While we do not expect a huge amount of investor rejections of the SOP vote request, there will be a number of negative recommendations from proxy advisory firms (ISS and/or Glass Lewis (GL)) against issuer plans in 2011. The question for companies is how to react if and when you receive notification of the negative vote advisory from ISS and/or GL. Last week, Katie Wagner of Agenda had a story discussing the tactics and strategies used by certain issuers to fight back against negative vote recommendations from the proxy advisory firms, not always successful.
Hitting the Reset Button
For the issuer whose SOP vote request is in the crosshairs of either proxy advisory firm, the release of a negative vote recommendation requires the affected company to take immediate steps to communicate with ISS/GL, and shareholders, it’s point of view concerning the proxy advisors’ analysis – why the company disagrees as it relates to the pay package approved by the Compensation Committee.
While the proxy advisory firms have spoken through their vote recommendations – and they have an amplified voice – issuers have the ability to communicate to the broader market via SEC disclosure and to strategically communicate to specific investors whose support will be key to overcoming ISS or GL. This represents a second opportunity to present the Compensation Committee’s philosophy of pay in the context of the company’s performance and to rebut the contentions and factual inaccuracies, if any, from the proxy advisory analysis.
Using The SEC Disclosure Regime: 8-K or Additional DEF 14s
An issuer in this situation should take a moment to view the points of disagreement with the proxy advisory firms and develop strong and contextual responses to refute their analysis. Those key points of response then become the heart of the company’s communication to shareholders. Once disclosed, as an 8K or DEF14 filing, the company can then reach out to those shareholders identified, by their governance advisor/proxy solicitor, as open to dialogue on the compensation issues in contention.
Some advisors have suggested, to companies in the middle of contested SOP votes, that the Compensation Committee make immediate changes to CEO or named executive officer pay in an effort to appease the proxy advisors and announce the adoption of their concept of “best practices in pay”. We would counsel that such a course of action in advance of conversations with shareholders would be premature and harmful to the issuer’s cause. If an issuer is prepared to seriously consider potential “horse-trading” on a compensation issue, it should be after discussions with shareholders, not prior to them. Issuers forced to undertake this effort should be focused on educating their shareholder base.
Who Speaks to the Shareholders
Usually the CEO or other members of senior management speak for the company on all issues. In this instance, however, having the CEO or one of the named executive officers discussing the board’s rationale for the officers’ compensation might appear self-serving and may be viewed as if the board and compensation committee is a rubber stamp for management – a belief held by many shareholders. The company should be prepared, if necessary, to have a member of the Compensation Committee (if not the committee chair) involved in the engagement discussions. Engagement with a director often underscores for shareholders the fact that the board was involved and knowledgeable about the company’s executive compensation process and that the CEO’s pay was not determined by executive fiat.
The disclosure and communications strategy outlined above provides a company with a fighting chance against the proxy advisory firms, could potentially shift shareholder votes, and, irrespective of the immediate 2011 outcome, creates the basis of a strong shareholder engagement program for the 2012 and 2013 proxy seasons.
Recently, Fidelity issued its 2011 Proxy Voting Guidelines. As promised, they are a significant departure from past guidelines in the area of equity plan proposals. Where in years past Fidelity looked to dilution as the guiding principle along with assorted other concerns in determining its vote on equity plan proposals, it has now replaced that with 3-year average burn rates:
– 1.5% for Large Caps–companies in the Russell 1000 Index
– 2.5% for Small Caps–companies not in the Russell 1000 Index
– 3.5% for Micro Caps–companies with a market cap under US$300 million
Here is what I believe to be true about the new Fidelity guidelines (thanks to Reid Pearson at Alliance Advisors for sharing what he had learned with me as well):
– The new guidelines, including the burn rate policy for equity plan proposals, is effective immediately;
– Fidelity will not use a multiplier for full-value awards, i.e., options granted during the fiscal year + full value awards granted during the fiscal year / weighted average common shares outstanding (this is the “Traditional Burn Rate” in my Burn Rate Calculator available under Reference Materials -> Excel Tools; this is also reported on ISS’s Proxy Reports as the “unadjusted burn rate”);
– Fidelity will be considering mitigating factors to permit them to support a plan when a company has burn rates that exceed the burn rate caps (similar to what Fidelity did with its prior dilution caps). But, Fidelity is still working out the details.
