Ownership guidelines (i.e., policies that place requirements on how many or how long shares of company stock are held by executives) are a way of ensuring that executives have an adequate amount of “skin in the game” when it comes to the long-term success of the company. Equity compensation for executives inherently boosts a personal interest in the company’s growth–the higher the stock price, the higher the reward. However, it can also come with the risk that executives may be prone to more high-stakes behavior that results in short-term returns instead of long-term growth.
Much of the legislation and regulations that has been introduced or finalized over the past year has incorporated some component of risk management and/or “Say-on-Pay.” I suspect that this will result in not only more companies that initiate some form of stock ownership guidelines, but also change the type of policies that we see. Companies must disclose any existing stock ownership policies–shareholders are likely to be on the look for them as they prepare to vote for or against executive compensation.
Types of Ownership Policies
There are basically two ways in which a company can regulate share ownership: how much and how long. This study, published on the 13th by Frederic W. Cook & Co, shows that the most popular policy to be a straight-forward “how much” approach: requiring the executive to hold a minimum amount of shares based a value equal to a multiple of cash salary, a specific number of shares, or a percentage of net profit shares. Unfortunately, this “traditional” ownership policy alone doesn’t necessarily provide the long-term focus that shareholders are looking for, especially if executives may simply leave the company and cash out.
Imposing a holding period on exercised/vested shares extends the amount of time executives are impacted by strategic decisions they make today. Holding periods are typically placed on a percentage of the net shares from transactions. They may range from one year from the transaction date to a period after retirement/termination. (The most popular holding period found in the Frederic W. Cook & Co. study was one year–I’m curious to see what next year’s study will show.)
RiskMetrics Group
The RiskMetrics Group launched its Governance Risk Indicators TM (GRId) in March of this year. The rating system in the GRId supports both types of ownership policy, with the highest score going to policies that require a value of shares at 6x salary to be held and a holding period on at least 50% of net profit shares that goes to or beyond retirement/termination.
7th Annual Executive Compensation Conference
If you’ll be in Chicago next week for our 18th Annual NASPP Conference, you’ll have plenty of opportunities to take in great sessions on risk management & “Say-on-Pay”. Also, don’t forget that your registration to the NASPP Conference includes access to the 7th Annual Executive Compensation Conference, which boasts a special “Say-on-Pay” track of panels and sessions addressing executive and director share ownership policies.
If you can’t make the Conferences in person, or you find that you are torn between multiple sessions, don’t forget that we will be recording all the sessions. You will be able to purchase the recorded webcasts individually, as a custom package of five sessions, or get access to the entire set. Even better, it’s not too late to take advantage of the 10% discount!
Last Tuesday, I blogged about the Say-on-Pay provisions of the Dodd-Frank Act, but the Act includes a number of other corporate governance provisions that are of interest to stock plan professionals. Luckily, the presentation I attended by Mike Andresino of Posternak Blankstein & Lund and David Wise and Sara Wells of Hay Group at the Silicon Valley NASPP chapter meeting covered these aspects of the Act as well.
The Dodd-Frank Act: More Than Say-on-Pay The Dodd-Frank Act is very broad in scope, with banking legislation and consumer protections as well as regulating private placements and private investment funds–that’s nice to know, but we don’t really care about any of it for purposes of this blog. I want to focus on the areas of the Act that are likely to intersect with my readers’ job responsibilities.
Internal Pay Equity
As I noted in my June 29 blog, the Act requires companies to disclose the ratio of CEO pay to the median pay of all other employees. I understand that the jury is still out on how this ratio will actually be computed–preparing a Summary Compensation Table for all employees just to calculate their median pay may not be feasible–but, regardless, this disclosure is likely to cause a lot of consternation (David Wise pointed out that it was a top focus of the business lobby). The definition of all employees could include employees in overseas operations, including, say, manufacturing plants in countries where wages are considerably lower than in the United States. We are only beginning to contemplate the implications of this disclosure.
