Most clients intuitively understand that delisting – or uplisting – will affect equity compensation plans, but forward-thinking advisors will also take a moment to highlight some of the less obvious nuances. This Thompson Hine memo (pg. 3) walks through how these events affect plan metrics, compliance, and the value of awards to employees. Here are the high points:
1. Metrics: If your stock is quoted on an over-the-counter market following delisting, your stock price may no longer accurately reflect the company’s true value. In such circumstances, different performance metrics (such as EBITDA) may be more appropriate for equity programs. Newly listed companies should make sure to look at peer data.
2. Employee Incentives: Delisting may reduce the attractiveness of equity incentives. First, your stock price may not be aligned with the company’s true value. Second, if after delisting the company also deregisters with the SEC (so-called “going dark”), the shares that employees receive upon exercise of their stock options or vesting of restricted stock will no longer be freely tradeable. Resale restrictions generally include a minimum one-year holding period. Third, if the company previously had any institutional investors, they may exit their positions in the company’s stock, and some brokerage firms may be unwilling to hold OTC securities.
3. Blue Sky Compliance: Using equity after going dark requires an exemption from registration under federal and state securities (known as “blue sky”) laws. Securities anti-fraud rules also continue to apply. The company will need an exemption from registration both to grant any future equity awards and to permit employees to exercise any stock options that may be outstanding at the time of going dark. Such an exemption is usually available, but companies should work with legal counsel to evaluate the eligibility criteria and any restrictions. In addition to federal laws, many states require a notice filing and a few states (such as California) impose more complexities.
4. Public Disclosures: Even after going dark, the company may want to provide scaled-down reports. Public information is necessary for sales by affiliates under securities resale laws.
5. Shareholder Numbers: After going dark, monitoring shareholder numbers is also important – if certain thresholds are crossed, the company will be required to reregister and file reports with the SEC.
We’ve posted the transcript for the recent webcast: “Proxy Season Post-Mortem – The Latest Compensation Disclosures.” Mark Borges, Dave Lynn & Ron Mueller shared their latest takes on these topics:
Annual Meeting Experience
Say-on-Pay Results
Pandemic-Related Compensation Adjustments and Disclosures: Are They Behind Us?
ESG Metrics
CEO Pay Ratio
Director Compensation Disclosure
Perquisites Disclosure
Shareholder Proposals
Proxy Advisory Firm Interactions
Recent and Expected SEC Rulemaking
For more info on these topics (and more) as we head into the 2022 proxy season, register now for our “Proxy Disclosure & Executive Compensation Conferences.” This virtual event is happening October 13th – 15th in a live & interactive format – i.e., you’ll be able to ask questions of our all-star panelists. The panels will also be archived for later viewing by attendees, and transcripts will be available. Here’s the agenda – 18 panels over 3 days!
I blogged a couple of years ago that part of the reason Carlos Ghosn said that he restructured and hid his pay was because he was worried that people in Japan, where Nissan is headquartered, would criticize his high levels of compensation. This new book delves into the whole saga – and acknowledges “culture clashes” as a big factor in Ghosn’s unraveling.
The book looks like a very interesting read, but you probably don’t need 400 pages to tell you that international operations are full of complexities. What’s highlighted here is that if you have executives in countries that traditionally frown upon huge pay packages (e.g., France, Japan), you may want to think twice before paying them according to US benchmarks.
Programming Note: The Advisors’ Blog will be off the rest of this week, returning next Monday.
As the dust settles from this year’s annual meeting season, in the weeks ahead we’ll likely start hearing of company plans and potential strategies in response to low say-on-pay vote results. For those who might be starting to think ahead, I’ve resurrected a blog posted last year highlighting actions tech companies took in response to low say-on-pay vote results. As we learn more about this season’s results, we’ll post more, but here’s the repost of last year’s blog entry:
Earlier this year, I blogged about disclosure of investor engagement following a failed or low say-on-pay vote result. With a failed or low say-on-pay vote result, most companies will consider a variety of actions and a recent Compensia memo reviewed low say-on-pay vote results at technology companies to help shed light on actions companies took. Each company will make decisions about changes to compensation design or structure based on its own circumstances, although it’s helpful to know what other companies have done if you find yourself dealing with this issue.
