Yesterday, the SEC announced an action to clawback bonuses and stock profits from a former CEO under Section 304 of Sarbanes-Oxley. The SEC asked the U.S. District Court for the District of Arizona to order the former CEO of CSK Auto Corporation, Maynard Jenkins, to reimburse the company for more than $4 million that he received in bonuses and stock sale profits while the company was committing accounting fraud. This is the third Enforcement action that the SEC has brought regarding CSK’s alleged accounting shenanigans, which resulted in two restatements – one of them charges four of the company’s executives with wrongdoing (but not the former CEO).
Although this is not the first Section 304 action from the SEC, it’s the first one where the “clawee” isn’t alleged to have violated the securities laws. The SEC has brought very few 304 actions since the provision was enacted seven years ago, mainly because of the uncertainty over what constitutes the “misconduct” required by the provision. Here is how Section 304 opens:
If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer…
As noted in the “D&O Diary” Blog, “there is no requirement in Section 304 that the CEO or the CFO from whom the reimbursement is sought have any involvement in the events that necessitated the restatement. Indeed, the statute doesn’t require any showing of wrongdoing or fault at all.” And remember there is no private right-of-action under 304 – only the SEC can enforce it.
Okay, so what type of “misconduct” did the SEC find here? For openers, the SEC’s press release refers to the CEO as the “captain of the ship.” Did the SEC decide that the captain is responsible for the ship and that alone is enough to find “misconduct”? I don’t think so.
Based on a cursory reading of the SEC’s complaint, I believe the SEC found that the captain engaged in some “misconduct” – but that misconduct didn’t amount to a violation of the securities laws. I get to this conclusion by noting that a number of the allegations (i.e. #43-47) in the SEC’s complaint explain the “conduct” and “misconduct” by the company that led to this action and then #48 states: “By engaging in the conduct described above, Jenkins violated, and unless ordered to comply will continue to violate, Section 304(a) of the Act, 15 U.S.C. § 7243(a).”
There’s not a lot of meat in the SEC’s allegations to explain what role the former CEO actually had in the accounting fraud, leaving the SEC open to criticism (such as this Ideoblog commentary). But maybe that’s the SEC’s point – that merely being captain of the ship while rampant fraud occurs on your watch is “misconduct” enough. We’ll be posting memos analyzing this case in our “Clawback Policies” Practice Area.
At a minimum, the SEC’s action seems like a wake-up call to CEOs and CFOs of companies that have had restatements due to some accounting misconduct: you are not safe – the SEC may come after you. And hopefully, this action will spur companies to attempt to enforce their own clawback policies (Equilar reports more than 64% of the Fortune 100 now have them; compared to just 17% in ’06). I’m not aware of any company that ever has (although it’s possible it has happened behind closed doors). I imagine companies sometimes deal with situations where it’s not clear if their own clawback policy – or Section 304 – applies. Or if it does apply, whether it’s prudent to seek recapture from the executive (weighing cost/time of litigation; indemnification issues, etc.).
We just posted a complimentary copy of the Summer 2009
issue of the “Proxy Disclosure Updates” which analyzes how
the latest proxy disclosures looked, particularly noteworthy in the wake
of ARRA, EESA and the other regulatory responses to the crisis. This valuable
quarterly newsletter is part of the Lynn, Borges & Romanek’s “Executive
Compensation Annual Service.” The other part is the 1000-plus page Treatise…
Coming Soon: 2010 Executive Compensation
Disclosure Treatise and Reporting Guide: Now that we have seen the SEC‘s
proposals and Treasury’s legislation – that will force you to radically change
your executive compensation disclosures and practices before next proxy season
– we are wrapping up the ’10 version of Lynn, Borges & Romanek’s “Executive
Compensation Disclosure Treatise and Reporting Guide,” which we will deliver to
subscribers by early October.
Act Now for $100 or More
Discount: To obtain this hard-copy ’10 Treatise when its printed in October
(as well as get online access to the ’09 version right now on CompensationDisclosure.com, as well as the valuable
quarterly “Proxy Disclosure Updates“), you need to try a no-risk
trial to the Lynn, Borges & Romanek’s “Executive Compensation
Annual Service” now. If you order now, you can take advantage of
a $100 or more discount.
