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Executive Compensation: Is the Glass Half Full or Half Empty?

As reported in the current issue of The Pomerantz Monitor, shareholders of Citigroup made news in April when 55% of them voted against the pay package awarded to CEO Vikram Pandit. Citi’s shares have plummeted by over 80% the past few years, and yet Pandit was set to receive not only a $12 million salary but a bonus package worth just as much. As a Wall Street Journal columnist pointed out, shareholder outrage was probably piqued by the fact that the financial targets that must be met to trigger incentive awards are preposterously low:  Pandit and four other senior executives would be entitled to incentive compensation totaling $18 million even if Citigroup loses $7 billion this year.

The negative shareholder vote was the first time that investors had rejected a compensation plan at a major U.S. bank. The WSJ calls the vote “more than a stinging rebuke for its board and management. It is a shot across Wall Street’s bow.”

A subsequent WSJ article stated that “Vikram Pandit is looking awful lonesome,” because influential shareholder advisory firms Institutional Shareholder Services and Glass Lewis recommended votes in favor of executive-compensation plans at Bank of America, Morgan Stanley and Wells Fargo; and ISS subsequently gave its stamp of approval to Jamie Dimon’s $23 million 2011 compensation package at J.P. Morgan Chase. As the WSJ opined, “That leaves Lloyd Blankfein as Mr. Pandit’s last hope for some company in his misery.”

Hit Them in the Wallets: What if Executives Were Held Personally Liable?

Some of you may recall our post from last year regarding the surprise rejection of the Citibank SEC settlement whereupon Judge Rakoff expressed his disdain with the evasive language "neither admit nor deny." 

In their  Dealbook article, Why S.E.C. Settlements Should Hold Senior Executives Liable the authors Claire Hill and Richard Painter review the findings of the Congressional hearing on the subject and  make a provocative argument to hit the defendent in their wallets instead. 

Hill and Painter say that "Requiring settlements to include an admission of guilt is not the best way to proceed. A more effective approach would be to make senior, highly compensated officers of the bank pay some portion of the fine."

"The Congressional hearing addressed the fact that a penalty assessed against an entity is effectively paid by its shareholders. The shareholders neither caused the behavior that led to the fine nor were they responsible for preventing it. By contrast, the Citigroup officers who were responsible do not bear a significant portion of the penalty, except to the extent they are shareholders or their bonuses are tied to earnings, now reduced by the penalty. They thus have little incentive to change their behavior."

Say on Pay, Lessons Learned

On  February 22, 2012 the Harvard Law School Forum on Corporate Governance and Financial Regulation published a report entitled “Lessons Learned: The Inaugural Year of Say-on-Pay” Anne Sheehan, the Director of Corporate Governance at the California State Teachers’ Retirement System (CalSTRS), says “For CalSTRS the first year of Say-on-Pay was a learning opportunity as it helped us to refine our voting process for future years.”

Showing a number of charts and metrics considered in their votes Sheehan continued “CalSTRS believes that all companies should use value-creating performance metrics for short- and long-term incentive plans. While we understand that boards of directors require some flexibility when determining compensation, we believe the majority of executives’ incentive pay should be transparent and easily understood by shareholders. Although there is no one-size-fits-all solution to executive compensation, we believe the over-use of discretion in most plans can lead to outsized compensation levels and fails to meet the spirit of section 162(m) if the Internal Revenue Code which requires performance-based pay to be predetermined and objectively measurable…. we believe that poorly structured pay packages harm shareholder value by unfairly enriching executives at the expense of owners – the shareholders.”

As Kevin LaCroix of the D&O diary observes: “Sheehan’s post and her description of the approach of CalSTRS heading into the second say-on-pay cycle makes it clear that there will be continued pressure on many companies regarding their compensation practices and disclosures,”

Wall Street’s “Moral Minority”

A New York Times article has revealed that long before Occupy Wall Street, the Sisters of St. Francis of Philadelphia were battling Wall Street over corporate responsibility. For the last thirty years, the Sisters have used the investments in their retirement fund to become Wall Street’s moral minority.

Using their status as shareholders, the nuns fought with Kroger over farm worker rights, with McDonald’s over childhood obesity, and with Wells Fargo over lending practices. They have met face-to-face with the heads of Lockheed Martin, BP, and General Electric. Most recently, they advised Goldman Sachs executives that the bank should protect consumers, rein in executive pay, increase its transparency, and remember the poor.

With their moral authority, the Sisters of St. Francis “can really bring attention to issues,” said Robert McCormick, chief policy officer of Glass, Lewis & Company, the proxy voting firm. “You haven’t seen shareholder activism until you see a nun battling it out with the CEOs. They can be devastating,” said Michael Passoff in a 2005 article on religious shareholder activists. Passoff works in the Corporate Social Responsibility Program for As You Sow, a leading organization in the strategizing and organizing of shareholder campaigns.

The nuns have been waging this war since 1980, when St. Francis Sister Nora Nash formed a committee with her community to combat troubling developments at the businesses in which they invested their retirement fund. The Roman Catholic order of over 500 nuns has teamed up with other orders and faith-based investing groups on shareholder resolutions. Much of Sister Nora’s activism takes place under the Interfaith Center on Corporate Responsibility, an umbrella group which includes Jews, Quakers and Presbyterians.

