– Melissa Burek, Margaret Engel and Kelly Malafis , Compensation Advisory Partners
In this survey, we present the findings of our review of 2010 proxy disclosures from a sample of Fortune 500 companies. The study includes 85 companies, representing seven industry groups. Here are some highlights from our findings:
– 75 companies or 88% make some type of affirmative disclosure related to their assessment of risk in the compensation program.
– Of the 10 companies that did not address compensation risk in their proxy statements, 5 or 50% filed their proxy statements prior to the publication of the SEC’s final disclosure rules in December 2009.
– 71% of the companies that make risk-related disclosures indicate that a formal risk review was conducted and comment on their assessment.
– Reflecting broad market trends, a significant majority of our research companies–68 of 85 companies or 80%–maintain some form of clawback provision.
– A financial restatement is required in nearly all cases. Further, 48 companies (71% of those with a clawback) disclose that fraud or misconduct are triggering events. Twelve companies (18%) disclose a non-compete/non-solicitation/confidentiality violation as a trigger, and three include improper ‘risk analysis’ as a trigger.
– The majority of companies have stock ownership guidelines for their executives, typically expressed as a multiple of salary. While less common, many companies also have stock holding requirements where executives must hold a percentage of net shares from stock option exercises or vesting of restricted shares for a period of time. Within our sample, 17 companies, or 20% made changes to their stock ownership requirements.
On September 9th, the SEC approved an amendment to NYSE Rule 452 that prohibits any member broker from voting on an executive compensation matter without customer instructions. This amendment, which is immediately effective, implements Section 957 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The new prohibition on broker discretionary voting will extend not only to the “say-on-pay” and other executive compensation votes added by Section 951 of the Dodd-Frank Act, but also to any kind of executive compensation matter that is the subject of a shareholder vote. It will affect all member brokers voting shares of companies listed on the NYSE, Nasdaq or other national securities exchange, or not listed at all. The same voting practices are likely to be followed by bank custodians, consistent with current practices.
The amendment to NYSE Rule 452 and related changes to the NYSE Listed Company Manual Section 402.08 add any matter that “relates to executive compensation” to the list of matters on which member brokers may not give or authorize a proxy to vote customer shares without instructions from beneficial owners. According to the commentary, a matter “relating to executive compensation” includes – but is not limited to – the three advisory votes required by Section 951 of the Dodd-Frank Act (i.e., “say-on-pay,” “say-when-on-pay,” and advisory votes on “golden parachutes”).
As noted above, Rule 452 as amended eliminates broker discretionary voting on any kind of executive compensation matter that is the subject of a shareholder vote. This could include, for example, cash-based incentive plans for executive officers (irrespective of the impact on average annual income), executive officer performance measures and other executive compensation matters that may be presented to shareholders in accordance with stock exchange rules and/or Section 162(m) of the Internal Revenue Code.
Under Section 957 of the Dodd-Frank Act, the SEC is authorized to determine by rule any other “significant matters,” beyond executive compensation, as to which national securities exchanges must prohibit broker discretionary voting. The SEC has not to date identified any such other “significant matters.”
I pulled the following from this press release from Carter Ledyard, the law firm which won this case:
On September 30, 2010, in an important case of first impression, the United States Court of Appeals for the Second Circuit held that public companies may not indemnify their CEOs or CFOs from liability under Section 304 of the Sarbanes Oxley Act, which mandates that if a public company is required to restate its financial reports as a result of misconduct, the CEO and CFO must reimburse the company for any bonuses, incentive compensation, or trading profits that they earned during that period.
The Second Circuit held that Section 304, whose purpose is to prevent CEOs and CFOs from profiting by misleading investors and regulators about the financial health of their companies, does not provide a private cause of action and may only be enforced or waived by the SEC. Allowing a public company to indemnify and release its officers and directors from liability under Section 304 would nullify the SEC’s authority to pursue the Section 304 remedy or to grant exemptions from the statute.
The case before the Second Circuit, In re: DHB Industries, Inc. Derivative Litigation, Docket No. 08-3860-cv (2d Cir. Sept. 30, 2010), was an appeal from the approval by the United States District Court for the Eastern District of New York of a settlement of derivative lawsuits brought on behalf of shareholders of a public company formerly known as DHB (now Point Blank Solutions, Inc.) against former CEO David H. Brooks, former CFO Dawn Schlegel, and other former officers and directors of the company. One of the key provision of the settlement was that DHB would indemnify Brooks and Schlegel from any liability under Section 304 of the Sarbanes Oxley Act.
