As I blogged on TheCorporateCounsel.net today, on Friday, Corp Fin issued nine new Compliance and Disclosure Interpretations on a variety of topics – including this one repeated below regarding the CD&A and performance targets:
Section 118. Item 402(b) – CD&A – Question 118.07
Question: In Compensation Discussion and Analysis (CD&A), is a company required to discuss executive compensation, including performance target levels, to be paid in the current year or in future years?
Answer: No. The CD&A covers only compensation “awarded to, earned by, or paid to the named executive officers.” Although Instruction 2 to Item 402(b) provides that the CD&A should also cover actions regarding executive compensation that were taken after the registrant’s last fiscal year’s end, such disclosure requirement is limited to those actions or steps that could “affect a fair understanding of the named executive officer’s compensation for the last fiscal year.” [Mar. 4, 2011]
Sidenote: In his “Proxy Disclosure Blog,” Mark Borges gives us the latest say-when-on-pay stats: with 365 companies filing their proxies, 49.8% triennial; 4.6% biennial; 40.2% annual; and 5.4% no recommendation.
Check out Steve Quinlivan‘s piece entitled “Disney Takes on ISS” from the Dodd-Frank Blog, repeated below:
Disney has reacted to ISS’ no vote on its say-on-pay vote by filing additional definitive proxy materials. Styled as a letter to shareholders, Disney notes:
We write with respect to the ISS Proxy Report you may have seen regarding the proposals to be voted on at The Walt Disney Company annual shareholder meeting. We take serious issue with ISS’s recommendations against the Company’s position on the advisory vote on executive compensation and the shareholder proposal regarding performance tests for restricted stock units. We set forth below why we believe the two negative ISS recommendations are unwarranted.
1. ISS’s recommendation to vote “against” the advisory vote on executive compensation relates to a practice that no longer exists. The recommendation appears to be grounded on a concern that the Company “recently extended excise tax gross ups.” But, in point of fact, the Company’s Compensation Committee has adopted a policy, fully disclosed in the proxy statement, that prohibits excise tax gross ups in any future agreements with executive officers, or in any material amendments or extensions of existing agreements, unless the provision is submitted to approval by shareholders. The “recent” extension of a gross up that ISS refers to (which would not be permitted under the new policy) occurred over a year ago, was fully disclosed in a Company filing on January 8, 2010, well prior to last year’s annual meeting and prior to last year’s ISS proxy report, which made no mention of it. Subsequent to that time, the Compensation Committee, in response to feedback from shareholders, adopted a policy that would prohibit tax gross ups as outlined above. For that reason, we urge that you vote in favor of the advisory vote on executive compensation.
2. In its original recommendation to support the shareholder proposal regarding performance tests for restricted stock unit awards, ISS made frequent reference to what it argued was the short-term nature of a one-year earnings per share component of the Company’s current performance test. In point of fact, however, the EPS test is a three-year test. ISS acknowledged this mistake in the introduction to its update, but the body of the report (which relied on that error) and the rationale supporting the recommendation remained unchanged. Again, we believe that, on the basis of a corrected record, ISS’s rationale does not hold. The three year EPS measure is an integral component of a long-term performance test that was designed to tie vesting of RSU’s to the attainment of long-term performance metrics.
For the foregoing reasons, we believe ISS’s recommendations are unwarranted and urge you to vote “for” the advisory vote on executive compensation and “against” the shareholder proposal relating to performance tests for restricted stock units.
In this podcast, Dave Lynn and Marty Dunn engage in a lively discussion of the latest developments in securities laws, corporate governance, and pop culture. Topics include:
– The latest FAS 5 developments, including recent Staff comment trends
– A debate on Say-on-Pay voting standards
– Fond memories of life at the Commish
Here is news from Cleary Gottlieb (here is a related blog from Paul Hodgson):
Recently, the Board of Directors of the Federal Deposit Insurance Corporation approved a Notice of Proposed Rulemaking on incentive-based compensation arrangements pursuant to Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “NPR”). The NPR is an interagency publication created jointly by the FDIC, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Office of Thrift Supervision, the National Credit Union Administration, the Securities and Exchange Commission and the Federal Housing Finance Agency.
