NEW YORK--A shareholder advisory "say-on-pay" vote is likely to become mandatory in the first 100 days of the new administration, no matter which party wins, Brian T. Foley said June 19.

In the push for say-on-pay, Foley said executive severance is a "hot button" issue. This is especially true in cases where the chief executive officer's performance has been mediocre, or the company has experienced a sudden collapse, but it is also an issue even where a company is doing well, he added.

Foley, managing director of Brian T. Foley & Co., White Plains, N.Y., spoke at the American Law Institute-American Bar Association's annual executive compensation conference. He addressed executive compensation practices targeted by investor activists and impacted by tax code Sections 409A and 162(m).

Underestimating Momentum of Say-on-Pay

Foley also said most companies are "underestimating the impact of mandated say-on-pay because most proposals to date have not garnered majority support." If say-on-pay is mandated, companies are also underestimating the impact that "sheer volume would have on the ability of large institutional shareholders and proxy advisory groups to assess" the various pay programs on a company-by-company basis, Foley said.

He explained that because of these factors, say-on-pay will most likely not be individual shareholder say-on-pay; rather, it will be large advisory services like "RMG [formerly Institutional Shareholder Services] and Glass Lewis say-on-pay" because smaller institutional shareholders will look to advisory services for advice on how to vote.

Foley said many companies now require majority voting in director elections. If a mandatory say-on-pay vote is added, he said, it is possible that the two campaigns will enforce each other. Thus, if a company does not act on a no vote in a say-on-pay campaign, shareholders will be advised to vote no in the director elections. "Directors are sensitive about shareholder votes, particularly 'vote no' campaigns," Foley commented.

In a June 20 session, Ronald O. Mueller, a partner in the Washington, D.C., office of Gibson, Dunn & Crutcher, said media reports that the push to put say-on-pay proposals on proxy ballots is floundering are not accurate, noting that more proposals were voted on and more were passed this year than last year, although proponents did not get the overwhelming support they may have expected.

Responding to the question of what will happen to say-on-pay, Mueller said both presidential candidates have supported say-on-pay legislation. He summarized activity in the House and Senate, which included:

p  S. 2866, introduced April 15 by Sen. Hillary Clinton (D-N.Y.). Mueller said S. 2866 is a much broader bill, and includes amendments to tax code Section 409A to limit the amount of compensation that may be deferred, and Section 14 of the Securities Exchange Act to provide a mandatory shareholder vote on executive compensation at every public company. The bill would also require a separate vote on change in control golden parachute agreements, he said. A similar provision is in the Frank/Obama bills, Mueller said.

A Better Way To Go

Saying that say-on-pay "is a bit of a blunt instrument," Mueller explained that it measures for and against, but it "doesn't always indicate for or against all or what part [of the pay package] you don't like." A better way to go, he said, is to go out and to talk to shareholders.

Noting conversation always helps, Mueller said companies are reaching out to shareholders. Some are convening sessions for specific feedback from major shareholders and others are calling large shareholders to talk about company policy, he said. For companies, this is the time of year to "reach out, introduce ourselves," and allow shareholders to express their concerns, Mueller said.

Both Foley and Mueller cited Riskmetrics Group's research paper "Explorations in Executive Compensation," issued in May, that examines opening dialogues between investors and companies concerned about this issue. In particular, Mueller cited the paper's discussion of peer group benchmarking.

Change in Control and Severance Pay

In discussing the ways in which severance pay practices are changing, Foley, at the earlier session, said some shareholder activists are proposing elimination or phase out of employment contracts and cash severance pay plans for executives.

On this issue, he said there is a place for contracts "in most circumstances," and in practice many change in control cash severance agreements are being scaled back, with more conservative extension and renewal features. "Companies are moving away from sweeteners," Foley said.

Among the issues that should be revisited, and possibly revised, are definitions and payment triggers, the extent of options' and stock appreciation rights' (SARs) post-termination exercisibility, and supplemental executive retirement plans (SERPs) and the interplay between SERPs and severance and other exit pay, Foley said.

Regarding severance, he said "you have to look at every severance agreement on its merits." According to Foley, "it is not a one-size-fits-all situation."

