Here’s an excerpt from this blog by Cooley’s Cydney Posner:
Here’s an interesting report from Bloomberg on a soon-to-be-published study that concludes that stock analysts are actually worse at predicting corporate earnings now, after a number of regulatory actions to increase transparency and prevent research analyst conflicts of interest, than they were prior to these actions. In the wake of the dot-com crash and the Enron scandal, Congress, regulators and SROs enacted laws and adopted rules designed to increase transparency, improve corporate disclosure and prevent analyst conflicts, e.g., SOX (2002) and various conflict-of-interest rules adopted by the exchanges. While the study found an improvement in forecasting in the early 2000s right after adoption of these rules, the improvement was short-lived. The study showed that forecast accuracy significantly declined over the longer term despite the reduction in analyst conflicts of interest.
Also see this article entitled “9 ways companies fool you with earnings.” And don’t forget that Regulation A+ takes effect tomorrow, June 19th. As noted in this blog, the SEC has denied Montana’s request to stay it’s implementation…
Are Non-GAAP Disclosures Coming Under Renewed Scrutiny?
Here’s an excerpt from this blog by Cooley’s Cydney Posner:
A new study from the Associated Press, discussed in this AP article, shows a strong resurgence in the use of non-GAAP financial measures, most often reflecting numbers that are more favorable than GAAP numbers. The AP analyzed results from 500 major companies, based on data provided by S&P Capital IQ, a research firm, showed that the spread between GAAP and non-GAAP earnings has grown substantially over the past five years. For 21% of companies, non-GAAP profits reported in the first quarter were higher than net income by 50% or more, compared with 13% five years before. Although 72% of the companies had non-GAAP profits that were higher than net income in both the first quarter of this year and five years earlier, adjusted earnings were 16% higher this year compared with 9% five years ago. In the study, 15 companies “with adjusted profits actually had bottom-line losses over the five years.“ Moreover, the article contends, “the financial analysts who are supposed to fight corporate spin are often playing along. Instead of challenging the companies, they’re largely passing along the rosy numbers in reports recommending stocks to investors.”
Typically, the non-GAAP adjustments eliminated charges for layoffs, failed business operations or other restructuring charges, declines in the value of patents or other intangible assets, or charges related to employee equity comp. Whether or not these exclusions are fair, properly presented or even help investors see the financial results “through the eyes of management,” they are once again drawing the attention of critics. Indeed, former SEC chief accountant Lynn Turner is quoted in the article as contending that “companies are still touting ‘made-up, phony numbers’ as much as they did 15 years ago, perhaps more….” And one investor was quoted as finding the data “more confusing than it’s been in a long time, and the reason is all the junk they put in the numbers” and complaining of the time wasted “sifting through the same ‘nonsense’ figures…. confronted back in the dot-com days.”
In 2013, the head of the SEC’s Financial Reporting and Audit Task Force indicated at an AICPA conference, as reported by the WSJ, that the SEC was looking at the use of these non-GAAP measures “with an eye toward possible enforcement cases.” In particular, they were reportedly concerned about “mislabeling,…when companies use common, well-defined terms to refer to their own performance measures” and “trends and patterns that could indicate a risk of fraud, such as cases in which a company shows high reported earnings but has lower earnings for tax purposes, or when a company has a high proportion of transactions that are kept off its balance sheet.” While no big splashy cases have yet materialized as a result, frothy markets tend to invite the attention of concerned regulators, especially regarding issues that have attracted press scrutiny.
Political Spending Disclosure: House Bill Would Bar SEC From Adopting Rules
Yesterday, the House Appropriations Committee approved the “2016 Financial Services and General Government Appropriations” bill, which includes some items that don’t pertain to funding the SEC. [It’s a shocker that Congress would do that!] In addition to not giving the SEC an increase in funding (as I’ve blogged before), Section 625 of the bill prohibits the SEC from adopting a rule that would require public companies to disclose their political spending. We’ll see if that provision survives as this bill winds its way through the sausage machine..
