Death, taxes and proxy season. Although it may seem like you just filed your 2017 proxy, the 2018 proxy season is on the horizon. This quick reference guide identifies considerations based on themes from 2017, offers recommendations and resources for the upcoming season and discusses expected future changes in disclosure rules that public companies will want to keep on their radar as proxy preparations begin.
Tips From the 2017 Proxy Season
- Consider whether you are effectively telling your "compensation story." Investors have become more sophisticated in evaluating whether companies are paying their executives for performance. To effectively sell your compensation program to your investors, make sure you outline your company's strategic business goals and how your performance metrics and targets drive these goals. Note that although relative total shareholder return (TSR) is still a dominant performance metric used by investors, increasingly additional financial and operational metrics are being taken into account and investors are looking for these additional metrics in pay programs. For example, 2017 was the first year that ISS compared, as part of its qualitative analysis, CEO pay of peer companies using multiple financial metrics rather than just TSR.
- Consider disclosing your board's self-evaluation process to show how the board identifies and addresses gaps in skills and viewpoints, as well as how the board approaches tenure, diversity and succession. Investors also want to know how the specific experience and expertise of directors helps them oversee corporate risks and provide meaningful insight and oversight to management.
- Make sure your board is engaging in a comprehensive risk assessment of your compensation program. Item 402(s) requires disclosure of each issuer's compensation policies and practices as they relate to risk management. According to our research in preparing Shearman & Sterling LLP's 15th Annual Corporate Governance and Compensation Survey, more than half of the Top 100 US Companies1 disclose that they mandate an annual risk assessment. In light of recent news, these risk assessments should include not only financial risk, but reputational risk. Further to this end, consider a review of your company's clawback and recoupment policies.
- Consider a review of any gender pay disparity within your organization. Our Survey identified gender pay as one of the most common compensation-related shareholder proposals of the 2017 season. ISS also noted the increase in these proposals over the last few years and is proposing a new voting policy (discussed below) with respect to these proposals.
- Provide robust disclosure with respect to non-GAAP financial measures. Not only is such disclosure expected by investors, but non-GAAP measures have become a focus of SEC comments in contexts both inside and outside of compensation. Remember that, to the extent non-GAAP financial measures are cited in the CD&A other than with respect to performance target levels, the requirements of Regulation G and Item 10(e) of Regulation S-K must be met.
- Know your shareholders by proactively engaging with them on company performance and key compensation decisions. Historically passive institutional investors are becoming more active, focusing on such hot button issues as performance and pay misalignment, board diversity and non-objective performance criteria. Open letters to public companies and voting guidelines issued by such investors as Vanguard, Blackrock and State Street are must reads for understanding the increasing focus of institutional investors on corporate governance.
Recommendations and Resources for 2018
- One day you'll gather the grandchildren around and tell them all about how you were there the first time public companies disclosed their pay ratios. As this tale reaches its exciting conclusion, you'll tell them of how the SEC swept in at the last minute with some much appreciated guidance, that, most importantly, eased the burden with respect to independent contractors. Our client publication discussing the new guidance is available here.
- Although the media will likely focus on the disclosed pay ratios, companies are reporting that their biggest concern about this disclosure will be employee reactions. Be prepared with an employee communication plan as employees may not be pleased to see where they rank in relation to the median employee. Some possible steps may include preparing an FAQ for employees and training managers on how to respond to inquiries.
- ISS and Glass Lewis have released their updated voting guidelines for 2018. In addition, ISS released a set of preliminary FAQs describing changes to its Quantitative Pay-for-Performance tests and its Equity Plan Scorecard. A more complete set of FAQs, as well as a white paper, will be issued in mid-December. The following is a summary of ISS's compensation related-updates. Glass-Lewis did not have any updates related to compensation.
- Director Elections – Non-Employee Director Pay: This new ISS policy would explicitly provide for adverse vote recommendations for board committee members who are responsible for approving non-employee director compensation when there is a pattern (two or more consecutive years) of excessive non-employee director pay without a compelling rationale. Currently, avoiding excessive non-employee director pay is one of five global principles underlying ISS's compensation evaluation. In addition, ISS votes case-by-case on management proposals seeking shareholder ratification of non-employee director compensation based on certain qualitative factors listed in its guidelines. There will not be an impact on 2018 vote recommendations.
- Shareholder Engagement: ISS has clarified its approach to assessing whether the board has provided a robust response to a say-on-pay proposal that received less than 70% of the votes cast. The updated policy requires companies to disclose the timing and frequency of engagements, as well as whether independent directors participated. In addition, the company should disclose the specific concerns voiced by dissenting shareholders and meaningful actions taken to address the shareholders' concerns. ISS notes that it considers not only whether a company has made changes to pay and/or disclosure, but also the quality of the changes relative to the feedback received.
