Reminders for the 2023 Annual Report and Proxy Season

By Heyward Armstrong, Alex Bowling and Olivia Jamrog

As public companies prepare their 2022 annual reports and 2023 proxy statements, they will need to contend with a host of new requirements and disclosure updates stemming from the current geopolitical and economic environment, a bevy of Securities and Exchange Commission (SEC) regulatory activity and several revisions to the Delaware General Corporation Law (DGCL). This Client Alert provides an overview of these requirements and steps that public companies can take to navigate the upcoming Form 10-K and proxy season.

• Risk Factors (Form 10-K Item 1A; Item 105 of Regulation S-K): Public companies should carefully review their risk factors to ensure that all risks are up-to-date and adequately described. Companies should pay particular attention to situations where they previously described a risk in hypothetical terms and subsequently experienced such risk, an issue particularly prevalent in the cybersecurity area and which has been a focus of SEC enforcement activity. Given the number of challenges companies may be facing in this economic and geopolitical environment, consider disclosing or updating the following risks, among others, to the extent applicable:
  • Market conditions – Consider whether changes in global economic conditions, including volatile equity markets, may adversely affect the company’s business, revenues and earnings, as well as plans for growth and ability to access capital markets to raise funds for general corporate purposes or transactional activity.
  • Inflation and interest rates – Consider updating risks related to inflation and rising interest rates, such as increases in operating costs or changes in the company’s ability to obtain financing, and any impacts on results of operations.
  • COVID-19 – While it is likely too early to completely eliminate COVID-19 specific risk factors, companies may be able to streamline their disclosures to account for risks currently faced and to eliminate or de-emphasize risks that are no longer expected to be material.
  • Cybersecurity – As cybersecurity incidents, data misuse and ransomware attacks continue to proliferate and become more sophisticated, the SEC has heightened review of, and commenting on, cybersecurity-related disclosures. Consider updates to these disclosures, including whether the company has experienced any data breaches or other security incidents and whether there are any increased cyber-related risks associated with remote work.
  • Russia-Ukraine Conflict – Consider whether Russia’s invasion of Ukraine has had any direct or indirect effects on the company’s business. Companies may consider including disclosures on Russian sanctions, increases in commodity prices, vendor and supplier impacts and impacts on the availability and cost of energy. In particular, companies may consider whether any such disclosures would be appropriate for risk factors, MD&A, business discussion or financial statement footnotes.
• Pay-Versus-Performance (Item 402(v) of Regulation S-K): 
  • As discussed in detail in our September 16, 2022 publication, the SEC finally adopted the “pay-versus-performance” disclosure requirement called for under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). Disclosure under the new rule will be required in all proxy and information statements that are required to include Item 402 of Regulation S-K executive compensation disclosure for fiscal years ending on or after December 16, 2022. For calendar year-end companies, the new disclosure will be required beginning with their 2023 proxy statements.
  • In light of the complexities of the new rule, companies should begin preparing the required disclosures as soon as possible.
• Universal Proxy Rules (Schedule 14A Exchange Act): In November 2021, the SEC adopted universal proxy rules that are effective for the 2023 proxy season. Key amendments to the rules include the following:
  • Amendments applicable to all director elections – The SEC amended existing Exchange Act Rule 14a-4(b) making changes relating to voting options and standards applicable to all director elections. Under the amended rules, proxy cards must include an “against” option (as opposed to a “withhold” option) if state law gives legal effect to votes cast against a nominee. When state law does not give legal effect to votes cast against a nominee, such form of proxy must not provide a means for shareholders to vote “against” any nominee and must instead provide a means to “withhold” authority to vote for each nominee. The amendments also provide that proxy cards must give shareholders the ability to “abstain” in a director election when a majority voting standard applies. In addition, proxy statements under the amended rules must disclose the method by which votes will be counted, including the treatment and effect of a “withhold” vote, in an election of directors.