Meanwhile, as noted in this article, over 20 advocates sent a letter to President Obama requesting that the upcoming SEC Commissioner be filled by folks who support corporate political spending disclosure rulemaking. And this article cites a new report – and petition – that supports the view that the next new Commissioner shouldn’t have ties to entities that the SEC regulates…
With so many companies now improving their proxy disclosures, I’ve decided to hold an annual contest for proxy disclosures. The deadline for nominations is Wednesday, July 1st. The winners will be decided by you – via anonymous popular voting. In three weeks, I will post the nominees to be voted upon in the following 14 categories – in the meantime, please submit your nominations by emailing them to me.
– Self-nominations permitted
– Max of 3 nominations per company
– No need to explain why you’re nominating a proxy for a category(ies). Just let me know the company name and the category(ies) for which it is being submitted.
Here’s the categories:
1. Best Overall Proxy (Combined Online & Print)
2. Best Print Proxy – Large Cap
3. Best Print Proxy – Mid-to-Small Cap
4. Best Online Proxy – Large Cap
5. Best Online Proxy – Mid-to-Small Cap
6. Most Improved Print Proxy
7. Most Improved Online Proxy
8. Most Persuasive Supplemental Letter/Additional Soliciting Materials
9. Best Executive Summary
10. Best CD&A
11. Best CD&A Summary
12. Best Shareholder Engagement Disclosure
13. Best Director Bios Disclosure
14. Best Shareholders Letter
Sights & Sounds: “The Women’s 100 Conference ’15″
Just wrapped both of my “Women’s 100” Conferences over the past two weeks – DC and Palo Alto. Like last year, they were very interactive & loads of fun. Here’s a nice note from Mintz Levin’s Megan Gates about it. [By the way, Megan & her team are doing a great job with their new blog – check it out!] Also check out this emotional speech by Prudential’s Peggy Foran, who earned the “Linda Quinn Lifetime Achievement Award” in DC.
Here’s a 40-second video that gives a little bit of the DC event’s flavor (with a nice wave cheer) – and then below that is a 40-second video of the Palo Alto event (great “boom shakalaka boom” at the end):
Here’s some thoughts from Baker & McKenzie’s Dan Goelzer: Recently, Audit Analytics released its annual report on financial restatement trends, “Financial Restatements 2014–A Fourteen Year Comparison.” The study concludes that the absolute number of restatements is constant and the severity of restatements is relatively low, although there is a trend toward more restatements by large public companies. According to the report synopsis and AA’s blog:
– During the last five years, the number of public company restatements has remained essentially flat. Restatements peaked at 1,842 in 2006. By 2009, restatements had fallen to 761. Restatements rose to 836 in 2010 and have remained near that number through 2014.
– While the overall number of restatements is relatively constant, the number of accelerated filers – the largest public companies – announcing restatements is rising. In 2009 and 2010, 171 accelerated filers restated. That number has increased each year since 2010. In 2014, 309 accelerated filers restated.
– The severity of restatements remained low in 2014, consistent with AA’s findings during the past several years. In 2014, the average public company restatement resulted in an income adjustment of $1.9 million, the lowest adjustment amount in eight years. In addition, AA’s blog states that “virtually all” of the severity indicators tracked by Audit Analytics remained low in 2014. The severity indicators are negative impact on net income; average cumulative impact on net income per restatement; percentage of restatements with no impact on income statement; average number of days restated; and average number of issues identified in restatement.
A somewhat different perspective emerges from a report released by Cornerstone Research. That report, entitled “Accounting Class Action Filings and Settlements—2014 Review and Analysis,” finds that securities class actions with accounting-related allegations increased in 2014; 69 new accounting cases were filed, an increase of 47 percent over 2013. (Cases are considered “accounting cases” if they involve allegations related to Generally Accepted Accounting Principles (GAAP) violations, auditing violations, or weaknesses in internal control over financial reporting.) Other highlights of the Cornerstone report include:
– More than one in four of the accounting class action complaints referred to an SEC inquiry or action. This is the highest level of private accounting suits that parallel SEC enforcement cases since Cornerstone began tracking this variable in 2010.
– Accounting cases involving restatements increased to the highest level in seven years – both in terms of the number of cases filed (29) and as a percentage of total accounting cases (42 percent).
– Since 2010, the majority of accounting cases have included allegations of internal control weaknesses. In 2014, 60 percent of cases filed involved internal control weaknesses.
– The “Disclosure Dollar Loss Index” for accounting cases involving restatements increased to its highest level since 2005. The Disclosure Dollar Loss Index is a measure of the decline in market capitalization at the end of the class period.
In Cornerstone’s press release, Dr. Elaine Harwood, a Cornerstone Research vice president and head of the firm’s accounting practice, offered this explanation for the increase in class action litigation alleging accounting violations: “The increase appears to be, at least in part, a result of the SEC’s heightened focus on accounting-related fraud as demonstrated by the substantial growth in accounting case filings that refer to inquiries or actions by the SEC.” As to the reasons why more class actions relating to restatements were filed in 2014, Dr. Laura Simmons, a Cornerstone Research senior advisor, observed: “The increase in filings of cases involving restatements is consistent with our finding of a relative increase in negative stock price movements surrounding restatement announcements in 2014 as compared to recent years.”
Comment: The Audit Analytics study is consistent with other research indicating that the reliability of financial reporting has increased post-Sarbanes-Oxley. However, as Cornerstone’s research indicates, market-moving restatements, while rarer than in earlier years, still can have severe consequences, both in terms of SEC action and private litigation.
A few months ago, I blogged an excerpt from an article that quoted the SEC’s Chief Accountant Jim Schnurr as saying that “there is virtually no support to have the SEC mandate IFRS for all registrants.” Now, a few weeks ago, Jim gave a speech in which he seemed to disagree that IFRS is dead in the US (as noted in this article). Here’s an excerpt from his speech:
As I mentioned publicly last month, the staff has recently heard from a number of different constituents about IFRS: preparers, investors, auditors, regulators and standard-setters. We heard three key themes through those discussions: There is virtually no support to have the SEC mandate IFRS for all registrants. There is little support for the SEC to provide an option allowing domestic registrants to prepare their financial statements under IFRS. There is continued support for the objective of a single set of high-quality, globally accepted accounting standards. So, while full-scale adoption or an option does not appear to have support, it does not mean we ‘bury’ the underlying objective of a single set of high-quality, globally accepted accounting standards. On the contrary, constituents continue to support that idea. So, the real questions are: what is the path to achieve that objective and how do we get there?
Delaware House Approves Curb on Fee-Shifting Bylaws
Here’s news from the Delaware Law Weekly (also see this memo):
The state House of Representatives on Thursday unanimously approved SB 75, the annual package of amendments to the Delaware General Corporation Law, which included a measure that would prevent stock corporations from enacting bylaws that impose attorney fees and costs on plaintiffs who lose after filing lawsuits alleging corporate waste or wrongdoing. The measure now goes to the desk of Gov. Jack Markell, who is expected to sign it into law.
“SB 75 helps preserve the balance between shareholders and management and ensures that shareholders in Delaware corporations have access to the Court of Chancery,” said Kelly Bachman, Markell’s press secretary. “The governor would like to thank the Corporation Law Council for its continued efforts to improve Delaware law and preserve Delaware’s place as the leading state of incorporation.”
Approval—which required a two-thirds vote—came on a 40-0 vote with one state representative absent.
Chief Deputy Secretary of State Richard J. Geisenberger came to the chamber before the vote to answer lawmakers’ questions and said its drafters were confident that the bill would maintain the delicate balance of Delaware’s franchise in corporate regulation, which he said is worth $1.1 billion annually to the First State. The state should aim, Geisenberger said, “to strike a balance between the attractiveness of our corporate statute to managers and [the needs of] raising capital from shareholders.”
He added that he did not think banning stock corporations from adopting fee-shifting bylaws posed a risk to Delaware’s attractiveness as a state of choice for incorporation. He stressed that another key provision of the act allows corporations to state in their bylaws that claims under the DGCL be brought only in the courts of Delaware.
Recently, Corp Fin announced a new policy that the Staff will publicly release “no review” letters for registration statements that are not selected for review. These “no review” letters will be posted on Edgar in a company’s “correspondence” stream. A company and its advisors would already know about a registration statement not being selected for review – so this move really only benefits third parties who wanted to know.
