Due to unprecedented demand and limited space at our conference hotel for the “17th Annual NASPP Conference,” we are forced to end San Fran Conference Registrations at the end of today, Friday, October 16th for those attending live in San Francisco. This includes attending the pre-conference – the “4th Annual Proxy Disclosure Conference” – in San Francisco. After today, attendance in San Fran will be “sold out”!
You Can Still Attend Via Video Webcast: In the alternative, you can still attend the “6th Annual Executive Compensation Conference” (held on 11/10) – which is paired with the “4th Annual Proxy Disclosure Conference” (11/9) – by video webcast. You automatically get to attend both Conferences for the price of one. Here is the agenda for both Conferences.
Order Audio from NASPP Conference: In addition, you can still hear each – and any – of the 36 panels you wish from the NASPP Conference by ordering the downloadable audio and course materials.
Recently, I blogged about how Microsoft became the first company to take a triennial approach to say-on-pay. Yesterday, Prudential adopted a biennial model – starting with its 2010 annual shareholders’ meeting, the company will have a non-binding say-on-pay on its ballot every other year.
One of the biggest concerns we have – and we imagine boards (and their advisors) caught in this spot also are worried as well – is that many companies reloaded on options and other incentive awards this past Spring when the stock market was at its depths. Now that we’ve seen a 58% market rebound in six months, how are those proxy disclosures gonna look to shareholders, journalists, regulators and the general public? Clearly, this windfall will not be due to long-term performance.
In his latest article, Bud Crystal provides some examples of what we might be seeing on a widespread basis. Definitely worth a read.
Those of you attending our upcoming “4th Annual Proxy Disclosure Conference” – either in San Francisco or by video webcast – will not only receive practical guidance about how to deal with drafting disclosures to try to rein in a potentially messy shareholders relations issue, you will also guidance from the companion conference – the “6th Annual Executive Compensation Conference” – about how to fix this problem. Register for the Conference now.
It is widely reported that Bank of America’s board decided on Friday to reverse course and waive its attorney-client privilege so that the SEC, Andrew Cuomo and others will soon know the details regarding “who advised what” when it came to BofA deciding not to disclose the circumstances regarding bonuses paid to Merrill Lynch employees. According to this NY Times article:
The board reached a tipping point after bank executives held conversations over the last two weeks with the office of New York’s attorney general, said the people briefed on the matter. Mr. Cuomo’s office threatened to charge individual bank executives, including Mr. Lewis, with wrongdoing, these people said. The bank also faced a deadline this week to provide a log of its private legal documents to a House committee.
The bank notified Mr. Cuomo’s office of its decision on Monday, and will do the same in a separate case pending against it by the Securities and Exchange Commission. The bank will also provide documents to investigators in Congress, Ohio and North Carolina, where the bank is headquartered.
SEC (and BofA) Requests a Jury Trial: Is That Normal?
Last week, both the SEC and Bank of America filed a notice in the US District Court-SDNY seeking a jury trial. I searched the SEC website and confirmed my hunch that it is not at all uncommon for the SEC to ask for a jury trial, particularly when the circumstances indicate that their action will be contested. There looked to be at least a dozen complaints filed already in 2009 with demands for jury trials.
Bear in mind that most cases are filed as settled cases, so there would never by a jury trial demand in any of those. For example, in this case, the SEC didn’t initially file a demand for a jury trial because BofA settled (and then Judge Rakoff didn’t accept the settlement).
Ohio Attorney General Files Class Action Lawsuit against Bank of America
It’s not just New York Attorney General Andrew Cuomo and the SEC going after BofA (and a horde of private plaintiffs; this Bloomberg article notes Delaware VC Strine refused to dismiss a case against BofA yesterday). On September 28th, the Washington Post article noted the Ohio Attorney General has filed a class action lawsuit against Bank of America and its executives over the bank’s alleged failure to disclose losses and bonuses prior to its acquisition of Merrill Lynch.
In his “Proxy Disclosure” Blog, Mark Borges has already blogged three times about the challenges of determining how much money recently “resigned” CEO Ken Lewis will walk away with from Bank of America. As Marked noted in his first blog: “All it took was one hour, two college degrees, and over 20 years’ experience in the executive compensation area to come up with this “ball park” figure. Does anyone still think that we don’t need a “walk-away” number as part of the executive compensation disclosure?”
We have been touting the need for better transparency in the severance and change-in-control contexts for quite some time – pushing the need for companies to disclose their “walk-away numbers.” This is not even about responsible pay practices – this is squarely in the hands of lawyers who draft for a living. This is about better transparency. It’s time for you to make a difference.
Those of you attending our upcoming “4th Annual Proxy Disclosure Conference” – either in San Francisco or by video webcast – will not only receive practical guidance about how to craft such a disclosure, you will also get a pro-forma example of what this looks like…register for the Conference now.
