Shearman & Sterling recently released its 2023 Corporate Governance & Executive Compensation Survey. Among other topics, the survey reviews disclosure practices among the largest 100 US public companies concerning executive departures, which have been the subject of closer attention following the McDonald’s enforcement proceeding earlier this year. Here are some of the key findings:
– Of the executive officer departures disclosed in Forms 8-K filed by the Top 100 Companies during the period reviewed, none characterized the executive officer’s exit as being a result of the “mutual agreement” or “mutual decision” of the company and the executive officer. However, a survey of these disclosures reveals that describing an executive officer’s departure as “mutual” in other ways remains a common practice.
– Although the sample size and the period of review is limited, the fact that none of the Top 100 Companies used historically common phrasing to characterize the termination may be an indicator of the beginning of a shift in disclosure practices.
– Separation payments were disclosed in connection with 23% of executive officer terminations, with 17% of executive officer retirements disclosed describing amounts paid to executive officers in connection with their retirement, including six companies that described new agreements executed in connection with the executive officer’s retirement.
– Separation payments were also described with respect to one of the terminations characterized as a termination without cause, one termination characterized as an involuntary separation and approximately half of the other termination descriptions identified. In certain of the disclosures, the company expressly indicated that the circumstances of the executive officer’s termination of employment were consistent with a “qualifying termination” under the company’s existing executive severance plan or the executive officer’s employment agreement.
– There was no indication that any new entitlements were not disclosed. In this set of termination disclosures, there does not appear to be any perceivable shift in approach, which suggests that companies are not expanding disclosure to cover an explanation of why they determined to make (or not make) payments under existing entitlements.
The survey also noted a number of interesting findings in other areas. For example, it found a 25% increase in the number of Top 100 Companies with a director specifically identified as having cybersecurity experience, and a 42% jump in disclosure of director-specific diversity information.
Three Corp Fin Staffers were guest speakers during the Employee Benefits, Executive Compensation and Section 16 Subcommittee Meeting at the Winter Meeting for the ABA Federal Regulation of Securities Committee last Thursday. During the meeting, they shared thoughts about first-year PvP disclosures.
Jennifer Zepralka, Chief of the Office of Small Business Policy, described the Staff’s review procedure. The team used XBRL tagging to identify disclosures that appeared to be lacking, but once the Staff reviewed those disclosures in full, they discovered the issues were often tagging problems. When disclosures were missing, the Staff focused on forward-looking “fix it” comments rather than inquiries that would start a back-and-forth with the registrant (for example, on topics like how equity was valued for CAP).
The Staff was surprised by the frequency of PvP sections lacking relationship disclosures, noting that some companies said they didn’t include certain relationship disclosures since their compensation committees don’t use or consider net income, for example, even though the rule doesn’t use that standard. The Staff also noted that many companies mistakenly used a broad-based market index, failed to include the CSM in the tabular list or identified two CSMs (or didn’t clearly identify any additional measure presented in the table as supplemental).
Beyond the problems identified in the comment letters, the three Staff members, including accounting folks, also discussed areas where even compliant disclosures could benefit from some improvements in year two. Here are their suggestions:
– Disclosures could be more readable in Plain English and focus more on the information that’s useful to investors
– Poor presentation practices caused meaningful information to be hard to find
– Graphical relationship depictions were generally more effective than narrative discussions
– For companies who used graphs, visual choices mattered — some clearly showed relationships while others obscured the relationships
– While not required by the rule, it’s helpful to identify what index the company chose by footnote or otherwise
– With non-GAAP company-selected measures, the description of how the metric was calculated was sometimes unclear or hard to find
– Footnote disclosure for all years in last year’s table do not need to be repeated next year unless material to an investor’s understanding under CDI 128D.03
Their final tip for improving PvP can be summarized as: “involve your accountants.” The Staff members thought the accounting team was an underutilized resource for first-year PvP disclosures. Here are areas where the accounting team could assist:
– Preparing disclosures, including narrative descriptions, to benefit from their knowledge and expertise in fair value assessments for GAAP purposes – Determining the CSM (some companies selected metrics that were inconsistent with the definition of “financial performance measure” and the accounting team would have recognized this) – Ensuring the correct numbers are reported as “net income” (see CDI 128D.08) – Considering the impact of retirement eligibility and other conditions on equity awards (accountants are already considering for the requisite service period, but note that the treatment of market conditions under GAAP differs from the PvP treatment) – Assessing the valuation techniques allowable under ASC 718 and crafting disclosure if you are changing your valuation technique as permitted under CDI 128D.20
This WTW memo is chock-full of helpful tips for companies that may find themselves in mandatory clawback territory. We’ve addressed a number of the technical and high-level questions a board will need to consider when a company faces a restatement, but this article is focused on managing a good process. For example, it lists items you should include on the agenda for your first special meeting convened after a restatement to make clawback-related process decisions. Here are two of those agenda items:
– Determine if the clawback team is managed by external counsel using compensation experts. Fundamentally, the committee must consider conflict-of-interest questions where management helps to determine clawback values. Our view is that the risk of this being an issue for shareholders diminishes when the sums involved are smaller, the calculation is simpler, and the assumptions or judgment calls needed to complete the calculation are fewer. The more there is at stake, the more likely that both shareholders and officers will question the results and ask about the source of funds, state legal authority and individual taxation; the more complicated the process of performing the calculations becomes, the more plausible these objections will be.
