Compensation Committee Corner : Executive Compensation Lawyer & Attorney : Winstead Law Firm : Director Liability, Employee Benefit Arrangements

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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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):

• Annual vote recommendation filed by Navistar International Corporation in its proxy statement on January 14, 2011.
• Biennial vote recommendation filed by Fair Isaac Corporation in its proxy statement on December 27, 2010.
• Triennial vote recommendation filed by Tyco International Ltd. in its proxy statement on January 14, 2011.
• Affirmative abstention from any recommendation filed by Jack In The Box, Inc. in its proxy statement on January 13, 2011.

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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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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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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 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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