Recently, we started using this “Board Dashboard” as a wake-up call to our clients. Our Dashboard provides an independent review of executive compensation based on these four “Fairness & Risk Tests”:
1. Defensible and business relevant peer group
2. Defensible job matching for compensation benchmarking
3. Pay-for-performance (including proper strategic performance metrics and risk horizons)
4. CEO and enterprise internal pay equity
Here is an anecdotal story about one client for whom we conducted a comprehensive executive compensation and incentive risk review:
Upon review, we found that:
– The company’s peer group was fine after we adjusted and removed outliers as compared to previous peer group used in the past – so we ranked “Green Light” on the Dashboard
– The job match for each role for compensation benchmarking also needed to be adjusted because it was a privately-held company with material ownership by one large shareholder who sat on the board. So that was fixed by benchmarking COO roles at other companies – a ” Green Light” on proper CEO job matching for benchmarking purposes. In the past, they had benchmarked CEO roles which led to ratcheting up the comparable CEO pay benchmarks.
– On pay-for-performance, the board was provided a cautionary “Yellow Flag” as the 3-year return on invested capital (ROIC) was in the second quartile and thus below median of the agreed business relevant peer group; yet CEO and executive pay was in the upper end of the third quartile (about 70th percent) – so clearly pay-for-performance alignment was out, but not at an extreme level. A LTIP re-design would fix much of the problem and move them into the “Green Flag” zone for next year.
– Internal pay equity was the big “Red Flag” for the board. Both the CEO role to the Named Executive Officers and the CEO role to the 3rd management layer down pay differentials which was over 8x (should have been 6x max). This suggested there was something wrong with the management structure and/or pay-delivery design.
The board asked us to look at the management enterprise structure and its internal pay equity from top to bottom. We put their data into our proprietary management structure analysis and internal pay equity database and the resulting output was fascinating. The company had 53% of manager-to-direct reports in the “Green” internal pay differential zone – the good news – as they fell within the optimal zone of 1.4 to 2.4x target range.
BUT the company had 24% of “manager-to-direct report” pay differentials less than 1.4x – a proxy indicator of a possible organizational jam up and overlayering and to everyone’s surprise, we identified 23% of manager-to-direct report pay differentials that were too big with over 150 managers who were identified on the Internal Pay Equity Differential report with large pay differentials of 6x, 10x and 20x+. These large differentials for 23% of managers are all in the Moody’s “Red Flag” risk zone of greater than 3x.
The board, CEO and HR head had no reporting systems to identify that they had 9+ layers of management (where only only 5 value-adding management layers are required) as well as the distribution of internal pay equity differentials which were far out of normal distribution.
So by reviewing the enterprise management structure and the internal pay equity and pay delivery review process, it was determined for this one client that:
– The CEO was overpaid by about 30%
– The Head of HR is overpaid by 2x-plus
– Overall enterprise compensation was excessive by 17% of the Total Cost of Enterprise Management (TCEM)
Now, the Board has asked for an offsite presentation regarding all the Red Flags and risks we found. Since the CEO is only 24 months from retirement, the board has set a plan to fix these management structure, over-layering and equitable pay delivery design problems and realize over $50 million+ of cashflow increase opportunity for shareholders upon CEO succession.
Below is an excerpt from my recently submitted comment letter to the SEC regarding its proposed change in the reporting of stock awards in the Summary Compensation Table (here is my full comment letter, you may want to read my oncluding paragraphs with more details on the approach that uses realized values and how this is taking more of a tally sheet approach to the SCT):
Current Approach: Report the “fair value” of stock option and stock awards to executive officers and directors that are expensed during that year for financial reporting under FAS 123R.
Proposed Change: Report instead the grant date “fair value” of the full awards made/granted that year under FAS 123R, not what was expensed for the prior grants.
I think the proposed approach will only continue investor confusion and the media’s uncertainty on how to report compensation that executives receive. It perpetuates the misunderstanding about whether the SCT is providing an accurate picture of what an executive (or director) “makes.” Instead of proposing to go back to the approach the SEC originally adopted in the summer of 2006 for stock options and stock awards in the Summary Compensation Table, the SEC should consider using in the SCT the “Values Realized” numbers from the table for Options Exercised and Stock Vested.
Below are seven reasons why the SEC should reconsider its proposed change and re-propose for comment the approach that requires disclosing realized values in the SCT:
1. Investors, other than institutional investors and others schooled in accounting, do not think about stock compensation in terms of the accounting rules and valuation models. Investors think about what is actually realized and received. The SCT should be a tally of how much an executive “made” in the past year according to the tax code definition of compensation, assuming no deferral of income.
2. All the other numbers in the SCT are amounts of actual compensation that the senior executive/reporting person actually received/was paid in the prior year (or could have if not deferred). The dollar numbers for all other compensation items are real amounts that executives could spend or put in the bank. This is not true with the grant date FAS 123R value, as grants must first vest, and then (for options) be exercised.
