Action Items to Prepare for the 2019 Proxy Season November 15, 2018 Brought to you by Winston & Strawn’s Employee Benefits and Executive Compensation Practice
Today’s Webinar Presenters Michael Melbinger Nyron Persaud Employee Benefits and Executive Employee Benefits and Executive Compensation Practice Compensation Practice Chicago New York mmelbinger@winston.com npersaud@winston.com 2
Overview Lessons Learned from 2018 Proxy Season 1. 2. Year 2 of CEO Pay Ratio Disclosure Hot Issues for the Upcoming 2019 Proxy Season 3. Non-Employee Director Compensation Issues Changes to Smaller Reporting Company Definition Code Section 162(m) Disclosures Renewed Focus on Perk Disclosure 4. New(er) Issues from ISS, Glass Lewis and Other Investors Board Gender Diversity Gender Pay Equity ISS Proposed Policy Update – EVA Screen Review and Drafting Tips 5. Shareholder Say On Pay/Frequency General Annual Compensation Committee Shareholder Proposals Compensation Clawback Policies Shareholder Approval of Equity or Cash Incentive Plans 3
Lessons Learned from 2018 Proxy Season
2018 Say on Pay Results • Average Say on Pay vote result is 90.3%, the lowest since 2012 and down from about 92% in 2017 • Shareholder Say on Pay failure rate in 2018 is 2.7%, which is higher than the year-end failure rates in the previous two years • 55 Russell 3000 companies failed to obtain majority approval of their Say on Pay proposals • ISS recommended a vote AGAINST Say on Pay for approximately 14% of companies it reviewed in 2018 • ISS effect? • Average approval with ISS “For” – 95% • Average approval with ISS “Against” – 64% *Data from Semler Brossy October 4, 2018 Say on Pay Report 5
2018 Say on Pay Results • Uptick in institutional investors voting “Against” companies’ Say on Pay proposals • CalPERS voted Against companies’ Say on Pay proposals 43% of the time in 2018. Prior to this year, CalPERS’ highest percentage of Against voted for Say on Pay was less than 18%, a year-over-year increase of more than double • But 5 other investors voted Against Say on Pay proposals even more frequently than did CalPERS, led by Allianz Global Investors, which voted Against its portfolio companies’ Say on Pay proposals a whopping 79% of the time • Overall, SSOP failure were up in 2018 to 52, from the historic low of only 34 in 2017 • Many companies feel like they must react to any Say on Pay vote with an approval rate below 80% 6
Year 2 of CEO Pay Ratio Disclosure
CEO Pay Ratio – Overview • A non-event for the vast majority of companies. The media reported some disclosures, particularly the higher ones, but the story “never got legs.” • Company must disclose: a. The median of the annual total compensation of all employees of the company, excluding the CEO b. The annual total compensation of the CEO of the company c. The ratio of (a) to (b) 8
CEO Pay Ratio – Overview • The disclosure requirement does not apply to: • Smaller reporting companies • Foreign private issuers • Multi-jurisdictional filers • Emerging growth companies • Registered investment companies • Transition rule for newly public companies • Disclosure is required for the first fiscal year after the effective date of the initial public offering • Non-Calendar Year Filers • The rule is effective for a company’s first full fiscal year beginning on or after January 1, 2017 9
CEO Pay Ratio – Median Employee • Many companies should be able to use the same median employee in 2019 as they used in 2018. • SEC rules require a company to identify its median employee only once every three years (and calculate total compensation for that employee each year), unless there has been a change in: • the original median employee’s circumstances, or • the company’s employee population or employee compensation arrangements that the company “reasonably believes would result in a significant change in its pay ratio disclosure.” • For example, if the median employee used in calculating the 2017/2018 ratio received a large bonus or equity award in 2018, the company probably could not use that employee in the 2019 proxy. 10
CEO Pay Ratio – Median Employee • In determining whether to use the same median employee, consider the following: • Significant acquisitions or divestitures that could impact the employee population • Reductions in force or other significant employee turnover • If the 2017/2018 median employee has terminated from employment or received a significant increase in compensation, the company may consider substituting an employee with comparable pay as the median employee. • Some companies identified alternate median employees the first time around in the event of changes impacting the initial median employee 11
CEO Pay Ratio – Lessons Learned • Keep it simple • Applies to the methodology and the disclosure • Investors observed that they found lengthy explanations of the ratio and alternative ratios to be confusing • Resist the urge to explain or provide supplemental disclosure 12
CEO Pay Ratio – Statistics • Average ratio for S&P 500 companies was 160:1 • For the Fortune 1000, it was 158:1 • For the Russell 3000, it was 71:1 • Median employee pay was $69,000 for S&P 500 versus $108,000 for the tech industry • Highest ratios were in retail, consumer discretionary and consumer staples and materials • Lowest ratios were in financial, healthcare and utilities industries 13
CEO Pay Ratio – Statistics • 19% of the Russell 3000 provided some sort of supplemental pay disclosure such as adjusted workforce, full-time only employees used to find median or adjusted CEO pay due to one-time awards • Some companies noted a low pay ratio this year due to caveats to prepare for higher ratios in the future * Statistics from Compensation Standard’s “Pay Ratio & Proxy Disclosure Conference,” https://www.compensationstandards.com/member/blogs/consultant/2018/10/some-pay-ratio-stats-military-below-51.html 14
Hot Issues for the Upcoming 2019 Proxy Season
Hot Issues for the Upcoming 2019 Proxy Season 1. Non-Employee Director Compensation Issues 2. Changes to Smaller Reporting Company Definition 3. Section 162(m) Disclosures 4. Perk Disclosure 16
ISS Scrutiny • Beginning in 2019, ISS will recommend against compensation committees where elevated non-employee director (NED) pay persists over multiple years without compelling justification, e.g., payments to reward for performance or “extraordinary service,” payments in consideration of scientific or other specific topical experience, and special payments related to corporate transactions or investigations • “If ISS assesses that an individual director has failed in his or her oversight responsibilities at one company and this has resulted in a negative ISS vote recommendation, ISS may note this in the proxy research of other companies where that director serves on the board • Types of oversight shortfalls that may be relevant to the assessment in such a situation are a pattern of poor stewardship of compensation practices, risk oversight failures relating to fraud or other forms of corporate malfeasance, risk oversight failures related to business operations (such as cyber security), and/or oversight failures regarding protection of shareholder rights or shareholder value. 17
Litigation of Director Compensation • Shareholder derivative suits: Plaintiffs sue a company “on behalf of shareholders” • Demand requirement under Delaware law • The demand requirement is excused if: • A majority of the board was “ interested ” in the allegedly wrong decision or lacked independence, or • The decision was not the product of a valid exercise of business judgment 18
How Can Boards Address These Issues Proactively? • Board can reduce the risk of a lawsuit over director pay by: 1. Placing limits on both the cash and the equity components of its compensation–or an aggregate limit–and have these limits approved by shareholders, generally as part of the larger stock incentive plan 2. Submitting the board’s compensation package to shareholders for approval, either separately or as part of the larger stock incentive plan 3. Embracing best practices in board compensation and gain some protection that way 19
Non-Employee Director Compensation Issues • Compensation Committee Best Practices • Independent compensation consultant review, including benchmarking board members’ compensation against the company’s peer group • Enhance the compensation committee charter (or equivalent document) • Enhance proxy statement disclosure on the process for setting board compensation 20
Hot Issues for the Upcoming 2019 Proxy Season 1. Non-Employee Director Compensation Issues 2. Changes to Smaller Reporting Company Definition 3. Section 162(m) Disclosures 4. Perk Disclosure 21
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