Yesterday, as noted in this press release, the SEC unanimously proposed rules to implement Section 952 of Dodd-Frank that would direct the exchanges to adopt listing standards relating to compensation committees regarding their use of compensation consultants and other advisors as well as conflicts of interest. These rules ultimately will provide a granular definition of “independence” in the compensation context.
From scanning the proposing release that was posted last night, the proposed rules would not add much to Section 952, much to the chagrin of those who emailed me after the meeting and were expecting the SEC to come up with a rules package that the exchanges could just adopt. But even if the exchanges are charged with fleshing out the statute, the SEC surely will be heavily involved behind the scenes as often happens with new listing standards since the SEC must approve them.
Dodd-Frank requires that final rules in this area be adopted by July and the deadline for comments is April 29th. Even if final rules are adopted timely by the SEC, it’s still possible that listing standards may not be in place before the 2012 proxy season since I believe the July deadline doesn’t apply to the exchanges. Memos on the proposal are being posted in the “SEC Rules” Practice Area.
Lest anyone think that unfavorable “say on pay” votes will only strike outliers who make massive blunders, take notice of the 55% unfavorable vote that Shuffle Master announced last week. This one is the toughest to explain so far, because the most extraordinary items in Shuffle Master’s summary compensation table relate to interim CEOs who were appointed after the death of the company’s CEO (see the comment below from ISS). In terms of 2010 compensation decisions, there was about a 15% increase in total compensation for continuing executives. Further, although the company’s stock price has fallen about 75% from its $40 high about 5 years ago, it had quintupled since its $2 low in March 2009 — with the last year displaying continued growth (from about $8 to over $10). Interestingly, four institutional investors own about 30% of the company (BlackRock, Wells Fargo, Oppenheimer Funds, and Eagle Asset Management). Perhaps this influenced the outcome.
Notably, the executive compensation disclosure in Shuffle Master’s proxy statement omitted an executive summary, as did those for Jacobs Engineering and Beazer Homes — driving home, again, the importance of being proactive in telling the company’s “story” that justifies the executive compensation decisions being disclosed.
Regarding Shuffle Master’s unfavorable vote, here is the observation posted by ISS: “The vote at Shuffle Master appears to reflect investor concerns over the severance terms in an employment agreement that was reached with interim CEO David Lopez in February. That agreement included a “modified single-trigger” provision that would have allowed Lopez to receive severance if he decided to leave the company within 90 days of a change in control. Many investors object to single-trigger provisions that don’t require executives to actually lose their jobs to receive a payout.”
For tables tracking unfavorable votes and close-calls: see my site, ExecutiveLoyalty.org.
During the 2011 U.S. proxy season, executive compensation likely will be the primary focus of most institutional investors, although there will be fewer pay-related shareholder proposals on the ballot this season. As required by the Dodd-Frank Act, most large and mid-cap companies will hold their first advisory votes on compensation this year. For institutions with diverse holdings, this mandate has resulted in a significant increase in their proxy season workload given that more than 4,000 U.S. companies will hold pay votes this year.
Investor representatives have said they plan to take a principles-based, holistic approach to advisory votes and indicate they would not generally withhold support based one specific pay practice, such as the payment of tax gross-ups. Many investors have focused on pay for performance, although they are using different metrics to assess shareholder returns. Some investors, such as the Ohio State Employees Retirement System, have said they plan to send letters to companies that explain their reasons for voting against management.
After voting on “say on pay” and “say when,” investors will find few pay-related shareholder proposals on their ballots this season. ISS is tracking 59 such resolutions, as compared with 175 last year, when 77 shareholder “say on pay” resolutions were filed. Among this year’s filings are 13 resolutions submitted by labor investors and retail investors that seek minimum retention requirements (such as a five-year lockup) for equity grants to executives. So far, Allstate, General Electric, and four other companies have prevailed in no-action challenges at the Securities and Exchange Commission by arguing that the resolutions’ reference to “executive pay rights” was impermissibly vague.
The Laborers’ International Union of North America and other labor funds have filed a new proposal at nine companies in the energy or real estate sectors that ask them to link executive pay to sustainability metrics. This measure was inspired in part by the BP oil spill, the Massey Energy mine explosion, and other environmental disasters. That proposal has been withdrawn at MDU Resources, while two other resolutions face no-action requests.
