Just when you thought you were finally getting a handle on the executive compensation disclosures, the SEC is considering changing them. According to an alert by McGuireWoods, the SEC staff has reviewed the disclosure requirements of Reg S-K (all of them, not just the disclosures relating to executive compensation) and issued a report that includes recommendations for further review. The JOBS Act of 2012 (not to be confused with the Jobs Creation Act of 2004) required the study with respect to disclosures by emerging growth companies, but the SEC expanded it to cover all companies.
The staff’s recommendations with respect to the executive compensation disclosures are fairly vague; they point out that these disclosures can be quite lengthy and technical and further review might be warranted on this basis, as well as to confirm that the information disclosed is useful to investors. The staff also suggests that the disclosures be reviewed to determine if they need to be made simpler for smaller companies.
So maybe the disclosures will change and maybe they won’t. According to the report, there weren’t any comments submitted to the SEC’s JOBS Act website on the executive compensation disclosures. Interestingly, there were two comments suggesting that the table disclosing the number of shares outstanding and available for grant under stock plans approved by shareholders and not approved by shareholders could be eliminated (and one comment that this table shouldn’t be eliminated, proving once again that you can’t please all the people, all the time).
According to McGuireWoods, at this time, the SEC is still formulating an action plan with respect to the study; a time frame hasn’t been specified for completing any further reviews called for under the study, much less promulgating and transitioning to any new rules.
Did You Know?
I did learn a couple of interesting tidbits when reading the section of the SEC’s report that covered the executive compensation disclosures. I thought you might be interested to know that:
The executive compensation disclosure rules have been amended more often than any other rules for disclosures required under Reg S-K.
The executive compensation disclosures, albeit in a very different format, have been around since the very first registration statement (Form A-1) implemented in 1933.
Back in 1933, the disclosure was required for any directors, officers, or other persons earning in excess of $25,000. This seems like a pretty low threshold, but then I ran the amount through the Bureau of Labor Statistic’s inflation calculator. In today’s dollars, that’s around $450,000.
In 1972, the threshold for disclosure was increased to compensation in excess of $40,000. According to the inflation calculator, that’s around $223,000 in today’s dollars.
It wasn’t until 1992 that the threshold was increased to $100,000. In today’s dollars, that’s about $166,000. $40,000 in 1972 was the equivalent of about $134,000 in 1992, so my guess is that we have a ways to go until the SEC decides to increase the threshold again.
ISS has proposed changes to its corporate governance policy for 2014. You have until November 4 to comment on the changes.
What’s Changed?
In terms of stock compensation, or even compensation in general, not much. So the good news is this maybe isn’t something you have to spend a lot of time on this year and I can have a short blog entry today. Of course that’s also the bad news–things aren’t going to get any better next year in terms of the restrictions ISS places on your stock compensation program.
Evaluating Alignment of Pay to Performance
The only proposal that relates directly to compensation that ISS is looking at changing is the Relative Degree of Alignment (RDA) measure, which compares the difference between a company’s TSR ranking and its CEO’s pay ranking among its peers. For example, if the company’s TSR ranks in the 25th percentile among its peers (meaning that the company’s TSR is better than only 25% of its peers) and its CEO’s pay is in the 75th percentile (i.e., the CEO’s pay is more than 75% of his/her peers), ISS might be concerned that there is a pay for performance misalignment. This is just one of several measures ISS uses to assess whether CEO pay aligns with company performance.
Currently ISS calculates RDA on a one-year and three-year basis. They are proposing to eliminate the one-year calculation and instead consider only three-year RDA. If your RDA score has been trending downwards, you are probably pleased as punch about this; if your RDA score has been trending upwards, you are probably a little less thrilled (but what goes up most come down and, under the proposed calculation, if you do have a down year, that year won’t impact your RDA score as much).
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.
NASPP: What is the most critical thing NASPP Conference attendees need to know about your topic?
Wendy: Proxy strategy is not one size fits all, and smaller companies–whether small reporting companies, emerging growth companies, or mature small cap companies–may have to work harder, and more creatively, to communicate their compensation message. Smaller companies face very different compensation issues than larger cap companies, including:
Delivering equity compensation value when stock price is less than a few dollars and the stock is thinly traded or volatile,
Creating meaningful cash-based performance incentives when budgets are tight, and
Recruiting in a talent pool that includes both pre-IPO and large cap executives.
Smaller companies must then craft an individual approach to communicating their decisions in the proxy, given the scaled down reporting rules applicable to SRCs and EGCs, the different shareholder base who will be reading the proxy, and the tests designed by proxy advisory services that don’t account for the special circumstances of small cap companies. This panel has first hand experience helping smaller public companies make the hard decisions on compensation design, understand the reporting optics of these decisions, and then effectively communicate these decisions in the proxy and in pre-meeting shareholder outreach campaigns.
NASPP: What common mistake do companies make and how can they avoid it?
Wendy: Smaller public companies often feel compelled to use buzz words like “performance” or follow the compensation decisions or disclosure practices of other companies who are current or perhaps aspirational peers. In doing so, smaller companies lose the real message of their program and sometimes come across as talking the talk but not walking the walk. To have a meaningful proxy disclosure, the compensation team must be willing to have open, frank, fully informed discussions with management and the board, providing information beyond benchmark numbers and statistics on the frequency of a given policy or disclosure. At the time compensation decisions are made, smaller companies must consider how their decisions will be viewed not only one or two years from now but as part of a longer term trend of the direction of their executive compensation program.
NASPP: What is the silver lining to your topic?
Wendy: Compensation strategy is like a giant ocean liner. Rarely is it too late to avoid the iceberg ahead–but it does take time, good tools, and lots of preparation to steer the ship onto a different course.
NASPP: Tell us three things people don’t know about you.
Wendy:
After law school, I drove in an 18-wheeler cab–without a trailer attached–from Seattle to Banff, and the Canadian border patrol didn’t know what to make of it.
I learned freestyle wrestling in college from US Olympic team members as a club sport and I can still perform a headlock-hiptoss (although I risk throwing out my back at this point).
I still remember, from my 9th grade final exam, and can sing a glowing rendition of “La Marseillaise” in French. But I can’t remember how to order dinner or have even a basic conversation.
Realizable pay has quickly emerged as a hot topic for this proxy season. In today’s blog, I offer a few thoughts on realizable pay as it relates to stock compensation.
Why Realizable Pay?
Realizable pay has emerged as a method for evaluating whether executive pay aligns with company performance. It’s an alternative to comparing company performance to total pay as disclosed in the Summary Compensation Table. For equity awards, pay is disclosed in the SCT at grant and is based on the grant date fair value. Arguably, the pay disclosed in this table is for future performance, not current performance. Also, the grant date fair value is not necessarily a predictor of how much compensation execs will actually receive under the arrangement.
Realizable pay, however, is based not on grant date fair value but on the current value of the company’s stock. Thus, where equity awards are a significant component of executive pay, realizable pay can make for a more compelling story for shareholders: high levels of realizable pay are likely the result of an elevated stock price, which in turn probably means that the company is performing well. On the other hand, poorly performing companies have lower stock prices, resulting in underwater stock options and low levels of realizable pay.
What Is Realizable Pay?
Realizable pay is not a mandated disclosure, so there is no standard definition for it. Generally, it can be expected to include cash compensation paid during the year, plus the intrinsic value of options and awards held by the executive. But, of course, it’s more complicated than that.
Which awards/options? Awards typically vest and pay out in three to four years, but options can be outstanding for up to ten years. The standard that is emerging seems to be to include only options and awards granted within a specified period (e.g., three years). The idea is that the grants that are generating the company’s current performance are the ones made in recent years; grants made earlier generated performance in an earlier time frame.
Vested and Unvested? Technically, executives can really only realize the value of options and awards that are vested. Most companies, however, seem to include both vested and unvested options and awards in realizable pay.
Performance Awards? Where execs hold performance awards, a decision also need to be made as to whether to include these awards at threshold, target, or maximum. These awards could also be included at the level at which they are currently expected to pay out, but companies may be uncomfortable with this approach as it potentially signals management’s expectations as to future company performance.
When Is Realizable Pay Not Realizable?
When ISS calculates it, of course. ISS includes the current Black-Scholes value of options in realizable pay, rather than just their intrinsic value (see “Proxy Advisor Policies for 2013,” November 27, 2012). The Black-Scholes value is generally always going to be higher than the intrinsic value (think fast: ten points if you can name two situations where the Black-Scholes value would not be significantly higher than intrinsic value), so this has the effect of increasing the pressure to outperform peers.
Last week, on April 5, President Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. Intended to make it easier for startups to raise capital and go public, JOBS has three primary thrusts: 1) making it easier to raise capital (including “crowdfunding” and unregistered offerings), 2) making it easier for companies to go public, and 3) making it easier for newly public companies to be public (e.g., reduced public reporting). Today I begin looking at the provisions of JOBS that are relevant to stock compensation.
Reduced Disclosures for EGCs
JOBS creates a new category of company, an “Emerging Growth Company.” An EGC is essentially a company with less than $1 billion in revenues that is private or has been public for less than five years (I’m simplifying this, there are a couple of other requirements). In addition to provisions designed to encourage investment in EGCS and allow them to explore an IPO without filing a public registration statement, JOBS also reduces the public disclosures and reporting EGCs are subject to.
In the context of compensation, EGCs are allowed to comply with the executive compensation disclosures required for smaller reporting companies (companies with a public float of less than $75 million or, if unable to calculate public float, revenues of less than $50 million). This results in the following changes to their disclosures:
Disclosure for only top three, rather than top five, NEOs
No CD&A
Only two years reported in Summary Compensation Table
Fewer tabular disclosures: only the SCT, Outstanding Equity Awards at Fiscal Year-End Table, and Director Compensation Table
Dodd-Frank “Light”
EGCs also don’t have to comply with some of the provisions of the Dodd-Frank Act, including:
Say-on-Pay, et. al.
CEO pay ratio disclosure
Disclosure relating executive pay to company financial performance
Of course, right now, there aren’t any companies required to comply with the CEO pay ratio and executive pay for performance disclosures because the SEC hasn’t promulgated rules on these yet. JOBS only adds to the long list of SEC rule-making projects and I’ve read speculation that the SEC won’t make the deadlines under JOBS because of Dodd-Frank and other rulemaking projects that are still outstanding.
I also find it ironic that, just 21 months after Congress decided that shareholder advisory votes on executive compensation were a critical component of an effective corporate governance system, that policy has now taken a back seat to other considerations when it comes to recently-public companies.
Finally, I can’t quite get my head around the reasoning for exempting emerging growth companies from the CEO pay ratio requirement. It was my understanding that the complaints of the business community that the provision is too burdensome were falling on deaf ears in Congress. Yet, it appears that Congress has just decided that the provision is too burdensome for newly-public companies – a group that, ostensibly, doesn’t face the same compliance challenges of large, global companies.
Stay tuned; next week I’ll discuss the new shareholder thresholds for required registration.
NASPP Conference Early-Bird Rate Ends on Friday The early-bird rate for the 20th Annual NASPP Conference ends this Friday, April 13. This rate will not be extended, so don’t wait any longer to register.
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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 NASPP’s newly updated online Stock Plan Fundamentals program–don’t wait; the first webcast is this Thursday.
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