  • Universal proxy cards – The SEC adopted new Rule 14a-19 to require the use of “universal” proxy cards in all non-exempt director election contests. Under the new rule, each party in a contested election is required to distribute its own universal proxy card, which must include the names of all nominees for director for whom proxies are solicited, enabling shareholders voting by proxy to vote for whatever combination of nominees they choose. Dissidents are required to notify companies of their intent to solicit proxies and the names of their nominees at least 60 calendar days prior to the anniversary of the previous year’s annual meeting date. This notice requirement is in addition to any advance notice requirements set forth in the company’s governing documents.
  • Compliance and disclosure interpretations – In August 2022, the SEC issued three compliance and disclosure interpretations (C&DIs) relating to the universal proxy rules. C&DI 139.03 provides that, when a company’s advance notice bylaw provision requires earlier notice than Rule 14a-19(b)(1), the company would satisfy Rule 14a-5(e)(4) by disclosing only the earlier advance notice bylaw deadline in the proxy statement. However, to the extent the advance notice bylaw provision does not require the same information as that required by Rule 14a-19(b), the company’s proxy statement must clearly state the need for a dissident shareholder to comply with the additional requirements of Rule 14a-19(b) as compared to the advance notice bylaws, if any. When drafting 2023 proxy statements, companies are reminded to include the notice and filing deadline for dissidents conducting a director election contest.
  • Bylaw amendments – Following the effectiveness of the universal proxy rules, many companies have amended the advance notice provisions in their bylaws to, among other things, (a) add a requirement that the dissident shareholder comply with Rule 14a-19 and provide a certification as to such compliance, including that the dissident shareholder solicit 67% of the voting power of the company’s shares entitled to vote on the election of directors; (b) expand the advance notice bylaw to include more detailed information on parties with whom the dissident shareholder is collaborating; and (c) permit the company to disregard proxies to the extent that the dissident shareholder fails to comply with the requirements under Rule 14a-19 or to provide documentary evidence of such compliance prior to the shareholder meeting. It is a best practice for a company to make any such changes on a “clear day” before any campaign is initiated.
• Say-on-Frequency Vote (Rule 14a-21(b) Exchange Act): As a reminder, companies are required to conduct an advisory vote on the frequency of the say-on-pay vote at least once every six years. Public companies that last included a say-on-frequency vote in 2017 (e.g., companies that first included the say-on-frequency vote in 2011 when the rules took effect) will need to conduct another vote at their 2023 annual meetings, asking shareholders if the say-on-pay vote should occur every one, two or three years. This will need to be done even if the company is already conducting its say-on-pay vote annually and intends to continue this practice.
• CEO Pay Ratio (Item 402(u) of Regulation S-K): For CEO pay ratio calculations, companies should consider the three-year limit on using the same median employee for comparison purposes. Companies should assess whether their workforce compositions or compensation arrangements have materially changed. If there has been a change that would result in a significant change to the company’s pay ratio disclosure, the company will need to identify a new median employee. Even if a company uses the same median employee as it used in its proxy statement filed in the previous year, it must disclose that it is using the same median employee and briefly describe the basis for its reasonable belief that no changes have occurred that would significantly affect the pay ratio.
• Glossy Annual Reports (Rule 14a-3(c) Exchange Act): Beginning January 11, 2023, companies must furnish “glossy” annual reports to the SEC via EDGAR in PDF format. The electronic submission of the glossy annual report must contain the same graphics, styles of presentation and prominence of disclosures contained in the report and should not be re-formatted, re-sized or otherwise redesigned for purposes of the EDGAR submission. The amendments eliminate the requirement to furnish paper copies of the annual report to the SEC, and the glossy annual report must be submitted to the SEC no later than the date on which the report is first sent or given to shareholders.
• D&O Questionnaire Updates: Consider updating director and officer questionnaires in advance of 2023 annual meetings to cover: 
  • SEC disclosure requirements under the Iran Threat Reduction and Syria Human Rights Act of 2012, including the extension to certain Russian individuals and entities.
  •  Any certifications required under advance notice bylaws, as well as consent to being named as a director in any proxy statement in which a director is to be elected (including a dissident’s proxy statement in light of universal proxy rules).