Relationship of Pay to Performance
Companies will be required to disclose the relationship of executive compensation to corporate financial performance. Like Say-on-Pay, this is another provision that I naively thought we already had–i.e., the performance graph in the executive compensation disclosures. Silly me. As Mike Andresino pointed out, the Act doesn’t limit the disclosure to just the top five NEOs, so this “pay for performance” disclosure could be quite a bit more work to put together than the performance graph.
According to a Pearl Meyer & Partners memo on the Act that we’ve posted in the NASPP’s Say-on-Pay Portal, there are lots of issues to resolve for this requirement, including which “executives,” what “compensation,” what “financial performance,” the time period the disclosure covers, and whether the disclosure is on an aggregate or individual basis (or by component of compensation–imagine what fun that would be to put together).
Clawbacks
The Act expands the requirements for companies to adopt clawback policies for compensation paid to executives beyond what was required under Sarbanes-Oxley. According to the NASPP’s 2010 Domestic Stock Plan Design Survey (co-sponsored by Deloitte), only 32% of respondents have clawback policies for stock compensation and of those that don’t, only 20% are considering adding one. That’s going to have to change.
Broker Non-Votes
The Act requires the SEC to direct the stock exchanges to prohibit brokers from voting uninstructed shares for director elections, executive compensation matters (e.g., Say-on-Pay), and any other significant matter (brokers are already prohibited from voting uninstructed shares on matters relating to stock plans).
This doesn’t leave a whole lot that brokers can vote uninstructed shares on. Mike Andresino pointed out that if there’s nothing in the proxy that brokers can vote on without instruction, companies may have problems achieving a quorum at shareholder meetings.
Compensation Committees
The Act requires the stock exchanges to establish new independence standards for compensation committee members. In addition, the committee must have the ability to retain its own independent (per standards to be determined by the SEC) comp consultants, legal counsel, and other advisors.
18th Annual NASPP Conference Scheduled for Sept 20-23, the 18th Annual NASPP Conference is timed perfectly to help our members prepare for mandatory Say-on-Pay and all of the other executive pay reforms required under the Dodd-Frank Act. Just announced–we’ve added a special Say-on-Pay track, featuring key advice and real-world strategies from in-the-know practitioners. Register for the Conference today.
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 I keep an ongoing “to do” list for you here in my blog.
Tune in next Tuesday, August 10, for the NASPP webcast highlighting the results of the 2010 Domestic Stock Plan Design Survey (co-sponsored by Deloitte, survey support provided by the CEP Institute). There’s sure to be some surprises!
Refer new members to the NASPP so you qualify for the August raffle and Conference discount available through our New Member Referral Program.
Don’t miss your local upcoming NASPP chapter meetings in Boston, Chicago and Michigan. In addition, the San Francisco chapter is hosting its annual all-day program at the bucolic Wente Vineyards on August 11–I’m looking forward to it and hope to see you there.
Last Wednesday, July 21, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law, making Say-on-Pay votes mandatory for all public companies in the United States.
The New Say-on-Pay Vote When I first heard the phrase “Say-on-Pay,” I naively thought to myself, “What’s so new about that; haven’t we had “Say-on-“Pay” for stock compensation since 2003, when the NYSE and NASDAQ implemented rules requiring listed companies to submit virtually all stock plans to a shareholder vote?” Well, on Thursday of last week, I had the good fortune to attend the Silicon Valley NASPP chapter meeting, where Mike Andresino of Posternak Blankstein & Lund presented a summary of the new rules, along with David Wise and Sara Wells of Hay Group. In today’s blog, I present some of Mike’s comments regarding how these new rules differ from current law and practices.
What Exactly Are Shareholders Voting On?
Despite my initial oversimplification, this is actually a sea change for executive compensation in the United States. Shareholders will be voting on all compensation paid to NEOs, as disclosed in the proxy–cash bonuses, individual awards, exercise and award transactions, perks (including use of corporate aircraft)–the whole shebang. And it’s an all or nothing vote–a little scary when you think about it. If shareholders are really irritated about that huge award payout the former CEO received under his severance agreement when he left last year, they might express their displeasure by voting against all of this year’s executive pay. One grant or award transaction by an exec (or one perk) that is particularly irksome to shareholders and there goes the whole Say-on-Pay vote. There is some concern that shareholders may even use the Say-on-Pay vote to express displeasure over company practices or policies that have nothing to do with executive compensation.
