United States: Say-on-Pay, The Golden Parachute, And Other Executive Compensation Issues

Introduction

In the aftermath of the 2008 financial crisis, compensation programs and practices have become the subject of intense regulatory and shareholder scrutiny. In light of the non-binding shareholder say-on-pay vote required by Dodd-Frank, as well as the other executive compensation provisions of Dodd-Frank that the SEC is in the process of implementing, public companies are enhancing both their proxy disclosures and their shareholder engagement efforts. As these companies adapt to this new regulatory regime, they are also facing new challenges to their director compensation programs in light of recent Delaware case law. This chapter will discuss the new challenges facing executive compensation decision makers, and the strategies employed in response.

Regulatory Pressures and Corporate Governance

Executive compensation governance measures form a key part of the Dodd- Frank Act (Dodd-Frank)1 and, by the end of the summer of 2015, the SEC had either finalized or proposed rules implementing all of Dodd-Frank's executive compensation provisions. The most well-known reform under Dodd-Frank is the required say-on-pay vote, which mandates that each public company provide its shareholders with a non-binding vote on the company's executive compensation program. Since being implemented in 2011, say-onpay has caused many companies to reconsider their pay programs and the manner in which those programs are disclosed to shareholders.

In addition to say-on-pay, Dodd-Frank will require each public company to disclose the relationship of its pay to its performance (using a total shareholder return metric), the ratio of its CEO's compensation to the median compensation of all other employees, and the company's policies on hedging. Further, Dodd-Frank will require each company to implement and disclose a policy requiring the recovery of certain erroneously awarded incentive-based compensation.

Although certain of these rules have yet to be finalized, companies have already begun to adapt to this new regulatory regime. Each year, Shearman & Sterling LLP surveys the corporate governance and executive compensation practices of the one hundred largest US companies (Top 100 Companies). This year's survey shows, for example, that of the Top 100 Companies, ninety-six already disclose that they prohibit hedging of company stock and eighty-seven of the Top 100 Companies already maintain clawback policies. This voluntary compliance reflects the fact that many proxy advisory groups consider these policies to be an element of sound corporate governance and risk management.

Clawback Policies and Practices

In July of 2015, the SEC proposed rules to implement Dodd-Frank's clawback provision. Under Dodd-Frank, issuers will be required to recover incentive-based compensation that is received by an executive officer of the issuer during the three-year period preceding the date on which the company is required to restate a financial statement due to a material error, to the extent that compensation is in excess of what would have been received had it been determined using the restatement.

Unlike the clawbacks mandated by Sarbanes-Oxley, which require misconduct to trigger a clawback, the proposed Dodd-Frank rules provide for unqualified "no-fault" recovery. In addition, companies will have limited discretion as to whether to enforce the clawback policy. Unless recovery would be impracticable due to expense, or recovery would violate a home country rule, the policy must be enforced.

Our survey shows, however, that the voluntary policies currently in place at the Top 100 Companies are not uniform, and that their application varies as to the events that trigger recovery, culpability standards, the individuals covered, the types of compensation subject to recovery, the level of board discretion as to whether to seek enforcement, and the time period covered by the recovery policy. Once the rules under Dodd-Frank are finalized, most companies will need to either amend their current clawback policies or adopt a supplemental policy that conforms to the SEC's requirements.

Compensation Committee Requirements

Directors charged with sitting on a company's compensation committee must comply with the independence standards of the securities exchange or association on which the company is listed. In addition, companies need to be aware of the "outside director" requirements of Section 162(m)2 of the tax code, and the non-employee director requirements of Section 16 of the Exchange Act. The possibility exists that a compensation committee member will satisfy the independence requirements of the exchange, but will fail to be an "outside director" under Section 162(m) or a nonemployee director under Section 16. Companies need to carefully monitor the activities and relationships of their board members to ensure they do not lose an expected deduction under 162(m), or inadvertently cause an insider to have to disgorge profits under Section 16.

