A Mid-Season Look at 2022 Shareholder Proposals

As we sit squarely in the middle of proxy season, we have a useful vantage point from which to consider already announced shareholder proposals and anxiously await investor feedback on those matters presented for shareholder votes. From this vantage point, corporate directors can better anticipate and prepare for trends that may ultimately be presented to them.

If the most recent shareholder proposals can be considered a guide, directors should plan on a busy wrap-up to this proxy season. This is the case given continued investor focus on environmental, social, and governance (ESG) matters, renewed pressures on diversity, equity, and inclusion (DE&I) initiatives, and increased attention to the corporation’s social voice. All of these issues must be considered against the backdrop of the war in Ukraine and the twin economic pressures of increasing inflation and the prospect of an economic slowdown.

Corporate boards should keep their fingers on the pulse of possible investor interest in these and other nontraditional topics emerging from the 2022 proxy season.

Established Procedures

Public company shareholders can submit proposals for consideration at a corporation’s annual meeting through a well-established process that is administered by the US Securities and Exchange Commission (SEC). The SEC requires proponents to satisfy certain procedural and substantive requirements before a proposal is included in a company’s proxy statement. The SEC views the shareholder proposal process as fundamental to shareholder democracy and it is actively involved in adjudicating disputes between companies and proponents as to whether a company may properly exclude a shareholder proposal from its proxy statement.

In November 2021, the SEC issued guidance in which it scaled back the basis on which companies could properly exclude shareholder proposals. In applying the “ordinary business” exclusion, in which companies are permitted to exclude a proposal if it deals with a matter relating to the company’s ordinary business operations, the SEC had historically focused on the nexus between a policy issue and the company’s business, which led to many shareholder proposals being excluded where nexus was lacking. In the recent guidance, the SEC clarified that it will no longer focus on the nexus between the policy issue and the company but will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal. In so doing, the SEC indicated it will consider whether the proposal raises issues with a broad social impact such that it transcends the ordinary business of the company. For example, a proposal relating to greenhouse gas emissions would not be excludable solely because greenhouse gas emissions are not a significant business issue for a company since climate change has broad societal impact.

What We’ve Seen to Date

A variety of indicators, including SEC data, suggests that the volume of shareholder proposals submitted during this proxy season will meet or exceed the heightened pace of the last several years. Many of these proposals fall into the ESG field. Indeed, recent news report noted that more than 500 ESG-related shareholder proposals had been submitted by mid-March, which reflects a 22 percent increase compared to the same time last year.

Significant and potentially controversial resolutions continue to be proposed outside of the ESG area, including those dealing with topics such as new product risk and the conduct of business in countries with authoritarian governments.

Based on available data, many of the resolutions submitted to date can be allocated into the following categories:

Corporate Governance: Resolutions in this bucket focus on special meeting thresholds, employee representation on corporate boards, use of an independent board chair, director background evaluations, DE&I and civil rights expertise for directors, written consent practices, continued use of dual class shares, virtual shareholder meetings, and director retirement requirements.Environmental: Resolutions relate to the removal of certain ingredients or practices from the supply chain, environmentally sensitive packaging, terminating support of fossil fuel initiatives, greenhouse gas emission controls, ending deforestation, environmental justice audits, limitation of natural gas use, recycling commitments, climate change risks, and food and water equity matters.Discrimination: Proposals target the institution of civil rights and DE&I audits, workplace non-discrimination, and management diversity commitment.Human Rights: Proposals relate to human rights violations in countries where a company conducts business, forced labor in the supply chain, use of child labor, human rights audits in certain international business lines, and the rights of indigenous peoples.Lobbying: Resolutions target the alignment of lobbying activity and support of the Paris accords.Executive Compensation: Proposals focus on pay equity gaps along gender and racial lines, review and approval of executive severance and termination pay, restatement clawbacks, limitation of the use of options and bonuses, deducting legal defense costs from incentive compensation, regulating changes to compensation metrics, and golden parachutes.Political Spending: Proposals suggest banning the practice.Business Practices: Resolutions relate to conversion to a Delaware public benefit corporation or California social purpose corporation, employment agreement concealment clauses, anticompetitive business practices, arbitration of securities law matters, the development of certain controversial products, investments in certain industries and products, and paid sick leave.

