Chapter 8
Proxy Statements

Learning objectives

  • Identify the relationship of the proxy statement to the SEC’s other reporting requirements.
  • Determine the involvement of the accountant in the preparation of the proxy statement.

Introduction

Because of the geographic dispersion of the owners of a public company, it is unlikely that a quorum could be obtained at any meeting that required a vote of the shareholders. As a result, the use of proxies and proxy statements were developed to facilitate such votes. A proxy is broadly defined as any authorization given to someone by security holders to act on their behalf at a stockholders’ meeting. The term proxy also refers to the document used to evidence such authorization. Persons soliciting proxies must comply with Regulation 14A of the 1934 Act, which prescribes the content of documents to be distributed to stockholders before, or at the same time, such solicitation occurs.

The informational content of the proxy statement provided to the stockholders depends on the action to be taken by the stockholders. Schedule 14A prescribes the informational content required based on the specific circumstances.

When the vote is solicited in connection with certain transactions involving the registration of securities on Form S-4 (for example, exchange offers, mergers, transfer of assets), the S-4 prospectus may be expanded to serve as the proxy statement or informational statement for the transaction under Section 14 of the 1934 Act. In such cases, the filing is commonly referred to as a “joint proxy statement/prospectus.”

After a brief review of Regulation 14A and Schedule 14A, the remainder of this chapter will focus primarily on the accounting or financial requirements of the proxy statement. Registration statement requirements in connection with solicitations and disclosures concerning the independent public accountant will also be discussed.

Knowledge check

  1. A proxy statement is used to
    1. Facilitate shareholder voting.
    2. Provide shareholders with information in connection with shareholder meetings when no vote is being solicited by management.
    3. Replace a quorum at any meeting that required a vote of the shareholders.
    4. Eliminate the need for shareholder meetings.
  2. A joint proxy statement or prospectus is used when
    1. Proxies are being solicited for a meeting at which stockholders will vote on the election of directors.
    2. Proxies are being solicited for an annual shareholders’ meeting where new directors are being elected and the independent auditors are being ratified.
    3. A vote is solicited in connection with certain transactions involving the registration of securities.
    4. A vote is solicited in connection with management compensation.
  3. The rules covering the filing requirements for proxy statements are set forth in
    1. Regulation 14A.
    2. Regulation 14E.
    3. Item 10 in Form 10-K.
    4. Item 11 in Form 10-K.

Regulation 14A

The SEC derives its authority to regulate the solicitation of proxies from the Exchange Act and from the Investment Company Act of 1940. Section 14(a) of the Exchange Act states:

Based on this statutory authority, the SEC established Regulation 14A to regulate proxy solicitations. The proxy rules of Regulation 14A apply to the solicitation of a proxy with respect to securities registered under Section 12 of the 1934 Act, that is, Section 12(b) and 12(g) companies. Regulation 14A does not apply to companies whose securities are registered only under the Securities Act of 1933 (that is, Section 15(d) companies — companies that have only publicly traded debt).

Regulation 14A includes the requirement to furnish the following information to the SEC and to shareholders before any annual or other meeting of shareholders:

  • A proxy statement. Includes information on matters to be voted on and other information, as defined in Schedule 14A.
  • A proxy card. Specifies issues other than director elections on which a shareholder can vote (for, against, abstain), director elections on which a shareholder can vote (for or withhold authority to vote for), when a shareholder may grant voting authority to another party, and indicates if the proxy is solicited on behalf of the board of directors.
  • Annual report to shareholder. Accompanies or precedes annual meetings at which directors are to be elected. Rule 14a-3 outlines the information required in the annual report to shareholders.

Rules 14a-1 through 14a-21 of Regulation 14A discuss proxy requirements including information to be provided to security holders, filing requirements, security holder proposals, presentation of information in proxy statements, and the prohibition on including false or misleading statements. This chapter focuses on Schedule 14A — Information required in proxy statement and the following related rules: Rule 14a-3 — Information to be furnished to security holders, Rule 14a-6 — Filing requirements, and Rule 14a-8 — Shareholder proposals.

Proxies and proxy statements are different from other SEC filings because they are required to be sent directly to the security holders. Registration statements are filed directly with the SEC. Annual reports on Form 10-K are filed with the SEC and are furnished to the shareholder only on request. Typically, the proxy materials must be given to the shareholders at least 20 days prior to the meeting date. Companies listed on the New York Stock Exchange must provide shareholders 30 days to review the materials.

Dodd-Frank Act—Implications on corporate governance

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, considered to be one of the most comprehensive reforms of the U.S. financial industry in years. Although many provisions of the act relate primarily to banks and the financial regulatory system, the new legislation also had a significant effect on corporate governance and executive compensation practices and disclosures for public companies in general. More than 90 provisions in the Dodd-Frank Act required SEC rulemaking. The SEC has made significant progress toward completing those tasks. Specific provisions of the act that affect proxy disclosure requirements are discussed throughout this chapter.

Internet availability of proxy materials

The SEC rules require companies and soliciting persons to follow the notice and access model for providing information on the internet for all solicitations not related to a business combination.

Issuers and other soliciting persons are required to post their proxy materials on a website and provide shareholders with a Notice of Internet Availability of Proxy Materials (the notice). The issuer or other soliciting person may choose to send the notice only (the “notice only” option) or may furnish paper copies of the proxy materials along with the notice (the “full-set delivery” option). An issuer does not have to choose one option or the other as the exclusive means for providing proxy materials to shareholders.

Under the “notice only” option, an issuer follows the same procedures established under the existing voluntary notice and access model. The notice must be sent at least 40 calendar days before the shareholder meeting date, or if no meeting is to be held, at least 40 calendar days before the date that votes, consents, or authorizations may be used to effect a corporate action.

An issuer following the “notice only” option must provide shareholders with a method to vote as of the time the notice is first sent to shareholders. The final rules do not require an issuer to establish an internet voting platform. Rather, an issuer can satisfy this requirement through a variety of methods, including providing an internet voting platform, a toll-free number for voting, or a printable or downloadable proxy card on the website.

Under the “full-set delivery” option, an issuer will follow procedures that are substantially similar to the traditional means of providing proxy materials in paper. The issuer must still notify shareholders of internet availability of the proxy materials and must still post the proxy materials on an internet website.

The SEC notice and access proxy rules were established because surveys showed that issuers using only the notice and access delivery method had a lower percentage of retail shares voted by shareholders than issuers using the full-set delivery option. The content of the notice

  • is required to identify clearly and impartially each separate matter intended to be acted on and that will be considered at the shareholders’ meeting (the rules do not specify the exact language to be used);
  • need not mirror the structure or format of the proxy card;
  • is required to indicate that it is not a form for voting (commonly referred to as “proxy card”); and
  • can be accompanied with an explanation of the electronic notice and access model to promote shareholder understanding of how to access the proxy materials and how to vote.

The notice should not contain

  • materials designed to persuade shareholders to vote in a particular manner; or
  • notice of change in the method of the delivery of proxy materials for a selected group of shareholders.

The rules require soliciting persons other than the issuer to file a preliminary proxy statement within 10 calendar days after the issuer files its definitive proxy statement and to send its notice to shareholders no later than the date on which it files its definitive proxy statement with the SEC.

Electronic shareholder forums

The SEC rules facilitate the use of electronic shareholder forums (for shareholder-to-shareholder and issuer-to-shareholder communications). The rules were designed to open up new avenues for real-time communications among shareholders, and between shareholders and the companies they own.

Rule 14a-17(a) clarifies that issuers and shareholders are entitled to maintain such forums, provided they otherwise comply with federal and state securities laws and the issuer’s charter and bylaws. In summary,

  • with respect to participation in forums, Rule 14a-2(b) (6) provides an exemption from most of the proxy rules for any participant in an electronic shareholder forum provided that the communications occur more than 60 days prior to the date announced by the company for its annual or special meeting of shareholders, and the communicating party does not solicit proxy authority while relying on the exemption. A participant in an electronic shareholder forum will be eligible to solicit proxy authority after the date that the exemption is no longer available, provided that the solicitation is conducted in accordance with Regulation 14A; and
  • if the meeting date is announced less than 60 days before the meeting, then the exemption for such statements ceases to apply two days after the announcement.

