My husband recently interviewed with a start-up – and like many private companies, a big portion of the pay package was equity. If you’re an optimist who thinks you’ve found the next Uber – and you don’t expect any major expenses before their potentially far-off liquidity event – that’s pretty exciting. But if you’re married to a securities lawyer who tends to see more risks than benefits…you keep looking.
That said, maybe we’ll revisit the discussion now that this Stanford memo has compiled info & stats about resale restrictions, the secondary market and average discounts. Based on a sample of 34 companies, 56% allow employees to sell or pledge a portion of their vested equity awards. Among those that allow sales:
– 67% allow sales back to the company
– 40% allow sales on a secondary marketplace – e.g. SharesPost, Equidate, EquityZen, Nasdaq Private Market
– 47% allow sales to third-parties not through a private company exchange
– 7% allow pledges.
– Employees who sold averaged a 39% discount to subsequent IPO pricing
As you’d guess, many companies have a right of first refusal. What surprised me was that 40% of companies allow employees to sell at any time at their own election – and 14% don’t require any company approval. And here’s one other thought to chew on:
Perhaps more important for the company is that allowing the sale of vested equity awards potentially distorts employee incentives. In structuring their compensation programs, companies decide on the correct mix of cash and equity to attract, retain, and motivate employees to pursue company objectives. An employee who is allowed to sell vested equity awards is effectively being allowed to convert variable, performance-based pay to a fixed amount of cash, significantly reducing (and distorting) the future incentive value of the compensation program.
Clawbacks & forfeitures were a hot topic at our “15th Annual Proxy Disclosure/Executive Compensation Conference” and the accompanying NASPP conference. We dove into what’s discussed in this Washington Post article – the trend of broadening clawback provisions to cover hard-to-define concepts like “reputational damage” – and the emerging concept of whether to penalize executives for undisclosed sexual misconduct that occurred before they were hired.
In these scenarios, a clawback (or forfeiture) could be triggered by termination for “cause” – with a few approaches to defining that term:
– Employment agreement includes a representation that the executive hasn’t been the subject of a sexual harassment claim, guilty of prior claims or even that they’d never engaged in harassment or misconduct – with a breach of that representation constituting “cause” for termination
– Explicitly refer to sexual harassment in the wording of severance arrangements or in the employment agreement definition of termination for “cause”
– Employment agreement refers to a violation of company policies (while an employee) as “cause” for termination – and prohibited behavior is defined in the code of conduct
And since this is all part of a bigger trend, there eventually could be some convergence with the types of reps that are making their way into merger agreements (see our DealLawyers.com blog on that) – or even venture capital deals. This WSJ article says investors in that space are trying to craft a standard provision that would penalize portfolio companies for executive or employee sexual misconduct, harassment and other issues. Here’s an excerpt:
Eamon Devlin, managing partner at MJ Hudson, a law and advisory firm that works with private-equity funds and investors, says that with pension funds increasingly being held accountable for where their money is invested, such a clause could become standard practice in investment agreements.
To be sure, finding usable wording for a #MeToo clawback clause that covers different countries and a range of different types of bigotry and harassment, without being pages and pages long, has proved challenging, says Bill Liao, a general partner in a VC firm. Lawyers who have donated their services to the initiative have run 30 different versions past him already, he says. Mr. Liao has been drumming up support among investors and venture capitalists. He aims to have the clause ready within the next year.
We talk a decent amount around here about performance targets for incentive awards – here’s a blog about how they tend to compare to earnings guidance. And it’s easy for shareholders & the media to run with that shorthand. But when you’re doing the detailed work to help compensation committees develop performance plans – and maybe also, when you’re communicating to shareholders, that’s not exactly the best thing to emphasize. As articulated in this Semler Brossy memo, it’s the performance range around target that actually drives payouts.
