As I head out for a two-week email-free vacation (I have some blogs tee’d up to go out while I’m gone), I have to admit surprise by Judge Jed Rakoff’s decision to not approve this week’s settlement between the SEC and Bank of America over allegations of misleading proxy materials because the bonus obligations due to Merrill Lynch employees were not fully disclosed.
BofA had agreed to pay a $33 million fine, which I suggested recently was on the high side for a non-scienter violation. Personally, I thought the SEC was trying a new approach and acting fast – as bringing charges against individuals will take considerably longer. Take my poll below to express what you think.
According to this Reuters article, the Judge’s order states: “Despite the public importance of this case, the proposed consent judgment would leave uncertain the truth of the very serious allegations made in the complaint.” The order is linked from this “WSJ Law Blog.” Judge Rakoff will hold a hearing on the case on Monday in his US District Court, Southern District of New York.
Poll: The SEC and Bank of America Settlement
Take a moment to participate in this anonymous poll:
In this podcast, Susan Wolf of Schering-Plough describes her company’s experience with using a survey to canvas shareholders about their executive pay practices, including:
– Why did the company decide to try a survey?
– What was the reaction of shareholders?
– Were there any surprises? What would you change if you did it again?
Heads I Win, Tails You Lose: The Banks Never Stopped Paying Bonuses
What am I talking about? Surprised that they’ve returned so soon to the bad old ways of short-term bonuses? They never even stopped.
Using powers unavailable to mere researchers, Andrew Cuomo, NYC’s Attorney General has forced the banks to fess up what they did on bonuses last year. Yes, LAST year. AS they were driving the rest of the economy down the pipe. AND as they were asking the government for money – or being forced to accept it.
No Rhyme or Reason – The ‘Heads I win, Tails You Lose’ Bank Bonus Culture (see, you don’t even have to make this up!) is a 22-page report that concludes after months of investigation:
Thus, when the banks did well, their employees were paid well. When the banks did poorly, their employees were paid well. And when the banks did very poorly, they were bailed out by taxpayers and their employees were still paid well.
The report lists banks paying out more in bonuses than they received in income (Goldman, Morgan Stanley, J.P. Morgan Chase), in some cases with half the TARP funding being paid out in bonuses. Others paid out billions in bonuses while seeing a loss (Citigroup and Merrill Lynch). Bank of America and Citigroup saw performance crippled in 2008, yet compensation expenses stayed at EXACTLY the same level as they had in 2007, one of the best bull years.
O.K. O.K. I’m sorry about all the capital letters, but really, I’m surprised this whole report isn’t printed in UPPER CASE. It’s certainly well calculated to make the blood of any shareholder (or Congressman) boil. The usual excuses for this kind of behavior are offered, in this case by Merrill Lynch executives, that employees in units that performed well should not suffer because of the huge losses engendered by other less successful units.
But somewhere along the line the overall financial health of the whole firm must be taken into account (phew, got through that sentence without any upper case at all).
Johnny and Jane’s Allowances
Let’s try and liken this to family finances to try and bring it down to the level of common sense and reality, rather than the fantasy and lunacy that reigns on Wall Street and in the other banks.
Mom and Dad bring in a good pay packet each week. Johnny and Jane have their list of chores and get their allowances for doing them each week. Let’s see food and lodging as base salary and allowances as bonuses. But then Dad loses his job, has to stay home, and takes over Johnny and Jane’s chores during the week, when they are at school. The dishwasher continues to get stacked, the laundry done, the lawn mowed, the trash put out. Johnny and Jane aren’t doing the chores any more, and the family income is halved so their allowances are cancelled. Fair enough. But then Dad starts going out looking for other work and has to attend interviews, he’s away most of the time, or at home writing applications, working on his resume. Johnny and Jane have to take up the chores again. But do they get their allowances back?
Yeah.
When Dad gets another job.
That’s how real people live.
