Executive Compensation

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SEC Publishes Final Rule and Concept Release on Equity Compensation Offerings

On July 18, 2018, the SEC voted unanimously both to issue a final rule and to solicit public comment through a concept release relating to the federal securities rules that govern the issuance of employer stock pursuant to compensation arrangements. Davis Polk discusses the SEC’s final rule and concept release here.

The final rule and the concept release were published to the Federal Register on July 24, 2018. The final rule is effective as of July 23, 2018, meaning that companies can rely on it immediately as of that date. The SEC is accepting comments relating to the concept release until September 24, 2018.
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Delaware Court Finds Continued Compensation to Incapacitated Chairman Could Render Directors Liable for Claims of Waste and Bad Faith

In an unusual finding, the Delaware Court of Chancery held that demand was partly excused and claims for corporate waste, bad faith and unjust enrichment could proceed against CBS Corporation for compensation paid to its former Executive Chairman, Sumner Redstone, who later became Chairman Emeritus.  The plaintiff alleged that Mr. Redstone became incapacitated yet continued to receive compensation for work he did not perform.

The court noted that claims of corporate waste and bad faith require a plaintiff to show that the board’s decision was “so egregious or irrational” that it could not be based on a valid assessment of a company’s best interest, and amount to an “extreme factual scenario.” 
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New Tax Act Has Meaningful Implications for Broad-Based Employee Benefit Plans

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA), which generally went into effect for tax years beginning on or after January 1, 2018.  The TCJA provisions affecting executive compensation (for example, the elimination of the performance-based compensation exception to Section 162(m) of the Internal Revenue Code) have received signification attention, but the TCJA also has meaningful implications for broad-based employee benefit plans and programs.

A memorandum that provides an overview of the key TCJA provisions impacting employee benefits is available here.
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Administering Compensation Programs in the Wake of the Tax Cuts and Jobs Act – New Section 162(m)

The Tax Cuts and Jobs Act (TCJA) significantly changes Section 162(m) of the Internal Revenue Code, effective for tax years beginning after December 31, 2017. While supplemental regulatory guidance is likely, the impact on companies’ compensation programs and planning processes is immediate.

For an in-depth discussion of the significant changes, ways companies can address them and areas where the new rules present uncertainty, see our memorandum.
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Another Twist in the Challenges to Director Compensation

In a series of cases challenging the magnitude of equity award compensation that boards have provided for their non-employee directors, the Delaware Chancery Court suggested that if the awards were made within a “meaningful limit” approved by shareholders the court would review these challenges under the standard business judgement rule rather than requiring an entire fairness review.

Many companies took heed, seeking shareholder approval for amendments adding a director award limit to their stock incentive plans. However, the Delaware Supreme Court recently put into question whether a meaningful limit would actually help to avoid an entire fairness review.

While it is hard to believe that a reasonable limit approved by shareholders would be of no value in rebutting a challenge to an otherwise defensible equity grant, boards should focus on the entirety of their approach to determining non-employee director compensation.
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Where the Final Tax Reform Bill Landed on Executive Compensation

On December 15, the Conference Committee reconciling the House and Senate tax reform bills released its full bill text to be voted on by both chambers of Congress and, if approved, presented to the President. The compensation provisions in the final bill are substantially the same as those in the Senate bill. The most important of these provisions are as follows:

Deduction Limit on Executive Compensation Paid by Public Companies.

The final bill makes the following changes to Section 162(m):

  • The exceptions for performance-based compensation (including stock options) and commissions are repealed.
  • The list of covered employees is expanded to include the CFO.

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Year-End Compensation Planning in Light of the House Tax Reform Proposal and Proposed Changes to the Taxation of Stock Options

Over the past week, Republican lawmakers in the House of Representatives have proposed sweeping tax reform legislation, including a series of amendments to the initially proposed bill. As companies enter their year-end compensation planning to develop compensation programs for 2018, they may wish to keep in mind certain aspects of the proposed legislation that may dramatically change how companies choose to compensate employees, executives and directors. A memorandum outlining these issues is available here.

Additionally, a blog post summarizing changes proposed by Representative Brady’s amendment to the bill relating to the taxation of stock options and restricted stock units granted by private companies is available here.
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House Tax Bill Upends Key Executive Compensation Rules and Makes Changes to Employee Benefits

On Thursday of last week, Republicans in the House of Representatives released a proposed tax reform bill that includes several provisions that would significantly impact compensation of directors, executives and employees. The bill also includes provisions relating to 401(k) plans and other employees benefits.

