The Advisors' Blog

The messy story of McDonald’s Corporation’s decision to terminate its former CEO Stephen Easterbrook added another chapter yesterday, when the SEC announced that it had initiated settled enforcement proceedings against the former CEO and the company arising out of his departure.  This excerpt from the SEC’s press release explains its allegations:

According to the SEC’s order, McDonald’s terminated Easterbrook for exercising poor judgment and engaging in an inappropriate personal relationship with a McDonald’s employee in violation of company policy. However, McDonald’s and Easterbrook entered into a separation agreement that concluded his termination was without cause, which allowed him to retain substantial equity compensation that otherwise would have been forfeited. In making this conclusion, McDonald’s exercised discretion that was not disclosed to investors.

Subsequently, in July 2020, McDonald’s discovered through an internal investigation that Easterbrook had engaged in other undisclosed, improper relationships with additional McDonald’s employees. According to the SEC’s order, Easterbrook knew or was reckless in not knowing that his failure to disclose these additional violations of company policy prior to his termination would influence McDonald’s disclosures to investors related to his departure and compensation.

Without admitting or denying the SEC’s allegations, Easterbrook consented to a cease & desist order prohibiting future violations of the antifraud provisions of the federal securities laws, and imposing a $400,000 fine and a five-year officer and director bar.  The company consented to a cease & desist order prohibiting future violations of Section 14(a) of the 1934 Act and Rule 14a-3 thereunder.

As Liz blogged last year, the company sued the former CEO and reached a settlement under which it “clawed back” over $100 million in equity awards and cash based on the company’s claims that the board wouldn’t have approved a separation agreement characterizing his termination as “without cause” if it had been aware of his dishonesty and additional misconduct.  The company’s efforts to claw back that compensation, together with its other efforts to cooperate with the SEC’s investigation, resulted in the agency’s decision not to impose a financial penalty on the company.

Commissioners Peirce and Uyeda dissented from the SEC’s decision with respect to the company. In their dissenting statement, they expressed their view that the SEC was rewriting the disclosure requirements of Item 402 of Reg S-K through an enforcement proceeding. Here’s an excerpt:

We are unaware of prior Commission or staff actions or positions applying Item 402 in the way that the Order does.  Additionally, the Order can be read to suggest that the underlying reasons for why the company decided to terminate a named executive officer “without cause” instead of “with cause,” and vice versa, need to be disclosed under Item 402.  Such “hiring and firing discussion and analysis,” however, is beyond the rule’s scope.

The statement went on to note that industry practice for complying with Item 402 has developed over many years, and that an enforcement action is not “a reasonable regulatory approach” for announcing a novel interpretation.

It seems to me that the dissenters make a good point – executive termination disclosures tend to be terse, often for sound business and legal reasons. Imposing a requirement that companies must disclose the reasons why they opted to treat a particular termination as being “without cause” adds another layer of complexity to an already challenging process, without in most cases providing a significant benefit to investors.

– John Jenkins

On December 16th, ISS issued a new set of Equity Plan FAQs and a new set of Compensation Policies FAQs.  This Edward Hauder Blog summarizes the changes.  Here are a couple of excerpts from the blog that provide an overview of the changes:

Equity Compensation Plan FAQs.  ISS announced several changes, including how it will determine the common shares outstanding (CSO) when there are economic proposals such as mergers or acquisitions that are on the agenda, how burn rate will be considered (including the new Value Adjusted Burn Rate methodology), implications of a change in index membership or GICS classification within the last three years, and changes with respect to the Equity Plan Scorecard (EPSC) model.

Compensation Policies FAQs.  ISS indicates that there will be no changes to any of the quantitative pay-for-performance (P4P) screens for 2023 used to inform its Say-on-Pay (SOP) vote recommendations. However, ISS did change how it will use its Financial Performance Assessment (FPA) measure in 2023 by expanding the number of situations that it can be used to change the ultimate P4P concern level. Starting February 1, 2023, ISS can use FPA result to not only move a low bordering medium concern company to a medium concern or a medium concern company to a low concern, ISS will be able to move concern down to medium for certain high concern companies and up to high concern for certain medium concern companies.

The blog points out an additional point worth noting concerning how ISS will use the FPA result – since FPA is a proprietary ISS and it has not fully disclosed how it calculates these amounts, companies will have a very difficult time determining their FPA score and how it will impact ISS’s assessment of their P4P concern level.  In turn, that’s going to make it harder for these companies to assess what recommendation ISS will make on their say-on-pay proposal.

