I try not to duplicate what Mark Borges and Mike Melbinger write on their blogs because I figure that y’all are reading all three of the blogs on this site. But I just loved the recap that Mark provided in this blog about how Chipotle leveraged its proxy disclosure to really give shareholders a full understanding of the efforts they made over the last year in the face of a well-publicized campaign against the company’s executive compensation practices by one of its shareholders. A great example of usable disclosure about shareholder engagement…
Twenty-one comment letters have been submitted about the SEC’s proposed rules on disclosure of hedging by employees, officers and directors, including ours.
The Council of Institutional Investors (CII) states that 54% of Russell 3000 companies and 84% of the S&P 500 companies prohibit employees from hedging shares. CII supports the proposed requirement that the disclosure should cover all employees, not just officers, in order to obtain information about whether employees are “allowed to effectively avoid restrictions on long-term compensation through hedging.” While acknowledging that the disclosure about employees’ equity holdings below the executive level may not be as relevant for investors, CII believes that it may still have implications for a company’s “bottom line.” The Florida State Board of Administration (the SBA) is similarly supportive of requiring companies to disclose the hedging status of all incentive-based compensation, regardless of whether it is given to directors, officers or other employees.
In contrast, the Business Roundtable (the BRT) agrees with the importance of disclosing whether hedging by executive officers is banned, but argues that whether employees are permitted to hedge is not material to investors. The BRT notes that nearly 95% of the 60 publicly traded companies whose CEOs are members of the Business Roundtable prohibit hedging by executive officers and 85% extend that prohibition to directors. The Society of Corporate Secretaries and Governance Professionals (the Society) also endorses limiting the disclosure requirement. In addition, the Society asks the SEC to clarify the difference between hedging and general portfolio diversification, so that the rules would distinguish between instruments that provide exposure to a broad range of issuers or securities, such as broad-based indices, exchange-traded funds, baskets, and those that are principally designed to hedge particular securities or have that effect.
Here’s an excerpt from this piece by Semler Brossy’s Seymour Burchman and Blair Jones:
Compensation committees are often tempted to follow conventional wisdom and follow how other companies, especially peers, have traditionally structured their payouts, using either a symmetric payout curve, or a payout curve with equal ranges above and below target. Two practices are common: using 90 percent of target for threshold and 110 percent of target for maximum or using 80 percent of target for threshold and 120 percent of target for maximum. Executives then usually get 50 percent of their target bonuses if they achieve the lower level and 150 or 200 percent if they achieve the higher one. A cap of 200 percent helps compensation committees avoid encouraging unacceptable risk-taking and paying too much for windfalls.
Because thresholds and maximum payout levels need to take into account many factors, particularly the relative predictability and volatility of performance outcomes as well as investor expectations, compensation committees need to move beyond conventional practices. They should instead use analyses that are tailored to their company.
For example, consider the case of a branded food company with stable revenues. This company has launched several high-growth, albeit unproven, initiatives to develop innovative products in new categories in addition to expanding geographically. For years, executives have delivered predictable results which were rewarded by payouts fitting a narrow symmetric payout curve, one with a 95 percent threshold and 105 percent maximum. (See Figure 1.) As a result, the compensation committee considers whether, and how, to adjust the range in light of the shift to a strategy with less predictable outcomes.
The SEC is now moving fast on the last of its Dodd-Frank rulemakings! Yesterday, as noted in this press release, it released additional analysis from its “DERA” (former nickname of “RiskFin”) Division related to its pay ratio proposal. Comments on this new analysis are due by July 6th (coincidentally, the same deadline as the P4P proposal). As I blogged yesterday, the SEC has become more cautious during its rulemaking process since a 2011 court decision struck down part of the SEC’s proxy access rule after finding the economic analysis was incomplete – so the practice of releasing additional economic analysis for public comment is becoming fairly common.
