Seyfarth just released its Human Capital Disclosure Report — now in its third year. Based on a review of HCM disclosures of 200 companies in 2023 10-Ks, the report provides the following general trends — although it also recognized that the disclosures continued to vary widely from company to company:
We saw an increase in the number of HCM disclosures we reviewed specifically referencing culture up an average of 82.5% across industries.
Despite recent Supreme Court decisions raising issues about factoring race into college admissions decisions, we continued to see most HCM disclosures include reference to DEI efforts with 93.5% of the HCM disclosures we reviewed across industries including references to DEI principles. The number of companies including more detailed statistics related to diversity and year-over-year comparisons continued to increase with the number of companies that included demographics reporting increasing to 60.5% across industries (up from 44% in 2021).
While not at the same level of DEI references, we saw consistent numbers in the references to pay equity reviews in the HCM disclosures we reviewed—with 28.5% across all categories mentioning pay equity efforts—and most industries reflecting the same or increased references to pay equity reviews.
Perhaps not surprisingly, many of the HCM disclosures we reviewed focused on recruitment and retention efforts as a critical part of their HCM strategy. As part of that effort, employee benefits continue to play a front and center role. In addition to the compensation element, which is impacted by the pay equity analyses noted above, we saw many references to the importance of the company’s employee benefits package. These references often included mention of standard employee benefit programs, such as retirement plans and medical benefits, but many also referenced additional benefits offerings, such as mental health and well-being benefits, mindfulness tools, caregiver (caring for infants as well as disabled or elderly family members), and family planning and fertility benefits.
We also saw many HCM disclosures focus on employee engagement, noting engagement surveys, and other ways to assist employees with their professional development and general education. Many disclosures referenced remote and hybrid work options reflecting a continued desire for flexibility within the workforce. Companies also seemed focused on developing their talent pipeline, as another tool for retention and health of the business. We saw references to a variety of course offerings and programs, including traditional coursework from universities (some virtual) as well as mentorship and sponsorship programs. We also noted references to more discreet topics such as mindfulness, financial literacy, and English as a Second Language courses.
[T]he number of references to board level oversight of human capital issues in the HCM disclosures we reviewed (regardless of industry) continued to increase with an average of 45.5% reporting board oversight in this area, up from 25% in 2021 and 42% in 2022.
This Compensia Thoughtful Pay Alert discusses trends and key practices among companies in the technology industry that award executives PSUs with a relative TSR metric. The use of relative TSR remains popular (approximately 64% of the covered technology companies granted PSUs with a relative TSR metric), with some companies (particularly in the software space) making some improvements in program design to strengthen pay and performance alignment.
Where both relative TSR and financial metrics are weighted components of the plan formula (85% of the companies including both types of metrics), TSR accounts for, on average, 45% of the payout.
The other 15% of companies use relative TSR results as a modifier to adjust payouts determined using financial or absolute stock price metrics, generally +/- 25 percentage points. No company eliminated a relative TSR metric for the current year, while 10 companies introduced relative TSR PSUs for the first time.
The alert highlights these design improvements:
– Bar raised on performance levels required for target and maximum payouts (i.e., above 50th percentile at target and above 75th percentile at max)
– Payout caps added for negative absolute TSR (nearly 50% of companies)
– Adjustment in measurement approaches
On measurement approaches, the alert says percentile rank remains the most common (at 70%), but “more companies are questioning the impact of using a percentile rank approach on the plan outcomes” since select indices are “becoming increasingly weighted toward a small group of highly-valued companies (i.e., top 10 constituents represent 30% of the S&P 500; Apple, Microsoft, Amazon, NVIDIA, Alphabet and Meta represent 40% of the NASDAQ).” This is causing an uptick in companies considering or implementing a Percentage Points vs. Index approach (25%) or Points vs. Median approach (5%). The alert reviews the advantages and disadvantages of each approach.
In early 2023, the SEC announced the adoption of rules implementing a T+1 settlement system. The transition to the shorter settlement cycle will occur on May 28, 2024. Nasdaq and NYSE recently published alerts about this transition and its impact on distributions of cash, stock or warrants — in particular, NYSE reminded listed issuers to avoid consummation of corporate actions during this transition, to the extent practicable.
With this transition around the corner, this Morgan Lewis blog discusses the implications for stock plan professionals, noting that “employers will have one less day to calculate the withholdings owed with respect to employees’ equity compensation and deposit those withholdings with the IRS and state tax authorities.”