On September 14, 2010, Brooks and former COO Sandra Hatfield were convicted on 31 criminal charges stemming from their participation in a conspiracy involving massive securities fraud and theft of company assets. Schlegel had earlier pled guilty to having participated in this conspiracy. The SEC currently has actions pending against Brooks, Schlegel and Hatfield in the Southern District of Florida, in which it seeks disgorgement of $186 million under Section 304. The effect of today’s ruling by the Second Circuit is that DHB, which is currently undergoing bankruptcy proceedings in the United States Bankruptcy Court for the District of Delaware, In re Point Blank Solutions, Inc., Case No. 10-11255-PWJ, is no longer bound by the terms of the settlement to reimburse its officers and directors for their liability under Section 304, and is instead eligible to recoup those funds itself if the SEC’s pending actions are successful.
I just posted the Fall 2010 issue of the Compensation Standards newsletter, in which Mark Borges provides ten timely tips for preparing say-on-pay disclosure.
Note that we are making a big change for 2011 – we are moving the online version of “Lynn, Borges & Romanek’s Executive Compensation Disclosure Treatise & Reporting Guide” onto this site from CompensationDisclosure.com. So that when you renew for 2011 – remember that all memberships expire at the end of the year – you gain immediate access to it. And the 2011 version of the Treatise will be posted within the next few weeks; the 2010 Treatise is posted now for renewers.
In addition, Mark and Dave will be writing more content for the quarterly issues of Compensation Standards newsletter, as that newsletter will now include the content that would have otherwise gone into the now-merged “Proxy Disclosure Updates.” Drop our HQ an email if you have questions how this will work going forward at info@compensationstandards.com. Renew your CompensationStandards.com membership today.
Yesterday, the Boston Globe ran this breathless story at the top of page one. I went into it expecting an analysis about the judgment calls we all make in drafting compensation disclosure and thought there might be journalistic oversimplification as typically happens in the mass media. Some might say that pay disclosure is not necessarily a science, but an art.
However, one has to concede that math is still a science – and the Globe’s research certainly raises eyebrows about how seriously some companies are taking their pay disclosures. The Globe looked at about 210 local company proxy statements, adding up the columns in the summary compensation tables. It turns out that 55 times – at 34 companies – the totals of the columns did not match the number the company reported in the “Total” column. Um, that’s over 15%.
At most of these companies, the Globe determined (or the company conceded) that it was some sort of math or clerical error – transposed numbers, extra digits, etc. In some cases, when the company updated the stock compensation numbers for the past years using the SEC’s new methodology, they just changed the column in the middle of the table but didn’t update the total. Truly, the devil is always in the details and I would urge companies to double-check their numbers this year as I imagine a lot of newspapers are going to be following the Globe’s lead and do the math themselves in their local areas. Thanks to Mike Andresino of Posternak for bringing the article to my attention!
On Friday, the SEC listed the specific rulemakings that are planned for October in this schedule. As noted earlier, the schedule includes proposals for say-on-pay and say-on-golden parachutes, as well as disclosure of voting by institutional money managers on executive pay. Proposals regarding compensation committee/advisor independence; mine safety and disclosure relating to resource extraction issuers are not coming until November.
Among other planned rulemakings, October also includes a request for comment on a study regarding reducing the costs of smaller companies complying with Section 404 of Sarbanes-Oxley (ie. internal controls). The SEC will also establish five new Offices this month: Whistleblowers, Credit Ratings, Investor Advocate, Women and Minority Inclusion and Municipal Securities. Here is testimony before the Senate Banking Committee from SEC Chair Schapiro regarding how the rulemaking is proceeding.
– Eeva Raikkonen and Salvatore Tedesco, ISS’s European Research Team (Brussels)
The European Commission recently released reports on Member States’ application of two recommendations on executive remuneration and financial services sector pay. The reports complement a package of proposals intended to strengthen the European financial system. The pay guidance, released in April 2009, is a non-binding instrument that invited Member States to take measures to implement the main principles by the end of 2009. The EC reports outline the state-of-play one year after the publication of the remuneration guidelines.
The first, more general recommendation on remuneration gave guidance on the structure of remuneration policies and their governance with a focus on variable pay, in order to better align pay with performance. The EC’s report finds that half of the recommendations on remuneration at listed companies have been endorsed by 10 of 27 Member States, while eight countries say they are still in the process of taking necessary steps.
