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From the Pages of The Pomerantz Monitor: SEC Signals Another Compensation "Clawback" Attempt

After years of inaction, the SEC is apparently now ramping up its efforts to enforce the "clawback" provision of the Sarbanes Oxley Act. The provision allows the recovery of incentive compensation from the CEO and CFO if the financial results on which the awards were based are later restated. After recently suing two retired executives under the provision, the SEC has now sent a “Wells Notice” to the CEO of Beazer Homes USA, telling him that the staff has recommended that proceedings be brought to recover some or all of his incentive pay.

Neither in this case nor in the other two were the targets of the claim accused of any wrongdoing in connection with the misstated financials. The statute itself is silent on whether wrongdoing by the "clawee" is a requirement for a clawback claim. As these cases mount up, it is becoming more and more likely that the courts will have to rule on that issue.

From the Pages of The Pomerantz Monitor: Corporate Library Sounds Off on Executive Over-Compensation

The Corporate Library is a research firm devoted to business in general and corporate governance in particular. It specializes in accumulating massive amounts of information about the performance and management of public corporations, which it stores on a database available by subscription. 

But the Library is not merely a source of information. Nell Minow, CEO and co-founder of the Library, is a shareholder activist; and so is the other co-founder, Robert Monks, who also created and now runs Institutional Shareholder Services. Minow has advised Congress and the Treasury Department on the recent financial crisis; and the two of them have been involved in successful shareholder campaigns to oust the CEOs of American Express, Kodak, Waste Management, Westinghouse, and other companies. Minow is an adviser to Congress and the Treasury Secretary on compensation issues. Her take on massive bonuses handed out at bailed out firms: “these guys are doing more to destroy capitalism than Marx.”

As reported in the New Yorker magazine, Minow is not a fan of government efforts to limit compensation. The last major attempt to rein in executive compensation by the government was a change in the tax code limiting the deductibility of cash compensation to executives to $1 million. In hindsight, this reform effort backfired, because it encouraged companies to find different ways to lavish compensation on executives, such as through exorbitant incentive awards and stock option grants, which eventually ballooned into the current mess. In general, government is far less clever in devising financial controls than business is in circumventing them.

Minow believes that full disclosure, coupled with enhanced shareholder rights and duties, is the way to go, and that institutional investors, such as pension plans and mutual funds, should be prodded into taking more seriously their fiduciary duties towards their investor clients.  

Minow’s position is that if the CEO is being grossly overpaid, the company will likely tank; and she has developed, over the years, a list of tell-tale signs of excess, including granting stock options with strike prices below current market value (Global Crossing); granting retirement packages to CEOs who don’t actually retire (Halliburton’s deal with Dick Cheney); having directors who own little or no company stock (Enron); lowering the bar for incentive performance awards when performance worsens; approving retention bonuses for CEOs serving a prison sentence (Fog Cutter); excluding certain types of felonies as grounds for dismissal for cause (Tyco); and directors’ frequent absences from board meetings.  

From the Pages of The Pomerantz Monitor: The Party Continues on Wall Street

As Shaheen Rushd reports in the September/October issue of The Pomerantz Monitor, analysts and public officials have blamed the near-collapse of the financial system in large part on excessive pay, both its outsized amount and the fact that short-term risk-taking was rewarded. Despite the public outcry, it is business as usual at the country’s biggest corporations, including those that were bailed out with taxpayer money. The pay frenzy continues.

According to a recent report by the Institute for Policy Studies: “The 20 U.S. financial firms that have received the most bailout dollars from taxpayers awarded their top five executive officers, in the three years through 2008, pay packages worth a combined $3.2 billion. These 100 financial executives . . . averaged $32 million each. One hundred U.S. workers making the 2008 average wage would have to labor over 1,000 years to make as much as these 100 executives.”

New York Attorney General Cuomo has uncovered even more shocking facts — nine banks that received bailout money paid an astounding $33 billion in bonuses for 2008. These same nine banks had combined 2008 losses of almost $100 billion. The banks set aside a higher percentage of their revenues for compensation in 2008 than in 2007: 45% in 2008 from 41% the year before. Where is the link between compensation and performance? Significantly, despite the fact that short-term risk-taking was a big cause of the financial meltdown, the NYT reports that a study by James F. Reda & Associates of the 200 largest U.S. companies reveals that they have made “short-term incentives a bigger component of compensation.”  

