According to the most recent edition of the “Spencer Stuart” board survey, the CEO was the only insider serving as a director on approximately 60% of S&P 500 boards. This Sidley memo says that a recent study indicates that may not be such a good thing:
Based on S&P 1500 company data from 2003 to 2014, the study concluded that companies with lone-insider boards (i.e., boards with no inside directors other than the CEO) awarded their CEOs “excess pay” (i.e., pay above what factors such as firm size, CEO age, CEO tenure, CEO equity ownership, industry, stock returns and performance would predict), with such CEOs receiving approximately 82% more pay than CEOs at peers with more than one insider on the board.
The study found that, as compared to their non-lone-insider peers, companies with lone-insider boards (1) have a $2.99 million larger pay gap between the CEO and other top management team (TMT) members, (2) are 1.27 times more likely to experience financial misconduct (defined as instances of financial restatements that are not due to clerical errors or minor accounting issues) and (3) experience poorer performance (e.g., a 10% lower return on assets).
The study says that analyst coverage and a high percentage of institutional share ownership mitigated the negative effects of a sole insider board on CEO pay vs. company performance – but not for pay gaps between the CEO & other executives or financial misconduct.
While We’re on the Topic of Inside Directors…
This “Columbia Blue Sky” blog discusses a new study by Virginia Tech’s Prof. Donald Bowen that says maybe those pre-SOX insider dominated boards weren’t so terrible after all. This excerpt summarizes the study’s results;
In a new working paper, I examine these questions by taking a new approach that exploits the implementation of the law. In short, the independent board mandates defined independence such that some directors could reclassify from non-independent to independent.
The effect of this definition is that while some firms—“treatment” firms—were required to change the membership of the board to meet the requirement, other firms—“placebo” firms—complied not because their directors changed, but because the classification of their directors changed. Importantly, the social and economic relationship between the CEO and director are largely unchanged for reclassified directors. As such, the reclassifications made boards at placebo firms more independent legally, but not economically.
My main tests show that placebo firms significantly outperformed treatment firms following the introduction of the independent board rules. I also show that the specific conditions that determine whether a firm is defined as a treatment firm or placebo firm are effectively random. This gives the estimated performance advantage of placebo firms a causal interpretation and implies that treatment firms performed worse because their boards were changed. In other words, the mandated governance policies impeded the conduct of firms targeted by the regulations.
Overboarding: What’s Good for the Goose. . .
This WSJ article points out that overboarding is a big issue for institutional investors – and this excerpt says that some big players are using their voting clout to curb the practice:
BlackRock, the world’s largest asset manager, cast 168 votes against directors this year due to overboarding concerns. It fought the reelection of directors at companies such as Charter Communications Inc., Pfizer Inc. and PayPal Holdings, Inc., according to filings and a spokesman for the money manager.
BlackRock wasn’t alone – the article says that last year, State Street cast votes against 69 CEOs who served on more than 3 boards & against 22 non-CEO directors who each sat on more than 6 public boards.
But this blog from Professor Ann Lipton suggests that these institutions may not be the right folks to lead the charge on this issue:
Most mutual fund companies employ a single board – or a few clusters of boards – to oversee all of the funds in the complex. This can result in directors serving on over 100 boards in extreme cases. State Street’s Equity 500 Index Fund, for example, reports trustees who serve on 72 or 78 boards within the complex. BlackRock’s Target Allocation Funds have trustees who serve on either 28 and 98 different boards (depending on how you count).
I’ll admit this is something of a cheap shot: presumably each fund is much more similar to the other funds than are the various companies at which overboarding concerns are raised. Still, when you get to over 20 funds per director, that’s a lot, no? Or 50 funds? Especially since the funds have varying interests – they might stand on opposite sides of a merger, or invest at different levels within a single firm’s capital structure, or compete for limited opportunities like IPO allocations and pre-IPO shares.
Yesterday, the House Financial Services Committee approved 23 bills – including two pieces of legislation that would repeal Dodd-Frank’s conflict minerals & mine safety and health disclosure requirements.
