ON Securities : Securities Lawyer & Attorney for Corporate Governance & Executive Compensation Matters

How to Play Say-on-Pay

It's a pretty good bet that non-binding shareholder advisory votes on executive compensation ("Say-on-Pay") will be adopted this year and will become mandatory for public companies, probably starting with the 2010 proxy season. There are several different pieces of proposed governance reform legislation in Congress, and virtually every one of them would, if adopted, require Say-on-Pay. See the ON Securities Cheat Sheet for details. If Say-on-Pay becomes a reality, this would be in line with the prediction I made in my StarTribune Business Forum commentary last April.

So, what does Say-on-Pay look like in practice, and what is the likely outcome of the shareholder vote? A recent alert by Compensia, a compensation consulting firm, gives a good summary of the proxy statement language used by various companies and the reported results to date. So far, very few companies have reported the results of advisory votes, but in most cases the resolutions approving compensation have passed by wide margins. We should see the reported results of many more votes soon - hundreds of financial institutions that received TARP funds were required to conduct advisory votes in the past few months. The results of most of these votes will be reported in 10-Qs over the next few weeks, and we should get a clearer picture of the atmosphere for these proposals, especially within the financial services industry.

Assuming Say-on-Pay is required to be on the ballot in 2010, what should companies do now? At the very least, companies should start planning early to review their proxy statement disclosures, including CD&A, to address concerns that institutional investors are likely to raise. I recommend reading the RiskMetrics 2009 report, "Evaluating U.S. Management Say On Pay Proposals" (note: you will need to create a free RiskMetrics account if you don't already have one). This report outlines a set of factors that RiskMetrics advises investors to consider in evaluating an advisory vote. Expect RiskMetrics to come out with a more specific set of guidelines in preparation for the 2010 proxy season. Compensia, in its alert, also recommends planning a program of shareholder communications regarding compensation matters.

Another resource is the Say-on-Pay web forum, sponsored by Corporate Secretary magazine, which looks like it will be providing ongoing analysis of Say-on-Pay votes.

What is your company doing to get ready for Say-on-Pay? How much of a pain will it be? Post a comment below or send me a confidential e-mail.

Updated Cheat Sheet Posted

We have just posted an updated version of the ON Securities Cheat Sheet under the Resources listing on the home page of this Blog. The updated document describes the Corporate Governance Reform Act of 2009 introduced by Minnesota's own Rep. Keith Ellison. The Cheat Sheet also reflects the actual introduction of the bill previously proposed by Treasury Secretary Geithner and now introduced by Rep. Barney Frank.

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As described previously, on July 1, 2009, the SEC approved by a 3-2 vote an amendment to New York Stock Exchange Rule 452 to eliminate broker discretionary voting in uncontested elections of directors. Of all the recent proposals (see the ON Securities Cheat Sheet), this was the first to be adopted, and this change may have the biggest practical impact on corporate governance for most companies. The rule change is effective for shareholder meetings held on or after January 1, 2010, and it is likely to make it more difficult to get affirmative votes in favor of management's slate of directors.

So for management of a public company, is this your worst nightmare? Maybe it's a little early to start screaming. But at the very least, it's not too early to do some advance planning to avoid surprises for the board. And for the in-house attorneys I work with, it's always a good idea to avoid surprises for the board. Or you WILL have something to scream about.

So what should a company do to prepare? Georgeson, a leading proxy solicitation firm, recently did a good explanation of the possible impact of the amendment, including three main tips:

Analyze - run some numbers to determine the possible impact of the amendment on your next election, including the possible impact of factors that might lead proxy advisory firms like ISS/RiskMetrics to recommend a vote against the incumbents.

Communicate - develop a communication plan to educate retail investors on the importance of voting and a last-minute "get out the vote" campaign, just in case.

Prepare - develop a damage control plan in case of a large percentage of negative votes (or a failed election, in the case of a company that has adopted majority voting for directors).

I talked to one in-house attorney who has started to run analyses of historical vote patterns to predict how the next election will come out. What is your company doing? And how much impact do you think the amendment to the broker voting rules will have? Post a comment below or send me an e-mail.

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Is your head spinning from the number of new developments in corporate governance and compensation reform? Are you dizzy from trying to remember whether "say-on-severance" is part of the Schumer Bill or the Treasury Department's white paper? Is your heart racing from trying to keep track of the progress of shareholder access proposals?

We have just the answer - the ON Securities Cheat Sheet will cure what ails you. The Cheat Sheet is a one stop shop for "capsule summaries" of each bill and regulatory proposal being considered. These capsules are sure to make you feel better - and in the spirit of health care reform, this remedy is ABSOLUTELY FREE!

We can't promise that the Cheat Sheet contains the most in-depth analysis available of each bill and regulatory proposal. But it's helpful just to be able to scan the different proposals. For example, it's helpful to see that Say-on-Pay for all public companies is proposed as part of the Schumer bill, the Peters bill, and the Treasury Department's legislative proposal. At the same time, the SEC's proposals issued on July 1 included proposed Say-on-Pay standards for TARP recipients, which have previously been subject to Say-on-Pay requirements under the recovery bill.

We will continue to include the Cheat Sheet in the "Resources" section featured on the home page of this blog, and we will do our best to keep the document up to date. Since you'll be able to put the developments in context, your head should stop spinning. However, I can't make any promises about dizziness. Watching progress of the various proposals making their way through Congress and the regulatory agencies reminds me of the arcade game where you can watch the little mechanical horses race around and around the track, with the lead constantly changing. Here's a great video that shows you what I mean.

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More on the SEC's Proposed Amendments to Disclosure Rules

As described previously, the SEC's newly proposed amendments to its disclosure rules, issued on July 10, 2009, would require significant new proxy disclosures - disclosure of compensation policies and their impact on risk and risk management, and a new method for reporting of the value of equity awards in the Summary Compensation Table. The proposals include other notable requirements as well. Here is a description of what is covered and what is not covered in the proposals:

Compensation Consultant Information. The amendments, if adopted, would require additional disclosures about compensation consultants, if they play any role in determining or recommending executive or director compensation. The proxy statement would need to include information about the fees paid to the consultant and any affiliates of the consultant during the last fiscal year; the additional services provided to the company by the consultant and its affiliates; and whether the consultant was recommended by management.

Since that time, the issue of consultant conflicts has surfaced numerous times. A 2007 study commissioned by a House committee found that the data "suggested" a correlation between the levels of CEO pay and percentage of the consultant's fees derived from services other than executive pay advice. However, a 2008 academic study coauthored by professors at the Wharton School found "no compelling evidence" that consultants with higher level of non-executive services were engaging in "rent extraction" (i.e., giving executives higher pay to keep the non-executive business). In any event, the SEC is proposing to mandate the enhanced disclosures, which seem likely to "chill" compensation committees' use of consultants that provide other services to the company.

Other Proposed SEC Disclosure Requirements. The SEC's proposed amendments would also require:

• new disclosures about the qualifications of directors and director nominees, including a statement about the specific skills they possess that qualify them to be directors and committee members;


• disclosure of the company's leadership structure, including the identity and role of a lead director, if the company has one;


• disclosure of the board's role in the risk management process; and


• current reporting of the results of shareholder votes on Form 8-K.

The release also proposes technical amendments to the proxy solicitation rules.

What the Proposed Amendments DO NOT Do. Notably, the SEC's proposed amendments do change or clarify the compensation disclosure rules in their most problematic area - the extent to which the company must disclose the performance target levels upon which compensation is based, and whether the target levels may continue to be excluded based on competitive harm. This issue is certainly the source of the most frequent SEC comments on proxy disclosures. However, the SEC's proposing release requests public comment on whether the exclusion based on competitive harm should be eliminated. The release, on page 65, also encourages any interested person to suggest additional changes to the rules. Stay tuned, and look for final rules this fall, so they can be effective for the 2010 proxy season.

"Love the Orange"

In launching the ON Securities Blog, one of my major decisions was the color environment (after all, if the site looks great, who cares about the content?). WordPress software has some cool choices, and I really liked the color scheme called "Love the Orange" - in fact, I loved it. After I had taken decisive action and made this selection, one of my partners validated my choice by telling me that "orange is the new power color." Who knew? Of course this selection has made a big impact on my life - see the picture of my new, powerful identity.

