An Alabama state judge recently temporarily froze executive payments at Regions Financial Corporation at the request of a Louisiana pension fund. While company officials say the order has been lifted and the lawsuit moved to federal court, the case is another example of how shareholders are using litigation to try to constrain executive pay.
In a derivative lawsuit filed in May, the Louisiana Municipal Police Employees Retirement System claimed that Regions executives were awarded excessive bonuses while the company was receiving $3.5 billion in assistance from the federal government’s Troubled Asset Relief Program. The lawsuit also alleged that management misled investors about its $10 billion acquisition of AmSouth Bancorp in 2006. The pension fund claimed that executives and directors breached their fiduciary duties, wasted corporate assets, and engaged in gross mismanagement, according to news reports. The defendants include CEO Dowd Ritter, two dozen current and former executives and directors, auditor Ernst & Young, and Merrill Lynch. The Louisiana pension fund, which is seeking to place $155 million in compensation into a trust, also urges Regions to adopt governance reforms and fully comply with TARP pay restrictions.
The Regions lawsuit is the latest example of what appears to be a resurgence in shareholder litigation over executive pay decisions this year. In other high-profile cases, investors filed suit in April over American International Group’s $165 million in retention bonuses and sued Bank of America over the $3.6 billion bonuses paid to Merrill Lynch employees shortly before the investment firm was acquired.
However, investor lawsuits over executive pay are not new. Shareholders filed more than 150 derivative lawsuits over misdated stock options at technology and health care companies in 2006 and 2007. While some of the backdating derivative cases were accompanied by securities class-action lawsuits, most of them were not.
Derivative lawsuits can be difficult to pursue because the laws of Delaware and other states generally require investors to file a demand that the company management bring the case before proceeding on their own, or show that such a demand would be futile. Lawsuits over compensation can be especially difficult, because Delaware courts generally have applied the “business judgment” rule to analyze pay decisions by independent directors. In perhaps the best-known Delaware case over pay, a Chancery Court judge ruled in 2005 that Walt Disney directors did not breach their fiduciary duties when they approved a multi-million dollar severance package for former executive Michael Ovitz.
However, there have been recent Delaware rulings for investors in lawsuits over misdated options at Maxim Integrated and Tyson Foods that have made it more difficult for companies to get derivative lawsuits dismissed and have increased the negotiating leverage for investor lawyers. In addition, there was the February decision in Delaware over the $68 million exit package received by former Citigroup CEO Charles Prince. While the court dismissed claims that executives and directors failed to properly monitor subprime mortgage risks, the court held that investors could proceed with their claims over Prince’s exit package.
In his ruling, Chancery Court Judge William Chandler noted that “the discretion of directors in setting executive compensation is not unlimited….Indeed, the Delaware Supreme Court was clear when it stated that ‘there is an outer limit’ to the board’s discretion to set executive compensation, ‘at which point a decision of the directors on executive compensation is so disproportionately large as to be unconscionable and constitute waste.’”
While derivative lawsuits often result in governance changes, they usually don’t lead to large settlements or judgments. One recent exception is the $2.88 billion verdict issued on June 18 by a judge in Alabama against former HealthSouth CEO Richard Scrushy. In that case, the company’s new management participated in the derivative lawsuit, which re-litigated many of the same fraud allegations that were the subject of an earlier criminal trial where Scrushy was acquitted. While it’s unclear how much Scrushy still has, investor lawyers say they hope to recover $100 million.
Other notable settlements include UnitedHealth, where investors, who also filed a securities lawsuit, obtained an $895 million settlement over misdated options. At American International Group, investors obtained a $115 million settlement over commissions paid by AIG to C.V. Starr, a privately held affiliate controlled by former Chairman Hank Greenberg and other AIG directors.
Meanwhile, investors continue to negotiate settlements in securities class-action actions over alleged options backdating. Recent examples include a $72 million agreement obtained by Marvell Technology Group investors in early June and a $13.5 million accord negotiated by Sunrise Senior Living shareholders in February, according to RiskMetrics Group data.
