April 27, 2010

Australia Looking to Take Say-on-Pay One Step Further

Below are three items that I recently blogged on’s “The Advisors’ Blog“:

As noted in the excerpt below of this article from Manifest (a European proxy advisor service), Australia may take the concept of say-on-pay further than proposed here in the US (here is the Australian’s full response on this topic):

Australian Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen has delighted Australian shareholders with plans to introduce extensive executive remuneration reforms designed to force boards to be more accountable and give shareholders more power.

In a ringing endorsement of the Productivity Commission’s review of executive pay which was published in January this year, the Rudd administration has announced that it will introduce legislation to implement many of the PC’s 17 recommendations, including the “two strikes” proposal, which will strengthen the non-binding vote on remuneration and set out consequences where companies do not adequately respond to shareholder concerns on remuneration issues.

As currently proposed, the two strikes and re-election resolution would work as follows:

– 25 per cent ‘no’ vote on remuneration report triggers reporting obligation on how concerns addressed; and
– Subsequent ‘no’ vote of 25 per cent activates a resolution for elected directors to submit for re-election within 90 days.

It is not clear whether it would be the entire board to be submitted for re-election, just the remuneration committee or the chairman, however there will be a further opportunity for input as there during the consultation process ahead of the final drafting of amendments to the Corporations Act 2001.

An unexpected but welcome addition to the proposals is a “claw-back” provision which would require a director or executive to repay to the company any bonuses calculated on the basis of financial information that subsequently turned out to be materially misstated. Bowen asserted that the introduction of a claw-back provision “warrants further analysis, as it would help strengthen the ability of shareholders to recover overpaid bonuses that have occurred as a result of materially misstated financial statements.”

Issuers have expressed their concerns in the Australian media calling the proposals “heavy handed”. Speaking to ABC News, John Colvin from the Institute of Company Directors said: “We’re a bit perplexed and quite frankly bemused at why we would have such a heavy-handed, red-taped, legislative approach to this area,”

“Whilst there are examples of, and we acknowledge those, of pay outcomes which haven’t been in line with either company expectations… on the whole Australian remuneration of corporate governance has been very good.” The Australian Shareholders Association (ASA) said that the response was “much stronger than they had anticipated.”

“We think that it’s a very well-measured, very well-considered report,” said an ASA representative “from the ASA’s point of view it certainly went a little bit further than we had asked, but we’re very positive about the recommendations and we’re very hopeful that they’ll have the effect of making boards much more accountable on this issue which is very important to shareholders.”

AFL-CIO Actively Attacking Bank Pay

Recently, the AFL-CIO launched “PayWatch 2010” and announced it is focusing on the six largest banks this year – Bank of America, Citigroup, Wells Fargo, Morgan Stanley, JPMorgan Chase and Goldman Sachs – when the companies hold advisory votes on executive compensation later this month and in May. They also are focusing on the bank’s lobbying on financial reform.

As part of this focus, the AFL-CIO plans to stage protests at the banks’ annual meetings and may oppose compensation committee members. The AFL-CIO also is planning a rally this Thursday on Wall Street, with hope for more than 10,000 demonstrators.

Here’s a silly AARP video on big banks and financial reform that might tickle you entitled “A Financial Protection Sing-A-Long.”

Survey of Recent Disclosures: Board’s Role in Risk Oversight

Below is an excerpt from this Akin Gump memo, based on their survey on recent risk oversight disclosures:

To assess the types of disclosures that companies are providing about the board’s role in overseeing risk management, we reviewed preliminary or final proxy statements filed by 50 randomly selected S&P 500 companies since the February 28, 2010 effective date of the new disclosure rules. The results of our survey, categorized by the various types of disclosures, are set forth below.

Separate Section Devoted to Risk Oversight

Ninety-two percent of surveyed companies had a designated section in their proxy statements for risk oversight. This section typically stood alone, but sometimes was combined with the section addressing board leadership structure. Typically, the section was located in the portion of the proxy statement discussing corporate governance matters and was often titled “The Board’s Role in Risk Oversight” (or words of similar effect).

Statements about Management’s Primary Risk Management Responsibility

Twenty-four percent of surveyed companies included a statement to the effect that management is primarily responsible for risk management, while the board’s role is one of oversight.

Sample disclosures are set forth below:

Sunoco, Inc.: “Management of risk is the direct responsibility of the Company’s CEO and the senior leadership team. The Board has oversight responsibility, focusing on the adequacy of the Company’s enterprise risk management and risk mitigation processes.”

Peabody Energy Corporation: “Management is responsible for the day-to-day management of the risks we face, while the Board, as a whole and through its committees, has responsibility for the oversight of risk management.”

AT&T Inc.: “Assessing and managing risk is the responsibility of the management of AT&T. The Board of Directors oversees and reviews certain aspects of the Company’s risk management efforts.”

Strategic Direction

Forty-two percent of surveyed companies explained that oversight of risk management was an important or integral part of the board’s role in the strategic planning process.