Don’t expect restraint any time soon. Goldman Sachs, a bailout recipient, has already set aside a whopping $11 billion for this year’s payouts, and Morgan Stanley is not far behind ($6 billion).  Executives are also poised to receive windfalls because, as the Institute of Policy Studies Report finds, “firms lavished new stock awards on their executives earlier this year, as share prices hit bottom, and these awards — thanks to the bailout — have inflated in value.”  

From the Pages of The Pomerantz Monitor: SEC Brings First Clawback Action

The September/October issue of The Pomerantz Monitor reports on the first “clawback” action brought by the SEC for violation of Section 304 of the Sarbanes-Oxley Act. Section 304 of SOX provides that if a company is required to restate its financial results because of “misconduct,” the CEO and the CFO “shall reimburse” the company for any bonus or other incentive-based compensation received during the year following the issuance of the erroneous financial statement. This provision was obviously designed to deprive the two principal officers of any benefit they derived from reporting inflated financial results, such as achieving a certain level of earnings or revenues. If those benchmarks were not really achieved, the two chief officers should not keep benefits that they received under false pretenses. 

Frustratingly, courts have held that there is no private right of action for shareholders to “claw back” these overpayments. Because companies are typically loath to invoke this remedy and the SEC has done nothing to enforce it, Section 304 has been a right without a remedy. Making matters worse, without any caselaw, no one really knows whether the misconduct that must occur in order to trigger the clawback has to be committed personally by the CEO or CFO.

This issue may soon be clarified. On July 22, 2009 the SEC brought the first action under SOX’s clawback provision to recover compensation, and it does not even accuse the defendant of committing any misconduct. The SEC enforcement action charges Maynard L. Jenkins, the former CEO of CSK Auto, with receiving over $4 million in bonuses and profits on the sale of stock within one year of CSK’s issuance of false and misleading financial results for 2002-04. The SEC concedes that the actual accounting fraud was committed by other CSK officials, who were sued earlier. 

There is no requirement in Section 304 that the CEO or the CFO from whom the reimbursement is sought have any involvement in the events that necessitated the restatement. Indeed, the statute doesn’t require any showing of wrongdoing or fault at all by these individuals. 

On September 15, 2009, Jenkins filed a motion to dismiss the SEC’s high-profile case against him, stating that the SEC “is attempting to impose a Draconian penalty on an admittedly innocent person.”

To be continued . . .

Report Recommends Establishing Clear Link Between Pay and Performance

The Task Force on Executive Compensation convened by the Conference Board Governance Center to address the loss of public trust in the processes for oversight of executive compensation issued recommendations for corporations to restore credibility and public trust in pay practices and oversight. Some of the recommendations include asking companies to establish “a clear link between pay, strategy and performance” and to provide “compensation that is fair, affordable and clearly aligned with actual performance.”

Some supporters of the report include AFC Enterprises, Albemarle Corp., AT&T Inc., the California State Teachers’ Retirement System, Cisco Systems Inc., Hewlett-Packard CO., NASDAQ OMX Group Inc., Securities Industry and Financial Markets Association and Tyco International Ltd.

Robert E. Denham and Rajiv L. Gupta, co-chairs of the Task Force believe that shareholders “deserve to see executive compensation programs that serve shareholders’ interests and are explained to shareholders in thoughtful dialogue. Implementing the compensation principles we recommend is an important step in restoring the damaged trust in American companies.”

From the Pages of The Pomerantz Monitor: LAMPERS Takes on Excessive Compensation

As reported by Fei-Lu Qian in an April PomTalk post, the Louisiana Municipal Police Employees’ Retirement System (“LAMPERS”) took the responsible step in demanding answers and accountability from directors of Chesapeake Energy by filing a “books and records” demand in a state court of Oklahoma. If the demand is granted, shareholders of Chesapeake will be able to examine the company’s corporate documents to see if the board’s approval of a $75 million bonus to its chief executive officer was proper. In the May/June issue of The Pomerantz Monitor, Marc Gross more fully explains the background of the lawsuit commenced by Pomerantz on behalf of LAMPERS to recoup the $75 million bonus.