Primary Lessons and Projections from the Proxy Season

Midway through the 2022 proxy season, the following lessons and projections can be gleaned by boards:

ESG-related initiatives will remain front and center, particularly as climate change-related policy initiatives move forward and environmental incidents are highlighted in the media.Social justice issues are primarily (but not exclusively) focused on the performance of racial, gender, and DE&I audits. Human rights concerns remain of interest with proposals relating to international companies.Proposals remain with respect to traditional governance issues such as the status of the lead independent director, board composition, and director background evaluations.There is continuing interest in resolutions aimed at curtailing certain controversial business practices.Greater attention may be given to board commitments to compliance in response to evolving Delaware decisions on board oversight of mission-critical risks.There may be a need to respond to governance-related proposals arising from recent challenges to state diversity statutes and from pressure to increase director refreshment in order to make room for additional diverse directors.Increased emphasis on director effectiveness may lead to additional demands for enhanced full board and individual director evaluation processes.New resolutions may arise from the acute social issues of the day, including legislation and judicial decisions regarding abortion, voting rights, and sexual preference, and their impact on a company and the culture of its workforce.

Overarching lessons relate to both the enduring value associated with a board commitment to direct engagement with major shareholders and the ability to respond to acceptable resolutions with internal reviews and other measures intended to address shareholder concerns in as confined and restricted a way as possible.

Michael W. Peregrine and Eric Orsic are partners at McDermott Will & Emery.

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Why the CEO and Board Need to Prioritize Security Crisis Management

Business decisions are hanging in the balance as the war in Ukraine challenges the status quo. It is no surprise, then, that well-established cybersecurity threats, such as ransomware, may not be at the top of the boardroom agenda now.

Yet the oversight could be costly—and not just financially. In its State of Cybersecurity Resilience 2021 research, for example, Accenture found that 20 percent of costs associated with ransomware and extortion incidents are attributed to brand reputation damage.

Business priorities are in the spotlight following any ransomware attack, and your security team should have an incident response plan in place that details how to get the business up and running again. But Accenture’s research suggests that the connection between business strategy and security efforts could benefit from being even more closely aligned.

Board members need to consider how the business currently responds to cyber crisis events and ask themselves:

Are we treating cyberattacks as “just a security problem”? Enterprise crisis response is a team sport, so your security team’s traditional cyber-incident response plans should evolve. A business-focused crisis management approach is necessary to deal with modern destructive events.Are our crisis communications fit for purpose? Cyberattacks are complex, and existing crisis communications often lack the transparency and agility to deal with them. A predefined decision framework—coupled with a greater understanding of the industry, its regulations, and customers—can support more robust crisis communications.How comprehensive is our approach? Think about your business and the business of others: as attack surfaces evolve, crisis response needs to extend to address impacts on customers, corporate subsidiaries, suppliers, third parties, investment portfolios, and mergers and acquisitions targets.

Buying In

Disruptive roadblocks such as pandemics and geopolitical issues aside, opportunity is knocking on the boardroom door. Recent times have shown us how business models can be reinvented, supply chains restructured, and increases in productivity made a byproduct of remote working.

Businesses have gained new momentum from this period of compressed transformation, and we’ve all been amazed by the scientific and technological breakthroughs that have made it possible. But perhaps most importantly, we’ve been shown how collaboration and communication make all the difference to the end game.

Because boards steer the business, their decision-making must be influenced by the right information. Having a holistic “bigger picture” means they can adjust the overall strategy to suit. In its State of Cybersecurity Resilience 2021 research, Accenture found that many organizations are already improving the C-suite channel to security teams—72 percent of chief information security officers are now reporting to key business decision makers, whether that’s boards (23 percent) or CEOs (49 percent).