Foley also focused on clawback provisions, saying companies have not addressed clawbacks, but they should "take a look at putting one in" if and when say-on-pay arrives. Clawback are contract provisions requiring executives to repay bonus and incentives payments under certain specified circumstances. Section 304 of the Sarbanes-Oxley Act requires the clawback of CEO and CFO bonuses in the event of financial restatements due to fraud or misconduct.

There are a variety of issues to be sorted out, Foley said, including who is included in a clawback provision, whether it is performance based or misconduct based, and what types of compensation should be included. There is little disclosure on existing clawback agreements, and there is also a gap in having a policy and enforcing it, Foley said.

Regarding the impact of Section 409A on change in control severance agreements, Foley said compensation committees have an obligation to shareholders to make sure they have done what they can to make the company marketable.

There are many things the board and the executive could be doing, including opening negotiations, Foley said, but he noted that it is important to restructure a severance agreement to fit it into the short-term deferral rule under Section 409A and to do so now while the transition period is still in effect. Otherwise, it could create a "significant 409A obstacle to the acquirer," he said.

According to Foley, in reviewing change in control severance agreements, companies should:

p   make sure the amount is paid out in a lump sum instead of installments;

p   make sure the amount is paid out prior to the end of the applicable short-term deferral period;

p   make sure the agreement conforms to the safe harbor rules for good reason terminations; and

p   if there is a 13-month walkaway right, make sure the severance rights end and all severance payouts are made prior to the end of the short-term deferral period, starting on the first day of the walkaway period.

In addition, companies should "seriously consider adding a clawback feature," he said.

Disclosure of Executive Pay

In a June 20 session, Anne Krauskopf, senior special counsel in the Division of Corporation Finance, Securities and Exchange Commission, reviewed the SEC staff findings in the 2007 staff disclosure project. She said SEC will base its next steps on what it learned in the review process.

If companies are seeking clarification of the review process, Krauskopf said they should go the Web page for the Division of Corporation Finance and click on a new feature, "Filing Review Process."

Krauskopf said the review process (195 PBD, 10/10/07; 34 BPR 2460, 10/16/07) and comment letters opened a dialogue with a company, which could then be resolved in different ways. However, Krauskopf said, "Remember this: a comment to one company may not apply to your company."

Regarding the staff disclosure project, Krauskopf said if a company's disclosures were not reviewed under the project, it "doesn't mean you can continue with a mark up" of last year's Compensation Discussion and Analysis (CD&A). The review of 350 companies was a special project, she said, and now that it is complete, "we haven't folded up our tents and gone home," Krauskopf said. Under the Sarbanes Oxley Act triennial reviews of all companies are mandated, she said.

As Krauskopf has stated (24 PBD, 2/6/08; 35 BPR 340, 2/12/08), nondisclosure of performance targets must be substantiated.

"Companies were on notice that they should be prepared to provide competitive harm analysis and that the standard would be the same as the confidential treatment standard," she said. Krauskopf also said the competitive harm standard can vary from company to company. It is a facts and circumstances situation, Krauskopf said, referring to the "significant comment" the agency made when it adopted the rules to explain its position in striking a balance between investor interests and company interests.

She also said that it was clear from the instructions for the CD&A that it may be relevant to go back and discuss things that relate to a past or current year.

Mark Borges, of the California-based consulting firm Compensia Inc., speaking with Krauskopf on disclosure issues, said companies need to face that there may be a "need for some negative disclosure in the CD&A." The staff questions tended to suggest that "if you don't do something you might need to mention it," Borges said. Look to see whether there is a connection or relationship between two elements, and "include language people will understand where elements linked and where they didn't," he said.

Under SEC's 2006 amendments to the executive compensation disclosure rules, the CD&A is expected to contain the company's explanation of material elements of the company's compensation policies and decisions for named executive officers.

Explorations in Executive Compensation is available at http://blog.riskmetrics.com/2008/05/explorations_in_executive_comp.html. The SEC's review policy is available at http://sec.gov/divisions/corpfin/cffilingreview.htm. Course materials are available from ALI-ABA at http://www.ali-aba.org.

By Mary Hughes

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