According to this Wall Street Journal item, the number of companies disclosing anti-pledging policies so far this proxy season has increased to 107 from just 8 last year:
Proxy-advisory firm Institutional Shareholder Services said in November that it could begin looking at any hedging or pledging of company stock by executives as a “failure in risk oversight,” since a margin call could force executives to sell their stock at an inopportune time. ISS said it would consider whether companies disclosed an antipledging policy in their proxies, but could recommend that investors vote against corporate directors if there is “significant” pledging.
So argues the Wall Street Journal, in an article that appeared yesterday:
Steven Kaplan, a finance professor at the University of Chicago’s Booth Graduate School of Business, likes stock options as executive compensation in most cases. But he finds it odd that ISS classifies performance-based shares differently than stock options, since the two forms of equity can deliver the same returns and offer the same incentives.
Mr. Kaplan offers an example of an executive who receives three million options with an exercise price of $10. If the stock rises to $15, the executive can make $15 million; if it rises to $20, the executive can make $30 million. Directors can create the same payouts and incentives with a grant of restricted stock, where the executive receives one million shares if the stock rises to $15, and 1.5 million shares if the stock rises to $20.
“The payoffs are identical. Options are not pay-for-performance, but restricted stock is—completely irrational,” he says.
Pretty ironic if true, given the hatred institutional shareholder groups display for options and the adoration they lavish on performance shares.
But is it? (True, that is.) One thing the article mostly ignores is that performance shares are generally earned based on relative, rather than absolute, TSR performance. In other words, performance shares are generally earned only to the extent the company’s TSR outperforms the TSR of a selection of peer companies. Performance shares generally aren’t designed to pay out on the achievement of absolute TSR numbers. Stock options, in contrast, generally provide value for any increase in share price, regardless of relative performance.
So performance shares and stock options typically have a lot less in common than the article suggests. The more accurate comparison, perhaps, would be to stock options with an indexed strike price… something most shareholder groups, I imagine, would be fine with.
NYSE companies have until July 1 to amend their compensation committee charters to reflect the new requirements relating to the independence of compensation consultants and other advisors. See our previous discussion here. Nasdaq companies do not have to have amended their compensation committee charters by July 1, but do have to have formally given the compensation committee the authority to retain, supervise and compensate independent advisors by that date.
In addition, both NYSE and Nasdaq companies must examine the independence of any compensation consultants or other advisors to the compensation committee which are retained by the committee or which provide the committee with advice on or after July 1. The examination must occur before the advisor is retained or the advice is provided. Companies which have not already done so should begin the process of determing who the compensation committee’s advisors are and obtaining the necessary information from the advisors to allow the committee to examine their independence before the July 1 deadline.
A New York agency has found that a lump-sum settlement payment from a nonqualified deferred compensation plan by a New York employer to a former employee that is not a New York resident is not subject to New York state income taxes.
The decision interprets 4 USC 114(a), which prohibits states from taxing “retirement income” paid to non-residents, even if the compensation is paid by a resident employer or was earned while the payee was a resident. The statute defines “retirement income” as including payments under a nonqualified deferred compensation plan, if the payments are made periodically for life or at least ten years.
In the case at hand, the employee, who was not a NY resident, had commenced receiving periodic payments from two nonqualified deferred compensation plans of his former NY employer, before the employer had gone bankrupt. As part of the bankruptcy settlement, the employee’s payments were commuted to a lump sum. The NY agency held that the lump sum payment still qualified as “retirement income” for purposes of the rule in 4 USC 114(a), in spite of the fact it was not a periodic payment. It’s unclear if the agency would have reached the same result if the lump sum had been been the original form of payment, instead of resulting from the bankruptcy.
Although the facts are limited, employers should keep in mind the rule in 4 USC 114(a) when paying out periodic nonqualified deferred compensation payments to nonresidents, so that appropriate state taxes are withheld.
Yesterday, the IRS proposed new regulations limiting the deductions that certain health insurance issuers may take for compensation paid to their employees (and other service providers, excluding certain bona fide independent contractors) to $500,000 per service provider per year, starting for most companies in 2013.
The regulations implement Section 9014 of the new healthcare reform law (PPACA) (previously discussed here) and are ostensibly intended to prevent health insurance companies from deriving a tax benefit from using the expected new revenues generated by the sale of minimum required insurance coverage in order to increase executive pay, a tax policy the wisdom of which this Blog declines to an express an opinion.
The proposed regulations depart from the current 162(m) rules in several important respects (and are similar in this way to the TARP-related 162(m) rules for troubled financial institutions from several years ago), including:
- the fact they apply to private companies as well as public ones (the current non-TARP 162(m) rules only apply to public companies);
- the $500,000 deduction limit itself, unindexed to inflation (the current non-TARP 162(m) limit is $1 million, also unindexed);
- in their application to all employees and other service providers (excluding certain independent contractors) who provide services at any time during a given taxable year (the current non-TARP 162(m) rules generally apply only to the CEO and three other most highly-compensated executives, excluding the CFO, who are employed on the last day of the year);
- in their application to post-2009 deferred compensation as well as current compensation (the current non-TARP 162(m) rules effectively only apply to current compensation); and
- in their lack of an exemption for stock options and other “performance-based” compensation (the current non-TARP 162(m) rules exclude options and “performance-based” compensation from the $1 million limit).
