Tag Archive: SEC

Directors Can Add Valuable Perspective to SEC’s View of Sustainability

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The sustainability information in CSR reports is not, from our perspective, “investment-grade;” that is, it is not necessarily material, not industry specific, not comparable, and not auditable.

Business news headlines on any given day highlight the importance of sustainability issues such as resource scarcity, climate change, population growth, globalization, and transformative technologies. In today’s world, management of these and other sustainability risks and opportunities influences corporate success. Thus, understandably, investors are increasingly requesting information on how companies are managing these factors.

Aulana Peters

Aulana Peters

A concept release from the Securities and Exchange Commission (SEC) on disclosure effectiveness includes a lengthy discussion of sustainability disclosure. In the release, the SEC states that it is “interested in receiving feedback on the importance of sustainability and public policy matters to informed investment and voting decisions.” We hope that the SEC’s request for input on sustainability issues signals an understanding that the information investors consider “material”—much like the world around it—is changing. As a result, corporate disclosures should also evolve to provide investors with the information they need to make informed investment and voting decisions.

Sustainability issues are increasingly important to a company’s financial condition and operating performance, and thus merit the attention of its board. At more than 55 percent of S&P 500 companies, the board oversees sustainability, according to the Investor Responsibility Research Center Institute. Such boards are to be applauded for taking a more holistic view of risk oversight, and for getting out in front of global challenges.

This shift in focus by investors and the business community is driven by a growing recognition that sustainability issues are business issues, not only born of social or political concerns. One recent study found that when companies focus their efforts on managing material sustainability factors—namely, those critically linked to their core business—they outperform their peers with significantly higher return on sales, sales growth, return on assets, and return on equity. They also show significantly improved risk-adjusted shareholder returns.

Clearly, the board plays a key role in developing a company’s capacity to create long-term value and in safeguarding its assets. In this regard, a board’s careful consideration of information on material sustainability factors would help it to fulfill its oversight responsibilities, by assisting it in understanding, prioritizing, and monitoring business-related risks and opportunities.

For example, a board should regularly consider how its company measures, manages, and reports its material sustainability risks. A pharmaceuticals company might consider how it is addressing a $431 billion counterfeit drug market, where mitigation strategies in an increasingly complex, global supply chain could stem or reverse the loss of consumer confidence and company revenues, and prevent up to 100,000 deaths each year (see Roger Bate’s 2012 book Phake: The Deadly World of Falsified and Substandard Medicines). The plunging stock price and loss of goodwill suffered by Chipotle Mexican Grill after outbreaks of E. coli and norovirus at its restaurants demonstrate the way in which a failure to manage sustainability risk factors can seriously damage a company’s reputation and shareholder value.

Moreover, sustainability issues not only raise risks, but also present opportunities that can and should be taken into account by the board as it considers development and implementation of the company’s strategic goals.

Sustainability issues may have a material impact on a company’s ability to achieve such goals. For automakers, a strategy that incorporates fuel-efficient technologies and alternative fuels can help the company capitalize on legal and consumer trends regarding fuel economy and emissions in a market where car ownership is projected to triple by 2050.

Elisse Walter

Elisse Walter

Sustainability issues directly affect a company’s financial condition and operating performance. Therefore, it is not surprising that investors are increasingly demanding more effective and useful sustainability information. Many companies have made efforts to meet this demand through disclosures in corporate social responsibility (CSR) reports, by responding to questionnaires, or otherwise engaging with investors. The sustainability information in CSR reports is not, from our perspective, “investment-grade;” that is, it is not necessarily material, not industry specific, not comparable, and not auditable. To that point, a 2015 PwC study found that 82 percent of investors said they are dissatisfied with how risks and opportunities are identified and quantified in financial terms; 74 percent of the investors polled said they are dissatisfied with the comparability of sustainability reporting between companies in the same industry.

What the markets have lacked, until now, are standards that can guide companies in disclosing material sustainability information in a format that is decision-useful. These standards must be industry specific. Sustainability issues affect financial performance differently depending on the topic and the industry. Therefore, investors need guidance on which sustainability issues are material to which industries, and they need industry-specific metrics by which to evaluate and compare the performance of reporting companies.

