The rapid evolution of corporate governance trends witnessed in the United States over the past few years is expected to continue in 2023. As corporations grapple with complex corporate governance matters including environmental, social and governance (ESG) issues, cybersecurity, and cryptocurrency, they will also continue to face volatile economic conditions, supply chain disruptions, and workforce challenges.
During this period of heightened regulatory scrutiny, proactive corporations that anticipate and manage these rapidly changing trends can mitigate risk exposure, volatility, and shareholder and stakeholder concerns, thereby positioning themselves for success in today's competitive business landscape. Below are several key issues to watch in the new year.
Increased Activist Activity
Economic uncertainty, a volatile political climate, and declining equity values are expected to fuel activist investor engagement in 2023. The Securities and Exchange Commission's (SEC) recent rule change concerning universal proxy cards will facilitate activist engagement in director election proxy fights moving forward. Under this new rule, after August 31, 2022, proxy cards in contested director elections must include the names of all nominees of each side in the contest, including any proxy access nominees. The new rule also establishes notice and filing deadlines for both registrants and dissidents and prescribes formatting and presentation requirements for universal proxy cards.
These amendments make it easier and less costly for activists to put forward their own director nominees. When combined with the savvy use of social media tools, the SEC's new proxy card rule may substantially enhance activists' ability to mount cost-effective and successful proxy fights going forward that are less constrained by the formal requirements of elections in years past. This will increase pressure on companies to pay close attention to corporate governance matters, such as ESG issues, select viable nominees, and then effectively "make the case" for each nominee's election—particularly since the new proxy card requirements enhance shareholders' ability to select a combination of company and dissident nominees.
Investors and stakeholders are becoming increasingly aware of the impact of a company's operations on the environment and society, and they are demanding that companies take a more active role in addressing these issues. This trend will likely lead to increased pressure on companies to adopt more sustainable business practices and to disclose more information about their ESG performance.
On March 21, 2022, the SEC published its highly anticipated rule proposal requiring public companies to make new climate-related disclosures. The proposed new disclosures, which would be required in registration statements and periodic reports, include information about climate-related risks that are reasonably likely to have a material impact on a company's business, results of operations, or financial condition. The proposed rule would also require certain climate-related financial statement metrics in a note to companies' audited financial statements. The SEC is expected to finalize the rule in early 2023. Nonetheless, companies can start preparing for the proposed climate disclosures now by assessing their material climate-related risks and working to develop governance and reporting structures to address them.
The SEC's climate disclosure rule will be finalized even as the SEC has continued to step up its ESG enforcement. The SEC brought several enforcement actions alleging misleading ESG-related disclosures in 2022, and corporations should carefully verify the accuracy of all public statements related to ESG, as increased scrutiny is expected to continue.
Board Diversity and Inclusion Initiatives
In considering director nominations for 2023, boards should strive for diverse combination of knowledge, experiences, and backgrounds, being mindful that efforts to maintain or improve diversity may need to be recorded and disclosed.
Nasdaq's board diversity rule, which was approved by the SEC in 2021, requires listed companies to publicly disclose the diversity of their boards, either in annual proxy statements or on their websites. Additionally, by 2025 or 2026, depending on their listing tier, most Nasdaq-listed companies will have to have, or explain why they do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+. This summer, the Fifth Circuit Court of Appeals heard oral arguments in a lawsuit challenging the Nasdaq board diversity rule, but the court has not yet issued a decision.
In October, the SEC adopted final rules mandated by the Dodd-Frank Act concerning clawbacks of erroneously awarded incentive-based compensation from any current or former executive officers. Under new Rule 10D-1, if an issuer is required to prepare an accounting restatement, including to correct an error that would result in a material misstatement if the error were corrected in the current period (known as "Big R" restatements) or left uncorrected in the current period (known as "little r" restatements), the issuer must now recover any erroneously awarded incentive-based compensation paid, earned, vested, or granted to any current or former executive officers during the three years preceding the date of the required restatement. The amount that the issuer is charged with recovering is the amount of incentive-based compensation received in excess of the amount that otherwise would have been received based upon the restated financial measure. This clawback is required irrespective of whether the executive officer engaged in any misconduct or is at fault for the issue(s) requiring the restatement.
This new rule also compels national securities exchanges and associations to establish listing standards that require compliance with this new rule and imposes new disclosure obligations on the exchanges and the issuers. Exchanges must mandate disclosure of the policy, and issuers must also file their recovery policies as an exhibit to their Form 10-K. To date, no compliance exemptions to the new rule have been provided for smaller reporting companies, emerging growth companies, or foreign private issuers.
