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

In the spring, a securities law blogger’s fancy turns to thoughts of . . . proxy season. And baseball season. Wouldn’t it be great to combine the two?

Earlier this spring, the Minnesota Twins made news headlines by signing All-Star catcher and 2009 American League MVP Joe Mauer to a new 8-year, $184 million contract extension. As Joe Christensen of the StarTribune put it, “Relax, Twins Fans: Joltin’ Joe Stays”.

But what if Mauer were an executive at a public company? Based on new rules adopted by the SEC, as summarized in the ON Securities Cheat Sheet (PDF), after dealing with Mauer’s agent, the Twins (and their securities lawyers) would now have to deal with several newly required disclosures in the proxy statement for the team’s annual shareholders’ meeting. One new item requires public companies to discuss the risk aspects of their compensation policies and practices for employees, if these risks are reasonably likely to have a material adverse effect on the company. Speculating on how the Twins might approach such a discussion, the proxy statement might include the following:

[Hypothetical] Disclosure of Compensation-Related Risk. The compensation committee of the Minnesota Twins Baseball Club (herein the “company”) regularly conducts a risk assessment of the company’s compensation policies and practices for its executive officers and other employees. The committee’s assessment for the current year focused in large part on the company’s recent amendment to its employment agreement with Chief Offensive Officer and Chief Defensive Officer (COO/CDO), Joseph P. Mauer. The committee has determined that Mr. Mauer’s new compensation package, which guarantees him cash payments totaling $184 million through the 2018 Major League Baseball season, is reasonably likely to create a material risk for the company. The long-term and guaranteed nature of Mr. Mauer’s compensation eliminates meaningful performance-related compensation incentives that generally apply to whose contracts are incentive laden or for shorter terms. However, the committee believes that risks resulting from elimination of monetary incentives are substantially offset by Mr. Mauer’s highly competitive personality and desire to bring a World Series Championship to his home state of Minnesota. There is also a risk that Mr. Mauer’s high levels of annual compensation will hinder the Twins’ ability to employ the talent at other positions necessary to compile a winning team in the future. However, the committee believes it has appropriately balanced the risks arising from amending Mr. Mauer’s contract against the risk of recurring decreases in annual revenue from ticket sales that might have resulted had the company failed to do so.

And elsewhere in our hypothetical proxy statement, you might read the following:

[Hypothetical] Disclosure of Director Qualifications. The following is a narrative disclosure regarding the experience, qualifications, attributes or skills which, in light of the company’s business and structure, led the company’s board of directors to conclude that the company’s COO/CDO, Joseph P. Mauer, should serve on the board of the company, i.e., should be maintained in a leadership position. Such experience, qualifications, attributes and skills can appropriately be summarized as follows: ‘HE’S JOE MAUER.’

Let the proxy season begin. And Play Ball!

Thanks to my Maslon partner and Twins fan and securities lawyer extraordinaire, Alan Gilbert, for his assistance in drafting the above disclosures.

Image: Wikimedia Commons

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

As many readers know, under the new proxy disclosure rules, this year public companies are required to include a disclosure in their proxy statement to the extent that “. . . risks arising from the registrant’s compensation policies and practices for its employees are reasonably likely to have a material adverse effect on the registrant.” I have received questions from a number of public companies, asking how management and the compensation committee should evaluate this risk. In many cases, at the beginning of the process, they are fairly comfortable that the compensation practices at their company do not create disclosable risks (especially if the company is not a financial institution), but they want to make sure their evaluation is thorough and reasonable. In making this evaluation, the compensation committee has to broaden its scope beyond executive officers. On the other hand, it is generally not practical for the committee to evaluate the compensation of all employees.

I often point compensation personnel to the language of new Item 402(s) of Regulation S-K added by the new rules, which includes the following laundry list of “situations that might trigger disclosure”:

“. . . compensation policies and practices: at a business unit of the company that carries a significant portion of the registrant’s risk profile; at a business unit with compensation structured significantly differently than other units within the registrant; at a business unit that is significantly more profitable than others within the registrant; at a business unit where compensation expense is a significant percentage of the unit’s revenues; and that vary significantly from the overall risk and reward structure of the registrant, such as when bonuses are awarded upon accomplishment of a task, while the income and risk to the registrant from the task extend over a significantly longer period of time. . . .”

Item 402(s) specifies that the above list is not exhaustive; however, it is a good starting point. As one part of its evaluation, the committee should consider whether any of the company’s business units fit the descriptions in the above list. In any such subsidiary or division, the key employees or groups of employees should be included in the committee’s evaluation. If the compensation committee considers these employees or groups in addition to the compensation practices relating to executive officers, the committee can be more comfortable that its evaluation satisfies the requirements of the new disclosure rule.

