In a post last week, I wrote about the proposed revised Financial Choice Act (H.R. 10) now pending before Congress and the potential impact that the bill could have on the SEC’s enforcement program. In this post, I address the potential impact that the bill’s provisions could have on public company disclosure requirements and corporate governance. If the bill’s provisions are enacted into law, the measures could significantly alter or eliminate many of the Dodd-Frank Act’s disclosure and corporate governance requirements.
As I discussed in my prior post, in April 2017, Rep. Jeb Hensarling (R-Tex.) introduced an amended version of the Financial Choice Act that he had previously introduced last year. Because the latest version updates the prior version, the latest bill often is referred to as Financial Choice Act 2.0. The House Financial Services committee recently approved the bill and it now remains pending before the House of Representatives.
The bill would eliminate or revise a number of the Dodd-Frank Act’s key features relating to systemic financial stability. As I noted in last week’s post, the bill also contains a number of provisions that if enacted could substantially affect the SEC’s enforcement authority.
The current version of the bill also contains a number of noteworthy modifications to many of the Dodd-Frank Act’s disclosure requirements, as discussed in a May 10, 2017 Law 360 article by Yafit Cohn and Karen Hsu Kelley of the Simpson Thatcher law firm (here). A number of these disclosure requirements have proven to be controversial and the subject of significant criticism, particularly the Dodd-Frank Act’s disclosure requirements related to conflict minerals, extractive industries, and mine safety.
The Dodd-Frank Act’s conflict minerals disclosure requirements were intended to require listed companies to disclose whether their products were sourced from countries where the proceeds of mining for the specified minerals were used to fund armed conflict. While many may believe the provisions’ overall goals were laudatory, from the very beginning there have been questions whether the SEC’s public company reporting requirements should be used as a foreign policy tool. The SEC’s attempts to implement the requirements have been dogged by questions about their legality and constitutionality. The requirements have also been criticized as costly and burdensome for the reporting companies, while doing more harm than good in the countries the rules were designed to help. The proposed bill eliminates the conflict mineral disclosure requirements.
The Dodd-Frank Act’s extractive industries disclosure requirement was also subject to many of the same criticisms as the conflict minerals disclosure requirements. Dodd-Frank Act Section 1504 directs the Commission to issue rules requiring resource extraction issuers to include in an annual report information relating to any payment made by the issuer, a subsidiary of the issuer, or an entity under the control of the issuer, to a foreign government or the Federal Government for the purpose of the commercial development of oil, natural gas, or minerals. This rule was also criticized as a foreign policy objective masquerading as a corporate disclosure requirement, and also for imposing burdens on reporting companies while producing little benefit. The proposed bill would eliminate the extractive industries disclosure requirement.
Dodd-Frank Act Section 1503 directed the SEC to promulgate rules requiring that mining companies disclose certain safety information in their quarterly and annual reports. Much of this information is already required to be reported to the Mine Safety and Health Administration, so these duplicative disclosure requirements added reporting burden and expense while adding little additional benefit. The proposed bill would eliminate the mine safety disclosure requirements.
Provisions in the proposed bill would also eliminate a number of other Dodd-Frank Act disclosure requirements, including the provisions requiring pay ratio disclosure; the provisions requiring disclosure of employee and director hedging policies; and disclosures regarding chairman and CEO structures.
As readers of this blog well know, the Dodd-Frank Act enacted say-on-pay provisions requiring listed companies to hold periodic nonbinding advisory shareholder votes on executive compensation. Under the Dodd-Frank Act, these votes were required to be held “not less frequently than once every three years.” Under the revised Financial Choice Act, the say-on-pay vote is instead required “each year in which there has been a material change” to executives compensation. The bill also removes the Dodd-Frank Act requirements that at least once every six years companies hold a vote to decide whether the say-on-pay votes will take place every one, two, or three years.