The NPR has five key components: (1) requiring deferral of at least 50% of incentive compensation for a minimum of three years for executive officers of covered financial institutions with $50 billion or more in total consolidated assets; (2) prohibiting incentive-based compensation arrangements for executive officers, employees, directors or principal shareholders (“covered persons”) that would encourage inappropriate risks by providing excessive compensation; (3) prohibiting incentive-based compensation arrangements for covered persons that would expose the institution to inappropriate risks by providing compensation that could lead to a material financial loss; (4) requiring policies and procedures for incentive-based compensation arrangements that are commensurate with the size and complexity of the institution to help ensure compliance with the NPR’s requirements and prohibitions; and (5) requiring annual reports on incentive compensation structures to the institution’s appropriate Federal regulator.
As noted above, the NPR’s mandatory deferral requirement applies only to “executive officers,” which is defined as those persons holding the title or performing the function of one more of the following positions: (1) president, (2) chief executive officer, (3) executive chairman, (4) chief operating officer, (5) chief financial officer, (6) chief investment officer, (7) chief legal officer, (8) chief lending officer, (9) chief risk officer, or (10) head of a major business line. However, the NPR also specifically requests public comment on whether the mandatory deferral provisions should apply to a differently defined group of individuals, such as the institution’s top 25 earners of incentive-based compensation.
In addition to the mandatory deferral provisions described above, covered financial institutions with total consolidated assets of $50 billion or more will be required to take additional steps with respect to incentive compensation paid to “employees presenting particular loss exposure.” The institution’s board of directors (or a committee thereof) will be required to identify those covered persons (other than executive officers) who “individually have the ability to expose the institution to possible losses that are substantial in relation to the institution’s size, capital, or overall risk tolerance.” The board or committee will then be required to approve the incentive-based compensation arrangement for each identified covered person by specifically determining that the arrangement “effectively balances the financial rewards to the employee and the range and time horizon of risks associated with the employee’s activities, employing appropriate methods for ensuring risk sensitivity such as deferral of payments, risk adjustment of awards, reduced sensitivity to short-term performance, or extended performance periods.” Finally, the board or committee will be required to perform an evaluation of the effectiveness and suitability of the balancing methods used, as well as their ability to “make payments sensitive to all the risks arising from the employee’s activities, including those that may be difficult to predict, measure or model.”
The NPR will have a 45-day public comment period beginning after its publication in the Federal Register. Publication will occur after all seven of the Federal agencies listed above have formally approved its text, a process which is expected to be completed within the next several weeks.
Now that the SEC has wrapped up its rulemaking with respect to say-on-pay, one of the next corporate governance rulemakings on the agency’s list relates to advisor independence. Since the SEC came out with its revised disclosure rules regarding fees paid to executive pay consultants in early 2010, the default definition for independence has been whether or not the advisor provides other services, or at least other non-executive compensation services in excess of $120,000 in a given year.
Given all the various conflicts that could exist in the relationship between a company and its advisor, limiting consideration of independence to any single criterion would be a mistake. Instead, a compensation committee should be held accountable for affirmatively deciding whether it is getting independent advice by looking at all potential conflicts, not simply whether the advisor provides other services beyond those related to the compensation committee.
Congress had it right when they decided as part of Dodd-Frank that it was the obligation of the compensation committee to make the determination on independence, and that determination should be based on more than whether the advisor provides other services to the company. The legislation also acknowledged that it is possible to mitigate potential conflicts. I’m hoping the SEC’s rulemaking will provide constructive guidance about a range of potential conflicts and conflict mitigation approaches that go beyond a simplistic “other service” litmus test so shareholders can be confident in the governance process behind executive pay decisions. It might also be appropriate to require some form of certification so that those advising companies and boards feel accountable to shareholders.
I was a little surprised at the reactions that Mark Borges and I have received to our advice that – given the voting results so far – companies may reconsider recommending a triennial vote for say-when-on-pay (egs. Marty Rosenbaum and Amy Muecke; compare Dominic Jones who asks whether boards are using triennial recommendation as a diversion).
