Choate Notice
PROXY AND COMPENSATION DISCLOSURE AMID ECONOMIC UNCERTAINTY: PRACTICAL GUIDANCE FOR 2009
January 30, 2009
Among the many effects of the continuing difficult economic environment will be a significant refocusing by public companies of their year-end reporting. In our November 6th program “Periscopes Up: Managing Your Company In Turbulent Waters” (click here for more information) we highlighted a number of these changes, including the need to: •
reflect the current economic reality and trends within management’s discussion and analysis,
•
update risk factors, and
•
address audit-related issues such as asset impairment.
Compensation Discussion & Analysis in 2009 Companies will, of course, need to include in their CD&A a tailored discussion of the impact of the current economic environment on compensation decisions made in respect of the year just ended as well as any changes in philosophy, policy and practice going forward. Beyond that, however, many investors expect companies to address topics specifically addressed in the Troubled Asset Recovery Program, even if a company is not subject to TARP. Chief among those topics are: •
Role of Risk: what business risks does a company face and how does the structure of its compensation programs and decisions made in implementing these programs encourage appropriate, as opposed to excessive and unnecessary, levels of risk-taking.
•
Clawbacks: whether the company has a clawback policy and, if it does, why that policy is appropriately tailored to the risks faced and how the features of the policy curb the potential abuses that shareholders may be worried about.
•
Severance Payments: the extent to which the company provides severance payments to its executive officers, why that policy does not result in unwarranted risk-taking or excessive compensation and why that policy is in the company’s interests.
Companies will also want to ensure CD&A is drafted to address areas frequently focused on by the SEC in their review of compensation disclosure. In its comments after last year’s proxy season, the SEC cited the need of many companies to improve the following particular aspects of their CD&A: •
Analysis: The SEC continues to require that companies provide more analysis with respect to the material elements of compensation, how varying levels of compensation are arrived at and why specific compensation policies and decisions fit within a company’s overall objectives and philosophy. In a year in which many companies were not able to achieve the operating and financial objectives defined at the beginning of the year, CD&A should explain how compensation committee decisions—and actual payments and awards—reflected the difficult external environment. Companies should expect substantial scrutiny if performance objectives were not
Choate Hall & Stewart LLP
| Two International Place | Boston MA 02110 | t 617-248-5000 f 617-248-4000 | choate.com
Choate Notice
Another area affected by the current economic environment will be proxy and compensation-related disclosure. This Notice discusses issues that public companies should focus on this year when crafting that disclosure and managing the proxy solicitation process in connection with their annual meeting of shareholders.
met and discretion was exercised to award bonuses despite shortfalls or if there are significant compensation increases in the face of poor company performance. •
Performance Targets: The SEC has pushed hard to require that companies disclose financial and non-financial performance targets and convincingly substantiate any competitive harm rationale given to support non-disclosure. Competitive harm arguments have been more successful with respect to non-financial targets, as opposed to financial targets that would be apparent from the face of the company’s financial statements. Companies should provide a thorough and tailored explanation in CD&A about the nature of harm that could result from the disclosure of performance targets and how competitors could make use of that information, if disclosed.
•
Benchmarking: The SEC has requested not only disclosure of which of the company’s peers were used in establishing compensation decisions, but also how the peer companies were selected and why the peer companies are appropriate points of comparison. In particular, the relative financial performance of and the executive officer compensation paid by the peer group companies should be addressed. Attention should also be paid to the peer group analysis that RiskMetrics Group employs in recommending proxy voting for its clients, as described below.
RiskMetrics 2009 Corporate Governance Updates The RiskMetrics 2009 Corporate Governance Updates indicate an increasing emphasis on compensation practices, including the following: •
Poor Pay Practices: The 2009 Updates focus heavily on “poor pay practices,” which RiskMetrics defines to include, among other things, change-in-control agreements that include “golden parachute” excise tax gross-ups, tax gross-ups on executive perks, excessively lucrative employment contracts or perks and option backdating. The existence of these practices may prompt a “withhold vote” recommendation on compensation committee members and possibly all board members, and a “no vote” recommendation on the equity plans used to implement these “poor pay practices”.
•
Pay for Performance Disconnects: The 2009 Updates also subject compensation committee members to a new and expanded test to determine if a pay-for-performance disconnect exists in CEO compensation. The test broadened the group of peer companies that are used in making the evaluation and expanded the number of companies evaluated for a pay-for-performance disconnect, looking not only at companies with negative shareholder returns but also at companies with returns in the bottom-half of an expanded industry group.
