– Broc Romanek, CompensationStandards.com

Regardless of your political bent, you will enjoy’s last night’s 5-minute skit from “The Daily Show with Jon Stewart” that tackles the 1-year anniversary of Dodd-Frank. Jon Oliver is dressed up in a beaten-up costume representing the legislation and sings his answers to Jon’s questions about where the rulemakings stand now, etc. Pure comical genius:

– Anne Cotter, Leonard Street & Deinard

Here is something I recently blogged on our Dodd-Frank.com Blog: Section 954 of the Dodd-Frank Act requires national securities exchanges (meaning, for instance, the NYSE, Amex and Nasdaq) to adopt rules as directed by the SEC, which rules will require issuers to develop and implement a policy providing:

– for disclosure of an issuer’s policy on incentive compensation that is based on financial information required to be reported under securities laws; and
– that, if an accounting restatement is prepared, the issuer will recover any excess incentive-based compensation from any current or former executive officer who received such incentive-based compensation in the three preceding years.

Rules regarding Section 954 of the Dodd-Frank Act have not yet been proposed or finalized. However, we reviewed recent SEC filings to see what public companies are doing to prepare for the eventual adoption of the rules related to clawback policies:

Robbins & Myers. The board of directors of Robbins & Myers, Inc. adopted a compensation clawback policy and approved a compensation clawback acknowledgement and agreement. The form of acknowledgement and agreement provides that all annual incentives and other performance-based compensation granted on or after October 1, 2010 are subject to the clawback policy. The policy provides that the employee must repay or forfeit any annual incentive or other performance-based compensation as directed by the board of directors of the company if:

– the vesting of such compensation was based on the achievement of financial results that were subsequently the subject of a restatement of the company’s financial statements,
– the employee engaged in fraud or misconduct that caused or contributed to the need for the restatement,
– the amount of such compensation that would have been received by the employee would have been lower than the amount actually received, and
– it is in the best interests of the company and its shareholders for the employee to repay or forfeit the compensation.

Caplease. Under Caplease, Inc.’s recently adopted clawback policy, the board of directors may recover incentive compensation paid to any current or former executive officer of the company if all of the following conditions apply:

– the company’s financial statements are required to be restated due to material non-compliance with any financial reporting requirements under the federal securities laws (other than a restatement due to a change in accounting rules),
– as a result of such restatement, a performance measure which was a material factor in determining the award is restated, and
– in the discretion of the compensation committee, a lower payment would have been made to the executive officer based upon the restated financial results.

The clawback policy applies to any incentive compensation paid on or after December 7, 2010 and the recovery period is the three year period preceding the date on which the company is required to prepare the accounting restatement.

Employment Agreements

Signet. An employment agreement for a new CEO of Signet Jewelers Limited provides “[t]he Executive shall be subject to the written policies of the Board applicable to executives, including without limitation any Board policy relating to claw back of compensation, as they exist from time to time during the Executive’s employment by the Company.”

SuperMedia. An employment agreement for a new CEO of SuperMedia Inc. provides “[n]otwithstanding any other provision in this Agreement to the contrary, any “incentive-based compensation” within the meaning of Section 10D of the Exchange Act will be subject to claw-back by the Company in the manner required by Section 10D(b)(2) of the Exchange Act, as determined by the applicable rules and regulations promulgated thereunder from time to time by the U.S. Securities and Exchange Commission.”

Benefit Plans

Dover. Dover Corporation recently adopted a severance plan and a change-in-control severance plan. Each plan gives the corporation the right to recover amounts paid to an executive under the respective plan “if required under any claw-back policy of the Corporation as in effect from time to time or under applicable law.”

NACCO. Nacco Industries, Inc. recently amended its Value Appreciation Plan to provide “[t]he Employers may recover all or a specified portion of any Award paid after the Effective Date under the Plan . . . in the event the Participant, either during employment with the Employers or within two years after termination of such employment, commits an act materially adverse to the interests of the Employers or that materially disrupts, damages, impairs or interferes with the business of the Company and its affiliates.

Dominion Resources. The grant agreement for a recent award of restricted stock to the CEO of Dominion Resources, Inc. includes provisions regarding:

– recovery of shares in the event of restated financial statements as a result of fraud or intentional misconduct;
– recovery of shares in the event of fraudulent or intentional misconduct materially affecting the company’s business operations; and
– the award is subject to any clawback policies the company may adopt to conform to the Dodd-Frank Act.