While most public companies have clawback policies in place, such policies must still be reviewed to ensure compliance with the SEC's new rule. Such reviews are all the more imperative for companies that have previously operated under the benefit of certain exemptions. These new rules take effect January 27, 2023, with exchanges required to file proposed listing standards one month later. The new listing standards must take effect no later than November 28, 2023, and issuers will be required to adopt a clawback policy no later than 60 days following the date on which the new listing standards become effective on the exchange.
In March 2022, the SEC proposed new rules concerning cybersecurity risk management, strategy, governance, and incident disclosure. The proposed amendments would require, among other things, current reporting about material cybersecurity incidents and periodic reporting to provide updates about previously reported cybersecurity incidents. The proposal also would require periodic reporting about a registrant's policies and procedures to identify and manage cybersecurity risks; the registrant's board of directors' oversight of cybersecurity risk; and management's role and expertise in assessing and managing cybersecurity risk and implementing cybersecurity policies and procedures. The proposed rule would also mandate annual reporting or certain proxy disclosure about the board of directors' cybersecurity expertise, if any.
The SEC is expected to finalize the rules in 2023. In the meantime, companies should evaluate their procedures for evaluating cyber risks, as well as their boards' skills and experience in handling such matters.
Incorporating Rapidly Developing Technology into Business Processes
While the events surrounding FTX Trading Ltd. may have dampened companies' appetites to become eager new-adopters of cutting-edge but unproven business technologies, the use of blockchain, smart contracts, artificial intelligence (AI), and machine learning (ML) in various aspects of a company's business and operations will continue to grow in 2023.
Blockchain technology, the foundation of cryptocurrencies like Bitcoin, is a decentralized, digital ledger that records transactions across a network of computers. This allows for secure and transparent transfer of assets without the need for intermediaries. Smart contracts, which are self-executing contracts with the terms of the agreement written into lines of code, can be built on blockchain technology to automate various business processes. AI and ML, on the other hand, are technologies that enable machines to learn and make decisions without human intervention. As with any new technology, companies must evaluate their procedures for new risks introduced by the incorporation of these new technologies and ensure that their boards can adequately respond to any incident stemming from the use of these technologies.
Exculpation of Officers
Effective August 1, 2022, Section 102(b)(7) of the Delaware General Corporation Law (DGCL) was amended to authorize exculpation of certain corporate officers of Delaware corporations from personal liability for monetary damages related to breaches of their fiduciary duty of care. The amendment seeks to place officers and directors, who have long enjoyed exculpation from personal liability for monetary damages associated with breaches of the duty of care, on more equal footing.
Importantly, corporations must take action to avail themselves of the new law. For public corporations, implementation typically requires an amendment to the corporation's certificate of incorporation. It is important to note that the new officer exculpation provisions may not apply to an officer's breach of the duty of loyalty, and exculpation is not available for derivative claims brought by stockholders on behalf of the corporation.
Corporations should also be aware that the Department of Justice (DOJ) is increasing scrutiny of director interlocks. Under Section 8 of the Clayton Act, no person shall serve as the director or officer of two corporations when those corporations have capital of more than $41,034,000 or the companies have competitive sales of $4,103,400, subject to limited exceptions.
In announcing in October that it required the resignations of several directors who were simultaneously serving on the corporate boards of competitor companies, the DOJ's Antitrust Division signaled that increased enforcement of Clayton Section 8 would continue. Accordingly, boards should be proactive in determining whether any of their directors are serving on a competitor's board or on the board of a company that could foreseeably become a competitor.
Next Steps for Corporations
Clear communication among directors, senior executives, and investors—always at a premium—is even more imperative now as companies face growing risks and challenges in an increasingly volatile environment. Corporations must be mindful that public statements which have not been carefully considered, in particular, statements pertaining to ESG issues, are increasingly prone to create public relations problems that divert resources from maintaining and growing the business. In this business climate, such distractions can have outsized effects on the businesses' operations and development and can even metastasize to pose an existential threat.
Companies should ensure that executives and board members set the "tone at the top" to create a corporate culture that values integrity and professionalism. And while companies should always stay apprised of regulatory developments and industry trends, it is essential to ensure that executives and directors timely receive all of the relevant information needed to assess the risks, evaluate current policies and procedures, and develop strategies that balances the interests of stakeholders if and when significant developments arise.
To meet growing corporate governance challenges, corporations should also work with experienced counsel. Scarinci Hollenbeck's Corporate Transactions & Business Group has extensive experience advising public companies regarding regulatory obligations and other corporate governance matters. Our attorneys rely on best practices and practical strategies that are proven to help corporations establish effective corporate governance practices and maintain compliance in response to regulatory changes.
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