Say-on-Pay

The Eurozone crisis and ensuing populist resentment over perceived compensation excesses have given rise to a recent wave of compensation measures and restrictions in Europe. As we explain in our memo, the measures range from a cap on financial institution bonuses (the so-called “banker bonus cap”) in the EU, binding say-on-pay votes in several European jurisdictions and even criminal sanctions for violating compensation restrictions and corporate governance requirements in Switzerland. Simon Witty, a partner in our London office, explains the key aspects of these developments.

• What is the banker bonus cap?
  
  Under CRD IV, which is slated to go into effect for credit institutions (including banks) and investment firms (such as broker-dealer or wealth management firms) in January 2014, the basic rule is that bonus payments will be capped at 100% of total fixed pay or, with shareholder approval, 200% of total fixed pay. “Shareholder approval” means approval by either 66% of shareholders owning half the shares represented or, failing that, 75% of all shares represented.  The effective bonus cap can go up by up to 25%, if the pay is in the form of long-term deferred instruments (i.e., instruments deferred for a period of at least five years).
  
  But there is a lot more to the banker bonus cap than just the cap. There are, for example, rules on how much of the bonus must be comprised of equity compensation or certain capital instruments, how much must be deferred and for how long, clawbacks, mandatory deferrals or holdbacks for discretionary pension benefits and the collection of information for individuals who are paid €1,000,000 or more in any given fiscal year.
  
  
• Who will the banker bonus cap apply to?
  
  As to which institutions, the cap will apply to all credit institutions and investment firms in the EU.  The non-EU subsidiaries of institutions headquartered in the EU will also be caught, as will the EU subsidiaries of institutions headquartered outside the EU.
  
  For example, if a financial institution is headquartered in London, all of its relevant employees (including relevant employees located in New York or Hong Kong) will be affected, and, even if a financial institution is headquartered in New York or Hong Kong, its relevant employees working for an EU subsidiary will be affected.
  
  As to which employees at those institutions, the cap will not apply to all employees of a particular entity; rather, it will only affect employees whose professional activities have a material impact on the risk profile of the relevant financial institution. Examples of these employees are senior management; risk-takers; employees engaged in control functions; and employees whose total pay takes them into the same bracket as senior risk management and risk-takers.
  
  
• Which companies will be affected by the proposed say-on-pay requirements?
  
  The EU has announced a proposed mandatory EU-wide say-on-pay initiative. The U.K. is expected to implement a binding say-on-pay vote by October 2013, plus other related requirements. Another country that has received significant press coverage is Switzerland – its “Minder Initiative” introduces a binding say-on-pay vote, together with other executive compensation measures, which will come into force by March 2014. Germany and Spain have also announced say-on-pay initiatives, which will likely be binding.
  
  Our current understanding is that these developments will just affect the companies incorporated in those jurisdictions. In contrast to the CRD IV compensation restrictions, which will apply to non-EU financial institutions (at least partially), we do not have any reason to think for now that the say-on-pay initiatives will apply to, for example, U.S. or Hong Kong companies.
  
  
• How will binding say-on-pay work?
  
  In the U.K., the jurisdiction for which there is currently the most information, a binding shareholder vote will be held at least every three years on a company’s remuneration policy report, which is prospective in that it will set out the company’s future policy regarding the compensation (including “loss of office” payments) of directors, including executive directors. A company will continue to have an advisory shareholder vote each year on its remuneration implementation report, which is retrospective in that it will set out how the company’s compensation policy was implemented in the past fiscal year.

According to the latest Semler Brossy report, only three Russell 3000 companies (Nuance Communications, Digital Generation and Navistar) have failed their say-on-pay vote, with Navistar receiving only a startling 18% in favor. ISS has been recommending against companies about 9% of the time, and companies facing ISS opposition received 24% less support on average. Interestingly, ISS continues to reverse unfavorable recommendations. It did so for 17% of companies in 2012 and most recently for both Hewlett-Packard and Kaman Corp., after the company removed excise tax gross-ups from an executive's renewed change-in-control agreement. 
 
In a recent analysis, the consulting firm discussed why a company may encounter a significant reduction in votes from one year to next. While only a small number of companies see a truly meaningful reversal, the firm urges that “the low frequency of this event belies the significant risk companies may face if they become complacent in their approach…Garnering strong support in one year is certainly no guarantee for future Say on Pay success and no company is necessarily immune from such a reversal of fortunes.” It concluded that when a company's TSR performance declined and pay was not adjusted accordingly, the more thorough qualitative review ISS conducted once companies failed the first quantitative review identified problematic practices that were probably in existence in prior years. Companies may be "caught off-guard,” and therefore unprepared to respond, since those same practices that may never have even been mentioned in prior ISS voting reports were suddenly cited as the reasons that investors should vote against the proposal. Semler Brossy recommends being prepared, including "preemptive conversations" with the proxy advisers rather than making supplemental filings after-the-fact. 
 
In our view, this reflects the need for companies to understand, as outlined in the somewhat dense ISS white paper on their say-on-pay analysis, that an initial quantitative screen by ISS represents exactly what it sounds like: a test of a few numerical-based factors focused on the size of the overall compensation paid and the company's TSR performance, relative to peers. A more holistic approach, the so-called qualitative review, to the company's compensation program is not undertaken unless ISS believes that the initial test reflects a “misalignment” between pay and performance. In other words, a favorable recommendation by ISS in any one year is not a wholesale endorsement of the company's compensation structure, and in fact, ISS may have many issues with those practices if it actually has to get to the next step of examining them. 

So far, as we launch into the proxy season, only a handful of companies have filed additional soliciting materials to dispute proxy advisory firm recommendations. These materials were almost ubiquitous last season, and it is unclear whether the recent changes in the formulation of comparative peer groups by the advisory firms will curtail their numbers.

Piedmont Natural Gas Company provided in detail several points of contention with the ISS negative recommendation. In particular, the company argued that of the 12 peers that ISS used to compare their CEO compensation, 8 had not yet filed their most recent proxy statements. In addition, ISS' constraints around the revenue size and market capitalization in selecting the peer group, the company complains, resulted in ignoring several peers that the company believes to be more relevant to their business.    

National Fuel Gas Company faced a similar issue with respect to ISS using essentially 2011 executive compensation as a basis for evaluating their say-on-pay vote, as nearly 75% of the peer group compiled by ISS had not yet filed proxy statements for 2013 meetings. According to their filing, ISS attempted to adjust for this issue by simply increasing the total compensation of those peers by nearly 7%, which the company argued was "a crude general assumption" and not an accurate basis for comparison.

In what may serve as a warning to pay careful attention to the disclosure areas that the proxy advisory firms are most likely to examine, Hillenbrand indicated in their filing that ISS had erroneously concluded that they do not benchmark at the 50th percentile because “the language of our proxy statement did not state this point clearly.” All three companies received above 75% in support.

Hewlett Packard has yet to hold its meeting but has made several filings. In the midst of confronting efforts by CtW Investment Group targeted at their auditor ratification proposal and the election of several directors, the company announced recently that ISS has reversed its recommendation and is now supporting the company's say-on-pay vote. The first release provided no explanation but then a filing the next day highlighted recent changes which the company had disclosed in its Form 10-Q. The company had added total shareholder return as a metric to its 2013 awards and the compensation committee also committed to undertake a review of its compensation programs with a view towards including relative performance metrics in 2014 and future compensation plans.

In our recent client alert, “Recent Developments in Executive Compensation,” an open question was the fate of Gordon v. Symantec Corp. (and similar cases) after the court denied a preliminary injunction to enjoin the company’s say-on-pay vote.  At the time of our client alert, a demurrer to the plaintiff’s class action complaint was pending. 

On February 22, 2013, the judge in Symantec (the same judge who granted a preliminary injunction in Knee v. Brocade Communications Systems Inc. to enjoin a vote on an equity plan proposal) issued an order sustaining the defendants’ demurrer to the plaintiff’s complaint.  The Symantec court noted that once the shareholder vote on Symantec’s say-on-pay proposal was held at its annual meeting in October 2012, the direct disclosure claim was no longer available to the plaintiff and the plaintiff’s claim then became a derivative claim subject to a pre-suit demand requirement. 

The court further stated that the plaintiff, as a substantive matter, failed to plead a sufficient disclosure claim.  In other words, the plaintiff failed to demonstrate how the information she claimed should have been disclosed (e.g., fair summary of the competitive market analysis performed by the compensation consultant, other non-compensation consulting and business services that the compensation consultant performed, criteria used to select Symantec’s peer group, etc.) could be viewed as significantly altering the total mix of information already made available to Symantec’s shareholders. 

Even though the plaintiff still has ten days to amend her complaint and this judge’s ruling in Santa Clara California State court is not binding on other courts, this result is welcome news for U.S. public companies.  It reinforces the notion we posited in our client alert – at least with respect to say-on-pay proposals, these lawsuits are likely to face significant obstacles. 
The hope is that this may augur a dismissal of at least one other similar lawsuit in the near future.  Specifically, the parties in Gordon v. Cisco Systems, Inc. (which is pending before the same judge in Santa Clara California State court) stipulated that the demurrer in Cisco should be deferred until a decision in Symantec had been reached, because (i) the issues that were raised in Cisco are substantially similar to the issues that were under consideration in Symantec at the time and (ii) both actions involve the same plaintiff, the same plaintiff’s counsel and the same counsel for defendants.  Now that Symantec has been decided, it is likely only a matter of time before this result will be replicated in Cisco. 

It is also worth noting that, while all the reports on the recent lawsuit against Apple’s proxy statement in the Southern District of New York focused on the unbundling claim made by Greenlight for the charter amendment proposal, as we previously discussed here, little known is that the judge in that case also dismissed efforts by another plaintiff to enjoin the say-on-pay proposal.  That plaintiff had claimed that Apple’s use of terms like “experiences,” “input” and “peer group data,” when describing the compensation committee’s judgment in granting long-term equity, failed to provide sufficient information.  The judge found, however, that since the plaintiff did not identify any material omission in the proxy and since the compensation discussion and analysis section included in the proxy statement was compliant with the SEC rules, the plaintiff was unlikely to succeed on the merits. 