Advisory Vote
Of course, it is just an advisory vote, so if shareholders do vote against executive pay, the company isn’t left unable to pay executives over the coming year. (Unlike votes on stock plans, which are NOT advisory–if shareholders vote down your stock plan, that means no more stock plan.) But I expect that most companies that receive a majority (or even a large percentage) of votes against their executive pay will be forced into a dialogue with shareholders to address their concerns (especially since the Dodd-Frank Act also gives shareholders the right to add their own director candidates to the proxy).
Frequency of Vote
And with shareholder approval of stock plans, the company has control over how often it puts a plan to a shareholder vote. With a large share reserve, an evergreen plan, share replenishment, and conservative share usage, companies may be able to put off seeking approval for new plans/shares. With Say-on-Pay, shareholders vote on how often they get to vote on executive pay; this could be an annual vote (and, in no event, can it be less than every three years).
Golden Parachute Arrangements
Shareholders will have to be permitted to vote on any pay related to a change-in-control that they haven’t already voted on under a prior Say-on-Pay vote. This was likely included in the bill in respond to recent media criticisms of awards made in anticipation of mergers–see my October 20, 2009 blog entry “The Next Big Options Scandal…or Not.” The proxy related to the merger will include a vote on the merger and a separate vote on any previously undisclosed golden parachute arrangements. It isn’t completely clear what this vote accomplishes since it is advisory only and, in some cases, the shareholders of the target may not even end up being shareholders in the new company.
More Information
We’re posting new memos on the Dodd-Frank Act every day in the NASPP’s Say-on-Pay Portal.
Scheduled for Sept 20-23, the 18th Annual NASPP Conference is timed perfectly to help our members prepare for mandatory Say-on-Pay. Just announced–we’ve added a special Say-on-Pay track, featuring key advice and real-world strategies from in-the-know practitioners. Register for the Conference today.
The New Pay Legislation: Action Items With the new legislative pay reforms–particularly mandatory “Say-on-Pay” and the new “sleeper” internal pay equity disclosure–all eyes will be focused like never before on executive compensation practices (and the resulting proxy disclosures). You will need answers even before the SEC issues new rules and it is critical to have the best possible guidance. Free to registrants of the “18th Annual NASPP Conference,” “7th Annual Executive Compensation Conference,” and “5th Annual Proxy Disclosure Conference,” this pre-conference webcast on July 29 is the first step as part of the full Conferences that will provide the latest essential–and practical–implementation guidance that you need.
NASPP New Member Referral Program Refer new members to the NASPP and your NASPP Conference registration could be free. You can save $150 off your registration for each new member you refer, up to the full cost of registration. You’ll also be entered into a raffle for an Apple iPad and the new members you refer save 50% on their membership–it’s a win-win!
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 I keep an ongoing “to do” list for you here in my blog.
Say on pay is inevitable, but it’s difficult for stock plan managers to know exactly what that means to them. Because it’s practically unheard of for the equity compensation team to be on the decision-making side of executive compensation, it may feel easy to dismiss say on pay as an issue that can be overlooked.
However, availing yourself as a knowledgeable resource within your company elevates you as a subject matter expert. Being a part of the conversation when it comes to new policies or grant practices always helps ensure that the solutions coming down your pipeline are both effective and manageable. In that spirit, these are my top three action items for stock plan managers to prepare for say on pay:
Know what shareholders; hot buttons are for share-based compensation, including what features and provisions are likely to be unacceptable and those that increase the likelihood of acceptance. Take a good look at your company’s executive equity compensation to see how outstanding grants rate. Here are a few:
Pay for Performance – A significant majority of the bad press generated over executive compensation focuses on the disparity between executive compensation pay-outs and the relative success of the company during the same period. Pay for performance is more than simply slapping a performance condition on a grant, especially if the performance measures are not adequate to inspire long-term success. This year, we have a fantastic pre-conference program dedicated to performance awards, the Practical Guide to Performance-Based Awards. If you’re looking for ways to beef up your knowledge on performance awards, this is the program for you!
