The Advisors' Blog

– Broc Romanek, CompensationStandards.com

I talked to Ross Kerber of Reuters when he was working on this story a few times – the article repeated below digs into what is truly a perplexing set of circumstances:

Federated Investors Inc (FII.N: Quote, Profile, Research, Stock Buzz) objected to hundreds of executive pay packages in last year’s corporate proxy voting, a rarity in the don’t-rock-the-boat mutual funds industry. A review shows ambiguities in Federated’s record as a shareholder activist, however. For one thing, at the same time Federated mutual funds rejected pay plans at the likes of Bank of America Corp (BAC.N: Quote, Profile, Research, Stock Buzz), Apple Inc (AAPL.O: Quote, Profile, Research, Stock Buzz) and General Electric Co (GE.N: Quote, Profile, Research, Stock Buzz), they backed directors who set the pay.

Also, labor leaders do not view Federated as an ally in their efforts to reign in pay and other executive powers, since the funds also sided with management in controversial governance questions at companies such as Abercrombie & Fitch Co (ANF.N: Quote, Profile, Research, Stock Buzz) and Nabors Industries Inc (NBR.N: Quote, Profile, Research, Stock Buzz).

Federated’s voting “seems almost schizophrenic,” said John Keenan, corporate governance analyst for labor union AFSCME. Executives at family-controlled Federated would not discuss voting by the funds, a spokeswoman said. Federated’s outlier stance on proxy voting reflects how even the most striking votes may have just a minor impact on CEO pay under new rules passed after the financial crisis.

The goal was to give shareholders more oversight. Under so-called “Say on Pay” provisions of the 2010 Dodd-Frank financial reforms, most companies must hold advisory votes on executive compensation at least once every three years. The rule became effective last year and most companies got stamps of approval. Of 2,481 companies in the Russell 3000 index, through October only 38 failed to get a majority of shareholder support on pay, according to New York research firm GMI. Another 157 got less than 70 percent approval. Many of these companies now face pressure to make changes, since proxy advisory firms have promised closer scrutiny in 2012 of companies that did not get solid majorities last year.

Figuring out what changes to make may be difficult, however. About 40 percent of large investors will not give feedback, even in private, about their votes or the changes they might like to see, said David Drake, president of Georgeson Inc, a proxy solicitation firm. Some wish Federated were more forthcoming about the warning its votes seemed to send on pay. “If Federated is going to throw a yellow flag, Federated should at least describe what the foul is,” said Richard Susko, a partner at Cleary Gottlieb Steen & Hamilton. It represents corporations on compensation and governance matters.

CRISIS BLOWBACK

Mutual fund firms control about a quarter of U.S. stocks, but like Federated, most will not discuss specific votes, making their annual disclosures a rare window into their oversight. At Reuters’ request Jackie Cook, principal of Vancouver research firm Fund Votes, reviewed the voting of 28 Federated mutual funds during the year ended June 30. They opposed executive pay 83 percent of the time at S&P 500 companies, voting against the plans in 346 of 416 contests. In contrast, most mutual fund firms backed 80 percent or more of pay plans, Fund Votes found. That support was in line with recommendations of proxy adviser Glass, Lewis & Co.

In securities filings Federated said it will vote against compensation proposals that replace existing stock incentives with those having more favorable terms and against plans that fail to spell out maximum compensation levels. Frank Glassner, head of Veritas Executive Compensation Consultants, said the details do not explain the votes. Federated has “given a philosophy and not a methodology,” he said.

LYING LOW

Federated makes an unlikely executive pay critic. Its cofounder and chairman, John Donahue, graduated from West Point in 1946, then flew military bombers and began Federated in 1955 with friends from Pittsburgh’s Central Catholic High School. Donahue is now 87 years old and his 62-year old son Christopher is chief executive. The company was so traditional it prohibited women employees from wearing pants on the job until 2000. That was also the year Federated put up a big sign on its downtown headquarters, although it is now one of Pittsburgh’s largest financial firms.

