As Liz blogged last October, more and more companies are adopting annual limits on director pay, which became a common consideration in the wake of Delaware’s Investor Bancorp opinion. If you’re proposing a new plan this proxy season, this Pay Governance memo on director compensation discusses current levels of director compensation limits among S&P 500 companies.
Practice is split between defining annual limits as equity-based awards only or defining limits as a total of all cash and equity-based compensation. Both definitions have a median value of $750,000.
A limited number of S&P 500 companies define cash-only annual non-employee director pay limits with a median value of $500,000.
In our recent webcast — “The Latest: Your Upcoming Proxy Disclosures” — Ron Mueller discussed this year’s hot topics for compensation-related shareholder proposals. As we’ve discussed, we saw many proposals seeking shareholder approval of severance agreements last year. Ron noted in his commentary that this proposal is still common.
Ron also discussed three proposals that are new this year. Here’s an excerpt from the webcast:
One is requesting that companies amend their clawback policies […] the supporting statement alludes to the fact that if one executive engages in misconduct and, as a result, payouts are higher than they should have been, then other executives should also be forfeiting their compensation regardless of whether those executives themselves engaged in misconduct.
From the conservative side, there were some proposals out there asking companies to eliminate greenhouse gas reduction metrics as performance measures. More and more companies are including environmental metrics as part of their bonus programs, as one of their performance metrics. Here’s a proposal saying, “No, stop doing that.” It’ll be interesting to see what kind of traction that gets.
Lastly, another new proposal is asking for an annual Say-on-Pay vote on director compensation. As if that’s not novel enough, the two twists on that are that it has to be an advance vote before the directors get paid, not after the fact vote like Say-on-Pay for executives, and the proposal is in the form of a binding bylaw amendment. If it was approved by shareholders, it would go into effect automatically under most corporate law programs and most bylaws.
Ron also noted that it’s not always clear what exactly the proposals are asking for. And, in some cases, companies are increasing their engagement with proponents — especially since institutional shareholders are asking companies what each proposal is asking for, what the company is currently doing on that front and whether it met with the proponent and tried to negotiate out the proposal.
The SEC’s amendments to Rule 10b5-1 back at the end of 2022 spawned quite a few interpretive questions that are still being sorted out to this day. One of the areas that prompted questions is the scope of the exception to the limitation on overlapping open-market trading plans and the limitation on single-transaction trading plans that is provided for “eligible sell-to-cover” transactions. Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) defines an “eligible sell-to-cover” transaction as one where an agent is authorized to sell “only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award” where the employee does not otherwise exercise control over the timing of such sale.
Last summer, the ABA’s Joint Committee on Employee Benefits submitted a request for interpretive guidance to the Corp Fin Staff seeking clarification as to what actually qualifies as an “eligible sell-to-cover” transaction. There was a concern among practitioners that the language of the definition would limit the amount of securities to only the amount required to satisfy statutory minimum tax withholding rates, when some companies allow employees to designate a higher expected effective tax rate as the rate at which their employer will withhold taxes upon the vesting of a compensatory award. The group proposed the following interpretive Q&A to the Staff:
Question: Can a contract, instruction, or plan qualify as one providing for the sale of “only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award,” and thus be an “eligible sell-to-cover transaction” under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3), if it provides for the sale of shares at the rate identified by the employee as the employee’s expected effective tax rate, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules?
Suggested Answer: An “eligible sell-to-cover” transaction under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) means the sale of shares up to the tax rate designated by the employee for withholding, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules.
In a memorandum to the members of the ABA Subcommittee on Employee Benefits, Executive Compensation, and Section 16, Mark Borges, Alex Bahn and Ron Mueller describe their discussions with the Staff on this interpretive question, and note:
As a result of our informal discussion with the SEC Staff, we understand that the reference in Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) to “only such securities as are necessary to satisfy tax withholding obligations” is not intended to mean only the number of shares required to satisfy minimum tax withholding requirements and that the rule is not intended to use technical tax language or to disrupt practice with respect to legitimate tax arrangements. Put another way, the focus of the SEC Staff appears to be on whether the arrangement is designed to pay the tax obligation arising in connection with the vesting event, which can take into account the expected effective tax rate and is not focused on only the required tax withholding rate.
It appears the SEC Staff agrees with our proposed response and will interpret the provision to allow sales of shares to satisfy an employee’s expected effective tax rate. This interpretation, however, does not apply if any of the proceeds from the sale are intended to satisfy taxes relating to income from sources other than the vesting of a compensatory award. The SEC Staff thus cautioned that persons could not characterize a sale as an “eligible sell-to-cover” transaction where shares are sold with the intent of covering taxes for events unrelated to the vesting event. For example, selling shares in an “eligible sell-to-cover” transaction where the proceeds are intended in part to cover taxes for the sale of property other than the shares received in the vesting event would not be considered an “eligible sell-to-cover” transaction.
It is very helpful to know that the Staff is not reading the “eligible sell-to-cover” transaction exception so narrowly as to exclude the many situations where an expected effective tax rate is used to determine the amount of securities to be sold rather than the statutory minimum tax withholding rate, thus making this exception more useful to avoid running afoul of the overlapping plan and single trade restrictions.
