4/18/2016. Executive Compensation Update. Setting the Table

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Duane Morris LLP – A Delaware limited liability partnership

Executive Compensation Update

Darrick Mix

April 15, 2016

DM3/3865345.1

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Latest Developments in Executive Compensation

• Pay Ratio Disclosure

• Pay for Performance Disclosure

• Hedging Rules

• Dodd-Frank Clawback Rules

• Proxy Voting Policy Updates (ISS, etc.)

• FASB Changes in Accounting Treatment

• Compensation Litigation Developments

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Setting the Table

• Investor focus on executive compensation

continues unabated.

• Outreach to investors through disclosure and

other means is important.

• Changes in response to investor outreach or

say-on-pay votes should be highlighted.

• Several Dodd-Frank rules are still pending.

• Recent developments in compensation-related

litigation are noteworthy.

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Pay Ratio Disclosure

• New Rule 402(u) of Reg S-K requires covered

companies to disclose:

– The median of the annual total comp of all company employees excluding the PEO

– The annual total compensation of the PEO – The ratio of these two amounts

• Effective 2018 for fiscal years beginning on or after

January 1, 2017

• Covered companies must also provide other

explanatory disclosure and may include additional narrative disclosure and ratios

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Pay Ratio Disclosure

• Covered Companies: All reporting companies

must make pay ratio disclosure, except:

– Smaller reporting companies – Emerging growth companies – Foreign private issuers

– Registered investment companies

• Location of Disclosure: Filings required to include

Rule 402 disclosure – proxy statements, annual

reports on Form 10-K, and registration statements

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Pay Ratio Disclosure

• Measuring the Employee Population:

– Must consider the annual total compensation of “all employees” other than the CEO, including (subject to limited exceptions) all worldwide full-time, part-time, temporary and seasonal workers.

– Does not include independent contractors.

• Identifying the median employee:

– May use statistical sampling

– May use the same median employee for three consecutive years

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Pay Ratio Disclosure

• Presentation of the Pay Ratio

– May present the pay ratio:

 Numerically (e.g., 50:1)

 Narratively (e.g., 50 times the median of annual total compensation of all employees)

• Optional narrative disclosure and additional

ratios

• Disclosure of methodology, assumptions and

estimates

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Pay for Performance

• SEC Proposed rules April 2015; final rules have not yet

been adopted

• Proposed rules set up prescriptive, rigid system based

on Total Shareholder Return

• Would require proxy statement disclosure of the

relationship between executive compensation actually paid and financial performance

• New table: “Pay versus Performance” (see next slide)

• Graphic or narrative description of the between (1) pay

and company TSR, and (2) company TSR and peer group TSR

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Pay Versus Performance Table

10 Year (A) SCT Total for PEO (B) Compensation Actually Paid to PEO (C) Avg SCT Total for non‐PEO NEOs (D) Avg Compensation Actually Paid to non‐PEO NEOs (E) Total Shareholder Return (F) Peer Group Total Shareholder Return (G) www.duanemorris.com

Pay for Performance

• (A) Year: The most recent 3 FYs for the first year

the rule is effective, transitioning to 5 FYs once

fully implemented

• (B) SCT Compensation Total for PEO

• (C) Compensation Actually Paid to PEO: Would

reflect column (B) reduced by the report value of

pension accruals and stock awards and increased

by the vesting-date value of stock awards vested

during the year and the service cost of pension

accruals for the year

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Pay for Performance

• (D) Average SCT Total for non-PEO NEOs

• (E) Average Compensation Actually Paid to non-PEO NEOs: Subject to the same rules as

column (C).

• (F) Total Shareholder Return: This would be computed in the same manner as for the performance graph already required to be included.

• (G) Peer Group TSR: Would be the TSR for the peer group for the performance graph or the peer group reported in the CD&A.

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Hedging

• SEC proposed rules in February 2015; final

rules have not yet been adopted.

• Proposed rules would require disclosure

whether the company permits employees or

directors to engage in transactions to hedge or

offset any decrease in the market value of:

– equity securities that are granted as compensation – equity securities otherwise held regardless of the

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Hedging

• Proposed disclosure would be required in

proxy statements involving election of directors

• Companies would be required to describe:

– Which categories of transaction are permitted (if any) and which are permitted

– Which categories of persons are permitted to engage in hedging and which are not (if different) – The scope of permitted transactions in sufficient

detail to provide adequate explanation 15

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Clawback Policy

• SEC issued proposed rules under Dodd-Frank on July 1, 2015; would require exchanges to adopt new listing standards

• Final rules have not yet been adopted

• Dodd-Frank left little flexibility for SEC in adopting rules (e.g., limited Board discretion in whether to clawback) • Would require public companies to adopt and enforce

compensation “clawback” policies to recoup from executive officers incentive compensation payments resulting from certain accounting restatements

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Clawback Policy

• Companies/persons covered: Current and former executive officers of issuers with listed securities • Restatements that Trigger Clawback: A restatement to

correct an error deemed material to previously issued financial statements (Note: SOX § 304 clawback applied to CEO and CFO only and required misconduct) • Look-back Period: Three completed fiscal years prior to

the date the board concluded, or reasonably should have concluded, that previous financial statements contain a material error

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Clawback Policy

• Incentive Compensation Covered: Any compensation granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure; salaries, discretionary bonuses, and time-based equity awards are excluded.

