Back from vacation and I see that things have heated up in the case where US District Court Judge Jed Rakoff’s decision to not approve a $33 million settlement between the SEC and Bank of America over allegations of misleading proxy materials because the bonus obligations due to Merrill Lynch employees were not fully disclosed. When I left a few weeks ago, the Judge was about to hold a hearing to discuss the issues involved. At the hearing, he asked for briefs from both parties by August 24th.
On the 24th, the SEC and Bank of America submitted the briefs as requested by the Judge. Here is the brief submitted by the SEC, including the controversial Disclosure Schedule that was not included in the proxy materials as Exhibit A. Here is Bank of America’s brief that asserts that obligation to pay bonuses was disclosed.
As noted in this NY Times article, Judge Rakoff’s request for documentation regarding who was responsible for the decision not to disclose Merrill’s bonuses resulted in both parties blaming the lawyers in their briefs. Although as Tom Gorman notes, “The briefs read as if they were filed in two different cases.”
On August 25th, Judge Rakoff – apparently not very happy with the briefs – issued this order. As noted by Barbara Black in the “Securities Law Prof Blog“:
Judge Rakoff still isn’t satisfied with the explanations given to him by the SEC and the Bank of America about the settlement involving the disclosure (or lack thereof) of Merrill bonuses in the BofA proxy statement. He instructed the SEC to provide more explanation about why it didn’t follow SEC policy and seek penalties from individual defendants. He also didn’t accept the agency’s explanation that its hands were tied because the corporation asserted reliance on advice of counsel as a defense and would not waive the attorney client privilege and give the SEC the documents. How could the corporation base a defense on attorneys’ advice without disclosing the advice? The judge asked for further submissions due September 9th.
The Judge could hold a second hearing on the settlement – or he could approve or reject it after receiving this new rounds of briefs.
Here are a number of commentaries on what has transpired so far:
Back from a record-length vacation (two weeks without email!) and the papers over there are filled with stories about banker bonuses and how the French have gotten their bankers to agree to some restrictions. French President Sarkozy pushed hard for these restrictions and he intends to make it a big point at the upcoming G-20 summit so that French bankers don’t seek employment elsewhere. Here is a WSJ article from yesterday describing these developments.
On a lighter note, I thought I would share a few vaca videos that may interest you:
1. “Wall Street” English
One of my favorite moments in Paris was spotting a billboard on the subway promoting the Wall Street Institute, which promises to teach you how to speak “Wall Street” English and more. Maybe talking the talk in Paris is all it takes to be an i-banker? Here is the billboard:
2. Public Company Offerings in The Hague
While walking down the street in The Hague, I spotted a storefront which had a host of securities law and compliance books – unbelievable, eh? – including one entitled “Prospectus for the Public Offering of Securities in Europe.” See if you can spot it:
3. Dancing Along the Seine River
One of the nicer sights in Paris wasn’t in the guide books. We first spotted it during one of the river boat rides in the Seine – folks of all ages swing dancing along the banks (and many more just eating cheese and drinking wine). The second video below is a closer look as I went in to investigate. Like a storybook come true:
Recently, we wrapped up this study of director pay that found that total remuneration has halted its steady climb, actually falling back by 2.4% over the last year to $245,000 among the Top 200 companies.
In ’03, full-value stock awards represented only about 29% of the total received by directors vs. 41.5% in ’08. The use of options dropped in half – from 63% prevalence in ’03 to 31% in ’08. Cash retainers now comprise almost 29% of the total package. Board meeting fees and stock option awards are far less prevalent director pay elements in ’08 as compared to ’03.
I’m nearly back from vaca – here is another blog that I tee’d up to be posted in my absence. This one relates to a question that I received from a reporter: “When did the concept of ‘pay-for-performance’ first begin to be used?”
