August 11, 2016

Whistleblowers: What Should You Do Now With Your Agreements? (Round 2)

Here’s news from Scott Kimpel of Hunton & Williams: As described in this press release, the SEC brought a settled administrative case yesterday against a public company – BlueLinx Holdings – based on confidentiality & waiver provisions contained in employee severance agreements. The SEC determined that these provisions violated the anti-whistleblower rules it adopted under Dodd-Frank. Here’s the SEC order, which contains excerpts of the impermissible contractual language.

In addition to paying a penalty of $265k and contacting former employees to inform them about the SEC’s order, BlueLinx is required to include the following provision in new severance & other agreements with employees governing confidential information:

“Protected Rights. Employee understands that nothing contained in this Agreement limits Employee’s ability to file a charge or complaint with the Equal Employment Opportunity Commission, the National Labor Relations Board, the Occupational Safety and Health Administration, the Securities and Exchange Commission or any other federal, state or local governmental agency or commission (“Government Agencies”). Employee further understands that this Agreement does not limit Employee’s ability to communicate with any Government Agencies or otherwise participate in any investigation or proceeding that may be conducted by any Government Agency, including providing documents or other information, without notice to the Company. This Agreement does not limit Employee’s right to receive an award for information provided to any Government Agencies.”

As with a similar action that the SEC brought against KBR last year, there is no evidence that BlueLinx actually sought to enforce the troublesome provisions. In the SEC’s view, the simple presence of the language is enough to constitute a violation. I also note that although the defendant here was publicly traded and listed on the NYSE, the same prohibition would apply equally to a privately-held company.

SEC’s ALJs: The Stakes Go Up!

Here’s a memo from Wachtell Lipton’s Wayne Carlin & David Anders:

The U.S. Court of Appeals for the D.C. Circuit recently upheld the constitutionality of SEC administrative proceedings in Raymond J. Lucia Cos. v. Securities and Exchange Commission. This is a significant victory for the SEC. In recent years, the SEC has brought increasing numbers of enforcement actions as administrative proceedings, rather than in federal court. A number of litigants have fought back and attempted to challenge the SEC’s choice of forum, in part because the administrative process affords much more limited opportunities to conduct discovery and lacks other protections that exist in federal court.

The pivotal issue presented is whether administrative law judges are “officers of the United States” within the meaning of the Appointments Clause of Article II of the Constitution, or whether they are “lesser functionaries.” Officers of the United States must be appointed by one of the methods specified in the Appointments Clause, which is not the procedure followed for the SEC’s ALJs. The Lucia court was the first court of appeals to consider this issue on the merits, and it concluded that the ALJs are not officers of the United States, thereby rejecting the argument that they are improperly appointed. While other parties may continue to litigate this issue in other circuits, the Lucia decision will likely be influential and will be viewed by the SEC as a vindication of its increased use of the administrative forum.

A decision issued on August 5 by the SEC sitting as an appellate tribunal illustrates some of the perils of the administrative process. In the Matter of John J. Aesoph, CPA and Darren M. Bennett, CPA . The Commission upheld an ALJ’s determination that a partner and a senior manager from a Big 4 audit firm engaged in improper professional conduct in their audit of a regional bank in 2008 and 2009. The ALJ had imposed time-limited suspensions from practicing before the Commission, for periods of one year for the partner and six months for the senior manager. The two respondents appealed the decision on the merits to the Commission. In a cross-appeal, the Division of Enforcement argued that the partner should be suspended for three years and the senior manager for two years.

The Commission found that both respondents had engaged in improper professional conduct. In addition, by a 2-1 vote (with two continuing vacancies on the Commission), the Commission determined to impose stiffer sanctions on appeal than its own Division of Enforcement was seeking. The Commission denied both accountants the privilege of appearing or practicing before it, with a right to re-apply for reinstatement (after three years and two years, respectively). Enforcement had not sought a re-application requirement to follow the period of suspension. As Commissioner Piwowar explained in dissent, this requirement can add years to the process of reinstatement, thus making the impact on the respondents much more severe.

With the decision in Lucia, the trend of more cases in the administrative forum is likely to continue. Proceeding administratively also gives the Commission the ability to advance its programmatic goals more directly than it may be able to do in federal court.

More on “Study: Highest-Paid CEOs Actually Run Some of the Worst-Performing Companies”

Here’s a note from Pearl Meyer’s Dave Swinford in response to this blog that I ran on’s “The Advisors’ Blog”:

A recent Wall Street Journal article proclaimed, “Best-Paid CEOs Lag in Results, Study Says.” The article was based on an MSCI study titled “Are CEOs Paid for Performance? Evaluating the Effectiveness of Equity Incentives.” The article essentially, said two things: 1) the summary compensation table (SCT) in proxy disclosures does not predict what executives will actually receive; and 2) three years is not a long enough frame to measure the relationship between pay and shareholder returns.

This is not news.

Everyone in this business knows that the SCT measures accounting cost, not compensation actually paid or received. Three years is simply not long enough to get a good read on management’s long-term performance. The MSCI report makes these points, but then goes on to provide the headlines that excite the press.

MSCI argues that we should measure and report realized pay—something that a number of companies already do in their proxies. However, the authors of the study did not examine that, probably because the analysis would be extraordinarily time-consuming and complex.

There are other more important and relevant points we should glean from the MSCI study:

1. The SCT was not designed as a pay-for- performance (PFP) analysis tool. It started out as a measure of compensation expense when the SEC took an accounting approach to the compensation disclosure issue. However at that time, PFP was not the focus that it is today.

2. Corporate governance professionals and Congress (through Dodd Frank) are asking the proxy statement to provide information that current disclosure rules were not designed to provide, so we need something different, like realized pay.

The headlines make it sound as if executive pay is flawed, but the study says that the reporting of executive pay is flawed for the purpose of analyzing the relationship of pay- to- performance. That’s a big difference. Until we move away from SCT definitions of pay, and extend the time frame of evaluation to a minimum of five years, we will not be able to properly assess pay vs. performance.

A good analysis of PFP requires looking at financial performance beyond Total Shareholder Return (TSR) because TSR is impacted by many outside pressures over three- to- five-year time frames. Earnings growth and return on capital measures are far more indicative of management’s recent performance than TSR. They indicate fundamental company health, and both are more substantially within management’s control.

This is why the alternative measure reporting in the proposed SEC rules on pay versus performance is so important—TSR is not the answer for the time periods that we have been measuring. Until we sort out the basis for making pay versus performance comparisons, we will continue to debate CEO pay without the benefit of relevant or accurate facts.

Also see this rebuttal to the MSCI study from Pay Governance posted on…

Broc Romanek