As expected (and as I blogged last week), the SEC has issued a proposal for the pay-for-performance disclosure required under Dodd-Frank. Proxy disclosures aren’t really my gig, so I don’t have a lot more to say about this topic. Luckily, Mike Melbinger of Winston & Strawn provided a great bullet-point summary of the proposed disclosure in his blog on CompensationStandards.com. I’m sure he won’t mind if I “borrow” it.
The proposed rules rely on Total Shareholder Return (TSR) as the basis for reporting the relationship between executive compensation and the company’s financial performance.
Based on the explicit reference to “actually paid” in Section 14(i), the proposed rules exclude unvested stock grants and options, thus continuing the trend to reporting realized pay. Executive compensation professionals will need to sharpen their pencils to explain the relationship between these figures and those shown in the Summary Compensation Table.
For equity-based compensation, companies would use the fair market value on date of vesting, rather than estimated grant date fair market value, as used in the SCT.
The proposed rules also would require the reporting and comparison of cumulative TSR for last 5 fiscal years (with a description of the calculations).
The proposed rules would require a comparison of the company’s TSR against that of a selected peer group.
The proposed rules would require separate reporting for the CEO and the others NEOs—allowing use of an average figure for the other NEOs.
The proposed rules would require disclosure in an interactive data format—XBRL.
Compensation actually paid would not include the actuarial value of pension benefits not earned during the applicable year.
The proposed rules would phase in of the disclosure requirements. For example, in the first year for which the requirements are applicable [2018?], disclosure would be required for the last 3 years only.
The proposed rules exclude foreign private issuers and emerging growth companies, but not smaller reporting companies. However, the proposed rules would phase in the reporting requirements for smaller companies, require only three years of cumulative reporting, and not require reporting amounts attributable to pensions or a comparison to peer group TSR.
A Few More Thoughts
In the NASPP’s last Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting), usage of TSR targets for performance awards increased to 43% of respondents. With this new disclosure requirement, will even more companies jump on the TSR-bandwagon?
At least there’s one bit of good news: the disclosure covers only the NEOs, not a broader group of officers as was originally feared.
More Information
To learn more about the proposed regs, check out our NASPP alert, which includes a number of practitioner memos. The memo from Pay Governance includes a nifty table comparing the SEC’s definition of “actual” pay to the SCT definition of pay, traditional definitions of realized and realizable pay, and the ISS definition of pay.
It’s beginning to look this is going to be the year of Dodd-Frank rulemaking at the SEC. We may have the CEO pay-ratio disclosure rules by the end of the year, the SEC recently proposed rules for hedging policy disclosures, and now the SEC appears poised to propose the pay-for-performance disclosure rules this week.
Readers will recall that Dodd-Frank requires the SEC to promulgate rules requiring public companies to disclose how executive compensation related to company financial performance (see my blog entry, “Beyond Say-on-Pay,” August 5, 2010). In his April 24 blog on TheCorporateCounsel.net, Broc Romanek noted that the SEC has calendared an open Commission meeting for this Wednesday, April 29, to propose the new rules.
Broc’s Eight Cents
Broc offered eight points of analysis on this disclosure:
1. Companies can get the data and crunch the numbers. I don’t think that the actual implementation itself will be difficult.
2. But I think what could be particularly worrisome is having yet another metric to figure out what the CEO got paid and trying to explain all of it.
3. You know how companies have different schemes for granting equity, including type and timing. If the rules tend to try to fit everyone into a narrow bucket in order to try to line everyone up for comparability, and a company’s program doesn’t quite fit neatly into it, then the disclosure can get even more complicated.
4. There are two elements: compensation and financial performance. What is meant by “financial performance” for example? Maybe the SEC will just ask for stock price, maybe they’ll go broader.
5. A tricky part likely will be the explanation of what it all means—and how it works with the Summary Compensation Table.