Compensation Consultant Releases Study of Performance Metrics

Compensation consultants James F. Reda & Associates recently issued its Study of 2008 Performance Metrics Among Top 200 S&P 500 Companies (PDF). Reda studied 2009 proxy disclosures and has identified trends in compensation and disclosure practices. Among the findings included in the detailed tables:

• Long-term performance-based awards were used by 75% of these companies in 2008, compared to 67% in 2007.

• Stock option grants were used by 67% of these companies in 2008, compared to 64% in 2007.

• Short term incentive plans most often used metrics based on earnings per share or income.

• Long term incentive plans most often used metrics based on total shareholder return.

Reda also noted that the percentage of these companies that reported performance target levels in their proxy statements did not increase in 2008 compared to 2007. It will be interesting to see whether this percentage increases in 2010, as many companies have received SEC comments that ultimately would require disclosure of the performance targets for the prior year.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In “The Origins of Lehman’s ‘Repo 105’”, a recent post from the New York Times DealBook Blog, authors Michael J. de la Merced and Julia Werdigier discuss the so-called Repo 105 technique. Repo 105 came to light in the 2,200-page report of the court-appointed examiner in the bankruptcy case. Using this technique, Lehman was able to move $50 billion in debt off its balance sheets just before the end of each of the last several quarters leading up to the company’s collapse. The techniques used by Lehman are reminiscent of the types of misleading accounting practices I thought had ended after the Enron and WorldCom scandals:

"Like all repos, short for 'repurchase agreements,' it involved what amounts to a short-term loan, exchanging collateral for cash up front, and then unwinding the trade as soon as overnight. . . . Unlike other repos, the value of the securities Lehman pledged in Repo 105 transactions were worth 105 percent of the cash it received. . . . Yet the beauty of Repo 105 was that, . . . . the firm could book the transactions as a 'sale' rather than a 'financing,' as most repos are regarded. That meant that for a few days — and by the fourth quarter of 2007 that meant end-of-quarter — Lehman could shuffle off tens of billions of dollars in assets to appear more financially healthy than it really was."

The DealBook post goes on to describe that Lehman could not get any U.S. law firms to give a legal opinion that the transaction was a “true sale” rather than a loan. So Lehman went opinion-shopping and got the U.K.-based law firm Linklaters to give the “sale” opinion under English law. To accomplish this, Lehman moved the transactions offshore, to its European subsidiary (even though it still used a large amount of U.S.-originated securities). Even though Martin Kelly, a former financial officer, had questioned whether there was any purpose for the transactions other than to manipulate the balance sheet, Lehman’s top officers and advisors seemingly did not ask the hard questions. As described in this additional DealBook post on the topic, the examiner’s report leaves the door open for lawsuits and enforcement proceedings against all of these parties. We will be hearing about “Repo 105” for a long time to come.

A word for Repo 105 comes to mind that I always thought originated, like Lehman’s legal opinion, in the U.K.: “Shenanigans”. It turns out that its origin is uncertain, but it sounds Irish, so I guess that’s close enough.

Image: Wikimedia Commons

• Email This
• Print
• Comments
• Trackbacks
• Share Link

I am very pleased to announce the return of the ON Securities Blog. The blog is now part of the LexBlog network of legal blogs, and it features improved design as well as better functionality and support. I hope you will notice the difference.

As always, I will do my best to provide topical, useful and, if possible, entertaining commentary on securities compliance, corporate governance and executive compensation. The second part of this post, below, discusses the latest reform legislation being proposed by Senator Dodd, and places it in context with other proposed reforms in governance and compensation.

Occasionally, this blog will also cover other aspects of the world of private practioners and in-house counsel, or the new world of social networking – such as these previous posts:

• “I Am Not a Crook” described useful lessons learned from a legal ethics program taught by Bud Krogh, a former assistant counsel in the Nixon White House who served jail time for his role in the break-in of Daniel Ellsberg’s psychiatrist’s office.

• “Preview of Coming Attractions, and a Movie Review” included a review of the movie Julie and Julia, the first major film about blogging. The blog included a commentary about the relationship between bloggers and their readers.

• "The Color of Blogging", which described the "very important" choice of a color scheme for the first version of this blog (and told the story of the picture of me above).

I appreciate the support of the readers who made the blog a success the first time around. I will try to find new ways to reach out to readers in the near future. Let me know if you have any suggestions or other comments. 

