Negotiating Terms Within Executive Employment Agreements: The Board's Perspective

Posted on March 6, 2011 by Anthony Eppert

The purpose of this Post is to address some of the common issues that members of a Boards of Directors should consider when negotiating employment agreements with named executive officers.

Defining "Cause"

Consider defining the term "cause" to include a substantial under-performance of the executive (e.g., failure to achieve minimum financial goals for two consecutive fiscal years).

Additionally, consider the Board's use of after-acquired evidence to determine whether the executive terminated employment for "cause."  It could be that evidence supporting a termination of employment for cause is not found until after the executive has terminated employment for a reason other than cause.  Without an after-acquired evidence clause, the Board will not likely be able to change the characterization of the executive's prior termination of employment (and therefore the Company may remain contractually liable for associated severance pay benefits).  But if instead an after-acquired evidence clause were contained within the employment agreement, the Board could recharacterize and deem the executive's prior termination as one for cause (thus likely negating associated severance pay benefits).

Defining "Change in Control"

Ensure that the definition of "change in control" requires consummation of the transaction.  There are a few public examples where the term change in control was triggered upon execution of the underlying transaction document.  If such were the facts and the underlying transaction was not consummated (i.e., a failed deal), then the Board might see the makings of a shareholder derivative lawsuit, especially if the payouts to the executives were rich.

Implement Robust Clawback Provisions

Consider adding clawback provisions in addition to those required under Section 304 of SOX and the Dodd-Frank Act.  For example, consider adding a clawback for any breach of post-employment restrictive covenants (e.g., violation of a non-compete clause).  Additionally, but related, consider adding a clause that if the non-compete provision is ever judicially or administratively ruled to be unenforceable, then the executive must forfeit certain portions of his or her severance pay (including a return of any gains on equity awards that the executive sold after his or her termination of employment).

Require Automatic Resignation from the Board

It is surprising to me how many employment agreements I review that do not require the automatic resignation from the Board (and other Company-related entities) upon the termination of the executive's employment with the Company.  Failure to implement such a provisions provides the departing executive with "some" leverage at the time of his or her termination and, in instances where the executive does not resign from the Board, could be politically awkward until his or her term on the Board is complete.

Remember that Severance Pay Should be Bridge Pay, Nothing More

In setting the amount of any severance pay, keep in mind that severance pay packages should be designed to act as a bridge between jobs.  Therefore, consider limiting the amount of severance pay packages to 6 months base salary and bonus (or upward to 1 year base salary and bonus).  Additionally, consider whether it makes sense to offset the amount of any future severance pay by the amount of any income the executive earns from his or her new employer.

Design the Timing of Severance Pay as Salary Continuation

Absent a change in control of the Company, consider designing severance pay to take the form of salary continuation (as opposed to a lump sum payment).  Salary continuation is more friendly to the Board's position because it allows the Board to hold purse strings as a mechanism to enforce any post-employment restrictive covenants such as a non-compete clause.  However, the foregoing might not make sense if the executive's employment is being terminated in conjunction with a change in control.

Use Double Triggers for Change in Control Transactions (Try to Avoid Single Triggers)

Single trigger vesting events (i.e., accelerated vesting upon a change in control) are viewed disfavorably by institutional shareholder advisory services such as ISS.  For this reason consider using only double triggers (i.e., accelerated vesting only if there is both a change in control and a termination of the executive's employment).

Implement Non-Competes to Avoid Use of a 280G Tax Gross-Up

As background, executives generally prefer a tax gross-up for any change in control payments that would be subject to Section 280G of the Internal Revenue Code (absent a tax gross-up, the executive could be subject to a 20% excise tax on change in control payments).  However, tax gross-ups are highly disfavored by institutional shareholder advisory services.

Consider negating the need for any 280G tax gross-up by implementing a non-compete provision, the related compensation to which could act to reduce golden parachute payments subject to the 280G excise tax.  Keep in mind that the reduction is not on a dollar-for-dollar basis with the separation pay, rather, the reduction is generally based on the difference between the enterprise value of the company with and without the non-compete.  Thus, the value of the non-compete and the value of the 280G reduction could be a lot more than the severance pay directly associated with the non-compete (thus acting to also reduce other compensation subject to 280G, such as the present value of of equity awards that accelerate vesting upon the change in control).

To close, my experience is that Boards carefully consider the terms of executive employment agreements.  Hopefully the above is helpful with that endeavor.

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Should Proxy Statements Affirmately Address Controversial Pay Practices?

Posted on January 31, 2011 by Anthony Eppert

We now have our first failed say-on-pay proposal for this proxy season.  Discussed below, this failure raises the issue of whether companies should affirmatively disclose controversial pay practices or compensation issues within their proxy statements.  Minimally, the issue should be considered. 

Background

Generally, institutional shareholder advisory services such as ISS will only look to the "four corners" of the proxy statement in making its recommendation (i.e., it will not look at other filings of the issuer).  This means that if a company has a controversial pay practice or compensation issue, it should consider affirmatively explaining such issue in its proxy statement in the hopes of avoiding a possible negative recommendation from ISS (and applicable others). 

First Failed Say-on-Pay Proposal of this Proxy Season 

On January 28, 2011, Jacobs Engineering Group Inc. filed a Form 8-K (Found Here) showing that their advisory say-on-pay vote resulted in a majority voting "against" the proposal.  This is the first failed proposal for this proxy season.

It seems a cause for the failure related to a one-time grant of restricted stock to its executive officers.  The proxy statement contained little discussion about the grants.  Though I did not check, it can be inferred that ISS (or other service) recommended a "no" vote because the company later made an effort to explain the grants by filing additional materials to its proxy statement.  (Found Here)

Some Examples of Companies Providing Affirmative Disclosure

A few examples of companies providing affirmative disclosure of controversial pay practices or issues within their proxy statements are as follows:

  • FedEx Corporation explained in their proxy statement filed on August 16, 2010, why tax reimbursements associated with their executive officers' receipt of restricted stock was appropriate even though the company generally discontinued tax gross-ups.  (Found Here)
  • Level 3 Communications, Inc. discussed its rationale for single trigger vesting and 280G gross-up provisions in its proxy statement filed on April 2, 2010.  (Found Here) 
  • Saks Incorporated addressed its rationale for severance arrangements with its executive officers in its proxy statement filed on May 7, 2010.  (Found Here)
  • Intel Corporation addressed overhang and burn rate issues in its proxy statement filed on April 3, 2009.  (Found Here)

To close, companies should at least consider providing affirmative disclosure.

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Say-on-Pay Frequency: Issues to Consider

Posted on January 17, 2011 by Anthony Eppert

Issuers who hold their annual shareholders meeting after January 21, 2011, will have to implement say-on-pay as part of their proxy process.  At this first annual meeting, shareholders must also decide on the frequency of the say-on-pay vote, such frequency also becoming known as "say-when-on-pay."  The purpose of this Post is to discuss issues that should be considered when implementing say-when-on-pay. 

Background

Addressing the frequency of say-on-pay, issuers must offer shareholders the following four choices: annual, biennial, triennial and abstention.  Thereafter, the vote on frequency must be held by a separate resolution no less than once every six years.

Worth noting is that a majority of the issuers who have filed proxy statements this season have recommended triennial say-when-on-pay.

Some Reasons to Adopt an Annual Vote

  • There is a belief that annual votes will become routine, similar to annual ratification of an issuer's outside auditors.  Those following this thought believe that the scrutiny associated with an annual vote will eventually be less than the scrutiny associated with a biennial or triennial vote.
  • Another thought is that shareholder dissatisfaction is likely to be expressed in the say-on-pay process as opposed to utilizing withhold/no votes on compensation committee members.  Thus, as the thought goes, compensation committee members are more protected with annual say-on-pay.
  • ISS recommends annual voting.
  • There is real time disclosure and shareholder feedback associated with annual voting.
  • For those issuers with poor pay practices, annual voting may be preferred so that the taint associated with a no vote does not last for two or three years (as it would if biennial or triennial voting were implemented).

Some Reasons to Adopt a Biennial or Triennial Vote

  •  A biennial or triennial vote helps shareholders evaluate the long-term effects of an issuer's multi-year compensation structures.  In contrast, an annual vote encourages short-term thinking and focuses on interim results, such as a decrease in stock price.
  • Preparing for and implementing say-on-pay on an annual basis may be costly and mis-directs the attention of management.
  • Assuming shareholders express negative thoughts during the say-on-pay process, the compensation committee may need to time implement changes to various compensation policies and procedures. 
  • Some investors prefer a voting frequency that is longer than annual voting  (e.g., the United Brotherhood of Carpenters prefers triennial voting).
  • Certain registered institutional investment managers may find that annual reporting to the SEC on how they voted is too burdensome for every portfolio company.

Recommendation from the Issuer

Issuers have the opportunity in their proxy statement to recommend a voting frequency.  The following are some examples of recent examples (and links to their proxy statements) where issuers have recommended a frequency vote or have affirmatively abstained from such recommendation (or you can go here where I have cut and paste the applicable language into this PDF):

Any Worries with Recommending other than an Annual Vote?

For issuers who prefer other than an annual vote but are worried that such a recommendation may not succeed, consider offering an olive branch such as:

  • A written commitment in the recommendation that the issuer will resubmit its say-when-on pay the following year if the biennial or triennial recommendation does not receive the affirmative vote of a majority of the shareholders.
  • A written commitment in the recommendation that the issuer will resubmit the say-when-on-pay proposal at such biennial or triennial vote.

As a concluding thought, for those of you who are responsible for implementing say-on-pay and say-when-on-pay internally at the issuer, do not forget to set internal expectations as to what is an acceptable percentage of "no" votes.  It may be that your team thinks 10% or 20% "no" votes is acceptable, whereas your compensation committee may find such percentage appalling (or vice versa).

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New Compensation and Corporate Governance Rules: Internal Pay Equity Disclosure (Post 4 of 8)

Posted on September 12, 2010 by Anthony Eppert

Addressing the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Act"), I previously discussed clawbacks (Post 1 of 8), say-on-pay voting requirements and a new prohibition on certain votes from brokers (Post 2 of 8), and new disclosure and shareholder vote requirements for golden parachute payments (Post 3 of 8).  As stated in those prior posts, the Act contains significant executive compensation and corporate governance rules that apply to most public companies.  This Post 4 of 8 discusses a new rule under the Act to disclose internal pay equity of the CEO against all employees.

New Internal Pay Equity Disclosure

The Act requires a comparison of the CEO's annual total compensation (as disclosed in the Summary Compensation Table) to the median total annual compensation of all employees (other than the CEO), disclosed in the form of a ratio.  In developing data for the comparison, the median compensation of all employees must be calculated in accordance with the rules governing Total Compensation under the Summary Compensation Table.

Effective Date

No effective date was specified in the Act.  As we wait for guidance from the SEC, companies should consider the comment from SEC Chairwoman Mary Schapiro that rules will not likely be in place for the 2011 proxy season. 

Issues to Consider

Some of the issues a company should consider when implementing the above include:

  • Consider that it may take time to implement an internal system to track "total compensation" of non-CEO employees (using rules comparable to Total Compensation as disclosed in the Summary Compensation Table).
  • It is not yet known whether temporary, part-time and/or union employees would be included in the disclosure.
  • Consider that time may be needed to develop and compile compensation statistics for international employees residing in foreign jurisdictions (if such is required by the SEC to be part of the disclosure).
  • It is not yet known how pay for U.S. citizens on foreign assignments would be calculated.
  • To highlight the fairness of internal pay equity, consider whether to expand the above disclosure to discuss the CEO's Total Compensation against the Total Compensation of other executive officers within the company.  Consider whether to reflect such disclosure over one or more years.
  • In relation to the previous bullet point, consider whether the disclosure should include an analysis of an executive's wealth accumulation and/or internal buildup of cash, deferred compensation and equity (a.k.a., walkaway pay).