– H.R. 4248 would amend the Securities Exchange Act to repeal Section 13(p) – which directed the SEC to adopt its conflict minerals disclosure rules and related certification and audit requirements. The bill would also make conforming changes to the text of Dodd-Frank.
– H.R. 4289 would amend the Securities Exchange Act to repeal Section 1503 of the Dodd-Frank Act, which requires detailed disclosures about mine safety and health in the quarterly and annual reports they file with the SEC.
So, should everybody put their pens down? This recent blog from Steve Quinlivan says that’s not necessarily a good idea:
I recommend that anyone working on conflicts minerals to continue to work. Bills passed by the Financial Services Committee have a relatively poor track record of being enacted into law, at least over the short term. Similar provisions were included in the Financial Choice Act 2.0 which has not been enacted.
Tax Reform & CEO Pay: Adding to the “Museum of Unintended Consequences?”
The GOP’s ever-evolving tax reform proposal has produced a torrent of memos from law firms, accounting firms, & other advisors (we’re posting them on CompensationStandards.com). Not surprisingly, many of the memos focus on the impact of proposed changes in the treatment of executive comp. Among other things, the current version of the proposal would repeal the provisions of Section 162(m) that allow companies to deduct performance-based pay in excess of $1 million.
Congress’ willingness to tinker with executive comp reminds me of the old adage that those who don’t learn from the past are condemned to repeat it. Remember, the much reviled Section 162(m) itself was enacted in 1993 in an effort to align executives’ interests with those of stockholders.
Instead, as former SEC Chair Chris Cox put it, Section 162(m) “deserves a place in the museum of unintended consequences.” That’s because, instead of aligning management & shareholder interests, the emphasis on performance-based pay led to something else entirely, as Prof. Steve Bainbridge explains in this blog:
Although CEO pay had been growing fast relative to other metrics during the 1980s, it was in the 1990s that CEO pay really started to explode as a percentage of corporate profits and total wages. In large measure, this occurred because of a huge shift towards options and other forms of incentive pay that were tax favored under the 1993 amendments.
How big is huge? According to this study, in 1992, the S&P 500 granted options worth a total of $11 billion – a figure that rose to $119 billion by 2000. Boards & comp committees undervalued equity awards. In fact, as one director quoted in this 2016 NPR podcast put it, “we thought they were free.”
Changes in accounting rules subsequently made it clear that equity awards aren’t free – but big equity awards have become part of the executive comp landscape, and this recent Stanford study says that they continue to play an outsized role in executive pay, and an even more outsized role in its explosive growth.
Now, Congress is considering eliminating the “performance-based” pay loophole. What’s going to happen to equity awards & executive comp if this becomes law? You’ve got me – but history says that the consequences are unlikely to be what’s intended.
Activism: CEOs In the Crosshairs
This “Forbes” interview with Skadden’s Rich Grossman discusses the implications of an increasingly popular activist tactic – targeting CEOs for removal from the board through proxy contests. Here’s an excerpt from Rich’s comments:
I think most practitioners and governance experts would agree that one of the most important responsibilities of a board is the selection of the CEO, and the removal of the CEO from the board sends a very strong message, especially a board made up of a majority of independent directors.
While shareholders do not have the right to directly remove board-selected officers, if a CEO gets removed from the board in a contest, it’s a vote of no confidence. In those circumstances, I can’t imagine a board not looking at the situation and saying, “should we rethink our decision regarding the CEO?” It certainly makes for an awkward situation.
Why are CEOs being targeted? The approach ISS takes toward proxy contests seeking minority board representation is a big part of the reason:
Under the current ISS analytical framework, recommendations are made depending on whether the dissident is seeking a minority or a majority position on the board, with the standard for a dissident seeking minority representation being significantly easier to meet than if control is sought. The ISS minority contest standard — what I’ll call the “what’s the harm” standard — for replacing directors seems to apply regardless of whether the CEO is targeted.
