Header graphic for print

Just Compensation

Focusing on Issues and Trends in Corporate Governance and Executive Compensation

CEO Pay Ratio Disclosure – Comments to the SEC

Posted in Dodd-Frank Act

The SEC has received more than 30,000 comments on the proposed rules for pay ratio disclosure comparing a company’s CEO with the company’s “median” paid employee.  Mostof those are form letters expressing support for the disclosure without any substantive comments on the rules.

McGuireWoods has submitted comments to the SEC on the proposed rules that focus on the operational aspects of the pay ratio calculations.

Like most commentators, we believe that the most expense and effort will involve identification of the one individual who is the median employee.  Our recommendations include:

  • The median employee could be determined by using statistical sampling based on a definition of compensation other than “annual total compensation” under Item 402 of Regulation S-K.
  • Companies should not take into account leased employees, independent contractors or other individuals who are not statutory employees to determine the median employee.
  • Companies should be able to use a date other than the last day of the company’s most recent completed fiscal year for identifying the company’s employees for purposes of determining the median employee.

We also anticipate that the pay ratio is likely to vary substantially from year to year, due to changes in the compensation of the CEO.  We recommend that the rules allow companies to provide additional information to help shareholders understand the pay ratio disclosure.  This information might include a comparison of the current pay ratio with the pay ratio for prior years.  It might also include an explanation for the variance in the pay ratio from prior years, such as changes resulting from pension plan interest rate movement.

As others submit substantive comments of particular interest, we will note them here.

Observations on SEC’s pay-ratio proposal

Posted in Dodd-Frank Act

Last week, the SEC released it’s long-awaited proposed rules for the controversial CEO pay ratio disclosure requirement under the Dodd Frank Act. McGuireWoods’ summary of the proposed rule is here, including the following observations:

Under the Proposed Rules, affected companies would have a reasonable transition period in which to prepare for the pay-ratio disclosures and significant flexibility in implementing the disclosure…

[D]uring the transition period companies may want to experiment with different statistical sampling methods and different alternative compensation definitions to determine which methods yield which ratios. Companies who wish to take the statistical sampling approach may wish to engage internal or external experts in statistical sampling methods. This is especially important, as the Proposed Rules would require that any methodology be consistently applied and disclosure of any changes would be required.

It can be expected that some companies may, due to investor interest, voluntarily disclose the pay ratio in filings prior to the mandatory effective date [likely not until 2016 for companies with calendar-year fiscal years]. Companies may wish to consider doing a “dry run” of the calculations for their 2014 or 2015 proxies, and disclosing the ratio if they feel it is appropriate. Since the Proposed Rules may change when finalized, an early voluntary disclosure may be different from the later required disclosure, which may not be viewed as helpful.

It is possible that Institutional Shareholder Services, Inc. and other institutional shareholder advisory groups will develop proxy voting guidelines based on the pay-ratio disclosure. For example, such guidelines might provide “against” or “withhold” recommendations on say-on-pay votes or on the election of compensation committee members for ratios that exceed certain peer-group parameters. The annual updates of these advisory groups should continue to be monitored for developments in this area.

Based on experience with the current disclosure rules, there can be substantial variation in the CEO’s total compensation under Item 402 from year-to-year. The variation can relate both to items in the company’s control (performance awards and equity grants) and outside the company’s control (change in discount rates for pensions). By contrast, it is likely that the compensation for the median employee will not vary as much. Thus, a company may have to report widely-varying pay ratios over time.

Pay ratio rule release imminent

Posted in Compensation Disclosure, Dodd-Frank Act

According to this morning’s Wall Street Journal. Key paragraphs:

Rather than surveying the entire workforce, the SEC is expected to allow companies to consider a fraction of their employees when calculating median pay. It isn’t clear what percentage of the workforce would be included in the sample.

Companies would have to disclose the ratio between CEO compensation and the median pay of the sampled employee group. Median pay is the point on the income scale at which half the employees earn more and half earn less.

Clawback proposal approved by shareholders

Posted in Clawbacks, Dodd-Frank Act, ISS/Institutional shareholders

At the end of last month, McKesson Corporation announced that its shareholders had narrowly approved an advisory proposal urging the board of directors to implement certain changes to the company’s compensation clawback policy at is annual meeting.

The proposal, which was co-sponsored by an Amalgated Bank index fund and the UAW Retiree Medical Benefits Trust, requested that the board delete the requirement that the policy be triggered only if there was “intentional” misconduct pertaining to financial reporting that requires a restatement of result, or only if certain conduct produces a “material” negative revision of a financial or operating measure or a “material” detriment to the company’s financial results. The proposal also asked the board to publicly report the result of any deliberations to apply the policy. The vote came in the wake of McKesson’s payment of $350 million in 2012 to settle cases alleging overbilling customers and Medicaid programs.

The vote has drawn attention as one of the few shareholder proposals, if not the only proposal, regarding compensation clawback policies to be approved by shareholders, although, as this New York Times article notes, a half-dozen other pharmaceutical companies have recently agreed to implement certain prospective changes to their compensation clawback policies in response to pressure from the same groups that brought the McKesson proposal. 