6. I don’t think it will be difficult to produce the “math” showing the relationship of realized/realizable pay relative to TSR and other financial metrics, so long as:
– There’s a tight definition of realized pay
– We know what period to measure TSR (and if multiple periods can be used)
– We know what other performance measures can be included (if any) and if they can be as prominent in the disclosure as TSR
7. Another area of potential difficulty is explaining why there is not a tight or tighter correlation with TSR (“we use metrics other than TSR to drive our compensation; thus, the correlation is not very strong; on the other hand, our compensation is based on Revenue Growth and EBITDA Margin, and as Exhibit II demonstrates, the correlation is very significant”).
In addition, Dodd-Frank has no requirement for a relative ranking, and companies will need to decide if TSR and Pay should be put in some type of relative context (“relative to our peers, our realizable pay was well below the peers; so even though compensation is not tightly aligned with stock price performance the last 3 years, we did not pay our bums very much).
8. I think what may be the most difficult to address is a requirement to discuss what the Compensation Committee plans to change—and why is it now that it has performed the analysis?
Let’s Make It a Dime; Here’s My Two Cents
I’m not sure that the problem with executive compensation is that companies aren’t disclosing enough information about it. Isn’t this what the CD&A is for? Isn’t this why the stock performance graph is included with the executive compensation disclosures?
Moreover, does anyone think that any company will just come out and say that their executive compensation is not based on or tied to company performance in any way? I’m just not sure that public companies need one more disclosure to try to convince their shareholders that the amount of compensation they are paying to their executives is justified by the company’s performance.
In somewhat of a surprise announcement, last week the SEC proposed rules to implement the requirement under the Dodd-Frank Act that companies disclose their policies with respect to hedging by employees and directors.
This Has Nothing to Do With Yard Work
Hedging is a means by which investors protect themselves against downside risk—think “hedging your bets.” This is all well and good for the average investor, but when the investor in question is an officer or director of the company who has received compensatory awards of stock and/or options, hedging can be problematic. Companies grant equity awards to align their officers and directors with shareholders and to motivate them to increase the value of the company’s stock. If the officers and directors can use hedging instruments to protect themselves from downside risk, they might be less motivated by their equity awards.
Likewise, where a company has implemented ownership guidelines, if officers and directors can hedge against the stock they own to comply with the guidelines, then the guidelines aren’t terribly effective because officers and directors haven’t really assumed the risk of ownership.
More Controversial Than You Might Think
The proposal was issued via written consents of the Commissioners, rather than an open meeting, which is why it caught many of us by surprise. An open meeting would have been announced in advance and people that follow the SEC’s meeting schedule would have known it was happening.
I thought that this ought to be relatively simple—essentially, “disclose your hedging policy”—especially since companies are already doing this for their NEOs in the CD&A. But I guess nothing that the SEC does is very simple; the proposing release is 103 pages long. That is, however, shorter than the CEO pay ratio disclosure proposal, which clocked in at 162 pages.
Part of the complexity is that there are virtually an infinite number of possible types of arrangements and instruments that can be used to hedge a financial position. Complicated strategies like equity swaps, variable prepaid forward contracts, and collars (in case you are wondering, I have no idea what any of these things are, except that I do know that an equity swap is not the same thing as a swap exercise) and more straightforward transactions such as a short sale (I know what that is: a short sale is selling stock you don’t own yet—you are hoping the stock price will decline before you have to buy the stock to close out your position).
The SEC requests comments on a number of matters related to the rules, including:
Should the disclosure apply to all employees (the language included in Dodd-Frank) or just officers and directors (the individuals investors are probably most concerned about when it comes to hedging)?
Should the rules be part of corp governance disclosures under Reg S-K Item 407 or part of the Say-on-Pay disclosures under Item 402? The proposal includes them under Item 407, which means that shareholders technically aren’t voting on them as part of Say-on-Pay.
Types of equity securities that should be subject to the disclosure.
Should companies be required to disclose hedging activities that employees, officers, and directors have engaged in?
Should smaller reporting companies or emerging growth companies be exempted from making the disclosure or subject to a delayed implementation schedule?
Comments should be submitted to the SEC by April 20, 2015.
