The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Here is an interesting article from Bud Crystal with his view of the Black-Scholes model. I love his warning at the top of the piece…

– Broc Romanek, CompensationStandards.com

Below are the results from a recent survey that I just wrapped on TheCorporateCounsel.net regarding the topic of proxy drafting responsibilities (including items such as the amount of time consumed):

1. The following takes the lead in drafting the proxy statement at our company (excluding the executive compensation disclosures):

– In-house Securities Attorney – 63.4%
– In-house Human Resource Staff – 1.0%
– In-house Accounting Staff – 3.0%
– General Counsel – 11.9%
– Corporate Secretary/Assistant Corporate Secretary – 18.8%
– Outside Counsel – 1.9%
– Outside Consultant – 0.0%
– Other – 1.9%

2. The following takes the lead in drafting the CD&A/other executive compensation:
– In-house Securities Attorney – 45.9%
– In-house Human Resource Staff – 29.4%
– In-house Accounting Staff, including CFO – 1.8%
– General Counsel – 12.8%
– Corporate Secretary/Assistant Corporate Secretary – 11.0%
– Outside Counsel – 4.6%
– Outside Consultant – 1.8%
– Other – 1.8%

3. The following provides significant assistance in drafting the CD&A/other executive compensation disclosures:
– In-house Securities Attorney – 32.4%
– In-house Human Resource Staff – 32.4%
– In-house Accounting Staff, including CFO – 18.1%
– General Counsel – 14.3%
– Corporate Secretary/Assistant Corporate Secretary – 17.1%
– Other NEO(s) – 0.9%
– Outside Counsel – 21.0%
– Outside Consultant – 8.6%
– Other – 4.8%

4. The following are involved in reviewing and providing comments on the draft CD&A/other executive compensation disclosures:
– In-house Securities Attorney – 38.6%
– In-house Human Resource Staff – 46.6%
– In-house Accounting Staff, including CFO – 54.6%
– General Counsel – 54.6%
– Corporate Secretary/Assistant Corporate Secretary – 37.5%
– Other NEO(s) – 38.6%
– Outside Counsel – 60.2%
– Outside Consultant – 42.1%
– Communications Staff – 19.3%
– Independent Auditor – 20.5%
– Other – 15.9%

5. For the lead drafter, the following is the estimated amount of time devoted to drafting proxy disclosures for this year:
– Less than 100 hours – 14.5%
– 100-200 hours – 53.0%
– 200-300 hours – 16.9%
– 300-500 hours – 6.0%
– Too many hours to even estimate – 9.6%

6. For all those involved in drafting proxy disclosures (including the lead drafter as well as people outside the company), the following is the estimated amount of time devoted to drafting proxy disclosures for this year:
– Less than 100 hours – 3.5%
– 100-200 hours -14.9%
– 200-300 hours – 32.2%
– 300-500 hours – 24.1%
– 500-700 hours – 9.2%
– Too many hours to even estimate – 16.1%

– Broc Romanek, CompensationStandards.com

As has been the case for the past decade, the topic of executive compensation is dominating the proposals that shareholders have submitted to companies. And as usual, there is quite a variety regarding the focus of these proposals. One “flavor” of the proposals this year is a push by 30 faith-based investors – all of whom belong to the Interfaith Center on Corporate Responsibility – to use compensation as an instrument in the battle for health care reform.

As this press release indicates, at least 21 health industry companies received proposals asking them to publicly disclose the total compensation packages of their top executives, including their health care packages, vis-à-vis that of their lowest paid U.S. workers. According to the release, among the insurers, medical device makers and other companies receiving the resolutions are many of the leading opponents of Congressional action on health care reform.

This new pay-disparity proposal asks for a report covering:

1. A comparison of the total compensation package of our company’s top executives and our lowest paid employees (including health care benefits and costs), in the United States in July 2000, July 2004 and July 2009.

2. An analysis of any changes in the relative size of the gap between the two groups and an analysis and rationale justifying any such trend.

3. An evaluation of whether our top executive compensation packages (including, options, benefits, perks, loans, health care, and retirement agreements) would be considered “excessive” and should be modified to be kept within reasonable boundaries; and

4. An explanation of whether any such comparison of compensation packages (including health care benefits) of our highest and lowest paid workers, invites changes in executive compensation, including health care benefits for departing executives, to more reasonable and justifiable levels, and whether the Board should monitor the results of this comparison in the future-with greater equity as the goal.

– Broc Romanek, CompensationStandards.com

Now that the SEC’s new rules went into effect over the weekend (ie. February 28th), Corp Fin cleaned up all of their Compliance & Disclosure Interpretations on Monday morning that deal with the old Summary Compensation Table reporting scheme. It’s unusual to see CDI activity so early in the morning. That certainly woke me up!

