We have posted the transcript for our recent webcast – “More on Clawbacks: Action Items and Implementation Considerations” – during which Compensia’s Mark Borges, Ropes & Gray’s Renata Ferrari, Gibson Dunn’s Ron Mueller and Davis Polk’s Kyoko Takahashi Lin continued their excellent discussion from our 20th Annual Executive Compensation Conference on complex decisions and open interpretive issues that unlucky companies faced with a restatement will need to tackle. They covered:
– What to do if a restatement occurs
– Whether to amend other policies and agreements, or update other disclosures
– Maintaining your policy going forward (we are all going to get smarter about these policies over time!)
Members of this site or of TheCorporateCounsel.net can access the transcript to this program and all of our other webcasts by visiting the “archives” page. If you’re not a member, sign up today to get access to this essential guidance!
Also, if you are a member, make sure to confirm with your knowledge management folks that your subscription is being renewed before year-end. Many of our subscriptions run on a calendar-year basis, and you don’t want any interruption in access as we head into proxy season.
Speaking of year-end, barring big developments, this is our final blog of 2023! Happy holidays, everyone. Thanks for your participation in our sites this year – we couldn’t do this without you! I look forward to seeing many of you in 2024.
Compensation Advisory Partners recently analyzed disclosures made by 100 prominent companies to understand the relationship between CEO compensation and performance over a three-year period. They found that total shareholder return is correlated with executive pay, which is not too surprising since equity is a large pay component for many executives. However, the analysis highlights that other factors also affect pay:
Overall, we found that TSR performance explained 77% of CEO compensation. Although these findings indicate that performance is highly correlated with Compensation Actually Paid, once we eliminated a single outlier, the correlation was weak. To our surprise, TSR performance then explained only 18% of the variation in CEO compensation for the 99-company sample. Revenue explained 19% of the variation for this sample.
We conclude that factors other than TSR performance – for example, industry pay practices, the initial size of CEO packages using the Summary Compensation Table methodology, cash compensation levels and industry TSR performance, collectively explain the majority of the variation observed in Compensation Actually Paid.
The CAP team notes that relative Compensation Actually Paid and relative TSR performance rankings demonstrate that the relationship is sound at most companies, which should give investors comfort. That’s good news for companies too, since PvP may become a factor in say-on-pay voting decisions.
I blogged earlier this month about eroding support for equity plans during the 2023 proxy season. This Glass Lewis blog underscores that you should pay attention to overhang and overall support for your compensation programs if you expect to submit an equity plan proposal in the upcoming year. Here’s an excerpt:
In the U.S., the number of equity plan proposals that failed to receive majority support rose to its highest level in at least five years, more than doubling year-over-year. The number of proposals that passed with significant opposition rose more than 40%. The overwhelming majority of failed proposals had excessive overhang levels, either due to the basic share request or the effects of evergreen provisions. Twelve of the failed proposals had high overhang levels (some with the help of evergreen provisions) while three of the remaining proposals shared ballots with other proposals that saw high compensation-related opposition.
For the past few years, ESG metrics seemed to be gaining in prevalence in executive compensation plans – but, like “ESG” overall, their lack of specificity made them an easy target for criticism. A recent 32-page report from Farient Advisors reaches the conclusion that companies & advisors have taken the feedback to heart. But rather than backing away from ESG metrics, they’re refining them. Farient says:
Linking executive pay to stakeholder incentives is here to stay. For boards of companies, the research provides important insights into how corporate pay is being aligned with stakeholder metrics to better assess management performance and accountability.
Other key takeaways from this year’s research include:
– More than three-fourths of large companies now incorporate stakeholder measures into their incentive plans
– This prevalence is up by 5 percentage points compared to 2021 and 14 percentage points compared to 2020
– Differences between regions are reflective of each region’s industrial base, cultural norms, and local regulations. However, all regions but Canada are moving in the same direction—up
– Europe, the U.K., Australia, and South Africa lead the market with over 80% of large companies incorporating stakeholder measures into their incentive plans
This Morgan Lewis blog addresses when a company may be required to register plan interests under a nonqualified deferred compensation plan. It explains that, under decades-old SEC guidance, the interests of participants in an employee benefit plan constitute “securities” subject to the registration requirements when a plan is both “voluntary” and “contributory.”
– Voluntary plans are plans in which the employees have a choice as to whether to participate, as such choice constitutes an investment decision to participate in the plan. By contrast, if participation in a plan is mandatory, no choice (and thus no investment decision) is made. – Contributory plans are plans in which employees decide to contribute a portion of their earnings or savings to a plan. If a plan consists only of contributions made by the employer without the participants giving up anything to which they would otherwise be entitled, the plan is noncontributory.
