Four Senate Democrats have said they would oppose the repeal of a Dodd-Frank Act provision that would require companies to disclose the ratio between their CEO’s total compensation and the median total pay of all other employees. In a letter last week, Senators Robert Menendez of New Jersey, Tom Harkin of Iowa, Sherrod Brown of Ohio, and Carl Levin of Michigan defended Section 953(b) of the Dodd-Frank legislation and urged a corporate lobbying group to drop its opposition to this provision. Menendez and Brown are members of the Senate Banking Committee, which has jurisdiction over corporate disclosure issues.
“If we are to generate a long-lasting recovery, we need to ensure that hard-working middle class families are once again able to share in their company’s successes through rising wages and benefits, just like CEOs have done for decades,” the four senators wrote. “Section 953(b) of the Wall Street Reform Act will help to further this important goal by increasing transparency, encouraging firms to take a harder look at the rising pay discrepancies between CEOs and their workers, and providing investors and policymakers with a better understanding of pay.”
The senators’ letter specifically cited the $12 million pay package received in 2010 by Lowe’s CEO Robert Niblock, which the lawmakers said was “380 times the $31,637 pay of department managers” at the retailer. The letter also pointed out that some companies, such as Whole Foods Market and MBIA, have disclosed pay ratio information voluntarily in their most recent proxy statements.
Section 953(b) has not taken effect, and the SEC plans to issue proposed rules to implement this provision later this year. Companies and their advocates have complained that Section 953(b) would impose a significant compliance burden, especially on large multinational companies that have employees around the world. However, the AFL-CIO labor federation has argued that this provision would prod boards to set executive compensation based on a company’s own organizational needs, rather than based on executive pay at other firms.
On June 22, the House Financial Services Committee voted 33-21 to approve HR 1062, the Burdensome Data Collection Relief Act, which would repeal Section 953(b). It appears likely that HR 1062 will win approval from the Republican-controlled House of Representatives. The legislation’s prospects are less certain in the Senate, where Democrats still have a majority.
Meanwhile, institutional investors (which are Form 13F filers) still are waiting for the SEC to issue final rules on another Dodd-Frank mandate–the disclosure of proxy votes on “say on pay,” pay vote frequency, and “golden parachutes.” The SEC now states that the final rules will be released by the end of July, but the commission has made similar pledges since March. The filing deadline in the draft disclosure rules is Aug. 31, but agency observers expect that this deadline will be extended.
Equilar’s 2011 Executive Compensation Summit yielded some interesting observations from the June 13-15 panels and discussions:
– Dodd-Frank regulations: The general consensus of the panelists was that the regulations on clawbacks, CEO-to-median-employee pay ratio and other compensation-related provisions probably wouldn’t be to the exchanges until July 16th and that there would be a 90-day period for the exchanges to respond. At that point, the SEC would have up to a year to respond. Thus, the general sentiment was that many of the Dodd-Frank rules that have yet to be implemented probably won’t be instituted until the 2013 proxy season.
– Say on parachutes: While considerable attention has been focused on say on pay, there was some discussion related to anticipated increased attention and focus on say on parachutes. So far, these proposals have been under the radar, but there’s the potential for additional scrutiny to the extent that deals continue to increase if/when market conditions allow.
– Pay for performance: This discussion highlighted the greater use of graphic/tabular disclosures to get companies’ pay-for-performance message across. As we’ve all experienced, there are continued questions around how best to measure performance and pay and whether the SEC will provide any clarity regarding those questions (the general sentiment: doubtful).
– Clawbacks: One panel discussed clawback provisions and concluded that, while many companies have them, most do not comply with what’s expected to be required under Dodd-Frank. That said, most companies do not want to modify them at this point, but instead will wait until the final rules are issued to adopt/modify their provisions. (There also was some discussion about implementing clawbacks now with language stating that they would need to be compliant with any ongoing changes in the regulatory environment.)
– Say on pay: While say on pay was obviously a hot-button issue for 2011, one speaker observed that it’s really just another avenue for investors to review and comment about issues regarding pay. Instead of withholding votes from board/compensation committee members to express dissatisfaction with pay decisions, investors were voting against say-on-pay resolutions where they had issues with pay. With the former, potential remedies could possibly involve ousting a director; with the latter, there are a number of more targeted, reactive steps a company can take to respond to shareholders ahead of the next say-on-pay vote.