Some folks want Corp Fin to issue “no review” letters for preliminary proxy statements since the existing practice is that companies can presume that no comments from Corp Fin are forthcoming if they don’t hear from the Staff within 10 calendar days of filing, per Rule 14a(6)(a). Learn more about this process in our “Preliminary Proxy Statements Handbook.”
On the other hand, most folks like the fact that the Staff is silent and doesn’t issue a “no comments” letter if its ’34 Act filings are reviewed and the Staff has no comments. In other words, it’s possible that your 10-K was reviewed but the Staff had no comments – but you wouldn’t know that since they never contacted you. Typically, the ’34 Act review is only of the company’s financials, conducted by Corp Fin’s accounting staff. This review is necessitated by Section 408 of Sarbanes-Oxley, which mandates that every company’s periodic disclosures must be reviewed at least once every 3 years.
The rationale for not wanting a “no comments” letter is that you don’t want the CFO and Controller’s office getting excited and thinking they are doing a great job because Corp Fin didn’t issue any comments. Better to keep them on their toes…
Court Finds SEC’s Use of ALJ Likely Unconstitutional
The debate over whether the SEC’s use of administrative law judges in enforcement proceedings has ratcheted up a few notches. Last week, in Hill v. SEC, the US District Court for the Northern District of Georgia preliminarily enjoined the SEC from conducting the administrative proceeding brought against an alleged insider trader, finding a substantial likelihood that he will succeed on the merits of his claim that the SEC has violated the Appointments Clause of Article II of the US Constitution.
As noted in this blog, the Appointments Clause requires that “inferior officers” be appointed by the President, department heads or courts of law. SEC administrative law judges are not appointed by the SEC – they are hired by the SEC’s Office of Administrative Law Judges, with input from the Chief Administrative Law Judge, human resource functions and the Office of Personnel Management. The Court looked to the powers of the administrative law judge which are functionally comparable to that of a judge in making its decision.
As noted in this blog, this WSJ article indicated that the SEC will likely resolve this issue by having the Commissioners appoint its ALJs directly. But in the meantime the court’s ruling could spur similar challenges to the validity of current and past SEC proceedings – but the US government is fighting this new decision.
Tomorrow’s Webcast: “Proxy Season Post-Mortem – The Latest Compensation Disclosures”
Tune in tomorrow for the CompensationStandards.com webcast – “Proxy Season Post-Mortem: The Latest Compensation Disclosures” – to hear Ken Bertsch of CamberView, Alan Dye of Hogan Lovells, Dave Lynn of CompensationStandards.com and Morrison & Foerster and Ron Mueller of Gibson Dunn analyze what was (and what was not) disclosed this proxy season.
The SEC truly is getting it from all sides these days. As noted in this article, the House Appropriations Committee marked up a bill yesterday that would hold the SEC’s funding flat for the next fiscal year. The “2016 Financial Services and General Government Appropriations” bill would provide $1.5 billion for the SEC in fiscal 2016, the same budget level the agency is operating on this year. That number is $222 million less than what the Obama administration requested. The bill provides funding toward information technology projects at the agency – but prohibits the SEC from spending money out of a reserve fund established by Dodd-Frank…
Proxy Access: 5 Law Firm Comment Letter
A few days ago, five law firms – which handle the bulk of the Rule 14a-8 work out there – submitted this comment letter to the SEC regarding the agency’s ongoing review of the shareholder proposal process for no-action requests made under Rule 14a-8(i)(9) (ie. conflicting proposals).
There are 5 comment letters posted so far – including this one that includes a blog that I posted from an anonymous member as an attachment. Finding these comment letters can be tricky since there is no proposed rule – they are housed under the Corp Fin page, then head to the “Current Topics” box on the right side and you will see a link to “Share Your Views” on the Staff review of conflicting shareholder proposals – which has a link to “submitted comments” at the bottom…
Here’s the latest status check into how proxy access shareholder proposals fared during this proxy season.
Non-Partisan SEC Commissioners: Seeking Transfer Agent Update
A lot of ink has been spilled lately about the politicization of the SEC. But yesterday’s joint statement from short-timer Commissioners Aguilar & Gallagher – which was followed by a joint statement of support from Commissioners Stein & Piwowar! – do show that sometimes Commissioners from different political parties do work together. The Commissioners seek an overhaul of the transfer agent regulatory framework since that hasn’t been done in 30 years.
