Compensation Committees

No, this is not a riff on Hamlet’s soliloquy.  It’s about the current kerfuffle (one of my favorite words) about stock buybacks.  In case you’ve not heard, some (but not all) of the concerns about stock buybacks are as follows:

  • Plowing all that cash into buying back stock means that it’s not going into plant and equipment, R&D or other things that facilitate longer-term growth and job creation.
  • Companies are using the windfall from the 2017 tax act to buy shares back rather than to make investments that will create jobs and longer-term growth.
  • Stock buybacks artificially inflate stock prices and earnings per share, which contributes to or results in additional (i.e., excessive) executive compensation.
  • By reducing the number of shares outstanding, buybacks mask the dilutive effects of equity grants to senior management.

And now there’s another concern.  Specifically, in a recent speech, new SEC Commissioner Jackson announced that stock buybacks are being used by executives to dispose of the shares they receive in the equity grants referred to above.  And one of his proposed solutions is that compensation committees engage in more active oversight – or, rather, that compensation committees should be required to engage in more active oversight – of insider trades “linked” to buybacks.


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It may be nice to be your own boss, but setting your own compensation – and, at least arguably, giving yourself excessive pay – may get you in trouble.  A number of boards of directors have found that out, as courts have given them judicial whacks upside the head for paying themselves too much.  Not surprisingly, shareholders have gotten on the bandwagon as well.

Executive compensation – at least for public companies – has to be scrutinized and blessed by independent directors and, since the advent of Say on Pay, approved by shareholders (albeit on a non-binding basis).  In contrast, directors have long set their own pay, with little or no scrutiny and no requirement for independent review, much less approval.  (Director plans generally must get shareholder approval if they provide for equity grants, but neither the overall director compensation program nor specific awards have to be approved.)
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ASU 2016-09 - Share-Based Accounting
Photo by David Fulmer

Over the past couple of months, the FASB has been busy. I wanted to point out one recent change and my thoughts on its impact.

FASB has “simplified” share-based compensation accounting. I will always have a special place in my heart for old FAS123 since it was on my CPA exam a couple of decades ago.  Nevertheless, much has changed since then (APB No. 25 anyone?), including most recently:

  • No more APIC pools. Currently, tax benefits in excess of compensation cost are recorded in equity (specifically, Additional Paid In Capital or APIC). The accumulation of excess benefits has been known as an APIC pool. Tax deficiencies decrease the APIC pool. Under the new accounting rules, excess benefits and deficiencies are recognized in the period in which they occur.

My Take – Expect more income tax expense volatility from period to period. If the changes impact tax expense significantly, we could see more non-GAAP financial measures develop. Just be careful of the renewed focus on non-GAAP financial measures from the SEC.

  • No longer need to estimate forfeitures. GAAP currently requires you to estimate the number of awards that will be forfeited to calculate a more accurate amount of compensation cost each period. Under the new rules, you can continue to estimate or you can just reverse the compensation previously expensed when the forfeiture occurs. If you choose the new route, then you will have to hit retained earnings for the cumulative-effect adjustment incurred as a result of the change as of the beginning of the year the change is applied.

My Take – Again, there could be potentially more volatility if you elect to apply the new “actual” forfeiture approach.   A good example of volatility would be if a company had a significant layoff of employees. The increase in forfeitures during the layoff period would significantly
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Director fiduciary dutiesA recent case out of the Delaware Court of Chancery could result in heightened scrutiny of equity award grants to non-employee directors. Although this decision was rendered at the procedural stage of the case and the merits of the claims have yet to be fully analyzed, this case potentially affects directors of Delaware companies and those advising them on compensation-related matters.

In this case, a stockholder of Citrix, Inc. (“Citrix”) brought a derivative lawsuit against the Citrix board of directors alleging a number of things, including breach of fiduciary duty by the board of directors in awarding significant equity compensation awards. Specifically, the plaintiff alleged that restricted stock units (“RSUs”) granted to non-employee directors (who constituted eight of the nine Citrix board members) under the Citrix equity incentive plan, were excessive.