Information to be furnished to security holders

Rule 14a-3 provides that “no solicitation subject to this regulation shall be made unless each person solicited is concurrently furnished or has previously been furnished with a publicly-filed preliminary or definitive written proxy statement containing the information specified in Schedule 14A or with a preliminary or definitive written proxy statement included in a registration statement filed under the Securities Act of 1933 on Form S-4 or F-4 or Form N-14 and containing the information specified in such Form.” As provided in Schedule 14A, the information required in a proxy statement depends on the action to be taken by the shareholders.

Rule 14a-3(b) requires that annual reports to security holders accompany or be sent prior to proxy statements relating to annual meetings of shareholders at which directors are to be elected, and that these reports include the following:

  1. Audited consolidated balance sheets as of the end of the two most recent fiscal years and (b) statements of income, comprehensive income (if applicable), shareholders equity, and cash flows for each of the three most recent fiscal years. The requirements of Regulation S-X must be met except for the following rules that are excluded: certain provisions of Rules 3-01 to 3-20 of Regulation S-X (for example, financial information for businesses acquired and to be acquired, separate financial statements of subsidiaries not consolidated and 50% or less owned persons, separate financial statements of guarantors, separate financial statements of affiliates whose securities serve as collateral for the registrant’s securities), Rules 11-01 to 11-03 (pro forma financial information), and 12-01 to 12-29 (financial statement schedules) of Regulation S-X.
  2. Selected quarterly financial data for the last two years (Regulation S-K, Item 302).
  3. Information regarding changes in and disagreements with accountants (Regulation S-K, Item 304(b)).
  4. Five years of selected financial data (Regulation S-K, Item 301).
  5. Management’s discussion and analysis of financial condition and results of operations (Regulation S-K, Item 303).
  6. Quantitative and qualitative disclosures about market risk (Regulation S-K, Item 305).
  7. A brief description of the business during the most recent year.
  8. Information relating to segments, classes of similar products or services, foreign and domestic operations, and export sales (Regulation S-K, Item 101).
  9. Employment information for each director and executive officer.
  10. Information regarding dividend policy, market prices, and performance graph (Regulation S-K, Item 201).
  11. A statement that the company’s Form 10-K, including the financial statements and the financial statement schedules, will be furnished free of charges upon written request.

Certain items required in the proxy statement are identical to Part III, Items 10-14 of Form 10-K (for example, the information on the audit committee financial expert). The proxy statement requirements that are not required in Form 10-K include the information covered in the following section on the nominating committee, audit committee, compensation committee, board meetings, shareholder communications, and equity compensation plans.

Information on the nominating, audit, and compensation committees

Nominating committee disclosures

Schedule 14A, Item 7 requires registrants to disclose the information required by Regulation S-K, Item 407(c) (1) and (2), including the following:

  • Whether the company has a standing nominating committee or a committee performing similar functions, and if not, why not.
  • Whether a company has a nominating committee charter, and, if so, how shareholders can obtain or review the charter (the charter may either be posted on the company’s website or provided once every three years as an appendix to the proxy statement).
  • The nominating committee’s process for identifying and evaluating nominees and any difference in the manner in which the nominating committee evaluates shareholder recommendations; and whether, and if so how, the nominating committee or the board has a policy with regard to the consideration of diversity in identifying director nominees, and describe how this policy is implemented, as well as how the nominating committee or board assesses the effectiveness of its policy.
  • Whether the nominating committee has a policy regarding consideration of shareholder recommendations, and if not, why not. If the nominating committee has a policy, companies must disclose the material elements of the policy and the procedures to be followed by shareholders in submitting recommendations.
  • Any minimum qualifications that the nominating committee believes must be met by a nominating committee-recommended nominee and any specific qualities or skills necessary for any of the director roles.
  • If the nominating committee received a recommended nominee by a shareholder or group of shareholders who have beneficially owned more than 5% of the company's voting common stock for at least one year (as of the date of the recommendation), the names of the shareholders who recommended the candidate and the name of the candidate. To trigger this disclosure requirement, the recommendation must have been received by the company no later than the 120th calendar day before the proxy statement is mailed to shareholders, and both the nominating security holder(s) and the candidate must consent to the disclosure.
  • The category of each person or entity that recommended the director nominees who are included on the company’s proxy card (for example, security holder, non-management director, CEO, other executive officer, third-party search firm, or other specified source).
  • The function of any third party who, in return for a fee, assisted in identifying or evaluating potential nominees.

If a company does not have a nominating committee, the disclosures required must be provided with respect to the group of directors functioning as the nominating committee (or the entire board, if the entire board is acting as the nominating committee).

Audit committee disclosures

Schedule 14A, Item 7 requires registrants to disclose the information required by Regulation S-K, Item 407(d) (1), (2), and (3) including

  • whether the audit committee has a charter, and, if so, how shareholders can obtain or review the charter (the charter may either be posted on the company’s website or provided once every three years as an appendix to the proxy statement);
  • whether the company has a director that is not independent as defined by the listing standards applicable to the company — for any director that is not independent, the relationship that caused of the lack of independence should be disclosed and why the board appointed the individual director; and
  • the audit committee report discussed as follows.

Audit committee report

The report must appear over the printed names of each audit committee member to emphasize to shareholders the importance of the audit committee oversight role in the financial reporting process. In the audit committee report, the audit committee must state whether it has done the following:

  • Reviewed and discussed the audited financial statements with management
  • Discussed with the independent auditors the matters required to be discussed by Public Company Accounting Oversight Board (PCAOB) Auditing Standard 1301, Communications with Audit Committees
  • Received the written disclosures and the letter from the independent auditors required by applicable requirements of the PCAOB regarding the independent accountant’s communications with the audit committee concerning independence, and discussed with the auditors the accountant’s independence
  • Recommended to the board of directors that, based on the review and discussions referred to previously, the financial statements be included in the Annual Report on Form 10-K for the last fiscal year for filing with the SEC

Compensation committee disclosures

Schedule 14A, Item 7 requires registrants to disclose the information required by Regulation S-K, Item 407(e)(1), (2), and (3) including

  • whether the company has a standing compensation committee or a committee performing similar functions, and if not, why not;
  • whether the company has a compensation committee charter, and, if so, how shareholders can obtain or review the charter (the charter may either be posted on the company’s website or provided once every three years as an appendix to the proxy statement);
  • the compensation committee’s process for considering and determining executive and director compensation;
  • any services provided by compensation consultants and fees paid if such fees exceed $120,000, when they play any role in determining the amount of executive and director compensation, if they also provide other services to the company, and whether the compensation consultants were recommended by management; and
  • whether the work of the consultant raised any conflicts of interest, and if so, how the conflict is being addressed.

Listing standards for compensation committees

The SEC adopted Rule 10-C-1 to implement Section 952 of the Dodd-Frank Act. This Rule 10C-1 implements the act’s requirement for the SEC to direct the national securities exchanges to adopt listing standards related to the compensation committees of an issuer’s board of directors as well as its compensation advisers.

A listed company must meet the following standards in order for its shares to continue trading on its applicable exchanges:

  • Each member of an issuer’s compensation committee1 must be a member of the board of directors and must be independent.2
  • Each compensation committee must have the authority to retain or obtain the advice of a compensation adviser.
  • Each compensation committee must take into account specific factors identified by the SEC that may affect the independence of the compensation adviser before hiring a compensation adviser.
  • Each compensation committee is responsible for the appointment, compensation, and work of the compensation adviser.
  • Each issuer must provide appropriate funding for the payment of reasonable compensation to a compensation adviser appointed by the compensation committee.
NASDAQ compensation committee requirement

The NASDAQ amendments resulting from Rule 10C-1 require that all listed companies, including smaller reporting companies, have a standing compensation committee comprised solely of two or more independent directors. NASDAQ also requires that all companies other than smaller reporting companies adopt a formal, written charter for the compensation committee that includes the requirements of Rule 10C-1 and review this charter annually. Smaller reporting companies may codify the responsibilities and authority of the compensation committee either in a formal committee charter or a board resolution, and would not be required to review this resolution or the committee charter annually.