Cooley’s blog has a nice summary of the proposal, if you don’t want to read all 103 pages.
It’s been a while since I posted a stock compensation grab bag. Here are a few recent developments that don’t warrant their own entry but are still worth knowing about.
HSR Filing Thresholds
Good news: now executives can acquire even more stock! Under the Hart-Scott-Rodino Act, executives that acquire company stock in excess of specified thresholds are required to file reports with the Federal Trade Commission and the Department of Justice. The thresholds at which these reports are required have increased for 2015. See the memo we posted from Morrison & Foerster for the new thresholds, which are effective as of February 20, 2015.
If you have no idea what I’m talking about, check out our handy HSR Act Portal.
Final FATCA Regs
The Foreign Account Tax Compliance Act (FATCA) requires employees to report any overseas accounts that hold specified foreign financial assets, which could be interpreted to include stock awards issued by non-US corporations. The assets (stock awards, for our purposes) are reported on IRS Form 8938 (“Statement of Specified Foreign Financial Assets”), which is filed with the annual tax return. Final FATCA regulations, released in December 2014, clarify that unvested awards, do not need to be reported on Form 8938 until they have “substantially vested” (except in the case of a Section 83(b) election).
Dodd-Frank Rulemaking Update
The SEC has pushed back its agenda of rulemaking projects under the Dodd-Frank Act. The proposed rules for clawback requirements, disclosure of hedging policies, and pay-for-performance disclosures and the final rules for the CEO pay ratio disclosure have been pushed back to October 2015 (just in the time for the 23rd Annual NASPP Conference). This is despite comments from SEC Chair Mary Joe White last fall that the SEC was pushing to issue the final CEO pay ratio rules by the end of year. That’s a big delay—from the end of 2014 to October 2015—especially given the pressure on the SEC to issue these rules.
Section 83(b) Election Update
When making a Section 83(b) election, employees are required to include a copy of the election with their tax return for the year in which the election is made. In PLR 201438006, the IRS ruled that a Section 83(b) election was valid even though the taxpayer failed to attach a copy of the election to his Form 1040. If the failure had invalidated the election, employees could effectively revoke the election by “forgetting” to include it with their tax return—and, as we all know, Section 83(b) elections are irrevocable once the deadline to file them has elapsed.
I’ve been listening to the recordings of the sessions at the 22nd Annual NASPP Conference. And frankly, I’ve been surprised—pleasantly surprised by how much I’ve learned. All of the sessions I’ve listened to have been very enlightening, even the ones where I thought I already knew everything on the topic.
Take the session on pay-ratio disclosure. I wasn’t really sure how interesting this session would be, since the rules haven’t been finalized yet. I mean, really, how much could there possibly be to talk about? But it turns out that the panel had a lot to say and all of it was very interesting. So for today’s blog entry, I feature five things I learned from listening to the panel, “Pay Ratio (& Other Issues): Pointers from In-House.”
1. Run a Test Calculation.
If you haven’t already, you really should perform a test of how you will calculate your CEO pay ratio. It might prove to be harder than you expect. Patty Hoffman-Friedes of Seagate Technology noted that they actually didn’t get very far in their test, but they are now much more prepared for the final calculation. Things you haven’t thought about come to light. Patty noted that Seagate provides shoes to employees in China and they had to think about whether those should be included in compensation.
2. How Will the Ratio Be Used?
The panel spent some time discussing how the ratio will be used by ISS and investors. Although it isn’t clear how ISS will use the disclosure, everyone felt that they will eventually use it. But, as Patty noted, perhaps the bigger question is how the NY Times will use the disclosure.
Stacey Geer of Primerica brought up a concern that hadn’t occurred to me: how employees will react when they realize they are below the median. Valerie Ho from ICF explained that she is planning to educate her HR business partners on the ratio, so that they can be prepared to address employee inquiries. She will also be looking to them for feedback on what employees are saying about the ratio.
3. Your Peers Are the Wildcard.
As moderator Barry Sullivan of Semler Brossy noted, the first year the rules are in effect will be a little bit like the Wild West. Everyone will have to decide on an approach and draft their disclosure without really knowing what their peers will be doing and how their ratio will compare to that of their peers.
