Liz recently blogged that the SEC designated a longer period for taking action on proposed listing standards to implement Dodd-Frank clawback rules. This left companies who haven’t yet adopted a compliant policy unsure whether to jump on this now using the listing rules proposed in February or whether some additional time may be forthcoming. This FW Cook blog clarifies that clawbacks should be on your summer to-do list. Here’s an excerpt:
An April 24, 2023 SEC release (see here: link), while somewhat ambiguous, could be read to suggest that the SEC would not take action before June 11, 2023, although leaving open the possibility of a later approval date.
Recent conversations between SEC staff and executive compensation practitioners suggest that the SEC is leaning toward treating June 11, 2023 as the date for final action (actually, June 9 since June 11 is a Sunday). While practitioners have strongly lobbied for the SEC to delay action until the absolute deadline of November 28, 2023, the SEC so far appears unpersuaded, at least in part because of procedural reasons referenced in the April 24, 2023 release.
Given the substantial chance the SEC will approve the listing standards no later than June 9, 2023, this means a new policy would have to be in place by August 8, 2023 (i.e., 60 days later). Even though drafting a compliant policy may be relatively straightforward, seeking Board/committee review and approval over the summer could be challenging from a practical perspective. There are many boards and committees that don’t meet in the June/August period, so waiting until the SEC has acted may result in the need for special unanticipated actions, either through special meetings or possibly unanimous written consents.
Dust off your flip flops and your employment agreements, equity plans, deferred compensation plans and existing clawback policies since, as Morgan Lewis describes in this alert, there’s a lot to consider. The good news is that we have more resources, including multiple models of a Dodd-Frank-compliant policy, in our “Clawbacks” Practice Area. Plus, we’ve extended our June 27th webcast “Proxy Season Post-Mortem: The Latest Compensation Disclosures” by an additional 30 minutes to bring you the latest on clawback policies from our expert panel: Mark Borges, Principal at Compensia and Editor of CompensationStandards.com, Dave Lynn, Partner at Morrison Foerster and Senior Editor of TheCorporateCounsel.net and CompensationStandards.com and Ron Mueller, Partner at Gibson Dunn & Crutcher LLP.
If you attend the live version of this 90-minute program, CLE credit will be available. You just need to fill out this form to submit your state and license number and complete the prompts during the program.
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Liz recently blogged that things were looking up for say-on-pay in 2023 after record failures in 2022. As this Pay Governance viewpoint notes, that is especially welcome news given some added complexities in 2023—namely, pay-versus-performance disclosures and significant decreases in TSR in 2022 for the first time since say-on-pay votes were first mandated.
The viewpoint compares say-on-pay failure rates and TSR performance at the S&P 500 and comes to a surprising conclusion: the increase in the say-on-pay failure rate occurred during a period when annual TSR levels were among the highest recorded since 2011. The article attributes this to:
– Greater scrutiny of pay practices by proxy advisors and institutional investors as we move deeper into the SOP era.
– Heightened attention over the past several years to the quantum of pay provided versus prior years without regard to absolute or relative performance.
With those trends likely to continue, does that mean final 2023 say-on-pay failure rates are likely to be worse than last year? After all, as the article notes, “TSR performance can change much more rapidly than pay can adjust.” The article points to a few factors working in favor of companies and compensation committees:
– S&P 500 TSR looks better with a longer lookback period
– The use of relative TSR by proxy advisors and institutional investors
– S&P 500 TSR is up in the first quarter of 2023
– Pay-versus-performance disclosures may help show the alignment of “compensation actually paid” with TSR (compared to total compensation in the summary compensation table)
Corp Fin Director Erik Gerding and Chief Counsel Michael P. Seaman joined the “Dialogue with the SEC Senior Staff” session on Friday at the ABA’s Business Law Section Spring Meeting. Reminding us that Corp Fin’s hard work doesn’t end with the rule adoption, Erik noted that once a rule is effective, lots of work goes into implementation – training folks in the disclosure review program, working through the comment process and deciding how to provide guidance. Erik then outlined the Staff’s plan for the review program for PVP disclosures, which the SEC is considering in two buckets:
– For issuers that omitted the disclosures – either entirely or in part – comments will be issued asking about the missing pieces. Take note: Erik called out that the Staff may ask those issuers to delay an annual meeting until the required disclosures are made!
– For issuers that provided the required disclosures, the Staff may issue comments at the end of proxy season that are prospective in nature, recognizing the complexity of the rules and the number of interpretive questions. The Staff may also consider providing more broadly applicable guidance.