While we were tickled to see our March-April issue of The Corporate Counsel cited in footnote 44 of the release, we were even more excited that the SEC is soliciting comments on a number of important areas of the executive compensation rules, such as whether boards consider internal pay equity when they set the amounts of executive compensation. Here is a discussion of this fix – and others – that we urge you to consider when drafting your comment letters for the SEC on the executive compensation proposals.
Our “4th Annual Proxy Disclosure Conference“: Now that the SEC’s proposals are out – and broker nonvotes are gone – you need to register now to attend our popular conferences and get prepared for a wild proxy season:
“4th Annual Proxy Disclosure Conference” & “6th Annual Executive Compensation Conference.” You automatically get to attend both Conferences for the price of one; they will be held November 9-10th in San Francisco and via Live Nationwide Video Webcast. Here is the agenda for the Proxy Disclosure Conference. Register now.
Since the Treasury adopted its interim final rule on June 15th, the first of the requisite “luxury expenditure policies” have been posted online as required. Recall that the board for each TARP company is required to adopt such a policy (as well as file it with Treasury and post it online) before the later of ninety days after the closing date of the agreement between the Treasury and the TARP recipient or September 13th. We have started posting samples of these policies in our “Management Perks” Practice Area.
Here is something I recently posted on our blog: Judge, law and economics pioneer, prolific conservative commentator, and all-around polymath Richard Posner weighs in on the controversy over executive compensation on his blog. While he acknowledges that excessive compensation is a problem, he says:
It is not a momentous concern and costly measures to ally it would not be justifiable. Modest measures, such as making it easier for shareholders to replace directors than under the existing, Soviet-style system in which shareholders vote for or against the slate proposed by management, and requiring full disclosure and monetization of all forms of compensation paid CEOs and other top executives, may be sensible; but nothing more should be attempted.
The solving of the overcompensation problem would have little if any effect on risk taking by bankers and other financiers, so probably any efforts to solve it should be postponed until the economy recovers from its present sickness.
I am pretty sure that the economy cannot recover from “its present sickness” until it gets some medicine – and fixing executive compensation can be a powerful antibiotic to address the poor credibility and perverse incentives of flawed pay plans. And I am certain that if and when the economy recovers, no one will be interested in further reforms.
By definition, a problem needs a solution. I agree with Posner that the answer has to come from the board and appreciate his support for more legitimate and robust elections and hope he will recognize that this “effort to solve it” cannot be postponed.
The “newest old thing” these days is designing compensation plans that do not encourage excessive risk taking. “Experts” have identified risk as the hottest emerging issue for compensation committees, stating that “we” do not yet know how to create the proper relationship between pay and risk.
I fully agree that the word “risk” has never been used more in compensation committee meetings than in the last six months, but that doesn’t mean the concept is new. In fact, responsible directors have considered the risks and potential impact, good and bad, of every pay decision for decades.
While not explicitly termed “risk assessment” each time a salary increase is considered, or a short- or long-term incentive plan is adopted or modified, management and boards consider the risks associated with their actions, or lack of action. But in the old days, the considered risk was how decisions would impact the company, its operating results and stockholders. Now boards are confronted with the added risk of how regulators, legislators and the public will view their decisions, today and tomorrow, with the added benefit of 20-20 hindsight.
Debate continues as to whether Wall Street and its regulators had the proper controls to manage risk. However, it was aggressive business plans, approved by directors, which led to the highly-leveraged positions fatal to some firms. Compensation programs implemented to support such business plans were not the drivers of risk, but rather were designed to incent plan achievement.
Ironically, Wall Street has been down this road before. About twenty years ago, Wall Street recognized the high risk to shareholders if executives were paid solely in cash for short-term results achieved in a manner detrimental to the long-term success of the firm. Sound familiar? In response, Wall Street firms began to pay part of annual bonuses in shares subject to future price fluctuations. Therefore, if an individual earned an annual bonus through actions that were not in the best interests of customers, those customers would leave and, as the business suffered, so would the stock price on shares held by executives.