[caption id="attachment_255" align="alignnone" width="222" caption="Blogger a L'Orange"][/caption]

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Proposed Compensation Disclosure Amendments Affect Risk Disclosures and Summary Compensation Disclosure Table Values

Last Friday, the SEC issued its release that details the proposed amendments to the compensation disclosure requirements for public companies, which the SEC approved on July 1. If adopted, the changes would generally be effective for the 2010 proxy season. Two of the most important proposed changes:

CD&A. The SEC proposes to add a new instruction to the requirements for the Compensation Discussion and Analysis section of the proxy statement. A company would be required to disclose how its overall compensation policies for employees create incentives that can affect the company's risk level, and its management of risk. The disclosure is required if the compensation policies (including compensation of non-executives) create risks that may have a "material adverse effect" on the company. The new CD&A instruction includes a laundry list of situations that might require disclosure, such as the payment of bonuses based on short-term goals, in situations where the risk to the company extends over a longer period of time.

Comment: The examples in the instruction seem like they are lifted right out of the pre-meltdown playbooks of Lehman Brothers and other financial institutions - the bonus practices of these institutions clearly encouraged risky practices that brought down some of the institutions and nearly brought down the world economy. In other industries, it's hard to imagine that companies will come to the conclusion that their compensation practices create "material risks" for the company.




 




Assuming the SEC adopts the new instruction, I would guess that very few companies other than financial institutions will disclose anything but a generic sentence stating that the company has done the risk assessment and found nothing material. For the financial institutions that have accepted TARP funds, the American Recovery and Reinvestment Act of 2009 and the related Interim Treasury Regulations already require specific risk assessment in their compensation practices. For other companies, does the SEC really need to add two pages of instructions to CD&A, for such a limited result for most companies? My guess is that the Commission was responding to public pressure to do something about the risky behavior that led to the current economic mess.

 

Comment: This change reverses the last-minute change the SEC made in the SCT disclosures in December 2006, without public comment and just as the compensation disclosure rules were going into effect. The 2006 SEC release that implemented the "December surprise" stated the SEC's belief that "this disclosure ultimately will be easier for companies to prepare and investors to understand." In fact, the effect was just the opposite - the current amounts are difficult to calculate and confusing to investors, as each year's dollar amount includes a variety of equity awards that have been granted in different years and are amortized over time. As famously reported by Gretchen Morgenson of the New York Times, the current calculation method can actually lead to negative compensation numbers for some executives in some years. The new method, if it is adopted, will be more predictable and will relate more closely to the equity grants made in the year in question.

And that's not all. The proposed rules would make a number of other changes, which will be discussed in a future posting.What do you think of the proposed amendments? Post a comment below or send me an e-mail and let me know.

You Don't Have to Work at a Small Public Company to Enjoy These Podcasts!

Our June 24 program for the Small Public Company Forum is now available as a series of downloadable podcasts. The Forum program contains valuable insights from experienced professionals at several firms on:

• Detection of financial fraud, and Section 404 internal controls compliance.
• Raising money in the current economic environment.
• How to deal with underwater stock options (yes, this was my program with the singing fish!).

Unfortunately, the podcast does not come with the delightful breakfast hosted by the Forum sponsors. If you want to get notice of future programs, subscribe to RSS e-mail updates in the top gray box on the right side of the Forum website.

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ABA Releases Exposure Draft of Model Bylaw for Shareholder Access

TheCorporateCounsel.net Blog reports that the ABA's Task Force on Shareholder Proposals has released an exposure draft of a model bylaw for Delaware corporations to grant shareholder access - giving significant shareholders the ability to nominate one or more director candidates and have the candidates included in management's proxy statement. The model bylaw provides a company with flexibility in its provisions, including the percentage of the company's outstanding stock the stockholder must hold, and the length of time the stockholder must have owned the shares. The Task Force has asked for comments on the model bylaw.

It's not clear how many companies will voluntarily adopt the Task Force's model bylaw without being required to do so. The Delaware General Corporation Law was amended in April 2009 to add a new Section 112 to facilitate bylaws such as the model bylaw. Before 2007, numerous companies faced shareholder proposals supporting shareholder access. The SEC in 2007 determined that management could refuse to include these shareholder proposals in their annual meeting proxy statements. However, there may still be pressure on public company boards to allow shareholder access.

