The Corporate Library Blog

Final rules on compensation from the SEC

In a December 16 meeting, the SEC finalized its rules on proxy disclosures about compensation and a range of other factors, including director qualifications and filing votes at annual meetings. The rules will be effective from February 28, 2010, just in time for the proxy rush next season.

While there are a bunch of changes, frankly, I remain unimpressed about the extent of change.

Quite a bit about the final rules has changed from the draft rules that came out on July 1 (I blogged about those here). Except, of course, one thing that did not change was the one piece of it that I actually wanted them to change.

I mean, I know no one reads my blogs – well no one with the first name of Lloyd – but this was a letter to Mary Schapiro and I know she, or someone at the SEC, must have read that. But, no, the summary compensation table is going to include the estimated grant date value of equity awards along with the actual salary, actual bonus, actual benefits, actual etc. So it will still be a nonsensical mixture of different kinds of compensation.

On the other hand, looking on the bright side, this means that the discerning pay analyst will still have to subscribe to Board Analyst to find out exactly what executives actually made during the year because sure enough the summary compensation table ain’t gonna tell them.

One good thing, though, the rules state that, for fiscal years ending on or after Dec. 20, 2009, companies will be required to present recomputed disclosure for all fiscal years included in the tables, so at least as far as that’s concerned we’ll have apples to apples.

While that bit didn’t change, companies will be required to assess if their compensation policies and practices for all employees, not just executive officers, create risks that are “reasonably likely to have a material adverse affect on a company.” How much real, meaningful information will come out of the exercise remains to be seen.

The SEC stepped back, though, on its requirements for the disclosure of compensation consultant fees. Instead of just getting it all out there, which would have been much simpler, thresholds and exclusions were adopted.

Well, hey, how can you keep on producing 137-page documents if you keep things simple?

Fees won’t have to be disclosed if the amount of additional services provided to the company by the consultant or an affiliate is less than $120,000 during the company’s fiscal year. The requirement also makes an exception for consulting on broad-based plans such as 401k)s or health insurance plans, and other services such as surveys… so that’s just about everything then.

Expect few disclosures in this area, therefore.

Paul Hodgson - Senior Research Associate

Say on Pay: We want pay meetings and we want them NOW!

That’s the message from shareholders. If we are going to vote on Say on Pay, they are saying, we need to meet with boards, we need them to explain their pay strategy to us and then we’ll vote on it.

Of course we don’t have Say on Pay yet, but most shareholders feel it is coming. If not 2010, then 2011.
So forget analyst calls, forget earnings forecasts, executives and non-executive directors need to spend some time selling their pay plans to investors.

This was the fallout from Say on Pay in the U.K. and it’s going to be the fallout here, so companies that are prepared for it early will likely see their pay plans meet with far higher approval ratings than companies that make no effort.

Make no mistake, if you’re a corporate secretary, a board chairman, a CEO, a compensation committee chairman, a shareholder is going to be calling you to arrange a meeting. Maybe more than one shareholder. Wouldn’t it be better to get your diary out and arrange a meeting, inviting your ten largest investors rather than waiting for them to come to you?

You know, there’s a lot of controversy about Say on Pay, didn’t do much to prevent problems in the U.K., U.K. pay has been rising faster than U.S. pay, etc., etc. Well, show me the control group and I’ll listen to the claims, but regardless I can see one really big advantage of Say on Pay.

Say you are a director and performance has been miserable, the company’s losing money, competitors are trying to headhunt your executives, not only have bonuses not been earned, stock options are underwater, an activist shareholder is clamoring for perks to be cut. It’s nevertheless a brave director who will say: no bonuses, perks are slashed, any stock options are going to be premium-priced. Once that’s done, the CEO, the CFO and the COO jump ship to a competitor. You’d be off the board in a flash and virtually unemployable as a director.

With Say on Pay, on the other hand, it’s not you making this decision it’s: “That’s what we have to do to pass the Say on Pay test” It’s: “I’m not going to stand up at the annual meeting and explain why we awarded retention bonuses and repriced your options by giving you a mega grant at the historically low price. I’m just not going to do it.”

Say on Pay: Backbone for Boards

Download our free white paper to help you with Say on Pay by visiting this link.

For more information on The Corporate Library's Say on Pay products and services, please contact our sales team.