In a separate blog, Dave also shared guidance on whether a non-employee director can rely on the eligible sell-to-cover transaction exception.
1. Clawbacks
2. Pay vs. Performance Disclosures
3. CD&A Enhancements & Trends
4. Shareholder Proposals
5. Proxy Advisor & Investor Policy Updates
6. Perquisites Disclosure
7. ESG Metrics & Disclosures
8. Say-on-Pay & Equity Plan Trends, Showing “Responsiveness” to Low Votes
9. Status of Related Rulemaking
This webcast was a doozy – they spoke for over 90 minutes and covered quite a lot of ground. You will definitely want to check this out as we enter the proxy season, and the transcript is a low-time-and-effort way to get up to speed.
We’ve been getting a ton of queries about our 2024 Proxy Disclosure & 21st Annual Executive Compensation Conferences – and one of the most frequently asked question is whether we’ll be back in person this year. The answer is yes! Join us for these timely conferences taking place in San Francisco on October 14-15, 2024, or join us virtually (we will continue to offer a “hybrid” format).
The SEC’s regulatory agenda continues in 2024 amidst all types of uncertainty. We are truly “living in interesting times.” Make sure you are getting the practical guidance and expert knowledge you need (and expect!) from our conferences as rules, regulations and procedures continue to evolve. We will be posting the conference agendas and announcing the speakers soon, so stay tuned.
You can register now by one of two methods: by visiting our online store or by calling us at 800-737-1271. Sign up now for our early bird in person Single Attendee Price of $1,750, which is discounted from the regular $2,195 rate!
Meredith & I have blogged many times about the alluring concept of simplifying executive pay. Wouldn’t we all appreciate a bit less complexity in our lives? In this new 14-minute episode of the “Pay & Proxy Podcast,” Meredith explored this topic with Ani Huang, who is the CEO of the Center On Executive Compensation. Meredith & Ani discussed:
1. How did pay design get so complex?
2. Calls for “radical simplification” of pay design from prominent institutional investors
3. A real-world example of a company that has sought to simplify its pay programs
4. Key questions to ask when exploring simplification
Perks are a sensitive topic for investors – and as Meredith blogged last week, they may take you to court over the board approvals. In addition, the SEC’s Enforcement Division frequently investigates whether they are properly disclosed. A recent Bloomberg Law article from Jones Day identifies which types of perquisites are most likely to draw regulatory scrutiny. Here’s an excerpt:
Personal travel is the perk most frequently flagged by the SEC, appearing in all but two cases in the last 10 years. Most of those cases involved travel on commercial or chartered aircraft for vacations, sporting events, or other personal activities. Personal use of a company owned or leased aircraft came up in seven cases.
In those situations, the SEC requires a company to report the “aggregate incremental cost” of the executive’s personal use of the aircraft—that is, the direct operating cost attributable to the personal travel. In one case, the SEC faulted a company for disclosing the taxable value of its executives’ personal use of company aircraft, rather than the aggregate incremental cost — a much higher figure.
Several cases involved undisclosed payments for family and friends to accompany an executive to business events, such as a board meeting to which directors’ spouses were invited or to customer and industry receptions.
Not all the travel in these cases had an obvious personal purpose. In one case, a company reimbursed its CEO for flights to attend entertainment events sponsored by a company supplier. But in the SEC’s view, merely having a connection to the company’s business wasn’t enough to justify nondisclosure, because the travel wasn’t integrally and directly related to the executive’s duties.
The article says that undisclosed payments for personal expenses, personal entertainment, personal transportation (e.g., company vehicles), charitable donations, professional services, and housing expenses, round out the most common enforcement topics. The article then gives several pointers to mitigate risk. Check out our “Perks” Practice Area for our treatise chapter and other practical resources that can help you navigate this topic.
Given recent legal developments, this perspective from Shearman & Sterling encourages companies to consider a wholesale review of existing forms, including:
– offer letters and employment agreements
– separation agreements
– restrictive covenant agreements (including proprietary information and confidentiality agreements)
– equity award agreements
– employee handbooks
Many companies were already taking a fresh look at some of these forms in light of 2023 enforcement actions focused on language that potentially stifles corporate whistleblowing, but the alert highlights a number of other developments that should be considered for updates. Those include:
– Restrictions, notification requirements, outright bans and other regulator attention on non-compete clauses and other restrictive covenants that could operate as non-competes
– Developments impacting confidentiality provisions, including NLRB decisions and changes in state law regarding non-disclosure and non-disparagement covenants
– Potential interest in expanding definitions of cause to include behaviors causing reputational harm
– State laws impacting social media policies
– Separation disclosure considerations and timing requirements for a valid release
If your forms haven’t been “refreshed” in a while, it sounds like it’s time to get them back in front of your employment lawyers!
As compensation committees consider company performance and payout amounts under incentive compensation plans, the question of whether unplanned, discretionary adjustments should be made to address unusual or one-time occurrences will arise for some. Institutional investors often take issue with these adjustments when they result in greater payouts to executives, particularly if the company fails to articulate a strong rationale in its proxy materials.
