When it comes to ISS and the other proxy advisory firms, there certainly are many strong opinions and views. And the SEC’s proxy plumbing project has brought those to the fore. But even before a back-and-forth debate arose over this CNBC article, I recognized the article for what it is – a mass media piece written by someone without a background in the topic – and I tweeted as such.
For starters, I question the veracity of nearly every other premise in the article. There are an increasing number of proxy contests? I don’t think so. Mutual funds began using proxy advisory services in earnest only after the SEC’s 2003 rule that required disclosure of their voting records? Nope. The author mistakenly thinks the demand for proxy advisory services relates to regulations adopted this decade – but the reality is that institutions have been heavily relying on them ever since the first advisory firm was founded shortly after the DOL’s 1994 Avon letter. I would even go as far as to challenge this tenet of the article – that investors are relying more on proxy advisory firms than ever before. I have no hard facts to support this – but anecdotal evidence indicates that the opposite is true: institutions increasingly are choosing to vote their shares relying more on their own analysis.
I do agree with the article’s last words: “We should at least worry that their advice might fail just like the advice of the credit ratings agencies failed.” But my concerns are probably different than those harbored by the article’s author. So far, ISS has wielded its influence remarkably responsibly – unlike the failings of the credit rating agencies, whose blind-eye actions were a major factor in facilitating the recent financial crisis. Regardless of whether you agree with ISS’s views, it is hard to dispute that ISS has done more to effectuate change in corporate governance practices over the past decade than all other movers and shakers combined. Year after year, ISS raises the bar on what it believes are governance best practices. Again, this is something hard to dispute even if you don’t agree with their view on what are best practices.
My big concern these days is that ISS was sold – yet again – earlier this year, and is rumored to be on the block once more. I worry about ISS being capable of being fully supported by a parent and it’s ability to retain good people (Chris Young already has departed as head of ISS’s M&A advisory unit). I worry that ISS won’t have the resources to do a good job and that their reports will be filled with many errors – and that they will be too short-staffed to take corrections on a timely basis. I worry that a new acquiror might change ISS policies in ways that we can’t imagine. That is what CNBC should be writing about.
But the bigger issue perhaps is what type of world would we have without ISS? Does the corporate community really want to navigate a proxy season in which it must keep track of a set of diverse voting policies from all of their numerous holders? Will companies provide the additional resources to the corporate secretary’s office necessary to conduct this important task? Remember that so few companies have failed to earn majority support for say-on-pay in the United Kingdom because the proxy advisors there drive the process in a way that companies know what likely will pass – and what won’t. Without ISS, we may be looking at the Wild West here and companies could well be operating in the dark heading into their annual meeting as to what the outcome will be.
On the other side of the coin, do beneficial holders want to bear the costs of institutions beefing up their woefully understaffed proxy committees? This is the real reason why many institutions rely on ISS – cost savings. They don’t want to spend the money it takes to analyze proxy materials and make the decision about how to vote. Unlike what CNBC wrote, this is why institutions look to proxy advisory firms – and this is why the DOL wrote the Avon letter in the first place (before that letter, very few institutions bothered to vote).
Note that challenges to the CNBC article have been mounted by Andrew Clearfield in the comments to this blog – also see these thoughts from Nell Minow, one of the original leaders of ISS (you might also want to read Nell’s proxy plumbing comment letter).
CNBC’s John Carney then tries to rebut this criticism in this follow-up piece. He bizarrely claims – by citing an academic paper – that ISS’s influence is overstated. Not sure how this supports his original thesis? Anyways, I disagree with that paper’s conclusion that ISS controls 6-10% of the average vote. In practice, I believe most proxy solicitors – and companies – would opine that percentage should be doubled or even tripled.
For what it’s worth, I provided a clear description of how the ISS process works in our July-August 2010 issue of The Corporate Counsel. I wrote that piece because I had never seen anyone explain in detail what is involved – and knowing that is more important than ever now that we have mandatory say-on-pay.
Time to Comment on ISS’s Policies: Time to Speak Up
On Wednesday, as noted in this press release, ISS opened the comment period for it’s 2011 policies, as it has for the past several years. Here is their policy gateway where you can input your views.