Paul Hodgson — Senior Research Associate

Big Pay, Poor Performance: CEO Pay Webinar

Please join The Corporate Library's compensation experts on September 22 for a free CEO pay webinar, "Big Pay, Poor Performance: The Corporate Library's 2009 CEO Pay Survey.

The webinar, hosted by Senior Research Associate Paul Hodgson and Research Associate Greg Ruel, will feature an analysis of the CEO pay packages of five companies where the pay/performance links were most starkly broken in 2008. They will also review the main findings of The Corporate Library's 2009 CEO Pay Survey.

Receive 15% off the price of the CEO pay report just for attending!

Click here to register for this free webinar.

Britain Rools!

Just as we Brits are well-known for our addiction to queuing (that’s lining up to you lot), we are similarly enamored with rules. Somewhat unsurprisingly we’re first in the queue with some rules for bank bonuses. As reported by the New York Times, BloggingStocks and others, yesterday, the Financial Services Authority (FSA) confirmed the application of rules in a new policy statement. They are summarized below, but basically are about risk, adjusting for risk, making sure risk is taken into account, deferring bonuses if they are significant, and making them dependent on future performance as well. The kind of basic common sense compensation principles that it seems incredible were not already in place.

There is a welcome push to measuring non-financial performance – i.e. whether employees are indulging in risky behavior – and another for measuring the cost of capital when measuring profits, and not just basing bonuses on revenue. As well as what initially seemed like an extraordinary principle – make sure there is enough fixed compensation in the pay package. Huh? What was that? What do they want us to do? Raise salaries?

That’s the only principle where I’ve left the “guidance” in down below, because it needed a bit of explaining. What the FSA means is that when no bonus should be paid, they want the bank to be able not to pay it without landing the traders in the debtors’ prison (just joking, we got rid of those awhile ago).

Makes sense.

But wait a minute, is there an FSA for bar staff? I can see most waiters and waitresses going for that one too. Basic standard of pay so if we don’t get a tip…. No, no, no, hold on, hold on, this is Britain. We don’t tip. Queue, yes, but no tipping.

FSA’s Remuneration Principles

• A firm must establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk management
• A remuneration committee should:
  • exercise, and be constituted in a way that enables it to exercise, independent judgment;
  • be able to demonstrate that its decisions are consistent with a reasonable assessment of the firm’s financial situation and future prospects;
  • have the skills and experience to reach an independent judgment on the suitability of the policy, including its implications for risk and risk management; and
  • be responsible for approving and periodically reviewing the remuneration policy and its adequacy and effectiveness.
• Procedures for setting remuneration within a firm should be clear and documented and should include appropriate measures to manage conflicts of interest.
• A firm’s risk management and compliance functions should have significant input into setting remuneration for other business areas.
  • Remuneration for employees in risk management and compliance functions should be determined independently of other business areas.
  • Risk and compliance functions should have performance metrics based on the achievement of the objectives of those functions.
• Assessments of financial performance used to calculate bonus pools should be based principally on profits.
  • A bonus pool calculation should include an adjustment for current and future risk, and take into account the cost of capital employed and liquidity required.
  • The assessment process for the performance-related component of an employee’s remuneration should be designed to ensure assessment is based on longer-term performance.
• Non-financial performance metrics should form a significant part of the performance assessment process.
  • Non-financial performance metrics should include adherence to effective risk management and compliance with the regulatory system and with relevant overseas regulatory requirements.
  • The measurement of performance for long-term incentive plans, including those based on the performance of shares, should be risk-adjusted.
• The fixed component of remuneration should be a sufficient proportion of total remuneration to allow a firm to operate a fully flexible bonus policy.
  • Proposed Guidance:
    • If the fixed component (typically, base salary) of employee remuneration is low a firm will find it difficult to cut or eliminate a bonus in a poor financial year.
    • One measure of the effectiveness of this principle would be the ability of a firm (or part of it) not to pay a bonus in a year in which the firm (or part of it) makes a loss.
• The majority of any bonus should be deferred with a minimum vesting period if, when compared with the fixed component of an employee’s remuneration, the bonus is a significant proportion of that fixed component.
  • Any deferred element of the variable component of remuneration should be linked to the future performance of the firm as well as the employee’s division or business unit.

   

  Paul Hodgson — Senior Research Associate

Forward sales - why lose your own money when you can lose someone else's?

