A troika of developments include positive Say on Pay proxy voting trends, increased executive compensation related lawsuits and new Dodd-Frank rules in US stock markets
Continuing a recent trend, 2013 has been an eventful year for US executive compensation practices and disclosure. In particular, 2013 saw the continued evolution in proxy statement executive compensation disclosure and “Say on Pay” voting trends at US public companies and the continued influence of Institutional Shareholder Services (ISS) and other proxy-advisory firms on the Say on Pay voting results. Additionally, a wave of compensationrelated lawsuits and plaintiff’s law firm executive compensation “investigations” that began in late 2012 spilled into 2013. Finally, the New York Stock Exchange (NYSE) and NASDAQ Stock Market (Nasdaq) approved compensation committee and adviser independence rules under the Dodd- Frank Act. These rules will become effective in the second half of 2013.1
2013 Say on Pay
Since 2011, the Dodd-Frank Act has required large US public companies to conduct advisory “Say on Pay” shareholder votes and in 2013 the Say on Pay rules became applicable to many smaller US public companies for the first time.2 Although a comprehensive year-over-year comparison of Say on Pay results will not be possible until after the 2013 proxy season, the consulting firm Semler Brossy’s real-time reporting of shareholder votes offers insight as to how Say on Pay voting trends for 2013 compare with the overall voting patterns established in 2011 and 2012.3
General Positive Trend
To date, analysis indicates a trend toward slightly increased rates of shareholder approval for Say on Pay votes in 2013. In particular, companies that won shareholder approval of their Say on Pay packages in 2012 have generally seen continued shareholder approval in 2013 in even greater numbers, as the following statistics illustrate:
- Companies that received 50-70 percent approval rates in 2012 are now receiving an average of 18 percent more support in 2013.
- 77 percent of companies have passed Say on Pay votes in 2013 with over 90 percent shareholder approval, up from 73 percent of companies in 2012 and 71 percent of companies in 2011.
- 92 percent of companies have passed their Say on Pay votes thus far in 2013 with over 70 percent shareholder approval, consistent with 91 percent of companies in 2012 and 93 percent of companies in 2011.
- 39 companies that received less than 50 percent approval on their Say on Pay votes in 2012 have passed their Say on Pay votes in 2013 (averaging more than 40 percent more support in 2013).
Consistent with those positive voting trends, Semler Brossy’s 2013 analysis also reflects a slight decline in the rate of Say on Pay votes receiving less than 50 percent support in 2013. Of the 2,214 companies that held an annual meeting in 2012, 57 received less than 50 percent support for their Say on Pay votes, resulting in a 2.6 percent overall Say on Pay vote failure rate. By contrast, 38 of the 1,675 companies that have held an annual meeting in calendar year 2013 have received less than 50 percent support on their Say on Pay vote, reflecting an overall vote failure rate of 2.3 percent to date. Thus far, all of the companies that received less than 50 percent support on their Say on Pay votes in 2013 received a negative recommendation from ISS.
Continued Influence of ISS
ISS continues to be the most influential US proxy advisor and continues to have significant impact on Say on Pay voting results in 2013. Specifically, shareholder support for company pay programs continues to be markedly lower at companies whose Say on Pay proposals received ISS’ “against” recommendation. Thus far in 2013, shareholder support has been 30 percent lower for companies that received an “against” recommendation than for those that received a “for” recommendation, consistent with the 30 percent reduced shareholder support in 2012 and 25 percent reduced shareholder support in 2011. Glass, Lewis & Co., another important US proxy advisor, can also impact Say on Pay voting results, although for most companies its impact continues to be less significant than ISS.
ISS Positive and Negative Factors
The factor Semler Brossy most frequently cited as the likely cause for an ISS “against” vote recommendation is a payfor- performance disconnect. ISS evaluates pay-for-performance alignment based on both quantitative and qualitative factors. With respect to its quantitative analysis, ISS seeks to gauge the alignment of a company’s executive pay against company performance, evaluating the chief executive officer’s (CEO’s) pay against the company’s total shareholder return on both a relative and absolute basis. With respect to its qualitative analysis, ISS may consider some or all of the following: ratio of performance-based equity awards to time-based equity awards; the company’s peer group benchmarking practices; the rigor of performance goals (and the clarity of the related disclosure); and special circumstances, such as recruitment of a new CEO.