• Rule 10b5-1 Trading Plans and Related Disclosures (Rule 10b5-1; Items 402(x), 408 and 601(b)(19) of Regulation S-K; and Rule 16a-3(f)):

  • As discussed in our December 19, 2022 publication, the SEC recently adopted amendments to Rule 10b5-1, adding new conditions to the availability of the affirmative defense to insider trading liability. Rule 10b5-1 plans that are adopted by non-issuers on or after February 27, 2023 must comply with the new rules.
  • With the amendments, the SEC also imposed new disclosures public companies will need to make in their Exchange Act reports. On a quarterly basis, public companies must report insider use of Rule 10b5-1 and non-Rule 10b5-1 trading arrangements. On an annual basis, companies must disclose whether they have adopted an insider trading policy. A copy of any such policy must be filed as an exhibit to the company’s Form 10-K. Further, the new rules require certain tabular and narrative disclosures related to equity awards made near in time to the release of material nonpublic information in reports requiring executive compensation disclosures. Public companies will be required to comply with the new disclosure requirements in periodic reports and in proxy or information statements for the first full fiscal period that begins on or after April 1, 2023. Smaller reporting companies will have an additional six months to comply with the new disclosure requirements.

  • Finally, the SEC added a new checkbox to Forms 4 and 5 to indicate whether a reported trade is pursuant to a Rule 10b5-1(c) plan and amended the rules on the reporting of bona fide gifts. Such gifts that were previously permitted to be reported on Form 5 must now be reported on Form 4. Section 16 reporting persons will be required to comply with the amendments to Forms 4 and 5 and related rules beginning on April 1, 2023.

• Nasdaq Board Diversity (Nasdaq Rule 5605(f)):
  • Nasdaq-listed companies are already required to disclose a board diversity matrix, either in their proxy statement or on the company’s website. Beginning on December 31, 2023, Nasdaq companies must have at least one diverse director (and by later specified dates, two) or explain why the company does not meet this objective. Note that Nasdaq recently amended Rule 5605(f) to extend the compliance deadline from August 7, 2022, which was the deadline under the rule as originally approved, to simplify the timeframe for disclosures. Certain relief is provided for smaller reporting companies, as well as companies with five or fewer directors.
• Amendments under Delaware Law:
  • Officer liability – Section 102(b)(7) of the Delaware General Corporation Law (DGCL) was amended in August 2022 to extend exculpation rights for breaches of the fiduciary duty of care to certain officers of a Delaware corporation. Corporations are now permitted to adopt exculpatory language in their certificates of incorporation limiting the personal liability of both directors and certain officers for breaches of the duty of care for direct claims by stockholders. Delaware corporations may want to consider amending their certificates of incorporation to allow for officer exculpation based on the statutory change. We understand that many companies are already planning to do so during this proxy season.
  • Stockholder list – Section 219 of the DGCL was recently amended to eliminate the requirement that a corporation make a stockholder list available for inspection during a meeting of stockholders. Instead, Delaware corporation will need to make the list of stockholders entitled to vote available for inspection for a 10-day period prior to the meeting. Note that, if a company’s bylaws reflect the previous statutory requirement, the company would still have to comply with the requirement to make a stockholder list available during stockholder meetings going forward. Such companies should consider revising their bylaws to reflect the updated statutory language.
  • Meeting notice – Section 222 of the DGCL was amended to clarify that a notice of a stockholders meeting may be given in any manner permitted by Section 232 of the DGCL, which expressly allows notice by electronic transmission. In addition, Section 222 of the DGCL was amended to address issues related to the functioning of virtual stockholder meetings. Under the amended rules, if a virtual meeting is adjourned, including due to a technical failure to convene or continue a virtual meeting, notice need not be given if the time, date and place of the adjourned meeting are announced at the meeting, displayed during the time scheduled for the meeting on the virtual platform utilized for the meeting or set forth in the notice of meeting.
• Non-GAAP Interpretations: On December 13, 2022, the SEC staff issued updated C&DIs to address certain questions regarding the calculation and presentation of non-GAAP measures. The updated C&DIs can be found here and they are summarized below.
  • Misleading is based on the company’s specific circumstances (C&DI 100.01) – A company’s specific facts and circumstances determine whether an adjustment renders a non-GAAP measure misleading.
    • For example, presenting a non-GAAP performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading.
      • A normal operating expense will be evaluated by the SEC staff by reviewing an adjustment’s nature, effect and relationship to the company’s “operations, revenue generating activities, business strategy, industry and regulatory environment.”
      • A recurring operating expense includes not only one that occurs repeatedly, but also one that occurs occasionally (even at irregular intervals).
  • Equal or greater prominence (C&DI 102.10) – A company is required in earnings releases and SEC filings to present the most directly comparable GAAP measure with equal or greater prominence when disclosing a non-GAAP measure. The C&DI has been updated and divided into subsections as follows:
    • Subpart (a) clarifies that the equal and greater prominence requirement applies to both the presentation, and any related discussion and analysis, of a non-GAAP measure. This subpart also includes several examples of non-GAAP measures being presented in a manner that the SEC staff considers to be more prominent than comparable GAAP measures, including presenting an income statement of non-GAAP measures.
    • Subpart (b) provides additional examples of non-GAAP reconciliations that would give undue prominence to a non-GAAP measure over the comparable GAAP measure. One example is a forward-looking non-GAAP measure that excludes the quantitative reconciliation to the comparable GAAP measure without disclosing why such reconciliation is not available without unreasonable efforts along with the information that is unavailable and its probable significance.
    • Subpart (c) addresses what constitutes a non-GAAP income statement. The SEC staff clarifies that a non-GAAP income statement, whether presented alone or as part of a required reconciliation, is one that is comprised of non-GAAP measures and “all or most” of the line items and subtotals found in a GAAP income statement.
  • Proper labelling (C&DI 100.05) – A non-GAAP measure would be misleading if it is not identified or clearly described as such or if its label is not reflective of its nature as a non-GAAP measure.
    • The following are examples, among others, of when a label would not be reflective of a non-GAAP measure’s nature: (a) a non-GAAP measure labeled the same as a GAAP line item or subtotal when the two are calculated differently; and (b) a non-GAAP item labeled as “pro forma” when it has not been calculated in accordance with the pro forma rules in Article 11 of Regulation S-X.
  • Individually tailored accounting principles (C&DI 100.04) – A non-GAAP measure may be misleading if it is calculated using recognition and measurement principles that are inconsistent with the comparable GAAP measure. The updated C&DI provides a non-exhaustive list of examples that the SEC staff may consider misleading.
  • Level of description of non-GAAP measure not determinative (C&DI 100.06) – Even if a non-GAAP measure is accompanied by “extensive, detailed disclosure about the nature and effect of each adjustment,” it may still be materially misleading to investors. The C&DI does not include any examples.