- Pay-for-Performance Evaluation. Beginning in 2018, ISS will be including their "Relative Financial Performance Assessment" in their quantitative pay-for-performance evaluation methodology. This assessment compares the company's rankings to a peer group with respect to CEO pay and financial performance in three or four metrics (other than total shareholder return) as measured over three years. ISS currently provides this analysis in its research reports and may use it to inform its qualitative analysis if the quantitative analysis indicated a misalignment between pay and performance. ISS will be putting out a white paper with more detail.
- Gender Pay Gap Shareholder Proposals: As noted above, ISS is proposing to vote on a case-by-case basis on shareholder requests for reports on an issuer's pay data by gender, or a report on an issuer's policies and goals to reduce any gender pay gap. In considering its vote, ISS will take into account: (A) the issuer's current policies and disclosure related to both its diversity and inclusion policies and practices and its compensation philosophy and fair and equitable compensation practices; (B) whether the issuer has been the subject of recent controversy or litigation related to gender pay gap issues; and (C) whether the issuer's reporting regarding gender pay gap policies or initiatives is lagging its peers.
- Determine whether your company needs to seek shareholder approval of its stock incentive plan for additional shares or material changes to the plan. Also, do not overlook whether reapproval of the plan under which your company grants 162(m) performance awards is needed. If the last time shareholders voted to approve your company's 162(m) plan was 2013 or earlier, the plan should be disclosed and reapproved in 2018.
- If your company is adopting a stock incentive plan or revising an existing plan, consider including a director-specific "ceiling" (or other meaningful limits) on director compensation in order to obtain shareholder approval in light of recent litigation over director compensation.
- Determine if 2018 is a year in which your company is required to conduct a say-on-frequency vote. If your company went public post-2011, or is no longer an emerging growth company, 2018 may be your year.
- Consider amending your stock plans to take advantage of amended ASC 718, which permits withholding on equity awards up to the maximum individual tax rate without triggering liability accounting treatment. Both NYSE and NASDAQ have amended their shareholder approval FAQs to provide that shareholder approval is not necessary for these amendments.
- Review the independence of your board's compensation committee advisors under NYSE and Nasdaq listing standards and ISS's affiliated outside director test (available as part of its US Summary Proxy Voting Guidelines), as well as 162(m) and Section 16.
- Check your company's Director & Officer questionnaire to make sure it is up to date.
- Start thinking about how to present the executive summary of your company's Compensation Discussion & Analysis (CD&A). How can the company craft a compelling communication that is more visually appealing? Keep in mind that an executive summary can be an important tool to communicate with shareholders about what matters to your company. Keep it specific to have the biggest impact.
- Consider whether you will include alternative pay disclosures, such as realized or realizable pay, in your CD&A. Keep in mind that if included, shareholders may ask questions to the extent such disclosures are omitted or modified in future years. That being said, do not be afraid to remove duplicative or stale disclosures throughout your proxy more generally.
- Although inapplicable to proxy statements, make sure the exhibit indexes in your periodic reports (including your Annual Report on Form 10-K) and registration statements comply with the SEC's new rules requiring hyperlinks to each exhibit. These rules became applicable on September 1, 2017.
- Familiarize yourself with the SEC staff's recent guidance when relying on Rule 14a-8(i)(7) or 14a-8(i)(5) to exclude a shareholder proposal from your proxy materials. Our client publication on the guidance is available here.
- A number of the compensation-related rules required by the Dodd-Frank Act have been shifted to the category of "long-term actions" on the SEC's Regulatory Flexibility Agenda. As a result, issuers should not expect to see these final rules any time soon. Further, the Financial Choice Act 2.0, which passed the House of Representatives on June 8, 2017, would repeal or amend most of the compensation-related Dodd-Frank requirements. The chart on Appendix A lists each compensation-related Dodd-Frank provision, its current status and its treatment under the Financial Choice Act 2.0.
- On October 11, 2017, the SEC proposed rules that would modernize certain disclosures, including, among other things, exclude emerging growth companies from having to file a CD&A, and eliminate the requirement that Section 16 filers provide a copy of their Section 16 forms to the issuer. Further, companies would be allowed to rely on EDGAR filings when determining if they need Item 405 disclosure. Comments received are available here.2
- As part of the SEC's
disclosure effectiveness project, the Division of
Corporation Finance is reviewing Regulation S-K and Regulation S-X and
considering ways to improve reporting for both companies and
- In September of 2015, the SEC issued a request for comment on the Effectiveness of Financial Disclosures about Entities Other than the Registrant. Comments received are available here.
