One thing I probably don’t highlight enough is the wealth of knowledge that can be gleaned from the “Q&A Forums” on our sites. Dave Lynn recently answered this query below on the Forum on TheCorporateCounsel.net:
Question: The new proxy disclosure regulations require a description of excessive risk that may result from a company’s compensation plans for executives and non-executives. As I understand it, disclosure is only required if there is excessive risk. If a company has analyzed its compensation plans and determined there is not excess risk, then am I correct that there does not need to be disclosure about the analysis undertaken?
Even if that is correct are there other reasons why a company may want to disclose that they’ve undertaken the analysis even if it shows no risk (e.g., RiskMetrics, etc. review)?
Dave’s Answer: Actually, the standard is whether the risk is reasonably likely to have a material adverse effect on the company, as opposed to “excessive” risk. No disclosure is required if it is determined that this standard of materiality is not met. There are reasons why a company may want to disclose that it went through the process of evaluating the relationship between compensation and risk, most particularly due to investor interest in the topic (as well as interest of the proxy advisory firms).
There are really two levels of disclosure to consider – whether disclosure is required with respect to the relationship between compensation and risk for all employees pursuant to new Item 402(s) of Regulation S-K, and specifically with respect to the named executive officers pursuant to the pre-existing CD&A requirement.
Yesterday, the SEC announced that it has settled its two actions against Bank of America regarding alleged disclosure deficiencies in connection with BofA’s acquisition of Merrill Lynch (one action regarding bonus amounts; the other over operating losses). Not only will BofA pay $150 million to the SEC (to be distributed to harmed shareholders), it will adopt seven governance reforms – if Judge Rakoff approves the settlement (he rejected a $33 million settlement last September). The settlement doesn’t levy any penalties on current or former executives. Here’s the SEC’s litigation release – and here is the SEC’s brief supporting the settlement and notice of motion (with Exhibit A to that).
Here are the seven governance reforms that BofA would be required to implement for a period of three years:
– Provide shareholders with an annual non-binding “say on pay” on executive compensation
– Retain an independent auditor to perform an audit of the company’s internal disclosure controls
– Have the CEO and CFO certify they have reviewed all proxy statements
– Retain disclosure counsel who will report to the audit committee on the company’s disclosures
– Adopt a “super-independence” standard for the compensation committee that prohibits them from accepting other compensation
– Hire a “super-independent” consultant for the compensation committee
– Implement incentive compensation principles & procedures and prominently post them on the company’s site
While BofA’s problems with the SEC may be coming to a close, it’s problems with NY Attorney General Andrew Cuomo may just be starting over these alleged disclosure deficiencies. Yesterday, Cuomo announced that he had filed a civil suit against Bank of America, Lewis and former CFO Joe Price.
The SEC Enforcement Division’s Use of Governance Reforms: Something New?
I know there have been a number of “governance by gunpoint” settlements driven by judges over the past decade, where institutional investor plaintiffs obtained governance reforms from companies whom they had sued and then settled. But is this something new for the SEC?
Going back in time a little bit, it’s fair to say the SEC has somewhat engaged in this type of practice, but I had trouble digging up examples from the past few years. And there certainly hasn’t been a prior instance of the SEC requiring an advisory say-on-pay vote or imposing “”super-independent” criteria as part of a settlement. It’s certainly an interesting way to remediate what was essentially a disclosure issue (how about the one where an outside law firm will report to the audit committee on disclosure!).
Here are the few precedents I could think of where the SEC has used the settlement process to obtain some type of quasi-governance reform from a company: requiring the company to hire an independent consultant to review and recommend improved policies on things like accounting (e.g., Xerox and others) and FCPA compliance (many FCPA settlements in the 2002-2006 time frame), etc.
It will be interesting to see if this is a one-off type of settlement or a new Enforcement trend. Come hear a panel of former SEC Enforcement Staffers discuss this topic during TheCorporateCounsel.net’s upcoming webcast: “Big Changes Afoot: How to Handle a SEC Enforcement Inquiry Now.”
In talking with clients this year about the new compensation risk assessment in the proxy disclosure rules (S-K Item 402(s)), I have encountered about an even split between (A) those who intend to take the SEC up on its offer to “be silent” if the conclusion is that the company-wide compensation program is not “reasonably likely to have a material adverse effect on the company” and (B) those who, reaching the same conclusion, intend to disclose in general terms the process that was followed and features of the program that led to that conclusion.
Very few have opted to simply state the “all clear” conclusion without elaboration, which could give you all of the potential exposure (for being second-guessed by the plaintiff’s bar if something later goes seriously south) and none of the advantage of having a good story to tell.
Gearing up for 2011 and widely-expected mandatory say-on-pay, it makes good sense to start thinking now about how the CD&A and related compensation disclosures can best be stated to enlighten shareholders and not just technically comply with the disclosure rules. A clear and frank discussion of the risk assessment process can give comfort to shareholders on a number of fronts.
First, they will know that the company did not just overlook the new disclosure requirement. Second, they will see first hand how rigorous the review was and how it was conducted. Third, this is yet another opportunity for the company to extol its positive efforts to manage and control compensation-related risks, such as having an effective recoupment policy, long-term stock retention guidelines and an appropriate balance of compensation elements. In telling the “good story,” don’t let it be lost in a boilerplate recitation of the positive features of the program or the steps of the review. An individualized, thoughtful discussion goes a long way to assuring shareholders that the company is serious about assessing and controlling risk.