Recently, RiskMetrics canvassed some compensation consultants about whether they would find a peer benchmarking tool useful when helping to set executive pay levels. While I appreciate RiskMetrics’ desire to expand its services, their concept ignores the fact that peer group selection is not automatic and requires experienced analysis and judgment of numerous factors, many unique to each company.
To name just a few, in addition to industry and size (parameters that vary based on the nature of the business), we consider organization structure, financial structure, corporate strategy, performance metrics, ownership, global presence, make vs. buy/outsource, distribution channels, internal growth vs. acquisitions, etc.
I am also concerned that RiskMetrics’ fourth party automatic selection will require companies, as well as their consultants, to defend their selections vs. those of RiskMetrics in the event of a challenge, especially litigation.
Perhaps most important, I’ve also reviewed RiskMetrics’ historic selection of peers in numerous voting advisory reports and find them questionable – if not invalid – with respect to both pay and performance comparisons. Let me know what you think.
Things are moving fast on the legislative front as Rep. Barney Frank circulated a “discussion draft” on Friday of his “Corporate and Financial Institution Compensation Fairness Act of 2009” to the House Financial Services Committee. This bill is the House version of what Treasury sent to the Hill last Thursday.
– Dave Lynn, Partner, Morrison & Foerster and Editor, CompensationStandards.com
– Mark Borges, Principal, Compensia
– Jeremy Goldstein, Partner, Wachtell Lipton Rosen & Katz
– Jannice Koors, Managing Director, Pearl Meyer & Ptrs
– Mark Trevino, Partner, Sullivan & Cromwell LLP
Our “6th Annual Executive Compensation Conference“: Now that we have a sense of what Congress will likely pass before next year kicks off, 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.
Yesterday, Treasury announced that it has drafted
two different pieces of executive compensation legislation – one
related to say-on-pay and the other regarding compensation committee
independence – that they’ve sent to Congress as part of the “Investor
Protection Act of 2009.” Last week, Treasury began issuing other parts
of “The Investor Protection Act of 2009” and more sections are
forthcoming. These draft bills are consistent with the Obama
Administration’s White Paper that was released last month. Here is the say-on-pay press release and bill language – and here is the committee independence press release and bill language.
Rep. Barney Frank issued a statement
yesterday promising quick action in the House, specifically that the
“Financial Services Committee will be marking up legislation next
week.” It’s unknown what the timetable for consideration in the US
Senate will be.
Below is a summary of the two pieces of proposed
legislation, both of which would be implemented through SEC rulemaking:
1. Say-on-pay vote on executive compensation disclosures:
– Annual meetings after 12/15/09 will be required to
include a non-binding shareholder vote on the compensation disclosed in proxy
statements.
– The proxy or consent solicitation for any meeting after
12/15/09 involving an M&A transaction or sale of assets must include tabular
disclosure of golden parachute payments, and provide for a non-binding
shareholder vote to approve these payments.
2. Compensation committee independence:
– Compensation committee members would be subject to the
same additional independence standards as audit committees members under Rule
10A-3 (no consulting or advisory fees and cannot be an
affiliate).
– Compensation consultants, legal counsel and other
advisors to the committee shall meet independence standards to be promulgated by
the SEC.
– The compensation committee has the authority to retain
independent consultants and is directly responsible for their appointment,
compensation and oversight (copied from the audit committee oversight of
auditors).
– Proxy statements must disclose whether the compensation
committee has retained an independent consultant, and if not, why
not.
– The compensation committee has the authority to retain
legal counsel and is directly responsible for their appointment, compensation
and oversight (copied from the audit committee oversight of auditors). There is
no requirement that proxy disclosure be made as to whether the committee
retained such legal counsel.
– Companies must provide funding for the hiring of
independent consultants and legal counsel by the committee.
– The SEC is required to study the use of compensation
consultants and report to Congress in two years.
The SEC’s “Wish List”: 42 More Changes!?!
