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Board Trends at the S&P 1500

The latest issue of ISS Board Practices reflect incremental but meaningful changes in several key governance areas. For the first time, just slightly more than half (51%) of S&P 1500 companies have two people serving as CEO and chairman. Stark differences divide companies depending on size, as 30% of mid-caps are led by independent chairs compared to only 22% of large-cap companies. The largest companies are more likely to have lead directors, however. As a reminder that ISS policies do not always coincide with company determinations, 17% of the chairmen that companies consider to be independent are deemed “affiliated” by ISS.
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Can We Do Better by Ordinary Investors?

That is the title of a law review article by Delaware Supreme Court Justice Leo Strine. Chief Justice Strine wades into the debate taken up by Professor Lucian Bebchuk, who strongly advocates that managers who make investments be given increased shareholder power, against others who Professor Bebchuk has dubbed “insulation advocates,” namely those who favor wide discretion for corporate managers in the form of boards and executives. The first part of the article presents the two starkly opposing views between the direct democracy pushed by Professor Bebchuk and those concerned that the consequences of being subject to majority shareholder whims will lead to an intense focus on the short-term that harms corporations.
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A Review of Corporate Governance Practices Globally

The recently published OECD Corporate Governance Factbook examines the governance landscape across all 34 OECD member countries, with detailed charts and links by subject matter for given jurisdictions. The degree of ownership concentration is an essential element for consideration in framing corporate governance standards for companies. While the U.S., U.K. and Australia have dispersed structures, most OECD countries have controlling shareholders, such as family or state ownership, at their listed companies, with a few countries (Canada, Germany and Japan) having a mixed structure. 

In terms of legal and regulatory regimes, the U.S. is one of only three jurisdictions, along with India and Saudi Arabia, with corporate governance issues covered by either laws or regulations instead of national codes or principles under a “comply or explain” model.
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Conversation with Vanguard about Its Perspectives on Governance

Understanding the views of major shareholders becomes critical as companies head into the proxy season.  We are fortunate to get insights from Glenn Booraem, Principal & Fund Controller at Vanguard and head of their governance program, about Vanguard’s perspectives on key governance issues and engagement with their portfolio companies.

Davis Polk:  We understand that Vanguard sent letters out to many of the portfolio companies that you hold investments in this year.  How did you decide who to send letters to, what was the subject matter and primary objectives of those communications, and what has been the response like from the companies that received them?
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Conversation with Bob Lamm on Governance Today

To get a perspective on corporate governance challenges at public companies, we turn to a true expert, Bob Lamm. Until March 2013, Bob was Assistant General Counsel and Assistant Secretary at Pfizer Inc., where he was responsible for a broad range of securities and corporate governance matters. He joined Pfizer in 2008 after holding senior legal and governance positions with a number of major corporations, including W. R. Grace & Co., CA, Inc. and FGIC Corporation. Bob is currently Chair of the Society’s Securities Law Committee at the Society of Corporate Secretaries and Governance Professionals.

Davis Polk:  In your many years as an in-house governance lawyer, what are some of the biggest changes you’ve seen over time?
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Board Practices at S&P 500 Companies

For the first time, almost half of newly elected directors are retired, according to the 2013 Spencer Stuart Board Index released this month that focuses on directors at S&P 500 companies. One reason may be that 53% of current CEO’s do not serve on any corporate boards other than their own. The pool of new recruits is expanding, however, with 38% of board members acting as first-time directors at any public companies. In addition, boards are looking beyond active CEOs, COOs, presidents and vice chairmen. Division or subsidiary presidents and other functional leaders now make up more than 21% of new directors.
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J&J Settlement Includes Board Committee and Clawback

The Corporate Integrity Agreement between Johnson & Johnson and the Department of Health and Human Services, the purpose of which is to promote compliance with federal health care programs and FDA requirements, contains two particularly interesting corporate governance provisions in its 71 pages.

Under the agreement, J&J formed a Regulatory, Compliance and Government Affairs board committee comprised of independent directors. The agreement lists specific requirements for the committee, including quarterly meetings and reviewing the effectiveness of the compliance program, as well as a signed resolution by each member of the committee summarizing its review and oversight of the compliance program with specific language regarding the committee’s conclusion that the compliance program meets federal requirements and the obligations of the agreement.
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Audit Committees Encouraged to Review PCAOB Concerns on Internal Control Audits

The PCAOB wants audit committees to take note of a recent audit practice alert that it issued in light of a significant number of audit deficiencies observed in the past three years related to audits of internal control over financial reporting. Specifically, the alert indicates that audit committees might wish to discuss with their auditors the level of auditing deficiencies in this area identified in their auditors’ internal inspections and PCAOB inspections, request information from their auditors about potential root causes and ask how they are addressing the matters discussed, including inquiring about the involvement and focus of senior members of the firm on these matters.
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A Look Back to the 2013 Proxy Season: Problematic Director Elections

“For board members, 2013 was a tale of two proxy seasons,” declares the ISS 2013 Proxy Season Review, taking a page out of the NYC mayoral race playbook.