As reflected in this Senate tax bill markup, the Senate bill has been amended to reflect how the House bill was amended late last week to preserve Section 409A. I haven’t done a complete analysis of where the executive pay provisions stand in the Senate bill (I’ll blog that tomorrow on our “Advisors Blog” on CompensationStandards.com – or you can read the markup now) – but I can report that Section 409B has been killed thankfully…
In July, the SEC issued a highly-publicized Section 21(a) Report detailing the circumstances under which digital assets – such as “tokens” or “coins” – may be regarded as securities. In a recent speech, SEC Chair Jay Clayton touched on securities law issues surrounding ICOs – but as this blog from Duane Morris’ David Feldman notes, it was his off-script remarks that were the most interesting:
Chairman Clayton went a bit further today, going off his script to say that he has yet to see an ICO that doesn’t have “sufficient indicia” of being a securities offering. He also mentioned that the trading platforms could face SEC scrutiny and might have to either register as national securities exchanges or make clear they have an exemption from doing so.
Pro tip – If Jay Clayton hasn’t seen a ICO that didn’t involve a securities offering, you should expect the SEC to be skeptical of arguments that “this one’s different.”
ICOs: Disclose That I’m Getting Paid? But I’m a Celebrity!
I’ve reached the conclusion that the SEC is totally out of touch (said with “tongue in cheek”). If the folks who worked there watched TMZ like the rest of us, they’d know better than to suggest that our nation’s celebrities should have to comply with the law like ordinary people.
Unfortunately, based on this recent statement addressing unlawful celebrity promotional activities for ICOs, everybody at the SEC must be watching C-SPAN. Here’s an excerpt:
Any celebrity or other individual who promotes a virtual token or coin that is a security must disclose the nature, scope, and amount of compensation received in exchange for the promotion. A failure to disclose this information is a violation of the anti-touting provisions of the federal securities laws. Persons making these endorsements may also be liable for potential violations of the anti-fraud provisions of the federal securities laws, for participating in an unregistered offer and sale of securities, and for acting as unregistered brokers.
The reference to touting in the statement’s “parade of horribles” is interesting. Touting is prohibited by Section 17(b) of the Securities Act, but in recent years, it hasn’t featured prominently in the SEC’s enforcement efforts – that is, until last spring, when the Division of Enforcement conducted an anti-touting “sweep” targeting 27 firms and individuals. Of course, none of the defendants in those cases had their own television show, much less their own line of non-stick cookware. We’re posting memos about SEC enforcement actions in this area in our “ICOs” Practice Area.
ICOs: Most People Who’ve Heard of Coin Offerings Think They’re Illegal – and Plan to Invest
According to this LendEDU survey addressing public awareness of cryptocurrencies & initial coin offerings:
– 25% of Americans have heard of ICOs
– 21% of Americans believe that ICOs are illegal
– 15% of Americans intend to invest in ICOs
So, while roughly 85% of Americans who’ve heard of ICOs think they’re illegal, 60% of the members of that same group intend to invest in them. Now, I suppose some or all of that 15% could have come from the 75% of Americans whom the survey says have never heard of an ICO – but I’m not sure whether that’s better or worse…
Anyway, to me, this says 3 things:
– First, the SEC is going to have a heck of a time policing this stuff
– Second, the 60% deserve what they get
– Third, resistance is futile
Welcome to “DotCom II: The Tokening,” everybody! It’s a long way off, but we have just posted the flyer for this webcast: “The Latest on ICOs/Token Deals.”
This survey from communications firm Edelman says that companies have to do a lot to earn the trust of institutional investors – but that it’s worth their effort.
The report says that institutions are a pretty jaded bunch. They have a negative outlook about the political & investment environment, think companies are unprepared for the business risks created by the political climate, and don’t trust government or the media. Institutions also are prepared to act as change agents – 87% say they’d support an activist if they think change is necessary, & nearly the same percentage think that the companies they invest in aren’t prepared for an activist campaign.