Compensation committee independence standards

NASDAQ also adopted a revised independence requirement for compensation committee members regarding compensatory fees. To be considered independent, compensation committee members will not be able to accept any compensatory fees from the issuer or its affiliates, other than

  • fees for board service, and
  • payment of retirement benefits or deferred compensation for prior service with the company.

The restrictions on compensatory fees proposed by NASDAQ are not applicable to smaller reporting companies.

The NYSE amendments added to current independence standards for compensation committee members

  • the factors related to the source of committee members’ compensation and affiliations required by Rule 10C-1 (see previous); and
  • a requirement that the board consider “all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member.”

These requirements are in addition to the NYSE’s five “bright line” tests for determining independence for directors generally, and the current requirement that boards consider any other material relationships between the director and the listed company or its management. The NYSE also exempts smaller reporting companies from compliance with these new independence standards for compensation committee members.

Independence considerations for compensation committee advisers

Neither the NYSE nor NASDAQ proposed any specific additions to the six independence factors that compensation committees will be required to consider before selecting compensation consultants, independent legal counsel, or other committee advisers (advisers), other than in-house legal counsel. These factors include the following:

  1. The provision of other services to the listed company by the adviser’s employer
  2. The amount of fees received from the company by the adviser’s employer, as a percentage of the employer’s total revenue
  3. The policies and procedures of the adviser’s employer that are designed to prevent conflicts of interest
  4. Any business or personal relationship of the adviser with a member of the compensation committee
  5. Any stock of the listed company owned by the adviser
  6. Any business or personal relationship of the adviser or the adviser’s employer with an executive officer of the listed company

The NYSE amendments also include a general requirement that the compensation committee consider any other factors that would be relevant to the adviser’s independence from management.

Both the NYSE and NASDAQ amendments exempt smaller reporting companies from the requirement to conduct this independence analysis. The NASDAQ amendments emphasized, as does the SEC’s

Adopting Release for Rule 10C-1, that committees are not required to retain an independent adviser, but only to conduct the independence analysis described in the rule before selecting compensation advisers.

The amended rule also includes revisions to Item 407 of Regulation S-K to require the following additional disclosures in an issuer’s proxy or solicitation material for annual meetings at which directors are elected:

  • Whether the company retained or obtained the advice of a compensation adviser
  • Whether the compensation adviser’s work has raised any conflict of interest
  • The nature of any identified conflict of interest and how that conflict is being addressed (if applicable)

The listing standards requirements in Rule 10C-1 do not apply to smaller reporting companies. In addition, because Rule 10C-1 applies only to national securities exchanges and associations, the new listing standards will not apply to companies whose securities are quoted on the OTC Bulletin Board and the OTC Markets Group (pink sheets). In contrast, the revisions to Item 407 of Regulation S-K apply to all companies subject to the SEC’s proxy rules, including non-listed issuers and smaller reporting companies.

The release is available at www.sec.gov/rules/final/2012/33-9330.pdf.

Executive and director compensation disclosures

When stockholders are voting on the election of directors, Schedule 14A, Item 8 requires disclosure of information regarding compensation of directors and executive officers, as outlined in Item 402 of Regulation S-K. The schedule also requires disclosure of compensation committee interlocks and a compensation committee report. These disclosures are also required in Form 10-K.

This same disclosure is also required if stockholders are voting on

  • any bonus, profit sharing or other compensation plan, contract or arrangement in which any director, director nominee or executive officer will participate;
  • any pension or retirement plan in which any such person will participate; or
  • any granting or extension to any such person of options, warrants or rights to purchase any securities (other than warrants or rights issued to shareholders on a pro rata basis).

Board meeting disclosures, the board’s leadership structure, and the board’s role in risk oversight

Schedule 14A, Item 7 requires disclosure of board meeting requirements, board leadership structure, and the board’s role in risk oversight specified in Regulation S-K, Item 407(b) and (h), including

  • the number of board meetings held during the last fiscal year and the name of each director who attended fewer than 75% of the total number of board meetings and committee meetings for the committees on which the member served;
  • the company’s policy for board member attendance at the annual meeting and the number of board members who attended the prior year’s annual meeting;
  • if the company has standing audit, nominating, and compensation committees or committees performing similar functions — if so, identify each committee member, state the number of meetings held by the committees in the last year, and describe briefly the function of the committee;
  • whether and why the company has chosen to combine or separate the principal executive officer and board chairman positions, and the reasons the company believes that this board leadership structure is the most appropriate structure for the company at the time of the filing — in some companies the role of principal executive officer and board chairman are combined, and a lead independent director is designated to chair meetings of the independent directors; in these circumstances, the rules require disclosure of whether and why the company has a lead independent director, as well as the specific role the lead independent director plays in the leadership of the company; and
  • the extent of the board’s role in the risk oversight of the company, such as how the board administers its oversight function, and the effect that this has on the board’s leadership structure.

Shareholder communications disclosures

Schedule 14A, Item 7 requires the specific proxy statement disclosure requirements of Regulation S-K, Item 407(f) regarding shareholder communications with directors, including

  • whether a company has a process for shareholders to send communications to directors and, if not, why not; and
  • if a company has a process, a description of the process and, if all communications are not sent directly to the directors, a description of the process for determining which communications is sent.

Disclosures concerning the independent public accountant

When proxies are solicited in connection with an annual meeting at which directors are to be elected (including solicitations of consents or authorizations in lieu of such meeting) or in connection with the election, approval, or ratification of the independent public accountant, Item 9 of Schedule 14A requires the following disclosures in the proxy statement:

  • The name of the principal accountant selected or being recommended. If no accountant has been selected or recommended, the reasons should be discussed.
  • The name of the principal accountant for the most recently completed fiscal year, if different from the accountant currently being selected or recommended or if no accountant is currently selected or recommended.
  • A statement concerning (a) whether representatives of the principal accountant for the current year and for the most recently completed fiscal year, if applicable, are expected to be present at the meeting, (b) whether they will have the opportunity to make a statement if they so desire, and (c) whether they are expected to be available to respond to questions.
  • When there has been a change in the principal accountant or in the independent accountant at a significant subsidiary and the principal accountant has expressed reliance on such accountant during the two most recent fiscal years or any subsequent interim period, the circumstances surrounding the change must be disclosed to the same extent required in Item 4.01 of Form 8-K and Item 304(a) of Regulation S-K. This disclosure must be included in the proxy statement regardless of whether a Form 8-K has been filed.

The auditor independence rules, as captured in Item 9, require detailed disclosure concerning auditor fees and cover both the type of fees that must be detailed in proxy statements and the years covered by the disclosure. The categories of fees that must be disclosed are (a) audit fees (fees billed and expected to be billed for the fiscal year), (b) audit-related fees billed, (c) tax fees billed, and (d) all other fees billed.

The disclosures must show fees for each of the two most recent years. The fee disclosures are required only for the current auditor. The company may disclose predecessor auditor fees at its option, but should segregate those fees from the current auditor fee disclosures. Also, companies are required to describe, in subcategories, the nature of audit-related and all other services provided.

Audit fees include fees for professional services rendered for the audit of the annual financial statements and the reviews of interim financial statements as well as those normally provided by the auditor in connection with statutory and regulatory filings, even if not billed to an issuer as audit services. For example, tax services and accounting consultations, if provided in order to comply with PCAOB auditing standards, should be disclosed as audit services even if not billed to the issuer as such. In addition to services provided to conform to PCAOB auditing standards, the rules expand the types of fees that should be disclosed as audit services, to include fees for services related to comfort letters, statutory audits, attest services, consents, assistance with and review of documents filed with the SEC, and any other services that only the audit firm could reasonably provide.

Audit-related fees include services related to employee benefit plans; due diligence related to mergers and acquisitions; accounting assistance and audits in connection with proposed or consummated acquisitions; internal control reviews; and consultation concerning financial accounting and reporting standards.