Section 162(m)

Pursuant to Section 162(m) of the tax code, compensation payable to a company's CEO and its three other highest paid officers (other than the CFO) is not deductible if it is in excess of $1 million. An exception exists, however, for performance-based compensation that is approved by a compensation committee consisting entirely of two or more "outside directors." An "outside director" is a director who:

  1. is not a current employee of the company,
  2. is not a former employee of the company who receives compensation for prior services (other than benefits under a taxqualified retirement plan),
  3. is not a former officer of the company (regardless of whether he or she receives compensation for prior services), and
  4. does not receive "remuneration" from the company, either directly or indirectly, in any capacity other than as a director.

Notwithstanding the fact that Treasury Reg. 1.162-27(e)(2)3 states that the committee must consist "solely of two or more outside directors," the IRS has stated that these regulatory requirements will be met in the case of board action by unanimous written consent (so long as at least two members were outside directors), and actions by committees in which inside directors recuse themselves.4

Section 16(b)

Section 16(b) of the Exchange Act5 provides that a company insider, including a director, officer or 10 percent owner, is liable to the company for any profits resulting from his or her purchase and sale of the company's equity securities within any period of less than six months. To ensure that grants of equity compensation are exempt from this rule, the SEC promulgated Rule 16b-3 of the Exchange Act,6 which exempts transactions between an issuer and a director or officer that are approved by either the full board or a committee composed solely of two or more "non-employee directors."

To qualify as a non-employee director, the director cannot:

  1. Be an officer or employee of the company;
  2. Receive in excess of $120,000 in compensation, either directly or indirectly, from the company (or from a parent or subsidiary) for services rendered as a consultant or in any capacity other than as a director; or
  3. Have an interest in any "related party" transaction for which disclosure in the proxy statement would be required pursuant to Item 404(a)7 of Regulation S-K.

Although Exchange Act Rule 16b-38 states that the committee must consist "solely of two or more non-employee directors," the SEC has stated that non-qualifying directors can abstain or recuse themselves from action on the transaction, or the committee can form a subcommittee composed of two or more non-employee directors to approve the transaction.9

Director Independence Requirements of the Securities Exchanges

With respect to the independence requirements of the securities exchanges, both the NYSE and NASDAQ require members of their listed companies' compensation committees to be independent. One of the executive compensation provisions in Dodd-Frank requires the SEC to adopt rules directing the national securities exchanges and associations to prohibit the listing of any security of an issuer that does not comply with certain compensation committee (and compensation adviser) requirements. The exchanges and associations were charged with developing listing standards requiring each member of the compensation committee to be "independent." The SEC finalized its requirements in June of 2012, and in January of 2013, approved the listing standards of each of the NYSE and NASDAQ. Although it does not define the term "independent," Dodd-Frank does state that the exchanges must take into account certain "relevant factors" which include:

  1. A director's source of compensation, including any consulting, advisory or other compensatory fee paid by the issuer to such directors, and
  2. Whether a director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of the issuer.

Although the NYSE and NASDAQ have different definitions of "independent," both generally look to ensure that the directors have not, in the three previous years, been employees of the company, had a business relationship (other than stock ownership) with the company or familial relationship with employees of the company.

Although each exchange lists certain relationships that are a per se bar to independence, this list is non-exclusive and the board must examine each relationship and make an affirmative determination, considering all relevant facts and circumstances, as to a particular director's independence. Further, to the extent a director has a relationship that the company reviewed before determining that the director was independent, this relationship will need to be disclosed in the company's proxy statement pursuant to Item 40410 of Regulation S-K.

To continue reading this article, please click here

Footnotes

1 Dodd-Frank Act, Pub. L. No. 111-203, 124 Stat. 1376.

2 26 U.S.C.A. § 162(m).

3 Treas. Reg. 1.162-27(e)(2).

4 Priv. Ltr. Rul. 9732007, 9811029, respectively.

5 15 U.S.C.A. § 78p.

6 17 C.F.R. § 240.16b-3.

7 17 C.F.R. § 229.404(a).

8 17 C.F.R. § 240.16b-3.

9 American Society of Corporate Secretaries, SEC No-Action Letter, Q.1(b) (Dec. 11, 1996).

10 17 C.F.R. § 229.404.

Previously published in Inside the Minds—Recent Changes in Employee Benefits and Executive Compensation

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
Hughes Hubbard & Reed LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
Hughes Hubbard & Reed LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions