Editor: Please describe your practice area.
Dockery: Our corporate and securities group has a diverse practice, dealing with securities, corporate finance, M&A, corporate governance and other general corporate issues.
Editor: The rules that the SEC has promulgated under Dodd-Frank include “say-on-pay” rules. What do these rules stipulate?
Dockery: The two primary rules to which you are referring are the say-on-pay and the say-on-pay frequency rules. The former rule permits shareholders to vote on a non-binding advisory basis on the executive compensation package. The latter rule, the say-on-pay frequency rule, establishes how often shareholders will be asked to vote – whether every year, every two years or every three years. The say-on-pay frequency votes must be held at least once every six years. These various procedures are designed to give shareholders input into the executive pay practices of a public company. In regard to voting frequency, most corporations hold votes every year.
Editor: What issues do companies face if they receive an unfavorable advisory vote regarding executive pay that exceeds a certain percentage of votes cast?
Dockery: Since this is a non-binding advisory vote, there is no legal ramification, but clearly there is a PR and investor relations issue if they fail the vote. ISS, one of the big proxy advisory firms, generally considers a company to have failed to garner enough support if it gets more than 30 percent unfavorable votes. ISS will expect companies to take some action to address an unfavorable vote of this magnitude.
Companies that receive more than 30 percent unfavorable votes will normally take affirmative action to address some issues within their compensation programs as well as take aggressive measures to communicate these actions to their investors, particularly their institutional investors. Often, unfavorable votes are triggered by a substantial disconnect between pay and performance, leading companies to adopt clearer linkages between pay and performance measures, such as setting forth clear performance criteria for bonuses and stock awards.
Our experience is limited to the two years this rule has been in effect, but preliminary evidence is that companies that have failed the first year have taken the necessary steps to pass in the second year. Two important lessons learned are that shareholder education is essential and that there should be full transparency in tying executive pay to performance.
Editor: Recently some shareholders have challenged say-on-pay disclosure requirements by way of shareholder suits brought in advance of annual shareholder meetings. How have companies managed these suits?
Dockery: The recent wave of lawsuits on say-on-pay has been brought by plaintiffs’ counsel after the proxy statement has been filed but before the annual meeting. The suits seek to enjoin the holding of the annual meeting until more disclosure regarding the executive compensation process is provided. The allegation is that more disclosure is needed even though such disclosure is not required by Dodd-Frank or the SEC rules.
In some early cases where injunctions were granted, companies scrambled to settle these cases before the meeting by agreeing to provide additional disclosures and legal compensation to plaintiffs’ attorneys, who claimed the disclosures brought additional value. Some more recent cases have favored company defendants who have been able to get these suits dismissed on the basis that the requested additional disclosure doesn’t add to the total mix of information. Companies that are more aggressive in trying to get these suits dismissed are having greater success.
Editor: How have companies dealt with their large institutional shareholders in seeking their involvement regarding executive pay?
Dockery: Not only with companies that failed say-on-pay but with all companies, much attention is turned to contacting and working with large institutional investors in advance of shareholder meetings in order to educate their institutional holders on how compensation decisions are made and other corporate governance issues. This is designed to nip in the bud any concerns that institutional shareholders might have about the company, its pay practices or other issues.
A recent survey showed that of the companies surveyed, two-thirds had made an effort to contact at least some of their institutional holders prior to the annual meeting to communicate with them on corporate governance matters.
Editor: How does ISS (or its principal competitor, Glass-Lewis) obtain company information?
Dockery: Companies covered by ISS can now review and verify information used by ISS in computing its corporate governance score by utilizing a data verification tool provided by ISS on its website. The company has the opportunity to provide feedback directly to ISS, although this process must be completed before the company files its proxy statement. There is a blackout for data verification after the filing of the proxy statement and until ISS publishes its proxy analysis. Presumably, after the filing of the proxy statement, the company will have to contact ISS directly to resolve any issues noted by ISS in the proxy statement.
Editor: In June 2012, the SEC adopted final rules directing the stock exchanges to require compensation committee members of listed companies to meet heightened standards of independence and be authorized to retain, compensate and oversee advisors to the committee who would be independent. To date, are you seeing disclosures showing any conflicts of interest regarding these advisors?
Dockery: I am not aware of any disclosures addressing actual conflicts. Instead, there is much disclosure that there are no conflicts. Some companies have given very detailed reviews of factors that could cause conflicts but have confirmed that none exist. Others have simply stated that they’ve undertaken a review and determined no conflicts exist.
Editor: Dodd-Frank requires the SEC to develop rules requiring disclosure in annual proxy statements of the relationship between executive compensation actually paid and the company’s financial performance, as well as the CEO’s compensation to that of the other employees of the company. When are these rules anticipated to be implemented?
Dockery: That’s actually a very good question. The rules are listed under “pending action” on the SEC website.
Editor: As a matter of fact, aren’t some companies doing it already in their proxy statements?
Dockery: Similar to the adoption of clawback policies, another one of those pending actions, some companies have voluntarily adopted policies and procedures. The pay-for-performance is a little easier to address because there’s so much attention focused on that measure under the say-on-pay voting provision. I have not reviewed any proxy statements for companies that have added the pay ratio to its proxy statement as yet. There’s still some real question as to exactly how you measure that ratio, particularly for large companies with a wide range in pay. How do you take into account part-time workers, for instance?
Editor: What is the status of new listing standards relating to compensation committees and their advisors to be issued by the exchanges, which must be approved by the SEC in mid-year 2013?
Dockery: Baked into the listing standards is the requirement that the compensation committee – as well as its advisor – be independent. These standards were in fact proposed last year by the exchanges. They were approved by the SEC in January and will go into effect in mid-2013. This is one of those areas where a lot of companies are already in compliance with the disclosure and the independence requirements. The retention of advisors may receive more scrutiny because of the specific rules, but for the most part companies are not likely to engage advisors that had conflicts because of the appearance of impropriety.
Editor: From the standpoint of corporate governance, what matters under AS 16 are of particular importance to the audit committee?
Dockery: In general, AS 16 basically requires certain communications to be made by auditors to the audit committee, adding to existing requirements a small fraction of additional burden on the audit committees in reporting information. From a corporate governance standpoint, what this really translates into is more responsibility for the audit committee in terms of longer or more meetings close to the time of the audit. This requirement will place more responsibility on the committee to make sure the auditors are receiving the necessary information.
Editor: In previewing the 2013 proxy season, it seems that shareholder advocates are promoting environmental and social policy changes at corporations. Why do you think these subjects are dominant?
Dockery: These subjects are on the minds of many activist shareholders who are presenting a certain image to their constituents. Recently, I read that the amount of support for environmental and social responsibility proposals has more than doubled in the last five or six years. The average support was 10 percent in 2005, and it grew to over 20 percent in 2011. The number of these proposals receiving significant support has gone up as well. The number of proposals has leveled off over the last couple of years, but it’s still a significant number in the environmental and social responsibility field.
Editor: Have the rules eliminating broker voting on substantive measures diminished the number of votes that are cast?
Dockery: They certainly have. There are only a few matters that qualify for broker discretionary voting, one of which is ratification of auditors. One good reason for having this as an agenda item is to be able to count broker votes for purposes of establishing a quorum. However, they are not able to vote on the election of directors, matters relating to employee compensation plans, stock plans and matters of a substantive nature. Consequently, the votes for those matters are substantially lower as a raw total than they used to be. If a company has a large retail shareholder base, obtaining the requisite vote can be problematic, especially where majority voting is required. Companies that have large institutional client bases do not normally have this problem.