Another new proposal to receive some attention is a resolution submitted by the CtW Investment Group at Bank of America. That proposal, which urges the company to no longer reimburse relocating executives for losses on home sales, was filed in response to a $553,500 home loss subsidy paid to the president of the firm’s Countrywide home mortgage division. BofA argued that the proposal could be excluded because it related to “ordinary business” operations, but the SEC staff did not agree.
The SEC also rejected BofA’s challenge to a proposal from the Service Employees International Union that seeks to amend the bank’s “clawback” policy to permit the recovery of incentive compensation over the past five years. Bank of America argued that it had substantially implemented the proposal because it would be subject to Section 954 of the Dodd-Frank Act, which requires public companies to adopt a three-year recoupment policy. The SEC has yet to propose rules to implement that provision.
The SEC staff also rejected Goldman Sachs’ request to omit a novel proposal filed by the Nathan Cummings Foundation and religious groups. This resolution seeks a review of whether the firm’s executive pay, bonuses, and perks are excessive; an exploration of how sizeable layoffs and the pay for lowest-paid employees impact senior executive pay; and an analysis of how revenue fluctuations impact shareholders and the pay of the company’s top 25 executives. The investment bank argued without success that the proposal was vague or misleading, and related to ordinary business because it addressed general employee compensation.
However, Moody’s did obtain permission from the SEC to omit a new proposal from American Federation of State, County, and Municipal Employees that asked the credit rating firm to establish a set of best practices for its 10b5-1 trading plan, which permit executives to sell company stock through pre-planned transactions while reducing their potential insider trading liability. Moody’s successfully argued that the proposal related to compliance, an ordinary business matter.
On a long-standing resolution topic, the New York City pension funds and labor investors filed nine proposals that seek shareholder votes on severance benefits. In a notable no-action ruling, the SEC reversed itself in January and allowed a Teamsters’ golden parachute proposal to appear on Navistar International’s ballot. The company argued that severance benefits would be covered by its mandated “say on pay” vote, but the proponent pointed out that it was seeking a vote on future severance benefits, which was not covered by the advisory vote. The SEC staff has made clear that companies may exclude proposals that address pay elements that are covered by advisory votes.
The Amalgamated Bank’s LongView fund filed proposals at Anadarko Petroleum, Sunoco, and EOG Resources that seek to prohibit the accelerated vesting of equity incentives after a change in control. Investors also submitted two resolutions that target “golden coffin” benefits for the heirs of deceased executives. This proposal was withdrawn at Hewlett-Packard after the board adopted a policy to seek shareholder approval for such benefits for executives.
Recently, I learned that ISS made a mid-proxy season policy change that may affect vote recommendations for equity plans submitted to stockholders solely for purposes of Section 162(m) approval. Historically, ISS has always supported these proposals agreeing that it is in the best interests of the stockholders for the company to be able to grant awards under a plan that satisfies the 162(m) requirements for performance-based compensation that is excludable from the $1M deductibility limitation.
Effective immediately, ISS will no longer automatically support Section 162(m) proposals submitted by “IPO companies” – that is, companies whose public company stockholders have not previously approved their equity plans. Instead, ISS will further analyze the plan and proposal to determine whether any problematic features are more detrimental than the potential loss of tax deductions and if so, ISS will recommend voting against the proposal.
Going forward, ISS signaled that it also may also further scrutinize Section 162(m) proposals submitted by non-IPO companies (i.e., companies whose public company stockholders have previously approved their plans), but it suggested that this year it is primarily concerned with Section 162(m) plans submitted by IPO companies.
Broc’s note: On Wednesday, the SEC is holding an open Commission meeting to adopt rules that require the stock exchanges to maintain listing standards regarding independent compensation committees and advisors.
Recently, Corp Fin posted this no-action response to Wells Fargo regarding a shareholder proposal that asked the company to prepare a report “to describe the board’s actions to ensure that employee compensation does not lead to excessive and unnecessary risk-taking that may jeopardize the sustainability of the company’s operations. It further states that the report must disclose specified information about the compensation paid to the 100 highest paid employees.”
