Recently, I caught up with Ed Durkin, Director of Corporate Affairs at the United Brotherhood of Carpenters Pension, to conduct this podcast. In this podcast, Ed explains how the Carpenters Union reviews CD&As (here is a sample evaluation form that will help you understand the Union’s analysis process), including:
– How many CD&As does the Carpenters Union look at?
– What does the Union look for in a CD&A?
– How does the Carpenters engage with companies on their CD&A?
According to the January 12th Congressional Quarterly House Action Report, the House is expected to consider HR 384, the “TARP Reform and Accountability Act of 2009,” introduced by Congressman Barney Frank sometime during this week. Among other things, the proposed Act would expand the executive compensation provisions of the current TARP program by applying them equally to all TARP participants, regardless of the funding mechanism, and by imposing the additional executive compensation restrictions that were applied to the automotive industry in December.
As with other summaries of the bill, the CQ House Report states that the Act would “provide Treasury with discretionary authority to apply these executive compensation requirements to institutions that have already received TARP funds but have not yet paid them back to the government.”
I admit that, after reading the literal language of the bill, I am bit confused about where this notion of retroactivity comes from.
Specifically, Section 102 of the Act would add a new subsection (e) to Section 111 of EESA, including the following subsection addressing applicability of the new, more comprehensive executive compensation provisions:
“(4) Applicability to Prior Assistance. Notwithstanding any limitations included in subsection (a), (b), or (c) with regard to applicability, the Secretary may apply the requirements of and the standards established under this subsection to any assisted institution that received any assistance under this title on or after the date of the enactment of the TARP Reform and Accountability Act of 2009.”
To me, this pretty clearly seems to permit prospective application only. But I see five possible sources of ambiguity:
1. The title itself “Applicability to PRIOR Assistance” indicates perhaps that retroactivity was intended as a discretionary possibility. Otherwise, that title does not make sense.
2. One could read the words “any assisted institution that received any assistance under this title on or after the date of the enactment of the TARP Reform and Accountability Act of 2009” to include any institution that has not repaid the TARP funds in full before the enactment of the new law. In other words, this would mean that if an institution continues to hold TARP funds after the enactment date, it is considered to have “received assistance” under TARP on and after the enactment date. Loose drafting, at best.
3. If one were willing to move clauses around and invent commas where there are none, one could apply a strained (in my view) reading of the proposed subsection 111(e)(4) to say that the Secretary “may, on or after the date of the enactment of the TARP Reform and Accountability Act of 2009, apply the requirements of and the standards established under this subsection to any assisted institution that received any assistance under this title.” This reading would give the Secretary full ability to apply the new rules retroactively.
4. To the same effect, one totally uncommitted to Strunk & White might read “on or after the date of enactment” to modify “the requirements.” In that case, it would read: Treasury may apply the requirements of the new section [as in effect] on or after the date of enactment to any assisted institution that received any assistance under EESA. This reading would also give Treasury the authority to apply the restrictions to institutions that had already entered the program.
5. Maybe it is just a typo and will be corrected to say “on or before” rather than “on or after” the date of enactment.
The drafters of the bill appear to believe that it does give Treasury the authority to impose new terms retroactively. The summary posted on the website of the House Financial Services Committee, of which Congressman Frank is the chair, contains this statement: “Authority retroactive. Provides authority to Treasury to apply these expanded executive compensation provisions retroactively to existing recipient of direct assistance.”
It really comes down to two questions — whether Treasury will be given authority under the new Act to change the terms of engagement for prior TARP participants and, if so, whether it would choose do so.
Tune in next Wednesday for the CompensationStandards.com webcast – “The Latest Developments: Your Upcoming Proxy Disclosures—What You Need to Do Now!,” featuring Mark Borges, Alan Dye, Dave Lynn and Ron Mueller. This is the first of a two-webcast series, with the second one taking place the following Wednesday, January 28th.
Given the heightened importance of executive pay right now – and the high likelihood that Congress will pass “say-on-pay” legislation, this year’s compensation disclosures will receive unprecedented scruntiny by investors, employees, customers and the media (see this recent Financial Times article).
Renew Now: For those that haven’t renewed, the grace period ends later today. As all memberships are on a calendar-year basis, you will not be able to access these webcasts if you haven’t renewed for ’09 – so please renew today. The grace period ends at the end of today.
A while back, I blogged about how Carl Icahn was challenging the role of compensation consultants and asked if any consultant wanted to respond. The only answer I got was this:
My response is “who cares what Carl Ichan thinks?” Hasn’t he lost enough money recently, demonstrating his fading investment acumen, that his point of
view is not a good indicator of effective governance? Responding to his point of view only further publicizes his point of view and many reading that will assign further legitimacy to it.
