A while back, Ruth Wimer of McDermott Will taped a podcast with me on personal use of aircraft. Since Ruth wrote out her answers to some of the questions, I thought I would share them since they are so useful. Below is one answer:
The first point I would like to make about the common snafus in providing personal use of aircraft disclosures, is that there are actually three sets of rules, two from IRS, and the third from the SEC, that require documentation and substantiation of the use of the aircraft. The first IRS rule which virtually all companies with business aircraft are aware of, is the requirement by the IRS to include in income, the fair market value of personal flights provided to the executive or to his guests.
Although there are two different methods for imputing income under this rule, the more popular is the so called “SIFL” rule which is the Standard Industry Fare Levels, meant to equate to first class airfair, despite the fact that the plane transportation provided is more akin to a charter flight. Accordingly, most companies diligently track all personal travel, calculate the SIFL amounts, and put it in as taxable income on a W-2 or Form 1099 – the later for independent contractors such as Directors.
The other IRS rule is the relatively new deduction disallowance which hits the company that owns the aircraft and it is related to providing certain kinds of personal travel, that is, personal travel which looks like “entertainment, amusement, or recreation.” Therefore, for the company’s tax return, this new disallowance rule will deny a deduction for the fully loaded costs attributable to any passenger traveling for personal purposes which is also entertainment, amusement or recreation.
Therefore, an executive commuting from his residence to his primary office, or traveling to a funeral, would result in taxable income under the SIFL rules, but result in no deduction disallowance to the employer company which owns the aircraft. If the same executive, however, takes a vacation with guests or family, then the employer company would be required to determine fully loaded costs allocable to that flight and subtract it from the deductible expenses related to the aircraft on the company tax return.
Now, as I mentioned, the SEC has its own reporting and disclosure rules which require that for Named Executive Officers and Directors, perquisites be quantitatively disclosed, as well as requiring certain narratives even if there is no quantitative disclosure. In short, if all perquisites exceed 10K, then the footnotes would need to include a description of any personal airplane use even if it did not need to be quantitatively disclosed. If the airplane personal use “Aggregate Incremental Costs” exceed $25,000 or 10% of all perquisites, then that value needs to be disclosed. My apologies for the long introduction, but it is necessary to understand why there are so many snafus with respect to SEC disclosure.
The SEC’s definition of “Aggregate Incremental Costs” is not defined, and the practice is to use the costs which are incurred which are incremental for a particular flight wherein personal use exits. Therefore, If an executive is flying on business, and a guest such as a spouse is also on board, then since there were little or no additional costs, other than perhaps additional catering, then no dollar amount needs to be disclosed.
In a recent shareholder derivative case, the plaintiff alleged misreporting for SEC purposes stating that some of the fixed costs should also have been reported since the personal use percentage was significant. In the same case, it was alleged that all director flights to board meeting should be reported as a perquisite, which is a gross over generalization, as sometime a board member flying to a board meeting is in fact commuting which is a perquisite, but more often, attendance at a Board meeting is away from the primary work location for that Board meeting and therefore is not a commute and the result would be no personal aspects to that flight/no perquisite.
The common snafus also include, and this is for IRS as well as SEC, misidentifying flights which are personal as business flights, such as spousal travel to business meetings. Getting the number wrong for SEC sometimes, but not often happens, – case in point, a recent proxy statement filing showed the use of the IRS SIFL rates for SEC purposes which refers to costs, not the value of the flight to the executive.
Last month, I blogged the question about whether we have seen the last of “say-on-pay” litigation given the volume of dismissals in these cases. The reality is that these cases are not going away any time soon. For example, if you read the “cases” page of the Faruqi web site, it is clear that Juan Monteverde is not slowing down. There are numerous press releases and announcements.
Note that the NASPP Conference will include a panel – “Stock Plan Proposal & Say-on-Pay Litigation 2.0: How to Avoid the Sharks” – that features both the plaintiff’s lawyer who has brought the most lawsuits over proxy disclosures and stock plan proposals (Juan Monteverde of Faruqi & Faruqi) and the leading experts involved in defending these suits.
With mandatory say-on-pay now in its third year and fewer companies thus far failing to receive majority support than in 2012, shareholder proposals have in 2013 reclaimed some of the proxy season spotlight they once held. While this year’s crop of high-profile shareholder proposals focused largely on board reforms, a number of compensation-related resolutions and campaigns stood out, with the number of such filings also seeing gains in volume over 2012 and creeping back to levels last evidenced in 2010, prior to the Dodd-Frank Act’s obviating the need for investors to file say-on-pay resolutions.
