Yesterday, the SEC announced that it has (once again!) reopened the comment period for proposed listing standards relating to recovery of erroneously awarded compensation. This is the second time in less than one year that the Commission has reopened the comment period for its 2015 proposal, which would implement Section 954 of the Dodd-Frank Act. The proposal was first reopened for comment last October. I blogged in February about some of the notable responses so far.
Along with yesterday’s announcement, the Commission released this DERA memo to provide supplemental baseline data and analysis – which is now posted along with all of the comments to-date. The memo:
– Discusses the increase in voluntary adoption of compensation recovery policies by issuers (noting that the increase in voluntary adoption relative to the baseline in the proposing release may reduce the anticipated benefits and mitigate the anticipated costs of the proposed rules);
– Provides estimates of the number of additional restatements that would trigger a compensation recovery analysis if, as the Commission described in the October 2021 reopening release, the rules were extended to include all required restatements made to correct an error in previously issued financial statements (noting that while there are a lot more “little r” restatements, they would be less likely to trigger a clawback, and including “little r” restatements could increase both benefits & costs); and
– Briefly discusses some potential implications for the costs and benefits of the proposed rules.
This announcement about the reopened comment period arrived only one day after the SEC celebrated a SOX 304 clawback settlement. In that action, SEC Enforcement Director Gurbir Grewal said the action should “put public company executives on notice.” This 2010 Latham memo explains the difference between these two statutes and how the rules will coexist.
The pairing of an enforcement action with the additional study of the 2015 signals that the Commission means business on clawbacks. You’ll need to revisit your policies and plans with an eye toward new rules as well as new fodder that they may provide for activists and plaintiffs. This may also add to the trend of incorporating non-financial metrics into plans.
We’ll be sharing critical guidance on all of these issues at our “Proxy Disclosure & 19th Annual Executive Compensation Conference” this October. Our session on “Clawbacks: Where Things Stand” – 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 items to take in response to SEC rulemaking and enforcement activity. Here’s the full agenda for the Conferences – 18 sessions over 3 days. Our “Early Bird” rate expires tomorrow, June 10th – so make sure to register today for the best prices. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
Yesterday, in connection with charges against a software company for accounting-related misconduct that resulted in restatements of 4 years’ worth of previously filed financials, the SEC announced that the company’s founder and former CEO had agreed to reimburse the company for more than $1.3 million in stock sale profits & bonuses, as well as to return previously granted shares of company stock, pursuant to Section 304 of the Sarbanes-Oxley Act.
The SEC settled with 7 former employees for their role in the misstatements (including the longtime GC, who paid $25k in penalties). Unlike the former CFO and Controller, who are under the most scrutiny here, the CEO was not charged with misconduct. Here’s the 5-page settlement order, which summarizes the Section 304 violation as:
As a result of the conduct described above, Waldis violated Section 304 of the Sarbanes-Oxley Act of 2002, which requires the chief executive officer or chief financial officer of any issuer required to prepare an accounting restatement due to material noncompliance with the securities laws as a result of misconduct to reimburse the issuer for (1) any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the Commission of the financial document embodying such financial reporting requirement and (2) any profits realized from the sale of securities of the issuer during that 12-month period. Section 304 does not require that a chief executive officer or chief financial officer engage in misconduct to trigger the reimbursement requirement.
The order says that the restatement related to improper revenue recognition practices – including for transactions for which there was no persuasive evidence of an arrangement and prematurely recognizing software license revenue. According to the order, at least two of the revenue misstatements were facilitated through the use of “side letters or agreements” that had not initially been considered in recognizing revenue and materially changed the terms of the transactions.
Section 304 clawbacks are pretty rare, although there was one last year. Maybe we’ll see more as the Staff works through the restatements resulting from the SPAC boom. The SEC says that yesterday’s action should “put public company executives on notice that even when they are not charged with having a role in the misconduct at issue, we will still pursue clawbacks of compensation under SOX 304 to ensure they do not financially benefit from their company’s improper accounting.”
I blogged a few weeks ago about Pay Governance findings that ESG metrics aren’t leading to the executive windfalls that some had feared. A new Willis Towers Watson memo also defends the “new kid on the block” – pointing out that the challenges & drawbacks of ESG metrics are not all that different from those associated with financial & operational metrics.
If you take it as fact that financial & operational metrics are a good thing (not everybody does), then here are some “lessons learned” that WTW suggests can also be applied to the ESG context:
1. Establish more consistent disclosure requirements. Consistent disclosure will improve transparency and accountability, allowing stakeholders to make more informed decisions. For example, this may involve the consistent adoption of the Task Force on Climate-Related Financial Disclosure standards, or more consistent Human Capital Report disclosures.
2. Improve external standards. Over time, with enhanced disclosures, companies and investors can develop better external standards. For example, the ability of organizations such as Institutional Shareholder Services (ISS) and Glass Lewis (GL) to develop and deploy compensation plan assessment models only exists because of robust disclosure that has evolved over time. We would expect to see the rapid development of external ESG standards once enhanced, consistent disclosure requirements are in place.
3. Compile a set of precedents. Similar to how companies learned to understand the pitfalls of using certain financial and operating metrics by trial and error (e.g., don’t measure working capital or cash flow at a point in time because it drives poor timing decisions at year end), companies will learn how to adjust incentives when encountering pitfalls with certain ESG metrics as they gain experience with those metrics.
4. Apply appropriate weighting to ESG metrics. A relatively small weight (e.g., 15-20%) should be applied to ESG incentive metrics to properly signal the importance of the metric while not disproportionately weighting these metrics. We see a similar approach taken with financial metrics such as revenue and working capital, which are typically weighted less than 25% of the total incentive.
5. Ensure ESG results are measurable, actionable and tied to business strategy. Similar to financial metrics, it is important and possible to make sure ESG metrics are linked to business strategy, can be acted upon by participants and are measurable. For example, goals tied to achieving greater leadership diversity may work best when an incentive plan is geared towards a limited population of senior leaders. And climate-related goals could be disaggregated such that all participants understand how their actions can contribute to the successful execution of the strategy, much like financial metrics such as EPS are broken down via value driver analyses.
If you’re among the 60% of S&P 500 companies that have already added ESG metrics and are looking to take the next step – or among the large number of companies that are still in the “consideration” stage – make sure to visit our checklist on “ESG as an Executive Compensation Performance Component” for step-by-step practical guidance – as well as the other resources in our “Sustainability Metrics” Practice Area.
And tack on our “1st Annual Practical ESG Conference” for even more valuable information about ESG programs, risks & opportunities that could affect this new form of metrics. The Conferences can be bundled together for a discounted rate. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
Coming off of the pandemic, corporate and executive aircraft use is back in the spotlight in a big way. Demand for private travel is high, but continues to be scrutinized. Deals are moving faster than ever. In this 22-minute podcast, I talk with Cooley’s Brad Goldberg and Jet Counsel’s Stewart Lapayowker about:
1. The effect of COVID-19 pandemic on the demand for business aircraft – and what the market looks like today.
2. Two steps that companies, directors and officers can take to make sure they’re not running afoul of FAA, tax or disclosure regulations for business versus personal use.
3. The consequences of misclassifying business versus personal use.
4. How business aviation counsel and SEC disclosure counsel can best work together to make sure that board minutes and public disclosures are accurate.
5. The typical timeframe for aircraft deals today.
6. What companies can say (or not say) to reassure shareholders that private travel is in the company’s best interest.
7. How to increase security around tracking corporate flights, to prevent competitors and media from tracking whether a company is working on a transaction or acquisition.
8. Key advice that they always give to public companies that are considering an aircraft deal.
When it comes to perquisites, there is always something new to know – and perennial issues to remember! That’s part of the reason that our “Dealing with the Complexities of Perks” session with Compensia’s Mark Borges and Hogan Lovells’ Alan Dye is always one of the most popular discussions at our “Proxy Disclosure & Executive Compensation Conferences.” Don’t miss out on this year’s edition. Our “Early Bird” rate for the Conferences expires this Friday, June 10th – so register today for the best price. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
Liz previously blogged about how the SEC’s proposed insider trading rules can affect your option grant policies & practices. If you’re re-examining your option grant practices now, take a look at Foley’s short and sweet article outlining best practices on stock option grants for both private & public companies. The article gives a brief overview of the tax & regulatory considerations on grant timing and setting the exercise price, required approvals and other checklist items that companies sometimes overlook. One of these checklist items is to remember checking that the proposed option grants comply with the applicable equity plan’s terms – before the plaintiffs do it for you.
Here’s the latest Semler Brossy memo on say-on-pay results as of May 19, showing that 26 Russell 3000 companies have failed thus far (with 17 failures added since Semler’s last report, including Intel & PacWest Bancorp) – which brings the failure rate to 2.7%. The Russell 3000 failure rate is still lower than the failure rate Semler Brossy saw at this time last year (at 3.1%), but it’s above the average failure rate in 2020 (2.3%). Below are some additional excerpted stats:
– The current Russell 3000 average vote result of 90.4% is similar to the index’s average vote at this time last year (90.4%); the current S&P 500 average vote result of 88.3% is below the index’s average at this time last year (89.6%), and is consistent with the year-end vote result in 2021.
– The failure rates for the Russell 3000 and S&P 500 are lower than the failure rates at this time last year: the Russell 3000 is 40 basis points lower at 2.7% and the S&P 500 is 100 basis points lower at 3.4%.
– 10.0% of Russell 3000 and 10.8% of S&P 500 companies have received an ISS “Against” recommendation thus far in 2022.
You may also want to check out the chart on pg. 3 showing the likely causes of say-on-pay votes under 50% in 2022. The largest likely causes are problematic pay practices and mega-grants/special awards.
A recent Aon memo analyzed the evolution of human capital management disclosures among 103 filings from S&P 500 companies for the 2021 fiscal year – Year 2 of required disclosure. Below are some of the highlights:
– The most prevalent categories for HCM disclosure in 2021 were employment (quantitative) at 98%, talent development (qualitative) at 89%, and compensation & benefits (qualitative) at 83%.
– There’s still a lack of quantitative information in HCM disclosures generally. However, upon comparing year-over-year disclosures for 73 S&P 500 companies, companies are increasingly disclosing gender or race/ethnicity data, as well as quantitative data on employee geography and turnover data (though quantitative turnover data was still reported by less than 1/3rd of those companies).
– Just over half of the 103 companies disclosed both gender and race/ethnicity breakdowns of their workforce, and 41% had more comprehensive disclosure covering those quantitative diversity metrics with job type, career levels and other categories.
– Aon notes that there was a decrease in pay equity study disclosures – which may indicate that companies are acting on the 2020 pay equity audit results, instead of focusing on disclosures on the audits themselves.
Aon notes that “disclosing quantitative DEI factors by job type or career, discussing pay equity studies and addressing turnover” are getting traction, and companies can prepare by measuring these metrics & understanding the reasons behind company-specific trends. The article provides several other to-do actions on pg. 6, which includes considering revisions to your 2023 HCM disclosures now & building in time to review next year’s proposed disclosures with the committee responsible for human capital oversight.
Investors will continue to expect more from Human Capital disclosures going in to next proxy season – and another SEC proposal is still expected, too. There are step-by-step actions that you must take to keep approval ratings high for your comp committee. To arm yourself – and your board – with the info you need, register for our upcoming “Proxy Disclosure & Executive Compensation Conferences” – coming up virtually October 12-14. Among other critical topics, our agenda includes “Human Capital Disclosure – Mastering SEC & Investor Expectations” – with Aon’s Pam Greene, Gibson Dunn’s Ron Mueller, CalPERS Tamara Sells, and Wilson Sonsini’s Amanda Urquiza. Other sessions will include practical guidance on handling the compensation committee’s evolving role and how to protect your board from the next maelstrom.
Our “Early Bird” rate expires next Friday, June 10th – so register today for the best price. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
Yikes! Vice Chancellor Laster issued a 115-page opinion this week that should have you running to double check your equity grant ledgers & records. The facts of the case relate to a performance share award that could exceed plan limits if the performance is achieved:
The 2019 Plan limits the number of performance shares that the Committee canaward to any single individual in the same fiscal year. In March 2020, the Committee made two grants of performance shares to the Company’s chief executive officer (“CEO”), defendant Gerry P. Smith (the “Challenged Awards”). Each of the Challenged Awards entitled Smith to receive a variable number of performance shares, with the actual amount determined by the Company’s performance over a three-year measurement period that will end in 2023. If the Company performs well, then the aggregate number of shares that Smith is entitled to retain will exceed the limit in the 2019 Plan.
The plaintiff is a stockholder, and is asserting a claim for breach of the Plan. But there’s more. The plaintiff also appears to have successfully turned that claim that the grant was defective into a Caremark-like claim against the entire board. Here’s an excerpt:
In contrast to the preceding issues, which are governed by settled law, the plaintiff also advanced a novel theory. According to the plaintiff, all of the directors—including the directors who did not approve the Challenged Awards—breached their fiduciary duties by not fixing the obvious violation after the plaintiff sent a demand letter calling the issue to their attention. There is something disquieting about a plaintiff manufacturing a claim against directors by acting as a whistleblower and then suing because the directors did not respond to the whistle.
Nevertheless, the logic of the plaintiff’s theory is sound: Delaware law treats a conscious failure to act as the equivalent of action, so if a plaintiff brings a clear violation to the directors’ attention and they do not act, then it is reasonably conceivable that the directors’ conscious inaction constitutes a breach of duty. The same logic animates a Caremark claim that rests on the theory that the board consciously ignored proverbial red flags, although the source of the notice that the board receives is different.
Vice Chancellor Laster notes that this type of claim presents “obvious policy issues” – but:
The plaintiff, however, has pled what seems like one of the strongest possible scenarios for such a claim. The limitation in the 2019 Plan is plain and unambiguous. Under established precedent, the failure to comply with a plain and unambiguous restriction in a stockholder-approved equity compensation plan supports an inference that the directors acted in bad faith. The recipient of the Challenged Awards was a fellow fiduciary who faced the same obligation to fix the flawed grants as the other members of the Board. If there was ever a time when all of the directors had a duty to take action to benefit the Company by addressing an obvious problem, it is reasonably conceivable that this was it.
With admitted trepidation about knock-on effects, this decision permits the claim to survive pleading-stage analysis. In light of the policy implications that claims of this sort present, future decisions must consider carefully any attempts by plaintiffs to follow a similar path.
The defendants’ motion to dismiss was denied, and the case moves forward. Not legal advice, but this opinion suggests that if you get a demand letter, it’s worth taking this decision into account and fixing the identified issue – even if the plaintiff leverages that clean-up reaction for a settlement. The even better approach is to try to avoid the issue in the first place, through regular equity plan audits. See our checklist with step-by-step guidance on share counting.
If you find yourself exceeding plan limits, we also have an issue-spotting thread in our “Q&A Forum” (#177). Also see this blog about a 2013 Delaware case, and this blog about the “inducement grant” alternative.
A majority of big companies now include some type of ESG metric in their executive pay program. The jury is still out on whether that’s a good thing. One view is that “what gets measured gets managed” – so incorporating ESG goals into incentive plans shows that the company is serious about progress. At the same time, some people think that the real winners here will always be highly paid executives. Investors aren’t a monolith – they fall in both of these camps.
A recent Pay Governance memo says that the concern about using ESG incentives to improperly reward executives might be overblown – at least based on current data. Ira Kay, Mike Kesner and Joadi Oglesby looked at S&P 500 data to test the theory, and here’s what they found:
1. ESG reduced the overall payout at 75% of the companies using a weighted metric, with the median reduction equal to 9%.
2. Most ESG-weighted metric companies (56%) used a 20% weighting or less.
a. In some cases, the company used a scorecard approach and did not provide sufficient detail to determine the portion of the weighted metric attributable to ESG; in those cases, we included the entire weighting.
b. Many of the companies with a >20% weighting included ESG and other strategic metrics.
3. Of the companies that incorporated ESG metrics as part of a modifier, 33% increased payouts and the remaining 67% had no effect or reduced payouts.
4, The average impact on payouts for companies using a modifier on the financial performance metrics ranged from +35% to -14% and averaged +2%.
5. These findings indicate that the compensation committee members are acting conservatively in setting and scoring ESG goals — thus the narrow band around target for most companies.
The Pay Governance team notes that it’s still early days here – but ESG incentive criticism isn’t supported by current data. Visit our “Sustainability Metrics” Practice Area for analysis of ESG executive pay trends – including our checklist.
Last week was peak “annual meeting” – with 119 meetings on Thursday alone, according to data from ISS Corporate Solutions. Although the overall say-on-pay failure rate has held steady this year, median CEO pay set a record for the 6th year in a row ($14.7 million!), and that has resulted in a few failed advisory votes. This WSJ article recounts abysmal results at two high-profile companies, and mediocre support at others.
At one company that barely eked by, special awards were in the spotlight. SOC Investment Group filed this notice of exempt solicitation to discourage other shareholders from supporting management’s say-on-pay proposal, in which it advocates “near-zero” tolerance for special awards. Here’s an excerpt:
The company granted Named Executive Officers (NEOs), including the CEO, special “one-time” performance equity awards in addition to their ordinary-course equity awards in fiscal 2021, which we view as unnecessary for the following reasons:
1. Executives already have large amounts of vested and outstanding equity that reward them when the company’s shares appreciate.
2. The special award is not necessary because it rewards executives for what should constitute their normal job duties.
3. Special awards may not solve retention challenges and are a chief cause of executive overpay.
As a general principle, we believe that special awards are inappropriate in almost all cases and has become an overused practice in executive compensation, one that we advocate moving toward near-zero tolerance for. Notwithstanding our belief, in this specific case the company does not offer a particularly compelling rationale for the special award—the grant appears to reward for what we feel should be viewed as ordinary-course business decisions and efforts of executives in any large corporation.
The letter goes on to provide more rationale for each of these 3 points. If you are considering a special award, it’s worth reading this before you move forward, so that you’re prepared to justify the decision. As we’ve noted, granting a “special award” is akin to a mortal sin in the eyes of some proxy advisors & investors.