I know many boards have pondered long and hard and decided that triennial is in the best interests of shareholders – but if shareholders are clearly saying it’s not in their best interests, that surely must count for something? I say “pick your battles” in an effort to start off with a less confrontational engagement in this new “say-on-pay” world. With a statistically relevant number of results in, it’s becoming pretty clear that shareholders want an annual SOP even if the company has stable management and sound pay practices. For shareholders, those factors appear relevant as to how they vote on say-on-pay – but not relevant for say-when-on-pay.
Like I said in my original blog on this topic, the fact that so many companies are ignoring the clear will of shareholders over this minor topic (“minor” in comparison to SOP itself) will likely further galvanize shareholders to more closely scrutinize pay practices. As I hear from shareholders, they feel like companies are deciding what is in the “best interests of shareholders” without taking into account what shareholders have clearly said is in their best interests. Looking at this situation from their perspective, I can see why they might get upset.
As noted on Responsible-Investor.com, Australia’s government recently adopted legislation strengthening its say-on-pay requirements. One change was the adoption of a “two strikes” test, meaning that shareholders would have the opportunity to remove directors if the company’s remuneration report had received a ‘no’ vote of 25% or more at two consecutive annual general meetings. Another change is the prohibition of directors, executives and their “closely related parties” from voting on executive pay.
Also notable is that Novartis – a large Swiss company – garnered a 40% “against” vote on its first say-on-pay vote on Tuesday, as mentioned in this article.
Despite your company’s best efforts, it lost its say-on-pay vote. What do you do now?
Every board of directors believes that its compensation policies and programs are appropriately designed to support the company’s goals, strengthen the company’s ability to attract and retain highly qualified individuals, and appropriately link pay to performance. A typical first reaction to losing the say-on-pay vote may likely be to ignore it or blame it on ISS or others who do not “understand” the company’s compensation policies and programs. “Denile,” however, is a river in Egypt, and is not an appropriate approach to proper corporate governance, and, with a “no” vote, shareholders have spoken and a company should listen and respond to their disapproval.
We believe the first step must be to determine the cause of the “no” vote. Was there a flawed pay package? Was it due to ISS’s erroneous views of the company’s performance versus its so-called “peers” (which we note often bear little relationship to the company’s real competitors)? Was it a communications problem – a CD&A that failed to tie compensation with performance – and/or a weak solicitation effort in the face of a more general cynicism toward executive compensation? Was it simply, as many of the “no” votes are, a proxy for a general dissatisfaction with the company?
Whatever the reason, meaningful action is appropriate and, while disclosure such as “we will take this vote into account in setting future compensation” is a typical start, it is unlikely to pass muster over the longer term. More difficult questions will need to be addressed, such as whether a change in composition of the compensation committee would inject fresh ideas into the compensation program and (perhaps more importantly) illustrate to shareholders that the company is taking the vote seriously. On the other hand, a company also must consider the ramifications of bowing to such pressure.
To date, ISS and Glass Lewis have not announced their plans for responding to “no” votes on say-on-pay proposals, and we are hopeful that they will study this issue carefully before responding prematurely. That said, we are realists and expect they will adopt policies recommending withholding votes or voting against members of a compensation committee (and possibly others as well) who are seen as unresponsive or ineffectual at addressing a “no” vote. This, combined with majority voting and, should it survive judicial review, proxy access could leave directors exposed to significant election challenges.
The bottom line is that when a company receives a “no” vote with respect to its executive compensation policies and programs, it should listen carefully to the message that is being delivered by its shareholders and respond substantively. Although extremely time consuming, we believe one-on-one meetings with large shareholders are often essential to allow you to get to the bottom of what’s really on your shareholders’ minds and take real steps toward addressing their concerns.
Glass Lewis recently concluded a client-only presentation regarding updates to their policies for 2011 and what they see as trends for the upcoming year. As you probably know, Glass Lewis will not speak to you about your proxy, taking the approach that “if you have something you want us to consider, put it in a public filing.” They recently purchased the smaller advisory firm Proxy Governance and depending on the makeup of your shareholder base, you should be aware of their policies and likely vote recommendation if you’re facing a potentially close vote.