Dividend Payments – Shareholders generally don’t want to see executive compensation that pays out dividends or DERs on unvested shares. This follows right in line with pay for performance; shareholders don’t want to see that an executive will be eligible for dividends on unearned shares.
Long-term Focus – One of the hottest buttons for shareholders is whether or not executive compensation has a long-term focus. For equity compensation, this includes issues like minimum vesting periods (e.g.; at least 3 years, but preferably 5 years) and holding requirements. Increasing the length of time executives must wait before they can cash out their company shares reduces the temptation executives may feel to take excessive risks. Take a close look at your executives’ equity compensation and create a list of features or provisions that demonstrate a long-term focus.
Double-trigger – When it comes to change in control provisions in your grant agreements, shareholders (and potential acquiring companies) absolutely want to see a double-trigger for acceleration of vesting in the event of a change in control. If you haven’t already, take a close look at your grant agreements to see what your company’s change-in-control provisions look like.
Clawback Provisions – depending on how the House and Senate reconcile their final versions of their bills, clawback provisions could be required for listed companies. Shareholders generally like to see that clawbacks are not only in place, but also enforceable. Typically, clawback provisions are found in employment contracts, so have a conversation with your legal team to find out what your company’s current practice is and if that will be changing. Remember that clawback provisions can extend beyond fraud situations; they also may be part of other provisions such as non-compete requirements.
Know what your peer companies are doing and how it compares to your company. This is getting easier to do with enhanced proxy disclosure. If your company’s compensation philosophy already identifies peer companies or groups, then the difficult part has already been done for you. Check out the 2010 proxies from those companies and review their executive compensation practices. Also, keep up with the latest news on shareholder advisory votes; particularly keeping your eyes open for any executive compensation that does not garner vote of approval from shareholders.
Coordinate with your legal and compensation teams. First, it’s important to just keep the lines of communication open and be a part of the conversation. More specifically, find out if tackling say on pay (along with increased disclosure requirements) will require you to provide different or additional data and/or analysis. The earlier you know about additional data requirements, especially if they will ultimately be a periodic need, the more time you have to find the most efficient solution to providing that data.
The NASPP Conference’s Say on Pay Track
Hot off the presses! This week, we announced the “Say on Pay” track that we’ve added to our 18th Annual NASPP Conference. Don’t get left behind on decisions your company may be making in light of say on pay, join us for these essential sessions!
The Restoring American Financial Stability Act of 2010, passed by U.S. Senate on May 20th, contains provisions that apply to all public companies. Fortunately, you won’t need to read the daunting almost 1500 pages of the bill to weed out the pieces that could impact stock plan managers because we’ve posted the corporate governance and executive compensation portions, courtesy of Davis Polk. Here are the main sections that I think you should be aware of.
Say on Pay and Majority Voting
This bill, like the corresponding House bill, does include a required non-binding shareholder vote to approve executive compensation. Unlike the House bill, this legislation does not require a shareholder advisory vote on golden parachute payments. This provision would take effect six months after enactment of the bill. This does mean that say on pay for all public companies is eminent. Additionally, there is a provision that requires majority voting by shareholders in uncontested board elections that would require any board member who does not receive a majority vote to submit his or her resignation.
These two provisions mean that companies will need to prepare for the voting process, but also get a game plan together on how to address the possibility that shareholders will reject either uncontested board members or executive compensation. In both scenarios, the company can still choose to do what it wants–the executive compensation vote is non-binding and the board can reject a resignation letter. On that note, the CorporateCounsel.net blog this week covers three companies that are already grappling with how to respond to a shareholder rejection of executive pay packages; Motorola, Occidental Petroleum, and KeyCorp. I’ll definitely be tracking this blog to see how say on pay pans out! If you’re looking for more help with executive compensation, don’t forget that the 7th Annual Executive Compensation Conference is included with your 18th Annual NASPP Conference Registration.
Proxy Disclosures
Although this version of the bill does not require the chairman of the board and the CEO to be separate individuals, it does require companies to disclose the reasons they have chosen to keep these positions separate or combine them. In addition, there are a host of required disclosures regarding the company’s compensation committee and executive compensation. This includes a discussion of the relationship between executive compensation and financial performance as well as how the amount of executive compensation compares to the company’s financial performance or investor-return.
