What’s New in Executive Compensation for the Upcoming Proxy Season: Compensation Committee and Adviser Independence, ISS Guidelines and Shareholder Litigation
Public companies preparing for the upcoming 2013 proxy season will need to keep in mind a number of new developments related to executive compensation, including:
- New Securities and Exchange Commission rules that require 2013 proxy statement disclosure of compensation consultant conflicts of interest;
- Proposed NYSE and Nasdaq listing standards that will impose new requirements for future proxy seasons regarding independence of listed company compensation committee members and compensation consultants and other advisers; and
- New ISS and Glass Lewis proxy voting guidelines relating to compensation that will apply for the 2013 proxy season.
Public companies should also consider recent trends in additional executive compensation disclosure and shareholder litigation targeting executive compensation proposals.
This Update summarizes the key elements of these new rules, guidelines and trends, and provides practical guidance.
New SEC Rules Require Proxy Statement Disclosure of Compensation Consultant Conflicts of Interest
Earlier this year the Securities and Exchange Commission adopted new rules implementing Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which requires proxy statement disclosure of compensation consultant conflicts of interest. You can find the full text of the SEC’s adopting release containing the new rules here.
New Required Proxy Statement Disclosure of Compensation Consultant Conflicts of Interest. New Item 407(e)(3)(iv) of Regulation S-K requires companies to assess whether the work of any compensation consultant who has played any role in determining or recommending the amount or form of executive or director compensation raises any "conflicts of interest." If so, the company must disclose in its proxy statement the nature of any such conflict of interest and how it is being addressed.
- Effective for 2013 Proxy Season. A company must comply with the new compensation consultant conflict of interest disclosure requirements for proxy statements in connection with annual meetings to be held on or after January 1, 2013.
- Definition of “Conflict of Interest.” The new rule does not define "conflict of interest," but specifies that at a minimum the six factors identified in Rule 10C-1 for determining the independence of compensation consultants and advisers should be considered in determining whether a conflict exists. These six factors are:
- The provision of other services to the company by the firm employing the adviser.
- The amount of fees received from the company by the firm that employs the adviser, as a percentage of the firm's total revenues.
- The policies or procedures of the firm employing the adviser that are designed to prevent conflicts of interest.
- Any business or personal relationship between any compensation committee member and the adviser or the firm employing the adviser.
- Any stock of the company owned by the adviser.
- Any business or personal relationship between the company's executive officers and the adviser or the firm employing the adviser.
- Must Disclose Only Actual Conflicts of Interest. The new rule does not require disclosure of potential conflicts of interest or of an appearance of a conflict of interest. Companies must disclose only actual conflicts of interest.
- Exemption for Foreign Private Issuers and Other Companies Not Subject to SEC Proxy Rules. Companies that are not currently required to comply with SEC proxy rules—such as foreign private issuers—will not be required to provide the disclosure regarding compensation consultant conflicts of interest required for other issuers under Item 407(e)(3)(iv) of Regulation S‑K.
New Requirement Adds to Existing Compensation Consultant Disclosure Requirements. These new compensation consultant conflict of interest disclosure requirements add to the disclosure already required by existing Item 407(e)(3)(iii) of Regulation S-K, which requires companies to identify any compensation consultants who had a role in determining or recommending the amount or form of executive and director compensation, and to state whether such consultants were engaged directly by the compensation committee or by management or any other person.
- Update D&O Questionnaire for New Compensation Consultant Conflicts of Interest Disclosure. Companies should add a new question to the questionnaire they distribute annually to their directors and executive officers in connection with preparing the proxy statement and annual report that solicits information regarding any personal or business relationship between a director or executive officer and the individual providing compensation consulting services to the company, and/or with the entity employing that individual. Companies should also begin working with their compensation consultants to collect the other information required to provide the new disclosure based on the six factors set forth above.