The tax fees category should capture all services performed by professional staff in the audit firm’s tax division. Typically, it would include fees for tax compliance, planning, and advice.

All other fees categories would consist of all other fees paid.

The rules also require disclosure regarding audit committee actions. A company must disclose, in detail, the audit committee’s policies and procedures for approving audit and non-audit services. Alternatively, companies could include a copy of those policies and procedures with the proxy statement. Disclosure is also required about the percentage of fees reported in each category of audit-related fees, tax fees, and all other fees that were pre-approved by the audit committee pursuant to the policies and procedures disclosed. To the extent the audit committee has applied the de minimis exception, the issuer must disclose the percentage of total fees paid to the accountant where the de minimis exception was used. This information should be provided by category.

The rules require disclosure of the percentage of hours provided by individuals other than the principal accountant’s full-time permanent employees if greater than 50% of the principal account’s engagement hours to audit the issuer’s financial statements are provided by those individuals.

Knowledge check

  1. The information required by Regulation S-K Item 407, Audit Committee Financial Expert, is
    1. Required in proxy statements and in Form 10-K.
    2. Required only in Form 10-K.
    3. Required only in the proxy statement.
    4. Not required in either proxy statements or Form 10-K.
  2. The rule addressing the structure and activities of compensation committees amended the SEC’s proxy disclosure rules by requiring disclosure of
    1. Whether the company retained or obtained the advice of a compensation adviser providing they are not listed on a national exchange.
    2. Whether each member of an issuer’s compensation committee is independent and not a member of the board of directors.
    3. The audit committee’s responsibility for the appointment, compensation, and work of the compensation adviser.
    4. Whether the company retained or obtained the advice of a compensation adviser and whether the work of the compensation adviser raised any conflict of interest along with the nature of the conflict of interest.
  3. When stockholders are voting on the election of directors, the SEC requires the registrant to provide information in the proxy statement about the board of directors, compensation of directors and executive officers, the audit committee, and
    1. The independent public accountants.
    2. Properties.
    3. Risk factors.
    4. Submission of matters to a vote of security holders that occurred in the fourth quarter of the fiscal year.
  4. Under audit fees disclosure required by Item 9 of Schedule 14A, a company is required to disclose in the “audit fees” caption
    1. Audit services billed, or expected to be billed, by the principal accountant for the current and prior year.
    2. Amounts billed for audit services rendered during the fiscal year.
    3. Tax fees for services rendered and billed during the fiscal year.
    4. Audit fees billed by the current auditor and the predecessor auditor for audit services for the past two years.

Proxy statements: Voting on compensation plans

When stockholders are voting on an equity compensation plan, Item 10 of Schedule 14A requires disclosure regarding the plan as follows:

  • The material features of the plan being acted upon, each class of persons who will be eligible to participate therein, and the approximate number of persons in each such class, and state the basis of such participation
  • In the tabular format specified, the benefits or amounts that will be received by or allocated to each class of persons under the plan being acted upon, if such benefits or amounts are determinable, or if not determinable, the benefits or amounts that would have been received by or allocated to each class of persons for the last completed fiscal year if the plan had been in effect
  • If the plan to be acted upon can be amended, otherwise than by a vote of security holders, to increase the cost thereof to the registrant or to alter the allocation of the benefits, the nature of the amendments that can be so made
  • With respect to any pension or retirement plan, the approximate total amount necessary to fund the plan with respect to past services; the period over which such amount is to be paid and the estimated annual payments necessary to pay the total amount over such period; and the estimated annual payment to be made with respect to current services
  • With respect to any specific grant of or any plan containing options, warrants or rights submitted for security holder action, the title, terms, market value, tax consequences, and the amount received or to be received by class of persons

The following disclosures, as outlined in Item 201(d) of Regulation S-K, should be provided on an aggregate basis for all equity compensation plans (including individual compensation arrangements) in effect as of the end of the most recent fiscal year, even if such plans are not subject to security holder action. The information should be grouped by plans approved by security holders and plans not approved, for example:

  • Number of securities to be issued upon exercise of outstanding options, warrants, and rights
  • Weighted average exercise price of outstanding options, warrants, and rights
  • Number of securities remaining available for future issuance under equity compensation plans

The registrant must identify and describe the material features of each equity compensation plan in effect as of the end of the fiscal year that was adopted without shareholder approval.

Shareholder “say-on-pay” voting

Executive compensation of TARP recipients

Section 111(e) of the Emergency Economic Stabilization Act of 2008 (EESA) requires companies that have received financial assistance under the Troubled Asset Relief Program (TARP) to permit a separate shareholder advisory vote to approve the compensation of executives, as disclosed pursuant to the compensation disclosure rules of the SEC, during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding. The SEC amended the proxy rules for the requirements for U.S. registrants subject to Section 111(e) of the EESA.

The TARP recipients are required to have shareholders vote on executive compensation when they solicit proxies for the election of directors at an annual meeting. The vote does not bind the board of directors and will not be construed as overruling a board decision or creating or implying any additional fiduciary duty by the board. The advisory vote on executive compensation also does not limit the ability of shareholders to make proposals for inclusion in proxy materials related to executive compensation.

Exchange Act Rule 14a-20 requires registrants that are TARP recipients to provide the separate shareholder vote to approve the compensation of executives in proxies solicited during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding. The separate shareholder vote is required only when proxies are solicited in connection with an annual meeting at which directors are to be elected.

Registrants will have to disclose in Item 20 of Schedule 14A a statement that they are providing a separate shareholder vote on executive compensation pursuant to the requirements of the EESA, and to briefly explain the general effect of such vote. The vote on executive compensation required for TARP recipients was added to the list of items that do not trigger a preliminary filing requirement before definitive proxy materials are first sent to the shareholders.

Executive compensation of SEC registrants

In 2011, the say-on-pay vote described previously for TARP recipients was extended to all SEC registrants when the SEC adopted rules to implement the say-on-pay provisions of the Dodd-Frank Act. Section 951 of the Dodd-Frank Act added Section 14A to the Exchange Act, which requires companies to conduct a separate shareholder advisory vote at least once every three years to approve the compensation of executives using the same criteria as for TARP recipients (that is, the vote covers all compensation disclosed pursuant to Regulation S-K Item 402 for all named executive officers for whom such disclosure has been provided). For non-TARP recipients, Section 14A also requires companies to conduct a separate shareholder advisory vote to determine whether the issuer will conduct the shareholder advisory vote on executive compensation every 1, 2, or 3 years (“say-on-frequency”). The votes (both on executive compensation and on the frequency of voting on executive compensation) do not bind the board of directors and will not be construed as overruling a board decision or creating or implying any additional fiduciary duty by the board.

As with say-on-pay votes for TARP recipients, the vote on executive compensation required for all other issuers was added to the list of items that do not trigger a preliminary filing requirement before definitive proxy materials are first sent to the shareholders.

In addition to voting related to issuer executive compensation, Section 14A requires companies soliciting votes to approve merger or acquisition transactions to provide disclosure of certain “golden parachute” compensation arrangements (pursuant to new Regulation S-K Item 402(t)) and, in certain circumstances, to conduct a separate shareholder advisory vote to approve the golden parachute compensation arrangements.

Shareholder approval of executive compensation

Under Exchange Act Section 14A(a)(1) and Rule 14a-21(a), issuers are required, not less frequently than once every three years, to provide a separate shareholder advisory vote in proxy statements to approve the compensation of their named executive officers, as defined in Item 402(a)(3) of Regulation S-K. Rule 14a-21(a) specifies that the separate shareholder vote on executive compensation is required only when proxies are solicited for an annual or other meeting of security holders for which the rules require the disclosure of executive compensation pursuant to Item 402 of Regulation S-K.

The compensation of directors is not subject to the shareholder advisory vote. In addition, the issuer’s compensation policies and practices related to risk management and risk-taking incentives that are disclosed pursuant to Item 402(s) of Regulation S-K will not be subject to the shareholder advisory vote, as they relate to the issuer’s compensation for employees generally.

As with Item 20 for TARP recipients (explained previously), registrants are required to disclose in Item 24 of Schedule 14A a statement that they are providing a separate shareholder vote on executive compensation and to briefly explain the general effect of such vote.