The guidelines were not aimed at harmonising remuneration rules across Europe, and national provisions vary from one market to the next. For instance, while a minority of Member States have followed the recommendation that severance pay be limited to two years’ fixed remuneration, a number of countries have taken either a more lenient approach (by also including variable pay) or a more stringent one (by capping pay at one year’s fixed salary). The Member States were given discretion as to whether to incorporate the EC’s guidelines through legislation or corporate governance codes. The EC finds that recommendations have mostly been included in national corporate governance codes functioning on a comply-or-explain basis.
Clawback clauses (i.e., arrangements which permit companies to reclaim variable remuneration paid on the basis of financial results that proved to be flawed) have been very popular and were more likely to be regulated in law than other recommendations. Member States’ interpretation of the guidelines has also led to varying results. For example, few have complied with the recommendation to defer a major part of variable remuneration. In the EC’s view this is mainly due to varying degrees of familiarity with the concept.
The second EC recommendation specifically targeted remuneration at financial services sector companies. It was intended to ensure that remuneration policies do not encourage excessive risk-taking and are in line with the long-term interest of financial institutions. According to the June 2 EC report, 16 of 27 Member States have fully or partially applied the recommendation. While a further six are in the process of taking necessary steps, a “relatively high number” (five) have not initiated any measures or have put into place inadequate ones. The EC also points out that the scope of application of national measures varies. Only seven Member States apply consistent measures across the financial services sector, while six countries address only credit institutions.
The EC finds that at this stage it is difficult to assess if and to what extent financial institutions have put into place sound remuneration policies. In the EC’s view, financial institutions are unlikely to commit to a long-term and comprehensive reform of their remuneration policies before the adoption of pending legislation in this area, namely in the form of proposed amendments to the Capital Requirements Directive and the proposed directive on alternative investment fund managers. With regard to both recommendations, the EC concludes that “progress has been made but a significant number of Member States have yet to implement the Recommendations fully.”
In addition to gauging stakeholders’ views on general remuneration issues at listed companies through its green paper on corporate governance in financial institutions and remuneration policies, the EC has stated it will focus on the following issues in light of the findings: 1) proposing legislative measures targeting remuneration in the non-banking financial services sector in 2010-2011; 2) pushing for a swift agreement between Member States and the European Parliament on the pending legislative proposals that deal with remuneration issues, as well as strictly monitoring their implementation by Member States; 3) promoting, through its participation in the Financial Stability Board and the G-20, an effective application of similar rules on remuneration in the financial services sector on a global level; and 4) reassessing the situation regularly and proposing additional measures as necessary.
To help companies benchmark proxy officer change-in-control (CIC) costs, we recently analyzed 2010 proxy filings of 500 firms representing a wide cross section of industries and company sizes. Top five executives’ CIC costs, with CEO values shown separately, are presented both as a percentage of year-end market cap, and in absolute dollar terms. Here is the resulting study.
This type of analysis enables firms to reach beyond a traditional comparison of CIC benefits based on an examination of each CIC program design feature, and understand how aggregate CIC costs for named executive officers compare to the market. Comparison of CIC costs to market cap largely neutralizes the impact of stock prices on the value of equity vesting acceleration, and therefore total CIC benefit values, thus leveling the playing field between companies with rising and falling stock prices. Relative costs and prevalence of 280G excise tax gross-up provisions were also collected and analyzed.
– Roel Delgado, Nikeita Lea, and Nafeez Amin, ISS’s Taft-Hartley Research Team
Despite concerns that the end of broker voting in uncontested board elections would unleash a surge of withhold votes during the 2010 U.S. proxy season, the number of directors who failed to receive majority support declined this year. As of Sept. 1, 88 directors had failed to earn majority support, a slight decrease from the 93 board members during the same period last year, according to ISS data. In addition, the average opposition vote against directors at Russell 3000 companies was 6.1 percent, down from 7.4 percent during the same period in 2009. The average dissent levels in 2008 and 2007 were 5.1 percent and 4.9 percent, respectively.
Among S&P 500 firms, directors at 158 companies had at least 10 percent dissent this year, down from 171 in 2009, but more than 121 in 2008, 118 in 2007, and 95 in 2006. Only one of the 3,627 directors at S&P 500 firms up for election so far this season has failed to win majority support: Virgis W. Colbert at Stanley Black & Decker. Almost 54 percent of shareholders opposed his reelection after the company failed to adopt a majority-supported shareholder proposal to declassify the board. By contrast, 12 directors at six S&P 500 companies received majority opposition in 2009; and five directors at two S&P 500 issuers received such opposition in 2008.
Notwithstanding the overall lower levels of shareholder dissent, common threads were observed at those firms that received significant levels of dissent: ignored shareholder proposals and, just as last year, pay practice concerns.