- Evaluate Compensation Consultant Conflicts of Interest. Companies should begin now the process of working with their compensation consultants to develop a process for collecting the necessary information to comply with the new compensation consultant conflict of interest determination and disclosure requirements.
- Fee Disclosure Not Required if Compensation Committee Engaged Separate Consultant. The fee disclosure under existing Item 407(e)(3)(iii) is not required if the compensation committee (or the board of directors) and management have engaged different compensation consultants to provide advice on executive or director compensation, even if management’s consultant provides additional services to the company.
- Otherwise, Fee Disclosure Required if Fees for Other Services Exceeded $120,000. On the other hand, if the board of directors or compensation committee has not engaged its own compensation consultant, but management or the company has, and management engaged this consultant to provide advice on executive or director compensation as well as providing other services to the company—e.g., benefits administration, human resources consulting or product sales, but excluding where the consultant’s only role is consulting on broad-based plans available generally to all salaried employees that do not discriminate in scope, terms or operation in favor of executive officers or directors (e.g., 401(k) plans or health insurance plans) or providing survey information that either is not customized for a particular company or is customized based on parameters that are not developed by the consultant—and the fees for those other services exceeded $120,000 during the company’s fiscal year, then the company must disclose in its proxy statement:
- The aggregate fees paid for (i) work related to determining or recommending the amount or form of executive and director compensation and (ii) the additional services;
- Whether management was involved in the decision to engage the compensation consultant for the non-executive compensation services; and
- Whether the board of directors or the compensation committee approved the additional services.
New Disclosure Covers Same Compensation Consultants As Existing Disclosure. New Rule 407(e)(iv) covers the same universe of consultants as existing Rule 407(e)(iii), irrespective of whether management, the compensation committee, or any other board committee retained the consultant. Similarly, the new rule does not require companies to provide this disclosure for consultants who provide advice on broad-based plans or non-customized benchmarking data.
Proposed New NYSE and Nasdaq Compensation Committee and Adviser Independence Requirements
The new rules adopted by the SEC earlier this year implementing Section 952 of the Dodd-Frank Act also require the stock exchanges to adopt new listing standards regarding compensation committee and compensation adviser independence. SEC Rule 10C-1, which became effective in July 2012, directs the national securities exchanges to develop listing standards that address:
- The independence of the members on a compensation committee, considering relevant factors including, but not limited to:
- the source of a director's compensation, including any consulting, advisory, or other compensatory fee paid by the company; and
- whether the director is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.
- The compensation committee's authority to retain, oversee and compensate any compensation advisers; and
- The compensation committee's consideration of compensation adviser independence.
The New York Stock Exchange (NYSE) and the Nasdaq Stock Market have submitted proposed changes to their listing standards to the SEC for its approval. The proposed listing standards must be approved by the SEC and adopted by the exchanges no later than June 27, 2013. We expect that new listing standards will generally be effective by July 1, 2013, but that companies will have until the 2014 proxy season to comply with the requirements for compensation committee independence.
NYSE: Proposed Listing Standards
The following is a summary of NYSE's proposed changes to its listing standards. You can find the full text of NYSE's proposed release here.
Effective Dates. The NYSE proposed listing standards will generally be effective July 1, 2013. However, with respect to the compensation committee independence requirements, NYSE proposes to give listed companies until the earlier of their first annual meeting after January 15, 2014, and October 31, 2014, to comply, with certain transition periods discussed below.
Compensation Committee Member Independence. Current NYSE rules provide for a two-part independence test, consisting of five "bright-line" tests and an affirmative determination by the board that the director has no material relationship with the company. NYSE's proposed standards take a flexible approach in requiring that the two enumerated factors be "considered" as part of an additional test that would require the board to "consider all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director's ability to be independent from management in connection with the duties of a compensation committee member."
