As Yogi Berra might put it, “it’s like deja vu all over again.” Last week, the SEC tagged BlackRock for language in separation agreements that it believed created disincentives for whistleblowing. According to the SEC’s order, more than 1,000 departing BlackRock employees signed separation agreements containing violative language stating that they “waive any right to recovery of incentives for reporting of misconduct” in order to receive severance payments. This action is notable because BlackRock is one of the biggest institutional investors out there!
Last month, Broc blogged about the latest separation agreement case – the day after he blogged about another separation agreement case – and noted that more were on the way.
The SEC’s ongoing emphasis on separation agreements hammers home the need to modify agreements that may create impediments to whistleblowing. It’s also another excellent reason to tune into our upcoming webcast on TheCorporateCounsel.net – “Whistleblowers: What Companies Should Be Doing Now”…
A few days ago, CamberView announced that Bob McCormick – Chief Policy Officer of Glass Lewis – will join their shop. Bob has been a regular speaker at our “Proxy Disclosure Conference” and is a great guy…
Yesterday, the SEC sanctioned MDC Partners for violating Reg G & Item 10(e) of Reg S-K in connection with its use of non-GAAP financial measures. Some people are calling this the first non-GAAP enforcement case – but that’s not quite right. There aren’t many, but this isn’t the first non-GAAP case. In fact, this isn’t even the first non-GAAP case since the new CDIs!
Despite agreeing to comply with non-GAAP financial measure disclosure rules in December 2012 correspondence with the Commission’s Division of Corporation Finance, MDCA continued to violate those rules for six quarters by failing to afford equal or greater prominence to GAAP measures in earnings release presentations containing non-GAAP financial measures. Furthermore, for seven quarters between mid-2012 and early-2014, MDCA did not reconcile “organic revenue growth,” which as calculated by MDCA was a non-GAAP financial measure, to GAAP revenue.
In addition, the SEC announced that the company agreed to pay a $1.5 million penalty to settle charges that it failed to disclose certain perks enjoyed by its then-CEO. In April 2015, the company disclosed that the SEC was investigating its CEO’s expenses & the company’s accounting practices.
The SEC’s order says that the company disclosed a $500k annual perk allowance for its CEO – but didn’t disclose millions of dollars in additional perks. These included private aircraft usage, club memberships, cosmetic surgery, yacht and sports car expenses, jewelry, charitable donations, pet care, & personal travel expenses. The CEO resigned in July 2015 and returned $11.3 million worth of perks, personal expense reimbursements, and other items of value improperly received over a 5-year period.
One important change in the 2017 ISS policy updates with respect to ISS’ Equity Plan Scorecard (EPSC) policy is with respect to dividend and dividend equivalent provisions. Until the 2017 policy updates, ISS policy had been to recommend against equity plans that permitted the current payment of dividends or dividend equivalents on performance-based awards prior to the vesting of such awards. The policy permitted companies to accrue such dividends and dividend equivalents and pay them out when the performance-based award vested.
Now under the 2017 ISS policies (effective for shareholder meetings occurring on or after February 1, 2017), ISS will include a new factor under the Plan Features portion of its EPSC policy that will look to see whether dividends or dividend equivalents can be paid on any award under the plan prior to the vesting of the underlying shares/award. Companies that do not prohibit the payment of dividend and dividend equivalents on all plan awards before the awards vest, will receive no points under this factor. Companies that prohibit the payment of dividends and dividend equivalents until the awards vest (and can allow for accrual of such dividends/dividend equivalents), will receive full points under this factor. Because the ISS policy permit for the accrual of dividends and payment when the award vests, many companies will view complying with this prohibition to gain the points under the EPSC policy will make sense, and may enable them to gain a few additional shares in their request everything else being equal.
ISS has not yet released its FAQs on the new EPSC policy, but I expect that the FAQs will indicate that the old dividend/dividend equivalent policy with respect to performance-based awards has been supplanted by the new EPSC factor and anything less than a complete prohibition of the payment of dividend/dividend equivalents on all unvested awards will not provide any points under the EPSC policy.
Here’s an excerpt from this blog by Professor Jack Coffee:
So what should a reasonable and prudent board or compensation committee do? Obviously, one answer is to avoid the kind of extreme equity award that Valeant used to motivate its former CEO. But another answer is to counter-balance the impact of incentive compensation with an appropriately designed clawback. Clawbacks mandate the forfeiture of incentive compensation (including unexercised stock options and equity awards) on the occurrence of specified trigger events. Section 10D of the Securities Exchange Act of 1934 only requires a clawback in the event of an accounting restatement that reduces the earnings that produced the incentive award. Still, a responsible board can design a broader clawback that does not require a restatement to trigger it.