Hopefully the SEC will soon provide guidance on the above disclosure rules since companies will need time to implement an internal mechanism to track Total Compensation of all non-CEO employees.  Until then, stay tune for more posts on the Act (Posts 5 through 8)! 

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Accelerating Taxable Income into the 2010 Tax Year: Issues to Consider

Posted on September 7, 2010 by Anthony Eppert

It is expected that ordinary income tax rates, dividend income rates and long-term capital gains rates will increase effective January 1, 2011, due to expired tax cuts from the Bush administration.  Some companies are considering whether to accelerate payment of certain compensation for their key employees into the 2010 tax year to help those key employees take advantage of lower income tax rates.  The purpose of this Post is not to advocate such action, but to provide a summary of certain issues that should be considered when deciding whether to accelerate the payment of compensation.

BACKGROUND

The tax cuts from the Bush administration are scheduled to sunset at the end of the 2010 calendar year.  This generally means that if Congress fails to act prior to the end of the year, then effective January 1, 2011, tax rates will likely increase as follows:

  • the top ordinary income tax rate would likely increase from 35% to approximately 39.6%;
  • the top rate for qualified dividend income would likely increase from 15% to approximately 39.6%; and
  • the long-term capital gains tax rate would likely increase from 15% to approximately 20%.

ALTERNATIVES TO CONSIDER

Accelerating taxable income of a key employee into the 2010 tax year could be accomplished through a variety of means, a few of which are discussed below.

  • Cash Bonus Programs.  The full or partial payment of an annual cash bonus could be accelerated into the 2010 tax year.  A key issue to consider is whether any accelerated payment would violate the timing requirements of Section 409A.  Additionally, for those annual cash bonus programs that are intended to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended, a few other issues to consider include:
    • To maintain qualification under Section 162(m), the amount of money subject to the accelerated payment date would likely need to be discounted to reasonably reflect the time value of money.  This discount would likely be a small dollar amount. 
    • Additionally, and to continue qualification under Section 162(m), the compensation committee must certify the attainment of the stated performance goal prior to any payment.  This means an analysis should be performed as to whether the compensation committee could certify preliminary financial results or certify a portion of the financial results attained.  Any remaining balance owed to the key employee could then be paid in 2011 pursuant to the normal payment schedule, however, such 2011 payment would not likely qualify as performance-based compensation. 
    • In lieu of the above, the board or its compensation committee (as applicable) could pay a discretionary bonus to the key employee in 2010.  To avoid overpaying the key employee, the normal bonus scheduled to be paid in 2011 could be reduced by a corresponding amount assuming the board or its compensation committee (as applicable) retained negative discretion to reduce such payment.
  • Nonqualified Stock Options (“NSOs”).  Generally, the holder of an NSO recognizes ordinary taxable income at the time of exercise equal to the difference between the then fair market value of the underlying stock and the exercise price.  Due to the optionality of the stock option, the holder could exercise at any time, including within the 2010 tax year (absent a company policy to the contrary).  And even if the NSO is subject to a vesting schedule, the board of directors or its compensation committee could decide to accelerate vesting into the 2010 tax year (assuming such discretion was retained); however, keep in mind that accelerated vesting would likely negate the retention attribute that the vesting schedule was intended to create.
  • Restricted Stock and Stock Unit Awards.  As with cash bonus programs, a key issue to consider is whether any accelerated payment would violate the timing requirements of Section 409A.  Also, if the restricted stock award and/or stock unit award is designed to qualify as performance-based compensation under Section 162(m), then the above Section 162(m) analysis would generally apply.  However, if such awards are subject only to time-based vesting, then the board of directors or its compensation committee could decide to accelerate vesting into the 2010 tax year (assuming such discretion was retained); though keep in mind that accelerated vesting would likely negate the retention attribute that the vesting schedule was intended to create.

Additionally, the grant date of a restricted stock award could be accelerated provided the board of directors or its compensation committee takes appropriate action.  Assuming such award would be subject to a vesting schedule, the key employee recipient could make a Section 83(b) election in order to recognize ordinary taxable income on the date of grant (as opposed to the date of vesting), however, such election would generally have to be made, if at all, within 30 days from the date of grant.

SHAREHOLDER OPTICS

Any proposed action to accelerate the timing of a key employee’s taxable income should be properly vetted to determine the optics from the shareholder’s perspective (which is likely a factually intensive analysis).  How shareholders would perceive an accelerated payment is an issue for both public and private companies.  However, public companies should also consider:

  • Whether an accelerated payment or vesting would be inconsistent with the compensation policies and procedures set forth in the CD&A of the company’s proxy statement.
  • Whether and to what extent an accelerated payment would increase the named executive officer’s total compensation as set forth in the Summary Compensation Table of the company’s proxy statement.
  • Related to the above, whether an accelerated payment to a key employee would cause a change in the identity of the company’s named executive officers for the fiscal year.
  • Whether an accelerated payment would create CD&A optic issues if a named executive officer’s pay for the fiscal year increases when:
    • The financial performance of the company decreases.  This issue references the provision under the Dodd-Frank Act that would require (when the SEC issues rules) a company to disclose the relationship between the financial performance of the company and the compensation actually paid to its named executive officers (likely disclosed in the form of a graph or pictoral).
    • The median total annual compensation of all employees (other than the CEO) is relatively low when compared to the total compensation of the CEO after including the accelerated payment.  This issue references the provision under the Dodd-Frank Act that requires a comparison of the CEO’s annual total compensation (as disclosed in the Summary Compensation Table) to the median total annual compensation of all employees (other than the CEO), disclosed in the form of a ratio.
  • Whether an accelerated payment would be “material” such that the company would be required to file a Form 8-K.

To conclude this Post, companies should proceed with caution when deciding whether to accelerate the payment of compensation related items for one or more of its key employees. 

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New Compensation and Corporate Governance Rules (Post 3 of 8)

Posted on August 2, 2010 by Anthony Eppert

Over the last week I discussed clawbacks (Post 1 of 8), say-on-pay voting requirements and a new prohibition on certain votes from brokers (Post 2 of 8) under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Act"), signed into law by President Obama on July 21, 2010.  As stated in those prior posts, the Act contains significant executive compensation and corporate governance rules that apply to most public companies.  This Post 3 of 8 discusses a new requirement under the Act relating to golden parachute payments.

New Disclosure and Vote Requirement on Golden Parachute Payments

In addition to the new say-on-pay requirement discussed in a prior post (Prior Post), certain payments to named executive officers ("NEOs") in mergers and acquisitions must be adequately disclosed in the proxy or consent solicitation materials and submitted to the shareholders for their approval in the form of a non-binding shareholder resolution.  The disclosure must:

  • Describe in clear and simple terms any compensation arrangements with NEOs that are related to the transaction.
  • Describe the aggregate amount of all compensation that will or could be paid to the NEOs (including any conditions to payments).  AND
  • Include a separate non-binding advisory vote to approve the payments (though a separate vote is not required if the arrangements were previously subject to a say-on-pay vote).

Effective Date

The above disclosure and vote requirements apply to shareholder meetings that occur after January 21, 2011.

Issues to Consider

Some of the issues a company should consider when implementing the above include:

  • Consider reviewing current payment arrangements with NEOs to determine whether any golden parachute payments are aligned with the company's current compensation philosophy.  This should include a review of all prospective payments, including payments derived from employment agreements, incentive plans, bonus programs, etc.
  • Once a list of prospective payments is compiled, the next step is to ensure the payments will be adequately disclosed in accordance with rules to be issued by the SEC.  It may be that the disclosure rules will resemble current requirements under Item 402(j) of Regulation S-K.
  • Once the SEC issues disclosure rules, a determination should be made as to whether any prospective golden parachute payments should be disclosed and submitted to the shareholders for a say-on-pay vote prior to any known merger or acquisition.  Such prior disclosure and vote could avoid having to obtain additional disclosure and vote at the time of a merger or acquisition.