For these reasons, we foresee many situations where the committee would hire its own legal counsel and compensation experts to form the clawback team. To the extent it is available, preservation of attorney-client privilege in communications among the committee, the clawback team and the executive officer(s) also may be desirable.
– Set forth expectations/timing for the clawback team. We anticipate the following will be deliverables from the clawback team:
A complete Compensation Review Report that details all compensation potentially impacted
A Calculation Methodology Report that provides details on the methodology employed and the actual calculations
A presentation of the potential sources of funds to satisfy the clawback
A recommended proxy disclosure
It also discusses how to perform clawback calculations and how the compensation committee should determine the source of clawback funds. This article is worth reading now and saving for later in the event you’re involved in one of the early restatements post-effectiveness of Dodd Frank clawback policies.
Yesterday, the White House announced the “Fall 2023 Unified Agenda of Regulatory and Deregulatory Actions” – or as it’s lovingly called around here, the “Reg Flex Agenda.” SEC Chair Gary Gensler issued a statement about the SEC’s contributions.
As usual, the items on this list reflect the priorities of the Chair and you shouldn’t read too much into the dates – they are approximate timeframes, not commitments. In fact, I have heard that the Staff can only select from “April” or “October” when it submits the agenda, so when we say “targeting April,” what we mean is the earlier part of the year instead of the later part. When it comes to items that affect compensation committees, these two items are continuing again in the “proposed rule” stage:
FW Cook has released its 2023 survey of severance & change-in-control practices, which looks at trends among 200+ companies. We’ve been tracking severance as a shareholder proposal topic this past year or two, so it’s useful to also keep an eye on common practices. Here are the key takeaways:
– About 85% of companies provide CEO CIC severance, while about 75% provide CEO Non-CIC severance
– About 85% of companies providing CIC severance define cash severance as a multiple of salary plus bonus. This drops to about 60% for companies providing Non-CIC severance.
– 90% of companies fully accelerate all unvested time-based equity, while ~70% do so for performance awards (includes both single and double trigger provisions).
– The prevalence of double trigger CIC equity acceleration is 86%, up from 70% in 2016.
– For Non-CIC severance, majority practice is for time-based and performance-based equity to be forfeited (~55%), with only about 10% of companies fully accelerating outstanding equity.
Meredith blogged last week about the SEC’s fresh round of “Pay vs. Performance” CDIs. One of the CDIs reversed course from an earlier interpretation about how to value awards that accelerate upon retirement. This WTW blog explains the impact:
In the September C&DIs the SEC appeared to entertain this view and suggested that, for the purpose of determining compensation actually paid, an award that vests on an accelerated basis at retirement with no other substantive vesting conditions could be deemed vested at the date of grant for the purposes of PVP too. In effect, this approach meant that subsequent stock price changes for such awards would no longer impact compensation actually paid beyond the retirement eligibility date. This seems to contradict the intent of PVP disclosures. It also ran the risk of creating significant complexity for companies with pro rata accelerated vesting treatment of equity awards on retirement. We raised these concerns with the SEC, particularly given that the C&DIs remained unclear on this issue, and were pleased to see revised guidance reflected in the November C&DIs release.
The latest guidance says that “other substantive conditions” must be considered, in addition to retirement eligibility. These include a market condition, actual retirement, or the satisfaction of the requisite service period. While the language remains ambiguous, it does appear now to distinguish between retirement eligibility and actual retirement. Accordingly, for awards that provide for accelerated vesting on retirement, issuers can now value awards during the vesting period through to the date of an actual retirement rather than merely the retirement eligibility date.
WTW points out that this interpretation is more consistent with the methodology that companies used for Year 1 disclosures, better aligned with the rule’s intent, and less burdensome. This FW Cook blog agrees that while the CDI provides welcome clarification, it doesn’t fully resolve the disclosure questions, and delves into the ambiguity that remains:
The CDI now appears to indicate that for purposes of calculating CAP the concept of retirement eligibility is no longer an issue in the typical case where the holder must actually retire to be “vested.” This would be the result, for example, where the award contains an explicit service period and also states that vesting of the award will accelerate upon a termination due to retirement. In other words, even if there were no barrier to the holder retiring immediately, the act of retiring is itself treated as a substantive condition.