As Accenture cyberthreat intelligence has identified, ransomware is anyone’s game and is proving to be easier than ever—now, you can buy access and malware and simply execute a ransomware attack. This means ransomware and extortion practices are growing—there’s a 107 percent year-over-year increase in ransomware and extortion attacks and 33 percent increase in intrusion volume from ransomware and extortion.

Below are three areas boardrooms should consider closing the gaps between the business and security:

Introduce a “real-life” attack scenario. Ensure tabletop exercises with security personnel include executive-level simulations so that organizations can test their defenses against a typical ransomware attack. Imagine three lines of business are down due to an attack, with a threat actor asking for $10 million. You might need to determine in real time which business should be recovered, how to communicate your response, and who is responsible for making those decisions.Define a crisis decision framework up front. Identify decision-making thresholds aligned to the business strategy, the organization’s risk tolerance, its cyber communication strategy, and clear accountability for both technical and business decisions during a crisis event. Decision-making criteria should be reviewed and fine-tuned regularly to keep pace with organizational change.Document and use that framework. Shape the communication strategy and implement a balanced approach to threat containment and eradication by better preparing to speed up responses and ease the pressures of extortion demands.

With more agile, robust, and transparent crisis management capabilities, the CEO, board, and rest of the company can handle ransomware events better and improve overall cyber resilience.

Robert Boyce is a managing director in Accenture’s global cybersecurity practice.

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Federal Forum-Selection Provisions: A Key Tool to Defend Against Offering-Related Securities Lawsuits

Public companies and their directors and officers are frequent targets of shareholder class action lawsuits arising from an initial public offering or secondary public offering. These lawsuits, asserting violations of the Securities Act of 1933 (the “Securities Act”), are driven by experienced plaintiffs’ firms and can be extremely burdensome and costly to defend, especially if allowed to proceed into fact discovery. Companies often feel pressured to settle these lawsuits—even if the case is ultimately winnable—to avoid these costs and distractions to the business.

Understanding the background and effectiveness of federal forum provisions as a defense tool against Securities Act lawsuits is essential for directors, which the rest of this article explores.

Plaintiffs’ Lawyers Seek Advantages in State Court

Most securities claims are brought under provisions of the Securities Exchange Act of 1934 and must be litigated in federal court (not state court). Defendants in securities cases generally prefer litigating in federal court because the procedural standards are more favorable and the judges are usually more familiar with the intricacies of the law. Whether or not a case proceeds in federal court versus state court can often determine the outcome.

Lawsuits relating to an offering, however, often include claims under the Securities Act. In recent years, plaintiffs’ firms have taken advantage of a quirk in the law that allows plaintiffs to file lawsuits brought under the Securities Act in state court and bars defendants from moving these cases to federal court. This practice was affirmed by the US Supreme Court’s 2018 decision Cyan Inc. v. Beaver County Employees Retirement Fund.

Immediately following Cyan, the number of Securities Act lawsuits filed in state court skyrocketed to all-time highs. Companies increasingly faced costly and duplicative parallel state and federal actions, as well as multiple lawsuits in different state courts.

Companies Adopt Federal Forum Provisions

After Cyan, many companies amended their corporate charters and adopted federal forum provisions (FFPs) requiring that Securities Act lawsuits be brought exclusively in federal court. The theory was that if a plaintiff shareholder filed a Securities Act lawsuit in state court against a company that had adopted an FFP, the lawsuit could be dismissed on the grounds that it should have been brought in federal court.

In March 2020, the Delaware Supreme Court ruled in Salzberg v. Sciabacucchi that FFPs are facially valid under Delaware law. However, the Delaware Supreme Court acknowledged, “Perhaps the most difficult aspect of this dispute is not with the facial validity of FFPs, but rather, with the ‘down the road’ question of whether they will be respected and enforced by our sister states.” In other words, would state courts outside Delaware enforce FFPs?

Enforcement of Federal Forum Provisions in State Courts

In the two years since Sciabacucchi, the consistent answer among state courts has been “yes.”