In an attempt to increase the likelihood of a successful Say on Pay vote, many companies continued to refine their compensation programs in 2013. Most notably, many companies adopted compensation recovery policies (i.e., “clawback” policies) and instituted antihedging policies for their executives. Companies also continued to eliminate excise tax “gross-up” provisions and to increase senior executive stock ownership requirements. Perhaps most importantly, many companies continued to refine their compensation programs to increase the portion of senior executive compensation payable pursuant to performance-based equity awards.
Say on Pay and Other Executive Compensation Lawsuits
Since the enactment of the Dodd-Frank Act, compensation-related shareholder litigation has steadily increased. The first such lawsuits were shareholder derivative4 actions alleging breaches of fiduciary duties against directors of companies that failed their advisory Say on Pay votes, but nevertheless approved the executive compensation subject to such failed Say on Pay votes. Of the 22 such lawsuits filed, approximately half were dismissed either for plaintiffs’ failure to plead that they were excused from making a demand upon the defendant board of directors to bring the suit themselves (a threshold requirement in derivative actions) or due to the court’s recognition of the nonbinding nature of the Say on Pay vote. Approximately four of the cases settled, some resulting in significant attorneys’ fees.
The next type of compensation-related claim to arise took the form of class action lawsuits seeking to enjoin the company’s annual meetings based upon allegations of inadequate executive compensation disclosure in the company’s proxy statement. Of 22 such lawsuits filed, eight resulted in the denial of the sought preliminary injunction and 10 were either settled or withdrawn prior to the court’s ruling. In a recent ruling dismissing such a claim, the US District Court for the Northern District of Illinois stated that the only required disclosures are those mandated under the Dodd-Frank Act and Regulation S-K of the US Securities Act of 1933, and afforded the directors’ decisions deference under the business judgment rule.5 Thus, the majority of such actions were unsuccessful in obtaining the preliminary injunction against the target company’s Say on Pay vote and the number of such suits filed in the future may be expected to decrease. Indeed, although plaintiffs’ firms publicly targeted over 70 companies for “investigation” of executive compensation issues during the 2013 proxy season, it appears that few if any of these sorts of Say on Pay injunction lawsuits will be filed in 2013.
However, the filing of similar actions attempting to enjoin a company’s proposal to adopt or increase the number of shares reserved under equity compensations plans may persist. Although the merit of such cases is questionable and such lawsuits may be of little benefit to a company’s shareholders, it appears that the plaintiffs’ bar believes that such cases are more likely to result in a preliminary injunction (because the vote to increase the number of equity plan shares is not advisory) and thus to provide settlement leverage. Accordingly, cases seeking to enjoin a shareholder vote on an equity plan may be expected to continue, at least in the near future. Although no clear discernible pattern has emerged indicating which companies will be targeted, strong disclosures will put companies in a better position to defeat these actions. Companies would be well advised to continue to review all of their compensation plans and related securities law disclosure for compliance with applicable law and best practices.
Compensation Committee Independence Rules6
On January 11, 2013, the US Securities and Exchange Commission (SEC) approved the NYSE and Nasdaq proposed listing standards relating to independence requirements for compensation committee members and the selection of their advisers. These heightened independence standards became effective on July 1, 2013.
For those companies listed on the NYSE, compensation committee charters were required to be amended by July 1, 2013 to specify the additional responsibilities and authorities of the compensation committee as required in the final NYSE rules. For companies listed on Nasdaq, a compensation committee must be formed (such a separate committee was not required by Nasdaq before) but a revised compensation committee charter will not be required under the listing standards until 2014. Although Nasdaq-listed companies are not required to revise their compensation committee charters in 2013, such companies were obligated to clearly delegate similar responsibilities the NYSE rules to the compensation committee by July 1, 2013. Both NYSE and Nasdaq listing standards set forth guidance regarding the receipt of compensatory fees by compensation committee members. The NYSE requires its compensation committees to consider the source of the committee member’s compensation, while Nasdaq implements a strict prohibition on any such receipt of fees by a compensation committee member.
Further, effective as of July 1, 2013, compensation committees are required to analyze the independence of any compensation consultants and advisers that advise the compensation committee using the six factor test outlined in Rule 10C-1 under the US Securities Exchange Act of 1934 (along with any other factors the committee deems relevant). Any such analysis must be done in advance of the retention of the particular adviser and the analysis is expected to be performed on an annual basis.