Navigating the 2015 Annual Report and Proxy Season

2015 Overview

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2014 Buzz Words

►Boardroom Diversity Thirty Percent Coalition

►Shareholder Engagement SDX

►Sustainability SASB

►Risk Management FCPA Cybersecurity Compliance oversight Corporate reputation

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Digital/IT Top 5 List

►Does the company have the right internal expertise and leadership, and does the Board include members with relevant experience to oversee this area?

Consider need for Chief Information or Chief Security Officer ►Have the right outside advisors been engaged to consult and audit the

company’s digital/IT risks? ►Has the company assess its insurance coverage for security

breaches/incidents? ►Has the company formulated, practiced and continually reviewed its

crisis response plan for security breaches/incidents? ►Does the company have the right controls in place to identify and

disclose IT-related risks in its SEC filings?

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Corporate Governance and Institutional Investor Update

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2015 ISS Voting Policies

► Independent Chair shareholder proposals ►Political contributions proposals ►GHG emissions ►Equity Plan “Scorecard” methodology ►Unilateral bylaw/charter amendments ►Litigation rights bylaw provisions

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2015 Glass Lewis Voting Policies

►Board responsiveness to majority-approved shareholder proposals

► Independent board chair shareholder proposals ►Director independence ►One-off compensation awards ►ESPPs ►Clawback policies ►Unilateral reduction or removal of shareholder rights ►Fee-shifting bylaws ►Exclusive forum bylaws ►Director compensation bylaws

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Independent Chairman of the Board

►Prior policy – if a company had a robust lead director position and no governance or performance concerns, ISS would generally recommend against shareholder proposals to separate CEO/Chair

►New policy More “holistic” approach Multiple factors considered on more subjective basis ISS believes this will result in support of more separation proposals

►2014 experience: Most common governance proposal Overall support averaged 31% Five proposals received majority support

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ISS QuickScore 3.0

►New factors: Unilateral board action that materially reduces shareholder rights Disclosure regarding annual board evaluations

►Modified factors: Shareholder support for say-on-pay below 70% Shareholder support for directors below 80% (formerly 95%) Independence classification of directors elected between meetings Directors under investigation Enforcement actions by any regulator in last two calendar years

►Newly weighted factors: Number of women directors Number of audit committee financial experts

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Staff Legal Bulletin No. 20

►Joint guidance issued by Divisions of Investment Management and Corporation Finance on June 30, 2014

►Requirements for reliance on proxy advisory firms Capacity and competency Current and accurate information Investigation/elimination of material factual errors Identification and disclosure of conflicts of interest

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Director Tenure

► In 2014, ISS made two changes: Added director tenure to its calculation of a company’s QuickScore Consider proportion of directors who have served longer than nine years

► Institutional investors announced focus on tenure, often driven by desire to increase diversity and improve performance

► Increased company disclosure in response: Break-down of director tenures Policies affecting tenure (retirement ages, term limits) Expected director refreshment

► ISS and Glass Lewis generally oppose term and age limits However, if adopted, the board should enforce them

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Board Evaluations

►CII issued white paper requesting enhanced disclosure about board evaluation

Explanation of mechanics of evaluation process ►Full board self-review ►Review of board by management ►Review of board committees ►Review of board chair ►Review of committee chairs ►Review of individual directors

Discussion of most recent evaluation ►High-level overview of effectiveness of board, individual directors (not by

name) and board committees ►Agreed-upon improvements to enhance effectiveness

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2014 Shareholder Proposal Recap

►Total number of shareholder proposals down slightly in 2014 Larger companies receiving more social/environmental proposals ►Political spending/lobbying ►Climate change ►Sustainability reporting ►Human rights

Smaller companies drawing more attention for governance practices ►Separation of Chair/CEO ►Board declassification ►Majority voting in director elections ►Allow written consent by shareholders

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14a-8 Stakeholder Meetings

►Proposal by proxy Cases filed by companies against shareholder “proxies” were generally dismissed Unclear whether SEC would view proponent’s agreement not to sue as a withdrawal SEC continues to permit proposals by proxy

►Commentary on grounds for exclusion Vague and misleading References to non-public materials Substantial implementation – intention to do so

