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!

The Psychology of Equity Awards - A Compensation Consultant's View

This time of year, many public companies are drafting the Compensation Discussion and Analysis section of their proxy statement, including a description of how the company’s executive compensation program aligns the interests of executives with those of shareholders. But do the elements of compensation always have the desired effect? Not according to one compensation consultant.

Jim Sillery of Buck Consultants today gave an entertaining presentation to the Twin Cities Chapter of the National Association of Stock Plan Professionals entitled “Achieving Equity Effectiveness: A New Understanding.” Sillery gave several examples of studies showing that equity awards often do not provide the intended motivation for employees, including executives. Among his points:

  • Stock options became popular in the 1990s, at a time when there was unprecedented appreciation in stock price. Stock options had great motivational value (after all, the stock always went up), with no “cost” from an accounting point of view. Now, following two recessions in the past 12 years, stock options are underwater in many cases and don’t have the same motivating effect. At the same time, after changes in accounting rules, increasing shareholder activism and the imposition of mandatory shareholder votes on executive pay, options involve significant downsides.
  • Sillery discussed the concept of “equity effectiveness” – finding the point where the motivational value of compensation awards outweighs the costs, administrative effort and other negatives of a compensation program. In other words, balance the “right brain” factors that cause employees to perceive value with the “left brain” factors that cause headaches for the company – tax treatment, accounting treatment, compliance issues, etc.
  • Sillery discussed the characteristics of stock options vs. time-vested restricted stock vs. performance shares. As he shows in his presentation (PDF) (slide 17), the different types of awards have differing advantages in terms of potential appreciation, stability, etc. A lot of the value in each awards is in how they are communicated to employees. He describes a “kitchen table” test – would the participant be able to describe to a spouse the basic features of the award and how it will benefit them?
  • In an interesting sequence, he described generational and cultural differences that affect which type of award might provide the proper motivation. Baby boomers, Gen X’ers and Gen Y’ers have differing characteristics that may make different types of awards more attractive. Also, for global companies, employees from different countries have radically different perceptions that affect their perceptions of value, long-term vs. short-term view, etc.
  • Sillery said he often recommends that companies consider increasing in the performance shares component of equity compensation to provide flexibility. For example, the company can vary the terms of awards in terms of leverage/risk, performance metrics, payout, etc., to adjust for cultural differences in different countries and regions or for different categories of employees, while keeping the basic structure of the awards constant.

Public companies will always struggle to find the right compensation mix to properly motivate executives while minimizing costs and headaches. Maybe the best approach is to get a degree in psychology.

Incentive Design Study Sheds Light on Compensation Practices

As we approach the second proxy season featuring Say-on-Pay votes, public companies are under increasing pressure to describe how executive pay is tied to company performance. The compensation consulting firm James F. Reda & Associates recently issued its “Study of 2010 Short- and Long-Term Incentive Design Criterion Among Top 200 S&P 500 Companies” (PDF). This study provides a good snapshot of the types of practices large companies used in 2010 (reported in 2011 proxy statements) to provide the proper incentives to executives. Among the findings:

  • Although stock options remain popular, for the first time, the prevalence of grants of performance-based awards (performance shares, performance units, etc.) exceeded the prevalence of stock options (including stock appreciation rights).
  • For short-term incentive plans (generally annual bonus plans), earnings per share and income were the most common performance measures, followed by revenue, capital efficiency ratios and cash flow. For these plans, 72% of companies used two or more financial measures. Over the past several years, the percentage of companies using only one measure declined.
  • For long-term incentive plans, earnings per share and income were the most popular measures, followed by total shareholder return (TSR) and capital efficiency ratios (return on invested capital, etc.). For these plans, 40% of companies used only one measure, with this number declining. Almost the same percentage used two measures, with a smaller number using three or more measures.

The study also provides a lot of detail on target levels, maximum payouts, disclosure practices, etc. As companies are finalizing their 2012 compensation programs and preparing their proxy disclosures, the study should provide a useful reference.

Facebook’s Governance Structure: Not Everyone “Likes” It

As reported in this recent post, Facebook, Inc., which is preparing for its IPO, has a dual-class voting structure that gives founder Mark Zuckerberg a lock on controlling the company, now and for the foreseeable future. Now, certain shareholder groups are expressing their disapproval.

Earlier this week, the shareholder advisory service ISS published a research note that criticizes Facebook’s governance structure, as described in this DealBook post. One of ISS’s statements: “This is a governance profile with a defense against everything [but] hubris.”

Further, as reported by Bloomberg, the California State Teachers’ Retirement System (CalSTRS), which is an existing investor in Facebook, is planning to send a letter to the company questioning the governance provisions.

Of course, one of the features of Zuckerberg’s super-voting stock is that he is not required to listen to any outside parties who might criticize these practices. And if investors don’t like these governance provisions, they don’t have to invest. But it will be interesting to see whether there is so much criticism that the underwriters have to press for some changes in order to attract investors. The way it looks right now, this will be a hot stock no matter what. But stay tuned . . . .

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.

"Too Big to Fail" Doesn't Fail to Educate or Entertain

I just watched the new HBO movie Too Big to Fail, based on the book by Andrew Ross Sorkin about the events behind the financial crisis. In just over 90 minutes, the film has to gloss over some of the details, but it’s surprisingly entertaining. The film brought back memories of following the unfolding events of late 2008 - the Lehman Brothers collapse, the AIG bailout and many others that were happening every day. There are some classic scenes, such as Treasury Secretary Henry Paulson, played by William Hurt, basically locking the chairmen of the biggest banks in a conference room until they accepted TARP funds (whether they needed it or not).

The film is really well acted. Hurt’s performance as Paulson and Paul Giamatti as Fed Chairman Ben Bernanke are both great. But the film is especially worth watching for the performance of James Woods as Richard Fuld, the Chairman and CEO of Lehman Brothers. Whether he’s flatly dismissing Paulson’s demands that Lehman raise capital, or barging into the negotiation of the failed sale of Lehman to the Koreans, Woods paints a fascinating picture of an officer who can’t read the writing on the wall.

HBO also produced a companion documentary, Too Big to Fail: Opening the Vault on the Financial Crisis, featuring interviews with commentators and the actors. There’s a message in this commentary for everyone who sets compensation policy. Sorkin says the following about Fuld:

Dick Fuld had a billion dollars of stock in the company. He had more skin in the game than anyone else. He had every incentive to always do what you would think would be the right thing. He rode his billion dollars of stock down to $56,000.

