Corporate Governance and Proxy Season Developments Overview
Discusses key topics from the Society for Corporate Governance Chicago Chapter Meeting, including Dodd-Frank compensation-related rules, new SEC guidance, cybersecurity expectations, pay ratio disclosure requirements, and employee classification for disclosure purposes.
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The Society for Corporate Governance Chicago Chapter Meeting November 29, 2017 Lawrence Levin Partner, Co-Chair of the Securities and Public Company Practice Katten Muchin Rosenman LLP 525 West Monroe Street Chicago, Illinois 60661-3693 +1.312.902.5654 lawrence.levin@kattenlaw.com
Proxy Season Developments Status of the Final Four Dodd-Frank Compensation-Related Rules: Clawbacks of Compensation for Financial Restatements; Hedging Policy Disclosure by Employees and Directors; Pay Versus Performance Disclosure; and Pay Ratio Disclosure. New SEC Guidance on Shareholder Proposals (SLB 14I): Ordinary Business Exception; Economic Relevance Exception; Proposals by Proxy; and The Use of Images. 2
Proxy Season Developments (cont.) Disclosure Effectiveness Proposal: Omission of Confidential Information without a Confidential Treatment Request; MD&A Disclosure Reduced; and Other Proposed Changes. Cybersecurity Expect New SEC Guidance with Focus on: Disclosure Controls and Procedures; and Insider Trading Policies. Expanded Auditor reports (AS 3101): Inclusion of Auditor Tenure; and Disclosure of Critical Audit Matters (CAMs). Institutional Shareholder Services (ISS) and Glass Lewis 2018 Policy Updates 3
Pay Ratio Disclosure Regulation S-K Item 402(u) requires disclosure of: (a) the median of the annual total compensation of all employees of the issuer, excluding the CEO; (b) the annual total compensation of the CEO; and (c) the ratio of (a) to (b). Timeline: Disclosure will be first required for fiscal years beginning on or after January 1, 2017. For calendar year filers: 2017 Data for this year will be required to be compiled. 2018 Filings (e.g., proxy statements) will be first required to include such disclosure. 4
Pay Ratio Disclosure (cont.) Flexible approach to identifying the median employee . May select a methodology that is appropriate to the size and structure of the business and the way employees are compensated. Permitted to identify the median employee based on total compensation using either: full employee population; or a statistical sample of that population. Median employee may be: selected on any date in the fourth fiscal quarter; and used for three years (with some exceptions). 5
Pay Ratio Disclosure (cont.) Who is an employee? Generally includes: All worldwide, full-time, part-time, temporary and seasonal employees of the company or any of its subsidiaries. Excludes: Independent contractors and leased workers. May exclude: employees located outside the U.S. under two exemptions: data privacy law exemption; or de minimis (5%) exemption; new employees from business combinations and/or acquisitions. 6
Pay Ratio Disclosure (cont.) Reasonable estimates for median employee permitted when: calculating the annual total compensation; calculating any element of total compensation; or determining the annual total compensation of the median employee. Cost-of-living adjustments Disclosure required of: the ratio; the methodology used to identify the median; and any material assumptions, adjustments or estimates used to identify the median or to determine total compensation. Optional additional disclosure: narrative discussion; or additional ratios. 7
Pay Ratio Disclosure (cont.) Disclosure required in: Form 10-Ks; registration statements; and proxy and information statements. No disclosure required by: emerging growth companies; smaller reporting companies; foreign private issuers; Canadian MJDS filers; or registered investment companies. Transition period applies to newly public companies. Liability for Pay Ratio Disclosure: Treated as filed and not furnished. 8
Pay Ratio Disclosure (cont.) The SEC issued interpretive guidance in September 2017 regarding compliance with the pay ratio disclosure requirements in which the SEC emphasized that registrants have latitude to use reasonable estimates, assumptions and methodologies (including reliance upon existing internal records) to determine the pay ratio. The use of reasonable estimates, assumptions and methodologies would not provide the basis for an SEC enforcement action unless such disclosure was made or reaffirmed without a reasonable basis or was provided other than in good faith. 9
Pay Ratio Disclosure (cont.) The SEC s September 2017 interpretive guidance also clarified that the leased workers exclusion is not the exclusive basis for a registrant to determine that a worker is not required to be included in the data used to identify and calculate the annual compensation of its median employee. A registrant may instead apply a widely recognized test under another area of law (such as tax or employment law) to determine whether its workers are employees and are, therefore, required to be included in the pay ratio data. 10
Pay Ratio Disclosure (cont.) Action Items: What to do now to prepare for Pay Ratio disclosure? Read and understand the rule, as well as the C&DIs and guidance issued by the SEC. Assemble a team and designate a team leader. Develop an action plan and a timeline for compliance. Determine where the data is held and the number of payroll systems involved. Ensure that payroll systems and other related disclosure controls and procedures are in place to facilitate the determination of the median employee. Evaluate the employee population, including: what percentage of employees reside outside of the U.S.; and whether any non-U.S. employees are employed in a jurisdiction with data privacy laws that may affect compliance with the rules. Brief the Compensation Committee and/or the Board on the new requirements. 11