• Determination of Clawback Amount:

– The clawback amount would equal the amount, calculated on a

pre-tax basis, of incentive-based compensation received in excess of what would have been paid to the executive officer under the accounting restatement.

– For equity awards, the clawback will be the excess number

awarded; for shares already sold, the excess proceeds received 18

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Clawback Policy

• New Disclosure Requirements – the proposed

rules would require:

– Supplemental Proxy Disclosure:

 Any restatements completed in the past fiscal year that required recovery under the clawback policy  The existence of any outstanding balance of excess

compensation due for a prior restatement

– Filing of the clawback policy as an exhibit to an issuer’s Form 10-K or Form 20-F

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Proxy Voting Policy Updates

• Investors very focused on executive

compensation issues.

• Major shareholders focused on whether

performance goals are transparent and

sufficiently rigorous.

• In 2015, companies receiving a “no”

recommendation from ISS received 31% less

support on SOP and plan approval proposals

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Proxy Voting Policy Updates

• ISS Updates:

– Incentivize enhanced disclosure by externally-managed issuers (e.g., many REITs)

– Adopted new Equity Plan Scorecard (EPSC) for evaluating equity compensation plans

 Considers a range of positive and negative factors  For many companies, 3 “pillars” weighted as

follows: plan cost – 45%; plan features – 20%; grant practices – 35%.

 Maximum of 100 points; 53 needed for favorable recommendation

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Proxy Voting Policy Updates

– Updated FAQs: ISS may recommend a vote against compensation committee members if either “egregious” practices are identified or there are “recurring problematic issues or responsiveness concerns,” thus retaining maximum flexibility on voting recommendations.

• Glass Lewis Updates:

– Included one update to clarify the method of evaluation when considering compensation awards to executives outside of standard compensation packages

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FASB Modifies Rules for Stock-Based Compensation

• In an effort to simplify share-based reporting,

FASB ASU 2016-09 revises the following:

• Statutory Withholding: The new standard permits

share-based withholding up to the maximum

statutory tax rates (whereas currently an employer

may only withhold up to the minimum statutory tax

rate) without causing the award to be classified as

a liability.

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FASB Modifies Rules for Stock-Based Compensation

• Accounting for Income Taxes: The revised standard will require recording the tax effects of share-based payments at settlement or expiration on the income statement. Under the new rule excess tax benefits are also to be classified with other operating income tax cash flows as an operating activity.

• Forfeitures: The revised standard allows an entity to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur.

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FASB Modifies Rules for Stock-Based Compensation

• Intrinsic Value Accounting for Private Entities: Under the update, nonpublic entities will be permitted to make a one-time accounting policy election to switch from measuring all liability-classified awards at fair value to intrinsic value.

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Developments in Compensation Litigation

• Facebook / Espinoza Settlement

– Suit alleged that board had breached fiduciary duties by paying

excessive compensation to non-employee directors

– Chancery Court denied motion for summary judgment;

shareholder ratification had not been formally obtained

– Thus, director compensation subject to “entire fairness” review

– Settlement includes:

 Board will engage compensation consultant for board compensation  Company will include proposals at 2106 annual meeting for

shareholder approval of non-employee director compensation

– Takeaways:

 Periodically evaluate director compensation plans

 Evaluate limits in plans and consider benchmarking against peers 26

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Developments in Compensation Litigation

• Yahoo! Litigation

– Plaintiff stockholder Amalgamated Bank made an inspection

demand to investigate the hiring, compensation, and termination of Yahoo's COO.

– Plaintiff alleged that the board rubberstamped CEO Marissa

Mayer's decisions on the COO’s hiring and compensation structure and did not consider the possibility that de Castro could or should be terminated with cause, which would have caused the forfeiture of his unvested equity awards.

– To investigate that possibility Plaintiff made a demand for Mayer's

files under DGCL §220, including emails, and documents reflecting the discussions and decisions of the board.

– The court ruled that Mayer's documents, including e-mails, were

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Source Material / Further Reading:

– SEC Adopting Release on Pay Ratio Disclosure:

http://www.sec.gov/rules/final/2015/33-9877.pdf

– SEC Proposing Release on Pay for Performance Disclosure:

http://www.sec.gov/rules/proposed/2015/34-74835.pdf

– SEC Proposing Release on Hedging:

https://www.sec.gov/rules/proposed/2015/33-9723.pdf

– SEC Proposing Release on Clawbacks:

http://www.sec.gov/rules/proposed/2015/33-9861.pdf

– 2016 Proxy Voting Policy Updates:

https://www.issgovernance.com/file/policy/2016-americas-policy-updates.pdf http://www.issgovernance.com/file/policy/us-executive-compensation-policies-faq-21-jan-2016.pdf http://www.glasslewis.com/assets/uploads/2015/11/GUIDELINES_United_States_20161.pdf – FASB ASU 2016-09: http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176168028584&acceptedDisclaimer=true – Facebook/Espinoza Settlement: https://corpgov.law.harvard.edu/2016/03/10/facebook-settlement-litigation-over-director-compensation/ http://us.practicallaw.com/w-001-3911

– Yahoo! Records Litigation:

http://www.reuters.com/article/us-yahoo-ruling-severance-idUSKCN0VB2JX

http://www.delawarelitigation.com/2016/02/articles/chancery-court-updates/chancery-determines-that-electronically-stored-information-and-personal-emails-of-directors-must-be-provided-to-stockholders/