Note that one factor that does not change the analysis is whether the plan is a defined benefit plan or defined contribution plan, as both can be contributory.
The blog goes on to address what registration of plan interests entails:
Where plan interests are deemed to be securities, and thus registration under the Securities Act is required absent an applicable exemption (as discussed below), companies register on Form S-8 interests in the plan, rather than a fixed number of shares as a company would do for an equity incentive plan. The Form S-8 will register a dollar amount of plan interests as unsecured debt obligations of the company. The general requirement of Form S-8 is to provide a description of the securities offered; however, this does not apply to plan interests in a deferred compensation plan.
As with an equity incentive plan, registration on Form S-8 also requires the distribution (but not the filing with the SEC) of a prospectus to participants that includes material information about the plan, including its eligibility and contribution rules, investment terms, and tax effects.
This is addressed further in our Form S-8 Handbook, which we make available to members of CompensationStandards.com under our Form S-8 Practice Area. The Handbook includes this “word to the wise” — keep this in mind when looking at “precedent” for Form S-8:
There might not be a more murky area of securities law than Form S-8. Because this area is so challenging, bear in mind that there are varying degrees of compliance for Form S-8s. And even within the zone of compliance, there are also varying degrees of legitimate interpretation—so we typically do not take much comfort from what others are doing (or not doing).
Shearman & Sterling recently released its 2023 Corporate Governance & Executive Compensation Survey. Among other topics, the survey reviews disclosure practices among the largest 100 US public companies concerning executive departures, which have been the subject of closer attention following the McDonald’s enforcement proceeding earlier this year. Here are some of the key findings:
– Of the executive officer departures disclosed in Forms 8-K filed by the Top 100 Companies during the period reviewed, none characterized the executive officer’s exit as being a result of the “mutual agreement” or “mutual decision” of the company and the executive officer. However, a survey of these disclosures reveals that describing an executive officer’s departure as “mutual” in other ways remains a common practice.
– Although the sample size and the period of review is limited, the fact that none of the Top 100 Companies used historically common phrasing to characterize the termination may be an indicator of the beginning of a shift in disclosure practices.
– Separation payments were disclosed in connection with 23% of executive officer terminations, with 17% of executive officer retirements disclosed describing amounts paid to executive officers in connection with their retirement, including six companies that described new agreements executed in connection with the executive officer’s retirement.
– Separation payments were also described with respect to one of the terminations characterized as a termination without cause, one termination characterized as an involuntary separation and approximately half of the other termination descriptions identified. In certain of the disclosures, the company expressly indicated that the circumstances of the executive officer’s termination of employment were consistent with a “qualifying termination” under the company’s existing executive severance plan or the executive officer’s employment agreement.
– There was no indication that any new entitlements were not disclosed. In this set of termination disclosures, there does not appear to be any perceivable shift in approach, which suggests that companies are not expanding disclosure to cover an explanation of why they determined to make (or not make) payments under existing entitlements.
The survey also noted a number of interesting findings in other areas. For example, it found a 25% increase in the number of Top 100 Companies with a director specifically identified as having cybersecurity experience, and a 42% jump in disclosure of director-specific diversity information.
Three Corp Fin Staffers were guest speakers during the Employee Benefits, Executive Compensation and Section 16 Subcommittee Meeting at the Winter Meeting for the ABA Federal Regulation of Securities Committee last Thursday. During the meeting, they shared thoughts about first-year PvP disclosures.
Jennifer Zepralka, Chief of the Office of Small Business Policy, described the Staff’s review procedure. The team used XBRL tagging to identify disclosures that appeared to be lacking, but once the Staff reviewed those disclosures in full, they discovered the issues were often tagging problems. When disclosures were missing, the Staff focused on forward-looking “fix it” comments rather than inquiries that would start a back-and-forth with the registrant (for example, on topics like how equity was valued for CAP).
The Staff was surprised by the frequency of PvP sections lacking relationship disclosures, noting that some companies said they didn’t include certain relationship disclosures since their compensation committees don’t use or consider net income, for example, even though the rule doesn’t use that standard. The Staff also noted that many companies mistakenly used a broad-based market index, failed to include the CSM in the tabular list or identified two CSMs (or didn’t clearly identify any additional measure presented in the table as supplemental).