Here’s the changes:

– Withdrawn Question 119.04
– Withdrawn Question 119.05
– Withdrawn Question 119.11
– Withdrawn Question 119.12
– Withdrawn Question 119.15
– Revised Question 119.16
– New Question 119.24
– Withdrawn Question 120.05
– Revised Interpretation 220.01

– Broc Romanek, CompensationStandards.com

We just posted the registration information for our popular conferences – “Tackling Your 2011 Compensation Disclosures: The 5th Annual Proxy Disclosure Conference” & “7th Annual Executive Compensation Conference” – to be held September 20-21st in Chicago and via Live Nationwide Video Webcast. Here is the agenda for the Proxy Disclosure Conference (we’ll be posting the agenda for the Executive Compensation Conference in the near future).

Special Early Bird Rates – Act by April 15th: With anger over CEO pay at record levels, Congress and the regulators are intent on shaking things up and huge changes are afoot for executive compensation practices and the related disclosures – that will impact every public company. We are doing our part to help you address all these changes – and avoid costly pitfalls – by offering a special early bird discount rate to help you attend these critical conferences (both of the Conferences are bundled together with a single price). So register by April 15th to take advantage of this discount.

– Paul Hodgson, The Corporate Library

As I recently blogged on The Corporate Library’s Blog, Jesse Brill has been trumpeting this cause for at least the last six years: CEO pay differentials. Not differentials between CEOs, but differentials between CEOs and the executives who report directly to them. Not just Jesse, though. Mark Van Clieaf has been discussing and researching this issue since at least 2006. In fact, since 2007, when he published a paper that included statistics on the issue, he has been warning that some 40 percent of the Russell 3000 had pay differentials between the CEO and the median named executive officer pay of greater than 3X. 3X, according to Mark, is the danger point. And he’s got a point. Why would a CEO’s contribution be worth more than three times the next most important executive officer? Exceed that and, whoa, differentials in the rest of the firm are going to be completely outrageous, with CEOs earning three to five hundred times more than average employees.

Oh, no, wait a minute, they do, don’t they?

Despite this, Josh Martin in Agenda reports that only a handful of companies even pay lip service to internal pay equity. And many of these pay this lip service because they have been forced to by a campaign run by the Connecticut Office of State Treasurer.

Of course, some companies – DuPont (since 1990 apparently) and Intel – got there on their own. And the other 60 percent of the Russell 3000 are doing the right thing, but that’s still a lot of companies where the CEO is paid so significantly more than the other executive officers (and it gets worse when you use option profits and real equity values, rather than notional costs and grant date values) that you might be forgiven for thinking that the company could not be run without the CEO, in fact that the company could be run JUST WITH THEM and no one else.

Of course, this is complete nonsense. No company can be run just by the CEO. But some companies have been moving farther and farther away from the theory that a CEO is simply part of an executive team and is useless without his or her direct reports, their reports, theirs, in fact without all employees. Those that have moved the furthest – the Oracles, the Nabors Industries, Occidental Petroleums of this world – from this executive team concept are at the greatest risk from:

1. poor morale, not just in the executive team who feel undervalued, but throughout the entire company – employees read the newspapers!

2. succession planning problems. If the CEO is paid 10 times more than anyone else, who could possibly take his or her place?

But is it just activist investors and corporate governance gurus who care about this kind of thing? Well, no. Moody’s thinks it’s a credit risk, never mind an investment risk. And, let me tell you, any investor looking at a superstar CEO is thinking, “What happens if they walk under a bus?” That means short, not long. Risk, not risk free. Who needs that?

Now, the SEC is not going to do anything about this in terms of requiring specific disclosures. It’s not part of any of the compensation legislation making its way through congress at the moment. So it’s up to companies and directors to fix this one themselves… as I was quoted in Agenda Opinion saying so myself. Either reduce the differential or have a really good excuse for it.

Broc’s note: You should check out Paul’s recent blog entry entitled “Banks ASKING Government to Help Them Curb Pay and Bonuses: Now THAT’S News.”

– Mark Jones, Pillsbury LLP

During the current proxy season, compensation committees of public companies will want to take into account the new position of the IRS regarding the deductibility of performance bonuses paid upon retirement or termination of employment. Committees should review their incentive pay plans to determine whether these plans need to be restructured to preserve the deductibility of performance-based bonuses before being put before shareholders.