Clawbacks
The bill requires the SEC to direct exchanges to prohibit the listing of any company that does not adopt certain clawback policies. This provision is not included in the House bill. Stock plan managers should pay particular attention to this part of the bill. If it is enacted, you will need to work with your legal team to determine if your grant agreements need to be updated and nail down a policy on how to respond to financial restatements that trigger compensation recovery.
Get Smart
As you know, we’ve rolled out our NASPP Question of the Week. I’m really excited about this new challenge for NASPP members! What you may not know is that if you missed out on our first announcement, you still have the unique and never-to-come-again opportunity to catch up. The first four quiz questions will remain available at the full point value until the second month of our contest. So, don’t feel like you’re starting at a disadvantage–you can still work toward that number one position. Create your screen name and get started now!
Over the past week the final verdict came in for two of the cases I blogged about on April 15th.
First, former CEO of KB Home, Bruce Karatz, was convicted for concealing the company’s backdating scheme and faces up to 80 years in federal prison. Mr. Karatz was found guilty on four counts including making false statements on a quarterly report filed with the SEC and making false statements to the company’s outside accounting firm, but was acquitted of 16 other counts including three counts of securities fraud (the most serious charges against him). Mr. Karatz, in pleading non-guilty to all charges, had claimed that he was falsely targeted as part of the governments crack-down on illegal back-dating. With only four out of 20 charges resulting in a conviction, it looks like even the testimony against him from the former KB Homes HR Director, Gary Ray, wasn’t enough for the SEC to get the big win they were looking for on this one. (See thisRueters article.)
Alternatively, former Maxim Integrated Product’s CFO, Carl Jasper was found guilty on eight out of 11 counts against him. Mr. Jasper had claimed that the backdating scheme was above his pay grade (so to speak) and that former CEO, Jack Gifford, was an unstoppable force heading up the practice. (See thisBusiness Journal article.)
Both Mr. Karatz and Mr. Jasper intend to challenge their convictions.
Options Prevail!
Almost exactly one year after rejecting a proposal to ban stock options to senior executive officers (See thisAssociated Press article.), Pfizer shareholders got a second opportunity to vote on a very similar proposal. Once again, the proposal to eliminate all future option grants to executive officers was overwhelmingly rejected.
This year, the proposal was being brought by activist shareholder Evelyn Y. Davis, who obviously favors restricted stock over options, blaming the recent fluctuations in the market on “shenanigans” stemming from the granting of stock options. Coincidentally, shareholders did vote to give themselves an advisory vote on executive compensation, adding Pfizer to the list of companies engaging in some type of “say on pay.” (See thisYahoo! Finance article.)
I was thinking about this vote when I saw our own Broc Romanek’s April 17th Advisor’s Blog entry on CompensationStandards.com. He brought it to my attention that the Council of Institutional Investors published a checklist of the “Top 10 Red Flags to Watch for When Casting an Advisory Vote on Executive Compensation”. On that list is a call for stock options to be linked to performance, an approach to granting options that Ms. Davis seems to have missed.
If you’re looking for the best information available on executive compensation, you’ll be excited to know that your registration for the 18th Annual NASPP Conference includes a special bonus access to the 7th Annual Executive Compensation Conference! If you aren’t already registered, don’t miss out on the $200 discount that we are offering through May 14th. Register today!
Based on a recent IRS announcement and alerts we’ve received from law firms, the IRS is stepping up audit activity on executive compensation and employee benefit plans.
Employment Tax Audits On November 9, the IRS announced an employment tax research study that will include audits of 6,000 companies over the next three years. The study is expected to help the IRS determine areas of greatest compliance risk, which will aid in selecting and auditing future employment tax returns. Companies file employment tax returns to report taxes that have been withheld on employee wages.
According to an alert issued by Pillsbury, the audits will focus on worker classifications (i.e., employee vs. non-employee), fringe benefits, executive compensation, and qualified employee benefit plans. Levine & Baker also mention the impending audits in their January 2010 client newsletter, warning that companies would be ahead to review their tax practices now, before they get an audit notice and still may have an opportunity to address inadvertent errors.
