Securities Regulation Daily Investor Advisory Committee examines impact of COVID-19 on proxy issues
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Monday, December 7, 2020

Investor Advisory Committee examines impact of COVID-19 on proxy issues

By Lene Powell, J.D.

COVID-19-related trends noted by the panel included an emergency pivot to virtual annual meetings, a spike in goodwill impairment and write-downs, and many wrinkles involving executive compensation.

In a panel discussion of the SEC Investor Advisory Committee, members discussed the impact of the COVID-19 pandemic in the areas of shareholder meetings, accounting and auditing, executive compensation, and disclosure. Members looked back at the 2020 proxy session and ahead to the 2021 season.

The session was held on December 4, 2020 and moderated by Paul Mahoney, Interim Chairman and David and Mary Harrison Distinguished Professor of Law at the University of Virginia School of Law.

Virtual meetings. Perhaps the most tangible effect of the pandemic was that many companies that had not previously held virtual annual meetings did so for the first time this year. According to Darla Stuckey, President and CEO of the Society for Corporate Governance, about 2,500 virtual annual meetings were held this year, compared to 320 last year. Some of these took place in locations where state law does not allow virtual annual meetings, but the states issued executive orders to allow them. Stuckey hopes that these executive orders continue for the future. By and large, said Stuckey, the meetings went well, albeit with some scrambling and technological hiccups.

After the 2020 proxy season ended, Stuckey and Amy Borrus, the CEO of Council of Institutional Investors (CII), co-chaired a best practices group to outline expectations and evolving practices. Some challenging areas included:

  • Almost all the meetings were audio only, and investors did not like this because they wanted to see the company representatives.
  • The technology "wasn’t there yet." Providers did not have sufficient bandwidth, given the huge number and quick turnaround.
  • There was some skepticism around Q&A periods, with concerns that companies had shortened Q&A periods and cherry-picked questions instead of presenting them all. On the companies’ side, there was an issue about not necessarily knowing who had asked a question.
  • There were some hiccups around presentation of shareholder proposals, with technical issues and unclear processes.
  • There were some issues around handling shareholder access to the meetings.

The best practices group concluded that specific recommendations be developed for handling Q&A and presentation of shareholder proposals, following Rules of Order.

Regarding plans for the 2021 proxy season, Stuckey said she has heard that business travel may take two to three years to come back, or may never fully come back, because it has become clear how many meetings generally can be done virtually instead of in-person. Stuckey believes that virtual annual meetings will be much more used in the future, even in a non-emergency situation, though she expects only the very largest companies to go fully virtual. Fortune 100 companies have expensive meetings with a lot of people in attendance, while smaller companies may have meetings in a conference room at a law firm, with few attendees and no proposals. The cost of the technology to host a completely virtual annual meeting may be prohibitive for some companies. As a result, some companies may go to a hybrid model, she said.

Committee member J.W. Verret, a professor at Scalia Law School, said that while he believes companies should comply with the virtual annual meeting guidelines published this summer, he doesn’t understand the pushback against virtual annual meetings from CII. In Verret’s view, it’s a “no-brainer” that virtual meetings increase shareholder participation. He related an anecdote relayed to him secondhand, in which prominent shareholder advocate John Chevedden reportedly said about a virtual annual meeting, “Wow, this is great, I love this. I just participated in three shareholder meetings in three different time zones.”

Stuckey replied that she believes CII recognizes that virtual annual meetings can increase shareholder participation and has softened its stance for that reason. However, she noted a trade-off in that virtual meetings are sometimes audio only, and you can’t look the directors and chairman in the face, which can contribute to a lack of feeling of accountability, she said.

Accounting. Colleen Honigsberg, Associate Professor of Law at Stanford Law School, discussed accounting issues that her research shows have spiked during the pandemic.

First, regarding non-GAAP issues, although the pandemic has highlighted pre-existing concerns in this area, it has not necessarily raised a lot of issues that have not been thought about before, said Honigsberg. There was some concern that there would be an explosion of a new metric, "EBITDAC," or "Earnings Before Interest, Taxes, Depreciation, Amortization, and Coronavirus." However, although this made headlines, it turns out that companies have not really adopted it widely.

Of course, said Honigberg, companies wouldn't have to put coronavirus as a separate adjustment for the impact of COVID to actually hit non-GAAP numbers. Instead, the effect may be showing up in things like goodwill impairment and write-downs, which have really skyrocketed during COVID-19. The value of goodwill impairment more than doubled from 2019 to 2020. There were also huge percentage increases in write-downs and "special items," which include one-time charges like restructuring. Honigsberg noted that there may be some double-counting in this area.