Now this was a hard one to answer with precision since the true answer is the beginning of time. The only reason that anyone would pay anyone else is to receive some form of performance (or in legal terms, in exchange for “consideration.) But the reporter was referring to the movement in the executive pay world where plan design is more sophisticated. And since I am a relative newcomer to this area, I leaned on an old-timer for his input. Here is what I gleaned:
Pay for performance goes much farther back than 1994. Recall that one of the reasons for Section 162(m) was to ensure pay for performance ( and avoid taxpayer subsidies in the event pay was not performance based), so it had been an issue well before then.
So I would say either 1982 (the beginning of the bull market) or 1977 (when Peter Drucker submitted an op-ed to the Wall Street Journal arguing that management pay not exceed 25x’s the pay of the average employee).
With so much going on in the executive pay area, we continue to post numerous memos in all our Practice Areas, including a number of interesting one in our collection of memos about what to do about pay design in a down market. For example, check out this memo by Melissa Means of Pearl Meyer & Partners entitled “Dynamic Pay Modeling – A Holistic Approach to Execuitve Pay.”
“In the wake of the options backdating scandal, companies adopted equity grant policies that typically provide for fixed grant dates that occur during open window periods. In the case of an options exchange program, would you expect that the same considerations should apply to the grant date (i.e., the closing date of the exchange offer) of the new options to be granted? I would expect that it would, as otherwise, a claim could be made that the new options were timed to take advantage of material non-public information.
The second and related question is whether the same considerations should apply to the launch date of the options exchange program when the exchange ratios are set for a value-for-value option exchange. If there was negative news, that news might adversely affect the ratios and participating employees arguably could claim that they were harmed (although the disclosures in the tender offer documents typically state that the valuations could change and the employees would know the news before the expiration date, so that they could withdraw). However, if there was positive news, the participating employees likely would be receiving a greater number of options than they would have received if the exchange ratios had been calculated at the later date. Do you think this is a significant concern such that the SEC might question the timing?”
I responded that I think that exchange programs raise similar backdating issues as option grants, but they are perhaps a bit easier to resolve because the program is publicly-known and there is sufficient lead time to plan. Very few companies have the ability to conduct an exchange without shareholder approval and a tender offer. It seems to me that the shareholder approval process (both the CD&A and the specific proposal) as well as the tender offer provide good opportunities to both communicate the general terms of the timing of the exchange and any necessary modifications to the company’s grant practice policies.
The company will be able to establish the specific exchange period well in advance. It will presumably use the same care for the exchange that it uses in establishing regular grant cycles, or in making off-cycle awards. It ought to be able to plan for an exchange occurring during an open window. Also, the NEOs and directors are usually ineligible to participate in the exchange, thus eliminating a significant class of potentially problematic insiders. Of course, there is the risk that the exchange period may be required to be lengthened or that new material inside information arises (regarding an M&A transaction, for example) during the regrant period.
I believe that many of the timing issues can be dealt with by including within the terms of the tender offer (as most companies do) a right of the company to declare certain electing participants ineligible for the program during or shortly after the window. Presumably the directors, NEOs, company counsel and other compliance personnel ought to be able to reach a consensus at the end of the window whether anyone needs to be declared ineligible. Replacing options with restricted stock or restricted stock units would seem to take off some pressure too. The only blackout period required by law on option regrants would be the BTR rules applicable if a company is changing service providers for its 401(k) plan and has a stock fund that will be closed for more than three days.
Recently, Directors & Boards re-ran this interesting article that originally appeared in their Summer ’97 issue. Author Harold Geneen was CEO of International Telephone and Telegraph from ’59 til ’77:
Geneen on Executive Pay
You have to ask, “What are corporations paying those megamillions for?” The solemn answer comes back from the board of directors: “Demonstrated capability.” But if the company is doing well, surely the CEO’s predecessors deserve some credit. I propose breaking up Fortune 500 chief executives’ pay, giving one half to the incumbents and splitting the other half among his demonstrably capable predecessors and their heirs.
Absurd? Of course. That’s the point. At the moment, there is no logic in these things. The size of the pay package is dictated by habit. To be sure, most companies will hire consultants to advise them on an “appropriate level” of compensation, but all they do is tote up what everybody else in the industry is making and recommend that their clients pay roughly the same. They are, after all, eager to please their clients’ bosses. As I said, it’s a matter of habit.
