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!

Program Provides Update on Dodd-Frank Act Requirements

This month, I participated in an executive compensation program for the Twin Cities Chapter of Financial Executives International (FEI). In “A Perspective on Executive Compensation After Dodd-Frank”, compensation consultant Eric Gonzaga of Grant Thornton LLP and I gave an update on Dodd-Frank Act requirements, including new and upcoming SEC rules, and Eric gave his perspective on the latest trends in performance-based compensation – see our presentation materials here (PDF).

Highlights of the Dodd-Frank Act update included the following:

General Update. I presented the latest version of the ON Securities Cheat Sheet, with updates on the latest compensation and governance regulations. The Cheat Sheet is always available at the right hand side of the home page of this blog. It no longer includes projected dates for proposal and adoption of the SEC rules, because (1) the SEC’s web page that lists upcoming rulemaking activities under Dodd-Frank no longer discloses projected dates and (2) the SEC kept missing/changing the dates anyway.

Say-on-Pay. There is not much new in connection with the non-binding shareholder advisory vote on executive compensation, and the vote on the frequency of the Say-on-Pay vote. The results in 2012 are very similar to those in 2011. Average shareholder support once again is over 90%, but a handful of companies continues to experience negative votes. ISS and other advisory firms continue to have significant influence, approximately 20% of the vote by some estimates.

Advisory Vote Requirements for Smaller Reporting Companies. One of the great things about speaking to the FEI gathering was that it forced me to look back at all of my Dodd-Frank materials from 2012. I realized that we are coming up on a major compliance date for Say-on-Pay and Say When on Pay: smaller reporting companies, after a two-year exemption, will finally become subject to these advisory vote requirements (PDF) for annual meetings starting on January 23, 2013. See the SEC's Small Entity Compliance Guide (PDF) for these rules. Smaller reporting companies have not previously been required to include a Compensation Discussion and Analysis (CD&A) section in their proxy statements, and this will not change as a result of Say-on-Pay. The advisory vote will cover whatever is actually disclosed in the proxy statement – generally, just the compensation tables and the description of severance benefits. Some smaller reporting companies already voluntarily include some form of CD&A in their proxy statements, including an explanation of the company’s compensation philosophy and the reasons for the levels and types of the executives’ compensation reported in the tables. Companies that are not making these disclosures should definitely consider adding some version of CD&A in 2013, as it will be helpful in achieving a positive Say-on-Pay vote.

Proxy Disclosure Trends. For larger companies that continue to be subject to Say-on-Pay votes, proxy statement disclosures have been focusing more and more on describing Pay for Performance (P4P). I pointed to the Coca-Cola proxy statement, with its color graphics, and the Exxon Mobil glossy mailing on executive compensation (with companion video) as examples of effective communication. Compensation disclosures are looking more and more like political campaign pieces.

Upcoming Disclosure Requirements. We’re still waiting for these new compensation disclosure requirements from the SEC:

  • Pay vs. performance chart: will require disclosure of executive pay compared to the company’s financial performance (likely measured by Total Shareholder Return).
  • Pay equity disclosure: will require a comparison of median annual compensation of employees vs. that of the CEO, a rule that will likely result in reporting burdens for public companies.

Clawbacks. We’re also waiting for proposed SEC rules on recoupment of compensation by companies listed on stock exchanges – clawbacks. As described in this prior post, the exchanges will be directed to adopt listing standards requiring a clawback policy for listed companies. The policy must require recovery of incentive compensation (including stock options) from current and former officers during the three years prior to a financial restatement, to the extent the compensation was based on erroneous financial data. I continue to believe that the clawback requirements will be the “sleeper” under Dodd-Frank, creating lots of interesting issues for listed public companies.

Will Final Rules on Compensation Committee Advisers Lead to Engaging Independent Counsel?

On June 20, 2012, the SEC adopted final rules (PDF) under Section 952 of the Dodd-Frank Act (Section 10C of the Securities Exchange Act of 1934), covering independence standards for compensation committees of listed companies and their advisers. In themselves, the new rules are not too exciting. Consistent with Section 10C, the rules require the national securities exchanges, such as the New York Stock Exchange and Nasdaq, to adopt listing standards on these topics. The final rules raise some intriguing questions, including whether the listing standards will push public companies’ compensation committees  to engage independent counsel.

Timing. New Rule 10C-1 requires the exchanges to issue proposed rules on independence standards by September 25, 2012. Therefore, in the next few months, we will know a lot more about the approaches taken by the exchanges, and whether the exchanges’ standards will vary from each other. The exchanges must each adopt final listing standards that comply with Rule 10C-1, which must be approved by the SEC no later than June 27, 2013. 

Independence of compensation advisers. Rule 10C-1(b)(4) requires the exchanges to adopt standards requiring listed companies’ compensation committees to consider the independence of outside advisers, such as compensation consultants and legal counsel. The rule does not require that the advisers be independent, only that before engaging them, the committee consider their independence by taking six factors into consideration: (i) other services provided to the company by the advisory firm, (ii) amount of fees received by the advisory firm as a percentage of its total revenues, (iii) the advisory firm’s procedures for preventing conflicts of interest, (iv) business or personal relationships of the adviser with a member of the committee, (v) stock ownership by the adviser, and (vi) business or personal relationships of the adviser with an executive officer of the issuer. The exchanges may also require consideration of other factors.

The requirements of Rule 10C-1(b)(4) are mostly lifted directly from Section 10C(b)(2) of the Exchange Act. However, there were a few interesting changes under the Rule. First, in the final rules the SEC added the last of the six factors (relationships of the adviser to executive officers); surprisingly, that was not one of the factors listed in the Dodd-Frank Act. Second, the Instruction to Paragraph (b)(4) clarifies that the independence assessment is required for an adviser, including counsel, that “provides advice to the compensation committee.” Third, that Instruction clarifies that in-house counsel are not covered by the independence assessment requirements.

What outside law firms are covered? The new rule leaves some questions open to discussion. In what circumstances does outside legal counsel “provide advice” to the compensation committee so as to be covered by the assessment requirement? The answer is obvious where the law firm is engaged directly by the committee, in which case a partner of the law firm would be likely to attend committee meetings and would be available to answer questions of committee members. But what about a law firm that has little or no direct contact with the committee, given that the Instruction does not require that the advice be direct? Do the standards apply to outside counsel that provides compensation or governance advice to in-house counsel, who in turn incorporates that advice into her advice to the committee? What about outside counsel that provides compensation disclosure advice (or tax advice, or drafting or negotiation of agreements) to management where the work product is shared with and reviewed by the committee?

The answers may or may not be clarified by the exchanges’ listing standards. The independence assessment does not seem very relevant or important where the law firm has no direct contact with the committee, but the language of the Instruction seems broad enough to encompass this situation.

Will Committees Retain Independent Counsel? Mike Melbinger, in Melbinger’s Compensation Blog on (subscription site) also raises the question: Will the new assessment requirement cause compensation committees to engage independent counsel? Rule 10C-1(b)(4) allows the committee to continue to engage non-independent advisers after considering the six factors in the rule. But he points out:

Committees have retained independent legal counsel in recent years, but certainly not the majority of them. Those Compensation Committees who have not retained independent legal counsel will need to grapple with questions/factors 1 and 2 [of the six factors] . . . , just as they once did for their compensation consultant. . . . We all have seen this movie before – only starring the compensation consultants instead of legal counsel, and we all know how it ends. . . . [June 25, 2012 post.]

. . . [W]hen the SEC mandates a process such as this new independence assessment, it usually wants companies to reach – or at least consider – a certain result. Thus, the issue is one of following best practices. . . . [June 26, 2012 post]

Well stated, and if a law firm providing advice directly to the committee does derive a large percentage of its revenues from the company and has a very close relationship with the executives, the committee may feel pressure to engage independent counsel. Even though the independence assessment need not be publicly disclosed, the committee may still be concerned about exposure to liability in such cases, especially given the increased incidence of compensation-related litigation in recent years.

On the other hand, I’m not sure that compensation committees will be compelled to hire independent counsel in many cases. Given the size of many law firms, it may be rare for the fees to the individual client to represent a very large percentage of the law firm’s revenues. Also, if the law firm’s role is limited or does not involve direct contact with the committee, the committee probably will not feel much pressure to engage independent counsel. Once we see the exchanges’ proposed listing standards in September, we may know more about the likelihood of such engagements.

Dodd-Frank Rulemaking Timetable Delayed

In adopting the final rules under Section 952 of the Dodd-Frank Act as described above, the SEC got in just under the wire – the SEC’s Dodd-Frank rulemaking timetable listed those rules as being scheduled for January-June 2012. Several other sets of rules were not completed in June but are still listed under that schedule:

  • Propose rules regarding disclosure of pay-for-performance, pay ratios, and hedging by employees and directors (Dodd-Frank Sections 953 and 955).
  • Propose rules regarding recovery of executive compensation (i.e., clawbacks) (Dodd-Frank Section 954).
  • Adopt rules regarding disclosure related to “conflict minerals” and disclosures by resource extraction issuers (Dodd-Frank Sections 1502 and 1504).

Of course, the SEC now includes the following disclaimer at the beginning of the timetable: “This is an estimated timeline and may be subject to change.”

Say-on-Pay Update: How Does 2012 Compare With 2011?

It’s June, and the crush of annual meetings is, for the most part, finished. For most companies, this has been the second year in which a Say-on-Pay vote – an advisory shareholder vote on the company’s executive compensation – has been required under the Dodd-Frank Act. This is a good time to look at the shareholder votes to see if there has been a major change from 2011.

Semler Brossy’s latest Say-on-Pay Results report (PDF) reveals that not much has changed from last year. For the vast majority of companies, Say-on-Pay has passed with a significant margin of victory. Like last year, most companies have received greater than 90% approval.

It does appear that there will be more failed Say-on-Pay votes this year than last year. Mark Borges, in his Proxy Disclosure Blog on (subscription site) reports that 40 companies have failed to achieve a majority of affirmative votes this year, about the same number as all last year. Therefore, there will almost certainly be more negative votes in 2012 – but it’s unlikely that there will be a huge difference.

Of course, for some companies the results will be much different this year. For example, as reported in this previous post, Citigroup failed to get a majority positive vote this year, even though it won by a large margin last year. And Chiquita Brands International slipped on a banana peel this year – Borges reported that Chiquita got less than 20% Say-on-Pay support this year, compared to an 86% positive vote last year.

The 2012 proxy season so far teaches these lessons:

Don’t get cocky. As Citigroup’s experience demonstrates, a company can take nothing for granted, even if it did great on the vote in the previous year.

Supplemental proxies don’t seem to have a major impact. According to Semler Brossy, company responses to an “against” recommendation from ISS, filed in the form of supplemental proxy statements, do not appear to have a material impact on vote results. [On the other hand, they can’t hurt.]

Sue-on-Pay is still alive. As reported in this previous post, Citigroup was sued shortly after the negative Say-on-Pay was defeated, with claims based on the negative vote. 

Engage, engage, engage. Continue to engage with major shareholders and proxy advisory firms about executive compensation issues before, during and after proxy season. The day after the 2012 annual meeting, it’s not to early to start planning for 2013.

Perspectives on Citigroup's Negative Say-on-Pay Vote

As the 2012 proxy season kicks into high gear, Citigroup’s negative Say-on-Pay vote a couple of weeks ago remains the big story. Because of Citigroup’s size and prominence, the vote received a lot of commentary in newspapers and blogs. As Mark Borges pointed out in the Proxy Disclosure Blog on (subscription site):

This turns out to be Citigroup's fourth "Say on Pay" vote since 2009 - the first two were as a participant in the Troubled Asset Relief Program. I took a look at the support for the company's executive compensation program over this entire period, which went from 82% in 2009, 89% in 2010, and 93% in 2011 to just 45% in 2012. So it appears that there was a fairly consistent level of support for the program, which spiked in 2011 (the second consecutive year in which the company's CEO received essentially nominal compensation - $1 in 2010 and $128,000 in 2009) before the bottom fell out.

One lesson to be learned from the Citigroup experience: take nothing for granted. Because the vote was so positive the past several years, the company might have been blindsided by a wave negative shareholder reaction this year. As Borges pointed out, Citigroup’s CD&A disclosure this year matter-of-factly explained that the compensation committee viewed last year’s 93% support as an endorsement of its existing approach: “The committee considered the outcome of the most recent say-on-pay vote and stockholder perspectives [from stockholder engagement efforts] generally as factors in the 2011 compensation process. . . .”

In hindsight, maybe Citigroup should have anticipated tough sledding. Unlike 2009 and 2010, when the CEO, Vikram Pandit, had received compensation of $1 per year, in 2011 the story was very different, as Steven Davidoff pointed out in a DealBook post:

Last year, the Citigroup board paid Mr. Pandit almost $15 million, plus one-time retention awards with a potential value of $34 million, as calculated by I.S.S. The proxy advisory firm recommended against Mr. Pandit’s package because parts of his awarded pay were not based on Citigroup’s financial performance, Citigroup stock had declined by more than 90 percent in the last five years and Mr. Pandit’s pay package was not in alignment with that of his peers. . . . Citigroup in part defended this pay package by arguing that Mr. Pandit had not received a meaningful salary for the three previous years, being paid only a dollar a year. This was nice of Mr. Pandit, but it must be put against the fact that Citigroup paid about $800 million to acquire Mr. Pandit’s hedge fund, Old Lane, an investment that Citigroup subsequently wrote off completely. And Mr. Pandit received an $80 million payment from Citigroup last year as part of the Old Lane buyout. He’s not about to become part of the 99 percent anytime soon.

When ISS recommended a vote against Citigroup’s executive pay, the company could have filed and mailed supplemental proxy materials to tell management’s side of the story. As Semler Brossy points out in its latest weekly Say-on-Pay update (PDF), many companies, perhaps most, have responded to a negative ISS recommendation with supplemental proxy materials. Although Semler Brossy does question whether such supplemental materials have a material impact on the ultimate results of the vote, the practice does give the company an additional chance to tell its story.

Not that the Citigroup proxy statement was inadequate. It certainly seemed to follow many of the best practices of compensation disclosure, including a robust summary at the beginning of its CD&A disclosure. On the other hand, there’s a lot of information to digest in the summary, and they certainly did not follow the practices of some companies that are making effective use of graphics to make their point. Compare the proxy statement filed by Coca-Cola this year, which uses charts, tables and color captions really effectively to tell their story. Maybe graphics would not have been enough to save Citigroup’s Say-on-Pay vote, but they probably wouldn’t have hurt.

Future Trends in Proxy Materials as PR Pieces

Coca-Cola obviously put a huge amount of effort into its proxy filing, and I think that’s a trend that will continue in the future, fueled by examples of negative votes like Citigroup’s. I can envision public relations and graphics firms getting more involved, and proxy statements and supplemental materials will look more and more like political campaign mailings. For another example, see the graphics in this very impressive glossy supplemental piece, filed by Exxon Mobil as a companion to their proxy statement for the second year in a row.

Sue-on-Pay Is Still With Us

As has been widely reported, Citigroup was sued in federal court almost immediately after the negative Say-on-Pay vote. Mark Borges reported that this is the 11th “sue-on-pay” case based on a failed shareholder advisory vote. The sheer size of this case is likely to ensure that it will capture public attention.

Say-on-Pay Votes: New Resources Make It Easy to Keep Score

The Semler Brossy compensation consulting firm is publishing a very useful resource for those of us who want to “keep score” on the results of Say-on-Pay votes in 2012. “2012 Say on Pay Results” is a weekly publication of the cumulative results of Say-on-Pay shareholder advisory votes at Russell 3000 public companies. The most recent report includes the following stats:

  • The majority of companies continue to pass Say-on-Pay in 2012 with substantial shareholder support. So far, 71% of these companies have passed with over 90% support.
  • The report analyzes how vote results have changed in 2012. Companies that were below 70% in 2012 have generally received increased vote support in 2012. So far, all companies that failed in 2011 have passed in 2012.
  • ISS has recommended an “against” vote at 25 of these companies (16%) in 2012, compared to 12% in 2011. On average, shareholder support was 27% lower at companies with an ISS “against” recommendation.
  • So far, two companies have failed to get a majority positive Say-on-Pay vote: Actuant Corp. and International Game Technology. The Semler Brossy report provides data such as the 1-year, 3-year and 5-year total shareholder return (TSR) levels for these companies.
  • In “Vote of the Week”, the report analyzes a particular (high profile) Say-on-Pay vote. The March 28 report analyzes the Disney vote and the possible reasons they got a 57% positive vote, a decrease of 20% from their 2011 result.

I recommend bookmarking the URL: The most recent weekly Semler Brossy PDF report will pop up, including the most up-to-date statistics throughout proxy season.

Another good resource for analyzing early results is this report by Towers Watson. In the last section, this report includes a discussion of the companies that have done supplemental proxy filings, generally to counter points raised by ISS or other proxy advisory firms. Over 100 companies filed such additional soliciting materials last year, and Towers Watson reports that over 10 companies have used such filings this year. The report also analyzes the impact of an ISS “for” or “against” recommendation on Say-on-Pay votes.

Thanks to Broc Romanek in his Advisors Blog on (subscription site) for pointing out these resources.

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.

"Sue-on-Pay" Litigation Update: The Good News and the Bad for Boards

In recent weeks, there have been several important developments in litigation against companies that have experienced negative Say-on-Pay votes – what I refer to as “Sue-on-Pay” cases. It’s a good time to put these events into perspective. For public companies concerned about the adverse consequences of a failed Say-on-Pay vote, the recent litigation developments present a classic “good news - bad news” situation.

The good news for corporate boards is that two Sue-on-Pay cases have been dismissed in recent weeks:

  • The U.S. District Court for the Southern District of California granted defendants’ motion to dismiss in a Say-on-Pay lawsuit involving Pico Holding, Inc. As Mike Melbinger pointed out in the Melbinger Disclosure Blog on (subscription site), the court dismissed the plaintiffs’ case for failure to state a claim. The court relied on the language in Section 952(c) of the Dodd-Frank Act (848-page PDF), which specifically provides that “ . . . the shareholder vote . . . may not be construed . . . to create or imply any change to the fiduciary duties of such issuer or board of directors . . . [or] any additional fiduciary duties for such issuer or board of directors. . . .”
  • In early January, the U.S. District Court for the District of Oregon also dismissed the Say-on-Pay lawsuit involving Umpqua Holdings, Inc. Similar to the Pico case, the court relied in part on the language in 952(c). As reported in Blog, the court did not follow the reasoning of the U.S. District Court for the Southern District of Ohio, which declined to dismiss the federal Sue on Pay lawsuit involving Cincinnati Bell. The federal Cincinnati Bell decision was discussed in this prior post. [Note: After posting, I became aware that the Umpqua court dismissed the case without prejudice, meaning that the case may be revived.]

On the other hand, there was bad news recently for companies that may lose Say-on-Pay votes in the future. In December 2011, Cincinnati Bell announced that it has agreed to settle the shareholder derivative lawsuit in state court related to its negative Say-on-Pay vote (as opposed to the federal court case discussed above). The settlement in the state court case appears to be similar to that in the KeyCorp litigation, announced in March 2011. In these settlements, the defendants agree to make various changes in governance practices, and the company agrees to pay the legal fees of the plaintiffs’ law firms. In the KeyCorp case, the legal fees were $1.75 million. The fees in the Cincinnati Bell state case are still subject to negotiation and final approval (probably in April 2012), but presumably they will be substantial.

