In April, the New York Times partnered with Equilar for their annual CEO Pay study, based on the 200 largest companies to file proxies by the end of March. Now that most of the 2009 proxies are in, we’ve fleshed out our study to provide the latest data on CEOs broken into Small, Mid, and Large Caps, allowing companies to take a deeper look at pay trends.
Mid-cap CEOs saw both the only pay rise (1.7%) and the largest jump in bonus payouts, with the bonus rise echoed by the large-cap CEOs as well. In each of the three groups, healthcare CEOs netted the highest pay, and there’s evidence that early-2009 stock-option grants are rising in value more quickly than many recipients thought.
As we recently noted in this article, a recent SEC interpretation raises some potential accounting and disclosure implications for stock-settled performance share awards in cases where a company retains the discretion to modify the number of shares otherwise earned under a performance share award formula (i.e., the compensation committee has the ability to exercise “negative” discretion). Companies that award performance shares subject to discretion will want to review the SEC interpretation carefully and may want to modify their performance share plans to avoid adverse accounting consequences.
Example: A company awards stock-settled performance shares in January 2010. The award is subject to a performance period that runs from January 1, 2010 through December 31, 2012. The ultimate number of shares that will be delivered after the end of a three-year performance cycle (i.e., early in 2013) will vary based on an objective formula involving a performance or market condition (as defined in ASC 718). However, the plan allows the compensation committee to reduce the number of shares that would otherwise be delivered based solely on the objective performance formula.
Because of the committee’s ability to exercise negative discretion on the ultimate number of shares delivered, it’s possible that such a performance share award would not have an ASC 718 “grant date” until the award is settled, thus jeopardizing fixed accounting treatment for the award. Further, the proxy disclosure rules control the timing of disclosure by generally requiring equity awards to be disclosed in the compensation tables based on the award’s accounting grant date.
If this standard applied to a performance share award of the type described above, the award would not be reported in the tabular disclosure until the discretion is exercised or lapses, typically years after the awards were initially communicated to executives. However, the recent SEC guidance indicates that even though there might not be a grant date for an award of performance shares for accounting purposes, disclosure of the fair value should not be delayed if the “service inception date” (an accounting concept discussed below) precedes the grant date.
It’s worth noting that the use of negative discretion in determining the payout of performance share awards is not a new concept. This approach has been common at least since Section 162(m) of the tax code came on the scene in the mid-1990s. We can only speculate as to why auditors appear to be increasingly sensitive to the potential accounting implications of such discretion with regard to equity awards. Note also that performance awards denominated and settled in cash do not pose the same accounting issue because they could never qualify for fixed accounting treatment.
Read more about the accounting and disclosure implications of this SEC position in our article.
With the Senate and House expected to vote upon the Dodd-Frank Act – formally known as the “Dodd-Frank Wall Street Reform and Consumer Protection Act” – within the next few days – with President Obama then signing it before the 4th of July – the 2000-pages of the Act have been posted. Note that the passing of Senator Byrd last night might delay adoption of the legislation, according to this WSJ article.
We have also posted an excerpt consisting of just Title IX (the investor protections of the Act), which consists of 362 pages (Subtitle E, which includes the governance and compensation provisions, begins on page 207). Finally, here is a 10-page summary – and the Conference Report. We have posted these, as well as memos and scorecards in our new “Dodd-Frank Act” Practice Area, which I’m sure will grow like wildfire over the next few weeks.
Poll: The Acronym for the Dodd-Frank Act?
Back when the Sarbanes-Oxley Act was passed in ’02, it took a while for “SOX” and “Sarbanes-Oxley” to become the common way that folks referred to the historic legislation. An early movement towards “SarBox” never took off – thankfully – although a few still use that term for some reason. So now we have a new piece of legislation to “name.” I personally like the “DFA” – but doubt that will catch on. Please participate in this anonymous poll about how we should refer to the Dodd-Frank Act on a shorthand basis:
Racing to an artificial deadline, the House-Senate conferees worked into the wee hours this morning (5:39 am!) to finalize numerous open provisions in the RAFSA (renamed “The Dodd/Frank Act“?), much of it behind closed doors despite the decision to televise the negotiations on C-SPAN. Once again, thanks to Ted Allen of ISS who blogged along the way yesterday to give us the lowdown on the finalized corporate governance items that were still outstanding (we’ll have to wait to see the final bill to fully realize what transpired, that likely will take a few days):
On other open items, some answers are provided in this Washington Post article – and this Morrison & Foerster scorecard.