Just when we thought 10b5-1 trading plans had been perverted so far as to be the last refuge of the insider trade and that was it, along comes another idea for executives to sell their stock and have somebody else lose their shirt on it if the stock price – their own company’s stock price we’re talking about here – goes into a tailspin.

Announcing the latest, the greatest, the pre-paid variable forward contract.

A recent Gradient Analytics report found that many of these contracts actually preceded stock price declines or, as it says with magnificent understatement, “unusual levels of negative corporate events.”

I thought to myself no one can actually be doing this, can they. I mean, surely its illegal. Or just so horrible that no one would dare.

But no, even a cursory search by researchers at The Corporate Library turned up several examples. All of these, plus a list of companies that ban such arrangements – the only acceptable thing to do – can be found in my latest short report in our “Investing in Corporate Governance” series, called “Investing in Corporate Governance: Forward Sales." (Download a copy from our online store at http://www.thecorporatelibrary.com/info.php?id=76.)

The first example we found involves two directors at Freeport-McMoRan. Both B.M. Rankin, who is a member of the company’s public policy committee, and James Moffett, the current chairman of the board and former CEO, have engaged in pre-paid forward contracts via a limited liability company and a limited partnership, respectively, of which they are members or sole partners.

This is just not on.

While diversification is a general principle in stock ownership, the same rules do not apply to executives and directors. If these individuals do not want to hold company stock, if they do not want to be exposed to the risk, they should refuse it when the company offers it to them as compensation.

Paul Hodgson — Senior Research Associate

CEO of Beazer Homes Ian McCarthy asks "Really? We were doing that?"

It might be credible that CEO of Beazer Homes Ian McCarthy and the company’s board were unaware of exactly what was going in the company’s mortgage origination business – the mortgage fraud, the discount point fraud, the down-payment assistance fraud, the HUD-licensing fraud, the stated income fraud – all part of a federal investigation. It might be credible that they were unaware of the details, but were they responsible?

As CEO and board, yes.

Are they still the CEO and the board?

Yes.

While that might be credible, it is simply not credible that they were unaware of the cookie-jar accounting at the company that has been going on since 2000; hiding reserves that were in excess of maximum performance targets only to release them and hide expenses when the company’s financial performance took a nosedive. Yet the only person fired has been the chief accounting officer as a result of a separate SEC investigation. Yet even if they were unaware, incredible as it may seem, it was still their responsibility. The CEO signed the papers, after all, attesting to the accuracy of the accounts, a requirement of the Sarbanes-Oxley Act since 2002.

Are they still the CEO and the board?

Yes.

Details of the all the charges can be found here. But this is not the only lawsuit the company has faced/is facing/has settled. There are also ERISA lawsuits, a settled class action lawsuit, derivative shareholder actions, homeowners class action lawsuits, and multi-plaintiff lawsuits.

I’m sure none of those have anything to do with Mr. McCarthy or the board either.

And what of the pay?

According to Floyd Norris writing in the New York Times, a 2008 $600,000 bonus is being handed back by Mr. McCarthy, though quite why it was paid out in the first place for targets that comprised unit home closings, EBIT, cash flow, customer satisfaction, and compliance is difficult to comprehend.

But what of the prior bonuses? Mr. McCarthy earned over $27 million in bonuses since 2000, the beginning of the accounting fraud. The fact that the majority of the fraud decreased net income because it was “too high” rather than overstated it shouldn’t make any difference. Those sums should be returned also, along with any stock earned during the period, and the money used to compensate all the losers in this affair – shareholders, homeowners, former-homeowners, the list is a long one.

These accounting irregularities occurred both before and after Sarbanes-Oxley, and the Act’s requirements for internal controls and compliance appear to have made no difference to the continuance of the accounting fraud. And the Act is being challenged in the courts as being too prescriptive? This would appear to indicate that not only is it not prescriptive enough but that further checks and balances need to be inserted into the accounting process.

Paul Hodgson — Senior Research Associate

Goldman Sachs Compensation: So, it's true then

This is, like, almost a weekly event, Goldmanblogging.

So, almost 50 percent of revenues were reserved this last half year for compensation and benefits. Forget reserves, forget reinvestment. Forget let’s just make sure this is going to last...

A total of $11.4 billion for pay, up 33 percent from the same time last year and higher even than the first six months of 2007!

So much for those compensation principles about evaluating performance on a multi-year basis, we’re lucky here if they’re evaluating performance on a multi-month basis.