409A Audits Started Already According to a Jones Day alert that we posted on Naspp.com, the IRS has already started auditing deferred compensation arrangements for compliance with Section 409A. Recent Information Document Requests issued to companies undergoing audits have included items related to §409A compliance.
As described by Jones Day, the information requested by the IDRs includes:
Identification of arrangements that the company does not consider to be subject to §409A, but that create a legally binding right to compensation that won’t be paid until a later year. Stock options and restricted stock, of course, are prime examples of these types of arrangements. They also include plans that are exempted from §409A under the short-term deferral rule.
Terms and deadlines for making deferral elections, re-deferrals, and any payment accelerations.
The names of “specified employees” and payments made to them upon separation of service.
Certain information on stock options and SARs that may be subject to §409A.
Any §409A violations and whether the company participated in the §409A corrections program.
Technical Corrections to Section 423 Regs Turns out the IRS makes typos just like the rest of us. Technical corrections to the final regulations under Section 423 were issued on December 22, 2009. Nothing substantive, though, just a couple of minor textual errors. Just because I thought it would be cool, I’ve annotated the PDF of the final regs that we have posted here on Naspp.com with the corrections; see §1.423-2(a)(1) (pg 15), §1.423-2(d)(3) (pg 24), and §1.423-2(i)(5) Example 5 (pg 39). The full text of the corrections is on pg 46.
ShareComp 2010 The NASPP is happy to announce its support of ShareComp 2010, a fully virtual conference on stock compensation. NASPP members can attend the event for free using the sponsor pass “naspp”; feel free to share this sponsor code with others at your company.
ShareComp 2010 will be held live on February 23, 2010 and all presentations, documents, and booths will be available on-demand for a year afterwards. Presentations, solutions, and providers will focus on the needs of professionals in executive roles, finance, human resources, compensation, accounting and stock administration positions. Benefits of attending include:
16 hours of live global interactive learning and networking
Best practices for designing, implementing and managing stock compensation programs
Instructional sessions that will share real-world examples, tactics and lessons learned
Facilitated discussion forums with experts and practitioners
A searchable library, including presentations, Q&A sessions and booth materials
A year of access to the conference center and the materials
To find out more about, visit www.sharecomp2010.com. Register today for this no-risk, high-impact event (be sure to enter sponsor pass “naspp” for free registration). While you are attending the event, we hope you’ll stop by the NASPP booth.
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 I keep an ongoing “to do” list for you here in my blog.
Don’t miss Alan Dye’s webcast on Thursday January 28, on Section 16 developments.
The Sarbanes-Oxley Act contains an umbrella clawback provision requires that the CEO and CFO give back incentive compensation and stock sale profits in a year prior to any restatement that was caused by misconduct or fraud. Last year, the SEC filed a landmark complaint against the CEO of CSK Auto Corp (see the SEC Press Release) that sought to recoup incentive compensation resulting from accounting fraud without actually alleging that the CEO participated in the fraud. While Sarbanes-Oxley does not require that the executive actively participate in the fraud in order for the clawback provision to be invoked, this case marked a first for the SEC to open a case against an executive without alleging actual misconduct on the part of the individual.
For individual companies, a clawback is a contractual provision that provides the company with a means of recouping incentive compensation or stock sale profit from executives or top employees. The provision may apply to fraud, incentive resulting from incorrect financials, violation of non-compete provisions, or other violation of other specific restrictions within the agreement. Companies may include both equity compensation and cash bonuses in clawback provisions.
The existence of a clawback provision does not mean that a situation that violates the restrictive provisions will automatically result in funds being returned to the company. Most likely, the company will need to initiate legal proceedings in order to recoup any profits. Additionally, unless the agreement between the company and the executive details the repayment process, the company may need to negotiate the timing and manner of repayment.
Shareholders
Shareholders are most interested in performance-based clawback provisions that recoup profits resulting from accounting fraud. These types of clawbacks provide a critical protection to shareholders by forcing the executives to share in the financial losses related to inaccurate financial statements. This goes beyond performance-based pay arrangements where the executive only benefits if certain goals are reached (with the intention of aligning executive pay-out with shareholder benefit) because it reaches back to profits already realized by the executive rather than reducing future payout.
