Concurrent to the ushering in of new regulations governing executive remuneration across the U.K., Britain’s Financial Reporting Council (FRC) released for consultation Oct. 1 proposed changes to the U.K. Corporate Governance Code dealing with remuneration. Specifically, the FRC is now consulting on three proposals, including on clawback arrangements, whether non-executive directors who are also executive directors in other companies should sit on the remuneration committee, and what actions companies might take if they fail to obtain “at least a substantial majority” in support of a pay resolution.
This announcement was timed to coincide with the introduction of sweeping new pay rules for U.K. companies contained in Enterprise and Regulatory Reform Act 2013 and the Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013. Under the new rules, companies would provide for separate “policy” and “implementation” sections within the directors’ remuneration report with the former subject to a binding vote at least once every three years, and the latter to an advisory vote annually, as has been the case since 2003.
The new rules also require companies to report all elements of directors’ pay in a single, cumulative figure and to provide enhanced disclosure on performance conditions determining variable pay awards. Other elements of the new regulations govern disclosure around exit payments, and other requirements unrelated to remuneration.
In June 2012, the FRC agreed to a request from the government to consult on whether to amend the market’s governance regime to address the three aforementioned issues. The FRC decided that the consultation should be conducted after the government’s legislation on voting and reporting on executive remuneration took effect this week.
With regard to clawbacks, the FRC seeks comment on whether the current code requirement is sufficient, or whether to include a comply-or-explain presumption that companies have provisions to recover and/or withhold variable pay. At present, the code currently states that “consideration should be given to the use of provisions that permit the company to reclaim variable components [of remuneration] in exceptional circumstances of misstatement or misconduct.”
New rules that took effect Oct. 1, meanwhile, require companies to disclose in the directors’ remuneration policy if there are provisions for clawback, and to disclose in their annual reports the details of any sums recovered or withheld and the reason why. Given this, the FRC also seeks comment on whether the code should adopt the terminology used in the regulations and refer to “recovery of sums paid” and “withholding of sums to be paid,” and whether it should specify the circumstances under which payments could be recovered and/or withheld.
“It seems to me that the incorporation of clawback into the code is the most important of the three suggestions,” said David Paterson, head of corporate governance at the National Association of Pension Funds, in comments to Governance Weekly. “It is already common among large companies and with the growing use of deferred bonuses is implied in many more arrangements. Logically it is hard to see how a company can object to adopting a policy giving it the right to withhold a bonus which, with the benefit of hindsight, was not really ‘earned.'” Paterson’s comments reflect personal observations, with the NAPF still to consult with members on a formal response to the consultation.
Backing Paterson’s assertion regarding the adoption of clawback provisions, institutions in the U.K. have pressed companies on the issue, while a growing number of companies have moved in recent years to adopt such policies. An analysis of ISS Governance QuickScore data for the U.K. markets finds 76 percent of 88 large capital firms studied disclosing the existence of clawback policies as of Oct. 1, a jump of 34 percentage points over figures evidenced in 2011.
Responding to a claim by Secretary of State for Business, Innovation and Skills Vince Cable in 2012 that “there is a perceived conflict” that non-executive directors on remuneration committees who serve as executives elsewhere “have a personal interest in maintaining the status quo in pay setting culture and pay levels,” the FRC seeks comment on whether to “deter” such appoints under an updated code.
In its consultation, the FRC notes the presence of such directors has declined markedly in the 10 years to 2012 across the FTSE250, dropping from 42 percent of companies with such a director in 2003, to 15 percent in 2012. Still, the consultation notes, dissent on remuneration voting was higher, on average, at the companies in all 10 years, save for 2006 and 2009, suggesting shareholder concerns over pay are more prevalent at firms where remuneration committees include directors serving as executives at other firms.
Under the current code, executive directors of other companies would normally be classified as independent unless they “hold cross-directorships or have significant links with other directors through involvement in other companies or bodies.” Any changes will likely face opposition from directors’ groups and others, with critics likely to question the barring of otherwise well suited board members over perceived conflicts.
Similarly, the final issue for consultation will likely engender controversy with corporate advocates and others arguing boards are best suited to determine the level of remuneration report voting dissent warrants engagement with shareholders. The FRC is seeking comment on criteria for determining what constitutes a “significant percentage” as well as the time period within which companies should report on post-meeting discussions with shareholders and subsequent disclosure to the market.
Under rule rolled out, companies must include in the annual remuneration report details of the vote on any remuneration resolutions at the previous general meeting and, where there was a “significant percentage” of votes against a resolution, give “a summary of the reasons for those votes, as far as known to the directors, and any actions taken by the directors in response to those concerns.” However, because this only requires companies to report yearly, some suggest that an additional, earlier disclosure, explaining how the company intended to respond to the concerns raised might be helpful.