In addition to reading this review of the SEC’s new analysis (& this MarketWatch piece), check out my example that helps illustrate the SEC’s new findings:
– If the standard deviation of compensation (meaning the variability among positions) is 55%, and the exclusion of non-US, part time and seasonal jobs results in the elimination of 20% of the workforce from the calculation, the ratio would decrease by 15%
– Thus, a ratio of 300:1 would become 255:1
– If the standard deviation is only 25% – and the exclusion removes 20% of the workforce from the calculation – the impact is only 6.5%, thus the 300:1 ratio might drop to 281:1
Today is the last day left at the reduced rate. The SEC’s new pay-for-performance & hedging proposals – not to mention the coming clawback proposal and final pay ratio rules – are causing a stir – and you should prepare now. These rules will be among many topics that Corp Fin Director Keith Higgins & other experts will be talking to at our popular Conferences — “Tackling Your 2016 Compensation Disclosures” — to be held October 27-28th in San Diego and via Live Nationwide Video Webcast on TheCorporateCounsel.net. Act by the end of today, Friday, June 5th for the phased-in rate to get more than 20% off.
The full agendas for the Conferences are posted — and include the following panels:
– Keith Higgins Speaks: The Latest from the SEC
– The SEC’s Pay-for-Performance Proposal: What to Do Now
– Creating Effective Clawbacks (& Disclosures)
– Pledging & Hedging Disclosures
– Pay Ratio: What Now
– Proxy Access: Tackling the Challenges
– Disclosure Effectiveness: What Investors Really Want to See
– Peer Group Disclosures: The In-House Perspective
– The Executive Summary
– The Art of Communication
– Dave & Marty: Smashmouth
– Dealing with the Complexities of Perks
– The Big Kahuna: Your Burning Questions Answered
– The SEC All-Stars: The Bleeding Edge
– The Investors Speak
– Navigating ISS & Glass Lewis
– Hot Topics: 50 Practical Nuggets in 75 Minutes
Two days ago, Senator Elizabeth Warren wrote this 13-page letter to SEC Chair White expressing her unhappiness with the pace of the SEC’s rulemaking. Warren isn’t happy – and even used the Reg Flex Agenda as one reason why she feels that White hasn’t been truthful with her (see my blog from two days ago about how that is meaningless). Pretty wild stuff.
Though the SEC has recently reported it now expects to complete the rule by next spring, Ms. Warren said that deadline—revealed in a list of agency projects published by an arm of the White House—appears to contradict what Ms. White said in a face-to-face meeting last month with Ms. Warren. In that meeting, the SEC chairman predicted the SEC would complete the rule “by fall,” Ms. Warren wrote. “I am perplexed as to why you told me personally that the rule would be completed by the fall of 2015 when it appears that you were or should have been aware of additional delays,” Ms. Warren wrote.
The big news comes from this WSJ article, which says that the SEC will “soon” propose the clawback rules required by Section 954 of Dodd-Frank. If it happens as rumored, this surely is Exhibit A that the SEC’s Reg Flex Agenda is meaningless (as I hammered home in this blog yesterday) – because the SEC’s new Reg Flex Agenda had an April ’16 date for this activity. Here’s my quote in the WSJ piece:
Broc Romanek, a former SEC attorney who edits the websites CompensationStandards.com and TheCorporateCounsel.net, said the SEC should make sure it implements the new clawback requirements in a way that makes practical sense for companies and allows them discretion in determining whether it is economically efficient for them claw back pay, given legal, administrative or other expenses that may be involved. “It would not be ideal if a company is forced to spend more resources clawing back than [what] they would get in return,” he said.
The critical issue is whether the proposed clawback rules will be principles-based or prescriptive (remember how the recent P4P rule proposal was proscriptive, which was surprising to some). “Principles-based” means “just disclose what you have that you treat as a clawback.” And there are lots of tough questions about how a financial misstatement impacts compensation that may be indirectly – but not directly – based on financial performance, such as stock options (ie. how much is the stock price influenced by a restatement, as compared to performance criteria that is tied to EPS which is much more directly influenced). Remember this blog from last year: “Clawbacks & The New Revenue Recognition Rules: On a Collision Course?”