The use of clawback provisions can be helpful when companies are justifying their executive compensation.
Recent or Pending Legislation
Companies participating in the TARP are required to have clawback provisions relating to “materially inaccurate” financial statements. Additionally, TARP companies are required to exercise their clawback rights except in cases where they can demonstrate that it would be “unreasonable” to do so. This was further highlighted in the October determinations from the Treasury (see our alert). For more information on the TARP or other provisions under the Emergency Economic Stabilization Act of 2008, see our Economic Stimulus Legislation portal.
The proposed Senate bill, Restoring American Financial Stability Act (also known as the Dodd bill), goes one step further and recommends that all public companies be required to set clawback policies pertaining to inaccurate financial statements.
For Stock Plan Administrators
Hopefully, you will not need to deal with enforcing any clawback provisions your company may have. However, it’s a good idea to know if the company has clawback provisions in place and if there is a corporate policy on initiating repayment if they are triggered. One issue with clawbacks is that they may not be included in documentation that is normally accessible to stock plan administrators. They may be part of an employment or other separate agreement.
If you want to really take it one step further, educate yourself on the additional implications of recouping profit under a clawback provision. This may include how to handle previously remitted tax withholding or whether there are any 409A issues relating to the repayment method.
For more information on clawbacks and other provisions, check out the materials and audio from the Executive Compensation Conference, which we offered free of charge this year to everyone who attended the NASPP Conference.
More NASPP Value
We’ve added a new portal to the NASPP site, Shareholder Approval. It includes information on shareholder approval of stock plans, compensation, and options exchanges. Additionally, you will find exchange listing rules, legislation, proxy advisory firm recommendations, and more!
On October 22nd, the Treasury’s Special Master for TARP Executive Compensation announced his determinations on the compensation packages of the executive officers and most highly paid employees at the seven companies under his review. Some of the changes that he requires of these companies are surprisingly significant.
Aligning with Shareholder Interests
We’ve seen a real push recently to encourage companies to structure compensation, for executives in particular, in a way that better protects shareholder interests. Government initiatives include say on pay, compensation committee independence, and assessment of how compensation programs may lead to excessive risk-taking. What truly stands out about these determinations is that when the government is given the opportunity to directly influence compensation structure, it has turned to equity compensation as the solution.
Cash is not King
The Special Master’s rulings drastically reduced the cash compensation received by the most highly paid individuals at the companies under his review. For AIG, Bank of America, and General Motors, cash compensation was reduced by more than 90%! In lieu of cash, these employees will receive vested stock that comes with very specific holding requirements intended to ensure repayment of TARP funds and continued financial stability for these companies. These percentages are so high because cash compensation is capped at $500,000 for most of the relevant employees.
Performance and Holding Requirements
In addition to this major shift from cash to equity in base salary, the Special Master’s determinations also impose a pretty specific structure for incentive compensation. He looks to performance-based restricted stock with minimum vesting periods as well as holding requirements on the vested stock. This two-pronged approach is designed to encourage specific outcomes in company performance as well as adjust the focus of top employees from short-term gain to long-term growth.
The Big Picture
Companies will be taking a look at how the Treasury has dealt with executive compensation at these seven companies and trying to decide what that means to them directly. What these determinations do is give us a window into exactly what the Treasury feels is a compensation structure that aligns executives with shareholder interest and discourages excessive risk-taking for short-term gain. Other companies will want to keep that in mind as they review their own executive compensation structures.
For the Equity Compensation Professional
These determinations mean that more companies will be reviewing their own compensation practices. The savvy stock plan administrator will be looking for a way to at least be a part of the conversation so that the grants come out of any new compensation structure can be managed without exposing the company to additional risk due to excessively complex features. Get some guidance on how to do this at our NASPP Conference Session, Wagging the Dog: Stock Plan Administrator Meets Compensation Consultant. Since it’s pretty clear that restricted stock, performance-based vesting, and some way to encourage top employees to hold onto their company stock as a long-term investment are looked upon as favorable practices, stock plan managers will want to reach out and learn as much as they can about administering plans with these features.
