Here is something that GMI’s Paul Hodgson recently blogged:
In a press release last week, Sen. Carl Levin, D-Mich., and Sen. Sherrod Brown, D-Ohio, announced that they had introduced legislation to end tax breaks for stock options. Since they are considered performance-related pay, stock option expense is subject to corporate tax relief under Section 162(m) of the IRC. However, the tax relief is given on the actual expense of the stock options, based on the profits made by the executives at the time the options are exercised. This, Sen. Levin and Sen. Brown have discovered, is a much larger figure than the expenses recorded in company accounts, which estimates the cost of the option at its grant date. This differential, the senators claim, is a huge corporate tax break, and closing the loophole would net the Treasury about $25 billion.
This is priceless information and an eye-popping piece of legislation and there are almost too many conclusions here for one little blogger to deal with.
– If this is true, companies are seriously underestimating the costs associated with stock options, thus bamboozling shareholders and the markets.
– If this is true, companies are seriously underestimating the amount of pay being granted to their executives, thus bamboozling everyone.
– If this is true, I was right all along in insisting that the SEC use the amount recorded as profit as the proper record of pay for executives, even though it ignored me.
– If this is true, virtually every other pay survey – apart from ours – is not just wrong but seriously underestimates the amount of pay that executives receive.
But the real doozy is left to the end, in the summary of the bill. Just read this:
– make stock option deductions subject to the existing $1 million cap on corporate tax deductions for compensation paid to top executives of publicly held corporations.
In other words, stock options will no longer be considered performance-related pay under Section 162(m). That’s fine by me. I never thought market-priced stock options should be in the first place. Of course, there should be exceptions – premium-priced options, index-linked options, performance-vesting options. But if this went through this would be the death knell of the market-priced option for all but the smallest companies which aren’t affected by the $1 million cap anyway.
According to this Washington Post article yesterday, the SEC’s Commissioners have disagreed with its Enforcement Staff to settle the CSK Auto clawback case because the penalty amount was too low. It’s relatively rare that the Commission disagrees with its Enforcement Staff – but certainly not unheard of – but it is rare that a closed Commission meeting outcome like this is made public. Here is the WaPo article in its entirety:
The SEC has rejected a proposal by its own enforcement staff to settle a landmark case in which the agency is trying to force a former corporate chief executive to give up millions of dollars in bonuses and stock profits he received while the company was cooking its books. The plan to settle for significantly less money than the agency originally sought posed a test question for the Securities and Exchange Commission: Was the staff letting the former executive off the hook too easily? Or was the agency being overzealous when it brought the case in the first place?
Both sentiments combined to torpedo the deal when the commissioners weighed the proposal last week, according to a source close to the matter. The case involves Maynard L. Jenkins, former chief executive of CSK Auto, an Arizona-based auto-parts retailer that had to correct years of financial statements. In 2009, the agency sued Jenkins, saying he should repay the auto parts retailer more than $4 million that he reaped while the company was “engaged in a pervasive accounting fraud.” Jenkins, however, was not personally charged with fraud.
It was the first time the SEC had filed a so-called clawback suit to wrest money from an executive who was not accused of complicity in accounting fraud. The SEC was using the watershed Sarbanes-Oxley law enacted in 2002 in response to accounting scandals at companies such as Enron and WorldCom. The law calls for chief executives and chief financial officers to forfeit stock profits or bonuses they receive while their company is misleading the public about its financial performance.
He and the SEC staff notified the trial court in March that they had reached a tentative settlement, subject to approval by the SEC’s governing commissioners. On Monday, they notified the court that their efforts “have not been successful.” The proposed settlement was for less than half the amount the SEC originally sought, according to a second source familiar with the matter.
Jenkins and the staff thought the deal was in both his interest and that of the agency, but a bipartisan majority of the SEC’s commissioners disagreed, the first source said. Both spoke on condition of anonymity because the information involved internal SEC deliberations. “We cannot comment on Commission deliberations, but we will continue to pursue the case vigorously,” SEC spokesman Kevin J. Callahan said by e-mail. John W. Spiegel, a lawyer for Jenkins, declined to comment.
The law’s clawback provision was meant to hold top executives accountable for fraud and to prevent them from profiting from it. It can encourage executives to be vigilant, but it can also penalize executives who had nothing to do with the wrongdoing. The objective is to reimburse the company and shareholders. But it can cost companies money to recoup money.
