Now that the effective date of October 2nd has passed for the listing standards that implement Exchange Act Rule 10D-1, listed companies that have not already adopted a Dodd-Frank clawback policy have only a few weeks to do so before the compliance deadline of December 1st. But as suggested by the NYSE letter that we blogged about last month, companies applying for initial listing may have less leeway. In our “Q&A Forum” (#1487), a member recently asked about this:
In the NYSE issuer notification that went out a few weeks ago re clawbacks, it provided that “In addition, issuers submitting initial applications for securities to be listed on or after October 2, 2023 will be required to confirm the adoption of a compensation recovery policy as part of its listing application in Listing Manager.” So far, we have not seen an earlier deadline than December 1, 2023 being applied to Nasdaq initial listing applications. Is anyone aware of Nasdaq’s position?
Here’s what John said:
I have not seen any notice from Nasdaq, but the form of Corporate Governance Certification that’s required to be submitted for a new listing application that appears on Nasdaq’s website does include a new Section 5C, which requires a company to certify that it has adopted a clawback policy conforming to Rule 5608. That suggests to me that Nasdaq is requiring companies that are applying for listing after the October 2, 2023, effective date of the rule to have a policy in place.
As Meredith noted back in June, both NYSE 303A.14 and Nasdaq Rule 5608 are subject to cure periods for non-compliance. The NYSE covers that in 302.01F, and for Nasdaq, check out the 5800 series, particularly Rule 5810.
We are continuing to post memos, sample policies, and other practical resources in our “Clawbacks” Practice Area – I have also been finding the May-June issue of The Corporate Executive newsletter extremely helpful as I put the finishing touches on policies and help clients understand the ins & outs.
Since this is such a hot topic and we’re getting in to the 11th hour, make sure to also mark your calendars for the webcast that we’ve just scheduled for Thursday, November 16th at 2pm Eastern – “More on Clawbacks: Action Items and Implementation Considerations.” This is a follow-up to the excellent conversation that occurred at our “20th Annual Executive Compensation Conference,” because it was clear from that session that there are many questions bubbling up about these policies and how they’ll be implemented. If you missed the essential conversation at the Conference, you can still get access to the video archives & transcripts by emailing sales@ccrcorp.com or calling 800-737-1271.
Since at least 2016, we’ve been pondering the oversight responsibilities of the compensation committee that go beyond “executive compensation.” Thinking and practices are continuing to evolve – especially with new disclosure expectations around “human capital management,” evidenced by last month’s recommendations from the SEC’s Investor Advisory Committee about an HCM disclosure rule and guidance from certain asset managers that encourages disclosure of EEO-1 reports (“or else”).
This new 7-page memo from Semler Brossy gives a roadmap for committees looking to acknowledge HCM responsibilities in their charter. It recommends these steps to help directors fully consider their oversight role on this topic:
1. Clarify the HCM connection
2. Understand the current state
3. Define success
4. Determine responsibilities
5. Update the calendar
6. Share oversight & metrics with investors
In addition to the roadmap, the memo gives sample charter language, matrices for visualizing board responsibilities and HCM agenda items, and key HCM areas that boards & committees tend to oversee.
We’ve posted this resource in our “Compensation Committee Charters” Practice Area – make sure to refer back to it the next time you’re discussing roles or updating charters. Also check out this Semler Brossy article on whether you need a CHRO on your board, and Meredith’s blog about the tricky issue of talent retention in M&A.
Pay Governance recently analyzed over 400 biotech companies with greater than $50 million in market cap to better understand how compensation practices in these companies have shifted over the last three to five years. In this report on its findings, the team discusses how market volatility has impacted biotech companies’ equity compensation strategies, noting that “in this environment, significantly underwater options have put pressure on many companies’ equity incentive programs, requiring many to consider different approaches.” At a high level, they found that many biotech companies have adapted their strategies as follows:
– Increased use of restricted stock and restricted stock units (RSUs)
– Increased rate of aggregate annual equity usage (“burn rate”)
– Increased level of automatic equity reserve refresh rates and reliance on such refreshes (“evergreen provisions”)
– Decreased levels of available shares authorized for grant to employees (“share pool” or “equity reserves”)
– Increased levels of outstanding employee ownership (dilution)
After reviewing the trend data, the report concludes that the increased use of RSUs and the higher burn rates are here to stay — albeit at lower levels since both likely peaked in 2022 — with options continuing to be the preferred equity award type.