It’s amazing to me how often that individual SEC Commissioners put out their own statements – including dissents – these days. I wonder if that practice will continue beyond this current group of Commissioners…
Meanwhile, this WSJ article entitled “The SEC’s Recruiting Problem: Its Former Officials” talks about how former SEC Commissioners & Staffers are warning candidates for the upcoming two Commissioner slots that the job is full of dysfunction and that even the vetting process can be quite a challenge. Even with that as a backdrop, I’m pretty confident that a number of qualified individuals would be more than happy to become a Commissioner…
The average Fortune 100 firm has a staggering 320+ social media accounts with over 200,000 followers and 1500 employee participants who make over 500,000 posts to these accounts. Proofpoint Nexgate’s latest “State of the Social Media Infrastructure” report presents these (and other) concerning results of its analysis of 32,000+ social media accounts of Fortune 100 companies:
Findings
– The average company suffered from a total of 69 unmoderated compliance incidents during the study’s 12 month research window.
– Nine different U.S. regulatory standards triggered incidents, including rules and regulations of the SEC (e.g., Reg. FD), FINRA, FTC, FDA and the UK’s FCA.
– Financial Services Standards violations dominate the field. However, improper disclosure of confidential corporate activity accounted for 118 standalone incidents (i.e., 150 additional incidents crossed categories) – consisting of information regarding layoffs and restructurings, earnings and financial updates and M&A transactions. Reg. FD violations accounted for an additional 149 incidents.
– There were over 900 “Regulated Data” incidents consisting of improper disclosure of user names/passwords, SSNs, credit card numbers, etc.
The report also offers recommendations for developing a successful social media compliance program – summarized by Compliance Week.
See also this WSJ article discussing the various state social media laws, this Corporate Compliance Insights post, and this new FTI/NYSE Law in the Boardroom survey, which found that social media ranks among the top three areas about which directors have the least amount of confidence in their GCs’ oversight. And 91% of directors and 79% of GCs affirmed that they don’t have a thorough understanding of their company’s social media risks.
This recent CEB (Corporate Executive Board) blog identifies the most important triggers, and provides a decision tree, for determining when to develop a new or update an existing policy.
CEB research found that the seven most important reasons for writing a new policy or updating an existing one are:
New risk assessment results.
Revision of the company’s code of conduct.
New internal audit findings.
Publicized failure in the same or similar industry.
Shift in business strategy.
Merger, acquisition, or other organizational change.
Geographic expansion.
See the blog’s nifty decision tree, and this CEB Policy Management Toolkit on how to create and implement a policy on policies.
More on “The Mentor Blog”
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
– Spencer Stuart Addresses Board “Refreshment”
– Avoiding & Managing Boardroom Disputes
– Using COSO to Assess & Manage Cyber Risks
– Form 10-K Preparation Tips
– How to Proactively Tackle the Director Tenure Issue
This recently published paperseeks to undermine six myths about board gender diversity. I say “seeks” only because the rebuttal to one of the myths – that concerning the cause of gender disparity in the boardroom – is premised on an assumption with which I disagree, i.e., there aren’t enough women at the top of the corporate ladder who are potential candidates for directorships.
Not only do I disagree that there aren’t enough women at the top such that board diversity could be measurably improved (at least in the U.S.), but I also and – more importantly – disagree with the assumption that being a qualified director candidate is dependent upon being at the top of the corporate ladder. However, that’s just my personal view, and certainly all of the myths and associated discrediting facts are worth consideration.
Six myths about boardroom gender diversity:
– Popular boardroom surveys provide an accurate picture of women’s relative underrepresentation. – The financial crisis would not have happened if Lehman Brothers had been Lehman Sisters. – Female directors are just like male directors. – HR directors are to blame. – Adding a woman to your board will improve shareholder value. – Quotas are necessary to improve female board representation.
See this recently released NYSE Governance/Barker Gilmore survey, which found that more than half of company director respondents believe having a GC serving as an independent director on an outside board adds value to the company, and this recent Fortune articleidentifying (based on a PwC survey) five ways boards may differ if they had more women directors.
