I recommend that when companies revise their compensation committee charters to reflect the new NYSE and Nasdaq rules that they also consider updating their charters in other regards as well. Troutman recently reviewed the compensation committee charters for the S&P 100 and was surprised at how many of them were out of date. The focus of the review was to assess how deep within an organization compensation committees approve compensation levels.
A large plurality, but not a majority, provide for committee approval of the compensation of “executive officers.” A surprisingly large number tie approval to Section 16 “officers,” which is not a definition generally used in the compensation context, or various ill-defined groups such as “executive management” or “senior executives.” A significant number require full board approval of compensation, which also is surprising given board fatigue at many companies that large.
The important takeaway, however, is that the discussions of the roles of compensation committees in many companies’ CD&As do not reflect the authority that they have and supposedly are to exercise under their charters. Some over-state it; others under-state it; some do so significantly. Also, a solid majority of the charters do not reflect some of the responsibilities that the compensation committees have been charged with post-SOX, including administering stock ownership guidelines, making claw-back decisions, and assessing the risk aspects of compensation programs.
As a litigation risk minimizer, I recommend that compensation committee charters should clearly delineate which officers must have their compensation approved by the compensation committee – and I suggest “executive officers” as defined in Rule 3b-7, other officers that report directly to the CEO, and such other employees as are identified by the compensation committee in a resolution – and otherwise delegate to management the establishment of compensation to the extent delegable under the applicable plans. I also recommend that compensation committee charters be updated to otherwise reflect current practices and responsibilities.
Britain’s High Pay Centre is warning companies against the failure to link “at least half the performance pay of top executives to broad measures of success,” suggesting British businesses risk losing out to foreign rivals using such incentive models. The center, a non-partisan think tank established in the wake of the financial crisis to “monitor pay at the top of the income distribution,” said in a Jan. 14 report that executive pay packages across the largest 100 U.K. companies are “overwhelmingly” linked to short-term financial measures of corporate performance such as earnings and share price movement. As a result, the center argues, executives are “encouraged to focus on short-termism, cost cutting and the need for quick returns.”
The group notes that CEO pay has tripled to 4.8 million pounds in 10 years “without any accompanying long-term increase in share values.” “British business will erode its competitive edge even further if it doesn’t start looking beyond share prices and reward executives for their success in fundamental areas of non-financial performance,” said High Pay Centre Director Deborah Hargreaves in a Jan. 14 statement. “We’ve got to start taking a longer term view and that means persuading business that performance in areas like corporate social responsibility, employee engagement and customer satisfaction rates are the key to lasting business success.”
The report finds that total shareholder return (TSR) is used to calculate at least one element of performance-related pay at 74 of the largest 100 U.K. companies, with 96 companies using either TSR or earnings per-share (EPS), or a combination of both to determine performance for their chief executives’ long-term incentive plan. Most companies, the center argues, pay little or no regard to the long-term benefits of non-financial performance across areas like employee engagement, corporate social responsibility and customer satisfaction.
In addition to calling on businesses to link at least half of chief executives’ performance related pay to non-financial yardsticks, the High Pay Centre said it is seeking the introduction of mandatory reporting on social and environmental performance and a new tax and procurement incentives “to encourage companies to focus on wider measures of performance.”
The group also wants requirements for pension fund trustees, investment managers and commercial pension providers to take into account the social/environmental impact of their investments on beneficiaries and for employee representation on company boards “to challenge decisions based on short-term financial considerations that may jeopardise the company in the long-term.”
The High Pay Centre says longer-term institutional shareholders like the Association of British Insurers “support broader measures” of executive performance and says leading businesses like BP, Barclays and HSBC, who have suffered reputational damage, “have gone further than others to link top pay to non-financial measures of success.”
Hat tip to Ed Hauder of Exequity for notifying us of this development:
– ISS recently posted its whitepaper detailing its pay for performance (P4P) methodology:
The Evaluating Pay for Performance white paper provides an overview of ISS’ approach in evaluating Pay for Performance alignment. Originally published prior to the 2012 proxy season [Note: a revised version of the whitepaper was published in February 2012], the document incorporates further updates for 2013 that describe ISS’ new peer selection methodology and approach to measuring realizable pay.