Section 162(m) of the Internal Revenue Code generally limits a public company’s federal income tax deduction to $1 million for compensation paid to its chief executive officer and its three other top-paid officers (other than the chief financial officer). An exception from the $1 million limit applies for compensation that is payable “solely on account of” attainment of one or more performance goals. The performance goals must be determined by its compensation committee, comprised of two or more outside directors. Additionally, the material terms of the plan, including the performance goals, must be disclosed to and approved by a majority of the company’s shareholders, and the compensation committee must certify that the performance goals and any other materials conditions were in fact satisfied.

IRS regulations allow performance awards to be payable in the event of the participant’s death or disability or a change of control, even if the performance goal was not attained, without jeopardizing the award’s exemption from the $1 million deductibility limit. In private rulings issued in 1999 and 2006, the IRS applied the same logic to awards that were paid out upon termination of employment. However, the IRS reversed this position in Revenue Ruling 2008-13, reasoning that awards that are payable upon a participant’s termination of employment, voluntary resignation or retirement are not payable “solely on account of” performance, and, therefore, are not exempt from the $1 million limit. Revenue Ruling 2008-13 does not apply to awards paid under a performance period beginning on or before January 1, 2009 or under an employment contract in effect on February 21, 2008.

But awards to be paid under a performance period commencing after January 1, 2009 or under a newly adopted or revised plan or agreement that will be subject to the new rules. These arrangements, therefore, should be reviewed by the compensation committee to determine whether the awards will still be exempt from Section 162(m) under the IRS’s new interpretive standards.

The exception for performance-based awards is not available to companies that have received $300 million or more under the Troubled Assets Relief Program (TARP). In addition, the limit on the deductibility of compensation for the top executives of such companies (including the chief financial officer) is limited to $500,000. These restrictions continue until the company repays the moneys received or for any other reason is no longer subject to TARP.

Public companies should also take this opportunity to review their procedures to ensure that all performance-based awards, including incentive pay, performance-based equity awards, stock options and stock appreciation rights, are approved by an independent compensation committee and that all plans and arrangements providing for these awards, including the performance goals, are put before their shareholders at least every 10 years (every five years if the compensation committee has authority to change the performance measures used to establish the goal).

A grace period applies to performance-based plans in existence before a company’s initial public offering (IPO) from the date of the IPO through the first shareholder meeting after the end of the third calendar year following the year in which the IPO occurred. Shareholder approval is necessary for any awards made from the plan after the expiration of the grace period. Newly public companies may want to consider seeking this shareholder approval soon after the IPO, when company ownership may be concentrated and shareholder enthusiasm especially high, rather than waiting until the end of the grace period.

– Scott Landau and Bradley Benedict, Pillsbury Winthrop

As noted in our recent memo, regardless of the reasons for adopting a clawback policy, certain legal issues must be addressed at the outset of its implementation. A failure to take into account the legal context may undermine the company’s ability to recoup payments.

Wage laws in some states may limit the ability to recover amounts paid or owed in connection with the performance of services. Even some bonus compensation that has not yet been paid may not be forfeitable if the amount is considered “wages” that are owed to the employee. Often, the degree of employer discretion in awarding the bonus will be determinative as to whether the compensation is considered nonforfeitable. Once paid, however, even a discretionary bonus may be deemed to be wages not subject to forfeiture.

In the US, applicable state law may also limit the utility of clawbacks triggered by the breach of a restrictive covenant. Restrictive covenants may be wholly or partially unenforceable in some states. Recovery under such a clawback provision in these jurisdictions may not be possible. Multinational companies must consider applicable foreign law as well.

Relevant jurisdictions should be identified not only to determine the legal limitations to recovery, but also to ensure that appropriate steps are taken as soon as a policy is agreed upon to facilitate enforcement. At a minimum, this should include comprehensive documentation of employee communications, including acknowledgments and/or consents from the individuals subject to the clawback. The simplest enforcement mechanism, of course, is the forfeiture of prospective payments, but even these straightforward designs may be problematic if the employee may be construed as having a legal right to the compensation.

Another enforcement issue concerns the treatment of an employee who is financially unable to repay the required amount or who would suffer undue hardship by doing so. Both business and legal considerations may be implicated by the company’s actions. For example, agreeing to accept payment over an extended period of time could implicate the Sarbanes-Oxley Act’s prohibition against issuing companies granting loans or extending credit to executive officers and directors. A clawback policy that provides the company considerable discretion in application and enforcement will generally leave it with more options in such cases. Nevertheless, it may be desirable to determine default procedures to be followed in order to ensure consistent and fair implementation of the clawback.

