A Busy 2013 For Executive Compensation · 2013-08-09 · compensation, and oversight of the work of any compensation consultant, ... Plan must be entered into in good faith and not

© 2013 Winston & Strawn LLP

A Busy 2013 For Executive Compensation

Brought to you by Winston & Strawn’s Employee Benefits and Executive Compensation Practice Group

© 2013 Winston & Strawn LLP 2

Today’s eLunch Presenters

Michael Melbinger Employee Benefits and Executive

Compensation Chicago

[email protected]

Erik Lundgren Employee Benefits and Executive


[email protected]


Overview

New Compensation Committee Advisor Independence Rules

Rule 10b5-1 Trading Plan developments ISS comments on pledging (more than we expected) Summary of SSOP results Update on the various forms of litigation being

brought in connection with proxy statements General suggestions for improvement in proxy

drafting and process


New Compensation Committee Advisor Independence Rules


Independence of Compensation Committee and Advisors SEC issued Final Rules on June 20, 2012 (pursuant to Dodd-Frank Act) The NYSE and NASDAQ issued proposed listing rules in September 2012 (with most recent

amendments in January 2013) implementing the SEC rules, and final listing rules were approved by the SEC in January 2013

*Exceptions apply, including for foreign private issues and controlled and smaller reporting companies

Subject NYSE Effectiveness NASDAQ Effectiveness Disclosure of Compensation Consultant Conflicts of Interest

SEC Final Rule effective for 2013 proxy statement (for annual meetings on or after January 1, 2013)

Independence of Compensation Committee Members*

Earlier of first annual meeting after January 15, 2014 or October 31, 2014

Earlier of first annual meeting after January 15, 2014 or October 31, 2014

Responsibility to Consider Independence of Compensation Committee Advisers*

July 1, 2013 July 1, 2013

Authority/Responsibility of Compensation Committee and Funding for Advisers*

July 1, 2013 July 1, 2013

Compensation Committee Charter Requirements*

July 1, 2013 Earlier of first annual meeting after January 15, 2014 or October 31, 2014


Independence of Compensation Committee and Advisors (cont.) Authority of Compensation Committee and Funding

The compensation committee must have the following specific rights and responsibilities:

The compensation committee may, in its sole discretion, retain or obtain the advice of a compensation consultant, independent legal counsel, or other adviser;

The compensation committee shall be directly responsible for the appointment, compensation, and oversight of the work of any compensation consultant, independent legal counsel, or any other adviser retained by the compensation committee;

The Company must provide for appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to a compensation consultant, independent legal counsel, or any other adviser retained by the compensation committee;

The compensation committee may select a compensation consultant, legal counsel or other adviser to the compensation committee only after taking into consideration all factors relevant to that person's independence [from management] (including the six independence factors identified on the next slide)

The compensation committee’s written charter must address the rights and responsibilities identified above, and now for NASDAQ-listed companies, must include certain basic provisions, similar to those already required by the NYSE


Independence of Compensation Committee and Advisors (cont.) Selection of Compensation Consultant, Legal Counsel, and Other Advisers

(“advisers”) The Compensation Committee may select (or receive advice from) an adviser only after

considering the following factors: The provision of other services to the company by the person that employs the adviser (the “advisory

firm”) The amount of fees received from the company by the advisory firm as a percentage of the advisory

firm’s total revenue The policies and procedures the advisory firm has in place to prevent conflicts of interest Any business or personal relationship of the adviser with a member of the Compensation Committee Any stock of the issuer owned by the adviser Any business or personal relationship between the executive officers of the company and the

compensation adviser or advisory firm + NYSE Only: consider “all factors relevant” to assessing the adviser’s independence from management

The Committee must consider the independence of any adviser, including those retained by management, if the advice is provided (directly or indirectly) to the Committee

The Committee need not consider the independence factors before consulting with or obtaining the advice of in-house counsel


Independence of Compensation Committee and Advisors (cont.) Selection of advisers – cont.

