Executive Compensation

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Delaware Court Emphasizes Importance of Corporate Formalities in Facebook Director Compensation Case

The litigation against Facebook for their director compensation raised a question of first impression:  whether a disinterested controlling stockholder can ratify a transaction approved by an interested board of directors by expressing assent informally, instead of using one of the prescribed methods under Delaware corporate law, and be able to shift the standard of review from entire fairness to the business judgment presumption.

The board’s decision to approve the compensation of outside directors in 2013 was governed by the entire fairness review as a self-dealing transaction. After the filing of the lawsuit, which we previously discussed here and here, Mark Zuckerberg, who controlled over 61% of the voting power, approved the compensation in a deposition and with an affidavit.
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Chamber Declines to Litigate Pay Ratio Rules

The WSJ reported that the U.S. Chamber of Commerce will not be challenging the SEC pay ratio disclosure rules in court. Our memo on the final rules is here.

According to the article, the Chamber noted that the rule is not effective until 2018. The political landscape surrounding the rule could change after the 2016 elections. There have already been several Congressional efforts to repeal the rule.

The Chamber intends to continue focusing on the conflict minerals litigation.
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Delaware Court of Chancery Subjects Non-Employee Director Compensation to the “Entire Fairness” Standard

On April 30, 2015, the Delaware Court of Chancery held for the second time in three years that a decision by a board of directors or a board’s compensation committee to award equity to non-employee directors as part of their annual compensation constituted a self-interested transaction and, when challenged in a stockholder derivative action, that (a) stockholder demand was excused and (b) the decision would be reviewed under the heightened “entire fairness” standard. This holding comes despite the fact that the equity compensation plan in question, which included a per-person limit on grants, was previously approved by the company’s stockholders.

Read the full memo »
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Surveys Find Limited Pay-for-Performance Disclosure and Wide Use of Stock Ownership Guidelines

A Towers Watson survey found that only about 27% of Fortune 500 companies provided some type of pay-for-performance discussion in 2014. Only 4% of companies added new disclosure, while 5% eliminated it after including it in the prior year.

According to the survey, 29% of those that disclosed pay-for-performance at all offered an alternate pay calculation, such as realizable or realized pay. The vast majority used a pay-for-performance alignment approach that tied the achievement of performance metrics, typically total shareholder return, with the level of pay.  Three to five years was the most common time horizon. Last fall, Towers Watson found that while most companies conduct a pay-for-performance analysis, many do not disclose it.
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Talking to Tapestry’s Compensation Committee Leadership Network

Davis Polk partner Ed FitzGerald and I spoke in December with Tapestry’s Compensation Committee Leadership Network (CCLN) on forthcoming SEC executive compensation rules, as summarized in this Tapestry Viewpoints. The CCLN brings together a select group of compensation committee chairs from prominent companies to discuss ways to improve the performance of their companies and communicate effectively with shareholders through their compensation committee work.

The discussion included the Dodd-Frank clawback provisions, which as enacted do not consider fault to be a trigger, unlike the most common clawback policies that have already been adopted by companies. The vast majority of those require some form of misconduct.
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Facebook Defends Its Director Compensation in Delaware Litigation

Facebook is seeking to dismiss a lawsuit challenging the compensation paid to its non-executive directors, which we previously discussed here.

Although a board’s decision to grant compensation to its members generally falls outside the business judgment rule because board members are deemed personally interested in their compensation levels, if the board’s decision is approved by a majority of independent, disinterested and informed stockholders, then the business judgment rule presumption applies rather than the entire fairness standard.

Facebook argues in its motion to dismiss that the director compensation at issue was approved by the necessary stockholder majority because the company’s CEO and chairman, Mark Zuckerberg, beneficially owns approximately 17% of the company, and 55% of the voting power, as a result of its dual-class structure.
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Lawsuit Filed Against Facebook’s Director Compensation

A derivative action has been brought in Delaware Chancery Court alleging that Facebook’s board of directors breached their fiduciary duties and unjustly enriched themselves and wasted corporate assets through the compensation paid to the non-executive directors, with “a yearly take beyond what could be considered reasonable.” 