Courtesy of Glass Lewis, here is a summary of their presentation (the full presentation is not publicly available). Some of the points you might pay attention to:
1. What will drive their decision to vote Against Say on Pay votes?
-Misalignment of pay with performance (P4P grade of D or F)
-Insufficient disclosure
-Poorly formulated peer group(s)
-Guaranteed bonuses & high fixed pay
-Poorly-designed incentive plans with excessive payouts and unchallenging goals
-Too much reliance on time-vesting equity awards
-Egregious contractual commitments (tax gross-ups, golden parachutes, death benefits)
-Internal pay inequity
-Excessive discretion afforded the board in granting awards and adjusting metrics
2. When will they go beyond say on pay and vote against comp committee members?
-Behavioral issues: For example, option repricing without shareholder approval, or the granting of excessive and unjustified golden handshakes or golden parachutes
-Sustained Poor Pay-for-Performance: Judged by a history of “D”s and “F”s in the GL model
3. What were the major U.S. Policy updates?
Most were relatively minor and won’t apply to a broad spectrum of companies. Some of the more noteworthy were:
-Classified Boards: If we maintain concerns with affiliates or insiders who are not up for election, we will consider recommending voting against such directors at their next election if the concerning issue is not resolved.
-Excessive Audit Committee Memberships: We may exempt certain audit committee members from our standard threshold (i.e. serving on more than 3 public company audit committees) if, upon further analysis of relevant factors, we can reasonably determine that the audit committee member is likely not hindered by multiple audit committee commitments.
-Board Interlocks: We will also evaluate multiple board interlocks among non-insiders (i.e. multiple directors serving on the same boards at other companies) for evidence of a pattern of poor oversight.
-Stock Option Repricings: We recommend to vote against all members of the compensation committee when the company completed a “self tender offer” without shareholder approval within the past two years.
As a follow-up to my recent blog regarding “Say-on-Pay Frequency: Confusion Over Vote Counting,” here are a few interesting items:
1. As reflected in this nifty chart from our “Say-on-Pay” Practice Area, ExeQuity’s Robbi Fox has been tracking the proxy statements for the S&P 500 companies who have filed so far (as compared to voting results filed in Form 8-Ks) and out of the 36 S&P 500 companies that have filed proxies:
– Abstentions count as against, broker nonvotes have no effect -15 companies (42%)
– Abstentions and broker nonvotes have no effect -18 companies – (50%)
– Abstentions and broker nonvotes count as against – 3 companies – (8%)
3. Here’s an interesting piece called “Doing The Math On Proxy Odds,” which analyzes the potential use of vote modeling – in the form of “voting power analysis” – typically used in political campaigns in some proxy battles at public companies.
4. I agree wholeheartedly with Mark Borges’ blog last Friday entitled “Is it Worth Making a Triennial Vote Recommendation?” As I wrote in the Winter 2011 issue of the Compensation Standards newsletter in early January, most institutional investors have been vocal about their preference for an annual frequency – even if they didn’t really care about having it from a substantive perspective, they still wanted an annual vote to facilitate their ability to run their own peer comparisons (difficult to do if companies are holding SOP votes in different years). So these institutions decided to seek it from a process perspective.
So I’m not sure why companies continue to recommend triennial now that the early meeting results bear out that shareholders will often reject that frequency (as noted in ISS’s blog on Friday). As Tim Smith of Walden Asset Management emailed me over the weekend, he was initially angry about Dodd-Frank’s midnight addition of a frequency vote – but he’s now glad that frequency is on the ballot because rejecting the triennial recommendation has woken up many shareholders to the power that they now have with say-on-pay. It’s a reminder of what shareholder engagement is all about – listen to your shareholders and act on what they say. Clearly, many companies are choosing to operate in a bubble…
In his “Proxy Disclosure Blog,” Mark Borges gives us the latest say-when-on-pay stats: with 248 companies filing their proxies, 57% triennial; 6% biennial; 32% annual; and 5% no recommendation.