Now that the Delaware Court of Chancery has taken the unusual step of invalidating the compensation package that Tesla’s board of directors awarded to Elon Musk back in 2018, shareholder proponents are saying they see an opening for higher support on traditional corporate governance resolutions – including a proposal urging annual director elections that has been submitted to the company this year. This Reuters article quotes prolific proponent John Chevedden:
“People are going to be looking to rein in what’s going on,” said John Chevedden, an independent activist investor. He has put forward a resolution at Tesla’s upcoming shareholder meeting expected this spring that would replace a requirement for major corporate changes to gain support from two-thirds of all shares outstanding with a simple majority vote.
The article also points out that ISS has in the past recommended votes against certain Tesla directors due to CEO compensation concerns. The question is whether this year, the court’s findings will contribute to a drop in support from significant institutional holders who have previously cast “management friendly” votes.
It was the “moonshot” award that started it all. But last week, as you’ve probably heard, Elon Musk did not get the outcome he was hoping for in the Tornetta v. Musk litigation that has been winding its way through the Delaware Court of Chancery for several years.
The case challenged the record-breaking equity award that was granted to Musk in 2018 and – when the value of the company skyrocketed – came to be worth about $51 billion. Chancellor Kathaleen McCormick issued her 201-page opinion last Tuesday. As Tulane Law Prof Ann Lipton put it, “she took the extraordinary step of holding that Elon Musk’s Tesla pay package from 2018 was not “entirely fair” to Tesla investors, and ordered that it be rescinded.” Mechanically, it looks like the options that the company had granted to Musk will now be cancelled (none of the options had been exercised). Ann’s blog walks through the complex legal standards – & burdens of proof – that led Chancellor McCormick to this outcome. Here’s an excerpt:
Formally, in Tornetta, the court concluded that Elon Musk was a controlling shareholder of Tesla, at least for the purposes of setting his compensation package. The court considered both his 21% percent stake, and his “ability to exercise outsized influence in the board room” due to his close personal ties to the directors and his “superstar CEO” status. She recounted the process by which the pay package was set, noting in particular that Musk proposed it, Musk controlled the timelines of the board’s deliberation, and he received almost no pushback – board members and Tesla’s general counsel seemed to view themselves as participating in a cooperative process to set Musk’s pay, rather than an adversarial one.
What about the stockholder vote? That, too, was tainted, because – McCormick concluded – the proxy statement delivered to shareholders contained material misrepresentations and omissions. It described Tesla’s compensation committee as independent when in fact the members had close personal ties to Musk, and it did not accurately describe the manner in which his pay package was set – again, with Musk himself proposing it and the board largely acquiescing. With those findings in hand, McCormick did not rule on the plaintiff’s additional arguments that the proxy statement was misleading for other reasons (namely, it falsely described the payment milestones as “stretches” when in fact the early ones were already expected within Tesla internally.)
Chancellor McCormick said that the process leading to the approval of the compensation plan was “deeply flawed.” Advisors will also find it interesting that she reviewed an early draft of Tesla’s proxy statement and found it to be the “most reliable (indeed, the only) evidence” of the substance of the discussion that established the terms of Musk’s equity grant. Over the course of several drafts, the existence of that conversation was edited out – so, it was not mentioned in the as-filed proxy. The judge also took issue with this statement:
The Proxy disclosed that, when setting the milestones, “the Board carefully considered a variety of factors, including Tesla’s growth trajectory and internal growth plans and the historical performance of other high-growth and high-multiples companies in the technology space that have invested in new businesses and tangible assets.” “Internal growth plans” referred to Tesla’s projections.
According to the court’s findings, the proxy was misleading because it didn’t disclose that the company had projections that would show that the milestones would be achieved. As Ann explained in her blog, the court also took issue with describing compensation committee members as “independent” when – according to the record – they in fact had relationships that gave rise to potential conflicts of interest that should have been disclosed, and a “controlled mindset.” So, Chancellor McCormick concluded:
The record establishes that the Proxy failed to disclose the Compensation Committee members’ potential conflicts and omitted material information concerning the process. Defendants sought to prove otherwise, and they generally contend that the stockholder vote was fully informed because the most important facts about the Grant—the economic terms—were disclosed. But Defendants failed to carry their burden.
The case shows that process, common-sense thinking, and disclosure matter. If you’re involved in the compensation-setting and/or proxy drafting process, you may not win friends if you read everything with a critical eye and ask unwanted questions. It can be hard to find a way to do that tactfully. But now you have a case to point to that shows why it’s important.
Back in October, Liz blogged about a report from non-profit FCLTGlobal making the case for the “simplest” solution to what some investors consider the overcomplication of executive pay programs. That solution is, according to the non-profit, “direct stock ownership by executives, with long-term holding periods.”