Now, if it’s bonuses they might not be paying it all out straight away, it might have to be deferred, they might just have to account for it right now. But if that were the case, don’t you think it might be a good idea to say so? That’s just common sense PR. Now the sights of every investment activist, every politician from Barney to Schumer, probably Geithner and Obama too, are focused securely on Goldman Sachs, and no special pleading from former Secretaries to the Treasury this time.

Will they be able to do anything? Probably not, but it’s still going to be ugly.

Paul Hodgson — Senior Research Associate

Johnson & Johnson Board: Best In Class?

Ironfire Capital CEO Eric Jackson’s thoughts on ‘the best boards in America’, posted earlier today on TheStreet.com, are a worthwhile read. One of the more influential and highly successful activist investors, Eric identifies three key identifiers of strong boards: equity ownership, independence and time, all of which are key factors we consider in evaluating boards for investment and other clients. Eric then goes on to identify three boards as being among the best in America, including Berkshire Hathaway, Amazon.com and Johnson & Johnson. We couldn’t agree more with the first two in his list, but take issue with the last, and in so doing highlight a fourth key indicator of board strength or weakness: CEO compensation. True, Johnson & Johnson has outperformed most of its peers of late, and done significantly better than the market as a whole. But CEO William C. Weldon’s compensation, as reported in the company’s most recent proxy, seems not only excessive in absolute terms but is poorly aligned with sustainable shareholder interests as a matter of policy. In particular Weldon’s ‘long-term incentive compensation’ is based on too short a period to be considered long-term (three years) and is not tied to any performance metrics. For fiscal 2008, total realized compensation for Mr. Weldon was $25,555,543 - enough to pay 5 years of 2008 salaries for all other named executives at Johnson & Johnson combined. Best in class? Not where CEO compensation is concerned – and this is one of the very few measures of a board’s actual decision-making to which we have access.

Ric Marshall — Chief Analyst

 

Yale Governance Forum Recap

The Yale Governance Forum, coordinated by the Millstein Center at Yale’s School of Management, is always a great place to hear what major figures in governance are thinking about current topics in the field.  This year, recent extraordinary events in the markets and in government are giving people a lot to talk about.  Topics of lively discussion at the 2009 conference, held last Thursday and Friday, included:

• Say on Pay:  Is it an important right that shareholders should have to express opinions on a key aspect of governance?  Alternatively, is it a boondoggle that will just wind up serving as a shield for bad compensation, because shareholders — many of whom don’t have the requisite knowledge to evaluate comp policy — will overwhelmingly approve most pay packages?  Or will the governance community rise to the occasion and find ways to educate investors about compensation, so that they can make informed decisions?  Some think the only way it will be effective is if shareholders also begin to withhold votes from compensation committees.  Others think it’s a useful tool in its own right, and that if it becomes law it will be a landmark reform.
• Proxy Voting:  Should institutional investors disclose their intended proxy votes ahead of annual meetings, instead of waiting for the August 31 NPX filing deadline?  Some people think they should, in the cause of transparency and in order to exert more public influence on governance issues.  Others think the administrative burden of doing so — and the confusion that could result from votes changed at the last minute — mean it isn’t worth it.  The April 6, 2009, report TCL recently wrote for AFSCME (available in our online store) was discussed as an illustration of what we can learn when voting disclosures are analyzed.
• ESG Integration:  There was consensus that a range of stakeholders, including companies, socially responsible investors, and proxy advisory firms, are developing a more sophisticated view of social and environmental issues, and are discussing them in terms of their business and investment impacts.
• Private Equity:  Can private equity create more wealth than the public corporation model?  TCL’s June 10, 2009, report for IRRC (also available in our online store), which criticized governance at buyout-fund-backed IPO companies, was cited by skeptics of this view.  Others wondered whether there might be certain circumstances or phases of a company’s life cycle for which private ownership is optimal.

Kimberly Gladman, CFA, Ph.D. — Director of Research and Ratings

Nell Minow To Write For the HBR Debate: How To Fix Executive Pay

Nell Minow, Editor and Co-Founder of The Corporate Library, will join several of the nation's leading thinkers in executive compensation in the Harvard Business Review Debate: How To Fix Executive Pay. The debate will take place on the Harvard Business Blog over the next several weeks. While you're waiting for Nell's submission, check out the most recent entry to the debate from Prof. Steve Kaplan of the University of Chicago Booth School of Business.