In a January court filing, CSK Auto said it is responsible for Jenkins’s legal costs. The company has been billed “approximately $1.9 million in legal fees and costs associated with Mr. Jenkins and $1.5 million since litigation commenced” in the SEC’s case against him, according to a court filing by Jeffrey L. Groves, general counsel of CSK’s parent company, O’Reilly Automotive. Those costs have been covered by an insurer for CSK, according to another court document.
Jenkins is 68 and in declining health, his lawyers said in a January court filing. The SEC lawsuit has left him in financial limbo, they wrote. As long as it remains unresolved, he “cannot plan financially for his future and that of his family,” they said.
His defense team has argued that the SEC “is attempting to impose a Draconian penalty on an admittedly innocent person.” “The SEC’s nonsensical view is that Mr. Jenkins must pay (literally and figuratively) for . . . misconduct by others beca use he was the ‘captain of the ship,’ despite the fact that under its own view of the evidence, his crew was mutinous,” his lawyers have argued.The rejection of the settlement came soon after the SEC took flak for a settlement in which it fined J.P. Morgan Securities but took no action against any of the firm’s employees or executives. In another case, SEC Commissioner Luis A. Aguilar last week took the extraordinary step of publicly dissenting from an SEC enforcement action on the grounds that it was too weak. The rejection of the Jenkins settlement sets the stage for a civil trial.
Barring a new settlement, the case will test the SEC’s application of the clawback law, and it will call on the agency to prove that CSK’s accounting involved “misconduct” rather than innocent error.
We have posted the Summer 2011 issue of our Compensation Standards newsletter that contains practical guidance (and numerous specific examples) in the aftermath of a hectic proxy season. The Summer issue covers:
– The Evolving Role of the Executive Summary
– Coordinating the Executive Summary and the Say-on-Pay Supporting Statement
– The Newest Disclosure Tool – The Proxy Statement Summary
– The Second Round of Compensation-Related Risk Disclosure
– A Preview of the Coming Consultant Disclosure
– What to Expect in 2012
Print it out now so you can read Mark Borges’ guidance today…
– Jeffrey London, Mary Lou Zwick and Brian Witkowski, Kaye Scholer
As noted in our recent memo on clawbacks, there are a number of open issues that the SEC will presumably address with its regulations, including the definition of “executive officers” as explained above. What follows is a list of some of the more interesting issues left open by the statute:
1. Unilateral Policy versus Bilateral Agreements – The statute imposes an affirmative duty upon companies to recover excess incentive compensation but is silent as to whether the executive officer must consent to the clawback. Applying this rule literally, companies may be required to recover amounts that they are not contractually entitled to recoup. For example, most employment agreements provide that bonuses are vested once earned and, therefore, may not contractually be recovered. Similarly, mutual releases of claims entered into with departing executives presumably bar the company from asserting any claims to recover compensation. The regulations will need to address whether companies can unilaterally implement a clawback policy or whether they must obtain the executive officers’ consent.
2. Retroactivity – One of the more significant issues left open by the statute is whether the clawback requirements will apply retroactively to incentive compensation awards granted or paid prior to the effective date of the regulations. Along those lines, if the regulations do provide for retroactive application, it is unclear whether executive officers whose employment terminates before the regulations become effective will be subject to the clawback requirements. The regulations will also presumably address whether an individual who was not an executive officer at the time of an award of incentive compensation, but who becomes an executive officer prior to an accounting restatement, is subject to the clawback requirements.
3. Equity and Equity-Based Awards – Equity and equity-based incentive compensation awards present a number of issues open to interpretation under the statute. For example, the statute generally does not provide guidance as to the meaning of “incentive-based compensation.” However, it does reference stock options as one type of “incentive-based compensation.” The regulations could adopt a narrow definition of “incentive-based compensation” that excludes purely time-based stock options and restricted stock (i.e., limit the clawback only to performance-based compensation).
Another question is whether equity-based awards that were granted based on reported metrics, but which have not yet vested, will be considered “received” under the statute and therefore subject to the clawback requirements? And when are awards valued for purposes of determining excess compensation? Perhaps the rules will compare the value at the date of grant, or alternatively immediately prior to the announcement of the restatement (when the markets presumably have not priced in the accounting discrepancy), to the value immediately following the restatement or some other time?
