The following are excerpts from a recent Governance Exchange interview with Jella Benner-Heinacher, managing director and counsel for Deutsche Schutzvereinigung fur Wertpapierbesitz (DSW), which is Germany’s largest association of retail investors. The German government has commissioned DSW to study the impact of 2009 legislation requiring an advisory vote on executive compensation. Stephan Costa of the ISS London office conducted this interview.
Costa: The Act of Appropriateness of Management for Compensation came into existence a little over a year ago, in August 2009. This initiative changes the practice of management compensation and its determination by the supervisory board. DSW was tasked by the German government to study the effectiveness of this law. Can you provide us with some background and key findings of the study?
Benner-Heinacher: Sure. First of all, I would like to underline that this new law has had a large impact on our daily work and on the corporate governance practices in Germany. DSW was asked by the German government to prepare a study on our experiences with this new “say on pay” system for the 2010 proxy season. Although the study is not yet published, let me tell you about some of the key findings.
Let’s start with some statistics. Twenty-eight out of the 30 DAX companies–the leading and the largest companies in Germany–introduced a new pay system for directors. I find this to be quite revolutionary by German standards. Twenty-one out of 30 DAX companies consulted an external expert on remuneration for advice when they prepared their new pay systems. This indicates that, before now, this was not the case. In my opinion, this is quite revealing. And obviously, there was need for external advice.
Twenty-six of the 30 DAX companies actually put this new “say on pay” possibility on their agenda this season. One company didn’t put it up as a resolution, but [presented it instead] for informational purposes only. So, I would say the majority of the DAX 30 companies really used this new law, and tried to ask their shareholders to support the new pay system. This represents quite a big step for Germany.
Costa: What did the German government seek to achieve by introducing “say on pay”?
Benner-Heinacher: Its intention was very clear. It wanted to introduce a higher degree of responsibility for the members of the supervisory board. The supervisory board is responsible in Germany for fixing the remuneration of directors [on the management board]. This requires them to look at the long-term variable part of pay and sustainability regarding the incentives of pay. This can also be partially attributed to the lingering effects of the financial crisis.
Costa: Do you see a movement toward this aim being achieved?
Benner-Heinacher: Yes. But, we have to be careful, because we had a look at the DAX 30 companies, which are the leading and the largest companies in Germany. But we should not generalize. We also had a look at the midsize and the smaller companies in the MDAX, SDAX, and TecDAX. And to tell you the truth, there is still a long way to go. Only a few of the mid- and smaller cap companies really paid close attention to the new rules. The clear majority of the MDAX companies did not.
Costa: Do you think that there was a cost consideration of implementation?
Benner-Heinacher: No. I think it’s always the DAX 30 companies that lead the way in Germany. They’re still the model companies for corporate governance change. Everyone is looking at them to see what they are doing. For the first proxy season, these changes were accepted by the DAX 30 companies. Hopefully, the medium and smaller-cap companies will follow suit in 2011 and 2012.
Costa: Were there any examples of significant shareholder votes against remuneration this past proxy season? And if so, what were the shareholders’ reasons for opposing?
Benner-Heinacher: Yes. There’s actually one very good example, and that was the general meeting of Heidelberger Cement. The majority of shareholders–54 percent–voted against [management’s “say on pay” proposal.] Now you would say it’s not binding, and it’s only an advisory vote; but nevertheless, the public criticism was very loud. And the supervisory board promised that they will reexamine the pay system going forward.
The reason why the majority of the shareholders opposed the “say on pay” [proposal] was in their view the inappropriateness of the pay. And there was also an issue of a EUR 5 million extra bonus for the directors. This did not please the shareholders. Second, besides the inappropriateness, there was also a lack of transparency of the directors’ pay. So, if shareholders do not really understand the “say on pay” system and are not convinced that this is the right one, then they will vote no.
Costa: This legislation has aligned Germany with the U.K. and Holland, where it’s common practice for the shareholders to vote on executive remuneration and where companies consult investors on a regular basis about such issues. Have you seen a noticeable increase in dialogue between investors and the board, as we have seen in the U.K. and in Holland?
