The SEC’s Enforcement Division is committed to seeking clawbacks under Section 304 of the Sarbanes-Oxley Act – and they want you to know. Late last week, the Commission announced charges against a company and a former Senior VP of its largest division, related to misstated financials and fraud that the former employee allegedly carried out. The company’s CEO and CFOs faced Section 304 consequences:
In separate administrative proceedings, the company’s former CEO, James H. Roberts, and former CFOs, Laurel Krzeminski and Jigisha Desai, while not charged with misconduct, agreed to return more than $1.4 million, $327,000, and $176,000, respectively, in bonuses and compensation to Granite. These clawbacks were made pursuant to Section 304 of the Sarbanes-Oxley Act (SOX), which requires executives to reimburse certain compensation when an issuer is required to restate its financials as a result of misconduct.
The settlements with Roberts, Krzeminski and Desai follow another clawback settlement only 2.5 months ago. Both of these settlements relied on the SEC’s broad interpretation of Section 304 – which is that the statute supports clawing back incentives from CEOs and CFOs when there is any misconduct at the company, even if the executives were not personally involved. The SEC began applying this interpretation during the 2008 financial crisis, at which point clawback enforcement actions ticked up, and the Ninth Circuit affirmed this approach in 2016.
This action also arrives as we continue to anticipate final Dodd-Frank clawback rules. This Freshfields blog from late last year explains how that provision would differ from the existing Sarbanes-Oxley version. SEC Chair Gary Gensler has signaled that he wants to adopt those rules at about the same time as final “pay versus performance” rules – and that happened last week.
In commenting on the latest enforcement win, Gurbir Grewal, Director of the SEC’s Enforcement Division, reiterated the same warning from the June settlement – that this action should put executives “on notice”:
“We are committed to using SOX 304 as Congress intended: to incentivize a culture of compliance at public companies by ensuring that senior executives are not rewarded when their firms violate core reporting requirements. Executives should be on notice that we view SOX 304 as broad authority in seeking all forms of compensation that should be reimbursed to the company.”
Here is the complaint against the company, which it agreed to settle for $12 million after self-reporting the issue and remediating its controls, policies & procedures – and here’s the complaint against the former employee.
We’ll be sharing critical guidance on how to prepare for the new clawback rules and navigate the current enforcement environment at our “Proxy Disclosure & 19th Annual Executive Compensation Conference” this October. In particular, our session on “Clawbacks: Preparing for Final SEC Rules” – with Davis Polk’s Kyoko Takahashi Lin, CompensationStandards.com’s Mike Melbinger, Gibson Dunn’s Ron Mueller, and Hogan Lovells’ Martha Steinman – will give you practical action steps to take now. Here’s the full agenda for the Conferences – 18 essential sessions over 3 days. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
Yesterday, by a 3-2 vote, the SEC announced the adoption of final rules on “Pay Versus Performance” disclosure, which are required under the Dodd-Frank Act and had been a long time in the making. Here’s the 234-page adopting release – which I’ll be studying today in order to make sure we cover the most critical takeaways & action items during our upcoming “Proxy Disclosure & 19th Annual Executive Compensation Conferences.”
Even though the Pay vs. Performance rules were flagged as a near-term item on the Reg Flex Agenda, the announcement came as a surprise because there was no open meeting and the last few weeks of August are typically quiet at the SEC. In his statement, Commissioner Uyeda also criticized the SEC’s process in adopting this rule via a “reopening release” rather than a full-fledged re-proposal with new data & analysis.
However, there’s not really time for companies to focus on that – because the new Item 402(v) disclosure will be required in 2023 proxy statements! Dave blogged on TheCorporateCounsel.net this morning about the details around the compliance date and phase-in disclosure. Here are more details from the fact sheet (also see Dave’s overview on TheCorporateCounsel.net):
The rules will apply to all reporting companies, except foreign private issuers, registered investment companies, and Emerging Growth Companies. Smaller Reporting Companies (“SRCs”) will be permitted to provide scaled disclosures.
New Item 402(v) of Regulation S-K will require registrants to provide a table disclosing specified executive compensation and financial performance measures for the registrant’s five most recently completed fiscal years.
Registrants will be required to include in the table, for the principal executive officer (“PEO”) and, as an average, for the other named executive officers (“NEOs”), the Summary Compensation Table measure of total compensation and a measure reflecting “executive compensation actually paid,” calculated as prescribed by the rule.
The financial performance measures to be included in the table are:
– Total shareholder return for the company;
– TSR for the company’s peer group;
– The company’s net income; and
– A financial performance measure chosen by the company and specific to the company that, in the company’s assessment, represents the most important financial performance measure the company uses to link compensation actually paid to the company’s NEOs to company performance for the most recently completed fiscal year.