4. Indemnification Obligations – It is common practice for public companies to provide for indemnification of executives for certain costs incurred by the executive in defending against or settling a lawsuit, provided certain good faith requirements are met. As Dodd-Frank clawbacks are not limited to restatements due to misconduct, these indemnification provisions could potentially cause a company to be legally obligated to repay an executive officer for amounts the company recovers under its clawback policy. Companies could go a step further and enter into indemnification agreements specifically covering any amounts recovered under a clawback policy. As these agreements would undermine the purpose of the statute, and would be against public policy, the SEC will presumably need to address how Dodd-Frank will impact these arrangements.
5. Wage Laws – Clawbacks under Dodd-Frank could potentially violate applicable state wage payment laws or similar foreign laws. Although many state laws exempt incentive compensation, companies should be prepared to perform a review of the laws in the applicable jurisdictions once the regulations are implemented. Presumably, Dodd-Frank, as a federal statute, will preempt state wage payment laws, but this is not certain.
6. De Minimis Clawbacks – As drafted, the statute does not permit companies to forego a clawback in cases where the “excess” incentive compensation paid is de minimis or if the costs of recovery would exceed the recoverable amount. Whether the regulations will permit exceptions under these scenarios remains to be seen.
Last month, Premiere Global Services became the 40th company to file a Form 8-K reflecting a failure to get majority support for it’s say-on-pay agenda item (47%). A list of the Form 8-Ks of these companies is in CompensationStandards.com’s “Say-on-Pay” Practice Area (bearing in mind that totals for three of these companies are somewhat in dispute). 40 failures is less than 2% of all companies that had say-on-pay on their ballot this season.
So what does this all mean? On the one hand, the relatively low percentage of companies failing has led commentators to label say-on-pay as insignificant as a force for needed change, such as this blog by Bob Monks and this one from Paul Hodgson. On the other hand, many corporate advisors are holding up this season’s results as evidence that more change in pay practices is not necessary.
My take is that it’s too early to tell what it means (including what level of “against” votes is a red flag that some pay practices are problematic – clearly, there are levels below a majority that should give boards pause). I believe this year was a test year as many institutional investors weren’t prepared for the massive undertaking that a true look at pay packages for their portfolio companies entails. In addition, we didn’t see much in the way of grass roots movements – surprising in this social media age. The potential for potent and inexpensive campaigning online against a company’s say-on-pay vote will continue to loom. Five years from now – particularly when say-on-pay then applies to the numerous small companies that have a temporary bye right now – we’ll have a better sense of what say-on-pay really means.
To be honest, 40 failures is many more than I expected. That should be clear from the poll I posted on this blog back in January asking y’all to guess how many failures there would be. In hindsight, the choices I offered in the poll revealed how low I thought the numbers would be. I offered choices of 0 failures (which garnered 1% of votes); 1-2 failures (1%); 3-4 failures (3%); 5-10 failures (18%); and More than 10 failures (75%). I should have broadened the choices – and I will next year.
I’m still mystified that most directors appeared to be unsupportive of say-of-pay before Dodd-Frank mandated it. So many are resting easy now , having shareholders bless their pay packages with flying colors. As I blogged a few years back, these boards now have a likely shield from liability and from reputational attack. I could always understand why board advisors didn’t like say-on-pay – it’s a lot more work with no additional resources during an already busy proxy season – but I never understood why directors would be against it. But maybe they saw those say-on-pay lawsuits coming…
Four Senate Democrats have said they would oppose the repeal of a Dodd-Frank Act provision that would require companies to disclose the ratio between their CEO’s total compensation and the median total pay of all other employees. In a letter last week, Senators Robert Menendez of New Jersey, Tom Harkin of Iowa, Sherrod Brown of Ohio, and Carl Levin of Michigan defended Section 953(b) of the Dodd-Frank legislation and urged a corporate lobbying group to drop its opposition to this provision. Menendez and Brown are members of the Senate Banking Committee, which has jurisdiction over corporate disclosure issues.
“If we are to generate a long-lasting recovery, we need to ensure that hard-working middle class families are once again able to share in their company’s successes through rising wages and benefits, just like CEOs have done for decades,” the four senators wrote. “Section 953(b) of the Wall Street Reform Act will help to further this important goal by increasing transparency, encouraging firms to take a harder look at the rising pay discrepancies between CEOs and their workers, and providing investors and policymakers with a better understanding of pay.”