Pay Ratio Disclosure (cont.) Consider engaging outside advisors. Review the disclosures of voluntary early adopters. Consider the flexibility offered under the rules, including the options to: use alternative methodologies for identifying the median employee; determine the date used to select the median employee; exclude non-U.S. employees under the 5 percent exclusion allowance; exclude employees from current year acquisitions; and make cost-of-living adjustments to the compensation of employees who reside outside the jurisdiction of where the CEO resides. 12
Pay Ratio Disclosure (cont.) Consider presenting additional information, including additional ratios, to supplement the required ratio. Prepare for potential adverse shareholder and employee reaction. 13
Pay Ratio Disclosure (cont.) According to a survey by The Corporate Counsel, companies were at the following levels of preparedness as of July 2017: Level of Preparedness # of Responses Percent of Respondents 2.3% Fully prepared even prepared draft disclosure 3 Quite prepared but haven t prepared draft disclosure Somewhat prepared running pay calculation & statistical scenarios Barely prepared still assessing our workforce 17 13.3% 26 20.3% 72 56.3% 10 7.7% Wasn t pay ratio repealed? 14
Pay Ratio Disclosure (cont.) According to a survey by The Corporate Counsel, as of August 2017, companies planned to provide the following levels of disclosure: Level of Disclosure # of Responses Percent of Respondents Only the bare minimum disclosure 30 22% Expanded disclosure with some explanations & clarifications Expanded disclosure with alternate ratios 31 22% 9 7% Expanded disclosure with carve-outs 5 4% Approach not yet determined 54 39% 8 6% Wasn t pay ratio repealed? 15
Pay Ratio Disclosure (cont.) Based on a September 2017 survey by The Corporate Counsel, companies are planning to use the following date for their employee determination date: Determination Date # of Responses 18 Percent of Respondents 25.7% October 31st (or equivalent for non- calendar year companies) November 30th (or equivalent for non- calendar year companies) Fiscal year end Some other date 5 7.1% 25 22 35.7% 31.4% 16
Pay Ratio Disclosure (cont.) Based on a September 2017 survey by The Corporate Counsel, companies are planning to use the following consistently applied compensation measure (CACM): CACM # of Responses 19 Percent of Respondents 25.3% Taxable wages Base salary Total gross compensation Total cash compensation Some other measure None using annual total compensation instead 18 16 11 11 0 24.0% 21.3% 14.7% 14.7% 0.0% 17
Pay Ratio Disclosure (cont.) Based on a September 2017 survey by The Corporate Counsel, companies are planning the following with respect to the de minimis exemption: Use of De Minimis Exemption Not using the exemption # of Responses 36 Percent of Respondents 50.7% Using the exemption 10 14.1% 25 35.2% Don t know yet 18
Pay Ratio Disclosure (cont.) Based on a September 2017 survey by The Corporate Counsel, companies are planning the following with regard to the exclusion of employees of acquired entities from the determination of the median employee: Exclusion of such employees? Not applicable we do not have acquired entities Not excluding # of Responses 34 Percent of Respondents 47.9% 20 28.2% 14 3 19.7% 4.2% Don t know yet Yes, excluding 19
Pay Ratio Disclosure (cont.) The 2017-2018 ISS Global Policy Survey results indicate the following with respect to the proposed use/analysis of pay ratios: Use/Analysis % of Investor Respondents 6% % of Non-Investor Respondents 12% Compare the ratios across companies/industry sectors Assess year-on-year changes in the ratio at an individual company Both of the above None Other 3% 8% 63% 16% 12% 21% 44% 16% Source: 2017-2018 ISS Global Policy Survey: Summary of Results, published September 25, 2017. 20
Pay Ratio Disclosure (cont.) Source: Pearl Meyer on Point: Looking Ahead to Executive Pay Practices in 2018 Executive Summary 21
Pay Ratio Disclosure (cont.) Company Pay Ratio Filing Date Notes ITEX Corporation 3.8 to 1 11/1/16 Assists businesses with generating new sales through its proprietary payment technology platform. Its CEO made $12.4 million in 2015. Adams Resources & Energy, Inc. 5.7 to 1 4/11/17 Involved in the oil and gas industry and transportation of liquid chemicals. Had 654 employees (as of 12/31/16), most of whom were truck drivers. Its CEO made $400,000 in 2016. No equity issued to executives. Texas Republic Capital Corporation 6.1 to 1 4/11/17 Insurance holding company with five employees as of 3/16/2017. First Trinity Financial Corporation 7.5 to 1 3/27/2017 Insurance holding company that operates two life insurance companies across 26 states. Its CEO made $811,078 in 2016. Gencor Industries 13 to 1 1/20/17 Manufacturer of asphalt plants, soil remediation plants, combustion systems and heat transfer systems with less than 300 employees as of 9/30/16. Its CEO s total compensation was $606,418 in 2016. No stock options were granted to its NEOs. NovaGold Resources 13.5 to 1 3/23/17 Precious metals company with 12 employees (excluding its CEO) as of 11/30/16, whose median pay was $400,000. First Real Estate Investment Trust 15 to 1 2/24/17 REIT with 40 employees (30 full-time; 10 part-time) as of 10/31/16. Northwestern Corporation 22 to 1 3/16/17 Electricity and natural gas company with a little over 1,500 employees (as of 12/31/2016) that has voluntarily disclosed CEO pay ratio since 2010. Without equity, ratio would have been 10 to 1. Range Resources 77 to 1 4/7/17 Natural gas, gas liquids and oil company with close to 800 employees as of 1/1/17. Noble Energy 79 to 1 3/2/17 Crude oil and natural gas company with approx. 2,300 employees (as of 12/31/16) that has voluntarily disclosed CEO pay ratio since 2014. 22
Pay Ratio Disclosure and Communications How McDonald s is Navigating the Pay Ratio Process Communication Strategies for Varying Constituencies: Board and Compensation Committee; Management and Employees; Shareholders and Proxy Advisory Firms; and Others (Customers, Media, etc.). 23
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