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.
Yesterday, Shuffle Master filed this Form 8-K to reveal its become the third company this proxy season to fail to achieve a majority vote for say-on-pay as only 45% of shareholders voted in favor (here’s the other two). And Hemispherx Biopharma revealed it almost became the fourth with only 51% support as reflected in its Form 8-K.
In his “Proxy Disclosure Blog,” Mark Borges gives us the latest say-when-on-pay stats: with 739 companies filing their proxies, 44.3% triennial; 3.4% biennial; 48.8% annual; and 3.4% no recommendation. As Dave blogged a few days ago, the annuals have now passed the triennials…
Here is something that I blogged yesterday: It has now been two months since shareholders were able to render advisory votes on executive compensation. Of the 185 Say-On-Pay votes which have been reported through March 20th, the shareholders at two companies, Jacobs Engineering Group and Beazer Homes USA, have voted against approving the executive compensation of their named executive officers. A third company, IsoRay, reported that its “stockholders did not approve, on an advisory basis, the compensation of IsoRay’s named executive officers” even though it also reported that there were more “For” votes than “Against” votes on its Say-On-Pay proposal.
We note that Beazer also announced earlier this month that its Chief Executive Officer had reached a settlement with the SEC whereby he would repay back to Beazer approximately $6.5 million of previously received compensation, along with company shares and stock units. As reported by the SEC, the disgorged amounts represented the CEO’s entire fiscal year 2006 incentive bonus. Beazer had previously restated its 2006 financial statements and the forfeiture was required under the clawback provisions of the Sarbanes-Oxley Act which mandates that a CEO repay incentive compensation that was received as a result of the company’s erroneous financial statements.
One element of the Say-On-Pay rules is that shareholders also get to vote on how frequently the Say-on-Pay vote will be conducted at their company (“Say-On-Frequency”). In particular, shareholders can provide an advisory vote that states their wishes as to whether the Say-on-Pay vote should occur every one, two or three years. In soliciting the Say-On-Frequency vote, a company’s board of directors can provide its recommendation (or it can provide no recommendation) as to which frequency it believes shareholders should support.
Last month, we reported that there was a trend which indicated that shareholders preferred annual Say-On-Frequency voting at least with respect to companies which are not smaller reporting companies. This trend has continued as annual frequency has received the most shareholder votes at over 60% of the companies that have reported on their Say-On-Frequency votes (and at over 70% if smaller reporting company results are excluded).
This preference for annual voting is particularly evident with respect to those companies which are “Large Accelerated Filers”, as such term is defined under SEC rules (i.e., public companies with a market value of at least $700 million), with the shareholders at 84% of such companies supporting annual voting. A biennial frequency continues to be the ignored “middle child” as such frequency has received the most votes at only 4% of reporting companies.
Moreover, as illustrated in the voting results tables, with just one exception at a smaller reporting company, whenever a board of directors has recommended an annual Say-On-Pay vote, the company’s shareholders have so far always voted in support of such recommendation. Furthermore, even when a board of directors at a large accelerated filer has recommended triennial voting, the company’s shareholders have voted against such recommendation in favor of a more frequent vote at close to 80% of the time.
“Smaller Reporting Companies” (i.e., those public companies with less than $75 million of public float) have had more success garnering support for triennial voting but, as we noted last month, we expect that going forward more/most smaller reporting companies will take advantage of the two year exemption from Say-On-Pay that was provided by the SEC in its final rules (i.e., smaller reporting companies therefore will not conduct a Say-On-Pay vote until required in 2013). This two year delay for smaller reporting companies represented a change from the SEC’s proposed rules which did not provide any such transitional relief for smaller reporting companies.
Those smaller reporting companies that have conducted Say-On-Pay votes in early 2011 presumably had already filed their proxy statements (in accordance with the Reform Act and the SEC’s proposed rules) for their annual meeting of shareholders prior to the release of the SEC’s final rules which relaxed the Say-On-Pay requirements for smaller reporting companies. We have included their results even though technically they do not have to comply with Say-On-Pay until 2013. We note that since March 8th, only one smaller reporting company has reported a Say-On-Pay vote and we would expect this trend to continue as fewer smaller reporting companies will include a Say-On-Pay proposal in its annual proxy statement.