In short, institutional investors don’t have a lot of trust in key watchdogs of corporate conduct or in the companies in which they invest – and they’re prepared to take things into their own hands. All-in-all, this doesn’t sound like the recipe for a very pleasant “Investor Day” – but the report provides some insight into key areas that help build investor trust. According to the report:
– 69% of investors believe that the way a company treats its employees impacts their trust in the company
– 87% say the customer satisfaction plays a big role in their level of trust
– 86% say that a reputation for innovation builds trust
– 77% say that equal voting rights are an important measure of trust
– 99% trust a company with a clear strategy more than those without one
Other factors cited as helping to build trust include speaking out on social issues that impact business, providing guidance on future results, an active and engaged board, & efforts to keep shareholders informed.
So what’s the payoff? According to the report, trust drives valuation and investment decisions among institutions – 77% say they bought or increased their investment positions in companies that they trusted, while more than 70% did not invest or underweighted stocks of companies that they did not trust.
Proxy Advisors: Input Sought on “Best Practice Principles”
As Broc blogged back in 2014, a group of European proxy advisors put forward a set of “Best Practice Principles for Shareholder Voting Research.” That group – known as the “Best Practice Principles Group” – now includes ISS & Glass Lewis as signatories, & is soliciting input from companies & investors about on whether those principles need to be revised in light of market experience & regulatory changes.
Tune in tomorrow for the DealLawyers.com webcast – “M&A Stories: Practical Guidance (Enjoyably Digested)” – to hear Withersworldwide’s Ridge Barker, Ropes & Gray’s Jane Goldstein, Morgan Lewis’ Keith Gottfried and our own John Jenkins share M&A “war stories” designed to both educate and entertain.
Here are the 15 stories that will be told during this program:
1. Dig Your Well Before You Are Thirsty
2. Diligence Isn’t Just About Looking for Problems, But for Opportunities Too
3. Expect the Unexpected
4. Keep Your Eye on the Ball
5. Keep Your Friends Close (And Your Enemies Closer)
6. Strategic Deals Require Creativity & Patience
7. The Speech the Director Never Delivered
8. Another Rat’s Nest
9. Don’t Attempt to Win the Championship Football Game With an All-Star Basketball Team
10. What Does Collegiality Really Mean?
11. The Board Book’s Tale: Bankers, Stick to the Numbers!
12. Preparing for Battle
13. Driving a Deal Is Not Unlike Filming a Movie
14. Assumptions Make an *%$ Out of You & Me
15. A Deal So Nice, We Did it Twice
In the wake of Corp Fin’s new Staff Legal Bulletin No. 14I, we have scheduled a webcast for tomorrow, Tuesday, November 14th – “Shareholder Proposals: Corp Fin Speaks” – during which Davis Polk’s Ning Chiu will ask Corp Fin’s Matt McNair about how the new SLB should be applied in practice. This webcast is freely available – even to nonmembers.
As reflected in the memos posted in our “Shareholder Proposals” Practice Area, there are a number of open issues to consider after the SLB – particularly logistical issues about how boards can timely act to qualify for the Staff’s new “ordinary business” position…
Governance: Do Companies Really Need an LTSE to Think Long-Term?
Over on “The Mentor Blog,” Broc recently blogged about the Long-Term Stock Exchange – a proposed new stock exchange designed to promote a long-term approach to governance. Among other innovations, the LTSE would impose a moratorium on guidance and embrace tenure voting.
This recent blog from Andrew Abramowitz asks whether we really need a new exchange to accomplish a more long-term approach by companies:
What is less clear to me is why it has to be a new stock exchange that is the mechanism for implementing these changes. There is no reason why any company listed on the NYSE or Nasdaq cannot (with appropriate internal board and stockholder approval) voluntarily comply with all the requirements that LTSE imposes.
Assuming there could be broad agreement on a set of standards for long-term orientation – perhaps a group of law and business professors can create and update something like that – then any public company can voluntarily decide to adhere to those standards and publicize that fact.
