Keynote Remarks: "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!" – sponsored by TheCorporateCounsel.net and CompensationStandards.com

Transcript: John Olson on "The Board Presentation"

John Olson is a Senior Partner of Gibson Dunn & Crutcher LLP

September 12, 2006

MR. ROMANEK: Hi, I’m Broc Romanek. I’m humble to even be giving the introduction for such a giant and well-respected lawyer, John Olson. John’s accomplishments are too numerous to mention with over four decades of experience in the field.

First, you have John’s accomplishments within his own firm, opening up the Washington, D.C. office of Gibson, Dunn & Crutcher man years ago and building up that practice to a point now where, as you can see from the panelists for this conference, Gibson Dunn is all over the map.

Secondly, you have John’s accomplishments within the bar. John has served as the head of it seems almost every committee related to corporate and securities law in the ABA Corporate Governance, as well as many other special task forces and probably panels and missions that we don’t even know about.

And also, now in his later years, John is spending a lot of time including teaching students. Many of you probably don’t know, but John first taught at Cornell three years ago, I believe, last year at Northwestern and—this year anything?

MR. OLSON: Northwestern again.

MR. ROMANEK: Northwestern again. And so he’s imparting all of his great knowledge to the new lawyers in the field.

And finally, we have John’s accomplishments in corporate governance. John was the chair of the ABA’s Corporate Governance Committee, and he’s been with us along the whole ride of the CompensationStandards.com movement, serving as co-chair of our Annual Executive Compensation Conference from year one to year two to the upcoming 3^rd Annual conference next month. And it’s grown along with him, and we couldn’t have really done it without him. He’s such a leader, and when John speaks, I think everyone listens - and if they don’t, they should.

So who better to speak today on the topic of the board presentation "What should and should not be included?" John Olson, because I doubt there’s anyone out there that’s in more boardrooms than anyone I know.

Every time I talk to John or his assistant, John’s flying somewhere all over the world to a board presentation, and I really don’t know how he does it. He’s a ball of energy, and I hope I’ll have that kind of energy when I’m your age, even though you don’t look that old.

MR. OLSON: Enough already.

MR. ROMANEK: John Olson.

MR. OLSON: Well, I’m sure glad he had that "ball of energy" line at the end. I was feeling older by the minute as Broc was giving that introduction. I guess I have been practicing law for something over four decades, but, of course, I started at age 15—no. Actually, as I approach 70, I think, "This can’t be true. This really can’t be true. I can’t be 67 years old almost," but here we are.

I am in a lot of boardrooms, and what I’ve been asked to talk about for a few minutes just before lunch—and I’m conscious of the fact that you’ve had a lot of detail over the last day and a half and you’ve got more coming this afternoon, and you’re undoubtedly much more interested in lunch than hearing yet another speaker but I’ve been asked to talk about what you should be dealing with now in briefing a board of directors.

In other words, let’s get not quite 30,000 feet, but maybe 5,000 feet, above the details that we’ve all been worrying about in those 400 pages of the new release, and what’s going to go into the CD&A and all the many tables and so forth, and look at this from the point of view of what does a director want to know.

As Broc says, I’m in boardrooms almost every week, and I’m getting a lot of questions now from directors, and so this is based upon sort of an amalgam of both things I’m hearing from directors and things I think directors ought to hear from us as lawyers, counselors and advisors.

I’ve got five things I want to mention to you and then talk a little bit about the role of lawyers. First, directors, as we all know, and CEOs, who are usually directors, too, hate surprises. They particularly hate surprises that are personally embarrassing, and we can all think of cautionary tales of the recent past, let me mention a few:

An extremely well-known company, much admired for corporate governance and ably led for many years, a CEO subjected to a lot of public criticism and a lot of activism and a withhold campaign at their last annual meeting because the market is surprised by the amount of accumulated retirement benefits that this CEO has earned over 35 years of service to the company.

I know you can say, "Well, gee, that company brought it on itself by being at the head of the pack and making early disclosure of things that hundreds of other companies are only going to be disclosing next Spring. But, again, it’s a cautionary tale.

I don’t know whether the board in that case—I simply don’t know, because I wasn’t in that boardroom—had focused in advance on what was going to be disclosed, when it was disclosed, but I know that the consequences of that disclosure, and other issues having to do with corporate performance in the industry and so forth, have resulted in that CEO departing early, of change in management, and of the directors being subjected to a withhold campaign. Those are consequences that directors care about.