Each of these changes will create an incentive for companies both to provide a thorough discussion of compensation practices in this year’s CD&A and to ensure that the outcome of matters put to shareholder vote are not put at risk by a negative RiskMetrics recommendation.
e-Proxy is Now Mandatory for All Companies Last year, the SEC’s electronic proxy delivery, or e-Proxy, rules were mandatory only for large accelerated filers. This year, all filers are required to comply with the SEC’s e-Proxy rules, meaning that companies will need to follow either the “notice and access” model, the traditional “full set delivery” model or a stratified approach where some shareholders are sent proxy materials under the notice and access model while others receive full set delivery. The key differences between full set delivery and notice and access are: •
Timing: The notice and access model may require an acceleration of the past year’s proxy timeline. Under the notice and access model, companies must send the Notice of Internet Availability at least 40 days prior to the meeting. Broadridge has advised that it will need the final text of the Notice at least 7 days prior to this in order to meet this timing. No similar deadlines exist for companies following the full set delivery model.
•
Materials Mailed: Less is required to be sent to shareholders under the notice and access model. Under the notice and access model, only the Notice is required to be sent. Companies may only send a proxy to shareholders beginning 10 days after the Notice has been sent, or earlier if accompanied by both the proxy statement and annual report, but are not required to send proxy materials unless requested by a shareholder.
•
Impact on Shareholder Vote: Companies that have already adopted the notice and access approach have found that decreased voting resulted, particularly among retail shareholders. The impact of this decrease has been amplified by many brokerage firms electing either not to issue discretionary votes on “routine” matters such as uncontested director elections or adopting a form of proportional voting for the retail segment of their holdings. This issue becomes even more important for non-“routine” matters, such as an increase in the size of an equity plan, which many companies will be acting on this year due to the higher “burn” rate that has resulted from lower stock prices. Companies will need to think through both the substantive terms of matters put to shareholders and logistical issues that follow from the choice of one proxy distribution model over another.
•
Cost Savings: Cost savings may result from adoption of the notice and access model. However, companies should weigh these costs savings against such factors such as the need to ensure sufficient votes are returned to reach quorum and pass the matters being voted on and avoiding a second printing and/or mailing of proxy materials.
In this period of economic upheaval and uncertainty, public companies need to build into their reporting and annual meeting schedules sufficient time to allow careful consideration of the different ways in which their responses to the overall economic environment may affect their disclosure and processes. If you have questions about the subject matter of this Public Company Notice, please contact your lawyer at Choate or one of the following partners: William Asher Frederick Callori James Hackett James McDaniel John Pitfield
617-248-5087 617-248-5239 617-248-2133 617-248-5280 617-248-5093
| | | | |
[email protected] [email protected] [email protected] [email protected] [email protected]
© Copyright 2009 CHOATE HALL & STEWART LLP Information contained herein should not be construed as legal advice or legal opinions on specific facts. The enclosed material is provided for education and information purposes by Choate, Hall & Stewart LLP to clients and others who may be interested in the subject matter.
January 30, 2009
Among the many effects of the continuing difficult economic environment will be a significant refocusing by public companies of their year-end reporting. In our November 6th program “Periscopes Up: Managing Your Company In Turbulent Waters” (click here for more information) we highlighted a number of these changes, including the need to: •
reflect the current economic reality and trends within management’s discussion and analysis,
•
update risk factors, and
•
address audit-related issues such as asset impairment.
Compensation Discussion & Analysis in 2009 Companies will, of course, need to include in their CD&A a tailored discussion of the impact of the current economic environment on compensation decisions made in respect of the year just ended as well as any changes in philosophy, policy and practice going forward. Beyond that, however, many investors expect companies to address topics specifically addressed in the Troubled Asset Recovery Program, even if a company is not subject to TARP. Chief among those topics are: •
Role of Risk: what business risks does a company face and how does the structure of its compensation programs and decisions made in implementing these programs encourage appropriate, as opposed to excessive and unnecessary, levels of risk-taking.
•
Clawbacks: whether the company has a clawback policy and, if it does, why that policy is appropriately tailored to the risks faced and how the features of the policy curb the potential abuses that shareholders may be worried about.
•
Severance Payments: the extent to which the company provides severance payments to its executive officers, why that policy does not result in unwarranted risk-taking or excessive compensation and why that policy is in the company’s interests.
Companies will also want to ensure CD&A is drafted to address areas frequently focused on by the SEC in their review of compensation disclosure. In its comments after last year’s proxy season, the SEC cited the need of many companies to improve the following particular aspects of their CD&A: •
Analysis: The SEC continues to require that companies provide more analysis with respect to the material elements of compensation, how varying levels of compensation are arrived at and why specific compensation policies and decisions fit within a company’s overall objectives and philosophy. In a year in which many companies were not able to achieve the operating and financial objectives defined at the beginning of the year, CD&A should explain how compensation committee decisions—and actual payments and awards—reflected the difficult external environment. Companies should expect substantial scrutiny if performance objectives were not
Choate Hall & Stewart LLP
| Two International Place | Boston MA 02110 | t 617-248-5000 f 617-248-4000 | choate.com
Choate Notice
Another area affected by the current economic environment will be proxy and compensation-related disclosure. This Notice discusses issues that public companies should focus on this year when crafting that disclosure and managing the proxy solicitation process in connection with their annual meeting of shareholders.
met and discretion was exercised to award bonuses despite shortfalls or if there are significant compensation increases in the face of poor company performance. •
Performance Targets: The SEC has pushed hard to require that companies disclose financial and non-financial performance targets and convincingly substantiate any competitive harm rationale given to support non-disclosure. Competitive harm arguments have been more successful with respect to non-financial targets, as opposed to financial targets that would be apparent from the face of the company’s financial statements. Companies should provide a thorough and tailored explanation in CD&A about the nature of harm that could result from the disclosure of performance targets and how competitors could make use of that information, if disclosed.