If you joined us for the “Pay Versus Performance: What’s New for Year Two” panel during our 20th Annual Executive Compensation Conference, you’ve already heard a high-level overview of initial SEC comments on PvP disclosures to date and first-year mistakes seen by our panelists. Since then, Compensation Advisory Partners released this summary of the first 16 comment letters. The comments focus on missing required disclosures and issues with calculating “compensation actually paid.” Here are the common topics noted in the memo, separated by disclosure issues and CAP calculation issues:
– Missing required elements of the disclosure, such as a description of the relationships between Compensation Actually Paid (CAP) and the metrics or the list of 3-7 financial performance measures used to link CAP with company performance;
– Including multiple Company-Selected Measures, or not including the Company-Selected Measure in the tabular list of 3-7 most important financial performance measures;
– Failing to provide a reconciliation of non-GAAP measures selected as the Company-Selected Measure (CSM) against GAAP financial statements;
– Using a TSR peer group that does not match either the industry group used for Regulation S-K in the 10-K performance graph or the compensation peer group disclosed in the CD&A; or
– Incorrect footnote descriptions to the table that suggest misinterpretation of the rules.
– Not including or not identifying all NEOs who served in each year in the table;
– Using partial compensation received for the year for individuals in the table (e.g., if an individual is promoted to a Named Executive Officer (NEO) role during the year, only including compensation earned for the period served as an NEO); and
– Footnotes indicating a “year over year” change in fair value for awards that should be valued as of the date of vesting, rather than at year end.
The memo then lists and summarizes each comment letter, ranked by the recipient company’s annual revenue.
Our conference panelists highly recommended that companies start thinking now about what needs to change for year two of PvP to make sure this year’s preparation process is less of a mad rush than last year’s, and they shared great practice pointers for the second year of disclosure. For example, they suggested that companies shouldn’t feel obligated to maintain the same format for the relationship disclosure or stick with last year’s CSM if they now think another metric would be more appropriate (even if the compensation program is largely similar). If you missed our conferences, remember that you can still purchase access to the archives (including on-demand video plus easy-to-reference transcripts), and we are now offering the ability to earn CLE credit for watching on-demand sessions as well.
If you follow any of our other blogs, you may have noticed that we’ve been changing over from our traditional practice of having our blogs come from the email address of one of our editors. Beginning tomorrow, our “daily updates” email for The Advisors’ Blog will no longer be coming from Liz’s account but will instead come from Editorial@compensationstandards.com. Please follow these allowlist instructions to ensure that you keep getting our emails. If you are not currently receiving this blog, or any of our other blogs, by email, you can easily select any or all you want to subscribe to at the bottom of that page!
The Center for Audit Quality (CAQ) SEC Regulations Committee recently released the highlights from its meeting with SEC Staff on March 21, 2023. At the meeting, the SEC Staff clarified that instruction 1 to paragraph (v) of Item 402 of Regulation S-K — which provides the transitional relief that allows companies to initially disclose three years of pay versus performance information instead of five — applies when companies lose EGC status. Here’s an excerpt:
The Committee and the staff discussed the following question regarding implementation of the recently adopted Pay versus Performance rules:
If a calendar-year Emerging Growth Company (EGC) that completed its IPO in March 2020 lost its EGC status on December 31, 2023, how many years of Pay versus Performance disclosure would the registrant be required to provide in its annual meeting proxy statement to be filed in early 2024?
The staff confirmed that consistent with the transition provisions in S-K 402(v)(8) and Instruction 1 to S-K 402(v), the registrant referred to above would be required to provide three years of Pay versus Performance disclosure (two years for a Smaller Reporting Company (SRC)) in its early 2024 proxy statement.