Erik notes that the Staff doesn’t see the first season as establishing a settled practice and reserves the right, going forward, to make further comments as to how the rule should be interpreted. Liz previously blogged about commentary from the Staff earlier this year that the PVP comment process will be iterative and the Staff isn’t looking to be punitive for companies who presumably put in a good-faith effort to comply with the requirements, so that certainly seems consistent.
The Compensation Monitoring Contact Group (CMCG) of the FSB is tasked with monitoring the progress of financial institutions’ implementation of FSB’s Principles for Sound Compensation Practices and Implementation Standards. In its last report in November 2021, the CMCG observed an emerging trend that financial institutions are increasingly using non-financial measures in compensation programs and decided to examine this further in 2022, focusing on climate-related factors. The report on that study was released in April.
The study showed that there was a wide variety of quantitative and qualitative metrics used by financial institutions that addressed climate change in their compensation programs, including reductions in their own carbon footprint, growth of sustainable finance, improved climate-related leadership, training, innovation or disclosure, integration of ESG considerations into the decision-making process and external-based metrics such as ESG ratings and indices. On the last metric, there was a difference in opinion among participants as to whether it was advisable to use external ESG ratings:
Some participants noted that their firm uses external ESG ratings. Others that do not use them expressed caution that as financial institutions are at different stages of their journey and not targeting the same objectives, a financial institution’s relative position against peers does not always give a precise reflection of progress given different starting points. Instead, they felt that the core strategy is something which executives should be held accountable for and actual target relevant to the core strategy should be achieved instead of relative positions.
While metrics varied widely, the following challenges to incorporating climate change in compensation programs were nearly universally reported by participants:
– Data availability, reliability and analysis
– Difficulty in developing objectively measurable KPIs acceptable to all stakeholders
– The misalignment of long-term climate outcomes and annual compensation plans
– How to cascade climate targets beyond certain executives
– Regulatory and policy uncertainties
The survey concluded that financial institutions’ use of climate metrics in compensation is still at an early stage and, where used, the impact on total compensation remains modest.
During our recent webcast “The Top Compensation Consultants Speak,” Ira Kay described a Pay Governance study that used pay versus performance data of 50 S&P 500 companies that filed their proxies on or before March 10, 2023 to calculate the level of alignment of “compensation actually paid” with TSR, relative TSR, GAAP net income, and the company selected measure, which we subsequently blogged about. Now that more time has passed, Pay Governance has reviewed PVP disclosures of 160 S&P 500 companies that filed their annual proxies as of March 31, 2023 and has released a viewpoint with more takeaways for us. Here are the key findings from that data, the first of which confirms the conclusion in their prior study with this larger sample size:
– The new PVP disclosure is supportive of the current executive compensation framework used by most companies, as compensation outcomes are directionally aligned with shareholders’ interests. It also justifies their significant support for Say on Pay during the Say on Pay era these past 12 (going on 13) years.
– The fair value of the current year’s equity award has the greatest impact on the CAP absolute dollar amount.
– Higher performing companies (as measured by TSR) reported significantly higher CAP values than lower performing companies for each of the last three years (2020-2022).
– As explicitly expected by the SEC, CAP can be very volatile between years due to stock price changes and adjustments to expected performance outcomes.
– Changes in SCT total compensation, on the other hand, tend to move within a narrow range because the biggest drivers of the change relate to the current year’s annual incentive, a relatively small portion of total compensation, and changes in the grant date value of the current year’s equity awards, which are generally conservative.
Given these findings, the study concludes with thoughts for management and compensation committees:
In general, we do not believe companies should or will make program design changes to try to improve their PVP disclosure. However, we do recommend management and Compensation Committees consider the questions investors and other stakeholders might ask at the next shareholders’ meeting based on the new disclosure. These might include:
– Is the relationship of CAP and TSR sufficiently aligned?
– Are the relationships of CAP to the other financial performance measures included in the PVP table (GAAP net income and the company selected measure) sufficiently aligned, and if not, are the reasons explainable?
– Is the company’s TSR in line with its peers?
– Is the absolute quantum of CAP reasonable?
– Are the year-over-year changes in CAP driven by the company’s performance?
– Is the use of grant date fair values — as presented in the SCT and used as the primary pay-for-performance test by the proxy advisors, or the equity values as presented in the PVP disclosure — the best way to evaluate pay-for-performance? Or is some type of realizable/realized pay, that considers expected (realizable pay, similar to PVP disclosures) or actually realized pay outcomes, a better approach?
Even though “golden parachute” votes are a one-time advisory vote and arguably inconsequential, shareholders are still taking the opportunity to express displeasure with outsized arrangements – and they’re doing so more often. This memo from Compensation Advisory Partners says there may be a reason for the surviving entity to care about the structure, but we’re still in “wait & see” mode:
Beginning with the 2021 proxy season, Glass Lewis stated that they may recommend against the next say on pay vote or compensation committee members of the acquirer if an excise tax gross-up is introduced. To-date, we have not seen many shareholders vote against say on pay proposals of the surviving entity.
