United States: Mitigating The Impact Of A Material Weakness On The Election Of Directors

Where companies have disclosed repeated or ongoing material weaknesses in internal controls over financial reporting, or where a company's first material weakness requires a restatement of its financial statements, audit committee and other board members can receive negative voting recommendations from proxy advisory firms. This Legal Update discusses targeted disclosure and shareholder outreach strategies that mitigate the impact of material weaknesses on the election of directors.

Summary of Relevant Viewpoints

1. Institutional Shareholder Services (ISS) 2019 United States Proxy Voting Guidelines

When poor accounting practices have been identified, including fraud, misapplication of GAAP or material weaknesses, ISS will determine, on a case-by-case basis, whether to recommend a withhold/against vote for audit committee members and potentially the full board of directors. In making its determination, ISS will consider the severity, breadth, chronological sequence and duration, as well as the company's efforts to remediate or take corrective action.

2. Glass, Lewis & Co. (Glass Lewis) 2019 United States Proxy Paper" Guidelines

Glass Lewis typically defers to the judgment of the audit committee when assessing its decisions and actions and generally votes in favor of audit committee members. The quality of the financial statements and earnings reports and the effectiveness of internal controls generally serve as the barometer on which Glass Lewis assesses the audit committee. However, where accounting fraud, failures to timely file financial reports, financial statement restatements or material weaknesses occur, Glass Lewis may recommend a vote against all members of the audit committee.

Where a material weakness has been reported since the last annual meeting or is ongoing from a prior year and has not yet been corrected, Glass Lewis's policy is to consider whether to vote against all members of the audit committee. Glass Lewis takes into consideration the transparency of the audit committee report in the proxy statement in making its determination.

Mitigating the Impact of a Material Weakness on the Election of Directors

1. Proxy Disclosure

If proxy advisory firms view a company as transparent with shareholders, and the material weakness does not have a significant impact on the financial statements, it is possible that the proxy advisory firms will not make negative voting recommendations for the audit committee members.

ISS and Glass Lewis will only rely on a company's public disclosures in making voting recommendations, and Glass Lewis's voting guidelines specifically consider the transparency of the audit committee report in making its determination. It is important, and ideal, for companies to be proactive and use the proxy statement or other filings with the U.S. Securities and Exchange Commission (SEC) as an opportunity to address the material weakness in detail to avoid the negative voting recommendation. The audit committee report should answer these key questions:  

  • What is the scope of the material weakness?  If the material weakness is limited to a very narrow issue (e.g., accounting for income taxes or the proper classification of cash received from suppliers), be sure to highlight this fact.
  • Did the material weakness result in a restatement of the financial statements? Are the affected audited financial statements still fairly presented? If the accounting errors resulting from the material weakness were immaterial and led to immaterial revisions of the financial statements, emphasize that a restatement was not required and the financial statements continue to be reliable.
  • Is the auditor's opinion affected? If the auditor's opinion on the audited financial statements considered the material weakness and the material weakness did not affect the opinion on the financial statements, this is a good fact to clarify.
  • What steps has the audit committee taken in response to the discovery of the material weakness? Disclose whether the audit committee engaged an advisor to conduct an independent investigation into the accounting errors. An independent investigation overseen by the audit committee demonstrates the audit committee's engagement and the seriousness with which the issue has been addressed.
  • What is the company's remediation plan, and what steps has the company taken to be transparent with shareholders? Because transparency is a significant factor in avoiding a negative voting recommendation, it is important that the proxy statement not only explain the material weakness, remediation plan and other efforts being taken to improve internal controls, but to also include references to the previous Form 10-K, Form 10-Q and Form 8-K disclosures that have been made to date. If the material weakness continues to be ongoing, explain what is required before the company will consider it remediated (i.e., passage of time). 

2. Additional Soliciting Material

Additional soliciting material (which can take a variety of forms, such as a proxy supplement, letter to shareholders, slides, script or talking points) can be used to provide shareholders with information about a material weakness to the extent not covered in the proxy statement. These materials must be filed with the SEC on EDGAR and posted online with the annual report and proxy statement by the date first used. In practice, this disclosure can have a positive outcome on the voting results, even when a company initially fails to address the material weakness in the proxy statement so as to avoid receiving negative voting recommendations from the proxy advisory firms.