Late last month, the Vanguard Investment Stewardship team shared a new update about the asset manager’s approach to ESG metrics in compensation plans. This update follows earlier guidance from May 2022.
Vanguard implies that it’s time for more detail because it’s seeing a growing number of U.K. and European companies implementing ESG metrics. However, the insights & suggestions appear to be relevant to all portfolio companies, including U.S. companies.
Vanguard still doesn’t expect companies to use ESG metrics and recognizes there’s no one-size-fits-all approach to executive pay. But if a company does use ESG metrics, those metrics should be transparent, rigorous & well-planned – it’s not a place to “test-and-learn.”
The update explains that pay-for-performance alignment continues to drive Vanguard funds’ say-on-pay votes. The stewardship team gives these examples that may cause concerns & impact voting decisions:
1. The introduction of ESG metrics that are not clearly aligned to company strategy.
2. The inclusion of ESG metrics that are not linked to a financially material risk or opportunity, even where targets are quantifiable or clearly disclosed.
3. The introduction of ESG metrics without the disclosure of comprehensive definitions.
4. Increased weightings placed on ESG metrics or replacing financial metrics with ESG metrics without a disclosed compelling rationale.
5. Year-over-year optimum achievement of ESG targets. This may raise concerns over the rigor of plan design, including the level of rigor in the established ESG targets. This concern may be exacerbated when ESG metrics are not quantifiable or clearly aligned to a company’s annual reporting.
VIS also suggests these “best practices” (see the full 4-page update for more detail on what each of these mean):
1. Focus on materiality
2. Alignment to appropriate time horizons
3. Robust disclosure
4. Stretch targets
5. Use of underpins or modifiers where appropriate
6. Thoughtful approach to external indexes
Lastly, the update shares a few questions that Investment Stewardship reps may ask about ESG metrics during engagements.
Here are a couple of commonly held beliefs on executive pay:
1. Performance-based pay – linked to total shareholder return or other financial metrics – will help executives focus on delivering profits to investors.
2. Investors need a lot of information to assess whether that’s happening to their liking.
Despite all of our hard work on these two topics, executive pay continues to increase, and in some cases ascend into the into the stratosphere. A lot of people – including CEOs! – think it’s gone too far and have suggested pay caps. With all that head-scratching, maybe we should also consider whether “say-on-pay” and “pay versus performance” – and the complex executive pay programs that they spotlight – are part of the problem.
A recent 31-page report from Boston-based non-profit FCLTGlobal makes the case that commonly used pay metrics tend to incentivize short-term results at the expense of long-term performance. Here’s an excerpt:
The most effective remuneration structures are matched to a company’s objectives, strategy, and management. The simplest solution is direct stock ownership by executives, with long-term holding periods. This arrangement is similar to private equity-backed companies’ structures, where the focus is on executive wealth creation over time. This report offers practical tools to aid corporate boards in designing executive remuneration, calibrating long-term equity awards, and effectively communicating remuneration policies to shareholders. These actions include the following:
• Replacing approaches that are counterproductive in the long term, and focusing on rapidly building executive share ownership through restricted stock and share retention policies
• Applying alternative indicators to gauge compensation structure and incentives
• Streamlining corporate disclosure of pay practices, emphasizing the decision-making narrative Investors require simplified approaches to say-on-pay voting that are aligned with long-term remuneration design.
We propose a framework that focuses on five key elements: holding period, quality, targets, instruments, and progress, each of which is broken down into key elements that investors can use to update their proxy voting policies. This is a critical step to take: by clearly stating in writing what criteria are likely to lead to a no or yes vote, investors can lean into a set of principles that drive proxy voting and contribute to positive change at portfolio companies.
The report also says AI could play a role in next-gen executive pay:
We expect that over time, digital technologies like artificial intelligence will revolutionize the process of gathering remuneration data for proxy voting. Tools like pay duration and wealth sensitivity, which we present in this report, have complex data needs. But they need not be so complicated, given currently available technologies. The proxy agencies, who hold significant sway in proxy voting outcomes, could embrace these technologies to help broaden the tools available to companies and investors alike.
