While the 2013 proxy season requires a few immediate updates to the policies and procedures of public companies, many of the most significant changes for the new year will be on-going projects that must be started today in order to be prepared for new rules and additional disclosures that will become effective later in the new year. At the same time, the continued engagement of companies with their shareholders and proxy advisory firms provides a host of reasons for companies to revisit, revise and refine their internal corporate governance policies and the discussion of these policies in their proxy statements.

Compensation Committees and Compensation Advisors

In 2012, the SEC adopted final rules as required by the Dodd-Frank Act, directing the stock exchanges to establish listing standards for independent compensation committees and the selection and use of compensation advisors. While these listing standards will not be effective until mid-2013 or later, new disclosures required by the final rules are effective for proxy statements for annual or special meetings of shareholders at which directors will be elected occurring on or after January 1, 2013. Under amendments to Item 407 of Regulation S-K, companies must disclose in the proxy statement whether the work of any compensation consultants “raised any conflicts of interest,” and if so, how the conflict is being addressed.

The new consultant conflict disclosure is only required for companies that already disclose the role of compensation consultants in determining or recommending executive and director compensation under Item 407(e)(3)(iii). Companies that fall in this category now have the further obligation to determine whether the work of these compensation consultants raises a conflict of interest and if a conflict exists, to disclose the nature of the conflict and how the conflict is being addressed. To determine whether a compensation consultant has a conflict of interest, companies must consider the following six factors regarding the independence of compensation consultants listed in Rule 10C-1(b)(4):

  • The provision of other services to the company by the person that employs the compensation consultant; 
  • The amount of fees received from the company by the person that employs the compensation consultant, as a percentage of the total revenue of the person that employs the compensation consultant; 
  • The policies and procedures of the person that employs the compensation consultant that are designed to prevent conflicts of interest; 
  • Any business or personal relationship of the compensation consultant with a member of the compensation committee; 
  • Any stock of the company owned by the compensation consultant; and 
  • Any business or personal relationship of the compensation consultant or the person employing the adviser with an executive officer of the issuer.

Companies need to take several steps to assess potential compensation consultant conflicts. Companies should update their D&O questionnaires to cover business and personal relationships with compensation consultants. In addition, companies must gather information from their compensation consultants by questionnaire or otherwise with respect to services, fees, conflict policies and business or personal relationships between individual consultants engaged by the companies and their directors and executive officers. This information must be gathered for all compensation consultants covered by Item 407(e)(3)(iii). Once the appropriate information has been obtained, companies will need to determine whether a conflict exists. If a company determines that no conflict exists, then no disclosure is required, although a company has the option of disclosing that it evaluated its compensation consultants for potential conflicts and did not identify any.

During 2013, companies will need to prepare for new exchange listing standards that (i) adopt new requirements for listing companies to maintain independent compensation committees as defined by the standards, and (ii) impose new consultant independence considerations and committee responsibilities that will govern how compensation committees select and work with compensation advisors, including consultants, legal counsel and other advisors. The NYSE and NASDAQ stock exchanges have proposed new listing standards and submitted them to the SEC for approval. Under the proposals by both stock exchanges, new considerations and responsibilities for compensation committees to select and work with compensation advisors will be effective July 1, 2013. In order to implement these new listing standards, companies will need to review and update the charters for their compensation committees to ensure that the committees have the authority and responsibilities with respect to compensation advisors as required by the new standards. Both the NYSE and NASDAQ listing standards would require independent compensation committees meeting the new requirements to be in place upon the earlier of the first annual meeting after January 15, 2014, or October 31, 2014.

Companies will need to begin planning in 2013 in order to be prepared for the independence standards for 2014. The compensation committee independence standards proposed by both the NYSE and NASDAQ are primarily based on the existing director independence standards already in place for each exchange with an overlay of the specific requirements of Rule 10C-1. In particular, NASDAQ listed companies may have the greater adjustment in two cases: (i) companies that have not previously established separate compensation committees in reliance on the independent board member exception will be required to establish such committees by 2014, and (ii) NASDAQ has imposed a bright-line disqualification for any directors that receive consulting or other non-directors fees from their companies.