The Sustainability Accounting Standards Board (SASB), an independent 501(c)(3) nonprofit, was created to address this market inefficiency. The mission of SASB is to develop and disseminate industry standards for sustainability disclosure that help public corporations provide material, decision-useful information to investors via MD&A and other relevant sections of SEC filings such as the Form 10-K and 20-F. SASB’s standards are formulated with broad market participation and draw upon metrics already used by the corporate community. They will continue to evolve, as our world, and thus material sustainability issues, change.

Investors want to place their funds in entities that have good prospects for the future. To do so, they evaluate the information that is material to a company’s prospects. Not all that information rests in the financial statements that reflect a company’s current financial condition. We believe that, in today’s world, risks and opportunities not yet reflected in a company’s financial statements influence its success.  And, the information that is “material” to investors—much like the world around it—has changed.

To help companies disclose material sustainability information, the capital markets need standards for disclosure of sustainability information that are created by the market, specific to industry, and compatible with U.S. securities law.

The management and disclosure of sustainability issues merits the attention of directors. The public comment period for the SEC’s disclosure effectiveness concept release runs through July 21. This is an important opportunity for publicly held companies and their directors to be heard on these critical issues, and to stress the importance of a market standard that serves investors while not overburdening issuers.

Aulana Peters was an SEC Commissioner from 1984-1988. Elisse Walter was the 30th chair of the SEC. Peters and Walter serve on the SASB board of Directors.

FAQs on Two Recent Concept Releases on Audit Committee Matters

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1. On July 1, 2015, the Securities and Exchange Commission (SEC) issued a Concept Release on Possible Revisions to Audit Committee Disclosures. What does it say?

The release asserts that current  disclosure rules may not mandate enough disclosures about activities of audit committees  in the reports they make in annual proxy statements and explores possible disclosure mandates in several areas—most of them pertaining to the external auditor. The areas outlined are as follows:

  • Audit Committee’s Oversight of the Auditor
  • Audit Committee’s Process for Appointing or Retaining the Auditor
  • Qualifications of the Audit Firm and Certain Members of the Engagement Team Selected by the Audit Committee
  • Location of Audit Committee Disclosures in Commission Filings
  • Smaller Reporting Companies and Emerging Growth Companies

In addition to these areas, the SEC asks for comment on the possible need for disclosures on accounting and financial reporting process or internal audits and invites comment on the scope of audit committee work.

Throughout the 55-page release, the SEC asks questions—74 in all—seeking the views of interested parties, such as audit committee members and investors, on what disclosures would be valuable. All but two of these questions pertain to oversight of the independent auditor.

2. What exactly is a concept release?

A concept release is an early indication that an agency is thinking about a matter and may issue new rules or standards on it. Any agency may issue a concept release. This current SEC concept release is the only one issued so far in 2015, and it is the first SEC concept release issued since 2011. (There were no SEC concept releases at all from 2012–2014.) While there are no recent studies showing the correlation between concept releases and rulemaking, we can assume that new rulemaking may follow. In this sense, concept releases are not the same as interpretive releases, which interpret new laws or court decisions, or policy statements, which clarify the SEC’s positions on particular matters.

3. How does this SEC concept release fit into the SEC’s overall “disclosure effectiveness initiative”?

The release is aimed at improving audit committee disclosures in concert with the stated goal of the SEC’s ongoing disclosure effectiveness initiative, described in a recent NACD Directorship article. Under this initiative, the SEC’s Division of Corporation Finance is reviewing the disclosure requirements under Regulation S-K (regarding company disclosures generally) and Regulation S-X (regarding company disclosures in financial statements) to “facilitate timely, material disclosure by companies….” So far the SEC has focused on the forms 10-K (annual report), 10-Q (quarterly report), and 8-K (updates). Later phases of the project will cover the compensation and governance information in proxy statements.

If the SEC’s new concept release on audit committee disclosures leads to rules mandating additional disclosures that are not material to investors, it would operate against the goals of the initiative. As SEC Chair Mary Jo White said in her keynote speech at NACD’s fall conference two years ago, “[w]e must continuously consider whether information overload is occurring as rules proliferate and as we contemplate what should and should not be required to be disclosed going forward.”

4. Has NACD commented on the SEC’s concept release?

Yes. On Sept. 8, 2015, the NACD submitted a comment letter affirming the importance of improved disclosures. However, the letter also argues that the choice of what to disclose should be up to audit committees themselves because they are in the best position to describe how they are fulfilling those duties. The NACD letter cautions that information should only be included in a proxy statement (or any other disclosure for that matter) if it would be useful to investors.