The senators’ letter specifically cited the $12 million pay package received in 2010 by Lowe’s CEO Robert Niblock, which the lawmakers said was “380 times the $31,637 pay of department managers” at the retailer. The letter also pointed out that some companies, such as Whole Foods Market and MBIA, have disclosed pay ratio information voluntarily in their most recent proxy statements.
Section 953(b) has not taken effect, and the SEC plans to issue proposed rules to implement this provision later this year. Companies and their advocates have complained that Section 953(b) would impose a significant compliance burden, especially on large multinational companies that have employees around the world. However, the AFL-CIO labor federation has argued that this provision would prod boards to set executive compensation based on a company’s own organizational needs, rather than based on executive pay at other firms.
On June 22, the House Financial Services Committee voted 33-21 to approve HR 1062, the Burdensome Data Collection Relief Act, which would repeal Section 953(b). It appears likely that HR 1062 will win approval from the Republican-controlled House of Representatives. The legislation’s prospects are less certain in the Senate, where Democrats still have a majority.
Meanwhile, institutional investors (which are Form 13F filers) still are waiting for the SEC to issue final rules on another Dodd-Frank mandate–the disclosure of proxy votes on “say on pay,” pay vote frequency, and “golden parachutes.” The SEC now states that the final rules will be released by the end of July, but the commission has made similar pledges since March. The filing deadline in the draft disclosure rules is Aug. 31, but agency observers expect that this deadline will be extended.
Equilar’s 2011 Executive Compensation Summit yielded some interesting observations from the June 13-15 panels and discussions:
– Dodd-Frank regulations: The general consensus of the panelists was that the regulations on clawbacks, CEO-to-median-employee pay ratio and other compensation-related provisions probably wouldn’t be to the exchanges until July 16th and that there would be a 90-day period for the exchanges to respond. At that point, the SEC would have up to a year to respond. Thus, the general sentiment was that many of the Dodd-Frank rules that have yet to be implemented probably won’t be instituted until the 2013 proxy season.
– Say on parachutes: While considerable attention has been focused on say on pay, there was some discussion related to anticipated increased attention and focus on say on parachutes. So far, these proposals have been under the radar, but there’s the potential for additional scrutiny to the extent that deals continue to increase if/when market conditions allow.
– Pay for performance: This discussion highlighted the greater use of graphic/tabular disclosures to get companies’ pay-for-performance message across. As we’ve all experienced, there are continued questions around how best to measure performance and pay and whether the SEC will provide any clarity regarding those questions (the general sentiment: doubtful).
– Clawbacks: One panel discussed clawback provisions and concluded that, while many companies have them, most do not comply with what’s expected to be required under Dodd-Frank. That said, most companies do not want to modify them at this point, but instead will wait until the final rules are issued to adopt/modify their provisions. (There also was some discussion about implementing clawbacks now with language stating that they would need to be compliant with any ongoing changes in the regulatory environment.)
– Say on pay: While say on pay was obviously a hot-button issue for 2011, one speaker observed that it’s really just another avenue for investors to review and comment about issues regarding pay. Instead of withholding votes from board/compensation committee members to express dissatisfaction with pay decisions, investors were voting against say-on-pay resolutions where they had issues with pay. With the former, potential remedies could possibly involve ousting a director; with the latter, there are a number of more targeted, reactive steps a company can take to respond to shareholders ahead of the next say-on-pay vote.
Recognizing ours is a society built on competition, one presenter predicted that there will be a growing interest in keeping score as it pertains to say on pay in coming years, particularly relative to peers. There was also some debate about what constitutes an acceptable level of say-on-pay support or, alternatively, what was too much opposition. There was general agreement that anything below 70%-80% support means the company should really be examining what went wrong in terms of the compensation program relative to peers.
Finally, there was recognition that the easy work is largely behind us, meaning that companies have for the most part now rid themselves of problematic pay practices. The real work of identifying and implementing pay policies to incent the workforce in a way that’s in alignment with shareholder interests is just beginning.
Here’s something that I recently blogged on the “Dodd-Frank Blog”: The FDIC has adopted final rules which provide that the FDIC, as receiver of a covered financial company, may recover from senior executives and directors who were substantially responsible for the failed condition of the company any compensation they received during the two-year period preceding the date on which the FDIC was appointed as receiver, or for an unlimited period in the case of fraud.
A “covered financial company” is a financial company, other than an insured depository institution, which the Treasury Secretary has determined satisfies the criteria for FDIC receivership under Section 203(b) of the Dodd-Frank Act. Among other things, a determination by the Secretary under Section 203(b) requires a determination that the failure of the financial company would have serous adverse effects on the stability of the United States. “Financial companies” means bank holding companies, nonbank financial companies supervised by the Federal Reserve System and companies the Federal Reserve has determined are predominately engaged in activities that are financial in nature.
“Compensation” is broadly defined to mean any direct or indirect financial remuneration received from the covered financial company, including, but not limited to, salary; bonuses; incentives; benefits; severance pay; deferred compensation; golden parachute benefits; benefits derived from an employment contract, or other compensation or benefit arrangement; perquisites; stock option plans; post-employment benefits; profits realized from a sale of securities in the covered financial company; or any cash or noncash payments or benefits granted to or for the benefit of the senior executive or director.
The proposed rule provided a standard of conduct in which, among other things, a senior executive or director would be deemed “substantially responsible” if he or she failed to conduct his or her responsibilities with the requisite degree of skill and care required by that position. The final rule clarifies the standard and provides that a senior executive or director would be deemed “substantially responsible” if he or she failed to conduct his or her responsibilities with the degree of skill and care an ordinarily prudent person in a like position would exercise under similar circumstances. The revision clarifies that the standard of care that will trigger a clawback is a negligence standard; a higher standard, such as gross negligence, is not required.
In the event that a covered financial company is liquidated under Title II of the Dodd-Frank Act, the FDIC as receiver will undertake an analysis of whether the individual has breached his or her duty of care, including an assessment of whether the individual exercised his or her business judgment. The burden of proof, however, is on the senior executive or director to establish that he or she exercised his or her business judgment. State “business judgment rules” and “insulating statutes” will not shift the burden of proof to the FDIC or increase the standard of care under which the FDIC as receiver may recoup compensation.
The proposed rule provided that, in certain limited circumstances, a senior executive or director would be presumed to be substantially responsible for the failed condition of the covered financial company. The use of rebuttable presumptions for those individuals under the limited circumstances in the final rule is aligned with the intent shown in the statutory language; thus, the presumptions remain unchanged in the final rule.
The following presumptions apply for purposes of assessing whether a senior executive or director is substantially responsible for the failed condition of a covered financial company:
-The senior executive or director served as the chairman of the board of directors, chief executive officer, president, chief financial officer, or in any other similar role regardless of his or her title if in this role he or she had responsibility for the strategic, policymaking, or company-wide operational decisions of the covered financial company prior to the date that it was placed into receivership under the orderly liquidation authority of the Dodd-Frank Act;
– The senior executive or director is adjudged liable by a court or tribunal of competent jurisdiction for having breached his or her duty of loyalty to the covered financial company;
– The senior executive was removed from the management of the covered financial company under 12. U.S.C. 5386(4); or
– The director was removed from the board of directors of the covered financial company under 12 U.S.C. 5386(5).
The FDIC anticipates that it will seek recoupment of compensation through the court system using a procedure similar to the procedure that it currently uses when it seeks recovery from individuals whose negligent actions have caused losses to failed financial institutions. In those situations, the FDIC as receiver undertakes an investigation to determine if there are meritorious and cost effective claims and, if so, staff requests authority to sue from the Board or the appropriate delegated authority. Similarly the FDIC anticipates that it will investigate whether the statutory criteria for compensation recoupment are met, and, if so, staff will request authorization of a suit for recoupment. The final rule reflects this procedure by indicating that the FDIC as receiver may file an action to seek recoupment of compensation.
Last week, the 7th company that failed to garner majority support for their say-on-pay was sued – Cincinnati Bell in a federal district court in Ohio (here’s the complaint). For reasons I’m not sure of myself, I count this as the 8th say-on-pay related lawsuit even though this one didn’t involved a failed SOP. We continue to post pleadings from these cases in our “Say-on-Pay” Practice Area.
In the May-June issue of The Corporate Counsel that was mailed last week, some of these new positions are analyzed – get the “Rest of 2011 for Free” when you try a ’12 No-Risk Trial now.