In the case of stock option exercises or vesting/settlement of other stock awards, the stock will need to be delivered to employees’ brokerage accounts no later than one day after the DWAC date. Accordingly, employers will need to make payroll deposits by the second business day after the DWAC date instead of the third business day.
See the blog for a detailed discussion of the required timing of these deposits and the consequences of doing so after the deadline. Here’s the example it provides:
For example, assume that an RSU vests on a Monday, July 1, and the DWAC is that day. The new settlement date is July 2 and the payroll tax deposits are due July 3. But assume that the employer is unaware of the settlement date change and does not make its deposits until July 9 (after the long holiday weekend).
These deposits are now six days late, and the deposit penalty would be 5% of all the late deposits. If these deposits were made on July 8 the penalty would be only 2%, but under either scenario it is clear that the reduction of the settlement date (and therefore the liability date) by one day can significantly impact an employer’s penalty exposure.
The takeaway?
To avoid potential deposit penalties, whether employers make their own payroll tax deposits or hire a third-party payroll service provider to make deposits, employers should check to be sure that their scheduled dates of deposit for equity compensation are accelerated to accommodate the new T+1 rule.
A U.S. district court recently ruled in favor of Apple to dismiss a case that alleged ’34 Act and fiduciary duty violations relating to proxy statement disclosures about executive compensation, say-on-pay, and director elections. Bloomberg reported on the case when it was filed last year and this win.
Specifically, the plaintiff (a pension fund affiliated with the International Brotherhood of Teamsters) alleged that the company’s proxy misled investors by understating the value of equity awards in the CD&A. The plaintiff took issue with the fact that the number of RSUs granted to executives was calculated with the very common approach of dividing the target grant value by the closing stock price on the date of grant. So, the CD&A disclosed a “target value” of awards based on those figures.
The plaintiff said that the compensation committee should have used a Monte Carlo simulation to value the awards, which would have shown a higher value of compensation in the proxy disclosure, and which allegedly impacted the voting outcome. Here’s more detail from the opinion:
At the core of the Complaint is Plaintiff’s assertion that the amount of executive compensation disclosed in the compensation-narrative section of the 2023 Proxy Statement understates the actual compensation as disclosed in the compensation-tables section of the 2023 Proxy Statement. According to Plaintiff, “to accurately determine the grant date fair value of performance-based compensation that are based on [relative shareholder return], one needs to employ a somewhat complicated analytical derivative pricing model such as a Monte Carlo simulation. Here Apple did so for purposes of reporting the NEOs[‘] compensation in 2022 and 2023, but it failed to use such a model when awarding the performance-based RSUs.”
As a result, Plaintiff contends, “the 2021-2022 compensation actually cost Apple $31,707,610 more than the amounts disclosed in the 2023 Proxy Statement, and . . . Apple’s representations were materially false because they grossly understated the known costs of this compensation.
The court said that the plaintiff’s Section 14(a) complaint came up short in a couple of ways. First, the plaintiff didn’t adequately plead “loss causation” – because the advisory nature of the say-on-pay vote meant that the proxy statement hadn’t caused any injury, and the compensation information was not an essential link to director election decisions. On the substantive disclosure, the opinion says:
As another court noted in a previous executive-compensation-related suit against Apple brought under Section 14(a), there is no SEC rule requiring that a specific method for determining executive compensation be used, so long as the chosen method is disclosed. That principle applies here.
The Complaint effectively admits (by pasting excerpts of Apple’s disclosures in support of its claims) that Apple did precisely what Section 14a) and SEC rules require – presented its compensation process and methods through detailed compensation tables. [The Complaint says] “the proper way to determine the Grant Date Fair Values of performance-based equity compensation . . . is to use a sophisticated model such as a Monte Carlo simulation. Apple used such a model when accounting for these performance-based shares as demonstrated by the Grants of Plan-Based Awards Tables in its 2022 and 2023 Proxy Statements.”
Plaintiff does not allege that Apple was required to disclose anything more. That the compensation tables are in gray type and not graphically designed in color like the narrative section is inconsequential.
Overall, the dismissal of this complaint (with prejudice) is good news for companies. But as always, there are procedural nuances and specific facts that could have affected the outcome, particularly with respect to the fiduciary duty claims.