The comment period is short – ending on November 11th. Given the importance of this proxy season, this would be a good time to get involved if you haven’t before. ISS expects to release its 2011 policy updates in late November. Pat McGurn will discuss those during his annual webcast with us on January 27th.
It is obvious that there is no simple and broadly accepted way to assess either the performance of a company’s management team or the value of a pay package. In that light, the challenges of developing rules and disclosure in response to the new pay-for-performance disclosure obligation under Dodd-Frank become clear. Aside from widely-noted issues related to the valuation and timing rules for inclusion of different elements of pay, we readily identified many types of business and other considerations that could materially affect the disclosure approach in our recent memo. We suspect that companies will identify many others as they begin to consider how the new requirement could apply to them. We describe a few of them below:
– Lean Management – Arguably, pay versus performance assessments should take into account how much “bang for the buck” a company gets from its total management team. That is, assume two companies that have performed equally well and in which the five most highly-paid executives have earned the same compensation. Now assume further that one of the companies has a senior management team that is twice as large as the other. It would seem that the company with leaner management should provide pay versus performance disclosure that tells that story by looking at the issue on a relative basis and including more than just named executive officers in its analysis. Precise data to support this approach might be difficult to obtain, but it may not preclude the company from making the point.
– Cyclical Businesses – Companies in classically cyclical industries should consider presenting data in a manner that reflects that business reality. Possible approaches could include presenting data using multiple periods, or measuring performance based on the extent to which the variation in profitability was mitigated through the entirety of the cycle.
– Crisis Management – A disclosure approach that fails to distinguish performance in ordinary business environments from performance during short-term crisis periods will often not provide meaningful information. During the recent financial crisis, for example, the performance goals that underlie most incentive programs were set aside as many companies focused on steps needed to manage through the crisis. In addition, not surprisingly, management turnover increased, particularly at financial institutions. In order to present useful information on pay versus performance, those factors should be taken into account.
– Business Organization and the Identity of the NEOs – Between one and three of the named executive officers for a company will typically have divisional responsibilities, while the CEO, CFO and one or two other NEOs will have corporate-wide responsibility. Different divisions could have very different performance profiles. Often, using only corporate-wide performance metrics – or a crude “lumping together” of divisional metrics – to assess the relationship of pay to performance will be uninformative and unreflective of the actual correlation between pay and performance. Similarly, aggregating the pay of the entire executive team may mask significant interesting information about the relationship of pay to performance.
– Allocating Pay to Performance Periods – There are both obvious and subtle challenges in deciding how to best allocate pay to specific performance. For example, should an option be considered “actually paid” – i.e., taken into account in the pay for performance analysis – at the time it is granted or exercised, or at some other time? Should it matter whether the number of options awarded is fixed by contract or practice in relation to base salary levels, or instead varies from year to year based on individual performance assessments?
– The Need to Attract – Should elements of compensation that are explicitly not intended to reflect performance be included in the analysis? In many industries, companies must pay signing bonuses or other guaranteed minimum payment elements to attract employees. Is it appropriate for those elements of compensation to be excluded from the pay for performance presentation on the basis that the compensation committee’s incentive pay decisions should not be obscured by pay elements that are not intended to be performance-driven?
– Risk, Diversity and Other Intangibles – The correlation of pay to performance may be affected by aspects of compensation plan design whose purpose is to mitigate risk. Similarly, other “intangibles,” such as diversity or relative pay levels between senior management and rank and file employees, may be taken into account in assessing pay for performance. Can and should these factors be considered?
Section 951 of Dodd-Frank requires that any public company, at its first shareholders meeting on or after January 21, 2011, hold a separate vote “to determine whether Say-on-Pay votes will occur every 1, 2 or 3 years” (the SEC recently proposed rules implementing this provision). This vote has been called the frequency vote or “Say When on Pay.” The Say When on Pay vote must be held no less frequently than once every six years. In a previous post, I described some mechanical issues with offering all three choices of frequency (i.e., an annual, biennial or triennial Say-on-Pay vote).
But what frequency should companies recommend for Say-on-Pay votes – annual, biennial or triennial? Most public company officials will quickly react that they prefer a triennial vote. The advantages are obvious – Say-on-Pay votes create some additional drafting, solicitation and shareholder relations issues, and a triennial vote allows the company to avoid these issues in two out of every three years.