Whether the proposal is prescriptive or principles-based will in turn impact how much the rules drive a certain type of conduct – the more prescriptive, the more the SEC is making a judgment call and companies will have to come in line with what the SEC determines to be encompassed. And remember as to timing, the SEC’s rulemaking will just be the first step – because SEC will be proposing rules that the stock exchanges then have to adopt standards to implement…
I continue to see so many people citing the SEC’s Regulatory Flexible Agenda as an indication for when the agency will propose and adopt rules. Don’t believe that – it’s not true! As I’ve blogged about before, all kinds of whacky and aspirational stuff makes it into the Reg Flex Agenda, which then winds up as part of the OMB Unified Agenda (in this blog, Keith Bishop explains what the OMB Unified Agenda is). And then the timelines for proposing & adopting rules are rarely accurate.
The internal process at the SEC (and other agencies) is complicated – maybe one day I’ll explain it in detail (eg. pet projects get thrown in that have zero chance of moving; timelines thrown in simply to fill out the form). But trust me, it has NEVER been a reliable source for when things might move at the SEC. But go ahead and keep citing it if it makes you happy – even though it will likely prove you wrong in the end (as it does over and over). I find it funny how the Reg Flex Agenda is now a newsworthy item after being completely ignored for decades.
I’ve posted a bunch of memos on this development that’s covered in this blog by William Tysse:
In a Chief Counsel Memorandum issued last month, the IRS concluded that an executive retention arrangement violated Section 409A despite the employer’s efforts to correct the arrangement before the retention bonus vested.
The arrangement in question provided for a retention bonus that vested after 3 years of employment and was then payable over the two years after vesting. However, under the terms of the arrangement, the employer had the discretion to accelerate the payments and pay them in a lump sum on the first anniversary of the vesting date. The employer, recognizing that the arrangement failed to comply with Section 409A’s anti-acceleration rule, attempted to correct the arrangement by amending it to remove the employer’s ability to accelerate the payments. The amendment was made in the same taxable year in which the retention bonus vested, but before the actual vesting date.
The IRS ruled that the correction was ineffective because it occurred in the same year in which the retention bonus vested. The ruling is consistent with the IRS’s proposed Section 409A income inclusion regulations, which provide limited relief for corrections of Section 409A errors that occur before the year in which the deferred compensation vests, provided the correction is not part of pattern or practice to avoid Section 409A. Interestingly, the employer in question may have been able to correct the error in this case under the more formal correction procedure for 409A document failures set forth in Notice 2010-6.
The memorandum is a reminder that the options for correcting Section 409A problems after arrangements have been put in place are limited and few, and therefore retention agreements, long-term incentive agreements, employment agreements, severance agreements, change in control agreements and the like, all of which may be subject to Section 409A, should be reviewed for Section 409A compliance issues prior to adoption.
The latest memo from Pay Governance is unique and bears reading. Here’s the key findings:
1. Sustainable investing now represents approximately 11% of the invested assets under management in the US.
2. Some sustainable investors or shareholder activists file shareholder resolutions to influence corporate environmental and social (E+S) policy, and certain E+S proposals have garnered shareholders support levels at or above 30%.
3. ISS recommends “for” about 70% of such proposals, but voting investors appear to diverge from ISS with generally low levels of support on most proposals.
4. Additionally, ISS appears to recommend “for” proposals requesting additional E+S reporting and “against” proposals that would place operational limitations on corporate issuers.
5. Shareholder proposals seeking to require the inclusion of E+S metrics in executive incentive plans are almost always rejected by ISS and the majority of shareholders.
6. Despite the fact that some companies do maintain limited E+S metrics in annual incentive plans, executive incentive programs continue to focus on financial metrics that are direct drivers of shareholder value creation.