While McKesson’s unique circumstances certainly influenced the outcome, the vote has given new weight to a question that many other public companies have been grappling with, which is whether to adopt or expand a compensation clawback policy now in response to institutional shareholder pressure, or wait until the SEC has released proposed rules on the new clawback requirement under the Dodd Frank Act, which could come at any time.

Appellate court finds PE fund to be a “trade or business”

Posted in Private Companies

A recent First Circuit appellate court case has held for the first time that a private equity fund (a pair of funds, in fact) is a “trade or business” for purposes of ERISA multiemployer plan withdrawal liability. The direct implication for private equity funds, which you can read more about here, is that the funds may now be liable for the underfunded pension and multiemployer plan liabilities of their portfolio companies.

One of the indirect implications (and of relevance to this blog) is whether the “trade or business” rationale could be extended beyond ERISA to other areas of the Internal Revenue Code, and in particular to the areas governing the taxation of profits interests. Income allocated to management profits interests typically takes the character of the underlying income to the fund. If the fund is a passive investor, then the income to the fund typically passes through to the profits interest holder as capital gain. However if the fund is a “trade or business” and if the managers are actively engaged in that business, then income allocated to the managers’ profits interests may be taxed at higher ordinary income rates. While the First Circuit’s holding is limited to ERISA, the opinion casts a shadow on a pair of Tax Court precedents that practitioners have traditionally relied on for purposes of supporting the passive investor status of private equity funds in other tax-related contexts.

Profits interests remain safe for now, but in light of this new caselaw and Congress’s continuing interest in the subject, the question remains for how much longer.

Washington Post examines pay-ratio rule delay

Posted in Dodd-Frank Act

In case you missed it this weekend, the Washington Post did a long, front-page piece on the delay in implementation of the pay-ratio rules under the Dodd-Frank Act, which in spite of its length doesn’t offer much news on the all-important questions of when the rules are expected to be issued or what they’re expected to say:

Nearly three years later, the rule remains unfinished, with no sign of when it will be done….

Agency officials dispute criticism that they have “slow-walked” the rule and have repeatedly said their goal is to write a rule that works. They say their emphasis is not speed but effectiveness.

Now, with unions and other pay ratio advocates mounting their own lobbying effort to get the SEC to move, the agency’s new chairman, Mary Jo White, is vowing to redouble its efforts to complete the rule and other long-delayed regulations. Testifying before Congress in March, she said there is “no higher priority.” But, she added, the task “truly is daunting.’’

Shareholder suit on CEO retention grant survives motion to dismiss

Posted in Derivative Suits on Compensation, Exhanges/SROs, ISS/Institutional shareholders

Late last month, a Delaware chancery court allowed a shareholder derivative suit contesting the validity of a $120 million retention grant to Simon Property Group’s CEO to proceed past the motion to dismiss stage.

The suit was filed by the Louisiana Municipal Public Employees Retirement System in the wake of Simon Property Group’s failed 2011 say-on-pay vote. The crux of the plaintiff’s claim is that a $120 million equity-based retention grant to Simon Property Group’s CEO was not permitted under the terms of the company’s equity compensation plan.

The equity compensation plan was an omnibus plan that permitted various types of equity-based awards, including “performance units,” which were required under the terms of the plan to be subject to performance-based vesting conditions. The units the board of directors wished to grant to Simon Property Group’s CEO were scheduled to vest based only on the CEO’s continued performance of services. Therefore the company amended the equity compensation plan to remove the performance-based vesting requirement for performance units. It did not seek shareholder approval for the amendment.

NYSE listing requirements mandate that certain amendments to equity compensation plans be subject to shareholder approval. These amendments include expanding the types of awards that may be granted under the plan. The question before the court was whether the amendment removing the performance-based vesting requirement had the effect (as the plaintiffs argued) of expanding the types of awards that could be granted under the plan. Prior NYSE guidance had indicated that amendments that merely remove or eliminate vesting requirements, for example in connection with a change in control, did not require shareholder approval. Indeed, Simon Properties Group had obtained informal guidance (an email) from NYSE staff stating that shareholder approval was not required with respect to the amendment at issue.

The Delaware chancery court decided in favor of the plaintiffs, rejecting Simon Property Group’s argument that the amendment was not required, and calling into question the reliability of informal NYSE staff guidance on interpretive issues under the NYSE listing requirements.

The case contains a number of lessons for companies that sponsor equity compensation plans: (i) whenever amending a plan, pay careful attention to whether shareholder approval is required, whether under applicable exchange listing requirements or tax requirements or otherwise; (ii) understand that an amendment that creates a de facto new type of award — such as (as here) turning performance units into restricted stock units — will likely require shareholder approval; (iii) do not necessarily rely on informal exchange guidance in determining whether shareholder approval is required; and (iv) realize that non-performance-based equity awards, especially big ones and especially to the CEO, are likely to generate substantial shareholder resistance, including derivative suits and failed say-on-pay votes.