- In April of 2016, the SEC issued a concept release on the Business and Financial Disclosures required by Regulation S-K. Comments received are available, here.
- In July of 2016, the SEC issued proposed rules for Disclosure Update and Simplification that, amongst other things, would eliminate the equity compensation plan disclosure of Item 201(d). Comments received are available here.
- In August of 2016, the SEC issued a request for comment on Subpart 400 of Regulation S-K. Comments received are available here.
Status of Dodd Frank Compensation-Related Provisions
The following chart summarizes the executive compensation provisions of the Dodd-Frank Act ("Dodd-Frank"), as well as the most recent agency action with respect to implementation. In addition, treatment of each rule under the Financial Choice Act is discussed. The Choice Act passed the House of Representatives on June 8, 2017.
|Provision of Dodd-Frank||Requirement||Current Status||Treatment Under Financial Choice Act 2.0|
|Say-on-Pay § 951 of Dodd-Frank||Requires each issuer to provide its shareholders with a non-binding resolution approving the compensation of executives as disclosed pursuant to Item 402 of Regulation S-K. The vote must occur at least once every three years. In addition, once every six years the shareholders are to be provided with a non-binding resolution to determine whether the aforementioned say-on-pay vote is to occur every one, two or three years.||Final Rule issued by the SEC in January of 2011.||The Choice Act would only require the say-on-pay vote in those years in which there had been a material change to the compensation of executives from the previous year.|
|Listing Standards for Compensation Committees § 952 of Dodd-Frank||Requires the SEC to adopt rules directing the national securities exchanges and associations to adopt listing standards requiring each member of a listed issuer's compensation committee to be "independent." Requires additional rules and disclosures with respect to an issuer's use of compensation consultants and related conflicts of interest.||Final Rule issued by the SEC in June of 2012. Listing standards issued by NASDAQ and the NYSE approved by the SEC in January of 2013.3||The Choice Act does not affect § 952 of Dodd-Frank.|
|Pay for Performance Disclosure § 953(a) of Dodd-Frank||Requires a description of the relationship of compensation actually paid to the CEO and the average compensation actually paid to the NEOs, and the cumulative shareholder return of the issuer for the last five years. The description must also include a comparison of the issuer's cumulative TSR with the TSR of the peer group.||Proposed rule issued by the SEC in April of 2015.||The Choice Act does not affect § 953(a) of Dodd-Frank.|
|Pay Ratio Disclosure § 953(b) of Dodd-Frank||Requires issuers to disclose the ratio of its CEO's compensation to the median annual total compensation of all employees (except the CEO).||Final rule issued by the SEC in August of 2015. The first disclosures are to be made in 2018 (covering compensation paid during the first full fiscal year that began on or after January 1, 2017).||The Choice Act would repeal § 953(b) of the Dodd-Frank Act.|
|Recovery of Erroneously Awarded Compensation Policy § 954 of Dodd-Frank||Requires the national securities exchanges and associations to prohibit the listing of any issuer that does not develop and implement a policy mandating that, in the event the issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement, the issuer is to recover incentive-based compensation received by any current or former executive officer in the three-year period preceding the restatement that is in excess of what would have been paid under the restatement.||Proposed rule issued by the SEC in July of 2015.||The Choice Act would limit the executive officers affected by the rule to those that had control or authority over the financial reporting that resulted in the accounting restatement.|
|Hedging Policy Disclosure § 955 of Dodd-Frank||Requires issuers to disclose whether they permit directors or employees to purchase financial instruments intended to hedge or offset any decrease in the market value of the issuer's equity securities.||Proposed rule issued by the SEC in February of 2015.||The Choice Act would repeal § 955 of Dodd-Frank.|
|Restriction on Incentive-Based Compensation § 956 of Dodd-Frank||Prohibits incentive-based compensation arrangements that encourage inappropriate risk-taking by financial institutions that have assets equal to or greater than $1 billion.||Proposed rule issued by the six agencies charged with implementing § 956 issued in May of 2016.||The Choice Act would repeal § 956 of Dodd-Frank.|
1 The Top 100 Companies were selected based on a combination of their latest annual revenues and market capitalizations.
2 These rules were based on the recommendations of the SEC's Report on Modernization and Simplification of Regulation S-K, issued in November of 2016. The Report on Modernization and Simplification of Regulation S-K was the result of the FAST Act. The FAST Act included a mandate for the SEC to, among other things, make specific and detailed recommendations on modernizing and simplifying Regulation S-K requirements to reduce the costs and burdens on companies, while still providing all material information.
3 NASDAQ amended its listing standards in December of 2013.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.