Let’s push it a step further. There are bills to pay, right? Like debt, like “dividends to shareholders”, what is Mom going to do? Tell the utility company that she can’t afford to pay the electricity bill because Johnny and Jane need their allowances? Tell the bank that she can’t pay the mortgage because Johnny and Jane need their allowances or they’ll GO AND DO THE NEIGHBOR’S CHORES INSTEAD AND GET PAID BY THEM!? That’s a sure fire way to get your house repossessed.
And what if they had mortgage insurance? That’s like Treasury money, yes? But she used it to pay Johnny and Jane their allowances rather than using it to pay the mortgage? Someone’s going to get mad.
We’re very excited to announce that Corp Fin Deputy Director Shelley Parratt has joined our All-Star cast and will serve as the keynote for our “4th Annual Proxy Disclosure Conference.”
Now that Congress is moving on say-on-pay (and other compensation-changing initiatives), you need to register now to attend our popular conferences and get prepared for a wild proxy season. Remember that the “4th Annual Proxy Disclosure Conference” is paired with the “6th Annual Executive Compensation Conference” – so 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 Conferences. Register now.
SEC Settles Charges that BofA Failed to Disclose Merrill Lynch Bonus Payments
As noted in this press release, yesterday, the SEC settled charges that Bank of America misled investors about the bonuses paid to Merrill Lynch executives at the time of its acquisition of the firm. Bank of America agreed to settle the SEC’s charges and pay a penalty of $33 million. Here is the SEC’s complaint – and here is the litigation release.
The SEC alleges that in the joint merger proxy statement, Bank of America stated that Merrill had agreed that it would not pay year-end performance bonuses or other discretionary compensation to its executives prior to the closing of the merger without Bank of America’s consent. In fact, Bank of America had already contractually authorized Merrill to pay up to $5.8 billion in discretionary bonuses to Merrill executives for 2008.
Note that New York Attorney General Cuomo announced that his investigation was continuing – so this saga may not be over…
On Friday, the House passed H.R. 3269 “Corporate and Financial Institution Compensation Fairness Act of 2009,” which is Rep. Barney Frank’s latest version of a say-on-pay bill, mostly along partisan politics lines by a vote of 237-185. This follows the marked-up version of the bill that the House Financial Services Committee passed on Tuesday. There are notable differences between what the House passed and the language that the Obama Administration (through the Treasury Department) recommended in June.
Two years ago, the House passed a different say-on-pay bill by a vote of 269 to 134 (afterwards, then-Sen. Obama floated the same bill in the Senate but it never went anywhere). The Senate is not expected to consider similar legislation until sometime after the August recess – and it’s expected that there will be a tougher battle in the Senate over the bill’s terms.
Here is a final version of the bill. And here is the House Financial Service Committee’s marked-up version of the bill (with the only reported major change being the clawback reversal noted below) – and here is that Committee’s report.
Below are key provisions of the bill’s three major components, with commentary gleaned from a variety of sources:
1. Say-on-Pay: Section 2
– Likely Not Applicable to ’10 Proxy Season – Effective date for this Section is six months after SEC adopts rules implementing this Section; and the SEC is directed to adopt rules within six months of enactment of the bill into law. The upshot is that say-on-pay is not likely to be applied to the ’10 proxy season, but perhaps could be effective later in 2010. Treasury’s recommendation was to adopt something before the ’10 proxy season.
– FPIs Excepted – No Triennial Alternative – Requires annual non-binding vote on disclosure of executive compensation arrangements and “golden parachutes”; mark-up clarified that neither applies to foreign private issuers. Note that the idea of a triennial vote (ie. Carpenters Union’s alternative) was considered during the mark-up but defeated.
– SEC Might Exempt Small Businesses – Gives authority to the SEC to exempt certain types of companies from say-on-pay; SEC might use this to exempt smaller businesses. Treasury recommendation didn’t address this topic.
– Investment Managers Report How They Vote – Requires certain types of investment managers to report annually how they voted on say-on-pay at the companies for which they own at least $100 million of their equity at some point during the preceding 12 months. Treasury recommendation didn’t include this likely-to-be controversial item.
– No Tabular Format for Golden Parachute Disclosures – For say-on-pay on golden parachutes, tabular format eliminated during mark-up; and mark-up clarified that golden parachutes previously approved by shareholders must be disclosed, but need not be voted upon again. I can’t figure out why tabular disclosures were dropped – in my opinion, dropping it was not a good idea.
– Clawbacks Still Possible Even If Shareholders Approve Compensation – The mark-up had produced an amendment that would have prohibited clawbacks of compensation arrangements that had approved by shareholders – the only amendment made to the marked-up bill on Friday was striking this new provision. So under the bill approved by the House, clawbacks are still possible even if the compensation disclosure has been approved by shareholders.
2. Compensation Committee Independence: Section 3
– Even Longer Effective Date – The exchanges (as directed by the SEC) wouldn’t be required to adopt listing standards to implement this Section until 9 months after the bill was enacted.
– Compensation Committees Must Be Independent – The thrust of this section is to have independent compensation committees (although mark-up eliminated requirement that comp committee members not be “affiliated persons”). Some of the more controversial aspects of the Treasury’s recommendations were reined in by the House bill, as noted below.
– SEC Might Exempt Small Businesses – Gives authority to the SEC to exempt certain types of companies from this Section; SEC might use this to exempt smaller businesses. Treasury recommendation didn’t address this topic.
– No Need to Disclose Why Didn’t Hire Compensation Consultant – During the mark-up, the requirement to provide potentially embarrassing disclosure regarding why a compensation committee didn’t hire a consultant was struck. However, companies would be required to provide funding for compensation consultants (as well as lawyers) if the compensation committee wanted to hire one.
– Compensation Consultants Must Be Independent – The SEC must adopt independence standards for compensation consultants. The mark-up clarifies that these standards must be competitively neutral.
– Lawyers Need Not Be Independent – During the mark-up, the requirement for the compensation committee’s counsel to meet independence standards was eliminated.
– SEC’s Study – Within two years, the SEC must provide a study regarding the impact of its new independence standards to Congress.
3. Regulation of Compensation at Large Financial Institutions: Section 4
This Section would regulate pay at large financial institutions – those with more than $1 billion in assets – particularly their incentive-based pay packages. It would require federal regulators to prohibit “certain compensation” structures at large financial institutions if they could have a “serious adverse effect on financial stability.” It would also require federal regulators to adopt rules requiring these institutions to disclose their incentive-based pay plans for executives and employees – and then the regulators would determine if the pay packages are “aligned with sound risk management.”
This is quite a controversial Section (eg. the issue of whether the government can abrogate a private contract) – and it was not part of the Treasury’s recommendations. I would be surprised to see this Section survive the Senate, even with all the public anger over Wall Street bonuses. This recent Bloomberg article notes skepticism over this Section expressed by the Obama Administration and some Senators.
There is a hodge-podge of other provisions in the bill. One example is a GAO study of the correlation between compensation structure and excessive risk-taking. Note that the foregoing recap is subject to the caveat that we haven’t yet seen the final bill as adopted. Let me know if I got something wrong…
Recently, Ted Allen blogged about an important new case – Louisiana Municipal Police Employees v. Ritter – in which an Alabama state judge temporarily froze executive payments at
Regions Financial Corporation at the request of a pension
fund. In our “Comp Litigation” Portal, we have posted the complaint – and here’s the temporary restraining order.
And for those following compensation litigation, don’t forget the important Delaware Court of Chancery’s opinion on a motion to dismiss from In Re Citigroup Inc. Shareholder DerivativeLitigation.
According to this Bloomberg article, Germany recently passed a law that will limit the amount of compensation companies are permitted to pay their executives, surpassing the restrictions both in the U.S. and UK.
Highlights of the new law include:
– It will be easier for supervisory boards to cut board pay in the case of “extraordinary” developments.
– Supervisory boards will be subject to increased liability if they approve excessive salaries for management.
– If management board members are held liable for damage to the company, they can be held personally liable for at least 10% of the damage, but no more than 1.5 times their fixed annual salary.