Several illustrative examples are set forth below:

Valero Energy Corporation: “The Board also believes that risk management is an integral part of Valero’s annual strategic planning process, which addresses, among other things, the risks and opportunities facing Valero.”

Stryker Corporation: “A fundamental part of setting the Company’s business strategy is the assessment of the risks the Company faces and how they are managed.”

Bristol-Myers Squibb Company: “Our Board meets regularly to discuss the strategic direction and the issues and opportunities facing our company in light of trends and developments in the biopharmaceutical industry and general business environment. Our Board has been instrumental in determining our strategy to combine the best of biotechnology with pharmaceuticals to become a best-in-class next generation biopharmaceutical company. Throughout the year, our Board provides guidance to management regarding our strategy and helps to refine our operating plans to implement our strategy. Each year, typically during the second quarter, the Board holds an extensive meeting with senior management dedicated to discussing and reviewing our long-term operating plans and overall corporate strategy. A discussion of key risks to the plans and strategy as well as risk mitigation plans and activities is led by the Chairman and Chief Executive Officer as part of the meeting. The involvement of the Board in setting our business strategy is critical to the determination of the types and appropriate levels of risk undertaken by the company.”

Enterprise Risk Management

Fifty-four percent of surveyed companies expressly used the term “enterprise risk management.”

Sample disclosures are set forth below:

American Express Company: “The Company relies on its comprehensive enterprise risk management process (ERM) to aggregate, monitor, measure and manage risks. The ERM approach is designed to enable the Board of Directors to establish a mutual understanding with management of the effectiveness of the Company’s risk management practices and capabilities, to review the Company’s risk exposure and to elevate certain key risks for discussion at the Board level. The Company’s ERM program is overseen by its Chief Risk Officer who is an executive officer of the Company and a member of the Company’s most senior management.”

Express Scripts, Inc.: “In order to assist the board of directors in overseeing our risk management, we use enterprise risk management (“ERM”), a company-wide initiative that involves the board of directors, management and other personnel in an integrated effort to identify, assess and manage risks that may affect our ability to execute on our corporate strategy and fulfill our business objectives. These activities entail the identification, prioritization and assessment of a broad range of risks (e.g., financial, operational, business, reputational, governance and managerial), and the formulation of plans to manage these risks or mitigate their effects.”

Primary Responsibility at Board vs. Committee Level

Eight percent of surveyed companies stated that the primary responsibility for risk management oversight rests with the entire board, 34 percent of surveyed companies stated that primary responsibility is vested in one or more committees and 52 percent reflected that both the board and various committees have responsibility for risk management oversight.

Of those companies where primary responsibility is vested in one or more committees, 65 percent (22 percent of all surveyed companies) identified their audit committees as having primary responsibility, 18 percent had a separate committee expressly dedicated to risk management (all of these companies were in the financial services or insurance industries) and 18 percent stated that various board committees were responsible for overseeing the management of risks relating to the committee’s primary areas of responsibility.

Regardless of where primary responsibility rested, over half of the surveyed companies included descriptions of the specific types of risks that various committees of the board oversee.

Compensation Committee Responsibility for Determining Compensation Risk Disclosure

As discussed above, the new SEC disclosure rules require companies to discuss their compensation policies and practices for employees as they relate to risk management practices and risk-taking incentives if the risks arising from those policies and practices are reasonably likely to have a material adverse effect on the company. The new rules do not require a company to include any disclosure if the company has determined that the risks arising from its compensation policies and practices are not reasonably likely to have a material adverse effect.

RiskMetrics has announced that it does not take a position regarding whether companies should disclose their risk determinations where the company has determined that a material adverse effect is not reasonably likely. RiskMetrics does, however, advise companies “at a minimum” to discuss their process in reaching a determination and any mitigating features (such as clawbacks or bonus banks) that they have already adopted. RiskMetrics views this disclosure “as an opportunity for communication, not simply compliance” and expects that shareholders will be looking for a reasonably substantive discussion of the board’s process for determining whether the company’s incentive pay programs motivate inappropriate risk-taking and what they are doing to mitigate that risk.

Our survey shows that many companies elected to provide disclosure about their compensation risk determinations and the process the company undertook to make the determination.

– Compensation Committee Responsibility to Assess Risks. Sixty-eight percent of surveyed companies stated that their compensation committee was charged with either determining that the compensation policies and practices do not encourage excessive risk-taking or determining whether the risks arising from such policies and practices are reasonably likely to have a material adverse effect on the company.

– Disclosure of Determination. Seventy-four percent of surveyed companies expressed a determination that their compensation policies and practices either did not encourage excessive or unnecessary risk-taking (or used words of similar effect) or were not reasonably likely to result in a material adverse effect on the company. Of the 37 companies that disclosed a determination, 17 of them (46 percent) phrased their conclusion in terms of the absence of a material adverse effect, 15 companies (41 percent) expressed their conclusion in terms of not encouraging excessive or unnecessary risk-taking and the remaining companies phrased their conclusions in terms of a determination of an “appropriate level of risk-taking” or an “effective balance of risk and reward” or words of similar effect.