Are there any advantages to annual or biennial votes? In the recent pre-Conference webcast for this site, compensation consultants Mark Borges of Compensia and Mike Kesner of Deloitte brought up a few factors that should at least be considered before settling on a triennial vote recommendation:
– Some companies are coming to the conclusion that an annual vote is preferable, on the theory that an annual non-binding vote will seem routine after the first year – somewhat like the annual vote to approve the company’s auditors.
– Also, biennial or triennial votes may present a disadvantage because there will be “off years” with no vote. If ISS or other shareholder advisory services want to send a signal to the board about compensation in an off year, their only choice is to recommend a withhold vote against compensation committee members.
– It’s not clear whether the shareholder advisory services such as ISS will recommend annual votes or some other cycle. Companies should also be mindful of any stated preferences of their large shareholders.
On the last point, companies should not assume that institutional investors will all prefer an annual vote. In a post on Altman Group’s Governance and Proxy Review, “Open Questions on Dodd-Frank: Say-on-Pay Implementation (SOP) and Proxy Access,” Francis Byrd reports that many institutional investors have feared the prospect of being flooded by annual advisory votes for all of their portfolio companies. Such investors may be happy to vote for biennial or triennial advisory votes. Byrd also points out a common justification by companies for triennial votes – that many companies’ pay plans are crafted around three-year periods, and triennial votes allow investors to better judge the value of these plans.
In any event, the Say When on Pay vote presents a variety of strategic considerations, and public companies should start thinking about these considerations now.
Here is a PowerPoint entitled “Sample Pay-for-Performance Assessment” that I mentioned during the “5th Annual Proxy Disclosure Conference” last month that I hope you find useful.
Recently, we completed a study on director stock ownership guidelines. Here are the key findings:
– Ownership Policy Prevalence: The prevalence of Fortune 250 companies with publicly disclosed director stock ownership policies increased from 82.1 percent in 2008 to 84.0 percent in 2009. Ownership policy prevalence includes companies that have ownership guidelines, holding requirements, or both.
– Ownership Guideline Prevalence: Ownership guidelines grew in prevalence at Fortune 250 companies, with 79.4 percent of companies disclosing director ownership guidelines in 2009 compared with 77.5 percent in 2008.
– Holding Requirement Prevalence: The prevalence of holding requirements at Fortune 250 companies increased from 2008 to 2009, rising from 19.2 percent to 19.7 percent. An increasing number of companies used holding requirements in conjunction with ownership guidelines.
– Ownership Guideline Design: The prevalence of companies that defined ownership guidelines as a multiple of the annual retainer decreased from 57.0 percent in 2008 to 55.0 percent in 2009. In addition, the prevalence of companies that disclosed ownership guidelines as a fixed number of shares increased from 27.4 percent in 2008 to 23.8 percent in 2009.
– Holding Requirement Design: In 2009, 34.0 percent of director holding requirements at Fortune 250 companies were designed to be in effect only prior to the satisfaction of ownership guideline targets. Once ownership goals are met, these holding requirements are no longer active.
– Target Ownership for Directors: At Fortune 250 companies, the median value of the target stock ownership level for directors was $261,750 in 2009. Ownership guidelines targeted using a fixed number of shares increased from $212,150 in 2008 to $261,750 in 2009.
– Hardship Provisions: Among companies having ownership policies, the prevalence of companies disclosing hardship provisions for their directors decreased 4.3 percent in 2009.
– Other Practices: As companies continue to adjust to new disclosure regulations, more detail has emerged on key practices related to stock ownership policies. This report explores new disclosure related to compliance status, non-compliance penalties, and restrictions on hedging.
Not surprisingly, I received quite a bit of member feedback on my recent blog about the Boston Globe article that found many companies incorrectly totaling the amounts in their Summary Compensation Tables. Others are blogging about this story too, such as this entry from Mark Borges in his “Proxy Disclosure Blog.”
Here is a useful response from Jim Brashear of Zix Corporation:
I copied the summary compensation table from one of the SEC filings cited in the recent Boston Globe article on math errors in proxy statements, and I pasted it into this Word document. I wondered if the addition errors could have been avoided by some simple changes to how the Word tables were formatted. Avoided at least while the issuer and its counsel are working on the document in Word, before it gets handed off to the printer and is reformatted.