– Broc Romanek, CompensationStandards.com

Recently, the AFL-CIO released this white paper supporting Section 953(b) of Dodd-Frank regarding disclosure of pay disparity ratios.

– Broc Romanek, CompensationStandards.com

From this Cooley news brief: Equilar has issued a report on trends among the S&P 1500 in selecting peer groups in 2010. Apparently, companies change their peer groups quite a bit. According to Equilar, 55.8% modified their peer groups from 2009 to 2010. The most interesting finding was this: “companies benchmark to higher-revenue peers: 78.6% of companies had revenues equal to or below the 60th percentile of their peer group. The average revenue rank was around the 45th percentile.” This finding is consistent with those of earlier academic studies and just might account for the constant ratcheting up of executive pay.

– Broc Romanek, CompensationStandards.com

As I blogged a few weeks back on TheCorporateCounsel.net Blog, ISS recently released its 2011-2012 Policy Survey – comments are due by August 3rd. Although it’s only a survey, the questions, responses and comments serve as the basis for ISS’s policy formulation process. Here’s some thoughts on the survey from Amy Wood of Cooley – and here are thoughts from ExeQuity.

– Broc Romanek, CompensationStandards.com

Here is something that GMI’s Paul Hodgson recently blogged:

In a press release last week, Sen. Carl Levin, D-Mich., and Sen. Sherrod Brown, D-Ohio, announced that they had introduced legislation to end tax breaks for stock options. Since they are considered performance-related pay, stock option expense is subject to corporate tax relief under Section 162(m) of the IRC. However, the tax relief is given on the actual expense of the stock options, based on the profits made by the executives at the time the options are exercised. This, Sen. Levin and Sen. Brown have discovered, is a much larger figure than the expenses recorded in company accounts, which estimates the cost of the option at its grant date. This differential, the senators claim, is a huge corporate tax break, and closing the loophole would net the Treasury about $25 billion.

This is priceless information and an eye-popping piece of legislation and there are almost too many conclusions here for one little blogger to deal with.

– If this is true, companies are seriously underestimating the costs associated with stock options, thus bamboozling shareholders and the markets.

– If this is true, companies are seriously underestimating the amount of pay being granted to their executives, thus bamboozling everyone.

– If this is true, I was right all along in insisting that the SEC use the amount recorded as profit as the proper record of pay for executives, even though it ignored me.

– If this is true, virtually every other pay survey – apart from ours – is not just wrong but seriously underestimates the amount of pay that executives receive.

But the real doozy is left to the end, in the summary of the bill. Just read this:

– make stock option deductions subject to the existing $1 million cap on corporate tax deductions for compensation paid to top executives of publicly held corporations.

In other words, stock options will no longer be considered performance-related pay under Section 162(m). That’s fine by me. I never thought market-priced stock options should be in the first place. Of course, there should be exceptions – premium-priced options, index-linked options, performance-vesting options. But if this went through this would be the death knell of the market-priced option for all but the smallest companies which aren’t affected by the $1 million cap anyway.

And no bad thing either.

– Broc Romanek, CompensationStandards.com

According to this Washington Post article yesterday, the SEC’s Commissioners have disagreed with its Enforcement Staff to settle the CSK Auto clawback case because the penalty amount was too low. It’s relatively rare that the Commission disagrees with its Enforcement Staff – but certainly not unheard of – but it is rare that a closed Commission meeting outcome like this is made public. Here is the WaPo article in its entirety:

The SEC has rejected a proposal by its own enforcement staff to settle a landmark case in which the agency is trying to force a former corporate chief executive to give up millions of dollars in bonuses and stock profits he received while the company was cooking its books. The plan to settle for significantly less money than the agency originally sought posed a test question for the Securities and Exchange Commission: Was the staff letting the former executive off the hook too easily? Or was the agency being overzealous when it brought the case in the first place?

Both sentiments combined to torpedo the deal when the commissioners weighed the proposal last week, according to a source close to the matter. The case involves Maynard L. Jenkins, former chief executive of CSK Auto, an Arizona-based auto-parts retailer that had to correct years of financial statements. In 2009, the agency sued Jenkins, saying he should repay the auto parts retailer more than $4 million that he reaped while the company was “engaged in a pervasive accounting fraud.” Jenkins, however, was not personally charged with fraud.

It was the first time the SEC had filed a so-called clawback suit to wrest money from an executive who was not accused of complicity in accounting fraud. The SEC was using the watershed Sarbanes-Oxley law enacted in 2002 in response to accounting scandals at companies such as Enron and WorldCom. The law calls for chief executives and chief financial officers to forfeit stock profits or bonuses they receive while their company is misleading the public about its financial performance.