Despite its low profile, Federated has a history of shareholder activism when it comes to compensation. A 2006 study by AFSCME and others ranked Federated as the third toughest “pay constrainer” among 18 fund firms, based on their voting on measures such as management-sponsored pay resolutions. (AFSCME and other unions have been clients of Fund Votes, as have shareholder groups and academics.) Proxy votes are overseen by a Federated funds board that includes both Donahues, plus nine other trustees who would not comment for this article. John Conroy, a former funds trustee who retired early least year before most pay votes were cast, said the board at the time had no particular agenda on executive pay, but studied proxy matters closely. “We call them as we see them,” Conroy said.

Federated shares had fallen 34 percent in the 12 months ended January 10, compared with a 16 percent decline for an index of peers. The company has been dogged by heavy reliance on money market funds at a time when low interest rates forced it to waive fees. Unhappy investors have pressed for a bump in the dividend that has been 24 cents per share in recent quarters. Christopher Donahue has resisted, but says his family’s ownership helps him keep investor interests in mind. “I grew up with nine sisters,” he said at a conference in June. “I think they’re all stockholders and I like going to Thanksgiving dinner, too.”

MORE LEEWAY

Federated’s tough set of pay votes contrast with its own practices. Federated has two share classes of which only those held by a Donahue family trust had voting rights at its annual meeting. As a result, holders of Federated’s publicly-traded Class B shares did not vote on John Donahue’s $2.7 million 2010 compensation, or the $3.6 million paid to Christopher Donahue. Another feature of Federated’s structure also could play a role in its proxy voting. Many fund companies have an incentive to vote with management because the firms also seek to manage corporate retirement assets. But at Federated, those assets stood only at $2.5 billion, according to the latest survey by PlanSponsor magazine, compared with Federated’s $352 billion in total assets at September 30.

Such a small retirement business would give Federated the flexibility to vote its heart on pay, said University of Michigan professor E. Han Kim. Although it might anger executives with its pay votes, Kim said, Federated has “nothing to lose.” Even as they were swatting at pay plans, Federated funds opposed only two percent of corporate directors in the last proxy season, Fund Votes found. Many other shareholders also went easy on directors, according to ISS, which advises institutional shareholders on proxy voting. It found only 45 directors at U.S. companies who lost elections last season, roughly half the 91 directors defeated in 2010.

Behind the trend was the new ritual of “Say on Pay.” Many negative votes – such as Federated’s – did not send the harshest possible message on compensation. Rather, said Georgeson’s Drake, the votes were “like a pressure release valve.”

– Broc Romanek, CompensationStandards.com

According to this memo from Wachtell Lipton:

In a decision reaffirming directors’ authority to determine executive compensation, the United States District Court for the District of Oregon has ruled that a suit against bank directors arising out of a negative “say on pay” vote should be dismissed. The court determined that plaintiffs failed to raise a reasonable doubt that the challenged compensation was a reasonable exercise of the board’s business judgment. This is the first federal court decision to dismiss such an action, a number of which have been filed in state and federal courts across the country in the wake of the Dodd-Frank Act. Plumbers Local No. 137 Pension Fund v. Davis, Civ. No. 03:11-633-AC (Jan. 11, 2012).

At issue in Davis was a decision by the compensation committee of Umpqua Holdings Corporation to pay increased compensation to certain executive officers for 2010 — a year in which the bank’s performance had improved and met predetermined compensation targets, but total shareholder return was allegedly negative. In a subsequent advisory “say on pay” vote, a majority of the shares voted disapproved of the 2010 compensation. Plaintiffs claimed that it was unreasonable for the Umpqua board of directors to increase compensation and that the shareholder vote rejecting the compensation package was prima facie evidence that the board’s action was not in the corporation’s or shareholders’ best interest.

The court rejected both of plaintiffs’ arguments. Applying Delaware and Oregon law, the court determined that plaintiffs’ “essential position . . . that if a simple comparison reveals a level of compensation inconsistent with general corporate performance, the business judgment presumption is necessarily overcome, [is] a position that is unsupported by the applicable standards.” The court also held that the Dodd-Frank Act did not alter directors’ fiduciary duties and that a negative “say on pay” vote alone does not suffice to rebut the business judgment protection for directors’ compensation decisions. In so holding, the court expressly declined to follow a prior federal court decision which had denied a motion to dismiss in a “say on pay” action in the Southern District of Ohio, NECA-IBEW Pension Fund v. Cox, No. 11-451 (S.D. Ohio, Sept. 20, 2011).

Davis is a powerful reminder that directors of both financial and non-financial companies may base compensation on long-term goals and choose the yardsticks by which to measure executive performance with confidence that courts will respect their good faith business judgment.

– Mark Poerio, Paul Hastings

As I recently blogged, higher-than-usual stakes attach this year to proposals for shareholder approval of new (or amended) cash incentive plans and/or equity award plans. This is mainly because of the two Delaware District Court decisions, which essentially highlight a litigation risk if a proposal for shareholder approval states or implies that awards “will qualify” – rather than “are intended to qualify” – either for exemption from Code §162(m) or as performance-based compensation for Code §162(m) purposes. While Code §162(m) has your attention, two further caveats are worth mentioning.

1. Five-year Rule – Although the normal life of a stock plan is 10 years, an exemption from Code §162(m) requires shareholder approval every 5 years if the plan follows the common practice of merely identifying a maximum per person limit and a menu of possible performance-based measures (as opposed to locking-in a formula for awards).

2. Vesting on Involuntary Termination or Retirement -The Treasury Department has issued a ruling to the effect that a performance-based award will lose its §162(m) exemption to the extent that the award will be paid-out, regardless of performance outcomes after 2008, in connection with the award holder’s termination of employment for a reason other than death or disability.

As a general precaution, public companies should be sure to carefully vet any proxy statement that proposes a compensation-related plan for shareholder approval (whether the plan involves cash or equity awards, or both).

– Broc Romanek, CompensationStandards.com

Ed Hauder of Exequity provides this presentation includes the latest ISS burn rate caps, as well as a chart looking at how the caps have changed from 2009 through 2012.

–Ted Allen, ISS

New York City’s pension funds have filed proposals at Goldman Sachs, JPMorgan Chase, and Morgan Stanley that call for stricter “clawback” policies to recover executive compensation. “No one should profit or be rewarded with bonuses when engaged in improper or unethical behavior,” City Comptroller John Liu said in a Dec. 21 press release. “These tougher clawback provisions will not only recover money that shouldn’t have been paid in the first place, but also set the tone for a stronger standard of conduct for company executives as well as their bosses.”

The proposals at Goldman Sachs and JPMorgan ask the financial firms to revise their current clawback policies, which only hold executives responsible for “material” losses. The proponents contend that the existing policies create “unrealistically high legal and financial standards for clawback actions,” and “[protect] executives from being held accountable.” All three resolutions ask the boards to hold executives responsible for the unethical conduct of their subordinates. “Under the current system, a senior executive can benefit when a subordinate engages in improper conduct that generates profits in the short-term, but that ultimately causes financial or reputational harm to the firm,” the investors contend.

Finally, the city funds urge the firms to amend their clawback policies to require the disclosure of any decision by their boards on whether or not to recoup executive compensation. The resolution at Goldman Sachs was co-filed by the UAW Retiree Medical Benefits Trust. The New York City funds reported that they held shares worth a combined $483 million in the three financial firms (as of Dec. 19).

– Broc Romanek, CompensationStandards.com

Tune in tomorrow for our webcast – “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 in response to say-on-pay–including the latest SEC positions–and the other compensation components of Dodd-Frank, as well as how to handle the most difficult ongoing issues that many of us face.

– Broc Romanek, CompensationStandards.com

We’ve heard such tremendous feedback from our week of executive pay conferences that was held back in November that we have decided to share this lengthy transcript from our plenary session entitled “Say-on-Pay Shareholder Engagement: The Investors Speak” in the form of this lengthy Winter 2012 issue of our Compensation Standards newsletter. The practical guidance provided during this panel from those that vote proxies at thousands of companies is timely as we gear up for another interesting proxy season.