New Item 402(v) also will require a registrant to provide a clear description of the relationships between each of the financial performance measures included in the table and the executive compensation actually paid to its PEO and, on average, to its other NEOs over the registrant’s five most recently completed fiscal years. The registrant will be required to also include a description of the relationship between the registrant’s TSR and its peer group TSR.
A registrant will also be required to provide a list of three to seven financial performance measures that the registrant determines are its most important measures (using the same approach as taken for the Company-Selected Measure). Registrants are permitted, but not required, to include non-financial measures in the list if they considered such measures to be among their three to seven “most important” measures.
Registrants will be required to use Inline XBRL to tag their pay versus performance disclosure.
In addition to Commissioner Uyeda’s procedural complaints, Commissioner Peirce issued a statement accusing the rules of being too prescriptive and going beyond what the Dodd-Frank Act required, without a cost-benefit analysis.
Meanwhile, Chair Gensler’s statement applauds the “consistent, comparable and decision-useful information” that the rule will provide and says the final version is actually more flexible than what was originally proposed. The flexibility he’s most likely referring to is the fact that the final rule allows companies to include non-financial performance measures in their list of the 3-7 “most important” measures and also disclose those measures in a table as they see fit, as called out in Commissioner Crenshaw’s supporting statement. By contrast, financial measures are required to be disclosed if companies are linking pay and performance to them. Commissioner Lizárraga also supported the final rules.
Honestly, I’m still processing the tight implementation schedule here. I had to read this cruel “fake out” part of the release about 6 times:
In order to give companies adequate time to implement these disclosures, we are requiring registrants to begin complying with Item 402(v) of Regulation S-K in proxy and information statements that are required to include Item 402 disclosure for fiscal years ending on or after December 16, 2022.
In light of this timeframe, I urge anyone who hasn’t registered for our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” to claim their spot now! This virtual event is only 6 weeks away – and we’ll be discussing key steps you need to take to comply with these new rules in a dedicated panel with Bindu Culas of FW Cook, Howard Dicker of Weil Gotshal, Renata Ferrari of Ropes & Gray and Maj Vaseghi of Latham. We’ll also be addressing Pay vs. Performance during “The Top Compensation Consultants Speak” and “SEC All-Stars: Executive Pay Nuggets” panels.
Here are the full agendas for the Conferences – 18 critical sessions over the course of 3 days. To claim your spot, you can sign up online, email sales@ccrcorp.com, or call 1-800-737-1271. Let us equip you with the practical action items you need to face this avalanche of SEC rulemaking!
Sullivan & Cromwell has just published an analysis of say-on-pay and equity plan voting for annual meetings held through June 30th (the date by which ~90% of US public companies hold their annual meeting). Here are the key takeaways from the 15-page memo – which also includes a summary of the ISS analysis framework & predictions for 2023:
Say-on-Pay Voting:
• Although public companies continue to perform strongly, with overall support levels averaging 88% among the S&P 500 and 90% among the Russell 3000, more companies fail compared to prior years
• Continued turnover in failed votes, with 57% of companies that failed last year achieving over 70% support this year
• Four S&P 500 companies fail in both 2021 and 2022, all of which are criticized by ISS for limited or inadequate responsiveness to shareholders’ concerns
• ISS negative recommendations highlight continued importance of pay-for-performance assessment, with the most important factor remaining alignment of CEO pay with relative total shareholder return
• The most significant qualitative factors in negative recommendations are limited, opaque, or undisclosed performance goals and the use of above-target payouts
Equity Compensation Plan Voting:
• Broad shareholder support for equity compensation plans, with only two Russell 3000 companies failing to obtain shareholder approval for an equity compensation plan, and overall support levels at Russell 3000 and S&P 500 companies averaging around 91%
Back in 2019, director compensation was in the spotlight due to litigation over pay to Goldman Sachs’ board members. That case ultimately settled – and one of the terms of the settlement was that future claims would be released if shareholders approved the director compensation program in the future.
On Twitter last week, Ann Lipton pointed out that the settlement has now been overturned – as improper for immunizing future compensation arrangements, versus the arrangement that had been challenged.
The part that’s important for anyone structuring compensation arrangements and advising boards is that in its opinion, the Delaware Supreme Court made sure to point out that the Investors Bancorp ratification defense invokes a deferential “business judgment rule” standard of review – but it doesn’t bar claims entirely. Submitting a compensation plan for shareholder ratification gets you a very long way, but you may still have to go to court and make an argument.
You can still register for our always-popular conferences – the “Proxy Disclosure & 19th Annual Executive Compensation Conferences” – to be held virtually Wednesday, October 12th – Friday, October 14th. With new SEC rules, record numbers of shareholder proposals, and relentless regulatory & investor scrutiny, your proxy disclosures – and the actions that support them – are more important than ever. Our Conferences provide practical guidance about rule changes, Staff interpretations, emerging disclosure risks, investor and proxy advisor positions, executive pay expectations, the board’s role, and more.