While the say-on-pay vote is likely to be limited to the compensation of NEOs, the wider compensation program should be of interest to shareholders and may influence their views.
RiskMetrics Group recently announced that its Research Group is allowing companies some flexibility in their burn rate commitments for 2010. Companies that have a 3-year average burn rate that exceeds their GICS industry group cap must either publicly commit to maintaining their burn rate for the next three years at the burn rate cap for their GICS industry group as determined by RiskMetrics for that year or face a negative vote recommendation on their equity compensation plan proposals from RiskMetrics.
Some of the approaches that RiskMetrics’ Research Group has found acceptable include:
1. Committing to the average between the 2009 and the 2010 RiskMetrics burn rate caps,
2. Committing to the average between the 2010 and the 2011 RiskMetrics burn rate caps, and
3. Committing to the 2010 cap for one year, the 2011 cap for one year, and the 2012 cap for the last year.
As a result of the significant declines in the RiskMetrics Burn Rate Caps for 2010, RiskMetrics had little choice other than to work with companies on this issue. I’ve spoken to companies that were willing to let RiskMetrics recommend against their plans as a result of this policy and would then discuss with their shareholders how inflexible RiskMetrics was being on this issue given the dramatic shift in burn rate caps. It sounds like RiskMetrics’ Research Group heard this message and decided that some flexibility was warranted.
I think this will make the commitment a little easier for companies to swallow, but the last two options do present their own concerns. Yes, equity grants (# of awards granted) probably increased on average for 2009. Yes, that data was not included in the burn rate caps that RiskMetrics came out with for 2010. Yes, when those 2009 grants get factored into the 2011 burn rate caps, the caps will likely rise from where they sit for 2010. But by how much and to where exactly? Good questions, with not very good answers at this time. Hence, the last two options are a little less certain for companies but offer an opportunity for an increase in the rate a company commits to, but the exact extent of it will be unknown until subsequent years, but they should be better than simply committing to the 2010 burn rate caps.
I recently spoke with an audience of in-house lawyers and HR staff and got into a spirited debate over the need to pay excessive CEO packages in order to recruit and retain top talent. The old argument of “everyone else is doing it.”
I’m not going to rehash all of the arguments against such thinking – just leave you with my bottom line. I’ve worked in-house and seen how some managers get elevated to the top position and just simply aren’t as good as others in the CEO job. It’s just a fact of life – not every CEO is best suited for that job. Some are better than others. And some are definitely replaceable. It’s now a party line that “not everyone can be paid in the top quartile” – but when it comes to actually putting together a pay package, people forget the party line.
I leave you with the following excerpt from a recent article in “Corporate Board Member”:
For years boards were held hostage by star CEOs who were in such demand that they could write their own employment contracts. Not anymore. With unemployment at nosebleed rates, your boy or girl is most likely staying put. The employment potential of CEOs is directly proportional to how well their companies’ shares performed during their tenures. David Yermack puts it bluntly: “When you run your own stock down 80%, where are you going to go?”
It has taken a little time for boards to realize they have the upper hand. According to Equilar research, at least 40 companies announced that they were paying cash retention bonuses to their top executives between July and December 2008, but fewer than a third included the CEO. Equilar noted that “some special awards, particularly those for chief executives, contain unique performance-based vesting requirements focused on overcoming current challenges.”
For example, JCPenney disclosed in a December 8-K filing that it was granting its CEO, Myron E. Ullman III, as many as 500,000 shares “to provide an incentive for performance during the current economic environment and to recognize Mr. Ullman’s willingness to continue his services to the company.” The award caps out at $25 million, and Ullman, who has no employment contract or severance agreement other than one covering a change in control of the company, could get all of that if he sticks around until December 2011–but only if Penney’s annual total stockholder return grows to 29.1% or more by the end of the period. And he’ll get nothing, even if he hangs in there for three years, unless the return is at least 11.3%.
A common worry that the CEO may have wanderlust could be baseless. When Watson Wyatt surveyed 85 outside directors of large U.S. companies in March and April, 68% of them said that their boards or compensation committees were not concerned or were only slightly to moderately concerned about retaining high-performing executives. In fact, there is so much managerial talent around that this might be an opportunity for companies to upgrade. “Dump the dead wood,” suggests J. Richard, who runs his own J. Richard & Co. compensation consulting firm in Half Moon Bay, California. “That’s where boards should be extremely proactive.”
As you may recall from Corp Fin Deputy Director Shelley Parratt’s speech at our Conference in November, the SEC Staff appears to be drawing a “line in the sand” this year regarding when proxy statement amendments may be necessary. The Staff expects companies to carefully consider the Staff’s positions – including those expressed in comments to other companies – when drafting executive compensation disclosure, and that material noncompliance with the rules and the Staff’s positions will potentially trigger a request for an amendment of the disclosure (rather than fixing the disclosure in future filings).
We just mailed the January-February issue of The Corporate Executive, which includes a comprehensive analysis of typical Staff comments and how you may avoid related pitfalls, including:
– Representative Staff Comments–and Our Practical Guidance
– Guidance for Your 2010 Proxy Disclosures: The Staff’s Executive Compensation Comments
– How We Got To This Point on Executive Compensation Disclosure
– Getting the Analysis Right
– Revisiting Performance Target Disclosure
– Individual Performance
– Benchmarking
Act Now: Please try a 2010 no-risk trial to have this issue rushed to you.