Nonetheless, the Symantec and, in the say-on-pay preliminary injunction context, Apple successes do not mean that U.S. public companies should relax and assume that the plaintiffs’ bar will be deterred.  At least one law firm that has been particularly active in filing these types of lawsuits has recently identified several more companies which it is investigating for potential breaches of directors’ fiduciary duties in connection with say-on-pay proposals.  Given that the proxy season is upon us, we continue to recommend that companies pay extra attention to their executive compensation disclosure.

On December 20th, ISS issued two extensive FAQs on their voting policies. This post covers the compensation items (a previous post covered the non-compensation items).

Although the compensation FAQs contain a number of items previously posted by ISS, there are a few new items worth noting, including:

• For the CEO Tally Sheet table, how the present value of all accumulated pension benefits (qualified and non-qualified) is calculated (page 7).
• The FAQs explain the methodology used in evaluating a company’s pay for performance, including how an initial quantitative analysis affects the ultimate vote recommendation for say-on-pay proposals and the factors that ISS considers when it conducts a qualitative review (such as the ratio of performance- to time-based equity awards, benchmarking processes and realizable pay vs. grant pay) and how ISS will treat CEOs who have not been in the position for three years (pages 9-11).
• The FAQs indicate that realizable pay, which is only relevant for S&P 500 companies where the company’s initial quantitative screen shows a high or medium concern, will include all amounts actually paid or realized during the specified measurement period.  ISS does not use the intrinsic value of stock options for its realizable pay calculation, because it views as important the economic value of underwater options (pages 9-10).
• In exceptional cases, an ISS peer group can contain 12 companies (page 17).
• For companies with fiscal year-ends subsequent to December 31, 2012, ISS will provide the opportunity to communicate changes made to its peer group (page 18).
• The FAQs discuss the issues surrounding problematic pay practices, including how ISS views the grant of retention awards to executives who did not receive a payout after a performance cycle ended due to failure to achieve goals (pages 19-21).
• The FAQs elaborate on ISS’ say-on-golden-parachutes policy, such as how ISS would treat: (i) a company that technically triggered a change in control but did not experience a bona fide change in control, (ii) performance measures that would not have been achieved in the absence of a decision to accelerate performance-based awards, (iii) the determination of whether specific payouts are “excessive” and (iv) existing problematic change-in-control severance features (pages 22-23).  ISS indicates that the best practice for paying out performance-based awards is pro rata vesting of the award based on current achievement.  In determining whether a golden parachute payout is excessive, ISS considers factors such as the value of the payout on an absolute basis, or one or total payouts relative to the transaction’s equity value.
• The FAQs address how ISS would determine the cost of an equity compensation plan for newly public companies and companies with limited partnership units (pages 24-25).

Glass Lewis recently released its 2013 Proxy Season Guidelines for the 2013 proxy season, which will go into effect for shareholder meetings taking place after January 1, 2013, an abridged version of which is publicly available. These updates should be viewed in conjunction with Glass Lewis’s policies on its say-on-pay analysis, which it updated in July, as discussed here. 

One of the more notable changes is regarding board responsiveness to a “significant” shareholder vote. Glass Lewis’s new policy provides that it will scrutinize board responses to any vote by 25% or more of shareholders (excluding abstentions and broker non-votes) against management’s recommendation on any proposal, including  “against” or “withhold” from a director nominee, “against” a management-sponsored proposal or “for” a shareholder proposal. Glass Lewis will assess board responsiveness on a case-by-case basis and will include a review of the company’s public disclosures following the annual meeting at which the vote took place.

Similarly, Glass Lewis’s policy is that at companies that received a shareholder vote of greater than 25% against their say-on-pay proposals, the board shall demonstrate engagement with and responsiveness to shareholders and that they will look for disclosure to this effect. In the absence of such disclosure, Glass Lewis will recommend holding compensation committee members accountable.

The updates also provide that in evaluating proposed equity-based compensation plans,  plans shall not count shares in such a way as to understate the potential dilution or cost to shareholders (the “inverse” full-value award multipliers); should not contain excessively liberal administrative or payment terms; and should select performance metrics that are challenging and appropriate.

Given say-on-pay votes, companies are interested in understanding how their shareholders view executive compensation. At the always informative NASPP conference, Michelle Edkins from BlackRock and Ann Chapman from Capital Research both mentioned a recent paper from Charles Elson of the Weinberg Center for Corporate Governance, titled "Executive Superstars, Peer Groups and Over-Compensation – Cause, Effect and Solution."

The paper argues that tying CEO compensation to external peer group benchmarking is unnecessary at best because the practice is based on a faulty premise of easily transferable executive talent. Citing various other studies, they question the frequency of CEO turnover, in particular, movements by public company CEOs to another public company. 

The authors believe that targeting compensation levels to either the 50th, 75th or 90th percentile of this peer benchmark has led to rising executive pay. This then creates a "leapfrog effect" through networks formed by the peer grouping process, as one company's "overpayment" then ripples through other companies for which they are a peer.

Instead, the authors advocate for a complex process of diminishing the focus on external benchmarking and developing instead internally created standards based on the specific nature of individual organizations. 

It's an interesting time to discuss peer benchmarking, as we've seen the influence in the past year of proxy advisory firms relying and evaluating companies' performance against their own formulated peer groups. The use of peer groups by those firms and companies are unlikely to go away, so perhaps the important point here is not so much whether companies find the paper's conclusions to be persuasive, but that it is useful to be aware that key institutional investors are reviewing these types of studies about compensation-setting. The paper’s arguments, and other similar external criticisms, may factor into investors' assessment of companies' compensation practices as they make voting decisions.

Since our last blog post on say-on-pay litigation in January 2012, there have been several dismissals of say-on-pay lawsuits on procedural grounds – principally the failure of plaintiffs to satisfy the demand standard, which requires a plaintiff seeking to bring a derivative action to first make a demand on the corporation’s board so that it can determine whether to pursue the action. Under Delaware law, failure to make a demand may be excused if the plaintiff can raise a reasonable doubt that (1) a majority of the board is disinterested or independent or (2) the challenged act was a product of the board’s valid exercise of business judgment. In particular, a number of lawsuits were dismissed, because they could not satisfy the first prong and could not successfully establish that a failed say-on-pay vote rebuts the board’s business judgment to satisfy the second prong.

For example, in January 2012, a plaintiff, without making a pre-suit demand, filed a lawsuit against Navigant Consulting, which had increased executive compensation for 2010 despite negative shareholder return. Although the plaintiff alleged that a say-on-pay approval vote of 45% was enough to excuse the demand requirement, a federal district court in Illinois applied Delaware law and ruled that this alone was not enough to raise a reasonable doubt of the board’s valid exercise of its business judgment. The court pointed out that the plain language of Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act provides that say-on-pay requirements do not (1) create or imply any change in the fiduciary duties or (2) create or imply any additional fiduciary duties of the company or its board.

Similarly, in March 2012, a California federal district court dismissed a lawsuit against Intersil Corporation, where the compensation of the company’s named executive officers for 2010 had increased by an average of 41.7% over the prior year. Intersil had received 44% approval for say-on-pay. The plaintiff did not make a pre-suit demand, and the court, applying Delaware law, held that additional facts must be pled to raise a reasonable doubt that the decision was not a valid exercise of the board’s business judgment.

A few months later in June 2012, in Monolithic Power Systems, the same California federal court, again applied Delaware law and held that a 36% say-on-pay vote did not raise a reasonable doubt of the board’s valid exercise of its business judgment when it increased executive compensation. 

These cases, decided by federal courts applying Delaware law, contribute to a line of cases holding that a failed shareholder say-on-pay vote alone does not rebut the business judgment rule presumption afforded to a board’s decisions, including in the realm of executive compensation. In contrast, a prior federal case applying Ohio law, the Cincinnati Bell decision, excused pre-suit demand on the board on the basis that, under Ohio law, the business judgment rule is an affirmative defense and not an element of excusing demand. It should be noted that, shortly after the Cincinnati Bell case was decided, the case was settled and thus there will be no appeal.

Despite the Cincinnati Bell ruling, which at this point appears to be anomalous, the growing consensus appears to be that courts will continue to defer to a board’s decisions regarding executive compensation, as long as such decisions are made in good faith and pursuant to the board’s fiduciary duties. For example, in Jacobs Engineering, the Superior Court of California, applying California corporate law, which the court stated is identical to Delaware corporate law, ruled that a say-on-pay approval vote of 45% in 2011 was not enough to rebut the board’s business judgment. Similarly, in BioMed Realty Trust, a Maryland federal district court, applying Maryland law, ruled that the mere involvement by directors in a challenged transaction as well as a say-on-pay approval of 46% was not enough to raise a reasonable doubt of the board’s valid exercise of its business judgment.
           
Despite these recent dismissals, there are still three ongoing say-on-pay lawsuits pending – against Hercules Offshore, Dex One and Janus Capital Group – that were filed prior to the annual shareholder meetings held in 2012.

Plaintiffs appear to be undeterred and continue to file say-on-pay lawsuits, which typically allege low or negative approval for say-on-pay as evidence of inappropriate pay practices. For example, in July 2012, a lawsuit was filed against First Merit Corp., which received 46% approval for its 2012 executive compensation. Plaintiffs alleged that the board’s decision to raise executive compensation was inappropriate, since the company’s stock price had declined by approximately 25% during 2011 and its long-term shareholder return had been negative over the last 10-, 5-, 3- and 1-year periods. Similarly, plaintiffs filed suit against Simon Property Group earlier this month, which received a say-on-pay approval of 26%, alleging that its board improperly approved the CEO’s compensation package, which had included a $120 million retention award through 2019 that is tied to the CEO remaining employed by the company, rather than being tied to the company’s performance. This lawsuit surprised many because Simon Property had experienced high performance (e.g., as disclosed in its 2011 proxy, the company stated it falls within the 94th percentile of all companies in the S&P 500 Index over the past 10 years). Additionally, plaintiffs have filed a lawsuit related to compensation disclosure, despite receiving positive approval on say-on-pay. For example, in July 2012, plaintiffs filed suit against Johnson & Johnson, alleging breach of fiduciary duties concerning the disclosures in the company’s annual proxy statements filed from 2008 through 2012. Johnson & Johnson received a 55% say-on-pay approval in 2012. These cases are all currently pending.

We are pleased to announce the publication of Getting The Deal Through – Corporate Governance 2012. Davis Polk lawyers Arthur Golden, Thomas Reid and Sapna Dutta authored the “Global Overview” chapter. 

We note this year that, as the wave of post-financial crisis corporate governance reform continues across the globe, the impact of the significant burdens on the regulators that are responsible for implementing these reforms is becoming increasingly visible. That said, we are also seeing a subtle divergence in the nature of these regulatory efforts in different parts of the world.  In the United States, regulatory efforts have focused primarily on implementation of the Dodd-Frank Act, which continues to require significant time and has resulted in delays in the rulemaking schedule. In contrast, Europe has seen more in the way of new initiatives, including the publication of the European Commission’s Green Paper on a future EU-wide corporate governance framework and the U.K. government’s significant proposals intended to curb executive compensation.

As the year goes on, we expect that U.S. and European companies will continue to experience intense pressure from regulators and shareholder advocacy groups in respect of their corporate governance practices on a number of fronts. It is inevitable that the reaction to the financial crisis of 2008 and the ongoing Eurozone crisis should provoke such severe and prolonged reaction.  What remains to be seen, if, as and when global economic conditions stabilize, is whether or not these ongoing governance reforms ultimately do anything to improve the competitiveness or actual governance of individual companies or the North American or Western European economies, or whether they are simply a series of responses – ranging in nature from remedy to retribution – that may be understandable, but perhaps not efficient in the long term. 

Read the “Global Overview” chapter >

For the past two proxy seasons, companies have criticized how proxy advisory services have selected company peer groups in order to evaluate “pay for performance” for purposes of making say-on-pay voting recommendations. Recently, Glass Lewis announced changes in their peer group selection methodology that will affect annual meetings held after July 1, 2012.

On July 12, 2012, Glass Lewis hosted a “proxy talk” during which they outlined enhancements to their proprietary pay-for-performance model. The most significant development is the change to peer groups. Since 2003, Glass Lewis has been using a process that is based on GICS codes, industry group and geographical region, but they will now use a “market-based” peer group approach developed with Equilar. Akin to social networking, Equilar starts with each subject company’s self-disclosed peers (direct peers). They also examine (a) the peers disclosed by the direct peers (second-degree peers), (b) the companies that use the subject company as a peer (incoming peers) and (c) the peers disclosed by incoming peers. The focus is on the direction of peer relationships and the similarity of peer groups, with peers ranked based on the strength of the connection, to ultimately identify up to 30 companies as the peer group for purposes of the say-on-pay analysis. The Glass Lewis report will display differences between the company’s self-disclosed peers and the Equilar-derived peer group.

Other enhancements include changes in performance metrics that Glass Lewis will consider (which includes total shareholder return, change in operating cash flow, EPS growth, return on equity and return on assets). In addition, there will be a slightly longer outlook of three-year weighted average of total compensation for CEO and Top 5 executives, instead of the prior test of one year. Glass Lewis’ dreaded letter grades will no longer be subject to a forced “curve” distribution, but will be assigned based on the relative level of compensation and performance against peers.

There is also a qualitative element to the analysis which Glass Lewis continues to emphasize, with the details largely similar to ISS in terms of the focus on the mix of pay, targets and metrics and best practices. Glass Lewis does tend to criticize companies for perceived poor or lack of disclosure.

Glass Lewis recommended against 16% of companies it reviewed in 2012 so far. While Glass Lewis does not offer any consulting services, companies can subscribe to Equilar to obtain the peer group information.

In related news, ISS, which also uses a GICS code-based peer group selection system (albeit different from Glass Lewis), announced that they will be changing their process for the upcoming proxy season, with effect for companies with annual meetings after February 1, 2013. We understand that this will be covered in ISS’s policy survey, which is expected to come out shortly.

Cognitive bias leads to faulty decisionmaking, warned Vice Chancellor J. Travis Laster at the National Conference of the Society of Corporate Secretaries and Governance Professionals. In his address, he used an example of a Delaware case to demonstrate the collective desire to develop information to support a preconceived goal rather than reach independent conclusions, the fallacy of groupthink that avoids hard questions, the tendency to prefer data that confirms a prior belief and the likelihood of taking immense risks to avoid losses, noting that the Court looks for the presence of those biases in examining cases. We also heard from the leaders of two influential proxy advisers, ISS and Glass Lewis, that each firm will change to new methodologies in the coming proxy season for constructing the all-important peer group against which they assess CEO compensation and form say-on-pay recommendations, making predictability an ever elusive goal for now.

Such were the examples of the range of discussions focused on effective corporate governance, from thoughtful debates on the relationship between companies and their shareholders to practical advice on the nuts and bolts for board functions, all centered around the conference theme – The Shape of Things to Come. Over 800 attendees gathered to hear from an impressive roster of experts, including investors, regulators, academics, consultants and counsel, and also to learn from each other given the unique opportunity to gather with other like-minded professionals whose primary role is to support boards. Since one regret is that it was not possible to attend all the sessions and take advantage of everything being offered, the following is a somewhat random selection of highlights arranged around the theme of anticipating what may be in store in the near future:

Regulators.  In his speech, Commissioner Troy Parades underscored SEC efforts toward rigorous rulemaking, including quality cost-benefit analysis based on solid economics. He stressed the need for pragmatic regulation that avoids being overly burdensome for companies in terms of compliance, but also informs investors without engulfing them in too much unnecessary information. SEC staff from the Division of Corporation Finance were present to discuss their hard work writing rules as mandated by first Dodd-Frank, and now the JOBS Act. Rules with deadlines have clear priority, but otherwise both sets of legislation are being tackled simultaneously. The staff specifically declined to address the timing for when we will see proposals on the remaining executive compensation rules under Dodd-Frank, affectionately known as the “gang of four” (pay-for-performance, hedging policy, clawback and internal pay ratio). During this past proxy season, 332 Rule 14a-8 no-action letter requests were processed, a 5% increase from last year, with average response periods of 38 days. The SEC whistleblower program is receiving about 8 complaints a day, with a significant number of those reports also being made to companies at the same time. The staff is keenly aware of the anti-retaliation provisions and may even ask companies for personnel files to confirm the absence of negative actions toward employees who came forward.

Active, or Activist, Investors.  In his keynote, Ralph Whitworth, founder of Relational Investors and a board member at Hewlett-Packard, stressed the importance of not letting the emphasis on board collegiality suppress directors from asking tough questions.  He captured it succinctly with a statement about the need for a director to be likeable, without having others believe that the director wants to be liked. There was active and vigorous debate at another session on whether the Section 13D 10-day reporting period should be shortened, during which a representative from Pershing Square argued that all shareholders benefit from the increased liquidity and stock price brought on by activist actions, and claimed that the available data shows that it is quite rare that investors who are required to file 13Ds ultimately accumulate more than a 10% ownership stake. 

Shareholder Engagement.  BlackRock’s willingness to devote 20 people to their engagement effort on a global basis is due in part to its inability to merely walk away from a vast majority of its investments that are made on an indexed basis. The firm talks to companies privately when they perceive issues, and expect directors to be available for discussions when there are significant say-on-pay problems. They recommend that off-season engagement focus primarily on the effectiveness of company boards, with executive pay being only a part, but not the key point, of the discussion. Engagement this year has increased exponentially, CalSTRS indicated, while the AFL-CIO announced that over half of the shareholder proposals it submits are withdrawn after negotiations with companies. One example of the divide between companies and proponents appears in the wide ranging views of which information should be captured when companies decide to adopt a policy to disclose political spending. 

Board Dynamics and Elections.  The need for directors to be willing to challenge what they are being told, even at the cost of being perceived as disruptive, was discussed in more than one session. The recent emphasis on individual director qualifications raised the concern that other directors may place over-reliance on board members who are labeled as having functional expertise, obscuring the need for all directors to have a general understanding of the company. Director elections (and as a byproduct, proxy access) continue to be a hot topic. While only a few directors receive a majority lack of support, those tend to be at companies that have plurality voting and thereby able to fully ignore shareholder sentiment. Some investors have developed a short list of problem directors and will vote against those directors at every company where the directors serve. 

Executive Compensation.  Speculation abounds over the rising number of companies that are disclosing realizable, or realized, pay, with some 40% of large-caps including this element in their proxy statements. But others lamented the lack of a cohesive and recognized method that would allow for comparability. Over 100 companies filed supplemental materials this season.  While most investors thought they were somewhat helpful, they generally do not change investor voting and in some situations triggered criticism when new information was presented that was not found in proxy statements. There was widespread agreement among investors that those filings, and subsequent investor discussions, should avoid being merely, or even largely, an attack on the proxy advisory firms’ recommendations. 

These brief highlights represent only a small portion of the active dialogue and discourse that made the conference a valuable resource as governance matters continues to gain prominence and affect both the workings and reputations of companies, in particular, as Chancellor Laster indicated, the underlying state law itself has changed very little while there has been enormous shift in the reality of the power balance between shareholders and companies. These are suitable times to have author Bethany McLean, known for her writing on Enron and the financial crisis, provide the closing address. She explored the causes of one financial scandal after another, questioning whether company leadership were willing to engage in candid assessments of their organizations’ risks and problems. 

Doug Chia, the Chairman of this 66th national conference and Assistant General Counsel and Corporate Secretary at Johnson & Johnson, reiterated his support for providing a forum where complex governance issues can be aired and understood, “We wanted to give governance professionals who support management and boards an opportunity to hear from and discuss the perspectives of the numerous constituents who influence the debate on effective corporate governance, and also a chance to engage with and learn from each other.“

Following closely on the heels of its announcement of a package of proposals  intended to curb executive remuneration, the U.K. Government recently published a consultation paper focusing on the content of remuneration reports of UK-incorporated quoted companies that would disclose the compensation of directors, including executive directors.  While much of the consultation paper simply echoes the announcement, which we summarized in our memo, it is fairly detailed and merits a close read.  Here are selected highlights:

• Remuneration reports would have two parts:
  • A policy report setting out all elements of a company’s remuneration policy and key factors that were taken into account in setting the policy. This part of the report will only be required when there is a shareholder vote on the policy.
  • An implementation report on how the policy was implemented in the past financial year, setting out actual payments to directors and details on the link between company performance and pay.

• The policy report would cover the following six elements:
  • Tabular disclosure of the key elements of pay and supporting information, including how each supports the achievement of the company’s strategy, the maximum potential value and performance metrics (the consultation paper helpfully provides an example in an annex at the end). This table would be accompanied by a narrative explanation of whether the remuneration policy for directors differs from the policy for other employees and, if so, an explanation of why.
  • Information on employment contracts.
  • Scenarios for what directors would get paid for performance that is above, on or below target, presented in graphical form.
  • Information on the percentage change in profits, dividends and overall spending on pay.
  • The principles on which exit payments would be made, including how they would be calculated, whether the company would distinguish between different kinds of departures or the circumstances of any exits and how performance would be taken into account.
  • Material factors that have been taken into account when setting the pay policy, specifically employee pay and shareholder views.
    • While the U.K. Government did consider requiring the disclosure of a CEO-median employee pay ratio, it concluded that this information would not be meaningful and, instead, proposed that the policy report set out information including the percentage increase in pay of the workforce and the percentage increase in pay of the CEO.
    • The policy report would also set out how shareholder views were taken into account in setting remuneration policy.

• The implementation report would cover the following nine elements:
  • Single total figure of remuneration for each director, presented in a specific tabular format disclosing: salary, benefits, pension, bonus, long-term incentives and total.
  • Performance against metrics for long-term incentives, including the following details:
    • What the performance conditions were and the relative importance of each.
    • Within each performance condition, the targets originally set and the potential level of award achievable.
    • For each performance condition, how the company performed against the targets set for that condition.
    • Where the remuneration committee had discretion, how it exercised that discretion.
    • The resulting level of award.

For those elements of pay that were awarded in relation to the financial period being reported on and were subject to deferral, the implementation report would also set out the percentage deferred and whether it was deferred in cash or shares.

• Total pension entitlements (for defined benefit plans).
• Exit payments made in the previous year, with further detail including:
  • The level of compensation received broken down into the key elements.
  • An explanation of how each element was calculated.
  • An explanation of how the decisions made relate to the policy on exit payments.
• Variable pay awarded in the previous year, including the following details for awards made in the current year under long-term incentive plans:
  • Scheme – the type of long-term award (e.g., shares, matching shares, options).
  • Basis of award – calculation of face value (e.g., X times base salary).
  • Face value.
  • Vesting maximum if above face value.
  • Percentage of the award that would vest at threshold performance.
  • Date performance period ends.
  • Summary of performance criteria if not set out elsewhere.
• Total shareholdings of directors.
• Chart comparing company performance and CEO pay.
• Information about who has advised the remuneration committee.
• Shareholder context, meaning:
  • How shareholders voted on both the binding vote and the advisory vote at the previous year’s annual shareholders meeting, set out as a percentage of votes cast.
  • Percentage of shareholder base that abstained.
  • Reasons for significant dissent where known.
  • Action taken by the remuneration committee in response.

• In addition, specified sections of the remuneration report, including the single total figure for remuneration, would be required to be audited.

• The remuneration report would be prefaced by a statement to the shareholders from the Chairman of the Remuneration Committee summarizing the key messages on remuneration and the context in which decisions have been taken.  The proposal declined to prescribe a form for this letter.

• Consistent with the current regime, the proposal would apply to all UK-incorporated quoted companies and would apply to the remuneration of all directors, with the intent that it would be most relevant for executive directors.  The U.K. Government intends to work with the UK Listing Authority to consider whether the requirements of the Listing Rules need to be reviewed.

• The consultation closes on September 26, 2012 and the proposed provisions would take effect for companies whose reporting years end after October 2013.

• These proposed regulations would replace, and not supplement, the existing disclosure requirements of remuneration reports.  Specifically, they would revoke and replace Schedule 8 of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (S.I. 2008/410).

Today, the SEC rules on the independence of compensation committees and advisers were published in the Federal Register. As we described in our memo, the listing exchanges have 90 days to propose implementation, and then a year from today to finalize the standards with approval from the SEC.

Since those are the outside dates, the listing exchanges can act much sooner. Depending in part on the comments received on the proposed standards, final standards may be adopted in time to apply to the 2013 annual meeting. We hope that the transition period for compensation committee independence standards will accommodate the fact that many boards evaluate director independence months before proxy statements are issued with related independence disclosure. Companies and boards will need sufficient time to modify their processes to evaluate additional independence factors required, or possibly even change the composition of their compensation committee.

In terms of compensation adviser independence, since there is no public disclosure required, the rules may not be affected by the proxy season (and proxy statement) timing. The importance in this case is for the listing exchanges to provide sufficient transition periods for companies to gather the necessary information and the compensation committee to examine the required factors. Companies will also need to consider whether their governance documents, including committee charters, should be modified to reflect the new rules.

As a reference, in a rule filing on April 2003, NYSE allowed companies 18 months following SEC approval to comply with the requirement to have a majority of independent directors (classified boards had 30 months if the affected director was not up for election). By the time the SEC approved those and other governance rules for NYSE and Nasdaq in November 2003, the implementation schedule had been revised to apply to the following year's annual meeting.

While proxy season has ended for most companies, there are a number of governance matters worth keeping an eye on during the summer months:

SEC Rulemaking.  The SEC website noting upcoming Dodd-Frank activity still indicates a number of actions slated before the end of June, including proposing rules regarding disclosure of pay-for-performance, pay ratios, hedging by employees and directors and recovery of executive compensation. It was recently updated to reflect the adoption of final rules on compensation committees and advisers, which we discussed here. As we are in the last week of June, it is likely that the Commission will again delay the actions into the next time period – July to December 2012. Watch for the SEC Sunshine Act meeting notices that usually come out on Wednesdays regarding Commission discussions of proposed or final rules, as summer is traditionally an active month for SEC rulemaking. 

NYSE and Nasdaq Listing Standards.  The SEC final rules on compensation committees and compensation advisers gave the listing exchanges wide latitude in proposing standards of implementation, including the possibility of imposing additional prohibitions or other restrictions. The exchanges have 90 days from the time the rules are published in the Federal Register, and the proposed standards are subject to public comment. 

ISS Policy Survey.  Last year, ISS released its policy survey to its client institutions and corporate issuers in early July. The survey forms the basis for possible changes to ISS policies with respect to voting recommendations on such matters as director elections, say-on-pay and shareholder proposals. 

Say-on-Pay.  The current count is 49 companies with failed votes. June has been a particularly active month, with eventful annual meetings at Nabors and Chesapeake but also with Safety Insurance Group being the first company to fail its vote even after receiving support from ISS. ISS likely recommended in favor of the company because it scored "low concern" on the three quantitative pay-for-performance tests, but shareholders rejected that formulaic approach. Consulting firm Semler Brossy indicates that shareholders may have been concerned about the company's performance and possibly the absence of changes or description of shareholder outreach that might have been expected as a result of the prior year's 67% favorable vote. Interesting events continue to unfold, such as Abercrombie & Fitch announcing changes to CEO compensation immediately after its vote received only 25% in favor. The company indicated that the CEO will forego two semi-annual equity grants that he is entitled to under his employment agreement. As the season winds down, we will begin to see whether there are any lessons to be learned from this second year of experience. 

Shareholder Proposals.  As the overall results of shareholder proposals are tallied, it may be useful to analyze not only the average votes, but also where companies received either much higher or lower support for the proposals that your company may have already received, or may be at risk of seeing for the 2013 meeting. Proposals often also reflect the current governance environment in terms of which practices are becoming more widely adopted by companies and expected by investors as a result of high support, such as board declassification. 

Shareholder and Proxy Advisory Firm Engagement.  The summer months may be an ideal time to reach out to shareholders, and proxy advisory firms if needed, either on specific issues or as a way to make introductions or otherwise keep in contact with those no longer harried by the proxy season. 

Yesterday marked an active day on the corporate governance front. First, the U.K. Government announced “a far reaching package of reform to strengthen the hand of shareholders to challenge excessive pay.” The hallmark of this package is a binding shareholder vote on prospective compensation and exit payments. Other elements include a continued shareholder advisory say-on-pay vote, as well as enhanced disclosure regarding actual amounts of remuneration paid during the prior year.

Second, the SEC finalized its rule requiring listing standards for compensation committees and their advisers, as required by the Dodd-Frank Act. The final rules largely adopt the SEC’s proposed approach, which in turn closely follows the original statutory language. However, there are a few changes, such as narrowing the disclosure requirement regarding compensation consultants, which many had complained as overly extensive. In any event, there is much more to come, as the exchanges must now propose listing standards on several key elements within 90 days of the SEC rule’s publication in the Federal Register, and it is conceivable that they may expand beyond the limited statutory language. There may also be practical implications for companies in terms of possible committee charter amendments and procedures for the committee to consider adviser independence and consultant conflicts.

We will be summarizing both developments in further detail, but wanted to alert our readers in the interest of time.

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.

Percentage Approval	Large Accelerated Filers by Say-on-pay Vote   (as of May 18, 2012)	Large Accelerated Filers by Say-on-pay Vote (as of May 20, 2011)
90-100%	454	540
80-89%	85	126
70-79%	40	65
60-69%	22	40
50-59%	23	14
40-49%	8	9
30-39%	4	7
20-29%	3	1
0-19%	0	0
Total	639	802

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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.

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.

On Tuesday, I was fortunate to co-moderate a NYSE-sponsored webcast with Judy McLevey at the NYSE, as we discussed the leading proxy and governance issues for 2012 with a group of recognized experts that included Doug Chia from Johnson & Johnson, Michelle Edkins and Robert Zivnuska from BlackRock, Gordon McCoun from FTI Consulting and Pat McGurn from ISS.  An archive of the webcast is available here. Judy first informed us that while 285 companies have held annual meetings, 430 more are slated for April with another 970 currently scheduled for May.  The panelists then provided interesting perspectives and useful advice on several issues relevant to public companies today, including the following:

Proxy Statements.  Doug discussed J&J's efforts to start from scratch for this year's proxy statement with an eye toward redesigning it for the individual investor, noting that a number of companies have attempted to make their documents attention getting, almost like glossy annual reports.  Due to its large volume of holdings, Bob stated that BlackRock's starting point for proxy review are the summaries generated by proxy advisor firms, before they dive into the proxy statements themselves.  CD&A summaries with the board's perspective, clarified through tabular and graphical disclosure, has been a helpful innovation, but they are not as enthusiastic about proxy summaries that may be trying to get ahead of proxy advisors and fail to include data that BlackRock would find important, such as conflicts of interests.

Say-on-Pay.  Pat reiterated that ISS has changed its methodology to place more emphasis on the three-year and five-year timeframe in its initial quantitative pay-for-performance analysis, as well as review overall pay magnitude.  More companies are providing proxy disclosure that already anticipates investor (and ISS) concerns, as a preemptive strike, which has proved to be helpful in allowing ISS to get information out to their clients faster and possibly avoid the need for so many of the ancillary filings made last year.  As a result of these and other improvements, Pat predicts that there will not be a substantial increase in opposition in 2012.  There has only been one instance so far of ISS making negative recommendations against the compensation committee as a result of unresponsiveness to the prior year's low votes.  Overall, average support levels are at 91% with 9% against, and the number of ISS' negative recommendations are currently running in the low teens.

Shareholder Engagement.  According to Bob, BlackRock has seen a significant increase in shareholder engagement during the post-season period, from July through February, as companies reach out to investors to interpret their vote result in order to build in those perspectives into their compensation committees' processes.  Board members have even met directly with investors when there have been real concerns.  While triggered by compensation, BlackRock has used these engagement opportunities to also speak to companies about other governance or performance questions.  Since BlackRock and likely other investors are not looking at the proxy statements until a week or two before the vote is due, Michelle emphasized that building an existing relationship with investors is the best way to facilitate those last-minute panicked calls to try to obtain support in the face of negative proxy advisory firm recommendations.  Doug recounted J&J's broad outreach efforts in light of the company's 61% support for say-on-pay in 2011, as they devoted more time and resources to gain an understanding of the vote results and explain their story.  On his part, Gordon believes that the 2012 proxy vote will be as much about the engagement process companies have undertaken in response to the 2011 say-on-pay vote as on the compensation paid. 

Shareholder Proposals.  Shareholder engagement is also the reason that there are fewer proposals this year, as companies and proponents agree on compromises after negotiations.  After speaking with hundreds of investors, Pat stated that it continues to be difficult to predict the level of support that proxy access shareholder proposals will receive.  About a dozen proposals are likely to come to vote.  Investors have indicated that rights to access should only be available at a reasonable ownership level, but have not quite agreed upon what level is reasonable.  Interestingly, the length of the holding period seem to be less of a concern to investors.  In giving their views on several different proposals, Bob and Michelle indicated that BlackRock believes a strong lead independent director can provide sufficient independent oversight without the need for an independent chair in all instances, but that a declassified board coupled with majority voting really enhances the accountability of directors.  With respect to the popular political contributions proposals, BlackRock conducts a case-by-case analysis on the nature of the proposal and the kinds of disclosure the company is already making.  Their advice for company opposition statements in proxy statements is to avoid starting with the conclusion that the proposal is not in the best interest of the company and instead focus on how the company has already addressed the concerns raised in the proposal. 

At the Walt Disney Company’s annual meeting of shareholders today, shareholders approved Disney’s controversial executive compensation plan and voted to reelect Disney’s slate of directors, despite negative recommendations by the ISS.  ISS had recommended against voting for the members of Disney’s Governance and Nominating Committee because of the decision to appoint its Chief Executive Officer, Bob Iger, as Chairman of the Board at the annual meeting, thereby reversing “a commitment to independent board leadership without conducting outreach to shareholders beforehand.” Disney had not combined the roles of CEO and Chairman since 2004.   ISS also recommended against Disney’s say-on-pay vote.

Disney had vigorously opposed the negative ISS recommendations. In recent SEC filings, Disney asserted that its action of combining the CEO and Chairman roles was part of a well thought-out succession and transition plan for its CEO who is expected to retire in 2016. Disney also stated that it expected to appoint an independent lead director with duties and responsibilities “that, ironically, exceed in scope those recommended by ISS.” Disney found that ISS’s recommendation on its compensation plan are “based on both flawed premises and methodology.”  Disney disputed ISS’s choice of peer group and also compared its total shareholder return to that of the S&P 500 and found that it was four times greater during Mr. Iger’s tenure as CEO.   

Disney’s executive compensation plan was reportedly approved by 56.6% of the shares cast while 42.8% opposed.  This is down from last year when 76.8% shares supported the compensation plan and 22.7% opposed it.  Although Disney might deem this a “win”, it will be interesting to see if this relatively low approval rate will result in greater scrutiny of its compensation plan by shareholders and proxy advisory services next year.

CalSTRS recently released a paper, “Lessons Learned: The Inaugural Year of Say-on-Pay,” in which they detailed their reasons for voting against companies’ 2011 Say-on-Pay proposals.

Surprisingly, CalSTRS voted against 23% of the say-on-pay proposals on which they voted during the 2011 proxy season, citing a pay for performance disconnect as the primary reason. In looking at the pay for performance disconnect, CalSTRS found that most of the companies they voted against had negative 5-year performance numbers. Other pay for performance issues noted by CalSTRS were companies’ failure to prioritize or fully explain the “laundry list” of performance metrics listed in the proxy statement and problems in peer group selection, including: a failure to adequately disclose the rationale of the peer group selection, too large a peer group, mismatch of size of peers and inclusion of companies in an unrelated industry.

CalSTRS’s second reason for negative say-on-pay votes was the ratio of CEO to named executive officer pay.  CalSTRS said that, although it would not be the sole factor in determining their vote, a pay ratio over 3 times would cause them to question a company’s practices.

A CEO base pay of over $1 million was listed as the next reason for a negative vote.  CalSTRS also found it troubling when companies used peer benchmarking to pay above the median, “particularly when companies targeted the 75th and 90th percentile.”  CalSTRS noted that this type of pay benchmarking would be a “renewed focus” next year.

Finally, in an effort to make proxy disclosure more understandable for the average investor, CalSTRS lauded the use of plain English executive summaries and additional tables to describe actually realized executive pay.

In a sampling of the companies against which they voted, CalSTRS found that the industries receiving the most negative votes were consumer discretionary, energy and industrials.

CalSTRS’s “Lessons Learned” can be found here.

Among the new proxy disclosure requirements under the Dodd-Frank Act is the mandate that issuers disclose in their CD&A “[w]hether, and, if so, how the registrant has considered the results of the most recent shareholder advisory vote on executive compensation… in determining compensation policies and, if so, how that consideration has affected the registrant’s executive compensation decisions and policies.”  Thus far, the vast majority of the 110 large accelerated filers who filed proxy statements in the 2012 season through February 29, 2012 have addressed this new requirement in their CD&As.  Generally, the disclosure has been fairly predictable: those that received lower shareholder approval ratings on say on pay in 2011 have provided lengthier disclosure, often addressing changes made to their compensation programs, while those that received stronger shareholder support have simply stated that they have considered the results and decided to continue their previous compensation practices in light of the support.

However, 14 large accelerated filers have failed to disclose the effect of the 2011 say on pay vote results in their CD&As.  Of these, 9 did not mention the say on pay vote in their CD&A at all.  Five companies reported last year’s vote results but did not go on to discuss whether or how the company considered the result.

Interestingly, the failure to disclose the effect of last year’s say on pay vote has not negatively affected either ISS recommendations regarding this year’s say on pay proposals or say on pay results in 2012.  Of the 14 companies discussed above, the 9 that have received a recommendation on their 2012 say on pay proposal from ISS have all received a “for” recommendation.  Of the 14 companies discussed above, the 6 that have reported their 2012 say on pay results as of February 29, 2012 have all received above 90% shareholder support.  The lack of focus on the new disclosure by ISS and shareholders may be because all of these companies received at or above 89% shareholder support in 2011.  Query whether the SEC will be as forgiving with respect to companies that do not address the new disclosure requirement.

The Oregon district court provided a ray of hope for companies fearing the possibility of shareholder say on pay litigation when it handed down its January 11, 2012 decision granting Umpqua’s motion to dismiss a shareholder derivative suit alleging directors’ breach of duty and officers’ unjust enrichment after an increase in executive compensation.  In the decision, Magistrate Judge Acosta rejected the shareholders’ arguments that demand was futile because the directors were not independent or disinterested.

In Umpqua, plaintiff-shareholders argued that, where directors were likely to be subject to liability for the challenged actions, they could not be disinterested.  The court rejected that reasoning in this context, saying that an adverse say on pay vote coupled with the award of increased compensation did not reach the necessary threshold of substantial likelihood of liability necessary to show that demand would be futile under Delaware law.  (See our October 17, 2011 blog post on the success of companies in dismissing shareholder say on pay suits under Delaware and New York law).  That reasoning had been successful in defeating dismissal under Ohio law in Cincinnati Bell, a case filed by the same firm representing the plaintiffs in Umpqua.  The Oregon court disagreed, stating that accepting the reasoning “that presuit demand is itself suggestive of impending liability [and] is sufficient to create the type of self-interest that triggers the demand futility exception. . . would permit every derivative action plaintiff to argue that demand is futile. . . because no board would be able to act objectively in evaluating presuit demand.”  This would essentially negate the purpose of the demand requirement.

Despite the positive nature of the Umpqua decision for potential defendant-companies and the fact that, as the Umpqua decision points out, the holding in Cincinnati Bell has recently been called into question by jurisdictional defects, Cincinnati Bell Inc.’s December 20, 2011 decision to settle one of the say on pay shareholder suits may continue to fuel the plaintiffs’ bar’s desire to bring further suits.  For example, suit was filed against Navigant Consulting, Inc. on January 19, 2012 in the Northern District of Illinois alleging breach of fiduciary duty on the part of the board and executive officers for increasing executive compensation during a period of decreasing shareholder value.

