As you continue to work through the technicalities of your upcoming pay vs. performance table, this FW Cook blog gives a heads up on valuing equity awards that use relative total shareholder return as a performance metric. Here’s an excerpt:

Companies often estimate the value of “in-flight” awards (awards partway through the performance period) by using the “Intrinsic Value method,” which estimates value by determining a payout percentage based on the current percentile ranking and then multiplying that payout by the current stock price.

It turns out that in many cases the Intrinsic Value method produces a value quite different from the “Fair Value,” which is the value used for accounting purposes and required for the PVP table. The difference is most acute for awards tracking at no payout, where the valuation required for the PVP table can produce valuations near target payout in some cases.

The blog includes a table from Infinite Equity that may be helpful in estimating fair value of these awards at different points during the performance period. The FW Cook team explains:

As companies develop estimates for CAP for their 2023 proxy statements, we believe that a table like this can be a reasonable placeholder for estimated Fair Values (at least until the end of the year when a final Monte Carlo simulation to determine Fair Value will be required). Although the table reflects a specific set of assumptions, so that results may diverge for some plan designs, we think it is still a useful tool for companies that would like to develop insight into their 2023 PVP table and have not yet started full valuations.

The table may be particularly helpful in cases where current percentile rankings are extremely high or low and there is significant time for the awards to run since this is where the divergence between Intrinsic Value and Fair Value is the greatest.

Make sure to register and join us for our 3-hour special session next Thursday, November 10th, on the SEC’s new pay vs. performance rules. We will be explaining how to handle major interpretive questions and how to put this new disclosure in context for say-on-pay, and will also walk through our sample disclosures – which registrants of this special session will be able to download in real-time. That resource alone is well-worth the price of admission!

– Liz Dunshee

Yesterday, by a 3-2 vote, the SEC adopted rules that will (eventually) require exchange-listed companies to maintain “clawback policies” for “the recovery of erroneously awarded incentive-based compensation received by current or former executive officers.” The SEC’s original proposal on these rules dates back to 2015. The Commission reopened the comment period in October 2021 and again in June 2022.

Here’s the 230-page adopting release – and the press release and 2-page Fact Sheet. Stay tuned for expert guidance via a CompensationStandards.com webcast on this topic – as well as in-depth analysis & practical takeaways from Dave Lynn in The Corporate Executive. We’ll also be posting the inevitable deluge of memos in our “Clawbacks” Practice Area. In the meantime, here’s a “baker’s dozen” things to know:

1. Rule Requires Policy & Disclosure: Nearly all exchange-listed companies will have to adopt and comply with a clawback policy that conforms to these new rules, and will also have to provide disclosure in proxy & information statements and annual reports about the policies and how they are being implemented.

2. Delisting at Stake: A company will be subject to delisting if it does not adopt and comply with a compensation recovery policy that meets the requirements of the listing standards.

3. Applies To “little r” Restatements: That policy must provide that, in the event the issuer is required to prepare an accounting restatement, including to correct an error that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period (“little r” restatements), the issuer will recover incentive-based compensation paid to its current or former executive officers based on any misstated financial reporting measure.

4. Three-Year Lookback: The policy must apply to compensation received during the three-year period preceding the date the issuer is required to prepare the accounting restatement.

5. Applies to Current & Former Executives: The policy has to direct the company to recover erroneously awarded compensation from both current and former executive officers.

6. Three Limited “Impracticability” Exceptions: The only allowable exceptions to enforcing the policy are:

– Direct expenses paid to third parties to assist in enforcing the policy would exceed the amount to be recovered and the issuer has made a reasonable attempt to recover;

– Recovery would violate home country law that existed at the time of adoption of the rule, and the issuer provides an opinion of counsel to that effect to the exchange (regarding state laws, which Emily blogged about last year as a potential issue, the SEC says on page 92 of the adopting release that it’s not aware of any state laws that would clearly prohibit recovery, although executives may assert that as a defense and companies may need to address such matters as part of the recovery process); or

– Recovery would likely cause an otherwise tax-qualified retirement plan to fail to meet the requirements of the Internal Revenue Code.