I got this from a member yesterday: In this late 2007 letter, a group of Senators lobbied then-SEC Chair Cox to head off the SEC from considering the use of a 5% shareholder ownership requirement because it would “…effectively bar most shareholders from ever filing such proposals…This threshold should be eliminated.” Yet that exact same threshold is what some – but not all – of these same senators argued for this week over the objection of House conferees. Just another day in Washington.
More on “My Ten Cents: Say-on-Pay”
On “The Corporate Library Blog,” Paul Hodgson blows off some steam about the decision to allow flexibility beyond one year for SOP. Although not having an annual SOP certainly means less work for our community of board advisors, is it really a good thing for Corporate America? During an “off-year” when SOP is not on the ballot, shareholders may well choose to vent frustration over a company’s pay package by voting against re-election of the compensation committee (or the full board). Not a good result for them.
Plus my reaction is a bit different than Paul’s because I still believe that say-on-pay has the potential to derail the progress towards responsible pay as boards at the numerous companies who inevitably will receive support from 90-plus percent of their shareholders will think that they are doing a great job in setting pay, even though some of their processes are still broken (eg. the heavy reliance on peer group benchmarking). I don’t like SOP much at all.
In other words, most boards should be thanking their “lucky stars” for say-on-pay because it gives them cover, both reputationally and probably also from liability. Given that, I’ll never understand the knee-jerk reaction from the corporate community to oppose SOP so vehemently as I’ve blogged before. On the other hand, maybe companies do have a reason to be scared of SOP since three companies failed to obtain majority support for their MSOPs over the past month…
I was being interviewed by a business writer for his publication’s annual executive pay story and he asked about an interesting footnote in a proxy statement. A CEO had received performance share grants in 2007 and 2008, which of course appear in the Summary Compensation Table at their grant date fair value. The performance thresholds were not achieved so he had received zero compensation from the grants that had been reported as $1.75 million and $1.15 million for those two years.
I happen to be familiar with that company’s executive compensation practices because it is a member of the peer group of a client of mine. I had noticed the interesting disclosure when reading their recent proxy:
The stock awards granted to Mr. X in 2008 and 2007 were performance restricted stock grants with multi-year performance goals. The goals were not achieved and none of the stock awards vested. Accordingly, Mr. X received no common shares or other value from these awards. These performance restricted stock grants are, however, under SEC rules required to be reported as compensation even though the performance restricted stock never vested and no value was delivered to the recipient.
The company was sure to mention three times in three sentences that no pay resulted from this pay disclosure. It is clear that he did not get paid that $2.9 million.
The writer wondered whether this is a new problem that stems from the change in SEC disclosure rules and I told him it is far from a new problem and one with roots going back to the 25+ year debate about accounting for equity-based compensation awards – remember the anti-FAS123 argument (pre-1995) that expensing stock options could result in a company recognizing an expense when no pay was ever delivered to the employee. Mr. X’s employer has revived that opposition by highlighting to investors that the pay numbers may not be pay numbers at all but are just hijacked accounting expense figures masquerading as pay.
Performance equity awards may require only a year or two or three to confirm that the reported numbers will yield or did yield zero pay, however, unlike stock options which could take up to ten years for the same realization.
In a proxy season that produced a $22.5 million dollar variation in one CEO’s reported pay among various business publications, the “vaporware” aspects of some performance-based equity plans – combined with similar plans in some companies paying at the maximum with investors accusing companies of sandbagging goals – will raise more questions about performance equity plans as a solution to the CEO pay-for-performance issue.
Join Elizabeth Dodge of Stock & Option Solutions and me for the NASPP’s “Practical Guide to Performance-Based Awards” pre-conference program on Monday, September 20th (immediately preceding the NASPP’s National Conference) in Chicago.