In this interesting new article, Ivey Business School Professors Seitjs, Gandz, and Crossan and Post-Doctoral Fellow Byrne elaborate on their previously published notion that being an effective board member requires competencies, character and committment by further exploring the aspect of character.
Based on meetings and surveys with over 780 directors and prospective directors, the paper discusses in detail the important – but too often ignored – attribute of character as represented by 11 character dimensions deemed to play a critical role in director effectiveness including judgment, integrity, accountability and others.
Among other things, the survey results revealed that boards don’t spend enough time addressing or assessing the character of their director nominees, despite believing that character is very important. In that context, the article offers a number of tangible recommendations to aid the director search, evaluation and performance review processes.
We have heaps of helpful resources in our “Board Composition” Practice Area.
More on “The Mentor Blog”
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
– Code of Ethics/Conduct Primer
– Audit Committee Role in Improving Disclosure
– CEO Succession Planning Guidance for CEOs & Boards
– Addressing Key Governance Challenges in International Markets
– Study: How Board Gender Impacts M&A Decision-Making
A recently released CFA Institute study reveals significant investor concerns about current standard-setter initiatives (see FASB’s Private Company Council and Simplication Initiative) to create differential or reduced financial reporting requirements for nonpublic companies; extend certain alternative private company reporting requirements to public companies; and simplify certain public company reporting requirements. The proposed changes are purportedly driven by a desire to reduce companies’ compliance costs which, although certainly a laudable objective, presumably shouldn’t be pursued single-mindedly at the expense of impeding investors’ understanding and utility of companies’ financial performance and prospects.
The CFA Institute’s 2014 member survey found that:
– 82% of respondents believe differential standards will decrease comparability – so, create comparability challenges for those investing across public and private companies
– 73% believe differential standards will increase complexity rather than reduce it (by, e.g., prompting investors to seek alternate ways to obtain information including accessing management on a one-on-one basis; substantially raising the burdens and costs associated with going public or acquiring a private company)
– 65% believe differential standards will result in the loss of information useful to their financial analyses (e.g., reduced disaggregation of information; substituting presentation of items on the face of the financial statements by disclosure)
The report also notes that FASB is currently considering whether to extend certain private company accounting alternatives to public companies – a move favored by only 6% of CFA Institute members.
See CFA Institute’s Mohini Singh’s blog summarizing the study. For additional information, you may contact Mohini at Mohini.Singh@cfainstitute.org.
Identifying Opportunities for Nonprofit and For-Profit Boards to Learn From Each Other
In this Columbia Law School blog, Stanford Graduate School of Business Nicholas Donatiello, David Larcker and Brian Tayan discuss their recently published paper, “What Can For-Profit and Nonprofit Boards Learn from Each Other About Improving Governance?“. The thought-worthy paper focuses on lessons that for-profit and nonprofit directors can learn from each other to improve their respective governance (based in part on this recent nonprofit governance survey) including:
Lessons for Nonprofits:
– Formal governance processes
– Focus on fiduciary obligations
– Expertise and stability
Lessons for Corporate Boards:
– Balanced power with CEO
– CEO compensation
– Gender balance
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
– Vanguard Discloses Engagement/Voting Specifics
– FCPA Compliance: Third Party Diligence Framework
– Study: Investor Holding Periods Have Not Shrunk
– Germany Moves on Board Gender Diversity
– Should Directors Take a “Gap” Year?
[Hi. It’s Randi blogging again this week so, to be clear, the views I express are my own and don’t necessarily reflect those of Broc or anyone else…]
In the brief time since the SEC published the proposed Pay vs. Performance rule, there’s been a fair amount of criticism aimed at the proposal’s use of TSR as the sole “approved” metric by which investors will gauge the correlation between executive pay and corporate performance. In a perfect example of what one of my very seasoned and wise former board members during my GC days would likely characterize as the tail wagging the dog, investors’ desire for comparability across companies is trumping the proposal’s use of performance metrics that actually make sense given each company’s unique facts and circumstances and that drive behavior consistent with a long-term view.