7. New Exhibit to Annual Report: The clawback policy must be filed as an exhibit to the annual report, under Item 601(b)(97) of Regulation S-K.

8. Disclose Application of Policy: Companies must disclose how they have applied their recovery policies, including:

– The date on which the company was required to prepare an accounting restatement & the aggregate dollar amount of erroneously awarded compensation attributable to such accounting restatement (including an analysis of how the recoverable amount was calculated) or, if the amount has not yet been determined, an explanation of the reasons and disclosure of the amount and related disclosures in the next filing that is subject to Item 402 of Regulation S-K;

– The aggregate dollar amount of erroneously awarded compensation that remains outstanding at the end of its last completed fiscal year;

– If the financial reporting measure related to a stock price or TSR metric, the estimates used to determine the amount of erroneously awarded compensation attributable to such accounting restatement and an explanation of the methodology used for such estimates;

– If recovery would be impracticable pursuant to 17 CFR 240.10D-1(b)(1)(iv) (“Rule 10D-1(b)(1)(iv)”), for each current and former named executive officer and for all other current and former executive officers as a group, disclose the amount of recovery forgone and a brief description of the reason the listed registrant decided in each case not to pursue recovery; and

– For each current and former named executive officer, disclose the amount of erroneously awarded compensation still owed that had been outstanding for 180 days or longer since the date the issuer determined the amount owed.

– If compensation is recovered, companies must also reduce figures in the Summary Compensation Table, under a new instruction to that item.

9. XBRL Tags Required: Companies will be required to use Inline XBRL to tag their compensation recovery disclosure.

10. New Form 10-K Check Boxes: The rules add two new check boxes on the cover page of Form 10-K. One to indicate whether the financial statements included in the filings reflect correction of an error to previously issued financial statements, and one to indicate whether any of those error corrections are restatements that required a recovery analysis.

Hopefully someone smarter than me will clarify, but it does not seem immediately clear from the release whether these check boxes (especially the first one) will be required for Form 10-Ks that are filed in 2023, after the SEC rule is effective but before companies have to make any other disclosure about policies.

11. Comply in Late 2023/Early 2024: Assuming the typical Federal Register time frame and that the exchanges fully leverage the permitted compliance & effective date windows, we’re looking at an effective date in approximately January 2023 (60 days following publication of the release in the Federal Register), exchanges proposing listing standards in approximately February 2023 (90 days following publication of the release in the Federal Register), those listing standards becoming effective in approximately November 2023 (1 year after the publication date), and companies having to adopt policies in early January 2024 (within 60 days of the effective date of the listing standard), with disclosure following in annual reports and proxy statements that are filed after that date.

The release states, “We would not expect compliance with the disclosure requirement until issuers are required to have a policy under the applicable exchange listing standard.”

12. Plenty of Work Required Between Now & 2024: I’m sure nobody reading this thinks they can wait until December of next year to throw together a clawback policy. You hopefully have already been socializing the notion with the board and executives, and probably have some form of existing policy and concepts in plan documents and agreements. Now, you’ll need to analyze how those align with the new rule, what changes are needed, whether and how to position policies & agreements to overcome defenses that may apply under state laws and anticipate tax and other consequences, what disclosure will look like, etc. The expectation from most folks I’ve talked to is that the exchange listing standards will track the SEC rule pretty closely – but of course we won’t know for sure until they actually submit the proposals.

13. Don’t Forget Other Clawback Rules & Enforcement Initiatives: As Dave blogged earlier this week on TheCorporateCounsel.net, companies must also be mindful of the interplay with SOX 304 clawbacks and current enforcement initiatives when preparing policies and related compliance efforts. This Freshfields blog from late last year explains how Dodd-Frank clawbacks generally differ from the existing Sarbanes-Oxley rule.

As expected, the rules are prescriptive – and companies will face a lot of challenges in adopting and enforcing the policies that they require. That is not the fault of the Staff, but is a function of a stale mandate on a very complicated topic, made even more complex by the intervening prevalence of “little r” restatements.

– Liz Dunshee

The stock market’s 2022 nosedive is creating rough waters for say-on-pay votes. According to this Willis Towers Watson blog, we are now at record failures for the Russell 3000 – as well as lower overall support levels. Here’s more detail from the blog:

Despite a slow and rather business-as-usual start to the 2022 proxy voting season, the year-to-date outcomes have reached record territory for say-on-pay (SoP) failures. As of September 30, 2022, there were 78 SoP failures for companies in the Russell 3000, seven more than the previous highest number of failures on record since SoP inception (71 total in 2021).

Not only has the overall rate of SoP proposals failing to receive majority support increased to 4%, but the average level of shareholder support has dipped below 90% for the first time in 10 years. The percentage of companies receiving strong support (defined as greater than 90%) has declined (70% of Russell 3000), though moderate support remains the norm (86% received greater than 70% support).

The first half of the year largely reflects pay and performance ending with the 2021 calendar year, and though it seems like a distant memory at this point, 2021 saw strong total shareholder return (TSR) performance. The overall strength in the market played a role in strong performance and compensation results for fiscal 2021; however, the first nine months of 2022 have seen global economic uncertainty and enormous market volatility, yielding sustained and deep TSR losses. For companies with non-calendar fiscal years, the perfect storm of CEO pay increases confronting bear market territory has led us into record SoP failure territory.

The blog points out that proxy advisors and investors are scrutinizing executive pay for CEOs as well as other NEOs – and are also expecting companies to show “responsiveness” to mediocre or low support. The way to do that is to engage with shareholders and disclose those engagement efforts and any resulting actions in the proxy statement. For additional practical guidance, check out our chapters on “Say on Pay Solicitation Strategies” and “Say on Pay Disclosure Strategies” – included in the newly updated edition of Lynn & Borges’s Executive Compensation Disclosure Treatise (which is included online as part of your membership to this site) – as well as our checklist on “Shareholder Engagement for Say-on-Pay.”

– Liz Dunshee

I’ve blogged a couple of times about the resurgence this year of shareholder proposals that suggest a cap on executive severance amounts (we also discussed this at our recent “Executive Compensation Conference”). In response, some companies have limited the cash component of severance – although that doesn’t go as far as the proponents want.

A new 7-page FW Cook memo provides a detailed status update on these proposals – and points out possible unintended consequences of policies that limit severance benefits. Here’s the intro:

Amid the significant increase in shareholder proposals at Russell 3000 companies over the past year, the most prevalent executive compensation-related proposal is to limit severance payments. The proposal is substantially similar in each case and typically requests that companies seek shareholder approval for any senior manager’s new or renewed pay package that provides for severance or termination payments with an estimated value exceeding 2.99 times the sum of base salary and target bonus. This shareholder proposal has appeared on proxy ballots at 17 Russell 3000 companies over the last year and received significant shareholder support: in five cases it passed, and in the other twelve, 33-49% of shareholders voted “for.”

The proposals were written to include the value of cash severance and the value of equity awards where vesting accelerates, which means many companies’ existing severance arrangements will exceed the 2.99x threshold, especially for involuntary terminations in connection with a change-in-control (CIC).

Looking ahead, companies may increasingly be compelled to adopt policies to limit executive severance benefits, but doing so could have unintended consequences that may not be in the best interests of shareholders or result in unfair outcomes for covered executives.

After summarizing proposal trends, pointing out that a majority of large-cap companies provide severance in excess of the proposed threshold, outlining one company’s engagement campaign and responsive policy, and explaining “best practices” and purposes of severance benefits, the FW Cook team offers these parting thoughts:

If proposals to limit severance continue to gain traction with shareholders, companies may be compelled to adopt conforming policies. However, doing so could have unintended consequences, including the potential adoption of compensation structures that run counter to traditional “best practices” principles.

Perhaps most importantly, limiting severance could hinder the effectiveness of CIC severance policies that are intended to align executive’s interests with those of shareholders in the context of deal negotiation. At the extreme, without appropriate CIC severance protection, executives may be perversely encouraged to delay or derail a transaction that may be good for shareholders but result in loss of employment and forfeiture of outstanding equity compensation accumulated over multiple years of employment.

We also note that in the context of talent attraction and retention, this type of limitation creates an uneven playing field for public companies versus privately held and PE-backed companies that are not subject to such restrictions. It also handicaps widely held public companies versus controlled companies who can “push through” shareholder approval.

In summary, while efforts to reduce the cost of severance may be well-intentioned, such proposals could have negative implications that outweigh the benefits.

– Liz Dunshee

Similar to the current situation in which we find ourselves, there was some head-scratching when the SEC originally proposed pay vs. performance rules in 2015. For a few years, though, some companies were voluntarily disclosing a “pay vs. performance” graph in the proxy statement – as an acknowledgement of the proposal and also because investors & proxy advisors were incorporating “pay-for-performance” metrics into say-on-pay models.

Yet, as we’ve noted, those disclosures have been dropping off. A recent Equilar blog underscores that trend:

In 2021, just 9% of the Equilar 100 — the 100 largest U.S. public companies by revenue—disclosed a graph that showed the relationship between their executives and financial performance. While this is up one percentage point from 2020, the figure is down overall by nearly 50% since 2017 when 18.2% of companies disclosed a Pay for Performance graph. The percentage of companies that disclosed a Pay for Performance graph has also declined from 2017 to 2020, before slightly rebounding in 2021. Of course, given the SEC’s August announcement, the prevalence of disclosures will certainly accelerate in the coming years.

The question is, will these voluntary disclosures fall by the wayside in 2023, now that the SEC has mandated a format for pay vs. performance disclosure? My guess is that they will. There are already going to be multiple defined terms between the CD&A, executive compensation tables, and the new pay vs. performance disclosures. It will be important to tell a clear story, and adding yet another graph to the mix may not be the best way to do that. On the other hand, if the mandated format suggests that pay & performance are misaligned at certain companies, perhaps they will use supplemental disclosures to overcome that.

We’ll be discussing the pros & cons of voluntary supplemental pay vs. performance disclosures at our November 10th special session – 3 hours of practical guidance on complying with this new rule. Register today!

– Liz Dunshee

Yesterday, the SEC posted a Sunshine Act Notice for an open meeting of the Commissioners to be held next Wednesday, October 26th. Corp Fin Staff will also be attending – Renee Jones, Erik Gerding, Elizabeth Murphy, Lindsay McCord, and others. After years of anticipation, the agenda includes:

The Commission will consider whether to adopt rules to implement of Section 10D of the Securities Exchange Act, as added by Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

We had a great session at our Executive Compensation Conference last week about what you need to think about when reviewing and updating your clawback policy in light of recent enforcement activity and these expected final rules. If you missed it, you can still get access to the on-demand archives of this session and all of the other practical guidance from our Conferences by emailing sales@ccrcorp.com. Stay tuned for more guidance as we receive and analyze the final rules.

In the meantime, here are some of my latest blogs on this topic – and more guidance is available in our “Clawbacks” Practice Area:

– Clawbacks: First-Ever DOJ-Wide Policy Reinforces Role in Compliance

– Clawbacks: Are You Ready for New Rules?

– Take Note: SEC Enforcement Gets Another SOX 304 Clawback

– Clawbacks: They’re Complicated

– Clawbacks: SEC Reopens Comment Period…Again!!

– Clawbacks: Revenue Recognition Problem Leads to SOX 304 Settlement

– Clawback Proposal: Notable Comments

– Liz Dunshee

It’s hard to believe that the ISS Equity Plan Scorecard has been around for only eight years. Given the prominent role it plays in submitting equity plans for shareholder approval, it feels like it’s been here forever. This recent blog from ISS Corporate Solutions takes a closer look at the “Plan Features” & “Grant Practices” pillars – both of which are intended to balance shareholder protection interests with flexibility for plan administrators. Specifically:

Plan Features: one factor in evaluating the “Plan Features” pillar is minimum vesting. Most companies stipulate a minimum vesting period of a certain number of years from the date of grant of an award where the minimum criteria apply. While these vesting requirements apply to all award types as stipulated in the plan, some plans allow for a carve-out for a certain number of shares where these restrictions do not apply and the administering committee may establish lesser restrictions or none at all. Typically, the carve-out applies to 5% of the shares authorized for issue.

Grant Practices: Another place where shareholder comfort and administrator flexibility intersect is on the topic of post-exercise/post-vesting shareholding requirements. Some administering committees think of holding periods as fixed time periods necessary to attain minimum ownership levels.