The notion of doing away with performance programs isn’t new, especially in Europe, and Liz’s blog identified Norges Bank as one investor that continues to push for simplified pay. But Norges is not alone. In 2019, CII overhauled its executive compensation policy and urged companies to reduce the complexity of their incentive plans.
Although it’s leading to a fair number of against votes by Norges, this can all seem somewhat… theoretical… for many companies. But this report just released by the Center On Executive Compensation (a division of HR Policy Association) addresses practical considerations for pay simplification and gives an example. Here’s an excerpt regarding Unilever:
Under the revised approach to incentives, executives were encouraged to invest up to 100% of their annual incentive payouts in Unilever shares. The company matched the participants’ investment based on the performance of the company. The amount of the company match ranged from 0% to 200% of the participants’ share investment and vested over a 4-year period.
Why do that? The stated rationale for this change was to simplify rewards; increase shareholding levels throughout Unilever’s management population; ensure consistent alignment of performance measures with strategy; and increase the timeframe over which incentives are delivered. Since the time period over which the incentive is earned matched the time period of the reported performance results, it was easier to communicate to executives. Further, a co-investment approach ensures the executive risks his or her own money in company shares, creating real alignment with shareholders. […]
Drawing on research from behavioral economics, one might expect the incentive effect of investing an executive’s own money to be increased effort to create shareholder value and avoid loss. This research suggests that individuals are more highly motivated to avoid losses than to seek gains, suggesting the co-investment model may help create sustained shareholder value while avoiding excessive risk.
The report notes that simplification isn’t for everyone. “[I]t is important that companies engage with investors to understand the extent to which complexity is truly the driver of concerns over the current structure of long-term incentives, if the underlying motivation for simplification is an effort to rein in pay rather than reduce complexity, or whether investors have multiple objections to current executive compensation designs.” It includes a list of key questions the committee should ask when considering simplification and some examples of alternative approaches for committees that want to explore them.
This Wachtell post on the HLS Blog regarding the 2024 compensation season reminds us that the American Rescue Plan Act of 2021, which feels like a lifetime ago, included a new change to IRC §162(m). And, given the effective date of the change, compensation committees and their advisors may want to consider this when structuring 2024 long-term incentive awards. Here’s an excerpt:
Section 162(m) of the Internal Revenue Code disallows a federal income tax deduction to public companies for certain compensation in excess of $1 million during a company’s taxable year to “covered employees” which is generally defined to include the company’s named executive officers. The American Rescue Plan Act amended the definition of “covered employees” for tax years beginning after December 31, 2026 to include an additional five highest compensated employees.
While the expanded definition does not become effective for several years, companies might consider structuring long-term incentive awards to individuals who might be covered by the expanded definition to vest and be paid in 2026 in order to avoid a lost tax deduction.
Tune in at 2:00 pm Eastern today for our annual webcast “The Latest: Your Upcoming Proxy Disclosures” to hear from our panelists, Mark Borges of Compensia and CompensationStandards.com, Alan Dye of Hogan Lovells and Section16.net, Dave Lynn of Goodwin Procter and TheCorporateCounsel.net and Ron Mueller of Gibson Dunn. They are planning to delve into all the latest compensation hot topics, including:
– Clawbacks
– Pay vs. Performance Disclosures
– CD&A Enhancements & Trends
– Shareholder Proposals
– Proxy Advisor & Investor Policy Updates
– Perquisites Disclosure
– ESG Metrics & Disclosures
– Say-on-Pay & Equity Plan Trends, Showing “Responsiveness” to Low Votes
– Status of Related Rulemaking
Members of this site are able to attend this critical webcast at no charge. If you’re not yet a member, try a no-risk trial now. Our “100-Day Promise” guarantees that during the first 100 days as an activated member, you may cancel for any reason and receive a full refund. The webcast cost for non-members is $595. You can sign up by credit card online. If you need assistance, send us an email at info@ccrcorp.com – or call us at 800.737.1271.
We will apply for CLE credit in all applicable states (with the exception of SC and NE, which require advance notice) for this 90-minute webcast. You must submit your state and license number prior to or during the program using this form. Attendees must participate in the live webcast and fully complete all the CLE credit survey links during the program. You will receive a CLE certificate from our CLE provider when your state issues approval, typically within 30 days of the webcast. All credits are pending state approval.
Last week on TheCorporateCounsel.net blog, Dave shared highlights from the discussion during the panel he moderated at the Northwestern Securities Regulation Institute called “Taking a Fresh Look at Company Policies.” One of his blogs is especially relevant to this audience as it focuses on three compensation policies that companies should review in light of recent SEC action. The panel suggested companies establish or revisit their equity grant policies and practices in light of SEC developments in this area — namely, Staff Accounting Bulletin No. 120 and new Item 402(x) of Regulation S-K.
What do those policies look like? This recent client alert from White & Case and Equity Methods includes sample equity grant procedures and guidelines, which “companies can consider as practical guidelines, even if they are not adopting a formal equity grant policy,” and an illustrative timeline for equity awards.
Here’s how the sample addresses a common issue — timing the vesting of full-value awards:
For the vesting of Full Value Awards, if the Company plans to facilitate sales of equity by award recipients with access to MNPI to cover withholding taxes, the vesting date should be scheduled to occur in an open quarterly window under the Company’s insider trading policy and when the Company otherwise is not expected to have MNPI.
If this is not feasible, the Company may provide for language in the award agreement that “locks in” and makes automatic the sales without any discretion by the award recipient. This may be, but is not required to be, in the form of a formal 10b5-1 plan (which includes the applicable cooling-off period and certification of no MNPI by the insider at the time of grant).
CalSTRS is the largest educator-only pension fund in the world – with assets totaling approximately $327 billion as of the end of last year. If your company is one of the 9,000 in the CalSTRS’ portfolio – which you can check on this page – then you should know that these principles will be used as a voting framework at your AGMs – and the stewardship priorities will guide engagements. For executive compensation, CalSTRS says that one of the main changes is to include a provision ESG metrics. Here’s what it says:
ESG Incentive Metrics: Companies should determine how to best incorporate material environmental, social or governance risks into compensation plans. Metrics should be measurable and linked to a company’s ESG risks or key priorities.
Another change that will affect compensation & human capital committees is that the updated principles include detailed expectations on board responsibilities for human capital management and human capital disclosure. Here’s a paraphrased excerpt:
– Human Capital Management: Boards should have an active role in setting company culture and oversight of the company’s approach to human capital management, which comprises employee wellbeing; incentives and compensation; retention and development; health and safety; fair labor practices; commitment to diversity, equity and inclusion; pay equality; employee development; providing a workplace free of sexual harassment and other forms of harassment; and promoting ownership and accountability. Companies should ensure they employ effective oversight of human capital management practices for domestic and international employees, as well as employees throughout their value chain.
– Human Capital Reporting: Comprehensive reporting on human capital incorporates the practices noted above alongside strategy considerations and can be tailored to each business. However, there are metrics that are foundational to all companies and provide investors with a baseline for understanding human capital management quality. Four foundational metrics that are necessary in reporting include: workforce headcount, total workforce cost, workforce stability metrics, and workforce diversity data.
– Employee Diversity Disclosure: Companies should annually disclose their EEO-1 report, to enable shareowners to understand the composition of the workforce and provide context for workforce investment and strategy decisions. This information would also allow investors to assess the board’s diversity, relative to its workforce
On the hot topic of clawbacks, like Glass Lewis and ISS, CalSTRS’ principles also say that they expect companies to have policies that allow recoupment for situations beyond what is legally required.
Both the principles and the stewardship priorities show that CalSTRS is holding steady with ESG-related topics. CalSTRS says that engaging on these topics is consistent with its fiduciary duties:
The Stewardship Priorities lay the foundation for corporate engagements and market-wide efforts to mitigate potential risks to the portfolio. These priorities are designed so staff can use the influence CalSTRS has as a significant global investor to promote sustainable business practices and public policies that drive long-term financial success on behalf of California’s public educators.
Do you have a process in place for deploying your new clawback policy in the unfortunate event of a restatement? It may be useful to think through that in advance. But right now, the only thing that people seem to be sure about is that it is going to be a complex exercise to calculate and recover excess incentives. This Barnes & Thornburg blog walks through a hypothetical to help illustrate the types of issues that may arise. Here it is:
John Smith is the chief executive officer (CEO) of Company X, whose equity securities are listed on NASDAQ, and he’s held this role since Jan. 1, 2010. In February 2021, the Board of Company X approved a compensation package for the CEO that included a performance-based equity incentive award for the Jan. 1, 2021, through Dec. 31, 2023 performance period. The target performance-based equity incentive award was based on 150 percent of base salary, which equaled 11,000 shares for the CEO. The payout opportunity equaled 0 percent (minimum), 100 percent (target), and 200 percent (maximum), with the growth in earnings per share (EPS) compared to the growth in peer companies’ EPS during the same period. Each named executive officer (NEO), including the CEO, was entitled to earn the performance shares at the end of the performance period depending on attainment level satisfied in respect of such EPS performance targets.
The Compensation Committee met in February 2024 to review the extent to which the CEO earned the 2021 equity incentive award. During the 2021-2023 performance period, the Compensation Committee analyzed the GAAP EPS growth over the performance period and using previously established payout matrix determined that the CEO was entitled to a payout of 200 percent of the target award. As a result, the CEO was awarded 22,000 shares in February 2024.