Over the next few months the SEC will likely provide guidance on the above disclosure and voting rules.  Until then, stay tune for more posts on the Act (Posts 4 through 8)!

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New Compensation and Corporate Governance Rules (Post 2 of 8)

Posted on July 29, 2010 by Anthony Eppert

A few days ago I discussed clawbacks (Post 1 of 8) under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Act"), signed into law by President Obama on July 21, 2010.  As stated in that prior post, the Act contains significant executive compensation and corporate governance rules that apply to most public companies.  This Post 2 of 8 discusses a say-on-pay requirement under the Act (the other say-on-pay requirement applies to golden parachute payments and will be addressed in Post 3 of 8) and a new prohibition on the ability of brokers to vote on compensation-related matters.

New Say-on-Pay Requirement

Under the Act, shareholders of most public companies must be provided with a non-binding advisory vote on executive compensation as disclosed under SEC rules.  Specifically: 

  • A vote is required at least once every three years, beginning with the first shareholder meeting that occurs after January 21, 2011.  In other words, say-on-pay will be required for many public companies this upcoming proxy season.
  • At this first annual meeting, the shareholders must also decide on whether the vote should be held every one, two or three years (thereafter a vote on frequency must be held by a separate resolution no less often than every six years). 

New Prohibition on Certain Votes from Brokers

The Act requires national securities exchanges to prohibit brokers from voting on executive compensation matters (including say-on-pay), director elections and any other significant matter (as determined by the SEC). 

Effective Date

Say-on-pay votes apply to shareholder meetings that occur after January 21, 2011.  The rule prohibiting certain discretionary voting by brokers is effective July 21, 2010.

Issues to Consider

There are many issues a company should consider when implementing say-on-pay, and even more if the company has a large percentage of retail shareholders.  These include:

  • How should a company revise its proxy statement to incorporate the mechanics of the say-on-pay mandate?  How should it frame the resolution?  Should the board of directors make a recommendation on the frequency of the vote? 
  • Consider whether a company should make changes to its CD&A and tabular disclosure since shareholders will now be voting on its overall disclosure.
  • Assuming retail shareholders typically vote with management, it would follow that the influence of institutional shareholder advisory services (e.g., RiskMetrics Group, Glass Lewis) could be disproportionately increased if the beneficial owners of the shares do not provide voting instructions to the retail shareholders.  This means a company may want to revisit its ability to comply with mandates set by shareholder advisory services (e.g., review change in control policies, employment agreements, separation pay arrangements, etc.).
  • For those companies with a large percentage of retail shareholders, consider implementing ongoing educational campaigns with shareholders and beneficial owners to explain the company's compensation programs and educate beneficial owners that a failure to provide the broker with specific instructions would be the equivalent of a "no vote."
  • Though say-on-pay is "nonbinding," keep in mind that compensation committee members would need to react to a failed say-on-pay proposal or risk receiving withhold votes during their reelection.  Last proxy season the shareholders of three companies voted against management say-on-pay proposals (KeyCorp, Occidental Petroleum and Motorola).  It could happen.

Given the number of action items a public company will need to consider or implement, the best advice is to prepare early, especially if shareholder educational campaigns need to be conducted.  Until then, stay tune for more posts on the Act (Posts 3 through 8)!

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New Compensation and Corporate Governance Rules (Post 1 of 8)

Posted on July 26, 2010 by Anthony Eppert

The legislation I have been following (Prior Post 1, Prior Post 2) is no longer a bill sitting on the steps of Capitol Hill.  On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Act").  The Act represents significant legislation containing executive compensation and corporate governenance rules that apply to most public companies.  Due to the significance of the Act and the fact blog entries are not intended to be lengthy, I will address the Act in 8 separate entries, beginning with clawbacks.