•
Benchmarking: The SEC has requested not only disclosure of which of the company’s peers were used in establishing compensation decisions, but also how the peer companies were selected and why the peer companies are appropriate points of comparison. In particular, the relative financial performance of and the executive officer compensation paid by the peer group companies should be addressed. Attention should also be paid to the peer group analysis that RiskMetrics Group employs in recommending proxy voting for its clients, as described below.
RiskMetrics 2009 Corporate Governance Updates The RiskMetrics 2009 Corporate Governance Updates indicate an increasing emphasis on compensation practices, including the following: •
Poor Pay Practices: The 2009 Updates focus heavily on “poor pay practices,” which RiskMetrics defines to include, among other things, change-in-control agreements that include “golden parachute” excise tax gross-ups, tax gross-ups on executive perks, excessively lucrative employment contracts or perks and option backdating. The existence of these practices may prompt a “withhold vote” recommendation on compensation committee members and possibly all board members, and a “no vote” recommendation on the equity plans used to implement these “poor pay practices”.
•
Pay for Performance Disconnects: The 2009 Updates also subject compensation committee members to a new and expanded test to determine if a pay-for-performance disconnect exists in CEO compensation. The test broadened the group of peer companies that are used in making the evaluation and expanded the number of companies evaluated for a pay-for-performance disconnect, looking not only at companies with negative shareholder returns but also at companies with returns in the bottom-half of an expanded industry group.
Each of these changes will create an incentive for companies both to provide a thorough discussion of compensation practices in this year’s CD&A and to ensure that the outcome of matters put to shareholder vote are not put at risk by a negative RiskMetrics recommendation.
e-Proxy is Now Mandatory for All Companies Last year, the SEC’s electronic proxy delivery, or e-Proxy, rules were mandatory only for large accelerated filers. This year, all filers are required to comply with the SEC’s e-Proxy rules, meaning that companies will need to follow either the “notice and access” model, the traditional “full set delivery” model or a stratified approach where some shareholders are sent proxy materials under the notice and access model while others receive full set delivery. The key differences between full set delivery and notice and access are: •
Timing: The notice and access model may require an acceleration of the past year’s proxy timeline. Under the notice and access model, companies must send the Notice of Internet Availability at least 40 days prior to the meeting. Broadridge has advised that it will need the final text of the Notice at least 7 days prior to this in order to meet this timing. No similar deadlines exist for companies following the full set delivery model.
•
Materials Mailed: Less is required to be sent to shareholders under the notice and access model. Under the notice and access model, only the Notice is required to be sent. Companies may only send a proxy to shareholders beginning 10 days after the Notice has been sent, or earlier if accompanied by both the proxy statement and annual report, but are not required to send proxy materials unless requested by a shareholder.
•
Impact on Shareholder Vote: Companies that have already adopted the notice and access approach have found that decreased voting resulted, particularly among retail shareholders. The impact of this decrease has been amplified by many brokerage firms electing either not to issue discretionary votes on “routine” matters such as uncontested director elections or adopting a form of proportional voting for the retail segment of their holdings. This issue becomes even more important for non-“routine” matters, such as an increase in the size of an equity plan, which many companies will be acting on this year due to the higher “burn” rate that has resulted from lower stock prices. Companies will need to think through both the substantive terms of matters put to shareholders and logistical issues that follow from the choice of one proxy distribution model over another.
•
Cost Savings: Cost savings may result from adoption of the notice and access model. However, companies should weigh these costs savings against such factors such as the need to ensure sufficient votes are returned to reach quorum and pass the matters being voted on and avoiding a second printing and/or mailing of proxy materials.
In this period of economic upheaval and uncertainty, public companies need to build into their reporting and annual meeting schedules sufficient time to allow careful consideration of the different ways in which their responses to the overall economic environment may affect their disclosure and processes. If you have questions about the subject matter of this Public Company Notice, please contact your lawyer at Choate or one of the following partners: William Asher Frederick Callori James Hackett James McDaniel John Pitfield
617-248-5087 617-248-5239 617-248-2133 617-248-5280 617-248-5093
| | | | |
[email protected] [email protected] [email protected] [email protected] [email protected]
© Copyright 2009 CHOATE HALL & STEWART LLP Information contained herein should not be construed as legal advice or legal opinions on specific facts. The enclosed material is provided for education and information purposes by Choate, Hall & Stewart LLP to clients and others who may be interested in the subject matter.