This Semler Brossy insight reviews recent adjustment practices by Fortune 100 companies specifically focused on the type of discretionary adjustments met with skepticism from institutional investors — those made outside of a pre-defined metric (for example, further adjustments beyond those in the definition of an Adjusted EBITDA metric). Looking at the 2023 proxy statements of 92 Fortune 100 companies, Semler Brossy found that very few made discretionary, upward adjustments:
We found that 22 companies (approximately 24 percent) adjusted incentive payouts or targets. Of those companies, 10 made changes only to Annual Incentive Plans (AIP), 10 adjusted only Long-Term Incentive (LTI) plans, and 2 made changes to both AIP and LTI plans. Of these, the majority (14) were downward adjustments, which tend to receive minimal scrutiny from investors.
Of the eight companies (approximately 9 percent) that made upward adjustments to incentives (six of 12 LTI adjustments, two of 12 AIP adjustments), all displayed a positive total shareholder return (TSR) in the year of adjustment. This is an important distinction: upward adjustments are received more positively when they align with the shareholder experience (e.g., positive TSR) and business outcomes. Additionally, upward adjustments typically were made due to factors outside management’s control such as macroeconomic factors (COVID-19, Ukraine conflict) or tax and accounting regulatory changes. Commentary from ISS on these upward adjustments was generally minimal in most cases (none received “Against” recommendations).
The main factors driving adjustments were “macroeconomic factors, M&A activity, pay vs. performance misalignment, changes to company long-term strategy, and tax-related regulatory changes,” while adjustments were not made for “changes in market supply and demand or competitive landscape, non-tax and accounting regulatory changes, or changes in interest rates.” The insight notes other circumstances that commonly result in adjustment, including “restructuring costs, renegotiation of contract terms, foreign currency fluctuations, asset impairments or write-offs, litigation costs, accelerated items, and impacts from natural disasters.”
In terms of navigating and communicating adjustments to lessen or manage potential criticism, the insight notes the importance of considering upfront whether the adjustments are aligned with the shareholder experience and business outcomes, considering whether the adjustments relate to factors outside management’s control, and, in all cases, clearly articulating a strong rationale. Preferably, companies would set a framework for adjustments before a performance cycle begins and then “have consistent and symmetrical application of the pre-defined guidelines” so that the adjustments occur in both directions and don’t inherently favor management.
As personal use of corporate jets is on the rise, scrutiny continues apace. The latest legal challenge involving personal aircraft use & disclosures comes in the form of a derivative suit against Skechers alleging breach of the duty of oversight, waste, breach of contract, and disclosure violations. In Conte v. Greenberg (Del. Ch.; 2/24), Vice Chancellor Zurn granted the defendants’ motions to dismiss on the basis that plaintiff failed to show demand futility.
Plaintiff argued that at one point, “more than 50% of each airplane’s use was for personal travel” by defendants, the company’s CEO/chairman and his two sons, who were also company officers and who collectively controlled 55% of the voting power of the company, and their family members. Plaintiff also argued that “the higher ratio of personal use caused the Company to lose certain favorable tax treatment.” Alleging that the Skechers board failed to impose meaningful restraints on personal use of corporate jets, plaintiff pointed to the compensation committee’s request that management make recommendations for a policy setting reasonable limits on such personal use although no such recommendations were ever presented.
But the opinion concluded that none of the compensation committee members faced a substantial likelihood of liability on any of the claims. Concerning the Caremark claims for inadequate oversight, VC Zurn declined to infer bad faith based on the committee’s inaction since “the magnitude or severity of the risk decreases, more facts are required to support an inference of bad faith.”
Plaintiff has not met his significant burden of pleading that the allegedly excessive compensation was such that a decision not to address it with a formal policy, alone, supports an inference of bad faith. That risk was contained; it was limited to the use of two corporate assets by a discrete group of individuals, as compared to a widespread operational deficiency. The Company was not violating an internal policy or any regulations, which can support an inference of bad faith.
The allegedly excessive personal airplane use was also of a relatively minimal magnitude. In 2021, Skechers’ gross profit exceeded $3 billion and its operating expenses totaled about $2.5 billion. The Management Defendants’ airplane perquisite compensation totaled about $5.3 million over four years; with one exception, it represented between about 0.5% and 4.9% of each of the Management Defendants’ annual compensation during that time. The tax gross-up payments—the only aspect of the airplane perquisite compensation FW Cook identified as problematic—represent even less of that compensation: about $1.6 million over the same period. On average, the tax gross-up payments made up less than 1% of the executives’ total compensation from 2018 through 2021.
While this is seemingly a helpful case for corporates, Tulane Law Prof Ann Lipton pointed out that the opinion “is striking for what it didn’t do” — that is, it didn’t dismiss the Caremark claim “on the grounds that Caremark is limited to violations of law. Instead, [VC Zurn] simply held that under the particular facts of this case, the complaint did not allege that the directors’ failures to act were so egregious as to suggest bad faith.” That, Ann points out, could be “the sound of a potential expansion of Caremark.” TBD.