That means that this ruling may not entirely deter plaintiffs from bringing claims against other companies on similar grounds, if they find a good target. It’s another reminder that your executive compensation disclosures are being closely scrutinized and can be fodder for litigation – even if you did everything correctly. Stay safe out there!
The Dodd-Frank clawback policies that are now required under exchange listing standards don’t apply to incentive-based compensation that was received by executives before the October 2, 2023 effective date. How exactly will that play out in practice? This Winston & Strawn blog says that the answer depends on the “Restatement Determination Date” – which is the date that a company is determined to be required to prepare an accounting restatement. Here’s more detail:
For issuers with calendar year fiscal years, if the Restatement Determination Date occurred on or before December 31, 2023, then the Recovery Period runs from January 1, 2020 through December 31, 2022, i.e., the three completed fiscal years immediately preceding December 31, 2023. Since any incentive-based compensation received before the Final Rules’ October 2, 2023 effective date is not subject to clawback thereunder, any restatement with a Restatement Determination Date on or before December 31, 2023 will not result in a clawback under the Final Rules. This is because, for calendar-year issuers, the three-year lookback period for the Recovery Period would consist of fiscal years that all ended prior to October 2, 2023, resulting in no incentive-based compensation being received during the Recovery Period and on or after October 2, 2023. Therefore, no incentive-based compensation is subject to such issuer’s Clawback Policy. See Example 1 below.
There are different results for a calendar year issuer if the Restatement Determination Date occurs after December 31, 2023, as illustrated in Example 2 below.
In addition, the results may differ if the issuer is not a calendar year filer depending on the Restatement Determination Date. See Example 3 below for an example of an issuer with a June 30 fiscal year end that had a Restatement Determination Date after October 2, 2023, but that results in no incentive-based compensation subject to such issuer’s Clawback Policy since the Recovery Period would consist of fiscal years that all ended prior to October 2, 2023.
This blog walks through several examples, which are good to read alongside the hypo that I flagged a couple months ago. It recommends establishing a clear record that the policy has not been triggered, if you find yourself in that situation, and reviewing any clawback policies that the company has adopted voluntarily that may nevertheless apply. It concludes with this example of what to do if a restatement does trigger analysis, but if no incentives were erroneously paid due to the financials being corrected prior to the payout:
For example, a calendar year issuer granted Performance Shares with a 2021–2023 performance period that are deemed received as of December 31, 2023. In February 2024, the Board of Directors determined that a restatement of the 2022 financials was required. If the required restatement of the 2022 financials is completed in March 2024 in connection with the 2023 Form 10-K and the Compensation Committee’s determination of the performance results for 2023, the Compensation Committee should evaluate whether the performance goal had been attained by using the restated financials for the portion of performance relating to fiscal year 2022. Since that award is received after October 2, 2023, it is subject to clawback under the issuer’s Clawback Policy. However, it should not result in erroneously awarded compensation due to a restated financial performance measure since the Compensation Committee evaluated the performance goal using the restated financials. We recommend establishing a clear record of the Compensation Committee analyzing the impact of the restatement and adopting resolutions reflecting the Compensation Committee’s determination that no erroneously awarded compensation was received by any executive officer. Depending on the timing, this evaluation could be completed as part of certifying the performance results for such incentive-based compensation award.
The stories keep coming from the Delaware Court of Chancery’s decision to invalidate the 2018 “moonshot” award to Elon Musk. The WSJ reported late last week that the plaintiff’s lawyers have asked the court to approve a fee payment in Tesla stock with a value of $5.6 billion!! The directors’ defense costs also need to get paid.
The D&O insurance arrangements will dictate whether the company can pass that bill along to the insurance carrier. At least at one point, Tesla had a custom insurance policy, so it’s hard to know what the mechanics will be here. This blog from Woodruff Sawyer’s Priya Huskins explains how the coverage typically works – which is good to think through if you’re looking at your own policy:
The Tesla case was a derivative suit against the board of directors, so the proceeds of the shareholder’s win technically go back to the company. This is also what happens anyway when an equity grant is rescinded.
Legal defense costs of directors subject to a derivative claim are indemnifiable by a company, assuming the company is not bankrupt. Thus, if a company is buying classic D&O insurance, one would expect the directors’ defense costs to be paid by the D&O insurance policy, subject to the self-insured retention (similar to a deductible).
These costs will not be paid by D&O insurance if a solvent company is only buying a Side A policy, a policy that only responds to non-indemnifiable claims.
