank of China by placing large sized bid orders for ABC shares to drive up the prices of related warrants. The orders were cancelled immediately after he sold the warrants at inflated pries, reaping profits of $15,500.

August 26, 2016
Disclosure Effectiveness: Item 400 Series "Proposal"
by John Jenkins

Yesterday, as the latest in Corp Fin’s disclosure effectiveness project, the SEC posted an 8-page "request for comment" on the disclosure requirements in Subpart 400 of Regulation S-K. The scant press release named three topics in particular – management, certain security holders & corporate governance – but it ignored the "biggie": Item 402’s executive pay & related-party transactions.

Some from the SEC have been saying that Item 402 is a lower priority for the disclosure effectiveness project – yet the "request for comment" covers the Item 400 series waterfront. But Item 402 is addressed in just a cursory way – page 6 mentions Item 402 as a bullet, just like all the other 400 Items. Maybe if enough folks request changes in the 402 area, the SEC will propose something there – but I doubt it given the magnitude of that undertaking & the fact that Item 402 got its last overhaul a mere decade ago (which is why Item 402 is a lower priority for this project)...

As Broc has blogged before, we have no idea why this is a "request for comment" – and not a "concept release" – but given the short length of the "request for comment," the difference must allow the SEC to avoid the regulatory trappings of a full-blown concept release.

The "request for comment" notes that the comments received will assist the SEC in "carrying out the study of Regulation S-K required by Section 72003(a) of the FAST Act."

By the way, the SEC also extended the comment period for the resource extraction/mining disclosures rulemaking a few days ago – the extended comment period ends on September 26th...

Using "Behavioral Ethics" in Compliance Programs

The "Conflict of Interest Blog" provides this roundup of recent articles addressing the use of the emerging field of "behavioral ethics" in corporate compliance programs. Behavioral ethics focuses on how people actually behave when confronted with an ethical dilemma, in order to understand why they so often act in a manner contrary to their best intentions. (Take a look at this Harvard Magazine article for a more in-depth discussion of what behavioral ethics is all about).

According to this blog– from Philip Morris’s Chief Compliance Officer – incorporating insights from behavioral ethics into compliance programs makes them more effective:

Leading behavioral ethics researchers, including Ann Tenbrunsel of Notre Dame and Linda Trevino of Penn State, have shown that concepts such as leader and peer influence, ethical fading, and blind spots have practical implications for compliance programs. This research has firmly established that compliance programs with communications, training and controls informed by behavioral ethics learnings are more successful in reducing the likelihood of misconduct and increasing the likelihood of whistle-blowing behaviors.

Transcript: "How to Apply Legal Project Management to Deals"

We have posted the transcript for our recent DealLawyers.com webcast: "How to Apply Legal Project Management to Deals."

John Jenkins

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8/26/2016 posts

The Harvard Law School Forum on Corporate Governance and Financial Regulation: The 2016 Proxy Season: Proxy Access Proposals
CLS Blue Sky Blog: A Plea for a Better Response to a Failed Say on Pay Vote
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Capitalizing on Capitol Hill: Informed Trading by Hedge Fund Managers
SEC Actions Blog: This Week In Securities Litigation (Week ending August 26, 2016)
CorporateCounsel.net Blog: Disclosure Effectiveness: Item 400 Series "Proposal"

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