– Who Made the Determination. Companies varied widely as to who made the risk determination regarding compensation programs and policies. Twenty-three companies (62 percent of those disclosing the determination) stated that the determination was made by the compensation committee, 10 companies (27% of those disclosing the determination) phrased the determination as being made by the company or “we” and, in the remaining instances, “management” made the determinations.

– Process for Determination. Sixty-five percent of those companies disclosing a risk determination provided disclosure of the process that the company or compensation committee undertook to make the determination.

– Location of Determination. Companies varied widely on the location of the disclosure in their proxy statements. Almost half of the companies included the disclosure in Compensation Discussion and Analysis. Other popular disclosure locations included under a separate heading in the corporate governance section, in the discussion of board oversight of risk or under a separate heading near discussions of compensation committee interlocks and compensation consultants.

– Risk-Mitigating Features. Regardless of whether a company disclosed a risk determination with respect to its compensation policies and practices, almost three-quarters of the surveyed companies discussed various features of their compensation programs and policies that are designed to mitigate excessive risk-taking.

The following excerpt from Kraft Foods’ proxy statement discusses the compensation committee’s process in evaluating compensation risks, risk-mitigating features contained in the company’s compensation policies and practices and the conclusion of the compensation committee with respect to such risks:

“Analysis of Risk in the Compensation Architecture

In 2009, the Human Resources and Compensation Committee evaluated the current risk profile of our executive and broad-based compensation programs. In its evaluation, the Human Resources and Compensation Committee reviewed the executive compensation structure and noted numerous ways in which risk is effectively managed or mitigated. This evaluation covered a wide range of practices and policies including: the balance of corporate and business unit weighting in incentive plans, the balanced mix between short-term and long-term incentives, caps on incentives, use of multiple performance measures, discretion on individual awards, a portfolio of long-term incentives, use of stock ownership guidelines, and the existence of anti-hedging and clawback policies. In addition, the Human Resources and Compensation Committee analyzed the overall enterprise risks and how compensation programs impacted individual behavior that could exacerbate these enterprise risks. The Human Resources and Compensation Committee collaborated with the Audit Committee in this analysis.

Additionally, we engaged an outside independent consultant to review our incentive plans (executive and broad-based) to determine if any practices might encourage excessive risk taking on the part of senior executives. The outside consultant noted several of the practices of our incentive plans (executive and broad-based) that mitigate risk, including the use of multiple measures in our annual and long-term incentive plans, Human Resources and Compensation Committee discretion in payment of incentives in the executive plans, use of multiple types of long-term incentives, payment caps, significant stock ownership guidelines, and our recoupment and anti-hedging policies. In light of these analyses, the Human Resources and Compensation Committee believes that the architecture of Kraft Foods’ compensation programs (executive and broad-based) provide multiple, effective safeguards to protect against undue risk.”

Reporting Processes

As previously discussed, the SEC suggested in the adopting release that, where relevant, companies disclose in their proxy statements whether the officers responsible for risk management report directly to the board or to a board committee or how information is otherwise received from such persons. Thirty-eight percent of surveyed companies identified their principal risk officer or officers by title and disclosed that the officer or officers reported directly to the board or a board committee.

Frequency of Entire Board Review

One-third of surveyed companies reported that the full board reviews risk management at least annually, 22 percent stated that the full board reviews risk management issues “periodically” or “regularly” and a few companies reported quarterly or semiannual reviews by the entire board.

Length of Disclosure

Most companies devoted at least two or three paragraphs to their discussion of the board’s role in risk oversight. The average length of the disclosures was 10 sentences, with the length of the discussion ranging from a high of 27 sentences to a low of three sentences. These numbers do not reflect any specific discussions of risks relating to compensation policies and practices or factors mitigating those risks.

Effect of Board’s Role in Risk Oversight on Leadership Structure

Only 20 percent of the surveyed companies specifically addressed the effect of the board’s role in risk oversight on the board’s leadership structure. Instead, most companies simply stressed in the discussion of their leadership structure the role that a lead director or the independent directors play in providing strong, effective oversight of management.

Set forth below are disclosures by several companies that expressly addressed the matter:

IBM: “The Board’s role in risk oversight of the Company is consistent with the Company’s leadership structure, with the CEO and other members of senior management having responsibility for assessing and managing the Company’s risk exposure, and the Board and its committees providing oversight in connection with those efforts.”

Teco Energy: “We believe that our Board leadership structure promotes effective oversight of the company’s risk management for the same reasons that we believe the structure is most effective for our company in general, that is, by providing unified leadership through a single person, while allowing for input from our independent Board members, all of whom are fully engaged in Board deliberations and decisions.”

The Coca-Cola Company: “The Company believes that its leadership structure, discussed in detail [above], supports the risk oversight function of the Board. While the Company has a combined Chairman of the Board and Chief Executive Officer, strong Directors chair the various committees involved in risk oversight, there is open communication between management and Directors, and all Directors are actively involved in the risk oversight function.”

– Broc Romanek