– Broc Romanek, CompensationStandards.com

A few weeks after the SEC announced it had settled (again) with Bank of America over its two actions against the company regarding alleged disclosure deficiencies in connection with BofA’s acquisition of Merrill Lynch (one action regarding bonus amounts; the other over operating losses), Judge Rakoff from the Southern District of New York ended his game of “will he or won’t he” and approved the settlement on Monday. As noted in this NY Times article, the Judge still expressed displeasure with the settlement – he called it “half-baked justice at best” – even as he issued this order.

Below is an excerpt from yesterday’s “Proxy Disclosure Blog” from Mark Borges that explains the changes to the SEC’s announced settlement:

As part of the Court’s order, he modified several of the remedial corporate governance and disclosure measures that BofA must follow for the next three years. Specifically, with respect to the requirements to engage an independent auditor to assess whether BofA’s accounting controls and procedures were adequate to assure proper public disclosures and to engage independent disclosure counsel to report solely to the audit committee on the adequacy of the bank’s public disclosures, the Bank’s choices must be fully acceptable to the SEC (not simply selected in consultation with the SEC), with the Court making the final selection if the parties cannot agree.

Interestingly, the Court also proposed that the selection of an independent compensation consultant to advise BofA’s compensation committee be made jointly by the compensation committee, the SEC, and the Court (rather than solely by the compensation committee) The Court gave the following reason for this suggestion:

The reason for this suggestion was the Court’s perception that too many compensation consultants have a skewed focus when it comes to executive compensation, concentrating on what they perceive is necessary to attract and keep “talent” (however defined), and more generally favoring ever larger compensation packages, while rarely taking account of limits that a reasonable shareholder might place on such expenditures.

However, in the face of BofA’s objection, the Court conceded the point, explaining that the matter should not be a “deal breaker,” especially in light of the “Say-on-Pay” vote that the Bank must conduct for the next three years.

While it’s possible that some of these remedial measures may be superseded by the legislative initiatives that are currently pending before Congress, the fate of these legislative proposals is still very much up in the air. Consequently, BofA’s disclosure practices may prove to be a very interesting “laboratory” over the next three years on the merits of these enhanced disclosure techniques.

Below is an excerpt from the NY Times’ article, noting that BofA still faces a battle with the New York Attorney General:

“The bank still faces a complaint filed last month by Andrew Cuomo, the attorney general of New York. The judge, after studying some of the evidence in Mr. Cuomo’s case, left room for that case to reach a different conclusion than the SEC’s.

In particular, the judge said the SEC had substantial evidence to support the bank’s claim that the dismissal of its general counsel, Timothy Mayopoulos, “was unrelated to the nondisclosures or to his increasing knowledge of Merrill’s losses.” That is the position the bank and its executives have argued since last spring, but Mr. Cuomo’s office asserts that the firing was related to advice from Mr. Mayopoulos.

Judge Rakoff said he had not determined which was right, but he said he was comfortable that the SEC’s conclusion was reasonable. “It is important to emphasize, with respect not just to the Mayopoulos termination but with respect to all the events that the attorney general interprets so very differently from the SEC, that the court is not here making any determination as to which of the two competing versions of the events is the correct one,” the judge wrote.

Mr. Cuomo’s complaint differs from the SEC’s in that it charges the bank as well as its former chief financial officer, Joe Price, and the chief executive, Kenneth Lewis, who retired early in part because of the mounting investigations into the merger.”

– Ed Hauder, Exequity

Well, as expected, RiskMetrics Research Group is being a little flexible when it comes to companies’ burn rate commitments for 2010 (for the full details, read this prior blog entry). But, as I indicated, given the speculative nature of two of the new allowable options, I don’t think many companies will easily undertake such commitments.

After giving this some thought, it seems to me that what RiskMetrics needs to do is provide an interim commitment equal to their current 3-year average burn rate or the applicable cap for their GICS under the 2010 caps, which would apply until either (1) the 2011 Burn Rate caps are typically produced and released, or (2) the 2011 Burn Rates and caps are produced on an accelerated basis, say by June 30, 2010, or September 1, 2010.

This would allow companies to commit to maintaining the burn rate at a reasonable level for a short period of time (no more than 1 year) until such time that RiskMetrics can pull, clean and assemble the 2011 Burn Rate Data. At that point, companies could then commit to either (1) maintaining their Burn Rate for the remaining portion of the 3 year period to the new 2011 Burn Rate cap, or (2) one of the other alternatives already set forth. This would enable companies to be in a better position to evaluate what they were committing to before obligating themselves. If not, and companies need RiskMetrics approval, I foresee a greater number of companies utilizing cash-settled equity vehicles such as cash-settled SARs and cash-settled RSUs, which don’t count towards burn rate as calculated by RiskMetrics.