– John Jenkins

Liz’s change in status has prompted us to rethink how we email our blogs to you each morning. At the end of the month, we’re going to change over from our current practice of having our blogs come from the email address of one of our editors. Going forward, all of our blogs will be sent from Editorial@TheCorporateCounsel.net. Our objective is to establish a sender address that won’t need to be changed every time there’s a change on the editorial masthead, which hopefully means that this will be the last time we have to ask you to take the time to whitelist our email addresses.

We know that whitelisting is kind of a pain in the neck, so we’ve put together this whitelisting instruction page to help you and your IT department understand what actions you may need to take in order to ensure there’s no disruption in delivery. We’re going to begin to send blogs from the Editorial@TheCorporateCounsel.net address over the course of the next several weeks, so please be sure to whitelist the new address at your earliest convenience.  We’re going to do this incrementally across our sites, and we’ll keep you apprised of when we plan to make the change for a specific site.

There are a couple of things that I also want to mention about this change. First, the name of the author of a blog will always appear in the email, so if you want to respond to the author, you can just click on the author’s name and their email address will pop up. Second, Editorial@TheCorporateCounsel.net isn’t a black hole. If you hit reply, your message will go to a folder that I’ll have access to. I’ll check that every few days and forward your email to the appropriate editor. Finally, thanks for your patience and cooperation.

– John Jenkins

Here’s a guest blog from J.T. Ho and Bobby Bee of Orrick, which passes along some helpful informal Staff guidance on the level of detail required in PvP footnote disclosure of “compensation actually paid”:

“A common question we have received from issuers as they prepare their new pay versus performance disclosures relates to just how much footnote detail is required to explain the calculation of “compensation actually paid.” Item 402(v)(3) of Regulation S-K requires (emphasis added):

“(3) For each amount disclosed in columns (c) [Compensation actually paid to PEO] and (e) [Average compensation actually paid to non-PEO named executive officers] of the table required by paragraph (v)(1) of this section, disclose in footnotes to the table each of the amounts deducted and added pursuant to paragraph (v)(2)(iii) of this section, the name of each named executive officer included as a PEO or in the calculation of the average remaining named executive officer compensation, and the fiscal years in which such persons are included. For disclosure of the executive compensation actually paid to named executive officers other than the PEO, provide the amounts required under this paragraph as averages.”

The question is whether the footnotes, as they relate to the pension value adjustments and equity award adjustments required by Item 402(v)(2)(iii)(B)(1) and Item 402(v)(2)(iii)(C)(1), could be limited to disclosing solely the aggregate amount calculated for pension value adjustments and equity award adjustments, respectively. This would be in lieu of having the footnotes disclose each of the amounts deducted and added, pursuant to sub-Items 402(v)(2)(iii)(B)(1)(i) – (ii) and sub-Items 402(v)(2)(iii)(C)(1)(i)-(vi), to arrive at such aggregate amounts, as presented in the “Model Pay Versus Performance Disclosure” from the Compensation Standards.com Special Session: “Tackling Your Pay Vs. Performance Disclosures.”

See an excerpt of the sample footnotes below, with the crux of the question whether issuers could disclose just the final adjustment columns, for each year, in their footnote disclosures:

Pension Value Adjustment Sample Footnote:

(x)….The amounts deducted or added in calculating the pension benefit adjustments are as follows:

Equity Award Adjustment Sample Footnote:

(y)…The amounts deducted or added in calculating the equity award adjustments are as follows:

We spoke with a representative from the SEC’s Office of Small Business Policy in the Division of Corporation Finance, who confirmed the SEC expects each of the amounts identified in the tables above to be included as part of the footnotes.

Issuers and service providers alike should take note of this expectation in connection with preparing and reviewing the pay versus performance disclosures.”

I apologize for the funky formatting of the tables. I wasn’t trying to pay tribute to Wonder Woman’s invisible jet – there are supposed to be row and column lines in the tables. In fact, they’re on my draft. Your guess is as good as mine as to why those lines don’t show up in published version of the tables, although I can’t rule out my own lamentable lack of skill as a cause.  For the record, the Word document that J.T. and Bobby sent was perfectly formatted.  Also, this kind of thing never happened when Liz was in charge. . .

– John Jenkins

FW Cook recently issued its annual Director Compensation Report, which reviewed director comp at 300 companies in order assess market practices in pay levels and the structure of compensation programs. This excerpt provides an overview of some of its key findings:

At the median, 2022 total compensation increased modestly among mid-cap and large-cap companies compared to small-cap companies, where compensation increased slightly more: the small-cap median increased 4.9% from $185,833 to $195,000, the mid-cap median increased by +1.1% from $236,000 to $238,500, and the large-cap median increased +2.0% from $294,167 to $300,000.