This November-December issue of the Deal Lawyers print newsletter was just posted – & also sent to the printers – and includes articles on:
– Setting the Record Straight: Regulation G Doesn’t Apply to M&A Forecasts
– Structuring Asset Deals: “Traditional” vs. “Our Watch, Your Watch” Constructs
– Controlling Stockholders: Forging Ahead With “Entire Fairness”
(Or Playing It Safer)
– PRC Acquirors: How M&A Agreements Handle Risks & Challenges
Remember that – as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers print newsletter – we are making all issues of the Deal Lawyers print newsletter available online. There is a big blue tab called “Back Issues” near the top of DealLawyers.com – 2nd from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.
And a bonus is that even if only one person in your firm is a subscriber to the Deal Lawyers print newsletter, anyone who has access to DealLawyers.com will be able to gain access to the Deal Lawyers print newsletter. For example, if your firm has a firmwide license to DealLawyers.com – and only one person subscribes to the print newsletter – everybody in your firm will be able to access the online issues of the print newsletter. That is real value. Here are FAQs about the Deal Lawyers print newsletter including how to access the issues online.
Yesterday evening, Senate Finance Committee Chairman Hatch released details of the Senate’s version of the Tax Cuts and Jobs Act. The most notable development for executive compensation is that the Senate bill generally contains the same executive compensation related provisions that were included in the first, and now outdated, release of the House bill (H.R. 1).
As previously reported, H.R. 1 was amended yesterday to remove Section 3801 of the bill, which provided for sweeping changes to the tax treatment of non-qualified deferred compensation, including stock options, under a new “Section 409B.”
For the moment, the new deferred compensation rules may be back on the table. The Senate Finance Committee meets for the first time on Monday, November 13 to begin consideration of the bill. Both the House and Senate versions are subject to further change, votes, and eventually reconciliation before final passage.
One of the giants from Corp Fin passed away earlier this week – Bill Morley. One of those rare gems that spent their entire career in the government, Bill served in various roles in Corp Fin over his 30 years – but he’s mostly remembered for being the Chief Counsel. One of his many roles was serving as the final arbiter of the shareholder proposal no-action letter process. Bill was considered “fair” by both sides. Not an easy feat to accomplish.
Here’s a remembrance from John Huber, who was Corp Fin Director in the ’80s: “He was my Chief Counsel after Peter Romeo went into private practice. As Chief Counsel, he was on top of no-action letters (reviewing each one before it went out), monitoring telephone calls/interps and keeping up-to-date with operations & rulemaking. At meetings when I asked what he thought, he would sometimes tell the group what the “least worst alternative” was. All that with the kindness & friendliness of a person who was indefatigable, never lost his temper and always cared about protecting investors. One of the best examples of the Corp Fin family.”
Bill retired in 1999. One of those guys that got pushed out by the Internet. Bill never wrote a single email – he didn’t want to learn new technologies. And when he was cleaning out his office, I walked by and realized there were boxes & boxes of historical documents sitting in his trash (we saved that stuff). Bill wasn’t sentimental about leaving at all. He was truly ready to enjoy life. To attend as many U. of Maryland lacrosse games as he could.
A year after retirement, Bill agreed to edit my new shareholder proposal treatise. Fifteen years of informal positions taken by Corp Fin where all up there, in his head. We met once a week for six months – I simply downloaded knowledge that no one else could match. The man sure knew his stuff. I’ve always treasured that time we spent together – such wonderful stories. There are no memorial plans yet – I will blog when we know more about that.
Here’s a 16-minute podcast that I taped with Bill in 2011, as he discussed his life in retirement – including:
– How did you wind up at the SEC?
– How do you recall the shareholder proposal process?
– Did you enjoy recruiting & hiring?
– What are among your fondest memories?
– What are you doing now?
It’s quite rare that I blog other than early in the morning. It’s too tempting to chase news across the day. But I thought I would throw up some big news regarding the earth-shattering House tax bill – even though it could be more complete if I waited til morning (including where we stand with the Senate version). Here’s the skinny about how the House made changes to its tax bill today (see this official summary):
1. The House has deleted the offending provisions about equity compensation from the bill (Section 3801 of the bill) – but it left in the provision allowing deferral of tax of stock options for private companies. And it sounds like the provision is modified that so it no longer applies to RSUs (it originally applied to both RSUs & options).