►Administrative matters Proposal wording – needs to be clear and impartial

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Renewed Focus on Audit Topics

►Auditor independence ►Enhanced disclosure about audit committee processes ►Auditor rotation ►Allocation of responsibility for risk oversight ►Anticipated SEC release to elevate the work of the audit committee

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Litigation Trends and Updates

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SEC Enforcement : Broken Windows

►“Broken windows” policy (Oct. 2013) Derived from the theory that if broken windows are fixed in a home, then more serious problems cannot flourish

►SEC intends to investigate/prosecute all sorts of violations to prevent the most significant abuses from occurring –

“even the smallest infractions are very often just the first step toward bigger ones down the road” A problem of finite resources?

►Example: On 9/10/14, SEC announced 34 companies/ individuals would be charged for failing to (timely) comply with Section 16(a) reporting requirements

$75K to $150K fines imposed against companies that “contributed to filing failures” by insiders or “failed to report insiders’ filing delinquencies”

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SEC Enforcement: Whistleblower Program

Program originated in 2010 (Dodd-Frank) Incentivizes whistleblowers to report to the SEC Financial reward to anyone who reports original information leading to more than $1 million in sanctions ►Trend: increasing number and dollar amount of awards ►$30 million awarded to whistleblower in Sept. 2014 ►9 awards in 2014 (4 total in prior years)

SOX protects whistleblowers against retaliation; employers may not harass or fire employees for reporting suspicious activity ►SEC suit against Paradigm Cap. Mgt. – punished trader after he reported

prohibited transactions Companies must take appropriate, timely action regarding misconduct that is reported internally (Aug. 2014 award to internal auditor)

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Shareholder Litigation Trends

►Shareholder Litigation (often derivative) involving public companies has often followed announcement of specific events

►“The ABCs” is a mnemonic to remember some of them: Accounting restatements Bribery allegations (and other FCPA investigations/ settlements) Compensation for executives (say-on-pay votes, Section 162(m) plans) Data breaches (Target: derivative lawsuits re failure to protect company from breach; Home Depot: 44 lawsuits filed by Nov. 2014)

►Core allegations are the same: Board members and/or officers

breached duties of care and/or loyalty

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Steps to Prevent / Mitigate Risks of Litigation

►Corporate policies and procedures Accounting standards – internal controls FCPA compliance Executive compensation (disclosure controls) Data security (rapid response protocols, firewalls, encryption) Whistleblower Policies – Encourage to report early and internally

►Train and educate employees ►Enforce policies through allocation of funding, staff ► Internal and external audits ►Remediate/mitigate findings of non-compliance ► Insurance (D&O and Data Breach)

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Common Corporate Responses to Litigation

►Tools used by public companies in responding to derivative suits

►“DEF” mnemonic: Demand—if a lawsuit is derivative (on behalf of the company by the shareholder), the shareholder must first make a demand on the Board ►Concept of “Demand Futility”

Exculpation—the articles of incorporation may exculpate some claims to the extent permitted by law (i.e., breaches of the duty of care) Form a special litigation committee—in many states, SLC recommendations for dismissal are upheld if SLC is disinterested and independent

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Books and Records Requests: the Wal-Mart case

►Latest pronouncement on scope of books-and-records demands in Delaware

►Court ordered production of documents related to Wal-Mart’s FCPA compliance, including documents protected by attorney-client privilege and work-product, regardless of whether they were ever provided to Board

►Officer-level documents may be required to show Board member knowledge of alleged wrongdoing (reporting relationship)

►Documents from time period outside of alleged wrongdoing may also be required (showing investigation procedures)

►Attorney-client privileged and/or work-product documents may be required if good cause is shown (Garner doctrine) 22

Best Practices For Books-and-Records Requests

►Memorialize Board and Committee minutes and agendas to show independence of Board

►Segregate documents so they can be easily produced in response to an inspection demand

Board and Committee minutes and materials Policies and procedures

►Limit involvement of C-level individuals in investigating allegations ►Confidentiality Agreements ►Carefully convey legal advice

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Conflict Minerals: Year Two

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Rule 13p-1 Requirements

►§ 240.13p-1 – Requirement of report regarding disclosure of registrant's supply chain information regarding conflict minerals