– Broc Romanek, CompensationStandards.com

Pretty interesting. Here is an excerpt from this Towers Watson press release on this topic:

The Towers Watson survey of 265 midsize and large organizations found 61% expect their total shareholder return for 2011 to decline or remain flat. Meantime, the same number (61%) expect their annual bonus pools for 2011 to be as large or larger than those for 2010. Additionally, 58% expect to fund their annual incentive plans at or above target levels based on their companies’ year-to-date performance. Nearly half (48%) of respondents also expect long-term incentive plans that are tied to explicit performance conditions to be funded at or above target levels based on year-to-date performance.

– Broc Romanek, CompensationStandards.com

With the official pushing of the SEC’s expected rulemaking timetable into the first half of this year from late ’11, many were resting easy that there would not be any new SEC executive pay positions to worry about this proxy season. Think again as this article from yesterday’s WSJ was an eye-opener, noting that Verizon has agreed to make additional pay disclosures in the Summary Compensation Table of its next proxy statement after a total of 11 Corp Fin comment letters and responses – dated between June and November – were recently posted on the SEC’s site (you can see these by looking at the “Upload” and “Corresp” documents in this Verizon filing stream, or look at these SEC comments and Verizon responses).

Here’s how Cleary Gottlieb characterized the news of this WSJ article:

An article on page B1 of today’s Wall Street Journal, entitled “Verizon Details $20 Million More in Pay,” discusses an interpretive position taken by the staff at the SEC, in correspondence with Verizon Communications Inc, regarding the reporting of performance-based equity awards under plans that reserve significant discretion for the compensation committee to adjust payouts based on non-objective criteria, in the Summary Compensation Table of a proxy statement. The position relates to a current issue that may affect the staff’s view of proper reporting of 2011 compensation in some of your 2012 proxies. The specific position taken by the staff does not appear to have been previously publicly reported. We are sending this quick note to alert you to the interpretive issue. Applying the staff’s position to a particular plan may require judgment of the specific plan terms, as well as accounting expertise.

Here is the WSJ article repeated below:

Verizon Communications Inc. has agreed to increase by $20 million the total disclosed pay for former Chief Executive Ivan Seidenberg, but the recently retired executive won’t be getting any more money. Verizon will recalculate Mr. Seidenberg’s compensation for 2009 and 2010 after the Securities and Exchange Commission said the company hadn’t properly disclosed discretionary grants of restricted stock given to Mr. Seidenberg in 2007 and 2008.

Verizon maintains its disclosures were proper, but agreed to make the changes in its forthcoming proxy statement to resolve the SEC’s concerns. “The SEC did not suggest that anything was improper in past disclosures, but they wanted a new method of disclosure going forward,” said Verizon spokesman Peter Thonis in a statement. “We have simply complied with a reasonable request, given that all of the information we provided was accurate and transparent.” The dispute relates only to Verizon’s disclosure of Mr. Seidenberg’s pay, and won’t change his actual compensation.

Mr. Seidenberg, who stepped down after 11 years as Verizon’s CEO on July 31 and as chairman on Dec. 31, was long one of the nation’s best-paid CEOs. He earned more than $130 million total from 2006 through 2010, according to Standard & Poor’s Capital IQ unit. The total includes salary, bonuses, and the value of restricted stock and stock options at the time they vested, including the $20 million at issue with the SEC. His pay was also a flashpoint for unions and Verizon critics. In 2006, the nation’s largest labor-union group, AFL-CIO, sought to oust directors on Verizon’s compensation committee, calling Verizon “the poster child for pay for pulse.” Last summer, amid a labor dispute, union representatives organized a candlelit “funeral for the middle class” outside Mr. Seidenberg’s home.

The clash highlights tougher SEC scrutiny of regulatory filings by big companies, as well as the challenge of valuing different flavors of executive pay. “It is becoming increasingly common” for the SEC to question details in quarterly and annual reports about executive compensation, corporate taxes and non-standard accounting measures, says John Olson, a partner at Gibson, Dunn & Crutcher in Washington, D.C. Still, pay consultants say it’s unusual for a company to change an already-reported compensation total.