In case you’ve just joined the fray, here’s just a sampling of recent, relevant critiques:
– LA Times columnist Michael Hiltzik shared his passionate critique of the rule proposal, noting (among other things) TSR’s imperfect correlation with corporate performance and its short-termism focus, i.e., tendency to drive executive behaviors that will boost TSR, but harm the company over the long-term. Hiltzik also criticizes the rule’s focus on “shareholder value” to the exclusion of everything else – a focus that ultimately distorts corporate behavior to the detriment of the broader economy.
– Based on its recently reported analysis of the link between various LTI measures and corporate performance, FEI concluded that TSR was the worst performance measure to drive positive corporate performance:
TSR, particularly on a relative basis, is a poor LTI measure. For the majority of companies granting performance-based grants, relative TSR is a commonly used performance measure. However, using TSR as a measure has a negative influence on company performance, except in the case where it has been used as a performance measure for each of the past five years. Moreover, TSR, particularly when measured against a group of companies (including a stock index), does not motivate executives, and is similar to a stock option in its nature (another form of lottery ticket), as it does not provide the line of sight necessary for oversight.
– The IRRC Institute submitted this comment letter to the SEC accompanied by recently published research on pay and performance alignment, which found a disconnect between TSR and performance:
“[T]he focus on share price appreciation through total shareholder return (TSR) obscures more than it reveals with share price as a capital markets performance metric. Factors which impact TSR such as fund flows, central bank policies, macroeconomics, geo-political risks and regulatory changes are all beyond the control of executive management.
– In this Fortune commentary, Eleanor Bloxham describes the proposal’s use of TSR as encouraging pay incentives that “fuel crisis”:
The American Bar Association and the Center on Executive Compensation, among others, have opposed the SEC’s prescriptive approach to this rule. In choosing total shareholder return (a measure of a company’s stock market price and dividends), the SEC admits that pay disclosure may have nothing to do with the actual way in which a corporate board makes compensation decisions. The problem is that this kind of measure may now have an influence on such decisions. Boards should not reward executives based on stock performance or dividends paid. They should reward executives based on the operational measures the executives in that company should be focusing on and can control. As a basis for incentives, a company’s stock price promotes undesirable CEO behavior, the kind that can lead to volatile swings in the economy. Those incentives helped fuel both the financial crisis and the stock market rout following the misdeeds of Enron and WorldCom’s top executives. Similarly, increasing dividends is not always wise, because they can strip a firm of the assets needed to make valuable long-term investments and the liquidity required to weather rocky times. The SEC should have required that companies report on the financial performance measures they currently use to determine compensation. Then, investors could sort out which companies actually understand performance measurement and which ones are clueless.
– In this recent article, Semler Brossy identifies TSR as a “flawed” incentive measure, noting:
Relative TSR rewards volatility more than steady performance. As they say, every dog has its day, and this is certainly true with relative TSR. We measured TSR for hundreds of companies over the recent 20 years and found that even long-term, bottom-quartile TSR performers can reach top-quartile heights in a given three-year measurement period — generally by ‘bouncing’ from a low share price. Further, relative TSR does little by way of focusing executives’ attention or driving behavior. Executives respond positively to incentive measures that reflect their day-to-day responsibilities. Rewards based on relative TSR are an affirmation of company success but do little to set the path to performance at the outset of a measurement period.
– Last but not least (for now), Steve Quinlivan shared these observations about the disconnect between TSR and executive pay:
What aberrations may exist? First, there may be no link at all between executive pay and TSR. This isn’t necessarily a governance faux pas. Executive pay may well have increased because of improved financial metrics the compensation committee chose wisely to reward while the stock price declined because of general market conditions beyond the executives’ control. Sure, the SEC invites the company to explain the reasons and to submit alternative measures of performance, but that will be hard to do without making it look like an apology. Perhaps this will engender a trend to tie incentives to TSR to make the discussion easy and that may not universally by the best thing for companies to do.
SEC Enforcement: Ongoing Choice of Forum Debate
This recent WSJ op-ed addresses the fact that the SEC’s Enforcement Staff’s recently issued guidance to forum selection in contested actions generally was not well-received by those who had criticized the apparent lack of objective criteria driving determinations about whether an action would be brought in federal district court or in an administrative proceeding before an ALJ. The authors, former director of the SEC’s Division of Enforcement and former SEC chief litigation counsel, suggest the SEC take these steps to “reclaim the high ground”:
– Develop meaningful, objective criteria for exercising its discretion to bring matters in-house that is the product of input from interested parties, including the defense bar
– Modernize the rules of procedure governing its in-house proceedings
– Avoid finding, on appeal, additional violations and imposing additional penalties beyond those assessed by the ALJs, who are independent government employees
See this recent blog discussing an ALJ’s denial of an accused’s request for more information about the Commission’s forum selection process, and memos about Enforcement’s recent guidance, which are posted in our “SEC Enforcement” Practice Area.
