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

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1 Executive Compensation Update Darrick Mix April 15, 2016 DM3/ 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 2 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. 3 1

2 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 4 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 5 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, parttime, 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 6 2

3 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 7 8 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 9 3

4 Pay Versus Performance Table 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) 10 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 11 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. 12 4

5 13 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 source 14 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 5

6 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 16 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 17 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 6

7 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 19 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 20 Proxy Voting Policy Updates ISS Updates: Incentivize enhanced disclosure by externallymanaged 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 21 7

8 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 22 FASB Modifies Rules for Stock-Based Compensation In an effort to simplify share-based reporting, FASB ASU 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. 23 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. 24 8

9 FASB Modifies Rules for Stock-Based Compensation Intrinsic Value Accounting for Private Entities: Under the update, nonpublic entities will be permitted to make a onetime accounting policy election to switch from measuring all liability-classified awards at fair value to intrinsic value. 25 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 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 s, and documents reflecting the discussions and decisions of the board. The court ruled that Mayer's documents, including s, were appropriate for production 27 9

10 Source Material / Further Reading: SEC Adopting Release on Pay Ratio Disclosure: SEC Proposing Release on Pay for Performance Disclosure: SEC Proposing Release on Hedging: SEC Proposing Release on Clawbacks: Proxy Voting Policy Updates: FASB ASU : Facebook/Espinoza Settlement: Yahoo! Records Litigation: