Some Comments on the SEC's Proposed Pay Ratio Disclosure Rules

Last week, the SEC issued its long-awaited proposed pay ratio disclosure rules (PDF), required by Section 953(b) of the Dodd-Frank Act. As has been widely reported, the rules will adopt new Item 402(u) of Regulation S-K, requiring public companies to disclose the ratio of the median annual total compensation of all employees to the annual total compensation of the CEO. The public comment period for the rules expires on December 2, 2013.

The SEC’s fact sheet on the proposed rules gives a helpful summary. I also saw an especially helpful posting on The Conference Board Blog: “The Five Most Important Things Companies Need to Know and Do About the SEC’s Proposed CEO Pay Ratio Rules” by Jim Barrall of Latham & Watkins. To paraphrase:

  • The rules don’t apply to smaller reporting companies or certain other categories.
  • The rules will likely take effect in 2014, first applying to 2015 for calendar year companies, with the first report likely due in the proxy statement (or Form 10-K if no proxy statement is filed) in early 2016.
  • The proposal allows substantial flexibility in complying with the rules, including permitting statistical sampling or reasonable estimates. Issuers can also use simplified measures to identify the median employee.
  • The most burdensome and costly aspect of the rules is the inclusion of part-time, seasonal, temporary and non-U.S. employees in determining the median employee.
  • During the next two months, companies should start to determine how to gather and analyze the necessary information, and should consider filing comments with the SEC about the burdens of doing so.

Here are a few more points:

  • In a commentary on (subscription site), Mark Borges  speculates that most companies will include the disclosure somewhere in Compensation Discussion and Analysis in the proxy statement – in the executive summary, in the discussion of internal pay equity or benchmarking, or in a separate subsection of CD&A.
  • Borges also points out that the SEC’s Proposing Release allows the company to supplement the required disclosure with a narrative. The company may also include additional ratios, as long as they are clearly identified and not misleading, and not presented with greater prominence than the required ratio. So companies will have a chance to tell their own story.

Commentary. The disclosures will be a pain to deal with, and will be expensive for global companies in particular. But it looks like the rule is here to stay. During 2015 in preparation for the first disclosures, companies will spend a lot of time and resources determining the best method for determining the median employee and that employee’s total compensation as calculated under Item 402(c)(2)(x) of Regulation S-K. But life will go on, and after the first year, the process should get easier.

As been stated in many other commentaries, the benefit of the disclosure to investors is uncertain at best. I agree with Borges’ statements, reported in this Wall Street Journal article, that company-to-company comparisons won’t be all that meaningful, but the ratio will be most useful in assessing pay equity over time as it grows or shrinks. But regardless of the utility of the required disclosures themselves, hopefully compensation committees will ultimately view the new requirement as an opportunity to communicate their policies in a positive way.

The Ratio

[Disclaimer: An attempt at Item 402(u)-related humor follows. Because sometimes we just have to laugh.]

Soon a public company will be required to identify its median compensated employee and compare that employee’s compensation to that of the CEO. What if a company took this disclosure to the next level: don’t we want to learn something about the employee? Maybe you could see something like this in a future proxy statement:

After a careful study utilizing its proprietary statistical sampling analysis, the Company has determined that its median compensated employee (“MCE”) is Ralph Snowden, age 37, pictured below. Since 2008, Mr. Snowdon has served as a senior fry cook at the Company’s West Des Moines, Iowa restaurant. Prior to that time, he held a wide variety of kitchen positions with companies in the fast food industry. As shown in the Summary Median Compensation Table (“SMCT”) below, in 2015, our MCE’s total annual compensation was $37,440. In 2015, the mathematical ratio of the total annual compensation of Ralph Snowden to that of our CEO, Ruth Swenson (the “Ralph to Ruth Ratio”) was one-to-238, or 0.0042016-to-one.

Wouldn’t that be more fun? But now that I think about it, I’m not sure any part of Item 402(u) will work in Minnesota, where all the employees are above average.

Thanks to my partner, Alan Gilbert, for the concept for "The Ratio."

The Readers' Guide to Annual Meeting Lawsuits

As an increasing number of companies have been hit (or threatened) by shareholder derivative lawsuits prior to their annual meeting, the number of articles, posts and other materials discussing these cases has also increased. A few of these articles, discussed below, should be on the reading list for anyone who might be faced with defending one of these actions.

The annual meeting lawsuits are filed after the mailing of the proxy statement, seeking to enjoin the shareholder vote or votes based on purported incomplete or misleading disclosures and claimed breaches of the directors’ fiduciary duties. I have called these cases the second generation of “Sue-on-Pay” lawsuits, because they focus mainly on the Say-on-Pay vote and, often, a separate shareholder vote to increase the share authorization of an equity plan. [A third type of claim, not compensation-related, sometimes relates to a shareholder vote to increase the share authorization under the corporation’s charter.]

Most of these lawsuits have been filed by the Faruqi & Faruqi law firm; a review of that firm’s web site shows that since the beginning of 2013, they have announced investigations relating to at least 20 companies’ annual meetings, a step often followed by the commencement of a derivative lawsuit. These cases have become more widely known as a result of a recent Wall Street Journal article, “Anxiety Stalks Proxy Season” by Emily Chasan.

A recent post by David Katz of the Wachtell, Lipton law firm, “The New Wave of Proxy Disclosure Litigation,” offers some very specific and helpful tips on advance preparation for the possibility of an annual meeting lawsuit. Katz first focuses on crafting proxy disclosures that are more likely to withstand challenge, and on advising the board of directors on the possible risk of litigation. Then he provides some tactical advice about steps that might help the company move quickly in the event of litigation:

Companies that are sued in this context and decide to vigorously contest the allegations frequently have been successful. One tactic that has been helpful in some cases is to procure affidavits from significant institutional shareholders to counter the allegations. Such an affidavit can be very persuasive to a court; moreover, in our experience, institutional shareholders generally are not supportive of this type of litigation. Having an institutional shareholder submit a declaration gives the lawyer defending the company the ability to draw a sharp contrast between the interests of shareholders and the interests of plaintiffs’ lawyers who file these lawsuits on behalf of small individual shareholders who often serve that function in multiple cases. Companies that engage regularly with their significant institutional shareholders are more likely to be able to leverage these relationships to procure support when confronted with these lawsuits. Companies have also successfully engaged experts in areas such as disclosure practices to effectively resist preliminary injunction motions. Prior planning is important to be able to marshal the resources necessary to defend against these lawsuits.