For
those that don’t think that there have been enough regulatory changes
proposed so far this year – or this decade for that matter – you’ll be
happy to see this list
of 42 desired changes that are reported to have been sent by the SEC to
Congress. The 42 changes would impact quite a few areas of the federal
securities laws – and are unlikely to be grouped together into a single
bill. Rather, parts may be embedded into other legislation, etc.
With executive compensation issues firmly in the public spotlight, the SEC is once again considering expanded CD&A disclosure requirements. The SEC’s most recent proposals include improved disclosure on the connection between compensation and risk, greater detail on overall compensation philosophy and design, and further insight into potential conflicts of interests between compensation consultants and the companies they advise.
With these developments in mind, Equilar recently used its “Compensation Consultant League Table” database to complete an analysis of executive compensation consultant market share at Fortune 1000 companies. In 2008, boards at 90.7% of Fortune 1000 companies retained the services of at least one compensation consulting firm.
The following table lists the Top 10 consulting firms, by executive compensation consulting market share during ’08, at Fortune 1000 companies:
1. Towers Perrin – 19.3%
2. Frederic W. Cook & Co. – 17.5%
3. Hewitt Associates – 14.5%
4. Mercer Human Resources Consulting – 11.4%
5. Watson Wyatt Worldwide – 7.5%
6. Pearl Meyer & Partners – 5.4%
7. Semler Brossy Consulting Group – 3.8%
8. Hay Group – 2.3%
T-9. Exequity – 1.6%
T-9. Deloitte Consulting – 1.6%
Note: FY 2008 market share percentages are based on a total of 867 engagements with boards of directors at 824 of 908 Fortune 1000 companies studied. See methodology statement below for more information. Also note that Towers Perrin and Watson Wyatt announced plans to merge into a new firm called Towers Watson on June 29, 2009. The combined firm would have a market share of 26.8 percent.
Additional Key Findings:
– Top 10 Firms Lose Overall Market Share as Smaller Firms Proliferate – In 2008, Fortune 1000 companies listed a total of 53 executive compensation consulting firms as advisors to their boards of directors. Among these firms, the Top 10 consulting firms held a combined market share of 84.9 percent. In contrast, Fortune 1000 companies listed only 42 executive compensation consulting firms as advisors in 2006, when the Top 10 consulting firms held a combined market share of 93.8 percent.
– Independent Firms Gain Market Share – In 2008, independent executive compensation consultants held 39.3 percent of engagements with boards of directors at Fortune 1000 firms, up from 37.4 percent of engagements in 2007. Market share for independent firms had increased from 35.0 percent to 37.4 percent between 2006 and 2007. Independent firms are defined by Equilar as companies that focus primarily on executive compensation consulting.
– Full-Service Firms Maintain Market Share Above 60% – Full-service firms, which are defined by Equilar as companies that offer accounting, broad-based HR, retirement and/or benefits consulting in addition to executive compensation services (though not necessarily to the same client), held 60.7 percent of engagements with boards of directors at Fortune 1000 firms in 2008.
Readers of this analysis should take the following methodology notes into consideration:
– To study trends on the use of executive compensation consulting firms at public companies, Equilar reviewed disclosures at 908 firms listed in the Fortune 1000 index. Each firm covered by the study has an updated CD&A statement for fiscal year 2008.
– Among the companies included in this analysis, 824 firms (or 90.7 percent) retained an executive compensation consultant to advise their board of directors on executive pay. The remaining firms either have no consultant or a consultant retained by management. For the purposes of tracking market share at Fortune 1000 companies, Equilar only considers direct engagements between a board of directors and a consulting firm.
– In some cases, a board of directors may engage multiple executive compensation consulting firms during the course of a single year. Equilar counts these cases as a full engagement for all consulting firms involved. As such, the 824 companies with an executive compensation consultant for their board of directors produced a total of 867 engagements in fiscal year 2008.
Here is an extended version of Equilar’s compensation consultant market share analysis, including data on year-over-year changes in market share. Equilar is an information services firm specializing in executive compensation research.
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.