The Advisors' Blog

– 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.]

– Broc Romanek, CompensationStandards.com

As noted by Steve Quinlivan in his Dodd-Frank.com Blog:

Cincinnati Bell has agreed to settle one of the say-on-pay law suits which is pending against it in the Hamilton County Court of Common Pleas. The lawsuit arises out of the shareholder’s “say on pay” vote taken at Cincinnati Bell’s May 2011 annual meeting. The Dodd-Frank Wall Street Reform and Consumer Protection Act signed into law in July, 2010, requires that all public companies solicit an advisory shareholder vote on executive compensation. We previously reported on a related case here and here which survived a motion to dismiss.

According to Phillip R. Cox, Chairman of Cincinnati Bell’s Board of Directors, “The proposed settlement includes features which will clarify the Company’s executive compensation policies and which will more clearly communicate these policies to our shareholders. Importantly, the changes represented by this agreement should better assist our shareholders’ understanding of how these policies are applied to covered employees.”

One of Plaintiffs’ Counsel, Ed Korsinsky, adds that: “The longer-term and perhaps most important aspect of the settlement is that it provides a binding agreement that executive compensation decisions remain consistent with the Company’s pay for performance philosophy and that the Board of Directors will continue to clearly articulate the Company’s philosophy to its shareholders.” As part of this settlement, Cincinnati Bell will, among other things, reaffirm its pay for performance practice and provide for an annual discussion of its philosophy related to executive compensation.

Many may conclude the failed say-on-pay law suit which is settled for disclosure relief will become a shake down for an attorney fee award, much like numerous cases filed to block an acquisition. It will be interesting to see what kind of fee award the court grants for this type of “success.” That may drive how many of these litigations are filed in the future.

But the case settled is a different one than the case which survived a motion to dismiss. The effect of the settlement on that case, pending in the United States District Court for the Southern District of the Western Ohio Division, is unclear. However, that case has taken some unusual twists and turns.

After the court denied the defendants’ motion to dismiss, the defendants learned that diversity jurisdiction did not exist. Plaintiffs failed to identify itself as a citizen of Georgia and one of Cincinnati Bell’s defendant directors was a citizen of Georgia. Plaintiffs attempted to correct the subject matter jurisdiction by amending the complaint to drop the director which resides in Georgia and voluntary dismissal of the director. The court granted defendants motion to strike the amended complaint and voluntary dismissal as procedurally improper. Apparently the plaintiffs can still a motion to amend the complaint following the proper procedures.

But there is another twist to the case that can only make the defense bar smile. The court sua sponte issued an order to the plaintiffs attorney to show cause why the attorneys should not be sanctioned under Rule 11 for failure to conduct a reasonable inquiry into the factual contentions as to the alleged diversity. The court ultimately concluded it was an honest mistake but found the attorneys “incomplete answer to the Court’s direct question of him at oral hearing represented misbehavior of an officer of the Court in his official transactions.” As a result, the court revoked the attorneys pro hac vice admission in the case.

– Broc Romanek, CompensationStandards.com

The repercussions for those boards that rushed during the ’08-’09 market crash to dole out outsized option packages to their executives continues in the form of this front-page article in Friday’s NY Times. Hopefully, boards (and their advisors) will remember all this negative publicity if we experience a similar downturn this year – otherwise we will wind up with legislation that could well kill off options altogether as noted at the end of this blog from William Tysse of McGuire Woods, repeated below:

Are “tax breaks” from stock options a “windfall” for corporations?

The New York Times seems to think so. Their argument runs as follows:

Thanks to a quirk in tax law, companies can claim a tax deduction in future years that is much bigger than the value of the stock options when they were granted to executives. This tax break will deprive the federal government of tens of billions of dollars in revenue over the next decade….

In Washington, where executive pay and taxes are highly charged issues, some critics in Congress have long sought to eliminate this tax benefit, saying it is bad policy to let companies claim such large deductions for stock options without having to make any cash outlay….

A stock option entitles its owner to buy a share of company stock at a set price over a specified period. The corporate tax savings stem from the fact that executives typically cash in stock options at a much higher price than the initial value that companies report to shareholders when they are granted.

But companies are then allowed a tax deduction for that higher price.

(Somewhat later, the article does get around to acknowledging that the employees who exercise the options are also taxed at that higher price — often at individual rates higher than the corporate rate.)

The proposal that the article seems to advocate — i.e., to allow companies a deduction for only the accounting expense of the option, instead of the gain recognized on exercise — raises a number of questions:

– Should companies be allowed this deduction as expense is recognized, even if the option ultimately expires unexercised, because for instance the employee terminates when the option is underwater?
– Should individuals be taxed only on the accounting expense as well — regardless of when (or indeed if) they exercise the options, and regardless of the actual gain they realize upon exercise?
– What economic difference is there between “cash outlays” and share outlays that would justify this disparate treatment? Although the article focuses on options, wouldn’t the same logic apply to other forms of stock-based compensation, such as restricted stock? And wouldn’t this change, if implemented, simply push companies to pay the same compensation in cash instead of shares? Is that a desirable policy result?