“Every registrant . . . having conflict minerals that are necessary to the functionality or production of a product manufactured or contracted by that registrant to be manufactured, shall file a report on Form SD”

►Three main steps required: Determine if company is covered by the rule

If so, make a reasonable country of origin inquiry (RCOI) into whether conflict minerals in the products originated from the DRC or adjoining countries, or came from scrap or recycled sources

If RCOI is inconclusive, exercise due diligence on the source and chain of custody of the conflict minerals based on a recognized framework

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Ongoing Litigation

►National Association of Manufacturers, et al v. SEC April 2014: A split D.C. Circuit found that the rule ran afoul of the First Amendment to the extent that it required companies to state that any products have not been found to be “DRC conflict free” ►SEC issued a statement allowing companies to stop short of labeling

products as “DRC conflict free” or “DRC conflict undeterminable”

November 2014: The US Court of Appeals for the D.C. Circuit granted petitions by SEC and Amnesty International for a rehearing

December 2014: The SEC and Amnesty International filed supplemental briefs arguing for the court to overturn the April ruling

►Change in Congress could also lead to legislative reform

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Year One: Observations and Trends

►Approximately 1,300 Form SDs filed in 2014 About 22% of SEC’s estimate

Very few independent private sector audits

►Common trends: Filing both a Form SD and a CMR (77%)

Using the OECD guidance for Due Diligence

Using EICC/GeSI Conflict-Free Sourcing Initiative Template to survey suppliers

Almost everyone (80%) found products to be DRC conflict undeterminable

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Year One: Observations and Trends (continued)

►Some variations: Overall length

Description of suppliers surveyed and response rates

Discussion of follow-up with suppliers

Discussion of RCOI/Due Diligence

Disclosure of Smelter/Refiner information

►SEC observations: Try to avoid RCOI/Due Diligence overlap

Avoid suggesting that products are conflict-free without expressly saying so

Disclose Smelter/Refiner information if facilities are known 28

Year One: Five Common Questions

►Am I covered by the rule? ►None of my suppliers are responding to me. What do I do? ►Do I need to disclose smelters and refiners?

What do I do if I find out that I have a supplier in a sanctioned part of the world (i.e., Central Bank of North Korea)?

►What is the difference between my RCOI and Due Diligence? ►How will companies handle some of the technical requirements?

Where should I post conflict mineral information on my website?

Should I discuss my conflict minerals policy in my Form SD?

Who should sign the Form SD?

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Looking Ahead: Take-Aways for Year Two

►Review filings of competitors and peers in industry group ►Consider SEC observations and modify filings accordingly

Disclose Smelter/Refiner information, if known

Clarify RCOI/Due Diligence in filings ►Department of Commerce published a list of Smelters/Refiners of conflict

minerals this fall as required by Dodd-Frank

Avoid language that describes products as conflict-free without audit

►Use new template from Conflict-Free Sourcing Initiative (Revision 3.01 or later)

►Focus on supplier education and training ► If relevant, make this part of your M&A due diligence

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Exhibits: What’s Attached to Your Form 10-K?

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Exhibit Filing Overview – General Principles

►Governed primarily by Item 601 of Regulation S-K Exhibit Table identifies exhibits required to be filed with each filing type

Exhibits can generally be incorporated by reference from prior filings ►Remember: incorporated document must include the SEC file number of

the report or registration statement with which it was originally filed

►Disclosure controls are key to identifying required exhibits ►Versions of Form 10-K (electronic or printed) delivered to

shareholders as annual report may omit all exhibits

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Form 10-K/Form 10-Q Common Exhibits

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No. Description Form 10-K Form 10-Q 2 Plan of acquisition, reorganization, arrangement, liquidation or succession

3(i) Articles of Incorporation 3(ii) Bylaws 4 Instruments defining the rights of security holders, including indentures 10 Material contracts 13 Annual report to security holders, Form 10-Q, or quarterly report to security holders 14 Code of Ethics 19 Report furnished to security holders 21 Subsidiaries of the registrant 23 Consents of experts and counsel 24 Power of attorney 31 (i) Rule 13a-14(a)/15d-14(a) Certifications; (ii) Rule 13a-14/15d-14 Certifications 32 Section 1350 Certifications