Blog posts summarizing these provisions are available at https://www.taxreformandtransition.com/2017/11/house-tax-bill-upends-key-executive-compensation-rules/ and https://www.taxreformandtransition.com/2017/11/house-tax-bill-changes-to-employee-benefits/.

These posts summarize the initial version of the tax reform bill proposed in the House. The bill is undergoing changes through the mark-up process in the House, and the Senate is expected to release its own bill soon, which may include very different provisions relating to compensation and benefits.
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SEC Issues Interpretative Guidance on Pay Ratio Rules, Reinforcing Flexibility and Providing Relief

As companies are coming to grips with the reality that the pay ratio rules will not be delayed, the SEC yesterday issued interpretative guidance that went a long way toward reassuring companies that they have sufficient flexibility and can exercise their best judgment in determining the median employee and the resulting pay ratio, thereby reducing compliance costs.

This came in the form of a brief Commission guidance and separate Staff interpretations.  In addition, although no mention was made in the press release touting these SEC actions, the Staff also updated and in one case withdrew its prior pay ratio guidance in the Division of Corporation Finance compliance and disclosure interpretations (CDIs) from last year (see Section 128C).
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The Drivers that Continue to Dog Say-on-Pay

Although the failure rate for 2017 say-on pay results achieved an all-time low of just 1.3%, the number belies the fact that more than 2,000 say-on pay proposals have either received negative recommendations from ISS or less than 70% support, or both, since say-on-pay resolutions started in 2011.

Approximately 12% to 14% of companies run into problems every year.  As companies have become more proactive with shareholder engagement, the number of companies that received “against” recommendations from ISS and still achieved more than 70% support has increased in the last three years, while the number of companies with those negative recommendations that received less than 70% favorable votes have fallen. 
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EEOC Reports Seeking Employer Pay Data Stayed

New EEOC regulations seeking pay data will not go into effect in March 2018 as planned.  According to the EEOC, the Office of Management and Budget (OMB) informed the Commission that it is initiating a review and instituting an immediate stay of the effectiveness of the pay data collection aspects of the revised form that was adopted in September 2016, in accordance with its authority under the Paperwork Reduction Act (PRA).

While the acting chair of the EEOC had opposed the revised form at the time it was approved, the EEOC reportedly lacked sufficient votes to reverse course.  Some groups had asked congressional lawmakers to pass laws to prohibit the EEOC from enforcing the rule. 
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MSCI Pay Report Finds Misalignment Between Reported Pay and Shareholder Returns

A new MSCI report reviewed 429 large-cap U.S. companies from 2006 to 2015 and found that, on a 10-year cumulative basis, total shareholder returns of those companies whose compensation was below their sector median outperformed those companies where pay exceeded the sector median by 39%. The conclusion was reported in the WSJ. SEC disclosure rules focused on annual pay were criticized for obscuring these trends.

The report aggregates its data to arrive at its conclusions. The underlying data for individual company results are not provided. The largest company in the study was Apple ($591 billion market capitalization) and the smallest company was PPL Corp.
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Supplemental Proxy Filings on Say-on-Pay Do Not Affect Overall Vote Results

A recent Semler Brossy report that examined supplementary proxy materials on say-on-pay proposals since 2011 found no material impact on the vote outcome for companies that made those filings in response to a negative ISS recommendation.  The average results for companies that received an “against” recommendation and made a supplemental filing are equal to or below the results at companies that received negative recommendations and did not file additional materials.

While the number of these filings have decreased from a high of 113 in 2012 to just 38 three years later, companies continue to file them.  So far this year there has even been an increase. 
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Delaware Case Addresses Board Process for Hiring and Terminating Executive

The Delaware Court of Chancery recently issued a 75-page opinion granting additional books and records related to the hiring and termination of Yahoo’s chief operating officer (COO), which triggered nearly $60 million in severance payments after only 14 months on the job. The Court determined that a credible basis exists to infer that there is possible mismanagement that would warrant further investigation.

According to the opinion, in initial discussions with the compensation committee about the potential hire, the CEO “cryptically” withheld the individual’s name, position and qualifications while asking the compensation committee to approve a compensation package that the compensation consultant had explained was more than what the peer data supported.
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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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