Dodd-Frank Say-on-Pay and Other Executive Compensation Developments

Transcription

1 Dodd-Frank Say-on-Pay and Other Executive Compensation Developments Daniel Beebe, Esq. DSB Legal Consulting Presented to the Corporate Section of the Orange County Paralegal Association May 2, 2013 The board of directors is the highest governing authority within the management structure at any publicly traded company. Among the board of directors responsibilities at public companies is establishment of the compensation committee. The compensation committee sets base compensation, stock option awards, and incentive bonuses for the company's executives, including the CEO. 1

2 A director owes a duty to exercise good business judgment and to use ordinary care and prudence in the operation of the business. They must discharge their actions in good faith and in the best interest of the corporation, exercising the care an ordinary person would use under similar circumstances. Directors' decisions, including determination of executive compensation, are typically protected under the business judgment rule, unless they breach one of these duties or unless the decision constitutes waste. Say-on-Pay was part of the overall reforms necessitated by the bailout of Wall Street Investment Banks and Credit/Lending Institutions from , Chairman of the Financial Services Committee Rep. Barney Frank sponsored legislation that gave shareholders a non-binding vote on executive compensation. Then Senator Barack Obama authored a "Say-on-Pay" proposal, but his legislation stalled in the Senate The Emergency Economic Stabilization Act of 2008 (EESA), which established the Troubled Asset Relief Program (TARP), required Say on Pay resolutions at companies with outstanding funds from the TARP In July the House passed H.R. 3269, the "Corporate and Financial Institution Compensation Fairness Act of 2009" that included a section that allowed for a Say-on-Pay' for all public institutions in the U.S The House and Senate bills were reconciled in a final bill that was signed by President Obama in July, 2010 called The Dodd Frank Wall Street Reform and Consumer Protection Act. 2

3 The Dodd-Frank Act changed the prior regulatory structure in an effort to streamline the regulatory process, increase oversight of specific institutions regarded as a systemic risk, and amending the Federal Reserve Act to promote transparency. Changes include: 1. The consolidation of regulatory agencies, elimination of the national thrift charter, and new oversight council to evaluate systemic risk; 2. Comprehensive regulation of financial markets - including increased transparency of derivatives (bringing them onto exchanges); 3. Consumer protection reforms including a new consumer protection agency and uniform standards for "plain vanilla" products as well as strengthened investor protection; 4. Tools for financial crises, including a "resolution regime" complementing the existing Federal Deposit Insurance Corporation (FDIC) authority to allow for orderly winding down of bankrupt firms, and that the Federal Reserve (the "Fed") receive authorization from the Treasury for extensions of credit in "unusual or exigent circumstances"; 5. Various measures aimed at increasing international standards and cooperation including proposals related to improved accounting and tightened regulation of credit rating agencies. 6. Required registration of previously exempt investment advisors who were previously not required to register with the SEC (if the investment adviser had fewer than 15 clients during the previous 12 months and did not hold itself out generally to the public as an investment adviser). The Act is categorized into sixteen titles and, by one law firm's count, it requires that regulators create 243 rules, conduct 67 studies, and issue 22 periodic reports. The Act contains more than 90 provisions that require SEC rulemaking, and dozens of other provisions that give the SEC discretionary rulemaking authority. 3