The Compensation Committee is not precluded from retaining an adviser that is not independent The Compensation Committee is not required to implement or act consistently with the advice of

the adviser Nothing in the rule is to affect the ability or obligation of the compensation committee to exercise

its own judgment in fulfillment of its duties

Compensation Consultant Conflict of Interest Disclosure (Effective for 2013 Proxy Statement) For any compensation consultant that played a role in determining or recommending the amount

or form of executive or director compensation* (whether hired by the committee or the company), the final SEC rules require disclosure if the work of the consultant raised any conflict of interest

If a conflict of interest is raised, the company must disclose the nature of the conflict of interest and how the conflict is being addressed

In deciding whether there is a conflict of interest that may need to be disclosed, companies should, at a minimum, consider the six independence factors identified above for each such consultant

*Other than any role limited to (i) consulting on any broad-based employee plan or (ii) providing non-customized information and no advice


Independence of Compensation Committee and Advisors (cont.) Action Items for Compensation Committees and Companies

Assess[ed] independence* of compensation consultants to the company and the compensation committee prior to 2013 proxy statement filing to comply with conflict of interest disclosure requirement

Prior to receiving advice from advisers, assess independence* of all advisers to comp. committee (including legal counsel) May need to anticipate which advisers may be asked to provide advice to the

compensation committee during the coming year so they can be “vetted” in advance

Amend compensation committee charter prior to compliance deadline Confirm/assess independence of the compensation committee members

*Independence assessment conducted by the compensation committee based on information (i) received from the advisers as to the six independence factors and (ii) received from responses to new questions in D&O questionnaires


Rule 10b5-1 Developments


Rule 10b5-1 – Legal Background

What Constitutes Insider Trading? Rule 10b-5 prohibits “manipulative and deceptive devices,” including

the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the securities of that issuer, or to any other person who is the source of the material nonpublic information

Beginning in 2000 - Easier Standard for Plaintiffs a purchase or sale of a security of an issuer is “on the basis of”

material nonpublic information about that security or issuer if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale


Rule 10b5-1 – Legal Background (cont.)

Rule 10b5-1 creates affirmative defense: a person’s purchase or sale is not “on the basis of” material nonpublic

information if the person making the purchase or sale demonstrates (through a pre-established trading Plan) that: Binding Plan is established when insider is not aware of material nonpublic

information; Amount, price, and date of trades (including formulas) are specified or delegated

to another person with sole discretion to determine this (where other person also is not aware of material nonpublic information) with no subsequent influence by seller/purchaser; and

Trades must comply with the Plan – can’t alter or deviate from plan or enter into or alter a corresponding or hedging transaction

Plan must be entered into in good faith and not as part of a plan or scheme to evade the rules


Rule 10b5-1 – Legal Background - SEC Staff Q&A Liability for termination?

NO (but may invalidate prior affirmative defense if not in good faith or if part of a pattern to evade rules)

Modification creates “New Plan” Must reevaluate all of the legal requirements/factors at that time (including

no material nonpublic information)

Can do sale outside of Plan (if no, material nonpublic information) Because it’s “same way,” it’s not hedging But may show pattern of abuse of rule

No 10b5-1 defense if Plan established when in possession of material nonpublic information, even if transactions delayed until after release of information However, may not be a securities violation because trade is not on the basis

of the particular information


Rule 10b5-1 – Legal Background - 2007 Developments Academic study showed that insiders with 10b5-1 Plans

were outperforming those without 10b5-1 Plans Suggested manipulation and abuse of rules SEC Staff Response

SEC to focus on multiple, overlapping plans by a single executive Companies should provide symmetrical disclosure 10b5-1 plans to be reviewed as part of ongoing trading or disclosure

investigations of companies


Rule 10b5-1 – Legal Background - Recent Developments Rule 10b5-1 trading plans are back in the spotlight The Wall Street Journal, November 2012,

“Executives’ Good Luck in Trading Own Stock” The Wall Street Journal, December 2012, “Pension

Funds Seek Insider Curbs, In Letter to SEC Chairman, Group Expresses Concern That Executives Benefit from Improper Trades”

The Wall Street Journal, April 2013, “Directors Take Shelter in Trading Plans”

15


Rule 10b5-1 – Legal Background - Trading Plan Partial Checklist Rule of thumb – enter into Plan at least 30 days before trade Comply with Rule Set price, amount, and date(s) or formula No modifications by broker No material information (insider or broker engaging in transaction) Company ability to terminate Forms 4 and 144 procedures Good-faith recital No hedging Length of Plan (not too short, not too long) Review all of the language, even the boilerplate (each Plan is unique) Gradual sales vs. all at once


Rule 10b5-1 – Lessons from Litigation

Don't actively amend/modify 10b5-1 Plans Defeats “the very purpose of 10b5-1 plans, which were created to

allow corporate insiders to ‘passively’ sell their stock based on triggers, such as specified dates and prices, without direct involvement” (Countrywide)

Amendments may support inference of scienter (fraudulent intent) and survive motion to dismiss

Multiple plans in short period calls good-faith requirement into question (Countrywide)

Consider public disclosure of Plans Increases chances of successful motion to dismiss in private securities

litigation SEC views this as evidence of good-faith


Rule 10b5-1 – Other Legal Requirements

Compliance with insider trading policy of company Ensure consistency/carveouts

Section 16 Valid 10b5-1 Plan does NOT create safe harbor from Section 16

reporting requirements or liability Consider footnote disclosure in Form 4

Form 8-K (optional) Symmetrical disclosure

Proxy Statement (CD&A) Relevant disclosure in light of pending hedging disclosure

requirements of Dodd-Frank?