It is encouraging that the California federal judge in the Pico Holding case and the Oregon Federal judge in the Umpqua Holdings case followed the lead of a Georgia state court in the case involving Beazer Homes in August 2011, as reported in this blog post. These courts promptly dismissed the stockholder claims that resulted from the failed Say-on-Pay vote. More courts appear to be reading Section 952(c) of the Dodd-Frank Act as meaning what it says – the Say-on-Pay vote does not “create or imply any change” to the fiduciary duties of the company or the board. Therefore, the vote cannot be used to rebut the business judgment rule or to provide evidence that the directors breached their duties. Assuming the vast majority of courts reach this result eventually, then plaintiffs’ counsel will be discouraged from bringing such claims.

However, the settlement in the Cincinnati Bell state court litigation is likely to have the opposite effect. The announcement of the second settlement of such a case less than a year after the KeyCorp settlement, probably involving another large award of attorneys fees, is likely to encourage further litigation in the short term. This factor raises the stakes further for the 2012 Say-on-Pay vote, making it even more important for the management and boards of directors of public companies to engage with their shareholders, carefully draft their proxy statement disclosures and document their compensation decisions, and minimize the chances of a failed Say-on-Pay vote.

A Tally of "Say When on Pay" Votes in 2011

With 2011 behind us, it’s interesting to look back at the results of public companies’ “Say When on Pay” shareholder advisory votes regarding the preferred frequency of Say-on-Pay votes, as required under the Dodd-Frank Act. Numerous commentators, including me, spent a lot of time last year “watching the scoreboard” last year – would companies recommend an annual, biennial or triennial vote, and how would the shareholders ultimately vote?

Mark Borges recently published his tally (as of year-end) of 3,149 companies’ proxy statements in his Proxy Disclosure Blog on (subscription site). According to Borges’ tally, these companies recommended as follows in their “Say When on Pay” shareholder advisory votes on frequency:

Annual Say-on-Pay vote recommendation: 1,686 companies (54%)

Biennial Say-on-Pay vote recommendation: 83 companies (3%)

Triennial Say-on-Pay vote recommendation: 1,297 companies (41%)

No recommendation: 83 companies (3%)

Borges also reported that, as of the end of the year, of the 1,270 companies where the Board of Directors has recommended that future Say-on-Pay votes be held every three years, 624 (49%) have seen their shareholders indicate a preference for annual "Say on Pay" votes. Interestingly, this means that at around half of the companies where the Board recommended a triennial vote, the shareholders went along with that preference, despite predictions that shareholders would overwhelmingly favor annual votes. Some of these companies represented special cases (majority of shares controlled by a handful of shareholders, etc.), but this does not explain the large number of cases where the triennial recommendation carried the day.

I would guess that we won’t hear much about Say When on Pay votes in 2012, because most companies have now made their decision about how often to hold their Say-on-Pay votes. However, I am still curious about two Say When on Pay questions:

  • For companies where the Board recommended a triennial vote but the shareholders expressed a preference for an annual vote in a close vote, will any of them try to achieve a different result with another Say When on Pay vote this year? Note that the Say When on Pay vote must be held at least once every six years, but there is no limitation on how often the vote may be held.
  • The shareholder advisory firm Glass Lewis last year stated that, where the Board of Directors recommended a triennial Say-on-Pay vote, they would look at these proposals on a case-by-case basis. This contrasts with the approach of ISS, which has a policy of always favoring an annual vote. Did Glass Lewis actually support any board’s recommendation for triennial votes?

If anyone can shed light on either of the above questions, send me an e-mail (I won’t publish your name without permission) or post a comment.

ON Securities Blog Named a Minnesota Top Blawg – Again!

I am pleased to report that, for the second straight year, ON Securities Blog was named as a “Top 25 Minnesota Blawg” by the editors of the Legal News Digest and the Minnesota State Bar Association’s Practice Blawg. Here is the complete list of the Top Blawgs.

A Look Forward to 2012, and Some Highlights of 2011

My plans for New Year’s Eve are saved! I don’t need to sit at home on Saturday night waiting for the SEC’s to-be-issued proposed and final rules under the Dodd-Frank Act that have been long been listed on the SEC's Dodd-Frank web page under the category “December 2011 (planned).” I checked again today, and I found that the caption above those items has now been changed to “January – June 2012 (planned).” Further, the items that had been labeled “January – June 2012 (planned)” have been changed to “July – December 2012 (planned).”

Therefore, public companies have a lot to look forward to from the SEC in 2012, subject to the possibility that the agencies best-laid “plans” will go astray again:

  • Proposed and final rules for disclosure of pay vs. performance and pay equity (Dodd-Frank Section 953).
  • Proposed and final rules disclosing the company’s policy toward hedging (Section 955).
  • Independence standards for the compensation committee and standards for compensation committee advisors (Section 952).
  • Recovery of incentive compensation – rules directing the exchanges to require listed companies to implement clawback policies in connection with accounting restatements (Section 954).

Not to mention an interesting second proxy season involving say-on-pay advisory votes, and the possibility of shareholder proposals under Rule 14a-8 regarding proxy access. Stay tuned. As always, the ON Securities Cheat Sheet has been freshly updated to reflect all of the new “planned” dates and is always available at the right side of the home page. 

A Look Back at 2011

Here is an informal list of some of my posts in 2011 that fostered a lot of comments or might be useful to review:

“Boards’ Recommendations on the “Say When on Pay” Vote: The Debate Continues,” in which I was part of a national debate on the recommendations Boards of Directors should make on the “Say When on Pay” frequency votes.

“If the Shareholders Say "Nay-on-Pay", Get Ready for "Sue-on-Pay," which described the very interesting “Sue on Pay” lawsuits based on failed advisory votes on compensation. This subsequent post also described the Cincinatti Bell case, which I maintain was a “game changer.”

“How to Encourage Internal Reporting By Whistleblowers,” with some good practical tips.

“Payback Time: How to Prepare for Required Clawbacks Under Dodd-Frank.”

And here are some 2011 posts that were simply fun to share with readers:

“How Do Top Films Relate to the New Shareholder Advisory Votes?”, which related the films The Social Network and The King’s Speech to the world of Say-on-Pay votes.

“’Too Big to Fail’ Doesn't Fail to Educate or Entertain,” a review of the movie Too Big to Fail.

“More Proxy Advisor Insights: Through The Looking Glass (Lewis),” including an “alternate version” of Glass Lewis’s “Proxy Talk” service, if it were moderated by Mike Myers as a “Coffee Talk with Linda Richman” segment.

“Why Am I Inspired By the Songs of Stephen Sondheim?” - including my musical offering illustrating the title of the post.

I wish all of my readers a wonderful and safe New Years celebration and a happy, healthy, prosperous and inspiring 2012!

Payback Time: How to Prepare for Required Clawbacks Under Dodd-Frank

Compensation attorney and fellow blogger Mike Melbinger recently gave an excellent presentation in Minneapolis on the clawbacks required under the Dodd-Frank Act. His message – start getting prepared now for some complex and sensitive issues. His presentation was sponsored by the
Twin Cities Chapters of the National Association of Stock Plan Professionals and the Society of Corporate Secretaries and Governance Professionals.

Melbinger’s presentation, “Payback Time: Issues and Answers on Clawback Provisions” (PDF), at page 7, includes the operative language of Section 954(b)(2) of the Dodd-Frank Act requiring the SEC to adopt rules that will require listed public companies to recover compensation from executives in the event of a financial restatement. The SEC has not yet proposed its rules under Section 954, although the SEC’s website still states that the proposed rules are planned for December 2011, with final SEC rules planned for January-June 2012. However, even when the final rules are adopted, the requirements will not be effective until the New York Stock Exchange, Nasdaq and other exchanges adopt their own rules incorporating clawbacks into their listing requirements. This could take several additional months.

However, now is the time to consider how to prepare for the requirements. Melbinger’s “Compensation Committee Action Items” include the following:

  • Take an inventory of all plans, programs and arrangements that provide for incentive compensation tied to financial metrics.
  • Review the structure of compensation packages.
  • Review who within the company should be subject to the clawback policy – i.e., just the present and former executive officers required under Section 954, or others, such as directors, senior finance personnel, or all participants (possibly limiting the last category to those actually at fault)?
  • Check indemnification and mandatory arbitration clauses for clawback litigation issues.
  • Check enforceability of choice-of-law provisions – this may be especially important for employees in states such as California with wage and hour laws that may affect the employer’s ability to recover compensation.
  • Include clawback language that references Dodd-Frank to incorporate the final rules into any new executive compensation grants and agreements – until the rules are final, this language need not be very specific, but it will help document the parties’ intention to incorporate the final rules into all executive arrangements.

Melbinger reported an interesting development – at least one insurance company is offering director and officer liability coverage to insiders in some cases of clawback liability. Obviously, if the individual was involved in misconduct, public policy would prevent them from being indemnified or insured, but this policy might not apply if the individual is not at fault.

Melbinger also touched briefly on tax issues involved in clawbacks, and suffice it to say that the tax treatment will not be simple. Generally, the clawback will be invoked in a later year than the year the compensation was earned, and applicable rulings will prevent the executive from amending the prior year’s return. Further, it will be tricky to offset the clawback obligation against future deferred compensation owed the executive, because this could lead to an inadvertent violation of the rules under Code Section 409A.

All in all, clawbacks will create interesting issues for corporate counsel and headaches for public companies and possibly executives. Melbinger showed this video as an illustration of what a “clawback” might feel like.


Happy Holidays, and Sharing Inspiration, from Maslon

I wanted to share with my readers the Maslon Law Firm's holiday greeting: “Inspiration – Pass It On”. Check it out – all 85 Maslon attorneys have shared their thoughts about what inspires us. For each of the first 200 submissions (including the attorneys’), Maslon is donating $25 to the Minneapolis Institute of Arts' Art Adventure Program, which facilitates arts education to nearly 100,000 K-6 students across the state. We have already received a total of 118 submissions, and it’s fun to see what everyone came up with. Please feel free to share your inspiration on the site.

So what inspires me? “Studying the Songs of Sondheim” – I’m a fanatic fan of Broadway composer Stephen Sondheim. In a future post, I’ll share some of my favorites, and lessons we can all learn from the master lyricist.

Happy Holidays to all!

More Proxy Advisor Insights: Through The Looking Glass (Lewis)

As I reported in this prior post, the recent Proxy Disclosure Conference sponsored by (subscription site) featured a session called “The Proxy Advisors Speak”, featuring insights from representatives of ISS and Glass Lewis on how to gain their positive recommendations. This is critically important in the upcoming season of Say-on-Pay advisory votes on executive compensation.

David Eaton, the Glass Lewis representative, made these points:

  • Glass Lewis, like ISS, evaluates its Say-on-Pay recommendations on a case-by-case basis. Glass Lewis focuses on four key issues: compensation structure; disclosure of policies and procedures; amounts paid; and the link between pay and performance.
  • In evaluating pay for performance, Glass Lewis uses a proprietary formula (PDF) and grades each company “on an A to F forced curve.” They also do a qualitative analysis of program design and implementation, compensation mix and the appropriateness and balance of the metrics used.
  • Glass Lewis focuses strongly on the quality of compensation disclosures, grading each company on a Poor/Fair/Good scale. For the S&P 500, the quality ratings for disclosure improved significantly from 2010 to 2011. “Poor” ratings declined from 19% to 5%, and “Good” ratings increased from 15% to 22%.
  • Eaton cited the following companies’ disclosures as good examples of the use of CD&A to provide a rationale and justification for committee decisions, not just the requisite facts and figures: Entergy Corp., PartnerRe Ltd., Coca-Cola, W.W. Grainger, Waste Management and Newmont Mining.
  • The primary change in Glass Lewis’ policies for 2012 relates to companies that received high negative votes in 2011, generally indicated by a greater-than-25% negative vote (compared to the 30% threshold used by ISS in its updated policies). For these companies, Glass Lewis “. . . will look for language in the proxy that the compensation committee is taking last year’s vote seriously and have engaged with large shareholders. We will hold compensation committee members accountable for a failure to respond.” Their policy is less specific than ISS’s new policy for such companies (see my most recent post), but it places similar importance on engagement and disclosure of the engagement.
  • Glass Lewis is open to meeting with any company outside of the solicitation period and “proxy season blackout periods.” Further, they publish their reports an average of three weeks before the annual meeting, allowing for sufficient time to revise reports in the event of errors or omissions.

“Proxy Talk”

Eaton also reported that Glass Lewis hosts “Proxy Talk” conference calls to discuss a shareholder vote or issue in depth. These calls are generally used when there is a major issue, such as a proxy fight or shareholder proposal, but Glass Lewis offers this vehicle generally as a way to facilitate engagement between public companies and institutional investors. If the company requests a call, Glass Lewis’ research team representatives serve as moderators, and shareholders can submit questions, providing an open forum “. . . to provide further color on specific issues”. 

This all sounds great, but when I heard about Proxy Talk, all I could think of was “Coffee Talk with Linda Richman,” Mike Myers’ classic creation on Saturday Night Live. Imagine if Glass Lewis hired Linda Richman to host “Proxy Talk”: 

Linda: Hello, and welcome to Proxy Talk. I’m Linda Richman, filling in this week for my good friends at Glass Lewis. Long story short, on this week’s show, we’re going to interview the CEO of General Electric, Jeffrey Immelt. Welcome to Proxy Talk, Jeff.

Jeff: It’s a pleasure to be here.

Linda: First, I just want to say that I’m very excited to talk to you, because GE owned NBC until last year. And of course, NBC is the network that broadcast “Barbra Streisand: The Concert” in 1995. Just thinking about it, I’m dying. Now I’m getting a little verklempt. Talk amongst yourselves. I’ll give you a topic. The Dodd-Frank Act wasn’t about anyone’s dad, and it was neither "frank" nor an "act". Discuss. [Pause.] 

Linda: There, I feel better. Now, we’ll take a call from a stockholder. The number is 555-4444. Give us a call, we’ll talk, you know, no big whoop.

Caller: Hello, Linda, what do you think of Barbra’s new CD?

Linda: Are you kidding? It’s like buttah. Each song is like a stick of buttah. It’s to die for. Do you have a question about GE’s proxy statement?

Caller: What do you think of GE’s CD&A section?

Linda: It’s also to die for. In fact, Glass Lewis gave it a grade of “Like Buttah.” And Jeff, I love the part about how you renegotiated your stock options last year before the Say-on-Pay vote. You’re beautiful. Don’t go changing just to please me. But I still can’t believe you sold NBC to a cable TV company. The only good part is that Comcast has several channels that show “Yentl”. No big whoop.

Now, wouldn’t that spice up proxy season?


ISS 2012 Policy Updates, Continued: Board Response to a High Negative Vote

As discussed in my last post, the proxy advisory firm ISS recently issued its 2012 Updates to its U.S. Corporate Governance Policy (PDF). One important change relates to the board’s response to a high negative vote. For companies that experienced a lot of “thumbs down” votes from shareholders at the last annual meeting, ISS’s evaluation of the board’s responsiveness will affect ISS’s recommendation on the upcoming Say-on-Pay vote. Not only that, but this evaluation will also inform ISS’s voting recommendations for compensation committee members in the election of directors.

The new formulation is much more specific than in the previous Policy. ISS will evaluate responsiveness on a case-by-case basis if the previous Say-on-Pay proposal received less than 70% of the votes cast. Therefore, ISS has for the first time specified the “red zone” range where the negative votes are high enough to create significant concern. For these under-70% companies, ISS’s evaluation will take into account the company’s responsiveness to the negative votes, including:

  • Disclosure of engagement efforts with major investors;
  • Actions to address issues that contributed to the low level of support and other recent compensation actions;
  • The recurring or isolated nature of the issues raised;
  • The company’s ownership structure; and
  • Whether support was less than 50%, which requires the highest degree of responsiveness.

In its “Rationale for Update,” ISS specifies the disclosures it will look for in the proxy statements of these companies that received under 70% the previous year:

. . . At companies that fail to receive a meaningful level of support on their say-on-pay proposals, shareholders will seek substantive and meaningful disclosure in determining whether the company has taken sufficient actions to address the compensation issues that contributed to the low level of support. Companies should discuss their outreach efforts to major institutional investors and provide the specific actions that they have taken to address the compensation issues that resulted in a significant opposition votes. These specific actions should ideally be new rather than a reiteration of existing practices. Companies should refrain from providing boilerplate disclosure, as it does not enable shareholders to gauge the level of effort taken by the company. Placement of such information should be readily identifiable.

For the companies in this situation for their upcoming annual meeting, it is important to be making explicit engagement efforts now rather than waiting until after the proxy statement is mailed. These engagement efforts should be aimed at determining the reasons for the negative votes. These efforts should be completed far enough in advance of the annual meeting to plan specific actions to address shareholder concerns, and to draft appropriate disclosures in the proxy statement. Note that ISS is looking for proxy descriptions of specific new actions taken by the board and expects the information on engagement and responsiveness to be in a readily identifiable place in the proxy.

For more thoughts on the joys of “engagement” with shareholders, see my special Valentine’s Day post on engagement. Love is in the air!

ISS Policy Updates Shed Light on Pay-for-Performance Analysis

The proxy advisory firm ISS last week issued the 2012 Updates to its U.S. Corporate Governance Policy (PDF). The Updates outline this year’s changes to ISS’s policies in recommending investor votes at public companies’ shareholder meetings. Essentially, the policies say when ISS will act like the popular kids on Facebook and “like” a company’s postings – see this prior post. These recommendations are especially important in the upcoming proxy season, the second year of mandatory Say-on-Pay votes on public company compensation. ISS’s methodology and rationale also provide useful guidance for drafting compensation disclosures, as described below.

The 2012 Updates have been widely reported; for example, see these helpful summaries by the compensation consultants Frederic W. Cook & Co., Inc. (PDF) and Towers Watson. This post focuses on ISS’s pay-for-performance (p4p) methodology, which is critical in determining its Say-on-Pay vote recommendations. My next post will discuss another critical ISS policy – its evaluation of the board of director’s response in cases where the company experienced high levels of opposition in a previous Say-on-Pay vote.

P4P Methodology. Starting on page 9 of the Updates, ISS describes its new methodology for determining pay-for-performance alignment. This is described as a two-part test – first, ISS screens companies to identify the level of alignment between pay and performance over a sustained period; if a company shows unsatisfactory alignment, then ISS uses a second-stage qualitative analysis to arrive at a final recommendation.

For companies included in the Russell 3000 index, in the first phase ISS uses quantitative tests of alignment relative to a peer group and on an absolute basis. First, ISS compares the company’s TSR (total shareholder return) rank within a peer group, as measured over one-year and three-year periods, and the multiple of the CEO’s total pay relative to the peer group median. The peer group is generally comprised of 14 to 24 companies selected based on size and industry group. Second, the quantitative analysis also considers alignment on an absolute basis between the company’s trend in CEO pay over the past five fiscal years and the trend in the company’s TSR over the same period.

