Entering 2013, companies find themselves in a climate of uncertainty, highlighted by precarious debt crises (both at home and abroad), sociopolitical unrest in various regions around the globe, and unpredictable economic growth. While difficult to predict the full impact of these and other external pressures, highlighted below are certain key issues trending in corporate governance that private investment funds and the boards of directors of their portfolio companies should be aware of in planning for 2013 and beyond.
The election of director candidates will become increasingly scrutinized in 2013. Not only will directors be expected to have industry and financial expertise, the evolving marketplace requires that directors be well-equipped to oversee IT and international risks. In addition, highly publicized demand for diversity in the boardroom is increasing, especially in the area of gender imbalance. Companies are faced with the very difficult challenge of shifting board composition in favor of these new highly sought characteristics while weighing the importance of continuity. Discussions altering the makeup of the board should be candid and collegial; it may be helpful to focus discussion on a list of actual director candidates emphasizing, the board's aspirational characteristics.
Recent developments reinforce the importance of the board's role in developing a detailed CEO succession plan. In 2010, the SEC restricted the ability of companies to exclude from proxies shareholder proposals seeking information relating to CEO succession plans as well as the board's role in doing so. Compounding the issue are higher CEO turnover rates and increasing incidents of CEO incapacity, as well as the top- heaviness of 43% of S&P 500 CEOs serving as board chairs. Even more than in 2012, boards should seek to develop transparent and fulsome succession plans with the active participation of current CEOs.
Say-on-Pay. As say-on-pay enters its third proxy season allowing shareholders to vote on executive compensation policies, the two-year exemption from reporting for smaller reporting companies (public float of less than $75 million) will no longer be available as of January 21, 2013. In addition, proxy advisor Institutional Shareholder Services ("ISS") in its 2013 U.S. voting guidelines (i) refined its say-on-pay analysis on peer group selection methodology; (ii) extended the say-on-golden-parachute analysis to new, existing, renewed or legacy arrangements; and (iii) assessed shareholder proposals to link executive compensation to external metrics (e.g., environmental and social). Boards of smaller reporting companies who previously relied on the two-year exemption should be informed as to ISS guidelines and other guidance on say-on-pay.
Pending Dodd-Frank Regulations. Although the SEC is behind in rule making since the Dodd-Frank Act went into effect three years ago, there is speculation that it may finalize new rules for executive compensation clawback policies and executive/worker pay ratio.
Directors should consider a company's compensation policies (including both director and officer's compensation) in anticipation of the aforementioned regulatory and shareholder risks. Companies should consider developing policies to communicate potentially controversial compensation issues both internally and externally.
Directors should continue to monitor material relationships and activities of advisors to boards of directors very closely. Recent opinions by Delaware courts have criticized directors for failing, early in the engagement of an advisor, to become aware of conflicts of interests and to analyze the impact of such conflicts and protective measures in the best interests of the company. Conflicts should be treated on a case-by-case basis with due regard for each situation's nature, business context and relevant legal case law; in failing to do so, a board potentially could overlook interested transactions or invalidate a transaction that otherwise might have been approved by the courts.
Health Care Reform
On January 1, 2014, the play-or-pay provisions of the Patient Protection and Affordable Care Act of 2010 (health care reform) will go into effect. Generally, employers of 50 or more full-time employees will have to pay a penalty if (i) they do not offer health coverage to their full-time employees or (ii) they offer health coverage but the coverage does not meet affordability or minimum value requirements. The penalty varies depending on which failure happens. If no coverage is offered to at least 95% of an employer's full-time employees, and one or more of the employees enrolls in a state insurance exchange and receives a federal government subsidy, the employer will be required to pay $2,000 a year for each full-time employee (minus 30 full-time employees). If the coverage offered is not affordable or does not provide minimum value, the penalty is $3,000 a year for each full-time employee who receives the federal subsidy (but not more than the "no coverage" penalty). This year boards will need to weigh whether to play-or-pay, and in that analysis consider the costs of offering health coverage, paying the applicable (non-deductible) penalties, and the actions of the company's competitors. If an employer decides to pay, the board will need to understand the company's obligations under the Act as well as the impact the elimination (or reduction) of employer-provided health benefits will have on employee morale.
On November 14, 2012, the SEC and Department of Justice released a 120-page guide providing a detailed analysis of the Foreign Corrupt Practices Act, including guidance on definitions of foreign officials, improper gifts, travel and entertainment expenses, and how successor liability applies in the M&A context. Directors should be keenly aware of the restrictions and related laws that prohibit U.S. companies and citizens from making improper payments to foreign government officials. Companies should consider developing or enhancing protocols, compliance and deterrence programs or other processes to monitor such activity.
Several high-profile data breaches cost companies millions in 2012. It is reported that President Obama may issue an executive order to combat the rise in breaches in the private sector with hopes of securing the nation's digital infrastructure. More than in years past, board discussions have focused on data security in the context of overall company risk assessment. The rapid development of cloud computing and mobile technology would only seem to support that trend.