Rule 10b5-1 – Criticism and Best Practices

Council of Institutional Investors (“CII”) argues that the SEC should make the following changes to Rule 10b5-1: Provide that Rule 10b5-1 plans could only be adopted during

company-approved trading windows; Ban multiple or overlapping plans; Require a delay, preferably of three months or more, between

adopting the plan and executing any trades; Require disclosure of the plan, the terms of the plan, or

changes to the plan Require plans to prohibit frequent modifications or

cancellations Prohibit insiders from trading outside a plan, once adopted


CLE Presentation Code


Dodd-Frank Act - Disclosure of Hedging by Employees and Directors Hedging activity likely to decline after final rules

adopted Although hedging is not prohibited by Dodd-Frank,

disclosure obligation expected to chill practice of hedging by employees/directors

Outright sale of stock remains the best (only) way to manage/diversify an individual’s portfolio

10b5-1 plans are more important than ever


Current Environment – Tension for Employee/Director Stockholders

HOLD YOUR SHARES

• Stock Ownership Guidelines

• Hold Until Retirement Movement

• Align with Shareholders • Stand Behind the

Company • Limit Risk-taking

SELL YOUR SHARES

• Incentive Structure • Fruits of your labor • Personal Finance 101 –

Diversify • Lock in Gains and Limit

Losses

vs.


Review or Adopt Hedging and Pledging Policies


Hedging and Pledging Policies

CEO of Chesapeake Energy was forced to sell 31.5 million shares (94% of his holdings) in October 2008 after receiving a margin call Had pledged shares as collateral in a margin account to

purchase additional shares of Chesapeake. When the market collapsed during the financial crisis, he was forced to sell at a steep discount

Green Mountain Coffee Roasters founder and Chairman had pledged 78% of his shares. In 2012, he received a $123 million margin call, forcing him to sell a large chunk of his stock Not in accordance with company’s insider trading policies



ISS Final Policies for 2013 Key Change: Indicating by footnote that hedging of company

stock and significant pledging of company stock by directors and/or executives are considered failures of risk oversight

Under extraordinary circumstances, vote AGAINST or WITHHOLD from directors individually, committee members, or the entire board, due to: Material failures of governance, stewardship, risk oversight; Failure to replace management as appropriate; or fiduciary

responsibilities at the company; Egregious actions related to a director’s service on other boards that raise

substantial doubt about his or her ability to effectively oversee management and serve the best interests of shareholders at any company



ISS Final Policies for 2013 Examples of failure of risk oversight include, but are

not limited to: bribery; large or serial fines or sanctions from regulatory bodies; significant adverse legal judgments or settlements; hedging of company stock; or significant pledging of company stock!!



Officer or Director may pledge 20% or less of his/her stock ownership

Total number of shares collectively pledged by all persons covered by the policy would not exceed 2% of the Company's total outstanding common stock following the pledge

The pledger has the financial capacity to repay the loan without resort to the pledged securities

The pledge does not mitigate in any respect the risks of stock ownership to the pledger

The pledger would continue to meet stock ownership guidelines with unpledged stock alone

Pledger provides information to the Board demonstrating compliance with the above conditions


Dodd-Frank Act - Disclosure of Hedging by Employees and Directors Section 955 requires disclosure in annual Proxy

Statement whether the Company permits any employees or directors to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds) that are designed to hedge or offset any decrease in the market value of equity securities that are/were: Granted to the employee or director as compensation; or Held, directly or indirectly, by the employee or director


Hedging by Employees – Action Items

Learn of any current hedging or pledging arrangements among officers and directors

Review and revise existing policies Adopt new policies Consider early adoption of a Dodd-Frank Act

compliant anti-hedging policy


ISS Report Excerpt

Compensation Committee Communication & Responsiveness

Disclosure of Metrics/Goals Annual incentives Yes Long-term incentives Yes

Pay Riskiness Discussion Process discussed? Yes Material risks found? No

Pledging/Hedging of Shares Anti-hedging policy Company has robust policy Anti-pledging policy Company has a policy but includes waivers Pledging of at least 1,000 shares of company stock by NEOs or directors No