Some Affiliates May Be Eligible to Serve on Compensation Committee. The proposed standards do not prohibit individuals with affiliate relationships from serving on the compensation committee as long as such relationships are considered as part of the overall independence evaluation. NYSE particularly notes that significant share ownership in the company can align the committee member's interest with those of unaffiliated shareholders and give them an economic interest in ensuring that the company's compensation is not excessive.
- Compensation Committee Authority and Responsibilities. As required by SEC
Rule 10C-1, the proposed NYSE listing standards require that compensation committees have the following specified authorities and responsibilities:
- Compensation committees must have the authority, in their sole discretion, to retain or obtain the advice of compensation consultants, independent legal counsel, or other advisers (compensation advisers).
- Compensation committees must be directly responsible for the appointment, compensation, and oversight of the work of any compensation advisers.
- Companies must provide appropriate funding for the payment of reasonable compensation, as determined by the compensation committee, to the compensation advisers, if any.
- Before selecting any compensation adviser, compensation committees must take into consideration the six independence criteria specified in SEC Rule 10C-1, which are the same six factors enumerated above for identifying compensation adviser conflicts of interest under Rule 407(e)(iii).
Compensation Adviser Independence. The proposed NYSE listing standards require that compensation committees may only select a compensation adviser after taking into consideration all factors relevant to that person's independence from management, including at a minimum the six factors enumerated above for identifying compensation advisor conflicts of interest. No single factor is determinative of independence. These factors must instead be considered as a group. This new requirement also applies to board members who oversee executive compensation matters in the absence of a committee, and extends to outside legal counsel as well as compensation consultants retained by management or by the issuer.
- Exception for In-House Counsel. These factors need not be considered before consulting with or obtaining advice from in-house counsel.
Compensation Committee Charters. The proposed NYSE listing standards replace existing requirements for listed company compensation committee charters (which already required most of the specific items now required by new SEC rules) with the exact wording of the four specified authorities and responsibilities in SEC Rule 10C-1 enumerated above.
Some Companies Exempt from New Requirements. Proposed NYSE listing standards would exempt the following companies from the new requirements: controlled companies, limited partnerships, companies in bankruptcy, closed-end and open-end funds registered under the Investment Company Act of 1940, issuers with only preferred stock or debt securities listed, and foreign private issuers (discussed below).
- Effective July 2013 and Certification Required. NYSE proposes to require companies to revise compensation committee charters by July 1, 2013 to incorporate the new requirements, and submit an annual certification to NYSE affirming that the charter satisfies NYSE listing standards.
- Relief for Smaller Reporting Companies. The NYSE proposes to exempt smaller reporting companies from the new compensation committee independence rules and the requirement that the committee considers the independence of its compensation advisers.
- Relief for Foreign Private Issuers. Current NYSE listing standards allow a foreign private issuer to follow home country practice in lieu of compliance with NYSE’s compensation committee requirements if the company discloses the differences in its corporate governance practices from those practices required of U.S. companies under NYSE’s corporate governance listing standards. This can be a brief general summary of any significant differences included in the company’s annual reports on Form 20-F. Foreign private issuers not using Form 20-F may instead include this “significant difference” disclosure on their websites in English or in their annual reports to shareholders. NYSE proposes to continue this approach by granting a general exemption from the proposed new compensation committee requirements to foreign private issuers that follow home country practice and provide this “significant difference” disclosure.
Cure Periods. NYSE proposes to adopt the cure provision mandated by SEC Rule 10C-1, which requires appropriate procedures for a listed company to have a reasonable opportunity to cure any non-compliance with the listing standards required by SEC Rule 10C-1. NYSE further proposes to allow a member of a listed company compensation committee that ceases to be independent in accordance with the requirements of SEC Rule 10C-1 for reasons outside the member’s reasonable control, with notice by the company to the exchange, to remain a compensation committee member until the earlier of the next annual meeting or one year from the occurrence of the event that caused the member to be no longer independent, but only in circumstances where the compensation committee continues to have a majority of independent directors.Transition Periods. NYSE proposed to extend to the proposed new compensation committee requirements the existing transition periods available to the following four categories of newly-listed companies.