Director compensation structure remains consistent with prior years, with an average mix of 60% equity and 40% cash compensation, across the entire sample. Small-cap companies tend to have the highest cash weighting (average of 44%) while large-cap companies tend to have the lowest (average of 36%).

Most companies have continued to simplify cash payments by replacing meetings fees with larger board annual cash retainers (only 8% of the total sample pay meeting fees). Most companies continue to use fixed-value equity award guidelines, with full-value stock awards remaining the most common form of equity compensation and providing the most consistent means to align director pay with shareholder interests. Equity grants most commonly vest immediately, or cliff-vest after one year.

– John Jenkins

The SEC’s adoption of the Dodd-Frank clawback rules triggered a process that will ultimately result in the adoption of new clawback listing standards by the NYSE & Nasdaq. That process may take up to a year, but this Bryan Cave blog provides some key dates that companies should keep in mind as they work to implement clawback policies that comply with the listing standards ultimately adopted by the exchanges:

The new Clawback Rules apply broadly to most companies with securities listed on a national securities exchange, including smaller reporting companies, emerging growth companies, foreign private issuers, controlled companies and debt‑only issuers. Issuers should consider the below dates when considering modification of existing clawback policies to conform to the rules, or in adopting initial clawback policies.

– January 27, 2023 (i.e., 60 days following Federal Register publication): Effective date of SEC’s Clawback Rules.

– February 24, 2023 (i.e., the last business day before the 90th day post-Federal Register publication): Deadline for NYSE, Nasdaq and other national securities exchanges (the “Exchanges”) to file with the SEC proposed listing standards that will require their listed companies to develop and implement compensation recovery policies that comply with the Clawback Rules.

– November 28, 2023 (i.e., one year following the Federal Register publication): Latest date by which the listing standards of an Exchange must become effective. Any incentive-based compensation that is granted, earned, or vested wholly or in part on or after such effective date must be subject to a compliant clawback policy. Moreover, the disclosure requirements under the Clawback Rules must appear in all of a company’s proxy statements, information statements, and annual reports filed on or after the effective date.

– January 27, 2024 (i.e., 60 days following the latest date on which the Exchanges’ listing standards may become effective): Latest possible date for a listed company to adopt a compliant clawback policy if the listing standards of the applicable Exchange were to become effective on the latest possible date (i.e., November 28, 2023); note that the deadline could be significantly earlier depending on exactly when the applicable listing standards become effective.

The blog recommends that companies without clawback policies begin preparing policies that conform the requirements laid out in the SEC’s rules and that those with clawback policies review them with a view to identifying necessary changes. In addition, employment agreements and compensation arrangements should be evaluated in order to determine whether adjustments are necessary, and the impact of clawback rules on the structure of existing compensation programs should be assessed.

– John Jenkins   

I’ve blogged a few times about pay transparency laws, which are continuing to proliferate (see this Seyfarth memo about new requirements that go into effect in Washington beginning January 1st). This Aon memo gives an overview of the latest regulations – and recommends steps to prepare based on your company’s current bandwidth & resources. Here’s an excerpt:

First, think about the salary ranges themselves. Are ranges well established and ready to be shared both internally and externally? Some businesses already have established and well-maintained salary structures. In fact, 90 percent of companies surveyed by Aon said they at least have salary ranges in place.

– The quick fix: Spot check the market competitiveness for certain roles relative to your peer group.

– The better approach: Start with an updated job architecture to make sure you have jobs and people in the right roles in the first place, since that serves as the foundation of pay equity. You could also conduct an accelerated salary structure design initiative, which many total rewards teams are dropping everything to complete.

Next, consider existing employees’ positions in their salary ranges. Are they currently paid in a way your organization would be able to defend? When they ask to see the range of pay for their job, will it be easy to provide and explain where they are in the range — and why? Employee questions can quickly expose any real or perceived inequities.

– The quick fix: Take your prior pay equity analysis and come up with a list of employees who make significantly less than comparable peers. Once you identify those individuals, notify the manager and develop a plan for corrective actions.

– The better approach: Revisit your Pay Equity analysis with a focus on what it is you are paying for. Is it true that only fully proficient employees are paid above the midpoint? What else drives pay? Is it tenure or experience or education or reporting to the right manager?

Then, consider manager preparedness. How ready are managers to handle these tough questions from employees? Do all managers have a solid understanding of how the pay program works? Communication will be key.

– The quick fix: Provide managers with answers and talking points for tough questions and share your plan for tackling any pay equity issues.