Benner-Heinacher: Yes. We are seeing a real strengthening of the dialogue between the institutional investors, investor representatives such as DSW, and the issuers. Not as much at the board level, because in the German system, it’s the investor relations manager who is tasked with meeting with shareholders. But it is fair to say that there is an ongoing dialogue, especially before the general meeting season even gets started.
As noted in this K&L Gates memo, the FSA in the United Kingdom has released a set of Remuneration Policy Statement Templates and other guidance. And here’s updated information from Barbara Nims and Gillian Emmett Moldowan repeated from Davis Polk’s blog:
On August 5, 2011, the UK Financial Services Authority (FSA) proposed two draft “Dear CEO” letters providing guidance on issues relating to the revised Remuneration Code, which came into force on January 1, 2011. The Remuneration Code covers a relatively wide-range of financial institutions in the UK (both UK firms and non-UK firms with branches in the UK) including banks, building societies and broker-dealers (over 2,500 institutions in all). The letters, one of which is for firms in proportionality tier 1 and the other for firms in proportionality tiers 2, 3 and 4, detail how the FSA plans to monitor implementation of the Remuneration Code and provide guidance on FSA policy with regard to the Code. Each letter contains annexes that provide specific guidance on the following topics: the definition of “Code staff”, expectations regarding qualifying long-term incentive plans and how firms may interpret the share-equivalent payment instrument alternatives.
The tier 1 letter and the letter for tiers 2, 3 and 4 differ with respect to how the FSA will assess a firm’s compliance with the Remuneration Code. Each tier 1 firm will be subject to an annual compliance review, which will include, among other elements, meetings between the FSA and the firm. Further, while all firms are required to prepare a Remuneration Policy Statement (RPS) within a given timeframe, only tier 1 firms must automatically submit their policies to the FSA (non-tier 1 firms need only submit an RPS if specifically requested by the FSA). A RPS template for tier 1 firms was published by the FSA along with the “Dear CEO” letters. The RPS templates for tier 2, 3 and 4 firms were published on April 19, 2011.
Here is the FSA notice announcing the proposed guidance, including links to the draft “Dear CEO” letters and annexes. The FSA is inviting comments to the proposed letters until September 2, 2011.
As expected, the Canadian Securities Administrators (CSA) have released a final version of the proposed disclosure amendments to Form 51-102F6 Statement of Executive Compensation. Issuers with fiscal years ending on or after Oct. 31, 2011, will be subject to the amended disclosure rules.
Pursuant to these updated rules, issuers will be required to disclose the following significant provisions:
– A detailed explanation in the Compensation Discussion & Analysis (CD&A) section as to whether and why a company is relying on the competitive harm exemption to not disclose performance goals;
– Information pertaining to peer compensation benchmarking groups, including a description of why the benchmarking group and selection criteria are relevant to the company;
– Also in the CD&A, a new requirement that companies disclose whether the board of directors considered the implications of the risk associated with the company’s compensation policies and practices;
– A new provision in the CD&A requiring a company to disclose whether any director or named executive officer (NEO) is permitted to purchase hedging instruments to offset a decrease in the market value of equity securities granted as compensation or otherwise held by the director or NEO;
– Greater compensation committee disclosure including members’ independence and relevant experience as well as an overview of how the committee functions;
– Expanded disclosure with regard to the work performed by compensation advisers and a breakdown of the fees paid to each consultant for services related to executive compensation and all other services, if any;
– Clarification that disclosure regarding the methodology used to calculate the grant date fair value of all equity-based awards must accompany the Summary Compensation Table (SCT) in which the grant date fair value amounts appear;
– A new column in the incentive plan awards table which discloses the value of vested share-based awards that have not been paid out or distributed;
– To calculate the annual lifetime pension benefit payable for those NEOs who are not yet eligible for benefits, the company must assume that the NEOs are eligible to receive payments or benefits at year-end. Also, any company contributions made on behalf of any NEO under a personal retirement plan must be disclosed in the “Other Compensation” section of the SCT. The non-compensatory amounts for defined contribution plans will no longer be required disclosure.
