Comments on the SEC’s reopened “clawbacks” proposal were due at the end of November. As usual, though, the SEC has continued to welcome submissions even after that deadline, and letters have continued to roll in as recently as last week. You can view all of the comments submitted – from 2015 to present – on the SEC’s website. Here are a few notable ones:
– NYSE Group (commenting on the delisting standards that exchanges would apply in determining whether an issuer has complied with its recovery policy and advocating for Exchange staff discretion)
Many of the comments reiterate concerns that were previously raised in response to the 2015 proposal. Not surprisingly, investors are general supportive of broader corporate clawback policies, and issuers are advocating for more bright-line tests that are tied to financial statement materiality. The Davis Polk letter also discusses issuer compliance costs and the potential impact on executive compensation arrangements. There are differences of opinion on some points – e.g. whether to include a Form 10-K cover page checkbox – even amongst the issuer community. The Staff certainly has a lot to consider as it moves towards finalizing this rule.
The blog recommends that you take the SAB and these proposed rule amendments into account when considering the timing of 2022 option grants. Here’s an excerpt about what will be required if the proposal is adopted as-is:
The proposal expands the information all companies would need to disclose, not just those companies required to add a footnote to their ASC 718 expense disclosures referenced in the above example. The proposal would require all public companies, under new section 402(x), to include a description in their 10-K annual reports of their option/SAR grant policies and practices, how they determine the timing of grants (predetermined dates during the year or not), and the influence of material nonpublic information in their compensation committees’ grant timing and grant valuations.
This discussion would also be included in the company’s compensation discussion and analysis, so that shareholders can understand company option grant timing practices when considering say-on-pay votes, when approving executive compensation plans and when electing directors. We expect that these will become garden-variety discussions that all companies will be required to include, unless special circumstances exist.
For companies that make grants to named executive officers within 14 days before or after the release of material nonpublic information on quarterly reports or 8-Ks, the SEC would require additional disclosures so that shareholders understand with complete transparency how the process works. The SEC believes that many companies, after the end of a completed fiscal quarter or annual period, hold meetings with their boards of directors a week or two before issuing the earnings release when they are likely aware of material nonpublic information that could affect the stock price of the company. Rather than propose a facts and circumstances test, the SEC proposed a black letter rule that would mandate disclosure within this time frame.
This tabular disclosure would be required for companies that make awards within 14 calendar days before or after the filing of a periodic report on Form 10-Q or Form 10-K, an issuer share repurchase, or the filing or furnishing of a current report on Form 8-K that discloses material nonpublic information (including earnings information).
Instructions are provided as to how these columns must be populated, with rules substantially similar to those in the current proxy disclosure rules. All public companies must abide by the option disclosure rules, including smaller reporting companies.
The WTW team notes that if the proposal is adopted, companies could be required to provide this additional disclosure in 2023 proxies, about 2022 grants. For that reason, even though we don’t yet have the final rules, companies may want to take a second look at their 2022 grant cycle. It may be prudent to reconsider grants that are expected to fall within 14 days before or after earnings or other announcements that could affect share price – or at least consult with legal counsel on whether to be so proactive. Remember that the SEC is also looking for comments on aspects of the rule that may not work well in practice (and since the proposal still hasn’t been published in the Federal Register, which will start the clock on the comment period, you have extra time to get those in).
Here’s an excerpt from WTW’s blog, with parting thoughts:
If the regulations are finalized during 2022, it is likely that the SEC will allow companies and insiders some ramp-up time before they must comply with the new restrictions. It would certainly be worthwhile for companies to consult with their stock plan administrators to determine what actions need be taken to meet the new rules. The question of whether it makes sense to adopt the new requirements before they are finalized becomes a legal question that SEC counsel can help determine.
There’s been a lot of back & forth on whether shareholders actually provided lower support for say-on-pay resolutions last year. That’s probably because the data was mixed. Semler Brossy’s year-end summary explains:
– The Russell 3000 average Say on Pay vote (90.4%) was consistent with the prior two years.
– The Russell 3000 did see an uptick in failures (63).
– At least 32% of failures happened because of Covid-19 pay actions.
– In the S&P 500, average vote results decreased to 88.3%. This was 130 basis points below the prior year result and 210 basis points below the Russell 3000 average vote.
It’s easy to go around & around with stats, but the bottom line is that companies should not get complacent about say-on-pay. I’ve previously blogged that low support is “blood in the water” for activists. Semler Brossy’s report says that over the past 5 years, average direct support at companies that received a say-on-pay vote below 50% in the prior year is 5% lower than at companies that received above 70% support.