In the letter, NACD proposes that audit committees take voluntary action by finding new ways of disclosing the broad scope of their work. NACD has also offered to convene a meeting between the SEC and audit committee leaders in order to accomplish this.

The NACD letter followed a more detailed comment submitted to the SEC on Aug. 3, 2015, by Dennis Beresford, a member of the NACD board of directors, an experienced director and audit committee leader, and the former chair of the Financial Accounting Standards Board (FASB).

In his letter, Mr. Beresford states that the concept release focuses too heavily on the audit committee’s relationship with the auditor, which he says is important but should not dominate the committee’s work. He notes that of the 74 questions asked in the release, all but the last two focus on this topic.

Based on his experience, Mr. Beresford suggests that audit committee reports need to cover a wider range of topics, as suggested by the Audit Committee Collaboration, a group that includes NACD. In order of priority, these topics include:

  • Scope of duties (as referenced in the audit committee charter).
  • Committee composition (especially information on qualifications of the “audit committee financial expert”).
  • Oversight of financial reporting (highlighting how the committee is assessing the quality of financial reporting).
  • Oversight of independent audit (selection of the audit firm and lead engagement partner, and compensation, oversight, and evaluation of the audit firm). Mr. Beresford argues that the disclosure of the lead engagement partner’s name is unnecessary. [This is the subject of a separate Public Company Accounting Oversight Board (PCAOB) release on Rules to Require Disclosure of Certain Audit Participants on a New PCAOB Form.]
  • Risk assessment and risk management (which is often assigned to the audit committee).
  • Information technology (such as cybersecurity, which is also often assigned to the committee).
  • Internal audit (namely, internal audit plan review and results).
  • Legal and compliance (such as any discussions with legal counsel).

This list of possible topics for voluntary audit committee disclosures accords with NACD’s own publications on audit committee work. These subjects are frequently discussed in meetings of our Audit Committee Chair Advisory Council and in the webcasts and gatherings we produce with KPMG’s Audit Committee Institute.

Notably, Mr. Beresford warns against turning these subjects into mandatory “check-the-box” disclosures. Because audit committee reports are still in an early stage of development, he hopes “that the SEC allows them to continue to develop largely as ‘best practices’ without becoming overly prescriptive [emphasis added].” Regarding disclosure of the name of the lead engagement partner, he says that this should be left to the discretion of audit committees: “If they felt it would be useful to investors, they could include it in their reports in the proxy statement.”

5. Are there any other agency concept releases that audit committee members should know about?

Yes. On July 1, 2015, the PCAOB issued a concept release on Audit Quality Indicators (AQIs) with a comment deadline of Sept. 29, 2015. The release notes that “[t]aken together with qualitative context, the indicators may inform discussions among…audit committees and audit firms.”

NACD does not plan to comment on this release. However, we note that NACD member J. Michael Cook, chair of Comcast’s audit committee, together with Comcast’s executive vice president and chief accounting officer, Lawrence J. Salva, sent a comment letter advising the PCAOB of their views: “We encourage the PCAOB to be judicious with regard to the number of recommended AQIs, as we believe too many AQIs would lessen their impact. As you have previously noted, audit committees have many responsibilities and a limited amount of time, and as you are aware, audit quality requires more than measurable indicators; skepticism and independence are necessary to turn quantifiable indicators into real audit quality.”

6. What is the key takeaway from the SEC and PCAOB concept releases for audit committees?

The SEC and PCAOB are being proactive on the audit committee front. The SEC wants audit committees to say more about their activities in the proxy statement, and the PCAOB wants audit committees to use specific metrics to judge the quality of audits. Comments from the director community have pointed out the importance of ensuring that disclosures are material and that metrics are useful. In response to these two concept releases, audit committee leaders and members might consider taking two main actions:

  • Review disclosures and their metrics to ensure they are useful.
  • Reach out to the SEC and PCAOB to express views on these matters.

A Final Word

SEC and PCAOB regulators strive to strengthen the U.S. economy through enlightened rulemaking, but they cannot do it alone. They need to hear the voice of the director. NACD members can make a positive difference in this regard.