Here’s who should attend:
– Anyone responsible for preparing and reviewing proxy disclosures – including ESG and executive pay disclosures and responses to shareholder proposals.
– Anyone responsible for implementing executive and equity compensation plans or who counsels or advises boards on their oversight responsibilities, including CEOs, CFOs, independent directors, corporate secretaries, legal counsel, HR executives and staff, external reporting teams, accountants, consultants, and other advisors.
For more details, check out the agenda – 18 panels over 3 days. Our speakers are fantastic and this is truly a “can’t miss” event for anyone involved with proxy disclosures, corporate governance, and executive compensation.
Conference attendees will not only get access to our unique & valuable course materials (coming soon) – we’ll also be making video archives and transcripts available after the conference, so that you can refer back to all of the practical nuggets when you’re grappling with your executive pay decisions, disclosures and engagements. Plus, our live, interactive format gives you a chance to earn CLE credit and ask real-time questions.
Register today! In addition, check out the agenda for our “1st Annual Practical ESG Conference” – which is happening virtually on Tuesday, October 11th. This event will help you avoid ESG landmines and anticipate opportunities. You can bundle the Conferences together for a discount.
In its recent “Proxy Season Briefing,” Glass Lewis shares these takeaways from meetings through June 30th (see my Proxy Season Blog on TheCorporateCounsel.net for highlighted takeaways on their director recommendations):
– Say-on-Pay: Glass Lewis recommended in favor of 84.3% of resolutions. Common concerns that led to “against” recommendations included excessive grants/compensation (41.6%), poor program or award design structure (34.9%), pay & performance disconnect (34.7%), other concerning pay practices (16.7%) and insufficient response to shareholders (15.8%). The report notes that many companies within the wave of new listings gave their executives outsized awards, which contributed to proxy advisor objections. There was also an uptick in retention one-time awards.
– Equity Plans: Glass Lewis recommended in favor of 85.7% of equity plan resolutions. Common concerns that led to “against” recommendations included evergreen provisions (44.7%), repricing provisions (27.3%), pace of grants/excessive grants (12.4%), cost of plan (13.0%) and excessively dilutive/high overhang (6.8%).
The report also notes that average compensation for CEOs of S&P 500 companies has continued to tick upwards year-over-year.
Join us virtually October 12-14th for our upcoming “Proxy Disclosure & 19th Annual Executive Compensation Conferences,” where we’ll be covering how to position disclosures for favorable proxy advisor recommendations, and how to avoid common areas of concern. Here are the full agendas – 18 action-packed sessions over the course of 3 days. To register, you can sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
Under newly effective amendments to Sections 152, 153 and 157 of the Delaware General Corporation Law, companies now have greater flexibility in equity grant procedures. The amendments – as set forth in proposed form in this Skadden markup – clarify the ability of the board to delegate authority for stock issuances (Section 152) and for options and other rights (Section 157) – and harmonize these sections so that they’re finally consistent with each other. Under both sections, the delegating resolution needs to include:
– A maximum number of shares, rights or options that may be issued (including the maximum number of shares that can be issued pursuant to the rights or options);
– A time period during which the shares, rights or options may be issued (including the time period for issuing shares upon exercise of the rights or options); and
– A minimum amount of consideration for which the shares, rights or options may be issued (including the shares issuable upon exercise of the rights or options) – which may be based on a formula or other “facts ascertainable” that are set forth in the resolution – e.g., trading price on a particular date.
The person or group receiving the delegated authority also can’t grant equity to themselves. Check out this Troutman Pepper memo for more details. Even though the newly consistent treatment and flexibility is a welcome change, anyone drafting minutes and documenting equity awards still needs to be careful to observe the technical requirements, since foot-faults can invalidate grants.
Companies are currently grappling with a volatile market, with many companies seeing their stock prices decline substantially over the past few months. At the same time, the SEC continues to push ahead with compensation-related rule proposals – which raises the stakes for compensation committees approaching executive compensation planning in a rocky environment.
For guidance on navigating these issues, join us tomorrow at 2pm Eastern for our webcast – “Executive Compensation & Equity Trends in a Volatile Environment.” Hear from Compensia’s Mark Borges, Morrison Foerster’s Dave Lynn, Gibson Dunn’s Ron Mueller and Semler Brossy’s Greg Arnold, as they share insights on:
– Handling Equity Grant & Rule 10b5-1 Plan Practices in Uncertain Environment
– Key Issues & Considerations for Option Repricing
– Hedging & Pledging Issues
– Executive Pay Structuring Considerations in Volatile Market
– Use of Retention Awards and One-Time Grants
– Disclosure and Shareholder Engagement Planning around Compensation Decisions
– Maintaining Equity Plans Under Pressure
– Other Emerging Compensation Trends During Market Volatility
After giving commenters two new bites at the apple – and releasing a DERA memo to analyze costs & benefits – the SEC is aiming to (finally) adopt clawback rules this fall. The end result of the rules will be that listed companies will need to adopt & disclose policies for recovery of incentive compensation that exceeds what would have been paid in the absence of an accounting restatement. It sounds like a simple concept, but it’s very, very complicated. And the topic hasn’t gotten any more straightforward since 2010, when it was first mandated by the Dodd-Frank Act.