FCLT – which stands for “focus capital on the long-term” – also delves into company & investor frustrations with say-on-pay, the shortcomings of TSR as a pay metric, and actions for boards of directors. At the back, there’s a chart with “do’s & don’ts” for improving long-term alignment.
The notion of doing away with performance programs isn’t a new one, especially in Europe. I most recently blogged about it in August, when Norges Bank continued its push for simplified pay structures. This year, Norges voted against say-on-pay at companies that were “most materially misaligned” with the firm’s preferred approach – which worked out to 1 in 10! That said, US investors have been reaping returns right along with executives these past few years. So, there’s probably not consensus on whether US executive pay is “broken” enough to fix.
FW Cook has released its Annual “Top 250 Report” – which examines the long-term incentive practices & trends of the 250 largest companies in the S&P 500. This year’s report gives special focus to design trends that have emerged since the COVID-19 pandemic (i.e., pre-2020 to current). Here are the key findings:
Prevalence of total shareholder return (“TSR”) metrics has increased 7 percentage points since 2019, with most companies combining market-based metrics with at least one other financial performance metric…
• Increased use of TSR metrics is driven by pressure to better align long-term incentive payouts with shareholder outcomes, despite program participants’ limited control over external factors that influence stock price movement.
• Most companies use TSR with at least one other performance metric (85% prevalence), and the prevalence of using it as a modifier of payouts based on other metrics has grown by 50% since the start of the pandemic (38% prevalence now, up from 25% in 2019)
Non-TSR financial goal ranges have widened to account for goal-setting difficulties, while relative TSR award designs have become more rigorous…
• Wider ranges between threshold and maximum goals for non-TSR financial metrics make it more likely to earn at least some portion of the award while making an above-target earnout more challenging.
• For relative TSR, more companies are setting above-median target goals (30% prevalence now, up from 24% in 2019) and implementing caps on payouts if absolute TSR is negative (34% prevalence now, up from 26% in 2019).
Performance measurement using multiple, discrete annual goals has increased in prevalence…
• 12% of companies measure long-term incentives in annual increments, double the rate in 2019, which is most common in the Communication Services (29% prevalence), Information Technology (24%), and Health Care (19%) sectors.
• However, proxy advisors and investors often express concern that annual goals do not incentivize long-term performance and continue to prefer multi-year end-to-end measurement periods, which remain much more prevalent.
• Setting annual performance goals year-by-year (vs. all-at-once at grant) further deleverages performance risk and has increased by 30% in prevalence (46% prevalence now, up from 36% in 2019), despite being subject to more external scrutiny than upfront goal-setting.
Frontline involved a dispute over the effect of a non-competition agreement contained in Equity Incentive Grant Agreements entered into between a parent entity, fund entities of the parent’s private equity owners, and employees of an operating subsidiary of that parent entity. Through the Equity Incentive Grant Agreements the employees received equity units in the parent, and in exchange agreed to certain non-competition covenants. But the operating subsidiary employer was not a party to the Equity Incentive Grant Agreements and the non-competition provision only prohibited the operating subsidiary’s employees from going to work for a competitor of the parent. […] The employees terminated their employment with the operating subsidiary and went to work for what was alleged to be a direct competitor of the operating subsidiary.
Vice Chancellor Will found that the “parent’s business was owning the operating subsidiary, not engaging in the business in which the operating subsidiary engaged.” And, concerning the plaintiff’s argument of mutual mistake:
Vice Chancellor Will acknowledged that what was intended by the non-competition agreement “was to prevent the employees from working for a competitor of its operating subsidiary.” But what was intended and what was said were in this case two different things. According to the court, no showing was made here that the parties had reached “a specific prior understanding that differed materially from the written [equity grant] agreements” that were signed by the parties. And simply failing to properly draft the restrictive covenant in a manner the plaintiff may have intended, to thereby support the equity grant that was given to the employee, was not, according to the court, a mutual mistake.