I think there are a few open questions on the new Fidelity guidelines as well. For example, since Fidelity will look at historic burn rate, will it look at prospective burn rate at all in terms of the size of the share request and how many years it might last? Does that matter to Fidelity? One would assume that exceptions will have to made for extraordinary situations that cause a spike in burn rates from typical practice, but what will Fidelity be looking for in order to approve such exceptions?
Will Fidelity make allowances to its general burn rate caps for companies in various industry groups that have historically had higher burn rates (technology and biotech come to mind)? If not, what will this mean for these companies’ ability to gain shareholder approval of equity compensation plan proposals and continue to make use of equity awards as part of their compensation packages? We’ll have to wait and see how Fidelity ends up developing these guidelines further to see what the practical implications will be for share requests.
Tune in tomorrow for the webcast – “What the Top Compensation Consultants Are NOW Telling Compensation Committees” – to hear Ira Kay of Pay Governance, Mike Kesner of Deloitte Consulting and George Paulin of Frederic W. Cook & Co. discuss what every director and compensation committee member should be asking, and focusing upon, today as well as practical guidance, inside tips and red flags from those “in the know.”
Note: You need Windows Media to listen to the webcast. Since our webcast provider no longer supports it, Real Player will not work going forward.
Both Disney and HP filed materials with the SEC strongly condemning ISS’s no recommendation on say-on-pay and other matters. Disney ultimately changed course and received support on its advisory vote on executive compensation, while HP did not. Why the differences in strategy? We do not know because we were not involved, but perhaps a few clues can be ascertained.
ISS apparently had two issues with Disney’s proxy statement. ISS objected to tax gross-ups in executive employment agreements. ISS also recommended voting for a shareholder proposal regarding performance tests for restricted stock unit awards.
Disney ultimately eliminated the tax gross-ups from the executive employment contracts prior to the meeting. Perhaps after engaging with a few key shareholders, it determined that absent such action its rational set forth in response to ISS’s recommendation was not going to carry the day. The key here however was there was something Disney could do, given the cooperation of its executives. By taking that action, it avoided the embarrassment of a failed vote and having to spend board resources to deal with the issue in the upcoming year. Perhaps Disney also reasoned that by removing that institutional irritant it was more likely institutions would not be persuaded by what appeared to be ISS’s weak recommendation with respect to the shareholder proposal on restricted stock units.
Like Disney, ISS had two issues with HP. One appeared to center on the employment arrangements in connection with its new CEO. The other was a concern regarding its CEO’s participation in indentifying director candidates.
While HP may have found ISS’s recommendation on say-on-pay offensive, it devoted scant attention to supporting its pay-for-performance philosophy in its additional materials. Only a single paragraph at the end of three pages of text addressed that issue. But unlike Disney, there was no immediate action HP could take to correct the situation before the shareholder vote. We assume that asking its new CEO to return his signing bonus and renegotiate his employment package was not an option. So HP stayed the course.
It is also likely that HP’s primary concern was ISS’s recommendation against the reelection of three directors as a result of the nominating process. HP has a majority voting standard. If a director fails to receive a majority of votes for reelection, it triggers a process where the director must submit his or her resignation to the governance committee for consideration. That process would have put HP governance back in the spotlight. As pointed out by Martin Lipton, ISS’s logic was tenuous, if not unsupportable. So it is not a surprise HPs materials centered on this point.