– Board members will only be able to cash in their share options after four years (the current requirement is after two years).
– Disclosure of executive compensation will become mandatory unless 75% of shareholders vote against it.
This new law is in addition to the restrictions passed last October, which limit compensation for top executives at banks taking government bailout funds to €500,000 ($670,000) and bans bonuses, stock options and severance.
Germany has a two-tier board system: a management board and a supervisory board. The supervisory board of large corporations is composed of 20 members, ten of which are elected by the shareholders, the other ten being employee representatives. The supervisory board oversees and appoints the members of the management board and must approve major business decisions.
We recently released our report, which analyzes compensation disclosures filed by 50 companies in early 2009 and compares them to our findings during the prior two years (see this blog from last Spring) to glean what they foretell about ’10 CD&As. The new report also includes data on pay disclosures by participants in the TARP. Among our findings:
– 65% of companies with performance-based cash incentive plans disclosed their specific targets, with 19% of the remaining companies giving a reason for withholding those details.
– 30% of the companies studied disclosed examining their incentive plans to ensure they do not encourage unnecessary and excessive risk-taking
– 40% of companies disclosed clawback provisions, up significantly from 28% in 2008 and 22% in 2007 (due largely to a requirement that companies receiving funds from the Troubled Asset Relief Program have clawbacks in place.)
– 74% of companies reported ownership guidelines for executive equity awards, up from 70% in 2008 and 62% in 2007.
As an independent compensation consultant to boards, I should be delighted with the Treasury’s proposed legislation requiring consultants hired by compensation committees to be independent. I am not delighted. I am very concerned for two reasons:
1. Independence does not guarantee high quality consulting or high quality compensation. Anyone can hang out a shingle and call themselves a compensation consultant. Our profession is in sore need of generally accepted principles and standards, as well as a rigorous certification process for consultants.
2. This could cause a shake-up in the consulting industry, forcing firms to be either board consultants or management consultants. I am not sure this is healthy. It will also add unnecessary expense for companies, especially smaller companies. While larger firms can afford two consultants – one for management and one for the board – this is just not cost effective or operationally efficient for smaller companies.
Before the financial crunch, the battle between regulators and bankers used to be one-sided; both agreed that bankers generally knew best, Breakingviews says. Bonuses, for example, were an internal matter. Post-crisis, however, regulators want more say. Britain’s Financial Services Authority, run by Hector Sants, has just laid down a line — a tough one by its usual standards — on multiyear guaranteed bonuses.
In a letter sent to more than 40 chief executives, it suggested such practices “may be inconsistent” with its pending approach to remuneration, which is based on keeping rewards aligned with risk. Institutions based in Britain are not happy, especially with the idea that employment contracts signed as early as March, when the F.S.A. published its first consultation paper, could come under scrutiny, Breakingviews says. To them, the approach seems unfair and gets in the way of the high pay revival sweeping the industry. Even government-controlled banks, including Royal Bank of Scotland in Britain and Citigroup in the United States, are paying up for talent, the publication notes.
In theory, regulators could stop not only multiyear guarantees but also any reversion to old pay practices. The F.S.A. and its peers in the United States and elsewhere could decide that gargantuan pay packages were simply off the table, Breakingviews says. A few months ago, such a blanket decree, with a few exceptions, seemed plausible, it says. In practice, the mood has changed, the publication suggests. The exceptions could now become the rule, Breakingviews argues. When governments are turning a blind eye to the hiring practices of the banks under their control, regulators will have trouble being much tougher, it says.
The F.S.A. may still try, Breakingviews says. Banks would be foolish to ignore its letter completely or protest too loudly, the publication says. The regulator has the authority to levy fines or even to increase capital requirements for institutions it judges are careless about pay, it notes. But wily bankers can probably protect their rewards without direct confrontations, according to the publication. Better to cut back on egregious contract terms, while marshaling persuasive arguments about how bankers and traders are getting extra pay for keeping a particularly close eye on the risks they are taking, Breakingviews says.