The Dodd-Frank Act also contained broad executive compensation clawback provisions, requiring companies to implement a policy providing that if the company restates financial statements from a prior reporting period, the company will recover incentive compensation paid to any current or former executive officer that received incentive compensation during the three-year period preceding the restatement. These provisions have been criticized on, among other grounds, the fact that the compensation clawback could be imposed on an individual who was not involved in and unaware of the matters that led to the restatement. The bill amends the clawback provisions to specify that the provisions apply only where “such executive officer had control or authority over the financial reporting that resulted in the accounting restatement.”
In addition to the disclosure-related provisions, the Financial Choice Act also contains a number of provisions relating to corporate governance issues and procedures.
First, the bill alters the ownership thresholds under current SEC rules regulating who may submit proposals for inclusion in proxy materials. Under current rules, a shareholder holding either shares representing at least $2,000 in shareholder value or 1% of the company’s securities may submit a proxy statement proposal. The bill eliminates the eligibility provision based on the specified dollar amount, limiting proxy proposal eligibility to those holding at least one percent of the company’s securities. The bill also increases the period during which these shares must be held from one year to three years. In addition, the bill changes the resubmission requirements, specifying that an issue may not be resubmitted unless the proposal previously received six percent of the vote if proposed once in the last five years, received at least 15 percent if voted on at least twice during the last five years, or 30 percent if voted on three times in the last five years (increasing these figures from the current requirements of three percent, six percent, and ten percent, respectively).
Second, the bill modifies exemptions for internal control reporting and attestation for smaller companies. The bill would create an exemption from auditor internal control attestation requirements for companies with total market capitalization under $500 million and for depositary institutions with assets under $1 billion. The bill also extends the Emerging Growth Company exemption from auditor attestation requirements, allowing companies with less than $50 million of average annual gross revenues to continue to qualify for the exemption until the earlier of the tenth anniversary of the company’s IPO or the end of the fiscal year in which the company’s average annual gross revenues exceeds $50 million.
Finally, the bill contains a number of provisions requiring the registration of and regulating proxy advisory firms. The bill requires proxy advisory firms to be registered with the SEC and to provide calendar year end reports. The bill specifies that the SEC should promulgate rules on proxy advisory firms’ conflicts of interest, and to create rules on prohibited practices relating to the provision of proxy advisory services.
From the perspective reporting companies, the Financial Choice Act 2.0 would introduce a number of welcome reforms. Many of the Dodd-Frank Act’s disclosure requirements were controversial and generally were viewed by reporting companies as burdensome, costly, and distracting. The Dodd-Frank Act’s disclosure provisions that sought to advance various foreign or domestic policy goals through corporate reporting requirements arguably represent a departure from the securities laws’ purposes of protecting investors. Even if these disclosure requirements embodied arguably worth policy goals, the actual disclosure requirements accomplished little to advance these policy goals while imposing burdens on U.S. companies to which their foreign competitors were not subject, putting U.S. reporting companies at a competitive disadvantage.
The bill’s proposed corporate governance reforms also may represent welcome changes for reporting companies particularly with respect to the proxy statement proposal eligibility requirements. As the Simpson Thatcher lawyers noted in their article about the bill to which I linked above, the eliminating the dollar value eligibility provision could “significantly decrease the number of shareholder proposals.” To be sure, in recent years, investors holding shares representing these nominal amounts have relied on these eligibility requirements to submit proxy proposals relating to environmental and social change policies. If the one percent requirement becomes the sole eligibility criterion, “shareholders will have a significantly more difficult time effecting change through the shareholder proposal process.” Among other things, this could ease financial burdens on reporting companies.
Of course, it remains to be seen whether or not the bill ultimately will be voted into law, and if so, in what form. Up until this point in the process there have been relatively few amendments, but changes could be introduced as the bill completes the process in the House of Representatives and as it makes its way through the Senate. It is also important to note that the earlier version of this bill successfully made its way through the House but failed to win sufficient support in the Senate. In the new climate and with a Presidential administration focused on reforming many of the Dodd-Frank Act’s provisions, the current version of the bill could succeed where the prior version failed. Because of the number and significance of the reforms the bill would put into effect, it will be important to monitor the bill as it proceeds through Congress.