- Companies listing in connection with their initial public offerings (IPOs) or that did not have a class of common stock registered under the Exchange Act prior to the listing date.
- Companies listing in connection with a spin-off or carve-out; companies listing upon emergence from bankruptcy; and companies previously registered under Section 12(g) of the Exchange Act.
- Companies previously registered under Section 12(b) of the Exchange Act to the extent the national securities exchange on which they were listed did not have the same requirement; and
- Companies that cease to qualify as a controlled company or a foreign private issuer.
NYSE also proposed a new transition period for companies that cease to be “smaller reporting companies.”
Nasdaq: Proposed Listing Rules
The following is a summary of Nasdaq's proposed changes to its listing rules. You can find the full text of Nasdaq's proposed release here.
Effective Dates. The proposed new requirements for compensation committee authorities and responsibilities would be effective for Nasdaq companies immediately upon the approval of the new listing standards by the SEC. The proposed listing standards must be approved by the SEC and in place by June 27, 2013. If a company does not have a compensation committee, the standards will apply to independent directors who determine compensation for the company's CEO and other executive officers. Companies must comply with remaining portions of the proposed rules by the earlier of the second annual shareholders meeting after the effective date of the new listing rules and December 31, 2014. Certain transition periods apply, as discussed below.
Nasdaq Will Require Compensation Committees. Nasdaq's current listing rules allow executive compensation to be determined by either a compensation committee of one or more independent directors or by independent directors constituting a majority of the board's independent directors. Nasdaq's proposed new listing rules would require each listed company to have a compensation committee consisting of at least two members, each of whom must be independent—which would align Nasdaq’s requirements with NYSE's listing standards.
Compensation Committee Member Independence. Current Nasdaq listing rules, like current NYSE listing standards, provide for a two-part independence test that specifies seven categories of directors who cannot be considered independent and also requires the board of directors to affirmatively determine that the director has no relationship that, in the opinion of the board, would interfere with the exercise of independent judgment in carrying out the director's responsibilities. Unlike the NYSE proposal, the proposed Nasdaq listing rules would prohibit independent compensation committee members from accepting, directly or indirectly, any consulting, advisory or other compensatory fee from the company. There is no "look-back" period for this prohibition. Like NYSE, Nasdaq notes that while the board should consider a director’s affiliation with the company, significant share ownership is not a bar to service on the compensation committee.
- Retains Existing Exception for One Non-Independent Director. Nasdaq retains an existing exception allowing a company, in certain exceptional and limited circumstances, to have one non-independent director serve on the compensation committee for up to two years, as long as the committee has at least three members, the non-independent director is not an executive officer or employee or family member of an executive officer, the board determines that such individual's membership on the committee is required by the best interests of the company and its shareholders, and this committee membership is disclosed either on or through the company’s website or in the proxy statement for the next annual meeting.
- Retains Existing Cure Periods. Nasdaq also proposes to permit a company with a compensation committee that fails to comply with member independence requirements because of vacancy or because a member ceases to be independent would be permitted to cure the noncompliance by the earlier of the next annual shareholder meeting and one year from the occurrence of the event that caused noncompliance—which is similar to the timing under current Nasdaq listing rules for a listed company to cure noncompliance with the requirement to have a majority independent board.
Compensation Committee Authority and Responsibilities. The proposed Nasdaq listing rules require that compensation committees have the four specified authorities and responsibilities enumerated above for the NYSE listing standards.
Compensation Adviser Independence. The proposed Nasdaq listing rules require that compensation committees may only select a compensation adviser after taking into consideration all factors relevant to that person's independence from management, including at a minimum the six factors enumerated above for identifying compensation advisor conflicts of interest. Under the Nasdaq proposal, no single factor would be determinative of independence, and the committee must consider these factors as a group. This listing rule would also apply to board members who oversee executive compensation matters in the absence of a committee, and would extend to outside legal counsel, as well as compensation consultants retained by management or by the company.