Honigsberg said the overarching question with non-GAAP numbers is whether companies provide the information to prop up earnings and confuse investors or non-GAAP does really provide valuable information for investors. In general, the academic literature is fairly positive about non-GAAP and does suggest that it really provides a valuable source of information for investors, she said. One proposal that may be helpful for these transitory adjustments is to ask companies to separate recurring investments from non-recurring investment, to make it easier to identify what is going to be persistent.

Turning to internal controls issues, on the issue of whether internal controls requirements should be more flexible to better accommodate different companies’ responses to events, Honigsberg said the system should not be that every company has the exact same controls. At the same time, however, in her research she has seen many of the same internal control weaknesses occur across many, many companies, and they are actual weaknesses that the new emphasis on remote work due to COVID has revealed or caused. Therefore, she thinks it’s important to have specific internal control requirements, as long as companies have some flexibility in implementing them.

Honigsberg gave the example of a finance workflow in which a comptroller reconciles the general ledger and two staff accountants post and make edits to the general ledger. When COVID hit, one of the accountants was laid off, or is working at night because they’re taking care of a child during the day. As a result, the comptroller is given the ability to edit the ledger. This causes an internal control issue because the person who’s reconciling the ledger is also able to edit it, said Honigsberg. She has seen company disclosures indicating that remote work and staff reductions has jeopardized companies’ ability to properly segregate duties, as in the example. In addition, the increase in remote work can cause cybersecurity issues, Honigsberg observed.

Finally, regarding going concerns, Honigsberg has not found evidence to indicate an increase in going concern modifications due to COVID-19, as some feared might arise. A small number of companies, between 60 and 80, have filed going concern modifications that reference COVID-19. Regarding why the number is not higher, Honigsberg pointed out that the going concern is an auditor’s prediction of what will happen over the next 12 months, whereas audit opinions look back over the previous 12 months. With COVID-19, the hope is that there is reason for optimism in the next 12 months, for example that we will have mass vaccinations relatively soon. However, it is also possible that these filings may just be delayed, and we will see this start to show up, said Honigsberg.

Executive compensation. Matt DiGuiseppe, Vice President at State Street Global Advisor, discussed issues relating to executive compensation, which is receiving "elevated attention" due to COVID-19. The economic fallout from the pandemic could render many compensation-linked performance targets simply unattainable, he noted. Further, the pandemic has highlighted many aspects of executive compensation that cannot be captured quantitatively, especially since the impact of COVID-19 is not uniform across businesses.

“Simply relying on the same set of adjustments to financial measures that have always been used, such as the backing out of the impact of extraordinary events, like, say, a government-mandated shutdown of the business, without attention and consideration to the magnitude of the adjustments, could result in executive compensation outcomes that do not match the experiences of the broader employee base,” said DiGuiseppe.

Disclosure. Regarding disclosure matters, DiGuiseppe said State Street expects heightened investor scrutiny around discretionary executive compensation decisions due to the pandemic. State Street will use a case-by-case approach to voting on executive compensation, evaluating each board's decisions and the specific circumstances of each company. Enhanced disclosure of the board's decision-making process will be key to the evaluation voting, and State Street will expect clear concise, plain English disclosure of executive compensation and how it is aligned with the company's strategy.

In particular, said DiGiuseppe, State Street is looking to see clear disclosure of performance against expectations, including how and why expectations may have changed materially in reaction to the pandemic, and how payout opportunities have been adjusted alongside changes in performance expectations. State Street wants to understand how executive compensation decisions including the adjustments to performance goals align with changes to compensation at the company more broadly, including potentially layoffs and furloughs.

Finally, State Street would like companies to avoid making retention awards that do not have a longer vesting period than the company's normal equity grants, said DiGiuseppe. Although attraction and retention are key aspects of any compensation program, State Street would like companies to consider whether special retention grants have sufficiently long vesting periods to benefit shareholders. In addition, replacing or replacing underwater options, or making grants to replace options that expired out of the money this spring, would also be something that State Street would like companies to think about. Further, timing off-cycle equity grants through the bottom of the market, or changing equity structures, such as increasing the proportion of stock options to take advantage of volatility, are things that will attract a critical eye, said DiGiuseppe.

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