Panelists recommend using your outside advisors—attorneys and compensation consultants—for a sanity check, since they will at least have some insight into trends and practices among their clients. Ask for feedback on your methodology and help with drafting the disclosure.
4. Year-Over-Year Comparisons Are Likely to be a Challenge.
Several panelists noted concerns about how much variation will exist in the results from one year to the next. If the median employee shifts from the United States to another country, if the company acquires another company, if there is a significant reduction in force, if a new CEO steps in—all of these events, and lots more, could cause significant year-to-year variability in the ratio, which could be confusing for investors and the media. Before you decide on a methodology, make sure you run comparisons of the results for the past several years, so you can get a feel for how much the number changes from one year to the next. And keep this potential for variability in mind when drafting the disclosure.
5. Thorough, Accurate, Ease of Calculation, Reliable, and Reproducible (and Defensible)
The panel touched on the various approaches companies can take to find the median employee. Primerica has 1800 employees located in the US and Canada; Stacy Geer can download W-2 income to a spreadsheet and calculate the median in about ten minutes. But fellow panelist Charles Grace of EMC—with 60,000 employees in 75 countries and upwards of 30 payroll systems—has a much more involved decision-making process. Include all employees in the calculation or use statistical sampling? What compensation to include? Patty Hoffman-Friedes noted that the range of approaches Seagate is considering could involve using salary, using actual wages earned, including benefits, or including all elements of compensation (even shoes for those employees in China).
Patty explained that Seagate has five touchstones that they are using to evaluate the methodologies: thoroughness, accuracy, ease of calculation, reliability, and reproducibility. Barry Sullivan noted that a sixth is defensibility. I think these are great touchstones for any company to consider as it decides on a methodology.
On September 18, the SEC proposed highly anticipated rules governing the ratio of CEO to median employee pay that public companies will be required to disclose in their proxy statements. In today’s blog, I provide a summary of the proposed rules.
Background
We’ve known this was coming since the Dodd-Frank Act was signed into law. The Act requires the SEC to adopt rules mandating that public companies disclose the ratio of CEO pay to that of the median pay of all other employees (see my blog entry “Beyond Say-on-Pay,” August 5, 2010). It’s taken a while for the SEC to propose the rules because, well, it’s a complicated topic and the SEC has a lot on its plate these days, including a host of other rulemaking projects under Dodd-Frank and the Jobs Act, not to mention investigating Rule 10b5-1 plans.
You Win Some
The Act requires that the ratio of CEO pay to median employee pay be based on “compensation” as defined for purposes of the Summary Compensation Table. So, in a worst case scenario, you could have had to prepare an SCT for all employees just to figure out the median employee compensation.
And, if you want, you can certainly still do that. But, for most companies, it’s about all they can do to put together the SCT for the 5+ execs for whom disclosure is required. So, instead, the proposed rules allow companies to figure out which employee represents the median based on any consistent, systematic method (e.g., based on W-2 income), then determine only that employee’s compensation as per the SCT. The pay ratio disclosure would then simply be the CEO’s pay as compared to the pay of the one employee that represents the median.
You Lose Some
That was the good news. The bad news is that the SEC has interpreted “all employees” to be literally all employees. That includes part-timers, seasonal, and temporary employees, and both US and non-US employees employed as of the last day of the company’s fiscal year. Pay for employees that were hired during the year can be annualized, but annualization is not permitted for seasonal or temporary employees. Likewise, location-based cost-of-living adjustments or full-time adjustments for part-time employees are not permitted.
More Information
For more information, see the NASPP Alert “SEC Proposes CEO Pay Ratio Disclosure Rules.” The proposed rules were issued just days before the NASPP Conference, so speakers at the Conference were able to address them during their presentations. In particular, Keith Higgins, the Director of Corporation Finance at the SEC, discussed the proposed rules in his keynote during the Proxy Disclosure Conference, and Mike Kesner of Deloitte provided a tutorial on the proposed rules in the session “Pay Disparity Workshop & How to Ensure Your Pay Practices Pass.” You can purchase the video of the Proxy Disclosure Conference or purchase the audio for Mike’s session.
