The potential dilutive effect of option granting practices over the past decade has been the subject of intense investor interest – and many companies are now taking action in response to this uprising. Learn more about equity burn rates in this excellent article from ISS.
Tomorrow’s D&O Insurance Webcast
On TheCorporateCounsel.net, don’t forget tomorrow’s, Wednesday, April 13th webcast – “D&O Insurance Today” – during which Joseph McLaughlin of Simpson Thacher, Patricia Villareal of Jones Day, and Kit Chaskin of Sachnoff & Weaver will analyze why you should be taking a second look at your D&O insurance policies – and provide practical guidance about what to do about your policies today.
Now That’s My Kind of CEO!
Perusing the special CEO pay supplement in yesterday’s WSJ, I loved this interview with Biomet CEO Dane Miller so much that I just had to copy an excerpt. Note that Dane’s salary just passed $500k for the first time and that the other NEOs get paid nearly the same as him. Here is a fraction of the interview:
WSJ: Does shared greed mean the board becomes captive of management?
Dr. Miller: Some organizations that pay their senior management large sums also tend to pay their boards large money. They tend to want to keep each other happy.
WSJ: Should your cash compensation more closely reflect your employer’s record results?
Dr. Miller: Earnings grow on behalf of shareholders. If revenues and earnings should drop, I would expect my compensation program to go in that direction as well. But I don’t think there is any direct connection between the growth in revenues or earnings and what a company should compensate its CEO. If everybody’s pay increase paralleled the increase in revenues and earnings, the company’s results wouldn’t increase.
WSJ: But isn’t that what pay for performance is all about?
Dr. Miller: Our compound annual growth rate approaches 20% in both earnings and revenues. Taking the 20% growth number back 20 years, the corporation probably couldn’t afford me today.
WSJ: Clearly, collecting a huge salary would bother you — especially when you walk around the factory floor talking to workers earning $15 or $20 an hour. What else makes you uncomfortable about making an obscene amount as CEO?
Dr. Miller: Everyone should have a little problem making an obscene amount of money on the backs of shareholders.
On Thursday, the SEC issued this interpretive release concerning prohibited conduct in connection with securities distributions under Regulation M, particularly with a focus on IPO allocations.
The release is a reminder that Reg M prohibits any attempts to induce aftermarket purchases during a restricted period and it lists 7 activities that the SEC believes violates Reg M (based on three enforcement actions the SEC recently brought). Section V (page 19) covers policies, procedures and systems underwriters should have, and states that firms also should take corrective action if breaches occur. The release says that the SEC will continue to solicit comments on its guidance – until June 7th – as it continues to monitor IPO allocation practices.
SEC Barely Adopts Regulation NMS
Last Wednesday, the SEC passed controversial Regulation NMS with another close 3-2 vote (Chairman Donaldson sided with the Democratic Commissioners). Reg NMS is a set of market-structure reforms that will force brokers and exchanges to guarantee the best available price to investors, so long as that price is immediately executable. Also known as the “order-protection rule,” it will apply to all marketplaces – including the Nasdaq Stock Market – and will require markets to go to a competing market if there is a better price. Opponents wanted the freedom to choose “speed” and “certainty of execution” over best price. Here is the related press release.
The SEC set a April 6, 2006 effective date, which some believe will eventually have to be pushed back because the technology won’t yet be available.
A Few Thoughts on Director Compensation
One hot topic today is how much to pay directors. I’m not sure I agree with the tone of this article from the Pittsburgh Gazette Review, which indicates that directors are lining their pockets. Directors face long hours these days, and more importantly, a heap of potential liability – and should be compensated accordingly.
One key to director’s pay is independence. Because of the unique nature of the who sets board pay – the directors themselves – the amounts and processes of setting pay are more susceptible to attack than CEO pay. In the complaints filed against directors for setting excessive CEO pay packages, their independence universally is assailed, with their own pay package being used as exhibit #1 against them.
