Skadden is out with its annual checklist of matters to consider for the upcoming annual meeting & reporting season. It provides updates on proxy advisor policies, recent voting trends that could affect 2022 planning, and recommended steps. This year’s version is 48 pages long! As always, it has headings and navigation links to skip to what you need, and it’ll also be posted soon to our “Proxy Season” Practice Area.
Here are key items that the Skadden team recommends thinking about for executive compensation (also see my earlier blog):
1. Incorporate “lessons learned” from the 2021 say-on-pay votes and compensation disclosures and prepare for 2022 pay ratio disclosures
2. Consider trends & developments on employee, environmental, social & governance metrics in executive compensation
3. Evaluate Hart-Scott-Rodino Act implications in executive compensation
4. Note status of pending SEC rulemaking relating to clawback policies under Dodd-Frank
Yesterday, proxy advisor ISS published updated “FAQs” for pandemic-related pay adjustments. This 6-page document refines the FAQs originally published in October 2020, and explains how ISS will approach these issues beginning in the 2022 proxy season.
The new document notes that the upcoming proxy season will be the third year in which the pandemic has been in play (and the second year of executive pay proxy disclosure occurring under pandemic conditions). Many of the temporary base salary reductions have been lifted, and the “surprise element” of the pandemic is no longer applicable. So:
As in pre-pandemic years, any mid-year changes to metrics, performance targets and/or measurement periods, or programs that heavily emphasize discretionary or subjective criteria will generally be viewed negatively. This will be of particular focus for companies that exhibit a quantitative pay-for-performance misalignment.
However, in certain circumstances lower pre-set performance targets (as compared to 2020) and/or modest year-over-year increases in the weighting of subjective or discretionary factors may be viewed as reasonable for companies that continued to incur severe economic impacts and uncertainties as a result of the pandemic in 2021 (see question #5 below). As before, Companies should clearly explain target setting and any changes to the program, to allow investors to evaluate the compensation committee’s actions and rationale.
The FAQs discuss what disclosure would be useful if mid-year adjustments are made, and/or if incentive targets are lowered below prior-year levels due to pandemic issues. Regarding long-term incentives, the FAQs now say:
As before, changes to in-progress long-term incentive cycles will generally be viewed negatively, particularly for companies that exhibit a quantitative pay-for-performance misalignment. Modest alterations to go-forward cycles (i.e., awards granted for the cycle beginning in 2021) may be viewed as reasonable, particularly for companies that continue to incur severe negative impacts over a long-term period.
For example, some movement from quantitative to qualitative metrics or modest increases in the proportion of time-vesting awards. More drastic changes, such as shifts to predominantly time-vesting incentives or short-term measurement periods, would continue to be viewed negatively. Companies should clearly explain any changes to the program, to allow investors to evaluate the compensation committee’s actions and rationale.
The theme of these FAQs is that investors are expecting a return to traditional incentive structures. They want a strong link to performance and disfavor one-time awards. Deviations from that will be viewed negatively and should be accompanied by robust explanations. The FAQs also clarify that in 2022, ISS will return to its regular scoring thresholds for the Equity Plan Scorecard (it had raised the passing score for some companies in 2021).
Bruce Brumberg – who among other roles has blogged on this site and is the co-founder of myStockOptions.com – recently alerted me to his updated page on year-end planning for anyone who receives or is involved with equity compensation.
Bruce notes that multi-year tax planning is more important than ever (and while some individuals cannot be reined in, perhaps by helping your execs look ahead, you can avoid a situation in which they are liquidating a lot of holdings via a Twitter poll). Here are 4 tips that he highlights:
Recently, Willis Towers Watson partnered with the World Economic Forum’s Climate Governance Initiative to publish this 34-page guidebook on whether & how to use executive compensation incentives as part of strategic climate transition plans. The guidebook looks at director & investor views, case studies, and pros & cons of environmental-based incentive compensation. It also offers a “design spectrum” (pg. 16) and principles to consider when selecting metrics (pg. 17).
The guidebook recommends a 6-step cycle for using executive pay to accomplish “net zero” goals:
1. Align climate priorities with business strategy. Incorporate clear organizational climate priorities into the fabric of the company’s enterprise risk and opportunities framework.
2. Climate goals tied to the net zero vision. Articulate a clear net zero vision by 2050 (or earlier) and set short-, medium- and long-term milestones toward the vision.
3. Select the right metrics. Considering company’s net zero vision/milestones and incentive design, determine the right climate metrics.
4. Fit-for-purpose incentive design. Reference market practice and the company’s own climate objectives to finalize the incentive design mechanism and formula.
5. Tell the story with disclosures. Design and metrics selection should be disclosed clearly, aligned with business strategy and other climate and ESG disclosures.
6. Evolve and learn over time. Review effectiveness and adjust design, metric(s) and goal(s) over time.
As this FW Cook blog highlights, a few unique dynamics are making it more challenging than usual to ensure that your compensation peer group remains accurate:
– Industry Consolidation. With the gangbuster M&A dealmaking year, it’s no surprise that industry consolidation is flagged as adding difficulty to peer group selection. FW Cook notes that companies can use “compensable factors” to help screen potential compensation reference companies – sample compensable factors include quantitative factors like margins and revenue growth, and qualitative factors like global sprawl or place in the business cycle.