Conflict Minerals Rules

In response to the extreme levels of violence in the Democratic Republic of the Congo (DRC), which Congress felt was financed in part by the trade of “conflict minerals,” Congress required the SEC to adopt regulations requiring additional disclosure by SEC reporting companies that use conflict minerals in product manufacturing. The rules require public companies to complete a three-step analytical process to determine if conflict minerals are used in the manufacturing of their products, and if so, to determine the country of origin of the conflict minerals. Conflict minerals include tantalum, tin, tungsten and gold. Compliance with these new requirements is likely to require a large undertaking for certain companies in 2013. All categories of SEC reporting companies are covered by the new rules, including foreign private issuers and smaller reporting companies. Disclosures regarding the use conflict minerals, if required, will be reported for each calendar-year, beginning 2013, on a new Form SD that must be filed by May 31 of the following year.

The first step of the analysis is for a company to determine if conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the company. If not, no further inquiry or disclosure is required. Assuming a company is not entitled to stop at step one, the second step in the process is for the company to conduct a reasonable country of origin inquiry in good faith to determine if the minerals originated from the DRC or adjoining countries. If, after conducting an inquiry, the company (i) knows that the minerals did not originate in the DRC or adjoining countries, or (ii) has no reason to believe that the minerals may have originated in the DRC or adjoining countries, then the company must disclose on Form SD that it conducted a country of origin inquiry, the results of the inquiry as well as its determination on the basis of the inquiry. Any company, whose country of origin inquiry cannot satisfy the requirement of step two, must undertake a “due diligence” review of the source and chain of custody of its conflict minerals and file a Conflict Mineral Report as an exhibit to its From SD. As a result of the due diligence review, an issuer must determine whether its products fall into one of three categories – DRC Conflict Free, Not Been Found To Be DRC Conflict Free or, DRC Conflict Undeterminable. The last category is only available on a temporary basis for two years (four years for smaller reporting companies).

Applying the conflict mineral rules to the particular circumstances of a company will require significant resources and time. Companies should not delay in forming internal multi-disciplinary teams to conduct their evaluation of the company’s products under the new rules. Many of the terms in the new rules are not defined, although some guidance has been provided by the SEC, and the teams will need time to make judgments, identify suppliers and collect information. In addition, companies should consider reaching out to industry associations to create and/or follow industry-wide standards for compliance with the new rules. Unlike its position with respect to other controversial rules, the SEC has not voluntarily stayed the application of the conflict mineral rules in response to legal challenges to the rules by the US Chamber of Commerce and other parties, and reliance on the rules being overturned would expose a company to significant risks. For more information, please see our corporate update “SEC Adopts Controversial Disclosure Rules Regarding the Use of Conflict Minerals and Government Payments by Resource Extraction Issuers” which can be found here.

Government Payments by Resource Extraction Issuers

Resource extraction issuers (i.e., public companies engaged in the commercial development of oil, natural gas or minerals) are required to disclose certain payments made by them, their subsidiaries or entities controlled by them, to the U.S. government and foreign governments, including sub-national governments. Disclosure is required for payments made to further the commercial development of oil, natural gas or minerals in amounts equal to or exceeding $100,000 during the fiscal year. Commercial development includes exploration, extraction, processing and export, or the acquisition of a license for any of the foregoing. The term payments includes taxes, royalties, fees, production entitlements, bonuses, dividends and infrastructure improvements. There are no exemptions from disclosure as a result of confidentiality provisions in contracts, prohibitions on disclosure contained in foreign law, or commercially or competitively sensitive information. A resource extraction issuer will be required to file the annual disclosures on new SEC Form SD, which will be due no later than 150 days after the end of its fiscal year, beginning with fiscal years ending after September 30, 2013. The initial report is only required to disclose payments made after September 30, 2013. For example, for an issuer with a December 31 year-end, the first report on Form SD will be due by May 30, 2014 and will be required to cover the period from October 1 to December 31, 2013. Future filings will cover the full fiscal year. Like the conflict minerals rules, the government payments rules have been challenged in court, but the rules have not been stayed pending resolution of the challenge. For more information, please see our corporate update “SEC Adopts Controversial Disclosure Rules Regarding the Use of Conflict Minerals and Government Payments by Resource Extraction Issuers” which can be found here.