In that view, a company may specify that a newly hired or promoted executive has a certain number of years to attain the ownership levels that are set. If an executive officer fails to meet that target, he/she may be required to hold a minimum of the net shares resulting from any future vesting of equity-based awards until the minimum ownership guidelines are met. Through this approach, holding periods can be used as a vehicle to accelerate the attainment of minimum ownership levels.

… Administering committees have flexibility to adopt palatable alternatives like 12-month post-exercise or post-vesting holding period or hold-to-end of employment/retirement policies which in turn translate into a longer-term view on stock price performance that would be welcomed by shareholders.

The blog gives example disclosures for each of these items. Make sure to also check out Chapter 15 of Lynn & Borges Executive Compensation Disclosure Treatise for more guidance on ISS’s Equity Plan Scorecard and all of the disclosure that’s required when you’re submitting a plan for shareholder approval.

– Liz Dunshee

A recent memo from Compensation Advisory Partners looks at 2022 CFO pay relative to CEOs, based on 130 companies with median revenue of $14 billion. Like CEOs, it’s safe to say that CFOs are doing pretty well this year, due to strong 2021 performance. Here’s what the data shows for total compensation:

– 2021 saw the largest year over year increases at median in the last 10 years; the last time we saw increases in the 15% – 20% range was after the financial crisis in 2008/2009.

– Median 2021 increases in actual total direct compensation (i.e., cash plus equity) for CEOs and CFOs were 18% and 17%, respectively, substantially higher compared to 2020 (3% and 4%, respectively) driven by large increases in variable incentives (annual incentive payouts and long-term incentive awards).

– As in prior years, CFO total compensation continues to approximate one-third of CEO total pay.

The report also looks at 10 years of changes in total comp. Here’s an excerpt:

CFO pay has generally tracked with CEO pay, though CEO pay has had higher highs and lower lows, as is expected for the top role. There is only one year – 2012 – that CEO pay fell compared to the prior year, but increases at median were less than 5% for most of the last 10 years for both CEOs and CFOs. 2021 saw by far the largest increases in total compensation, reflective of strong 2021 performance and compounded by below-average increases in 2020.

With 2022 being a more difficult year for stock price performance, the report says that payouts to CFOs are not expected to jump by as much next year.

– Liz Dunshee

We are wrapping up Conference week! Today is our “19th Annual Executive Compensation Conference” – Wednesday & Thursday were our “2022 Proxy Disclosure Conference.” Both conferences are paired together and they’ll also be archived for attendees until next August. If you missed these conferences or our “1st Annual Practical ESG Conference” but want to purchase access to the archives, email sales@ccrcorp.com – and we’ll also have a link available soon on this page to do that. Here’s more info for people who are attending:

– How to Attend: We have emailed a direct access link for the Conference to all registered attendees, from info@ccrcorp.com. Use that link to go to the Conference platform, then follow the “Proxy Disclosure/Exec Comp” tab to see the agenda for today, enter sessions, and add them to your calendar. All sessions are shown in Eastern Time – so you will need to adjust accordingly if you’re in a different time zone. Here’s today’s agenda.

If you are experiencing a technical issue on our conference platform and need assistance, please email Evan Blake (eblake@markeys.com) with our Event Manager Victoria Newton (vnewton@ccrcorp.com) on copy, and they will reply to you asap. If you have any other questions about accessing the conference, please email our Event Manager, Victoria Newton (vnewton@ccrcorp.com).

– How to Watch Archives: Members of TheCorporateCounsel.net or CompensationStandards.com who have registered for the Conferences will be able to access the conference archives on these sites using their existing login credentials beginning about a week after the event, and unedited transcripts will be available to these members on TheCorporateCounsel.net and CompensationStandards.com beginning about 2-3 weeks after the event. If you’ve registered for the conferences through CCRcorp but are not a member, we will send login information to access the conference footage and transcripts on TheCorporateCounsel.net or CompensationStandards.com.

If you registered for the conferences through NASPP, you will receive access to the video archives from NASPP.