The New Dodd Bill: A Preview of Possible Governance and Compensation Reforms

On March 15, Senator Christopher Dodd released a new 1,300+ page discussion draft of his proposed comprehensive financial reform legislation, the Restoring American Financial Stability Act of 2010 (PDF). In addition to the provisions designed to reform the banking industry, the draft bill includes a variety of corporate governance and executive compensation reforms. For all public companies, the bill would

• require Say-on-Pay, a non-binding annual stockholder vote on executive compensation;

• authorize the SEC to require proxy access, which would enable major stockholders to nominate director candidates and have the nominees included in management’s proxy statement;

• authorize compensation committees to hire consultants and counsel, and establish standards for independent advisors to compensation committees;

• require proxy disclosure of executive pay vs. performance (including a chart); and

• require disclosure of whether the company permits hedging by directors and employees, and why the company chose to (or not to) separate the positions of chair and CEO.

For all listed companies, the draft bill would

• require majority voting for directors (with standards for accepting or rejecting the resignation of directors);

• establish independence standards for compensation committees; and

• require a clawback policy for all executive officers in the event of financial restatements.

I have reflected these features of the Dodd bill in a newly updated version of the ON Securities Cheat Sheet (PDF). The Cheat Sheet is a two-page summary of recent and proposed reforms affecting corporate governance and executive compensation, including SEC rules and proposed legislation. It’s meant to be an antidote for the dizziness and disorientation caused by diving into 1,300 page documents. To make it an even more handy reference, you can always find a link to the most up-to-date version on the home page of this blog, in the orange box at the right side cleverly captioned “ON Securities Cheat Sheet”.

The Dodd bill includes many of the same governance reforms as the Shareholder Bill of Rights Act of 2009 (PDF), introduced by Senator Charles Schumer in May 2009 and also described in the Cheat Sheet. Like the Schumer bill, the draft Dodd bill includes corporate governance reforms, with some variations. For example, the Dodd bill authorizes, but does not require, the SEC to provide proxy access to facilitate stockholder nomination of director candidates. Also, both bills require majority voting for directors for uncontested elections of listed companies. However under the Dodd bill, if a director does not receive a majority of affirmative votes, the board of directors may elect to accept that directors resignation or, by a unanimous vote, reject the resignation. This is different from the Schumer bill, under which the board is required to accept the director’s resignation.

Over the next several months, the provisions of the various bills in Congress will continue to be reconciled, and the SEC will continue to consider its proposed rules. The pace of reform has slowed somewhat, but as I have said before, the various reforms are still jockeying for position like horses in an arcade game making their way around a race track, with the lead constantly shifting – similar to the game in this video:

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In the past couple of weeks, the IRS began to mail audit notices to companies in its first major study of employment tax practices in 25 years. Even companies that are not targeted right away should be aware of the new program, and the shift it signals in the IRS’s posture toward executive compensation.

Last fall, the IRS announced that it will randomly select 2,000 businesses per year over the next three years for examination of their employment tax practices as part of the Employment Tax National Research Project. The IRS announcement says that the examinations “will be comprehensive in scope”. Over at Bloomberg, reporter Ryan J. Donmoyer confirmed that the examinations will include a detailed review of executive compensation tax practices for the subject companies.

Commentary. If your company is one of the lucky 2,000 selected for examination this year, you obviously have your work cut out for you. But if you don’t get a notice, why should you care about the IRS program? Because it signals a shift in IRS policy toward complex executive compensation taxation issues. Your friendly tax collector is likely to get less friendly when it comes to executive compensation.

Employers structuring executive compensation programs have to deal with the complex and sometimes fuzzy requirements of:

• Section 409A covering non-qualified deferred compensation; and
• Section 162(m), the cap on deductibility of some executive compensation of public companies.

Clients have often asked us about the risk of an IRS audit covering these and other executive compensation tax issues. Until now, there was very little evidence that the IRS was targeting these areas.

However, the IRS’s new initiative indicates that there may well be a new focus on compensation tax issues, and the initial 6,000 targeted companies will just be the first step. One of the main goals of the new initiative is “. . . to determine compliance characteristics so IRS can focus on the most noncompliant tax areas.” In other words, expect the IRS to use the information gathered in the study to get more aggressive with a broad range of companies in connection with specific practices under Section 162(m) and Section 409A.

Therefore, executive compensation professionals at public companies (and privately held companies as well) should be reviewing their compliance with executive compensation tax requirements with additional care.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link