Calls for Stock Retention
ISS is tracking 34 votes year-to-date for proposals calling on executives to retain a significant portion of their equity awards until reaching retirement age, well in excess of the roughly two dozen that came to a vote in 2012. The increase in the volume of filings is largely attributable to retail shareholder activists, including John Chevedden, who have led the campaign in 2013.
Average support for the resolution in 2013 stands at 24.4 percent of votes cast “for” and “against,” with two votes–International Business Machines and Actavis–seeing support levels in excess of 40 percent. Average support this year aligns with that evidenced in 2012 and is slightly higher than that for 2010 and 2011. Two more votes–at Delta Air Lines and McKesson–are expected over the coming weeks.
Stock retention proposal proponents typically call on the compensation committee to adopt a policy requiring that senior executives retain a “significant” percentage of equity awards until reaching normal retirement age, with a recommendation that the committee adopt a share retention percentage requirement of at least 75 percent of net after-tax shares. Advocates suggest such policies will better align the interests of executives with those of shareholders and typically target companies with weak executive stock ownership guidelines.
Companies typically counter that their stock ownership guidelines are sufficient to align executives’ interest with those of shareholders and caution against adopting such prescriptive policies that would hinder a company’s ability to attract and retain high caliber executives.
Prorata Vesting
While fewer in number than proposals calling for stock retention, resolutions seeking to bar the accelerated vesting of equity awards upon a change-in-control have seen higher average support levels–33.4 percent of votes cast “for” and “against”–across 27 resolutions voted to date. (Notably, ISS tracked 45 pro-rata vesting proposal filings for 2013, with many being omitted at the U.S. Securities and Exchange Commission.)
Beyond barring accelerated voting, these resolutions typically provide that any unvested award may vest on a “pro rata basis” up to the time of a change-in-control. Proponents also seek to ensure performance goals are met to the extent any such unvested awards are based on performance, and specify the requested policy be prospective without “affecting any contractual obligations that may exist at the time.”
Companies receiving these resolutions often argue against the request by noting it is the prevailing practice among larger companies that typically see the proposal, and that accelerated vesting benefits shareholders by sharpening management’s focus on value creation, given they are apt to realize awards concurrent to shareholders doing so through the change-in-control transaction.
This year, six resolutions–at Walgreen, Honeywell International, Gannett, Quest Diagnostics, Alaska Air Group, and Raytheon–saw support above 40 percent though none secured a majority of “for” votes. Moreover, support levels are down from 2012 when average support touched nearly 40 percent of votes cast “for” and “against.” Still, the 45.7 percent support level at Quest this year is the highest level dating back to January 2010.
New Proposals See Mixed Results
A new crop of peer group proposals, filed by the Utility Workers Union of America and calling for an end to the practice of benchmarking the CEO’s total compensation to that of CEOs of peer companies, went to a vote this year at NiSource, Consolidated Edison, and FirstEnergy. The companies argued against support for the proposal, typically noting that peer group usage was just one of many factors in determining CEO pay and that performance-based measures outweighed consideration of pay relative to peers. Consolidated Edison holders voting “for” and “against” gave 11.2 percent backing to the resolution, the highest of the three.
Meanwhile, the AFL-CIO had greater success on a similar yet slightly different proposal filed to Waste Management. The labor fund sought a more nuanced policy that called for the compensation committee to use a benchmark not exceeding the 50th percentile company peers, when peer group benchmarking is used to establish target awards for senior executive compensation. That proposal netted 21.9 percent support.
Another proposal new for 2013 on performance standard disclosure for 162(m) plans went to a vote at Nabors Industries, and Abercrombie & Fitch–and filed to two others firms–receiving support of 25.3 and 21 percent, respectively, a solid showing for a first-year resolution. The proposal, which urges the compensation committee to adopt a policy that all equity compensation plans submitted to shareholders for approval under Section 162(m) of the Internal Revenue Code specify the awards that will result from performance, also was filed at Chesapeake Energy and Citigroup, according to ISS records.
Clawback Success Through Negotiations
Perhaps the most significant win for supporters of tougher executive pay curbs were campaigns by the UAW Retiree Medical Benefits Trust (URMBT), the New York City Comptroller’s Office (“New York City Funds”), and Amalgamated Bank on strengthening clawback policies.
