Disclosure

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.

The PCAOB has proposed a framework for reorganizing existing auditing standards based on topics. Currently, existing standards consist of "AS Standards," which are new or amended standards adopted by the PCAOB, or "AU Sections," which are interim auditing standards originally from the American Institute of Certified Public Accountants that the PCAOB adopted in April 2003. Over time, some AU sections became superseded and replaced by PCAOB rules.

The topics will be grouped into the following categories: general auditing standards for broad principles and activities; audit procedures; auditor reporting; matters relating to SEC filings; and other matters. Certain interim standards will also be replaced in the process, but the changes are not expected to impose new requirements on auditors. A comparison with the existing standard is provided in an appendix. Comments are due by the end of May.

The SEC has published a notice to solicit comments on proposed rule changes by the New York Stock Exchange to its Listed Company Manual.

The NYSE’s proposed rule changes would require listed companies to utilize a web portal operated by the NYSE, www.egovdirect.com, or a designated email address when providing certain notices to the NYSE as required under its Listed Company Manual.  The current listing requirements require notification via various methods, such as fax, telephone, telegram, letter, or email, that vary depending on the event requiring notification.  The proposed rules would apply to some, but not all, of the events requiring notification by the Listed Company Manual, including: fixing a date for the closing of transfer books or taking of a record of shareholders; any dividend action or action related to a stock distribution;  fixing a date for any meeting of shareholders; publicity and notice of partial or full redemptions; setting a date for any meeting of shareholders; and notification by the transfer agents of shares outstanding at the end of each calendar quarter. The proposals also provide that, in emergency situations, notification may be provided by telephone and confirmed by fax.

The NYSE also proposed two clarifying changes.  First, where material corporate developments are disclosed between 9:00 a.m. and 5:00 p.m. EST, the proposed rules clarify that verbal communication should be given to the NYSE at least 10 minutes before the public release of information and a copy of the text of the announcement should transmitted via the proposed web-based notification procedures at least 10 minutes before the release of the information.  Second, the proposed rules would make changes to make clear that notices of redemption should be made by telephone and a web-based transmission of text in accordance with the proposed rules, by removing the requirement of delivering notices of redemption by hand.

Finally, the proposal would reduce the number of copies of a proxy statement that a listed company is required to submit from six to three and would make certain other administrative changes.

Comments on the proposed rules are due by December 18, 2012.

As we discussed here, the PCAOB recently approved Auditing Standard No. 16, Communications with Audit Committees. While the bulk of the new standard concerns communications that the auditors are required to provide to the audit committee, one notable provision relates to inquiries required to be made of the audit committee by the independent auditor. Under the new standard, auditors are required to inquire whether the audit committee “is aware of matters relevant to the audit, including, but not limited to, violations or possible violations of laws or regulations.” This expands the inquiries of the audit committee required by previous auditing standards, which required the auditor to inquire of the audit committee regarding the matters important to the identification and assessment of risks of material misstatement and fraud risks.

As at least one comment letter on the proposed standard noted, the new standard could jeopardize attorney-client and work product privileges. In its adopting release, the PCAOB acknowledged the criticisms of the comment letter regarding the risk of loss of privileges, but declined to exclude the language. The PCAOB stated that it did not remove the language because “limiting the scope of information that the audit committee might provide to the auditor could severely affect the auditor’s ability to conduct an effective audit…Due to the audit committee’s oversight responsibilities, it is appropriate for the auditor to ask the audit committee for information relevant to the audit, including matters related to violations or possible violations of laws or regulations.” The final standard did exclude language from an interim proposal which would have required the auditor to inquire of the audit committee about matters that “might be” relevant to the audit, somewhat narrowing the scope of inquiry.  However, the risk of loss of privileges remains an issue. The PCAOB did not provide guidance to companies regarding mitigating such risk.

If approved by the SEC, Auditing Standard No. 16 will be effective for audits of financial statements for fiscal years beginning on or after December 15, 2012.

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 >

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).

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.

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

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

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

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

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

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.

• Just in time before most proxy statements are issued, the SEC staff has issued a CDI on how say-on-pay resolutions should be described on proxy cards and voting instruction forms, with specific examples given of resolutions that would be considered compliant.  The four examples (To approve the company’s executive compensation; Advisory approval of the company’s executive compensation; Advisory resolution to approve executive compensation; and Advisory vote to approve named executive officer compensation) all contain the notion of "approval" in casting the vote.   The Staff indicated it was concerned that some resolutions, such as "To hold an advisory vote on executive compensation," are not sufficiently clear.
• Western Union has announced that it will drop its plans to adopt a proxy access bylaw, in light of its decision to declassify its board and "its ongoing assessment of whether proxy access should be included in the Company’s corporate governance structure."
• CalPERS, other pension funds and investors submitted a letter to the SEC asking that the Commission focus on certain priorities in the next 12 months.  The list includes proxy access, the remaining executive compensation provisions required under the Dodd-Frank Act, International Financial Reporting Standards (IFRS) and corporate disclosure on sustainability issues, such as environmental matters and board diversity. 
• As noted on TheCorporateCounsel.net, Apache and John Chevedden have reached a settlement in the Southern District of Texas, permitting Apache to exclude Chevedden's shareholder proposal, which Apache had disputed with respect to Chevedden's proof of ownership.  Chevedden's appeal in the Fifth Circuit with respect to a similar prior case (KBR v. Apache), is pending. 
• The NY Post reports that a whistleblower has filed a complaint with the SEC alleging that an employee in the Boston office of ISS has been providing proxy solicitors with shareholder voting data in exchange for cash and gifts. 

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 .

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 .

On October 19, we posted about the Federal Reserve’s recently released report detailing its horizontal review of incentive compensation practices at 25 large banking organizations.  The report notes that the Fed intends to implement the Pillar 3 compensation disclosure requirements adopted in July by the Basel Committee on Banking Supervision.  The required disclosures are quite extensive (e.g., compared to the disclosures currently required for U.S. public companies).  As the disclosures will be public, banks may be criticized for their compensation practices.  On the plus side, banks will have a window into their peers’ practices.

The Pillar 3 requirements are limited to disclosure and do not mandate particular forms or amounts of compensation.  But if the impact of other disclosure regimes is any guide, the requirements may cause banks to modify their compensation practices.  (Separately, the Fed, jointly with six other federal agencies, has proposed a rule under Section 956 of Dodd-Frank that would subject financial institutions to substantive compensation requirements—see our March 3 memo).

The Basel Committee expects banks to comply with the Pillar 3 requirements from January 1, 2012.  But as the Fed’s report does not specify when it intends to propose rules implementing the requirements, it is not clear when the requirements will apply to Fed-regulated banks.  Nor is it clear how closely the Fed’s rules will adhere to the letter of Pillar 3 or whether the Fed will propose its rules jointly with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (as it has for rules implementing previous Basel regulations).

Pillar 3 requires 18 qualitative and 11 quantitative disclosures, with the quantitative disclosures covering, and broken down between, senior management and other material risk takers.  Here are a few examples:

Qualitative:

• The types of employees considered senior managers and material risk takers, including the number of employees in each group.

• How the bank ensures that risk and compliance employees are compensated independently of the businesses they oversee.

• The measures the bank will implement to adjust remuneration if performance metrics are weak, including the bank’s criteria for determining “weak” performance metrics.

• The bank’s policy on deferral and vesting of variable compensation and, if the fraction of variable compensation that is deferred differs across employees or groups of employees, the factors that determine the fraction and their relative importance. 

Quantitative:

• The numbers and total amounts of guaranteed bonuses, sign-on awards and severance payments granted in the fiscal year.

• For deferred compensation, the total amount outstanding (with a breakdown by cash, equity, equity-based and other forms) and the total amount paid out in the fiscal year.

• For compensation generally, a breakdown by fixed/variable, deferred/non-deferred and form (cash, equity, equity-based and other forms).

• Information about employees’ exposure to compensation adjustments, both implicit (e.g., fluctuations in the value of shares or performance units) and explicit (e.g., malus, clawbacks or similar reversals or downward revaluations of awards).  Such information must include the total amount of outstanding compensation exposed to such adjustments and the total amount of reductions during the fiscal year, with the reductions broken out by those due to implicit versus explicit adjustments.

Banks are expected to provide the disclosures on one site or in one document.  But Pillar 3 provides the Fed with discretion to permit banks to cross-reference to a different site or document if equivalent disclosure has already been made under an accounting or listing requirement relating to the same time period (e.g., proxy statement disclosure under Item 402 of Regulation S-K).  The Fed also would have discretion to exempt banks fully or partly from the requirements, depending on the banks’ risk profile, and to exempt certain types of compensation as immaterial, proprietary or confidential.

Contact Barbara Nims.

As is their customary timing, on Friday afternoon the SEC issued several updated CD&I interpretations of particular interest to the governance community:

 

–Information About Non-Continuing Directors.  The SEC clarified a previous CD&I regarding disclosure of certain biographical information, under Item 401(a) and Item 401(e), about directors whose terms of office will not continue after the annual meeting.  Both requirements may be omitted so long as a company provides its Part III of Form 10-K information by incorporating from the proxy statement, and the company files its proxy statement within 120 days after its fiscal year-end.  This means most public companies would not have to provide this disclosure.  (116.10 of the Regulation S-K CD&Is)

 

–Use of Non-GAAP Information in Proxy Statements.  The SEC indicated that non-GAAP financial information that does not relate to pay target levels, but is included in the CD&A or other parts of the proxy statement, are subject to the non-GAAP rules under Regulation G and Item 10(e).  The rules provide a specific exemption for disclosure of target levels that are non-GAAP financial measures.  As part of the increased effort to demonstrate the connection between pay and performance, companies are more frequently referring to corporate financial data, including non-GAAP financial information, in their discussion of executive compensation.

 

However, for purposes of pay-related disclosure only, a company can include the required GAAP reconciliation and other information in an annex to the proxy statement, so long as the company includes a prominent cross-reference.  Alternatively, the company can provide a prominent cross-reference to the pages of the Form 10-K that contain the required disclosures, if the non-GAAP financial measures are the same as those included in the Form 10-K, and the Form 10-K incorporates the proxy statement's Item 402 disclosure as part of its Part III information.  It appears that an attached annex or Form 10-K are the only options, and it would not be sufficient to instead cite to a website where the reconciliation is posted. (118.08 of the Regulation S-K CD&Is and Item 108.01 of the Non-GAAP Financial Measures CD&Is)

 

–Broker Non-Votes in Frequency Vote Disclosure.  The SEC confirmed the disclosure of the number of broker non-votes for the advisory vote on the frequency of say-on-pay is voluntary, not required, under Item 5.07(b) of Form 8-K.  (121A.03 of the Form 8-K CD&Is)

 

Relevant links below:

 

Regulation S-K: http://www.sec.gov/divisions/corpfin/guidance/regs-kinterp.htm

 

Exchange Act Form 8-K: http://www.sec.gov/divisions/corpfin/guidance/8-kinterp.htm

 

Non-GAAP Financial Measures: http://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm

 

Contact .

In recent months, the SEC staff has increasingly raised the disclosure of loss contingencies required by FASB ASC 450-20-50 (formerly known as FAS 5) in comment letters and as a discussion point at conferences and meetings.

In particular, the staff is focusing on whether and when a company discloses an estimate of the "possible loss or range of loss" associated with unaccrued loss contingencies. Prodded by the staff, several large financial institutions (American Express Company, Bank of America Corporation, Citigroup Inc., The Goldman Sachs Group Inc., JPMorgan Chase & Co., Morgan Stanley and Wells Fargo & Company) gave an estimate of possible loss or range of loss above their existing reserves for the first time in their Form 10-Ks for the 2010 fiscal year and updated those estimates in their 2011 first quarter Form 10-Qs. The staff is now pressing other companies to also do so.

Recently, the staff has indicated that it is also focused on understanding when a company determines it has sufficient information to make an accrual. If a company discloses a significant litigation settlement or a change in its loss contingency accrual, the staff is now more likely to scrutinize the company's previous loss contingency disclosures and inquire as to whether a company disclosed sufficient information about the impending loss. Accruals (or updates to accruals) or settlements for which there was no prior disclosure may be challenged.

Contact Richard Sandler.

Commenters to the SEC's proposed rules on listing standards for compensation committees, including issuers, law firms, consultants and organizations like the Society of Corporate Secretaries and Governance Professionals and the Chamber of Commerce, argued vehemently for the SEC to (a) narrow the definition of "advice" given by a consultant and (b) retain existing disclosure exemptions for consultants that work only on broad-based plans and non-customized data. The SEC may be surprised to find such passion surrounding what are merely proposed amendments to existing disclosure obligations.

Disclosure would be required when a compensation committee has retained or obtained the advice of a compensation consultant, a change from the current rule which is triggered when a consultant plays a role in determining executive compensation. Commenters' discord stems from a proposed instruction indicating that "obtained the advice" could include whenever a committee or management has requested or received advice from a consultant, even in the absence of a formal engagement, a client relationship or any fees paid. The SEC suggests this change would have minimal practical impact, but commenters decried this instruction as being overly broad and captures all types of information generated by consultants, even casual conversations or materials soliciting potential clients.

The proposed rules would also eliminate a current disclosure exemption for consultants that only work on broad-based plans that do not discriminate and favor executives, and data that is not customized for a particular company and about which the consultant does not provide advice. Commenters advocated for the retention of this exemption, arguing that this type of work does not represent a conflict of interest and also may not be competitively neutral, as mandated by Dodd-Frank, since the larger consultants tend to provide this service.

Contact .

There continue to be multiple areas of legislative activity to repeal or amend certain provisions of Dodd-Frank, including draft legislation to require employees to communicate internally before making whistleblower claims to the SEC. In March House Republicans announced a bill to eliminate the provision to disclose the ratio between the CEO’s compensation and the median annual total of all employees. Recently the AFL-CIO denounced this attempt to “water-down” Dodd-Frank, expressing their belief that this disclosure would have a “profound impact.” on executive compensation. According to their data, the average total compensation for S&P 500 CEOs is now about 343 times that of the average American worker, up from 42 times in 1980.

Contact Ning Chiu.

Last week House Republicans announced that they are drafting five bills to eliminate or change parts of the Dodd-Frank Act.  One of the five is the elimination of the provision to disclose the ratio between the CEO’s compensation and the median annual total of all employees.  Could this possibly come to fruition?  Unlikely given the hurdles of getting any kind action out of Congress lately, but it’s a space to watch.  The latest SEC timeline aims for proposing and adopting final rules on the pay ratio disclosure in the August-December timeframe.  

Contact Ning Chiu. 

The SEC staff issued a surprising CDI recently.  Seems that the biographies of directors who are not standing for re-election are required to be disclosed under both Item 401(a) and Item 401(e) of Regulation S-K, if not technically in the proxy statement, then in the Form 10-K.  Why investors would be interested in the bios of directors who won’t be continuing is a bit of a mystery.  And for those of you who have asked – Item 401(a) only applies to your current directors.  If they resigned before your published your proxy statement, you don’t have to worry about their biographies.

Contact Ning Chiu.