Despite last week’s wild stock market fluctuations and all of the other factors pointing to a dampened year for IPOs, there are still plenty of companies that are looking to go public in 2022 (and plenty of SPACs that want to help them). Once a company’s governance structure is in place, this 7-page Pay Governance memo gives a good overview of what compensation committees of pre-public companies should do as they prepare for the big debut. Here’s the executive summary:
• Compensation program planning is a critical part of the comprehensive and time-consuming process necessary to transition from private to public ownership.
• There are several facets of the compensation program to consider through the transition, such as:
— Establishing/Updating a Compensation Philosophy
— Reviewing/Aligning Executive Pay Levels to Business Objectives and Competitive Practice
— Developing a Long-term Incentive (LTI) / Equity Program Strategy
— Reviewing/Establishing Severance and Change in Control Policies
• Advance planning, incremental decisions, and careful analysis of external and internal factors in each of the above areas can help.
As Liz noted last month, the SEC has been looking at whether to reopen the comment period on its 2015 pay-for-performance rule proposal. Yesterday, the SEC announced that it’s moving ahead with that – and John gives us the details over on TheCorporateCounsel.net blog today:
Yesterday, the SEC announced that it was reopening the comment period for the Dodd Frank-mandated pay-for-performance disclosure rules that the agency proposed way back in 2015. Here’s the 29-page reopening release & the 2-page fact sheet. This excerpt from the fact sheet summarizes the reasons for the SEC’s decision to reopen comments as well as some changes to the initial proposal that are being contemplated:
The Commission received numerous comment letters on the 2015 proposing release. In light of the regulatory and market developments since 2015, the Commission is providing the public the opportunity to submit additional comments on the 2015 proposal, and to address the additional requirements the Commission is considering in the reopening release issued today. These additional requirements include, among other things:
– Whether registrants should be required to disclose additional performance measures beyond total shareholder return;
– Whether, if required, pre-tax net income and net income would be useful additional financial measures;
– Whether registrants should be required to disclose the measure that in the registrant’s assessment represents the most important performance measure used by the registrant to link compensation actually paid during the fiscal year to company performance (which is called the “Company-Selected Measure”); and
– Whether registrants should also be required to disclose a tabular list of a registrant’s five most important performance measures used to determine compensation actually paid.
Commissioner Peirce issued a brief dissenting statement in which she contended that “the additional requirements raised in this release go well beyond the statutory mandate of Section 953(a), are not responsive to the comment file, and do not seem warranted in light of current executive compensation practices related to company performance.” Commissioner Lee weighed in with a supporting statement and Commissioner Crenshaw provided one as well.
The reopened comment period will expire 30 days after publication of the release in the Federal Register. However, the SEC hasn’t exactly been rocketing into print with its recent rule proposals – the 10b5-1 & buybacks proposals still haven’t been published – so it’s possible that the reopened comment period actually may be quite a bit longer than that.
CEO pay continues to be scrutinized by long-term investors, employees, activist investors, & the media. This Pay Governance memo gives us a sneak peek at where they think CEO pay is headed, after analyzing pay data – consisting of base salaries, actual bonuses (not target), and reported grant date fair value of long-term incentive awards – of S&P 500 companies with CEOs of 3+ years tenure. Here is an excerpt of their CEO pay projections:
– We expect 2021 overall CEO actual TDC [total direct compensation] to increase in the low- to mid-single digits due to stronger financial results than projected at the beginning of the year when bonus goals were set; there will be some variation with strong performing industries likely seeing increases in compensation.
– The Aggregate S&P 500 Index year-over-year revenue and operating income for 2021 are currently forecasted to increase by 16% and 37%, respectively (S&P Capital IQ).
– We expect median CEO target pay increases in early 2022 to be in the mid-single digits and possibly higher given very strong financial and TSR performance (S&P 500 was +29% in 2021); this increase will be primarily made by increases in LTI compensation.
– In certain high-growth industries (e.g., technology and biotechnology) and high-performing companies, CEO increases could be greater than 10% (primarily with larger LTI awards) because of a highly competitive labor market, while executives in slow-growth industries or heavily impacted companies might see no increases.
Liz previously blogged about the growing number of companies incorporating ESG metrics – and how ESG in executive compensation is likely here to stay. But ESG can mean a lot of things, and it’s difficult to know sometimes which “ESG” topic is being utilized in executive compensation. While metrics can (and should) vary by industry, one topic that seems to be employed across almost all sectors is DEI, according to an analysis last summer.
To get more granular, Teneo did a deep dive on how companies are specifically incorporating diversity, equity & inclusion metrics into executive compensation. Teneo looked at the largest 100 companies in the Fortune 500, as well as those that “publicized DEI compensation ties or that were otherwise publicly committed to improving DEI performance,” with all but one company in the US. Here are some of the highlights:
– Strong DEI incentive metrics align with the company’s long-term strategy. The most common metric is diverse representation among leadership.
– A Teneo study of S&P 500 companies found that over half of 2021 Sustainability Reports included at least one demographic target, with 42% of companies including both gender and racial/ethnicity goals. By setting goals, companies are treating DEI like any other business priority, ensuring accountability and tracking progress.
– Communicating exactly how much pay is at risk based on DEI performance creates accountability. The most common weighting for DEI metrics in the STI and LTI is 10%. Quantifying the impact on pay is considered more transparent from a shareholder perspective, and the pay affected is viewed as more strongly performance based.
– The most common weighting was 10% of the incentive payout for those that quantified the impact. However, the range of disclosed weightings varied from less than 5% of the bonus to determining 100% of the PSUs earned. There is no universally ideal weighting system, but investors and proxy advisors have questioned whether weighting DEI and other ESG-related metrics below a certain level is effective at holding executives accountable for performance.
– While most companies embedded diversity considerations in their annual incentive, 17% of companies in the study incorporated DEI metrics in long-term incentive (LTI) design, an emerging best practice.
Here’s BDO’s latest study examining director and select board compensation practices of 600 middle-market public companies. Data was collected from proxy statements filed between April 2020 and March 2021 – right in the thick of the pandemic. The study found that, based on Form 8-Ks filed between March – June 2020, 14% companies reduced board pay levels by 50% for an average of six months, but these were temporary reductions. BDO notes that at the end of the year, “retainers and fees were slightly above the prior year, which reflects the recognition that boards face an ever-changing array of complex challenges” – including navigating shareholder activism, tackling changing regulations and monitoring supply chain disruptions & other risks. Here are some of the other highlights:
– Director total compensation increased by 2.3% in fiscal year 2020 over fiscal year 2019
– Committee retainers and fees decreased 2.7%, continuing the trend to provide cash-based compensation through board fees rather than for individual committee work.
– Full-value stock awards continue to outpace stock options. Stock awards increased 2.5% over the prior year, whereas stock options decreased by 11.6%. Total equity compensation rose 2.2%
– For middle-market companies, industry membership is a critical consideration when benchmarking director compensation. Directors in the healthcare and life sciences and technology industries are the highest paid. On the other end of the continuum, financial services banking directors are paid one-quarter of the compensation received by those in the highest paying industries.
This Latham memo reminds us that companies need to furnish – by this upcoming Monday, January 31st – annual information statements to people who exercised ISOs or purchased ESPP shares during 2021. Companies also need to file an information return with the IRS in February or March, as applicable.
The memo explains what must be included in the returns and information statements, how to deliver the information statements to employees & former employees, exceptions to filings, possible penalties for noncompliance and more – and also provides links to the IRS forms.
We’ve posted the transcript for the recent webcast: “Compensation Committee Responsiveness – How to Regain High Say-on-Pay Support.” Aileen Boniface of Clermont Partners, Steve Day of Calfee, Halter & Griswold, Brad Goldberg of Cooley and Tara Tays of Pay Governance discussed what has been triggering low say-on-pay votes and how to recover. Among many useful nuggets from this program was this suggestion made by Brad:
Each company needs to figure out exactly why shareholders voted against the proposal. The best way to do that is to read the proxy advisor reports and start to engage with your key shareholders. Typically, people are going to start with the significant shareholders in the top 15 or 25, which is the best place to start. Once you identify what the issues were and who you’re going to reach out to, you need to form the team, and there’s questions there of who’s involved. Key outside participants often will be the comp consultant and companies will often look to a proxy solicitor to help with the effort as well. Another key thing to consider is who from management — and more importantly, who from the compensation committee — can attend these meetings. Are you confident that the directors in your compensation committee are going to have sufficient knowledge of the program and be able to present in a meaningful way?
Tara also noted:
When there are significant changes that need to be made to executive compensation programs to increase shareholder support with respect to say-on-pay, it’s important to ensure the appropriate due diligence is taken around what makes sense for the company and what’s going to allow the company to continue to motivate executives, especially in this time. There shouldn’t be any rash decisions made. It is going to take a couple of meetings to get to the right solution to make sure that they position the programs in the right direction going forward.
Don’t rush into it. Take the time that’s needed. Make sure that the appropriate research is done in terms of what peers are doing, in terms of what the company can do with respect to forecasting a certain performance metric that’s being changed, with respect to their incentive plan designs. Then, make sure that there’s a balanced approach taken in terms of what shareholders want to see, what institutions want to see, and what’s needed for the company in order to drive results in the future.