For example, ISS recommended a vote against the members of one company's audit committee when the company did not address the material weakness in its proxy statement.  The company filed additional soliciting material strongly disagreeing with the ISS recommendation and making the case for why shareholders should vote for the audit committee members. The company explained that the scope of the material weakness was limited to its income tax accounting and that the errors were immaterial and did not require a restatement of the financial statements, which continued to fairly present the company's financial condition and results of operations.

In addition, the company highlighted the transparency of its previous disclosure about the steps it was taking to remediate and enhance its internal controls, and reiterated those plans. The company also emphasized that its audit committee members were all qualified and that the committee had been vigilant in its oversight of the company's financial reporting and remediation efforts. The voting results showed that the ISS recommendation had a minimal negative impact on the final results for the audit committee members, each of whom was re-elected.

Similarly, after another company failed to address a material weakness in its proxy statement, Glass Lewis recommended a vote against its audit committee members. The company also filed additional soliciting material emphasizing that the material weakness was related to a very narrow issue. The company pointed out that it was the audit committee's oversight and decision to appoint the company's auditor that led to the discovery of the deficiency. The company then highlighted in detail the significant experience, skills and expertise of each audit committee member. Although the audit committee members received more votes against their election than other directors did, the impact was small, and each was re-elected.

3. Shareholder Outreach

A proactive plan to engage in shareholder outreach is also helpful where a vote against directors has been recommended by the proxy advisory firms. A proxy solicitor can help a company to identify those of its large shareholders that do not strictly follow ISS or Glass Lewis recommendations and to make sure that these shareholders understand the nature of the material weakness, its impact on the financial statement, and the company's corrective efforts.

It is important to note that some institutions will not engage with companies during the proxy solicitation season due to workload and other constraints, so it is recommended that shareholder outreach be done as a supplement to (and not in place of) the preparation of additional soliciting material. In fact, the additional soliciting material can facilitate shareholder engagement because the material can be emailed to the company's contact at an institutional investor who might be too busy to schedule a telephone call or meeting but might be willing to read or pass along the material to others within the organization who are responsible for proxy voting.

Role of the Audit Committee

Generally, an audit committee does not participate in the design and evaluation of internal controls but does have a responsibility to oversee the audit and the financial reporting process. It's important that audit committees do not simply rely on the audit of the company's internal controls to identify significant deficiencies and material weaknesses before they result in a misstatement. In 2015, the Public Company Accounting Oversight Board (PCAOB) issued a communication to audit committees, Audit Committee Dialogue1, that reported that many audit opinions concluding that a material weakness had been identified had been issued concurrently with (or after) the company's disclosure of the related accounting error. In some cases, the error came to the company's attention from outside of the financial reporting process entirely, through a regulatory investigation or whistleblower activity.

The PCAOB recommended that audit committees proactively engage auditors in dialogue to help ensure that audits of internal controls achieve their objective to identify material weaknesses before a material misstatement occurs. Questions that the PCAOB recommended audit committees ask auditors include:

  • What are the points within the company's critical systems processes where material misstatements could occur?
  • How has the audit plan addressed the risks of material misstatement at those points?
  • How will the auditor determine whether controls over those points operate at a level of precision that would prevent or detect and correct a potential material misstatement?
  • What is the auditor's approach to evaluating the company's controls for significant unusual transactions or events, such as the acquisition of assets and assumption of liabilities in a business combination, divestitures, and major litigation claims?
  • If the company enters into a significant or unusual transaction during the year, how will the auditor adjust the audit plan, including the plan for testing internal controls related to the transaction? For example, how would the company's acquisition of a significant enterprise during the third quarter affect the audit plan for the year? How might the auditor's materiality assumptions change?

Where a company or its auditor has identified a potential material weakness, the PCAOB recommended that the audit committee ask key questions of the auditor, including:

  • What has been done to probe the accuracy of its description?
  • Could the material weakness identified be broader than initially described?
  • Could it be an indication of a deficiency or material weakness in another component of internal control?


1 https://pcaob us.org/sites/digitalpublications/audit-committee-dialogue

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2019. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions