Editor: Tell us about your practice.
Vaillant: I am a partner in the Corporate, Securities and Financial Institutions Practice Group, focusing on commercial and capital transactions, mergers and acquisitions, strategic alliances and general corporate matters. I help startup companies with arrangements for financing and public companies with their securities offerings. I also counsel companies and senior management about compliance issues under the federal securities laws and the rules of various securities exchanges, including those relating to executive compensation.
Editor: What are your thoughts on the current proxy season's results of the say-on-pay requirements?
Vaillant: The results have been a bit surprising. Predictably, companies that have performed well enjoyed strong support for their compensation programs, while poorly performing companies with very rich compensation programs may have been viewed as out of sync with their performance and, thus, may have failed to receive strong support. In some cases, they failed to receive majority approval.
During this first year that shareholders have had a voice on the issue, we might have expected more mixed results, with many shareholders voicing their concerns. Instead the vote in favor of compensation programs has been overwhelmingly high. Just a few weeks ago, ISS reported that in 91 percent of companies that are subject to say-on-pay and had already held their annual meetings, the shareholders voted to approve the current compensation programs. That is a bit surprising given the amount of publicity given to large company payouts.
Companies that failed to get approval have faced significant problems. Suits are being brought against their boards of directors, compensation consultants and senior officers, alleging violations of corporate internal policies and breaches of fiduciary duties. This is surprising because the Dodd-Frank Act itself expressly states that the shareholder vote can't be construed to create or imply any change in the fiduciary duties of the issuer or the board.
Editor: Would a negative vote be a strong reason for companies to make changes in compensation arrangements?
Vaillant: It might. While circumstances vary, depending on the company and industry involved, directors should not take their cues solely from the vote. While shareholder views are important, boards have fiduciary obligations arising from their responsibility to maintain company assets and use them wisely. Sometimes, this may require them to pay what appears to shareholders to be extraordinarily generous compensation in order to attract an executive whose talents are particularly needed by the corporation.
It would be an unfortunate consequence for boards to adopt shareholder views and revamp their compensation programs on a wholesale basis. Boards are in the best position to understand the needs of their companies and to make a judgment about what is necessary to retain and incentivize executives. Obtaining the views of shareholders about a corporation's executive compensation program is important, but I don't think it should dictate.
Editor: How important is it for boards to carefully analyze the outcome of the vote?
Vaillant: Boards can learn much about critical shareholder attitudes from such an analysis. A negative say-on-pay vote certainly is a strong signal of shareholder dissatisfaction, and a marginal affirmative vote may not be strong enough to send a clear message.
Boards also should revisit the say-on-frequency vote because of the short-term obligation to report results on the SEC Form 8-K, which must be amended not later than 150 days after the end of the annual meeting to disclose the board's decision on frequency. While companies were split early in the season, they overwhelmingly shifted - largely in response to proxy advisory firm recommendations - from three years to one year on the issue of frequency.
Editor: Did proxy advisory firms play a significant role in affecting the vote?
Vaillant: That was certainly true on the say-on-frequency vote, but difficult to pin down with respect to say-on-pay. There were many instances when the advisory firms recommended against but the shareholders approved. Many institutional shareholders look to ISS, Glass Lewis and others as information sources but do not necessarily follow their recommendations. Some institutions feel that ISS has a one-size-fits-all approach to compensation, which doesn't take into account the differing circumstances among companies and industries. Many savvy institutions took the view that company boards and compensation committees knew what they were doing.
Editor: Are companies using outside professionals to check the proxies and ensure that the vote is correct?
Vaillant: There is a definite trend toward using proxy solicitation firms because companies and shareholders feel more comfortable if there is an independent third party doing the actual tabulation.
Editor: Do you expect companies will want to discuss with their legal advisors how to react to a negative vote?
Vaillant: I have not represented a company that had a negative vote. When a vote was not overwhelmingly affirmative, we have been invited to join compensation committees and consultants in discussions about whether the company should conduct more extensive reviews of existing compensation programs beyond its routine review process.
In many cases, the problem may be inadequate or unclear Compensation Disclosure and Analysis (CD&A) contained in the proxy statement, ineffectively demonstrating the interrelation between performance and compensation and leaving shareholders to guess or make assumptions. As a consequence, some companies believing their programs to be effective should revisit their CD&A for next year's proxy statements to ensure clarity and emphasize the direct relationship between performance and compensation.
Regarding specific compensation issues, companies should both review whether option plans should be tied more closely to a performance standard and assess employment arrangements to ensure compensation is correlated with performance and doesn't include extravagant perqs, for example, that it does not include tax gross-ups. Direct correlation of performance with pay is critical. While wholesale revamping of compensation programs may be unnecessary, strategic fine tuning will be required - and that is what we're seeing.
Editor: When companies successfully attract a spectacular CEO at a substantial expense, how can they avoid triggering a negative vote or misunderstanding?
Vaillant: Boards of directors must understand the company itself and not make determinations based solely on shareholder impressions. The company's industry may dictate necessary measures to attract, retain and incentivize certain executives. If a company's good performance can be tied to having an extremely talented CEO, then the pay-for-performance nexus should be self-evident. Conversely, bad performance will indicate that a CEO's high compensation is not justified. These issues should be outlined and addressed in agreements and incentive programs in order to enable shareholders to appreciate the value and to not feel unduly at risk.
Editor: How important is it for companies to seek experienced counsel when they are preparing their proxy statements?
Vaillant: Given today's voting procedures and the trend toward greater disclosure on compensation issues, companies should be prepared, at a minimum, to avoid a negative vote. Seeking qualified legal and benefits counsel and compensation consultants enables companies to structure successful programs and employment agreements in the first instance. Further, company disclosures must be correct, transparent and strategically fashioned to respond to a possible negative recommendation from an ISS or a Glass Lewis. Qualified advisors can help companies both highlight key executives' performance and reflect solid due diligence in board decisions about compensation.
Editor: Should a board work with proxy advisory firms to ensure they understand the company's plan before they issue recommendations?
Vaillant: While ISS usually does not meet with companies beforehand, they may release recommendations as much as two weeks before a company's scheduled annual meeting. If a company perceives the possibility of negative feedback, it should be prepared with a response, which can come in a number of forms.
One response is to convince ISS to meet with the company and discuss issues, and there were a number of such meetings this last proxy season. Some companies decided, for example, to tweak certain of their employment agreements and were able to reverse the negative recommendation. The key to convincing ISS to stray from usual procedures and reverse negative recommendations is prospective action - actual amendments to employment agreements.
Another response is to send preemptive communications to shareholders. This past proxy season, a number of companies filed additional proxy solicitation materials - letters addressed directly to shareholders - that laid out the company's compensation analysis, defended compensation committee decisions and demonstrated the alignment of pay programs to performance. This strategy prevailed in a number of instances.
Editor: Do you expect to see companies focusing more on marketing their compensation strategies to shareholders?
Vaillant: Yes. We've already seen it this past season. When facing negative recommendations, companies may opt to file additional proxy solicitation materials and to conduct face-to-face discussions or targeted telephone campaigns with key shareholders and decision-makers - all in an effort to better communicate the alignment of pay programs with performance and to defend compensation committee decisions. We will likely see more firms doing this as well as revisiting their CD&As and including executive summaries in their CD&As.
Editor: Will there be greater focus on approaching the dominant institutional shareholders on an individual basis?
Vaillant: That's certainly a possibility. We've already seen some face-to-face discussions with key shareholder decision-makers. Companies that employ transparent compensation programs that reflect clear interrelation with performance have less need for such communications. Companies with more complex, or perhaps opaque, compensation programs may need to reach out to institutions to ensure that their votes are well-informed.
Editor: Are there emerging issues regarding claw-back provisions and provisions that more directly relate compensation to a specific performance target?
Vaillant: The Dodd-Frank Section 954 claw-back provisions go far beyond those instituted in Sarbanes-Oxley. Under Section 954, companies making accounting restatements can recover incentive-based compensation from current or former officers for the last three years, which diverges substantially from what SOX originally required. This is for all institutions, not just financial institutions.
Lawsuits may arise from a compensation claw-back and involve questions as to whom the litigation should be enforced against and for what amount incentive compensation restitution should be sought. Also, there are difficulties with respect to the nature of the claw-back and how it will be treated from a tax standpoint.
Editor: Are you expecting to see more derivative litigation?
Vaillant: It's possible. I think it will depend on the outcome of the suits that have already been filed. At least one suit has settled already with a settlement including compensation program revisions by the company sued. These lawsuits will bear a difficult burden of proof, at least as to breach of fiduciary duties, because boards that have acted properly can invoke the business judgment rule and show that they performed due diligence and analyses necessary to develop appropriate compensation programs.
While these first few suits may be a good indicator for the future, it seems likely that litigation will increase and that the results will be very fact-specific, so we will have to wait for additional developments before making predictions about the future.
Editor: What are the lessons or any general conclusions you draw from this proxy season?
Vaillant: One significant lesson is that further emphasis on appropriate disclosure will help companies effectively depict their programs in proxy materials, which may avoid negative votes assuming a company's programs are sound. In addition, the overwhelming consensus among shareholders was for say-on-frequency to be scheduled annually. In extremely limited circumstances, a company might be able to justify, on the basis of relevance to their particular compensation programs that are tied to a two- or three-year mark, having a biennial or triennial vote; however, this would not apply to most. What we are seeing is that most companies that recommended three years - and then received negative feedback - conceded to the shareholders' preference for an annual say-on-frequency.