FAQs on the New SEC Pay-Ratio Rule

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On August 5, 2015, the Securities and Exchange Commission released its final pay-ratio rule under the Dodd–Frank Wall Street Reform and Consumer Protection Act (hereafter Dodd–Frank). The announcement comes more than five years after Congress passed Dodd–Frank in July 2010 and nearly two years after the SEC first proposed the pay-ratio rule in September 2013. The release describing the new rule is a 294-page document that will be analyzed and applied in the weeks and months to come. Meanwhile, here are some basic FAQs to help boards and compensation committees understand the implications of this much-anticipated development.

  1. What disclosure will the new rule require?

While the release explaining it demands further study, the new rule can be summarized as follows:

  • Companies will be required to disclose the ratio of the median pay of all employees, excluding the “principal executive officer” (in most cases, the CEO), to the total pay of that principal executive officer for the most recently completed fiscal year, as disclosed in that year’s summary compensation table. The calculation for median employee pay can be made for any time during the last three months of the year.

The final rule defines employees as “any U.S. and non-U.S. full-time, part-time, seasonal, or temporary worker (including officers other than the [CEO]) employed by the registrant or any of its subsidiaries as of the last day of the registrant’s last completed fiscal year” (p. 216). Like the proposed rule, the final rule allows statistical sampling and estimates as long as these are “reasonable” (p. 14). Although the word reasonable appears at least 100 times in the release announcing the rule, it is not defined because the SEC believes that “companies would be in the best position to determine what is reasonable in light of their own employee population and access to compensation data.”[1]The ratio would have to appear in any filing that requires executive compensation disclosure, including 10-K annual reports, registration statements, and proxy statements. The SEC final rule specifically mentions the compensation discussion and analysis (CD&A) and the summary compensation table. “In this manner, the pay ratio information will be presented in the same context as other information that shareholders can use in making their voting decisions on executive compensation” (p. 39).

  1. When will the new rule go into effect?

Companies must begin reporting the new data in the first fiscal year beginning on or after January 1, 2017. The pay ratio will appear in the 2018 proxy statement disclosing compensation for 2017. After that, companies will be required to update the disclosure at least once every three years.

  1. To whom will the new rule apply?

The new rule will apply to all U.S. public companies but exempts smaller reporting companies (defined as having a public float of less than $75 million) and emerging growth companies (defined as a having total annual gross revenues of less than $1 billion during their most recently completed fiscal year). It also exempts foreign companies (including Canadian companies listing in the United States) and investment companies (mutual funds). The rule also contains an exemption for U.S.-based global companies that cannot access the median pay data due to foreign data-privacy laws. New public companies would not need to comply with the new rule until their first annual report and proxy statement after they register with the SEC.

  1. What aspects of the rule are likely to raise concerns in boardrooms?

In a comment letter filed on December 1, 2013, NACD expressed concerns that the rule defined the term employees too broadly. We encouraged the SEC to increase the flexibility of the pay-ratio rule by permitting the use of industry averages, by defining employees as full-time U.S. employees, and by permitting supplemental notes to correct any distortions caused by the use of “total pay” figures. The SEC’s final rule does not specifically authorize the use of industry averages, although it appears to permit their use to supplement company-based data. Nor does the final rule exclude part-time workers or foreign workers, allowing an exclusion of only up to 5 percent of a non-U.S. workforce.

In combination, these factors in the final rule may cause the ratio of median employee to CEO pay to appear relatively small in industries that employ part-time or non-U.S. workers. Over time an industry pattern may emerge, but initially there could be a hit to reputation. Boards can start now in preparing for potential impact on company reputation and employee morale.

  1. What do boards and committees need to do in the short term?

First, board members should become familiar with the requirements of the new rule, with help from their compensation committees and their compensation advisor. Then they will be in a position to ask informed questions. Compensation committees can begin by asking their chief human resources officer (CHRO) and chief financial officer (CFO) the following questions:

  • Do we have the information available to calculate the two numbers required for the ratio so that the board can begin its analysis? What technical and definitional issues, if any, may arise in this calculation, and what support might you need to resolve those issues? What is your rough estimate of the cost of calculation (e.g., staff time, data systems requirements, and/or third-party analysis)?
  • Will you work with an external compensation firm or other external consultant (such as a payroll expert) to determine the ratio?
  • Can the external advisor estimate the ratios of peer companies on the basis of publicly available data? What are the pros and cons of having the company’s consultant collaborate with the board’s compensation advisor in calculating such estimates?