Why did Tyco International succeed with an approach similar to HP while HP failed? We suspect it is because Tyco’s materials were much more precise and informative as to why a pay-for-performance link existed and therefore persuasive to institutional investors. HP’s arguments were general and vague in comparison.
Yesterday, as noted in this press release, the SEC unanimously proposed rules to implement Section 952 of Dodd-Frank that would direct the exchanges to adopt listing standards relating to compensation committees regarding their use of compensation consultants and other advisors as well as conflicts of interest. These rules ultimately will provide a granular definition of “independence” in the compensation context.
From scanning the proposing release that was posted last night, the proposed rules would not add much to Section 952, much to the chagrin of those who emailed me after the meeting and were expecting the SEC to come up with a rules package that the exchanges could just adopt. But even if the exchanges are charged with fleshing out the statute, the SEC surely will be heavily involved behind the scenes as often happens with new listing standards since the SEC must approve them.
Dodd-Frank requires that final rules in this area be adopted by July and the deadline for comments is April 29th. Even if final rules are adopted timely by the SEC, it’s still possible that listing standards may not be in place before the 2012 proxy season since I believe the July deadline doesn’t apply to the exchanges. Memos on the proposal are being posted in the “SEC Rules” Practice Area.
Lest anyone think that unfavorable “say on pay” votes will only strike outliers who make massive blunders, take notice of the 55% unfavorable vote that Shuffle Master announced last week. This one is the toughest to explain so far, because the most extraordinary items in Shuffle Master’s summary compensation table relate to interim CEOs who were appointed after the death of the company’s CEO (see the comment below from ISS). In terms of 2010 compensation decisions, there was about a 15% increase in total compensation for continuing executives. Further, although the company’s stock price has fallen about 75% from its $40 high about 5 years ago, it had quintupled since its $2 low in March 2009 — with the last year displaying continued growth (from about $8 to over $10). Interestingly, four institutional investors own about 30% of the company (BlackRock, Wells Fargo, Oppenheimer Funds, and Eagle Asset Management). Perhaps this influenced the outcome.
Notably, the executive compensation disclosure in Shuffle Master’s proxy statement omitted an executive summary, as did those for Jacobs Engineering and Beazer Homes — driving home, again, the importance of being proactive in telling the company’s “story” that justifies the executive compensation decisions being disclosed.
Regarding Shuffle Master’s unfavorable vote, here is the observation posted by ISS: “The vote at Shuffle Master appears to reflect investor concerns over the severance terms in an employment agreement that was reached with interim CEO David Lopez in February. That agreement included a “modified single-trigger” provision that would have allowed Lopez to receive severance if he decided to leave the company within 90 days of a change in control. Many investors object to single-trigger provisions that don’t require executives to actually lose their jobs to receive a payout.”
For tables tracking unfavorable votes and close-calls: see my site, ExecutiveLoyalty.org.
During the 2011 U.S. proxy season, executive compensation likely will be the primary focus of most institutional investors, although there will be fewer pay-related shareholder proposals on the ballot this season. As required by the Dodd-Frank Act, most large and mid-cap companies will hold their first advisory votes on compensation this year. For institutions with diverse holdings, this mandate has resulted in a significant increase in their proxy season workload given that more than 4,000 U.S. companies will hold pay votes this year.
Investor representatives have said they plan to take a principles-based, holistic approach to advisory votes and indicate they would not generally withhold support based one specific pay practice, such as the payment of tax gross-ups. Many investors have focused on pay for performance, although they are using different metrics to assess shareholder returns. Some investors, such as the Ohio State Employees Retirement System, have said they plan to send letters to companies that explain their reasons for voting against management.
After voting on “say on pay” and “say when,” investors will find few pay-related shareholder proposals on their ballots this season. ISS is tracking 59 such resolutions, as compared with 175 last year, when 77 shareholder “say on pay” resolutions were filed. Among this year’s filings are 13 resolutions submitted by labor investors and retail investors that seek minimum retention requirements (such as a five-year lockup) for equity grants to executives. So far, Allstate, General Electric, and four other companies have prevailed in no-action challenges at the Securities and Exchange Commission by arguing that the resolutions’ reference to “executive pay rights” was impermissibly vague.