Sister Nora said that she and the order “want social returns, as well as financial ones.” She added, “when you look at the major financial institutions, you have to realize there is greed involved.”

The full New York Times article can be found here.

Say-on-Pay Update

As we have reported in earlier posts on “Say-on-Pay,” the Dodd-Frank Act provides for an advisory shareholder vote to approve executive and board compensation at most public companies.  While companies have overwhelmingly passed their Say-on-Pay votes this proxy season, 39 out of approximately 2000 companies have reported failures.  Twenty-five percent of these failures have occurred in the energy sector, and almost all failed votes have followed on the heels of a “no” recommendation by the institutional investor watchdog, Institutional Shareholder Services.

The Dodd-Frank Act also provides that shareholders decide how frequently Say-on-Pay votes are held -- the options ranging from every one to three years.  As expected, companies who failed this year’s Say-on-Pay vote also saw their shareholders demand such votes every year.

While these votes are advisory in nature, plaintiffs are using failures to bolster unjust enrichment and corporate waste claims in shareholder lawsuits.  The stronger cases have coupled these claims with federal claims under the proxy rules, often attacking a company’s “Pay-for-Performance” policies.  So far, two such shareholder lawsuits -- against KeyCorp and Occidental Petroleum -- have settled.  A significant part of the KeyCorp settlement included substantial compensation policy reforms.  The terms of the settlement in Occidental (whose CEO Ray Irani has been paid almost $300 million over the past decade) are largely confidential.  The remaining cases are pending.

We are encouraged that shareholders are standing up for the principle -- both at the corporate ballot box and in litigation when necessary -- that public companies should not increase executive compensation as shareholder returns decline.

From the Pages of The Pomerantz Monitor: Institutions Want a Say on Corporate Political Expenditures

As reported in the current issue of The Pomerantz Monitor, a few months ago, Home Depot applied to the SEC for permission to exclude from its proxy statement a resolution proposed by shareholder NorthStar Asset Management. The proposal would require that the company disclose its policies on political contributions, and report on its political spending for the previous year and its anticipated political spending for the next. In addition, NorthStar’s proposal would require that the proxy statement analyze whether the spending is consistent with the company’s values and whether it poses risks to the company’s brand, reputation, or shareholder value. These plans would be blocked unless 75% of the shareholders voted to approve them. Similar proposals are now scheduled for a vote at  Citigroup, I.B.M., Charles Schwab, Prudential, JPMorgan Chase and other corporations.
      
Home Depot told the SEC that NorthStar’s resolution would interfere with the company’s ordinary business operations and was therefore improper. The SEC ruled in favor of NorthStar, affirming that resolutions which present a “significant social policy issue” are not excludable even if they may otherwise intrude on ordinary business.

These events come in the wake of last year’s Supreme Court’s decision in Citizens United, which held that corporations have First Amendment rights to spend unlimited amounts of money on political advertisements and other independent political activities. In response to that ruling, Congress has tried, but so far failed, to pass legislation that would require that political ads disclose the identities of those who paid for them. The ruling threatens to give big money even greater influence on elections. That is why shareholders are increasingly pressing to assert some control over corporate political expenditures.

In an Op-Ed piece published in The New York Times, John Bogle, former Vanguard chief executive, applauded NorthStar’s resolution, concluding that “America’s institutional investors must stand up to the Supreme Court’s misguided decision and bring democracy to corporate governance . . . and take that first step along the road to reducing the dominant role that big money plays in our political system.”

Firm Value Improved by Shareholder Access to Proxy Vote

A recent working paper published by Harvard Business School researchers presents evidence supporting regulatory efforts to increase shareholder power by providing proxy access to board elections.  The results suggest that the financial market puts a positive value on the election of shareholder-sponsored board members. 

The researchers studied the share prices of companies after the Securities Exchange Commission suspended its recently-passed “shareholder proxy access rule,” which would have made it easier for investors to nominate directors. 

Specifically, they found that the greater the stake of activist investors in a company, the more negatively the share price was impacted by news of the rule suspension.  In other words, the companies that would have been the most affected by the new rule suffered the largest drop in value.

One researcher explained that “[t]he biggest conclusion we draw from this is that allowing owners to have more power and influence with corporate decision-making, on balance, seems to be valuable in the eyes of the stock market.”

New Proxy Rules Already Impacting Pending Litigation

The SEC’s new proxy access rules, enacted on August 25, 2010, have already found there way into court.  Based on the rule changes adopted by the SEC, the Second Circuit recently remanded Bebchuk v. Elec. Arts, Inc. to the Southern District of New York for reconsideration of its previous dismissal of the case.  We’ve previously commented on the new rules here and here.

The Electronic Arts matter arises from a proposal by Harvard law professor Lucian Bebchuk to amend the company bylaws and establish a procedure for the placement of shareholder proposals into company proxy materials.  Opponents of the proposal noted that it potentially ran afoul of the SEC proxy rules as they then existed:

Professor Bebchuk's proposal is significant, in part, because it would enable a company's shareholders to amend the bylaws to permit shareholders to submit director nominees for inclusion in the company's proxy statement, even though proposals relating to the election of directors are excludable under Rule 14a-8, the SEC's shareholder proposal rule.   Accordingly, the proposal represents an effort to gain "proxy access" – that is, access to a company's proxy statement for the purpose of nominating directors.

The District Court agreed with that reasoning and granted EA’s motion to dismiss; holding that Bebchuk’s proposal was excludable under Rule 14a-8(i)(3) as contrary to the SEC’s proxy rules.  See Bebchuk v. Elec. Arts, Inc., No. 08-5842-cv (2d Cir. Sept. 13, 2010).  Now, nearly two years after that District Court dismissal, the Second Circuit has ruled that the SEC’s changes to the its proxy rules “may bear on the issues presented in this appeal” and the case should be remanded for reconsideration.  Id.   

SEC Set to Approve Proxy Access, But for How Many?

The Securities and Exchange Commission is meeting Wednesday to consider proposed proxy access rules that will allow shareholder nominations of board candidates and will require companies to print the names of such candidates directly onto corporate ballots.  The rules are expected to pass through the Commission on a 3-2 vote, with the two sitting Republican commissioners voting no.  However, based on recently-leaked details (the SEC has not yet officially released any details of the proposed rules), there may be reason to question just how broad the scope of the eventual proxy rules will be.

In order to prevent short-term or small-bore investors from sparking contested board elections, the proxy access rules are expected to require that investors own at least a 3% stake in a company for as long as three years before they can nominate candidates on the company’s ballot.  At first blush, that seems reasonable enough.  However, for the largest issuers, investors holding a 3% stake will amount to a very small pool indeed.  The SEC had initially proposed a “tiered” approach that would have set the minimum stake at 1% for large companies, 3% for midsized companies, and 5% for small companies.  That rule, however, has apparently been rejected in favor of a flat requirement.

Couple that with other details leaked today and the application of the rules get even narrower.  An anonymous source tells Reuters that the SEC will likely grant a three-year grace period for “small companies” to comply with the proxy access rules.  If that turns out to be the case, then, in the near term, the proxy rules will except the very companies most likely to have a significant pool of investors holding the minimum 3% stake to nominate board candidates.  In other words, many investors seeking to take advantage of the new proxy rules may find themselves stuck in the middle – owning too little of the big fish to qualify for proxy access but, at the same time, unable to access the proxies of smaller companies for which they do own enough.

The New Wall Street Reform and Consumer Protection Act: Proxy Access and the SEC

As we should all know by now, last week, on July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act.  For the complete text, click here or click here 

 

Strengthening Corporate Governance through Proxy Access is specifically addressed.  See Title IX – Investor Protections and Improvements to the Regulation of Securities, Subtitle G – Strengthening Corporate Governance, Sec. 971. Proxy Access.  Proxy access makes it easier for shareowners to nominate their own candidates for corporate board directors by letting them place their nominees for director on the company’s proxy card.  Currently, the only way that shareowners can present alternative director candidates at a U.S. public company is by waging a full-blown election contest. For most investors, that is onerous and prohibitively expensive.  For more about Proxy Access, from the Council of Institutional Investors, http://www.cii.org/resourcesKeyGovernanceIssuesProxyAccess. 

 

In particular, the Proxy Access provision, § 971, amends Section 14(a) of the Exchange Act by adding a new subsection (1) that explicitly gives the SEC the authority to issue rules permitting shareholder access to proxy materials in order to nominate candidates to the Board of Directors.  As previously addressed in a Pomtalk post on July 15, 2010, entitled, “SEC Seeks Comments on Proxy System,” the SEC is currently seeking public comments on the U.S. proxy system and asking whether rule revisions should be considered to promote greater efficiency and transparency.  

 

More specifically, Title IX – Investor Protections and Improvements to the Regulation of Securities, Subtitle G – Strengthening Corporate Governance, Sec. 971. Proxy Access, provides: 

(a) PROXY ACCESS … The rules and regulations prescribed by the [SEC] … may include –

(A) a requirement that a solicitation of proxy, consent, or authorization by (or on behalf of) an issuer include a nominee submitted by a shareholder to serve on the board of directors of the issuer; and

(B) a requirement that an issuer follow a certain procedure in relation to a solicitation described in subparagraph  (A).’’.

(b) REGULATIONS.—The Commission may issue rules permitting the use by a shareholder of proxy solicitation materials supplied by an issuer of securities for the purpose of nominating individuals to membership on the board of directors of the issuer, under such terms and conditions as the Commission determines are in the interests of shareholders and for the protection of investors.

(c) EXEMPTIONS.—The Commission may, by rule or order, exempt an issuer or class of issuers from the requirement made by this section or an amendment made by this section. In determining whether to make an exemption under this subsection, the Commission shall take into account, among other considerations, whether the requirement in the amendment made by subsection (a) disproportionately burdens small issuers.

 

See http://thomas.loc.gov/cgi-bin/query/F?c111:6:./temp/~c111Q9Hs5H:e1747149