4 Section 951 of the Dodd-Frank Act amends the Securities Exchange Act of 1934 by adding Section 14A, which requires companies to conduct a separate shareholder advisory vote to approve the compensation of executives. Section 952 of the Act requires compensation committees to be composed exclusively of independent directors. Relevant factors the exchanges must consider include the source of compensation of the director and whether a director is affiliated with an issuer or a subsidiary or an affiliate of a subsidiary. Section 953 says companies must disclose the relationship between executive compensation actually paid and the financial performance of the issuer. Section 951 of the Dodd-Frank Act amended the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) by adding Section 14A(a), which requires: Beginning with the first annual shareholders' meeting taking place on or after Jan. 21, 2011,Companies to conduct a separate shareholder advisory vote to approve the compensation of executives, as disclosed pursuant to Item 402 of Regulation S-K (Enhanced Proxy Disclosure). Vote on Say on Pay must happen at least every three years, and frequency on say on pay at least once every six years. Frequency vote results must be disclosed within four business days of stockholders meeting on Form 8 K. Vote relates to approval of compensation of named executive officers (i.e., named in proxy compensation tables) generally as disclosed in the proxy statement, but not individual elements of compensation or corporate practice. Nature of vote is advisory so cannot compel companies to do anything. Companies also are required to provide additional disclosure regarding "golden parachute" compensation arrangements with certain executive officers in connection with merger transactions. 4

5 Say on pay has promoted companies communication with stockholders to convey important elements of compensation policy to stockholders and get stockholder input. Say on pay has aided in providing company transparency to assist stockholders in understanding the company s compensation philosophy and align interests of management and stockholders. Use the Compensation Discussion & Analysis (CD&A) section to tell the story about compensation decisions and rationale - avoid boilerplate descriptions. Use of layered narrative, highlighting critical aspects of compensation and pay performance early in CD&A. Address in detail how the company has considered the results of the most recent say-on pay vote in determining compensation policies and decisions. Use of graphs and charts to effectively communicate the pay for performance relationship based on measures such as revenue and earnings per share growth. Clearly state targets for performance based compensation, the actual performance and payout based on the performance Include supplemental compensation tables that provide explanation of compensation issues and how performance targets are met. Provide a clear rationale for inclusion of peer group companies. 5

6 Raul v. Rynd, C.A. No LPS (D. Del. March 14, 2013): The plaintiff challenged the board s compensation decisions, alleging that increased compensation in a year when the company posted a net operating loss and negative shareholder return violated the company s pay-for-performance philosophy and rendered the company s compensation disclosures in its proxy statement misleading. Holding: The plaintiff s allegations based on the advisory vote fail to recognize the realities of Dodd-Frank namely, that the Act explicitly prohibits construing the shareholder vote as overruling the Board s compensation decision or altering directors fiduciary duties. The Raul decision reinforces the Dodd-Frank Act s bar on attempts to use the advisory shareholder vote to overrule directors business judgment on matters of executive compensation. 6

7 Withhold votes from directors that don t respond adequately to shareholder concerns about pay. Institutional shareholders may sell some or all of their position, effecting the share price. Large shareholders may nominate their own directors (see Rule 14a 11, proxy access rule) through the public company s proxy statement and work to revise executive compensation for the next proxy period/advisory vote. In 2012, about 2.6% of companies failed to get majority approval, compared with approximately 1% in 2011; 72% obtained 90%+ approval in 2012, consistent with 2011; and 91% obtained 70%+ approval in 2012, slightly down from 93% in Results suggest that shareholders, although not more likely to vote against say on pay generally, are refining their analysis of compensation practices and financial performance and focusing negative votes on particular companies with problematic pay practices. Source: Preparing for the 2013 Proxy Season, 7

8 Where past executive compensation was paid based on misstated earnings or artificially attained targets, federal law allows the clawback or repayment of previously received performance-based compensation: Dodd-Frank Act 954, 15 U.S.C. 78j-4(b) (now Exchange Act Section 10D) Sarbanes-Oxley Act of ; 15 U.S.C. 7243(a) Note: The Emergency Economic Stabilization Act of 2008 (EESA) as added by Section 7001 of the American Recovery and Reinvestment Act of 2009 (ARRA); 12 U.S.C. 5221(b)(3)(B) has a clawback provision however it is applicable only to recipients of assistance under the Troubled Asset Relief Program (TARP) that have not repaid the Treasury). 1. Applicability. The Dodd-Frank Act requires the SEC to direct the exchanges to prohibit the listing of securities of issuers that have not developed and implemented compensation claw-back policies providing: for disclosure of the companies policies to recoup any incentive compensation paid on the basis of erroneous financial information reported under securities laws; and that, if an accounting restatement is prepared, the issuer will recover any excess incentive-based compensation, including stock options, from any current or former executive officer, regardless of fault, who received such incentive-based compensation in the three years preceding the corporate restatement. 2. Trigger Event. Accounting restatement due to material noncompliance with reporting requirements under securities laws. 3. Executives Covered. DFA 954 explicitly covers any current or former executive officer. 4. Compensation Covered. Incentive-based compensation (including stock options) in excess of what would have been paid under the accounting restatement. 5. Period Covered. Three-year period preceding the date the company is required to prepare the accounting restatement. 8

9 No government clawback actions have been initiated due to SEC rule-making delays on key Dodd-Frank Act provisions about disclosure and executive compensation. The SEC missed its previously announced deadline of December 31, 2011, for finalizing clawback rules. Most recent rule-making schedule had SEC finalizing clawback rules second half of 2012 Since clawback rules can be written in so many different ways, many companies are choosing to wait for SEC guidance prior to implementing. July 13, J.P. Morgan Chase announced that it would seize millions of dollars of compensation from rogue traders. The recovered sums included restricted stock and canceled stock options grants. There continue to be very few reported internal enforcements of compensation clawbacks for chief executive officers, chief financial officers, and other senior executive officers and employees pursuant to U.S. securities laws. 9

10 1. Applicability. Clawback provisions under the Sarbanes- Oxley Act only applied in cases of intentional fraud. 2.Trigger Event. [M]isconduct resulting in required restatement of any financial reporting required under securities laws. 3. Executives Covered. CEO and CFO only. 4. Compensation Covered. Bonus or other incentive-based or equity-based compensation; in addition to compensation clawback, recovery of profits of certain sales of securities is required. 5. Period Covered. [T]he 12-month period following the first public issuance or filing with the [SEC] (whichever occurs first) of the financial document giving rise to the required restatement. SEC v. O'Leary, Case No. 1:11-cv-2901 (N.D. Ga.) On August 30, 2011, the Securities and Exchange Commission (SEC) announced a settlement with James O'Leary, the former chief financial officer of Beazer Homes USA, to recover approximately $1.4 million in cash bonuses, incentive and equity-based compensation, and profits from his sale of Beazer stock during the period of time that Beazer committed "accounting misconduct." The SEC's complaint did not allege that O Leary participated in any misconduct, but rather O Leary was required, under Section 304 of Sarbanes-Oxley, to reimburse Beazer more than $1.4 million that he received after Beazer filed materially false financial statements during fiscal year 2006). 10

11 Academic research finds that voluntarily adopted clawback provisions appear to be effective at reducing both intentional and unintentional accounting errors. The same study also finds that investors have greater confidence in a firm's financial statements after clawback adoption, and that boards of directors place greater weight on accounting numbers in executive bonuses after a clawback is in place (i.e., pay for performance sensitivity increases). Source: 'Does Voluntary Adoption of a Clawback Provision Improve Financial Reporting Quality?' by dehaan, Ed; Hodge, Frank; and Shevlin, Terry J. (2012) Contemporary Accounting Research, forthcoming. Executives may have existing contracts that may be at odds with clawback provisions of Dodd-Frank. In anticipation of the SEC final rule adoption on clawbacks, a company should consider the following options: Do nothing - adopting a wait and see approach. Adopt a short/interim policy that is expected to be amended in a more robust manner once final rules are adopted. In conjunction with the above bullet, have executives sign a contractual arrangement under which each executive agrees (as to all then existing and future arrangements) to comply with the Dodd-Frank clawback requirements (when effective) and any clawback policy adopted by the company as such is amended from time to time. (The preferred approach) Adopt a formal and robust clawback policy. (Less desired approach, since proposed rules have not been issued and policy would likely need to be amended.) 11