In this light, let’s take a closer look at Wells Fargo & Co’s policy, because, in this one unique respect, Wells Fargo may supply a model for other companies to emulate. Wells Fargo’s 2016 Proxy Statement indicates that the triggers for clawbacks and recoupments include (with respect to restricted stock awards and performance shares):
1. “Misconduct which has or might reasonably be expected to have reputational or other harm to the Company or any conduct that constitutes ‘cause’;”
2. “Misconduct or commission of a material error that causes or might be reasonably expected to cause significant financial or reputational harm to the Company or the executive’s business group;”
3. “Improper or grossly negligent failure, including in a supervisory capacity, to identify, escalate, monitor or manage, in a timely manner and as reasonably expected, risks material to the Company or the executive’s business group;”
4. “An award was based on materially inaccurate performance metrics, whether or not the executive was responsible for the inaccuracy;” and
5. “The Company or the executive’s business group suffers a material downturn in financial performance or suffers a material failure of risk management.”
These are broad provisions that go well beyond financial restatements (but do leave business judgment discretion in the board as to whether to implement them). In reality, most boards will stonewall and not impose clawbacks when they have discretion. Still, the real lesson of Wells Fargo may be that pressure can mount to the point where the board will be compelled to invoke a clawback. Also, shareholders can sue derivatively, and Wells Fargo has been sued in a derivative action in California, which may prove hard to dismiss.
In the approaching Era of Trump, clawbacks may be the last line of defense for shareholders. Clearly, incentive compensation is here to stay, but it should be reasonable and needs to be counterbalanced by broad clawbacks. If activists lobby Institutional Shareholder Services, using the Wells Fargo clawbacks as their model, the proper design of clawbacks could move to front and center on the corporate governance stage.
In response to my outpouring of love for SunTrust Banks’ clawback policy, Meredith Miller – Chief Corporate Governance Officer of the UAW Retiree Medical Benefits Trust – reminded me that the impetus for SunTrust’s updated policy was a shareholder proposal submitted by the Trust and others that comprise an investor coalition on clawbacks. This coalition has been operating since 2013, starting with sending proposals to a group of Pharma Six – and then later, an expanded proposal that included disclosure of the use of the clawback which they have successfully achieved adoption at McKesson, Bank of America, JP Morgan, Allergan, Stryker and SunTrust. The coalition submitted this comment letter to the SEC on its clawback proposal back in 2015 that outlines the coalition’s efforts…
Also see this blog from myStockOptions.com about ExxonMobil’s fine clawback. And see this Willis Watson memo about how companies are adopting stronger clawbacks despite the SEC’s proposal not being adopted yet…
Although good CEOs make a big difference, bad CEOs may matter even more. Indeed, the consequences of destructive leadership are well documented, and they are most severe at the top. Jeffrey Skilling’s greed cost Enron shareholders $63 billion. Carly Fiorina lowered HP’s stock price by 50% while firing thousands of employees, paying herself handsomely, and touring the lecturing circuit. Stan O’Neal’s reckless risk-taking sunk Merrill Lynch, yet he still managed to walk out the door with $161.5 million in severance. Although these examples may seem extreme, they are simply bigger and more famous than thousands of other less-known examples.
For instance, narcissistic CEOs pay themselves substantially more (in salaries, bonus, and stocks) even when they fail to boost business performance. Meta-analytic studies suggest that destructive CEOs, who tend to be more antisocial, volatile, and overconfident, generate higher levels of turnover, counterproductive work behaviors (bullying, theft, and cheating), and lower levels of employee engagement. It is difficult to estimate the combined economic cost of these outcomes. In the U.S. alone, the productivity losses of disengagement could amount to $550 billion, not to mention the negative effects on employee health and well-being. Clearly, CEOs are not the only determinant of disengagement, but research indicates that leadership is a significant predictor of people’s engagement (both high and low).
Tune in tomorrow for the webcast – “The Latest Developments: Your Upcoming Proxy Disclosures” – to hear Mark Borges of Compensia, Alan Dye of Hogan Lovells and Section16.net, Dave Lynn of CompensationStandards.com and Morrison & Foerster and Ron Mueller of Gibson Dunn discuss all the latest guidance about how to overhaul your upcoming disclosures in response to pay ratio and say-on-pay – including the latest SEC positions, as well as how to handle the most difficult ongoing issues that many of us face.
In our “Say-on-Pay” Practice Area, we’re posting a number of new memos on say-on-frequency since many companies will have that on their ballot this year – including this CII memo…