However, the CDI may leave open one potential situation where the interpretive issues noted in our October 24th blog could still apply. The issues previously noted may arise if the award agreement explicitly states that a holder is vested upon the earlier of the requisite service period or meeting the definition of “retirement” (as opposed to actually having to retire). We also recognize that there will be some award agreements that do not clearly fit into one category or the other, due to nuanced differences in drafting.
We note that the specific language used for the CDI is unusual and could have been more precise as to its intent and impact, but we cannot think of any other interpretation, and other practitioners with whom we have discussed have reached the same conclusions. As such, in light of the revised CDI, companies should yet again review their equity award agreements to assess the specific language around retirement favorable vesting, in order to determine how they may be impacted by this guidance.
According to a recent 12-page recap from WTW, this year has been relatively quiet when it comes to say-on-pay failures, with only 49 this year, compared to 69 last year and 60 in 2021. However, votes on equity plans indicate eroding support on that front. Here’s an excerpt:
We have observed some headwinds for equity plan share requests. We have observed one failure within the S&P 1500, similar to last year at this time (two failures at this time in 2021); however, ISS opposition is the highest at 17% compared with 13% at this time in 2022 and 2021. Support is at 89% compared with 91% at this time in 2022 and 2021.
Companies should monitor their investors’ voting guideline updates and engage with stakeholders to address proactively any potential issues anticipated ahead of planned stock plan proposals. With talent pressures continuing, companies should manage share pools to avoid unexpected surprises and factor any potential headwinds into their incentive programs.
WTW notes that these challenges come at the same time that companies may be needing to use more of their share pool to attract talent. This off-season will be a good time to monitor investor sentiment on dilution and provisions that are considered “problematic.”
Some of the largest US companies are implementing (or considering) cybersecurity metrics in comp programs — and specific metrics may be appropriate in certain cases (for example, after a cyber event or when upgrades are planned) — but this Semler Brossy article highlights an important cybersecurity-related consideration for comp programs at all companies. That is, whether the board has the flexibility to make compensation adjustments when a cyber event occurs.
The article argues that boards should have the freedom to adjust earned compensation based on a qualitative assessment that considers whether the related cyber risk was avoidable, the level of communication to the board, whether mitigation plans were implemented and the appropriateness of management’s situation-specific judgment calls. For example, this WSJ article highlighted one company with no cybersecurity metrics in its executive compensation programs whose board canceled short-term incentive bonuses for certain top executives after a significant cyber event.
Clawbacks may play a role here as well. Here’s an excerpt from the Semler Brossy article:
In addition to developing a framework for determining adjustments to current-year compensation, boards should review the clawback language to assess where there is flexibility to claw back compensation, if appropriate (e.g., the breach was caused by gross negligence or reasonable mitigation steps were not taken to limit damage after the breach). In considering whether to add such a clawback, and the appropriate language, a review of risk clawbacks added by many large financial institutions after the financial crisis may also be informative.
Liz recently shared that ISS’s peer group review & submission window is open until next week Tuesday, December 5th. Glass Lewis has also opened its peer group submission window for companies with meetings from March 2024 to September 2024, and it runs until Friday, December 15th. Glass Lewis walks through how and why to submit your peer group on its website. If you’re looking for a resource to share internally that’s a “one-stop-shop,” check out this Compensia alert with info on the process for both ISS and Glass Lewis.
Last month, the Latham team released a client alert with 24 frequently asked questions on the SEC’s final clawback rule and the related listing standards. In the latest Pay & Proxy Podcast, I’m joined by Keith L. Halverstam & Maj Vaseghi, Global Chair and Vice Chair, respectively, of Latham’s Public Company & Board Representation Practice, to discuss some of the FAQs related to the implementation of a clawback policy. In this 24-minute podcast, Keith and Maj cover the following topics:
– “Little r” restatements & the SEC’s expansive interpretation of what constitutes “material noncompliance with any financial reporting requirement” – Steps a company needs to take under a clawback policy following a determination that a restatement is required – “Difficult” financial metrics where the erroneously awarded compensation can’t be determined by a simple mathematical recalculation – Challenges with collecting erroneously awarded compensation
– Planning ahead for policy implementation
– When erroneously earned shares have been sold at a gain
We’re always looking for new podcast content, so if you have something you’d like to talk about, please reach out to me at mervine@ccrcorp.com.