Yesterday, negotiations over the regulatory reform bill resumed with a goal to wrap them up by this Thursday, to allow sufficient time for the President to sign the legislation by July 4th. The loose schedule for this week’s House-Senate conferee consideration is noted at the end of this WSJ article (here’s the latest on the Volcker Rule from the Washington Post).
During negotiations on financial reform legislation on Tuesday, U.S. Senate conferees agreed to drop their opposition to a House provision to require public companies to hold separate shareholder votes on “golden parachute” payments, according to Dow Jones Newswires.
The conference committee’s negotiations will continue on Wednesday. House and Senate lawmakers still have not reached an agreement on a Senate proposal to require investors to hold a 5 percent stake to nominate board candidates under the SEC’s proposed proxy access rule, according to Dow Jones. House lawmakers and investor advocates argue that a 5 percent threshold would be too high.
Meanwhile, Steve Nieman – an employee-shareholder of Alaska Air Group – who has nominated director candidates in the past at his employer (remember VotePal.com) has filed a “Notice of Assertion of Right to Proxy Access” at Alaska Air ahead of next year’s annual meeting. I believe the timing is intended to set up a potential lawsuit in the event that Congress does include a 5% ownership threshold in a proxy access provision.
We have posted the 2nd Quarter 2010 issue of the “Proxy Disclosure Updates” (which is part of the Lynn, Borges & Romanek’s “Executive Compensation Annual Service”) that includes a proxy season post-mortem from Mark Borges, complete with analysis of the latest proxy disclosures filed during the just-completed season.
Act Now: To gain access to the complete version of this issue immediately, try a No-Risk Trial to the Annual Service today.
Below is news from Cleary Gottlieb (here is related WaPo article):
Yesterday, the Federal Reserve (the “FRB”), the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corporation (collectively, the “Agencies”) jointly issued final guidance on sound incentive compensation policies (the “Final Guidance”). The Final Guidance follows the FRB’s publication of proposed guidance on sound incentive compensation policies (the “Proposed Guidance”) in October 2009. The Final Guidance states that it is “designed to help ensure that incentive compensation policies at banking organization do not encourage imprudent risk-taking and are consistent with the safety and soundness of the organization” and is structured around three key principles:
– Incentive compensation arrangements at a banking organization should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risk;
– These arrangements should be compatible with effective controls and risk-management; and
– These arrangements should be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.
The Agencies’ joint press release first notes four areas that the FRB had found to be “deficient” at large, complex banking organizations (the “LCBOs”) during its horizontal review of incentive compensation practices at those firms that has occurred so far in 2010. The press release stated that:
– “Many firms need better ways to identify which employees, either individually or as a group, can expose banking organizations to material risk.”
– “While many firms are using or are considering various methods to make incentive compensation more risk sensitive, many are not fully capturing the risks involved and are not applying such methods to enough employees.”
– “Many firms are using deferral arrangements to adjust for risk, but they are taking a ‘one-size-fits-all’ approach and are not tailoring these deferral arrangements according to the type or duration of risk.”
– “Many firms do not have adequate mechanisms to evaluate whether established practices are successful in balancing risk.”
The Agencies expect to follow up with the LCBOs on these and other areas for improvement as the horizontal review process continues in 2010.
The Final Guidance is largely consistent with the Proposed Guidance in terms of its substance but contains a number of important clarifications and observations that help elucidate the Final Guidance’s three principles described above. These include:
– Maintaining a principles-based framework, rather than adopting a more formulaic rules-based approach, such as that adopted in European jurisdictions such as the UK and France;
– With respect to foreign banking organizations with US operations, reaffirming a deference to such organizations’ home country supervisors, while at the same time asserting that the incentive compensation policies and practices of a foreign bank’s US operations should be consistent with the Final Guidance;
– Re-emphasizing that different employees (and different groups of employees) should have compensation arrangements that differ based on the type and level of risk that such employees create;
– Providing a specific baseline definition of employees who constitute “senior executives” and therefore fall within the first category of “covered employees” subject to the Final Guidance;
– Emphasizing that a firm’s “risk-management procedures and risk controls that ordinarily limit risk-taking do not obviate the need for incentive compensation arrangements to properly balance risk-taking incentives”;
– Providing a strong indication that senior executives should have a substantial portion of their compensation deferred over a multi-year period and based on company-wide financial performance with the actual number of equity-based instruments ultimately received dependent on the firm’s (or “ideally” the executive’s) performance;
– Declining to specifically prohibit golden parachutes, but suggesting that organizations consider including “balancing features” such as risk adjustment or deferral requirements extending beyond an employee’s departure in such arrangements; and
– Highlighting the regulatory challenges inherent in addressing the risk implications of golden handshake arrangements, particularly in circumstances where the hiring organization is not subject to supervision by the Agencies.