• Clawback Rules (Rule 10D-1 Exchange Act): 
  • Finally adopted – In October 2022, the SEC adopted rules implementing the incentive-based compensation recovery (clawback) provisions of the Dodd-Frank Act. Listed companies will be required to adopt a clawback policy providing for recovery of incentive-based compensation erroneously received by current or former executive officers (based on the same definition used for determining which officers are subject to Section 16 reporting requirements) during the three completed fiscal years immediately preceding the year in which the company is required to prepare an accounting restatement due to material noncompliance with financial reporting requirements. Erroneous payments must be recovered even if there was no misconduct or failure of oversight on the part of an individual executive officer.
  • Disclosure implications – Listed companies will be required to (a) file their written clawback policies as exhibits to their annual reports, (b) indicate by check boxes on the cover page of their annual reports whether the financial statements included in the filings reflect a correction of an error to previously issued financial statements and whether any of those error corrections are restatements requiring a recovery analysis of incentive-based compensation under their clawback policies and (c) disclose how they have applied their clawback policies during or after the last completed fiscal year.
  • Triggering restatements – The rules require that the clawback policy adopted be triggered by both “Big R” and “little r” accounting restatements. A “Big R” restatement occurs when a company is required to prepare an accounting restatement that corrects an error in previously issued financial statements that is material to the previously issued financial statements. A “Big R” restatement requires the company to report the restatement under Item 4.02 of Form 8-K and to amend its filings promptly to restate the previously issued financial statements. By contrast, a “little r” restatement corrects an error that would result in a material misstatement if the error were left uncorrected in the current period or the error correction was recognized in the current period. A “little r” restatement generally does not require Form 8-K filing.
  • Next steps – Securities exchanges must submit listing standards to the SEC within 90 days of the final rules being published in the Federal Register on November 28, 2022. The listing standards must become effective no later than November 28, 2023. Once effective, companies will have 60 days to adopt a compliant clawback policy, by no later than January 27, 2024. Companies should be prepared to adopt a clawback policy much sooner than this date, depending on how quickly the listing standards become effective.
• Electronic Filing of Form 144: Beginning on April 13, 2023, certain Forms 144 must be filed electronically with the SEC via EDGAR. The electronic filing requirement pertains to Forms 144 related to the sale of securities of an issuer subject to the reporting requirements under Section 13 or 15(d) of the Exchange Act. This change will impact company insiders rather than the company itself, and we expect that brokers will be prepared to comply with the new rules.

• Reg Flex Agenda: According to the SEC Fall 2022 Reg-Flex Agenda, a number of rules are in the final rule stage and are set to be approved in the first few months of 2023. Agenda items involve major proposals, including climate disclosure, cybersecurity, share repurchases and amendments to Rule 14a-8, which, if approved, will likely impose substantial burdens on reporting companies. While these proposals are unlikely to affect upcoming Forms 10-K and proxy statements, companies are encouraged to closely monitor SEC regulatory activity and begin taking steps in anticipation of the impact proposed regulatory changes may have on their reporting obligations during applicable transition periods.

If you have any questions regarding this Client Alert or your Form 10-K or proxy statement, please do not hesitate to contact a member of the Public Companies group or your regular Smith Anderson lawyer.