The report (free registration required) provides a wealth of information, detailed lists and graphics on key events for meetings between January and June 2013, including describing companies affected by say-on-pay challenges, shareholder proposals and director elections. Rather than repeat the numerous statistics cited, most of which follow trends from prior years, or recall events we previously covered, this first part of a series of posts covers some of the more interesting highlights. A second post will cover executive compensation and finally, governance and social shareholder proposals.
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Exclusive Forum Provisions: Is Now the Time to Act?

Exclusive forum provisions in corporate bylaws and certificates of incorporation are back on the agenda for many companies. We reviewed the trend data in a June 2012 briefing and predicted that few companies would adopt exclusive forum provisions until there was guidance from then-pending litigation in the Delaware Court of Chancery. That guidance came this past June in the form of Chancellor Strine’s decision upholding the validity of board-adopted exclusive forum bylaw provisions at Chevron and FedEx. Most recently the plaintiffs in that litigation dropped their appeal, so for now Chancellor Strine’s decision stands in support of the proposition that, unsurprisingly, Delaware views the selection of a Delaware forum as at least facially valid.
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Plaintiffs Abandon Appeal on Exclusive Forum Case

On October 15, plaintiffs Boilermakers Local 154 Retirement Fund and Key West Police & Fire Pension Fund filed a notice of voluntary dismissal to drop their appeal to the Delaware Supreme Court regarding the decision by the Delaware Court of Chancery upholding exclusive forum provisions by Chevron and Federal Express, which we discussed here.
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CII Focuses on Director Tenure and Universal Proxy Ballots

Director tenure has come under increasing focus, as indicated by CII’s new policies focused on board evaluation of tenure. There is no presumption that any specific term length is problematic or that there should be a stated term limit, but rather, CII encourages boards to weigh whether “a seasoned director should no longer be considered independent.” Twenty-six percent of directors at Russell 3000 companies have more than 10 years of service and 14% have more than 15 years.

CII notes that a nonbinding approach is used in Europe, where the European Commission advises that nonexecutive directors serve no more than 12 years and directors with more than 9 years of service in the U.K.
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Glass Lewis Position on Exclusive Forum Provisions

As the exclusive forum case continues to wind its way through the Delaware courts in an appeal, which we cited here, Glass Lewis announced that its position remains unchanged.

According to Glass Lewis, 70 companies have adopted exclusive forum provisions since the ruling in June by the Delaware Court of Chancery upholding those bylaws at Chevron and FedEx.  Glass Lewis continues to believe that exclusive forum bylaws are “generally not in shareholders’ interests since they unnecessarily limit full legal recourse by preventing shareholders from bringing suit in a forum of their choosing.”

The proxy advisory firm indicates that shareholders should be able to vote on the adoption of such bylaws.  
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California State Senate Resolution “Urges” More Women on Public Boards

resolution adopted by the California State Senate in late August “urges” that within the three-year period from 2014 through 2016, “every publicly held corporation in California” with nine or more board members have at least three women, those with five to eight members have at least two women, and those with fewer than five members have at least one woman. The resolution is currently pending in the judiciary committee of the State Assembly.

The full resolution consists of seven “whereas” paragraphs citing studies about the lack of women on public boards and potential impacts on corporate performance, and two resolutions: one acknowledging the “body of evidence” and the state’s stake in the issue, and the second “urging” the achievement of the numerical goals referred to above.
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Justice Steele Discusses Emerging Delaware Law at Society Conference

Hearing from Chief Justice Myron Steele of the Delaware Supreme Court was another highlight of the Society of Corporate Secretaries and Governance Professionals’ National Conference. Justice Steele began his remarks by questioning whether there was a need to discuss a change in the Delaware paradigm given the evolving nature of stock ownership from 1967, when 70% of shares were held by retail investors, to the current composition where institutional investors now hold those 70%.

With this more sophisticated base, he indicated that there will be a struggle going forward as to whether Delaware law should continue to focus on protecting shareholders from themselves.
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BlackRock’s Governance Views at the Society’s National Conference

One of the invaluable benefits of attending the national conference of the Society of Corporate Secretaries and Governance Professionals is the opportunity to hear from key stakeholders of public company corporate governance. As just one example, Michelle Edkins of BlackRock discussed  “CEO Succession, Management Development and the Board.”

Michelle explained that BlackRock believes it has a responsibility to monitor boards of directors as part of its role in being guardians of their clients’ assets. The governance team at BlackRock and their approach to proxy voting was recently profiled in the New York Times, where proxy analysis was analogized to speed dating.
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Analyzing the Delaware Court Decision to Uphold Exclusive Forum-Selection Bylaw Provisions

The Delaware Court of Chancery upheld the facial validity of exclusive forum-selection bylaw provisions in a recent decision.  As we explain in our memo, the opinion is notable for both its scope and limitations. Scott Luftglass from our litigation practice and pmills from our M&A practice explain the key aspects of exclusive forum-selection provisions and the opinion from Chancellor Leo E. Strine Jr.

What is the purpose of exclusive forum-selection bylaws?

