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

This year, for the first time, public companies have been required to include a disclosure in their proxy statement to the extent that “. . . risks arising from the registrant’s compensation policies and practices for its employees are reasonably likely to have a material adverse effect on the registrant.” In a blog post today on compensationstandards.com (subscription site), Andy Mandel and Larry Schumer of Buck Consultants described a study they completed (PDF) about the voluntary risk disclosures (or lack thereof) in the proxy statements of 200 large public companies.

They report some interesting findings:

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

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

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

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

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

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

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

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

Image: Wikimedia Commons
 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Let the proxy season begin. And Play Ball!

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

Image: Wikimedia Commons

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

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

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

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

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

Compensation Consultant Releases Study of Performance Metrics

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

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

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

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

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

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

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