The 10-K was filed in late February 2024. In April 2024, the accounting team, working with its external auditor, discovered an accounting issue. After an investigation into the issue, the Audit Committee determined that its financial statements for 2022 and 2023 would need to be restated via a big R” restatement. (A “big R” restatement requires the issuer to file an Item 4.02 Form 8-K and to amend its filings promptly to restate the previously issued financial statements. In contrast, a “little r” restatement generally does not trigger an Item 4.02 Form 8-K, and an issuer may make any corrections the next time the registrant files the prior year financial statements.)
The restatement resulted in a decline in GAAP EPS for both 2022 and 2023. A 10-K/A was filed in May 2024 to restate the financial statements for the fiscal years ended Dec. 31, 2022 and 2023. The restated GAAP EPS amounts meant that the CEO was only entitled to 100 percent of the 2021-2023 target award, not 200 percent.
Will the compensation committee be required to claw back the award? Check out the blog for the answer…
For the first year of pay versus performance disclosure in 2023, Corp Fin took a very high-level approach to comment letters and issued only futures-based comments. This year may be different.
Yesterday at the Northwestern Securities Regulation Institute, Corp Fin’s Chief Counsel Michael Seaman discussed the Division’s expectations for year 2 of this rule. Michael noted that the Staff expects that companies and their counsel have digested comments from the first year of disclosure, as well as the two rounds of CDIs that were issued last fall. In other words, go back and look at those now so that they’re fresh in your mind as you draft this year’s proxy.
While the disclosure review team hasn’t completely finalized its approach, it’s likely that the Staff may ask companies for more analysis and correction rather than simply a commitment to correct issues next year. The Staff is still not out to issue comments that will put your annual meeting date at risk unless there’s a major issue. But you may get a comment after your meeting that delves into disclosure details and requires you to respond with analysis. Michael also shared a few tips and observations for this year’s disclosure:
– Remember to include the required “relationship” disclosure as a separate element of your disclosure. It’s not sufficient to simply say there’s no relationship.
– If you’re using a non-GAAP company selected measure, be sure to disclose how that measure is calculated from the GAAP financials.
– In the table itself, make sure you’re using the exact headings that the rule dictates. If you’re providing supplemental disclosures, take a look at the adopting release for how to approach that.
If you do receive a comment, here’s “what not to do”: don’t try to argue that your disclosures conform to longstanding common practices. Given that this disclosure requirement is only one year old, Corp Fin will not find that persuasive.
We blogged last month about Shearman & Sterling’s annual “Corporate Governance & Executive Compensation Survey” – which always provides a wealth of information. The firm is now out with a 9-page condensed version that is a good reference as we head into proxy season. It includes a handy “housekeeping” checklist at the end. Here are a few key reminders relating to executive compensation:
– New Disclosures. As highlighted above, there is new SEC guidance on pay versus performance disclosure that companies should be mindful of heading into the second year of required pay versus performance disclosure in proxy statements. Companies must also file their clawback policy as an exhibit to their annual report and indicate (via checkboxes on the annual report cover page) whether the filing includes errors or corrections to previously issued financial statements and whether these errors or corrections led to analysis of the clawback of executive officer compensation.
– Equity Grant Timing. The SEC has provided guidance on how to account for and disclose equity compensation awards granted shortly before certain material non-public information is released. Amendmentsto Rule 10b5-1 and Item 402(x) of Regulation S-K requiring tabular disclosure of option awards granted to NEOs within four business days before and after certain filings alongside changes in share price around the time of disclosure will take effect with respect to grants made in 2024 (with disclosure in the 2025 proxy statement). Companies should be mindful of this new disclosure requirement when making grants in 2024.
– Say-on-Pay and Say-on-Frequency. Determine whether the 2024 proxy statement should include either a “say-on-pay” and/or “say-on-frequency” shareholder vote.
– Equity Plan Adoptions or Amendments. If adopting or amending an equity compensation plan, make sure that any disclosure complies with Item 10of Schedule 14A, the plan provides adequate limits on director compensation (including any cash compensation) and be mindful of changes to burn rate calculations within the ISS Equity Plan Scorecard that took effect for meetings held on or after February 1, 2023, and the updates to ISS’s Proxy Voting Guidelines disfavoring equity plans giving boards full discretion over awards in the event of a change in control.
– Alternative Pay Disclosures. Consider whether to include (or continue to include) alternative pay disclosures—such as realized or realizable pay— in light of the addition of the new pay versus performance table while being mindful that shareholders may ask questions to the extent these disclosures are omitted or modified in future years.