Most notably, several decisions from California and New York state courts have upheld and enforced FFPs following Sciabacucchi. In 2020 and 2021 combined, more than 80 percent of state court Securities Act lawsuits were filed in either California or New York. Plaintiffs’ firms routinely file Securities Act lawsuits in these states due to perceived strategic advantages, including less stringent pleading standards and some individual courts allowing plaintiffs to engage in fact discovery before a ruling on the motion to dismiss—a practice that is not allowed in federal court.

In California, at least four separate state court decisions have enforced FFPs in lawsuits brought against Restoration Robotics, now part of Venus Concepts, Uber Technologies, Dropbox, and Sonim Technologies. A New York state court likewise recently enforced an FFP in dismissing a lawsuit brought against Casa Systems, and a Utah state court enforced an FFP in a lawsuit brought against Domo.

Key Takeaways for Companies and Boards

Companies that anticipate making a public offering should strongly consider adopting FFPs in their charters if they have not done so already. FFPs provide an effective, practical defense against shareholder class actions brought under the Securities Act. While plaintiffs may still file Securities Act lawsuits in federal court, an FFP can effectively deter weaker lawsuits and gives the company the best shot at winning early and avoiding a costly settlement down the line.

Furthermore, even if an FFP is adopted after the offering at issue, this likely would not render the FFP ineffective. While the law is still evolving on this issue, numerous court decisions have held that analogous forum-selection clauses are enforceable even if adopted after the alleged wrongdoing occurred.

Finally, while the enforcement of FFPs adopted by Delaware corporations is now relatively settled, some uncertainty remains about whether FFPs adopted by companies incorporated outside of Delaware are valid and enforceable. While this issue has not yet been addressed by any state courts, the recent decisions in California, New York, and Utah suggest that FFPs could similarly be held effective.

Jonathan Rotenberg is a partner and Paul Yong is an associate at Katten Muchin Rosenman.

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Using Executive Pay as a Tool for M&A Success

Mergers and acquisitions (M&A) deals create a cascade of new considerations for boards, and in many deals, talent retention and executive compensation are some of the most important factors to get right. Companies across industries—especially in the tech and biotech space—view their people as their top asset.

A strong management team is critical to a company’s value and performance and incentivizing employees and treating them fairly are essential ingredients in the transaction’s success. Boards need to pay particular attention to compensation before, during, and after a deal closes to ensure that all-star talent stays in place.

At the same time, boards face increasing hurdles when it comes to executive pay. Last year’s M&A boom, combined with labor-demand pressures due to the Great Resignation, and the normalization of remote work broadening executives’ opportunities, gave management teams more negotiating power when it came to compensation.

Executive pay is also a topic that is often thrust into the limelight. Employees, media, investors, and other stakeholders have increasingly scrutinized pay equity in organizations, and companies open themselves up to real reputational risks if pay is deemed unfair. Some public companies have faced challenges in getting shareholder support in the advisory “say on pay” votes, and other shareholder proposals related to pay are on the rise. From a regulatory perspective, the US Securities and Exchange Commission requires robust executive compensation disclosure for public companies, and certain states and cities (such as Portland, Oregon and San Francisco, California) have tax penalties related to executive pay ratios. 

Complicating things further, the current economic environment is in a state of uncertainty. The first quarter of 2022 saw another surge of coronavirus cases, a tougher regulatory environment, and a new war in Ukraine, leading to market volatility and a slowdown in dealmaking. Interest rates, while still low, are rising, and high inflation is impacting consumers.

All in all, there is a perfect storm of factors making compensation committees’ oversight of executive pay more complex and nuanced than ever, especially when companies are pursuing a deal. Boards need to evaluate whether compensation packages and retention arrangements are appropriate to hold on to a company’s executive talent, if that is a key goal, while balancing stakeholder interests and market pressures.

Before, during, and after a deal, board compensation committees for both acquirers and target companies should consider doing the following:

Ensuring seamless cultural integration. Cultural integration is a crucial ingredient to ensuring that a new, combined company thrives after the deal is done. From an executive pay standpoint, compensation committees must ensure that strategic incentive metrics are appropriate to the new company’s specific business model and culture.

