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.’’
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.
As discussed in this McGuireWoods client alert, the Senate finance committee staff recently published a report describing various potential legislative changes that could impact executive compensation, either individually or as part of a broader package of tax reform. Potential reforms to Section 162(m) of the Internal Revenue Code were featured prominently in the report:
Congress has recently taken the opportunity to substantially expand the Section162(m)deduction limitation as it applies to both financial institutions that participated in the government’s Troubled Asset Relief Program (TARP) and health insurance companies. Congress’s willingness to expand Section 162(m) in these specific areas suggests a broader expansion is something more than a remote possibility. The specific reform proposals listed in the report include:
- Repealing the limitation completely (presumably on the basis that Section162(m)encourages the use of stock options, which have recently fallen out of favor among institutional shareholder groups and some policymakers)
- Expanding the group of covered employees (notably, the expanded version of Section 162(m) that applies to health insurance companies covers all employees)
- Removing stock options from the performance-based compensation exemption
- Capping the deduction at the lower of a multiple (e.g., 25 times) of the lowest compensation paid to any other employee or a set dollar amount
Other potential Section 162(m) reforms that are not mentioned in the report might include removing the performance-based compensation exception completely and limiting the deduction of deferred compensation as well. Both of these were features of the expanded versions of Section 162(m) applicable to TARP institutions and health insurance companies.
Interesting article in the NY Times about the corporate governance team at BlackRock, including these tidbits shedding some light on BlackRock’s otherwise mysterious corporate governance guidelines:
BlackRock is no activist investor. In fact, it’s far from it. It has never sponsored a shareholder proposal, and it rarely broadcasts its actions….
BlackRock has also voted against or withheld votes from compensation committee members at companies when it thinks that they pay executives too much. Still, the A.F.L.-C.I.O. said that in 2012, the firm voted against board nominees at just 6 percent of United States companies. In contrast, the federation voted against 42 percent of all board nominees. And BlackRock almost always sides with management in “say on pay” measures….
BlackRock has rarely voted to split the role [of CEO and Chairman], believing that if a company has a strong lead director, there is likely no need to sever the roles.
The examples cited in the article indicate that where BlackRock has been more active, it has generally been with respect to directors — overboarding, directors who have served too long, directors who are paid too much, or directors with conflicts of interest.
The article also suggests that BlackRock may be “quietly stirring” and becoming more engaged or “activist,” which may or may not be true, but in any case it is a useful reminder that not all institutional shareholders vote in lockstep with proxy advisory firm recommendations, and that direct outreach to shareholders remains an important tool in winning shareholder support for directors and management proposals.
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.