Plaintiff alleges that the individual director compensation of $461,000 is 43% higher than peer companies, including Amazon and Walt Disney, which generate more revenue and profit. In making this peer group calculation, plaintiff removed from Facebook’s disclosed list of peers certain companies, such as Apple, Google and Microsoft. It claims those entities are not comparable to Facebook because their market cap and other financial metrics make them much larger.
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Supreme Court: Severance Payments are Subject to FICA Payroll Taxation

On March 25, 2014, in United States v. Quality Stores, the Supreme Court held that severance payments to employees who are involuntarily terminated are taxable as wages for purposes of Social Security and Medicare taxation under the Federal Insurance Contributions Act (FICA).

In the 18-page opinion authored by Justice Kennedy, eight justices sided unanimously with the government (Justice Kagan did not participate in the case). In reaching its conclusion that no general exception exists for severance payments from the definition of “wages,” the Court looked to the plain meaning of the FICA statute, which defines “wages” as “all remuneration for employment,” the statute’s legislative history and regulatory background, as well as the recognized principle from a prior Court holding (Rowan Cos.
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Beyond the Numbers: Factors that Influence ISS Recommendations for Say-on-Pay

While only 142 Russell 3000 companies have failed say-on-pay in the last three years from over 7,000 companies with those votes, 893 companies had to counter negative recommendations from ISS. By now it is well-known that ISS uses both a quantitative test and then examines qualitative factors. The qualitative review is triggered when a company receives “high” concern on the quantitative metric that examines, among other things, the CEO pay and total shareholder return to other companies, but the review may also occur even when a company receives less than “high” concern. 

The qualitative review becomes critically important because only half of those companies that fail the initial numerical test ever receive “against” recommendations from ISS.
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A Look Back to the 2013 Proxy Season: Say-on-Pay

Say-on-pay is our focus in the second of our series on looking at the past season, through reviewing the ISS post-season report. The vote continues to be routine for most companies, as almost 80% of the Russell 3000 companies receive support above 90%.

To get these kinds of results, companies recognize that it’s crucial to score favorably in ISS’ evaluation. Contrary to what some may believe, a mark of “high concern” under the ISS quantitative test will not automatically translate into a negative recommendation. This was proven during the season with ISS recommending against say-on-pay for only 51% of those companies, as the qualitative analysis allowed ISS to recommend in favor of the remaining companies notwithstanding poor quantitative scores.
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Conference Board Working Group Establishes Framework for Standardized Supplemental Pay Disclosure

Disclosure of realizable pay and realized pay may be all the rage, but the fact that a wide range of different practices exists led the Conference Board Working Group on Supplemental Pay Disclosure, working jointly with the Center on Executive Compensation and the Society of Corporate Secretaries and Governance Professionals, to develop a framework to assist in providing greater consistency and comparability. The current ad-hoc approach by companies have been criticized for diminishing the potential value of the disclosure to investors.

The framework outlines 11 conceptual points, including the need to measure performance using primarily total shareholder return (TSR) given that is how investors assess company performance, but also incorporating other financial metrics that can justifiably demonstrate shareholder value. 
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Active Investors Weigh In on SEC Pay Ratio Proposal

Comment letters continue to flow in, almost overwhelmingly supportive so far, on the SEC proposed rule for pay ratio disclosure. More than 19,000 form letters and over 150 specific letters, primarily from individuals, have been submitted.