Only 4 days until the 17th Annual NASPP Conference! The Conference is sold out, but you can still sign up for the live nationwide video webcasts of the 4th Annual Proxy Disclosure Conference and the 6th Annual Executive Compensation Conference–you get both webcasts for the price of one.
You can hear any–and all–of the NASPP Conference sessions by purchasing the downloadable audio. Purchase just the sessions you want or save by purchasing one of the package deals.
The writing is on the wall; risk management through effective compensation practices is a hot topic right now. Recent regulatory developments and government initiatives indicate that all pubic companies may eventually need to explain to shareholders and investors how their compensation practices help align employee performance with shareholder interests and safeguard the company against excessive risk. I’m not just talking about your executive compensation, either. Now is the perfect time to take another look at your company’s equity compensation practices and decide if they are motivating employees to take reasonable risks that will help your company grow without encouraging excessive risk-taking behavior.
This Senate Bill, introduced on May 19th of this year, would require companies to create a board committee to oversee company risk management. Specifically, it calls for companies’ risk management committees to be independent of their audit committees. While this bill does not call for publication of risk management in compensation practices, it does put a focus on the importance of managing risk.
On June 10th of this year, Treasury Secretary Tim Geithner made a statement outlining the measures the Treasury Department will be promoting to help create financial stability. Among the focal points in this press release are several statements about how companies should be dealing with risk management. First, the Treasury encourages all company compensation committees to not only conduct, but also publish risk assessment of pay packages. Additionally, it calls for companies to ensure that compensation is structured in a way that fixes an appropriate time horizon for risks. To do this, the Treasury asks that companies provide their risk managers with the “appropriate tools and authority to improve their effectiveness at managing the complex relationship between incentives and risk-taking.”
On July 1 of this year, the SEC submitted its proposal on changes to compensation disclosures. In particular, this proposal includes requiring companies to discuss how they are managing risk-taking through compensation practices. The proposal doesn’t necessarily require this discussion for all companies; it is only required if the risks may have a “material effect” on the company.
Get Involved!
This trend of focusing on risk management encompasses your company’s broader compensation practices. It is important for your company to review its compensation practices (especially in light of the current economic situation) and stock plan administrators should be getting involved in what this will mean for equity compensation.
When it comes to managing risk, the most obvious way to tackle the issue is through performance-based incentives. Effective performance grants are good for everyone, and the economic conditions have made it clear that a review of performance metrics is warranted. Make sure that your stock plan team is involved in conversations on how to improve your performance metrics; not only to help make them more effective, but also to make sure you will be ready to administer the grants when they are awarded.
One of the most important points to make about performance grants is the need for a well-balanced mix of performance goals. When awarding performance grants to your executives and other key employees, using just a single metric (like share price or revenue) puts too much emphasis on just one target and potentially increases inappropriate risk taking by key employees. A good mix includes both short-term and long-term goals so that strong performance must be met and maintained. Even better, including both internal and external goals helps promote behavior that not only meets your company’s internal targets, but also keeps it competitive in the marketplace. For ideas on how to create effective performance-based compensation, check out our Performance Plans Portal.
Another great way to encourage sustained growth and effective risk taking is to put a long-term focus of at least a portion of equity compensation for your key employees. This can be done by requiring key employees to maintain a meaningful position in your company’s stock. What we’ve seen recently that has shareholders (and employees) in an uproar are executives who can leave the company and cash-out on huge equity compensation packages, but leave behind a company that is poised to fail because of ineffective risk management on the part of those executives. Companies are dealing with this by establishing hold-through-retirement policies, ownership guidelines, and claw-back or forfeiture provisions. Be sure to check with your risk manager, compensation committee, or head of compensation to see if any of these strategies are in store for your company’s equity compensation program.
Don’t forget, if you are not able to attend in person, you can listen in from your desk. The NASPP keynote address and the full Executive Compensation Conference will both be available live, and the entire NASPP Conference will be available on video archive. Sign up now, and take advantage of the 10% discount on the audio archive!