The new rules fail to provide a figure defining a “significant percentage,” but recent guidance from the GC100 and Investor Working Group suggests “companies may wish to consider votes against in excess of 20 percent as being significant, although there may be reasons why, for some companies, a higher or lower level might be more appropriate.” According to the results of ISS’ 2011-12 benchmark policy survey, on a cumulative basis, 86 percent of investor respondents (and 52 percent of issuers) believed an explicit response is warranted if the say-on-pay vote received more than 40 percent opposition, and 72 percent of investors (versus 40 percent of issuers) believe that opposition in excess of 30 percent requires an explicit response. Those figures apply to the U.S. market and came in the wake of the inaugural year of mandatory pay votes in 2011. Such voting in Britain dates back to 2003, as noted earlier. “The 20 percent test for ‘significant dissent’ is highly subjective,” cautioned Paterson. “It is for companies to judge whether a particular level of opposition to their remuneration policy warrants a review.”
If changes to the code are ultimately proposed, they will be subject to consultation in the first quarter of 2014. The new code would then apply to accounting periods beginning on or after Oct. 1, 2014.
Last week, Oracle became the 65th company to fail its say-on-pay in ’13 – see the Form 8-K. Oracle has failed two years in a row (last year with 41% support) and CEO Larry Ellison’s pay has received much press. Here’s a recent DealBook column about the latest vote – and some information from CalSTRS about Ellison’s pay…
We felt that the keynote remarks of Gibson Dunn’s John Olson at our recent conference were so important for all practitioners to hear that we transcribed them and are making them freely available among other important remarks made at our conferences over the years…
It’s still early – as most comment letters don’t get submitted until right before the deadline, which is December 2nd for this rulemaking – but the SEC already has received more than 32,000 comment letters on its pay ratio proposal, including roughly 20k using one form letter and another 8k using a second form, 3k using a third form and 1k using a fourth. Most of the form letters simply say they support Dodd-Frank’s Section 953(b). The others express more explicit support for the actual SEC proposal. So far, there haven’t been too many meetings with SEC Commissioners on this rulemaking – here’s that list.
My favorite one so far comes from a woman who claims she is with “Baker Schonchin Holdings Corporation,” a company that I couldn’t find via an online search:
We, at Baker Schonchin Holdings Corporation, believe it in our best interest, and that of our shareholders, employees, business partners, government affiliates, and customers, to willingly disclose payroll statistics, which include, but are not limited, to the following information: Name of Employee, Job Title, Yearly Salary, Department, City, State, Country, and any related pertinent details.
We strive towards a more transparent, ethical, and accountable business entity, so that we may present a more favorable corporate philosophy, but more importantly, that we are the # 1 leader, in moving forward, as a corporation, that refuses to do those practices, that are illegal, secret, or otherwise unsavory in nature. We strongly encourage our peers, to ensure that disclosure of salaries of all employees, is done so in a way that affirms the fair practices that are already in place, with respect to the vision, mission, and values of said company. Thank you.
I hope you noticed the initials of the company cited: “BS Holdings”…
In this podcast, Juan Monteverde of Faruqi & Faruqi provides some insight into how he determines which disclosure lawsuits to pursue, including:
– What types of disclosure lawsuits are you pursuing these days?
– How do you determine which particular company’s disclosure to target?
– Have you been discouraged by some of the court’s rulings?
– Do you think you might use pay ratio disclosures as fodder for lawsuits once the SEC adopts a final rule?
Check out Mike Melbinger’s blog about “something benignly calling itself the “Shareholder Foundation,” which is a front group (or “shill”) for strike suit lawyers seems to be getting in on the game, presumably based on the [limited] success and [very wide] publicity achieve by Faruqi.”
After a year of study by The Conference Board to define “realizable pay” and “realized pay,” this 19-page report has emerged recommending consistent definitions and laying out principles for linking pay to performance.
A Sept. 16 report by the National Association of Pension Funds identifies U.K. companies that bucked a 2013 trend for “quiet diplomacy” by failing to respond effectively to shareholder concerns about remuneration. The NAPF analysis shows that while most companies who faced significant rebellions by their shareholders in the “shareholder spring” of 2012 “have listened and learned,” there are a few who have not. Afren, Immarsat, and Babcock are among 10 FTSE companies highlighted which, having received a warning from shareholders last year, received more than 15 percent dissent (votes against and abstentions) on their remuneration report in 2013, the NAPF said in a statement. The report details where the three companies fell short of investor expectations, as well as those which saw significant increases in support this year, such as Aviva, Tullow Oil, and Quintain Estates.