Investors active on executive compensation issues are starting to providing input, as both the International Brotherhood of Teamsters and Pax World Management submitted letters in support of the proposal. Teamsters believes the pay ratio disclosure will help investors evaluate CEO pay levels in the context of a company’s compensation system. It also indicates that it intends to monitor how the ratio changes over time, which some commentators have expressed could become a more meaningful indicator that companies need to be concerned about, rather than the initial disclosure. 
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Federal Jurisdiction Over Say-On-Pay Lawsuits

The Ninth Circuit recently issued an opinion in Dennis v. Hart, in which it held that the district court lacked subject matter jurisdiction over various say-on-pay lawsuits originally filed in state court and subsequently removed to federal court. In 2010, the board of directors of PICO Holdings, Inc. increased executive compensation notwithstanding that the company reported negative annual net income and free cash flow for the year. In a May 2011 advisory vote on executive compensation, 61% of PICO’s shareholders voted against the 2010 compensation package. The PICO board, however, made no changes to compensation following the vote.

Shareholders subsequently filed lawsuits in California state court asserting various state common law claims, including breach of fiduciary duty.
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Delaware Court Finds Informal NYSE Guidance Unpersuasive

Delaware Chancery Court Judge Leo Strine ruled earlier this month that the lawsuit against Simon Property Group regarding the CEO’s compensation can proceed. The suit, brought by the Louisiana Municipal Police Employees Retirement System, alleged among other things that the company failed to obtain shareholder approval before amending an equity plan that allowed the board to grant a retention bonus to the CEO of over $120 million. The company’s counsel argued, without success, that the company had received informal guidance from the NYSE that approval was not required.

The plan, adopted in 1998, required that performance units granted must be tied to financial performance.
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Second Circuit Finds No Liability Under Short-Swing Profit Rules for “Pairing” Transactions That Relate to Two Different Classes of Equity Securities

The Second Circuit recently issued a decision that relates to whether a sale of one class of equity security and a purchase of a different class of equity security issued by the same company can be “paired” under Section 16(b) of the Exchange Act to result in required profit disgorgement by the transacting insider. The Court held that, absent any guidance from the SEC, an insider’s purchase and sale of shares of different types of stock in the same company does not trigger liability under Section 16(b) where those different classes of securities are separately traded, nonconvertible and have different voting rights.
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Chamber of Commerce Asks the SEC to Review Glass Lewis

The U.S. Chamber of Commerce recently sent a letter to the SEC asking the regulator to “monitor the activities” of Glass Lewis, questioning whether the proxy advisory firm’s recent vote recommendations for the 2012 Canadian Pacific Railway meeting was influenced by its parent company, the Ontario Teachers’ Pension Board. The letter pointed out that the Ontario Teachers’ opposition to the board of directors of Canadian Pacific Railway was followed by Glass Lewis issuing a recommendation that shareholders vote for the alternative slate of directors. The Chamber questions the “tangible conflicts of interest in the operation of proxy advisory firms.”

Glass Lewis issued a press release refuting the Chamber’s assertions.
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Exxon Webcast on Executive Compensation Represents Another Method of Shareholder Outreach

This proxy season there has been a lot of focus on companies filing additional soliciting materials to supplement proxy disclosure, with a particular focus on executive compensation in light of the say-on-pay vote. Exxon Mobil has taken a particularly interesting approach turning a two-dimensional paper communication into something more dynamic by inviting interested persons to a company-sponsored webcast on executive compensation.

The webcast represents an additional proactive step Exxon has taken. On the same day it filed its proxy statement, Exxon took the unusual step of also filing a colorful presentation filled with data, graphs and photos to explain how its pay-for-performance approach focuses on the long-term nature of its capital-intensive business. 
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The Use of Additional Soliciting Materials for Say-on-Pay Votes

In year two of say-on-pay, we find that companies continue to file additional materials to solicit for favorable votes. These additional materials are generally in the form of a brief letter to shareholders highlighting aspects of executive compensation.  Most are in the form of descriptive narratives, although a few companies use graphs and charts and even PowerPoints. While a few are filed early on following the proxy statement, the majority appear to be in response to negative recommendations on say-on-pay from proxy advisory firms. 