Ignored Shareholder Proposals
A key contributing factor to high protest votes at S&P 500 firms this year were corporate failures to implement majority-supported shareholder resolutions. At six S&P 500 companies, board members received more than 40 percent opposition for this reason. Twelve FirstEnergy directors received more than 30 percent opposition at the company’s annual meeting in May after failing to implement several majority-backed shareholder proposals for the fourth consecutive year. This display of investor dismay follows the company’s failure to adopt four proposals seeking to adopt simple majority voting provisions, reduce the threshold for calling special meetings, establish a proponent engagement process for shareholders, and adopt a majority vote standard for director elections.
At Ball Corp., four directors received more than 41 percent dissent after the company failed to implement declassification proposals that earned majority support in 2009, 2008, 2006, and 2005. The company also declined to opt-out of a 2009 Indiana law that established classified boards as the state’s default standard.
There was more than 40 percent opposition this season at Vornado Realty Trust after the board failed to act on a majority-backed proposal to require majority voting for the election of directors. There also was more than 40 percent dissent at Chesapeake Energy after the board declined to implement proposals to declassify the board and to adopt a majority voting standard. At Motorola, there was more than 30 percent opposition after the board did not fully adopt a majority-supported shareholder proposal to give 10 percent shareholder groups the right to call special meetings; the board opted for a 20 percent threshold.
Pay Concerns
During the 2010 season, tax gross-up payments and other compensation practices continued to spur significant levels of dissent across the S&P 500 universe, according to ISS data. Two compensation committee members at Abercrombie & Fitch received more than 40 percent opposition amid a “vote no” campaign by the American Federation of State, County and Municipal Employees (AFSCME) Pension Plan. The labor pension fund raised concerns about succession planning and entrenchment, and argued that the committee has “approved guaranteed pay that fails to link pay to performance.” AFSCME also cited a $4 million lump-sum payment for ending CEO Michael S. Jeffries’ company aircraft usage as a significant concern.
Investor concerns around pay and performance linkage and equity compensation practices also contributed to more than 40 percent opposition to compensation committee members at Eastman Kodak and Fortune Brands.
Shareholders continue to oppose pay panel members who approve tax gross-up provisions as evidenced by the more than 30 percent dissent levels at Hess Corp., Noble Energy, and PerkinElmer. Executive perks, problematic change-in-control provisions, and pay-for-performance disconnects also contributed to more than 30 percent withhold votes against pay panel members at Aetna, Occidental Petroleum, GameStop, Urban Outfitters, Vulcan Materials, Boston Scientific, and the NASDAQ OMX Group.
At Occidental, compensation committee members received more than 30 percent opposition, even though there was a management “say on pay” (MSOP) proposal on the ballot where investors could express their views on pay. The votes at Occidental suggest that some investors will vote against directors and oppose MSOP proposals in cases in long-standing pay concerns.
Tax gross-ups and retention payments also contributed more than 20 percent dissent at Abbott Laboratories. A pay panel member at Dr Pepper Snapple Group also received more than a 20 percent protest vote, apparently due to the provision of excise tax gross-ups and tax reimbursement on personal aircraft usage.
Shareholders of Fidelity National Information Services again expressed disapproval of the company’s executive pay practices by withholding more than 20 percent support from the only compensation committee member up for election this year. Among investors’ likely concerns were retention bonuses and the lack of a maximum cap on bonuses for synergy cost saving incentives. Last year, the sole Fidelity compensation committee member who stood for reelection received more than 30 percent shareholder opposition.
Other Drivers of High Protest Votes
Insufficient attendance at board and committee meetings remains a determinant of shareholder votes as seen at PepsiCo where a director who failed to attend at least 75 percent of board meetings received more than 40 percent opposition. For the same reason, director nominees at Molson Coors Brewing and Applied Materials received greater than 30 percent dissent while a director at Supervalu faced more than 20 percent opposition. Concerns about “overboarding”–a director serving on more than six boards or an outside CEO serving on more than two other boards–contributed to more than 20 percent negative votes at Laboratory Corporation of America, Advanced Micro Devices, Qwest Communications International, and Coca-Cola Co.
At Massey Energy, all three nominees, who were members of the board’s Safety, Environmental and Public Policy Committee, received more than 40 percent withhold votes. The company was a target of a “vote no” campaign by the CtW Investment Group, which represents union-backed investment funds, and a group of state pension funds. The consortium of investors expressed concern with the lack of board oversight of company management, particularly around the issue of safety. The dissident group pointed to extensive statistics from the U.S. Mine Safety and Health Administration, highlighting high levels of compliance failures at the Upper Big Branch mine, where 29 miners were killed in April, and other Massey operations over the last few years.
