Transcript Presentation title - Posternak Blankstein & Lund LLP

Wall Street Reform and Executive Compensation
A briefing on the Dodd-Frank Act
November 16, 2010
Boston NASPP
Overview of Dodd-Frank Act
Overview of Dodd-Frank Act
Overview

The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law on July 21 by
President Obama

This landmark piece of legislation addresses a range of issues, including:

Banking regulation

Consumer protection

Regulation of private placements and private investment funds

Executive compensation and governance reforms

This presentation outlines the key executive compensation and governance provisions included
in the legislation, and the likely impact on executive compensation next year and beyond

Note that the Act directs the Securities and Exchange Commission (SEC) and the securities
exchanges to interpret the law and make new rules, many of which are yet to come
© 2010 Hay Group. All Rights Reserved
3
Overview of Dodd-Frank Act
The impact of regulatory reform – a new world order


Dodd-Frank is a law that enhances the power and influence of your company’s institutional
shareholders on executive and director pay matters

Access to more and “better” information about pay programs (via disclosure rules)

Regular opportunity to tell directors how they feel about their pay decisions (via say on pay)

Institutional investment managers must disclose how they voted

Changes to broker voting, which will dilute the impact of the more typically management-friendly
votes

Institutional shareholder advisory groups gain more power (ISS, Glass Lewis)

CEO pay ratio – a meaningless statistic designed to embarrass executives & directors
Shareholders will be forced to be more vocal on these issues, inside and outside of say on pay
© 2010 Hay Group. All Rights Reserved
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Overview of Dodd-Frank Act
Dodd-Frank Act: key executive pay and governance provisions
Area
New authority for
shareholders
New disclosures
Independence
standards
Provision
Description
Say on pay vote
Gives shareholders an advisory vote on exec pay – rules proposed,
effective for meetings held after 1/21
Golden parachute vote
Gives shareholders an advisory vote on payments related to a changein-control – rules proposed, may be effective for meetings held after
1/21
Proxy access
Gives shareholders greater ability to nominate their own director
candidates – delayed in court challenge
CEO pay ratio
Requires disclosure of CEO pay to median employee pay
Pay for performance
Requires disclosure of relationship between pay and company financial
performance
Chairman / CEO roles
Requires disclosure of rationale on whether or not to split
Comp committee
Requires that committee members be “independent” and that they have
the ability to retain their own counsel and consultants
Consultants
Requires the committee to consider factors relating to the
“independence” of their advisors
© 2010 Hay Group. All Rights Reserved
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Overview of Dodd-Frank Act
Dodd-Frank Act: key executive pay and governance provisions (cont’d)
Area
Provisions that apply
to shareholders
Managing the risk
profile of
compensation
Provision
Description
Broker discretionary voting
Prohibits member brokers from voting customer shares without
receiving their voting instructions – already in effect
Disclosure of investment
manager voting
Requires annual public disclosure of how institutional investment
managers vote on say on pay and golden parachutes – rules proposed
October 2010
Clawbacks
Requires disclosure of company policy on clawbacks, including
recoupment of excess pay in the event of restatement
Employee and director
hedging policies
Requires disclosure of any policies in place relating to ability to hedge
the change in value of the company stock
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and
Governance Provisions
Key Executive Pay and Governance
Provisions
SEC Issues Rulemaking Calendar


October –November 2010

Proposal regarding Shareholder votes on Executive Compensation and Golden Parachutes

Propose exchange listing standards on Compensation Committee Independence, Compensation
Committee advisor independence and Compensation Committee consultant conflicts
January – March 2011



Adopt Rules Regarding Shareholder votes on Executive Compensation and Golden Parachutes
April – July 2011

Adopt exchange listing standards on Compensation Committee independence, Compensation
Committee advisor independence and Compensation Committee consultant conflicts

Propose rules regarding disclosure of pay-for performance, pay ratios and hedging by employees
and directors
After July 2011

Under development
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Pay / Say-on-Frequency / Say-on-Golden Parachute

SEC issued proposal on Shareholder approval of Executive Compensation / Golden
Parachute on October 18, 2010

Comment period on proposal through November 18, 2010

Effective Dates

For first Annual or Other Meeting of Shareholders occurring on or after January
21, 2011 for which proxy rules require executive compensation disclosure

Proxy statements filed before January 21, 2011 for meetings after such date must
include Say on Pay / Say on Frequency

Effective regardless of status of SEC proposal

Disclosure around Golden Parachute arrangements in merger proxy NOT effective
until final rules issued
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Pay / Say-on-Frequency / Say-on-Golden Parachute

(ISS Proposals)
Say-On-Pay

ISS’ Executive Compensation Evaluation policy applies to Say-On-Pay

Policy consists of three sections:


Pay for performance

Problematic pay practices

Board communication and responsiveness

Recommendations issued under the Executive Compensation Evaluation policy will
apply to Say-On-Pay if on ballot
If egregious practices are identified, or if a Company previously received a negative
recommendation on a Say-On-Pay resolution related to an issue that is still on-going, ISS
may also recommend Withhold votes against Compensation Committee members
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Pay / Say-on-Frequency / Say-on-Golden Parachute

Say-On-Frequency


ISS will adopt a new policy to vote in favor of companies providing for annual Say-On-Pay
Say-On-Golden Parachute