Recognizing ours is a society built on competition, one presenter predicted that there will be a growing interest in keeping score as it pertains to say on pay in coming years, particularly relative to peers. There was also some debate about what constitutes an acceptable level of say-on-pay support or, alternatively, what was too much opposition. There was general agreement that anything below 70%-80% support means the company should really be examining what went wrong in terms of the compensation program relative to peers.
Finally, there was recognition that the easy work is largely behind us, meaning that companies have for the most part now rid themselves of problematic pay practices. The real work of identifying and implementing pay policies to incent the workforce in a way that’s in alignment with shareholder interests is just beginning.
Here’s something that I recently blogged on the “Dodd-Frank Blog”: The FDIC has adopted final rules which provide that the FDIC, as receiver of a covered financial company, may recover from senior executives and directors who were substantially responsible for the failed condition of the company any compensation they received during the two-year period preceding the date on which the FDIC was appointed as receiver, or for an unlimited period in the case of fraud.
A “covered financial company” is a financial company, other than an insured depository institution, which the Treasury Secretary has determined satisfies the criteria for FDIC receivership under Section 203(b) of the Dodd-Frank Act. Among other things, a determination by the Secretary under Section 203(b) requires a determination that the failure of the financial company would have serous adverse effects on the stability of the United States. “Financial companies” means bank holding companies, nonbank financial companies supervised by the Federal Reserve System and companies the Federal Reserve has determined are predominately engaged in activities that are financial in nature.
“Compensation” is broadly defined to mean any direct or indirect financial remuneration received from the covered financial company, including, but not limited to, salary; bonuses; incentives; benefits; severance pay; deferred compensation; golden parachute benefits; benefits derived from an employment contract, or other compensation or benefit arrangement; perquisites; stock option plans; post-employment benefits; profits realized from a sale of securities in the covered financial company; or any cash or noncash payments or benefits granted to or for the benefit of the senior executive or director.
The proposed rule provided a standard of conduct in which, among other things, a senior executive or director would be deemed “substantially responsible” if he or she failed to conduct his or her responsibilities with the requisite degree of skill and care required by that position. The final rule clarifies the standard and provides that a senior executive or director would be deemed “substantially responsible” if he or she failed to conduct his or her responsibilities with the degree of skill and care an ordinarily prudent person in a like position would exercise under similar circumstances. The revision clarifies that the standard of care that will trigger a clawback is a negligence standard; a higher standard, such as gross negligence, is not required.
In the event that a covered financial company is liquidated under Title II of the Dodd-Frank Act, the FDIC as receiver will undertake an analysis of whether the individual has breached his or her duty of care, including an assessment of whether the individual exercised his or her business judgment. The burden of proof, however, is on the senior executive or director to establish that he or she exercised his or her business judgment. State “business judgment rules” and “insulating statutes” will not shift the burden of proof to the FDIC or increase the standard of care under which the FDIC as receiver may recoup compensation.
The proposed rule provided that, in certain limited circumstances, a senior executive or director would be presumed to be substantially responsible for the failed condition of the covered financial company. The use of rebuttable presumptions for those individuals under the limited circumstances in the final rule is aligned with the intent shown in the statutory language; thus, the presumptions remain unchanged in the final rule.
The following presumptions apply for purposes of assessing whether a senior executive or director is substantially responsible for the failed condition of a covered financial company:
-The senior executive or director served as the chairman of the board of directors, chief executive officer, president, chief financial officer, or in any other similar role regardless of his or her title if in this role he or she had responsibility for the strategic, policymaking, or company-wide operational decisions of the covered financial company prior to the date that it was placed into receivership under the orderly liquidation authority of the Dodd-Frank Act;
– The senior executive or director is adjudged liable by a court or tribunal of competent jurisdiction for having breached his or her duty of loyalty to the covered financial company;
– The senior executive was removed from the management of the covered financial company under 12. U.S.C. 5386(4); or
– The director was removed from the board of directors of the covered financial company under 12 U.S.C. 5386(5).