100 XBRL-Related Documents 101 Interactive Data File

Item 601(b)(2) – Acquisitions/Dispositions

►Must file (or in corporate by reference) any material plan of acquisition, disposition, reorganization or liquidation, and any amendments thereto, described in the report

►Exhibits/schedules may be omitted So long as they are not themselves material

Must covenant to provide them supplementally to SEC

Consider impact of Titan Corporation enforcement proceeding

►May remove agreements from exhibit list when they are no longer discussed in the report

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Item 601(b)(3) – Articles & Bylaws

►Required exhibit to both Form 10-K and Form 10-Q ►When articles or bylaws are amended, a complete copy, as amended,

should be filed as an exhibit Does not require articles or bylaws to be restated, but rather that the exhibit contain a full set of the articles or bylaws with amendments

In some cases, it may be prudent for the amendment to be presented as a redlined document

►Often incorporated by reference Confirm with every filing that the latest version is referenced

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Item 601(b)(10) – Material Contracts

►What is a “material contract”? Agreement not made in the ordinary course that is material to the company (quantitative and qualitative considerations) The following agreements are required to be filed unless immaterial in amount or significance: ►Contracts with directors, officers or significant shareholders ►Contracts upon which the business is substantially dependent (customer

contracts, supply contracts, license agreements) ►Acquisition or sale of property, plant and equipment in excess of 15% of

fixed assets ►Material leases

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Item 601(b)(10) – Material Contracts (continued)

►Each Form 10-K should contain a comprehensive list Contract should be filed if (i) material and (ii) it (A) is to be performed during/after the filing of the report or (B) was entered into not more than two years before the filing

►File “new” contracts with the Form 10-K or Form 10-Q covering the period during which the contract was executed or became effective

You can file early, but still list (and incorporate) for subsequent report for applicable period

►Schedules/exhibits to material contracts required to be filed ►All amendments to material contracts need to be filed with report for

covered period, even if amendment itself is immaterial Form 8-K not required for immaterial amendments

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Item 601(b)(10) – Compensatory Arrangements

►Management contract and compensatory plans/agreements If NEOs participate, agreement is deemed material and must be filed

If other executive officers participate, agreement only needs be filed if material in amount or significance

Arrangements that apply generally to all employees on a non-discriminatory basis are exempt and do not need to be filed

►Compensatory arrangements should be identified as such in the exhibit list (“*” often used to denote)

►Form 10-K requires filing of agreements in effect during the year even if the participant NEOs have departed before year-end/filing

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Item 601(b)(31) and (32) – CEO/CFO Certifications

►The following errors require a corrected Item 601(b)(31) certification accompanied by the entire report:

The certification identifies the wrong periodic report ► Incorrect period/date reference

► Incorrect form type

The certification omits a conformed signature

The certification fails to include a date

►Corrected certifications must bear the date of the “replacement” Form 10-K/A or Form 10-Q/A

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Requests for Confidential Treatment

►What information can be redacted? Information to be redacted must pose risk of competitive harm ►Simply being “confidential,” is not enough ► “If this information was known to our competitors, they could . . . “

Cannot redact information that is required disclosure or otherwise material (i.e., information must not be necessary for protection of investors) Redacted information must be confidential and not otherwise disclosed ►Should be “surgical” redaction

Term of confidential protection typically limited to duration of agreement ►Term is initial term (up to 10 years), not optional renewal periods ►Confidential treatment expires after 3 years if agreement is terminable at will ►May request extension prior to expiration

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Requests for Confidential Treatment - Process

►Must submit application for confidential treatment to the SEC in hard copy no later than the date the redacted exhibit is filed

Exhibit list of filing should identify that confidential treatment has been requested for portion of the agreement

►Must provide unredacted version of agreement to SEC Version filed with EDGAR should identify redacted language

► If Staff denies confidential treatment in whole or part, revised agreement must be filed as amendment to earlier report

►Consider internal process for identifying confidential information and notifying counterparties

►Consider agreements you may be a party to that may be material to the other party

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Corporate Bylaws: A New Governance Battleground

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Who is in Charge of Corporate Bylaws?