According to recent ISS research, the golden parachute vote failure rate rose to 15.6% in 2022 – a big jump from the failure rate that ranged from 10.3 – 14.5% for the preceding 6 years. The research also shows that the higher failure rate is correlated with higher golden parachute values. Here are a few key takeaways:
– The median CEO golden parachute value also increased significantly, from $7.9 million in 2021 to $12.9 million in 2022.
– Median total golden parachute values for failed proposals were considerably higher than passing proposals.
– Equity values represented a higher proportion of total CEO parachute values for failed golden parachute proposals at 63.4% of total payment in 2022 compared to 52.9% in 2021.
The ISS write-up dives into the numbers, as well as problematic equity acceleration and other problematic practices that could lead to adverse voting recommendations (and may be a contributing factor to the overall higher failure rate). Here’s ISS’s conclusion:
The 2022 spike in the median CEO golden parachute value coincided with an increase in the say-on-golden parachute failure rate. The magnitude of golden parachute payments appears to be a significant factor in many investors’ voting decisions, further highlighted by the stark difference in median golden parachute values between failed and passing proposals.
For failed proposals in 2022, the average value of cash-based payments declined while equity values represented a higher proportion of total CEO parachute payments compared to 2021, and problematic equity acceleration emerged as a more prevalent concern. Concerns identified in 2022 point to potential issues with single trigger acceleration, coupled in some cases with above-target acceleration of performance shares; in other words, the conditions in which CEOs would receive a significant portion of their golden parachute payments – on a single-trigger basis with potentially enhanced amounts – likely played a role in the increase in the say-on-golden parachute failure rate in 2022.
The treatment of equity in severance packages, coupled with increasing magnitude, remains an area of significant concern for many shareholders and that ISS will continue to monitor.
The process for setting director pay has become more fraught in recent years as the result of Delaware case law – leading some companies to adopt annual limits on compensation. In a recent article, Mayer Brown’s Lawrence Cunningham walks through the “inherent conflict” in setting director compensation – and suggests that it’s also important to think carefully about who holds the power to set these arrangements. Here’s an excerpt:
Probing substantive independence may help. Compensation will matter more to some directors than to others, bearing on their independence. All other things being equal, directors will feel less dependent on their board position when they are wealthier, higher paid, own more shares in the company or have many other comparable opportunities.
Reposing decisions over board compensation in those members may improve the integrity of the decision-making process. Indeed, if some directors were willing to accept no pay, they might be the ideal decision makers on what to pay the others.
It is tempting to consider enlisting compensation consultants for recommendations. Such consultants can add value to the process by providing relevant and reliable market research on prevailing practices and fair levels. Again, however, the consultants’ own fees and potential for repeat assignments may incentivize bidding high.
Nor would it help to have the directors delegate their compensation determination to management. That poses a broader conflict of interest since boards’ duties include appointing and overseeing managers.
Directors might consider submitting their compensation plans to a shareholder vote. After all, shareholder approval is the standard step to insulate an interested transaction from scrutiny in favor of business judgment rule deference. A common solution is for boards to propose compensation plans for shareholder approval that establish upper limits on the annual amount per director.
Under recent cases in Delaware, however, the value of shareholder ratification has become more limited. Courts credit such approval only when the approved compensation plan is fixed, not one where directors retain any discretion over it.
At many companies, the compensation committee sets or recommends director pay, so taking a closer look at whether those directors are disinterested and delegating this decision making to a subcommittee would be an extra step – but it may be worth the effort if director pay is higher than at peer companies or the company has another reason to think the decision would be challenged.
Lawrence observes that board pay has increased significantly over the past 20 years – which aligns with the increase to directors’ workloads, the competitive market for qualified board members, and litigation & reputational risks. He also notes that it’s important to benchmark the amount and structure of director compensation arrangements, in addition to having “bulletproof” procedures.
Yesterday, the SEC posted notice – for the NYSE, Nasdaq and other SROs – that it would designate a longer period for taking action on proposed listing standards to implement Dodd-Frank clawback rules. This action follows comment letters that were submitted earlier this month to urge a longer lead-time – and it’s welcome news to anyone trying to keep up with the demands of recent SEC rulemaking.
That said, don’t get too excited. For each exchange, the Commission has designated June 11th as the date by which it will either approve or disapprove – or institute proceedings to determine whether to disapprove – the proposed rule change. Under Section 19(b)(2) of the Exchange Act, that’s the outside date of 90 days from the date the notices of these proposals were published in the Federal Register. If the Commission hadn’t designated this longer period, it would have had to act by April 27th.