Although it doesn’t attempt to grapple with any of these issues, the article does go on to note that legislation to enact this change has been floating around in Congress for years, but has never gone anywhere. Despite this, budget shortfalls and election year politics may nevertheless conspire to turn 2012 into the year that this change finally becomes law. And that would likely spell the end of stock options for good.

– Broc Romanek, CompensationStandards.com

Yesterday, ISS published its promised white paper that describes the pay-for-performance methodology under which it will implement its 2012 policy updates. ISS will begin to apply this new methodology on February 1st. Here’s an excerpt from a Wachtell Lipton memo by Michael Segal, Jeannemarie O’Brien, Jeremy Goldstein and Timothy Moore (that will be posted later today):

The test is one of the primary methods by which ISS determines whether to recommend for or against a company’s management say-on-pay vote, with companies failing the test being deemed to have a “pay for performance disconnect.” In determining whether there is a “pay for performance disconnect” this proxy season, ISS will measure the degree of alignment between CEO pay and total shareholder return within the subject company’s peer group for a one- and three-year period, as well as the absolute alignment between CEO pay and the company’s TSR over a five-year period.

The white paper specifies that ISS will select 14 to 24 peer companies against which the subject company’s TSR performance and CEO pay will be measured for the one- and three-year periods ending on the last day of the month closest to the subject company’s fiscal-year end. Peer companies will be limited to those in the same two-digit GICS category as the subject company, each with annual revenues (or assets for financial companies) between 0.45x and 2.1x the subject company’s revenues (or assets) and a market capitalization between 0.2x and 5x the subject company’s market capitalization. This list of companies will then be filtered to 14 to 24 companies in the subject company’s six-digit GICS category (or four- or two-digit category if fewer than 14 companies exist in the six-digit category), with companies “closest in size” (presumably based on market capitalization or assets) selected first and larger and smaller companies added to maintain the subject company at or near the median size of the list of peer companies.

“Super-mega” non-financial companies (approximately 25 Russell 3000 companies each with greater than $50 billion in annual revenues and at least $30 billion in market capitalization) will collectively comprise a stand-alone peer group, and ISS will compare their respective one- and three-year TSR performance and CEO pay against the members of that group. In each case, annual revenues, assets and market capitalizations will be determined as of June 1 or December 1 (presumably the relevant year is the year prior to the year in which the proxy is definitively filed).

Now that the white paper has been released, companies can assess how their TSR performance and CEO pay will compare to that of their peers under ISS’ test. Companies should use the criteria set forth in the white paper to determine whether they are likely to have a “pay for performance disconnect” based on these criteria, and, if so, what actions, if any, are advisable to take in light of this analysis.

Yesterday, ISS also announced a new version of its Governance Risk Indicators (GRId 2.0), and issued information about the changes that will become effective in February.

– Broc Romanek, CompensationStandards.com

A long while back, Frederic W. Cook & Co. issued this report that examines change-in-control trends over the three year period, 2007-2010. It shows that practices are evolving as multiples come down and double-triggers become more popular, as well as gross-ups going the way of the Dodo…

– Broc Romanek, CompensationStandards.com

In this podcast, Larry Cagney of Debevoise & Plimpton explains a new idea for an executive compensation program – Debevoise & Plimpton Retention Incentive Bonus (the “DEEP RIB”) – that takes a slice of an executive’s future short-term incentive compensation and converts it into a long-term investment in the company’s stock (essentially, it is a mandatory executive stock purchase program that pre-funds an executive’s purchase out of future bonuses, but in a way that does not implicate the personal loan provisions of SOX), including:

– What is the “DEEP RIB”?
– How does it stack up to long-term incentives in place today?
– What types of companies should consider this?
– What are the reactions from clients so far?

– Broc Romanek, CompensationStandards.com

Here’s a query recently posted in our “Q&A Forum” (#893):

Does anyone have a sense of what market practice will be with respect to say-on-pay frequency votes this year for companies whose shareholders voted in favor of annual say-on-pay votes last year? I wonder whether companies that recommended in their 2011 proxy statements that shareholders approve say-on-pay votes every three years, but whose shareholders voted for annual say-on-pay votes, might take another shot at getting approval for a vote every three years? Probably only makes sense to do so for certain companies (i.e., close vote last year, or perhaps a significant change in institutional ownership), but there’s nothing prohibiting a company from putting a say-on-pay frequency proposal up for a vote again this year, right?

And here’s how Dave Lynn answered the question:

You are correct, the Say-on-Frequency proposal could be put up for a vote again this coming year if a company elected to do so, as the Dodd-Frank and SEC rule requirement is that the vote be taken at least every six years, but doesn’t prohibit an earlier advisory vote. I would be very surprised to see many company’s trying again on the Say-on-Frequency vote unless, as you say, there was some compelling change in circumstances that would indicate the vote will go the other way.