And although the basic tools of board pay often are identical to those used for CEO pay (i.e. cash and equity), the primary goals of the two types of pay differ considerably. I believe director pay should be designed to incentivize directors to act independently and preserve the company’s value; whereas CEOs should be rewarded for superior corporate performance and growing the company’s value. I am no expert, but I don’t think this is an area that is well understood and likely will evolve over the next few years.
The Commission has announced the agenda and participants for the upcoming Internal Controls Roundtable, to be held next Wednesday, April 13. The Roundtable will be an all-day affair, from 9 to 5:30. It is open to the public and will also be webcasted. More information on the Roundtable is available.
Sarbanes-Oxley, UK Style
Portions of the United Kingdom’s Companies (Audit, Investigations and Community Enterprise) Act 2004 went into effect this week, placing U.K. companies under stricter auditing controls in an effort to improve the reliability of financial reporting and the independence of auditors. The Act also aims to strengthen the powers of company investigators.
The main requirements of the Act are:
• requiring directors to state in the Directors’ Report that they have not withheld any relevant information from their auditors and giving auditors rights to information from employees as well as officers – failure to comply is a criminal offense, including making a false statement in the Directors’ Report;
• requiring companies to publish details of non-audit services provided by their auditors;
• imposing independent auditing standards, monitoring and disciplinary procedures on the professional accountancy bodies; and
• strengthening the role of the Financial Reporting Review Panel in enforcing good accounting and reporting.
“many other peer corporations require their chairman and certain other executive officers to use company aircraft for personal as well as business travel. As a result, at those corporations, personal use of company aircraft by the chairman and those other executive officers is not treated as a perquisite or personal benefit and the costs associated with such personal use of company aircraft are not reported in the proxy statement. The Company has not required the chairman and other executive officers to use corporate aircraft for personal travel. Mr. Weldon is taxed on the imputed income attributable to personal use of company aircraft and does not receive tax assistance from the Company with respect to these amounts.”
In the words of Alan Beller (in his 10/20/04 speech at our Executive Compensation Conference): “simply stating that company executives must always fly in company planes (or drive in company cars, or accept any other benefit) for security reasons does not relieve a company from considering whether these benefits are perks.” There is more in the “Airplane Use” Practice Area on CompensationStandards.com. Maybe next year, J&J will name names!
A lot has been written about the new class action law, but I haven’t seen much about how it might impact securities litigation. Learn more in this interview with Charles Rothfeld on Future of Securities Class Actions.
SEC Speaks on Titan Section 21(a) Report
On DealLawyers.com, we have posted the transcript of the remarks from Brian Breheny, Chief of Corp Fin’s Office of Mergers & Acquisitions, on the Titan Report from our webcast, “30 M&A Nuggets in 60 Minutes” (remainder of transcript coming soon).
In addition, a few days back, I guest blogged in “The Deal Guys Blog” about what Corp Fin Director Alan Beller said on the topic at the ABA Spring Meeting. Of course, this was a hot topic during the Negotiated Acquisitions committee meeting. [By the way, an informal splinter of that committee – calling itself the “Order of the Sub-Genius – will be presenting the 1st Annual Dr. Gonzo award at its fall meeting in Las Vegas!]
Yesterday, the SEC posted this Briefing Paper for the April 13th Roundtable on internal controls. The Paper lists the Roundtable’s agenda, consisting of 6 Panels, as well as a summary and discussion questions. Here are the 6 panels (speakers not yet announced):
Panel 1 – The First Year
Panel 2 – Reporting to the Public
Panel 3 – Planning and Design
Panel 4 – Documentation and Testing
Panel 5 – Using Judgment in Communications and Conclusions
Panel 6 – Next Steps
The Future of Electronic Road Shows
At the ABA Spring Meeting, there was much discussion about the future of the offering process – a topic I will address this Friday at the “Cybersecurities Law Conference – 10th Anniversary of Cybersecurities Law.” Back when I was in Corp Fin’s Office of Chief Counsel, I remember spending countless hours trying to get the Bloomberg e-roadshow no-action response out – and how ridiculous the framework was (and still is) due to the outdated restrictions imposed by the ’33 Act.
Now with reform looming to remove many of these restrictions, how might future roadshows look? For starters, look at VentureCapitalTV.com, where you can watch videos of executives from start-ups doing elevator pitches. After ’33 Act reform is implemented, it’s easy to imagine a pleathora of these “one-stop” sites that will house e-roadshows.
And what about a banker who dissects the daily grind of a physical roadshow in a blog, as that type of concept for a blog is very popular (in a way, its the online equivalent of reality TV – see this popular blog from a benchwarmer on the Phoenix Suns). Don’t laugh; one set of i-bankers already has started this ThinkBlog.
On Thursday, the Delaware Supreme Court issued an order in a case that had been appealed by Roy Disney last year. Roy seeks to have the confidentiality restrictions lifted on the sensitive executive pay information he had successfully obtained in his books & records request to the Walt Disney Company. Roy has said that he wants to publicize the pay information in his quest to improve governance practices at the company. The order is posted in “Books & Records” section of the “Compensation Litigation Portal” in CompensationStandards.com.
In remanding the case back to Chancery Court, the Supreme Court requested that Vice Chancellor Lamb make specific factual findings about the confidential nature of the documents in question and to balance the harm and benefits of lifting the confidentiality designation. This kind of balancing approach may suggest the test for getting confidential documents is not quite as stringent as Vice Chancellor Lamb had articulated in his initial decision, in which he set a high bar for plaintiffs trying to overcome a confidentiality designation by the company.
Crocodile Tears over Executive Compensation
I cringe when the media does a special report on executive compensation (like the NY Times on Sunday and USA Today last Thursday) because my dad will call me and ask why Corporate America continues to perpetuate excessive pay practices. To answer him, I resort to my top four explanations of this dilemma:
1. “Who’s in Charge” Fingerpointing – Talk to most compensation consultants or lawyers about responsible practices and they are quick to point out that they have no control over what is paid and many feel they have no obligation to speak up to directors to advise them on responsible practices.
My hunch is that directors – most of whom serve in that role on a part-time basis – value the wisdom of their advisors and would welcome such input. And surprisingly, quite a few lawyers subtly talk in terms of representing the CEO, rather than the corporate entity for which they truly should serve. Need some backbone here.
2. The Catch-22 of Benchmarking – Unfortunately, nearly all compensation committees – based on the advice of their consultants – resort to relying on traditional benchmarking surveys to determine pay levels. This is true despite the fact that most agree that the compounded “ratcheting-up” effect of two decades of wanting to be in the top 25% has rendered survey data useless. Other benchmarking methods, such as internal pay equity, have yet to widely take hold.
The “Catch-22” here is that everyone is looking to the consultants for guidance in this area, but they are loathe to say their past data is bad – because that would be some form of admission of past failures. This cycle has to be stopped for normalcy to return.
3. Strong Dose of Alice in Wonderland– I don’t know how else to explain it other than a lack of common sense, as I just don’t see how a CEO would be motivated to perform better if she was paid only $5 million rather than $50 million per year. At some point, more compensation will not get you more performance – and if anything, might reduce performance as immense wealth sometimes can change one’s ego and personality. And providing huge pay packages to retirees or severed officers – or “golden hellos” as mentioned in this recent Washington Post article – doesn’t seem to provide shareholder value as its not tied to performance.
4. Soft Legal Standards – Arguably, there is no real law that prevents directors from establishing excessive pay practices. The state legal standards are the law of corporate waste (which has no teeth whatsoever) and the array of fiduciary obligations that directors have, which essentially requires that the proper process be followed. In fact, as noted in the Integrated Health decision in Delaware, to avoid personal liability under a lack of good faith charge, only the barest minimum of process need be present (unless Vice Chancellor Chandler really surprises in his Disney decision come this summer).