Additionally, such deferred payouts served as a retention tool, as well as creating significant ownership and shareholder alignment. It is clear from the losses realized by executives at Bear Stearns and Lehman Brothers that there was significant “skin in the game,” a fact that should have counterbalanced any desire to take risky positions only to generate short-term payments. Sometimes businesses make bad decisions, and pay has nothing to do with it. Given the investment these employees had in their firms, it is difficult to believe how compensation plans alone created a high risk culture.
Let’s be clear – risk assessment should be an important part of every pay-related decision made by compensation committees. Specifically, assessment should focus on:
– Whether performance goals are fair and reasonable in light of past performance, market conditions and the competition. Are they based on a thorough review process by the full board that defines the pay for performance range from minimally acceptable to exceptional?
– Consideration of unintended consequences. Could the pay program create an incentive for behavior that rewards executives, while detrimental to the company and its shareholders? Has the probability of a black swan been considered?
– Will the compensation program address the often unmentioned risk that the firm may not be able to attract, retain and motivate executives essential to the firm’s success?
– Are currently accepted “best practices” considered in the design? If not, why not? Unfortunately, to complicate the issue, there are examples of “old” best practices that are now viewed negatively.
– Is the program sufficiently flexible to permit the compensation committee to recognize and adjust for special situations that, left ignored, could either create undeserved windfalls or penalize executives unfairly?
The events of the last two years have been tragic from a business and stockholder viewpoint. The fact that many employees of impacted companies were recipients of very large pay packages prior to the market collapse certainly provides blame-seekers with a terrific target. Unfortunately, with the benefit of hindsight, the cause of the downfall is not compensation-related, but rather, poor business decisions driven by risky business strategies. Decisions to take on increasing levels of risk were pushed by investors and analysts focused on short-term growth, earnings and stock gains with little concern for the risk profile necessary to achieve the desired performance.
But, one must consider the fates of management and boards who resisted the push. Their lack of relative performance would certainly have doomed their tenure given market demands for ever higher earnings and stock price. Lest we forget, although it is true that the last several years saw high investor gains mirrored by huge pay packages, we also saw dramatically shorter tenures, particularly at the most senior levels as boards quickly replaced “non-performers.”
There are undoubtedly many reforms to be considered as boards work to rebuild shareholder confidence, and assuring that pay programs continue to support business strategy is certainly one of them. But it is foolish to believe that a new, elaborate exercise that considers pay and related risk is a new approach that will magically avoid past mistakes. This process has been firmly entrenched in the work of compensation committees for many years. The real need is for recognition that engaged board oversight of rigorous business planning, including risk assessment, will serve to avoid the mistakes of the past far better than a more complex compensation process.
Yesterday, the SEC voted 3-2 to approve the NYSE’s proposal to amend Rule 452 (and Listed Company Manual Section 402.08) to eliminate broker discretionary voting for director elections. The amendment to Rule 452 will be applicable to meetings held after January 1, 2010 (but won’t apply to a meeting that was originally scheduled to be held in 2009 if adjourned to a date after January 1st).
As I’ve mentioned before, in my opinion, this change is the biggest of the reforms that companies face – bigger than proxy access, say-on-pay, etc. Here is the SEC’s press release addressing all of its actions yesterday – and here is Chair Schapiro’s opening remarks (and Commissioners Walter’s statement and Aguilar’s statement).
Commissioners Casey and Paredes opposed the proposal, both stating that the broker nonvote issue should be considered in the broader context of rejiggering the proxy process (read “proxy access”) as well as examining more completely the impact of this change on companies. In his opening remarks, Commissioner Paredes noted they weren’t alone – 93 comment letters (out of a total of 136) also urged a comprehensive review of the proxy system. They also expressed concerns that the change would disenfranchise retail holders at the expense of more control by institutional investors.
Since all the other Commissioners agreed with the importance of studying the proxy system’s “plumbing,” near the end of the meeting, Chair Schapiro stated that the SEC would conduct this type of review later this year. I see roundtables in our future. If interested in reviewing “live tweets” that occurred during the meeting, see @footnoted and @simonbillenness.