►State law generally authorizes the board of directors to adopt and amend bylaws without shareholder approval

Consider any state law limitations

►Recent trend toward unilateral board adoption of bylaws has drawn investor scrutiny

► Investors argue that if new/amended bylaw is good for shareholders,

then request shareholder approval of it for shareholder validation

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Exclusive Forum

►Courts have generally upheld validity of bylaws and enforced them General standards – must be adopted before “wrongdoing” and not with a sinister purpose A court upheld selection of headquarters state (North Carolina) over state of incorporation (Delaware) Courts have generally upheld exclusive forum bylaws adopted on eve of sale of the company ►However, anticipation of specific litigation may yield a different result

►About one dozen proposals put to shareholder vote in 2014 proxy

season ISS recommended against all, but almost all passed

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Fee-Shifting

►DE court upheld board-adopted bylaw that required a losing plaintiff to pay company’s attorneys fees and costs

►Facts are important

Non-stock DE membership corporation

►DE bar acted to propose legislation limiting the ruling to non-stock corporations

Legislation expected to be considered in 2015

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Other Notable Bylaw Amendments

►Requirements on Shareholder Seeking to Call Special Meeting Allergan adopted bylaw that allowed shareholders to call special meeting, but bylaw required disclosure of two years of trading history and disclosure of all associates, each of whom are deemed to be making the same proposal

►Prohibition on Receipt of Director Compensation from Third-Party (aka

“golden leash”) Agrium and Hess adopted bylaws prohibiting director nominee from serving on the board if he/she receives compensation from a third-party (such as a dissident shareholder running a proxy contest)

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Other Bylaw/Governance Topics

►Shareholder rights: Shareholder right to call a special meeting Right of shareholders to act by written consent Elimination of super-majority requirements Cumulative voting

►Administrative matters: Make sure advance notice bylaws require disclosures of derivative interests Contemporary notice/communication provisions Permit virtual shareholder meetings Clarify that Chairman of the Board is not an “officer” position Clarify Chairman’s right to adjourn shareholder meetings

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ISS/Glass Lewis Policies

►Unilateral board adoption of bylaw/charter amendments ISS: Generally vote against/withhold some/all directors if amendment materially diminishes shareholders’ rights or could adversely affect shareholders Glass Lewis: May recommend vote against Chair or all members of Governance Committee if amendment reduces or removes important shareholder rights

►Litigation rights ISS: Case-by-case analysis of proposed bylaws that impact shareholders’ litigation rights (exclusive venue, fee-shifting) Glass Lewis: Generally vote against exclusive venue and fee-shifting bylaws, subject to consideration of certain factors related to exclusive forum bylaws

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Proxy Access

►Proposals with 3%/3 year threshold perform well 6 proposals received majority support Average support was almost 40%

►New York City Comptroller’s Board Accountability Project Climate change Board diversity Excessive CEO pay

►Shareholder proposal developments Whole Foods’ no-action letter granted ►Conflicts with company proposal providing proxy access for 9%/5 year

shareholders ►Would such a proposal constitute “substantial implementation”?

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Executive Compensation Approvals

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Approval Analysis Overview

►Requirements: State corporate law Stock exchange rules ►Comp Committee approvals ►Shareholder approval of equity compensation plans

Plan/agreement documents IRS Code Section 162(m) SEC Section 16

►Other considerations: ISS/Glass Lewis/Investor policies Prior disclosures Impact on future votes

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Delegation of Authority – Stock Options and Rights

►Most states permit delegation of authority to approve the grant of stock options or other “rights”

Plan can be amended to permit delegation without shareholder approval Adopt any required authorizing resolutions to permit delegation Set grant parameters – share limits Limit scope to non-Section 16 employees who are not expected to become “covered employees” in the near term Make sure that any obligation to “report” back to the Board doesn’t require approval by the Board Determine scope of delegated authority – determine grantees and number of shares

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Delegation of Authority – Stock Options (continued)