3. FAS 123R involves theoretical numbers based on assumptions. No other compensation numbers in the SCT are theoretical or based on assumptions. All the other numbers are actual amounts that executives have received. The severe stock market downturn shows that these assumptions and the models used for employee stock option valuation often prove to be unintentionally flawed or inaccurate.
4. For compensation-planning purposes, FAS 123R does not represent the way all companies value stock grants for determining the size of the grants or their value at grant, whether options , restricted stock, or performance shares. Many companies use either different methods or modifications to FAS 123R valuation models for setting grant sizes and their compensation guidelines.
5. FAS 123R and the models used for valuing options and performance-based equity awards for accounting purposes were not developed for comparing the value of stock compensation to the value of cash. By using it in the SCT, it represents to regular investors that this is a guaranteed, fully transferrable, certain amount, similar to the salary or bonus amounts appearing in the SCT.
6. For annual cash bonuses and long-term cash incentives, companies report only what is actually received/paid in that year, not the value of bonuses offered or some value for potential long-term cash incentives. For stock grants it should be the same in that the amount actually realized is what should appear in the SCT.
7. FAS 123R value will often not represent actual value realized, which is the concern of investors. In rising markets, it will underestimate, potentially by large amounts for stock options, the actual gains from stock grants. In falling markets, it will overestimate the value, particularly with stock options that go underwater. The rulemaking petition submitted by Ira Kay and Steven Seelig (May 26, 2009, File No. 4-585) clearly explains the dilemma in using a fixed date for FAS 123R valuation. We support their petition proposing an approach to SCT valuation for stock and option awards focused on the “pay realizable” as an alternative to using the actual realized value.
As expected, the G-20 Summit ended with the release of these implementation standards that were developed by the Financial Stability Board in conjunction with the G-20 and provide the greatest degree of detail to date on global compensation regulation that could impact global financial institutions. These implementation standards build upon the principles that the FSB issued back in April.
The implementation standards focus on what the FSB considers the critical topics to be addressed first: Pay Structure and Risk Alignment; Governance; Compensation and Capital; Disclosure; and Supervisory Oversight. The Standards state that
“[f]irms and supervisors should ensure the process of implementation is begun immediately and pursued rigorously in their respective jurisdictions.” In a joint statement issued by the UK Treasury, the five largest UK banks – Barclays, HSBC, Lloyds, Royal Bank of Scotland and Standard Chartered – said they welcome the new rules and expressed hope that “there is parity both nationally and internationally on these issues.”
Perhaps not the best online organization, but I have been posting related content in our “Bonuses” Practice Area…
As we commence work on our umpteenth (more than 50th) option exchange, I am struck by a few thoughts:
1. It seems like a colossal waste of resources to have to go through the tender offer process in order to replace, for example, 1000 underwater options with a new 100 share option grant.
2. The motivation for these option exchange programs is principally to get rid of the dilution effects, and simply the bad morale effects, of having significantly underwater options hanging out there year after year, disclosed in financial statements, etc.
3. Many companies doing these exchanges add these shares back to the share pool, thus prolonging the use of the pool. Even if they do not due to institutional shareholder resistance, the exchange has the effect of eliminating the outstanding options. The new grants are a necessary add-on, otherwise employees would not voluntarily relinquish their underwater options, although they probably see little or no value in them.
Mulling all this over, I was wondering whether a new form of option grant might solve some of these problems down the road, should we have a similar situation where vast number of companies have significantly underwater options at the point of vesting. Here is how this would work. A company would make a normal option grant (for example, current fair market value grant with a 10-year term, vesting annually over 4 years). However, the terms of the grant initially would provide that if, at the end of the full vesting period (4 years), the options were underwater by more than a specified amount (this could be a percentage of the exercise price or it could be made with reference to the prior 12-month high trading price or other measure), the option would simply be forfeited at that point.
Because the option expense would have been amortized over the vesting period, I am assuming that there would be no significant accounting effect of this (other than perhaps the impact of such a provision in the original valuation of the option on the grant date, which, if anything, would decrease the fair value for accounting purposes).
The self-cancelling or forfeiture clause in the option would remove any need for a tender offer since there would be no employee consent involved and no consideration for the forfeiture/cancellation. Moreover, the options would no longer be outstanding for dilution purposes.
Whether the company chooses to return these shares to the share pool in the plan would be up to them. If resistance from institutional shareholders to a provision that would add all of them back to the share pool, is anticipated and they are not added back, this would still have positive effects. I would think, moreover, that the company could at least project forfeitures for these options and add that number of shares back to the pool. For example, if, at the 4-year vesting point, it is estimated that 40% of those options would be forfeited, then I would assume it would be acceptable to add back 40% of the cancelled shares to the share pool.
Because I am a lawyer and not a compensation consultant, I am sure that I have overlooked many reasons why this is a bad idea, but I thought I would stick my neck out and throw out this idea for others to comment on. I do know that if such a provision had been included in the grants of all the companies now doing option exchange programs, none of them would be doing these programs, with significant attendant savings.
Anyway, perhaps this will stimulate some discussion.