A lot of lawyers don’t know that you can use Word tables very much like Excel spreadsheets. It’s particularly easy to sum columns and rows of adjacent cells that all contain numbers. If there are intervening cells that are empty or have non-number characters, it’s a bit more complicated to sum the cells, but it can still be done.
In my Word document, the top table is straight from the SEC filing (only names redacted). The bottom table shows how I cleaned up the table to remove the cell “padding”, replaced the dashes with zeros and, most importantly, inserted into the far right column a formula that calculates automatically the sum of the columns to the left. (I left one blank column between Year and Salary so that the formula would not add the year date to the compensation amount.
Inserting a formula is done in Word from the Table menu by selecting Formula. Word will even suggest the correct formula – in this case “=SUM(LEFT)”. Then, the author selects the Number Format to display $ and the commas (delete the cents if you don’t want them). Voila, no more simple addition errors! If there are changes to numbers in the table, you may have to refresh the formula cells by selecting them and pressing F9 – but that refresh happens automatically when the document is printed.
And here is a follow-up from a member: While this would work, since most company’s external reporting departments already prepare the tables in Excel, all you need to do is copy the Excel table in Excel and then paste it into the Word document at the proper location. You can even re-open the table in the Word document while in Word and edit the Excel spreadsheet.
By the way, here is a follow-up article from the Boston Globe that includes some quotes from a SEC spokesperson. I agree with the thoughts in the article from Lynn Turner that it would be impossible for Corp Fin Staff to be involved in checking the math when conducting their disclosure reviews. For me, not only is it impossible, it is impractical. Who would ever think that the team of folks that draft disclosure documents wouldn’t bother to check the math…and is Corp Fin expected to foot every row and column of numbers in the financials too when a filing is selected for review?
– impose a structure,
– assist board/committee in compliying with fiduciary duties,
– help ensure legal compliance, and
– give attorney-client privilege protection, when necessary.
Check it out and give Mike and Eric your feedback…
Mike Melbinger noted last week on his blog that the disclosure of the relationship between compensation and risk will be an important element of consideration for ISS and investors in the upcoming proxy season, so now is the time to start thinking about how to “do it right.” One thing that I have found helpful in benchmarking risk assessments has been the plethora of data points that can be gleaned from the hundreds of comments letter responses that have been submitted on EDGAR in response to the Staff’s comment asking companies to explain what they did to reach their conclusions as to whether disclosure was required under Item 402(s) of Regulation S-K (which effectively resulted in disclosure that was not otherwise required). In most cases, these responses talk about a process whereby:
– compensation programs were reviewed, particularly focusing on incentive compensation programs;
– program features were identified which could potentially encourage excessive or imprudent risk taking;
– the specific business risks that related to such features were identified;
– mitigating factors (if any) were identified;
– an analysis was undertaken to determine the potential effects of the risks and the impact of the mitigating factors; and
– an analysis was undertaken of the particular situations described in Item 402(s) as they apply to the company.
The findings that companies often reached were similar, focusing on:
– the mix of compensation, which tended to be balanced with an emphasis toward rewarding long term performance;
– the use of multiple performance metrics that are closely aligned with strategic business goals;
– the use of discretion as a means to adjust compensation downward to reflect performance or other factors;
– caps on incentive compensation arrangements;
– the lack of highly leveraged payout curves;
– multi-year time vesting on equity awards which requires long term commitment on the part of employees;
– the governance, code of conduct, internal control and other measures implemented by the company;
– the role of the compensation committee in its oversight of pay programs;
– frequent business reviews;
– the existence of compensation recovery (clawback) policies;
– the implementation of stock ownership or stock holding requirements;
– the use of benchmarking to ensure the compensation programs are consistent with industry practice;
– the uniformity of compensation programs across business units and geographic regions, or alternatively, the differences employed to reflect specific business unit or geographic considerations; and
– the immaterial nature of some plans.