Another example: former directors of the New York Stock Exchange—good people, all with distinguished reputations—are still testifying in litigation between the State of New York and Messers. Grasso and Langone. Again, without getting into the merits of that, the public perception is that those directors did not know all of the benefits that were being accrued for Mr. Grasso during his very successful tenure in leading the exchange.

I think directors today, looking at those and many other cautionary examples, are not going to be forgiving of their advisors if there are surprises.

So I think the number one job of all of us is to help boards of directors understand the consequences of this new disclosure environment in terms of how the corporation, and their stewardship of the corporation, is going to be perceived by all of the many constituencies out there.

So my first point is, the world is watching, and there will be a lot more to see come next Spring, as you’ve been hearing for the last day and a half. And the board better get a very good preview of coming attractions now, and I don’t just mean a five-minute trailer with Tom Cruise jumping through a flaming fish tank. I mean the whole story, albeit in encapsulated form.

This is a very titillating topic. Every morning at breakfast, we open the New York Times and the Washington Post, and about the second or third thing my wife says is, "I can’t believe how much those executives are being paid. Did you read about the $300,000 worth of airplane trips for personal use for that executive? Did you realize that another executive has a home security system, and it costs more than our second home?"

This stuff is going to be out there in the public domain, and the press and the shareholder activists are just salivating. For instance, Gretchen Morgenson has got five columns already written, I’m sure. All she has to do is fill in the names. You just want to be sure that your company and your CEO and board are not the names that Gretchen is going to fill in when she writes those Sunday columns next Spring, but some company will be there. Floyd Norris, I’m sure, is already thinking about what he’s going to say, so you need to be ready, and your board needs to understand. Now, how do you do that? You can’t just go in an give a 15-minute presentation, and I don’t think you can leave it to the comp committee.

The comp committee has a very important role to play in determining CEO compensation, understanding how everything fits together and getting independent advice and so forth, and we’ve been talking about that. But I think the whole board—look at the examples I’ve just given you, the cautionary tales of the prominent company, the New York Stock Exchange—the whole board needs to have some basic information. They need to see a mock-up of the new comp table, and they need to see it now, not a week before the filing of the proxy. They also need to see at least an outline of the CD&A draft.

What is management going to say about the compensation programs? How are they going to justify each element of the programs? Do those justifications make sense? How do the different elements of the program tie together? How does the accumulation of the possible future benefits get justified and so forth?

They need to see a tally sheet. I know if Jesse were here—I know he’s somewhere out in online land looking over us—he would be saying, "Tally sheets, tally sheets, tally sheets." Well, it’s not a bad thing to bring tally sheets into a board meeting.

The board needs to understand that people outside of the entity are going to look at pay equity and look at proportionality, and they need to be able to answer the question why it makes sense for our CEO to be paid 175 times what the highest paid engineer in the company receives, if indeed that’s what’s happening.

The board needs to understand why they’re still granting options to somebody who already has options equal to 10 percent of the shareholders’ equity of the company, if indeed they are.

So you need to have that information in front of the board, and I think it needs to be there now, including a mock-up of the new comp tables and at least an outline of what the primary elements are going to be in the CD&A. I would schedule an hour at the next board meeting or a very early board meeting, no later than October or November, to talk about what this new world is going to be like and what the company is going to be presenting to the new outside world, to all these constituencies, next Spring.

It’s too late to wait until you’re reviewing the proxy, because my next point is that senior executive compensation has to be justified. It has to be justifiable, and it has to be justified from a zero base every year. I think if the board and the comp committee are not looking at compensation from a zero base every year, you get into the problem that some companies are facing of an accumulation of benefits and grants, and having consultants come in and saying, "This is what everybody else is doing, so let’s add this on." Pretty soon, you’ve got every single program, including the kitchen sink, and you’ve never stepped back and looked at the logic. I think you’ve got to step back.

This should be done every year. My view is the compensation committee does the heavy lifting, and then reports to the full board and spends however long it takes to inform the board. If this is a program that doesn’t change much year to year, it may only take half an hour. But if you’re making changes, it takes an hour. And any element that’s being added to senior executive compensation, or subtracted, or changed in any material respect, needs to be zero base justified.