Oh, boy! Check out today’s front-page article from the Washington Post about how the SEC was warned in ’04 by a SEC Staffer about Madoff – but yet the SEC didn’t follow up. And that Staffer’s boss ended up marrying Madoff’s niece. The article is quite in-depth and is likely to result in more headaches for the SEC. I’ll cover this more extensively next week.
The Surprise: SEC Proposes Expedited Disclosure of Voting Results
Although most of the SEC’s big open Commission meeting went as telegraphed by earlier statements by the SEC Chair, there was one big surprise. The SEC proposed a new Form 8-K requirement for companies to disclose the results of a shareholder vote within four business days after the end of the meeting at which the vote was held (in contested elections, the final results would be permitted to be delayed under certain circumstances).
As I’ve complained before, the current disclosure standard doesn’t elicit voting results for weeks – or sometimes months – after the vote, which doesn’t really work in today’s more competitive annual meeting environment.
Not a Surprise: SEC Proposes Say-on-Pay for TARP Recipients
Not surprisingly, the SEC also proposed rules – by a 5-0 vote – that would help implement Section 111(e) of EESA to permit an annual advisory non-binding shareholder vote on executive compensation. The SEC’s proposal clarifies how these requirements apply to TARP recipients in the form of new Rule 14A-20. The SEC has already posted the proposing release for this one; could be record time for that. Here is Corp Fin’s opening statement.
During the open Meeting, it was pointed out that – outside of the EESA mandate – the SEC Staff has allowed the inclusion of say-on-pay proposals. Commissioner Casey note that she only supported this proposal because it was required under EESA.
SEC Proposes Changes to Executive Compensation Disclosure Rules
No surprises here either. As expected, the SEC proposed amending Item 402 of Regulation S-K as follows (here is Corp Fin’s opening statement):
– Broader CD&AS to cover risk – provide information about how a company’s overall compensation policies create incentives that can affect the company’s risk – and the management of that risk, including policies for employees generally, including non-executive officers. Such disclosure would only be required if the risks arising from those compensation policies may have a material effect on the company. The SEC did not propose any requirement that would not require the disclosure of specific salaries of any individuals beyond those already required.
– Improved reporting of stock and option awards – revise way in which stock and option awards are reported in the Summary Compensation Table and Director Compensation Table so that it’s based on the award’s fair value on the grant date. This would reverse the December ’06 “surprise.”
– More disclosure about compensation consultants – in an effort to allow shareholders to evaluate potential conflicts, require disclosure about compensation consultant fees and services (and their affiliates) when they play any role in determining the amount or form of compensation for executives and directors, but only if those consultants (or their affiliates) also provide other services to the company.
In his “Proxy Disclosure Blog,” Mark Borges provided in-depth analysis of the proposals yesterday.
SEC Proposes More Corporate Governance Disclosures
Finally, the SEC proposed a few governance disclosure enhancements, including revising Item 401 of Regulation S-K to require more disclosure about each director’s particular experience, attributes and skills that are appropriate for the person to serve as a director and as a member of any committee to which the person is appointed; extend the disclosure of the director’s board memberships to the past 5 years; and expand disclosure of legal proceedings to the prior 10 years.
In addition, the SEC proposed requiring disclosure of why the board selected a particular management/leadership structure, particularly why the board chose to combine or separate the board chair and CEO positions. Although not proposed, the SEC’s proposing release will solicit comments about whether the SEC should require disclosure about director diversity, including whether diversity is a factor considered when nominating director candidates.
Yesterday, two of the heavyweights in the compensation consulting business agreed to merge in an effort to cut costs through job cuts and streamlining operations. Under the deal, Towers Perrin (a privately-held entity) and Watson Wyatt (a public company) will combine to form “Towers Watson.” The combined company will have 14,000 employees which reportedly will rival Hewitt and Mercer as the largest compensation advisory firm. Here is a Washington Post article.
Okay, the big question for those of us focused on CEO pay – what will happen to the board advisory practices of the firms. As I understand the answer (made in response to a question asked about the consultant independence issue on the merger conference call yesterday afternoon: “They are committed to all aspects of our human capital practice and will plan on integrating the two practices once the deal goes through.”