Honest to Betsy, we didn’t think that we would have more than one Executive Compensation conference nor did we think that CompensationStandards.com would be more than course materials for last year’s conference. And I truly hope that we won’t have to keep these up long, but it sure doesn’t look good.
For a refresher of the many issues still present in the compensation area, I strongly urge everyone to go back and read our “12 Steps to Responsible Executive Compensation Practices” from the May-June 2004 and Sept-Oct 2004 issues of The Corporate Counsel, which are still freely available to everyone on CompensationStandards.com.
As I dig out from under after 4 days at the ABA’s Spring Meeting in Nashville, I chuckled at the WSJ article on Friday which noted this excerpt from Monarch Casino’s 10-K (emphasis added by me):
“There has been no change in our internal controls over financial reporting during the year ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reports.
We are in the process of our compliance efforts mandated by Section 404 of the Sarbanes-Oxley Act of 2002. As we have done our due diligence in trying to understand the requirements and corresponding work necessary to successfully document our system of internal controls to the standards and satisfaction of third parties, we have encountered egregious estimates of time, dollars, outside consultant fees, and volumes of paperwork. As our implementation has progressed, we have yet to realize any control, operations or governance improvements or benefits. Additionally, and most importantly, the estimated potential cost to our shareholders in relation to the benefits, or even potential benefits, is unconscionable. We believe that these additional costs and expenses will merely confirm the existence of an already effective and functioning control system that already conforms with a recognized system of internal controls.
Although we intend to diligently pursue implementation and compliance with the Section 404 requirements, we do not believe it is in our shareholders’ best interests to incur unnecessary outsized costs in this effort. As we are a single location company with an extremely involved, hands-on senior management group in a highly regulated industry with significant insider ownership, the potential benefits to be derived from the Section 404 requirements are believed to be minimal. Consequently, we will make every effort internally to comply with the Section 404 requirements but will minimize what we believe to be the unreasonable and unnecessary expense of retaining outside third parties to assist in this effort.
As a result of this cautioned approach and the complexity of compliance, there is a risk that, notwithstanding the best efforts of our management group, we may fail to adopt sufficient internal controls over financial reporting that are in compliance with the Section 404 requirements.”
Wonder if these issues will be addressed at the SEC’s 404 Roundtable next week…
Corp Fin Updates “Current Accounting and Disclosure Issues” Outline
Even though dated March 4th, Corp Fin posted last week an updated version of its “Current Accounting and Disclosure Issues” outline. Note that its Table of Contents – pages 1-4 – indicate which sections are “Revised” and which are “New.”
AFSCME Loses Lawsuit Against AIG Over Proxy Access
As reported by ISS, the American Federation of State, County and Municipal Employees (known as “ASFCME”) sued AIG on February 25th in a New York City federal court after the SEC Staff advised AIG on February 14th that it could omit a binding shareholder proposal that seeks to amend the company’s bylaws to allow shareholders to nominate directors. Here is ASFCME’s press release on the lawsuit.
On March 22nd, ISS reported that the federal judge had dismissed the lawsuit. As you might recall, before this AIG no-action response, Corp Fin had already permitted the exclusion of similar proposals at Walt Disney, Halliburton, Qwest Communications and Verizon over the past two proxy seasons. It’s pretty rare for lawsuits to be filed over Rule 14a-8 actions by the SEC.
Mark Borges continues to amaze in his daily dissections of recent proxy comp disclosures in his “The Compensation Disclosure Blog.” Here is his take on Intel’s just-filed proxy statement: This year’s Intel proxy statement is a model of proactive, comprehensive disclosure. Take, for example, Andy Grove’s cover letter to shareholders. In it, he addresses two significant issues that affect proxy voting; one new – the debate over plurality voting for directors, and one no-so-new — broker voting on compensation plans:
“Your Intel stockholder vote is more important than ever in 2005. Each share of our stock that you own represents one vote. If you do not vote your shares, you will not have a say in the important issues to be voted on at the annual meeting. The 10 nominees receiving the most votes “for” election will be elected as directors; and to pass, each other proposal included in this year’s proxy statement will require a majority of votes present or represented at the annual meeting. Many of our stockholders do not vote, so the stockholders who do vote influence the outcome of the election in greater proportion than their percentage ownership of the company. In addition, banks and brokers that have not received voting instructions from their clients cannot vote on their clients’ behalf on “non-routine” proposals, such as approval of amendment and extension of the 2004 Equity Incentive Plan and the Executive Officer Incentive Plan, which further reduces the number of votes cast.”
