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

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

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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.

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

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

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

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

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

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

New SEC Interpretations

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

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

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