Significant New Requirements for Compensation Committee Charters. The proposed Nasdaq listing rules also impose significant new requirements for compensation committee charters. Current Nasdaq rules do not require a listed company compensation committee to have a written charter. Proposed new Nasdaq rules will require each listed company to adopt a formal written compensation committee charter. The charter, among other things, must set forth:
- Exception for In-House Counsel. These factors need not be considered before consulting with or obtaining advice from in-house counsel.
The proposed new Nasdaq rules would also require a listed company to review and reassess the adequacy of the formal written charter on an annual basis
- Must Adopt or Update Charter by 2014. Under the proposed Nasdaq listing rules, each listed company compensation committee must have a formal written charter that meets the specified requirements in place by the earlier of the second annual shareholders meeting after the effective date of the new listing rules and December 31, 2014.
Some Companies Exempt from New Requirements. Nasdaq proposes that asset-backed issuers and other passive issuers, cooperatives, limited partnerships, management investment companies, controlled companies, and companies with only debt securities listed be exempt from the new listing rules, which is consistent with Nasdaq’s current practice for rules regarding compensation committees.
- Relief for Smaller Reporting Companies. Nasdaq proposes to exempt smaller reporting companies from the new compensation committee eligibility requirements relating to compensatory fees and affiliation, as well as the requirements relating to independent compensation consultants and advisers. Smaller reporting companies must have a compensation committee of at least two independent directors, and must adopt a formal written compensation committee charter or board resolution specifying the compensation committee's responsibilities and authority. Smaller reporting companies are not required to review the charter or board resolution on an annual basis.
- Relief for Foreign Private Issuers. Current Nasdaq rules allow a foreign private issuer to follow home country practice in lieu of compliance with Nasdaq’s compensation committee eligibility requirements if the company discloses the differences in its corporate governance practices from those practices required of U.S. companies under Nasdaq’s corporate governance rules. This can be a brief general summary of any significant differences included in annual reports on Form 20-F. Foreign private issuers not using Form 20-F may include this “significant difference” disclosure on their websites in English or in their annual reports to shareholders. Nasdaq proposes to continue this approach by granting a general exemption from the proposed new compensation committee eligibility requirements to foreign private issuers that follow home country practice and provide this “significant difference” disclosure, as well as additional disclosure as to why it does not have an independent compensation committee, if applicable.
Transition Periods. If a company does not have a compensation committee, the new Nasdaq listing rules will apply to independent directors who determine compensation for the company's CEO and executive officers. A company that ceases to be a “smaller reporting company” would have the same schedule for phasing in compliance with these new requirements as a newly public company.
Certification Requirements. Nasdaq proposes to require each listed company to certify to Nasdaq that it has adopted a formal written compensation committee charter and that the compensation committee will review and reassess the adequacy of the formal written charter on an annual basis—which is similar to the existing audit committee charter certification requirement. In addition, Nasdaq proposes to require each listed company to certify to Nasdaq, no later than 30 days after the applicable implementation deadline applicable, that the company has complied with the amended listing rules on compensation committees. Nasdaq will provide companies with a form for this certification. A company that ceases to be a “smaller reporting company” would have 30 days to certify to Nasdaq that it has adopted a formal written compensation committee charter including the required content and has complied, or will comply within the applicable phase-in schedule, with the requirement regarding compensation committee composition.
- Consider Independence of Current Compensation Committee Members Under Proposed New Requirements. Although the stock exchange compensation committee independence requirements remain subject to public comment and SEC approval, companies should analyze the independence of their current compensation committee members under these proposed new independence requirements, as well as the independence of any new committee members they may be planning to add at the upcoming annual shareholders meeting. Nasdaq companies that do not have a compensation committee should prepare to comply with these new requirements.
- Evaluate Current Compensation Committee Charters. Companies should begin now the process of considering the manner in which the compensation committee charter would need to be updated (or a new charter adopted) upon the effectiveness of the new listing standards, expected to be in July 2013.
- Evaluate Compensation Adviser Independence. Companies should begin now the process of working with their compensation advisers to develop a process for collecting the necessary information to comply with the new compensation adviser independence determinations. One key issue to keep in mind is that, for these purposes, “adviser” includes traditional compensation consultants, as well as “any other adviser” to the compensation committee, which includes attorneys, consultants, and any other type of compensation adviser, whether retained by the compensation committee or management, or otherwise engaged by the company. Because the SEC declined to define what it means by “provides advice to the compensation committee” for purposes of these new requirements, companies should also consider the types of information the compensation committee reviews and the source of this information for purposes of determining whether the compensation committee needs to evaluate the independence of such information sources.
- Keep in Mind That Neither SEC nor Stock Exchanges Require Companies to Obtain Independent Compensation Advice. While new SEC rules implementing Section 952 of the Dodd-Frank Act and the related stock exchange listing standards require that before engaging any compensation adviser the compensation committee must consider the adviser’s independence, they do not require the company or the compensation committee to retain, or obtain advice only from, independent advisers—or at all. Nor do they require a compensation committee to implement or act consistently with the advice or recommendation of any adviser it has retained, or otherwise affect the ability or obligation of the compensation committee to exercise its own judgment. Further, the compensation committee does not have to engage or be directly responsible for the appointment, compensation, or oversight of a compensation adviser that is not retained by the compensation committee, such as a compensation consultant or legal counsel retained by management.
ISS 2013 Corporate Governance Policy Updates Affecting Executive Compensation
Institutional Shareholder Services (ISS) updated its proxy voting guidelines on November 16, 2012, effective for meetings held on or after February 1, 2013. You can find the full text of the ISS 2013 Corporate Governance Policy Updates here. The most significant changes relate to ISS's peer group selection process, the consideration of realizable pay for large cap companies and consideration of pledging as a factor that could affect director election recommendations. ISS has announced that it will issue FAQs relating to the updated proxy voting guidelines in early December 2012.
New Methodology for Selecting Pay-for-Performance Peer Group. As part of its say-on-pay voting recommendation, ISS conducts an analysis initially based on a quantitative "pay-for-performance" screen that measures a company’s CEO pay levels and total shareholder return (TSR) for one and three years compared with CEO pay and TSR for an ISS-selected peer group. The quantitative screen also measures trends in CEO pay compared with the company's annualized TSR over five years. If a company demonstrates a significant pay-for-performance misalignment under these quantitative tests, ISS performs a qualitative evaluation to determine the probable cause or any mitigating factors.
ISS previously focused its pay-for-performance analysis on the company’s Standard & Poor (S&P) Global Industry Classification Standard (GICS) industry group, which frequently omitted the company’s competitors and/or included firms that the company did not consider to be competitors for business or executive talent. Under the new methodology, ISS incorporates information from a company's GICS group as well as from GICS groups represented in the company's self-selected executive compensation benchmarking peer group identified in the company’s proxy statement to identify peers more closely aligned by industry, and then prioritizes peers that would put the company near the median of the peer group; are in the peer group selected by the company; and consider the company as a peer. ISS has also made minor adjustments to its size requirements, especially at very large and very small companies, and will look at revenue rather than assets for some types of financial companies. ISS has announced that it will open a web portal where companies can confidentially input any changes to their peer groups they want ISS to consider.