Another good post counsels that companies in the process of drafting their proxy statements should be cautious before trying to tailor their disclosures to avoid litigation. In “Changing Your Proxy Disclosures May Not Be the Right Way to Fend Off Annual Meeting Litigation”, Steve Seelig of Towers Watson goes through a laundry list of the types of proxy statement disclosures frequently sought by plaintiffs in these cases and analyzes in very specific terms whether it makes sense to address them in advance. For example:

Equity Plan and Share Authorization Votes . . . [W]e view the request for information on dilutive impact and estimates of run rates to be reasonable and relatively easy to fulfill.  With this information, shareholders can see the current state and forecasts of future dilution, but we would only disclose forecasts based on historical patterns. . . . We are less enthusiastic about providing share usage projections developed for the compensation committee as these often contain hypotheticals that do not come to pass. . . .

Finally, the Society of Corporate Secretaries & Governance Professionals has made available the materials from a January webinar on “Protecting Your Company from Proxy Disclosure Litigation” (PDF). A panel of in-house counsel, outside counsel and a Society representative present a laundry list of steps that can serve as a checklist for a public company that wants to be as prepared as possible.

Or, if you don’t want to do advance planning, you can just file your proxy statement and collectively try to look invisible – maybe look into this company’s claims that it has created an invisibility cloak using its “Quantum Stealth” technology. Hey, buddy, does that cloak come in size “Corporate”?

The Cheat Sheet is Back!

We have posted the latest version of the ON Securities Cheat Sheet (PDF), including the updated status of all of the governance and compensation developments under the Dodd-Frank Act. After several months with very few changes, in January the SEC approved the changes in the listing standards of Nasdaq and the New York Stock Exchange relating to compensation committees and their independence. The Cheat Sheet covers, in one place, the specific requirements of the new listing requirements, the effective dates, and which new provisions cover smaller reporting companies. Check it out.

Thanks to my colleagues Alan Gilbert and Leah Fleck for their help in bringing the Cheat Sheet up to date.


New Brand of "Sue-on-Pay" Litigation Targets Annual Meetings

Call it “Sue-on-Pay – The Sequel.” 

In 2011, several public companies faced lawsuits after losing their Say-on-Pay shareholder advisory votes on executive compensation mandated by the Dodd-Frank Act. As reported in this prior post, a few of these first generation “Sue-on-Pay” lawsuits resulted in settlements, while many since that time have been dismissed. However, in early 2012, a new round of compensation-related lawsuits began, and these lawsuits use a new tactic that presents real dangers. Companies need to use caution in preparing proxy materials for annual meetings, especially in certain cases as described below.

The plaintiffs in this new round of cases have sued over 20 companies prior to their annual meeting, seeking to enjoin shareholder votes based on purported incomplete or misleading disclosures. See “‘Say on Pay’ and Executive Compensation Litigation: Plaintiffs’ New Racket”, posted on the D&O Diary blog by securities litigation attorneys Bruce Vanyo, Richard Zelichov and Christina Costley of the Katten firm. The cases focus on two types of shareholder vote: (1) the Say-on-Pay vote and also, very often, (2) a separate shareholder vote to increase the share authorization of an equity plan (a “share authorization vote”). The attempt to delay vital corporate activities through litigation is similar to the tactic that has been used successfully over the past several years by plaintiffs’ lawyers in merger and acquisition-related litigation. If the litigation threatens the timing of the important events, the defendant company will often be willing to agree to a settlement to end the litigation so life can go on. For a new comprehensive discussion of the impact of the M&A litigation, see “The Trial Lawyers’ New Merger Tax” (download) issued by the U.S. Chamber Institute for Legal Reform.

Vanyo, et al. report that several companies have settled the compensation-related cases in 2012, notably Brocade Communications Systems, Inc. In that case brought in California state court, plaintiffs claimed various disclosure deficiencies in the proxy statement, including failure to include projections of future stock grants under the plan and planned share repurchases, as well as the failure to include the board’s peer group analysis of share usage under the plan. The court issued an order enjoining the share authorization vote. In the ensuing settlement, the company had to delay for a week the portion of the annual meeting involving the share authorization vote. The company was forced to file a supplemental proxy statement in which it disclosed, among other things, the board’s internal projections regarding future stock grants. As is often the case in these types of settlements, the only cash payment was up to $625,000 in fees to plaintiffs’ counsel.

Comment. Reportedly, some of these second-generation Sue-on-Pay lawsuits have been brought solely in connection with the disclosure in the Say-on-Pay advisory vote. However, in Brocade and the other cases where plaintiffs have reportedly been successful in obtaining injunctions and/or achieving settlements, the common denominator is that the company was also seeking an increased share authorization for an equity plan. Although I don’t have access to the courts’ rulings or the settlement documents in all of these cases, I believe plaintiffs can present these share authorization vote cases in a more compelling way:

  • For many companies’ proxy statements in the past few years, the share authorization vote disclosures have been given less thought and scrutiny than the compensation discussion and analysis section that sets the stage for the Say-on-Pay vote. Often, the share authorization disclosure describes the equity plan in detail but gives little or no background on how the requested amount of the share authorization was chosen, the company’s share usage or the board’s intentions in connection with share usage going forward. Therefore, it is fairly straightforward for plaintiffs to pick apart these disclosures and point out alleged deficiencies.
  • The applicable SEC disclosure rule for share authorization votes (Item 10 of Schedule 14A) includes disclosure requirements that relate to some of the deficiencies claimed by counsel in Brocade. (In contrast, the rules for Say-on-Pay votes themselves include no substantive disclosure requirements, but rather refer to the other compensation disclosures, which are usually more polished.) For example, Schedule 14A requires that the proxy statement disclose the number of options to be received under the plan, “if determinable,” by executive officers as a group and other specified persons and groups. In practice, companies generally don’t include these disclosures, because the amounts are not considered to be determinable prior to the compensation committees’ actual decisions to make the awards. Even though the Brocade plaintiffs apparently did not base their argument on this point, a future plaintiff might be able to convince a court that the proxy disclosure rules were not followed adequately.