2. The changes to Section 162(m) still stand (Section 3802 of the bill). I think that’s a done deal, assuming they can get the rest of the bill passed. It’s clearly a revenue raiser and if the corporate tax rate is only 20%, companies probably don’t care about the deduction as much anyway. I’m sure it’s a trade-off many companies are willing to make.
So the upshot is that all of Section 3801 is struck – so no changes to the taxation of NQDC – and 409A still stands, so no big changes to the taxation of options & RSUs. And this is a week of my life I can never get back. We’ll be posting the new horde of memos that are sure to come in our “Regulatory Reform” Practice Area on CompensationStandards.com…
Yesterday, SEC Chair Clayton gave a speech about transparency – here’s an excerpt about the lack of retail voters:
I have become increasingly concerned that the voices of long-term retail investors may be underrepresented or selectively represented in corporate governance. For instance, the SEC staff estimates that over 66% of the Russell 1000 companies are owned by Main Street investors, either directly or indirectly through mutual funds, pension or other employer-sponsored funds, or accounts with investment advisers. And, if foreign ownership is excluded, that percentage approaches approximately 79%. Yet it is not clear whether in our rulemaking processes the views and fundamental interests of long-term retail investors are being advocated fully and clearly, either by individual investors or groups that represent them.
Since I arrived at the agency, I have made concerted efforts to reach Main Street investors across the country, and this has resulted in productive conversations with individuals, as well as those who advocate for them. Many others at the SEC, including Rick Fleming, our Investor Advocate, and the Office of Investor Education and Advocacy, concentrate on retail investors generally and have outreach efforts focused on investors who are teachers, students, serve in the military, or live in retirement communities.
A majority of Main Street America’s dollars are invested in vehicles where the investor – the person with their money at risk – is not the voting shareholder. Often voting power rests in the hands of investment advisers who owe a duty to vote proxies in a manner consistent with the best interests of the fund and its shareholders. A question I have is: are voting decisions maximizing the funds’ value for those shareholders?
In situations where the voting power is held by or passed through to Main Street investors, it is noteworthy that non-participation rates in the proxy process are high. In the 2017 proxy season, retail shareholders beneficially-owned 30% of the shares in U.S. public companies; however, only 29% of those shares voted. This may be a signal that our proxy process is too cumbersome and needs updating.
Meanwhile, NY Times’ Gretchen Morgenson wrote this column recently entitled “Small Investors Support the Boards. But Few of Them Vote”…
Has “Notice & Access” Caused Retail Holders to Stop Voting?
Here’s a note from Lynn Turner: “The proxy retail investor participation rate use to be much higher but dropped dramatically when the SEC took action to eliminate distribution to investors of paper proxies and ballots a decade ago with ‘e-proxy.’ If the SEC wants to increase retail investor interest and voting, the could likely get a good start by undoing their previous mistake! Many people told the SEC at the time that they were making a mistake. History has now proven those people right.
Interesting that the retail investors in this country holding equities are typically older people who have lived long enough to build up larger investment balances. Those are the people who you have to reach to get to vote. In our general elections, many of those use paper mail in ballots which has increased participation in voting. Unfortunately, the SEC took an opposite tack several years ago and chose to reduce participation by retail investors. Their objective was achieved as Chair Clayton notes his speech.”
Novel Ways to Boost Retail Voting: The BofA Story
Some companies with sizable retail bases have found novel ways to boost retail voting. Remember this podcast with Peggy Foran & Ed Ballo about Pru’s “Trees (& Totes) for Votes” program.
More recently, Bank of America’s Ross Jeffries & Gale Chang talked to Carl Hagberg – as reflected in this article in Carl’s “Shareholder Service Optimizer” – about how BofA’s campaign to donate $1 if a shareholder voted produced real results. The number of BofA accounts voting went up 8% with this unique campaign (nearly 50k more voters). Nice!