The extraordinary bonus was awarded to Chesapeake’s CEO and co-founder, Aubrey McClendon. McClendon’s total compensation for 2008 was $105 million, making him the highest paid executive in the country at a time when the company’s earnings plummeted 50% and stock price tumbled 60%. The company claims that it granted the bonus – five times McClendon’s average annual compensation, including both salary and bonus – to reward him for his role in selling off certain oil and gas properties during 2008.

The real purpose of the bonus, we submit, was to bail out McClendon from his personal financial problems precipitated by the fall in the company’s share price. In other words, Chesapeake used corporate funds to insulate its CEO from the consequences of the corporate meltdown, while shareholders got stuck with their losses

The bail out was even larger than at first appeared. After the lawsuit was filed, Chesapeake issued a Proxy Statement indicating that it also agreed to pay McClendon over $12 million for his personal art collection.

In its opposition to our lawsuit, Chesapeake argues that if it weren’t for the bonus, McClendon might have jumped ship in favor of other opportunities. This seems far fetched, given that McClendon founded the company and still has a sizable stake in its wells. Moreover, the Board had other ways to insure his retention, like lowering the share ownership requirement – which it did – and providing loans to help him meet his obligations.

A similar books and records strategy was used successfully at the start of the Disney/Ovitz excess compensation case, and is favored by Delaware courts. Although Chesapeake is an Oklahoma corporation, that state follows Delaware corporate law.

We believe that the Chesapeake case warrants support by other public pension funds concerned with corporate governance reforms, either by direct intervention or a letter to the court. If ever there was a time to draw the line on excess compensation, it is now.

In pursuing this claim, Pomerantz harkens back to its roots. The firm’s first major case was Gallant v. Mitchell, where Abe Pomerantz sought to recoup interest-free loans that officers of National City Bank awarded themselves to tide them through the Great Depression (loans which they ultimately forgave). After trial, Abe recovered $1.8 million, a small fortune in the 1930’s.

From the Pages of The Pomerantz Monitor: Return of the Overpaid Investment Banker

As Joshua Silverman reports in the May/June issue of The Pomerantz Monitor, when it comes to sharing the pain caused by the economic downturn, corporate America has two standards: one for the working class, and another for highly-paid executives.

When business hits the skids, workers are routinely asked to, and do, shoulder large cuts in pay and benefits, and many are laid off. Auto workers and airline employees, among others, have suffered repeated layoffs and drastically reduced their total compensation under hard-earned collective-bargaining agreements. But corporations treat their executive compensation agreements differently. Contracts suddenly become “inviolable” or are even sweetened substantially. Companies rarely ask their top executives to take a pay cut, even when they are hurtling towards insolvency.
Nowhere is the insulation of top executives from the consequences of their own failures more apparent than at the investment banks. All have taken billions of dollars in taxpayer bailouts after their recklessness drove the global economy into a recession. Under these circumstances, one would expect that belt-tightening would be in order. Although payouts were down last year, they seem ready to bounce right back.
Salaries at large Wall Street institutions currently stand at near all-time record levels. As the New York Times recently reported, the first quarter 2009 payments suggest that Goldman Sachs will pay its employees an average of $569,220 per worker, less than 1% down from 2007’s record payout. First quarter salaries for the 26,142 employees in JPMorgan’s investment banking and trading divisions annualize out to an average of $510,000. These are not salary averages of the bankers only, but of all employees from receptionist to CEO.

Investors pay a heavy cost for these obscene salary levels. Compensation costs can eat up 50% or more of an investment bank’s revenue. Reducing them would substantially increase profitability, allowing the banks to return more to investors in the way of dividends and share buybacks, and to redeem more quickly the TARP handouts they receive from U.S. taxpayers. This in turn would reduce the banks’ expenses and increase their tangible common equity.