The lingering issue presented by this June date is that the original proposals from the exchanges said that they’d be effective on the date approved by the SEC (see pg. 31 of the NYSE’s proposal and pg. 31 of Nasdaq’s proposal). So, unless the exchanges amend that portion of their proposed listing standards, if the SEC approves them in June, that’s when they’ll go effective. That will start the 60-day clock for listed companies to adopt a compliant clawback policy – putting the deadline in early August. That’s still a lot earlier than many folks originally expected, and means you can’t delay work on your clawback policy.
We’ll continue to cross our fingers that this plays out more in line with the originally expected timeframe of a November effective date for the exchange listing standards and a January 2024 compliance date. Keep following this blog for updates & practical guidance as the date nears (one way or the other) – and make sure to use the resources available in our “Clawbacks” Practice Area (including a sample policy). And, mark your calendars for our “Proxy Season Post Mortem” webcast – 2pm ET on Tuesday, June 27th, as we’ll touch on this as a “hot topic.” As always, an archive replay and transcript will be available to members following the live program.
If you aren’t already a CompensationStandards.com member with access to these resources, start a no-risk trial today! Our “100-Day Promise” guarantees that during the first 100 days as an activated member, you may cancel for any reason and receive a full refund. If you have any questions, email sales@ccrcorp.com – or call us at 800.737.1271.
Although large company stocks performed pretty well during the first quarter of this year, the impact of the bumpy market might be affecting executives’ decisions on whether to find greener pastures – and boards’ decisions on how far to go to retain them. In a recent memo, Semler Brossy points out that retention awards are increasing:
Tighter and more competitive candidate pools have led to higher executive pay. Meanwhile, poor market conditions have eroded much of the equity hold companies rely on to retain their existing talent. We analyzed S&P 500 companies from 2019 to 2021 and found that retention awards are increasing, notably since the start of COVID. Additionally, current board concerns over retention could mean the practice increases in 2023 and beyond.
The Semler Brossy team acknowledges that special retention awards come with a high risk of investor criticism – but says that risk can be worth it if the awards are done right. The memo shares three important considerations – here are a few excerpts from each section:
1. Is now the right time? It is essential for boards to step back and ask what makes this particular time or situation unique, and how special awards might make a real difference. Do investors find the criticality of the individual executive’s role apparent and worthy of a special award? Have the company’s communications supported this narrative to help investors understand the unique situation?
2. Does the existing compensation program have enough holding power to retain the executive(s)? Sometimes, a poor performance year makes a management team question whether the plan works. We advise clients to review performance/payouts over a multiyear period before fearing the worst. . . . Often, making potential opportunities more transparent and rallying executives around achieving these goals is enough to strengthen their commitment.
3. How will the company structure the special award (i.e., performance and vesting)? A special award’s structure will often dictate its external reception. Investors and proxy advisors evaluate four design features in special awards: magnitude, performance requirements, vesting and forfeiture provisions. The memo includes a chart that shows guardrails for these design features, and commentary from S&P 500 analysis.
At the end of the day, the frequency with which the company makes these types of awards is one of the most important considerations. It’s difficult to call something a “special award” if you’re doing it regularly, which the Semler Brossy folks also point out:
Boards should also exhaust all regular compensation actions and consider the internal and external operating environment before undertaking a special award. Lastly, special awards should be kept isolated, making them truly “special” rather than a perpetual practice.
Compensation committees have been struggling to set appropriate performance hurdles, especially for long-term awards, in these challenging markets. Equilar recently released a publication (available for download) analyzing trends in plan design, and—not surprisingly—long-time favorite, relative TSR, is only increasing in popularity as a performance metric. Here is Equilar’s summary of their key findings:
Relative TSR reigns supreme. The use of the metric grew in prevalence among Equilar 500 CEO LTIPs by nearly 13 percentage points from 52.8% in 2017 to 65.7% in 2021.
Return on capital loses momentum. ROC was the only Equilar 500 NEO performance metric to decrease in prevalence in 2021, declining from 40.1% in 2020 to 39% in 2021.
Three is the magic number. Three-year performance periods are by far the most common time horizon set for Equilar 500 executive LTIPs, increasing from 86.7% in 2017 to 90.6% in 2021.
CEO LTIPs call for higher performance ranges. Award payouts for Equilar 500 CEO LTIPs were most commonly triggered when performance hit 80%, and capped when performance hit 120% of target, with 84 of the 119 metrics falling within this range.
Max payouts are most commonly double the target. A maximum payout range of 200% the target was the most prevalent across the Equilar 100, with 88 metrics including that parameter as the high mark for CEO LTIP performance awards in 2021.