– How to Earn CLE Online: We are applying for up to 15 hours of CLE credit for the Proxy Disclosure & Executive Compensation Conferences in applicable states – approvals of actual credit vary based on each state. Please read these “CLE FAQs” carefully to confirm that your jurisdiction allows CLE credit for online programs. You will need to respond to periodic prompts every 15-20 minutes during the conference to attest that you are present. After the conference, you will receive an email with a link. Please complete the link with your state license information. Our CLE provider will process CLE credits to your state bar and also send a CLE certificate to your attention within 30 days of the conference.

– Thanks To Our Sponsors! Our sponsors have helped make this event possible, and we are proud and grateful to have their support. Our Platinum Sponsor for the Proxy Disclosure & 19th Annual Executive Compensation Conference is Morrison Foerster, and our Silver Sponsor is Argyle, who also sponsored our 1st Annual Practical ESG Conference this week. Please visit their pages!

You can still register to view today’s event and get on-demand archive access to all of the Proxy Disclosure and Executive Compensation Conference from this week! Email sales@ccrcorp.com or call 1-800-737-1271, Option 1. Archives and transcripts will be available on-demand until July 31, 2023, to help you navigate challenging proxy season issues.

– Liz Dunshee

One of the sessions that I am most excited for at tomorrow’s “19th Annual Executive Compensation Conference” is the panel on key compliance steps for the SEC’s new pay versus performance rules. This session includes FW Cook’s Bindu Culas, Weil Gotshal’s Howard Dicker, Ropes & Gray’s Renata Ferrari, and Latham’s Maj Vaseghi. When the rules were issued in August, we immediately extended the time slot for this session, so that we could give due attention to the complexities of the rule and the initial action items that are needed to comply.

However! There is a lot to talk about – more than can be covered in just one hour. This recent memo from Sustainable Governance Partners highlights one aspect – whether the newly mandated pay versus performance disclosure will affect investors’ voting decisions. Here’s an excerpt:

At this point… we think the jury is still out. These requirements are intended to greatly improve transparency and standardize the calculations and presentation of this data, thereby providing investors with consistent, comparable information from all companies. Ideally, the end result is better-informed voting decisions. But as we know, sometimes standardization comes at the cost of nuance; and many will note the burden of further disclosure, namely the calculation of Compensation Actually Paid. It’s undoubtedly more complicated than dropping a grant date fair value into the Summary Compensation Table, as equity awards need to be re-valued at the end of each year or at the time of vesting.

Perhaps like the CEO Pay Ratio disclosure, the utility of the PVP disclosure will begin to grow over time. In the first year of this disclosure, however, we expect PVP disclosure will not be widely influential on institutional investors or the proxy advisors, each of which will have little time to incorporate this new data into their quantitative pay and performance models.

Ultimately, the usefulness of this disclosure will be determined by the market. Do investors feel better informed? Does the disclosure properly identify pay and performance disconnects? As issuers engage with institutional investors this Fall, we recommend asking investors for their thoughts on the new disclosure – in particular, how they will be using the new disclosure to evaluate and/or compare executive compensation plans.

Because of all of the questions that are arising with this rule – and the work that will be required – we are hosting a 3-hour special session on November 10th from 1-4pm Eastern. This special session will be a critical follow-up discussion to the panel at this Friday’s conference.

Our November 10th special session will dive into the many interpretive questions that advisors and boards are struggling to understand (with Sidley’s Sonia Barros, Compensia’s Mark Borges, WilmerHale’s Meredith Cross, EY’s Mark Kronforst, and Morrison Foerster’s Dave Lynn), the big picture impact (panelists include SGP’s Rob Main and ISS Corporate Solutions’ Jun Frank), and walk through a sample disclosure that Mark Borges & Dave Lynn are preparing (with additional commentary from Fenwick’s Liz Gartland and Gibson Dunn’s Ron Mueller). Sign up now, and join us on November 10th.

Make sure to also keep watching our “Pay-for-Performance” Practice Area for new memos about this rule, as we all process what compliance will look like. Although a number of heavy-hitter law firms, compensation consultants and trade organizations are urging the SEC to postpone the compliance date for these rules until the 2024 proxy season, there is no sign yet that the SEC is going to do that. Full steam ahead…

– Liz Dunshee