New Clawback Requirement More Expansive than Section 304 of SOX

As a listing requirement, national securities exchanges will require companies to implement clawback policies (a.k.a. recoupment policies) that are more expansive than current requirements under Section 304 of the Sarbanes-Oxley Act (“Section 304”).  Under the Act:

  • The clawback policy must be triggered any time the company prepares an accounting restatement resulting from material noncompliance with any financial reporting requirement (in contrast, Section 304 applies only when a restatement of financial statements is “required” and is the result of “misconduct”).
  • Once the clawback policy is triggered, it would apply to all incentive-based compensation paid to current and former executive officers (in contrast, Section 304 applies only to the CEO and CFO).
  • The look back period for which incentive-based compensation is subject to clawback is the three-year period preceding the date on which the restatement is required (in contrast, the look back period under Section 304 is twelve months).
  • The amount subject to the clawback is the difference between the amount paid and the amount that should have been paid under the accounting restatement.

Effective Date

No deadline was provided within which national securities exchanges must implement this rule.

Issues to Consider

Previously (Prior Post) I set forth issues that should be considered in designing clawback policies.  Due to the Act's requirements, I am updating that Post with the following:

  • Clawback policies should be revisited to determine what changes would be required under the Act.
  • Determine “who” should be responsible for clawback enforcement (e.g., a risk assessment officer, the compensation committee, the full board of directors) and what repayment procedure should be used once a clawback is triggered.
  • Determine whether the clawback policy should be more expansive than required under the Act.  For example, consider adding more events that would trigger the clawback than currently required under the Act, such as poor performance, violation of noncompetes, negligence, etc.  As I previously addressed (Prior Post), one reason for a strong clawback policy is that it can act as a mitigating factor to negate risk assessment disclosure under recent SEC rules (which require narrative disclosure of compensation policies and practices that are “reasonably likely” to have a “material adverse effect” on the company). Plus, a strong clawback policy acts as positive CD&A disclosure.
  • The above should involve a current analysis and review of all compensation arrangements between a company and its executive officers (e.g., employment agreements, bonus arrangements, equity awards) to ensure proper integration between such arrangements and a company's new clawback policy.

 We will likely see more activity in this area as the national securities exchanges begin to implement this rule.  Until then, stay tune for more posts on the Act (Posts 2 through 8)!

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Compensation and Corporate Governance Bill Passes the Senate

Posted on May 31, 2010 by Anthony Eppert

 It looks like Senator Dodd's bill entitled "Restoring American Financial Stability Act of 2010" (PDF, pages 1056-1090) finally got its legs in that it was approved by the Senate on May 20, 2010 (though a copy of the bill did not become available to us until last week).  The purpose of this Post is to highlight some of the compensation and corporate governance changes within the Senate bill that would affect public companies. 

Reconciliation

In July 2009 the House of Representatives passed the Corporate and Financial Institution Compensation Fairness Act of 2009, which was introduced by Representative Frank (the "Frank Bill").  In December 2009 the House passed the Wall Street Reform and Consumer Protection Act of 2009, which incorporated a variety of bills, including the Frank Bill.  The Senate bill will have to be reconciled with the House bill.  It may be a few months before legislation is enacted. 

Overview of the Senate Bill

As discussed in a prior post (Prior Post), the compensation and corporate governance provisions of the Senate bill and House bill are similar in many respects.  Thus, the following is intended to highlight the more significant provisions under the Senate bill: 

  • Say-on-Pay.  Say-on-pay provides shareholders of public companies with a non-binding vote on the compensation of named executive officers.  This is not a new development in terms of proposed legislation and is similar to the House bill. 
  • Discretionary Voting by Brokers.  Discretionary voting by brokers in connection with executive compensation matters (including say-on-pay) and other "significant matters" would be eliminated absent specific instructions from the beneficial owner.  This provision is not present in the House bill.  If this provision survives reconciliation, it is likely to result in fewer shares of retail shareholders being voted absent a specific effort by issuers to educate their shareholders that voting is necessary.
  • Majority Voting.  This provision would generally require a board member to tender his resignation if his election was uncontested and he failed to receive a majority of the votes cast. 
  • Pay v. Performance.  The annual proxy statement would have to describe the relationship between compensation actually paid and the financial performance of the company.  This could be disclosed in a graph or pictorial.
  • Clawbacks.  Continued listing on a national securities exchange would require the issuer to develop a clawback policy more robust than currently required under Section 304 of Sarbanes-Oxley.  The more robust clawback policy would (i) include all executive officers (not just the CEO and CFO), (ii) eliminate the requirement that a clawback be triggered due to "misconduct," and (iii) expand the period covered from 12 months to 3 years. 