In terms of employee plans, there was a lot of discussion in the comment responses regarding sales incentive plans, often focusing on controls in place on those plans such as caps, negative discretion, prepayment review, and recovery in the event of error or fraud, etc. The responses often note that the analysis was conducted by management with the concurrence or consultation of the compensation committee, and they also frequently referenced the use of compensation consultants in performing the analysis, with that consultant in many cases being the same compensation consultant that the compensation committee used for other compensation matters.
Note that these proposals weren’t a product of an open Commission meeting. The SEC smartly issued this set of proposals without the fanfare of an open meeting, which is not required if all of the Commissioners sign an order (ie. seriatim). Probably since these proposals are required by Dodd-Frank – and time is of the essence – the SEC went with what used to be the traditional route of getting a proposal out of the SEC (more recently, nearly all proposals are the product of open Commission meetings; it wasn’t that way a decade ago).
Say-on-Pay: What Should September 30th Fiscal Year End Companies Do?
You may recall that Dodd-Frank requires that say-on-pay must be included in proxy statements relating to a company’s first annual or other meeting of shareholders occurring on or after January 21, 2011 – regardless of whether the SEC has adopted final rules by then. The comment deadline for both rulemakings is November 18th – so it will be a tight squeeze for the SEC to adopt final rules by January 21st (but it is doable).
I have been hearing from a number of companies with 9/30 fiscal year ends that were freaking out because they didn’t have SEC guidance on a number of issues. Now, they have some guidance – even though it isn’t final. One big issue for these companies related to their proxy preparation schedule because they didn’t have any relief from the preliminary proxy filing requirements yet. Fortunately, in the SEC’s proposing release, the SEC does provide some relief on page 65. Here is that excerpt:
Rule 14a-6 currently requires the filing of a preliminary proxy statement at least ten days before the proxy is sent or mailed to shareholders unless the meeting relates only to the matters specified by Rule 14a-6(a). Until we take final action to implement Exchange Act Section 14A, we will not object if issuers do not file proxy material in preliminary form if the only matters that would require a filing in preliminary form are the say-on-pay vote and frequency of say-on-pay vote required by Section 14A(a).
In the proposing release, the SEC also states that these companies are permitted to conduct the frequency vote on the basis of the proposed four choices – every year, every two years, every three years, or abstain.
The ‘Former’ Corp Fin Staff Speaks on Proxy Access & Dodd-Frank
This is a “biggie.” Tune in tomorrow for the 75-minute webcast on TheCorporateCounsel.net – “The ‘Former’ Corp Fin Staff Speaks on Proxy Access & Dodd-Frank” – to hear former Senior Staffers Brian Breheny of Skadden Arps; Marty Dunn of O’Melveny & Myers; John Huber of Latham & Watkins; Brian Lane of Gibson Dunn and Dave Lynn of TheCorporateCounsel.net and Morrison & Foerster weigh in on what do now that the proxy access rules are stalled, plus analysis of all the latest from the SEC’s Corp Fin on Dodd-Frank related-matters – including say-on-pay and more. If you’re not a member of TheCorporateCounsel.net, try a no-risk trial for 2011 and gain access to this webcast for free.
The SEC staff has rejected a no-action request by Winn-Dixie Stores to omit a proposal from Schultze Asset Management that seeks an annual “say on pay” vote. The Florida-based grocery retailer argued that it had “substantially implemented” the proposal because its board adopted a governance policy in July that calls for a biennial vote on compensation. Winn-Dixie plans to hold its first advisory vote at its 2010 annual meeting on Nov. 10. The staff of the SEC’s Corporation Finance Division did not agree, noting: “We are therefore unable to conclude that Winn-Dixie’s policies, practices, and procedures compare favorably with the guidelines of the proposal such that Winn-Dixie has substantially implemented the proposal.”
The staff ruling is potentially significant because many U.S. companies likely will seek to hold less frequent advisory votes after the 2011 proxy season, and some activist investors may continue to use shareholder resolutions to press for annual votes. The Dodd-Frank Act requires U.S. issuers to hold a pay vote at their first annual meeting after Jan. 21, 2011, and directs companies to conduct a vote on the frequency of future pay votes at that meeting (and then once every six years). Given this mandated vote on frequency, companies may have better luck in their efforts to exclude similar shareholder proposals next season. However, the SEC may rule differently on 2012 proposals when a frequency vote will not be on corporate ballots.