This also leads to a steady escalation in the size of compensation packages. Are CEOs worth their paychecks? If so, by what standards? Who sets the standards? Who enforces them? To what extent does dumb luck decide the total?
All good questions — and ones that can’t be answered by outbursts of moral indignation. Once we let our gut reaction to supposed excesses guide our social policy, we will be well on the way to socialism.
Going Beyond Hot Air
I have a suggestion. Why not just use logic? To start off, why not ask: What is excessive? There should be some measure of reasonableness. You have to set some objective standards for measuring worth. Otherwise, all you get is hot air. One critic says, “This is unfair. Who can be worth that much?” And the CEO’s defenders retort, “That’s the price of genius.”
If I had to choose, I would err on the side of paying too much for proven performance. It’s a risk, but it’s a smart risk. However, I would ask a lot of questions: Was the performance really as extraordinary as everybody seems to think? Against what odds did he achieve it? How did the company’s profits and stock price stack up against others in the same industry?
Unfortunately, most boards don’t delve too deeply into the methodology of calculating the true worth of performance. Doing so might ruffle feathers. Much easier to follow the practice of posing two simple questions to the CEO: What did you make last year? And what should your increase be this year?
I’m oversimplifying, of course. Boards deliberate the question of the CEO’s pay with great solemnity. Then, nine times out of 10, they approve a double-digit raise.
‘What Are You Worth?’
Only when a company is desperately seeking a new chief to put its house in order does the question become: What are you worth? Unfortunately, in such a crisis, the rigorous analysis that would make sense in ordinary times becomes irrelevant. All the probing of the candidate’s strengths and weaknesses boils down to a single question: Can he save the company?
If the answer is “no,” he is worth nothing. If the answer is “probably not,” he is worth nothing. If the answer is “maybe,” he is worth nothing. If the answer is “probably,” he is worth nothing. Only if the answer is “yes” is he worth even a penny. But in that case, he is worth pretty much whatever he asks.
While it would be a mistake to assume that the number of prodigies capable of running a big corporation is so small that boards have no choice but to pay them $5 million or more, it would also be a mistake to shrink from paying whatever it costs to get the best. After all, it is the most important investment a company ever makes.
So important, in fact, that the question shouldn’t be: How much does he, or she, cost? The main question is: How do we know he really is the best?
As I’m now on my first lengthy vacation of this decade, I’ve tee’d up a few blogs on matters that I’ve been meaning to blog about – except for new developments got in the way. For example, the TechCrunch blog ran this interesting piece – Steve Jobs On “The Value of Stock Options” – back in April…
We recently wrapped up our Quick Survey on “Corporate Airplane Use by Outside Directors.” Below are our results:
1. At our company, when it comes to allowing non-employee directors to use the company’s plane to travel to – and from – board meetings:
– Yes, we allow – but we disclose the aggregate incremental costs associated with such use as director perks in the Director Compensation Table – 1.0%
– Yes, we allow – but we believe such travel is for a business purpose and thus do not disclose it in the proxy statement – 60.8%
– Yes, we allow – but we believe such travel is for a business purpose and therefore only disclose that such travel is permitted in the narrative portion of the proxy statement – 12.4%
– Yes, we allow – but only a percentage of the amounts associated with such use is considered for a business purpose – so some of the cost is disclosed in the Director Compensation Table – 0.0%
– No, we don’t allow non-employee directors to fly on the company plane to our board meetings – 7.2%
– No, as a result of a recent change in our travel policy, we no longer allow non-employee directors to fly on the company plane to board meetings – 1.0%
– We don’t have a company plane – 17.5%
We just dropped the Summer 2009 issue of the Compensation Standards print newsletter in the mail (remember that as a member of this site, you get the print newsletter as a bonus). Since the issue provides timely analysis of all the regulatory reforms that have recently taken place, we have posted the issue online (use link above) since you may want to read it now and get up-to-speed on the radical changes taking place in the executive pay area.