Connecting strategic metrics to overall strategy. Recent pushes to tie diversity, equity, and inclusion (DE&I) and environmental, social, and governance (ESG) issues to executive pay are ramping up, but there is no one-size-fits-all model, and companies need to carefully consider whether and how to implement metrics. Any such metrics should be developed in consideration of the company’s overall DE&I and ESG strategies. Board members and management teams should consider their vision for where the new company stands on DE&I issues, as well as a holistic ESG strategy, to begin effectively tying compensation to these commitments.

Balancing the need for retention with other factors. Compensation packages and retention agreements should be generous enough to incentivize management team members to successfully guide the new, combined company after a deal closes. But compensation decisions should also consider the input of the full spectrum of stakeholders, including shareholders, investors, employees, customers, and suppliers. In these circumstances, investor outreach efforts can be helpful.

Integrating human capital management (HCM) into business strategy and, in turn, executive pay. In recent years, board mandates have expanded into issues related to talent and HCM, which involves taking a closer look at areas that may have historically been seen as human resources duties, such as recruiting, training, and performance planning, to uncover new opportunities to drive employee engagement and business value. As boards continue to get familiar with HCM, they can add value by taking into consideration how HCM ties to the new, combined company’s business strategy and how to integrate HCM into incentives in compensation plans.

Evaluating how inflation and market volatility may impact executive pay. Market volatility and an uncertain economy can impact compensation awards that have financial performance targets. Because changes in market conditions can lead to significant fluctuations in company performance and stock price, performance-based incentive goals may be seen as less certain and equity grants as less incentivizing. Additionally, executives may be expecting increased base salary amounts at rates higher than we would ordinarily see in a given year. While it is impossible to know how long market turbulence will last, the overall state of the economy is always an important consideration in all compensation decisions.  

Executive compensation is rarely a simple formula, and the stakes are high to get it right—especially in M&A. But with their nuanced understanding of a company, its management team, and the market at large, boards are in an excellent position to use compensation as a valuable tool for guiding their organizations to long-term success.

Jean McLoughlin is partner and cochair of the executive compensation group at Paul, Weiss, Rifkind, Wharton & Garrison.

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How Compensation Committees Are Battling Uncertainty, Talent Woes

Some experts say attracting and retaining talent isn’t all about the money. But amid the Great Resignation, what else are compensation committees thinking about? To discuss this and how boards are managing uncertainty in their pay plans, NACD in late March brought together speakers Eric Hosken, partner at Compensation Advisory Partners; Lori Miller, partner at Farient Advisors; Matt Turner, a managing director at Pearl Meyer; and Christine Y. Yan, a board member at Ansell, Cabot Corp., Modine Manufacturing Co., and Onsemi. Lindsey Baker, NACD director of partner relations, moderated the event. Below are key questions and answers from that conversation.

How can companies keep incentive plans effective and relevant in this uncertain environment?

Turner: Number one is the category of performance measures themselves. Performance measures are drivers of value. But are there things you can do to tailor the measures to remove some of the variability? You want your management team to be responsible for all aspects of how value is created, but you also want to make sure that they’re focused on the things they can control.

Number two are the performance ranges. Most of my clients have widened their performance ranges not only for profit, but also for revenue growth for 2022, reflecting the increased expected variance of results. A good rule of thumb is to avoid plus or minus X percent just because that’s what peers are doing. What are the factors that are driving the expected variability in your results? That may lead you to a plus or minus threshold. It might even be asymmetrical. You might say, “We know where the downside risk is. We know what the upside risk is. There’s more on one side than the other.” Factor that in.

Number three is the number of measures. We’re seeing an increase in the number of performance measures in short-term and long-term plans. Part of that is driven by the [environmental, social, and governance] agenda. But part of it is companies taking a good look and saying, “We want to make sure we have covered the full range of performance aspects that lead to value creation for shareholders.” That might mean an incremental measure in your plan.