Interestingly, Carl recently posted this rebuttal in advance of an article coming soon from Corporate Board Member about Icahn-proofing your board. Attacking Carl surely will be well-received in many corporate quarters – and likely will attract media attention (like this!) – but in Icahn-proofing the board, you probably are also insulating it from legitimate questioning by concerned investors. We’ll have to wait for the article to see what it says (if the article indeed is coming; it wasn’t part of their Jan/Feb. edition)…
Back in September, the Canadian Securities Administrators (CSA) adopted new executive and director compensation disclosure regulations after three years of proposals that commenced after the SEC adopted new rules (the CSA rules were last signficantly revised back in ’94). The new disclosure rules took effect on December 31st. While the revised rules follow the general theme and structure of the SEC’s new rules (eg. CD&A), Canadian regulators sought to simplify them.
Most Canadian issuers that are also subject to SEC reporting requirements can choose to disclose under either CSA or SEC rules. Many Canadian issuers have already voluntarily adopted “best practice” disclosure standards or aligned their disclosure practices with provisions of the latest CSA proposals, so they will now be amending their disclosures to fine-tune them (many issuers voluntarily adopted disclosure standards advocated in the “Best Practice in Compensation Disclosure” published by the Canadian Coalition for Good Governance.) In our “International” Practice Area, we have posted memos regarding the new rules.
In this past Sunday’s NY Times, an economist – Robert Frank – wrote an essay about whether Congress should limit executive pay. Although Frank makes some accurate observations, the piece is typical of most written by academics and others who are not familiar with the processes by which executive pay is set (Frank’s lack of knowledge is evident when he states that “salaries” drive job choices – not true since salaries are just a nominal part of CEO pay packages, at least at larger companies). Frank cites the two primary reasons for heightened pay over the past few decades is that market caps for companies have grown and that executives are more likely to change jobs these days.
Although I agree that those two factors have contributed to escalating pay, they are not the major factors. As I wrote several years ago in my “Open Letter to All Journalists,” you need to understand what is happening in the boardroom – particularly compensation committee meetings – to really understand why executive pay has risen. It’s these board processes (eg. peer group benchmarking; severance/COC arrangements because “everyone else is doing it”; annual option mega-grants) that continue to be broken and have inadvertently led to excessive pay. Fixing these processes is critical, including the very difficult task of unwinding past arrangements.
I continue to contend that Congress shouldn’t force boards to fix their processes – boards should be doing that themselves. But if boards don’t soon – and they sure have been slow to figure out their role in fixing the problems of executive pay – it seems inevitable that Congress will act.
And unfortunately, I believe any new Congressional action won’t solve our pay problems because boards (with the help – and even prodding – of errant advisors who forget their represent the company, not the top managers) always seem to find a way around artifical limits, thereby “creating” unintended consequences.
Boards must be accountable and need to take a leadership role here. I remain stunned as most boards still don’t seem to have figured this all out yet…as I’ve blogged before, the few companies taking responsible pay actions appear to have the CEO leading the charge rather than the directors.
Financial services companies (among others) should consider taking proactive steps to go well beyond the minimal (and ineffective) TARP requirements to reform their executive compensation practices, including:
1. Re-set the pay mix: Financial services executives earn a very high proportion of their pay (cash compensation and restricted stock) based on short-term results. This is virtually unheard of in every other industry, where the lion’s share of compensation (60% – 75%) is based on long-term, equity based incentives. Companies need to adopt long-term incentive arrangements tied to the Company’s long-term business plan that reward sustainable, long-term improvements in financial and stock price results. Performance shares tied to earnings growth and relative total shareholder return are likely to be used far more extensively than in the past.
2. Roll-back pay levels: Pay levels at some financial institutions routinely exceeded $30 million, and were justified based on pay for performance. Boards would be well-advised to reduce pay levels to more sensible levels. A good place to start would be by targeting the median, and allowing performance to drive above or below median pay. Another important step would be to cap incentives at 200% to 300% of target levels. While these reductions could lead to the loss of some executive talent to hedge funds, private equity, and start-up investment firms, this step is essential to restoring investor and taxpayer confidence.
3. Adopt “hold backs” and “hold to retirement” policies: An important method for keeping executives focused on sustained, long-term performance is to adopt “hold back” and “hold to retirement” policies. A “hold back” provision generally applies to the annual incentive, where a portion of the earned incentive is held back for at least one year (and sometimes longer), and subjected to future performance conditions.
Thus, if one year’s financial performance funds a maximum payout, a portion of the incentive is held back and paid only if the subsequent year’s financial targets are achieved. Holdbacks may vary depending on participant’s level in the organization or size of the award, and a 25% to 40% holdback is common. “Hold to retirement” provisions require that executives retain [50%] of the after tax value of earned equity incentives. This requirement is in addition to the regular stock ownership requirements. Hold until retirement provisions help to ensure the amount of wealth the executive ultimately accumulates is, in part, tied to the Company’s total shareholder return during their career with the Company.
4. Eliminate perquisites, gross-ups and other “executive entitlements”: In order to promote internal equity and fairness, many companies treat all employees the same when it comes to benefits and some impose a higher cost burden on those that can best afford it. [Citicorp was one of the first companies to charge executives for the full amount of their healthcare benefits.]
While it is difficult to quantify the level of resentment and lost productivity resulting from the perceived injustice created when executives keep lavish perquisites and benefits while employees endure higher healthcare premiums, suspended 401(k) contributions and layoffs, it is likely substantial. Shareholder ire is also caused by tax gross-ups, with the harshest criticism leveled at tax gross-ups on executive perquisites.