Similarly, they might consider asking the following two questions of the independent firm that advises the board on CEO and senior management pay:

  • What information, if any, is currently available on estimated ratios of employee/
    CEO pay for our industry peers so we know where we stand?
  • If you will be working with the company’s external advisor in collecting relevant data and/or preparing estimated ratio information (if one is retained by CHRO/
    CFO), would such activity be perceived as compromising your independence under current SEC rules? If so, how can we proactively counteract such a perception?

Having gained insights from these initial questions, directors might want to consider the following:

  • How comprehensive and compelling are our current published disclosures about our pay philosophy? Have we clearly communicated the link between our strategy, pay plan design, and pay outcomes?
  • Does our pay philosophy include employee pay beyond the executive level? Are there opportunities to address this issue in a more detailed way? For example, does our published pay philosophy specifically discuss the issue of pay distribution patterns and/or “fairness”? If not, is this something we might consider addressing?[2]
  • What information, if any, have we received from surveys regarding employee satisfaction with compensation levels?
  • What feedback, if any, have we received from our major shareholders about our compensation plan and our pay-for-performance track record? If we have heard concerns, what have we done to resolve them?
  • If the early estimated ratio for total pay appears out of proportion to any available estimates for our peers and/or industry, how should we interpret this discrepancy? What would this tell us about the structure of our reward system?
  • What would be the impact of early voluntary disclosure?
  1. What implications might this new rule have for D&O liability?

Any new disclosure rule immediately triggers potential director liability, absent a safe harbor provision. Although shareholder lawsuits against companies are often triggered by weak stock prices, the putative grounds for lawsuits are usually based on alleged disclosure violations, particularly in changes-of-control.[3] For more on D&O litigation, see the May–June 2015 issue of NACD Directorship.

  1. Is the new rule likely to be challenged?

It is possible that trade groups such as the U.S. Chamber of Commerce may try to get the rule vacated by a federal court. In a statement released via e-mail on August 5, David Hirschmann, president of the Chamber’s Center for Capital Markets Competitiveness, stated,We will continue to review the rule and explore our options for how best to clean up the mess it has created.” In the past this type of cleanup has meant legal action. In July 2011, the Chamber joined the Business Roundtable to successfully vacate a proxy access rule under Dodd–Frank that would have mandated a particular form of shareholder access to director nominations via the proxy ballot. Similarly, in April 2014, the National Association of Manufacturers and others succeeded in getting a court to declare an aspect of the conflict minerals rule under Dodd–Frank to be a violation of free speech.

  1. What long-term impact might the new rule have on human capital at corporations?

Compliance with the new rule is important, but the core issue for companies remains the same: developing a pay structure, at all levels of the organization, that is aligned with the firm’s strategy and aimed at long-term value creation. Sustained corporate performance is based in large part on human talent, and compensation is one of the key factors in motivating employees. Furthermore, payroll and benefits represent a significant percentage of capital allocation at many companies. For these reasons, among others, many boards will likely take a greater interest in pay at lower levels, and they will want independent verification of a wider band of pay practices. More broadly, a growing number of boards are stepping up their oversight of management’s talent development activities across the organization. For guidance, directors can turn to the Report of the NACD Blue Ribbon Commission on Talent Development.

  1. What resources does NACD have to help compensation committees cope with this and other current compensation matters?

The following NACD resources may be helpful:

NACD will continue to monitor the pay-ratio disclosure issue and other Dodd–Frank compliance matters as they evolve, providing further guidance and perspective on these and related matters.


[1] “Consistent with the proposal, the final rule does not specify any required methodology for registrants to use in identifying the median employee. Instead, the final rule permits registrants the flexibility to choose a method to identify the median employee based on their own facts and circumstances“ (p. 113). “The proposed rule did not prescribe specific estimation techniques or confidence levels for identifying the median employee because we believed that companies would be in the best position to determine what is reasonable in light of their own employee population and access to compensation data” (p. 98).

[2] Note: “Fairness” was one of the five principles of pay recommended by NACD in the Report of the NACD Blue Ribbon Commission on Executive Compensation (2003), and was also cited in the more recent Report of the NACD Blue Ribbon Commission on the Compensation Committee (2015).

[3] Josh Bradford, D&O Claims Trends: Q2 2015, Advisen Ltd., July 2015.