The above updates have not been significantly altered from when they were initially proposed in November 2010. As Canada’s executive compensation disclosure rules evolve to align closer to the U.S. model, these amendments should allow shareholders a better understanding of how and why executive compensation decisions are made as well as the overall outcomes of those decisions.
– Jeannemarie O’Brien and Jeremy Goldstein, Wachtell Lipton
As noted in this memo, a number of derivative suits have been filed in recent months alleging that the senior executive compensation plans at public companies do not comply with Section 162(m) of the Internal Revenue Code. Section 162(m) provides that any compensation paid to the CEO and next three highest compensated proxy officers (other than the CFO) in excess of $1 million per year is not tax deductible unless, among other things, the compensation is subject to objective performance metrics that have been disclosed to and approved by shareholders.
The complaints generally allege that the performance goals established by the plans are not sufficiently objective to comply with Section 162(m) and that the purported failure of the plans to comply with Section 162(m) renders the required proxy disclosure false and misleading in violation of Section 14(a) of the Securities Exchange Act. In addition, the complaints allege that the provision of non-deductible compensation to senior executives constitutes waste, unjust enrichment of the executives and a breach of the directors’ duty of loyalty.
We view these suits as meritless and symptomatic of the excesses that led to reform in other areas of shareholder litigation. In each of the challenged plans that we have reviewed, the terms of the plans do in fact comply with Section 162(m) and the disclosure relating to the plans expressly states that non-deductible compensation may be granted if the compensation committee determines that doing so is in the best interest of the company.
Moreover, the complaints that we have reviewed, alleging that the performance goals are not sufficiently objective to comply with Section 162(m), reflect a basic lack of understanding of the operation of typical Section 162(m) plans in which the compensation committee establishes an objective Section 162(m) goal, which, if met, would then provide the committee with the discretion to make an award below the amount authorized by the plan. This “plan within a plan” structure is expressly permitted by the Code. In addition, there is no legal obligation for compensation committees to grant only compensation that is deductible under Section 162(m). The courts have largely gotten this right by ruling against the plaintiffs on motions to dismiss (see, for example, Justice Stark’s well reasoned opinion in Seinfeld v. O’Connor).
These suits nonetheless serve 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. Companies should design plans to make compliance with Section 162(m) as easy and straightforward as possible. The “plan within a plan” design is the most efficient means of achieving this goal. Equally important, proxy disclosure should not guarantee that all compensation awarded will comply with Section 162(m). Instead, proxy disclosure should say that plans are “intended to” comply with Section 162(m) and that the company may elect to provide non-deductible compensation.
As I head out on vacation, I thought I would leave you with this interesting two-part series of memos from the proxy solicitor, Alliance Advisors, regarding how say-on-pay played out this past proxy season:
With the odds of Congress taking action to alter Section 953(b) of Dodd-Frank – the section eliciting pay disparity disclosures – looking pretty slim, the battle to influence the SEC ahead of a proposal coming out is heating up. Last week, I blogged about the AFL-CIO’s new white paper on the topic.
Now we have this comment letter from 22 corporate lawyers (which is not yet posted with the other comment letters sent to the SEC). Here’s a description of the comment letter from Cleary Gottlieb:
Although final rulemaking on the Dodd-Frank (Section 953) CEO pay ratio disclosure requirement has now been delayed until the first half of 2012, we thought you would be interested in this SEC comment letter that addresses many of the conceptual deficiencies of the requirement. The comment letter was a collaborative effort by many leading executive compensation lawyers and supports wholesale repeal of the requirement or, failing that, advocates several modifications to ease the burden of the requirement. Those modifications include:
– At least two years of implementation time following adoption of the rule;
– Exclusion of non-US employees from the calculation;
– A safe harbor for using W-2 compensation (or comparable measurement for non-US employees, if they are included in the calculation) in lieu of “total compensation” as defined by the proxy rules for non-NEO employees;
– A “good faith efforts” standard for determining the median amount of pay;
– Flexibility in selecting the date as of which median pay is determined; and
– Authorization to provide an alternative voluntary measure of relative CEO pay, such as for example the ratio of CEO pay to average pay of private non-farm workers as compiled by the Bureau of Labor Statistics, which would promote comparability of disclosure across companies.