ISS Will Consider Realizable Pay for Large Cap Companies Only. ISS will now include “realizable pay” of executives in its qualitative evaluation for large cap companies—which apparently will mean S&P 500 companies. Large cap companies will have realizable pay included in their research reports. ISS calculates realizable pay as "the sum of cash and equity-based awards during a specified performance period being measured, based on equity award values for actual earned awards or target values for ongoing awards, calculated using the stock price at the end of the performance measurement period." ISS will revalue stock options and stock appreciation rights using the Black-Scholes option pricing model based upon the remaining term and updated assumptions. Although it does not state how it would use realizable pay in comparison to grant date pay as reported in the summary compensation table, ISS notes that "realizable pay consideration may mitigate or exacerbate CEO's pay-for-performance concerns."
Treatment of Pledging and Hedging. Under "extraordinary" circumstances, ISS will recommend that shareholders vote “against” or “withhold” their votes for individual incumbent directors, committee members or the entire board, as appropriate, if the company has experienced material failures of risk oversight. Starting in 2013, ISS will consider any amount of hedging of company stock by executives or directors as a material failure of risk oversight that will warrant a negative vote recommendation, and will consider “significant” (to be defined) pledging of company stock on a case-by-case basis. ISS believes that any hedging of company stock—through covered call, collar, or other derivative transactions—severs the ultimate alignment of the executive’s or director’s interests with shareholders’ interests. ISS believes that pledging company stock as collateral for a loan is not a responsible use of equity and may have a detrimental impact on shareholders if the director or executive is forced to sell the pledged shares. In determining recommendations for election of directors of companies who currently have executives or directors with pledged company stock, ISS will consider the following factors.
Transition Rule Regarding Board Responsiveness for Majority Supported Shareholder Proposals. Starting in 2014, ISS will recommend that shareholders vote “against” or “withhold” votes for incumbent directors who fail to act on a shareholder proposal that received the support of a majority of votes cast at the previous year’s annual shareholders’ meeting. Under the transition rule, for 2013 ISS will follow its current practice of recommending that shareholders vote “against” or “withhold” votes for incumbent directors who fail to act on a shareholder proposal that was approved by a majority of outstanding shares in 2012 or by majority of votes cast in both 2012 and one of the two prior years. ISS considers directors to have responded to a shareholder proposal if the board fully implements the proposal or includes it as a management proposal at the next annual shareholders meeting if a shareholder vote is required. For situations involving less than full implementation, ISS will consider the specifics on a case-by-case basis, taking into account the subject matter of the proposal, the level of shareholder support, the board’s shareholder outreach efforts, and any actions the board has taken in response to these efforts.
- Assess Any Hedging or Pledging Activity by Insiders in Light of New ISS Policy. Existing SEC Rule 403(b)(3) currently requires proxy statement disclosure (usually included in a footnote to the beneficial ownership table) of the amount of beneficially owned shares that have been pledged by directors and named executive officers. Companies should assess the amount of pledged securities in light of the new ISS policy.
- Consider Updating Current Insider Trading Policy. Many insider trading policies restrict or prohibit insiders from hedging or pledging company securities. Given ISS’s new interest in this topic, companies should evaluate their current insider trading policies and consider adding specific provisions to address hedging or pledging of company securities in advance of the Dodd-Frank rulemaking requiring disclosure of hedging policies.
- Consider Including Additional Proxy Statement Disclosure Regarding Pledging. Companies that permit pledging should consider adding proxy statement disclosure regarding the factors described above that ISS has specified it will consider in determining director vote recommendations.
Glass Lewis Proxy Voting Guidelines for the 2013 Proxy Season That Affect Executive Compensation
Glass Lewis released an overview of its updated proxy voting guidelines for 2013 on November 8, 2012. These guidelines, which are immediately effective, incorporate a mid-year revision to Glass Lewis's say-on-pay guidelines. You can find the full text of the Glass Lewis Guidelines: 2013 Proxy Season here. Significant changes from last year relating to executive compensation include a new peer group selection methodology, other updates to its proprietary pay-for-performance model and a new factor in evaluating equity-based compensation plan proposals.