He and the SEC staff notified the trial court in March that they had reached a tentative settlement, subject to approval by the SEC’s governing commissioners. On Monday, they notified the court that their efforts “have not been successful.” The proposed settlement was for less than half the amount the SEC originally sought, according to a second source familiar with the matter.

Jenkins and the staff thought the deal was in both his interest and that of the agency, but a bipartisan majority of the SEC’s commissioners disagreed, the first source said. Both spoke on condition of anonymity because the information involved internal SEC deliberations. “We cannot comment on Commission deliberations, but we will continue to pursue the case vigorously,” SEC spokesman Kevin J. Callahan said by e-mail. John W. Spiegel, a lawyer for Jenkins, declined to comment.

The law’s clawback provision was meant to hold top executives accountable for fraud and to prevent them from profiting from it. It can encourage executives to be vigilant, but it can also penalize executives who had nothing to do with the wrongdoing. The objective is to reimburse the company and shareholders. But it can cost companies money to recoup money.

In a January court filing, CSK Auto said it is responsible for Jenkins’s legal costs. The company has been billed “approximately $1.9 million in legal fees and costs associated with Mr. Jenkins and $1.5 million since litigation commenced” in the SEC’s case against him, according to a court filing by Jeffrey L. Groves, general counsel of CSK’s parent company, O’Reilly Automotive. Those costs have been covered by an insurer for CSK, according to another court document.

Jenkins is 68 and in declining health, his lawyers said in a January court filing. The SEC lawsuit has left him in financial limbo, they wrote. As long as it remains unresolved, he “cannot plan financially for his future and that of his family,” they said.

His defense team has argued that the SEC “is attempting to impose a Draconian penalty on an admittedly innocent person.” “The SEC’s nonsensical view is that Mr. Jenkins must pay (literally and figuratively) for . . . misconduct by others beca use he was the ‘captain of the ship,’ despite the fact that under its own view of the evidence, his crew was mutinous,” his lawyers have argued.The rejection of the settlement came soon after the SEC took flak for a settlement in which it fined J.P. Morgan Securities but took no action against any of the firm’s employees or executives. In another case, SEC Commissioner Luis A. Aguilar last week took the extraordinary step of publicly dissenting from an SEC enforcement action on the grounds that it was too weak. The rejection of the Jenkins settlement sets the stage for a civil trial.

Barring a new settlement, the case will test the SEC’s application of the clawback law, and it will call on the agency to prove that CSK’s accounting involved “misconduct” rather than innocent error.

– Broc Romanek, CompensationStandards.com

We have posted the Summer 2011 issue of our Compensation Standards newsletter that contains practical guidance (and numerous specific examples) in the aftermath of a hectic proxy season. The Summer issue covers:

– The Evolving Role of the Executive Summary
– Coordinating the Executive Summary and the Say-on-Pay Supporting Statement
– The Newest Disclosure Tool – The Proxy Statement Summary
– The Second Round of Compensation-Related Risk Disclosure
– A Preview of the Coming Consultant Disclosure
– What to Expect in 2012

Print it out now so you can read Mark Borges’ guidance today…

– Jeffrey London, Mary Lou Zwick and Brian Witkowski, Kaye Scholer

As noted in our recent memo on clawbacks, there are a number of open issues that the SEC will presumably address with its regulations, including the definition of “executive officers” as explained above. What follows is a list of some of the more interesting issues left open by the statute:

1. Unilateral Policy versus Bilateral Agreements – The statute imposes an affirmative duty upon companies to recover excess incentive compensation but is silent as to whether the executive officer must consent to the clawback. Applying this rule literally, companies may be required to recover amounts that they are not contractually entitled to recoup. For example, most employment agreements provide that bonuses are vested once earned and, therefore, may not contractually be recovered. Similarly, mutual releases of claims entered into with departing executives presumably bar the company from asserting any claims to recover compensation. The regulations will need to address whether companies can unilaterally implement a clawback policy or whether they must obtain the executive officers’ consent.

2. Retroactivity – One of the more significant issues left open by the statute is whether the clawback requirements will apply retroactively to incentive compensation awards granted or paid prior to the effective date of the regulations. Along those lines, if the regulations do provide for retroactive application, it is unclear whether executive officers whose employment terminates before the regulations become effective will be subject to the clawback requirements. The regulations will also presumably address whether an individual who was not an executive officer at the time of an award of incentive compensation, but who becomes an executive officer prior to an accounting restatement, is subject to the clawback requirements.