– Uneven Impact of COVID-19 Pandemic on Companies. We’ve previously blogged about executive pay being potentially impacted by the pandemic’s disparate impact on companies. FW Cook suggests a couple approaches a company can take: (1) delay making changes to peer groups until market conditions stabilize, (2) broaden the peer screening criteria, and (3) use supplemental measurement periods to help normalize for market disruption.
– Blurring of Industry Lines. As WSJ wrote a while back, everyone can be a “tech” company now, which adds to the confusion when choosing peer companies. FW Cook suggests potentially broadening the peer group to increase exposure to a company’s new end markets and segments (e.g., a brick-and-mortar retailer might include online retailers / ecommerce companies) or transitioning from using revenue to market capitalization.
As Liz previously blogged, the ISS window for peer groups closes this Friday, December 3rd. Even if you’re not submitting changes to the proxy advisor, it’s not too late to continue refining your peer group process.
ESG has been a hot topic all year for executive compensation – it’s been talked about so much that it feels like everyone is doing it, but it’s still quite uncommon in most industries. Here’s a breakdown from ISS on where the E&S metric usage stands now:
– The uptick in the use of E&S performance metrics in compensation observed over the last two years appears to be driven by societal developments like climate change awareness, #MeToo, BLM, and COVID-19
– Social metrics like worker safety dominate but the growth rate of environmental metrics is higher, signifying increased importance
– Safety metrics remain most common, although climate change and diversity-related metrics experienced the biggest upswings
– Diversity, CSR, and staff-relations metrics were used across all sectors in 2020
– The utility sector has the highest prevalence of E&S metrics, although the real estate sector and consumer staples experienced the biggest jumps of late
– E&S metrics are included in STIPs more often than LTIPs, with large cap companies leading the way
– Companies that include E&S metrics in executive compensation plans often choose to include more than one such metric
If you’re ready to take the leap, we previously covered the do’s and don’ts of tying ESG to executive pay during our Executive Compensation Conference. Contact info@ccrcorp.com now to register and gain access to these talking points if you missed the Conference – here’s an agenda of all the sessions you can learn from.
Yesterday, the SEC’s Office of the Chief Accountant and the Division of Corporate Finance issued guidance – via Staff Accounting Bulletin No. 120 – on how to properly account for “spring-loaded awards” made to executives. Spring-loaded awards are awards granted by a company to an executive shortly before disclosure of material non-public information to which the market is likely to react positively.
As stated in the SEC’s press release, SAB No. 120 says that companies estimating the fair value of spring-loaded awards in accordance with ASC Topic 718 “must consider the impact that the material nonpublic information will have upon release.” Here are the main changes that SAB No. 120 makes:
– Amends and replaces the interpretive guidance in Topic 14.D., Certain Assumptions Used in Valuation Methods. SAB No. 120 states that when companies are granting share-based awards while in possession of MNPI, companies should consider “whether adjustments to the current price of the underlying share or the expected volatility of the price of the underlying share for the expected term of the share-based payment award are appropriate when applying a fair-value-based measurement method to estimate the cost of its share-based payment transactions.”
– Rescinds guidance in Subtopic 14.A., Share-Based Payment Transactions with Nonemployees, noting that ASU 2018-07 made Subtopic 14.A. no longer relevant.
– Edits to the following subtopics to conform to updated GAAP terminology from FASB’s ASC Topic 718 (as updated by FASB’s Accounting Standards Updates): Subtopics 14.B., Transition from Nonpublic to Public Entity Status; 14.C., Valuation Methods; 14.D., Certain Assumptions Used in Valuation Methods; 14.E., FASB ASC Topic 718, Compensation – Stock Compensation, and Certain Redeemable Financial Instruments; 14.F., Classification of Compensation Expense Associated with Share-Based Payment Arrangements; 14.I., Capitalization of Compensation Cost Related to Share-Based Payment Arrangements; and 5.T., Accounting for Expenses or Liabilities Paid by Principal Stockholder(s).
This guidance is interesting because the Staff calls out the application of its guidance when companies have positive MNPI. As a result, SAB No. 120 seems to lean towards a concept of “fairness,” which we’ve also seen previously in the say-on-pay / pay ratio context. Make sure this guidance makes it into your internal controls and disclosure checks to avoid any surprises down the road!
Compensation committees are again tackling setting executive pay under uncertain circumstances. Semler Brossy issued a brief memo on the three trends they expect for 2021 executive pay levels:
1. An overall increase in CEO pay in both the S&P 500 and Russell 3000 – and it looks like early indications are bearing this out: companies that have already disclosed 2021 pay levels are averaging a 9.3% increase in base salaries.
2. A growing variance in compensation between the top and bottom corporate performers – the sectors that did well during the pandemic should see larger increases in target pay levels and stronger incentive-pay outcomes.
3. An uptick in the prevalence of performance-based equity – last year, companies moved away from performance-based stock towards time-based vehicles given the uncertainty of the pandemic. Companies will likely return to having performance-based stock in their long-term incentive plans.
The memo also emphasizes that clear rationale should be provided in the proxy statement for special actions like one-time awards or discretionary payouts. We blogged previously about lower say-on-pay votes this year due to Covid-related pay actions – we’ll be on the lookout for how boards and companies incorporate this investor feedback as they set executive pay levels and prepare pay-related disclosures this year. Mark your calendars for our December 16th webcast, “Compensation Committee Responsiveness: How to Regain High Say-on-Pay Support.”
Here’s something that my colleague John Jenkins wrote yesterday for TheCorporateCounsel.net: If you’re looking for a primer on how not to implement disclosure controls & procedures surrounding the disclosure of executive perks and stock pledges, be sure to check out this settled enforcement proceeding that the SEC announced yesterday. This excerpt from the SEC’s press release summarizes the proceeding:
The Securities and Exchange Commission today announced that Texas-based oilfield services company ProPetro Holding Corp. and its founder and former CEO Dale Redman have agreed to settle charges that they failed to properly disclose some of Redman’s executive perks and two stock pledges.
The SEC’s order finds that Redman caused ProPetro to incur $380,594 worth of personal and travel expenses unrelated to the performance of his duties as CEO. He also failed to disclose to company personnel that he had pledged all of his ProPetro stock in two private real estate transactions. During the same period, ProPetro failed to properly disclose $47,591 in additional, authorized perks it paid to Redman. As a result of these failures, the company issued public filings that included material misstatements regarding executive perks and stock ownership, and failed to accurately record Redman’s perks in its books and records.
While the defendants neither admitted nor denied the allegations made by the SEC, they consented to a C&D and the former CEO agreed to pay a $195,046 penalty. But in order to understand the alleged shortcomings in the company’s disclosure controls & procedures surrounding perks and pledges, you need to check out what the SEC claimed in its Order Instituting Proceedings. Highlights include:
– The CEO had a 50% ownership interest in a company that owned an airplane that he used for business travel. It sent invoices to the company for his flights, which the CEO initialed for approval and passed on to the accounts payable supervisor in the same manner as all other vendor invoices.
– Despite a policy prohibiting personal use of company credit cards, the CEO and his family made over $125,000 of personal charges that were not reimbursed and were not disclosed in the company’s proxy statement.
– The CEO pledged stock without obtaining prior board authorization, and subsequently obtained board approval of a negative pledge arrangement with another bank that prohibited him from disposing of the stock. He did not inform the board of the earlier pledge, nor did the company disclose either pledge in its proxy statements for several years.
How did all of this (and more) get missed? Part of the answer appears to be a lax approach to handling D&O questionnaires. Here are paragraphs 24 & 25 from the SEC’s Order:
24. On January 27, 2017, approximately one week after the close on the loan for his first ranch with its associated stock pledge, Redman completed his “D&O Questionnaire” for the disclosures in the company’s Form S-1 Registration Statement. Redman completed and signed the 2017 D&O Questionnaire, but left the line item for pledged shares blank. In 2018, Redman did not complete a D&O Questionnaire at all. On January 21, 2019, Redman completed the D&O Questionnaire but did not submit Schedule B, “Security Ownership and Recent Transactions in Company Securities,” which should have described his ProPetro equity ownership including his stock pledges.
25. Redman also did not identify in his D&O Questionnaires any of his personal trips on the Aviation Co. Learjet, the personal charges he made on the corporate credit card, or the additional perquisites authorized by the company. In his 2017 D&O Questionnaire, Redman included some perquisites for his company car, but failed to include any of the additional perquisites detailed above. In 2018, Redman failed to complete a D&O Questionnaire. On January 21, 2019, although Redman included some perquisites in his D&O Questionnaire, he did not disclose the personal air travel, any of the personal credit card charges reimbursed by the company that year or the various previously authorized perquisites detailed above.
The good news for the company was that the SEC lauded its cooperation. The bad news for the company’s executives was that in order to get that pat on the back, the board replaced them with an entirely new management team.
This 29-page memo from FW Cook analyzes 2021 director pay at 300 companies of various sizes & industries. For the most part, practices around board retainers, equity grants, annual compensation limits and stock ownership guidelines have remained pretty steady from year to year. One area that is changing, though, is that more companies are establishing an ESG-related committee. Here’s what FW Cook found about that:
Thirty-six of the 300-company sample, (12%) included an Environmental, Social, and Governance (ESG)-related committee. Of those companies, 22 were in the Energy sector (61%), five were in the Financial Services sector (14%), five were in the Retail sector, and four were in the Industrial sector (11%). Additionally, 18 were large-cap (50%), 13 were mid-cap (36%), and only five (14%) were small-cap.
ESG committee chair retainers were $15,000 at the median, which we observe to be aligned with the median of Nominating/Governance committee chair retainers for the 2021 study broadly. About one-third of companies with an ESG committee provide a member retainer or meeting fees.