Risk Mitigators Clawback policy beyond SOX Yes CEO stock ownership guideline 5X

Stock holding requirements Stock options: Until stock ownership guidelines are met / Restricted Stock: Until stock ownership guidelines are met


Say on Pay – 2013 Results


Say on Pay – 2013 Results*

Overall passage rate for Say on Pay remains high Approximately 41 companies (2.3% of Russell 3000) failed to

obtain majority approval of their Say on Pay proposals Institutional Shareholder Services (“ISS”) cited Pay for Performance

Disconnect or Problematic Pay Practices at most of these companies

77% of companies passed with over 90% approval ISS recommended a vote AGAINST Say on Pay at

approximately 13% of companies it reviewed ISS effect?

Average approval with ISS “for”: 95% Average approval with ISS “against”: 65%

*Data from Semler Brossy Say on Pay Results Summary – 6.19.13


Say on Pay – 2013 Results*

Some likely reasons for failed Say on Pay votes: Pay and performance disconnect Rigor of performance goals Special awards or mega-grants Non-performance-based equity Problematic pay practices

*Data from Semler Brossy Say on Pay Results Summary – 6.19.13


Executive Compensation Litigation


Executive Compensation Litigation

Annual Meeting Disclosure Litigation Say on Pay Litigation Sec. 162(m) Litigation Just Plain Too Much Pay Litigation Failure to Claw Back Enough Compensation


Limit the Number of Shares Available for Director Awards


Limit the Number of Shares Available for Director Awards In Seinfeld v. Slager, the plaintiffs sued Republic Services, Inc., each

member of its board of directors, and three officers, making five serious claims based on Republic’s compensation decisions: Payments made to departing CEO were for past services, not required by

contract and, therefore, were a waste of corporate assets Directors’ approval of certain payments was wasteful because they were not

tax-deductible under Code Sec. 162(m) Defendant directors breached their duty of loyalty and wasted corporate

assets by awarding stock with time-based vesting instead of performance-based vesting

Defendant directors improperly awarded employee bonuses because the requirements of the bonus scheme under which the bonuses were awarded were not met

Defendant directors paid themselves excessive compensation



A condition precedent to filing a shareholder derivative suit is to file a demand with the company’s board of directors that it investigate and/or bring legal action to remedy the alleged wrong against the company

However, this “demand” is excused if (a) a majority of the board was “interested” in the allegedly wrong decision or lacked independence, or (b) decision was not the result of valid business judgment



Since the SEC changed the “disinterested director” requirements, conventional wisdom has been to provide for stock awards to non-employee directors from the same stock incentive plan that the company uses to provide awards to everyone else

Four alternatives for company/board action, with the cost and effort of each increasing in nearly direct correlation to the amount of protection it affords to compensation committee members and other directors


Risk of Shareholder Derivative Litigation Compared to the Cost of Reducing the Risk

Cost/ Effort

Risk

Higher

Higher

Lower

Lower

Adopt a New, Separate Stock Plan for Non-Employee Directors

Amend Stock Plan to Impose Limits on Awards to Non-Employee Directors and Seek Shareholder Approval

Amend Stock Plan to Impose Limits on Awards to Non-Employee Directors

Omnibus Plan with No Limits on Director

Awards


Limit the Number of Shares Available for Director Awards Establish a new plan for non-employee directors only, with

reasonable limitations on the awards that may be made Amend existing omnibus stock plan to add limitations on the

awards that may be made to non-employee directors Amend existing stock plan to add limitations on the awards

that may be made to non-employee directors or to specify an annual award amount for each year

Do nothing and take the risk that no shareholder derivative litigation will be brought against the company for executive compensation matters



Each company/board should weigh the costs of seeking shareholder approval under the first two alternatives, and the additional protection they provide, against the potential risk of getting sued before the company/board can adopt more comprehensive protection


Other Issues


Other Issues

Add Clawback Provisions Modify Equity Compensation Plan Disclosure Updating the Compensation Committee Charter TSR and Other Performance Share Awards Increase in Shareholder Proposal Activity


Questions?


CLE Presentation Code


Thank You.


Contact Information

Michael Melbinger Employee Benefits and Executive


(312) 558-7588 [email protected]

Erik Lundgren Employee Benefits and Executive


(312) 558-8012 [email protected]

Documents

A Busy 2013 For Executive Compensation · 2013-08-09 · compensation, and oversight of the work of any compensation consultant, ... Plan must be entered into in good faith and not