The Final Guidance also contains a number of suggested procedural steps for covered “large banking organizations” which should be familiar to those LCBOs currently undergoing the FRB’s horizontal review. These procedural steps include:
– Identifying employees who are eligible to receive incentive compensation and whose activities may expose the organization to material risks (including the three categories of “covered employees” described in the Final Guidance);
– Identifying the types and time horizons of risks to the organization from the activities of these employees;
– Assessing the potential for the performance measures included in the incentive compensation arrangements for these employees to encourage the employees to take imprudent risks;
– Including balancing elements, such as risk adjustments or deferral periods, within the incentive compensation arrangements for these employees that are reasonably designed to ensure that the arrangement will be balanced in light of the size, type, and time horizon of the inherent risks of the employees’ activities;
– Communicating to the employees the ways in which their incentive compensation awards or payments will be adjusted to reflect the risks of their activities to the organization; and
– Monitoring incentive compensation awards, payments, risks
taken, and risk outcomes for these employees and modifying the relevant arrangements if payments made are not appropriately sensitive to risk and risk outcomes.
More specifically, the Final Guidance suggests that the board of a large banking organization take a particularly active role in reviewing incentive compensation arrangements. Suggested steps include:
– Reviewing, on at least an annual basis, an assessment by management, with appropriate input by risk-management personnel, of the effectiveness of the design and operation of the firm’s incentive compensation system with respect to appropriately incentivizing risk-taking; and
– Periodically reviewing both backward-looking reports reviewing incentive compensation payouts relative to risk outcomes and forward-looking simulation analyses of compensation based on a range of performance levels, risk outcomes and the amounts of risk taken.
The Final Guidance notes that the Agencies “intend to actively monitor the actions being taken by banking organizations with respect to incentive compensation arrangements and will review and update this guidance as appropriate to incorporate best practices that emerge.” Furthermore, the FRB will be preparing a report on trends and developments in compensation practices at banking organizations “after the conclusion of 2010.”
– John Savarese and Wayne Carlin, Wachtell Lipton Rosen & Katz
The SEC recently achieved a significant victory in its campaign to use the “clawback” provision under Sarbanes-Oxley to force the return of incentive-based compensation by CEOs and CFOs to issuers, even when they are not personally responsible for any alleged “misconduct” in SEC v. Jenkins, No. CV 09-1510-PHX-GMS (D. Ariz. June 9, 2010).
The court in Jenkins denied a motion to dismiss the SEC’s complaint seeking an order directing Maynard Jenkins, the former CEO of CSK Auto Corporation, to pay back to CSK over $4 million in bonuses and stock sale proceeds that Jenkins received during a period for which CSK’s financial statements were later restated. The case is noteworthy because the SEC has pointedly not charged Jenkins with any wrongdoing, notwithstanding that other former CSK executives have faced both civil and criminal accounting fraud charges. (See our memo, SEC Pursues Unprecedented Sarbanes-Oxley “Clawback,” July 24, 2009.)
Sarbanes-Oxley Act Section 304 requires a CEO or CFO to return incentive-based compensation to an issuer when a financial restatement occurs “as a result of misconduct . . . .” The Jenkins court rejected the argument that this obligation can arise only where the “misconduct” has been committed by the CEO or CFO in question. Rather, the court held that the triggering event is misconduct by the issuer, acting through any of its officers, agents or employees.
As this was a motion to dismiss, the court did not address the ultimate merits of the SEC’s particular claim against Jenkins. Nor did the court’s opinion answer some important open questions concerning the scope of this extraordinary remedy. Jenkins had argued that the SEC was obligated to specify the portion of his incentive-based compensation during the relevant period that the SEC would contend was traceable to the misstatement of CSK’s financial results.