Therefore, it is reasonable to assume that plaintiffs will have better luck getting traction with cases that involve a share authorization vote than in cases that involve only a Say-on-Pay vote. In fact, there is some anecdotal evidence that lawsuits that relate solely to a Say-on-Pay vote may be defended more readily by the company with less likelihood of a delay in the annual meeting. For example, we have learned of two recent court cases involving annual meetings where there the only compensation-related item on the agenda was the Say-on-Pay vote - there was no share authorization vote. In both cases, plaintiffs’ motion for a TRO was denied by the court in time to hold the annual meeting as originally scheduled. This blog post by Cornerstone Research describes one of the cases, involving Symantec.

Recommendations. At least in the near future, it is likely that these lawsuits to enjoin shareholder votes will continue. Therefore, as other commentators have pointed out, companies should use caution and make sure their compensation disclosures are as complete and accurate as possible.

I would add that companies that intend to seek share increases in the share authorizations for their equity plans should be especially cautious. The proxy disclosures on this topic should be as complete as possible. If the board has considered analyses of share usage or projections of future grants, the company might consider including summaries of this information in the proxy statement. Further, practitioners should take a fresh look at Item 10 of Schedule 14A and err on the side of more disclosure.

For a company that is uncertain about whether to seek an increased share authorization in 2013, my advice would be to delay that vote until 2014 if possible. By that time, the litigation may have died down, or strategies to defeat such lawsuits may be clearer.  

A Few Enhancements on the Way!

I'm delighted to announce that two of my partners in Maslon’s Business & Securities Group, Alan Gilbert and Paul Chestovich, will join me to write some of the posts for ON Securities going forward. Alan and Paul have each written guest posts in the past. Maslon attorney Leah Fleck provided research for this post and will continue to provide editorial assistance. I will continue to be the Blog’s Editor.

In the near future, we will also seek feedback from readers about the Blog, including subject areas you would like to see covered. Also, if any readers would like to write a guest post or contribute to the Blog in some other way, please send me an e-mail.

As always, I would like to thank our readers for their support and feedback over the past three and a half years!

Survey Results Reveal Attitudes About Pay Equity Disclosure

According to a recent survey about the “pay equity” disclosures that will be required in future public company proxy statements, most respondents believe the requirement will be fairly burdensome, but many respondents haven’t spent much time figuring out specifically how their companies will comply. Broc Romanek reported on the results of the survey, conducted by, today in the Advisors’ Blog on (subscription site).

Background. Once SEC rules are adopted, Section 953(b) of the Dodd-Frank Act (848-page PDF) will require proxy statement disclosure of the ratio of the CEO’s annual total compensation to the median annual total compensation of all other employees. Under a timetable that was recently delayed, the SEC expects to propose these rules between January and June 2012 and to adopt final rules between July and December 2012. The disclosure requirement is likely to apply to next year’s proxy statements.

As reported in this prior post, the requirement has been controversial. Companies and commentators have been concerned about the degree of effort that the disclosures will require, and even about whether it will be possible for some companies to comply. An AFL-CIO comment letter in support of the disclosure requirement argued that the SEC should facilitate the calculations by permitting statistical sampling to determine median compensation levels, and by allowing companies to base the median employee pay level on cash compensation.

Survey Results. The results of the (non-scientific) survey (PDF) revealed:

  • Over half of the respondents said that their company has not yet considered how they will comply with the rules.
  • Of the respondents who have assessed the impact of the disclosure rule, only 14% believe the reporting burden will be not too great. The remainder believe strict compliance will either be burdensome or impossible, depending on whether statistical sampling is allowed.
  • Only one respondent reports that their company’s board, when setting executive pay, currently actually reviews and considers the ratio for which the Dodd-Frank Act requires disclosure. On the other hand, almost half of the respondents’ companies consider a different ratio when setting compensation levels – the ratio of the CEO’s pay to that of other senior executives (rather than all employees).

Comment. The last point is consistent with my experience – most boards review and consider the ratio of CEO pay to the compensation of other executives, rather than to that of the average employee. I believe this is consistent with the priorities of most institutional investors. Romanek further discussed internal pay equity in this recent blog post in Blog.

Why Am I Inspired By the Songs of Stephen Sondheim?

As I said in my last post, the theme of the Maslon Law Firm’s holiday project is “Inspiration – Pass It On”. My inspiration – “Studying the Songs of Sondheim.” So why am I inspired by the songs of Stephen Sondheim? And can he teach any lessons to those of us who draft disclosure and communication documents for a living?

I’ve been a fan of musical theater at least since high school, when I got a chance to play Tevye in Fiddler on the Roof. I still love the classic musicals, but I find the shows of Sondheim to be more funny, moving and ultimately challenging than those of any other composer. From the twisted fairy tales of Into the Woods to the revenge of the murderous barber, Sweeney Todd, to the life and art of painter George Seurat in Sunday in the Park With George, Sondheim brings rich characters to life through his songs.