Some of the questions that have to be asked and answered are: Why do we need this element of compensation at all? Why do we still grant options to somebody who already has a significant equity stake? Why are we granting more restricted stock to the founder of the company who has 25 percent of the stock? What possible motivation is that providing other than sort of a scoring against other executives of other companies who may have a different background?

More questions: Why are severance and change in control provisions in place for an executive who has been there for five years and has already accumulated a significant equity, and therefore, is already aligned with the interest of other shareholders? Do you really need to have a severance package to retain that executive? Why have a severance package for an executive who’s two years from retirement? Why have a change of control package for somebody like that?

These are hard questions, and you’re not going to be real popular with the CEO if you ask those questions, but if you’re not asking those questions and the board is not facing those questions now, then when the time comes in the Spring and the rest of the world is asking those questions, the company is not going to have answers, and you’ve got to be able to answer those questions.

I’m not telling you that there’s one answer. The answer may be that these things make sense, but the board better have thought about—and I’m not talking just about the comp committee, but the whole board—and be prepared to answer those questions.

Another irritant that we hear about regularly, why is the company paying dividends on unearned and restricted shares? I don’t have the ability to get dividends on shares I haven’t paid for yet. Why do the senior executives? What is the rate of the return being paid on deferred compensation?

I can defer a portion of my compensation. If I defer a portion of my compensation at Gibson, Dunn & Crutcher, we call it a contribution to capital, and I don’t get a penny’s worth of interest on it. I mean, it’s the worst investment in the history of man. It declines in value every year, but if I am an executive of the X, Y, Z Grand company, I can defer a portion of my compensation, and I get a return. And at some companies, it’s a return that is well above the market, and it’s guaranteed no matter what the market does. Is that fair? Do other employees get that?

Why do your senior executives need a supplemental retirement plan, a SERP? I know it’s fashionable. I know consultants like to recommend them. I know they’re glamorous. Joe has one; Mary wants one, too. But what’s the justification for that? Has the board thought about that? Do we need that to retain the executive? If the executive already has a net worth through his or her years at the company of $50 million in significant equity, why do they need a SERP? Why? The janitor doesn’t have a SERP. The chief engineer doesn’t have a SERP. The head of investor relations doesn’t have a SERP, and the general counsel probably doesn’t have a SERP, so, you know, why for the executives?

So I think you’ve got to go back and do a zero based analysis, and you’ve got to do it rigorously every year. And if boards are not doing that, they’re not going to be able to answer the hard questions, and, folks, the hard questions are not going to stop coming. This new disclosure is not going to be something that’s going to be a one-year thing. It’s going to be focused on every year.

The next point—and this is one we all know—we just don’t like to talk about it. I call it planes, trains and automobiles, and I’ll tell you why in a second.

Let’s get rid of those hard to explain perks. They just make executives look petty and the board look lax. What’s the point in making your CEO look petty, cheap, and your board like they’re asleep at the switch and that they’ll give Joe or Mary everything they want? What’s the point of that?

That’s not good counseling. It’s not good governance. It’s not smart, and lots of companies are doing away with perks. You don’t really need to have unlimited personal use of the corporate jet or even limited personal use at some cheap rate. I don’t care what the tax determinations are. I don’t care how the SEC ends up, if they ever do, figuring out how you determine the incremental cost of those things. I don’t care.

By the way, one of the reasons directors really care about these things is their perks are going to be looked at, too, starting next year. As you know, it’s not going to just be senior executive perks—not that it wasn’t supposed to be dealt with before but now it’s very explicit. You’ve got to deal with it.

I saw one situation—I won’t name the company—last year where they disclosed something like $5.65—some of you may know about this—in connection with the personal use of an airplane by a member of the board of directors.

I asked the person who prepared the disclosure, "What was it?" It was the cost of the catered lunch—the additional lunch box—on the corporate jet for a director’s wife who was not going to the meeting, but flew along keeping the director company going to a corporate meeting.

That’s kind of silly, but why do we even have people worrying about that? We have people worrying about that because most of us don’t get free rides in business jets and have to actually go through security, take our shoes off, leave our toothpaste behind, and give our perfume to the nice lady from TSA who already has 75 bottles of it, because we can’t bring it on the plane.

