Preparation For 2016 Fiscal Year-End SEC Filings And 2017 Annual Shareholder Meetings

Author:Ms Megan Gates and Pamela B. Greene
Profession:Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.

As our clients and friends know, each year Mintz Levin provides an analysis of the regulatory developments that impact public companies as they prepare for their fiscal year-end filings with the Securities and Exchange Commission (the "SEC") and their annual shareholder meetings. This memorandum discusses key considerations to keep in mind as you embark upon the year-end reporting process in 2017.1

As was the case last year, there are no SEC rule changes that will take effect for the 2017 year-end reporting process. There are, however, a few key issues that companies should focus on this year.

Say-on-Frequency: Time for another shareholder vote. For companies that held their first say-on-pay vote six years ago, it is now time to revisit the say-on-frequency vote. Companies that held a say-on-frequency vote at their 2011 annual meeting are required to again include a non-binding resolution in their proxy statements to ask shareholders how often they want to conduct say-on-pay votes for the next six years: once a year, once every two years, or once every three years. Institutional Shareholder Services (ISS) has stated that based on its 2016 ISS Policy Survey, two-thirds of investor respondents indicated they preferred annual say-on-pay frequency. ISS believes that holding a say-on-pay vote every year enables the vote to correspond to the majority of the information presented in the accompanying proxy statement, and allows investors to comment upon issues in annual incentive programs in a more timely fashion. Companies that have not yet reached the six-year anniversary of their first say-on-pay vote, and thus are not required to present a say-on-frequency proposal this year, should consider adding a statement to their proxy statement to the effect that a say-on-frequency vote is not required this year (and state the year that such vote will be required) in order to inform shareholders that this vote was not simply overlooked. Form 8-K for Say-on-Frequency. Companies that are required to conduct their say-on-frequency vote this year must remember to report, under Item 5.07 of Form 8-K, the company's determination as to how frequently it will hold the say-on-pay vote in the Form 8-K required to be filed within four business days of the shareholder meeting (or by amendment to that Form 8-K filed no later than 150 calendar days after the date of the shareholder meeting at which the say-on-frequency vote was taken), but in no event later than 60 days prior to the deadline for the submission of shareholder proposals under Rule 14a-8 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), for the subsequent annual meeting. Say-on-Pay: Considerations for 2017. As in past years, shareholder support on say-on-pay resolutions in the 2016 proxy season continued to average above 90% across all companies. Say-on-pay continues to be perceived as a year-to-year item, in which success in past years is no guarantee of success in the current or future years, and companies should not become complacent about achieving the necessary support, even if they have enjoyed strong support in prior years. The advent of say-on-pay continues to cause companies to reevaluate their compensation-related disclosures in their proxy statements, in particular the Compensation Discussion &Analysis (CD&A) section, with both advocacy and disclosure in mind. In addition, issuer engagement with institutional shareholders has become an integral part of the say-on-pay process, with many companies reaching out to their largest shareholders in the months following the annual meeting to discuss pay practices. Director Compensation in the Spotlight. As discussed in more detail below, the Delaware courts have shifted direction towards more shareholder protection by applying an entire fairness standard of review instead of the business judgment rule with respect to claims of excessive director compensation. In order to avoid a lawsuit (or win on a motion to dismiss) companies should consider setting forth in their equity compensation plan a shareholder-approved cap (based either on a number of shares or cash value) representing the maximum amount that the company may compensate its non-employee directors in equity, which cap should be set at a meaningful limit. This cap should be included in the equity plan when the plan is next brought to shareholders for approval. In the meantime, companies should evaluate director pay each year and make adjustments accordingly and confirm that director compensation is in line with the company's peer group. Unless the courts provide clearer guidance on this topic, we expect that plaintiffs will continue to file shareholder derivative claims with regard to perceived excesses in director pay. Caution When Using Non-GAAP Financial Measures. Increasingly the SEC has been providing comments regarding compliance with the rules on the use of non-GAAP financial measures. As a result of its review of these disclosures, in May 2016 the SEC issued Compliance & Disclosure Interpretations (C&DIs) reflecting its concern that companies are not complying with Regulation G and are supplanting and not supplementing their press releases and SEC reports with non-GAAP financial measures and as a result, disclosure of a company's financial results is becoming distorted. Under Regulation G, companies must include a reconciliation of the differences between each non-GAAP financial measure used with the most directly comparable financial measurement from GAAP. Management also must disclose why it believes the non-GAAP measures provide useful information to investors about the company's financial condition and results of operations. In addition, many proxy statements now include non-GAAP financial measures. If non-GAAP financial measures are presented in the proxy statement for any purpose other than disclosure of target levels relating to compensation, such as to explain the relationship between pay and performance or to justify certain levels or amounts of pay, then those non-GAAP financial measures are subject to the requirements of Regulation G and Item 10(e) of Regulation S-K. However, in these pay-related circumstances only, the SEC allows a company to include the required GAAP reconciliation and other information in an annex to the proxy statement, provided the proxy statement includes a prominent cross-reference to such annex or, if the non-GAAP financial measures are the same as those included in the Form 10-K that is incorporating by reference the proxy statement's Item 402 disclosure as part of its Part III information, by providing a prominent cross-reference to the pages in the Form 10-K containing the required GAAP reconciliation and other information. NASDAQ Companies Must Update Director and Officer Questionnaires for Golden Leash Disclosure. Effective for proxy statements filed on or after August 1, 2016, NASDAQ Rule 5250(b)(3) requires its listed companies to disclose, either on the company website (no later than the day the proxy statement is filed) or in the proxy statement itself, the material terms of all agreements and arrangements between any director or nominee for director, and any person or entity other than the company, relating to compensation or other payment in connection with such person's candidacy or service as a director. Payments that are exempt include those that (a) relate only to reimbursement of expenses in connection with candidacy as a director; (b) existed prior to the nominee's candidacy (including as an employee of the other person or entity) and the nominee's relationship with the third party has been publicly disclosed in a proxy statement or annual report; or (c) have already been disclosed in a proxy statement or Form 8-K. After the initial disclosure, companies must continue to provide the disclosure on an annual basis only if new arrangements are entered into until the earlier of the resignation of the director or one year following the termination of the agreement or arrangement. We have updated our form of Director and Officer Questionnaire in order for companies to solicit this information from their directors. Section 16 in the News: Potential Section 16(b) Liability Relating to Tax Withholding and Net Exercise Transactions. We are aware of a shareholder who has submitted letters to a number of public companies seeking disgorgement of short-swing profits under Section 16(b) of the Exchange Act from Section 16 officers when the company has withheld shares to cover an officer's tax obligation or the officer has net exercised a stock option and that transaction (which is deemed to be a sale to the company) occurs within six months of the officer's open market purchase of securities of the company. The shareholder contends that the approval of a plan or agreement by the board (or an appropriate committee) that provides discretion for the insider to determine how a tax obligation may be paid, or allows for net withholding of shares to satisfy the exercise price of a stock option, creates a non-exempt disposition of securities under Section 16(b). Although we believe that these transactions should be considered exempt under Rule 16b-3(e) (which rule exempts officer and director transactions that are approved in advance by the board or an appropriate committee thereof), if the agreement that sets forth these provisions was previously approved by the board or an appropriate committee, we recommend that prior to any withholding to cover taxes with respect to equity awards, or any withholding of shares to net exercise a stock option, the board of directors or a properly constituted committee should specifically approve the transaction, including referencing the individual, agreement and exact date of the netting out of the shares to cover the tax or exercise price and the formula to be applied in such transactions, in order to provide written proof that the...

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