The Laborers’ International Union of North America and other labor funds have filed a new proposal at nine companies in the energy or real estate sectors that ask them to link executive pay to sustainability metrics. This measure was inspired in part by the BP oil spill, the Massey Energy mine explosion, and other environmental disasters. That proposal has been withdrawn at MDU Resources, while two other resolutions face no-action requests.
Another new proposal to receive some attention is a resolution submitted by the CtW Investment Group at Bank of America. That proposal, which urges the company to no longer reimburse relocating executives for losses on home sales, was filed in response to a $553,500 home loss subsidy paid to the president of the firm’s Countrywide home mortgage division. BofA argued that the proposal could be excluded because it related to “ordinary business” operations, but the SEC staff did not agree.
The SEC also rejected BofA’s challenge to a proposal from the Service Employees International Union that seeks to amend the bank’s “clawback” policy to permit the recovery of incentive compensation over the past five years. Bank of America argued that it had substantially implemented the proposal because it would be subject to Section 954 of the Dodd-Frank Act, which requires public companies to adopt a three-year recoupment policy. The SEC has yet to propose rules to implement that provision.
The SEC staff also rejected Goldman Sachs’ request to omit a novel proposal filed by the Nathan Cummings Foundation and religious groups. This resolution seeks a review of whether the firm’s executive pay, bonuses, and perks are excessive; an exploration of how sizeable layoffs and the pay for lowest-paid employees impact senior executive pay; and an analysis of how revenue fluctuations impact shareholders and the pay of the company’s top 25 executives. The investment bank argued without success that the proposal was vague or misleading, and related to ordinary business because it addressed general employee compensation.
However, Moody’s did obtain permission from the SEC to omit a new proposal from American Federation of State, County, and Municipal Employees that asked the credit rating firm to establish a set of best practices for its 10b5-1 trading plan, which permit executives to sell company stock through pre-planned transactions while reducing their potential insider trading liability. Moody’s successfully argued that the proposal related to compliance, an ordinary business matter.
On a long-standing resolution topic, the New York City pension funds and labor investors filed nine proposals that seek shareholder votes on severance benefits. In a notable no-action ruling, the SEC reversed itself in January and allowed a Teamsters’ golden parachute proposal to appear on Navistar International’s ballot. The company argued that severance benefits would be covered by its mandated “say on pay” vote, but the proponent pointed out that it was seeking a vote on future severance benefits, which was not covered by the advisory vote. The SEC staff has made clear that companies may exclude proposals that address pay elements that are covered by advisory votes.
The Amalgamated Bank’s LongView fund filed proposals at Anadarko Petroleum, Sunoco, and EOG Resources that seek to prohibit the accelerated vesting of equity incentives after a change in control. Investors also submitted two resolutions that target “golden coffin” benefits for the heirs of deceased executives. This proposal was withdrawn at Hewlett-Packard after the board adopted a policy to seek shareholder approval for such benefits for executives.
Recently, I learned that ISS made a mid-proxy season policy change that may affect vote recommendations for equity plans submitted to stockholders solely for purposes of Section 162(m) approval. Historically, ISS has always supported these proposals agreeing that it is in the best interests of the stockholders for the company to be able to grant awards under a plan that satisfies the 162(m) requirements for performance-based compensation that is excludable from the $1M deductibility limitation.
Effective immediately, ISS will no longer automatically support Section 162(m) proposals submitted by “IPO companies” – that is, companies whose public company stockholders have not previously approved their equity plans. Instead, ISS will further analyze the plan and proposal to determine whether any problematic features are more detrimental than the potential loss of tax deductions and if so, ISS will recommend voting against the proposal.