Here’s news from this memo by Wachtell Lipton’s Paul Rowe & Jeremy Goldstein:
Recently, the Delaware Supreme Court upheld a Chancery Court determination that a board did not commit waste by consciously deciding to pay bonuses that were non-deductible under Section 162(m) of the Internal Revenue Code (Freedman v. Adams, Del. Supr., __ A.2d __, No. 230, 2012, Berger J. (Jan 14, 2013)). Unlike claims of gross negligence, claims of waste are not subject to exculpation or indemnification by the company and therefore have the potential for personal liability of directors.
The original suit was brought in 2008 by a shareholder of XTO Energy (later acquired by ExxonMobil) as a derivative claim. The suit alleged that XTO’s board committed waste by failing to adopt a plan that could have made $130 million in bonus payments to senior executives tax deductible. The board was aware that, under a plan that qualifies for the “performance based compensation” exception of Section 162(m), the company could have deducted its bonus payments, but, as the company disclosed in its annual proxy statement, the board did not believe that its compensation decisions should be constrained by such a plan. The Chancery Court held that the shareholder failed to state a claim. The Supreme Court agreed, holding that the decision to sacrifice some tax savings in order to retain flexibility in compensation decisions is a classic exercise of business judgment.
Like other recent Section 162(m) suits about which we have written, this suit serves as a reminder that careful attention must be paid to the design and administration of plans intended to comply with Section 162(m) and that disclosure relating to tax deductibility must be carefully drafted. Helpful in this case was the fact that the board was aware of Section 162(m), made a conscious decision not to avail itself of Section 162(m) and disclosed its reasons for so deciding. Moreover, this case serves as a reminder that aspirational “best practices” are not synonymous with legal requirements that may result in liability. Indeed, the Supreme Court expressly stated that “even if the decision was a poor one for the reasons alleged by Freedman, it was not unconscionable or irrational.”
Thus once again, the Delaware courts have demonstrated that directors need not be deterred from paying executives in amounts and forms that they deem necessary or advisable to attract, retain and incentivize executives. Indeed, doing this effectively is one of the highest priorities for any board of directors.
Yesterday, the SEC finalized the NYSE & Nasdaq listing standards related to compensation committees and their advisors (here’s the NYSE order & Nasdaq order). Last Friday, both exchanges amended their listing standards, as noted in this blog. Here are the effectiveness timetables, as noted in this Cooley news brief:
– NYSE companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new standards for compensation committee director independence. All other provisions will become effective on July 1, 2013 for NYSE companies (e.g., provisions relating to the authority of a compensation committee to retain and fund compensation consultants, legal counsel and other compensation advisers and the responsibility of the committee to consider independence factors before selecting or receiving advice from these advisers).
– Nasdaq companies will be required to establish the committee’s authority and responsibility under Rule 5605(d)(3) in the committee charter, resolutions or other board action by July 1, 2013. Nasdaq companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the remaining provisions (including a mandatory charter amendment to establish the authority noted above).