Disclosure Relating to Iran Sanctions

On August 10, 2012, the Iran Threat Reduction and Syria Human Rights Act of 2012 (Iran Act) was signed into law. The Iran Act expands U.S. sanctions against Iran and Syria, subjects U.S. companies to liability for Iran-related sanctionable activities conducted by their foreign subsidiaries and amends the Exchange Act to impose new disclosure obligations on SEC reporting issuers. A public company must disclose information in its annual and quarterly reports filed with the SEC after February 6, 2013, about Iran-related activities knowingly conducted by it or its affiliates, including: activities related to Iran’s petroleum industry; activities contributing to Iran’s ability to acquire or develop weapons of mass destruction or support terrorism; activities with specified persons, including Iran’s Revolutionary Guard Corps; and activities that support Iran’s acquisition of technologies that are likely to be used to commit human rights abuses against the Iranian people or to restrict, disrupt or monitor the free flow of information. Disclosure of these activities is required even if the activities are not prohibited or sanctionable with respect to the person engaging in them.

If an issuer or its affiliates knowingly engage in any reportable activities during the period covered by an annual or quarterly SEC report, the issuer must provide a detailed description of the activity in the report, including the nature and extent of the activity, gross revenues and net profit attributable to the activity, and whether the issuer or affiliate intends to continue the activity. If any activities are disclosed in the issuer’s annual or quarterly reports, the issuer must also file a separate notice regarding the activity with the SEC, and the SEC must then post that information on its website. Further, upon receipt of a notice, the SEC is required to forward the issuer’s periodic report to the President of the United States, the Senate Committees on Foreign Relations and Banking, Housing and Urban Affairs, and the House of Representatives Committees on Foreign Affairs and Financial Services. The President is required to initiate an investigation into the reported activity and make a determination within 180 days of initiating the investigation as to whether sanctions should be imposed on the issuer.


Say-on-pay continues to be a focus for many public companies. Although a significant majority of companies received shareholder approval of their say-on-pay proposals in 2012, there was a slight increase in the number of companies that failed to receive majority shareholder support. A negative recommendation from Institutional Shareholders Services, Inc. (ISS), based on its pay-for-performance analysis, was often a factor in these failed votes or resulted in lower shareholder support for the companies’ say-on-pay proposals. A key element in a negative ISS recommendation is a lack of alignment between CEO pay and total shareholder return performance relative to a peer group selected by ISS. Other factors in a negative vote often include problematic pay practices and lack of effective shareholder engagement regarding executive compensation.

In 2013, the focus for most public companies will be on making the compensation discussion and analysis (CD&A) a clear and effective explanation of the company’s policies to support its say-on-pay proposals. In addition, it will be useful to consider a company’s compensation policies in light of the updated voting policies of the proxy advisory firms. This review should not dictate a company’s compensation policies and decisions, but it can inform a company’s determination of its policies, highlight topics to address in the CD&A and allow the company to anticipate potential questions from the proxy advisory firms and shareholders. Companies will also need to consider the results of the prior year’s say-on-pay votes and discuss in the CD&A how compensation decisions this year were impacted by that vote. If a company received less than 70% shareholder support for its say-on-pay proposal in the prior year, ISS will apply heightened scrutiny to this year’s proposal. Perhaps most importantly, companies need to engage their major shareholders in a dialogue regarding executive compensation, particularly if shareholder support for prior say-on-pay proposals has been less than 75%, and to provide feedback from this dialogue to their compensation committees. For most companies, say-on-pay is an annual event and regular part of the proxy season. A number of companies, however, are on two or three-year cycles, making it more important for those companies to start early on updating their say-on-pay activities. For smaller reporting companies, 2013 will be the first year that they are required to hold a vote on a say-on-pay proposal.