Certainly, it’s helpful when executives have “skin in the game”. When executives receive a significant amount of their compensation in the form of equity, and they are required to hold much of the equity until after requirement, these features probably do help the company discourage excessive risk-taking behavior. This only goes so far, however - many Wall Street executives like Fuld had huge amounts of equity at risk, and it still didn't prevent the financial collapse.

"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.

Public Companies Should Prepare for Say-on-Pay By Considering Their Pay Practices

Under Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF), public companies must hold a shareholder advisory vote on executive compensation, starting with the first shareholders meeting on or after January 21, 2011. In June, in anticipation of the adoption of the Dodd-Frank Act, the compensation consulting firm Towers Watson surveyed 251 midsized and large public companies on their preparations for Say-on-Pay and other compensation practices. In July, the firm published its report, titled “With Say on Pay Looming, Companies Move to Further Tighten the Link Between Executive Pay and Performance” (PDF).

The Towers Watson survey of these companies found that only 12% of the respondents said they were very well prepared for Say-on-Pay, with 46% saying they were somewhat prepared. When asked what steps they are taking to prepare, 69% of the respondents said they were identifying potential executive pay issues and concerns in advance, with 60% reporting that they are improving their CD&A disclosures to better explain the rationale and appropriateness of their pay programs.

The survey included a question about specific pay practices the respondents had recently changed or are considering changing (Figure 5). The two most commonly mentioned changes were

  • requiring double triggers before acceleration of unvested long-term incentive awards (including stock options) upon a change in control (20% recently changed, with another 8% expecting or considering a change), and
  • eliminating tax gross-ups for golden parachutes (18% recently changed, with another 15% expecting or considering a change).

However, the respondents reported concerns about taking away existing benefits due to concerns about retaining executives.

Must the Say-on-Pay Vote Necessarily Include Severance Programs?

Several in-house attorneys have recently asked me whether the Say-on-Pay vote must include an evaluation of the company’s executive severance agreements and programs, including change-in-control policies. The answer is yes. Section 951(a)(1) of the Dodd-Frank Act requires that the vote cover “the compensation of executives, as disclosed pursuant to [Item 402 of Regulation S-K].” Since severance and change-in-control arrangements are disclosed in the proxy statement pursuant to Item 402(j), they are necessarily included in the Say-on-Pay vote.

The “Say on Golden Parachutes” advisory vote required under Section 951(a)(2) of the Dodd-Frank Act is a separate requirement, and is not an alternative to covering severance arrangements in a company’s regular Say-on-Pay vote. A Say-on-Parachutes vote only occurs in the context of a special shareholders meeting to approve an M&A transaction. The vote need not be conducted on any change-in-control compensation arrangements previously covered in a Say-on-Pay vote. Therefore, the Say-on-Parachutes vote will only apply to arrangements entered into relatively recently before the M&A deal (i.e., parachute payments negotiated since the last annual meeting).

Image: Picasa

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



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.



Say-on-Pay Provision of the Dodd-Frank Act Raises Many Questions

As I reported previously, the House-Senate Conference Committee has agreed on the final provisions of the Dodd-Frank Act (including the corporate governance and compensation provisions starting on page 207 of Title IX of the Act (PDF)). The provision that will probably have the greatest immediate impact on public companies is the requirement for regular shareholder advisory votes on executive compensation (Say-on-Pay).

In a pair of posts on his Proxy Disclosure Blog at, Mark Borges of Compensia provided a great analysis of the Say-on-Pay requirements. He also discussed some open questions about how practical effect of the requirements. Borges’ blog is a subscription service, but he gave me permission to provide excerpts from his posts:

. . . New Section 14A(e) gives the Commission the authority, by rule or order, to exempt an issuer or class of issuers from the "Say on Pay" requirement. . . . . I don't expect the SEC to unilaterally exempt smaller reporting companies from the "Say on Pay" requirement without first soliciting input from the public; particularly the investor community. Consequently, this may be an issue that's assigned a low priority between now and year-end. . . .

This requirement [for Say-on-Pay] is to become effective for the first annual meeting of shareholders occurring after the end of the six month period beginning on the date the Act is signed into law. . . . As long as it is signed into law by Labor Day, the requirement will be in effect for the 2011 proxy season.

. . . One question that has surfaced is whether the advisory vote will necessitate the filing of a preliminary proxy statement. . . . Currently, Exchange Act Rule 14a-6 does not require the filing of a preliminary proxy statement in connection with a "Say on Pay' vote, but only in the case of a company subject to . . . [TARP]. While I expect the SEC to amend the rule to exempt the votes under Exchange Act Section 14A(a) from the preliminary proxy statement filing requirement, we'll have to wait and see how things unfold . . . .

While we've had plenty of time to consider the effects of the "Say on Pay" vote itself, the decision of the House-Senate Conference Committee to let shareholders determine the frequency of the vote - annually, biennially, or triennially - presents a host of questions that will play out over the next several months. Starting with the 2011 proxy season, companies will be required to conduct a shareholder vote to determine how often the "Say on Pay" vote will be held and, thereafter, to resolicit shareholder input on this matter at least once every six years. . . . It seems to me that, in drafting the resolution for shareholder consideration, a company should be permitted to structure the vote to be a choice between an annual vote and a periodic vote (that is, either every two or three years, in the company's discretion). In other words, the resolution should be a choice between two alternatives, since I'm not sure that the difference between a vote every two years or every three years is as significant as the difference between an annual vote and a less frequent vote.

However, the plain language of Section 14A(a)(2) appears to require that companies permit shareholders to choose between holding the vote every one, two, or three years. That is, I expect that the SEC Staff, if it chooses to address the question, is likely to require that shareholders be presented with all three choices. While that appears to be consistent with Congressional intent, it raises the possibility that the decision will be made by a plurality of shareholders (meaning that a majority of shareholders may not favor the choice that ultimately prevails). . . . As a reader pointed out, in many (perhaps most) states [including Delaware], the decision with respect to the frequency of the "Say on Pay" vote will require majority approval of the shareholders. . . . [W]hat happens if none of the three choices receive a majority? Proposed new Section 14A(a)(2) doesn't provide a default resolution. . . .

And, as Marty Rosenbaum of Maslon Edelman Borman & Brand has pointed out, it's not entirely clear whether the frequency vote (unlike the "Say on Pay" vote itself) is intended to be a binding vote - although it appears that it should be (otherwise it's pointless). If it is, then some sort of technical amendment (or SEC rulemaking) will be required as proposed new Section 14A(c) provides that the "shareholder vote referred to in subsections (a) and (b) shall not be binding on the issuer or the board of directors of an issuer . . . ." As presently drafted, this language encompasses both of the votes described in proposed new Section 14A(a), not just the general "Say on Pay" vote contained in Section 14A(a)(1).