And we kind of resent the fact that, you know, people can walk on one of these planes. And it’s okay if it’s business, and it’s okay if it’s justified, but why should senior executives and their entire family have those? Maybe there are security reasons in some cases. I’m skeptical. I know Alan Beller, sitting back there, has been skeptical publicly in the past about the security justification for that kind of use.

Same thing for a full-time car and driver. Very nice to have. I’d love to have a full-time car and driver, and my wife would really be relieved if I had a full-time car and driver given my driving record, but I don’t have that.

My law firm doesn’t do that for me, and it’s not that I’m resentful, but it’s just that the rest of the world thinks that, you know, this is not something that’s appropriate. And if you’re going to have that kind of personal use, you need to explain it. It’s a lot simpler to say to an executive who has a base salary of $3 million a year and a bonus potential of 150 percent of that, "I think you can afford to hire a car and driver for personal use when you need it. We will be happy to help you make the arrangements, but let’s not be reporting this as something the company is going to give you. What’s the point?"

So let’s get rid of these planes and automobiles, and let’s also get rid of the train in the picture, which is the post-retirement gravy train, which was so embarrassing to one major company. Even though they made a disclosure, it hadn’t been detailed, it hadn’t been focused on. That company went through an SEC enforcement action. It was settled on a very amicable basis, but it was embarrassing, and the senior executive, to his credit—former senior executive—gave up a lot of the perks, and the company has changed its policies, but why put yourself in that position?

There is no real justification for saying, "Gee, you’ve done a wonderful job, whatever your name is—Jack or Joe or Jim—and you’ve made, you know, half a billion dollars and earned every penny of it in your 40 years for the company. And because we like you so much, you’re never going to have to pay another bill the rest of your life, free flowers, baseball tickets, apartment." That doesn’t make any sense.

What is the benefit to the company of that? How do you justify that? The answer is you can’t, and you shouldn’t try. You should tell people, "Just back down a little bit. You’ve got plenty of money, you’ve got a comfortable retirement. We’ll help you make arrangements, but pay your own way."

So, that’s a little bit of sermonizing, even though it’s not Sunday, but I’ve seen so many clients, great companies, be unnecessarily embarrassed by this stuff.

It’s not important from a financial standpoint. It’s not going to make or break a company, but it just looks awful. It looks like the executive’s interests are self-centered and that the board is asleep at the switch, and it’s easy, easy, easy, and you don’t want to have that picture for your board in today’s environment.

My next point—I won’t be going too long—options. I’m not going to talk about back dating. I’m assuming—and shame on you if it’s not true—that every one of you who advises a company has seen to it that at least a careful internal review has been made for all past option grants and option grant practices.

As you know, under the new rule, you’re going to have to describe those practices and any variations from them, and either you’re dealing with those problems or you don’t have them. My question is, what are you doing going forward?

Now, obviously, the quick reporting required by the current Section 16 rules has helped a lot. It’s harder to back date, but there are still questions about timing, pricing, when decisions are made, and how they are documented. Going forward, I think the right answer 99 and 44/100th percent of the time, at least for continuing employees, is to have one or two annual grant dates that are fixed in advance and everybody knows, and that coincide with a compensation committee meeting.

Let’s have decisions made by the compensation committee, certainly for all Section 16 subject people, even if they’re not subject to 162(m). Let’s have it occur after earnings have been released and you’ve got—ideally—after you’ve got a 10-K or 10-Q on file with all of the required information. And if you do that, I think it’s going to be very, very hard to criticize option granting practices.

You all have individual things you deal with, but I think companies that have done that, historically, have had very few problems.

And a lot of the problems I’m seeing are problems of sloppiness, or problems of not thinking ahead, as to the consequence of picking a particular date. If you pick your date in advance, be sure it’s in a window period.

If pricing is at market on that day, and if all grants are approved by the compensation committee of the board of directors, I think you will not have a problem going forward.

My final point—and it goes back to the last panel—is don’t forget about the sleeper in all these new rules, which is related party transactions. All the writing in the press—and I know you folks have been ahead of the press on this—has been about executive comp disclosure and perk disclosure and so forth.

The related party transaction rules are changing too, as you well know, and as you’ve just been hearing, changing both in their scope and in their disclosure requirements. Companies will have to disclose policies, and how they apply those policies, and any variations from the policies for related parties.

If you’re a NASDAQ company, you’re already in that universe.