Disclosure required in CD&A

Item 402(b)(1) of Regulation S-K requires issuers to address in CD&A whether and, if so, how their compensation policies and decisions have taken into account the results of the most recent shareholder advisory vote on executive compensation. Because companies with outstanding indebtedness under the TARP will continue to have an annual say-on-pay vote until they repay all such indebtedness, this disclosure is required for all registrants, including TARP recipients subject to EESA.

Shareholder approval of the frequency of shareholder votes on executive compensation

Under Exchange Act Rule 14a-21(b), issuers are required, not less frequently than once every six calendar years, to provide a separate shareholder advisory vote in proxy statements for annual meetings to determine whether the shareholder vote on the compensation of executives required by Section 14A(a)(1) “will occur every 1, 2, or 3 years.”

Issuers are required to disclose in Item 24 of the proxy statement that they are providing a separate shareholder advisory vote on the frequency of say-on-pay votes. Item 24 also requires issuers to briefly explain the general effect of this vote, such as whether the vote is nonbinding and to provide disclosure of the current frequency of say-on-pay votes and when the next scheduled say-on-pay vote will occur.

Required proxy card form

Exchange Act Rule 14a-4 provides requirements about the form of the proxy that issuers are required to include with their proxy materials. Rule 14a-4 permits proxy cards to reflect the choice of 1, 2, or 3 years, or abstain on the frequency vote. On all other matters, the proxy card provides a voting choice between approval or disapproval or an abstention with respect to each separate matter to be acted upon, other than elections to office.

Disclosure of golden parachute arrangements and shareholder approval of golden parachute arrangements

Under Item 402(t) of Regulation S-K, quantitative and narrative disclosure is required with respect to any agreements or understandings — whether written or unwritten — between each named executive officer and the acquiring company or the target company, concerning any type of compensation — whether present, deferred, or contingent — that is based on or otherwise relates to an acquisition, merger, consolidation, sale, or other disposition of all or substantially all assets.

This disclosure is required in a proxy statement soliciting shareholder approval of a merger or similar transaction or a filing made with respect to a similar transaction only of compensation that is based on or otherwise relates to the subject transaction.

The required quantitative disclosure must be presented in tabular form, as follows:

Golden parachute compensation
Name (a) Cash $ (b) Equity $ (c) Pension NQDC $ (d) Perquisites/ Benefits $ (e) Tax reimbursement$ (f) Other$ (g) Total $ (h)
PEO
PFO
A
B
C

Elements that must be separately quantified and included in the total will be any cash severance payment (for example, base salary, bonus, and pro rata non-equity incentive plan compensation payments) (column (b)); the dollar value of accelerated stock awards, in-the-money option awards for which vesting would be accelerated, and payments in cancellation of stock and option awards (column (c)); pension and nonqualified deferred compensation benefit enhancements (column (d)); perquisites and other personal benefits and health and welfare benefits (column (e)); and tax reimbursements (for example, tax gross-ups) (column (f)), and “other” for any additional elements of compensation not specifically includable in the other columns of the table (column (g)). All columns will require footnote identification of each separate form of compensation reported. The final column in the table requires disclosure, for each named executive officer, of the aggregate total of all such compensation (column (h)). Separate footnote identification of amounts attributable to “single-trigger” arrangements and amounts attributable to “double-trigger” arrangements, is required so that shareholders can readily discern these amounts.3

Item 402(t) requires issuers to describe any material conditions or obligations applicable to the receipt of payment, including but not limited to non-compete, non-solicitation, non-disparagement, or confidentiality agreements, their duration, and provisions regarding waiver or breach. In addition, a description must be provided of the specific circumstances that would trigger payment; whether the payments would or could be lump sum, or annual, and their duration; by whom the payments would be provided; and any material factors regarding each agreement. The narrative disclosures required by Item 402(t) are modeled on the narrative disclosure required with respect to termination and change-in-control agreements.

Pay ratio disclosure

In August 2015, the SEC adopted a rule mandated by Section 953(b) of the Dodd-Frank Act. The rule amended Item 402 of Regulation S-K and requires issuers to disclose

  • the median annual total compensation of all employees except the CEO;
  • the annual total compensation of the CEO; and
  • the ratio of the median annual total compensation of all employees to the annual total compensation of the CEO.

These disclosures are collectively referred to as the “pay ratio” disclosures and are intended to help inform shareholders when evaluating a CEO’s compensation.

The pay ratio rule permits the use of estimates, assumptions, and statistical sampling to determine the median employee. In September 2017, the SEC adopted interpretive guidance that states the SEC will not take enforcement action that challenges a registrant’s pay ratio disclosures if the estimates have a reasonable basis and are made in good faith. The interpretive guidance also clarifies that

  • the consistently applied compensation measure used to calculate the median employee may be derived from existing internal, such as tax or payroll, records even if those records do not include every element of compensation, for example, equity awards; and
  • the determination of workers that meet the definition of an employee may be drawn from pre-existing published guidance under employment or tax laws.

Companies are required to provide the pay ratio disclosures for their first fiscal year beginning on or after January 1, 2017.

Other rules required by the Dodd-Frank Act

The Dodd-Frank Act also requires the SEC to adopt other rules regarding executive compensation and the manner in which a corporation is governed.

Director and employee hedging policies. Section 955 requires issuers to disclose whether directors and employees are permitted to hedge against a decrease in value of equity securities granted as compensation. In December 2018, the SEC adopted a rule that requires companies to disclose whether they have adopted practices or policies regarding the ability of employees (including officers) and directors to hedge the company’s equity securities. If no such policies exist, the company must disclose that fact or indicate that hedging transactions are generally permitted. These disclosure requirements are effective for registrants other than smaller reporting companies and emerging growth companies for fiscal years beginning on or after July 1, 2019. Smaller reporting companies and emerging growth companies must provide these disclosures for fiscal years beginning on or after July 1, 2020.

Additionally, the following rule proposals have not yet been finalized:

Pay-for-performance. Section 953 requires issuers to disclose executive compensation compared to stock performance charted over a five-year period (“pay-for-performance”). The SEC proposed the pay- for-performance disclosures in April 2015, but has not released the expected timing of the final rule.

Compensation clawback policies. Section 954 requires the SEC to direct the exchanges to adopt listing standards that require issuers to develop and implement compensation clawback policies under which they must recover incentive-based executive compensation paid over a three-year look-back period if the issuer has a material accounting restatement. These rules were proposed in July 2015.

Proxy filing requirements

Rule 14a-6 requires that preliminary copies of the proxy statement and related materials be filed with the SEC at least 10 calendar days prior to the date definitive copies of such material are first sent or given to shareholders. Such materials should be appropriately marked as “Preliminary Copies” and the date that definitive materials are to be mailed to the shareholders must be stated in the filing. Earlier submission (usually more than 20 days) is advisable to allow time for any changes that may be required as a result of the SEC’s selective review process.

The SEC has provided some relief in the area of proxy material review. Preliminary proxy materials need not be filed with the SEC if the solicitation relates to an annual meeting (or special meeting in lieu of the annual meeting) of shareholders where the only matters to be voted on are

  • the election of directors;
  • the election, approval, or ratification of accountants;
  • a shareholder proposal;
  • the approval or ratification of certain compensation plans (that is, restricted stock, SARs, or stock options) or amendments to such plans (this exemption, however, does not extend to the approval of awards made pursuant to such plans);
  • with respect to a registered investment company or business development company, a proposal to continue, without change, any advisory or other contract or agreement that has been the subject of a proxy solicitation for which proxy material has previously been filed;
  • with respect to an open-end registered investment company, a proposal to increase the number of shares authorized to be issued;
  • a shareholder nominee for director included pursuant to 14a-11; or
  • a vote to approve the compensation of executives as required pursuant to Section 14A(a)(1) or Section 111(e)(1) of the EESA.

Information in preliminary proxy material will be made available for public inspection upon filing unless confidential treatment is obtained. Any action taken under Item 14 of Schedule 14A (mergers, consolidations, acquisitions and similar matters) is afforded confidential treatment provided the proxy does not involve a roll-up transaction and the material is clearly marked “Confidential, For Use of the Commission Only.” In such cases, the proxy will not be available to the public until it is filed with the SEC in definitive form.

Before the registrant files the preliminary material, the accountant should read the entire text and compare it with the financial statements. This procedure is intended to avoid inconsistencies and misleading comments of which the accountant may have knowledge.

Proxies are required to be submitted electronically. If a proxy is being filed with an S-4 (joint proxy statement or prospectus), signatures for the electronic submission are in typed form rather than manually signed. Manually signed pages (or other documents acknowledging the typed signatures) must be obtained prior to the electronic filing. The registrant must retain the original signed document for a period of five years after the filing of the related document and provide it to the SEC or the staff upon request.

In the unusual circumstances that the audit has not been completed by the time of the filing, the SEC requires that a letter from the independent accountant, addressed to the registrant, accompany the preliminary material. The accountant should state in the letter that he has read the preliminary proxy statements and will allow, upon completion of the audit, use of the report on the financial statements. The financial statements covered by the report, and the date of the report, should also be specified in the letter. When preparing the letter, the accountant should avoid using general terms such as considered or reviewed in describing the work, and avoid expressing approval, either directly or indirectly, concerning the sufficiency of disclosures in the text. When a proxy statement is prepared for a proposed merger, the letter should relate only to the company with which the accountant is familiar. (An example of an accountant’s letter to a registrant is included as example 8-1.)

Copies of the definitive material mailed to stockholders should be filed with the SEC no later than the date such material is mailed to the stockholders.

If changed circumstances or new events arising between the time the proxy solicitation is mailed and the stockholders’ meeting date cause the proxy material to be materially false and misleading, the amended or revised proxy should be disseminated promptly to the stockholders and to the SEC (with markings clearly indicating the changes).

Knowledge check

  1. Under Regulation 14A Rule 14a-6, when preliminary proxy statements are required, they must be filed with the SEC along with related materials at least
    1. Ten calendar days prior to the date that definitive copies of such material are first sent to shareholders.
    2. Twenty days or more prior to the date definitive copies are sent to shareholders.
    3. Twenty days prior to the meeting date.
    4. Thirty days prior to the meeting date.
  2. A proxy statement involving a proposed merger for which shareholder vote is required must include the information required by
    1. Item 9 of Schedule 14A.
    2. Item 10 of Schedule 14A.
    3. Item 11 of Schedule 14A.
    4. Item 14 Schedule 14A.
  3. Before the registrant files the preliminary proxy material, the independent accountant should
    1. Read the entire text and compare it with the financial statements.
    2. Do nothing.
    3. Review only the sections related to the independent public accountant’s audit fees and the ratification of the independent accountant.
    4. Issue an audit opinion on all financial information contained in the proxy material.

Shareholder director nominations

For more than a decade, the SEC has debated taking action to make it easier and less expensive for small but substantive groups of shareholders to nominate director candidates. Certain business organizations object to this action and have questioned the authority of the SEC to make rules affecting this process. The Dodd-Frank Act provided the SEC with explicit authority to address director nominations, and in 2010, the SEC adopted changes to its proxy and other rules to facilitate the rights of shareholders to nominate directors to a company’s board. The SEC’s action was controversial. The SEC adopted the rules in a 3-2 vote after receiving 715 comment letters.

In September 2010, the controversy continued when the Business Roundtable and the U.S. Chamber of Commerce petitioned the U.S. Court of Appeals to review the SEC’s proxy access rule. In response, the SEC ordered a stay that stopped the rules from taking effect until the court renders its decision.

In July 2011, the U.S. Court of Appeals vacated the proxy access rule (Rule 14a-11) the SEC had adopted in 2010 to facilitate the rights of shareholders to nominate directors to a company’s board, and subsequently the SEC confirmed that it would not appeal the court’s decision. In September, the SEC issued Release 33-9259, notifying registrants that the amendments to Rule 14a-8 and the other rules finalized with Rule 14a-11 become effective September 20, 2011.

The amendments to Rule 14a-8 facilitate shareholders’ ability to adopt bylaw changes that allow them to include their nominees in a company’s proxy materials. Rule 14a-8 is different than Rule 14a-11 because it provides proxy access to shareholders only at companies whose shareholders adopt bylaw changes. Rule 14a-11 would have provided proxy access to shareholders at all companies without such bylaw changes. Rule 14a-8 as amended requires companies to include in proxy materials shareholder proposals that would amend a company’s bylaws governing proxy access if the proposals do not conflict with SEC proxy rules, state law, or federal law. Shareholders must own at least $2,000 in market value, or 1%, whichever is less, of the company’s shares for at least one year to be eligible to make a proposal to change company bylaws. If the proposal is approved, shareholders would have access to the director ballot in the following year.

In October 2016, the SEC proposed amendments to the federal proxy rules to require the use of universal proxies in all non-exempt solicitations in connection with certain contested elections of directors. As proposed, the universal proxies would include the names of both registrant and dissident nominees and thus allow shareholders to vote by proxy in a manner that more closely resembles how they can vote in person at a shareholder meeting (shareholders currently voting by proxy can be limited to the selection of candidates provided by the party soliciting the shareholder’s proxy). The SEC also proposed amendments to the form of proxy and proxy statement disclosure requirements to clearly specify the applicable voting options and voting standards in all director elections. Comments on the proposal were due in January 2017.

Shareholder proposals

Regulation 14A permits shareholders to submit proposals for action at a forthcoming meeting of the shareholders. Rule 14a-8 establishes the guidelines for such proposals. It is structured in the form of answers to series of questions, which shareholders would typically have when desiring to submit a proposal for inclusion in a company’s proxy statement.

To submit a proposal, a shareholder must beneficially own at least 1% of the company’s voting shares or shares with a market value of $2,000 for at least one year (and continue to own such shares through the meeting date). No more than one proposal and an accompanying supporting statement, limited to 500 words, may be submitted for each meeting. A proposal that is to be presented at an annual meeting must be received at the registrant’s executive offices no less than 120 calendar days in advance of the release of the proxy statement to the shareholders.

Question (9) of Rule 14a-8 lists 13 bases on which companies may rely to exclude a shareholder’s proposal. Shareholder proposals may be omitted from the proxy statement by the registrant for various reasons, including but not limited to the following: (1) the proposal would violate any state, federal or foreign laws; (2) the proposal is contrary to any of the SEC’s proxy rules and regulations (which prohibit false or misleading statements); (3) the proposal relates to operations that account for less than 5% of the registrant’s total assets and net earnings and gross sales for its most recent fiscal year; (4) the proposal deals with a matter relating to the conduct of the registrant’s ordinary business operations; (5) the proposal relates to the specific amount of cash or stock dividends; (6) the proposal relates to a personal claim or grievance against the registrant, (7) the proposal relates to the election to board of directors, or (8) the proposal is counter to a proposal being submitted by the registrant. If a proposal deals with substantially the same subject matter as a prior proposal submitted to the shareholders in a proxy statement for an annual meeting or a special meeting held within the last five years, it may be omitted by the registrant if it failed to meet certain criteria. Specifically, the proposal can be omitted if it was presented at one meeting and received less than 3% of the vote; at two meetings and received less than 6% of the vote in the second submission; and at three meetings and received less than 10% of the vote in the latest submission.

The SEC, in practice, has revised some of its views on what shareholders’ proposals may be omitted from the proxy statement and is now less inclined to grant a company permission to leave an item out. In particular, the SEC reversed its long-standing views on shareholder proposals relating to executive compensation, and now believes that these are appropriate subjects for shareholder votes. The SEC published in Staff Legal Bulletin (SLB) No. 14A its views on shareholders proposals relating to equity compensation plans that would potentially have a dilutive effect. Although in the past the SEC staff took the view that proposals of this nature could be excluded because they relate to general employee compensation, which is an ordinary business matter, in SLB 14A, the staff stated that the matter of executive compensation has become a significant social policy issue that is widely debated and thus can no longer be considered excludable as an ordinary business matter.

(The SEC has subsequently issued SLB 14B, SLB 14C, SLB 14D, SLB 14E, SLB 14F, and SLB 14G to provide further guidance with respect to its shareholder proposal rule [discussed later in this chapter] and to clarify and update the staff’s guidance provided in SLB 14 and 14A.)

Shareholder proposals regarding say-on-pay

As discussed previously, the SEC adopted rules to implement the say-on-pay provisions of the Dodd- Frank Act, requiring companies to conduct a separate shareholder advisory vote at least once every three years to approve the compensation of its named executive officers. Section 14A also requires companies to conduct a separate shareholder advisory vote to determine whether the issuer will conduct the shareholder advisory vote on executive compensation every one, two, or three years.

In conjunction with these rules, the SEC has added a note to Rule 14a-8(i)(10) to permit the exclusion of a shareholder proposal that would provide a say-on-pay vote, seeks future say-on-pay votes, or relates to the frequency of say-on-pay votes in certain circumstances if, in the most recent shareholder vote on frequency of say-on-pay votes, a single frequency (that is, one, two, or three years) received the support of a majority of the votes cast and the issuer has adopted a policy on the frequency of say-on-pay votes that is consistent with that choice.

For example, if in the first vote a majority of votes were cast for a two-year frequency for future shareholder votes on executive compensation, and the issuer adopts a policy to hold the vote every two years, a shareholder proposal seeking a different frequency could be excluded so long as the issuer seeks votes on executive compensation every two years.

Similarly, a shareholder proposal that would provide an advisory vote or seek future advisory votes on executive compensation with substantially the same scope as the say-on-pay vote required by Rule 14a-21(a) is subject to exclusion if the issuer adopts a policy on frequency that is consistent with the majority of votes cast.

In light of the nature of the frequency vote — with three substantive choices — it is possible that no single choice will receive a majority of votes and that, as a result, there may be issuers that may not be able to exclude subsequent shareholder proposals regarding say-on-pay matters, even if they adopt a policy on frequency that is consistent with plurality of votes cast.

Proxy statements: Financial information

When solicitations are made by management for the election of directors, the proxy statement must be preceded or accompanied by an annual report to stockholders that includes financial statements as discussed previously. An accountant’s consent is not required to be filed with a proxy statement unless it is included in or incorporated by reference to a registration statement.

Additionally, for certain other proxy solicitations, pro forma financial statements must be prepared in accordance with Rules 11-01 to 11-03 of Regulation S-X, if any of the following conditions exist:

  • During the latest year or subsequent interim period, the registrant purchased a significant business or a significant interest in a business accounted for by the equity method.
  • After the most recent balance-sheet date, the registrant acquired a significant business in a purchase transaction, or consummation of such a transaction is probable.
  • Securities being registered are to be offered to the stockholders of the acquired company, or the proceeds from the sale of the securities are to be used in a significant business acquisition.
  • Disposition of a significant portion of the business has occurred or is probable and is not fully reflected in the historical financial statements.
  • The registrant was part of another business (for example, division or subsidiary).
  • Other significant events have occurred or are probable (for example, reorganization, debt refinancing).

In addition, interim financial statements may also be required to comply with the age of financial statements requirements outlined in Rule 3-12 of Regulation S-X.

Issuance or modification of securities

If action is to be taken regarding (1) authorization or issuance of securities other than for exchange or (2) modification of securities, the financial statements that would be required in a registration statement (Form S-1 or S-3) must be included in the proxy statement or under certain conditions, incorporated by reference. Such financial statements must satisfy the requirements of Regulation S-X, including financial information required by Rule 3-05 and Rules 11-01 to 11-03 of Regulation S-X with respect to transactions other than the matter under vote; however, no Regulation S-X financial statement schedules are required, except those for insurance companies, certain real estate companies and management investment companies prescribed by Rules 12-12 through 12-14, 12-15, 12-28, and 12-29 of Regulation S-X.

Mergers, consolidations, acquisitions, and similar matters

Proxies may be solicited for mergers, consolidations, acquisitions, and similar matters. In such cases, the general financial statement requirements of the registrant and the other company may be the same as those mentioned in the preceding paragraph except that the acquirer would have to present financial statements for only the latest two fiscal years and interim periods. The SEC amended Section 14A to require companies soliciting votes to approve merger or acquisition transactions to provide disclosure of certain “golden parachute” compensation arrangements and, in certain circumstances, to conduct a separate shareholder advisory vote to approve the golden parachute compensation arrangements. See the previous discussion of the amended rules.

The SEC adopted revisions to the rules and regulations applicable to takeover transactions. The rules were intended to balance, simplify, and centralize the disclosure requirements, and eliminate regulatory inconsistencies in mergers and tender offers. Most importantly, the rules updated and reduced the financial statement requirements in certain takeover transactions.

Cash merger

Financial statements and other information about the acquirer in a cash merger is required only if the information is material to the shareholders’ evaluation of the transaction. Such information generally would not be needed when the consideration is solely cash and the acquirer has demonstrated that it is financially able to satisfy the terms (that is, the offer is not subject to any financing condition); however, if considered material, that is, the target shareholders are voting and financing is not assured, such information is required. Financial statements and other information about the target in a cash merger are required only if the acquirer’s shareholders are voting on the transaction. The following table outlines the financial statement requirements for the acquirer and the target depending on which shareholders are voting.

  Financial statements
Voting shareholders Required Not required
Acquirer only Target financial statements that comply with Regulation S-X
3 years plus interims 		Acquirer financial statements Pro forma information
Target only Acquirer financial statements if acquirer has not demonstrated that it is financially qualified to meet the terms of the transaction
2 years plus interims 		Target financial statements
Acquirer financial statements and pro forma information if acquirer is financially qualified

Target financial statements are required to be audited when the target is a public company. If the target is a nonreporting company, then financial statements for the latest fiscal year must be audited if practicable. The nonreporting target’s financial statements for prior years need not be audited if they were not previously audited.

Stock mergers

Financial statements for targets not subject to the SEC’s reporting requirements (that is, nonreporting company) are generally not required if the acquirer’s shareholders are not voting on the transaction. In such situations, the target’s shareholders would not expect to receive the same level of information required for a public reporting company and would most likely rely on the acquirer’s financial statements for voting or investment decisions. If the target’s significance to the acquirer as determined under Rules 3-05 and 1-02(w) of Regulation S-X is more than 20%, financial statements are required.

The following table summarizes the financial statement requirements based on the filing status of the target, whether the acquirer shareholders are voting, and the significance of the target.

Filing status of the target Are the acquirer shareholders voting? Target significant at or above the 20%? Target financial statements requirements
Registrant N/A N/A 3 years plus interims under Regulation S-X4
Nonreporting Yes N/A 3 years plus interims under Regulation S-X4
Nonreporting No Yes Latest year — GAAP financial statements Previous one or two years — GAAP financial statements if the target has provided its shareholders with these statements
Nonreporting No No Not required5

Additionally, to the extent financial statements for the nonreporting target are required, the financial statements for the latest fiscal year must be audited only to the “extent practicable,” and audited financial statements are not required for years before the most recent fiscal year if such statements had not previously been audited. This relief does not apply if the proxy statement is included in a Form S-4 filing and any of the securities are to be offered to the public by a person deemed to be an underwriter. In those cases, audited financial statements are required for the periods determined by Rule 3-05 of Regulation S-X.

Actions taken with respect to the types of transactions identified here also require the inclusion of certain financial data and statements (pro forma as well as historical). The specific requirements are described in the following text.

Financial data

The following additional financial data, for both the registrant and, in merger proxies, the other company, must be included in the proxy statement:

  • Selected financial data (Item 301 of Regulation S-K) and if material, selected financial data on a pro forma basis, giving effect to the transaction (except as noted in previous text).
  • Historical and pro forma:
    • Book value per share as of the date of the financial data presented.
    • Cash dividends declared per share for the periods for which financial data is presented.
    • Income (loss) per share from continuing operations for the periods for which financial data is presented.