That sounds like the right answer for a deal that needs to get through. Of course, the answer could change suddenly – either in response to client demands for independence or to the SEC executive pay proposals that become public tomorrow. Does “Towers Watson” sound too much like Sherlock Holmes lore? Maybe “Towers Wyatt” would have been better?
In May, Senator Richard Durbin introduced two bills aimed at curbing “excessive” compensation: the “Excessive Pay Shareholder Approval Act” (Bill S. 1006) and the “Excessive Pay Capped Deduction Act of 2009” (Bill S. 1007).
The Excessive Pay Shareholder Approval Act would require a supermajority (i.e., 60 percent) of the shareholders to approve the compensation structure of any employee for any year in which the employee receives in excess of 100 times the compensation of the average employee of that company. Compensation would be defined to include salary, commissions, fringe benefits, deferred compensation, retirement contributions, options, bonuses, property and other pay.
In addition, a company would be required to disclose the following in its proxy materials:
– the compensation paid to its lowest paid employee;
– the compensation paid to its highest paid employee;
– the average compensation paid to all of its employees;
– the number of employees who are paid more than 100 times the average employee compensation; and
– the total compensation paid to employees who are paid more than 100 times the average employee compensation.
The Excessive Pay Capped Deduction Act would limit the normal federal tax deduction for compensation for executives to 100 times the compensation of the average worker at that company. Compensation would be defined to include salary, commissions, fringe benefits, deferred compensation, retirement contributions options, bonuses, property and other pay. Employers exceeding this deduction limit would need to report certain pay information to the IRS:
– the amount paid to the employee receiving the lowest amount of compensation during such year;
– the amount paid to the employee receiving the highest amount of compensation during such year;
– the average compensation of all of its employees during such year;
– the number of employees receiving compensation that is more than 100 times the average employee compensation during such year; and
– the amounts paid to the employees receiving compensation that is more than 100 times the average employee compensation during such year.
As promised by Chair Schapiro earlier this month, the SEC has calendared an open Commission meeting for next Wednesday, July 1st, where it will consider proposals related to executive compensation disclosures, TARP’s say-on-pay and other corporate governance issues. It also will consider approving the NYSE’s “elimination of broker non-votes for director elections” proposal. This is a biggie.
There is one curious item on the SEC’s agenda – I have no idea what the second part of Item 3 relates to: “to clarify certain of the rules governing proxy solicitations.” I haven’t heard anything about problems with the proxy solicitation requirements. Any ideas?
Early Bird Expires Tomorrow: With the SEC’s goal to have new executive compensation disclosure rules in place before next proxy season – combined with the real likelihood of say-on-pay legislation and the loss of broker nonvotes for director elections – our the “4th Annual Proxy Disclosure Conference” (whose pricing is combined with the “6th Annual Executive Compensation Conference”) will be more important than ever. These Conferences will be held at the San Francisco Hilton and via Live Nationwide Video Webcast on November 9-10th.
Take advantage of reduced rates that will expire tomorrow, June 26th by registering now. These rates will not be extended – there will be no early bird discounts after Friday!
To ensure that a company’s long-term incentive program is competitive and cost-effective, we evaluate its fair value transfer (the total pre-tax expense of LTI awards as a percentage of market capitalization at grant). A FVT measurement:
– Quantifies the aggregate pre-tax compensation cost of LTI grants in a given period (the cost of which will likely be spread over multiple years for purposes of determining earnings);
– Normalizes equity compensation values and costs for differences in stock price and resulting market-cap size; and
– Facilitates trade-offs between various LTI vehicles since all types of awards are expressed on an economically equivalent basis.
In this Alert, we recently compared the aggregate fair value transfer data for the first quarter of 2009 to the first quarter of 2008 to provide insight into how companies changed their grant practices to address the sudden market decline. We found that FVT rates increased in 2009 across all industry and size cuts of our 150-company sample. This increase in FVT was not the result of higher absolute equity compensation grant values, but was because companies granted more shares to offset stock price declines. At the median, the dollar-value of equity compensation decreased (-25%), but not as much as the median decline in stock price (-41%).