The FDIC anticipates that it will seek recoupment of compensation through the court system using a procedure similar to the procedure that it currently uses when it seeks recovery from individuals whose negligent actions have caused losses to failed financial institutions. In those situations, the FDIC as receiver undertakes an investigation to determine if there are meritorious and cost effective claims and, if so, staff requests authority to sue from the Board or the appropriate delegated authority. Similarly the FDIC anticipates that it will investigate whether the statutory criteria for compensation recoupment are met, and, if so, staff will request authorization of a suit for recoupment. The final rule reflects this procedure by indicating that the FDIC as receiver may file an action to seek recoupment of compensation.
Last week, the 7th company that failed to garner majority support for their say-on-pay was sued – Cincinnati Bell in a federal district court in Ohio (here’s the complaint). For reasons I’m not sure of myself, I count this as the 8th say-on-pay related lawsuit even though this one didn’t involved a failed SOP. We continue to post pleadings from these cases in our “Say-on-Pay” Practice Area.
In the May-June issue of The Corporate Counsel that was mailed last week, some of these new positions are analyzed – get the “Rest of 2011 for Free” when you try a ’12 No-Risk Trial now.
Here’s something that I recently blogged: A key ingredient of the six remarkably similar say-on-pay lawsuits filed recently involves a lack of specificity by the defendant companies and directors in disclosing what they mean in their executive compensation policies when they say they have a “pay for performance” program. Most companies leave their policies deliberately vague or describe them only at a high level, yet stating that a company will pay for performance has made its way into most policies we see.
Has this vagueness helped? In the suits filed so far, the plaintiffs have claimed that the defendants do not pay for performance when their executives’ pay has increased while total shareholder returns (TSR) have decreased. While that may appear to compensation professionals to be an overly simplistic view of the world, absent a different argument being made by the company in its proxy and Compensation Discussion and Analysis (CD&A), this basic measurement may be the only criteria by which the issue can be evaluated, at least until the next round of pleading on the cases.
The language used as the basis for the plaintiffs’ complaint in each of these cases comes directly from the company proxy and consistently cites the company’s claim that its pay program is designed to reward outstanding performance. However, none of the pleadings filed to date cite any mention of how the compensation committee explains to shareholders the rationale for reaching that conclusion, or how they would prove it. In most of the cases, this is because that explanation is absent from the CD&A.
Said differently, the defense of these cases might be easier if companies were able to describe in their proxy disclosures that they measure performance in a different way than the plaintiffs, who simply use the Summary Compensation Table number and compare it to TSR.
This heightens the need for companies to take additional care to demonstrate how they pay for performance and in a manner that reflects the consideration the compensation committee gave to the matter before making its pay decisions. Certainly, this should mean looking at what pay versus performance would look like for the company as it attains various levels of TSR. But, more importantly, it should take into account:
1. How the company measures pay
2. What it means by “performance”
3. Whether the company believes pay and performance should be measured absolutely or in relative terms (by comparison to peers), or in some combination
4. The time period over which they should be measured.
Enhancing the CD&A with this information can facilitate shareholder support for a favorable vote on say on pay — and a more proactive defense than not making the case at all.
As a threshold matter, the litigation should not be successful. Courts in the past consistently have given boards broad latitude in setting compensation, see, .e.g., the Walt Disney litigation, and there is no reason to believe that the imposition by Congress of non-binding say-on-pay votes is going to change that. But there is an inconvenient truth here, and that is that at most companies the CD&A overstates the company’s commitment to the compensation approach described. In fact, the common thread among the seven cases that have been filed so far is that the compensation awarded did not fully reflect the compensation approach described in the CD&A.
In reality, a board often has to be more flexible than as described in a CD&A, and where a company has gone through several difficult years, the board easily can conclude that it needs to pay management better than the CD&A might contemplate in order to prevent an exodus of talent or to reward management for doing as well as it did in tough times.
The question then is whether CD&As should be “softened” in order to contemplate variances. Two views exist on this within my own office. One is that you cannot overtly state in a CD&A that you may not follow the approach that you have described because it will undercut the integrity of the compensation process and disclosure and lead to an ISS recommendation against your say-on-pay proposal. The other is that you must or you put yourself at risk of proxy statement based litigation. In an upcoming proxy statement, one of our clients intends to include the following:
Even under our pay-for-performance approach there may be periods of poor financial performance by the Company during which we may decide that it is appropriate and in the best interests of our shareholders to give raises, grant equity awards, or award bonuses. For example, we might conclude that the poor financial performance was not due to the performance of the executives, or we might conclude that the compensation of one or more executives is not competitive such that we are at risk of losing important talent.
Similarly, we might conclude that the financial performance would have been worse but for the efforts of one or more executives and that it is appropriate to reward them for their efforts. In addition, we may hire a new executive and for competitive reasons determine to pay the executive at a level necessary to attract and retain him or her. While we expect these exceptions to be uncommon, they may occur and are not intended to diminish our overall commitment to pay-for-performance.
In the end, if well defended, we do not expect any of the remaining lawsuits to be successful, and we hope that boards continue to base their decisions on what is good for shareholders and not what they have said in prior CD&As. It is unfortunate that some companies – see Broc’s recent blog – have been settled as that simply encourages more.
Here’s news from Cooley’s Cydney Posner culled from this news brief:
Here’s some potentially happy news for issuers: a report from BNA indicates that ISS plans to review certain of its methodologies in light of company complaints that ISS negative recommendations on say-on-pay proposals during the most recent proxy season were unwarranted.
First, during a recent webcast, ISS Executive Director Patrick McGurn said that ISS will review the way it values options. More specifically, in SEC filings, companies report the grant date fair value of options in accordance with GAAP, while ISS uses valuations provided by Equilar Inc. However, Equilar valuations tend to be higher because of the volatility measures that it uses. (See, for example, the additional soliciting materials from GE, which contended that, by using the wrong volatility measures, ISS had overvalued the grant date fair value of the CEO’s option by over $7 million.) According to the article, ISS plans to request comment on the issue related to option values from its institutional clients and expects to settle the issue by next year.
The second issue that has frustrated companies is ISS’ methodology in developing peer groups for purposes of evaluating pay for performance. Pay-for-performance “disconnects” were among the most common reasons for negative ISS recommendations. In determining compensation, companies typically evaluate their pay and pay-for-performance statistics relative to selected peer groups. ISS’ concern is that companies inappropriately pack their peer groups with “outsize” companies to inflate comparable compensation and thereby justify otherwise insupportable pay packages. Instead, McGurn believes that companies should be “‘baking in pay-for-performance metrics’ that drive the company’s compensation strategy.” In making its own peer group determinations, ISS uses Global Industry Classification Standard (GICS) codes, a private market industry standard familiar to institutional investors, according to ISS.
Companies argue that ISS’ peer groups exclude many companies that are generally recognized as true competitors and include many companies that are not true competitors and may even be in entirely different and unrelated businesses. (See, for example, the additional soliciting materials from Northern Trust.) Unfortunately, the article suggests that we should not expect much movement in this area: according to McGurn, “I don’t see us moving away from that methodology.” However, he did indicate that ISS “will consider providing clients with a ‘matrix of different ways’ to look at pay-for-performance. A handful of metrics would be available for each company that would help institutional investors judge a company’s pay practices.”
A recent Marketwatch article concludes with one quotation condemning golden parachute tax gross-ups for executives as a “skeleton in the closet” (Paul Hodgson of GovernanceMetrics International), and another one saying “It’s time for these to go” (Charles Elson, a University of Delaware professor specializing in corporate governance).
What really should go are tax gross-ups that are poorly considered or poorly structured. Employers certainly need to understand the significant cost for these commitments. There are instances, however, when a tax gross-up may represent a fair balancing — or arms’ length negotiation — of employer interests and executive incentives. For example, the shift to performance-based stock awards and longer-term incentives dramatically changes the calculus behind the golden parachute rules, by increasing the parachute payments that are deemed to occur from an acceleration of vesting.
While good governance often warrants longer-term incentives, there are occasions when the consequent shift in compensation structures should include a limited tax gross-up (such as for some protection above threshold materiality triggers). The protection is often key to the hiring of an executive to turn-around a failing or stalled company, especially if the lion’s share of the compensation package comes in the form of performance-based incentives that become vested on a change in control. This is not meant to defend tax gross-ups generally, but instead to suggest that exceptions be recognized for soundly considered actions and constructs. Unfortunately, say-on-pay’s empowering of proxy advisors is at times resulting in excessive rigidity. Check out my “Executive Loyalty” Blog…