According to a study of 100 early filers with revenues greater than $1 billion that we recently completed, average CEO total compensation increased +39% in 2010 while average total shareholder return equaled +25% and average net income increased +30%.
There are three factors contributing to the gains. First, base salaries that were reduced or held constant in 2009 were increased in 2010. Second, cash bonuses increased +43% as a result of stronger performance. Finally, we saw a +41% increase in the value of equity compensation granted in 2010. Although executives will not realize cash gains on these awards until they are vested, they nevertheless provide both retention and a link between CEO pay and performance. Nearly 80% of the equity awarded in 2010 will only provide value if the stock price appreciates or certain performance goals are met.
The study also confirms that profitability continues to be the key determinant of compensation. In instances where profitability increased in 2010, incentive cash compensation increased +53% over 2009 values, versus a -9% decrease among companies with lower profits. Furthermore, among the eight unprofitable companies in the study group, CEO total compensation decreased on average by -14%, while increasing +44% for CEOs of profitable companies.
Pay Mix
Equity continues to serve as the primary compensation vehicle for CEOs. For the 100 CEOs in the study group, equity compensation comprised 43% of total compensation, bonuses and other cash-based incentives represented 35% and base salaries just 22%.
Trends in Pay Elements
Comparing 2010 compensation to that in 2009 for all 100 CEOs in the study group, the study finds that:
– Salaries increased +11%
– Cash incentive compensation increased +43%
– Equity compensation increased +41%
– Total compensation increased +39%
– Revenues were up by +15%
– Net Income was up by +30%
– Total shareholder return was +25%
Here is something I recently blogged on the “Conglomerate Blog“: In finalizing a draft of a symposium piece on executive compensation last week for some very patient editors, I had a chance to read the 500-plus page Final Report of the Financial Crisis Inquiry Commission. Just to give you a sense of whether executive compensation is an issue there, note that “systemic risk” is used 29 times in the 410 page majority opinion. The term “compensation” is used 79 times. Here are some takeaways:
At least in “dicta,” the Final Report seems to understand that incentive compensation skews the decision-making of those outside of the “top five” executives on which most reform legislation and reformers are focused. The Final Report mentions the compensation schemes of financial institutions, Bear Stearns, Fannie Mae and Freddie Mac, Lehman Brothers, and even mortgage originators. The report seems to understand how incentive compensation gives the recipient an “option,” so that option theory kicks in and those with no downside take on additional risk. Most importantly, in several places it seems that the Commission understood it was not just the CEOs, including its “Conclusions” section:
Compensation systems — designed in an environment of cheap money, intense competition, and light regulation — too often rewarded the quick deal, the short-term gain — without proper consideration of long-term consequences. often, those systems encoursaged the big bet — where the payoff on the upside could be huge and the downside limited. This was the case up and down the line — from the corproate boardroom tot he mortgage broker on the street.
But the Commission still chose to focus on sticker-shocking salaries of CEOs and other officers. The Final Report mentions the takehome salaries of at least 23 named individuals, in addition to giving aggregate salaries for various groups of individuals and institutions. The Commission seems to be very interested in reporting that individuals at financial institutions, which were struggling by 2008 and some of which failed, had very nice salaries. However, even if there compensation was in the multi-million dollar range, that compensation did not push these multi-billion dollar companies over the edge. So the dollar amount has little mathematical value here. Now generally we might be appalled because we believe that the CEO must have done a horrible job if the firm went into trouble, and why should we pay horrible CEOs all that money? That is in interesting question, but the question posed to the Commission was what caused the financial crisis, and the report doesn’t do that great of a job linking these high salaries to the crisis except in the most general way: because so much money was at stake, executives became too comfortable with excessive risk, which caused the financial crisis. I think this argument goes to far in suggesting that incentive compensation with no downside makes CEOs immune to risk. CEOs do get fired, much more often I would guess than getting their pay cut. Stock price drop doesn’t give traders or mortgage originators a reputational hit, but it does give CEOs one, and their reputation has a pretty high market price.