Companies of Tesla’s size will often choose to self-insure indemnifiable claims, and some might go so far as to set up a captive to handle non-indemnifiable claims.
In any case, don’t expect insurance carriers to “pay” anyone the value of an executive’s voided compensation agreement given the standard exclusions in D&O insurance policies for that sort of thing. Even worse, to the extent a board is found to have engaged in wrongdoing, you might see insurance carriers attempt to claw back defense costs from the company.
I blogged a few weeks ago that personal travel is the perk that is most likely to catch the attention of the SEC. The Commission isn’t the only agency that is scrutinizing the use of corporate jets, though. This NYT article says that the IRS is rolling out an “aircraft audit” initiative to evaluate whether companies have improperly deducted expenses for airplanes that were sometimes being used for personal travel, and whether individuals have properly recognized income relating to personal travel benefits. They’re starting with about four dozen audits and will go from there. Here’s more detail:
The scrutiny of corporate jet use will involve new data analytics tools, which the I.R.S. has been developing with the $80 billion in funds it was granted through the Inflation Reduction Act of 2022, to determine when executives or other company officials might be using corporate planes for vacations and private trips. The agency plans to begin dozens of new audits that will focus on large companies, partnerships and wealthy taxpayers.
The deductions can be worth tens of millions of dollars. And according to this WSJ article, more companies have been jumping on the bandwagon:
Overall, the number of big companies providing the perk rose about 14% since 2019, to 216 in 2022, figures from executive-data firm Equilar show. The number of executives receiving free flights grew nearly 25%, to 427.
The article says that this worked out to an aggregate spend of $65 million on executives’ personal jet travel in 2022. Keep in mind that the SEC has made a big deal of using data analytics in its enforcement initiatives and loves a good headline. If the IRS is leveraging these tools to identify perks, the SEC – which as I mentioned, is already focused on personal travel – may not be far behind with its own type of sweep. It is a good time to pay extra attention to your perks analyses & disclosures! This blog from Gunster’s Bob Lamm recaps what goes into the perquisite analysis for the purpose of proxy statement disclosure:
– A benefit (such as aircraft usage) is “not a… personal benefit if it is integrally and directly related to the performance of the executive’s duties”.
– “[A]n item is a… personal benefit if it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees.”
– The “concept of a benefit that is ‘integrally and directly related’ to job performance is a narrow one” and would not be satisfied by a determination that the benefit would qualify as an “ordinary” or “necessary” expense for tax or other purposes or that the perquisite provides some benefit or convenience to the company, as well as to the executive.
– “If an item is not integrally and directly related to the performance of the executive’s duties, the second step of the analysis comes into play. Does the item confer a direct or indirect benefit that has a personal aspect (without regard to whether it may be provided for some business reason or for the convenience of the company)? If so, is it generally available on a non-discriminatory basis to all employees? For example, a company’s provision of helicopter service for an executive to commute to work from home is not integrally and directly related to job performance (although it would benefit the company by getting the executive to work faster), clearly bestows a benefit that has a personal aspect, and is not generally available to all employees on a non-discriminatory basis” (emphasis added).
If, as seems apparent, the SEC doesn’t view the helicopter example as being a close call, what do you think it would say about an executive claiming that her husband’s travel on the company jet to a conference she is attending in Costa Rica is “integrally and directly related” to the company’s business? And many other examples would reach similar conclusions.
For a great primer on corporate aircraft use, check out this 22-minute podcast that I taped a couple years ago with Cooley’s Brad Goldberg and Jet Counsel’s Stewart Lapayowker.
As Liz blogged last October, more and more companies are adopting annual limits on director pay, which became a common consideration in the wake of Delaware’s Investor Bancorp opinion. If you’re proposing a new plan this proxy season, this Pay Governance memo on director compensation discusses current levels of director compensation limits among S&P 500 companies.
Practice is split between defining annual limits as equity-based awards only or defining limits as a total of all cash and equity-based compensation. Both definitions have a median value of $750,000.
A limited number of S&P 500 companies define cash-only annual non-employee director pay limits with a median value of $500,000.
In our recent webcast — “The Latest: Your Upcoming Proxy Disclosures” — Ron Mueller discussed this year’s hot topics for compensation-related shareholder proposals. As we’ve discussed, we saw many proposals seeking shareholder approval of severance agreements last year. Ron noted in his commentary that this proposal is still common.