Finally, don’t discount the use of discretion, the ability to look at the results at the end and recognize that you know that doing this job can’t always be reduced to a couple of performance measures.

How have the boards you are involved with shifted conversations to reflect more recent human capital needs?

Yan: Seventy-five percent of my boards have changed the compensation committee to human capital and compensation. A lot of companies have changed not just the name, but also the charter to reflect that human capital is the most important asset of the company. The committee looks at hiring practices and diversity, equity, and inclusion. For diversity, we look at workforce representation from minority groups, pay equity, and talent and leadership development. How do we keep our employees safe during COVID? We also talk about flexibility and work policy post-COVID. With employee engagement surveys, we look at turnover stats and employee engagement scores to see how engaged people are beyond the CEO and their direct reports.

One of my boards would go to operating locations a couple times a year before COVID to visit locations. The board had opportunities to interact with employees. One of the trips, we had a picnic and we invited all employees. Any employee could walk up to a board member and ask any questions and vice versa. That open environment gives the board a chance to directly see how the organization is truly living and breathing the company’s value and purpose, and feel the company’s culture deeper down in the organization.

Another thing I like to do is arrive at a board meeting the day before and have dinner with an affinity group and have open dialogue with them. Some topics [I would discuss with them] include what is going well for them and where improvement needs to be made. Is our company providing the right opportunity, making sure everybody’s voice is heard, and driving a culture of openness and inclusion? These informal interactions provide a lot of insights into company culture.

How has COVID-19 impacted the market for executive talent and what are the implications for executive compensation?

Hosken: It doesn’t matter where you’re located. There is competitive pressure on wages for executives and it’s giving executives more flexibility. The positive side for some companies in smaller cities, where you may feel like you don’t have as many options for talent (and where, historically, you had to not only find the right candidate, but the right candidate that was willing to relocate to your city) is that now those companies are realizing that they can compete for talent elsewhere, but also that they have to pay a nationally competitive wage to do it.

You also have the potential for people to move or to decide they don’t want to live in high-cost cities like New York anymore. They may want to go somewhere with a lower cost of living, and it doesn’t necessarily mean that they’re going to have to take lower pay. Many companies have different salary structures for people in different locations, and there’s going to be pressure for that to go away. For more and more talent, the United States is going to see a national labor market, especially for jobs that aren’t rooted to a single place.

Some executives feel like it’s very important for the management team to have face time together, even if there are people that are located in Hong Kong—they want them to spend time with the executive staff in the home office. Zoom doesn’t really replicate that discussion-in-the-hall type of situation. Some companies are going to approach hybrid work as, “We want you in the office, and out of the office on an exception basis.” But other companies, by the nature of their workforce, are going to be remote a lot of the time. The biggest impact on executive compensation is the change in the market from local to more national.

With increased expectations of the compensation committee, how have committee chairs’ relationships with management, consultants, and the board shifted?

Miller: In the past, our relationships used to be more routine and predictable. Now, we work a lot with the committee chair and management to talk about what should be on the agenda. Committee meetings are much more fluid. In addition to the standard agenda items, more topics are getting raised that require follow up at the next meetings, such as talent management and retention. What’s going on with attrition? How are we losing people? What insights do we get from the exit interviews? We’re working a lot more with the committee chairs to help design how the meetings should flow. The committee chair is driving what’s important and they don’t want to hear, “Well on this day, we normally do goal setting, and on this day, we do compensation levels.”

The amount of time that I’ve seen the chairs commit to these committees is exorbitant. They almost feel like they are employees. Committee chairs are having a lot of meetings in between, too, dealing with whatever new issues are coming up and raising questions, providing guidance. What do we need to work on? How do we want to make this meeting run? What does management want to talk about? I’ll have clients who will tell me, “I had three board committee meetings last week because we’re dealing with the issue of workforce safety, or we’re dealing with talent.” The relationship [between management and the board] is much closer right now. They are seeking out advice from the directors more often.

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