The dispute between Verizon and the SEC has been brewing since June, though it only recently became public, when the 11 letters exchanged between the company and the agency were posted on the SEC’s website. SEC rules call for such letters to be posted 45 days after an issue is resolved, which occurred in early November in Verizon’s case.

At issue was how the company should disclose grants of restricted stock given to Mr. Seidenberg in 2007 and 2008. The grants were tied to the performance of Verizon’s stock over three-year periods, as well as the board’s assessment of Mr. Seidenberg’s performance on several strategic initiatives, such as revenue growth and subscriptions to Verizon’s fiber-optic video service.

Verizon reported the grants in its proxy statements for 2007 and 2008, as SEC rules require. At the time, it valued the grants based on the performance “target,” though it specified that Mr. Seidenberg could receive more shares if his, and Verizon’s performance, exceeded the targets. In 2008, the company said that the grant if Verizon were to meet its targets through the next three years would be 355,210 shares of Verizon stock, then valued at $13.1 million. After the three-year period ended in 2010, Verizon directors awarded Mr. Seidenberg 838,457 shares, then valued at $30 million.

Verizon’s stock performance accounted for some of the increase, but SEC staffers said Verizon should have included the discretionary portion of the award, roughly $13.8 million, in the “summary compensation table” of the proxy statement filed last March. That’s the convenient headline number often cited in media reports and by some investors. The summary compensation table reported Mr. Seidenberg’s 2010 compensation as $18.2 million. Including the discretionary grant would have increased the total 76%, to $32 million. For 2009, the SEC wanted Verizon to boost Mr. Seidenberg’s reported total compensation by $6.5 million, to $24 million. Verizon’s calculation method “has had and, may in the future, have the effect of under reporting compensation” in the summary table, the SEC said in an Aug. 5 letter. An SEC spokesman didn’t respond to requests for comment.

Mark Borges, a principal at Compensia, a management consulting firm, says there’s room for interpretation in the SEC’s rules for reporting performance-based awards, because company plans differ. But he says the SEC increasingly has been pushing companies for more disclosure. “The staff really wants companies, particularly when it comes to CEO compensation, to be as forthcoming as possible,” he says. Verizon’s Mr. Thonis says the company had disclosed the range of values for the grant in 2008, the amount ultimately awarded, and highlighted the figures in its proxy statement and in letters sent to some big shareholders.

– Ted Allen, ISS

As I recently blogged: Retail investor activist Jim McRitchie has filed a shareholder proposal at Apple that calls for an annual non-binding vote on outside director compensation at the technology company.

“This proposal is similar to our management’s proposal on this same ballot enabling us to cast a vote in regard to the pay of our executives,” McRitchie wrote in a recent blog posting about his resolution. “This shareholder proposal simply extends the shareholder voting opportunity to apply to our directors. Some of our directors are paid more than $1 million for work that may take less than 400 hours per year–or $2,500-plus per hour.”

In response to this proposal, Apple argues that the compensation for its non-employee directors is “reasonable and appropriate.” The California-based company points out that a substantial portion of directors’ pay is equity-based to “further align” the interests of directors with shareholders. The company said it has retained an independent compensation consultant to review its director pay each year. Apple plans to hold its 2012 annual meeting on Feb. 23.

Two outside Apple directors earned more than $1.07 million in total compensation from the company, while two others received more than $840,000, according to ISS’ 2011 report on Apple.

Investor proposals on director pay have had mixed success in recent years, as most shareholder activists have focused on advisory votes on executive pay, which were mandated by the Dodd-Frank Act of 2010. During the 2011 proxy season, five say-on-director-pay resolutions went to a vote and averaged almost 17 percent support, according to ISS data. The best showing was 46.4 percent approval at Chesapeake Energy, where outside directors receive personal aircraft usage as a perk.

[Broc’s note: This is not the first company to receive this type of “say-on-director-pay” proposal. This blog notes that three companies received this proposal last season.]