I’d consider sending out the D&O questionnaire early, and then sending an update out later. I think you’ve got to do independent diligence beyond the D&O questionnaire by doing Googling, checking press clips and understanding what affiliations your directors, senior officers and members of their families have with other organizations with whom your company may be doing business.

And I know our good friend Peggy Foran at Pfizer has done that for years, and she tells me that she’s found a lot of things that directors simply forget about or don’t focus on.

The stuff is all going to be laid out, and it also implicates the independent judgments that the board is required to make and disclose under stock exchange requirements.

Under the new rules, you need to do that work-up now because you don’t want to have a director told, just before the proxy goes out, "Oh, by the way, we’re going to have to disclose that the company does X business with the company of which your daughter is an executive or where your brother-in-law is the CEO," and this is news to the director. It’s embarrassing. It may impact whether or not the director is able to serve on a certain committee.

You need to face those issues now, and not wait until you’re about to file your proxy statement. And I know this puts a burden on you, but I think the board wants to be briefed on that. I think the briefing that I talked about earlier, an hour with the board for them to understand what you’re going to say under these new rules, needs to include at least a few minutes of whether there are going to be any new disclosures about directors, senior officers, and members of their families with respect to related party transactions, and if so, do you want to do anything to modify the situation by changing committee assignments or by anticipating the issues that may come from those disclosures?

I should have said—when we were talking about the zero based compensation plan—it may well be if you do that presentation on compensation early, that your compensation committee, informed by the board discussion, will want to revisit some elements of compensation and at least be able to say in the CD&A that changes have been made in those elements which seem less easy to justify.

So those are the things I think you need to do right now with the board of directors.

And just a final word, what about the lawyers? Well, first of all, in the American Bar Association three years ago, there was a presidential task force that looked at lawyers' ethical rules. I had the honor of serving on that group, which was ably chaired by Jim Cheek. And one of the things that was re-emphasized, not new but re-emphasized, was that the lawyer for a corporation has a duty to the corporation. The duty is not to the management.

Now, on the day-to-day, obviously, you work with management. You’re hired by the managers, but every one of us who is a lawyer, inside or outside, has a duty to the corporation. That duty includes the obligation to warn of possible consequences of decisions, including consequences that may affect the perception of the corporation in terms of quality of management and in terms of integrity. Negative perception may have financial consequences as a result of either inappropriate compensation decisions, hard-to-explain compensation decisions or, worse still, fear to disclose elements of compensation or related party situations.

So I think lawyers have a special responsibility not just to be scriveners, not just to prepare the comp tables, but to look ahead and warn the board and senior management that there is going to be this kind of scrutiny next Spring and to think through how it’s going to impact the corporation.

I think lawyers also have a responsibility to insist, at appropriate times, that independent counsel be hired. And those of you who have heard me before know that one of my pet peeves is that compensation committees, advised by compensation consultants, negotiate the CEO’s contract, and perhaps those of other senior executives. They don’t go out and hire independent counsel, who is not beholden to the CEO and is not part of the corporation, and doesn’t regularly work for the company, to represent the committee in those negotiations.

So you’ve got a committee who is negotiating with a CEO who’s probably got a really terrific lawyer—like Joe Bachelder or somebody like that—negotiating for him or her, if it’s an incoming CEO. And you’ve got the compensation committee advised by the corporate general counsel or by regular outside counsel. As good as they may be, as good as their benefits partner may be or their employment partner may be, it’s not going to be credible. It’s not going to be credible when disputes arise in the future if the compensation committee didn’t get advice from somebody who is not beholden, or will not be beholden, to that CEO. So I think that that is another thing that lawyers have to be aware of. There are certain times when, good as we are, we need to advise the compensation committee to get somebody who is independent of the situation and who has the authority to say, "I took a fresh look at this. I was beholden to no one—incoming or in place."

And finally, I think lawyers need to maintain our very refined sense of smell. If it doesn’t smell good, don’t just hold your nose. Say something. I’ve heard more lawyers over my lifetime—and I’ve done this a few times myself and always regretted it—who said, "You know, it doesn’t feel right, or it doesn’t smell right," and leave it at that.

Today, in this environment, if it doesn’t feel right, if it doesn’t smell right, you’d better do something about it, because the chances are increasing that somebody is going to pay a terrible price if that proposal or compensation feature that doesn’t smell right isn’t nipped in the bud, instead of being allowed to fester and get worse.

With that, thanks very much.