Beyond the problems identified in the comment letters, the three Staff members, including accounting folks, also discussed areas where even compliant disclosures could benefit from some improvements in year two. Here are their suggestions:
– Disclosures could be more readable in Plain English and focus more on the information that’s useful to investors
– Poor presentation practices caused meaningful information to be hard to find
– Graphical relationship depictions were generally more effective than narrative discussions
– For companies who used graphs, visual choices mattered — some clearly showed relationships while others obscured the relationships
– While not required by the rule, it’s helpful to identify what index the company chose by footnote or otherwise
– With non-GAAP company-selected measures, the description of how the metric was calculated was sometimes unclear or hard to find
– Footnote disclosure for all years in last year’s table do not need to be repeated next year unless material to an investor’s understanding under CDI 128D.03
Their final tip for improving PvP can be summarized as: “involve your accountants.” The Staff members thought the accounting team was an underutilized resource for first-year PvP disclosures. Here are areas where the accounting team could assist:
– Preparing disclosures, including narrative descriptions, to benefit from their knowledge and expertise in fair value assessments for GAAP purposes – Determining the CSM (some companies selected metrics that were inconsistent with the definition of “financial performance measure” and the accounting team would have recognized this) – Ensuring the correct numbers are reported as “net income” (see CDI 128D.08) – Considering the impact of retirement eligibility and other conditions on equity awards (accountants are already considering for the requisite service period, but note that the treatment of market conditions under GAAP differs from the PvP treatment) – Assessing the valuation techniques allowable under ASC 718 and crafting disclosure if you are changing your valuation technique as permitted under CDI 128D.20
This WTW memo is chock-full of helpful tips for companies that may find themselves in mandatory clawback territory. We’ve addressed a number of the technical and high-level questions a board will need to consider when a company faces a restatement, but this article is focused on managing a good process. For example, it lists items you should include on the agenda for your first special meeting convened after a restatement to make clawback-related process decisions. Here are two of those agenda items:
– Determine if the clawback team is managed by external counsel using compensation experts. Fundamentally, the committee must consider conflict-of-interest questions where management helps to determine clawback values. Our view is that the risk of this being an issue for shareholders diminishes when the sums involved are smaller, the calculation is simpler, and the assumptions or judgment calls needed to complete the calculation are fewer. The more there is at stake, the more likely that both shareholders and officers will question the results and ask about the source of funds, state legal authority and individual taxation; the more complicated the process of performing the calculations becomes, the more plausible these objections will be.
For these reasons, we foresee many situations where the committee would hire its own legal counsel and compensation experts to form the clawback team. To the extent it is available, preservation of attorney-client privilege in communications among the committee, the clawback team and the executive officer(s) also may be desirable.
– Set forth expectations/timing for the clawback team. We anticipate the following will be deliverables from the clawback team:
A complete Compensation Review Report that details all compensation potentially impacted
A Calculation Methodology Report that provides details on the methodology employed and the actual calculations
A presentation of the potential sources of funds to satisfy the clawback
A recommended proxy disclosure
It also discusses how to perform clawback calculations and how the compensation committee should determine the source of clawback funds. This article is worth reading now and saving for later in the event you’re involved in one of the early restatements post-effectiveness of Dodd Frank clawback policies.
Yesterday, the White House announced the “Fall 2023 Unified Agenda of Regulatory and Deregulatory Actions” – or as it’s lovingly called around here, the “Reg Flex Agenda.” SEC Chair Gary Gensler issued a statement about the SEC’s contributions.
As usual, the items on this list reflect the priorities of the Chair and you shouldn’t read too much into the dates – they are approximate timeframes, not commitments. In fact, I have heard that the Staff can only select from “April” or “October” when it submits the agenda, so when we say “targeting April,” what we mean is the earlier part of the year instead of the later part. When it comes to items that affect compensation committees, these two items are continuing again in the “proposed rule” stage:
FW Cook has released its 2023 survey of severance & change-in-control practices, which looks at trends among 200+ companies. We’ve been tracking severance as a shareholder proposal topic this past year or two, so it’s useful to also keep an eye on common practices. Here are the key takeaways:
– About 85% of companies provide CEO CIC severance, while about 75% provide CEO Non-CIC severance
– About 85% of companies providing CIC severance define cash severance as a multiple of salary plus bonus. This drops to about 60% for companies providing Non-CIC severance.
– 90% of companies fully accelerate all unvested time-based equity, while ~70% do so for performance awards (includes both single and double trigger provisions).
– The prevalence of double trigger CIC equity acceleration is 86%, up from 70% in 2016.
– For Non-CIC severance, majority practice is for time-based and performance-based equity to be forfeited (~55%), with only about 10% of companies fully accelerating outstanding equity.