There you have it. Borges’ posts contained ten times as much useful information as LeBron James’ television program on Thursday evening announcing his new team. And you didn’t have to spend an hour watching it.

Hay Group Program Analyzes Recent Changes in Executive Compensation

This month’s meeting of the Twin Cities Chapter of the National Association of Stock Plan Professionals featured an excellent webinar by William Gerek (PDF) and Dana Martin (PDF) of Hay Group in Chicago. View the webinar, “Executive Pay – A New World Order, or Business As Usual?”, to hear their analysis of the recently released results of The Wall Street Journal/Hay Group 2009 CEO Compensation Study. The webinar slides (PDF) may also be downloaded.

The speakers commented that 2009 was an unusual year. Many companies’ performance suffered in 2009 compared to previous years, because of ongoing effects of the economic downturn. However, many companies beat their budgets in 2009 (partly because budgets and targets were set at a more modest level in 2009 than in 2008). Also, total shareholder return increased in 2009 due to some rebound in stock prices from their very low levels at the end of 2008. Even though these factors made it difficult to draw a lot of conclusions, Hay Group had some interesting observations, including the following:

  • Total direct compensation to CEOs declined for the second straight year, a first in the history of the study.
  • The prevalence of perks declined, and among the companies still providing them, the values of various perks declined dramatically.
  • The Hay Group commentators observed a greater use of a “portfolio approach” to long term compensation. They believe compensation committees may be trying to address risk elements of compensation by emphasizing “balance” among compensation elements. However, they pointed out a danger in too much balance, which can water down the message a compensation committee wants to send about the specific types of performance that will be rewarded.

Happy viewing!

Image: Picasa Web Albums

Compensation Surveys Provide Insights Into Public Company Pay Practices

And the survey says . . . executives are still doing okay in this economy. Many media outlets have just released surveys of the 2009 compensation of public company executives. They generally reported higher cash compensation (especially bonuses) than for 2008, when many companies did not hit their earnings targets. Relative equity compensation value was harder to assess.

In “Median pay for Minnesota’s top CEOs dipped only slightly,” Christopher Snowbeck of the St. Paul Pioneer Press reported on these trends for Minnesota companies. He did a good job describing the bonus increase, which resulted from companies setting more realistic financial goals for 2009. He also spoke to me about the difficulty in assessing equity compensation levels from the Summary Compensation Table in proxy statements, and the need to look at the intrinsic value of the awards at the end of the fiscal year and over time. Check it out.

And you have to check out Chris’ Twitter feed. In his words, “Chris Snowbeck is so inspired by business news he writes haiku in response.” Seriously, haiku.

Bowne Conference Will Be Educational and Entertaining

I am excited to be presenting at the 2010 Bowne SEC Accounting, Compliance & Legal Issues Conference, to be held on May 27 in Minneapolis. My presentation is the Disclosure Update, where my panel will be providing tips on:

  • Update on SEC Disclosure Requirements, including Climate Change Disclosure and Guidance on Non-GAAP Measures
  • Securities Litigation and Enforcement Update - Bank of America Settlement, Lehman Brothers report and other developments
  • Impact of heightened SEC enforcement
  • Disclosure advice – what public companies should do to protect against liability

I’ll share some of the materials and tips in this Blog after the Conference – as well as the video clips we'll be showing to the attendees.

Also, if you can show up in person, I strongly encourage you to do so. This is always the biggest gathering of public company personnel in the Twin Cities, and it’s a great networking event. Nice lunch, too!

Congressman Frank Gives Update on Say-on-Pay

Congressman Barney Frank, at an appearance in Minneapolis last weekend, predicted that President Obama will sign financial reform legislation into law by the end of June. The Frank Bill and the Dodd Bill (summarized in the ON Securities Cheat Sheet (PDF)) both include governance and compensation reforms that may change as they are reconciled in conference committee. However, both bills include similar requirements for Say-on-Pay, the requirement that all public companies hold an annual non-binding vote on compensation. Therefore, it’s pretty clear that Say-on-Pay will be adopted this year and will likely be required for all public companies by next year’s proxy season.

Congressman Frank, an entertaining speaker with an impressive grasp of the financial system, spent most of his speech discussing the need for financial institution regulation. However, he also emphasized the importance of Say-on-Pay. He believes executive compensation has gotten out of line with the concept of paying the amount necessary to regain good management. Congressman Frank pointed out that Say-on-Pay has been used in the United Kingdom for a number of years.

The speech was sponsored by the Caux Round Table, an international network of business leaders based in St. Paul, Minnesota. This group works with business and political leaders worldwide to promote good governance practices. Caux Round Table has produced the Principles for Responsible Business (published in twelve languages), which address corporate responsibility issues, including some compensation and disclosure principles, and make interesting reading.

Another Company Loses Say-on-Pay Vote

In the RiskMetrics Blog under “Occidental Also Fails to Get Majority Support on Pay”, Ted Allen reports that Occidental Petroleum lost a shareholder advisory vote on compensation last week. This is the second major company to lose such a vote; as I reported last week, Motorola also recently lost its advisory vote.

Of course, these votes are purely advisory and have no direct impact on compensation practices. However, they may have a major indirect impact. For any company that loses a Say-on-Pay vote, RiskMetrics and other proxy advisory services are more likely to recommend a “withhold” vote against members of the compensation committee at a future annual meeting unless the company makes significant changes in its compensation practices. This will increase the pressure on compensation committees.

The threat of a large withhold vote against directors may have an even bigger impact in the future, because under the current version of the Dodd Bill, companies listed on stock exchanges (including Nasdaq) will also be required to adopt “majority voting” policies in director votes. If this provision is included in the final law, a director’s failure to receive a positive majority vote will result in a requirement that the director resign. Therefore, the current financial reform legislation could create a big incentive for board members to cater to the wishes of institutional investors, particularly on executive compensation issues.

Financial Reform Legislation is Coming, and Public Companies Should Start Planning Now for Say-on-Pay

Thumbs Up Thumbs DownThe Restoring American Financial Stability Act of 2010 (1,410 page PDF) (the “Dodd Bill”), which would reform regulation of financial institutions and the securities markets, has been introduced, and debate on the Senate floor has finally begun. It appears that the bill will probably be approved in the next few weeks in some form, followed by conference committee action to resolve differences with the Frank Bill that was approved by the House in December. The two bills include overlapping but differing governance and compensation reform provisions that apply to all public companies (or, in some cases, to all companies listed on a securities exchange). The ON Securities Cheat Sheet (PDF) has been updated, making it easier to compare these provisions in the two bills.

Both the Senate and House bills would require Say-on-Pay – an annual shareholder advisory "up or down" vote on compensation. Therefore, it is very likely that Say-on-Pay will be a reality by next year’s proxy season. Public companies should start planning for Say-on-Pay now, including considering what compensation practices might trigger a negative vote.

The Council of Institutional Investors (CII) just published “Top 10 Red Flags to Watch for When Casting an Advisory Vote on Executive Pay” (PDF), which provides rules of thumb to help institutional investors identify pay programs that might be objectionable. Whether you agree or disagree, the CII document makes interesting reading. Most of the red flags are pretty obvious, including option repricing. Others are more thought-provoking. For example, CII considers it a “problematic pay practice” to grant conventional (time-vested) stock options to the CEO. The CII document recommends:

To isolate management’s contribution to stock price performance, stock options should be indexed to a peer group or should have an exercise price higher than the market price of common stock on the grant date and/or vest on achievement of specific performance targets that are based on challenging quantitative goals.

"I’m Just a Bill"

Thinking about the committee process in Congress brought to mind the great "Schoolhouse Rock" series of animated shorts from the 1970s, and the episode called “I’m Just a Bill.” The song was written by the equally great Dave Frishberg (a songwriter who also wrote “My Attorney Bernie”), and it actually does a pretty good job of explaining the process by which Senate and House bills become laws.

Video: YouTube

Proxy Statements Report that Bonuses Come Back in 2009; Announcing a Great Conference for Minnesota Public Companies

Many public companies have recently filed their proxy statements including a description of executive compensation in 2009, and we are starting to see some analyses in the media of trends in executive compensation. In an article in the St. Paul Pioneer Press on April 8, “For Target's CEO, bonuses are back”, Christopher Snowbeck reported on Target Corporation’s disclosure of its CEO’s compensation in 2009 compared to 2008. Snowbeck reported that, like many companies, Target’s executives received much higher incentive compensation in 2009 than in 2008. In fact, a number of financial services firms, such as U.S. Bancorp and TCF Financial, paid hefty bonuses in 2009, compared to no bonuses in 2008.

Snowbeck asked for my opinion on whether this shift suggested that public companies are moving  toward greater emphasis on bonuses or other short term incentives. He quoted me as attributing the higher bonuses mainly to a different factor, which I called the "under-promise and over-deliver" principle:

For 2008, the year started out with high expectations, which were dashed by the end of the year. . . In 2009, compensation committees were careful to set realistic goals and [performance] targets to give executives a real incentive to turn things around, and many were able to meet or exceed more modest expectations.

By using the term "under-promise and over-deliver,” I wasn’t suggesting that executives or compensation committees are deliberately suppressing goals to boost bonuses. Instead, I just wanted to make the point that financial expectations at the beginning of the year (or other performance period) are a huge factor in ultimately determining bonuses.

In addition to the levels of incentives discussed in Snowbeck's article, there was another interesting aspect of the Target executives’ incentive compensation. Those incentives were actually based on two performance periods – for the first six months and last six months of the year. In an article in the Wall Street Journal on March 15, “Semiannual Bonuses Gain Traction”, Joann S. Lublin reported that many retail and high-tech companies have tried these semiannual bonuses, to help “. . . retain key players by dangling the carrot of two targets a year, while giving boards a chance to raise those goals quickly if economic conditions improve.” The article noted that at least 50 companies have recently disclosed plans to pay semiannual bonuses. [Note: a subscription may be required to read the entire Journal article.]

In his Advisors’ Blog (subscription required), Broc Romanek reported this feedback from his expert consultants about semiannual bonuses:

Semi-annual bonuses were adopted by a small fraction of companies due to those companies' inability (or unwillingness) to set 12 month financial targets due to the uncertainty of the economy. I've seen companies adopt the semi-annual approach and they seem to only pay the bonus when the calendar year is over. I imagine the compensation committees made sure the goals were stretch-based on the best available information at the time the goals were set. Some of these same companies retained the discretion to reduce bonuses prior to payment after taking stock of the year as a whole.

. . . This too shall pass, as compensation committees hate negotiating bonus targets two times per year (or even four times if you count the end-of-the-period negotiations on what to include - or exclude - in the final performance calculations).

SEC Accounting, Compliance & Legal Issues Conference Announced

Bowne of Minnesota has announced the 2010 SEC Accounting, Compliance & Legal Issues Conference, which will be held on Thursday, May 27, 2010 in the IDS Center in Minneapolis. The Conference is always a great way to get timely guidance and practical insights into the latest developments in corporate governance and SEC rules, regulations and initiatives. The faculty always includes experts from top Minnesota law firms and accounting firms, and the program is always well received.

I am one of the co-chairs of the Conference, as I have been for the past several years. I will be leading the Disclosure Update panel discussion, in which my partner Paul Chestovich will also participate. In that panel, we will provide information on new SEC disclosure requirements (including guidance on climate change disclosure), an update on securities litigation and SEC enforcement activity and practical tips on how to avoid liability. As the Conference approaches, I will be blogging about these topics further. Other panels will provide helpful updates on proxy statement disclosures, M&A developments and great information on accounting requirements.

To make it even better, the Conference is free! You are welcome to register here. Also, feel free to e-mail this post to anyone else you know who might be interested – use the “Send to a Friend” feature below or click on the envelope icon.

Never Mind!

After all the speculation about effective dates of the new amendments to the proxy disclosure rules, the SEC on Tuesday published a set of Compliance & Disclosure Interpretations that clarifies the effective date of the new amendments. The C&DIs clarify that the effective dates are indeed in line with the statements made at the public hearing at which the amendments were adopted.

The most important clarification is that companies with a fiscal year ended before December 20, 2009 will not have to comply with the new rules this year. A company with a fiscal year ended on or after December 20, 2009 will be required to comply, unless the definitive proxy materials and the Form 10-K are filed before February 28, 2010. The C&DIs also clarify some of the transition rules in connection with IPOs and other special situations.

Of course, the section of the ON Securities Cheat Sheet discussing the amendments has been updated consistent with the C&DIs.

Next week, I will discuss some examples of risk-based compensation analysis. In the meantime, you might review this previous post that includes insights from a recent Deloitte program on compliance with the new rules.

Again, Happy Holidays! For those of you in the Upper Midwest, if you have to drive, drive carefully.

Cheat Sheet Updated!

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

Stay tuned for other updates in the coming weeks.

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

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

Other Updates

A few other thoughts:

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

Compensation Turkeys of the Year, and a RiskMetrics Update For Dessert

turkeys3Just In Time For Thanksgiving - The Compensation Turkeys of the Year!

At Thanksgiving, our thoughts naturally turn to gluttony of all sorts. So it seems like a fitting time to recognize a few companies for granting awards to their executives that look so ridiculous they practically beg Congress to speed up compensation reform. A great place to look for these examples is the blog, which prides itself on posting the interesting stories "found in the footnotes" of SEC filings.

So pass the cranberry sauce and gravy, here are my nominees for the "Compensation Turkeys of the Year", all reported by in the past few weeks:

    Of course, Goldman Sachs makes the list for its announcement that it is setting aside around $17 billion for compensation and bonuses, calculated to be more than $700,000 on average for each of the company's 31,700 employees. I blogged about this last month. The bonuses are based on Goldman's financial results for the current year, and commentators disagree on how much the results were enhanced by the government bailout of AIG and other financial companies.
    Allis-Chalmers reported recently that healthcare benefit premiums and expenses for its CEO exceeded $72,000 last year. (That buys a lot of aspirin.)
    Microsoft announced that, for one new executive, they paid a relocation allowance of $4.1 million, and a related tax gross-up of $1.2 million.

These aren't the only examples of compensation that grab your attention, but they are just the most recent obvious ones. As Mark Borges pointed out at the NASPP Annual Conference and other presentations, when companies eventually are required to have advisory votes on executive pay (Say-on-Pay), most companies' compensation will be approved. However, to prevent a "no" vote, they will need to think about the compensation practices that appear the most excessive - personal use of corporate jets, tax gross-ups, etc. It will be interesting to see whether, in a couple of years, after compensation reform, the Compensation Turkeys of the Year will be extinct birds. Don't count on it.

If you have any other Compensation Turkeys of the Year you would like to report, send me an e-mail. (As with any other good whistleblower policy, I won't use your name unless you give permission.)

By the way, the picture above shows the family of wild turkeys that hung out in our back yard for the past few months. Leading up to Thanksgiving, though, I haven't seen them lately. Times are tough.

Anyway, have a fantastic Thanksgiving!

RiskMetrics Update

Last week I reported that RiskMetrics Group came out with its 2010 updates to its proxy voting guidelines, summarized here. The compensation policy has changed more in form than in substance from last year, integrating separate policies into a single policy. RiskMetrics also clarified its methodology when it has compensation-related recommendations for a company based on its analysis. If that company has a Say-on-Pay proposal on the ballot, RiskMetrics will generally apply its recommendations to that resolution. However, if egregious practices are identified, or if a company previously received a negative recommendation on a Say-on-Pay resolution and the issue is not resolved, RiskMetrics may recommend a withhold vote with respect to compensation committee members.

The new governance policy also changes RiskMetrics' standards when making recommendations with respect to shareholder rights plans and revises its director independence standards.

"What's Goin' On"?

informationSeveral new reports have been published that provide valuable information about what's going on in the public company world. Here are two that just came out:

    Pearl Meyer & Partners released a survey report covering companies' attitudes toward Say-on-Pay, which is currently required for TARP recipients but will not be required for other public companies until at least 2011. The survey found that most respondents were not very concerned about Say-on-Pay and are not yet taking specific steps to plan for shareholders advisory votes. The Pearl Meyer firm reports that virtually all advisory votes have passed, mostly by a sizeable majority. However, the firm cautions that institutional shareholders may get tougher on Say-on-Pay votes in the future. The survey report recommends some specific steps companies can take over the next several months to plan for Say-on-Pay.

    Frederick W. Cook & Co. released a report of its study of non-employee director compensation at the 100 largest New York Stock Exchange companies and the 100 largest Nasdaq companies. The study found that compensation levels generally stabilized in 2009 after several years of increases, which had tracked increased director responsibilities under the Sarbanes-Oxley Act of 2002. The study also found that the compensation mix changed, with more companies moving director equity awards out of stock options and into stock awards. Also, the declines in the equity markets had a significant impact on equity award values, especially at Nasdaq companies. The study outlines median compensation levels at these companies and examines a number of compensation practices.

One more update - hot off the presses: I noticed that RiskMetrics today published some of its 2010 policy information, which applies to all shareholder meetings occurring on or after February 1, 2010. The more comprehensive proxy voting guidelines will be published in December. However, the just-released documents shed some light on RiskMetrics' evaluation of compensation and governance practices for the 2010 season. It appears that RiskMetrics will make some changes to its approach in making recommendations on Say-on-Pay votes and other compensation-related votes. I will report further on this next week.

What's Up in San Francisco?

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

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

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

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

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

What's Up?

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

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

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

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

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

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

Getting Ready for Reform

congressMark Borges, the well known compensation consultant with Compensia, gave a very interesting talk this week at a joint meeting of the Society of Corporate Secretaries and Governance Professionals and the Twin Cities Compensation Network. Mark was gracious enough to give me permission to post his presentation, which is full of useful updates on governance and compensation reform and tips on how to get ready. One of the interesting features is a time line showing the dates of adoption and introduction of various legislative and regulatory initiatives, as well as a preview of what's to come. As I've said before, watching the progress of these initiatives through Congress and the SEC reminds me of the arcade game where you can watch the little mechanical horses race around and around the track, with the lead constantly changing - as in this great video.

Mark made these points, among many others:

    Given the amount of attention Congress is giving to health care reform, it is very possible that governance and compensation reform will be pushed to 2010 - unless there is some unforeseen crisis before then, which is always possible.

    Mark, like me, had thought the Shareholder Bill of Rights Act (the Schumer Bill) introduced in the Senate had probably been swept aside or at least delayed by the passage by the House of the Corporate and Financial Institution Compensation Fairness Act (the Frank Bill). Now, he believes that the Schumer Bill may be getting new traction. The Schumer Bill is heavier on governance reform than the Frank Bill, and some of these provisions may be grafted onto a financial institutions reform bill.

    Even though a shareholder advisory vote (Say-on-Pay) requirement likely will be part of any reform bill, it almost certainly will not be effective for the 2010 proxy season. Meanwhile, some major companies have voluntarily adopted other advisory vote models - in September, Microsoft adopted a triennial advisory vote, and in October, Prudential adopted a biennial advisory vote. If one of these approaches gains support, Congress may mandate one of these approaches rather than an annual vote on compensation.

I will mention some of Mark's other observations in a future post.

Good Times on Wall Street; The Cheat Sheet Changeth!

Wall Street Wealth

money-briefcaseJust as lawmakers and regulators are preparing to consider compensation reform once again, a new report has surfaced that's likely to turn up the heat on the debate. The Wall Street Journal reported that the major financial institutions are on pace to pay their employees around $140 billion this year - a record level. The Journal's study is based on compensation amounts these firms have accrued to date this year. Therefore, the amounts might be inflated. However, it's clear that the amounts will be back to pre-crash levels.

For example, the Journal projects that Goldman Sachs will pay $20 billion in compensation and benefits ($743,000 per employee) this year. Of course, Goldman is having a great year so far. But, as reported in the New York Times DealBlog, there is still a lot of debate over how much Goldman's results were helped by the government's bailout of AIG, which resulted in significant payouts to Goldman on AIG-insured contracts.

As reported by the Journal, its findings come at a time when the Obama administration's pay czar is preparing to issue his findings on pay packages at many of the financial firms that received TARP money. More generally, Congress will be considering reforms such as Say-on-Pay for all publicly held companies. One way or another, numbers like we're seeing from Wall Street are sure to affect the debate.

Are the banks paying the best and the brightest what they deserve, or do you think Wall Street greed is being rewarded by paying out bonuses fueled by taxpayer bailouts? Comment below or send me an e-mail.

Change (to the Cheat Sheet) You Can Believe In

It's been easy to keep the ON Securities Cheat Sheet up-to-date since early August - nothing really changed. All of the various legislative and regulatory reforms were dormant for a couple of months. (Probably waiting for the Olympic Committee to select a host city for 2016 and the Nobel Committee to select a Peace Prize winner.)

At long last, this month there has been a new development worthy of changing the Cheat Sheet. As reported in Bloomberg and elsewhere, the SEC has decided not to take any action on the proposed shareholder access rules this year, as it evaluates the many public comments on the proposal. The Cheat Sheet has been updated to reflect this decision, and as always, the updated version is available on the Resources section of this Blog.

The changes should start coming more quickly in the next few weeks. Stay tuned.

More Risky Business; Blogging Lawyers Gone Wild!

risk1More Risky Business - A Case Study in the Risk Aspects of Compensation

There was a fascinating article in the New York Times on Thursday about Merrill Lynch's 2006 bonus program, which resulted in large payouts to top management even as the company was sold to Bank of America in a distressed sale. The author of the article provides more in-depth analysis in a post in the Times' DealBook Blog. Of course, these pieces probably attracted my attention because the DealBook post starts with "Calling all compensation nerds".

The Times article lays out the ways in which the Merrill plan was supposed to align top management pay with long-term performance, but concludes that the plan "did not keep workers from taking risks that nearly sank the brokerage giant. And some of its senior executives still stand to collect millions of dollars in stock under the plan." The Blog post discusses the features of the plan that put a portion of the employees' bonuses at risk, provided for a partial clawback if return on equity was not adequate, and invested the bonus amounts in stock that was locked up for a year past the three-year term of the plan.

While the article itself focuses attention on the failings of the Merrill plan, the Blog post provides a more nuanced view of the effort put into structuring the program, and the reasons it may not have been fully effective:

The Bottom Line: Talk to people who were in the plan, and they will tell you it worked because Merrill executives lost money in the clawback in 2007 and also because of the sunken stock price. However, the executives all did better than regular investors who put in money at the same three points but did not have the firm's leverage to help. Of course, the executives work at the company, and the plan was meant to compensate them in part for that work.

Why did the plan fail to save Merrill? Some compensation experts suggested it should have been applied to far more people. Others said a single year's return on equity might not be the right metric. And others said risk management and capital rules also contributed to Merrill's problems.

I think the Merrill plan had many worthy features that should command the attention of compensation professionals, especially in the financial services industry where risk management will become the Holy Grail of compensation programs. The Blog analysis above points out that some adjustments in the Merrill program could have made it much more effective - for example, the plan should have applied to far more people. In the financial services industry, bonuses to employees at all levels fueled excessively risky practices. But just because the program didn't perfectly match investor losses with executive losses, that doesn't mean the Merrill program wasn't a worthy effort.

In-House Lawyer Bloggers - What's Next?

Here's a new one - The Corporate Counsel Blog reports that in-house corporate attorneys have joined the blogging world. For example, Doug Chia, Senior Counsel at Johnson & Johnson, is posting on J&J's corporate blog. Chia reports that he is encouraging other in-house attorneys to blog. One of his goals is to get relevant information to retail shareholders, in preparation for the next proxy season when brokers will not be able to vote without instructions from these shareholders.

What's next? I haven't seen any GC's tweeting - yet.

The Color of Your Parachute Has Changed

parachuteCompensation consultant Frederic W. Cook & Co. just published a study of recent changes in change in control agreements. The study focuses on the practices of the 125 largest public companies. Frederic Cook found that, of the companies that use change in control agreements, 57% made changes in the past three years, including a number of changes that make the agreements less "executive-friendly". The changes included the following:

    Many of the companies modified their excise tax gross-ups - the commitment to reimburse the executive for excise taxes payable as a result of excessive change in control payments. Eleven percent of the companies eliminated the gross-ups entirely. Another eight percent modified their gross-ups, moving to a modified gross-up formula instead of a full gross-up.

    Nine percent moved from single-trigger vesting of equity awards upon a change in control to double-trigger vesting.

    Nine percent modified their severance multiples. In many cases, the multiples for top officers were changed from 3X to 2X.

    The Cook study also describes numerous other changes.

The Cook study points out that the first two provisions described above (tax gross-ups and single-trigger vesting) are considered "poor pay practices" under the standards of RiskMetrics Group. If these provisions are contained in new or materially amended agreements, RiskMetrics may recommend to shareholders that they vote against compensation committee members at the next annual meeting. This factor may have resulted in pressure on compensation committees to change these provisions in their change in control agreements.

The Cook study points out that some of the legislation being considered in Congress would not only require "say on pay" but would also require "say on severance" - an annual non-binding shareholder vote to approve golden parachutes. The study predicts continuing changes in change in control agreements.

What do you think? Will change in control agreement practices continue to change? Comment below or send me an e-mail.

"Wanna Buy Some (D&O) Insurance?"; More Trends in Compensation

"Psst - Wanna Buy Some (D&O) Insurance?" This Survey Will Help.

umbrellaI was interested to read the most recent Towers Perrin survey of D&O insurance practices of around 2,600 public and private companies and non-profits. One of the purposes of the survey is to provide companies with information about the structure and cost of D&O insurance practices of a broad cross-section of companies. Towers Perrin emphasizes that the companies surveyed do not represent a scientific sampling. However, it is helpful to have a reference point for the range of coverage amounts and retention amounts for companies of various sizes.

This survey also reports on various insurance trends, including an increasing number of public companies purchasing only "Side A" coverage, which covers directors and officers only in situations where indemnification from the company is not available. This trend was especially apparent in very large organizations.

More From the Deloitte Executive Compensation Trends Presentation

Last week I mentioned the excellent materials prepared by Deloitte Tax for a presentation on trends in executive compensation, for the Twin Cities Chapter of the National Association of Stock Plan Professionals. A few other compensation trend observations worth noting:

    Around 40% of the largest companies changed their long-term incentive (LTI) plans or granting practices for 2009, including modifying performance measures, reducing LTI grant values, introducing intermediate goals, etc.

    The authors predict a significant decline in LTI grant values for 2009 - in light of lower stock prices, some companies had to reduce grant values in order to manage equity dilution.

    Surveys noted significant increases in executive compensation "clawback" arrangements for large companies.

Risky Business - Evaluating the Risk Components of Compensation

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

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

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

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

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

Memories of a Meltdown - and Lessons in Executive Compensation in Bad Times

dollarsign2The news today was filled with reports on the first anniversary of the collapse of Lehman Brothers. That event represented the first time most of us realized the extent of the financial disaster that played out over the following few months. Not exactly cause for nostalgia.

At around the same time, our local chapter of the National Association of Stock Plan Professionals (NASPP) produced a webcast/conference call entitled "Troubled Company, Workout and Bankruptcy Issues: A little 'gloom and doom' with your morning java." I moderated the panel discussion, which featured very topical discussions by Mike Meyer, a bankruptcy attorney with the Ravich Meyer firm, and Scott Feraro and Kathy Bonneville, compensation consultants with Seabury OCI Advisors, LLC. Obviously, this topic is just as relevant today as it was then. Just to keep on sharing the "gloom and doom", we have made the transcript available - it makes interesting reading. Topics included:

    The role of compensation and risk management in the financial meltdown, and ways to structure compensation in a troubled company situation

    Executive hiring, employment arrangements and retention in workout and bankruptcy situations - including the types of retention arrangements that will "fly" in bankruptcy court

    Strategies in dealing with underwater stock options

Let's hope for a better year ahead.

SEC Enforcement Follow-Up

The SEC just got another incentive to ratchet up its newly aggressive enforcement posture another notch. On Monday, as described in this New York Times article, Federal District Judge Jed Rakoff issued a scathing order (see the link in the Times article) that voided Bank of America's $33 million settlement with the SEC. The enforcement proceeding related to Bank of America's failure to disclose the approval of Merrill Lynch bonus payments in the merger proxy statement. The judge was especially hard on the SEC's failure to go after the individual officers of Bank of America, accusing the parties of using the shareholders' money to reach a settlement that absolves the individuals of responsibility. If a new settlement is not reached and the case goes to trial, the judge will have plenty more opportunity to chastise executives, lawyers and public officials alike. It will be interesting to see whether the negative publicity causes the SEC to take its enforcement activity to yet another new level.

Preview of Coming Attractions, and a Movie Review

Preview of Coming (Regulatory) Attractions

movie1The past few weeks have been fairly slow in terms of new developments in securities law, corporate governance and executive compensation. However, summer's over, and I'm expecting a flurry in the next few weeks. Take a look back at the ON Securities Cheat Sheet - a lot of these developments are likely to change as we head into the fall:

    Congress is back in session, and we are likely to see action on the Corporate and Financial Institution Compensation Fairness Act of 2009, passed by the House in July. Congress will likely try to reconcile that bill with the other legislation described in the Cheat Sheet, and I would expect that something will be enacted by the end of the year. Virtually every bill would require Say-on-Pay for public companies, but we don't know when the requirement will go into effect.

    Comment periods are ending for the SEC's proposed proxy disclosure and solicitation rules and the proposed shareholder access rules. The SEC will almost certainly adopt the disclosure and solicitation rules this fall. As described in this post, action on the shareholder access rules is more uncertain.

    The SEC and Treasury Department may further clarify compensation standards for financial institutions that received TARP funds - including the SEC's proposed rules to clarify Say-on-Pay standards for TARP recipients (maybe a preview of what Say-on-Pay will look like for other public companies).

    Companies preparing their proxy statements for annual meetings held starting on January 1, 2010 will be dealing with the reality of the elimination of broker discretionary voting, described in this post.

We'll be watching carefully - as Siskel and Ebert used to say, "The Balcony Is Open".

Mastering the Art of American Blogging - and Begging

Last weekend I saw my all-time favorite film about blogging - okay, maybe the only film I have seen about blogging. "Julie & Julia" follows two parallel true stories - Julia Child's authorship of "Mastering the Art of French Cooking", and Julie Powell's creation of a blog that chronicles her quest to prepare all 524 recipes in the Julia Child book in one year.

I agree with the critics who said that the Julia Child story is much more compelling, and Meryl Streep is wonderful as Julia. But I watched Julie's story with my "blogger hat" on, and I tried to figure out what made her blog successful. Aside from a good concept and great writing, she found a way to create a community among readers with a common interest, and she fed off their support and feedback.

Which leads me to the begging - I am gratified by the number of subscribers to the ON Securities blog, but I'd like to hear from you a little more often. I know it's not always easy - as expressed in an e-mail I received from one subscriber who provided a great comment but then said:

I need a trip to the Wizard of Oz before summoning up enough courage to post a response.

I've paraphrased his/her comment anonymously in the "Comments" section of my last post.

So my request is that you not hesitate to give me feedback - let me know when I'm right or wrong or off base, or if there's any information you would like me to provide in this space. My promise: reading my blog won't leave you as hungry as watching "Julie & Julia" or reading Julie's blog.

Back to the Future - New Options Backdating Study

[Editor's Note: Apologies to those who tried to read this post based on the e-mail update sent on Monday - that e-mail was sent inadvertently, prior to some corrections on the post.]

A story in the Wall Street Journal last week (subscription required to read complete story) described an interesting recent academic study on stock options backdating. The study found that several hundred companies that improperly backdated options never were caught or confessed. In the study, out of the University of Houston's C.T. Bauer College of Business, the authors used computer models to determine companies that are highly likely to have committed backdating. These companies featured "lucky" officers, who received option grants at or near the low points for their stock prices.

Based on this sampling of companies the researchers found that only around one-third of these companies had ever disclosed evidence of backdating. The authors extrapolated that at least 500 companies engaged in backdating that was never disclosed.

We are reading very little about backdating these days, compared to how much the story dominated the business headlines in 2006 and 2007. It's hard to imagine that there will be a new wave of SEC enforcement actions against previously undisclosed companies that backdated options.

However, the legacy of the backdating scandal lives on in the SEC's compensation disclosure rules that became effective in 2006. The scandal caused the SEC to suspect that companies were unfairly manipulating the pricing of stock options through the timing of option grants - practices such as "springloading". The SEC's 2006 adopting release clarifies that a public company must disclose any plan or program to coordinate the timing of stock option grants with the release of material non-public information.

We recommend that public companies adopt a written stock option grant policy, if they have not already done so. Careful adherence to such a policy can make it easier to establish that options are not being granted in coordination with the release of material non-public information.

Say-on-Pay Play-by-Play

footballAs I've said before, some version of a requirement for shareholder advisory votes on compensation (Say-on-Pay) is likely to be adopted in the next few months. The Say-on-Pay requirement will probably be similar to the Corporate and Financial Institution Fairness Act of 2009, recently adopted by the House and described in the ON Securities Cheat Sheet. In other words, Say-on-Pay has become a political football lately.

    [Editor's Note: You may have noticed veiled references to "football" in the title and the first paragraph of this post. The Editor of the ON Securities Blog categorically denies ANY relationship between these references and Brett Favre's announcement Tuesday that he signed a contract with the Minnesota Vikings.]

It looks like shareholder advisory votes will not be required until the 2011 proxy season. Still, it makes sense to keep track of the results of recent advisory votes to see how various companies have fared. Several hundred financial institutions that received TARP funds were required to hold advisory votes last spring, and their recently filed Form 10-Q reports disclose many of the results.

So, what does the scoreboard look like in Say-on-Pay season? Generally, the non-binding proposals to approve executive compensation did very well. Here is a sampling of the results from financial institutions with strong ties to the Twin Cities:

US Bancorp: 92.0% in favor
Wells Fargo Company: 92.8% in favor
TCF Financial Corporation: 69.5% in favor

If the SEC adopts its recent rule proposals, we will no longer have to wait several months to see the results of shareholder votes. Companies will generally have to report them on Form 8-K within four business days. It will practically be possible to follow the results on your BlackBerry, along with football scores.

    [Editor's Further Note: Did I mention that Brett Favre is joining the Vikings? All right, maybe I did have football on my mind.]

Watch Out For Those Claws!

The SEC's recent clawback action against Maynard Jenkins, the former CEO of auto supplier CSK Auto Corporation, has gotten more commentary than just about any other recent enforcement proceeding I can think of. The SEC is seeking reimbursement of $4 million in Jenkins' bonuses and profits from his stock sales during years when CSK's financial results were inflated by accounting fraud. What's getting all the attention? The SEC has not charged Jenkins individually with any wrongdoing. claws2

The SEC is seeking the clawback under Section 304(a) of the Sarbanes-Oxley Act of 2002, which allows recovery of incentive compensation following a financial restatement "as a result of misconduct." Section 304 doesn't specify that the misconduct be tied directly to the individual from whom the recovery is sought. However, the SEC, in its press release announcing the action, reported:

It is the first action seeking reimbursement under the SOX 'clawback' provision . . . from an individual who is not alleged to have otherwise violated the securities laws. . . . . 'Jenkins was captain of the ship and profited during the time that CSK was misleading investors about the company's financial health,' said Rosalind R. Tyson, Director of the SEC's Los Angeles Regional Office. 'The law requires Jenkins to return those proceeds to CSK.'

Much of the negative commentary accuses the SEC of overreaching, in a situation where it could not state an accounting fraud case directly against Jenkins. However, this case is an extreme one - Jenkins collected $4 million in bonuses and stock profits at a time when the company was committing massive accounting fraud. The COO, CFO, controller and another responsible officer were all indicted, and the latter two individuals have already pled guilty. Even if the SEC couldn't make a direct case against Jenkins for the fraud, this is the perfect test case for the extension of a Section 304 clawback beyond the responsible individuals to the "captain of the ship".

Regardless of the result in the case, the SEC has sent another signal that it is "loaded for bear" - as we reported in this post, the agency has a beefed-up enforcement staff and new energy. Regardless of the result in the Jenkins "no fault clawback" case, the SEC will be putting more heat on executives in the coming months.

Say-on-Pay Bill Passes the House; Cheat Sheet Updated!

On Friday, the House of Representatives passed the Corporate and Financial Institution Fairness Act of 2009. The Senate still needs to consider similar legislation, and any differences will need to be resolved.congress

For most public companies, the bill will (1) require an annual advisory vote on executive compensation ("Say-on-Pay") and (2) for exchange-traded companies, increase the independence requirements for compensation committee members. The bill also would, if enacted, regulate pay at the largest financial institutions. Blog in its August 3, 2009 post contains an excellent summary of the bill. As that blog points out, Say-on-Pay almost certainly will not be a reality during the 2010 proxy season.

The bill allows the SEC to exempt certain companies from both the Say-on-Pay requirement and the compensation committee requirements. Therefore, the SEC might exempt smaller companies from either or both provisions.

We have updated the ON Securities Cheat Sheet to include the revised status and content of this bill. As you can see, there are still several other bills making their way through the Senate and the House, as well as several proposed regulations that would impact governance and compensation. These bills and rules continue to jockey for position, like the toy arcade horses in the video that amuses me so much.

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

How to Play Say-on-Pay

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


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

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

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

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

Updated Cheat Sheet Posted

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

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


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

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

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

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

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

More on the SEC's Proposed Amendments to Disclosure Rules

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

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

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

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

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

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

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

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

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

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

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

"Love the Orange"

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

The SEC's July 1 actions in context; Singing Fish is a hit

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

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

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

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

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

However, to understand the impact of the July 1 actions, it is necessary to understand other current developments, some of which would have an even greater impact on a broader segment of companies:
    The Commission's Say-on-Pay proposals covered only TARP recipient companies. However, the Shareholder Bill of Rights Act introduced in the Senate by Senator Schumer, if adopted, would mandate Say-on-Pay for all public companies, as would two other bills currently being considered by Congress.

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

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

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

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

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

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