2013 Policy Updates by Proxy Advisory Firms

ISS and Glass Lewis & Co. revised their proxy voting policies for the 2013 proxy season. Both ISS and Glass Lewis addressed board responsiveness to shareholder votes in their updated guidelines. For meetings in 2013, ISS adopted a transition rule that it will recommend a vote against directors if the board failed to act on a shareholder proposal that received the support of a majority of the shares outstanding the previous year, or if the board failed to act on a shareholder proposal that received a majority of shares cast in the last year and one of the two previous years. For meetings in 2014 and later, ISS will recommend a vote against directors if the board failed to act on a shareholder proposal that received a majority of shares cast in the previous year. ISS generally considers a board to be responsive if it fully implements the proposal or management puts the proposal on the ballot for the next annual meeting if a shareholder vote is required to implement the proposal. If the board’s response is less than full implementation, ISS will consider its recommendation on a case-by-case basis based on the steps the company has taken to be responsive. Glass Lewis formalized a policy that it will review the board’s responsiveness on any issue where 25 percent or more of the shareholders vote against the board’s recommendation on any proposal.

ISS also updated its policies for pay-for-performance evaluations, hedging and pledging stock and say-on-golden parachute votes. ISS made two changes to its pay-for-performance polices. ISS will incorporate a company’s self-selected pay benchmarking peer group when selecting the peer group ISS uses to evaluate pay-for-performance. For large capitalization companies, ISS will include a comparison of “realizable” pay to grant date pay in its pay-for-performance evaluations. Realizable pay will measure pay based on the actual pay earned during a specific performance period as a result of final payouts of performance-based awards or changes in value due to gains or losses in stock price. ISS will recommend a negative vote on directors if directors or executives hedge their company stock and on a case-by-case basis will recommend a negative vote for pledging significant amounts of company stock. In addition, ISS will no longer grandfather existing change-in-control severance arrangements in its evaluation of say-on-golden parachute votes. Glass Lewis adopted revisions to policies for overboarding of public company CEOs, equity-based compensation plan proposals and exclusive forum provisions.

PCAOB Adopts New Standard for Communications Between Auditor and Audit Committee

On December 17, 2012, the SEC approved new Auditing Standard No.16, Communications with Audit Committees, (AS 16), as proposed by the PCAOB. AS 16 will be effective for audits of fiscal years beginning on or after December 15, 2012. The new standard will impact the engagement of an outside auditor and the communications between the outside auditor and the audit committee. Companies should review and prepare for any adjustments to audit committee meeting schedules and agendas that may be required by the new standard. It may be useful to also review the audit committee charter in light of the new standard.

Director Compensation under Delaware Law

The decision by the Delaware Chancery Court in Seinfeld v. Slager should cause companies to evaluate their process for approving director compensation. In the context of an executive compensation suit, the Chancery Court refused to dismiss a claim against directors that they may have breached their fiduciary duties by awarding themselves grants under an equity plan. The willingness of court to apply heightened scrutiny to this alleged “self-dealing” is a reminder that boards should be counseled to take and document appropriate diligence and care when approving changes to director compensation.


Many companies that have been filing interactive financial data will be losing their shield from liability for such data. Item 406T of Regulation S-T provides a temporary exemption from liability for interactive data files. Under the item, the exemption applies only to files submitted to the SEC less than 24 months after the company was first required to file the interactive data files with the SEC. Companies approaching the lapse of the exemption may want revisit their internal review and verification processes as a precaution.