Most notably, URMBT crafted two types of clawback policies, with the first meant for health care companies that had health care fraud settlements with the government and did not have existing clawback policies in place. The policy’s language, which was more rigorous than provisions of the Dodd-Frank Act (yet to be enacted) providing for recoupment, called for the recovery of pay promised but not yet paid out, applied to senior executive supervisors, and sought to broaden misconduct triggers beyond that which would trigger a financial restatement. The second policy, meanwhile, did not discriminate based on industry and was designed for companies with clawback policies in place, effectively asking boards to annually disclose whether or not it used its clawback policies and the circumstances under which they were used.
Following negotiations with companies where the first of the two policies was applicable, the URMBT announced in early April that it and other investors–including the New York State Comptroller’s Office, Hermes, and Connecticut Retirement Plans & Trust Funds–had reached agreement with pharmaceutical giants including Eli Lilly, Merck, Amgen, Pfizer, Bristol-Myers Squibb, and Johnson & Johnson to adopt a set of principles “setting an industry standard on clawbacks related to health care.”
In addition to the six pharmaceutical agreements, the Trust negotiated similar clawback agreements with Quest Diagnostics, Healthways, and, with New York City Funds, Boston Scientific.
With regard to the second policy, URMBT filed a proposal this year to Wal-Mart calling for enhanced disclosure, following allegations of bribery against the retailer in emerging markets such as Mexico and China. Just 4.8 percent of shares cast supported the measure at a June 7 annual meeting, though the figure climbs, notably, when an insider voting block is discounted, resulting in roughly 32.5 percent of independent investors backing the policy.
The Amalgamated Bank has filed a similar proposal to San Francisco-based McKesson, where a vote is expected on July 31. That proposal was challenged at the SEC with the company arguing it was vague and indefinite, materially false or misleading, and that implementation amounted to micromanagement of the company. SEC rejected McKesson’s petition in a May 17 no-action letter, stating, in atypically forceful language, “that the proposal focuses on the significant policy issue of senior executive compensation and does not seek to micromanage the company.”
Meanwhile, New York City Funds also scored a victory on the issue ofclawbacks, successfully negotiating agreement for enhanced polices with a number of financial services firm earlier this year. The funds withdrew clawback resolutions filed to Wells Fargo, Citigroup, and Capital One after all agreed to address the issue with Capital One agreeing to disclose the dollar amount clawed back so long as the event prompting the clawback “has been publicly disclosed in regulatory filings.”
Yesterday, the Washington Post ran this lengthy article – that started on the front page (ie. A1) – about how the SEC’s pay disparity disclosure rulemaking has been delayed for several years…
Last week, the U.K.’s Department of Business, Innovation, and Skills released final regulations governing directors’ pay. The main changes to the pay reporting regulations include: a pay policy, which will be subject to the new legally binding vote; an illustration of the level of awards that could pay out for various levels of performance meaning pay information is presented in a more understandable format; all elements of director’s pay will be reported in a single, cumulative figure (the regulations define how this should be calculated so that all companies are consistent in their approach); and improved disclosure on the performance conditions used to assess variable pay of directors.
– Matthew Roberts, ISS Germanic Markets Research, and Subodh Mishra, ISS Governance Exchange
Regulators released June 14 a draft ordinance meant to address demands raised earlier this year by Swiss voters for the government to clampdown on executive remuneration. On March 3, roughly two-thirds of Swiss voters supported a referendum, spearheaded by businessman-turned-politician Thomas Minder, which radically empowered shareholders on matters of pay. Minder’s initiative gave shareholders a binding annual vote on pay, barred severance awards and other types of “golden” pay, gave investors a greater say in board elections, and required greater disclosure of voting records and policies by institutional investors.
Under the proposed rules released last week, shareholders would annually approve, on a binding basis, the total remuneration of the board, executive management, and the advisory board each year on an aggregate basis for each governing body. Fixed pay would be approved for each governing body on a forward-looking basis while variable pay would be approved on a retrospective basis. Effectively, the approvals would equate to six separate resolutions.
The proposed ordinance states that company articles of association may establish a different modus of vote (e.g., approval of a “budget” reflecting a lump sum of fixed and variable for the upcoming year), while respecting the annual meeting assembly’s authority to approve total remuneration annually.