The historical and pro forma per share information must be disclosed in a comparative, columnar form. If securities are to be issued in an exchange of shares, pro forma per share data must be presented for the registrant and for the other company on an “equivalent” pro forma basis. Equivalent pro forma per share amounts are calculated by multiplying the pro forma amount (for the registrant) by the exchange ratio. Cash dividends and income (loss) from continuing operations per share amounts are required for the most recent fiscal year and interim period. Book value per share is required only for the most recent balance-sheet date.

Historical and pro forma financial statements

Consummation of proposed acquisitions may depend on acceptance by a minimum percentage of stockholders. Likewise, it may depend on stock prices remaining within a specified range with the final number of shares exchanged based on the market prices at the date of consummation. In these situations, even if the requirements are met, the number of shares ultimately offered in the exchange can affect the pro forma financial statements and per share data. In such cases, the SEC may require footnotes to the pro forma financial statements (and the selected financial data) reflecting different assumed percentages of acceptance or exchange ratios.

When many companies are targeted for acquisition, the SEC may permit the grouping of similar offerees in the pro forma financial statements, rather than requiring separate pro forma presentation of each combination. A note should explain the various transactions and disclose the maximum variances in the pro forma financial information that could occur for any of the possible combinations. For any transaction that requires shareholder approval in the proxy, the effects of that transaction must be separately disclosed.

In the event an acquiring company is contemplating changes in the accounting policies of a company to be acquired, the pro forma financial statements should reflect pro forma adjustments to the company’s operations based on the accounting basis to be adopted, with appropriate disclosure.

The SEC may permit the omission of any financial statements or require additional ones, depending on the circumstances. The criterion for this decision is whether the financial statements to be added or omitted are “necessary for the exercise of prudent judgment in regard to any matter to be acted upon.”

In addition to pro forma financial and historical financial information regarding the transaction being voted on, pro forma and historical financial statements of other acquired businesses may also be required. As previously discussed, historical financial statements of significant acquired businesses and related pro forma information are not required in a Form 8-K until 75 calendar days after an acquisition is consummated. Although this timetable generally applies to proxy statements and 1933 Act registration statements, sometimes information for certain acquisitions must be presented in such filings sooner. Generally, proxy statements and 1933 Act registration statements are required to present information required by Rule 3-05 and 11-01 to 11-03 of Regulation S-X. Under those rules, historical and pro forma financial statements may be required in proxy and registration statements not only for consummated past acquisitions but also for probable future ones, as follows:

  • Historical and pro forma financial statements of businesses acquired or to be acquired must be provided in proxy and registration statements as soon as the acquisition becomes probable if the significance of the acquiree exceeds the 50% level.
  • In addition, if the aggregate significance of all probable and completed insignificant acquisitions since the date of the registrant’s most recent audited balance sheet exceeds 50%, audited financial statements for a majority (measured based on significance level) of the insignificant acquirees must be provided.

Concluding whether a transaction is probable is highly judgmental. The SEC provides little guidance in this area, except to say that consummation of a transaction is probable when the registrant’s financial statements alone would not provide enough information for the reader to make investment decisions.

Historical and pro forma financial statements — Sale of a business

In proxy statements soliciting authorization for the disposal of a significant business, the registrant (seller) should include its audited financial statements for each of the two most recent fiscal years plus unaudited interim periods. Unaudited financial statements of the business to be disposed should be included for the same periods. The registrant should include pro forma financial information giving effect to the disposal for the latest complete fiscal year and subsequent interim period; if the disposal qualifies as a discontinued operation, the pro forma operating information should be presented for each of the past two years and interim periods. If three years plus interim historical financial statements are presented, then for discontinued operations, the pro forma financial statements should include three years plus interim periods. If consideration received by the registrant (seller) for the disposal includes unregistered securities of the acquirer, the acquirer’s audited financial statements may need to be provided for each of the two most recent fiscal years plus unaudited interim periods.

Summary information

The SEC staff generally requires presentation of a summary section at the beginning of the proxy statement for mergers and acquisitions. This summary section should contain the following information (together with cross-references to more detailed discussions in the body of the prospectus):

  • General information about the purpose of the solicitation, date and place of meeting, securities entitled to vote, record date, and appraisal rights, and a brief description of the securities being offered
  • A brief description of the transaction and the terms of the transaction agreement
  • A brief outline of the proposals to be voted upon, including the exchange rates
  • A summary of the tax consequences
  • A brief identification of the businesses of the parties to the transaction and a description of companies’ status, business, and corporate existence following the transaction
  • Information about the management of the surviving company, including the status of present management of the companies
  • Comparative stock prices for an appropriate period
  • Comparative net income, dividends, and book values per share on a historical and pro forma combined basis

Knowledge check

  1. In merger proxies, financial per share data for both the registrant and the other company that must be included in a proxy statement includes
    1. Historical per share data only.
    2. Historical and pro forma per share data.
    3. Not required for the other company.
    4. Pro forma per share data only, calculated on an equivalent pro forma basis.
  2. The SEC generally requires a summary section in the proxy statements for merger and acquisitions that includes
    1. Compensation of executives.
    2. Summary of the tax consequences.
    3. Compensation plan summary.
    4. A financial forecast for the combined entity.

Tender offers

In a cash tender offer, the bidder is required to provide financial statements when its financial condition is material to a security holder’s decision about holding the securities — whether the condition is material is a legal matter. Financial statements of the bidder often are required, especially if only a portion of the outstanding securities will be acquired. This is because those statements may be relied on by the holders of the target-company securities to evaluate their minority-interest position if they retain their shares in the target.

Financial statements of a bidder are not required to be provided if the bidder

  • makes a cash only offer,
  • makes an offer not subject to a financing condition, and either
    • the bidder is a public reporting company, or
    • the bidder makes an offer for all outstanding securities of the target.

If the bidder is required to provide financial statements, then the following information is required:

  • Audited financial statements for the latest two fiscal years
  • Unaudited balance sheets, comparative year-to-date income statements and related earnings per share data, statements of cash flows, and comprehensive income

In a tender offer that consists of all or partly registered securities, the requirements, including the financial statement requirements, follow the requirements of Form S-4.

If the bidder is a registrant that is subject to the periodic reporting requirements, then it may incorporate its financial statements by reference.

Review questions

  1. What is a proxy statement and why is it used?

     

     

  2. What is the major distinction between a proxy statement and other SEC filings?

     

     

  3. Why are annual reports generally included in proxy statement mailings to the shareholders?

     

     

  4. What SEC requirements have a major effect on the timing of proxy solicitations?

     

     

  5. What are the requirements for filing proxy information with the SEC?

     

     

  6. What information must be included in the “summary section” at the beginning of a proxy statement when a merger is proposed?

     

     

  7. Select the Schedule 14A proxy statement item that includes a requirement for disclosure of the process by which shareholders can communicate with directors.
    1. Item 6.
    2. Item 7.
    3. Item 8.
    4. Item 13.
  8. Under which proxy statement item must a company furnish information regarding the compensation committee?
    1. Item 5.
    2. Item 7.
    3. Item 8.
    4. Item 13.

Notes

  1. 1   The rule applies to any committee of the board that performs functions typically performed by a compensation committee (including executive compensation oversight), whether or not the committee is formally designated as a compensation committee.
  2. 2   Limited partnerships, companies in bankruptcy proceedings, registered open-end management investment companies, and foreign private issuers who disclose why they do not have an independent compensation committee are exempt from the independence requirement.
  3. 3   A “single-trigger” arrangement is an arrangement where the amounts payable are triggered by a change-in-control for which payment is not conditioned upon such a termination or resignation of the executive officer. In a double- trigger arrangement, amounts payable are triggered by a change-in-control for which payment is conditioned upon the executive officer’s termination without cause or resignation for good reason within a limited time period following the change-in-control.
  4. 4   Two years plus interims if a smaller reporting company.
  5. 5   Registrants are required to evaluate individually significant acquisitions in the aggregate under Regulation S-X, Rule 3-05. If the 50% significance level is reached in the aggregate, the registrant must present audited GAAP financial statements for a majority of the acquired entities for the most recently completed fiscal year and interim period.
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