3. Equity and Equity-Based Awards – Equity and equity-based incentive compensation awards present a number of issues open to interpretation under the statute. For example, the statute generally does not provide guidance as to the meaning of “incentive-based compensation.” However, it does reference stock options as one type of “incentive-based compensation.” The regulations could adopt a narrow definition of “incentive-based compensation” that excludes purely time-based stock options and restricted stock (i.e., limit the clawback only to performance-based compensation).

Another question is whether equity-based awards that were granted based on reported metrics, but which have not yet vested, will be considered “received” under the statute and therefore subject to the clawback requirements? And when are awards valued for purposes of determining excess compensation? Perhaps the rules will compare the value at the date of grant, or alternatively immediately prior to the announcement of the restatement (when the markets presumably have not priced in the accounting discrepancy), to the value immediately following the restatement or some other time?

4. Indemnification Obligations – It is common practice for public companies to provide for indemnification of executives for certain costs incurred by the executive in defending against or settling a lawsuit, provided certain good faith requirements are met. As Dodd-Frank clawbacks are not limited to restatements due to misconduct, these indemnification provisions could potentially cause a company to be legally obligated to repay an executive officer for amounts the company recovers under its clawback policy. Companies could go a step further and enter into indemnification agreements specifically covering any amounts recovered under a clawback policy. As these agreements would undermine the purpose of the statute, and would be against public policy, the SEC will presumably need to address how Dodd-Frank will impact these arrangements.

5. Wage Laws – Clawbacks under Dodd-Frank could potentially violate applicable state wage payment laws or similar foreign laws. Although many state laws exempt incentive compensation, companies should be prepared to perform a review of the laws in the applicable jurisdictions once the regulations are implemented. Presumably, Dodd-Frank, as a federal statute, will preempt state wage payment laws, but this is not certain.

6. De Minimis Clawbacks – As drafted, the statute does not permit companies to forego a clawback in cases where the “excess” incentive compensation paid is de minimis or if the costs of recovery would exceed the recoverable amount. Whether the regulations will permit exceptions under these scenarios remains to be seen.

– Broc Romanek, CompensationStandards.com

Last month, Premiere Global Services became the 40th company to file a Form 8-K reflecting a failure to get majority support for it’s say-on-pay agenda item (47%). A list of the Form 8-Ks of these companies is in CompensationStandards.com’s “Say-on-Pay” Practice Area (bearing in mind that totals for three of these companies are somewhat in dispute). 40 failures is less than 2% of all companies that had say-on-pay on their ballot this season.

So what does this all mean? On the one hand, the relatively low percentage of companies failing has led commentators to label say-on-pay as insignificant as a force for needed change, such as this blog by Bob Monks and this one from Paul Hodgson. On the other hand, many corporate advisors are holding up this season’s results as evidence that more change in pay practices is not necessary.

My take is that it’s too early to tell what it means (including what level of “against” votes is a red flag that some pay practices are problematic – clearly, there are levels below a majority that should give boards pause). I believe this year was a test year as many institutional investors weren’t prepared for the massive undertaking that a true look at pay packages for their portfolio companies entails. In addition, we didn’t see much in the way of grass roots movements – surprising in this social media age. The potential for potent and inexpensive campaigning online against a company’s say-on-pay vote will continue to loom. Five years from now – particularly when say-on-pay then applies to the numerous small companies that have a temporary bye right now – we’ll have a better sense of what say-on-pay really means.

To be honest, 40 failures is many more than I expected. That should be clear from the poll I posted on this blog back in January asking y’all to guess how many failures there would be. In hindsight, the choices I offered in the poll revealed how low I thought the numbers would be. I offered choices of 0 failures (which garnered 1% of votes); 1-2 failures (1%); 3-4 failures (3%); 5-10 failures (18%); and More than 10 failures (75%). I should have broadened the choices – and I will next year.

I’m still mystified that most directors appeared to be unsupportive of say-of-pay before Dodd-Frank mandated it. So many are resting easy now , having shareholders bless their pay packages with flying colors. As I blogged a few years back, these boards now have a likely shield from liability and from reputational attack. I could always understand why board advisors didn’t like say-on-pay – it’s a lot more work with no additional resources during an already busy proxy season – but I never understood why directors would be against it. But maybe they saw those say-on-pay lawsuits coming…