I blogged earlier this year about notable comment letters that pointed out these challenges. New research from two accounting professors reinforces that notion (although I’m not sure that’s entirely the point they set out to prove).
The professors started out by measuring the “severity” of voluntarily adopted clawbacks, as disclosed in 821 SEC filings for non-financial companies from fiscal years 2007 to 2010. I was struck by the fact that the data set is a dozen years old, but apparently that’s because they wanted to leave a cushion of time to detect a subsequent restatement announcement. Their measurement is based on 27 attributes across these 8 categories:
1. Span of employees covered (e.g., current and/or former CEOs, CFOs, key executives);
2. Retrospective number of years the clawback applies to (i.e., the look-back period);
3. Trigger events (e.g., financial restatement);
4. Absence of hurdles inhibiting a clawback (e.g., absence of proof of materiality);
5. Compensation subject to recovery (e.g., short-term, long-term);
6. Reach of compensation subject to recovery (e.g., excess compensation, full compensation);
Here’s where things get interesting. The professors not only found a wide variation in the strength of clawback policies, but that the more stringent policies tended to exist at companies where directors were paid in cash & stock awards, rather than stock options. They suggested that directors who receive stock options are more motivated to focus on short-term performance and implement weaker clawbacks.
They also looked at unintended consequences: specifically, R&D spend. They conclude that clawbacks can be a “double-edged sword” because management may decrease R&D spend to overcome an earnings decrease due to financial misreporting. Other unintended consequences that weren’t part of the study could include the delay of bad news or ineffective changes to compensation structures.
Lastly, the analysis suggests that some boards are “giving the illusion of good governance to placate stakeholders, as their window-dressed clawbacks lack teeth.” In other words, all clawbacks are not created equal – and that may not come through in the DERA analysis.
Reading this research paper reminded me of a conversation I had with a benefits lawyer when these rules were first proposed. She told me she didn’t even want to think about all the complications here and that she hoped she would be retired by the time they went into effect (it does not appear her wish will come true). While we do have a “Clawbacks” Practice Area for members and guidance in the “CD&A” chapter of Lynn & Borges’ Executive Compensation Disclosure Treatise about how to disclose policies & related forfeitures, I think a lot of folks have shared that sentiment and have understandably been sticking their heads in the sand on this issue, while we all “wait & see” what happens with the rules.
Now that SEC action appears to be imminent, it’s time to get up to speed. If you want the crash course, register for our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” – we have a session on “Clawbacks: Preparing for Final SEC Rules” with Davis Polk’s Kyoko Takahashi Lin, Gibson Dunn’s Ron Mueller, Hogan Lovells’ Martha Steinman, and our very own Mike Melbinger. Plus, 17 other panels, including an interview with Corp Fin Director Renee Jones. The Conference is being held virtually over 3 days – October 12th – 14th. Sign up online (via the conference drop-down), email sales@ccrcorp.com, or call 1-800-737-1271.
John blogged earlier this week on TheCorporateCounsel.net about whether buybacks are truly evil – or just misunderstood. One of the recurring criticisms of share repurchases is that they unfairly benefit executives in two ways: (1) by inflating stock prices on which awards are based, and (2) by providing executives with shares that they can resell at those inflated prices. John notes a recent study from three finance profs, which found little evidence for this. Here’s more detail:
It is well known that CEO pay increases in firm size and revenues and that bonuses are tied to accounting performance (Healy, 1985; Core et al., 1999; Murphy, 2013). Therefore, it is not surprising that the above-median repurchase firms’ CEOs earn more pay than the smaller, no-repurchase firms. Whether this difference represents excess pay for the above-median repurchase firms can be evaluated using the pay model described above. As reported in Table 4, the estimated excess pay for the CEOs of the above-median repurchase firms is $71,000. This amount is economically small, only about 0.9% of the average CEO’s total pay, and statistically insignificant.
Compared to the no-repurchase firms’ CEOs, the above-median firms’ CEOs earn $51,000 more excess pay on average (= $71,000 – $20,000). However, this difference is not statistically significant and is also economically small in relation to the average CEO’s pay. Overall, the small difference between the above-median firms and no-repurchase firms, the even smaller difference between all firms and no-repurchase firms, as well as the lack of a monotonic relation across the groups, collectively suggest that repurchases are not associated with excessive CEO pay.