Shareholder and derivative litigation against companies and/or their boards of directors often can be brought in multiple jurisdictions since companies have several places of operations. When parallel suits proceed in multiple jurisdictions (for example, in the state in which a company is incorporated and in the state in which the company is headquartered), the parties run the risk of inconsistent rulings, and the defendants bear the additional costs and burdens of having to litigate the same facts and issues in two jurisdictions.
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PCAOB Approves Auditing Standard No. 16, Communications with Audit Committees

Yesterday, the Public Company Accounting Oversight Board (PCAOB) approved Auditing Standard No. 16, Communications with Audit Committees, which supersedes its previous standards regarding communications with audit committees. The new standard seeks to improve communications between the auditor and the audit committee about significant audit and financial statement matters by requiring the auditor to communicate certain matters regarding the audit and financial statements to the audit committee in a timely manner and prior to the issuance of the audit. This is in contrast to the PCAOB’s previous interim auditing standard (AU Sec. 380), which did not require any communication with the audit committee prior to the issuance of the auditor’s report.
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The PCAOB Urges Audit Committees to Ask Auditors Tough Questions about PCAOB Inspections

In response to concerns that audit firms were either declining to provide important information or downplaying the results of PCAOB inspections, the PCAOB recently issued a report about how an audit committee can enhance discussions with auditors about PCAOB inspections to support the committee’s oversight role.

By law, the PCAOB may not disclose the nonpublic portion of an inspection report or other nonpublic inspection information, or compel an audit firm to make the disclosure to an audit committee.  Because of these legal restrictions, an audit committee would not even know whether a PCAOB inspection report found deficiencies in the committee’s own company – the very audit that it oversees. 
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PCAOB Reproposes Standards for Auditor Communications with Audit Committees

After receiving comments and hosting a roundtable, the PCAOB has reproposed for comment an auditing standard on Communications with Audit Committees by making modifications to its original proposal from March 29, 2010Both proposals update existing AU 380.  Comments are due by February 29, 2012, with the new standard anticipated to be effective for audits of fiscal years ending on or after December 15, 2012.

Overall, the proposal as it currently stands covers almost all of the existing topics under AU 380, and in addition contains specific enhancements or new requirements, such as:

  • providing the audit engagement letter to the audit committee and determining that the committee has acknowledged and agreed to the terms of the engagement;
  • inquiring of the audit committee about matters that might be relevant to the audit, including knowledge of violations or possible violations of laws or regulations or complaints or concerns raised regarding financial reporting matters;
  • discussing with the audit committee an overview of the audit strategy, including significant risks identified during the auditor’s risk assessment procedures, whether specialists will be needed and the extent to which the auditor plans to use the work of the company’s internal audit function or other parties;
  • with respect to critical accounting estimates, describing the process that management used to develop those estimates and changes to the process as well as any assumptions used by management that the auditor believes have a high degree of subjectivity;
  • informing the audit committee about difficult or contentious matters that triggered consultation outside the engagement team and that the auditor believes are relevant to the audit committee’s oversight of the financial reporting process;
  • discussing significant transactions that are outside the normal course of business for the company or otherwise appear to be unusual due to their timing, size or nature; and
  • communicating matters from the audit that are significant to the oversight of the company’s financial reporting process, including concerns regarding accounting or auditing matters that have come to the auditor’s attention.

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2011 Spencer Stuart Board Index Focuses on Board Composition, Organization and Process and Director Compensation

The latest Spencer Stuart Board Index (November 2011) finds that three-fourths of S&P 500 companies require annual election for directors and 79% have some form of majority voting.  41% of boards, almost double the percentage from 10 years ago, now split the roles of chairman and CEO, with 21% of those having truly independent chairs.  18 companies disclose a formal policy requiring separation of the two positions.

The Index highlights that this year saw the smallest increase of new directors being added in a decade, and nearly a quarter of those members are first-timers on public company boards.  Less than a quarter of directors are active CEOs, as more than half of active CEOs do not serve on an outside board.
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Gary Retelny Talks to Us as the Newly Appointed President of ISS

MSCI, the parent company of ISS, recently announced that Gary Retelny, a member of MSCI’s Executive Committee and its Corporate Secretary, has been appointed President of ISS.  As ISS is clearly an influential force in corporate governance developments, we asked Mr. Retelny about his new position.

Davis Polk: What are your primary goals and expectations for ISS as we approach the 2012 proxy season?

Gary Retelny: With only a few days “on the job” as ISS’ President, I still have a lot of listening and learning to do before I can articulate specific goals.  I hope to meet frequently with all our constituencies and provide a variety of forums for meaningful dialogue and of course, debate. 
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Governance Survey Questions Current Thinking on Board Composition

The 2011 Corporate Board of Directors Survey from Stanford’s Rock Center and Heidrick & Struggles suggests that active CEOs may not make the best board members.  We asked Professor David Larcker, corporate governance expert at Stanford, to discuss those and other findings.

Davis Polk: Active CEOs are generally considered prized board candidates due to their leadership experiences.  Do your survey results dispute that view?

Prof. Larcker: I don’t think our survey disputes it so much as qualifies it.  What we see in the survey results is that there are advantages and disadvantages to different types of directors, including active CEOs.  
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