Without getting bogged down in legal jargon, this paragraph provides a brilliantly concise and understandable explanation of why shareholder voting is important — and the potential consequences of failing to vote.
My main focus the first time through the proxy statement is on this year’s Board Compensation Committee Report. It includes many noteworthy items, including:
– A description of the Compensation Committee’s authority to engage, and actual retention of, compensation consultants. The Committee notes that, while it retained a consultant for two of the past three years, it did not do so in 2004 in connection with its work on 2005 executive compensation. The report goes on to say that the Committee is undertaking a study during 2005 of Intel’s executive compensation philosophy and design, and expects to engage outside experts to assist in this work.
– Disclosure that Intel’s employees, including its executive officers, are employed “at will” and do not have employment agreements, severance payment arrangements or payment arrangements that would be triggered by a corporate change in control.
– A statement that the Committee’s review of the company’s executive compensation programs and practices includes an analysis, for each executive, of all elements of compensation, consisting of base and variable cash compensation; stock option grants; retirement programs; and health and welfare benefits. The Committee compares these compensation components separately and in the aggregate to the compensation of Intel’s peer group companies.
– A statement identifying and reaffirming the company’s key strategic compensation design priorities: pay-for-performance, employee retention, cost management, egalitarian treatment of employees, alignment with shareholders’ interests, and continued focus on corporate governance.
– A description of the Committee’s consideration of internal pay consistency with Intel’s 100 most-highly paid employees in setting executive officer salaries and incentive baselines. The company monitors this data to ensure that executive officer compensation is not increasing at rates significantly beyond that of Intel’s other highly valued employees.
– A statement that, in setting executive compensation for 2005, the Committee reviewed the total remuneration that each executive officer could potentially receive in each of the next 10 years, under scenarios of continuing employment with the company or upon retirement from the company. (For these purposes, “total remuneration” included all aspects of an executive officer’s future cash-convertible benefits, total cash compensation (base salary plus incentive) from continuing employment, the future value of stock options under varying stock price growth assumptions (as well as, if applicable, the impact of accelerated vesting upon retirement), the value of any deferred compensation and profit sharing retirement benefits, and the value of health care benefits.)
– An indication that the company, long known as a stock option stalwart, is considering the use of performance stock, as well as other equity vehicles, as part of its long-term incentive program. The Report also discloses that, in 2004, approximately 99% of the company’s stock option grants went to employees other than its top six most highly-compensated executive officers, and that, for the period 2000 to 2004, only 1.2% of all option grants went to its top five most highly compensated executive officers (top six for 2004).
– A statement reaffirming the company’s egalitarian culture:
“Intel’s officers are not entitled to operate under different standards than other employees. Intel does not provide its officers with reserved parking spaces or separate dining or other facilities, nor does Intel have programs for providing personal-benefit perquisites to officers, such as permanent lodging or defraying the cost of personal entertainment or family travel. Intel’s office-building layouts are cubicle-based for all employees, including officers. Company-provided air travel for Intel’s officers is for business purposes only: Intel’s company-owned aircraft each hold approximately 40 passengers and are used in regularly scheduled shuttle routes between Intel’s major U.S. facility locations, and Intel’s use of non-commercial aircraft on a time-share or rental basis is limited to appropriate business-only travel. Intel’s health care, insurance and other welfare and employee-benefit programs are the same for all eligible employees, including Intel’s officers. Intel’s loan programs, although modest in nature, are not available to Intel’s executive officers. Intel has no outstanding loans of any kind to any of its executive officers, and since 2002, federal law has prohibited Intel from making any new loans to its executive officers. Intel expects its officers to be role models under its Corporate Business Principles, which are applicable to all employees, and Intel’s officers are not entitled to operate under lesser standards.”