The Corp Fin response is interesting. It notes that incentive compensation paid by a major financial institution to those that are in a position to cause the company to take inappropriate risks is a “significant policy issue” – but then the Staff goes on to note that the proposal relates to the compensation paid to a large number of employees, thus falling into the “general employee compensation” line of no-action letters since it was not limited to senior executive officers. As a result, the Staff allowed the company to exclude the proposal under (i)(7) as an ordinary business matter.
This letter is interesting also because it presented the Staff with the opportunity to take the position that the general compensation practices that lead to excessive and unnecessary risk taking (and board actions to avoid such risk taking) raise significant policy issues, which would arguably bring its no-action positions in line with the disclosures that the SEC recently concluded should be required in proxy materials. Even though some might disagree with the Staff’s position, it at least avoided yet another exception to the general rule that proposals relating to general employee compensation relate to ordinary business matters and may be excluded under (i)(7). Thanks to Keir Gumbs of Covington & Burling for pointing this letter out!
Yesterday, as reported in this Bloomberg article and ISS’s Blog, Hewlett-Packard became the fourth company to fail to receive majority support for its say-on-pay, with 48% voting in favor. The company hasn’t yet filed its Form 8-K – when it does, I will add it to our list of Form 8-Ks filed by companies that fail to earn SOP majority support.
And yesterday, I blogged that Hemispherx Biopharma issued this press release announcing that it garnered 51% support for its say-on-pay ballot item. Well, a few members reviewed the company’s proxy statement and Form 8-K and concluded that the company didn’t do its math properly.
These members noted the proxy disclosure that “abstentions will have the same effect as a vote against the proposal” – but that the company didn’t follow that formula when calculating the vote for its Form 8-K. Without getting into the issue of whether the proxy disclosure is correct, it seems like the company didn’t follow the standards disclosed in its proxy statement, an important point to consider as I wrote about in the July-August 2010 issue of The Corporate Counsel (in the section entitled “How to Calculate Voting Result Percentages: Read Your Bylaws (and Compare with Your Proxy).” I do believe this problem is not just an isolated circumstance – as there still is a significant amount of confusion regarding the application of voting standards and the calculation of the vote itself.
Parsing Prudential’s 2011 Proxy Statement
Last week, I repeated Mark Borges’ analysis of General Electric’s proxy statement and all the innovative things they did. A few days ago, Prudential filed its proxy statement and it also contains quite a few innovative items (as could be expected since Peggy Foran’s arrival at the company last year), including:
– 3-page “State of the Union” letter, describing the work the board had done over the previous year on compensation and governance; note this letter is from the board, not the CEO
– Two-page summary at the beginning (pages 7-8) that includes business highlights and summary compensation information
– Highlight boxes on sustainability (pg. 24), corporate citizenship (pg. 23) and shareholder engagement (pg. 22)
The entire proxy statement is filled with color and charts and serves as a good example of an attempt to make disclosure inviting for shareholders. And don’t forget Peggy’s novel “Totes for Votes” campaign to bring in more retail votes, as she recently discussed during our “Conduct of the Annual Meeting” webcast on TheCorporateCounsel.net.
Yesterday, Shuffle Master filed this Form 8-K to reveal its become the third company this proxy season to fail to achieve a majority vote for say-on-pay as only 45% of shareholders voted in favor (here’s the other two). And Hemispherx Biopharma revealed it almost became the fourth with only 51% support as reflected in its Form 8-K.
In his “Proxy Disclosure Blog,” Mark Borges gives us the latest say-when-on-pay stats: with 739 companies filing their proxies, 44.3% triennial; 3.4% biennial; 48.8% annual; and 3.4% no recommendation. As Dave blogged a few days ago, the annuals have now passed the triennials…
Here is something that I blogged yesterday: It has now been two months since shareholders were able to render advisory votes on executive compensation. Of the 185 Say-On-Pay votes which have been reported through March 20th, the shareholders at two companies, Jacobs Engineering Group and Beazer Homes USA, have voted against approving the executive compensation of their named executive officers. A third company, IsoRay, reported that its “stockholders did not approve, on an advisory basis, the compensation of IsoRay’s named executive officers” even though it also reported that there were more “For” votes than “Against” votes on its Say-On-Pay proposal.