The Final Report seems to have a lot of facts about the evils of compensation, but not a lot of theories. In addition to wanting us to know the salaries of various corporate officers, the Commission has a small section titled “The Wages of Finance: “Well, this One’s Doing It, So How Can I Not Do It?”” (Yes, the report has a very readable, narrative-based feel to it, but that makes it seems less than objective.) In this small section, the Commission weaves together a lot of factoids that don’t make a whole. First, the income gap in the U.S. is large, but the gap between financial industry salaries and regular industry salaries is bigger and has grown since the 1980s. (Margaret Blair has also written about this here.) Again, this seems damning to the industry, but I’m not sure why. The financial industry executives are paid more than executives of any other industry. Again, ok. This tells us nothing about what caused the financial crisis.
The Commission also points out what we already knew: most compensation is performance-based compensation. Why? Because reformers told us this was how to tie pay with performance. So, section 162(m) of the IRC limited the deductibility of non-performance-based compensation. And guess what, most compensation became performance-based compensation, which we now think leads to short-termism. If we tie compensation to profits on an annual basis, then we become fixated on profits right now, no matter what. Who could have guessed that?
The Final Report also reminds us that our investment banks used to be partnerships. This is an interesting point and one that others have made. The Commission believes this is a bad thing because now the executives have no skin in the game, get their big payouts every year, not the residual. So bankers became more risk-seeking with shareholder’s money. However, the report also points out that the compensation systems of these banks were the same after going public — distributing half the revenues at the end of the year. So, the report needs to tie that bow together if it’s making a compensation argument.
Finally, the Commission mentions that regulators cannot possibly compete in the labor market with financial whizzes. Why would anyone go work for the government if they can make millions in the private sector? Not sure what conclusion that leads us, too, then.
You should be aware of an effort by GovernanceMetrics who is providing its investor clients with analysis on executive compensation that can utilized in deciding to support a company’s advisory vote on executive compensation (Say on Pay – SOP). This effort represents a first for GovernanceMetrics International (the firm is a recent combination of The Corporate Library, Audit Integrity and GovernanceMetrics) which has not heretofore been involved in making direct recommendations on issues appearing in proxy statements.
The analysis does not make recommendations on a company’s SOP disclosures or CD&A, but instead reviews compensation disclosures to determine if a company generates a number of redflags on issues seen by GovernanceMetrics International as determinative of receiving “high”, “moderate” or “low” concern with respect to company’s compensation practices. No recommendation is attendant to these determination, so it is up to the investor to make their own decision as to how to interpret GovernanceMetrics’ concerns and their impact on the investor’s SOP vote.
Over the course of many governance-related events speakers from all sides in the governance debate have argued for a more qualitative review and analysis, by proxy advisory firms, of executive pay that spotlights positives and negatives in an issuer’s compensation practice (from the point-of-view of the reviewer) and allows the investor to make their own decision as to whether to support the board’s recommendation.
This type of analysis is reminisce of the work of the Investor Responsibility Research Center (IRRC). The IRRC, which was purchased by ISS, had a huge storehouse of governance data on compensation, shareholder resolutions, and other issues that could be put at the service of institutional shareholders seeking data to make decisions about proxy voting, investor engagements on governance, social and environmental issues. IRRC did not make recommendation on issues in the proxy statement, but did provide management’s case and the opposing view (or shareholder proponent’s view) without providing a recommendation to investors as to how their vote should be cast.
While GovernanceMetrics International’s effort does not fit the format of the well-remembered IRRC analysis model, it is can be seen as a move back in that direction. Irrespective of the potential impact on SOP votes, the reactions of institutional investors and issuers to this new model should be positive as it offers more than a simple up or down vote recommendation.
We have announced the line-up for our annual package of executive pay conferences to be held on November 1st-2nd in San Francisco and by video webcast: “Tackling Your 2012 Compensation Disclosures: The 6th Annual Proxy Disclosure Conference” and “The Say-on-Pay Workshop Conference.” Save 25% by registering now at our early-bird discount rates.