The court did not reject the concept that some portion of the bonuses and stock sale proceeds received by Jenkins during the relevant period may not have been fairly attributable to CSK’s misstatements. Instead, the court found that this issue requires development of a factual record, and cannot be determined on a motion to dismiss.
Similarly, the court did not reject the possibility that the amount or method of calculating the proposed recovery could be so excessive as to raise constitutional issues – again, that issue must await factual development.
While the Jenkins decision is not binding on any other court, this result in the first litigated no-fault clawback case will certainly reinforce the SEC’s view that this remedy can be deployed in appropriate cases, even in the absence of allegations of personal misconduct by a CEO or CFO. The SEC and its Staff have shown a willingness to pursue no-fault clawbacks in other cases, such as the recent $470,016 settlement by the former CEO of Diebold, Inc. SEC v. O’Dell, No. 1:10-cv-00909 (D.D.C. June 2, 2010). The issues left open by Jenkins signal that there is still room for vigorous advocacy – whether before the SEC or in court – over the proper scope and calculation of a clawback recovery.
A few days ago, the Financial Times included a thought-provoking article about how leverage and debt in the banking sector make stock price a risk-filled measure for executive pay. The article cites a paper titled “Executive Compensation and Risk Taking” that was recently presented at Columbia University. Overall, I suspect we will be seeing a healthy sophistication in the analysis of how business operations connect to the structuring of executive compensation. The best decision-makers will need to facilitate this dialogue in order to assure that the incentives they approve will reflect the desired balance between business objectives and risk tolerance.
Tune in today for the webcast – “The Latest Compensation Disclosures: A Proxy Season Post-Mortem” – to hear Mark Borges of Compensia, Dave Lynn of CompensationStandards.com and Morrison & Foerster and Ron Mueller of Gibson Dunn analyze what was disclosed (and what was not disclosed) during the proxy season.
A Lot of House-Senate Reconciliation Action on Governance Provisions: A Partial Skinny
Ted Allen of ISS does a great job of recapping the results of yesterday’s marathon negotiations over the regulatory reform bill’s governance provisions in this blog that he wrote at 12:30 am. Bravo to him on his stamina! The negotiations will continue today in this area and are still being televised on C-SPAN.
Here is a recap based on what Ted wrote and what others have written to me (note that it’s hard to know for certain what is going on and it could all change):
– Mandatory majority voting has been dropped from the bill as Senate conferees have agreed to eliminate it; this was not in House bill
– Proxy access provision could become more detailed as Senate conferees agreed to impose a 5% ownership standard and a two-year holding period on shareholders who wish to nominate directors (under Base Text, details would have been left up to the SEC); uncertain if House conferees will accept this change
– Say-on-pay could be altered to allow companies to hold them on a biannual or triennial basis rather than be forced to do so annually; not certain whether this will be accepted by either Senate or House conferees
– Senate conferees accepted a House provision to permanently exempt small issuers from SOX’s auditor attestation requirements – even though the Dodd bill didn’t have this provision in it
– Senate conferees didn’t accept House conferees’ proposal to mandate votes on “golden parachute” packages
– Senate conferees accepted House conferees’ proposal to require large institutional investment managers to disclose their say-on-pay votes
– Senate conferees accepted House conferees’ proposal to ensure that the SEC’s independence standards for compensation consultants are competitively neutral
– House conferees voted to add a new provision to permit private rights of action for aiding and abetting (overturning Stoneridge and Central Bank) even though there was no similar provision in Base Text (but this provision did exist in an older version of a House bill from last December); not likely that Senate conferees will accept this
– House conferees accepted SEC self-funding, as well as creation of new SEC offices for whistleblowers and ombudsman; Senate had already approved this in Dodd bill – but now some Senators are trying to strip the SEC’s self-funding. Proving my note at the beginning about how this all could change…
It’s interesting how some blogs have sprung to assist folks in contacting members of Congress to pressure them on these negotiations even as they happen – see this blog as an example. And it’s also interesting to note that even regulators are willing to express their view on the future of the reform bill, check out this “thumbs up and down” chart from NASAA…