We note that Beazer also announced earlier this month that its Chief Executive Officer had reached a settlement with the SEC whereby he would repay back to Beazer approximately $6.5 million of previously received compensation, along with company shares and stock units. As reported by the SEC, the disgorged amounts represented the CEO’s entire fiscal year 2006 incentive bonus. Beazer had previously restated its 2006 financial statements and the forfeiture was required under the clawback provisions of the Sarbanes-Oxley Act which mandates that a CEO repay incentive compensation that was received as a result of the company’s erroneous financial statements.
One element of the Say-On-Pay rules is that shareholders also get to vote on how frequently the Say-on-Pay vote will be conducted at their company (“Say-On-Frequency”). In particular, shareholders can provide an advisory vote that states their wishes as to whether the Say-on-Pay vote should occur every one, two or three years. In soliciting the Say-On-Frequency vote, a company’s board of directors can provide its recommendation (or it can provide no recommendation) as to which frequency it believes shareholders should support.
Last month, we reported that there was a trend which indicated that shareholders preferred annual Say-On-Frequency voting at least with respect to companies which are not smaller reporting companies. This trend has continued as annual frequency has received the most shareholder votes at over 60% of the companies that have reported on their Say-On-Frequency votes (and at over 70% if smaller reporting company results are excluded).
This preference for annual voting is particularly evident with respect to those companies which are “Large Accelerated Filers”, as such term is defined under SEC rules (i.e., public companies with a market value of at least $700 million), with the shareholders at 84% of such companies supporting annual voting. A biennial frequency continues to be the ignored “middle child” as such frequency has received the most votes at only 4% of reporting companies.
Moreover, as illustrated in the voting results tables, with just one exception at a smaller reporting company, whenever a board of directors has recommended an annual Say-On-Pay vote, the company’s shareholders have so far always voted in support of such recommendation. Furthermore, even when a board of directors at a large accelerated filer has recommended triennial voting, the company’s shareholders have voted against such recommendation in favor of a more frequent vote at close to 80% of the time.
“Smaller Reporting Companies” (i.e., those public companies with less than $75 million of public float) have had more success garnering support for triennial voting but, as we noted last month, we expect that going forward more/most smaller reporting companies will take advantage of the two year exemption from Say-On-Pay that was provided by the SEC in its final rules (i.e., smaller reporting companies therefore will not conduct a Say-On-Pay vote until required in 2013). This two year delay for smaller reporting companies represented a change from the SEC’s proposed rules which did not provide any such transitional relief for smaller reporting companies.
Those smaller reporting companies that have conducted Say-On-Pay votes in early 2011 presumably had already filed their proxy statements (in accordance with the Reform Act and the SEC’s proposed rules) for their annual meeting of shareholders prior to the release of the SEC’s final rules which relaxed the Say-On-Pay requirements for smaller reporting companies. We have included their results even though technically they do not have to comply with Say-On-Pay until 2013. We note that since March 8th, only one smaller reporting company has reported a Say-On-Pay vote and we would expect this trend to continue as fewer smaller reporting companies will include a Say-On-Pay proposal in its annual proxy statement.
According to a study of 100 early filers with revenues greater than $1 billion that we recently completed, average CEO total compensation increased +39% in 2010 while average total shareholder return equaled +25% and average net income increased +30%.
There are three factors contributing to the gains. First, base salaries that were reduced or held constant in 2009 were increased in 2010. Second, cash bonuses increased +43% as a result of stronger performance. Finally, we saw a +41% increase in the value of equity compensation granted in 2010. Although executives will not realize cash gains on these awards until they are vested, they nevertheless provide both retention and a link between CEO pay and performance. Nearly 80% of the equity awarded in 2010 will only provide value if the stock price appreciates or certain performance goals are met.
The study also confirms that profitability continues to be the key determinant of compensation. In instances where profitability increased in 2010, incentive cash compensation increased +53% over 2009 values, versus a -9% decrease among companies with lower profits. Furthermore, among the eight unprofitable companies in the study group, CEO total compensation decreased on average by -14%, while increasing +44% for CEOs of profitable companies.
Pay Mix
Equity continues to serve as the primary compensation vehicle for CEOs. For the 100 CEOs in the study group, equity compensation comprised 43% of total compensation, bonuses and other cash-based incentives represented 35% and base salaries just 22%.