For companies not included in the Russell 3000 index, in the first phase ISS uses an undefined process to determine whether pay and performance are misaligned.

Where the first phase indicates unsatisfactory alignment, there is a second phase qualitative analysis that examines the following factors “to determine how various pay elements may work to encourage or to undermine long-term value creation and alignment with shareholder interests”:

  • The ratio of performance- to time-based equity awards;
  • The ratio of performance-based compensation to overall compensation;
  • The completeness of disclosure and rigor of performance goals;
  • The company's peer group benchmarking practices;
  • Actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both absolute and relative to peers;
  • Special circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices (e.g., biennial awards); and
  • Any other factors deemed relevant.

ISS based its Policy Updates in large part on the results of its 2011-2012 Policy Survey (PDF). In its “Rationale for Updates”, ISS reports:

“. . . 94 percent of institutional respondents to ISS' 2009-2010 Policy Survey indicated that pay-for-performance is a critical or important consideration in their vote determinations. This year, another overwhelming majority of institutional respondents to ISS' 2011-2012 Policy Survey indicated two factors as relevant to evaluating pay-for-performance alignment: pay relative to peers is considered very relevant by 62 percent and somewhat relevant by 32 percent; and 88 percent believe pay increases that are disproportionate to the company's performance trend are very relevant to this evaluation (plus 11 percent who consider it somewhat relevant). . . .”

“In cases where alignment appears to be weak, further in-depth analysis will determine causal or mitigating factors, such as the mix of performance- and non-performance-based pay, biennial grant practices, impact of a newly hired CEO, and rigor of performance programs. For example, 81 percent of investor respondents to ISS' 2010-2011 Policy Survey said that the way a company's short-term and long-term incentive metrics relate to the company's business strategy is among their most important considerations in evaluating executive pay. If long-term alignment of TSR performance and CEO pay opportunities is weak, investors expect current pay and pay opportunities to be strongly performance-based.”

Comment. The Updates feature some welcome changes, including ISS’s more individualized approach to peer group identification, a longer-term approach through use of a five-year metric and a heightened focus on specific qualitative factors in the second phase of analysis.

Public companies should take heed of the survey statistics cited above and the resulting quantitative and qualitative factors to be considered by ISS in connection with its recommendations. In evaluating their compensation programs and their compensation disclosures, public companies should be mindful of these factors, which can serve as a checklist of compensation features and processes that should be highlighted in next year’s CD&A disclosures.


What Should Public Companies Know About the Proxy Advisors?

In the second year of mandatory Say-on-Pay votes on public company compensation, the proxy advisory firms such as ISS and Glass Lewis will be like the popular kids on Facebook: it’s important to get them to “like” the company’s postings. In other words, their positive recommendations are an important factor in winning the Say-on-Pay vote by the widest possible margin.

Therefore, one of the best parts of attending the recent Proxy Disclosure Conference sponsored by (subscription site) was attending the session called “The Proxy Advisors Speak”, featuring Carol Bowie of ISS and David Eaton of Glass Lewis. Seeing these individuals speak was like meeting the people behind the Facebook profile pictures.

These close encounters reinforced my conclusion that, whether or not you agree with their guidelines or recommendations, the representatives are serious professionals doing their best to navigate a flood of information and help institutional shareholders figure out how to vote. In other words, proxy advisors are people too.

Here are some of the important observations by Carol Bowie of ISS:

  • ISS has a team of trained analysts preparing for the proxy season, and every report passes through at least two analysts.
  • ISS tries to deliver research reports at least 21 days before the annual shareholders’ meeting; however, this can be 13 days during proxy season or less in contested meetings. S&P 500 companies receive draft reports shortly before publication to allow them to check the facts.
  • The compensation discussion and analysis (CD&A) section of the proxy statement should include an executive summary that outlines the overall structure of the compensation program. Also, it’s helpful if the CD&A provides key information in one place about short-term and long-term compensation programs, including why the company uses particular metrics; what were the targets and how were they determined; and what were the company’s financial results and the associated awards?
  • ISS is updating its policies for evaluation of Say-on-Pay votes in 2012, and the final policy updates will be released before Thanksgiving. As shown by its draft of the updated policies, ISS will still focus heavily on total shareholder return (TSR) (essentially, stock price) in evaluating the “performance” component of pay for performance. ISS is trying to strike a new balance between short-term and long-term factors, using a combination of one-, three- and five-year analyses.
  • In assessing compensation programs in 2012, ISS will focus a high level of scrutiny on companies whose proposals received less than 50% support from votes cast. In addition, for companies that received less than a 70% positive vote, surveyed institutional investors indicated that they expect an explicit response from the board with respect to shareholder engagement and actions taken as a result of the vote. ISS will likely give the Say-on-Pay votes of those under-70% companies more scrutiny as well.

In a future post, I’ll share observations of the Glass Lewis representative. Hopefully, these insights can help companies be “liked” in the upcoming proxy season.

Proxy Disclosure Conference Teaches the Importance of Pay for Performance

I have been attending the Proxy Disclosure Conference and Say-on-Pay Workshop sponsored by (subscription site) in San Francisco. The Conference and Workshop were unique, in that the speakers included representatives of:

  • Proxy advisory firms, including ISS and Glass Lewis.
  • Institutional investors, including CalSTRS, T. Rowe Price and BlackRock.
  • Proxy solicitors, including Georgeson and Innisfree M&A
  • Compensation consultants, including Compensia and Towers Watson.

The panel discussions covered proxy statement drafting issues and compensation structure issues in the wake of the first year of Say-on-Pay. I will be blogging about key takeaways from several of the sessions.

However, one key point came out time after time. The key to a clear victory in the Say-on-Pay vote is being able to demonstrate that the company practices “pay for performance”. (Ira Kay, compensation consultant with Pay Governance, calls it “p4p”.)

Of course, nearly every company says it practices pay for performance. However, there are many possible definitions of both “pay” and “performance”. The key is to adopt definitions that make sense in light of the company’s business and situation, and to be able to explain the link between pay and performance in a clear and compelling way. This will be especially important for companies that failed to achieve a majority positive vote in 2011, or companies that ended up in what speakers called the “Red Zone” – a positive vote in the range of 51% to 80%.

Other distractions, such as the frequency vote (Say When on Pay) and the mechanics of the Say-on-Pay vote, will fall by the wayside in 2012. This will just highlight the importance of the biggest compensation and governance issue in the coming months – p4p.

Image: Flikr

How to Encourage Internal Reporting By Whistleblowers

Under the SEC’s whistleblower rules (302-page PDF), adopted in May under the Dodd-Frank Act and described in this prior post, whistleblowers are not required to report perceived misconduct internally before going to the SEC. However, the SEC intended the rules to encourage internal reporting. There is evidence that most companies are still considering whether, and how, to maximize the chances that an employee will report internally first.

Broc Romanek, in Blog, recently published the results of a survey on whistleblower policies, with 33 companies responding. A majority of the respondents reported that they either intend to change their policies in response to the rules or have not yet decided. Further, a majority have not yet decided whether to provide incentives to report internally first, and a majority have not yet decided whether to create a system to alert employees of the benefits of reporting internally.

Obviously, the jury is out on the best way to incentivize internal reporting. Last month, RAND Corporation released “For Whom the Whistle Blows: Advancing Corporate Integrity and Compliance Efforts in the Era of Dodd-Frank” (free download available here), a report summarizing the conclusions and discussions of a recent symposium. The symposium featured speakers with widely varying views, and the 78-page report makes interesting reading. Some of the key points:

  • The speakers emphasized the important roles of the chief ethics and compliance officer and boards of directors.
  • It is critical to create a culture in which internal reporting is valued, whistleblowers are clearly and obviously protected, and employees have trust in the internal reporting system.
  • Companies can consider financial and non-financial incentives to make internal corporate reporting mechanisms more effective.

On the last point, some companies have considered paying their own bounties to whistleblowers to report internally first, as a way to combat the bounty to be paid by the SEC in successful external reporting cases. This is a controversial practice, and I have not yet heard of companies implementing such direct payments. The participants in the symposium also discussed providing non-financial incentives, such as acknowledgement by the CEO or recognition by the company. Others believe internal reporting can be enhanced through the management compensation system:

One suggestion offered to help reinforce internal reporting was that corporate compensation schemes could be tweaked to include a set of ethical leadership criteria for management, thereby supporting a culture in which internal whistleblowers are supported and valued. . . . [O]ne participant noted that the CEO and key senior executives could receive contingent compensation based on a range of performance metrics tied to ethical leadership, support of the compliance function, and successful efforts to contribute to ethical culture.

Another frequently discussed method of encouraging internal reporting, not discussed in the Report, is based on a compliance certification. Employees would be required to certify periodically to the effect that they have reported, or will report, any instances of certain types of wrongdoing to the company. In a recent webcast on (available by subscription), Sean McKessy, the Chief of the SEC’s Office of the Whistleblower, Division of Enforcement, engaged in a discussion of such certifications with several practitioners. McKessy expressed the concern that such a certification, if not properly worded, could conflict with an employee’s statutory right to report to regulators.

The bottom line is that there are a lot of methods to consider in encouraging internal reporting by whistleblowers. And most companies are still doing just that – considering what is the best approach among the alternatives.

Companies Disclose How They Considered Prior Say-on-Pay Votes In Setting Compensation

The first few companies have complied with a new proxy statement disclosure requirement relating to past Say-on-Pay votes. Item 402(b)(1)(vii) of Regulation S-K requires companies to disclose “ . . . [w]hether and, if so, how the registrant has considered the results of the most recent shareholder advisory vote on executive compensation . . . in determining compensation policies and decisions and, if so, how that consideration has affected the registrant’s executive compensation decisions and policies.” Mark Borges, in his Proxy Disclosure Blog on (subscription site), recently reported that four companies have complied with this requirement so far, including three TARP-participating financial institutions that have been required to hold Say-on-Pay votes since 2009. The following are excerpts from Compensation Discussion and Analysis in the proxy statements:

Hemispherx Biopharma, Inc.: [After reporting that the stockholders voted not to approve executive compensation, in a close vote.] “The Compensation Committee reviewed the result of the vote on the non-binding resolution causing them to reflect on the various elements of the 2010 executive compensation program. While it remains the goal of the executive compensation program to support long-term value creation, the Committee moved to enhance the program to better align the compensation options with our stockholders’ interests in supporting long-term value creation. Accordingly, two elements have been added to the executive compensation plan . . . .” [The changes were different pricing for reload stock option grants, and inclusion of shares of stock as a component of non-executive compensation.]

City National Bancshares Corporation: [After describing key components of executive compensation.] “The Committee monitors the results of the annual advisory ‘say-on-pay’ proposal and incorporates such results as one of many factors considered in connection with the discharge of its responsibilities, although no such factor is assigned a quantitative weighting. Because a substantial majority (98.1%) of our stockholders approved the compensation program described in our proxy statement in 2010, the Committee did not implement changes to our executive compensation program as a result of the stockholder advisory vote. . . .”

Premier Financial Bancorp, Inc.: “In arriving at its decision on 2010 executive compensation, the Compensation Committee took into account the affirmative shareholder ‘say on pay’ vote at the previous annual meeting of shareholders and continued to apply the same principles in determining the amounts and types of executive compensation. The specific compensation amounts for each of Premier's named executive officers for 2010 reflect the continued improvement in the Company's financial performance. . . .”

And, as Borges puts it, “For brevity, it's difficult to beat the statement in Oak Valley Bancorp's Compensation Discussion and Analysis: ‘The Company considered the Shareholder vote approving the Company's executive compensation for 2010 in making its proposal for 2011.’”

Comment. City National Bancshares and Premier Financial, at least, each had a greater-than-90% positive Say-on-Pay vote the previous year. For companies with similar results, the following year’s proxy disclosure of the impact of the vote should be straightforward. However, for a company that fails to achieve a positive vote, or that receives a narrower majority of positive votes, this disclosure will require a great deal of thought the following year, and the thought process should start shortly after the annual meeting: Should the company change its compensation programs in response to the vote? What changes would send the appropriate signals to our shareholders? Should the company engage with its shareholders to attempt to determine the meaning of the shareholder vote? How will we craft next year’s proxy disclosure about our consideration of the vote? Even before each annual meeting, the company’s internal and external advisors should discuss these issues with the compensation committee, and determine what percentage vote will be considered to “send a signal” to the committee.

In the wake of the current down year in the stock market, next year it may be more difficult for companies to achieve an overwhelmingly positive Say-on-Pay vote, and more companies may well get negative or borderline votes. For these companies, the following year’s proxy language about consideration of the prior Say-on-Pay vote will be subject to a great deal of scrutiny. Given the incidence of “Sue-on-Pay” shareholder lawsuits, as described in this prior post, these disclosures should not be taken lightly, and companies should anticipate the issues and plan accordingly.


I was saddened to hear of the passing yesterday of Apple Inc. founder Steve Jobs. He was an amazing innovator and created a huge amount of prosperity for many in this country. He also created a great deal of enjoyment in a much broader range of people around the globe – enjoyment of great music and the arts on Apple devices, and enjoyment of the elegant design of the products themselves.

In this prior post, I described the disclosure issues created by Jobs’ health problems over the years. Interesting reading, but it’s hard to imagine any other executive whose ongoing health issues would rightfully create so much concern about the company’s well-being. Good luck to Apple, and to all of us. We’ll miss you, Steve.

Recent Court Decision in Cincinnati Bell Sue-on-Pay Case Is a Game-Changer

A federal district court in Ohio recently denied the defendants’ motion to dismiss in a “Sue-on-Pay” derivative lawsuit against the officers and directors of Cincinnati Bell. This decision is a game-changer that will further embolden potential plaintiffs and plaintiffs’ attorneys in Sue-on-Pay cases and make directors and officers more likely to settle these cases.

The Cincinnati Bell lawsuit claimed that the directors had violated their duty of loyalty by approving compensation that was not in the best interests of the shareholders, based in large part on a 66% negative Say-on-Pay vote against approval of its 2010 executive compensation. Last week, the judge ruled that the plaintiff had pleaded a “plausible” claim featuring factual allegations that would, if proven, overcome the business judgment rule. He cites the plaintiff’s assertion that the negative shareholder vote provides “direct and probative evidence” that the 2010 compensation was not in the shareholders’ best interests.

I respectfully disagree with the judge’s ruling, which seems to ignore the language of Section 951(c) of the Dodd-Frank Act of 2010. As discussed in this prior post, Section 951(c) states that the Say-on-Pay votes “may not be construed . . . to create or imply” any change in directors’ fiduciary duties or any additional fiduciary duties. In fact, the judge mentions this statutory language in a footnote but dismisses its relevance with little analysis or discussion.

However, it doesn’t matter whether I agree with the judge, or even whether the Cincinnati Bell decision will ultimately be reversed on appeal. The decision is very significant in practical terms, even though the only other reported decision to date in a Sue-on-Pay case favors the defendants. Alison Frankel reports in her On The Case Blog on Reuters that a state court judge in Georgia recently dismissed a Sue-on-Pay lawsuit against the Beazer Homes board. But looking at these first two court decisions together, now there is a “1-1 tie” up on the scoreboard. Given the slow pace of litigation, that score may stay up on the board for a while, which is not encouraging for corporate boards. A procedural loss in one of the first decisions sends a clear message that many of these lawsuits will be messy and expensive, making settlements more likely.

As Broc Romanek advised in his recent post in Blog, a variety of factors may lead to more failed Say-on-Pay votes in 2012 – for example, “ . . . a rapidly declining economy and stock market – compared with all boats rising earlier this year.” It will be increasingly important next year for companies to focus on their proxy statement language and shareholder engagement, to maximize the chances for a positive vote and to mitigate the consequences of a negative vote. See this prior post, which includes some proxy statement advice from Towers Watson. I will be providing more tips as we approach the end of the year.

Image: Flikr


Opposing Groups Weigh in on Disclosure of CEO Pay Ratio

Should public companies be required to disclose the ratio of CEO pay to that of other employees, as provided by the Dodd-Frank Act? And if so, what should be included in the disclosures? Two groups with opposing viewpoints have sent comment letters to the SEC in the past few weeks, and these letters provide insights on the battle.

Section 953(b) of the Dodd-Frank Act (848-page PDF) directs the SEC to adopt rules requiring disclosure of the ratio of the CEO’s annual total compensation to the medial annual total compensation of all other employees. The SEC expects to propose the rules between August and December 2011 and to adopt final rules between January and June 2012.

The “pay disparity” disclosure requirement in Section 953(b) has generated considerable controversy. Business groups have complained that the calculation of the median pay of non-CEO employees will be extremely burdensome on public companies and will provide no useful information. On the other hand, some investor groups maintain that the information will be valuable and have urged the SEC to implement the requirement on a timely basis. The Burdensome Data Collection Relief Act (PDF) (H.R.1062), introduced in the House of Representatives in March 2011, would repeal Section 953(b) entirely.

In the last several weeks, two groups with very different opinions have provided their opinions to the SEC on how to make the rules workable for public companies, accompanied by a very thorough analysis. First, a group of executive compensation attorneys from 15 large law firms and Frederick W. Cook & Co., a compensation consultant, sent a joint comment letter to the SEC. First and foremost, all of the signatories to the joint letter support the repeal of the disclosure requirement. Short of repeal, the group makes the following suggestions to make the rule more workable:

  • Public companies should be given several years (at least two) to implement the requirements. This is necessary to allow companies to integrate their payroll systems, deal with international data privacy rules, etc.
  • Companies should be allowed to exclude non-U.S. employees. The attorneys assert that the ratio including non-U.S. employees will not be meaningful, and the calculation will be “extraordinarily burdensome” on many companies.
  • Compensation for employees other than named executive officers should be calculated on the basis of W-2 compensation.
  • Companies should be allowed to apply a good faith standard and very flexible timing rules.
  • Companies who do not wish to make or disclose the calculation should be allowed, in the alternative, to disclose the ratio of the total compensation of the company’s CEO to the average pay of all U.S. non-farm workers. (I.e., the denominator would not be company-specific.)

Second, the AFL-CIO recently sent a comment letter to the SEC that makes the following points:

  • The pay disparity ratio is material to investors and should be disclosed. The disclosure will encourage boards of directors to consider pay equity, and shareholders will be able to consider pay disparities in connection with say-on-pay votes. Further, high pay ratios can harm employee morale and thus affect corporate performance. The letter attaches an AFL-CIO white paper on the benefits of disclosure of pay disparity information to investors.
  • It is important to include non-U.S. employees in the calculation, and the other suggestions to the SEC in the letter will make the calculation feasible for even large multinational companies to make.
  • The SEC can, and should, permit statistical sampling to calculate the median compensation of non-CEO employees. The letter includes an extensive appendix with analysis of the legal authority for this and other assertions.
  • The SEC can, and should, consider permitting companies to identify their median employee compensation based strictly on cash compensation. This is one point on which the AFL-CIO and the group of 15 law firms seem to agree.

Based on the above statements, the AFL-CIO asserts that issuers “will have no difficulty” complying with the requirement if they have adequate controls.