Investment banks wrongly attempt to justify huge salaries by saying their most important assets walk out the door every night. Skilled workers are critical for all businesses. But investment bankers have driven their companies, and our economy, to the brink of disaster. As a group, they deserve pay cuts, not increases.  
The worst show of arrogance comes from one of the worst banks – Citigroup. Shareholders have seen their investments lose over 90% of their value since CEO Vikrim Pandit took the reigns. Yet last year, Pandit’s compensation package totaled $10.8 million. Despite the stock’s drubbing, Citi touts that Pandit is critically valuable both to the bank and our economy. Citi’s CFO even told an interviewer that replacing Pandit would be “incredibly destabilizing” for our entire financial “system.”

There are glimmers of hope. CalPERS and other institutional investors forced Bank of America to separate its Chairman and CEO positions after learning that CEO Ken Lewis approved huge bonuses for Merrill Lynch executives right before that company (now a subsidiary of Bank of America) disclosed huge operating losses.  But as the first quarter 2009 figures indicate, the country’s top investment banks still don’t get the message.  Banking salaries need to adjust to our new economic reality.

Who Gave “Say On Pay” Right? AFLAC

Earlier this month in an annual meeting, Aflac’s shareholders had their say on the company’s executive compensation policies. With 93% of Aflac’s shareholders saying “yes” to the compensation packages of its five top executives, Aflac became the first American public company to give shareholders a nonbinding voice on executive pay including its CEO’s compensation package of nearly $12 million. This extraordinary vote is of course the exception as there were more than 90 shareholder proposals this year alone that demanded companies give the same “say on pay” right.

Moreover, other companies should look toward Aflac as a model to what it actually means to be shareholder-friendly. To compensation experts like Irving Becker of the Hay Group, it is no surprise with the outcome as “Aflac’s CEO has created a lot of value for shareholders over his long tenure, and his pay package is shareholder-friendly.” According to Aflac’s press release, since Daniel Amos became Aflac’s CEO in 1990, the Company’s “total return to shareholders, including reinvesting cash dividends, has exceeded 3,867%, compared with 69% for the Dow Jones Industrial Average and 583% for the S&P 500.”

Still No Say-On-Pay

With at least $312 billion of asset write-downs and losses by financial firms since the start of 2007, investors thought this would be the perfect year to pressure corporate boards on executive pay and give shareholders non-binding advisory votes on executive compensation. In the past few years, shareholders in various companies have been trying to get more say on executive compensation through so called say-on-pay proposals, without much luck. Similar to past years, these proposals have failed at this year’s annual meetings at some of the major financial corporations that have posted the largest asset write-downs and credit losses since the beginning of 2007 such as Citigroup, Merrill Lynch, Bank of America and Morgan Stanley.

These defeats demonstrate the difficulty in changing policies at companies where large institutional shareholders such as Fidelity Investments “tend to oppose or abstain on say-on-pay proposals.” For instance, the proposals introduced by the American Federal of State, County and Municipal Employees for Citigroup and Morgan Stanley actually received less support this year than last year. According to Institutional Shareholders Services, it is “a little surprising given the shareholder anger at a lot of the companies” given the current financial crisis. Also, a compensation analyst at the Corporate Library suggests that institutional shareholders view these proposals “as a protest against the company’s compensation policy, and they don’t want to do that.”

Even CFOs Favor Say on Pay

According to a new survey by BDO Seidman, LLP, only 31% of chief financial officers at major technology companies believe that their companies allow shareholders to vote on their executive compensation plans. However, nearly two-thirds of the 100 CFOs surveyed “personally feel shareholders should have a say on executive compensation plans.” Also, interestingly, 65% of CFOs give credit to the compliance requirements of Section 404 of Sarbanes-Oxley in improving their companies’ processes. Another significant finding from this survey is that 81% of CFOs indicate that recent rules requiring more disclosure on executive compensation have had minimum impact on their companies to recruit and retain talented individuals.

“At a time when regulatory organizations are pushing for more executive compensation disclosure, it is reassuring that CFOs at technology businesses are supportive of shareholders having a greater voice in approving executive compensation levels,” said Andy Gibson, a Partner at BDO Seidman.