Trends in Pay Elements
Comparing 2010 compensation to that in 2009 for all 100 CEOs in the study group, the study finds that:
– Salaries increased +11%
– Cash incentive compensation increased +43%
– Equity compensation increased +41%
– Total compensation increased +39%
– Revenues were up by +15%
– Net Income was up by +30%
– Total shareholder return was +25%
Here is something I recently blogged on the “Conglomerate Blog“: In finalizing a draft of a symposium piece on executive compensation last week for some very patient editors, I had a chance to read the 500-plus page Final Report of the Financial Crisis Inquiry Commission. Just to give you a sense of whether executive compensation is an issue there, note that “systemic risk” is used 29 times in the 410 page majority opinion. The term “compensation” is used 79 times. Here are some takeaways:
At least in “dicta,” the Final Report seems to understand that incentive compensation skews the decision-making of those outside of the “top five” executives on which most reform legislation and reformers are focused. The Final Report mentions the compensation schemes of financial institutions, Bear Stearns, Fannie Mae and Freddie Mac, Lehman Brothers, and even mortgage originators. The report seems to understand how incentive compensation gives the recipient an “option,” so that option theory kicks in and those with no downside take on additional risk. Most importantly, in several places it seems that the Commission understood it was not just the CEOs, including its “Conclusions” section:
Compensation systems — designed in an environment of cheap money, intense competition, and light regulation — too often rewarded the quick deal, the short-term gain — without proper consideration of long-term consequences. often, those systems encoursaged the big bet — where the payoff on the upside could be huge and the downside limited. This was the case up and down the line — from the corproate boardroom tot he mortgage broker on the street.
But the Commission still chose to focus on sticker-shocking salaries of CEOs and other officers. The Final Report mentions the takehome salaries of at least 23 named individuals, in addition to giving aggregate salaries for various groups of individuals and institutions. The Commission seems to be very interested in reporting that individuals at financial institutions, which were struggling by 2008 and some of which failed, had very nice salaries. However, even if there compensation was in the multi-million dollar range, that compensation did not push these multi-billion dollar companies over the edge. So the dollar amount has little mathematical value here. Now generally we might be appalled because we believe that the CEO must have done a horrible job if the firm went into trouble, and why should we pay horrible CEOs all that money? That is in interesting question, but the question posed to the Commission was what caused the financial crisis, and the report doesn’t do that great of a job linking these high salaries to the crisis except in the most general way: because so much money was at stake, executives became too comfortable with excessive risk, which caused the financial crisis. I think this argument goes to far in suggesting that incentive compensation with no downside makes CEOs immune to risk. CEOs do get fired, much more often I would guess than getting their pay cut. Stock price drop doesn’t give traders or mortgage originators a reputational hit, but it does give CEOs one, and their reputation has a pretty high market price.
The Final Report seems to have a lot of facts about the evils of compensation, but not a lot of theories. In addition to wanting us to know the salaries of various corporate officers, the Commission has a small section titled “The Wages of Finance: “Well, this One’s Doing It, So How Can I Not Do It?”” (Yes, the report has a very readable, narrative-based feel to it, but that makes it seems less than objective.) In this small section, the Commission weaves together a lot of factoids that don’t make a whole. First, the income gap in the U.S. is large, but the gap between financial industry salaries and regular industry salaries is bigger and has grown since the 1980s. (Margaret Blair has also written about this here.) Again, this seems damning to the industry, but I’m not sure why. The financial industry executives are paid more than executives of any other industry. Again, ok. This tells us nothing about what caused the financial crisis.
The Commission also points out what we already knew: most compensation is performance-based compensation. Why? Because reformers told us this was how to tie pay with performance. So, section 162(m) of the IRC limited the deductibility of non-performance-based compensation. And guess what, most compensation became performance-based compensation, which we now think leads to short-termism. If we tie compensation to profits on an annual basis, then we become fixated on profits right now, no matter what. Who could have guessed that?
The Final Report also reminds us that our investment banks used to be partnerships. This is an interesting point and one that others have made. The Commission believes this is a bad thing because now the executives have no skin in the game, get their big payouts every year, not the residual. So bankers became more risk-seeking with shareholder’s money. However, the report also points out that the compensation systems of these banks were the same after going public — distributing half the revenues at the end of the year. So, the report needs to tie that bow together if it’s making a compensation argument.
Finally, the Commission mentions that regulators cannot possibly compete in the labor market with financial whizzes. Why would anyone go work for the government if they can make millions in the private sector? Not sure what conclusion that leads us, too, then.