If a vote is rejected, the board may make a second proposal at the annual meeting. If shareholders do not pass the second resolution, a special meeting must be convened within three months seeking approval.
On matters related to special, one-off, or bonus payments, the draft rules bar “remuneration in advance,” while allowing for sign-on payments . Severance payments–a rallying cry for those supporting the Minder referendum–are banned but non-compete agreements are permitted. Remuneration specifically for mergers, acquisitions, or other similar events is not allowed, but such events may be taken into consideration in the setting of variable compensation, the proposal stipulates.
More Say on Directors
The draft rules would allow shareholders to directly elect individual board members annually, as well as board chairman and members of the remuneration committee, as called for under the Minder referendum. The draft proposal also includes a provision that the annual meeting assembly can elect a vice chairman in order to prevent the possibility that a special meeting would have to be held if the chairman were to leave or otherwise be incapacitated.
With respect to overboarding, the draft regulations leave to the company’s articles of association a cap on the number of other board positions, while it remains unclear if the company set caps would apply only to Swiss companies and/or to privately held firms. Multiple directorships with a holding company group would be counted as one. The length of employment contracts, meanwhile, would also be regulated by company articles.
Investor Impact
Swiss-based pension funds will not be required to vote in all cases, under provisions of the draft rules. A number of funds had worried following the referendum that they would be penalized for doing so, even when the economic benefit of casting a vote was questionable.
Provisions allow for funds to abstain or not take part in votes at all if it is “in the interest of the pension fund members,” Investment & Pensions Europe reported. Provisions within the draft ordinance state that a pension fund’s board must draw up rules spelling out exactly how it will make decisions regarding members’ interests. In a televised press conference, a Justice Ministry spokesman said the government had set the fines for the violation of these regulations “milder” than other penalties within the legal framework “on purpose,” IPE reported. Funds must also report their shareholder voting activity to members at least once a year and will be given one year to comply with the rules that take effect Jan. 1.
Next Steps
Regulators intend to consult on the draft through July 28 with the aim of releasing final rules in late November. The rules would then take effect Jan. 1, though company articles of association must be amended within two years of that date.
The release of final rules is expected to occur within days of another referendum on pay, this one capping the ratio of highest paid employee to that of average rank-and-file at 12:1. In advance of the vote, the two heads of the main Swiss business lobby, Economiesuisse, announced on Wednesday they were both stepping down after the organization came under heavy fire over its failed campaign to oppose strict controls on executive pay, Reuters reported.
Economiesuisse, which represents 100,000 companies from all sectors employing 2 million people, lobbied hard against the Minder initiative, argued companies would leave Switzerland for more corporate-friendly locations and that businesses would suffer without flexibility to attract top talent. The group is likely girding itself for another fight over the pay ratio referendum, which most observers wrote off until voters made known their views in March.
This Sullivan & Cromwell memo discusses the Simon case that I blogged about last week (that blog included the hearing transcript & related pleadings – and here’s a blog from Ning Chiu). Here’s a summary of the S&C memo:
Louisiana Municipal Police Employees Retirement System v. Bergstein concerns a $120 million equity grant to the Chief Executive Officer of Simon Property Group, Inc. (“SPG”) and a related amendment to SPG’s stock incentive plan that was required to make the grant. The shareholder plaintiff alleges that the board of directors’ amendment of the plan was a breach of fiduciary duty because the plan mandated shareholder approval of amendments where required by law, regulation or applicable stock exchange rules. The defendants moved to dismiss, noting that SPG had received email confirmation from New York Stock Exchange staff that shareholder approval of the amendment was not required under NYSE rules. Ruling from the bench, Chancellor Leo E. Strine, Jr. denied SPG’s motion to dismiss, citing concerns that a staff email did not serve as a definitive interpretation of NYSE rules – particularly where, in Chancellor Stine’s view, the email to the NYSE did not adequately describe the broader circumstances.
The process SPG used is the customary one by which listed companies receive interpretations from the NYSE staff on governance matters, and Chancellor Strine’s ruling is at an early stage of the case. However, until there is more definitive guidance as to the weight that courts will give NYSE staff interpretations, listed companies should bear in mind the Chancery Court’s ruling when evaluating the weight that a court will give an NYSE email interpretation on a governance matter, particularly when evaluating whether a proposed change to an equity compensation plan would require shareholder approval.