As you can see from our agendas, this year’s pair of Conferences (for one low price) will be workshop-oriented more than ever before in an effort to provide the practical guidance that you need in the new say-on-pay world that we live in:
1. November 1st’s “Tackling Your 2012 Compensation Disclosures: The 6th Annual Proxy Disclosure Conference” includes:
– “Say-on-Pay Disclosures: The Investors Speak”
– “Say-on-Pay: The Executive Summary”
– “Drafting CD&A in a Say-on-Pay World”
– “The In-House Perspective: Changing Your Processes for ‘Say-on-Pay'”
– “Getting the Vote In: The Proxy Solicitors Speak”
– “Handling the New Golden Parachute Requirement”
– “The Latest SEC Actions: Compensation Advisors, Clawbacks, Pay Disparity & Pay-for-Performance”
– “Dealing with the Complexities of Perks”
– “Conducting – and Disclosing – Pay Risk Assessments”
– “Say-on-Frequency & Other Form 8-K Challenges”
– “How to Handle the ‘Non-Compensation’ Proxy Disclosure Items”
2. November 2nd’s “The Say-on-Pay Workshop: 8th Annual Executive Compensation Conference” includes:
– “The Say-on-Pay Process Playbook: Breaking It Down”
– “Say-on-Pay: How to Interpret Your Voting Results”
– “Say-on-Pay: How to Best Tell Your Story”
– “Say-on-Pay Shareholder Engagement: What’s Working – and What Isn’t”
– “How to Work with (or Against) the Proxy Advisors: Navigating the Say-on-Pay Minefield”
– “Pay-for-Performance Workshop: How to Properly Implement”
– “Plan Design Workshop: Hot Button Say-on-Pay Issues and More”
– “The Say-on-Pay Lightning Round: 50 Ideas to Implement Now”
In his “Proxy Disclosure Blog,” Mark Borges gives us the latest say-when-on-pay stats: with 514 companies filing their proxies, 46.3% triennial; 4.1% biennial; 44.9% annual; and 4.6% no recommendation.
House Republicans Seek to Repeal Dodd-Frank’s Pay Disparity Provision
As noted in this Market Watch article, House Republicans have been working on four separate discussion draft bills to repeal or change parts of Dodd-Frank and one draft bill to ease smaller company capital raising that is not Dodd-Frank related (here’s a piece from “The Hill” and a Reuters article). The article lists these 5 topics that would be addressed through the bills:
– No longer make credit-ratings firms liable if their initial ratings turn out to be faulty
– Exempt companies that use derivatives to hedge commercial risk from new requirements that they route their transactions through clearinghouses
– Exempt private-equity fund managers from registering with the SEC
– Overturn requirement requiring companies to disclose the median annual total compensation of all employees and calculate a ratio of how employee compensation compares with that of the CEO
– Increase the offering threshold for companies that don’t need to register with the SEC to $50 million from $5 million
My Final Four Predictions…
Notre Dame over Duke in final, Syracuse and Kansas State. And for the record, I have an #11 seed for the Elite 8 (Gonzaga) and #12 Richmond and #13 Oakland in the Sweet 16 (that’s three double-digit teams for the Sweet 16). And I have Kentucky beating Ohio State to make the Elite 8 also…
Here’s news from John Savarese and Wayne Carlin drawn from this Wachtell Lipton memo:
The SEC recently announced a settled enforcement action in which it obtained a “clawback” of prior compensation and stock sale profits from a CEO pursuant to Sarbanes-Oxley Section 304. SEC v. McCarthy, No. 1:11-CV-667-CAP (N.D. Ga. March 3, 2011). This case marks the second time the SEC has obtained this type of relief without alleging that the CEO in question personally engaged in any wrongdoing.
Section 304 requires a CEO or CFO to return incentive-based compensation to an issuer when a financial restatement occurs “as a result of misconduct. . . .” The SEC’s position is that the issuer’s “misconduct” alone is a sufficient predicate for this relief, and that it need not establish any personal misconduct by the CEO or CFO. The SEC’s position is supported by the one federal district court decision that has been rendered on this issue. SEC v. Jenkins, 718 F. Supp. 2d 1070 (D. Ariz. 2010).