Ron also discussed three proposals that are new this year. Here’s an excerpt from the webcast:
One is requesting that companies amend their clawback policies […] the supporting statement alludes to the fact that if one executive engages in misconduct and, as a result, payouts are higher than they should have been, then other executives should also be forfeiting their compensation regardless of whether those executives themselves engaged in misconduct.
From the conservative side, there were some proposals out there asking companies to eliminate greenhouse gas reduction metrics as performance measures. More and more companies are including environmental metrics as part of their bonus programs, as one of their performance metrics. Here’s a proposal saying, “No, stop doing that.” It’ll be interesting to see what kind of traction that gets.
Lastly, another new proposal is asking for an annual Say-on-Pay vote on director compensation. As if that’s not novel enough, the two twists on that are that it has to be an advance vote before the directors get paid, not after the fact vote like Say-on-Pay for executives, and the proposal is in the form of a binding bylaw amendment. If it was approved by shareholders, it would go into effect automatically under most corporate law programs and most bylaws.
Ron also noted that it’s not always clear what exactly the proposals are asking for. And, in some cases, companies are increasing their engagement with proponents — especially since institutional shareholders are asking companies what each proposal is asking for, what the company is currently doing on that front and whether it met with the proponent and tried to negotiate out the proposal.
The SEC’s amendments to Rule 10b5-1 back at the end of 2022 spawned quite a few interpretive questions that are still being sorted out to this day. One of the areas that prompted questions is the scope of the exception to the limitation on overlapping open-market trading plans and the limitation on single-transaction trading plans that is provided for “eligible sell-to-cover” transactions. Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) defines an “eligible sell-to-cover” transaction as one where an agent is authorized to sell “only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award” where the employee does not otherwise exercise control over the timing of such sale.
Last summer, the ABA’s Joint Committee on Employee Benefits submitted a request for interpretive guidance to the Corp Fin Staff seeking clarification as to what actually qualifies as an “eligible sell-to-cover” transaction. There was a concern among practitioners that the language of the definition would limit the amount of securities to only the amount required to satisfy statutory minimum tax withholding rates, when some companies allow employees to designate a higher expected effective tax rate as the rate at which their employer will withhold taxes upon the vesting of a compensatory award. The group proposed the following interpretive Q&A to the Staff:
Question: Can a contract, instruction, or plan qualify as one providing for the sale of “only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award,” and thus be an “eligible sell-to-cover transaction” under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3), if it provides for the sale of shares at the rate identified by the employee as the employee’s expected effective tax rate, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules?
Suggested Answer: An “eligible sell-to-cover” transaction under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) means the sale of shares up to the tax rate designated by the employee for withholding, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules.
In a memorandum to the members of the ABA Subcommittee on Employee Benefits, Executive Compensation, and Section 16, Mark Borges, Alex Bahn and Ron Mueller describe their discussions with the Staff on this interpretive question, and note:
As a result of our informal discussion with the SEC Staff, we understand that the reference in Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) to “only such securities as are necessary to satisfy tax withholding obligations” is not intended to mean only the number of shares required to satisfy minimum tax withholding requirements and that the rule is not intended to use technical tax language or to disrupt practice with respect to legitimate tax arrangements. Put another way, the focus of the SEC Staff appears to be on whether the arrangement is designed to pay the tax obligation arising in connection with the vesting event, which can take into account the expected effective tax rate and is not focused on only the required tax withholding rate.
It appears the SEC Staff agrees with our proposed response and will interpret the provision to allow sales of shares to satisfy an employee’s expected effective tax rate. This interpretation, however, does not apply if any of the proceeds from the sale are intended to satisfy taxes relating to income from sources other than the vesting of a compensatory award. The SEC Staff thus cautioned that persons could not characterize a sale as an “eligible sell-to-cover” transaction where shares are sold with the intent of covering taxes for events unrelated to the vesting event. For example, selling shares in an “eligible sell-to-cover” transaction where the proceeds are intended in part to cover taxes for the sale of property other than the shares received in the vesting event would not be considered an “eligible sell-to-cover” transaction.
It is very helpful to know that the Staff is not reading the “eligible sell-to-cover” transaction exception so narrowly as to exclude the many situations where an expected effective tax rate is used to determine the amount of securities to be sold rather than the statutory minimum tax withholding rate, thus making this exception more useful to avoid running afoul of the overlapping plan and single trade restrictions.
In a separate blog, Dave also shared guidance on whether a non-employee director can rely on the eligible sell-to-cover transaction exception.