More posts will follow as this legislation develops.  Till then, if you would like to learn more about the differences between the House and Senate bills, you can sign up for our free webinar entitled "Hot Topics in Executive Pay," to be held at 10:00 am (CST) on June 9, 2010.  Sign up can be found at http://www.winstead.com/AboutWinstead/ContinuingEducationWebinarSeries/CompensationBenefits.

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Avoiding "Sloppy" Equity Grant Practices

Posted on May 6, 2010 by Anthony Eppert

Over the years I have seen a number of poor practices and procedures associated with granting equity to key employees of a public company.  The purpose of this Post is to highlight some (not all) basic rules that public companies should consider when granting equity.

Authority to Effectuate Grants

Absent a valid delegation, only the board of directors has authority to grant equity.  If no delegation exists, the compensation committee may only make recommendations to the board.  The following assumes a valid delegation to the compensation committee exits.

Delegation from the Compensation Committee

Typically the compensation committee charter and the equity plan document that was approved by the company's shareholders will allow the compensation committee to delegate its granting authority to an inside director or a non-director officer of the company.  I generally disfavor such delegations.  My thought is that the administrative burdens associated with the compensation committee acting through written consent resolutions is not high enough to warrant additional delegations.  However, I do recognize there are instances where delegations to an inside director or a non-director officer of the company may be appropriate (e.g., in connection with routinely granting equity to new hires who are not executive officers and where the equity is granted within a limited period of time from the date of hire).  If a delegation from the compensation committee is appropriate, the following points should be considered:

  • Delegations must comply with applicable state law. 
  • Delegations should be governed by a written equity grant policy (the "Policy") that was approved by the compensation committee and/or the board.
  • The Policy should include a reporting mechanism to the compensation committee of all equity grants.  To avoid "date of grant" issues discussed below, the Policy should clearly state that only a "reporting" to the compensation committee is required (i.e., no ratification or approval by the compensation committee is required).
  • Attached as exhibits, the Policy should contain award agreements that were pre-approved by the board or the compensation committee.  This will help to avoid successful arguments that delegated awards contained favorable definitions and terms not previously approved by the board or the compensation committee.
  • The Policy should specify the total number of awards (individually and collectively) that may be made pursuant to the delegation.
  • Delegations should exclude the ability to make grants to those who are Section 16 insiders as of the date of grant (i.e., compliance with Rule 16b-3 (Link) requires the full board of directors or a committee of two or more non-employee directors to approve in advance all grants to Section 16 insiders).
  • Delegations should exclude grants to those who would be "covered employees" as of the exercise date (if a stock option) or vesting date (if a stock grant) (i.e., compliance with the performance-based exemption under Section 162(m) of the Internal Revenue Code requires such grants to be approved in advance solely by two or more outside directors).

Determining the Date of Grant

Another issue to consider is the date of grant.  An accurate date of grant is important to support accurate accounting charges and to avoid adverse tax consequences under Section 409A of the Internal Revenue Code.

The date of grant is generally the date the board or the compensation committee "approves" a grant containing "definitive terms."  If the board or the compensation committee acts prior to knowing the definitive terms, then the date of grant would typically be the date all definitive terms become known.

  • For purposes of the above, a grant is "approved" on the date the board or the compensation committee acts pursuant to written minutes.  If instead the board or the compensation committee acts pursuant to unanimous written consent resolutions, then the grant is approved on the date of the last signature.
  • Generally, definitive terms include the identity of the recipient, the number of shares subject to the award, the vesting schedule and the exercise price (if applicable).

Again, this Post does not cover all of the instances in which sloppy equity grant practices arise, however, it does cover the issues I see on a more frequent basis.

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