New Method for Selecting Peer Groups for Pay-for-Performance Analysis. For 2013, Glass Lewis has adopted a new “market based” method for selecting peer groups developed by Equilar that creates a pool of potential peer companies and then uses a proprietary algorithm to select up to 30 peers for a specific company based on the strength of the relationships between potential peer companies. Glass Lewis will also disclose the peer group it used for the pay-for-performance analyses and compare it to the company’s self-selected peer group. Glass Lewis will continue to emphasize mutually identified peer companies. However, the algorithm’s analysis of the strength of relationships may result in Glass Lewis not using some of these peer companies in its pay-for-performance model. This represents a significant change from Glass Lewis’ prior methodology that lacked transparency and created potentially very large composite peer groups based on sector, sub-industry, size (enterprise value), and location.
New Factor in Evaluating Equity-Based Compensation Plan Proposals. Glass Lewis evaluates equity-based compensation plans using a detailed model and analytical review, based on a list of "overarching principles." Glass Lewis has added to this list one new principal: plans should not count shares in ways that understate the potential dilution, or cost, to common shareholders (i.e., 'inverse' full-value award multipliers that count options and SARs against the reserve at less than one share).
Board Responsiveness to a Significant Shareholder Vote. Under current Glass Lewis proxy voting guidelines, if 25 percent or more of shareholders voted against the recommendation of management on a proposal and the board does not demonstrate some level of engagement and responsiveness to address the shareholder concerns, Glass Lewis may make a negative vote recommendation on future proposal (e.g., to recommend against a director nominee, against a say-on-pay proposal, etc.), unless they determine that the board did not respond appropriately. In evaluating board responsiveness, Glass Lewis generally reviews publicly available disclosures released following the date of the company’s last annual meeting. Glass Lewis typically looks for the following: board level changes in board membership, committee memberships, disclosure of related person transactions, meeting attendance or other responsibilities; changes to the company’s articles of incorporation, bylaws, or other governance documents; any press or news releases indicating changes in, or the adoption of, new company policies, business practices or special reports; and any modifications to the design or structure of the company’s compensation program.
What Should Companies Be Doing Now to Respond to Trends in Say-On-Pay Shareholder Litigation?
Following the enactment of the Dodd-Frank Act, plaintiff’s firms began filing shareholder actions against executive officers, directors, and compensation consultants of companies that failed to obtain the approval of a majority of their shareholders for executive compensation proposals. Because many courts have dismissed these actions, plaintiffs’ firms are trying a new tactic: suing in state court to enjoin public companies from proceeding with shareholder votes on say-on-pay and compensation plan proposals at annual meetings until the company publicly files supplemental disclosure…and pays attorneys’ fees to plaintiffs' counsel.
- Companies Should Aggressively Defend. Although some companies have chosen to settle these types of actions, recently some companies who mounted aggressive defenses have prevailed and obtained dismissals—e.g., Gordon v. Symantec Corp., Case No. 1-12-CV-231541 (Cal. Santa Clara County Superior Court). Although these dismissals may discourage plaintiffs' firms from continuing to pursue these types of actions, companies should be prepared to act quickly to defend actions and avoid interference with their annual meeting schedule.
- What Does This Mean for Executive Compensation Disclosure in Future Proxy Statements? While substantive changes to companies’ proxy statement disclosure regarding executive compensation will not likely discourage plaintiffs’ firms from bringing these types of actions, companies should exercise special care to ensure that executive compensation disclosure complies with all applicable requirements and presents an adequate explanation regarding the executive compensation proposals on which shareholders will be voting.
You can find the full text of the SEC’s adopting release containing the new rules here. You can find the full text of NYSE's proposing release here. You can find the full text of Nasdaq's proposing release here. You can find the full text of the ISS 2013 Corporate Governance Policy Updates here. You can find the full text of the Glass Lewis Guidelines: 2013 Proxy Season here.
You can find discussions of other recent cases, laws, regulations, and rule proposals of interest to public companies on our website.
© 2012 Perkins Coie LLP