Non-management directors who are affiliated with management (due to professional service fees, business transactions, or other ties) and who serve on key board committees (compensation, audit, or governance/nominating) also received high levels of opposition at a number of S&P 500 companies, such as: Jabil Circuit, Juniper Networks, and Rowan Cos. (all greater than 40 percent opposition); and Aon, Morgan Stanley, Dentsply International, and Medco Health Solutions (all had greater than 30 percent opposition).
Independence, Attendance, and Pill Concerns at Small Issuers
So far this year, there have been 48 companies in the Russell 3000 index where a director received more than 50 percent dissent, up from 44 companies in 2009. As is typical among smaller issuers, the vast majority of these companies do not have majority voting provisions or resignation policies. Investor calls for fully independent committees also contributed to high adverse votes at smaller issuers. Affiliated outsiders who serve on key board committees (audit, compensation, nominating or governance) received more than 50 percent disapproval at 12 companies. The highest level of dissent within the Russell 3000 index was at CSG Systems International, where shareholders withheld 80 percent of their votes from an affiliated outsider sitting on the nominating committee. At 10 other companies, directors failed to garner majority support apparently due to their poor attendance at board meetings. Overboarding concerns also contributed to majority withhold votes against four directors at different companies.
At least one director at Nabi Biopharmaceuticals, Kendle International, Michael Baker Corp., AMAG Pharmaceuticals, CIRCOR International, and EMS Technologies received majority opposition due to the board’s failure to seek shareholder ratification of a poison pill. Notably, all of Kendle International’s eight directors failed to obtain majority approval with their support averaging just 39 percent. The company has a plurality vote standard without a director resignation policy in place.
Pay concerns also generated high withhold votes at smaller issuers. The provision of tax gross-ups contributed to more than 30 percent dissent at Quidel Corp. Compensation committee members at CIBER and The Pantry received more than 50 percent opposition that apparently was due to disconnects between executive pay and corporate performance. Pay panel members also had more than 40 percent dissent at Universal Health Services (apparently because of severance packages), at On Assignment (after repricing of options without shareholder approval), and at Ikanos Communications (cash buyout options were adopted without shareholder approval.)
At the annual meeting of Fred’s Inc., a Tennessee-based retailer, the entire board received majority opposition for the second consecutive year. This vote apparently stemmed from two reasons. The company failed to implement a 2009 majority-supported shareholder proposal to adopt a majority vote standard in board elections. Additionally, the company’s poison pill, which the board renewed without shareholder approval in October 2008, remains in place. Notably, the company has a plurality vote standard for board elections with no director resignation policy in place. At Sterling Bancshares, one director received majority dissent after the board ignored a majority-supported declassification proposal.
As I blogged last week: I just returned from the Annual Conference of the National Association of Stock Plan Professionals (NASPP) in Chicago, and I came home with a briefcase full of notes and materials on best practices in executive compensation, compensation disclosures and corporate governance. I’ll share thoughts from individual sessions over the next few weeks, but I came away with these general thoughts:
– “Pay for Performance” was the mantra repeated by many of the speakers. The single most important factor in “getting to yes” in Say-on-Pay votes will be demonstrating the link between pay and performance. This must be done in the Compensation Discussion and Analysis (CD&A) disclosure in the proxy statement.
– It will be important to craft the summary section of CD&A carefully. The section should summarize the pay for performance link and should highlight best practices explained in more detail elsewhere. In this first proxy season involving mandatory Say-on-Pay, advisory services such as ISS, as well as institutional investors, will be scrambling to sort out the practices of many companies in a short time. Issuers will want to make it easy for investors to determine quickly that the company has sound pay practices.
– The Dodd-Frank Act will require a “Pay for Performance” proxy statement table. However, the enabling regulations won’t be adopted until April to July 2011, and the table will likely not be in effect until the 2012 proxy statement for most companies. The panelists speculated that the table will be based on a total shareholder return (TSR) measure. They recommended that companies consider whether other measures provide a better method for evaluating their performance relative to compensation (other metrics, peer group comparisons, etc.). If so, consider providing that data in the 2011 proxy statement as a “preemptive strike.”
– Clawbacks will be tricky for many companies, particularly companies listed on exchanges who will need to adopt a clawback policy next year under expected new rules. Companies that previously adopted clawbacks should highlight this fact in their next proxy statement, as it is considered a best practice by institutional investors. All public companies will have some choices to make about the scope and structure of the clawback policies, as I will cover in an upcoming post.