Tune in tomorrow for the webcast – “The Latest Developments: Your Upcoming Proxy Disclosures – What You Need to Do Now!” – to hear Mark Borges of Compensia, Alan Dye of Hogan Lovells and Section16.net, Robbi Fox of Exequity, 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 including these topics:
– Overview of key lessons from the 2012 proxy season
– The rise of the proxy summary
– Developments with CD&A and executive summaries – including realized/realizable pay
– The impact of the compensation committee and advisor independence rules in 2013
– Hedging and pledging policies in the wake of the 2013 ISS policy change
– Engagement strategies for 2013
– Compensation and governance shareholder proposals
As you know, a new SEC rule (Item 407(e)(3)(iv) of Regulation S-K) requires disclosure if a conflict of interest has arisen in connection with the work of a compensation consultant (whether selected by management or the compensation committee). To satisfy this disclosure requirement, companies will need to conduct a conflicts of interest assessment. This raises the question of whether companies will include voluntary disclosure (so-called “negative disclosure”) in their proxy statement when a determination of “no conflict” has been made. Here are the results from our recent survey regarding what companies are preparing to do:
1. For our next proxy statement, when it comes to the newly required conflicts of interest disclosure about compensation consultants (ie., Item 407(e)(3)(iv) of Regulation S-K), assuming that no conflict of interest is identified, our company:
– Has made a decision, at least at the staff level, whether to make voluntary negative disclosure (eg., as an anticipatory “best practice” or simply to signal to the SEC Staff and our shareholders that we were aware of the new disclosure requirement) – 62%
– Hasn’t yet figured out whether it will make any voluntary negative disclosure – 35%
– I hadn’t realized that there is a new conflicts of interest disclosure (and assessment) requirement! – 3%
2. For those of you who know which approach your company will take, our company intends to:
– Only provide disclosure if a conflict of interest is identified – and not provide any voluntary negative disclosure – 25%
– Provide voluntary disclosure that a conflicts of interest assessment was conducted and that no conflict of interest was identified – 67%
– Provide voluntary negative disclosure that works through one or more of the six non-exclusive factors supporting a “no conflict of interest” conclusion – 8%
With the SEC staring at yesterday’s deadline for its extension to approve the NYSE & Nasdaq proposals to comply with Rule 10C-1 under the Exchange Act comes this news from Davis Polk’s Ning Chiu on Friday:
Both the NYSE and Nasdaq have filed further amendments to their proposed listing standards on compensation committees and their advisers. The amendments copy directly from the exception in Item 407(e)(3)(iii) of Regulation S-K with respect to the proxy disclosure rules for compensation consultants.
The amendments clarify that a compensation committee is not required to conduct the independence assessment of an adviser whose role is limited to (a) consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors, and that is available generally to all salaried employees or (b) providing information that either is not customized or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.
The SEC enhanced proxy disclosure rules in December 2009 permitted these exceptions in response to commentators who suggested that broad-based, non-discriminatory plans and the provision of information, such as surveys, that are not customized, should not be treated as compensation consulting services that would raise conflict of interest concerns.
The NYSE amendment also added language indicating that nothing in the section requiring a compensation committee to consider the specific adviser independence factors is intended to limit compensation committees from selecting or receiving advice from any adviser that they prefer, including ones that are not independent. NASDAQ already had a similar statement.
My ten cents: Given that the SEC’s deadline to act was yesterday – and a statement is in both the exchange’s latest amendments saying they don’t consent to an additional extension for the SEC to act – maybe the SEC will approve the amendments today or soon enough. Since a portion of the new rules will be effective July 1st, they have to give companies time to comply…
Although over 100 companies faced the grim prospect of a “second strike”, only 13 companies actually received a “second strike” in the recently completed Australian proxy season (and only 2 had their board spill resolution approved). This seems to indicate that shareholders are taking this newly-granted responsibility quite seriously. Furthermore, companies are as well , as indicated by the increased dialogue and subsequent policy and design reform.
CGI Glass Lewis has found that “first strike” companies have been more proactive in consultations with, and feedback from, institutional shareholders, proxy advisors and remuneration advisors. As a result, their remuneration reports tend to be well explained with feedback from shareholders incorporated in those companies’ remuneration policy reviews.
Some companies, such as Bluescope Steel Limited, implemented remuneration freezes for executives until financial year 2013. Others, such as Crown Limited, undertook major efforts to improve their disclosure and explanation of remuneration practices. Some companies, such as Dexus Property Group, revamped their executive remuneration structures by introducing a deferred short-term incentive and a new long-term incentive plan, each of which, in our view, better align that company’s remuneration framework with shareholders’ long-term interests.
As previously mentioned, only 13 companies received a “second strike”. Of these, only two companies had their board spill resolution approved at their AGM. Subject to majority approval of a separate resolution (the “board spill resolution”) at the AGM, companies that receive two strikes (two consecutive votes of 25% or more against the remuneration report proposal) may face a board spill, where directors (except the managing director) would need to be re-elected to maintain their board seats.
This of course means that the two companies with majority-supported spill motions (Penrice Soda and Globe International) need to hold an extraordinary general meeting within 90 days to re-elect the board.