Sondheim’s songs are complex and work on many levels, making them fascinating and satisfying to study. While his music is often beautiful or stirring, the lyrics are always paramount and feature some of the greatest rhymes ever. For example, from Company:

When a person’s personality is personable,
He shouldn’t oughta sit like a lump.
It’s harder than a matador coercin’ a bull
To try to get you off of your rump.

Or, from A Little Night Music (note the two rhymes per line):

DeMaupassant's candor would cause her dismay.
The Brontes are grander but not very gay.
Her taste is much blander, I'm sorry to say.
But is Hans Christian Andersen ever risque?

But rhymes are only one example of Sondheim’s amazing choices of words. Consider the line in “I’m Still Here” from Follies in which the character reminisces: “Then you career from career to career.” And sometimes the lyrics are literally inspiring, as in “Our Time” from Merrily We Roll Along: “It’s our time, breathe it in, Worlds to change and worlds to win.”

I heard Sondheim speak a few years ago, and it struck me how much he loves wordplay – the challenge of finding that perfect combination of words to communicate precisely and economically what is going on. In the Preface of his 2010 book of collected lyrics and commentary, “Finishing the Hat,” Sondheim articulates his three principles of lyric writing:

They were not immediately apparent to me when I started writing, but have come into focus via Oscar Hammerstein’s tutoring, Strunk and White’s huge little book The Elements of Style and my own sixty-some years of practicing the craft . . . . In no particular order, and to be inscribed in stone:

Content Dictates Form

Less is More

God is in the Details

all in the service of


without which nothing else matters.

Not to trivialize Sondheim’s art, but doesn’t the above describe the best principles for drafting disclosure documents? Don’t you wish the writers of more 10-Ks, press releases and proxy statements would think more about Sondheim’s principles? For example, as the Compensation Discussion and Analysis sections of many proxy statements approach (or exceed) 20 pages, wouldn’t it be great if the writers practiced “Less is More” and always had “Clarity” as their mantra?

Anyone Can Whistle

In addition to being inspired listening to Sondheim’s music and reading the lyrics, I am also “Studying the Songs of Sondheim” in my voice lessons. Thanks to the magic of karaoke background tracks, here is my rendition of one of my favorite Sondheim songs, “Anyone Can Whistle”.


More Risky Business - Why the Compensation Risk Assessment Is Still Important

This year, for the first time, public companies have been 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.” In a blog post today on (subscription site), Andy Mandel and Larry Schumer of Buck Consultants described a study they completed (PDF) about the voluntary risk disclosures (or lack thereof) in the proxy statements of 200 large public companies.

They report some interesting findings:

  • Predictably, no companies reported that they found a reasonable likelihood that the compensation risk will have a material adverse effect. However, a majority of companies (67%) did include some voluntary risk assessment disclosure. Of these companies, a majority (63%) made an affirmative statement that there were no risks that created a material adverse effect.
  • Few companies described the process they used in their risk assessment. Instead, most of the disclosures focused on factors in their compensation programs that mitigate risk. The study lists the risk mitigation factors cited, including 58% of companies mentioning the balance of short-term and long-term incentives.
  • The SEC has started issuing comment letters asking for more detail on the assessment process. The authors reported that the SEC has issued such comments, not only to companies whose proxy statements were silent, but also to companies that stated their conclusion but did not include a discussion of the process.

Why is the risk assessment discussion an important consideration for the upcoming proxy season, when most companies will be dealing with the issue for the second time? Because this time, compensation disclosures will be the subject of a Say-on-Pay vote, and the risk assessment is an important factor that will be considered by many shareholders in casting their vote. At the recent Proxy Disclosure Conference sponsored by, Patrick McGurn of ISS reported that risk mitigation is the third greatest compensation-related concern reported by investors (behind pay for performance and problematic pay practices). Investors want a robust explanation of what the risk assessment examined, and how the company ensures that pay practices don’t incentivize the wrong behavior. At the same conference, Mark Borges of Compensia suggested that the summary section of Compensation Discussion and Analysis highlight the risk discussion and refer to the place where it is discussed more fully.

For more information on risk assessments, see this previous post for a description of how a compensation committee might select which non-executive pay programs to include in its evaluation. And, for a comprehensive description of risk elements examined by one company, see the 2010 proxy statement of Brown-Furman Corporation under “Compensation Risk Assessment” starting on page 36.

Talkin' Baseball and Proxy Statements Again: Compensation Risk and Director Qualifications Revisited

In the hope that it will bring the Minnesota Twins better luck in their upcoming trip to Yankee Stadium, I am providing this link to my post from March 29, 2010, entitled: “Talkin' Baseball, Joe Mauer and Proxy Statements: Hypothetical Disclosures of Compensation Risk and Qualifications.” In the post, I included “hypothetical” proxy statement language, as if Joe Mauer were the CEO of a public company. The language was meant to illustrate the following disclosures, which were required this year for the first time for public companies in their proxy statements:

  • A discussion of compensation-related risk under Item 402(s) of Regulation S-K, required if compensation is determined to create material risks. Of course, the “hypothetical” disclosure focused on the merits and risks of Joe’s then-newly signed $184 million contract.
  • A discussion of the qualifications of each member of the board of directors, including their special qualifications and skills. Of course, the “hypothetical” set of reasons read, in full, as follows: “HE’S JOE MAUER.”

Comment: In preparing for the upcoming proxy season, companies should focus anew on these sections of the proxy statement, even though they will generally be included for the second time:

  • Whether or not the Item 402(s) risk disclosure is technically required, many companies have chosen to discuss the process used by the Board or the Compensation Committee to analyze compensation–related risks. These discussions often include an analysis of features of the compensation program that mitigate risks. Such a discussion of risk mitigation factors will likely be one factor considered by shareholders in evaluating whether to vote in favor of the Say-on-Pay resolution on the ballot at the 2011 annual shareholders meeting. Therefore, the risk mitigation factors should be emphasized in the Compensation Discussion and Analysis section of the proxy statement.
  • The discussion of the qualifications of board members will take on added importance in future years (probably starting in 2012), when proxy access will likely give large long-term investors the ability to nominate director candidates and have them included in management’s proxy statement. It’s not too early to consider whether the reasons stated in the coming year’s proxy statement wlll provide shareholders a compelling reason to vote for management’s candidates in future years.

Image: Wikimedia Commons

SEC Staff Starts to Comment on Absence of Compensation Risk Disclosure; Say-On-Pay Update

New Item 402(s) under Regulation S-K requires public companies to assess whether risks arising from the registrant’s compensation policies and practices are reasonably likely to have a material adverse effect on the registrant. If so, the company must make a variety of disclosures about the company’s compensation practices as they relate to risk management. Smaller reporting companies are exempted from the requirement.

In making the assessment, the companies generally consider the features of the compensation program that mitigate risk. As previously reported in this blog in a post called "Disclosures of Compensation Risk: A Brisk Discussion of Risk," companies have generally concluded that their compensation policies are not reasonably likely to have a material adverse effect. Even though this conclusion makes disclosure unnecessary under Item 402(s), many (if not most) companies have voluntarily elected to include a disclosure in their proxy statements. Generally this consists of a few paragraphs, disclosing that the compensation committee or the full board made the risk assessment, the factors they considered, and some conclusion about the risk profile of the company’s compensation. Other companies have been silent, as permitted by the rules.

Mark Borges has reported in his Proxy Disclosure Blog (subscription service) that the SEC staff has started to issue comments to companies that are silent about compensation risk in their proxy statements. The staff comments request additional information on the risk assessment. In fact, some companies have received the comment even if they included a statement in the proxy statement about their conclusion but did not describe the risk assessment process.

Comment: Borges concludes, and I agree, that the staff is not requiring every company to make a disclosure. However, I think it is a good idea for public companies to include some disclosure on the process and the conclusion. Not only does this reduce the likelihood of a staff comment, but it shows investors that the compensation committee and/or the board engaged in a thorough and thoughtful process to assess compensation-related risk.

Say-on-Pay Proposals May No Longer Be a Slam Dunk

Last year, in a post called “Say-on-Pay Play-by-Play,” I reported that Say-on-Pay, a shareholder advisory vote on executive compensation, often results in an overwhelming vote for approval of the compensation. I reported on the election results for some companies that held advisory votes last year, mainly financial institutions that, as TARP recipients, were required to hold such advisory votes. The percentage vote in favor of approval ranged from 70 percent to 93 percent.

However, the landscape for Say-on-Pay votes may be changing. In “Investors Reject Motorola’s Pay Practices” in the RiskMetrics Blog, Ted Allen reported this week that in Motorola’s advisory vote, just 46 percent of the vote was in favor of the proposal, resulting in the proposal being defeated. In another post, Allen reported that American Express received a 37% negative vote and Wells Fargo received a 27% negative vote (compared to a 7% negative vote a year earlier).

Further, as Broc Romanek reported in “Proxy Season Look-In: How Say-on-Pay is Faring So Far” in Blog, the affirmative vote would have been even lower if brokers had not been able to cast discretionary votes for the proposals. Romanek notes that one of the provisions of the Restoring American Financial Stability Act of 2010 (1,410 page PDF) (the “Dodd Bill”), would eliminate brokers’ ability to cast discretionary ballots in such an advisory vote. Brokers would be required to receive timely instructions from street name holders in order to vote the shares for such a proposal. This change would make it even more difficult in the future to get approval for Say-on-Pay votes.

Talkin' Baseball, Joe Mauer and Proxy Statements: Hypothetical Disclosures of Compensation Risk and Qualifications

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


A Tip On Evaluating Compensation-Related Risk, and an Interesting Compensation Study

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.

Risky Business - A Panel Discussion on the New Proxy Risk Disclosures

At last week's meeting of the Twin Cities Chapter of the National Association of Stock Plan Professionals, I was the moderator of a very interesting panel discussion on the new compensation risk disclosures required in the proxy statements of public companies.

My fellow panelists were two nationally known compensation consultants: Don Delves of The Delves Group and Henry Oehmann of Grant Thornton.

The panel discussion centered around new Item 402(s) of Regulation S-K, recap printed in the panel's course materials (.PDF), and the underlying risk analysis that the compensation committee needs to perform to back up the risk disclosure. Don and Henry each included articles in the course materials that discuss the analysis of the relationship between compensation and risk, and the features of compensation programs that can mitigate risk.

We are preparing a transcript of the panel discussion, which I will make available to readers of this blog. A few highlights:

  • Henry gave very useful background about the origins of the compensation risk analysis concept. The analysis is most helpful in the financial institutions industry, where risk is inherent in the business and the risk management function is more developed. In non-financial industries, one benefit of the analysis may be an increase in the visibility and sophistication of the enterprise risk management function of public companies.
  • Don led a discussion of the process to be followed by a public company in conducting a compensation risk analysis. He recommended creating a task force of members of the company's internal financial, legal and HR teams. He also pointed out that Item 402(s) contains a laundry list of situations that might present compensation risks - divisions responsible for a disproportionate part of the company's earnings, etc. The task force can use this list as one point of reference for determining which compensation elements on which to focus.
  • I led a discussion of the actual disclosure required under Item 402(s). Many practitioners are recommending that, if the "reasonably likely" standard is not met, the proxy should be silent on the subject of compensation risk. I take a different view. First, the existing CD&A rules already require a discussion of the objectives of the program, and several of the suggested disclosure items under Item 402(b) would require a discussion of risk mitigation as a reason for specific compensation elements (of executives officers only). Second, I think it is helpful to put these CD&A disclosures in context by informing the reader that the compensation committee worked with management to conduct the required risk analysis, and by describing the conclusions of the process.

More Changes in the ON Securities Cheat Sheet (.PDF)

  1. I moved the SEC developments and other regulatory matters up to the first page.
  2. In the description of the proposed legislation on the second page, I updated the references to the financial reform bill introduced by Rep. Barney Frank.
  3. In response to questions from a couple of blog readers, I added a description of the elements of the draft bill released by Senator Christopher Dodd, even though it has not yet been formally introduced.

While the ON Securities Blog is still undergoing maintenance (which will make it better than ever), the current version of the ON Securities Cheat Sheet continues to be available on the home page of the national NASPP web site under "Portals - What's New" or on Maslon's Executive Compensation page under "Resources."

Disclosures of Compensation Risk: A Brisk Discussion of Risk

Of all the new proxy statement disclosure requirements, the compensation risk discussion under new Item 402(s) of Regulation S-K is probably the trickiest. If the compensation committee of a public company concludes that the risks arising from the company's compensation policies and practices are "reasonably likely" to create a material adverse effect on the company, then the company is required to make the disclosures identified in Item 402(s).

Of course, no compensation committee is going to want to make that disclosure. If the committee believes the company's compensation practices are likely to create a material adverse effect, in most cases, the committee will make changes to the compensation structure to reduce that likelihood. Therefore, in most cases, companies will come to the conclusion that they are not required to make the Item 402(s) disclosure. In that case, will most companies be silent in the proxy statement, or will they make a voluntarily disclosure?

The Corporate Counsel Blog last week pointed out three preliminary proxy statements filed under the new rules. See the filings for Eli Lilly and Company, Fortune Brands, Inc. and Analog Devices, Inc.  All of these proxy statements contain a voluntary disclosure about compensation risk, and they are all helpful examples. They briefly describe the process the committee used and focus mainly on the features of their compensation programs that mitigate risk.

All in all, I would guess that most companies will elect to say something in their proxy statements about the risk aspects of compensation. I think this is a good opportunity for the compensation committee to communicate something positive about its process. Also, note that, as in the Eli Lilly and Fortune Brands proxy statements, the Item 402(s) discussion ties nicely into CD&A, which discusses the elements of the executives' compensation meant to discourage excessive risk-taking.

One more note: there may be an unexpected downside to staying silent, even if Item 402(s) allows the company to do so. Mark Borges' Proxy Disclosure Blog (a subscription blog) last week reported on an interesting statement by an SEC staffer at the recent SEC Speaks conference in Washington, D.C. Apparently, if a company does not make any disclosure about material adverse compensation risks, the SEC staff in its next review will issue a comment asking the company to explain the analysis used to make its determination that no disclosure was required. Of course, the company's response to the comment will be publicly available fairly quickly after the response is filed.

SEC Issues New Release on Climate Change Disclosure - Your Chance to be Sustainable!

As has been widely reported, on February 2, 2010, the SEC issued its interpretive release on disclosures of the consequences of climate change. The SEC's interpretations are effective immediately, so the release is must reading for anyone responsible for disclosures at a public company.

The Federal Register version of the release is now available. This version prints out on 9 pages rather than 29 pages - a fabulous way to save paper and start your own "green" revolution in staying current with SEC requirements!

Fun With Numbers - Equity Awards Under the New Proxy Disclosure Amendments

Dollar SignAt our last seminar on the new proxy disclosure amendments, the attendees expressed interest in the change in reporting equity compensation awards in the Summary Compensation Table. I’ve included a modified version below of the example we included in the course materials (PDF), to highlight the difference between the old rules and the new rules.

Our example involved a CEO named Favre (consistent with our football theme). He received stock options in most of the past several years, but in 2008 he received a sizable restricted stock grant in lieu of an option grant:


Stock Options (3 Year Vesting)
Year Shares Grant Date Fair Value Expense/Year from the Grant
2009 50,000 $200,000 $66,667
2008 0 - -
2007 25,000 $90,000 $30,000
2006 100,000 $300,000 $100,000


Restricted Stock (5 Year Vesting)

Year Shares Grant Date Fair Value Expense/Year From the Grant
2009 0 - -
2008 50,000 $250,000 $50,000
2007 0 - -
2006 0 - -

The right hand column above represents the financial statement expense the company would recognize during each year of vesting. Under the old rules, the reported equity compensation amount for Mr. Favre in each year would have reflected the amount expensed in that year for all of the officer’s awards:


Summary Compensation Tables - Old Rules
  Year Stock Awards Option Awards
Brett Favre, CEO 2009 $50,000 $96,667
  2008 $50,000 $130,000
  2007 $0 $130,000

The dollar amounts reported in the table reflect portions of awards granted in multiple years, and therefore the impact of individual grants is smoothed out. For example, the “Option Awards” amount for 2008 ($130,000) reflects portions of the value of the options granted in 2006 and 2007.
By contrast, see the treatment under the new rules of the same awards to our intrepid CEO. The amounts reported for each year reflect the full grant date fair value of the awards granted in that year:

Summary Compensation Table - New Rules
Stock Awards Option Awards
Brett Favre, CEO 2009 $0 $200,000
  2008 $250,000 $0
  2007 $0 $90,000


Note that the smoothing out effect is gone – the impact of a large grant will be magnified in the year of grant. Therefore, a big equity grant will cause compensation levels for that individual to “bounce” in the year of grant. Companies need to plan for the possibility that there may be more changes in the “roster” of NEOs from year to year than under the old rules. Also, note that the amendments require that the previous years (2008 and 2007) be restated from the way they were reported in the proxy statement in previous years.

There are some other interesting aspects of the new reporting method, which I’ll describe in a future post.

New SEC Interpretations

The SEC staff just provided some interpretive guidance on some of the new proxy amendments to its Compliance & Disclosure Interpretations on Regulation S-K. Questions 116.05, 116.06, 117.04, 119.20, 128A.01, 133.10 and 133.11 relate to the new rules. For example, Question 117.04 relates to the Summary Compensation Table: if a named executive receives a grant in a particular year but forfeits the award in the same year, the grant date fair value of the award is still reported for that year.

The staff also added new questions on the the Form 8-K amendments to Compliance & Disclosure Interpretations on transition issues – see Questions 6 and 7.

Cheat Sheet Updated!

The ON Securities Cheat Sheet has now been updated to provide a summary of the SEC's proxy disclosure amendments at the top of the second page. Descriptions of the some of the pending legislation and other regulatory developments have also been updated. The Cheat Sheet continues to put the new legislative and regulatory developments in context by providing short summaries in one short handy reference (never more than two pages).

Stay tuned for other updates in the coming weeks.

SEC Adopts Proxy Amendments; Communication of Effective Date Is Not So Effective

SEC LogoOn December 16, 2009, the SEC adopted its amendments to the proxy disclosure rules - see the press release and the full 129-page release that includes the text of the rules. The release has led to some confusion about when the new rules are effective - the release mentions an effective date of February 28, 2010, but it does not specify exactly what that means. I agree with Mark Borges in the Proxy Disclosure Blog (subscription site), who assumes that the amendments apply to proxy statements and other applicable filings on or after that date.

Part of the confusion about the effective date resulted from a comment during the open meeting/webcast, to the effect that the rules apply to companies with fiscal years ending on or after December 20, 2009. That's not the correct test. The December 20 date does appear in the final release, but only as a separate effective date for new calculation of the dollar amount of equity compensation reported in the Summary Compensation Table. Let's hope someone provides some clarification soon about effective dates.

I'll blog further about the rules themselves, and I'll post a new version of the ON Securities Cheat Sheet soon that reflects the new rules. In my last post, I mentioned one of the "sleepers" in the rules. But I think there may be another one. The Commission added a requirement to discuss the nominating committee's policy on diversity of Board nominees and, if there is a policy, to assess its effectiveness. The Commission declined to define "diversity" for this purpose. This is another area where some companies will be scrambling to figure out what to disclose, and may find it difficult to come up with a consensus on this sensitive topic with virtually no lead time.

A Little Holiday Cheer from the SEC [Updated Post From 12/10/09]

SEC LogoAs many of you know, the SEC announced yesterday [December 9] that it will hold an open meeting on Wednesday, December 16 for the purpose of adopting its proposed amendments to the proxy disclosure rules. For a short summary of these amendments, see the ON Securities Cheat Sheet. The two questions on everyone's mind: When will the rules be effective? And what changes will the SEC make to the proposals? Most people I talk to believe the rules will apply to 2010 proxy season for companies with a December or later fiscal year end. However, that could certainly change. Assuming the final rules are similar to the proposals, many public companies will be busy over the next few weeks preparing for the new disclosures. Many people have focused on the requirements to include a risk disclosure in the CD&A section, the changes to the equity calculations in the Summary Compensation Table and the required disclosure of compensation consultant conflicts. But there are some "sleepers" too, such as the requirement to elaborate on the qualifications of each individual director nominee - drafting might be trickier than people think. We'll all be watching the SEC on Wednesday.

Other Updates

A few other thoughts:

  • In the Corporate Counsel Blog this week, Broc Romanek gave a great report on the Supreme Court arguments in a case challenging the constitutionality of the PCAOB.
  • Thanks to Mike Melbinger in the Melbinger Compensation Blog for pointing out this Chicago Tribune article, quoting U of Chicago business professor Steven Kaplan for his interesting perspective on why CEOs are not overpaid. Kaplan obviously is trying to be controversial - check it out. I especially like the comparison between the earnings of the 20 largest hedge funds in 2007 ($20 billion) and that of the S&P 500 CEOs combined in the same year ($7.5 billion).
  • The Maslon Holiday E-Card came out this week, and it's outstanding. Please check it out and accept my wishes for a very happy holiday season and a great 2010!

What's Up in San Francisco?

bridge1I've just finished three and a half very interesting days at the NASPP Annual Conference and the Proxy Disclosure Conference sponsored by in San Francisco. Aside from an unexpectedly big crowd and some great food, attendees encountered some interesting updates:

    Proxy Disclosure Rules. Shelley Parratt, Director of Corporation Finance of the SEC, addressed the group, and there were two main news items. First, she previewed the currently proposed amendments to the proxy disclosure rules. She didn't address when the amendments would be considered, but stated that the new rules "may well" be in place for the 2010 proxy season. The SEC staff still clearly wants to accomplish this goal. Since the rules probably won't be considered until early December, this will likely put proxy drafters and compensation committees in a bind.

    Second, apart from the new rules, Parratt discussed compliance with the proxy disclosure rules adopted in 2007 and indicated that the SEC staff will take a more assertive (aggressive?) posture in its comment process. The staff has observed that companies that have already responded to comments on these rules are doing a pretty good job of compliance, although they can always do better. On the other hand, companies that have not yet received the comments seem to be waiting to receive comments before complying with the staff's guidance. She indicated that companies should be more proactive in changing their practices before they get comments, because the SEC will be taking a "no more Mr. Nice Guy" approach. Instead of "futures comments" (amend your filings in the future to comply), the staff will now be requiring many companies to go back and amend their prior filings. The main areas to focus on: (1) make sure your CD&A contains real analysis of "how" and "why" compensation decisions were made, and (2) disclose the performance targets underlying incentive compensation, unless there is a really compelling case to support competitive harm.

    New Governance Reform Bill. There was some discussion of the financial reform bill released this week by Senator Christopher Dodd - the "Restoring American Financial Stability Act of 2009". Buried in the 1,136 page bill, which would reform the financial regulatory system, are numerous governance reforms that would apply to all public companies. These are very similar to the provisions of the Schumer bill, described in the ON Securities Cheat Sheet. See this description of the Dodd bill provisions in the Corporate Counsel Blog. The Dodd bill is significant to governance reform, because it may give momentum to the provisions of the other reform bills, which can now be reconciled and carried forward as part of financial institution reform.

    A New Ball Game. I bumped into well known compensation attorney and blogger Mike Melbinger, but he was rushing out to the Fox News affiliate to give an interview. It's very entertaining - he talked about AIG CEO Robert Benmosche's statement that he may leave the company because of the government's limitations on executive pay. Melbinger likened the Treasury to a baseball owner. He said that if you want your team to be successful (i.e., if you want AIG to pay back the $180 billion in government aid), you pay whatever it takes to hire C.C. Sabathia, rather than hiring a journeyman pitcher for a low price and hoping for the best. Even Melbinger, however, admitted that if everyone at AIG is driving around in Lamborghinis, you might have a PR problem.

What's Up?

question3Early November finds us in a kind of limbo - those of us who advise public companies on governance and compensation matters are waiting for something big to happen. But there's plenty of smaller stuff to report on - although most of these items present more questions than answers:

    Proxy Disclosure Rules. On November 4, SEC Chairman Schapiro gave a speech addressing current regulatory developments. She described the proxy disclosure rules but did not address when they would be adopted or considered. The Corporate Counsel Blog reports that the rules will not be adopted on November 9, as previously rumored. However, there is still a chance that the rules will apply for the 2010 proxy season. If so, there won't be much time to evaluate the rules, or to hold a compensation committee meeting to address the new disclosures. Stay tuned. . . .

    Proxy Access. Rep. Maxine Waters has proposed an amendment to the Investor Protection Act of 2009 (the current provisions of the Act are described in the ON Securities Cheat Sheet). The amendment would require the SEC to adopt rules permitting large shareholders to nominate directors in the company's proxy statement (proxy access). If added to the Act and ultimately adopted, this provision would enhance the SEC's position in adopting its proposed Rule 14a-11 granting proxy access.

    Say-On-Pay and Shareholder Surveys. Companies continue to conduct annual advisory votes on compensation on a voluntary basis. Meanwhile, as reported by the Corporate Counsel Blog, some companies, including Schering-Plough, have begun to survey their shareholders. This will provide more detailed data on shareholders' opinions about compensation practices and may emerge as an alternative or supplement to simple yes-or-no advisory votes.

    New York Power of Attorney Law. You may have read about the amendments to the New York power of attorney laws, effective September 1, 2009. See this Forbes article. The amendments impose strict requirements (font size, notarization, etc.) for powers of attorney, particularly those signed in New York by New York residents. The amendments have prompted a flood of articles and analyses, including speculation that the requirements could affect the validity of powers of attorney for SEC registration statements, Section 16 filings, etc. I agree with this analysis, indicating that, even though there is no definitive guidance, the validity of powers of attorney for SEC filings should be governed by SEC rules and not state law.

I should get updates on some of these items next week - I'll be attending the NASPP Annual Conference in San Francisco. Of course, I can't wait to share the information with the ON Securities readers. There may even be a tweet or two, if you can't wait for the Blog.

Risky Business - Evaluating the Risk Components of Compensation

risk1Last week, the Twin Cities Chapter of the National Association of Stock Plan Professionals hosted a presentation on hot topics in executive compensation, led by Tara Tays and Rive Rutke of Deloitte Tax. I have included their PowerPoint under the Resources section of this blog, and in a future post I will discuss some of the compensation trends they reported.

One of the hot topics covered by the presenters was compensation risk analysis. They presented a very high-level summary of steps a company should consider - see pages 12 and 13 of the PowerPoint. Financial institutions receiving TARP funds are already required to do this analysis; for other types of companies, they may not yet have initiated a formal risk analysis process, monitored at the Compensation Committee level.

As I discussed previously, if the SEC adopts its proposed amendments to the proxy rules, each public company will be required to disclose in its proxy statement how its overall compensation policies for employees (including compensation of non-executives) create incentives that can affect the company's risk level, and its management of risk. The disclosure is required if the compensation policies create risks that may have a "material adverse effect" on the company.

    Comment: The bottom line is that the proxy rule amendments requiring this risk disclosure may be effective in the upcoming proxy season. Public companies should start thinking about the analysis that must be completed by then, in order to be able to make a well-founded statement in the proxy statement. The recommended steps in Deloitte's flow charts will not apply to all companies, but at least they provide a benchmark for companies that have already started the process, or a starting point for those that have not.

What do you think of Deloitte's recommended approach? Do you have any tips to share? Send me an e-mail, or post a comment below. And be careful out there - it's a risky world.

Say-on-Pay - Oy Vey!; More Cheat Sheeting

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.

Announcing the ON Securities Cheat Sheet on New Developments - A Prescription for What Hurts


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.

More on the Proposed SEC Rules, including Compensation Consultant Disclosures; The Color of Blogging

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.

    Comment. When it considered the compensation disclosure rules in 2006, the SEC received public comments of institutional investors and others, who claimed that the fees paid to compensation consultants for other services created conflicts of interest and should be disclosed. The SEC declined to require this disclosure in the final rules. Just before the rules went into effect, a group of large institutional investors sent a letter to the 25 largest U.S. public companies, requesting that they include such information, and many companies complied voluntarily with the request.

    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"]Blogger a L'Orange[/caption]

SEC Release Provides Detail on Proposed Compensation Disclosure Amendments; Podcasts Available!

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.

Summary Compensation Table (SCT). The SEC proposes to change the calculation method for stock awards and option awards in the SCT to require disclosure of the grant date fair value of the aggregate awards to each individual. Currently, the SCT requires disclosure of the dollar amount recognized for financial statement reporting purposes for the individual for the relevant year under FAS 123R. This change will affect the total compensation line for each individual and may have a major impact on total compensation in some years and could change the individuals to be included in the SCT for the year. 

    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!).

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