Most companies acted to avoid the reputational damage inflicted by 2012’s high profile shareholder rebellions by engaging more and earlier with shareholders, says the NAPF, and also appear to be cautious about introducing change ahead of the remuneration disclosure regulations and the binding vote on remuneration policy which take effect this month. “We hope that highlighting the few companies where shareholders have felt compelled to give the company another reprimand will cause them to reflect, listen to shareholder concerns and introduce changes next year,” said NAPF head Joanne Segars in a statement. “We will continue to keep an eye on them and encourage all companies to assess whether their current remuneration practices align rewards to long-term success and returns to shareholders.”
This year’s inaugural report also explores shareholder voting on auditors, which has been in focus following corporate governance code changes last year recommending regular tendering and rotation of auditors, and sweeping reforms to the U.K.’s statutory auditor market expected soon from the Competition Commission.
The NAPF lists four “significant rebellions” against audit-related resolutions this year where shareholders signaled their dissatisfaction over high levels of non-audit fees, including at Pennon Group, Inmarsat, Unite Group, and Laird. Meanwhile, other companies headed off audit-related disputes by either tendering their longstanding auditor contracts or “indicating an intention to do so in the near future,” the report states. These included: HSBC, which moved the U.K.’s largest audit contract after a more than 20 year relationship with KPMG, according to the NAPF; Unilever, which ended a 26 year relationship with PwC; Land Securities, where PwC was replaced by Ernst & Young after 69 year tenure; and BG Group, where PwC replaced Ernst & Young, which had been in place since the company’s incorporation in 2000.
Given the “sensational” performance of the stock market in 2013, one-third of public company board members are concerned that a focus on equity pay is leading to a growing gap in compensation between the CEO and other members of the management team, according to findings from a BDO USA survey.
Of those expressing concern, the survey–conducted in September with 74 corporate directors of public company boards with revenues ranging from $250 million to $750 million–finds a majority (56 percent) believe the best approach to address the gap is to expand equity-based compensation to more members of the management team, while one-third (33 percent) suggest moving a larger portion of CEO compensation back to traditional, long-term cash or annual cash incentive programs, according to a statement. Just 11 percent suggest re-introducing executive perquisites back into the compensation mix for key employees.
“The concern with the gap in compensation between the CEO and other members of management is a subject we are increasingly being asked to address by clients,” said Randy Ramirez, senior director on compensation in the groups’ corporate governance practice. “Given the ongoing increase in equity markets and the SEC’s current proposal to require companies to disclose the ratio of CEO pay to median employee pay, this issue is only going to get bigger. Boards must decide whether they want to close the gap by expanding equity pay to other members of management, moving more CEO compensation back to traditional compensation or a combination of both of these strategies.”
When asked what performance measurement they consider the best substitute for at least a portion of equity-linked pay, board members cite profit growth (39 percent) and free cash flow (24 percent) as the most likely substitutes. Operational efficiency (18 percent), revenue growth (14 percent), and market share (6 percent) are the other alternative measurements cited by the directors.
Meanwhile, the survey finds 84 percent of directors expect to the spend the same amount of time on executive pay-related issues as last year, with just 8 percent saying the time allocation would be less, and another 8 percent saying more. By comparison, close to half of the board members cite succession planning (47 percent) and studying industry competitors (45 percent) as areas they would like to spend more time on, underscoring the dominance of pay in board discussions.
One of my in-house friends recently noted that a “sleeper” in the SEC’s recently-proposed rules on pay ratios involves the compliance date. Under the proposal, companies that don’t have December 31st fiscal year-ends might not have the luxury of an extra year before complying as December 31 year-end companies would.
As proposed, companies would have to begin complying for their first fiscal year commencing on – or after- the effective date of the rule. The proposing release explains that if the final requirements were to become effective sometime in calendar year 2014 – which is likely to be the case – a company with a fiscal year ending on December 31 would be first required to include pay ratio information relating to compensation for fiscal year 2015 in its proxy statement filed in 2016. This gives those companies a long transition period.
However, if the requirements were to become effective prior to July 1, 2014 – then companies with fiscal years beginning on – or after – July 1, 2014 would be required to include pay ratio disclosures for fiscal year 2014 in their proxy statements filed in 2015 for their 2015 annual meetings. They would not have the extra year’s worth of lag time.
The SEC can easily fix this problem by including a reference in the compliance provision to January 1st when it adopts final rules – which would in effect make the final rule effective for all companies for their 2016 annual meetings regardless of their fiscal year end…