– The better approach: Offer simulations and role play tough conversations to make sure your managers are answering difficult questions effectively. Ensure all people leaders are well educated on the process for setting and moving pay.

Finally, address the bigger philosophical question around transparency. Once companies comply with the laws in each jurisdiction, should they just treat everyone the same whether their state requires it or not? Or should organizations do the bare minimum as required?

– The quick fix: Ensure compliance with local pay transparency laws where necessary and develop plans in anticipation of further legislation.

– The better approach: Be a leader in the movement. Regardless of current requirements, take proactive measures: perform a pay equity analysis, identify existing gaps, revisit your job architecture and salary levels to improve your rewards programs, and implement continuing manager training. Even if your organization is not subject to specific pay transparency laws, lay the foundation for future disclosure and consider whether proactive disclosure makes sense for your business. For example, are your competitors disclosing salary ranges? Do leaders think it will be beneficial for talent acquisition efforts to have this level of pay transparency?

Visit the resources in our “Gender & Racial Pay Equity” Practice Area for more guidance on navigating pay audits, shareholder proposals, and disclosures.

Programming Note: This blog will be off tomorrow and next week for holiday celebrations. See you in 2023!

– Liz Dunshee

When the SEC adopted the new Dodd-Frank clawback rules back in October, I blogged about the two new checkboxes that the rules add to the Form 10-K cover page, and said:

Hopefully someone smarter than me will clarify, but it does not seem immediately clear from the release whether these checkboxes will be required for Form 10-Ks that are filed in 2023, after the SEC rule is effective but before companies have to make any other disclosure about policies.

Our members have continued to ask about this in our Q&A Forums over the past couple of months. It doesn’t make a lot of sense to require these checkboxes before the listing standards become effective and before the new clawback disclosures are required. To my knowledge, though, the Staff hasn’t come out with guidance to confirm that.

In the meantime, companies are trying to figure out how to handle the cover page in light of the rules being effective on January 27th. Please participate in this anonymous poll to share what you plan to do (and please email me if you’ve heard anything from the Staff!):

– Liz Dunshee

BlackRock Investment Stewardship is out with its its 2023 voting guidelines & Global Principles, which include sections on executive compensation. Here are a few things to note (also see this commentary from February):

– Goals, and the processes used to set these goals, should be clearly articulated and appropriately rigorous.

– BIS does not have a position on the use of sustainability-related criteria, but in our view, where companies choose to include them, they should be as rigorous as other financial or operational targets.

– Where compensation structures provide for a front-loaded award, we look for appropriate structures (including vesting and/or holding periods) that motivate sustained performance for shareholders over a number of years.

– When evaluating performance, we examine both executive teams’ efforts, as well as outcomes realized by shareholders. Payouts to executives should reflect both the executive’s contributions to the company’s ongoing success, as well as exogenous factors that impacted shareholder value.

– When evaluating special awards, we consider a variety of factors, including the magnitude and structure of the award, the scope of award recipients, the alignment of the grant with shareholder value, and the company’s historical use of such awards, in addition to other company-specific circumstances.

– Where executive compensation appears excessive relative to the performance of the company and/or compensation paid by peers, or where an equity compensation plan is not aligned with shareholders’ interests, we may vote against members of the compensation committee.

– In cases where there is a “Say on Pay” vote, BIS will respond to the proposal as informed by our evaluation of compensation practices at that particular company and in a manner that appropriately addresses the specific question posed to shareholders. Where we conclude that a company has failed to align pay with performance, we will vote against the management compensation proposal and relevant compensation committee members.

– BIS will generally support annual advisory votes on executive compensation.

– Liz Dunshee

One point that was made consistently at our fall conference and at our November “special session” on the pay vs. performance rules was that it will be much easier to use a line-of-business index for the TSR comparative disclosure, versus a “benchmarking” peer group. This blog from Infinite Equity shows just how cumbersome the disclosure can get when you have to manually re-balance the market weights and disclose year-over-year changes to a custom index.

This excerpt shares some pros & cons – check out the full blog for illustrative tables & calculations:

Given the additional calculations and complexities involved when creating a peer index some companies may be best served to select an in-line industry index based on the reasons laid out below:

– Rebalancing and weighting of peers is internally adjusted by the publishers of the index, i.e. no manual rebalancing

– If the peer group changes year over year the company does not need to track TSR performance against both the old and current index

In contrast selecting the CD&A peer group as the comparator group provides increased visibility and alignment with how executive compensation is determined, despite the additional rigor involved. However, ultimately it is up to the company to decide the approach that is best for them.

– Liz Dunshee