Because the non-employee directors who received the RSU grants in question constituted eight of the nine members of the Citrix board of directors, the plaintiff was successfully able to rebut the business judgement rule presumption and the defendants bear the burden of proving to the court’s satisfaction that the RSU grants were the product of both fair dealing and fair price (i.e., the “entire fairness” standard of review).

The defendants argued that
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I have read several reports quoting Mary Jo White, Chair of the SEC, as saying that the remaining Dodd-Frank corporate governance rulemakings will be out by year-end.  Admittedly, the reports aren’t clear as to what Chair White means.   Does she mean that the so-called pay ratio rule will be adopted in final form by year-end (in which case the disclosures wouldn’t be required until 2016)?  Or that by year-end the Commission will have proposed rules on hedging, clawbacks and pay-for-performance?  All of the above?  It’s anyone’s guess.

I have also read the daily emails I receive from the SEC entitled “Upcoming Events Update.”  (I get several of these “Updates” every day, even though they are identical and don’t seem to have been updated at all.  For those of you who don’t get these emails, they purport to announce things like every meeting of the SEC and every speech to be given by Commissioners and Staff members.)  For the last month or two, no open meetings of the SEC have been scheduled (and it’s virtually impossible for these rules to be proposed or adopted otherwise than at an open meeting).  So when I saw today that
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Bob Lamm's Golden Nugget's of Corporate Governance
Photo by Eric Roy/ Golden Nugget Casino, Las Vegas, late 80’s.

On September 30, Bob Lamm moderated a panel at a “Say-on-Pay Workshop” held during the 11th Annual Executive Compensation Conference in Las Vegas, Nevada.  The Conference is an annual event sponsored by TheCorporateCounsel.net and CompensationStandards.com – and emceed by our good friend, Broc Romanek – and features many of the pre-eminent practitioners in corporate governance and securities law. 

The panel, entitled “50 Nuggets in 75 Minutes,” may just be the CLE equivalent of speed dating – each of five panelists covers 10 “nuggets” – practical and other takeaways to help them do their jobs better – in a 75-minute panel.

Here are Bob’s 10 “nuggets,” reprinted courtesy of the Conference sponsors and Broc. 

1.    Engagement is a Two-Way Street – At this stage of the game, shareholder engagement is – or should be – a given, and one of a company’s normal responsibilities.  Along with that is the mantra “engage early and often”; in other words, don’t wait until you are faced with a negative vote recommendation to start reaching out to your major holders. 

What may not be part of the mantra is that engagement is a two-way street.  Your job (and that of your colleagues and even some directors) is to
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Looking into the future of changes to corporate governanceInterest in corporate governance has increased exponentially over the last several years, as has shareholder and governmental pressure – often successful – for companies to change how they are governed.  Since 2002, we’ve seen Sarbanes-Oxley, Dodd-Frank, higher and sometimes passing votes on a wide variety of shareholder proposals, and rapid growth in corporate efforts to speak with investors.  And that’s just for starters.   

These developments represent the latest iteration of what has become part of our normal business cycle – scandals (e.g., Enron, WorldCom, Madoff, derivatives), followed by significant declines in stock prices, resulting in public outrage, reform, litigation, and shareholder activism.   Now that the economy is rebounding, should we anticipate a return to “normalcy” (whatever that may be)?  Are we back to “business as usual”? 