More on “The Mentor Blog”
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
– Investors & Directors: Understanding & Bridging the Gaps
– Bolstering Compliance Programs: Compliance & Ethics Liaisons
– Old COSO Internal Controls Framework: “Qualified Pass” for 2014
– FCPA: SEC’s Director of Enforcement Talks Compliance Programs
– Overlapping Audit & Compensation Committee Memberships: Pros & Cons
The SEC is now moving fast on the last of its Dodd-Frank rulemakings! Yesterday, as noted in this press release, it released additional analysis from its “DERA” (former nickname of “RiskFin”) Division related to its pay ratio proposal. Comments on this new analysis are due by July 6th (coincidentally, the same deadline as the P4P proposal). As I blogged yesterday, the SEC has become more cautious during its rulemaking process since a 2011 court decision struck down part of the SEC’s proxy access rule after finding the economic analysis was incomplete – so the practice of releasing additional economic analysis for public comment is becoming fairly common.
In addition to reading this review of the SEC’s new analysis (& this MarketWatch piece), check out my example that helps illustrate the SEC’s new findings:
– If the standard deviation of compensation (meaning the variability among positions) is 55%, and the exclusion of non-US, part time and seasonal jobs results in the elimination of 20% of the workforce from the calculation, the ratio would decrease by 15%
– Thus, a ratio of 300:1 would become 255:1
– If the standard deviation is only 25% – and the exclusion removes 20% of the workforce from the calculation – the impact is only 6.5%, thus the 300:1 ratio might drop to 281:1
Today is the last day left at the reduced rate. The SEC’s new pay-for-performance & hedging proposals – not to mention the coming clawback proposal and final pay ratio rules – are causing a stir – and you should prepare now. These rules will be among many topics that Corp Fin Director Keith Higgins & other experts will be talking to at our popular Conferences — “Tackling Your 2016 Compensation Disclosures” — to be held October 27-28th in San Diego and via Live Nationwide Video Webcast on TheCorporateCounsel.net. Act by the end of today, Friday, June 5th for the phased-in rate to get more than 20% off.
The full agendas for the Conferences are posted — and include the following panels:
– Keith Higgins Speaks: The Latest from the SEC
– The SEC’s Pay-for-Performance Proposal: What to Do Now
– Creating Effective Clawbacks (& Disclosures)
– Pledging & Hedging Disclosures
– Pay Ratio: What Now
– Proxy Access: Tackling the Challenges
– Disclosure Effectiveness: What Investors Really Want to See
– Peer Group Disclosures: The In-House Perspective
– The Executive Summary
– The Art of Communication
– Dave & Marty: Smashmouth
– Dealing with the Complexities of Perks
– The Big Kahuna: Your Burning Questions Answered
– The SEC All-Stars: The Bleeding Edge
– The Investors Speak
– Navigating ISS & Glass Lewis
– Hot Topics: 50 Practical Nuggets in 75 Minutes
You might recall that Dodd-Frank requires that the SEC to review the “accredited investor” definition for natural persons beginning in 2014 and every four years thereafter. As part of its review process, the SEC has received a significant number of recommendations from comment letters and from two SEC advisory committees. While the vast majority of commenters recommended not changing the current definition, others recommended raising the financial thresholds cited in the definition or adjusting them for inflation. Still others offer alternate recommendations, including adding a new category for financial sophistication or allowing a percentage of income or net worth to be used in qualifying private placements. This memo does a great job of summarizing all this activity…
Also check out this Cooley summary of the latest meeting of SEC’s Advisory Committee on Small & Emerging Companies, focusing on the SEC’s disclosure effectiveness project. And see this “Crazy Quilt Chart of Regulation” graphic from SEC Commissioner Gallagher..