The Report finishes with a statement professing the Committee’s belief that Intel’s pay-for-performance executive compensation program sets the standard for best-in-class executive compensation practices. The same can be said for its BCCR.
PCAOB Proposes Standard on Reporting for Elimination of Material Weaknesses
Yesterday, the PCAOB proposed a standard regarding how to report the elimination of a material weakness. Here is the related press release and the 42-page proposal.
Okay, that title is my (lame) idea of an early April Fool’s joke – but here is a real NY Times article on inflation of salaries due to benchmarking. From the Museum of Hoaxes, here are the Top 100 April Fool’s Day Hoaxes of All Time. I like #4, when Taco Bell bought the Liberty Bell.
Jack Welch Defends His Retirement Perks
Last night, in an interview with Dan Rather on “60 Minutes Wednesday,” Jack Welch defended the retirement perks that he eventually gave up and became the basis for last year’s settlement with the SEC. Jack explained how he rejected $300 million worth of restricted stock near the end of his term as CEO, opting instead for the lifetime continuance of perks that became controversial when the scope of them were fully disclosed in his divorce proceedings. A video archive of the interview is available, including footage with Jack’s new wife.
Fairchild Executives Cut Pay to Settle Compensation Lawsuit
A few months ago, on CompensationStandards.com, we posted a complaint filed in Delaware that alleged breaches of fiduciary duty and disclosure regarding the way the CEO and other executives were being compensated. According to this article in the Washington Post, the company and defendant officers have settled the lawsuit by cutting their pay and discontinuing some questionable practices.
Bloomberg Entering the Legal Database Market?
According to the Maryland Daily Record, Bloomberg intends to challenge Lexis and Westlaw by entering the legal database market. I can’t find anything on Bloomberg’s site to confirm this March 25th article.
Yesterday, the SEC’s Office of Chief Accountant issued SAB 107 regarding the FASB’s option expensing standard. SAB 107 adds a new Topic 14 to the SAB series regarding Statement 123(R) and amends portions of some existing topics – as well as addresses a range of disclosure issues, from MD&A to non-GAAP measures.
As noted in the SEC’s press release, “Among other things, SAB 107 provides interpretive guidance related to the interaction between Statement 123R and certain SEC rules and regulations, as well as provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. SAB 107 also reminds public companies of the importance of including disclosures within filings made with the SEC relating to the accounting for share-based payment transactions, particularly during the transition to Statement 123R.”
In addition, the SEC’s Office of Economic Analysis posted this interesting memo regarding valuation and the economic impact of option expensing.
Don’t forget next week’s timely NASPP webcast – “What You Need To Know About Option Valuation” – which is the 3rd webcast from the NASPP on this important topic during the past few months (archives of the other webcasts are still available, including practical remarks from FASB staffers).
GAO Criticizes Security Measures at the SEC
According to a 29-page report released last week by the Government Accountability Office, computer security at the SEC is lax enough to put financial – and personnel – information at risk. The problems cited in the report run the gamut, from not implementing effective electronic access controls to weaknesses in other information system controls (including physical security, segregation of computer functions, and application change controls).
According to a Washington Post article on Friday, the SEC responded by pledging to address the issues by June 2006. A spokesman said the SEC already has installed “intrusion detection systems” and replaced firewalls.
Personally, I am always amazed that there have not been any reported hacks of the EDGAR system – as that has to be one of the most popular targets of the hacking community, even for the youngsters for whom it’s just a sport. It is easy to imagine the harm that could be caused by someone that hacked EDGAR (e.g. post a fake 8-K with some drastic news that is a market-mover).
April E-Minders is Up!
We have posted our April issue of E-Minders – as well as this interview with Denise Annunciata on State Law Research.