Gazing into a crystal ball can be risky, but I’m going to take a chance and say “no.”  While our economic problems have abated, I believe that the past is prologue – in other words, we’re going to continue to see more of the same: investor pressure on companies, legislation and regulation seeking a wide variety of corporate reforms, and the like.  Some more specific predictions follow: 

  • Increased Focus on Small- and Mid-Cap Companies:  Investors have picked most if not all of the low-hanging governance fruit from large-cap companies.  Sure, there are some issues that may generate heat and some corporate “outliers” that investors will continue to attack.  However, most big companies have long since adopted such reforms as majority voting in uncontested director elections, elimination of supermajority votes and other anti-takeover provisions, and shareholder ability to call special meetings, to name just a few.  If investors (and their partners, the proxy advisory firms) are to continue to grow,
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Golden leashes
Photo by Don Urban

The compensation disclosure rules contained in Regulation S-K are intended to provide meaningful disclosure regarding an issuer’s executive and director compensation practices such that the investing public is provided with full and fair disclosure of material information on which to base informed investment and voting decisions. However, as we pointed out in a blog from last year, not all compensation is covered by these rules, including compensation paid to directors by third parties (e.g., by a private fund or activist investors). These arrangements are commonly known as “golden leashes.”  The two examples I discussed previously related to proxy fights involving Hess Corporation and Agrium, Inc. In each case, hedge funds had proposed to pay bonuses to the director nominees if they were ultimately elected to the board of directors in their respective proxy contests. Additionally, in the Agrium, Inc. case, the director nominees would have received 2.6% of the hedge fund’s net profit based on the increase in the issuer’s stock price from a prior measurement date. The amounts at issue could have been significant considering this particular hedge fund’s investment in Agrium, Inc. exceeded $1 billion, but none of the nominees were ultimately elected to the Agrium, Inc. board.

Considering the large personal gains these director nominees could potentially realize under these types of arrangements, it could pose a problem from a corporate governance standpoint as it is a long-standing principal of corporate law that directors are not permitted to use their position of trust and confidence to further their private interests. Recognizing this potential problem, the Council of Institutional Investors (“CII”), a nonprofit association of pension funds, other employee benefit funds, endowments and foundations with combined assets that exceed $3 trillion, recently wrote the SEC asking for a review of existing proxy rules “for ways to ensure complete information is provided to investors about such arrangements.”

In its letter, the CII points out that existing disclosure rules do not “specifically require disclosure of compensatory arrangements between a board nominee and the group that nominated such nominee.” The CII believes that disclosure related to these types of third party director compensation arrangements are material to investors due to the potential
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Golden leashes
Photo by Don Urban

The compensation disclosure rules contained in Regulation S-K are intended to provide meaningful disclosure regarding an issuer’s executive and director compensation practices such that the investing public is provided with full and fair disclosure of material information on which to base informed investment and voting decisions. However, as we pointed out in a blog from last year, not all compensation is covered by these rules, including compensation paid to directors by third parties (e.g., by a private fund or activist investors). These arrangements are commonly known as “golden leashes.”  The two examples I discussed previously related to proxy fights involving Hess Corporation and Agrium, Inc. In each case, hedge funds had proposed to pay bonuses to the director nominees if they were ultimately elected to the board of directors in their respective proxy contests. Additionally, in the Agrium, Inc. case, the director nominees would have received 2.6% of the hedge fund’s net profit based on the increase in the issuer’s stock price from a prior measurement date. The amounts at issue could have been significant considering this particular hedge fund’s investment in Agrium, Inc. exceeded $1 billion, but none of the nominees were ultimately elected to the Agrium, Inc. board.

Considering the large personal gains these director nominees could potentially realize under these types of arrangements, it could pose a problem from a corporate governance standpoint as it is a long-standing principal of corporate law that directors are not permitted to use their position of trust and confidence to further their private interests. Recognizing this potential problem, the Council of Institutional Investors (“CII”), a nonprofit association of pension funds, other employee benefit funds, endowments and foundations with combined assets that exceed $3 trillion, recently wrote the SEC asking for a review of existing proxy rules “for ways to ensure complete information is provided to investors about such arrangements.”

In its letter, the CII points out that existing disclosure rules do not “specifically require disclosure of compensatory arrangements between a board nominee and the group that nominated such nominee.” The CII believes that disclosure related to these types of third party director compensation arrangements are material to investors due to the potential
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