It remains to be seen if court decisions such as that in Umpqua will quell the lawsuits.

NOTE: Umpqua was dismissed without prejudice.

Contact Kyoko Takahashi Lin. Contact Gillian Emmett Moldowan.

In December, ISS issued a whitepaper providing further guidance on its new pay-for-performance review framework first introduced in its 2012 proxy voting guidelines update (effective for meetings on or after February 1, 2012).  As described in our memo New ISS Policies Overhaul Say-on-Pay Analysis (November 29, 2011), the revised pay-for-performance methodology includes both a three-part quantitative analysis and a qualitative analysis.  The quantitative analysis is made up of two relative measures (“Relative Degree of Alignment,” comparing CEO pay and TSR performance against a comparison group over 1- and 3-year periods, and “Multiple of Median,” comparing the prior year’s CEO pay to the median pay of a comparison group for the same period) and one absolute measure (“Pay-TSR Alignment,” comparing trends in CEO annual pay and the value of an investment in the company over the prior 5-year period).

The whitepaper provides extensive detail on ISS’s pay-for-performance evaluation methodology, which continues to analyze pay based on award opportunity (and not realized pay) with a focus on Total Compensation as reflected in a company’s Summary Compensation Table.  Of particular interest, the whitepaper provides insight into (1) how ISS will construct a company’s relative alignment comparison group and (2) how the results of a company’s quantitative analysis will determine whether ISS considers the company to be at risk of having a pay-for-performance disconnect.

Comparison Group.  Comparison groups will consist of 14 to 24 companies selected from a database of more than 4000 companies (the Russell 3000 index, together with publicly traded peers disclosed by Russell 3000 companies in their proxy statements).  Comparison groups will be constructed twice per year, and will be selected from a group of companies within the same 2-digit GICS category, between 0.45 times and 2.1 times annual revenues (assets for financial companies) and with market capitalizations between 0.2 times and 5 times.  In constructing a comparison group, ISS will start with companies within the same 6-digit GICS category and those closest in revenue and market capitalization.  Approximately 25 unidentified “super-mega” non-financial companies (over $50 billion in revenue and at least $30 billion market capitalization) will make up their own comparison group.

Impact of Quantitative Analysis. The quantitative analysis is intended to identify companies with a likely pay-for-performance disconnect by identifying companies that are (1) high concern with respect to a single evaluation measure or (2) medium concern with respect to two or three evaluation measures.  The whitepaper includes the following table showing where results would trigger concern:

Measure	Medium Concern		High concern
Relative Degree of Alignment	-30	~25th percentile	-50	~10th percentile
Multiple of Median	2.33x	~92nd percentile	3.33x	~97th percentile
Pay-TSR Alignment	-30%	~10th percentile	-45%	~5th percentile

ISS’s new approach to evaluating pay-for-performance alignment is complex and may be difficult for companies to model on their own.  Despite this challenge, there are a number of actions companies can take to ready themselves for the second year of say-on-pay as described in our Say-on-Pay Year Two: a Planning Primer (December 13, 2011) memo.

Contact Kyoko Takahashi Lin. Contact Gillian Emmett Moldowan.

Proxy season 2012 has begun and we’re beginning to see disclosure on the impact of last year’s say on pay voting results.  As of December 16, 2011, 14 large accelerated filer companies have filed proxy statements for the 2012 season.  These proxy statements disclose whether, and to what extent, the companies considered the results of their 2011 management say on pay proposal and how that affected their compensation decisions and practices.  Unsurprisingly, the ten companies with high shareholder approval ratings (83% and higher) have provided simple and unremarkable disclosure.  These companies generally acknowledge their high ratings and cite them as support for continuing their compensation practices.

In contrast, disclosure varied among the four companies with lower shareholder approval ratings.  Mueller Water Products, Inc., who received approximately 78% approval from its shareholders in 2011, kept its disclosure short, indicating that the results were taken into account in determining the amounts of annual cash incentive awards for 2011 and in setting bonus targets for executive officers for 2012.  Johnson Controls, Inc., Jacobs Engineering Group, Inc., and Monsanto, Co., who had 60%, 45%, and 65% approval ratings respectively, all provided lengthy disclosure regarding how say on pay results were considered, and two companies disclosed changes in their compensation practices. 

Johnson Controls and Jacob Engineering both stated that feedback from investors was a factor in their decisions to modify their practices, with Johnson Controls changing annual and long-term incentive performance plan targets and Jacobs Engineering changing the form of awards and adding a performance condition to its long-term equity based incentive program.  In contrast, Monsanto did not alter its compensation practices in light of its results from say on pay.  Monsanto said that discussions with shareholders suggested no common reason for the negative votes and hypothesized that the results stemmed from poor fiscal performance in 2010.  Monsanto said it believes its compensation practices are sound and, based on improved performance in 2011, it thinks it will have improved say on pay results in 2012.

It appears that companies with solid support for their compensation practices are not providing extensive disclosure on the impact of say on pay results, while those who did not fare so well are taking steps to demonstrate they take say on pay seriously—even if they aren’t changing their compensation practices.  This bifurcated approach aligns with what we are hearing in discussions with other companies regarding disclosure for the 2012 proxy season.

Contact . Contact .

Engagement with shareholders plays an increasingly important role in strengthening issuers’ corporate governance practices.  With proxy season around the corner, we turn to Donna Anderson, a vice president of T. Rowe Price Associates, Inc., and global corporate governance analyst in the U.S. Equity Division of T. Rowe Price., for her perspective on company efforts.  In her current role, Donna leads the policy-formation process for proxy voting, shepherds the firm’s engagement efforts with portfolio companies, and is co-chair of the Proxy Committee.  She joined the firm in 2007, has 15 years of investment experience, and was recently named one of the "People to Watch" in the NACD Directorship 100. 

Davis Polk:  Part of the difficulty companies sometimes have with investor engagement is finding the right person to talk to, since institutions operate under different structures.  We understand that at T. Rowe Price, proxy voting responsibility is assigned to each fund manager, with recommendations from the industry analyst and the governance analyst.  What role do you play in voting decisions, and who should companies interact with in the first instance when they have an issue they want to discuss?

Donna Anderson:  We encourage companies to contact us however they wish. Typically, dialogue begins with a call from the IR department to our industry analyst or from the corporate secretary’s office to me.  Either way, we make every effort to have these discussions jointly. We believe it’s important to incorporate the investment context and the governance perspective when it comes to our voting decisions.

I would not want to leave you with the impression that our fund managers are equally engaged in every proxy voting decision. We do not expect them to be familiar with every corporate governance issue in every country where they invest. This is why we’ve deployed internal resources in this area, to support our managers’ ability to make these decisions. Generally speaking, our fund managers tend to follow the standard T. Rowe Price guidelines when it comes to the more arcane areas of corporate governance (certain shareholder proposals, takeover defenses, bylaw changes, forum selection provisions, etc.).  By contrast, they tend to be quite engaged and opinionated in the areas of director elections, compensation, equity plans, M&A, contested elections, and the like.

Davis Polk:  What are some of the issuer engagement efforts that you find to be useful, and what in particular would you advise companies to focus on, or even to avoid? 

Donna Anderson:  Our approach is an open-door policy.  If a company wishes to speak with us about corporate governance matters, we will gladly take the meeting.  The objective of this type of engagement should be establishing a two-way dialogue about substantive issues.  Once a relationship has been established, some companies find there’s no need to meet on a regular schedule (once or twice a year).  Other companies prefer regular, periodic contact as a way of collecting up-to-date feedback from their shareholders.  We are flexible about the method, but I would say that incorporating some level of proactive outreach to shareholders into a company’s governance program is an investment that pays off when the company encounters the inevitable setback.  It is frustrating for us to receive those panicked phone calls 48 hours before a shareholder meeting when the votes are flooding in and the company finally realizes its shareholders have serious concerns.

Another tactic I’m not sure is useful is placing the burden of engagement on shareholders. We receive a surprising number of form letters every year saying, in essence, “We at XYZ Corp. care about corporate governance. If you have anything you’d like to discuss, give us a call.”  We would not characterize this as proactive outreach. While we would like to have the time to respond to open-ended requests, the companies offering specific agenda items for discussion are the ones we put at the top of the priority list.

Sometimes an issue doesn’t arise until the midst of proxy voting season, and we understand that. We are always willing to have shorter, targeted discussions about particular voting issues. In this regard, we found this year’s supplemental proxy disclosures to be quite helpful. We did read them, and we thought they were effective and efficient vehicles for communication.

Davis Polk:  Tell us what issuer engagement was like during the 2011 proxy season, with say-on-pay being the primary focus as we were all learning in this first year.  Did you find companies prepared and ready to discuss issues or did you find that engagement was mostly reactionary?  What are you expecting now from companies with respect to their say-on-pay votes?  Are you currently inundated with requests for discussions?   

Donna Anderson:  I know some institutional shareholders are inundated, but that has not been our experience. We can tell from the call volumes that many calendar-year-end companies are drafting next year’s proxies now, but we do not experience nearly the level of inbound calls that some larger asset managers do.

This year, I found companies were well prepared for compensation-related discussions, by and large. We heard from companies who knew (or suspected) they would have a rough time getting through their first say-on-pay votes, and we heard from companies with very modest, well-constructed plans who simply wanted to know how their shareholders felt about their CD&A disclosures. For the more complex compensation discussions, we find it helpful when someone from the company’s HR team is on the line, but we’re not as comfortable speaking with external compensation consultants.

Davis Polk:  Recognizing that ISS recommended against the say-on-pay votes for 11% of the companies they covered while the rate of failed votes was much lower, at less than 2%, it appears that institutional investors approached the vote using their own independent analysis.  How does T. Rowe use proxy advisory services?  Should companies facing negative recommendations from proxy advisory services address those issues head-on with their investors, and if so, how should they engage in those discussions? 

Donna Anderson:  I’ve studied this year’s results, and there is no question in my mind that shareholders exhibited a lot of independent thinking on say-on-pay this year. It’s not just the small number of failed votes relative to ISS recommendations. There were also a couple of dozen companies that saw support levels for their pay votes in the 50’s and 60’s even with favorable ISS recommendations. I think each say-on-pay outcome reflects a unique concoction of past pay decisions, stock performance, shareholder characteristics, company size, proxy advisor recommendations, company outreach, and the quality of the compensation disclosure.

For our general voting guidelines, T. Rowe Price employed a scorecard approach to say-on-pay votes. Our view is, we shouldn’t be voting against pay plans when we only have one or two concerns. Our “no” votes should reflect a persistent pattern of concerns that we believe have not been adequately addressed. Our scorecard for this year included a 25% weight on our proxy advisors’ recommendations. We found their recommendations to be helpful in the many instances where our quantitative screening process identified situations that needed a more qualitative review. There were many occasions (on both positive and negative recommendations) where we agreed with the ISS or Glass Lewis analysis. In other instances, we thought they placed too much weight on short-term considerations (year-over-year changes in pay, for example) or one-off pay practices such as single triggers.

From a company’s perspective, I understand the impulse to react aggressively to a negative vote recommendation. I hope that, after this year, companies will see the proxy advisor recommendation as just one factor in the mix. Every company should be able to gain at least some new insight from an expert outsider’s review of their pay program, shouldn’t they? Why not react to their analysis in a more constructive, open-minded manner?  Also, companies should not assume all their shareholders follow ISS’s guidance. It’s not a great use of time, especially during proxy season, for a company to launch into a 10-minute monologue on all the reasons ISS has it wrong, only to find out that the shareholder subscribes to a different advisor or has a customized approach to pay. My advice to companies in this situation would be to remain calm, issue an 8-K if you feel the facts have been misinterpreted, initiate an outreach effort to your largest shareholders, and find out what their say-on-pay triggers are before you spend time on rebuttal.

Contact .

Section 951(b)(2) of Dodd-Frank requires companies to hold a non-binding shareholder vote on executive severance packages (golden parachutes) in connection with M&A transactions that are presented for shareholder approval.  Shareholder votes on golden parachutes have been required since April 25, 2011.  Pearl Meyer & Partners recently completed a study on the outcomes of such shareholder votes held between April 25, 2011 and September 26, 2011. 

According to the Pearl Meyer study, during this period, 37 companies included golden parachute disclosure and votes in their merger proxies, 24 of which to date have publicly disclosed the results of the golden parachute vote.  Each golden parachute vote received support of a majority of shareholders, with the median vote equal to 91% approval.  Interestingly, Pearl Meyer noted that the median support for the related merger transactions was 99%.  The study shows that shareholders are generally voting in favor of golden parachutes where the shareholders approve of the related merger transaction, but at slightly lower rates.

Pearl Meyer also noted that ISS issued reports on 32 of the 37 transactions.  Four of ISS’s reports contained a negative recommendation for the golden parachute votes.  Of the golden parachute votes that did not receive ISS support, according to the Form 8-Ks filed reporting the results of such votes, a majority of shareholders still approved each golden parachute vote (albeit by a percentage somewhat below the median – approval votes ranged from 57% to 95%).  Based on this early data, it appears that while ISS may have the ability to sway shareholder votes to some extent, the shareholders’ votes on golden parachutes are closely linked with shareholders’ views regarding the related merger transaction.  The “say on golden parachutes” vote therefore may not greatly affect a company’s decision(s) with respect to the golden parachute payments offered to executives and officers.

Contact .

As previously posted on June 24, several derivative lawsuits have been filed against companies that have failed their "say-on-pay" votes. The lawsuits seek a recovery for alleged excessive executive compensation. Earlier this month, Dex One Corporation became the eighth company sued. The Dex One lawsuit, filed in the Eastern District of North Carolina, claims that officers and directors breached their fiduciary duty to the company by awarding large increases in compensation to the management team while the company was in bankruptcy, followed by a share price decline of more than 95 percent. 

Since our last post on this topic, several companies with say-on-pay lawsuits have updated their disclosure. Cincinnati Bell indicated that two additional derivative lawsuits were filed naming the company's directors and named executive officers as defendants, and Hercules Offshore also disclosed the existence of a second lawsuit. As was the case with the two lawsuits against Occidental that followed on the heels of its first say-on-pay litigation, these additional suits are substantially similar to the initial complaints.  No further settlements have been announced. 

Even companies with majority support for say-on-pay have been subject to derivative claims alleging excessive executive compensation. One slight difference between those and the say-on-pay litigation is that those complaints generally have a broader focus than alleged pay-for-performance disconnects for executives, and may even include general pay practices across the entire company.

As the total number of say-on-pay lawsuits increases, we note the frequency with which the same plaintiff firms have appeared. Five firms (Barrack, Rodos & Bacine, Landskroner; Grieco & Madden, LLC; Robbins Geller Rudman & Dowd LLP; Strauss & Troy and The Weiser Law Firm, P.C.) have each filed two of the derivative lawsuits.

Contact . Contact

With the vast majority of this year’s annual shareholder meetings for U.S. public companies behind us (at least for those with calendar-year fiscal years), we wanted to update the findings that we shared in our last post on the subject.  As of the end of last week, 1,193 large accelerated filers had reported the voting results from their shareholder meetings.

Regarding approval of “say-on-pay”:

Large Accelerated Filers by Say-on-Pay Vote (as of July 1, 2011)
90-100% Approval	791
80-89% Approval	195
70-79% Approval	97
60-69% Approval	55
50-59% Approval	29
40-49% Approval	16
30-39% Approval	9
20-29% Approval	1
0-19% Approval	0
Total	1,193

 

 

 

 

 

 

 

 

 

 

 

 

 

Generally, approval for say-on-pay votes has remained high as the season has progressed, and the average say-on-pay result for all large accelerated filers is 89%.  Similar to what we reported at the height of the proxy season, less than 18% of large accelerated filers reported say-on-pay results below the 80% approval level, and less than 10% reported results below the 70% approval level.

A total of 25 large accelerated filers have lost their say-on-pay votes, and all of them received “against” recommendations from ISS.  To date, large accelerated filers with “against” recommendations have averaged 64% approval, while those with “for” recommendations have averaged 92% approval. – interestingly, these approval levels have been remarkably stable and are, in fact, identical to those we reported in our last post.  We believe the total number of public companies, including large accelerated filers, that have lost their say-on-pay votes is 37.

On the “say-when-on-pay” front, shareholders at 1,076 large accelerated filers voted in favor of an annual frequency (i.e., over 90% of all large accelerated filers).  Although votes for triennial have occurred with slightly greater frequency as the annual meeting season has progressed, only around 27% of all large accelerated filers that recommended a triennial frequency have had their recommendation endorsed by shareholders, and, in the great bulk of these cases, the triennial vote was supported by a controlling or at least very substantial insider shareholder.  The companies that managed to get a triennial vote, without insider support, included Bancorpsouth, Crocs, Linn Energy, Inc., Markel Corporation, SCANA Corporation and United Parcel Service.

Over 63% of the companies that have reported the results of their annual meetings have already adopted a say-on-pay frequency, and in 749 of 752 instances, the board of directors went with the recommendation of shareholders.  Curiously, in two of the three other instances (namely, Crocs and Green Mountain Coffee Roasters), a shareholder vote in favor of a triennial frequency has nonetheless resulted in the company adopting an annual frequency.  In the third, shareholders who voted in favor of an annual frequency saw the company (Annaly Capital Management) adopt a triennial frequency, which is what the board had originally recommended to its shareholders.  It remains to be seen what pressure, if any, companies that buck the stated preference of shareholders come under.

Contact Kyoko Takahashi Lin.

Some shareholders are using lawsuits as a new tactic to fight what they perceive as an escalation in executive compensation.  Shareholders are likely to find these suits difficult to push through the courts on their merits, but the suits can cost subject companies time and money, not to mention reputational harm brought on by negative media attention.

Last year, we saw shareholder derivative suits filed on behalf of KeyCorp (in Ohio state court) and Occidental Petroleum (in California state court) in connection with failed say-on-pay votes during the 2010 proxy season.  KeyCorp agreed, according to Reuters, to pay $1.75 million in attorneys’ fees and expenses to settle related suits and Occidental Petroleum, faced with three suits, settled one for an undisclosed amount and had two dismissed.  Both KeyCorp and Occidental announced significant changes to their executive compensation practices following the shareholder suits.

Similar lawsuits have been filed during the 2011 proxy season.  Earlier this month, a shareholder derivative suit Hercules Offshore, Inc. against the company’s directors, named executive officers and compensation consultant.  This suit represents the fourth shareholder derivative suit following a failed say-on-pay vote during the 2011 proxy season.  Suits have been filed on behalf of Umpqua Holdings (in Oregon), Jacobs Engineering Group (in California) and Beazer Homes USA (in Georgia) – all of which held meetings early in the proxy season.

In the suits on behalf of all six companies, the plaintiffs assert a disconnect between pay and performance, because of weakening corporate financial performance and increasing executive compensation.  However, unlike the suits filed in 2010, in which the plaintiffs claimed a multi-year history of excessive compensation at the respective companies, the suits filed this year focus on 2010 compensation relative to company performance.

The suits each claim that the directors breached their fiduciary duties, generally arguing that approving an increase in executive compensation not in line with the company’s disclosed pay-for-performance policy was an invalid exercise of the directors’ business judgment.  The plaintiffs argue that the failed say-on-pay votes rebut the presumption that the directors’ acted in the best interests of the company.  The validity of this argument is questionable in the case of the 2011 suits in light of the specific Dodd-Frank provision that the say-on-pay votes mandated by the Act do not create or imply any change to or addition to the fiduciary duties of directors.

Even so, if the cases get beyond a motion to dismiss, the outcome may be affected by the record (recall the Disney case from a few years ago).  Companies should consider what the background documents will show (including any compensation committee minutes) and be conscious of reviewing the record as closely as in, say, M&A matters.

Contact Kyoko Takahashi Lin. Contact Gillian Emmett Moldowan.

The Dodd-Frank frequency vote is of course "nonbinding", but companies that have "lost" the vote for triennial frequency have almost without exception decided that the better part of valor is to follow the shareholders' expressed will for an annual vote. With more than 60% of large accelerated filers having announced their decisions, only two companies have bucked the trend. Annaly Capital Management just filed an amended Form 8-K declaring that its board has determined that future say-on-pay votes will be submitted to shareholders every three years, even though annual say-on-pay received majority approval. Annaly Capital Management is the first large accelerated filer to follow the example previously set by American Reprogaphics Company, a small company, to conduct triennial votes. The vote wasn't close in either case; each company had received 70% or more shareholder support for an annual vote.

While signifying that it won't conduct another say-on-pay vote for three years, Annaly Capital Management indicated that the board will "continue to evaluate this decision annually." The company's annual meeting also resulted in one director receiving more "against" votes than "for" votes, it appears due to the director's failure to attend more than 75% of board and committee meetings. The company stated, also in the amended Form 8-K, that after considering the director's qualifications and past attendance history, the board determined that it would not be in the company's best interest to request the director's resignation. The company has a classified board, but interestingly, the Form 8-K declared that the director will serve until the company's next annual meeting, at which time the board expects the director to be re-nominated.

The story doesn't end there - will ISS recommend withhold votes for the board next year for not following the shareholders' will?

Contact . Contact .

May is high season for annual shareholder meetings for U.S. public companies, so we wanted to update the findings that we shared in our last memo on the subject.  As of the end of last week, 802 large accelerated filers reported the voting results from their shareholder meetings.

Regarding approval of “say-on-pay”, so far:

Large Accelerated Filers by Say-on-Pay Vote (as of May 20, 2011)
90-100% Approval	540
80-89% Approval	126
70-79% Approval	65
60-69% Approval	40
50-59% Approval	14
40-49% Approval	9
30-39% Approval	7
20-29% Approval	1
0-19% Approval	0
Total	802

 

 

 

 

 

 

 

 

 

 

 

 

 

In other words, less than 17% of large accelerated filers reported say-on-pay results below the 80% approval level, and less than 9% reported results below the 70% approval level.

A total of 16 large accelerated filers have lost their say-on-pay votes, and all of them received “against” recommendations from ISS.  To date, large accelerated filers with “against” recommendations have averaged 64% approval, while those with “for” recommendations have averaged 92% approval.  We believe the total number of public companies, including large accelerated filers, that have lost their say-on-pay votes is 26.

On the “say-when-on-pay” front, shareholders at 729 large accelerated filers voted in favor of an annual frequency (i.e., almost 91% of all large accelerated filers).  Less than a quarter of all large accelerated filers that recommended a triennial frequency have had their recommendation endorsed by shareholders, and, in the great bulk of these cases, the vote was supported by a controlling or at least very substantial insider shareholder.

Contact Kyoko Takahashi Lin.

Questions have come up about whether companies can declare how frequently they intend to hold say-on-pay votes in the Form 8-K announcing annual meeting results within four business days after the meetings, or whether they must wait and make the disclosure in an amended Form 8-K.  While this seems to demand a simple "why not" response, the confusion stems from the fact that careful readers of the rules noted that the Form 8-K itself only provides for disclosing future frequency in an amended 8-K, to be filed no later than 150 days after the end of the meeting and 60 days before the 14a-8 shareholder proposal deadlines. 

The instructions do not appear to be exclusive, and if a board has made a decision there seems to be no reason to later prepare an amendment and make two filings.  In fact, at least half of the companies that have announced annual meeting results so far have gone ahead and declared their future intentions with respect to the frequency of say-on-pay, in particular where (a) the board recommended annual and (b) votes were overwhelmingly in favor of annual. 

Contact .

When the SEC decided to eliminate the ability of brokers to vote on a discretionary basis without specific client instruction for director elections in July 2009, many predicted that it would seriously affect the ability of directors to obtain majority support.  The concern proved to be a false alarm.  As a result, when the Dodd-Frank Act required the elimination of broker discretionary voting for executive compensation matters, including say-on-pay, there wasn't nearly the same chatter. 

But it turns out that given the closeness of many of the failed say-on-pay votes, the reported broker non-votes would have made a real difference.  We calculated that 7 of the 21 companies reporting failed votes so far would have passed, in some cases by a decent margin, if the non-votes had actually been counted as "for" say-on-pay, which is not an unreasonable assumption given these discretionary votes generally favored management.  For one company, there were more broker non-votes reported than "for" votes. 

Currently for most companies the only proxy item that brokers can continue to vote on without client direction is auditor ratification.  In addition, many are not aware that the NYSE usually permits brokers to vote at their discretion on most management proposals to amend charters, including to declassify boards, eliminate supermajority provisions or allow special meetings of shareholders.  Since NYSE Rule 452 governing discretionary voting has a specific list of "cannot vote" items, items not on the list, and not viewed as contested, can be marked as a broker-may-vote matter by the NYSE.

Contact .

Although it often looks like proxy season 2011 is a one-topic event, say-on-pay is just one item on proxy cards.  Recent data reminds us that say-on-pay may even be the least controversial item.  ISS reports that as of May 9, shareholder proposals calling for declassifying boards (annual election of directors) won as much as 95% and 81% approval rates at MEMC Electronic Materials and Alcoa, respectively.  Average support so far for nine proposals is 69%, up from 61% last year.  Shareholder proposals on majority voting are also faring well, averaging 57% support at 14 companies, including 78% at SkyWest.

Recognizing the increased probability of getting these types of results, companies that receive such proposals often go ahead and implement without putting the shareholder proposals on the ballot.  Companies seeking management proposals to amend governance documents for declassification and majority voting have won more than 96% approval this year. 

Contact Ning Chiu.

When shareholders mark "abstain" on a ballot, what does it mean?  Does the meaning differ depending on whether it's to elect a director, vote on say-on-pay or a shareholder proposal?  The effect of abstentions in determining the pass/fail rate for an item depends on state law and corporate governance documents, but should they be excluded if we're trying to examine different companies' results for comparability?

 

You may be aware that it is ISS policy to ignore abstentions when reporting the results of shareholder proposals, citing Rule 14a-8(i)(12).  The approval rate of shareholder proposals determined by ISS feeds into their policy of recommending against boards for failure to implement proposals that receive majority support two out of three years in a row.  If abstentions were counted, it would decrease the level of support for these proposals.  Given the close votes received on written consent and special meeting proposals in recent years at some companies, whether or not abstentions are counted sometimes matter.

 

We're not aware that such a policy exists yet for say-on-pay.  In his RiskMetrics Insights blog, Ted Allen reports results that includes abstentions, as duly noted in the articles.  As a management proposal, abstentions have the opposite effect on say-on-pay than for shareholder proposals, by decreasing the level of support.  In both cases, the companies come out looking worse.

 

Thus far, abstentions have played a minor role in say-on-pay results, averaging about 1.9% of votes.  However, abstentions played the deciding role in causing Motorola to report a failed vote in 2010, a similar fate faced by Hemispherx BioPharma and Cooper Industries this year.  Hemispherx had nearly 16% in abstentions.  In the U.K., investors often "abstain" against say-on-pay in the first instance to express a milder form of dissatisfaction with executive compensation.

 

Contact Ning Chiu.

We released today a memo summarizing the say-on-pay results so far this proxy season, including eleven companies who have failed to get majority support and a number of others where the vote was close enough to suggest meaningful shareholder concerns.  My anecdotal experience so far this season suggests a couple of supplemental points:

• With every public company required for the first time this year to comply with say-on-pay, ISS is clearly swamped, and it's showing in terms of quality control: we've seen an unusual level of cases in which ISS made factual mistakes in its report, and even a couple of situations in which ISS missed issues that in other years would likely have concerned them.

• If you do face a negative ISS recommendation you will wish you had planned for it, because the recommendations generally come with only about two weeks to go before the meeting, which will not allow much time to plan and execute a communications campaign.  You can't predict in advance how ISS will react, but in the vast majority of cases you can determine whether you are at risk of a negative recommendation.  If you're at risk you should have a communications plan on the shelf and ready to execute, unless you're feeling lucky. 

Contact Bill Kelly.

 

We’re up to nine failed say-on-pay votes so far for the year. We’ll provide a client communication shortly on the latest state of play in the say-on-pay world, including the reasons reported for the negative votes, and interesting additional soliciting materials filed by companies facing negative ISS recommendations. But we still have a long way to go before we can get the full picture. While the last week in April saw 300 annual meetings held, there will be over 400 alone in the first two weeks of May and 650 in the third week of that month.

Contact Ning Chiu.

Notable recent support for triennial say-on-pay include Viacom, with insiders controlling about 80%, and Franklin Resources, which barely squeaks in 57% support for triennial even though insiders own approximately 35%.  The tide is starting to turn as more companies recognize that triennial is a long shot without some kind of insider block.  Our data shows 416 large accelerated filers and 188 S&P 500 companies had filed their proxy statements, with 59% of large accelerated filers and 64% of the S&P 500 now recommending for annual say-on-pay.

Contact Ning Chiu.

We’ve all engaged in the “what-if” scenarios of close votes on the say-on-pay frequency vote, faced by Green Mountain Coffee Roasters.  The company recommended triennial say-on-pay frequency and received 49.37% for annual and 49.99% triennial.  Talk about close.  Instead of keeping us in suspense as they are legally permitted to do, the company has announced that they will adopt annual frequency and hold another vote next year.  Would more a .01% support that pushed triennial into majority support made a difference to the board? 

Contact Ning Chiu.

While ISS voting recommendation reports for companies are not “public”, sometimes additional soliciting materials filed by a company are informative.  On March 2nd, Disney filed its first communication indicating that the ISS recommendation to vote against its say-on-pay proposal is based on the disclosure of excise tax gross-ups that was granted in January 2010, and the compensation committee has since then adopted a policy that prohibits excise tax gross-ups in any future agreements (including any material amendments).  It’s tough to battle ISS recommendations, as on March 18th, Disney filed another communication indicating that the company has amended four employment agreements to remove excise tax gross-ups entirely. 

Contact Ning Chiu.