How can compensation committees reduce the risk of ending up below threshold or above maximum? The memo suggests changing threshold & maximum performance levels annually to keep likelihood of achieving those levels at a set percentage – e.g. threshold performance expected to be exceeded 90% of the time & maximum performance expected to be achieved 10% of time. Here’s some recommendations on how to come up with those numbers:
– Review historical results for the company and its peers to assess probabilities
– Assess the current drivers of performance and the sensitivity of the various drivers on performance to supplement historical data & get a forward-looking perspective on an expected range of outcomes
– Understand how the incentive goals stack up against other Wall Street inputs – e.g. whether achieving target payout means that consensus earnings were achieved
– Test “sharing ratios” – how much of the company’s incremental earnings are being paid out in incremental bonuses – to confirm you’re within industry norms
– Establish guidelines for incentive adjustments at the beginning of the year – and ensure the adjustments are fair & adequately disclosed
Yesterday, the SEC posted this Sunshine Act notice of an open Commission meeting next Wednesday – December 5th – to consider a “request for comment” on the nature & content of quarterly reports and earnings releases. As we’ve blogged several times, the request is bound to seek comment on the reduction (and even elimination) of quarterly reporting – as tweeted by President Trump. Here’s an excerpt from this WSJ article that John is quoted in:
One question the SEC may ask in its release, up for a vote next Wednesday, is whether quarterly guidance about expected earnings from companies unnecessarily drives expectations for investors, and whether that guidance could be pared back. Earnings guidance is voluntary and isn’t required by the government. Among possible changes, the SEC could also reduce the number of disclosures required in quarterly reports, which some companies view as excessive in an age when company information is readily available to the public.
“Do we really need the ’thou shalts’ from the SEC in an age when we have so much more information at our fingertips?” said John Jenkins, partner at Calfee, Halter & Griswold LLP and an editor of TheCorporateCounsel.net.
Federal securities rules have required quarterly reporting since 1970, when the SEC required it as part of a formalization of stock-exchange practices that preceded the agency’s creation in 1934. The SEC’s planned meeting isn’t the start of a formal rule-making process and is intended to solicit feedback on how the quarterly reporting system is functioning and what improvements could be made, a step that could in the future lead to regulatory changes.
From Willis Towers Watson, here’s a summary of recent reports published by BlackRock, Vanguard, State Street Global Advisors and CalPERS about their stewardship, including executive pay and shareholder engagement…
Yes, you can get caught for not disclosing perks – and deferred comp – in other countries. Here’s the intro from this WSJ article:
Nissan Motor said it has uncovered numerous significant acts of misconduct by Carlos Ghosn and intends to oust him as chairman. Nissan released a statement Monday about Mr. Ghosn amid news reports in Japan that he was about to be arrested. Nissan said its investigation had been going on for several months.
It said Mr. Ghosn has been reporting compensation amounts in securities reports that were less than the actual amount. Nissan said that in regards to Mr. Ghosn, “numerous other significant acts of misconduct have been uncovered, such as personal use of company assets.” Mr. Ghosn wasn’t immediately available for comment.
The Japanese news reports said Mr. Ghosn was being interrogated on charges that he understated his income, causing the company to file allegedly false reports to Japanese securities regulators. Mr. Ghosn is also chief executive of French car maker Renault SA and chairman of Mitsubishi Motors Corp. Renault shares fell 13% in European trading on the news, which came out after the close of trading in Tokyo.
Here’s an article showing that the top-paid executives in Japan weren’t in fact Japanese, but rather mostly Westerners. Japanese companies tend to pay CEOs less, partly because of cultural ‘modesty’ norms. But this CNN report details how Japan’s corporate culture allows corruption to thrive…
As I blogged yesterday over on TheCorporateCounsel.net, the SEC recently published a larger list than usual to be reviewed last week as part of the SEC’s annual exercise – as required under the Regulatory Flexibility Act – to review how the agency’s rules are faring for smaller reporting companies. This year’s list boasts 43 rules (compare that to 2004; only 7 rules). Like in prior years, the rules listed for review aren’t limited to rules that affect small companies. And notably, the list doesn’t include the elimination of quarterly reports entirely for smaller companies – which I do think will eventually be proposed based upon comments made by Corp Fin Bill Hinman at an ABA meeting a few weeks ago.
What is the “biggie” on this list of rules to be reviewed? The executive pay & related-party disclosures rule amendments of 2006 (which was a huge overhaul for those old enough to remember) – see pages 5-6 of the list…and see the rest of my commentary on this development in this blog…
Last week, as noted in this Steve Quinlivan blog, ISS released five “preliminary” compensation FAQs, which includes a one-year deferral of its controversial policy over excessive director pay. There are no changes to the quantitative pay-for-performance screens nor changes to the passing scores for Equity Plan Scorecard (EPSC) evaluations of stock plan proposals (but there are new EPSC ‘overriding’ factors and a change to the change-in-control vesting factor). “Final” FAQs are expected in a few weeks…
Yesterday, ISS announced the 2019 updates to its proxy voting policies. We’re posting memos in our “Proxy Advisors” Practice Area (also see this blog from Exequity’s Ed Hauder – and this Davis Polk blog). Here’s the highlights for US companies – except as otherwise noted, the policies apply to meetings held on or after February 1st:
1. Board Diversity: Beginning in 2020 for Russell 3000 and S&P 1500 companies, the chair of the nominating committee (or other directors on a case-by-case basis) will receive an “against” recommendation when there are no women on the company’s board. Mitigating factors include a firm commitment in the proxy statement to appoint at least one female director in the near term, the presence of a female on the board at the preceding annual meeting, or other relevant factors.
2. Economic Value Added Data: During 2019, ISS research reports will feature Economic Value Added data as a supplement to GAAP-based measures that measure the alignment between CEO pay & company performance. Moving into 2020, ISS will consider the inclusion of EVA-based measurements as part of its Financial Performance Assessment methodology.
3. Board Meeting Attendance: ISS is codifying its case-by-case approach to chronic poor attendance without reasonable justification. In addition to voting against the director(s) with poor attendance, it will recommend voting against other directors. After three years of poor attendance, the policy applies to the chair of the nominating or governance committee; after four years, the full committee; and after five years, all nominees.
4. Management Proposals to Ratify Existing Charter or Bylaw Provisions: Similar to Glass Lewis’s new policy on conflicting & excluded proposals, ISS is codifying its policy to vote against individual directors, members of the governance committee, or the full board, where boards ask shareholders to ratify existing charter or bylaw provisions – taking into account factors such as the presence of a shareholder proposal addressing the same issue, the board’s rationale for seeking ratification, the actions to be taken by the board should the ratification proposal fail, whether the current provision was adopted in response to the shareholder proposal, previous use of ratification proposals to exclude shareholder proposals, the company’s ownership structure, etc.
5. Board Responsiveness to Ratification Proposals: ISS’s existing responsiveness policy is updated to reflect that failure to act on a failed “ratification” proposal will trigger a board responsiveness analysis at the next annual meeting.
6. Director Performance Evaluations: When identifying companies that have long-term underperformance, ISS will look at three- and five-year TSR during the initial screen – rather than using five-year TSR as part of a secondary step in the evaluation.
7. Reverse Stock Splits: ISS broadened its policy to allow analysts to take a case-by-case approach for companies that are not listed on major stock exchange and may have a legitimate need to carry out a reverse stock split. ISS is also broadening the factors it will consider for all companies – exchange listed and non-exchange listed, where substantial risks exist.
8. E&S Proposals: ISS is codifying its case-by-case approach to E&S proposals – to make more explicit that significant controversies, fines, penalties or litigation are considered.
The repeal of Section 162(m) means that there’s no longer a tax reason for companies to stick to objective financial metrics for incentive plans. And although institutional investors and proxy advisors continue to prefer measurable “performance-based” pay, some shareholders have also been advocating for pay structures that would incentivize achievement of E&S goals. This blog from Pearl Meyer’s Jim Heim says that, based on an informal survey with 138 responses, compensation committees and boards might have some appetite for change. But don’t expect any big shifts in the near-term. Here’s more detail:
– A sizeable minority (35% of board respondents and 25% of management respondents) affirm that they either anticipate or have already determined they will place greater emphasis on non-financial criteria in 2019. We suspect that very few of these respondents will use such non-financial measures as the cornerstone of their incentive plans. Instead, they are likely to incorporate individual or strategic goals as a modifier (e.g., increase or decrease calculated payout by 10%) to financial result-driven formulae, or as stand-alone goals that account for less than 25% of total incentive plan opportunity.
– There is a stark contrast between the percentage of management respondents (40%) vs. board respondents (19%) who simply indicate they are not considering this approach. This echoes earlier polls we have conducted which indicated that boards are more open to consideration of ESG (Environmental, Social, and Governance) measures than management teams, possibly because they feel they are under pressure from the investor community to at least explore the topic.
Jim goes on to note that shareholders are receptive to qualitative measures if the company can clearly articulate the goals, how achievement would yield shareholder value, and how the compensation committee ensures performance is rigorously assessed. If you’re thinking of going down this path, here’s some planning advice:
Companies that are contemplating a shift in the mix of measures included in their incentive plans would be well served to stress-test these designs (modeling various performance and “what if” scenarios) before the end of the year. Where non-financial statement measures are part of the mix, we encourage companies to game plan for pay disclosures. How might the new plan design be described in the CD&A section of next year’s proxy statement? Would the board support above target payouts on such measures even if the pay trend ran counter to income statement and/or shareholder return trends? How would such a result be explained to the investor community?