If the SEC adopts some of the suggestions in the letters, the disclosures will be more feasible for public companies, although the AFL-CIO’s assertion that companies will have no difficulty making the disclosure seems unrealistic. The utility of the disclosures is a separate issue and obviously depends on philosophy. According to the union’s letter and its white paper, its support for the disclosure is based on usefulness to investors in company stock. However, the union’s web site includes a web page devoted to support of Section 953(b). The web page expresses the union’s support for the disclosure in terms of workplace inequality, and the link to the page on its “Executive PayWatch” site invites the reader to “learn about the new disclosure requirement that is giving CEOs conniptions.”

Proxy Access Proposals: What Can We Expect to See Next Year?

 In “Will Investors File Proxy Access Proposals in 2012?”, in the RiskMetrics Blog, Ted Allen analyzes the possible impact of the D.C. Circuit Court’s ruling (discussed in this prior post) that struck down the SEC’s proxy access rule, Rule 14a-11. Rule 14a-11 grants to large shareholders of public companies the right to nominate directors and have the nominees included in management’s proxy statement.

Allen points out that the SEC may lift its stay on the related amendment to Rule 14a-8, which would allow shareholders to introduce proxy access proposals in 2012. He reports that there may not be a flood of proxy access proposals next year, due to institutional investors’ mixed feelings on these proposals and some complex dynamics:

Several investors said this week they are looking into submitting access proposals next season . . . . So far, it appears that the activist investor community is undecided about whether to file access proposals in 2012 and how many companies to target. There is a concern that the filing of dozens of access resolutions next season might bolster corporate arguments that the SEC should refrain from adopting a new marketwide access rule and just allow private ordering to work. There also is a concern that low support levels for poorly targeted proposals would be cited by corporate critics as evidence that most shareholders don't want access. Conversely, some activists argue that strong shareholder votes for access in 2012 could help prod the resource-stretched SEC to prepare a revised access rule. If activists do file access proposals next season, it appears that they may focus on a few high-profile companies with well-known governance issues.

One interesting issue is whether the shareholder access proposals would likely be votes on binding amendments to the bylaws or non-binding precatory votes that are merely recommendations to the board. Allen states: “Investors could file binding or non-binding resolutions, but some states require higher ownership thresholds for binding bylaw proposals.” Individual companies also may have bylaws that would require a supermajority vote by shareholders. Allen points to three examples of proxy access proposals in 2007, before the SEC stopped allowing such proposals under Rule 14a-8:

  • A binding access proposal involving Hewlett-Packard Corporation that won a high percentage of approval but did not pass. This proposal would have required a two-thirds positive vote under H-P’s bylaws.
  • Non-binding access proposals involving UnitedHealth Group, Inc. and Cryo-Cell International, Inc. The UnitedHealth proposal won a high percentage of approval but did not pass; the Cryo-Cell proposal passed.

Therefore, if the SEC lifts its stay on the amendment to Rule 14a-8, the resulting proposals are likely to include a mix of binding and non-binding proposals.

Cheat Sheet Updated for Changes in Dodd-Frank Rulemaking Timetable

As Broc Romanek pointed out in Blog, the SEC has modified its timetable for rulemaking under the Dodd-Frank Act. The ON Securities Cheat Sheet has been updated to include the additional dates. Most of the changes consist of adding a proposed time frame for final rules that have not yet been adopted, in many cases giving a range of January to June 2012. This makes it very unlikely that some of these rules, including the disclosure of pay relative to performance and the ratio of CEO pay to median non-CEO employee pay, will apply to the 2012 proxy season.

Stock Market Woes? Blame the Blue Guys!

We’re all still reeling from the stock market plunge this week so far. In his CNN show this evening, Piers Morgan showed footage of the New York Stock Exchange’s opening bell being rung on July 29 by . . . the Smurfs! He points out that, since that time, the Dow Jones Industrial Average has plunged by almost 1,000 points. Obviously, there must be a connection.

See the video below, if you want to know who’s to blame for the crummy stock market. You’ll be singing the blues!

If the Shareholders Say "Nay-on-Pay", Get Ready for "Sue-on-Pay"

A number of public companies this year have received a majority of negative votes in their shareholder advisory votes on executive pay (Say-on-Pay), required under the Dodd-Frank Act – see this prior post. In his Proxy Disclosure Blog on (subscription site), Mark Borges reported yesterday that at least 36 companies have experienced “Nay-on-Pay” votes.

In a Reuters article, “Hercules execs sued over failed ‘say on pay’ vote,” Tom Hals reported recently that Hercules Offshore, Inc. became the sixth company to face shareholder derivative lawsuits based on a negative Say-on-Pay vote. The others are, in reverse chronological order, Umpqua Holdings Corporation, Beazer Homes USA, Inc., Jacobs Engineering Group, Inc., Occidental Petroleum Corporation and KeyCorp. There are generally multiple lawsuits involving each company in various state and federal courts. These “Sue-on-Pay” lawsuits have caused a great deal of consternation in boardrooms, partly out of fear that every negative Say-on-Pay vote has the potential to lead to expensive and distracting litigation.

My colleagues and I have taken a preliminary look at the cases and have some observations:

Timing. The KeyCorp and Occidental Petroleum lawsuits were filed in mid-2010, after the advisory votes at those companies’ 2010 annual meetings. Both of those cases have been settled. The KeyCorp settlement is discussed below. A blog post from the Davis Polk law firm reported that Oxy Pete settled one case and got two others dismissed. The lawsuits involving the other four companies have all been brought in 2011, based on failed Say-on-Pay votes at the companies’ 2011 annual meetings.

The Law Firms. A couple of plaintiffs’ firms each show up in several of these cases. In the KeyCorp, Oxy Pete and Jacobs Engineering cases, the Weiser Law Group in the Philadelphia area is listed as one of the plaintiffs’ law firms, and Weiser was lead counsel in the KeyCorp settlement. The Robbins Geller firm in San Diego is listed as counsel in the Oxy Pete, Beazer, Umpqua and Hercules cases. Other firms show up as well, but these two firms seem to be common threads. Both are well known plaintiffs’ firms.

The Claims. The lawsuits are all derivative claims, meaning the plaintiff/shareholders are bringing claims against the individual directors on behalf of the corporation. Not surprisingly, the claims in the various cases are very similar: the directors allegedly (i) breached their duty of loyalty by deliberately diverting corporate assets to the executives at the expense of the shareholders and aided and abetted each other in these actions; (ii) committed corporate waste and caused unjust enrichment; and (iii) breached their duty of candor and full disclosure by stating in the proxy statement that pay was based on performance, concealing the overpayments. Many of the complaints include lovely charts showing that compensation increased significantly in the preceding year, while shareholder return decreased significantly. The claims in these cases are based on both the board’s original approval of the preceding year’s compensation and the failure to make immediate changes to the compensation programs following the Say-on-Pay vote. Plaintiffs also generally claim that the negative Say-on-Pay vote rebuts the presumption in favor of the boards’ actions under the business judgment rule.

One interesting side note for compensation consultants: in every one of the six lawsuits, the consultants were named as defendants, on the theory that they aided and abetted the directors’ bad actions and breached their contracts with the company by allegedly giving lousy advice. PricewaterhouseCoopers and Frederic W. Cook & Co. are each named in two lawsuits, with Mercer and Pearl Meyer & Partners each named in one. This development cannot be welcome news in the executive compensation consulting world.

The Merits and Procedural Considerations. Strictly on the merits, there should be meritorious defenses to these claims. The board, not the shareholders, is charged under state law with making compensation decisions, and the presumptions in favor of the directors’ actions should not shift based on a non-binding advisory vote. This is especially true in light of Section 951(c) of the Dodd-Frank Act (848-page PDF), which specifically provides that “ . . . the shareholder vote . . . may not be construed . . . to create or imply any change to the fiduciary duties of such issuer or board of directors . . . [or] any additional fiduciary duties for such issuer or board of directors. . . .”

However, procedurally, getting a final determination on the merits of any case still takes time, at least a matter of months, and the Sue-on-Pay cases are scattered in a variety of state and federal courts. In the meantime, as plaintiffs get some settlements, this could embolden these same law firms or other plaintiffs’ firms to bring more claims.

The KeyCorp Settlement. In March 2011, KeyCorp reported that it had entered into a comprehensive settlement agreement for the legal actions based on its 2010 Say-on-Pay vote. Note that the Dodd-Frank Act requirement was not yet in effect for this vote, but KeyCorp held its vote under a similar requirement for TARP recipients, which includes language on fiduciary duties that is very similar to the Dodd-Frank language – i.e., the advisory vote does not change fiduciary duties. See Section 7001 of the American Recovery and Reinvestment Act of 2009 (PDF). Nonetheless, after months of wrangling, KeyCorp settled the case on terms that are pretty typical for derivative settlements. KeyCorp agreed to make numerous changes in its compensation practices and procedures, and also agreed to pay $1.75 million in fees to the plaintiffs’ law firms.

In one of my favorite provisions of the settlement agreement, the plaintiffs’ firms boldly stated that they intended to ask the court to approve the payment of cash fees to the named shareholder plaintiffs. These fees would be paid in recognition of these shareholders’ service to the company and all of its shareholders, and the amount of said fees, if approved, would be deducted from the plaintiffs’ firms’ fees. The aggregate amount of said fees to be requested: $5,000.

Comment. Regardless of the merits of these lawsuits, any company in danger of losing a Say-on-Pay vote should be prepared for a Sue-on-Pay action. Until courts in a number of jurisdictions rule on motions to dismiss (and any appeals from dismissals are decided), the plaintiffs’ law firms are likely to be emboldened by settlements like the KeyCorp agreement. Advisors should prepare the board members for the prospect of being named individually, and public companies should be prepared for the potential expense and distraction of a lawsuit.

In this litigious atmosphere, corporate counsel should be especially attuned to keeping appropriate records of the process followed in connection with any compensation decisions. Even if a company received an overwhelming vote of support this year, the shareholders may not be so generous next year if the stock takes a dive but reported compensation keeps flying high. Also, if the company is not confident in the result of an upcoming Say-on-Pay vote, it will be very important to react quickly to a failed vote. Does the compensation committee want to make immediate changes, if those changes are possible? Does the company want to announce changes right away? In light of the settlement by Key, preparation will be key.

Thanks to my securities litigation partner, Rich Wilson, and our summer associate, Kathleen Crowe of Georgetown Law Center, for their invaluable help on this post.

Image: Flikr

The Say-on-Pay World According to Broc

Broc Romanek, the editor of and writer of the associated blog, spoke in Minneapolis last week at a meeting of the local chapter of the Society of Corporate Secretaries and Governance Professionals. His main topic was “Post-Proxy Season Wrap-Up,” and Broc gave practical advice on dealing with Say-on-Pay and other governance reforms during the remainder of this proxy season and in preparation for next year. He also talked about technology developments and offered some predictions on the impact of social media on investor relations.

There were several good takeaways from the program. How do I know? I was surrounded by in-house counsel, and I tried to take note of the times when everyone picked up their pens and scribbled notes on the handout. Here’s my list:

  • One big lesson: engagement with institutional shareholders is really difficult, especially for smaller companies that may have trouble getting their attention. This will continue unless and until the investors beef up their staffs big-time. How to deal with the issue? After proxy season is over, contact your big investors and ask how they want to be contacted (if at all) in the future. Get a dialogue going now.
  • The shareholder advisory service ISS has issued negative recommendations on Say-on-Pay for around 12% of companies so far this year. In other words, ISS has been friendlier to boards and management than many expected. ISS’s future direction is a little uncertain – the company has been sold several times, and Broc reported that it’s on the block again. But public companies shouldn’t wish for ISS to “just go away” unless it’s clear that any leading alternative would be better.
  • Companies need to be more careful about how they count the votes on Say-on-Pay and other matters. Broc cited data to the effect that a large percentage of companies are making mistakes in counting the votes (e.g., how will abstentions or broker non-votes be counted in determining whether a proposal was passed). Some companies are counting the votes in a way that does not match corporate bylaws and state corporate laws. Further, in some cases the voting results, as reported in Form 8-K, are not consistent with the previous proxy statement disclosures about how the votes would be counted. He urged professionals to double check the standards and the numbers.
  • Several companies have been sued after negative Say-on-Pay votes, with the complaint citing the vote as evidence of a breach of the board’s duties. The lawsuits may well be groundless, but boards of directors of these companies are reacting very strongly. Be sure to warn the board of the possibility.
  • Pay more attention to the investor relations page on your company’s web site. Company web pages are becoming more influential. Broc cited the writings of Dominic Jones on the IR Web Report blog, see “Stats show PR wires less effective than company web channels.” Google your company name and “executive compensation” and note the top 10 results – this provides clues about who is controlling the narrative. In this regard, pay attention to search engine optimization. For example, if you have an IR web page with “executive compensation” in the URL, the page’s search results will be improved. Keep tabs on services that make it easier for people to access your company’s information and provide feedback from mobile devices – soon, nearly everyone will be using tablets.
  • Broc expects shareholders meetings to become more like political campaigns. In a recent New York Times article, “Inciting a Revolution: The Investor Spring,” Gretchen Morgenson reported on a movement among the smaller shareholders of Celgene Corporation to organize a negative Say-on-Pay vote through social networking. Events like that are not yet common, but this is the wave of the future. Look at the IR web pages of European companies, where investor relations and shareholder meetings have been treated more like political campaigns, with video, etc.
  • On a related note, company personnel need to get conversant with Twitter fast, especially since many proxy solicitors don’t “get” social media yet. Institutional investors are reading tweets, and a majority of IR departments are on Twitter. Don’t get left behind. See Broc’s post from earlier this year, “Time for You to Consider Tweeting? The IR Pros Are....”

Broc also spoke effectively about the expanding use of social media, and the need for all of us to get more familiar with the new technology. I’ll blog about this in a future post.

GE Amends Terms of Existing Stock Options, Facilitates Positive Say-on-Pay Vote

Bloomberg reported on Wednesday that General Electric Company received a positive Say-on-Pay vote at its annual shareholders meeting. As disclosed in GE’s proxy statement filings, the company achieved this result, or at least increased the likelihood of an affirmative vote, through its recent restructuring of an existing equity award originally granted to the CEO in 2010. This may be a preview of things to come in the shifting balance of power between boards and shareholders, facilitated by the reforms under the Dodd-Frank Act of 2010. Here’s the time line:

  • On March 14, 2011, GE filed its annual meeting proxy statement. As required under the Dodd-Frank Act, the proxy statement included a non-binding shareholder advisory vote on executive compensation (Say-on-Pay).
  • On April 7, GE filed additional soliciting materials. The company disclosed that ISS, the shareholder advisory service, had issued a report recommending a “no” vote in GE’s Say-on-Pay vote. GE challenged ISS’s conclusions, including ISS’s valuation of the grant of 2 million stock options to CEO Jeffrey Immelt in March 2010. GE had valued the options at $7.4 million, while ISS valued the same options at $14.5 million. GE also challenged other aspects of ISS’s negative report.
  • On April 18, GE made an additional proxy filing reporting that the compensation committee, “with Mr. Immelt’s full support,” had modified the 2010 options to add performance-based vesting. Half of the options will now vest based on GE’s industrial cash flow, and the other half will vest based on the company’s total shareholder return compared to that of the S&P 500. GE reported that the change in the option award was based on “a number of constructive conversations with our shareowners.” In her Bloomberg article, “GE Ties CEO Options to Performance as Investor Meeting Nears,” Rachel Layne reported that, after the change in the options, ISS changed its negative recommendation and advised shareholders to support a positive Say-on-Pay vote.
  • On April 27, GE’s shareholders voted to approve the Say-on-Pay resolution, with 85 percent of the shares voted in favor of the resolution.

GE joined a number of companies this year that filed supplemental proxy materials challenging a negative recommendation by shareholder advisory services, as reported by Broc Romanek in Blog. At least one other company has made changes to its compensation programs in response to a negative recommendation. The Walt Disney Company eliminated tax gross-ups for golden parachute payments, which caused ISS to change its recommendation, as reported by Janine Sagar in Business Insider, and enabled a positive Say-on-Pay vote.

However, the GE saga marks a new era in direct communications about specific compensation terms that may be acceptable or unacceptable. It’s one thing for Disney to eliminate gross-ups, which are high on shareholders’ lists of unacceptable pay practices. It is another thing for GE to adjust, as part of a dialogue with shareholders, specific terms of a past award to base the payout on different performance metrics (i.e., industrial cash flow and relative shareholder return, rather than simple stock appreciation inherent in a stock option). This negotiation appeared to tip the balance in favor of a positive Say-on-Pay vote.

This back-and-forth dialog is the most obvious example yet of the increased power of shareholders, and shareholder advisory services, to limit or even define executive compensation under the Dodd-Frank Act regime.

Checklist for the Board: How to Respond to a Say When on Pay Vote

In the next few weeks, more public companies will hold their annual meetings, which will include the shareholder advisory votes on compensation required under the Dodd-Frank Act. One of these votes allows the shareholders to select the desired frequency of Say-on-Pay votes. Under this frequency vote, sometimes called “Say When on Pay,” shareholders may express a non-binding preference for whether Say-on-Pay votes should be held on an annual, biennial or triennial basis. After the annual meeting, the company will be required to report on the frequency with which it will actually hold Say-on-Pay votes, in light of the results of the shareholder vote – see new Item 5.07(d) of Form 8-K (PDF).

Therefore, once the annual meeting is held, the board of directors will need to report their response to the non-binding shareholder vote. So, what steps should the board of directors take following the Say When on Pay vote? Of course, if the shareholders chose the alternative that the board had recommended in the proxy statement, the determination is pretty easy. If the shareholders chose a different alternative, it’s a little more complicated. The process will be different for every company, but here is a checklist of governance steps and tips to consider:

  • The rule gives you five months – take it. Item 5.07(d) gives the company 150 days to file the 8-K that includes the response (but no longer than 60 days before the deadline for submission of shareholder proposals for the next year’s annual meeting under Rule 14a-8). The consideration of this determination should be put on the agenda for a future board meeting in advance of the deadline for reporting.
  • Consider the factors listed in the proxy statement. Many companies included in their proxy statement a list of factors they considered that caused them to conclude that the recommended frequency was in the best interests of the company and it shareholders. At the meeting, the board should discuss these factors once again, and balance them against the will of the shareholders expressed in the vote.
  • Consider the strength of the views expressed in the shareholder vote. Presumably, a strong majority vote in favor of one of the alternatives should be given more weight than a close vote where none of the three alternatives received a majority. In either case, it is perfectly appropriate for the board to follow the preference of the shareholders despite the board’s prior recommendation of a different alternative.
  • Consider having the compensation committee make a recommendation. Especially if the compensation committee initially recommended to the board the frequency expressed in the proxy statement, it may be appropriate to have the committee recommend the ultimate frequency of the Say-on-Pay vote to the board for its approval.
  • Document the deliberations carefully. Make sure the minutes reflect the matters considered by the board and/or the compensation committee in making its determination.

Frequency Vote Update

Mark Borges just published his updated tally (as of April 15) of 1,976 companies’ proxy statements in his Proxy Disclosure Blog on (subscription site). According to Borges’ tally, these companies recommended as follows in their “Say When on Pay” shareholder advisory votes on frequency:

Triennial Say-on-Pay vote recommendation: 839 companies (includes 36 smaller reporting companies)
Biennial Say-on-Pay vote recommendation: 66 companies (includes two smaller reporting companies)
Annual Say-on-Pay vote recommendation: 1,009 companies (includes 11 smaller reporting companies)
No recommendation: 62 companies (includes six smaller reporting companies)

As for the results of the votes to date, Borges provided a good summary:

. . . . 252 companies [have] reported the voting results from their annual meeting of shareholders.
Here are the shareholder preferences for the frequency of future "Say on Pay" votes:

- Of the 15 companies that have recommended a biennial vote, 11 have seen their shareholders express a preference for annual votes.

- Of the 145 companies where the Board of Directors has recommended that future "Say on Pay" votes be held every three years, 63 (or 43%) have seen their shareholders indicate a preference for annual "Say on Pay" votes. That number decreases to 42% - 52 of 125 companies) when you exclude smaller reporting companies.

- Of the nine companies where the Board of Directors has made no recommendation at all with respect to the frequency vote (excluding smaller reporting companies), eight have seen their shareholders state a preference for annual "Say on Pay" votes.

And, at one company, Qualstar Corporation, where the Board of Directors had recommended annual "Say on Pay" votes, shareholders expressed a preference for a triennial vote.


Hewlett-Packard is the Latest Company to Lose a Say-on-Pay Vote

It’s a case of “Nay-on-Pay”, as Paul Hodgson described it in his post on The Corporate Library Blog, “Hewlett-Packard latest company to feel the heat of a Say on Pay defeat.” At its annual meeting last week, Hewlett-Packard became the fourth public company this year to lose a Say-on-Pay vote, now required under the Dodd-Frank Act, with 50 percent of the shares voting against the resolution and 48 percent voting yes. The no votes have also outnumbered the yes votes at Shuffle Master, Beazer Homes USA and Jacobs Engineering Group, as reported in Ted Allen’s post on ISS’s RiskMetrics Blog, “Investors Reject H-P’s Pay Practices.”

These latter three companies are quite a bit smaller than H-P, and at least two of them had fairly obvious “red flag” issues. Shuffle Master had a CEO severance agreement with a “single-trigger” provision, as described in Allen’s post. Beazer Homes has been faced with shareholder lawsuits over its compensation practices and was the subject of a successful “clawback” proceeding, as described in this Bloomberg article by Jef Feeley and David Beasley, “Beazer Homes Directors Sued by Teamsters Funds Over Executive Compensation.”

On the other hand, the lost Say-on-Pay vote at huge H-P, ranked number 10 in the Fortune 500, is sure to get the attention of corporate America. This may be the public company equivalent of Kansas losing today to Virginia Commonwealth in the NCAA Men’s Basketball Regional Finals. H-P did not have such obvious compensation red flags, and it certainly had the resources to mount a vigorous communications campaign. However, Allen’s post cites several aspects of H-P’s compensation that could not have made large shareholders happy, and which resulted in ISS’s recommendation against the resolution:

[New CEO Leo] Apotheker's pay arrangements include substantial up-front signing awards of cash and stock, and severance provisions that would result in sizeable payouts--including automatic vesting of all his time-based equity--upon his termination without cause. Many aspects of the company's incentive programs are subject to board discretion as well, and depend on the board exercising its authority objectively--e.g., the granting of discretionary bonuses and approval of higher-than-median pay benchmarking. The company has paid substantial discretionary awards and does not disclose goals for the key metrics that drive payouts under its annual and long-term plans, even retrospectively. Without complete disclosure, shareholders cannot ascertain the rigor of the goals relative to payouts.

Allen also points out that the company had provided “generous severance payouts after the board ousted former chief executives Mark Hurd and Carly Fiorina.” The Bloomberg article also reports that ISS cited Apotheker’s participation in selecting new board members, which it deemed “inappropriate.”

H-P’s compensation committee will need to communicate with shareholders to determine the cause or causes of the lost vote and deal with them in the coming year. Likewise, other companies’ boards should try to learn lessons from the defeat at such a high profile company.

Proposed Conflict Minerals Disclosure Rules Will Create Reporting Challenges

Next month, the SEC is expected to adopt final rules under provisions of the Dodd-Frank Act requiring new disclosures of mineral-related activities, including the so-called “conflict minerals” disclosure requirement under Section 1502. The rules will affect companies in a broad range of industries if their products might utilize conflict minerals – gold and rare compounds mined in the Congo. These materials are used in electronic components, engine components, aerospace equipment, jewelry and other industries. Companies will be required to trace the source of raw materials in their products, or the components thereof, to determine whether conflict minerals are required and make the required disclosures, which must be audited.

The SEC issued proposed conflict minerals disclosure rules (PDF) in December 2010, and under Dodd-Frank, final rules must be adopted by April 15, 2011. The SEC has received more than 150 comment letters, summarized in a recent article by Arielle Bikard, titled “No Shortage of Opinions on the SEC's 'Conflict Minerals' Proposal,” on the Compliance Week website (subscription required):

Congress originally included the legislation in the Dodd-Frank Act to discourage companies from using conflict minerals, which warlords in the Congo use to finance their operations. . . .

Commenters generally said that compliance with such a broad rule, with so many undefined terms, will be a challenge. ‘We believe that without additional clarity in the areas of objective, criteria, and evidence, there will be significant inconsistency and lack of comparability of information in issuers' Conflict Minerals Reports,’ Deloitte & Touche wrote in a letter to the SEC. In particular, Deloitte warned, if a company can't determine the origin of the minerals, an independent private-sector outside auditor might not be able to gather enough evidence to form an opinion.

Companies were hoping that the SEC would narrow the language of the rule in the proposal, but open questions still abound, says Brian Breheny, partner at the law firm Skadden, Arps, Slate, Meagher & Flom. For example, the current language doesn't clarify whether a retailer of electronic goods has any obligation to study conflict minerals in the items it sells. Companies must also determine whether the mineral is 'necessary' to the production or to the functionality of the product. What exactly does 'necessary' mean? The proposal doesn't specify. . . .

The SEC is required to pass its final conflict-mineral disclosure rule by April 15. . . . Plenty of letter writers took issue with the rule's taking immediate effect. . . .

Regarding the last point, although the statute provides that public companies must comply with the disclosure requirements for the first fiscal year beginning after the effective date of the rules, some of the commenters are requesting that the SEC exempt companies from the requirement for the first full year after effectiveness. Assuming this does not happen, manufacturing companies in a broad range of industries should be planning to quickly conduct the due diligence necessary to meet the reporting requirements.

Proposed Disclosure Rules for Resource Extraction Issuers Will Also Be Interesting

In the Compliance Week article, Bikard also touched on the SEC’s proposed rules (PDF) on disclosure by public companies engaged in resource extraction, requiring disclosure of the payments these companies make to foreign governments. This disclosure is required by Section 13(q) of the Securities Exchange Act of 1934, added under the Dodd-Frank Act. As with conflict minerals, the SEC has received many comment letters on its proposed rules on the payments by resource extraction issuers. Bikard asked for my commentary:

Industry voices such as Exxon and the U.S. Chamber of Commerce are pushing the SEC to limit the scope of the rules in a variety of ways, says Martin Rosenbaum, partner at the law firm Maslon Edelman Borman & Brand. For example, they suggest that the ‘annual report’ required by Dodd-Frank be confidential on an individual company basis, and that only the SEC's compilation be made public, he says. They also want broad exclusions from any requirements that would be inconsistent with non-U.S. laws, and blanket exclusions for smaller companies.

On the other side are institutional investors that push for socially responsible investing, which strongly oppose limits on the reporting requirements, Rosenbaum says. They have an interest in obtaining this information for policy reasons, he continues, and they also argue that transparency on an individual company basis will benefit investors.

Expect some interesting developments in the disclosure rules under the Dodd-Frank Act in the next few months.

Analyzing Whether to Include the New Golden Parachute Disclosures in the Annual Meeting Proxy Statement

Under the Dodd-Frank Act, public companies involved in merger and acquisition transactions must hold a non-binding shareholder advisory vote on parachute compensation related to the merger (the “Say-on-Parachutes” vote) and must include new disclosures of parachute payments in the merger proxy statement or other filing relating to the transaction. On January 25, 2011, the SEC adopted final rules implementing these requirements (PDF), effective for merger-related filings on or after April 25, 2011. Unlike the other shareholder advisory votes under the Dodd-Frank Act, there is no two-year deferral of effectiveness for smaller reporting companies.

Since the Act was enacted last year, these golden parachute provisions have been outside the spotlight – public companies have understandably focused more of their attention on the separate Say-on-Pay and Say When on Pay advisory votes, which are both required at this year’s annual meeting. However, companies need to consider whether to include the new enhanced parachute disclosures in the annual meeting proxy statement, on a voluntary basis, in order to take advantage of a possible exception from the Say-on-Parachutes vote requirement in a later merger. As described below, most companies will choose not to include the enhanced disclosures in the annual meeting proxy statement.

The new SEC rules added Item 402(t) of Regulation S-K (see Release (PDF) at page 6043), which describes the parachutes disclosure required to be included in the merger proxy statement or other transaction-related filing, such as a tender offer statement. Item 402(t) requires a new Golden Parachute Compensation table with detailed information on the various payments to each named executive officer related to the transaction.

The Item 402(t) disclosures are not required any SEC filings until there is a merger or acquisition transaction. However, if the Item 402(t) disclosures are voluntarily included in an annual meeting proxy statement that includes a Say-on-Pay vote, the company might be able to subsequently use an exception under the statute and avoid the Say-on-Parachutes vote if there is a merger. In its adopting release for the final rules governing the Say-on-Parachutes vote, the SEC states, “we would expect that some issuers may voluntarily include Item 402(t) disclosure with their other executive compensation disclosure in annual meeting proxy statements soliciting the [Say-on-Pay vote] . . . so that this exception would be available to the issuer for a potential subsequent merger or acquisition transaction.”

Is it a good idea to include the voluntary Item 402(t) disclosure to take advantage of the exception? I believe most companies will conclude that it’s not worth it:

  • In its adopting release, the SEC made it clear that the exception from the vote requirement is very narrow. At the time of the merger, if there are any new or amended golden parachute arrangements since the date of the previous Say-on-Pay vote, the rules require a Say-on-Parachutes advisory vote on the new or amended arrangements. Even changes resulting from additional grants of equity or salary increases or the addition of a named executive officer would make the exception unavailable. Therefore, even if the company includes the Item 402(t) information voluntarily, it is very likely that there will be some changes to parachute compensation that will require a Say-on-Parachutes vote on the changes at the time of a merger. The merger proxy statement will be required to include two tables – one that shows all of the golden parachute compensation, and a second table disclosing only the new or revised arrangements subject to the vote.
  • If the Item 402(t) disclosure is added voluntarily to the annual meeting proxy statement, this will add even more complexity to that document in a section that is already complex and often confusing.
  • The addition of the voluntary Item 402(t) disclosure to the annual meeting proxy statement will call additional attention to the parachutes arrangements for purposes of the Say-on-Pay vote. In its 2011 Compensation Policy FAQs, ISS states that, if the company adds the voluntary disclosure, the information in the parachute table will “carry more weight” in ISS’s overall Say-on-Pay recommendation. Therefore, the voluntary disclosure could increase the chances of negative recommendations from proxy advisory firms on the Say-on-Pay vote.
  • Boards may not view the requirement of holding the Say-on-Parachutes vote at the time of a merger or acquisition as a great additional burden. The vote is non-binding, and unlike the regular Say-on-Pay vote, the directors who made the compensation decisions subject to the shareholder vote generally will not be continuing in office after the vote. That said, of course the directors would greatly prefer a positive advisory vote, and the vote must be taken seriously.
  • Depending on the structure of a future merger and acquisition deal, the Say-on-Parachutes vote may never be required anyway. Many cash mergers are structured as a friendly tender offer followed by a short-form merger. In those deals, there will be no Say-on-Parachutes vote because there is no solicitation of proxies or consents for approval of the ultimate short-form merger. However, the tender offer statement will be required to include the Item 402(t) disclosure.

For these reasons, I don’t expect to see a lot of companies elect to include the “Golden Parachutes Compensation” table required by Item 402(t) in their annual meeting proxy statements.


Update on Whistleblowers Under the Dodd-Frank Act; More on Frequency Vote Recommendations

In my previous post, “Whistle While You Work! SEC Proposes Whistleblower Rules under Dodd-Frank,” I reported on SEC’s proposed rules (PDF) under Section 922 of the Dodd-Frank Act, which provides a “bounty” to whistleblowers who disclose securities law violations leading to large monetary sanctions. The availability of the bounty could encourage potential whistleblowers to bypass reporting mechanisms within the company and report suspected violations directly to the SEC.

In a very interesting New York Post article last week, “SEC whistleblower call draws few tipsters”, Kaja Whitehouse reports that the expected flood of whistleblower tips to the SEC has not yet occurred:

The [SEC] has received just 168 complaints alleging corporate fraud in the first 6½ months of the program's existence, according to data the SEC provided to The Post through a Freedom of Information Act request. . . . At that rate, the SEC is receiving less than one tip a day -- hardly the flood that led the agency to delay staffing the program while it pleaded with lawmakers for more funding.

‘That's a lot less than I would have expected,’ said Steven Kohn, executive director of the National Whistleblowers Center in Washington, DC, which advocates for whistleblowers and pairs them up with lawyers. Kohn said . . . he expected the SEC . . . would receive closer to 3,000 whistleblower tips a year. . . . While the disappointing number might simply be the result of a slow start, whistleblower advocates say it may reflect the battle being fought over the SEC's final rules for governing the program, which are to be released in April. Among other concerns, the SEC has been asked to force employees to go through companies' internal whistleblower programs as a prerequisite to filing an official complaint.

Does that mean public companies should relax and stop worrying about their whistleblower procedures? Absolutely not. The complaints may come faster once the final rules are issued. And it only takes one complaint to tie up a lot of resources at a particular company.

Here is another interesting recent report on whistleblower claims by Compliance Week editor Matt Kelly, “Latest on Whistleblower Rules: Nothing Good.” Kelly reports that budget cuts at the SEC will leave the agency unable to investigate a large number of whistleblower complaints. This will increase the burden on public companies’ internal compliance programs, especially if a flood of whistleblower complaints does come.

Boards’ Recommendations on the “Say When on Pay” Vote: The Debate Continues

I got a lot of comments on my post last week about boards’ recommendations on the frequency vote required under the Dodd-Frank Act. In his subsequent post “The Debate Over Whether to Ignore Say-When-on-Pay Results So Far” on Blog, Broc Romanek said,

. . . I was a little surprised at the reactions that Mark Borges and I have received to our advice that - given the voting results so far - companies may reconsider recommending a triennial vote for say-when-on-pay (egs. Marty Rosenbaum and Amy Muecke). . . . With a statistically relevant number of results in, it's becoming pretty clear that shareholders want an annual SOP even if the company has stable management and sound pay practices. . . . [T]he fact that so many companies are ignoring the clear will of shareholders over this minor topic ("minor" in comparison to SOP itself) will likely further galvanize shareholders to more closely scrutinize pay practices. As I hear from shareholders, they feel like companies are deciding what is in the "best interests of shareholders" without taking into account what shareholders have clearly said is in their best interests. Looking at this situation from their perspective, I can see why they might get upset.

And the debate continues. Amy Muecke, in “Frequency of Say on Pay: The Statistics & Beyond,” responded that the results are still coming in, and there is evidence that some companies are successfully convincing shareholders to support triennial votes even in cases of companies with broad institutional holdings – citing Sanderson Farms as an example. And here is a commentary (PDF) released today in which Georgeson strongly supports the position that boards should make their own determination. I continue to believe that this is the correct approach, assuming as I do that most boards will take a very thoughtful approach – the board certainly should not take lightly the decision to support a triennial or biennial vote. Consider the following points, in addition to the ones I addressed in my previous post:

  • Although ISS will always support an annual vote, another proxy advisory firm, Glass Lewis, has announced (PDF) that it may support a “well-crafted” argument by the board in favor of a triennial or biennial vote.
  • I recently heard the comments of a representative of a company that has already been conducting biennial say-on-pay votes after previous negotiations with shareholders. That is one example of a situation in which management cannot just assume that the shareholders will vote in favor of an annual vote, although that is a possible outcome.
  • Hopefully, shareholders will not take a triennial or biennial recommendation, in the first year of  the frequency vote, as an indication that the board or management is "ignoring" the voice of shareholders. Given that companies are spending more time engaging with shareholders on compensation issues, hopefully the seriousness of these discussions will convince large shareholders that management is serious about listening. I hope the shareholders will focus more on the board’s subsequent reaction to a vote favoring annual say-on-pay than on an initial triennial recommendation, as long as it is thoughtful and explained carefully.
  • For a good discussion of this debate in light of the board's duty to do what it believes is in the best interests of the corporation, see this post by my partner, Paul Chestovich, in the Small Public Company Forum.
  • As Broc says, it is conceivable that shareholders will take the wrong message from a triennial recommendation and will be galvanized to take action in other areas. Therefore, the board should be cognizant of that risk. Again, good communications will be important in mitigating that risk, but will not eliminate it.


The Say When on Pay Vote: What Should a Board Recommend?

Should a public company board of directors be watching the “scoreboards” of previous “ballgames” when making a recommendation on this year’s frequency vote (“Say When on Pay”)? I’m referring to the tallies of the frequency votes of public companies that have already held their annual meetings this year. Keeping track of these votes, almost in real time, reminds me of watching ESPN’s BottomLine sports ticker. The conventional wisdom seems to be that boards of directors should base their recommended frequency on what they see on the sports ticker. I don’t agree, at least not in all cases.

It’s been widely reported that shareholders are generally casting a majority of votes in favor of an annual Say-on-Pay vote, even though the boards of directors in most cases have recommended a triennial vote. Many large shareholders have followed the advisory firm ISS’s blanket recommendation in favor of a vote for annual frequency, adding momentum to this trend. Last week, Mark Borges reported on these voting results in the Proxy Disclosure Blog on (a subscription site). He reported that a majority of companies recommending a triennial vote have had the shareholders vote in favor of annual votes. His statistics show that this trend toward an annual vote is even stronger at large companies – virtually no larger public companies have yet succeeded in bucking this trend (except a handful that have a single large shareholder who would agree with the board). He predicts, probably accurately, that this trend will continue.

How should the board respond? Here is Borges’ analysis:

So, at this point, is there any reason to make a triennial vote recommendation? My instinct says no - why put the board of directors in the position of having to make a difficult decision if - and when - the vote goes against you? I guess that a triennial recommendation still makes sense in two situations: one, if you're confident that your shareholders are in agreement with the recommendation, or, two, if you want to put shareholders on notice that, absent a near unanimous vote by shareholders, you prefer and intend to proceed with a triennial vote. Otherwise, I'm not sure that, at this stage, we aren't seeing the handwriting on the wall.

And Broc Romanek, in a recent post on The Advisors’ Blog on, agreed:

I agree wholeheartedly with Mark Borges' blog . . . . I'm not sure why companies continue to recommend triennial now that the early meeting results bear out that shareholders will often reject that frequency . . . . It's a reminder of what shareholder engagement is all about - listen to your shareholders and act on what they say. Clearly, many companies are choosing to operate in a bubble.

I have to respectfully disagree with Mark and Broc. The board should make recommendations based on its judgment about what is in the best interests of the company and its shareholders, after considering all relevant factors. For a company with stable management, sound pay practices and a long-term perspective on compensation, the board may legitimately believe that a triennial vote is the best option. And some large shareholders, notably the United Brotherhood of Carpenters, BlackRock Institutional Trust Company and Wellington Management Company, agree with this approach and will generally favor a triennial vote. Should the board ignore their viewpoints, especially if they are large shareholders?

Borges argues that, with a triennial recommendation, after the annual meeting it will be a “difficult decision” for the board to reverse course and recommend the annual vote favored by shareholders. Again, I disagree that this should be the deciding factor. The board can believe that a triennial vote is the best approach but later report that it has considered, and will follow, the preference expressed by the shareholders. I don’t see that as such a bad declaration by a board. However, it’s important that the board consider the right factors in advance, to avoid surprises:

  • Recognize that the triennial choice is an uphill battle in the best of circumstances.
  • If there have been, or will be, major changes in management or compensation practices, or other signs of instability, it is more difficult to conclude that a triennial vote is in the best interests of the shareholders. Recommend an annual vote.
  • Assuming that the actual vote is reasonably close, the board should carefully analyze the results in reaching its conclusion. Did the annual vote get a clear majority of the votes, or win by a narrow plurality? Did large shareholders who voted for an annual vote disclose the reasons for their vote to management? The final advisory vote rules under the Dodd-Frank Act give the company 150 days after the annual meeting to report a final decision on frequency. Take your time.
  • If the board doesn’t feel comfortable having the above discussion, then by all means the board should recommend an annual vote. But recognize that it’s not the only possible course of action.

I’ve talked to a number of in-house attorneys at companies of various sizes about this, and none of them believed that the above discussion was too difficult, or that it would cause great embarrassment to accept the will of the shareholders, or that somehow such a reversal by the board would embolden large shareholders more than they are already emboldened. Certainly, not every board will want to “go there” – everyone recognizes that the equation will be different for every board and every company. That’s one of the things that has made this issue so interesting.

Keep watching the sports ticker. Let’s just hope not every company will decide to forfeit based on the score of someone else’s game.

More Thoughts on Keeping Score: Shareholder Advisory Votes on Compensation

It’s early February, and everyone has their eyes on the score in the biggest game of the year. I don’t mean the Super Bowl (especially after the season the Minnesota Vikings had, which we’d all like to forget). I mean this year’s annual shareholders meeting for every public company. This year, the annual meeting is a whole new ball game, because for the first time, most public companies are facing two new shareholder advisory votes required under the Dodd-Frank Act: the frequency vote (“Say When on Pay”) and the Say-on-Pay vote itself.

This year so far, I’ve spent a lot of time focusing on the frequency vote, because it involves several tactical decisions for boards of directors, and new language to be drafted. Now the voting results are starting to come in. It’s becoming clear that the choice for an annual Say-on-Pay frequency has “The Big Mo” on its side, fueled by the recommendation of the shareholder advisory service ISS to support an annual frequency, and the stated preferences of a large number of institutional shareholders for an annual vote. According to the Proxy Disclosure Blog (subscription site) by Mark Borges of Compensia on earlier this week:

If you're keeping score, of the nine companies that recommended a triennial vote and have so far announced their voting results, five have seen their shareholders express a preference for annual votes. This week should help determine whether this early trend is going to hold.

I’ve advised companies to keep their eye on the ball, though. That means focusing more attention on the Say-on-Pay vote itself. Ultimately, the results of this vote will have more impact than the frequency vote. Borges reported the following earlier in the week:

There were 18 annual meetings of shareholders held this past week where shareholder advisory votes were conducted . . . . Of the 10 companies reporting the voting results from their annual meetings, nine reported that their executive compensation programs had been approved via "Say on Pay" votes, with passage rates ranging from 65.8% (Monsanto) to 99.4% (Tech/Ops Sevcon - a smaller reporting company). One company - Jacobs Engineering Group - disclosed that its "Say on Pay" vote had failed, with only 45.5% voting in favor of its executive compensation program.

Of course, I’ll continue to watch, and comment on, the scores at upcoming annual shareholders meetings. And I guess I’ll watch the Super Bowl too – it has much better commercials.

SEC Adopts Final Rules on Shareholder Advisory Votes; Thoughts On the First Reported Frequency Votes

As widely reported, on Tuesday the SEC in a 3-2 vote (again) adopted its final rules to implement the shareholder advisory vote requirements under Section 951 of the Dodd-Frank Act, including Say-on-Pay, the frequency vote, and Say-on-Parachutes. The final rules are similar to the proposed rules issued in October 2010. There are a few notable changes:

  • The final rules defer the advisory requirements for smaller reporting companies until shareholders meetings on or after January 21, 2013.
  • As in the proposed rules, public companies will need to disclose, in light of the shareholders’ frequency vote, how frequently they will conduct Say-on-Pay votes until the next frequency vote. Under the proposed rules, the disclosure generally would have been in the Form 10-Q for the quarter in which the vote was conducted. Under the final rules, the disclosure is required 150 calendar days after the annual meeting date (but not less than 60 days before the deadline for shareholder proposals for the following year). This gives the company around five months after the annual meeting to make the disclosure, compared to around three months under the proposed rules.
  • As proposed, Rule 14a-8 has been amended so that the company can exclude future shareholder proposals on the frequency of Say-on-Pay, but only if the board follows the wishes of the shareholders expressed in the frequency vote. Under the proposed rules, the company could exclude the shareholder proposal if it followed the alternative (annual, biennial or triennial) that received the most votes on a plurality basis. Under the final rule, the company can only exclude the proposal if one of the alternatives gets a majority vote and the company follows this alternative.
  • Consistent with the proposed rule, the final rule does not mandate specific language for the Say-on-Pay resolution, but Rule 14a-21(a) now includes an example that provides some guidance. On the language of the frequency vote resolution, the final rule doesn’t provide an example or much detail on the required language. No significant change here.
  • There are no major changes from the proposed rules on the say-on-parachutes vote and the new Item 402(t) disclosures of change in control payment arrangements. The final rule on these matters is effective for merger proxies filed on or after April 25, 2011. I will discuss the say-on-parachutes rules in more detail in a future post.

Of course, the ON Securities Cheat Sheet has been updated to summarize the final rules, as well as some recent changes to the SEC’s published timetable in adopting rules under the Dodd-Frank Act. Better yet, it still prints out on two normal pages, and I haven’t had to resort to a microscopic font size! Check it out.

The First Frequency Votes Are In; What Do They Mean?

The other major development regarding the frequency vote is that, this week, the first shareholder votes under Dodd-Frank are occurring, and the results will be reported by next week. A majority of companies so far have recommended triennial votes, and we will soon get an idea of the power of ISS’ “one-size-fits-all” policy to always recommend an annual vote. Yesterday, Monsanto held its annual meeting, and it reported a 63% vote for an annual frequency, even though management had recommended the triennial alternative. Results of other meetings should be reported on Form 8-K filings by next week.

Ted Allen of ISS, writing in RiskMetrics Group’s Risk & Governance Blog, speculated that, if the first several companies have similar results, this will cause many calendar year companies to consider recommending an annual vote in the first place: “If investors at other large-cap firms follow suit in the next few weeks, it appears likely that these results may sway boards at companies with late spring meetings to recommend annual votes. More results like today's vote at Monsanto may prompt undecided institutions to back annual votes as well.”

However, I think it’s important not to over-emphasize the importance of the first few votes. Monsanto had around 33% voting “no” on Say-on-Pay, and their financial results in 2010 did not appear to be very good. I would guess that the shareholders’ demand for an annual vote has something to do with the fact that shareholders don't fully trust the compensation committee’s judgment on compensation matters and want a forum every year. I'm still guessing that, if a company has built trust with shareholders, the shareholders will be more likely to support a triennial request, and that not all the shareholders will buy in to ISS's blanket recommendation for an annual vote. Also, I would predict that a small or mid-cap company is more likely to be able to get a triennial vote, because they are more likely to be able to “fly under the radar.”

I asked Francis Byrd, an officer of Laurel Hill Advisory Group and the author of the Byrd Watch Corporate Governance & Proxy Review, for his opinion on the above matters, and his response was interesting:

Voting results on frequency and the SOP vote will reflect, to a greater or lesser extent, the performance of the company, the quality of pay and how it is derived, and the ISS vote recommendation (which accounts for as much as 20-25% at some larger issuers). While I can’t comment directly on Monsanto, I would posit that those companies with greater trust and more open relationships with their shareholders will fare better with their frequency and SOP vote request.

If a company has had a history of poor pay practices (as defined by ISS), battles with large shareholders over compensation and poor financial returns, those headwinds may likely to be too much for the board’s frequency vote recommendation to overcome. A shareholder vote of 65% or more against a board recommendation cannot be entirely laid at the feet of ISS – the amount and quality of engagement (on both frequency and the advisory vote itself) with shareholders prior to the annual meeting and the stock’s total return may well have played a larger role in the defeat.

I believe it is still much to early in the season to determine how later filers will behave. Not all the filers seeking triennial votes may be routed. Irrespective of the Monsanto outcome, companies need not be victims. Positive SOP votes are about doing the homework and building in the time to conduct an investor outreach program that properly identifies shareholders and addresses their pay concerns.

On your last point about smaller filers and those with large retail share ownership it may be easier for some to “fly under the radar” but only if their top holders are supportive of the pay and frequency and if they can capture the retail holder votes they need. Remember, SOP will not be as familiar to retail shareholders voting this item – who likely to have not heard of it – and they may require some education efforts to bring them up to speed on an issue where they are likely to be supportive of management. For some small and mid-size companies this will necessitate calling campaigns to reach and educate their investors.

Regardless of the prospects, this is all uncharted territory. Companies that recommend a triennial vote do need to be prepared for the possibility that the shareholders will disagree. If that happens and a company goes with the wishes of its shareholders, there should be no negative consequences of an initial recommendation for a triennial vote. Further, if this happens, the company can always try again in a year or two, to see if they can persuade shareholders to support a triennial vote going forward.

How Do Top Films Relate to the New Shareholder Advisory Votes?

Effective communication. Engagement. Getting constituents to ignore the “noise” and buy in to your message. These are all important challenges faced by public companies this year as they prepare for the two new shareholder advisory votes required at their annual meetings under the Dodd-Frank Act: Say-on-Pay and the frequency vote.

These challenges are also important themes of the two best films of 2010: “The Social Network” and “The King’s Speech”. I loved both movies, although I agreed with the Golden Globes voters who gave “Social Network” the Best Picture nod last night. But I hadn’t focused on the connection between the two films until I read “Top Two Films Offer Lessons on Life and Media”, a very insightful commentary in the Minneapolis StarTribune by editorial writer and media commentator John Rash. As Rash points out, both films address the challenges of connecting with people in a new age of media:

In “Social Network”, the main character’s personality and his approach to relationships create difficulties in his business and personal dealings. Nevertheless, he finds a way to tap into the basic human desire for connection, creating a medium that has been adopted by 500 million (and counting) people.

In “King’s Speech”, the advent of radio presents a daunting challenge to a new king afflicted with a stammer. His ability to communicate with the masses ultimately depends on his personal friendship with a commoner from Australia.

As Rash puts it:

The Internet, and in particular social networks, have accelerated the rise of personality over policy. . . .

Ultimately both films are fundamentally about friendship - about how it's human, not wireless, connections that count. . . . Both films show how human bonds can be built or broken by the new challenges and opportunities of the new media age. Either way, the results are often consequential . . . .

Interesting observations. So can the films teach any lessons to public companies facing shareholder advisory votes for the first time? Maybe that, even in an age of new media, personal connections will continue to be important - possibly more important than ever. I’m working with numerous companies that are starting to worry about convincing large shareholders to support the company’s recommendations. Much of this process will be done one-on-one, through meetings and phone calls rather than over the Internet. The personal touch may be one way to combat negative feelings about corporate governance and executive compensation, fueled by the new media in the past couple of years.

One way or another, if you haven’t seen both films, don’t miss them.

The Big 1-0-0!

As I enter this post into the ON Securities website, the site tells me that this is the 100th post! The past year and a half has been an eventful period in securities law, corporate governance and executive compensation for public companies, and I have enjoyed the opportunity to comment on these events and get feedback from readers. During the time frame for the next 100 posts, and beyond, the developments should be just as interesting.

In this earlier post, I commented on another very good film: “Julie and Julia”. This was not only a well-acted portrait of Julia Child and a modern day follower, but it was also the first mainstream movie about blogging. As I said in that post, I welcome your continued feedback and hope the blogging process can be a two-way street.

Thank you for reading.

What Are Companies Recommending for the Frequency of Say-on-Pay Votes?

As has been widely reported, the Towers Watson compensation consulting firm recently released the results of a survey asking 135 public companies how often they expect to hold the Say-on-Pay advisory votes required under the Dodd-Frank Act. The survey results:

Triennial Say-on-Pay vote expectation: 39%
Biennial Say-on-Pay vote expectation: 10%
Annual Say-on-Pay vote expectation: 51%

Interestingly, the picture painted by this survey is quite different from that presented by the proxy statements filed so far in 2011. Mark Borges just published his updated tally (as of January 7) of 87 companies’ proxy statements in his Proxy Disclosure Blog on (subscription site). According to Borges’ tally, these companies recommended as follows in their “Say When on Pay” shareholder advisory votes on frequency:

Triennial Say-on-Pay vote recommendation: 45 companies (52%)
Biennial Say-on-Pay vote recommendation: 9 companies (10%)
Annual Say-on-Pay vote recommendation: 25 companies (29%)
No recommendation: 8 companies (9%)

So what’s the explanation? Why are the actual recommendations of filing companies (mostly triennial) so different from the expectations expressed in the Towers Watson and Romanek surveys (mostly annual)? In a post on Blog, “Poll Results: Say-on-Pay Recommendations”, Broc Romanek speculated that the survey results provide the more accurate reading, with the difference in the actual results caused by the “limited experience” with companies that have filed so far. (In fact, Romanek conducted his own informal survey, with results very similar to Towers Perrin’s: fifty percent of his respondents preferred an annual vote).

I have a different theory – I think the results of the surveys might have been affected by the demographics of the companies that responded. I checked in with Towers Perrin, and as it turns out, their 135 survey respondents tended to be larger companies. Eighty-three percent of the respondents had revenues of $1 billion or more, including forty-seven percent that had revenues of $5 billion or more. In other words, it appears that a sizeable majority were Fortune 1000 companies. Anecdotally, I believe larger companies are more likely to recommend annual votes, because the larger companies are more typically concerned about negative reactions from institutional investors, or about obtaining positive recommendations from the proxy advisory firms such as ISS.

Therefore, I think the recommendations of the companies that have filed proxies to date are more representative of the recommendations of the companies that will file in 2011. Certainly there is a broader range of companies represented by these filers (twenty percent of these filing companies have been  smaller reporting companies.) Of course, it’s just a theory – the “final score” at the end of the year will tell. One other unknown factor is the number of companies that will recommend a triennial Say-on-Pay vote but be faced with a shareholder plurality vote favoring an annual Say-on-Pay vote. One way or another, 2011 will be an interesting year.

Looking Back on 2010, and Looking Forward to a New Year

To quote the old Virginia Slims ad, we’ve come a long way, baby.

As we close out a very eventful year, it’s interesting to look back on how far corporate governance and executive compensation reforms have come since the end of 2009. I pulled out a copy of the December 23, 2009 version of the ON Securities Cheat Sheet (PDF) and was reminded that, a year ago, there were almost as many reform bills suspended in Congressional committees as there are members of Congress. That version of the Cheat Sheet summarized the provisions of the “Schumer Bill,” the “Frank Bill” (which was a repackaged version of the Obama Bill), and several other bills. The bills contained diverse but overlapping restrictions and limitations, responding to the fact that the near-collapse of the banking system and the worldwide economy was still fresh in everyone’s mind.

As we all know, after a long and tangled legislative process, what resulted was the Dodd-Frank Act. [For a musical lesson on how a bill makes its way through the legislative process, see this previous post, which in turn links to the “I’m Just a Bill” episode of the Schoolhouse Rock television show.]

In turn, the Act resulted in a long laundry list of anticipated SEC rulemaking projects, continuing into 2011. For a status report on the SEC’s rulemaking progress, see the latest version of the Cheat Sheet (PDF) (always available by clicking the box at the right side of the home page). As the Cheat Sheet shows, we’re waiting for proposed and final SEC rules on a variety of Dodd-Frank Act provisions. We’re also waiting for the results of the legal challenge to the proxy access rule, as described in this previous post.

I just updated the Cheat Sheet to reflect that the SEC did not meet its announced timetable for proposing independence standards for compensation committees and their advisors. These proposed rules were scheduled for December, but the Dodd-Frank rulemaking timetable on the SEC web site has been changed and now lists the proposed rules in the January-March 2011 time frame.

One More Frequency Vote Scoreboard in 2010

One last time in 2010, here is an updated scoreboard of the proxy statements filed so far that include the shareholder advisory votes required under the Dodd-Frank Act, including the ‘Say When on Pay” frequency vote. Based on Mark Borges’ updated tally (as of December 23) of 58 companies’ proxy statements in his Proxy Disclosure Blog on (subscription site), here’s the score:

Triennial Say-on-Pay vote recommendation: 32 companies
Biennial Say-on-Pay vote recommendation: 6 companies
Annual Say-on-Pay vote recommendation: 14 companies
No recommendation: 6 companies

The above tally included thirteen smaller reporting companies (7 triennial recommendations, 2 biennial recommendations and 4 annual recommendations).

Happy New Year

I want to wish all of you a safe New Year’s celebration and a happy and prosperous year in 2011!

ON Securities Named a Top Minnesota "Blawg"

The Minnesota State Bar Association’s PracticeBlawg just released its list of the “Top 25 Minnesota Blawgs,” and I am honored that the editors of the MSBA blog included ON Securities on the list. Thanks to the readers who nominated this blog. The PracticeBlawg editors said:

. . . Despite being a partner in the 80+ attorney Maslon firm, there’s no team of attorneys behind the scenes. It’s just Martin, writing timely content about issues facing public companies. On top of that, he offers an extremely useful ‘cheat sheet’ that he characterizes as a ‘one stop shop’ for the latest developments in executive compensation and governance. We call this one the best blawg by a lone attorney at a big time firm.

Well, I do produce the content of ON Securities on my own, but I’m far from being a “lonely guy”. I appreciate the support from the other attorneys in the Maslon firm and our marketing team. And thanks to the subscribers who rely on this blog as a source for up-to-date information on legal issues facing public companies.

Check out the other legal blogs on the list – it’s an interesting and eclectic group.

Animated Regulation FD Training Video is Informative and Entertaining

Melissa Gleespen, Senior Counsel, Securities and Corporate Law at Owens Corning has created this great computer-animated video as part of an internal training program on compliance with Regulation FD, the SEC’s prohibition against selective disclosure of material non-public information:

In a podcast interview with Broc Romanek on (content by subscription), Gleespen reported that the video was very easy and inexpensive to create on – she simply made some selections from a menu and typed in a script. This seems like an easy way to enhance a compliance training program, on Regulation FD or any other topic.

Compliance training is even more important now than ever, given the SEC’s expanded enforcement activity. In an article in, “Office Depot case highlights value of Reg FD policies,” Tim Human points out that Office Depot recently received a steep fine from the SEC for Regulation FD violations. The SEC cited Office Depot’s lack of a Regulation FD policy and failure to provide training on Regulation FD. By contrast, Human reports that the SEC let American Commercial Lines off the hook in a Regulation FD action against its CFO, with the SEC commending that the company had cultivated a culture of compliance through training.

With tools like the animated video above, you don’t have to be a Fortune 50 company to provide effective training.

Updated Scoreboard on the Frequency Vote (“Say When on Pay”)

In last week’s post, I provided a scoreboard of the proxy statements filed so far that include the shareholder advisory votes required under the Dodd-Frank Act, including the ‘Say When on Pay” frequency vote. Based on Mark Borges’ updated tally of 15 companies’ proxy statements in his Proxy Disclosure Blog on (subscription site), here’s the score:

Triennial Say-on-Pay vote recommendation: 9 companies
Biennial Say-on-Pay vote
recommendation: 1 company
Annual Say-on-Pay vote
recommendation: 4 companies
No recommendation: 1 company

I wouldn’t be surprised if the final score at the end of proxy season is in the same proportions shown above. Fortunately, this is one scoreboard we can keep watching from the safety of our offices, without the risk of an inflatable dome collapsing above our heads. . . .

Keeping Score: What Are Early Filers Doing About Say-on-Pay and Frequency Vote?

I’m getting a lot of questions from public companies lately that involve “keeping score.” In Say-on-Pay votes, what are other companies doing about drafting the resolution and the corresponding section in the proxy statement? In the frequency vote, are other companies recommending that shareholders approve holding the Say-on-Pay vote every one, two or three years? Of course, companies recognize that they need to make their own decisions. But no one wants to be an outlier. Plus, many companies with a calendar fiscal year end are holding board meetings in December, and management and in-house counsel want to be prepared if the directors ask, “What’s the score so far?”.

I know of at least six companies so far that have filed proxy statements (mostly preliminary proxies) that include the resolutions for Say-on-Pay and the frequency vote required under the Dodd-Frank Act: Johnson Controls, Inc., Visa Inc., Beazer Homes USA, Tyco Electronics, Woodward Governor Company and Ashland, Inc. And here’s the score.

Say-on-Pay: I don’t think there is anything unexpected in these six proxy statements. Pretty much all of the companies included some bullet points in the Say-on-Pay proposal describing some of the positive aspects of their pay practices, or the changes they have made in the past year to improve their programs. I’m sure there will be a lot of variations as more companies file in the next few months. However, I’ll bet a lot of the Say-on-Pay proposals will end up looking a lot like the ones already filed by these companies.

Frequency vote: The score for management recommendations is, three companies recommending a triennial vote; two companies recommending an annual vote. Interestingly, one company (Tyco) declined to take a position, stating that the Board “. . . has decided to consider the views of the company's shareholders before making a determination.” I think most companies will choose to recommend either a triennial or an annual vote. I think fewer companies will recommend biennial votes, which some perceive to have the appearance of a compromise.

Thanks to Mark Borges, who has been keeping track of proxy filings in his comprehensive Proxy Disclosure Blog on (subscription site).

Broadridge Says It’s “Prepared” to Include Four Choices on the Proxy Card

In its proposing release for the frequency vote rules (PDF), the SEC reported that some service providers might not be prepared to accommodate a proxy card with four choices (annual, biennial, triennial or abstain). Currently, IT systems for shareholder votes are set up for three choices (for, against or abstain). In response to concerns expressed by Broadridge Financial Solutions, Inc. and other vendors, the SEC indicated in the release that companies could include three choices on the proxy card (annual, biennial or triennial) if their vendors’ systems could not yet accommodate four choices.

Broadridge recently filed a comment letter (PDF) on the SEC’s proposed frequency vote rules. The letter says that modifications to the Broadridge systems to accommodate four choices are “well underway.” Broadridge says it estimates that the initial effort will require an investment of over 18,400 people hours, and that is prepared to support use of the new rules for shareholder meetings that occur on or after the January 21, 2011 effective date.

Of course, even the investment of 18,400 hours won’t guarantee that the vote will go off without a hitch. I have heard transfer agent representatives express concern that the data received by the transfer agent from Broadridge may be in a different format or difficult to tabulate. This should be an interesting year.

Recent Elections Not Expected to Have Major Impact on Corporate Governance

In a post in the ISS Insights Blog, “After Election Day, Governance Observers Expect Status Quo,” Ted Allen reports that the recent Congressional elections are unlikely to have a major impact on corporate governance reform under the Dodd-Frank Act. However, Republican control of the House of Representatives may mean that the SEC has fewer resources and a brighter spotlight on its activities:

Professor James Cox, a securities law professor at Duke University, said the SEC likely will receive substantially less funds than were authorized in Dodd-Frank Act. "This will likely starve the SEC's efforts to step up the size and experience of its staff to carry out inspections, which is frightening, considering the addition of thousands of investment advisers to the inspection mission of the SEC," Cox said.

While the prospects for any investor-friendly or pro-regulatory legislation are now "dead," Cox said, "It is unlikely that the House can push through reversals of any major legislation, including approval for proxy access." However, he said Congress may try to pass legislation to make "technical corrections" to the Dodd-Frank Act, and there may be some provisions that concern investors. Cox said House Republicans may await the outcome of the lawsuit filed by the U.S. Chamber of Commerce and the Business Roundtable before addressing proxy access.

There may be some uncertainty about the impact of the federal elections, but at least we know the results. Unlike the governor’s race in Minnesota, where we seem destined for an eternity of recounts. . . .

Useful Resource Analyzes Shareholder Preferences In the Frequency Vote

Nothing in the Dodd-Frank Act is currently raising more questions than the frequency vote, or “Say When on Pay.” Under the Act, at the first annual meeting on or after January 21, 2011, public companies must hold a separate non-binding vote in which shareholders will express their opinion on whether the Say-on-Pay vote should be held annually, biennially, or triennially. The frequency vote must be held at least once every six years. After their annual meetings, companies must disclose on Form 10-Q whether they will abide by the shareholders’ preference on frequency. Many public companies have asked me about the optimal frequency to recommend, as I addressed in this prior post.

One factor that companies should consider is the preferences expressed by their major shareholders. Phoenix Advisory Partners, a proxy solicitation firm, recently released a report entitled “Say on Pay Frequency: Annual, Biennial or Triennial – Considerations in Making Your Recommendation (PDF).” The most interesting thing about the report is that it is based on conversations with large institutional investors. For example, the report lists the names of a number of institutional investors who support annual Say-on-Pay: Walden Asset Management, AFCSME, etc. Phoenix also reports that the Council of Institutional Investors supports annual Say-on-Pay votes. On the other hand, T. Rowe Price has indicated that it may not take a blanket approach, but may tailor its recommendations based on the compensation practices of individual companies.

Image: Flikr

Whistle While You Work! SEC Proposes Whistleblower Rules under Dodd-Frank

The SEC yesterday issued proposed rules (PDF) under Section 21F of the Securities Exchange Act of 1934 (Section 922 of the Dodd-Frank Act), which provides a bounty to whistleblowers who disclose securities law violations leading to large monetary sanctions. This press release issued by the SEC summarizes the new rules. In order to qualify for a bounty under Section 21F, the whistleblower must “voluntarily” provide the SEC with “original information” that “leads to” successful enforcement in which the SEC obtains monetary sanctions totaling more than $1 million. The proposed rules clarify these concepts. The rules also define a number of types of individuals who are not entitled to the bounty, including the wrongdoers, persons with a pre-existing duty to report the information or attorneys or accountants in certain cases.

My main concern about Section 21F is that the bounty program will encourage employees and other potential whistleblowers to bypass the internal reporting systems public companies have carefully set up in the past decade to comply with the provisions of the Sarbanes-Oxley Act of 2002. The SEC has tried to address this concern in the proposed rules, which would facilitate and encourage internal reporting in the following ways:

  • The rules allow an employee to report information internally as a whistleblower and still get credit for original reporting to the SEC as of the same date – as long as the employee provides that same information to the SEC within 90 days of that date. According to the SEC, “ . . . employees will be able to report their information internally first while preserving their ‘place in line’ for a possible award from the SEC.”
  • The rules provide that the SEC may consider higher percentage awards for whistleblowers who report internally first, as long as the company has an effective compliance program.

Comment. The proposed SEC rules are an improvement over the provisions of the Dodd-Frank Act. However, there are still concerns that the bounty program will encourage whistleblowers to “take no chances” and report any questionable information to the SEC. The potential financial rewards for a whistleblower are huge.

Also, there are numerous reports that plaintiffs’ employment attorneys are actively encouraging whistleblowers to file reports. Broc Romanek in a post in Blog referred to this recent article, “Get Snitch Quick,” by Kaja Whitehouse in the New York Post about a lawyer who is playing a commercial in New York movie theaters before showings of “Wall Street: Money Never Sleeps.” The commercial directs viewers to go to his website,, to get information about whistleblower reporting. In the words of Gordon Gekko, “Greed is good. . . .”

In light of the bounty program, public companies will need to refine their whistleblower policies and training programs. This is only one of the aspects of Dodd-Frank in which we corporate lawyers will need to partner with our colleagues who specialize in employment law. Just wait until listed companies need to draft new clawback policies, under SEC and stock exchange rules expected in 2011, which will require companies to recover incentive compensation from former as well as current officers. . . .

ISS Recommends Annual Say-on-Pay Vote

In this draft policy recommendation, the shareholder advisory service ISS recommends that Say-on-Pay votes be taken annually as a way of providing the most meaningful communications between shareholders and public companies. Assuming the final ISS policy is to recommend an annual vote, this is one more consideration for boards of directors in deciding whether to recommend an annual, biennial or triennial vote, as described in this prior post.

Memorandum on Say-on-Pay and Other Advisory Vote Requirements Includes Executive Summary and FAQs

Maslon Law Firm has just released our memorandum (PDF) on the three new shareholder advisory votes required under the Dodd-Frank Act and the SEC’s recently proposed regulations (PDF): the Say-on-Pay vote, the frequency vote and the Say-on-Parachutes vote. We took it as a challenge to make the memo as user-friendly as possible for public companies and their advisors. The memo starts with an executive summary about the requirements, and the remainder consists of Frequently Asked Questions about each of the required shareholder votes. Here’s the executive summary:

Key provisions in the Act’s advisory vote requirements, as interpreted by the proposed SEC rules:

Say-on-Pay Vote: Public companies must hold a non-binding shareholder vote on executive compensation (the “Say-on-Pay vote”) at the first annual meeting on or after January 21, 2011. Pursuant to this vote, shareholders will be asked to approve the executive pay described in the proxy statement (including CD&A and the compensation tables). This vote must be held no less frequently than once every three years.

Frequency Vote: Also, at the first annual meeting on or after January 21, 2011, public companies must hold a separate non-binding vote (the “frequency vote”) in which shareholders will express their opinion on whether the Say-on-Pay vote should be held annually, biennially, or triennially. The frequency vote must be held at least once every six years. After their annual meetings, companies must disclose on Form 10-Q whether they will abide by the shareholders’ preference on frequency.

Requirements Not Subject to Adoption of Final SEC Rules: The above requirements to hold the Say-on-Pay vote and frequency vote at the first annual meeting on or after January 21, 2011 are effective regardless of whether the final SEC rules have been adopted.

Parachutes Disclosure and Say-on-Parachutes Vote: The proxy materials to approve any merger, sale of assets or similar transaction must include enhanced disclosure of the golden parachutes compensation to executives related to the transaction, including a table and narrative disclosure. The proxy materials must also include a separate shareholder advisory vote on the parachute compensation (the “Say-on-Parachutes vote”), unless the enhanced disclosure was part of a prior Say-on-Pay vote and there are no new arrangements. The parachutes disclosure and Say-on-Parachutes vote requirements are not effective until the final SEC rules go into effect.

Cheat Sheet Updated

The ON Securities Cheat Sheet (PDF) has now been updated to include a shorter summary of the advisory vote requirements. The Cheat Sheet also features a summary of all of the Dodd-Frank compensation and governance provisions, and a description of the proxy access rule, Rule 14a-11, the effectiveness of which has been stayed as a result of a legal challenge. True to form, the Cheat Sheet is still only two pages long!

Useful Resource on Risk Assessment

As stated in this previous post, it is important for public companies to focus this year on their assessment of risks related to their compensation programs. The proxy disclosure requirement in Item 402(s) of Regulation S-K is not limited to executive compensation programs, but the assessment need only cover compensation programs that might create a material risk for the company. One of the challenges for compensation committees and compliance officers is the creation of a reasonable process to select the compensation programs to examine and to assess the relationship of the compensation programs to risks that might face the enterprise.

Mike Melbinger, in his Executive Compensation Blog, has posted his comprehensive chart that outlines a very detailed process a public company can use for assessing risk. The chart contains many good ideas, so it is a helpful resource, even if you don’t intend to follow the entire 20-step action plan (for some companies, maybe a “12-step program” will do!).

SEC Issues Proposed Rules on Say-on-Pay and Related Matters

The SEC this afternoon issued its proposed rules on Say-on-Pay, Say When on Pay, Say-on-Parachutes and related matters under Section 951 of the Dodd-Frank Act. Here is the proposing release (PDF).

The release answers some questions we have been pondering since the adoption of the Dodd-Frank Act (and in some cases raise more questions):

  • The SEC confirmed that it will not object if companies do not file a preliminary proxy statement for Say-on-Pay or Say When on Pay resolutions – the same treatment it gave to TARP recipients who were required to hold Say-on-Pay votes starting in 2008.
  • Regarding Say-on-Pay, no specific language is required, but the resolution has to cover all compensation required to be disclosed in the proxy statement.
  • Companies will be required to address in CD&A how their compensation policies and decisions have taken into account the results of past Say-on-Pay votes.
  • Regarding the frequency vote (Say When on Pay), the SEC will definitely require four choices on the ballot: one year, two years, three years or abstain. The proxy card has to have the four boxes, but there are some transition rules if the transfer agent can’t tabulate four choices.
  • The SEC is affirming that the Say When on Pay vote is advisory, but the issuer must disclose in its filings whether it will follow the results of the advisory vote. If it does not, the rules will permit shareholder proposals in future years to change the frequency.
  • The SEC is requiring additional tabular information on change in control payments in merger proxies with respect to the Say on Parachutes vote. An issuer may voluntarily include that information in its annual meeting proxy statements, and in that case the Say on Parachutes vote will not be required in a future merger transaction if there are no changes.
  • Under the proposal, smaller reporting companies will be required to hold Say-on-Pay and Say When on Pay votes, even though the SEC had the statutory authority to exempt them from the rules.

Comment. Here is an updated list of Say-on-Pay action items in response to the proposed rules:

  1. Make sure compensation disclosures clearly describe the link between pay and performance, describe how the arrangements mitigate risk-taking behaviors, avoid misunderstandings on compensation design and prepare to explain any compensation structures or levels that may be unique to the company. Consider adding a summary section to CD&A.
  2. The board should review any executive compensation arrangements that may be classified by investors and governance rating agencies as "poor" practices. If any feedback has been received from investors on executive compensation, the board should decide the appropriate level of proactive shareholder engagement in this area.
  3. The board should think about the preferred frequency of periodic say-on-pay votes and determine how the board will recommend shareholders vote on this matter.
  4. The company should work with its advisors to determine whether a bylaws amendment will be required to accommodate a frequency vote with four possible choices (albeit a non-binding advisory vote).
  5. The company should work with its advisors to determine whether to include supplemental disclosures about golden parachutes in its annual meeting proxy statement, which may eliminate the need for a separate Say-on-Parachutes vote in connection with a future merger.

More questions will arise as we have more time to digest the 122 page release and as the SEC receives public comments on the rules. But this is a start.

Corporate Secretaries Group Makes Helpful Observations on Dodd-Frank Act Provisions

As public companies prepare for their first proxy season under the Dodd Frank Wall Street Reform and Consumer Protection Act (848-page PDF), I’m fielding many questions about implementation of the compensation and governance provisions of the Act. Unfortunately, given the broad language of the Act and the current absence of SEC regulations, there are not a lot of definitive answers.

However, the Society of Corporate Secretaries and Governance Professionals has provided a very thoughtful and helpful analysis. Darla C. Stuckey, Senior Vice President of the Society, in her testimony before the House Finance Committee last week, discussed the possible impact of various compensation-related provisions of the Act, as well as the Society’s “wish list” of possible regulatory clarifications. Ms. Stuckey’s testimony (PDF) makes interesting reading for anyone wrestling with preparation for the 2011 proxy season:

Say-on-Pay and Related Votes. The Society observes that the SEC is targeting January through March of 2011 for adoption of rules on Say-on-Pay and Say When on Pay. Since these votes are required at the first shareholders meeting on or after January 21, 2011, even January is too late to provide guidance for many affected companies. The Society requests that the SEC propose the rules in early October so the final rules can at least be adopted before January 21.

Advisory Firms. The Society also commented that the SEC should consider the power of proxy advisory firms (which would include ISS) in the Say-on-Pay process. A recent survey indicated that almost half of Society members reported 30% or more of the companies’ shares being voted in line with the advisory firms’ recommendations. Over 60% of respondents indicated at least one experience with an advisory firm’s recommendations being based on materially inaccurate or incomplete information, and of those recommendations, 60% were not corrected.

Comment. I have listened to several public company representatives complain about advisory firm recommendations based on inaccurate or incomplete information. Unfortunately, with the increased workload of the advisory firms in the coming year, this problem is not likely to get better.

Say When on Pay. The Society recommends that the SEC rulemaking should give weight to board recommendations on the frequency of Say-on-Pay votes. They suggest providing boards “a choice whether to offer a resolution with a single recommended choice (e.g., every two years), or a resolution that would give the board’s preference but ask for a vote on a one, two or three year frequency in a multiple-choice fashion.” The latter type of vote would involve a plurality vote of the shareholders.

Comment. The Society is asking the SEC to allow companies the discretion to offer When on Pay as a yes-or-no vote on a single recommended choice (e.g., an up or down vote on a triennial Say-on-Pay vote). I don’t believe it is clear that such a vote would be consistent with Section 951(a)(2) of the Act, which requires a separate resolution “to determine whether votes on the . . . [Say-on-Pay resolutions] will occur every 1, 2 or 3 years.” Ms. Stuckey included with her testimony a comment letter (PDF) on the Act to the SEC from the Center on Executive Compensation. That letter does make a cogent argument that the vote with a single recommended choice is consistent with the Act, but certainly doesn’t answer all questions about the SEC’s authority in this area. Ultimately, the SEC has to make a determination about its authority to permit a “single recommended choice” vote – and quickly, if it is to propose rules by early October, as requested by the Society.

If the SEC rules do allow an up or down vote on a single recommended choice, the rules will have to answer other questions. For example, if the shareholders vote against a triennial Say-on-Pay vote, what action will the board of a company be required to take in subsequent years – would the company then be required to hold annual Say-on-Pay votes, or could the board elect to hold biennial votes?

Internal Pay Ratio. The Act will require companies to present the median annual total compensation of all employees of the company (other than the CEO) and the annual total compensation of the CEO, then provide the ratio of these figures. These rules are expected to be in effect for the 2012 proxy season. Ms. Stuckey’s testimony makes it clear just how difficult and complex a task will be presented by the calculations. The Society recommends that the Act be clarified, either through a technical amendment or rulemaking, to provide that “all employees” be limited to full time U.S. employees, and that the total compensation amount exclude pension accruals, benefits and other non-cash items. According to an Alert from the Society dated September 28, 2010, Congressman Frank indicated his agreement with Ms. Stuckey on this issue.

The Society also commented on the Act’s clawback requirement, a subject I will address in a future post.

Legal Challenge Seeks to Invalidate the Proxy Access Rule

The U.S. Chamber of Commerce yesterday announced that the Chamber and the Business Roundtable filed a petition with the U.S. Court of Appeals challenging the SEC’s adoption of Rule 14a-11, the proxy access rule. This rule grants large shareholders the right to nominate directors in certain circumstances and have these nominees included in the company’s proxy statement. The petition claims, among other things, that the Rule is arbitrary and capricious and that the SEC failed to follow appropriate procedures. It’s not clear whether the petition will affect the Rule’s scheduled effective date of November 15, 2010.

"Pay for Performance" is the Key Phrase in Compensation - NASPP Conference Notes

I just returned from the Annual Conference of the National Association of Stock Plan Professionals (NASPP) in Chicago, and I came home with a briefcase full of notes and materials on best practices in executive compensation, compensation disclosures and corporate governance. I’ll share thoughts from individual sessions over the next few weeks, but I came away with these general thoughts:

  • “Pay for Performance” was the mantra repeated by many of the speakers. The single most important factor in “getting to yes” in Say-on-Pay votes will be demonstrating the link between pay and performance. This must be done in the Compensation Discussion and Analysis (CD&A) disclosure in the proxy statement.
  • It will be important to craft the summary section of CD&A carefully. The section should summarize the pay for performance link and should highlight best practices explained in more detail elsewhere. In this first proxy season involving mandatory Say-on-Pay, advisory services such as ISS, as well as institutional investors, will be scrambling to sort out the practices of many companies in a short time. Issuers will want to make it easy for investors to determine quickly that the company has sound pay practices.
  • The Dodd-Frank Act will require a “Pay for Performance” proxy statement table. However, the enabling regulations won’t be adopted until April to July 2011, and the table will likely not be in effect until the 2012 proxy statement for most companies. The panelists speculated that the table will be based on a total shareholder return (TSR) measure. They recommended that companies consider whether other measures provide a better method for evaluating their performance relative to compensation (other metrics, peer group comparisons, etc.). If so, consider providing that data in the 2011 proxy statement as a “preemptive strike.”
  • Clawbacks will be tricky for many companies, particularly companies listed on exchanges who will need to adopt a clawback policy next year under expected new rules. Companies that previously adopted clawbacks should highlight this fact in their next proxy statement, as it is considered a best practice by institutional investors. All public companies will have some choices to make about the scope and structure of the clawback policies, as I will cover in an upcoming post.

SEC Publishes Rulemaking Timetable

The SEC recently posted this rulemaking timetable for its regulations under the Dodd-Frank Act. Only the rules for Say-on-Pay (shareholder advisory vote on executive compensation) and Say on Parachutes (shareholder advisory vote on severance in connection with changes in control) are scheduled to be adopted in time for the 2011 proxy season. Those regulations are scheduled to be proposed in October to December 2010 and adopted in January to March 2011.

The ON Securities Cheat Sheet has been updated to include the anticipated proposal dates for other regulations implementing provisions of the Dodd-Frank Act.

Watch Out For Those Claws!

Speaking of clawbacks, Mike Melbinger, in his presentation on clawbacks at the Conference, used the video below in his presentation to illustrate a true “clawback” (i.e., one involving actual claws!). Mike is the author of the Executive Compensation Blog.

More Tips on Preparing for Implementation of Compensation Provisions of the Dodd-Frank Act

Today I attended a terrific presentation by Don Nemerov and Eric Gonzaga, compensation consultants with Grant Thornton, LLP, to a meeting of the Twin Cities Chapter of the National Association of Stock Plan Professionals (NASPP). The program materials are available here. The presentation covered the new executive compensation and corporate governance requirements under the Dodd Frank Wall Street Reform and Consumer Protection Act (848-page PDF), and what public companies should be doing to prepare.

Don and Eric spent much of their presentation talking about mandatory Say-on-Pay, the requirement under Section 951 of the Act that public companies submit their compensation to an advisory vote of the shareholders starting with the 2011 annual meeting. Slides 12 through 14 of the presentation contain charts that outline “potential drivers of ‘no’ votes" under the guidelines of the two most influential proxy advisory firms – RiskMetrics/ISS and Glass Lewis. Interestingly, the speakers described RiskMetrics as having policies that are more quantitative, while Glass Lewis takes a more principle-based qualitative approach.

The presentation included the following interesting points:

  • Starting with slide 36, the presentation includes a list of action items for each compensation-related provision of the Dodd-Frank Act.
  • Management and the board should do due diligence right away to determine whether the company’s pay will be considered reasonable relative to its performance. Performance will likely be evaluated by reference to total shareholder return (TSR), particularly by ISS/RiskMetrics.
  • Communication will be absolutely critical, and companies should start now in determining how to communicate the reasons for the company’s pay policies and why pay is reasonable relative to performance. If shareholders should be considering performance factors other than TSR, including performance relative to peers, the company should be thinking about how best to communicate this.
  • The company’s investor relations personnel are critical in this process and should be consulted early, including on ways to make the CD&A more effective in telling the pay-for-performance story.

I’m attending the NASPP Annual Conference in Chicago next week, where national speakers will be providing input on the latest developments in SEC rulemaking under Dodd-Frank. I should be able to pass along further tips on how public companies should prepare.

The SEC’s Proxy Access Rules Will Be Effective November 15, 2010

As reported in this previous post, on August 25, 2010, the SEC adopted Rule 14a-11, the shareholder access rule that was originally proposed on June 10, 2009. The Rule was finally published today (September 16, 2010). Here is the convenient Federal Register version of the Rule (127 page PDF). Therefore, we finally know the effective date of the Rule, November 15, 2010 (60 days after today's publication).

The critical date, however, is March 15, 2010. If a company mailed its proxy materials this year before March 15, then it will not be subject to proxy access rule for the 2011 proxy statement. This is because on November 15, 2010, a shareholder of the company would not be able to provide notice that is 120 days before the first anniversary of the 2010 proxy mailing. On the other hand, any company that mailed its proxy materials on or after March 15, 2010 will be subject to proxy access for the 2011 proxy statement. As Broc Romanek said in today’s post in Blog, beware “the Ides of March”.

In her blog, “The Filing Cabinet,” in Compliance Week today, Melissa Aguilar posted “Proxy Access Rules Effective Nov. 15 — Who’s Affected?”, in which I provided commentary on which companies will be affected by the rule in 2011, and on other aspects of the new rule.

Image: Picasa

Dodd-Frank Act Provision May Affect SEC Enforcement Settlements

The SEC has a new weapon in its enforcement proceedings, thanks to a provision in the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF). In an interesting article in DealBook, “Can the S.E.C. Avoid Scrutiny of its Settlements?” Professor Peter J. Henning points out that Section 929P of the Act “now allows the S.E.C. to impose a civil monetary penalty in an administrative proceeding ‘against any person’ who violates a provision of the federal securities laws.” Prior to enactment of the Act, the S.E.C. had to go to court to impose penalties against companies other than broker-dealers or investment advisors.

Professor Henning points out that this authority might have made a big difference in the SEC’s recently announced settlement of an enforcement proceeding against Citigroup over its disclosure of its exposure to subprime mortgages. Like the settlement in the Goldman Sachs proceeding, the Citigroup settlement is being delayed, as a federal district judge scrutinizes the settlement.

Under the new Dodd-Frank Act provision, Professor Henning says the SEC enforcement staff will be able to bypass the courts altogether on some types of proceedings by filing settled cases as administrative proceedings. This may allow the staff to act more quickly and impose sanctions on a greater number of companies more quickly. It’s hard to predict the impact of such a trend, however. The scrutiny of the judge in cases such as the Goldman Sachs settlement forced the SEC to get tougher in the final settlement, so the availability of administrative proceedings may make it easier for the SEC and its corporate targets to negotiate deals that are less tough than a federal judge would require. One way or another, however, the flurry of activity from the newly empowered SEC enforcement staff is sure to continue.

Show Me the Logo

Speaking of the empowered enforcement staff, the SEC obviously wants to showcase their toughness – I noticed the brand new logo that’s now prominently displayed at the upper right corner of the home page of the SEC’s website, just above a set of links to its latest high profile enforcement cases:





I’m not going to try to take any credit for the logo, but it does remind me a bit of the graphic I have used in this blog a few times:





I first used the "Busted" graphic in my post in September 2009, “’Busted’ - Don't Be Blindsided by the SEC's New Enforcement Posture,” in which I provided some tips for public companies to avoid problems with enforcement proceedings. I’ll provide an updated list of tips in an upcoming post.

Actually, one of my partners said the SEC’s new enforcement logo reminds him of another one – maybe the SEC is trying to show that its new “cops on the beat” are just as tough as the cops represented by this logo:


Should Management Automatically Recommend a Triennial Say-on-Pay Vote?

Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF) requires that any public company, at its first shareholders meeting on or after January 21, 2011, hold a separate vote “to determine whether Say-on-Pay votes will occur every 1, 2 or 3 years”. This vote has been called the frequency vote or “Say When on Pay.” The Say When on Pay vote must be held no less frequently than once every six years. In a previous post, I described some mechanical issues with offering all three choices of frequency (i.e., an annual, biennial or triennial Say-on-Pay vote). 

But what frequency should companies recommend for Say-on-Pay votes – annual, biennial or triennial? Most public company officials will quickly react that they prefer a triennial vote. The advantages are obvious – Say-on-Pay votes create some additional drafting, solicitation and shareholder relations issues, and a triennial vote allows the company to avoid these issues in two out of every three years.

Are there any advantages to annual or biennial votes? In a webcast (subscription only) sponsored by, compensation consultants Mark Borges of Compensia and Mike Kesner of Deloitte brought up a few factors that should at least be considered before settling on a triennial vote recommendation:

  • Some companies are coming to the conclusion that an annual vote is preferable, on the theory that an annual non-binding vote will seem routine after the first year – somewhat like the annual vote to approve the company’s auditors.
  • Also, biennial or triennial votes may present a disadvantage because there will be “off years” with no vote. If ISS or other shareholder advisory services want to send a signal to the board about compensation in an off year, their only choice is to recommend a withhold vote against compensation committee members.
  • It’s not clear whether the shareholder advisory services such as ISS will recommend annual votes or some other cycle. Companies should also be mindful of any stated preferences of their large shareholders.

On the last point, companies should not assume that institutional investors will all prefer an annual vote. In a post on Altman Group’s Governance and Proxy Review, “Open Questions on Dodd-Frank: Say-on-Pay Implementation (SOP) and Proxy Access,” Francis H. Byrd reports that many institutional investors have feared the prospect of being flooded by annual advisory votes for all of their portfolio companies. Such investors may be happy to vote for biennial or triennial advisory votes. Byrd also points out a common justification by companies for triennial votes – that many companies’ pay plans are crafted around three-year periods, and triennial votes allow investors to better judge the value of these plans.

In any event, the Say When on Pay vote presents a variety of strategic considerations, and public companies should start thinking about these considerations now.

Image: Flikr



SEC Reportedly Set to Approve Proxy Access For Large Shareholders

To paraphrase Bob Dylan, large shareholders are closer than ever to “knock-knock-knockin’ on the boardroom’s door.”

In a Wall Street Journal report today, “SEC Set to Open Up Proxy Process”, Kara Scannell reports that the SEC has scheduled a meeting on August 25, 2010 for approval of proposed Rule 14a-11 (PDF), the shareholder access rule that was originally proposed on June 10, 2009. Scannell reports that the Commission is expected to approve a revised version of the rule by a 3-2 vote, with the Republican Commissioners voting against approval. The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF) on July 21, 2010 clarified the SEC’s authority to order proxy access and thus removed a major legal concern about enforcement of the rule (Act Section 972).

Rule 14a-11 will grant to large shareholders of public companies the right to nominate directors and have the nominees included in management’s proxy statement. Scannell reports that under the language currently being negotiated (still subject to change), shareholders would be required to beneficially own at least 3% of the outstanding stock for at least two years before having the right to nominate directors. Under the original proposal, the threshold was 1%, 3% or 5% depending upon the size of the company, with a one year ownership requirement. The company would be required to include shareholder nominees for up to 25% of the board positions. If nominees are received above the 25% limit, access is granted on a first-come-first-served basis.

In an interesting post on the Altman Group’s Governance & Proxy Review, “Dog Days of Pre-Proxy Access Summer”, Francis H. Byrd discusses the stated intention of the CalSTRS pension fund and hedge fund Relational Investors to team up to seek four boards seats at the Occidental Petroleum 2011 annual meeting. The funds stated that the issues driving their intended contest are executive compensation and succession planning, not financial performance. Byrd points out that the joint 1% holdings of the funds will not be sufficient under the rumored 3% standard in the final proxy access rule, so it’s not clear that the funds will ultimately seek the board seats.

Byrd describes these lessons from the Occidental situation:

First, don’t let corporate governance issues – especially on compensation – fester. . . . The goal should be to limit surprise issues, and be proactive with both your largest holders and the governance influencers like CalSTRS or the NYS Common Fund.

Second, companies . . . . that have [received a majority vote or large vote in favor of non-binding shareholder proposals but] ignored such votes in the past – especially if their stock performance has struggled – will be prime targets for short slate campaigns. This also holds true for companies whose directors have been targeted in Vote No campaigns. Substantial withhold votes from directors could also serve as a beacon for activists seeking to run a potential short slate.

Lastly, your Say on Pay vote matters on more than compensation. Many investors, especially the activist institutions, view compensation as a window for judging the quality of board oversight and determining whether a CEO is ‘imperial’. . . . In that context, a failed Say on Pay vote could be viewed as a signal to an activist that there is at least some lack of confidence in the board and management.

As the proxy access rules quickly approach reality, public companies should plan accordingly – and listen for the knockin' on the boardroom’s door.

The "Say When on Pay" Vote Under Dodd-Frank - As Easy As 1-2-3?

Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF) requires that any public company, at its first shareholders meeting on or after January 21, 2011, hold two shareholder votes:

  • a shareholder advisory (non-binding) vote on the executive compensation disclosed in the proxy statement (Say-on-Pay), which must be held no less frequently than once every three years, and
  • a separate resolution “to determine whether Say-on-Pay votes will occur every 1, 2 or 3 years”.

The latter resolution has been called the Say-on-Pay frequency vote, or “Say When on Pay”. The Say When on Pay vote must be held no less frequently than once every 6 years. The SEC may adopt rules to exempt certain companies (including smaller companies) from these requirements.

The mechanics of implementing of the Say-on-Pay requirement are pretty clear. The shareholders get a yes-or-no advisory vote on all executive compensation disclosed in the proxy statement, which includes the compensation discussion and analysis section and the compensation tables.

The Say When on Pay vote raises a lot more mechanical issues and has created fierce debate among corporate lawyers. For example:

  • The language of the statute requires that all three choices (i.e., one, two or three years) be presented to shareholders. Can a vote with three choices (as opposed to a vote for or against a resolution) be accomplished consistent with state corporate law and the bylaws of particular companies?
  • If all three choices are presented, no one choice may get a majority. Can the bylaws specify  a plurality vote, just as director elections are decided?
  • Rule 14a-4(b) under the Securities Exchange Act of 1934 requires that a public company proxy card allow shareholders to specify approval, disapproval or an abstention with respect to each matter being voted on, other than elections to office. Does this rule prohibit a single vote on all three choices and if so, will the SEC amend the rule to allow for such a vote?
  • Can a company consistent with the Act adopt a “default” frequency for Say-on-Pay in its bylaws (e.g., every three years) and provide that this frequency can only be overridden by a majority vote for one of the other alternatives?

The SEC may clarify the situation, but public companies should start reviewing their bylaws and state corporate law and think about how to deal with the Say When on Pay vote. As the SEC weighs in or there are further developments, I will report them here. Companies should also consider what frequency they are going to recommend for Say-on-Pay votes – annual, biennial or triennial. This issue needs to be considered carefully, as I will discuss in a future post.

Of course, there could be more interesting ways to decide among choices of “1, 2 or 3” than to have a shareholder vote. If only annual meetings could be held on the old “Let’s Make a Deal” set, with costumed shareholders being given the chance to select Door Number 1, 2 or 3 to decide Say When on Pay:

You don’t need to watch the whole seven minute video to get the idea – but if you don’t, you’ll miss some great 1970s-era prizes, like a refrigerator with a built-in tape player!

New ON Securities Cheat Sheet Describes Provisions of the Dodd-Frank Act

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (final text of the Act, 848-page PDF). As previously reported, the Act includes numerous governance and compensation provisions that will affect all public companies, as well as comprehensive reform of the nation’s financial system.

I have updated the ON Securities Cheat Sheet (PDF) to reflect the final provisions of the Dodd-Frank Act. The front page of the Cheat Sheet now includes a complete summary of the governance and compensation provisions of the Act. For each provision summarized, the Cheat Sheet provides the section number for reference to the full section.

The back page of the Cheat Sheet includes a summary of some other provisions of the Dodd-Frank Act that affect many public companies or otherwise have an impact on the securities laws, including a whistleblower “bounty” program and an exemption, effective immediately, for smaller issuers from the attestation report requirements under Section 404(b) of the Sarbanes-Oxley Act. The back page also summarizes the SEC’s previously proposed proxy access rules, as well as some of the important changes in the SEC compensation and corporate governance rules adopted in 2009.

An up-to-date version of the Cheat Sheet will always be available by clicking on the box at the right side of the ON Securities Blog home page. I’ll continue to update the document to reflect the waves of SEC rulemaking that we can expect over the next few months. If you have any suggestions for ways to make the Cheat Sheet more useful or for other resources that might be helpful, please post a comment below or send me an e-mail.

Over the next few weeks, I will be posting on the various new requirements of the Act and the steps public companies should be taking to prepare for the new requirements. 

Note: If you want to print out the pages of the Act that contain the governance and compensation provisions, print out pages 466-496 and 524-540 in the PDF file.