5. Modify severance arrangements: In addition to modifying severance benefits to comply with TARP, consider:
– Broadening the definition of termination for cause to include poor performance.
– Eliminating excise tax gross-ups.
– Capping the severance multiple to 1x base salary and target bonus for non-change-in-control terminations and 2x for a change in control related termination.
– Adopting double trigger vesting provisions in a change-in-control (i.e., must have a CIC and lose your job).
– Linking severance protection with financial need. Thus, if an executive has accumulated significant wealth during their employment with the Company, no severance will be paid. Alternatively, phase-out severance protection within 5 years of hire or promotion to executive officer.
– Ira Kay and Steve Seelig, Watson Wyatt Worldwide
We just published a study – entitled “Executive Compensation in Uncertain Economic Times” – that shows that compensation committees had been making significant adjustments to how they compensate their CEOs even prior to the recent financial crisis.
The survey found that – for the first time in years – executives at companies that performed well were granted larger pay opportunities than their counterparts at weaker companies. Total direct compensation (TDC) opportunity for CEOs at high-performing companies was $10.7 million from 2005 to 2007, noticeably higher than the $8.1 million TDC opportunity for CEOs at low-performing companies. The lack of a historical relationship between performance and pay opportunity has been a source of significant criticism of corporate America. Total direct compensation opportunity includes base salary, annual incentives and new long-term incentive stock and cash grants.
While companies are taking steps in the right direction, challenges still remain. This year’s study also reveals that companies granting riskier compensation packages — a heavier mix of stock options with higher stock price volatility — tend to grant higher total compensation opportunity — $12.5 million versus $7.1 million for CEOs at companies granting less risky compensation.
Other findings from the survey include:
– CEOs at high-performing companies continue to earn more in realizable pay than their low-performing counterparts. At companies with above-median three-year total return to shareholders (TRS) from 2005 to 2007, CEOs earned a median realizable long-term incentive value of $5.5 million compared to $1.4 million for CEOs at companies with below-median TRS.
– Consistent with previous surveys, companies with high CEO stock ownership levels significantly outperformed companies with low CEO stock ownership levels.
– Even before the recent stock market slump, one out of three companies (34 percent) had stock options that were “underwater” in 2007, an increase of 60 percent over 2006. The average strike price among these firms was 28 percent below the current share price. These values do not reflect additional market declines of the year.
My colleague, Julie Hoffman, recently caught up with Dave Johnson, Executive Compensation Practice Leader at Ernst & Young, in this podcast to discuss putting IFRS’ impact on compensation on HR and Finance’s radars, including:
– How might IFRS impact executive compensation arrangements?
– As a result, who (besides the accounting/finance teams) needs to be conversant with IFRS at a company?
– What should companies be doing to prepare now for IFRS’ impact on compensation?
Reasons Why Folks Do “Best of” Lists
I was tempted to concoct some type of “best of” list – and then I got sarcastic about it and created this pie chart instead:
Brink Dickerson of Troutman Sanders reports that a preliminary filing of a proxy statement under Rule 14a-6(a) is required in connection with management say-on-pay proposals. While Rule 14a-6(a)(4) eliminates the filing requirement for the “approval or ratification of a [compensation] plan…or amendment to such plan,” Interpretation N.10 from the Manual of Publicly Available Telephone Interpretations makes it clear that this is a narrow exclusion and does not apply to after-the-fact approval of specific compensation (note that this set of interps may be updated any day now, per statements of Corp Fin Staff). In addition, the Corp Fin Staff confirmed for one of Brink’s colleagues that a management say-on-pay proposal would not fall within the Rule 14a-6(a)(4) exception.
A number of the companies with management say-on-pay proposals (egs. AFLAC, Littlefield and H&R Block) have filed preliminary proxy statements, but they had other proposals that would have triggered a preliminary filing in any event. Other companies appear to have overlooked this requirement.
Here is a response I received from a member in response to this blog fyi: Whether right or wrong, I believe common practice is that companies do not file preliminary proxy statements even when awards to employees are made subject to the approval by shareholders of a new plan or an amendment to an existing plan. And don’t forget this additional important nuance from NYSE and Nasdaq FAQs on Equity Compensation Plans – here is NYSE FAQ F-2 (2/18/04):
If shareholder approval of a new equity compensation plan is required, may grants be made before the approval is obtained, so long as the grants are forfeited if the shareholder approval is not in fact obtained?
No shares may be issued until the approval is obtained. This is because the Exchange requires that a supplemental listing application (“SLAP”) be filed before the shares are issued, and the SLAP will not be accepted unless any required shareholder approval has already been obtained. Grants may be made before shareholder approval, provided that no shares can actually be issued pursuant to the grants until it is obtained. For example, a listed company could grant stock options that would not become exercisable until after shareholder approval is obtained. On the other hand, restricted stock could not be issued before shareholder approval, because restricted stock is issued upon grant. Note, however, that the company could promise to issue restricted stock at a future date after shareholder approval is obtained.