Most companies will be unaffected by the new rules, which generally only apply to “health insurance issuers” (generally defined as state-licensed and -regulated insurance companies or HMOs) that receive at least 25% of their premiums from providing health insurance coverage which qualifies as “minium essential coverage” (i.e., coverage which an individual must obtain in order to avoid a penalty under PPACA), or their 80%-or-more controlling parents or 80%-or-more controlled subsidiaries (but specifically excluding any brother-sister entity within the controlled group), subject to certain de minimis exceptions.
Importantly, (i) the new rules do not apply to employers who sponsor self-insured group health plans merely because they sponsor such plans and (ii) premiums under an indemnity reinsurance policy (e.g., a policy reinsuring a self-insured group health plan) are not treated as “health insurance premiums” for this purpose.
However, even companies that are unaffected cannot be happy about the trend marked first by the TARP 162(m) rules and now by the PPACA 162(m) rules. How long before Congress decides that the narrower limitations on the deductibility of executive compensation at troubled banks and covered health insurance issuers would be good for the rest of corporate America as well?
As reported here, insurance behemoth AIG recently adopted a compensation clawback policy. This occurs several months after AIG exited the TARP program and ceased to be subject to the mandatory TARP clawback requirements. The actual policy is here. The events that trigger a clawback include:
1. A material restatement of all or a portion of AIG’s financial statements
2. Incentive compensation was awarded to, or received by, a covered employee based on materially inaccurate financial statements or on performance metrics that are materially inaccurately determined (regardless of whether the employee was responsible for the inaccuracy)
3. A failure by a covered employee to properly identify, assess or sufficiently raise concerns about risk, including in a supervisory role, that results in a material adverse impact on AIG, any of AIG’s business units or the broader financial system
4. An action or omission by a covered employee constitutes a material violation of AIG’s risk policies as in effect from time to time
5. An action or omission by a covered employee results in material financial or reputational harm to AIG.
The AIG policy comes in advance of the SEC rulemaking on mandatory clawback policies under Section 954 of the Dodd Frank Act, which has been expected for some time, but which the SEC appears to be no closer to proposing now than it was at this point last year. Given continued institutional shreholder pressure on this topic, the question that many companies are asking themselves is, should they continue to wait for the SEC rules, or go ahead and adopt a clawback policy now, even if they need to change it later when the SEC rules finally do come out? The answer will depend on the individual company, and while AIG presents some unique circumstances, examples like AIG show the trend may be shifting in favor of adopting a policy before the SEC rule comes out.
Readers of this blog will recognize the name of the plaintiffs’ firm featured in this New York Times report:
In recent years, the plaintiffs’ law firm Faruqi & Faruqi has given corporate America big headaches, filing a steady stream of shareholder lawsuits against companies related to executive pay as well as mergers and acquisitions.
Now, Faruqi & Faruqi has a headache of its own.
So says the Economist, including this bit:
CalPERS, the giant pension fund for California’s public employees, focuses its shareholder activism on the 300 firms in which it has the largest holdings. It has voted against executive pay packages at around 200 of them; significant reforms have followed at around half of those. At 50-odd firms it has voted against the pay package two years in a row. According to Anne Simpson, who oversees CalPERS’ activism, this year it and other shareholders will try to go after compensation-committee chairmen at firms that have now lost the say-on-pay vote twice. How these chairmen will react to being held personally accountable in such a public fashion will be interesting to watch.
On March 5, a bill was introdued in the Senate that would grant the SEC authority to carve out certain issuers from the “pay for performance” and the notorious “pay ratio” disclosures required by the Dodd Frank Act. We previously discussed problems with the pay ratio disclosure here and here. Here is the text of the amendment:
(c) Exemption- The Commission may, by rule or order, exempt an issuer or class of issuers from the requirements under section 14(i) of the Securities Exchange Act of 1934 (as amended by subsection (a) of this section) or subsection (b) of this section. In determining whether to make an exemption under this subsection, the Commission shall take into account, among other considerations, whether the requirements under subsections (a) and (b) disproportionately burden small issuers.
So argues Jones Day’s Manan Shah in this recent New York Times piece:
The problem is even worse for companies facing shareholder opposition to its pay policies. These corporations tend to incur even greater costs to proxy advisers, compensation consultants, lawyers and other advisers — and even more costs should the vote fail. This is likely to cause financial damage to the company through wasted assets and potential reputational harm, which could far outweigh the costs of the perceived “excessive” executive pay.
It is also unclear if the compensation changes recommended by proxy advisers are in the best interests of shareholders. A July 2012 working paper by the Rock Center for Corporate Governance found that revisions made by companies to their compensation programs in an attempt to conform to guidelines issued by proxy advisory firms actually produced a net cost to shareholders.