The compensation committee should still approve the “form of” award agreement, which may include terms for payment of the exercise price or taxes through forfeiture/withholding of shares Confirm that delegation doesn’t conflict with anything in compensation committee charter Confirm that grants pursuant to delegated authority are documented Watch out for “upward” delegation to full board or all independent directors (as it relates to grants to executives)

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Delegations of Authority – Restricted Stock

►State corporate laws generally prohibit the delegation of authority to grant stock, such as restricted stock

May be able to grant authority to CEO if he/she is a director and appointed as a committee of the Board for this purpose, but consider whether plan permits Note that the CEO may not be able to be a sub-committee of the compensation committee since he/she wouldn’t be a member of that committee

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Section 162(m) Approvals

►Ensure awards comply with plan / 162(m) requirements Limits on amount of awards Based on shareholder-approved metrics (re-approved by shareholders every five years)

►Compensation committee approval of awards Must approve specific metrics Set within first 90 days/25% of performance period (must be substantially uncertain of achievement at time of approval) Must be objective

►Compensation committee must certify payouts Can exercise negative discretion, but no “positive discretion”

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Say-on-Pay

►Average support is about 92% ►Percentage of failed votes remained around 2% ►Percentage of companies receiving between 50-70% approval

dropped to about 5% ►Percentage of companies receiving at least 90% approval increased

to about 75% ►Disclosure trends/best practices:

Executive summaries Charts / graphs What we do / what we don’t do lists

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ISS Equity Plan Scorecard

►Score of 53 (out of 100) generally required

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ISS Equity Plan Scorecard - Pillars

►Plan Cost – shareholder value transfer (SVT) Must be less than or equal to 65% of the ISS benchmark SVT (i.e., the “allowable cap”) to get full points

►Plan Features (all are binary – no points or full points): Automatic single-trigger vesting upon change in control Broad discretionary vesting authority Liberal share recycling Absence of minimum required vesting period (at least one year)

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ISS Equity Plan Scorecard - Pillars (continued)

►Grant Practices: Three year average burn rate relative to industry and index peers ► Must be </= 50% of ISS benchmark to get full points

Vesting schedules of CEO most recent equity grants ► >4+ yrs – full points; 3-4 years – half points; <4 years – no points

Plan’s estimated duration ► </=5 years – full points; 5-6 years – half points; >6 years – no points ► Sum of new shares plus remaining shares available, divided by annual burn rate

over prior three years Proportion of CEO’s most recent equity grants/awards subject to performance conditions (3 year look-back) ► >50% – full points; 33%-50% – half points; <33% – no points ► Options/SARs only performance-based if performance vesting conditions or

premium priced

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ISS Equity Plan Scorecard - Pillars (continued)

►Grant Practices (continued): Clawback policy that includes equity grants ► Yes – full points; no – no points

Post-exercise/post-vesting shareholding requirements ► >/=12 months – full points; <12 months/until ownership guidelines met – half points;

none – no points

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ISS Equity Plan Scorecard – Overriding Factors

►Certain factors may still result in an against recommendation: Liberal change of control definition Permitting repricing/cash-buyouts of underwater options or SARs without shareholder approval (need to expressly prohibit it) Problematic pay practices or pay-for-performance disconnect Other detrimental plan features ►Tax gross-ups related to plan awards ►Provision for reload options

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ISS Equity Plan Scorecard – What to do now?

►Figure out how you want to get 53+ points (or a good Plan B) ►Lower hanging fruit:

Plan to go back every 3-4 years Eliminate liberal share recycling Add a minimum vesting period, with exceptions (presumably OK with ISS) Monitor burn rate Make sure CEO awards have minimum three year vesting period (four for full points) Grant performance-based awards to CEO

►Do you need to pay for ISS’s consulting services?

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Glass Lewis Policies on Equity Compensation Plans

►Companies should seek more shares only when needed ►Requested share amounts should be small enough that

companies go back every 3-4 years ► If plan is relatively expensive, it should not grant options solely to

senior executives and board ►Annual net share count and voting power dilution should be limited ►Annual cost of plan should be proportional to business value ►Stated performance metrics should be challenging and appropriate,

and should be subject to relative performance measures ►Stock grants should be subject to minimum vesting and/or holding

periods sufficient to ensure sustainable performance and retention

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