– During the first year of advisory votes on executive compensation under Dodd-Frank, investors overwhelmingly endorsed companies’ pay programs, providing 91.2% support on average.
– Shareholders voted down management “say on pay” proposals at 37 Russell 3000 companies, or just 1.6% of the total that reported vote results. Most of the failed votes apparently were driven by pay-for-performance concerns.
– “Say on pay” votes spurred greater engagement by companies and prompted some firms to make late changes to their pay practices to win support.
– Investors overwhelmingly supported an annual frequency for future pay votes, even though many companies recommended a triennial frequency.
– Among governance proposals, the biggest story this year was the greater support for board declassification. Shareholder resolutions on this topic averaged 73.5% support, up more than 12% from 2010, and won majority support at 22 large-cap firms.
– Shareholder resolutions on environmental and social issues reached a new high of 20.6% average support. Five proposals received a majority of votes cast, a new record.
– The arrival of “say on pay” contributed to a significant decline in opposition to directors. As of June 30, just 43 directors at Russell 3000 firms had failed to win majority support, down from 87 during the same period in 2010. Poor meeting attendance, the failure to put a poison pill to a shareholder vote, and the failure to implement majority-supported investor proposals were among the reasons that contributed to investor dissent.
As it has done before, the SEC has adjusted its tentative rulemaking calendar to push back some of the expected proposal and adoption dates for the remaining executive compensation and corporate governance items on its agenda. Thanks to Mike Melbinger, who blogged this information yesterday on CompensationStandards.com (see Davis Polk’s blog for more analysis):
On Friday, the SEC modified its schedule for adopting rules relating to the Dodd-Frank Act, including the key provisions applicable to executive compensation, as follows:
August – December 2011 (planned)
– §951: Adopt rules regarding disclosure by institutional investment managers of votes on executive compensation
– §952: Adopt exchange listing standards regarding compensation committee independence and factors affecting compensation adviser independence; adopt disclosure rules regarding compensation consultant conflicts
January – June 2012 (planned)
– §953 and 955: Adopt rules regarding disclosure of pay-for-performance, pay ratios, and hedging by employees and directors
– §954: Adopt rules regarding recovery of executive compensation
– §956: Adopt rules (jointly with others) regarding disclosure of, and prohibitions of certain executive compensation structures and arrangements
July – December 2012 (planned)
– §952: Report to Congress on study and review of the use of compensation consultants and the effects of such use
Dates still to be determined
– §957: Issue rules defining “other significant matters” for purposes of exchange standards regarding broker voting of uninstructed shares
Thus, it seems unlikely that all five of the clawback, pay-for-performance, CEO pay ratio, incentive compensation rules for large financial institutions, and hedging by employees and directors provisions will be effective for next year’s proxy season. However, if they meet this schedule, one or two of the provisions will be effective for proxies filed after January (as with the say on pay rules, published in January 2011). Fortunately, the SEC will propose rules first (and already has for a couple of the provisions), so we should know well in advance which provisions will be final for the 2012 proxy season.
We continue to post numerous reports about the results of say-on-pay from this past proxy season in our “Say-on-Pay” Practice Area – including this one from Bentham Stradley and Ira Kay of Pay Governance. Also check out this blog from Matt Orsagh of the CFA Institute which describes say-on-pay developments in various countries.
Regardless of your political bent, you will enjoy’s last night’s 5-minute skit from “The Daily Show with Jon Stewart” that tackles the 1-year anniversary of Dodd-Frank. Jon Oliver is dressed up in a beaten-up costume representing the legislation and sings his answers to Jon’s questions about where the rulemakings stand now, etc. Pure comical genius: