Program Provides Update on Dodd-Frank Act Requirements

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


Happy Holidays, and Sharing Inspiration, from Maslon

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

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

Happy Holidays to all!

"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.