Comments on the proposed rules can be submitted to the SEC until December 2, 2013.
On January 16, the SEC approved the new NYSE and NASDAQ listing standards relating to compensation committee independence. As noted in the NASPP’s alert on the original proposals (“Exchanges Issue New Standards for Compensation Committee Independence“), the new standards include three primary requirements:
The compensation committee must be comprised of independent directors, based on a number of “bright line” tests (many of which were already applicable to independent directors under each exchange’s prior listing standards) as well as additional factors that the SEC suggested should be considered in determining a director’s independence. Also, NASDAQ will now require a separate compensation committee (the NYSE already required this).
The compensation committee must have authority and funding to retain compensation advisors and must be directly responsible for appointment, compensation, and oversight of any advisors to the committee.
The committee must evaluate the independence of any advisors (compensation consultants, legal advisors, etc.).
The final rules make only a few minor changes to the original proposals, including clarifying that the compensation committee will not be required to conduct the required independence assessment as to a compensation adviser that acts in a role limited to:
consulting on a broad-based plan that does not discriminate in favor of executive officers or directors of the company, and that is available generally to all salaried employees; or
providing information (such as survey data) that is not customized for a particular company or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.
Public companies now need to assess whether the compensation consultants and other advisors engaged by their compensation committee raise any conflicts of interest and disclose any identified conflicts in their proxy statement (for annual meetings after January 1, 2013 at which directors will be elected). Although not required, where no conflict of interest is found, we expect that many companies will include a disclosure to indicate this.
In his Proxy Disclosure Blog on CompensationStandards.com, Mark Borges of Compensia highlights a recent disclosure on this topic in Viacom’s proxy statement, which might be useful to review as you draft your own disclosure (if this isn’t your gig, perhaps you can score some points by forwarding it on to the person that will be drafting this disclosure).
And now for something a little lighter: a video by the blog Cady Bar the Door on the whistleblower provisions of the Dodd-Frank Act. I know you don’t care about the whistleblower provisions, but you should watch the video anyway. It might make you feel better about your own company’s general counsel.
BTW–if you think this would be a cool format to use for educating employees, you can make your own Xtranormal video. Just pick your characters, type in your dialogue, and Xtranormal does the rest. You can make at least one movie, probably more, for free.
Here’s your NASPP To Do List for the week:
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
Submit a question for the Question of the Week Challenge to be entered in a raffle for a free registration to the CEP Symposium (see last week’s NASPP To Do List for more information).
Register for our spring 2013 online Stock Plan Fundamentals program. Don’t wait–the early-bird rate is only available until February 15.
Order the audio from the 20th Annual NASPP Conference! Just $65 per session for NASPP members–less per session if you purchase a multi-session package.
Last week, the SEC issued final rules requiring US exchanges to adopt listing standards on the independence of compensation committee members and the use of compensation advisors by said committees.
I don’t have a lot to say about these rules because they don’t directly relate to stock compensation. Sure, the compensation committee typically has authority over the company’s stock plans and changing who sits on the committee and which advisors the committee relies on could have implications for the company’s stock plan, but there’s nothing specific to stock compensation in the rules. And, let’s face it, for purposes of this blog, there are only two categories of stuff: 1) Stock compensation and things that explicity impact it and 2) Things I don’t care about. But, despite that fact that the new rules seem to fall into category #2, it is a current development that, at least peripherally impacts our world, so I figured a blog entry might be in order.
Rules to Create Rules
The final rules issued by the SEC are 124 pages (and no, I haven’t read them all–see #2 above–but I did read a nifty summary by Morrison & Foerster). What strikes me is that here we have 124 pages of rules, but these aren’t actually the real rules yet. These rules just direct the exchanges (Nasdaq, NYSE) to adopt the rules. They don’t even tell Nasdaq and the NYSE what the rules should be, they just suggest things that should be considered in creating the rules. The exchanges now have around 90 days to propose the actual rules, which presumably will be subject to comment (although the SEC rules were already subject to comment) and then eventually the actual, final rules will be adopted. Just an observation, not a criticism of the SEC–they are just doing what they were instructed to do under Dodd-Frank.
Three Independence Standards
The rules require the exchanges to adopt rules requiring compensation committee members to be independent, taking into consideration sources of compensation paid to directors and any relationships directors have with the company or its officers. If you’re thinking that this sounds familiar, you’re right. For purposes of Section 16, most companies maintain a committee of two or more “nonemployee” directors and for purposes of Section 162(m), companies also ensure that the members of that committee are “outside” directors. Now the committee members will also have to be “independent” under the listing standards the exchanges adopt. My guess is that they aren’t going to just adopt the Section 16 or 162(m) definition (which are similar to each other but just different enough to be confusing) and that we’ll have a third standard to comply with.
Compensation Advisors
The rules also stipulate that the exchange listing standards require that compensation committees have sole authority to engage advisors (compensation consultants and/or attorneys) and that company provide funding to the committee to pay the advisors. The rules specify a number of independence factors that the exchanges are to direct compensation committees to consider when engaging advisors. The rules don’t preclude the committee from receiving advise from non-independent counsel or consultants (e.g., the company’s in-house or outside legal counsel).
Compensation committee reliance on independent advisors has been a best practice for many years now; I suspect that many companies already have practices that partially or fully comply with this requirement. Even so, given that the advisors your compensation committee hires are likely to be making recommendations on stock compensation issued to executives, it’s something to be aware of. See topics #1 and #2 in our recent webcast “Ten Equity Compensation Issues That Affect All Stock Plan Professionals (That No One Told You About).”
Disclosures
The final rules also update the disclosures companies are required to make with respect to compensation consultants, expanding the factors that must be considered in evaluating the independence of the consultants.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
Since it is a holiday week, I have a couple of lighter topics for my blog entry.
Behind Every Half-Baked Law Is an Over-Sensationalized Cause In his May 21 Compensation Blog entry on CompensationStandards.com, Mike Melbinger of Winston & Strawn states “…nearly every bad law in the field is the result of Congressional or agency reaction (or overreaction) to some widely publicized occurrence.” To prove it, Mike created a game in which readers can match each half-baked law (Mike’s phrase) with its cause. So you can join in on the fun, I’ve reproduced it here. Match the law on the left with its cause on the right.
Law
Cause
1. 280G
A. Enron executives
2. 409A
B. Change in control payments made to Bill Agee of Bendix in 1982
3. AMT
C. 2007 World Financial Crisis (Wow, was it really that long ago? Shouldn’t my investments have recovered by now?)
4. Dodd-Frank Act
D. Enron, Worldcom, Anderson
5. SOX
E. Treasury Secretary Joseph Barr testifies that, in 1967, there were a total of 155 individuals with incomes over $200,000 who did not pay any federal income taxes; twenty of them were millionaires.
10 pts to anyone who gets all five right. Answers next week.
Deal Cube Wars I’m not quite sure what a deal cube is–I guess it is some sort of souped-up paperweight given to lawyers to commemorate a deal they worked on–but that hasn’t stopped me from enjoying the Deal Cube Tournament that Broc Romanek is running in his blog on TheCorporateCounsel.net. Check out the cubes (he’s gotten readers to send in pictures of over 130 of them) and vote for your favorites. Some of them are quite clever. Broc’s blog is available for both subscribers and nonsubscribers, so anyone can join in on the fun.
Don’t Miss Out: Conference Early-Bird Expires on Thursday The early-bird rate for the 20th Annual NASPP Conference expires this Thursday. You can see by the program that this is going our most informative Conferences ever. You’re going to want to be there, so make sure you register by Thursday to save on your registration.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
Register for the 20th Annual NASPP Conference in New Orleans. Don’t wait, the early-bird rate is only available until this Thursday, May 31.