May 2012

We're at that stage during proxy season when observers analyze and come to preliminary views of the results so far, as we did ourselves in this memo. With more annual meetings having taken place, many focus on the voting tallies for shareholder proposals. The Conference Board's May Proxy Season Fact Sheet uses data for Russell 3000 companies as of the end of April and includes a detailed chart of each company's reported say-on-pay vote. The Manhattan Institute's Center for Legal Policy's Proxy Monitor's Mid-Term Report is based on its scorecard tracking every ballot proposal at Fortune 200 companies. Some of the notable details in these reports include:

• While governance proposals make up the bulk of proposals when examining Russell 3000 companies, political spending and executive compensation proposals dominate at the Fortune 200 companies that already have many of the governance practices (annual elections and majority voting) that are often the subject of those proposals.



• 30% of Fortune 200 companies faced political spending proposals, but support has actually decreased on average to less than 20%, in large part due to different levels of voluntary disclosures by many companies. Proposals seeking an advisory vote or direct prohibition on political spending have even received less than 5% support. The averages hide the disparate results at specific companies, with the same proposal garnering 19% at Sprint Nextel and 39% at AT&T, the highest level for a political contributions proposal.



• With mandatory say-on-pay already on proxy cards, executive compensation proposals now focus on limiting practices such as gross-ups, golden parachutes and death benefits, or requiring a certain period of equity award retention. The proposals average 26% support, though proposals calling for pro-rata vesting or prohibiting accelerated vesting upon a change-in-control are reaching upwards of 40%.



• Other than declassification, majority voting and elimination of supermajority provisions, other governance topics do not receive majority of shareholder support. For that reason, exceptions are always noted, as written consent proposals succeeded at Eastman Chemical and a handful of other companies and came very close with over 49% at Pfizer. A special meeting proposal passed at Allergen, and Sempra Energy is the first company to see majority support for an independent chair proposal this season.

With proxy season in full swing, we wanted to provide an update on this year’s say-on-pay findings to date and compare them to results from last year at this time, almost to the day.  As of the end of last week (May 18, 2012), 639 large accelerated filers reported the voting results from their shareholder meetings. Note that these results do not account for any companies that adopted a triennial or biennial say-on-pay vote, nor do they include smaller companies.

Approval for say-on-pay votes has remained high so far this season, as the average say-on-pay results for all large accelerated filers is 89%.  The findings to date reveal that less than 16% of large accelerated filers reported say-on-pay results below the 80% approval level (compared to less than 17% by this time last year), and less than 10% reported results below the 70% approval level (compared to less than 9% by this time last year).  Companies that garnered less than 70% approval last year received extra scrutiny from ISS this proxy season.

So far this year, a total of 15 large accelerated filers have lost their say-on-pay votes (compared to 17 by this time last year) - 14 of them received “against” recommendations from ISS.  To date, large accelerated filers with “against” recommendations that lost their say-on-pay votes this season have averaged 39% approval, while the large accelerated filer with a “for” recommendation that lost its say-on-pay vote received 41% approval. 

Large accelerated filers that received a “for” recommendation from ISS are averaging 92% approval this season. 

A total of 27 large accelerated filers reported losing their say-on-pay votes during the 2011 proxy season, of which all except one that have had their meetings to date (14) have reported shareholder approval in 2012.

This proxy season there has been a lot of focus on companies filing additional soliciting materials to supplement proxy disclosure, with a particular focus on executive compensation in light of the say-on-pay vote. Exxon Mobil has taken a particularly interesting approach turning a two-dimensional paper communication into something more dynamic by inviting interested persons to a company-sponsored webcast on executive compensation.

The webcast represents an additional proactive step Exxon has taken. On the same day it filed its proxy statement, Exxon took the unusual step of also filing a colorful presentation filled with data, graphs and photos to explain how its pay-for-performance approach focuses on the long-term nature of its capital-intensive business. In supplemental information filed more recently, Exxon took issue with specific aspects of the ISS analysis, including the peer group selected, which Exxon asserted failed to adjust for its size and complexity, since the company's revenue is more than 4X larger by revenue and 3.5X larger by market capitalization than the median of the peer group. 

On the webcast, which included a presentation, Exxon representatives discussed the company's business environment, the scale and scope of the company and its focus on the long-term nature of its business strategy. The company explained that together, these form the basis for customized compensation decisions, including a lengthy "hold-to-retirement" policy and a unique approach on the deferral of 50% of annual bonuses, a measure rarely seen outside of financial institutions. The company's focus on executive training, retention and succession was emphasized, including the fact that the company achieves its retention goals without change in control or severance agreements with senior executives. The company also discussed the shareholder engagement it undertook as a result of last year's say-on-pay vote. In response to questions during the webcast, the company noted how its programs focus on performance assessments that take a more holistic approach rather than concentrating on formulas that inspire executives to reach for only certain specific goals. The company received several questions about specific aspects of its pay decisions, the reasons for the webcast and the proxy advisory firms' recommendations.

The NYSE announced today that the Proxy Fee Advisory Committee (PFAC), formed in September 2010 and comprised of representative investors, brokers and companies, has published its recommendations to change the proxy fees. Brokers and banks are required under SEC rules to distribute company proxy materials to beneficial owners of securities, or shareholders holding in "street name." In turn, companies must reimburse them for their expenses. The NYSE regulates the amount of fees, subject to SEC review and approval.

The full Report by PFAC explains in summary form the complexities of the proxy distribution process, by reference to the SEC "proxy plumbing" concept release.  Over 80% of public securities are estimated to be held in street name. Broadridge, the primary intermediary for proxy distribution, reported that in 2011 it handled distributions to 90 million beneficial owners with accounts at over 900 banks and brokers, covering over 628 billion shares, at a cost of about $200 million to companies in the aggregate.

The Report painstakingly describes the careful work by PFAC in considering each of the four different type of proxy fee designed to compensate brokers for different services, an examination of the existing rationale based on the work involved and an evaluation of whether a change in fee is warranted based on recent developments, such as a move toward less paper distributions. According to the Report, it is expected that overall fees paid by companies will decrease by about 4% under the revised structure.

PFAC's recommendations include several changes to the existing fees and also streamlining the proxy fee categories to increase transparency. In addition, PFAC supported allowing companies to ask brokers for a list of the identity of non-objecting beneficial owners (NOBO) based on number of shares held or of those that have not yet voted proxies, without needing to pay for an entire list of all NOBOs. In order to encourage further retail investor voting, PFAC also recommended that the NYSE broach with the SEC the idea of a fee to pay for an "investor mailbox," through which investors can access proxy materials and voting forms through their brokers' website. 

For those interested in learning more, an archive version of a webcast sponsored by the NYSE is here.

PFAC's work is only the beginning. The NYSE indicated that it will initiate discussions regarding the PFAC’s recommendations with the SEC, after which the NYSE would expect to submit a rule change proposal to the SEC reflecting the outcome of these discussions. Any rule filing proposal would be published for public comment prior to SEC approval.

The U.K.’s implementation of “say on pay” in 2002 is widely considered the harbinger of mandatory “say on pay” in the United States. So far, in both countries, the shareholder advisory vote on executive compensation has been non-binding on companies and their boards. Now, the U.K. appears to be moving toward a binding regime. Earlier this spring, the U.K. government’s Department of Business Innovation & Skills (BIS) published a consultation paper setting out a range of measures, including:

• An annual binding vote on future remuneration policy;
  
  
• An increase in the level of support required on votes on future remuneration policy (up to 75% of votes cast);
  
  
• An annual advisory vote on how the company’s pay policy was implemented in the previous year (same as the status quo); and
  
  
• A binding vote on “exit payments” of more than one year’s salary – with “exit payments” including not only cash severance payments, but also the vesting of equity compensation, continuation of benefits, etc.

How This Differs from Current Practice

Currently, the U.K.’s “say on pay” vote is limited to a shareholder advisory vote on the compensation of the executive directors (by approving the directors’ remuneration report). The vote is retrospective in that it relates to the prior year’s compensation.  Under the proposal, the retrospective vote would remain advisory; however, there would also be a binding vote on future pay, where an affirmative vote would require a supermajority. Companies would be required to propose, at the start of the year, a pay policy for the upcoming year, including potential payouts and the performance measures that would be used. This proposal would then be put before shareholders. If, for some reason, the binding vote were lost, the company would be required to fall back to the last policy to be approved or hold another shareholders meeting so that shareholders could vote on a revised proposal.

To facilitate this binding vote on future remuneration, the U.K. government intends to publish draft regulations later this year, which will prescribe the content of remuneration reports. The regulations are likely to state that the section of the report that discloses the company’s future remuneration should include the following elements:

• The composition and potential level of pay for each individual executive director;
  
  
• How proposed pay structures reflect and support company strategy and key performance indicators;
  
  
• What the performance criteria are, how performance will be assessed and how this will translate into total level of reward for each individual under different scenarios (e.g., on-target and stretch performance);
  
  
• How and why the company has used benchmarks and other comparison data to inform pay levels and structures;
  
  
• How employee pay and views have been taken into account; and
  
  
• How shareholders’ views have been sought and taken into account, including the results of the previous year’s votes on remuneration.

In addition, there would also be a binding vote related to any severance arrangements for an executive director exceeding the equivalent of one year’s base salary. A company proposing to pay a higher amount would be required to provide detailed information explaining the proposed amount, how it was calculated and why it is deserved. This proposal would then be put to shareholders. If the vote were lost, the company would not be able to pay the exiting executive more than the basic limit. Existing arrangements would be required to be amended prior to legislative effectiveness (as noted below, currently slated for October 1, 2013).

What to Expect Next

Already, this spring has been a tumultuous one for U.K. public companies. Three major companies – including, most recently, Aviva, Britain’s largest insurer – have witnessed the departures or imminent departures of their CEOs, in connection with compensation arrangements that drew shareholder ire. And, just before their annual shareholders meeting, Barclays announced that a portion of the bonuses for the CEO and Finance Director would be subject to performance criteria. An unanswered question is whether these developments will serve to embolden shareholder activists, or whether they are Exhibit A that shareholders already have the ability to exert their will in compensatory matters.

As a formal matter, the consultation period closed on April 27, 2012, and our understanding is that a number of market players, including trade and business organizations, have commented on the proposals. The consultation paper notes that the government will consider the comments received and confirm the exact measures it proposes to take forward in primary legislation later this year, subject to parliamentary time being available. 

Subject to the parliamentary process, the government expects legislation on new shareholder voting rights and revised reporting requirements to come into force in spring 2013. These provisions would take effect for companies whose reporting years end after October 1, 2013, and for executive directors whose contracts are terminated after that date; thus, this would impact shareholders meetings held after October 1, 2013.

It is contemplated that, in the first instance, these changes will be adopted via amendments to the U.K. Companies Act (analogous to the general corporation law of many U.S. states). Thus, they would apply to all U.K. public companies (the consultation paper notes that there are over 1,000 U.K.-incorporated companies listed on the London Stock Exchange’s Main Market as of January 31, 2012, plus another 100 or so U.K.-incorporated companies listed on the NYSE, Nasdaq or in a European Economic Area state).

However, given the perceived anti-competitive effect that this could have on U.K.-incorporated companies (who might even seek to redomicile elsewhere), it remains to be seen if any changes along these lines will be implemented more broadly through other means, such as through the requirements of the UK Listing Authority or the index inclusion rules.

An increasing number of shareholders are filing solicitation materials advocating for a particular position on a voting matter at annual meetings, the flip-side to our recent discussion of companies filing additional soliciting materials to support management proposals. Some companies that are not accustomed to the practice may be surprised that the shareholder materials are filed under the company's EDGAR record, as a Notice of Exempt Solicitation. As permissible under Rule 14a-6(g)(1) and Rule 14a-2(b)(1), the solicitation is exempt from requiring the proponents to file accompanying proxy statements.

Since March 1st, shareholders have made over 30 such filings. More than half were filed by the proponents that submitted shareholder proposals being voted on at the meeting. The others generally focus on voting against director nominees. Recently, a coalition of state pension funds, including CalPERS and CALSTRS, urged shareholders to vote against the two directors up for re-election at Hospitality Properties Trust. Their letter states that they are taking this "extraordinary action" for several reasons, including the adoption of a poison pill by the company without shareholder approval and the absence of efforts to declassify its board after receiving more than majority support for shareholder proposals seeking annual elections for three consecutive years. Yesterday, the company announced that one of the directors received only 42% in support and resigned as a result. However, as the board determined that the low vote was not due to the director's "personal failings" but rather the board's disagreement with CalPERS, the board re-appointed the same director to the vacancy that his resignation created, and the director accepted. The composition of the board remained the same.

At Wellpoint, CtW Investment Group filed three separate letters to shareholders asking them to withhold support for two director nominees because of perceived lack of oversight for political spending. The most recent criticizes not only the company but also takes issue with ISS' support for the election of those directors and the advisory firm's recommendation to vote against a shareholder proposal on political contributions disclosure. CtW also asked Sotheby's shareholders to vote against its nominating and governance committee for their "failure to take decisive action and break with James Murdoch," a former board member. In another action directed at board members, the Comptroller of the City of New York encourages shareholders to vote against several director nominees at Wal-Mart for independence and compliance issues related to recent allegations of bribery at the company. 

Proponents who submitted shareholder proposals are using these materials as another way to hype their proposals, without being restricted by the 500-word limit imposed on supporting statements. They also use them to rebut the company's opposition statement in the proxy statement. The most prolific shareholders include Trillium Asset Management, urging support for their proposals asking that boards of directors adopt policies prohibiting the use of corporate funds for political purposes at 3M and Bank of America as well as proposals at Verizon and AT&T to commit to operate its network consistent with principles of network neutrality, which at 10 pages (with footnotes) was one of the longest. Most soliciting materials are from advocates of environmental and social issues, with a few covering executive compensation proposals. In addition, Amalgamated Bank filed a letter urging shareholders of Chevron to vote for its proposal to repeal an exclusive forum bylaw.

In early April, Norges Bank Investment Management filed a presentation on the proxy access proposals that it had submitted to six companies, including Wells Fargo. Norges had taken part in a Glass Lewis-sponsored proxy talk. Besides explaining the terms of the proposal, the presentation provides the reasons why it focused on these particular companies, citing issues ranging from stock price performance to governance matters such as combined CEO and chair positions, the absence of the right to call special meetings or the adoption of the right to call special meetings at higher thresholds than the 10% supported by a majority of shareholders, the existence of classified boards or the boards' rights to amend bylaws without shareholder approval. The claims are sufficiently wide-ranging as to make it difficult to predict what companies would not be targets.

The results at Hospitality Properties Trust is likely due to its fairly unusual fact pattern, and the ability of these shareholder soliciting materials to affect vote results is probably not meaningful for the most part. However, as a relatively simple and inexpensive means of shareholder communication, the use of these exempt filings could continue to appeal to these types of shareholder activists.

In 2011, companies included in their proxy ballots a choice for shareholders to advise on whether they preferred to cast advisory votes on executive compensation every 1, 2 or 3 years, the so-called "say-when-on-pay" or frequency vote. Item 5.07(d) of Form 8-K required issuers that did not otherwise announce their decisions earlier to file a second, amended Form 8-K. That deadline was months later, either 150 calendar days after the meeting or 60 days before the shareholder proposal deadline, whichever came first. The SEC Staff realized this year in reported news accounts that possibly hundreds of companies did not file the amended Form 8-K. 

Failure to file this Form 8-K can lead to the loss of Form S-3 eligibility, but the SEC Staff appears willing to consider granting a waiver to those companies that have implemented the frequency that the majority of shareholders supported, which was the case for all but a handful of companies. To obtain a waiver (which the Staff prefers to characterize as a "non-objection"), a company with an existing shelf registration or one that is about to file a shelf registration must file the amended Form 8-K and make a request by writing a letter and uploading it to the new SEC site. 

A company will work directly with Office of the Chief Counsel on the exact content of the letter, but in general the information may include:

• Whether the company has an existing Form S-3 registration statement or is planning to file one
  
• A request for the waiver, including any requests to use an existing Form S-3 registration statement or the ability file a new one
  
• Background on the frequency vote conducted and the board's decision as to the frequency selected
  
• The reasons for the failure to file the Form 8-K on a timely basis
  
• Whether the company received a shareholder proposal on the frequency of the advisory vote on executive compensation for the 2012 meeting
  
• Whether the company has previously failed to make any required Exchange Act filings on a timely basis
  
• Processes and procedures implemented to ensure timely Exchange Act filings in the future

The Staff will respond orally and will not confirm in writing. 

In year two of say-on-pay, we find that companies continue to file additional materials to solicit for favorable votes. These additional materials are generally in the form of a brief letter to shareholders highlighting aspects of executive compensation.  Most are in the form of descriptive narratives, although a few companies use graphs and charts and even PowerPoints. While a few are filed early on following the proxy statement, the majority appear to be in response to negative recommendations on say-on-pay from proxy advisory firms. 

Proxy disclosure this season has been thorough and detailed, which would suggest that additional materials are not technically necessary. However, even with lengthy disclosure on executive compensation, companies have many reasons to want to file additional materials. They may wish to highlight key aspects of compensation without worrying about including all the different aspects necessary for compliance with SEC rules, or the proxy advisory firms' reports have narrowed the main issues that become important to discuss. Some materials provide companies with a set of talking points or script for conversations with shareholders, and others believe that investors benefit from having a clear set of reasons in summary form as ammunition to reject the proxy advisory firms' recommendations.

A threshold question is whether to directly address the criticisms from the proxy advisory firms' reports. Most companies do usually focus at least on ISS pay-for-performance analysis (a favorite statement this season has been that the ISS peer group methodology is deeply flawed). This is not a surprise, since that analysis appears to be the primary source of most of the negative recommendations in the first place. 

So far, we have not seen many companies actually modify existing compensation in any way, along the lines that Disney and GE did last year. Recently however, NCR Corp. initially filed materials that advocated for the company's say-on-pay vote, explained its compensation decisions and rebutted ISS, but about a week later, the company indicated that after discussions with shareholders, it decided to add performance conditions to the CEO's existing special retention award that were initially granted as time-based restricted stock units.  This reportedly changed ISS' recommendations, and the company's vote was ultimately about 80% favorable.