Proxy disclosure this season has been thorough and detailed, which would suggest that additional materials are not technically necessary.
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Glass Lewis Makes an Attempt at Transparency, and Studies Try to Evaluate Proxy Advisory Services’ Influence

Glass Lewis released a brief overview that it calls a “Primer for Issuers.” Glass Lewis reiterates that it does not engage in discussions with companies during the proxy solicitation period because of concerns about the possibility of receiving material, nonpublic information. However, it will sometimes host a Proxy Talk conference call during which a company’s management or board can speak directly to Glass Lewis’ clients.

Board Matters. It is not always clear when a director will run afoul of Glass Lewis’ voting recommendations. The Issuer FAQ provides some information about related person transactions, noting that a director who controls more than 20% of voting stock would be deemed an affiliate. 
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Glass Lewis Makes an Attempt at Transparency, and Studies Try to Evaluate Proxy Advisory Services’ Influence

Glass Lewis released a brief overview that it calls a “Primer for Issuers.” Glass Lewis reiterates that it does not engage in discussions with companies during the proxy solicitation period because of concerns about the possibility of receiving material, non-public information. However, it will in some cases host a Proxy Talk conference call where a company’s management or a board can speak directly to Glass Lewis clients.

Board Matters. It is not always clear when a director will run afoul of Glass Lewis’ voting recommendations. The Issuer FAQ provides some information about related person transactions, noting that a director who controls more than 20% of voting stock would be deemed an affiliate. 
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SEC Sues to Clawback Compensation of Executives

Yesterday, the SEC sued two former executives of Arthrocare Corporation, a manufacturer of medical devices, to recover bonuses and stock profits they had received after the company had filed false financial statements. In doing so, the SEC continued its policy of seeking to apply Section 304 of Sarbanes-Oxley to executives who have not been personally charged with the fraudulent financial statements.

Under Section 304, if “an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct,” then its CEO and CFO is required to reimburse the issuer for certain compensation received or profits made from the sale of the issuer’s stock during the 12-month period after the fraudulent financial statement was filed.
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Coming Soon to a Bank Near You: Expanded Compensation Disclosure

On October 19, we posted about the Federal Reserve’s recently released report detailing its horizontal review of incentive compensation practices at 25 large banking organizations.  The report notes that the Fed intends to implement the Pillar 3 compensation disclosure requirements adopted in July by the Basel Committee on Banking Supervision.  The required disclosures are quite extensive (e.g., compared to the disclosures currently required for U.S. public companies).  As the disclosures will be public, banks may be criticized for their compensation practices.  On the plus side, banks will have a window into their peers’ practices.

The Pillar 3 requirements are limited to disclosure and do not mandate particular forms or amounts of compensation. 
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Federal Reserve’s Report on Incentive Compensation Practices – A Progress Report?

The Federal Reserve recently released a report detailing its horizontal review of incentive compensation practices at 25 large banking organizations.  The findings and recommendations are expressed in highly general terms, and set forth the Fed’s views on what financial institutions are and should be doing to identify practices effective in balancing incentive compensation arrangements and risk and formulate next steps in developing these practices.  Because the interagency rule on incentive compensation in the financial sector may provide a roadmap for future regulation in this area extending beyond financial institutions, the insight offered by the report may be helpful in structuring incentive compensation policies at any company.
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Another Win for Goldman

On October 4, 2011, we blogged about the dismissal of a series of lawsuits filed in New York by Goldman Sachs shareholders.  We noted that a similar shareholder suit against Goldman Sachs was pending in the Delaware Chancery Court.  Last week, that suit was dismissed.

With respect to executive compensation issues, the shareholders in the Delaware case claimed that Goldman’s directors breached their fiduciary duties by (1) failing to properly analyze and rationally set compensation levels for Goldman’s employees and (2) committing waste by “approving a compensation ratio to Goldman employees in an amount so disproportionally large to the contribution of management, as opposed to capital as to be unconscionable.”

Ruling on Goldman’s motion to dismiss for failure to make a pre-suit demand upon the board and for failure to state a claim, the Delaware Chancery Court found that a pre-suit demand was not excused because the plaintiffs failed to plead demand futility with sufficient particularity. 
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