Going forward, ISS signaled that it also may also further scrutinize Section 162(m) proposals submitted by non-IPO companies (i.e., companies whose public company stockholders have previously approved their plans), but it suggested that this year it is primarily concerned with Section 162(m) plans submitted by IPO companies.
Broc’s note: On Wednesday, the SEC is holding an open Commission meeting to adopt rules that require the stock exchanges to maintain listing standards regarding independent compensation committees and advisors.
Recently, Corp Fin posted this no-action response to Wells Fargo regarding a shareholder proposal that asked the company to prepare a report “to describe the board’s actions to ensure that employee compensation does not lead to excessive and unnecessary risk-taking that may jeopardize the sustainability of the company’s operations. It further states that the report must disclose specified information about the compensation paid to the 100 highest paid employees.”
The Corp Fin response is interesting. It notes that incentive compensation paid by a major financial institution to those that are in a position to cause the company to take inappropriate risks is a “significant policy issue” – but then the Staff goes on to note that the proposal relates to the compensation paid to a large number of employees, thus falling into the “general employee compensation” line of no-action letters since it was not limited to senior executive officers. As a result, the Staff allowed the company to exclude the proposal under (i)(7) as an ordinary business matter.
This letter is interesting also because it presented the Staff with the opportunity to take the position that the general compensation practices that lead to excessive and unnecessary risk taking (and board actions to avoid such risk taking) raise significant policy issues, which would arguably bring its no-action positions in line with the disclosures that the SEC recently concluded should be required in proxy materials. Even though some might disagree with the Staff’s position, it at least avoided yet another exception to the general rule that proposals relating to general employee compensation relate to ordinary business matters and may be excluded under (i)(7). Thanks to Keir Gumbs of Covington & Burling for pointing this letter out!
Yesterday, as reported in this Bloomberg article and ISS’s Blog, Hewlett-Packard became the fourth company to fail to receive majority support for its say-on-pay, with 48% voting in favor. The company hasn’t yet filed its Form 8-K – when it does, I will add it to our list of Form 8-Ks filed by companies that fail to earn SOP majority support.
And yesterday, I blogged that Hemispherx Biopharma issued this press release announcing that it garnered 51% support for its say-on-pay ballot item. Well, a few members reviewed the company’s proxy statement and Form 8-K and concluded that the company didn’t do its math properly.
These members noted the proxy disclosure that “abstentions will have the same effect as a vote against the proposal” – but that the company didn’t follow that formula when calculating the vote for its Form 8-K. Without getting into the issue of whether the proxy disclosure is correct, it seems like the company didn’t follow the standards disclosed in its proxy statement, an important point to consider as I wrote about in the July-August 2010 issue of The Corporate Counsel (in the section entitled “How to Calculate Voting Result Percentages: Read Your Bylaws (and Compare with Your Proxy).” I do believe this problem is not just an isolated circumstance – as there still is a significant amount of confusion regarding the application of voting standards and the calculation of the vote itself.
Parsing Prudential’s 2011 Proxy Statement
Last week, I repeated Mark Borges’ analysis of General Electric’s proxy statement and all the innovative things they did. A few days ago, Prudential filed its proxy statement and it also contains quite a few innovative items (as could be expected since Peggy Foran’s arrival at the company last year), including:
– 3-page “State of the Union” letter, describing the work the board had done over the previous year on compensation and governance; note this letter is from the board, not the CEO
– Two-page summary at the beginning (pages 7-8) that includes business highlights and summary compensation information
– Highlight boxes on sustainability (pg. 24), corporate citizenship (pg. 23) and shareholder engagement (pg. 22)
The entire proxy statement is filled with color and charts and serves as a good example of an attempt to make disclosure inviting for shareholders. And don’t forget Peggy’s novel “Totes for Votes” campaign to bring in more retail votes, as she recently discussed during our “Conduct of the Annual Meeting” webcast on TheCorporateCounsel.net.