The defendant in SEC v. McCarthy is the CEO of Beazer Homes USA, Inc. Beazer had previously restated its financial statements and entered into a settled cease-and-desist proceeding with the SEC, as well as a deferred prosecution agreement with the Department of Justice. The SEC also previously charged the company’s former chief accounting officer with violations of the antifraud provisions of the federal securities laws, but the CEO was never charged with any misconduct in any of these proceedings.
Under the Section 304 settlement, the CEO agreed to reimburse to the company $6,479,281 (comprised of bonus payments plus certain stock sale proceeds); 40,103 restricted stock units; and 78,763 shares of restricted stock. Although the SEC has been silent concerning its general approach to calculating the amounts recoverable under Section 304, this settlement may reflect a recognition that not all proceeds from the sale of stock are appropriately reimbursable. The SEC’s complaint alleges $7.3 million in stock sale profits during the relevant period, yet the portion of the settlement attributed to stock sale proceeds is $772,232.
Finally, the SEC has never publicly articulated the criteria it applies in determining whether or not to pursue such no-fault Section 304 relief. Greater transparency about the Commission’s criteria would be in the public interest. Now that the SEC has had some initial success in establishing that it can recover substantial sums from individuals who are not accused of any wrongdoing, it would be appropriate for the SEC to provide some explanation concerning when it will seek this extraordinary form of relief.
Section 951 of the Dodd-Frank Act requires companies that are subject to the SEC’s proxy rules to include in their proxy statements “a separate resolution subject to shareholder vote” to determine whether a shareholder vote on executive compensation will occur every 1, 2, or 3 years. However, the Dodd-Frank Act specifically declares that this vote shall not be binding on the companies or their boards of directors.
This leads to the question of how companies will describe the vote required with respect to these resolutions. See Item 21 of Schedule 14A. The Dodd-Frank Act and the SEC’s proposed rule do not specify a particular voting rule.
Recently, I came across this description in a proxy statement:
The proposal on whether advisory votes on executive compensation should be conducted annually, biennially or triennially will be determined by a plurality of votes, which means that the choice of frequency that receives the highest number of “FOR” votes will be considered the advisory vote of the Company’s stockholders. Abstentions and broker non-votes will not count as votes cast “FOR” or “AGAINST” any frequency choice, and will have no direct effect on the outcome of this proposal.
The voting rule described above is a plurality voting rule. This means that the choice that attracts the highest number of affirmative votes will be considered to have “won” even if a majority of the shares voting on the matter do not vote in favor of that particular choice. For example, if the corporation has 100 stockholders and the vote is 25 for 1 year; 45 for 2 years; and 30 for 3 years, the stockholders will be considered to have approved the choice of 2 years even though it attracted far less than a majority of the votes and more stockholders preferred a different outcome.
Although the above excerpt is from a proxy statement filed by a Delaware corporation, I will, for the sake of discussion, address the disclosure from a California perspective. Pursuant to Section 602(a) of the California Corporations Code, an “act of the shareholders” requires the affirmative vote of a majority of the shares represented and voting at a duly held meeting at which a quorum is present provided the number of shares voting affirmatively constitute at least a majority of the required quorum. Thus, California imposes a modified majority vote rule. Moreover, it seems to me that this rule should be applied even when determining whether the shareholders have adopted an advisory resolution. This would be consistent with many companies’ descriptions of the vote required with respect to ratification of the selection of auditors.
Thus, it is my view that the same voting rule should be applied to determine whether the shareholders have adopted a non-binding resolution as is used in determining whether they have adopted a binding resolution. In other words, an advisory resolution is still a resolution that can only be adopted by the voting rule imposed by or in accordance with applicable law.
When shareholders are given multiple choices, neither a plurality nor a majority voting rule provides directors with the best information regarding shareholder preferences. Thus, I have argued that corporations should be free to use other voting rules such as a Borda count or preference ranking system.
As a final note, there are two exceptions the California voting rule described above. First, a greater vote may be required by other provisions of the General Corporation Law or the articles of incorporation. Second, a special voting rule applies when there is a loss of a quorum during a meeting. See Cal. Corp. Code ยง 602(b).