A low say-on-pay vote result is described as a vote that failed to win shareholder support or for ISS, a vote receiving less than 70% support, and for Glass Lewis, less than 80% support. Some of the most common actions companies took (the memo delves further into each category of changes) include:
– Long-term incentive design changes – 92%
– Enhanced CD&A/outreach – 76%
– Performance share design changes – 60%
– Short-term incentive design changes – 44%
Compensia also found what it describes as “more dramatic” actions – 52% of the observed companies made a change to the membership of their Compensation Committee in the two years following an unfavorable result, while 36% of the companies subsequently changed their independent compensation consultant. Although the reasons for such changes usually cannot be directly attributed to the say-on-pay vote, it is possible that, in the course of their review, the Board of Directors determined that a fresh point of view might benefit the oversight of the executive compensation program.
Last, it’s also worth noting that the memo says although the size of a CEO’s pay package is generally a key factor in the analysis of a say-on-pay proposal, Compensia’s research was inconclusive as to whether a failed vote or low support ultimately resulted in a reduction in CEO pay in a subsequent year. The memo suggests when evaluating a failed or low say-on-pay vote result that companies consider the absolute level of CEO pay as a potential issue and whether a reduction is appropriate in light of shareholder concerns.
Back in April, I blogged about DOL cybersecurity guidance directed at ERISA plan sponsors and fiduciaries. At the time, many took note that the DOL guidance could be an indicator that plan sponsors and fiduciaries might find themselves subject to scrutiny over cybersecurity practices in DOL investigations. This Nixon Peabody memo warns, that if you haven’t already done so, plan sponsors and fiduciaries should take action to shore up cybersecurity practices and compliance plans because the DOL has started investigations into cybersecurity practices.
Should an investigation commence and for insight about what the DOL might ask, the memo provides a sample document request from one DOL investigation:
All policies, procedures, or guidelines relating to:
Data governance, classification, and disposal
The implementation of access controls and identity management, including any use of multi-factor authentication
The processes for business continuity, disaster recovery, and incident response
The assessment of security risks
Data privacy
Management of vendors and third party service providers, including notification protocols for cybersecurity events and the use of data for any purpose other than the direct performance of their duties
Cybersecurity awareness training
Encryption to protect all sensitive information transmitted, stored, or in transit
All documents and communications relating to any past cybersecurity incidents
All security risk assessment reports
All security control audit reports, audit files, penetration test reports and supporting documents, and any other third-party cybersecurity analyses
All documents and communications describing security reviews and independent security assessments of the assets or data of the plan stored in a cloud or managed by service providers
All documents describing any secure system development life cycle (SDLC) program, including penetration testing, code review, and architecture analysis
All documents describing security technical controls, including firewalls, antivirus software, and data backup
All documents and communications from service providers relating to their cybersecurity capabilities and procedures
All documents and communications from service providers regarding policies and procedures for collecting, storing, archiving, deleting, anonymizing, warehousing, and sharing data
All documents and communications describing the permitted uses of data by the sponsor of the plan or by any service providers of the plan, including, but not limited to, all uses of data for the direct or indirect purpose of cross-selling or marketing products and services
Please note that you may need to consult not only with the sponsor of the plan, but with the service providers of the plan to obtain all documents responsive to these requests. If you are unable to produce documents responsive to any of the forgoing, please specify the requests and the reasons for the non-production.
A recent Equilar blog takes a look at 2021 say-on-pay vote results so far and like other memos and reports, Equilar projects that 2021 could see the highest failure rate yet. One observation noted in the blog is an apparent trend between the magnitude of CEO pay and the level of support for say-on-pay proposals. Here’s an excerpt:
The overall trend is that of high median CEO compensation paired with low Say on Pay approval – see the blog for a chart showing 2021 median CEO pay vs. say-on-pay approval.
Median CEO pay was around $17 million for companies that fell under 50% approval. This exemplifies that high pay continues to be a matter of concern for shareholders. Though some companies did lower compensation, the data suggests that shareholders may still view it as too high. It is important to note that though shareholders’ reluctance to approve high pay is not a new phenomenon, zooming in on individual companies provides insight into COVID’s role in intensifying this effect.
One failure this year, Starbucks, shows just that. In 2020, Starbucks paid its CEO $14 million, a drop from $19 million in 2019. Starbucks received a 47% vote this year compared to a passing 84% vote last year, despite the lower pay. AT&T witnessed a similar event, failing its vote regardless of an $11 million drop in pay. Walgreens Boots Alliance joined in with CEO pay roughly $1.6 million lower than last year but over a 35 percentage point drop in approval. Though various factors are possibly at play, it’s likely that the pandemic heightened shareholders’ criticism of unnecessarily high compensation. It seems natural that, with economic uncertainty, shareholders are more willing to express disapproval if companies aren’t bearing their share of the burden.
In the past year, S&P 500 companies rapidly changed their executive compensation to incentivize diversity, worker health & safety, and other ESG metrics. In some cases, the metrics were added as one-time modifiers to individual payouts, and in many cases – particularly for D&I – the metrics were added to formulaic plans. This 10-page Semler Brossy memo catalogues many of the changes.
What we don’t know yet is whether these changes to comp plans will effectively motivate actions that support the long-term, sustainable performance that investors want. As I blogged yesterday, pay-for-performance already has some flaws. And just as ESG metrics are becoming mainstream, this WSJ piece from London B-School Prof. Alex Edmans argues that, except in a few unique circumstances, we may be barking up the wrong tree with these new incentives as well. Here’s an excerpt:
These unintended consequences might be even worse for ESG than financial targets. One challenge is that, for financial performance, only a couple of measures might be relevant. But ESG performance is multifaceted. Companies have a responsibility to many stakeholders—employees, customers, suppliers, the environment, communities and taxpayers—and for each stakeholder, many dimensions are relevant. Either the contract includes only a couple of ESG measures and the CEO ignores others, or it includes most of them and the contract becomes so complex that it loses any motivational effect.
A second problem is measurement. For a financial target such as earnings-per-share, there’s consensus on how to measure it. But that isn’t the case for an ESG metric. Should ethnic diversity be captured by the number of minorities on the board, in senior management, or in the workforce—or other factors such as the ethnic pay gap, or the proportion of minorities who get promoted from each level? Even ESG-rating agencies disagree significantly on how to measure ESG performance, so any measure might be perceived as unfair or ignore important dimensions.
The solution, Professor Edmans says, is to pay CEOs like owners – with long-term shares. That’s something that Norges Bank, which manages Norway’s huge sovereign wealth fund, has been saying since 2017 (here’s their policy, which I’ve blogged about a few times). Professor Edmans says that companies can get the benefit of motivation – without the risk of manipulation – simply by setting & reporting on ESG goals. CEOs are a competitive bunch!
It goes without saying that not everyone agrees with Professor Edmans’ take. If we’re locked into the pay-for-performance system – and existing financial goals are at odds with ESG – it makes sense to even the playing field and emphasize the strategic importance of these metrics.
Pay-for-performance tanks productivity, creates a risky compliance culture, causes undesirable conflicts among departments, is only useful for tasks involving physical labor (vs. “problem solving”), and harms customer relationships. Those of us who are involved with compensation should “just say no” to this blunt instrument and instead work on building a culture in which people care about the customer & each other. For example, by treating employees with respect and offering excellent training opportunities.
Those are the conclusions from this recent article from management consultant Roger Martin, whose faith in “pay-for-performance” has crumbled over the last 30 years. I usually blow off articles like this as fluff – but this one goes a bit deeper. It ties intuitive points to real-world events & research (which according to Prof. Martin, is more than can be said for pay-for-performance). Here’s more detail on a couple of the problems he points to:
Fourth, the gaming is without limit. Roy’s machine shop is a poignant example. For every worker, half their day was spent doing nothing productive. Tanking a whole year to reset the budget at an easy level. Stuffing the distribution channel to make the quarter. Chopping advertising spending to jack up this year’s profitability. Diluting the ingredients in the termite spray at the end of the year to make budget — yup, freely admitted to me by field staff at a former client. Opening accounts that customers never approved. Recognize that there is no limit!
Fifth, you can’t fool customers. They figure out that they have a big target on their backs. Your incentive compensation ranks far above their satisfaction. They figure out that are merely a means to your end. But of course, they aren’t powerless. They know that you are trying to make budget to get your bonus and they can wrap you around their finger as year-end approaches. Monetary incentive compensation is toxic for customers. And that is even if it is about customer satisfaction scores. With two of my last three car purchases, the salesperson pleaded with me to give him a perfect satisfaction score to help with his compensation — resulting in me never intending to purchase a car from their companies (Lexus and Range Rover) again — great cars, but terrible customer experience thanks to monetary incentive compensation.
It would require a huge amount of bravery to depart from pay-for-performance – from boards, managers, investors, proxy advisors, and consultants. Maybe even lawyers, as it’s just so different than what we’ve become accustomed to documenting and disclosing. The problem is that people at the top do need to communicate in some way what type of performance they want delivered, and it takes a lot of extra work to figure out what motivates each individual to get there – it may even require the investors/directors/managers to loosen their grip on specific metrics or outcomes. Combine that with frequent executive & employee turnover – and difficulty measuring things like culture – and many are left feeling that a “blunt instrument” is the only efficient option.
The thing is, more than a few investors are starting to show signs of disapproval – and even former execs are questioning it. This may be something where at some point, leaders will admit that the experiment isn’t delivering the results that were hoped for – and that adding ESG metrics isn’t a simple solution, either.
‘Tis the season…for updating off-season peer groups. ISS announced yesterday that their peer group submission window will be open from 9 am ET on Tuesday, July 6th until 8 pm ET on Friday, July 16th – for companies that have annual meetings slated to be held between September 16, 2021 and January 31, 2022. Here’s more detail:
As part of ISS’ peer group construction process, on a semi-annual basis, corporations are requested to submit changes they have made to their self-selected peer groups for their next proxy disclosure. ISS considers companies’ self-selected peer groups as an important input as part of its own peer group construction methodology.
Submissions should reflect peer companies used (or to be used) by the submitting company for pay-setting for the fiscal year ending prior to the company’s next upcoming annual meeting.
If you haven’t made any changes to your peer group, or you don’t want to provide the info in advance, you aren’t required to participate. That just means that ISS will automatically factor into its methodology the peers that you disclosed in your last proxy statement.
Meanwhile, Equilar’s peer group submission window is open through tomorrow – Wednesday, June 30th – targeting companies that file their proxy statement between July 15, 2021 and January 14, 2022. Institutional investors’ voting policies often say that they incorporate a third-party analysis to verify company peer groups, and some use Equilar’s research for that. The portal re-opens in December for spring filings (and any changes submitted after June 30th will be incorporated in that update).
Last week, I blogged on TheCorporateCounsel.net that the SEC has issued a record amount of whistleblower awards this year. Companies need to anticipate the possibility of whistleblowers and encourage employees to raise concerns internally – but that doesn’t mean you can prohibit them from going directly to the SEC! Doing so would violate Rule 21F-17 of the Exchange Act.
Last week, the SEC announced that it had settled an enforcement action with a brokerage firm that tried to do just that, by including this provision in its employee manual and related training:
Employees are also strictly prohibited from initiating contact with any Regulator without prior approval from the Legal or Compliance Department. This prohibition applies to any subject matter that might be discussed with a Regulator, including an individual’s registration status with FINRA. Any employee that violates this policy may be subject to disciplinary action by the Firm.
The manual defined “Regulator” to include the SEC. Meanwhile, the Code of Conduct said:
Nothing in this policy or any other Company policy or agreement is intended to prohibit you (with or without prior notice to the Company) from reporting to or participating in an investigation with a government agency or authority about a possible violation of law, or from making other disclosures protected by applicable whistleblower statutes.
That wasn’t enough to save the company from being tagged in the enforcement action – nor was the finding that no employees were actually prevented from communicating with the SEC about potential violations, or that the company took no action to actually enforce the restriction or prevent communications. Although the company didn’t admit or deny the findings in the SEC order, as part of the settlement they agreed to pay about $210k, revise the manual, alert their employees to the change, and promise not to do it again. See this Stinson blog for more details.
If you haven’t reviewed your employee manual and code of conduct lately, this is a good reminder to do so. If your comp committee is evolving into a “people committee,” they might have a hand in that.