The SEC's proposed rules on shareholder access, if adopted, will make shareholder access mandatory and will eliminate much of the flexibility incorporated into the model bylaw. The Task Force clarified that the model bylaw does not take the SEC's proposed rules into account. However, assuming the SEC's rules become effective, public companies will move to adopt bylaws to clarify the procedures and standards for shareholder access, and the Task Force's draft will be a useful starting point.

The King of Pop - and IP

Working with companies and entrepreneurs gives you an appreciation for innovative business leaders. And whatever you think about Michael Jackson, the guy was a genius within the entertainment business. Some of his business ventures are well known - like his purchase of most of the Beatles' music catalog in the mid-1980s. But until I read his Wikipedia profile, I didn't realize that he was the named inventor on an issued patent. Michael developed an illusion for dancers performing "Smooth Criminal" to lean far forward, as if defying gravity. The trick was originally done with wires, but the Gloved One helped develop special shoes for the trick, and in 1992 he and two co-inventors were granted U.S. Patent 5,255,452: "Method and Means For Creating Anti-Gravity Illusion". Unbelievable - see the video in this article.

If only he had survived long enough to develop "Method and Means for Creating an Economic Comeback."

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The SEC takes action on July 1, but that's not the whole story.

On July 1, 2009, the SEC voted to take several actions:

The Commission proposed rules that would clarify the statutory requirement that TARP recipients hold annual stockholder votes on compensation ("Say-on-Pay").

The Commission proposed revisions to the compensation disclosure rules that, among other things, would (1) disclose the relationship to risk of a company's overall compensation policies (not just policies covering top executives) and (2) disclose potential conflicts of interest of compensation consultants.

In probably the most important move, the Commission approved the New York Stock Exchange's proposal to eliminate discretionary voting in elections of directors. Therefore, brokers must receive instructions from the beneficial owner before voting. The conventional wisdom is that brokers acting without instructions generally vote in favor of management's slate, and that this change will reduce the percentage of shares voting for the director candidates in routine elections. The Wachtell Lipton law firm presented an interesting analysis of this issue in March, taking the position that the current broker votes in favor of management are a pretty good proxy for the votes of retail stockholders, who generally support management's candidates.

However, to understand the impact of the July 1 actions, it is necessary to understand other current developments, some of which would have an even greater impact on a broader segment of companies:

The Commission's Say-on-Pay proposals covered only TARP recipient companies. However, the Shareholder Bill of Rights Act introduced in the Senate by Senator Schumer, if adopted, would mandate Say-on-Pay for all public companies, as would two other bills currently being considered by Congress.

The Commission did not require that public companies adopt a specific structure to assess risk and ensure that compensation practices are consistent with the company's risk profile. However, the ARRA and the Treasury's interim final rules currently require the compensation committees of TARP recipients to perform specific risk management functions. Also, the Schumer bill would require that the board of directors of all public companies form a risk committee of independent directors to report to the board about the company's risk profile and the appropriateness of its compensation practices.

The elimination of discretionary voting by brokers takes on added importance because it could alter the balance of power between management and activist stockholders, especially for companies that have adopted majority vote standards in director elections. This shift would compound the potential increase in power by institutional investors that would result from the Commission's controversial proxy access proposal, reported here, which would allow large stockholders to nominate director candidates who would be included in management's proxy statements.

The bottom line: you need a scorecard to keep everything in context. The ON Securities Blog is working on a scorecard that will cover the SEC proposals, the Schumer bill, other pending bills and the Treasury regulations under TARP and the stimulus bill. What would you like to see covered? Send me an e-mail and let me know.

Maslon Small Public Company Forum's Inaugural Event is a success (singing fish and all).

On June 24, 2009, I participated in the inaugural event of the Maslon Small Public Company Forum, which included presenters from Maslon, Baker Tilly Virchow Krause, Carver Moquist & O'Connor, Feltl and Company and Internal Control & Anti-Fraud Experts, LLC. Course materials and podcasts of the presentations are available at the Small Public Company Forum website, which we hope will be a great resource for small public companies across the region.

For my presentation on underwater options entitled "Underwaterworld", I presented the "world's leading expert on underwater options": Big Mouth Billy Bass, the famous singing fish. You can watch Billy's full performance here. In his immortal words, once you solve your company's underwater options problem, you can take his advice: "Don't Worry, Be Happy!"

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