(ISS Proposals)
ISS will vote case-by-case on proposals to approve the Company's golden parachute
compensation, consistent with ISS policies on problematic pay practices related to
severance packages
Final “2011 Proxy voting Guidelines” to be issued in late November
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Pay

Non-binding Shareholder advisory vote on the compensation of the Company’s named executive
officers

Vote covers all named executive officers’ compensation

Covers CD&A, compensation tables and other Item 402 disclosure

Does not cover directors’ compensation

Does not cover disclosure about compensation policies and practices as they relate to risk
management and risk taking in general

Smaller reporting companies do not have to include CD&A

No preliminary proxy statement required

No discretionary broker voting

Future mandatory disclosure in CD&A on how Board has taken into account Say-on-Pay results

Smaller reporting companies do not have this requirement but may need to disclose in narrative
disclosure
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Pay

SEC is NOT prescribing specific form of resolutions for Shareholder advisory vote

Sample 1 (CitiGroup)


Sample 2 (Verizon)


Resolved, that the shareholders approve the overall executive pay-for-performance compensation policies and
procedures employed by the Company, as described in the Compensation Discussion and Analysis and the
tabular disclosure regarding named executive officer compensation, together with the accompanying narrative
disclosure, in the proxy statement.
Sample 3 (Motorola) (not meant to comply with new rules)


Resolved, that the stockholders approve the compensation of executives, as disclosed pursuant to the
compensation disclosure rules of the Securities and Exchange Commission, including the compensation
discussion and analysis, the compensation tables and any related material disclosed in this proxy statement.
Resolved, that the stockholders approve the overall executive compensation policies and procedures
employed by the Company, as described in the Compensation Discussion and Analysis regarding named
executive officer compensation (together with the accompanying narrative disclosure) in this Proxy Statement.
Sample 4 (Intel) (not meant to comply with new rules)

Do you approve of the Compensation Committee’s executive compensation philosophy, policies, and
procedures as described in the ‘Compensation Discussion and Analysis’ section of this proxy statement
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Frequency

Non-binding Shareholder advisory vote in proxy statements for annual meetings to determine
whether the Say-on-Pay vote will occur every 1, 2 or 3 years

First vote to be held at first annual or other meeting requiring executive compensation disclosure
following January 21, 2011 and then held not less often than every six years

Proxy card to allow for following choices: 1, 2, 3 years or abstain

Board may recommend a choice, but proxy statement must be clear that vote is a choice and not
a vote for or against

Disclosure in Form 10-Q during period in which Say-on-Frequency occurs stating Board’s decision
on frequency


Disclosure of Shareholder advisory vote on Form 8-K (Item 5.07) within four business days still
in effect
If Board policy consistent with plurality vote on Say-on-Frequency, Company may exclude
shareholder proposals on Say-On-Pay
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Golden Parachute

Two Parts to Say-on-Golden Parachute

Separate Non-binding Shareholder advisory vote



On “any agreements or understandings that such person [Company] has with any named executive officers of such issuer (or of the
acquiring issuer, if such issuer is not the acquiring issuer) concerning any type of compensation (whether present, deferred, or
contingent) that is based on or otherwise relates to the acquisition, merger, consolidation, sale or other disposition of all or substantially
all of the assets of the issuer” (Golden Parachute)
New disclosure obligations for Golden Parachute (In connection with seeking approval of merger)

Disclosure of any agreements Company has with NEOs (or NEOs of Acquiring Company) concerning compensation that is based on
transaction

Proposed rules provide more detailed disclosure than existing requirements to describe “substantial interest” by executive officers and
directors

Acquiring Company has similar disclosure obligations if it is seeking shareholder approval as well
Although not required under Dodd-Frank, SEC amended other forms to require Golden Parachute disclosure:

Going private transactions (Schedule 13E-3)

Third party tender offers (Schedule TO and 14D-9)

Bidders required to disclose Target Company’s Golden Parachute compensation arrangements after reasonable inquiry

Registrations statements on S-4 containing disclosure on mergers and similar transactions

Proxy solicitations that do not contain merger proposals but require Item 14 disclosure of Schedule 14A
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Golden Parachute

No specific language or form of resolutions proposed by SEC

Smaller reporting companies must comply

Shareholder advisory vote NOT required for:

Golden Parachute compensation between Acquiring Company and NEOs, but disclosure still
required

Golden Parachute compensation previously approved in an annual meeting S-O-P vote, but


Approval of existing change of control disclosure does not satisfy this requirement

New arrangements or revised terms would still be subject to separate vote
Annual meeting with no merger or similar vote (discretionary)
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Golden Parachute

New Tabular Disclosure (Item 402(t) of Regulation S-K)

If in merger proxy, assume triggering event took place on latest practicable date, and price per
share is closing price on latest practicable date

If in Annual meeting proxy, assume triggering event took place at year end and price per share
is closing price at year end

Multiple Tables required if approving Revisions or Amendments to Golden Parachutes only
Golden Parachute Compensation
Name
Cash
Equity
Pension
/NQDC
Perquisites
/Benefits
Tax
Reimbursement
Other
Total
PEO
PFO
A
B
C
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Golden Parachute

Cash – Cash Severance payments (base salary, bonus, pro rata non equity incentive
plan payments)

Equity – Dollar value of accelerated stock awards, in the money options for which
vesting accelerated, payments in cancellation of stock and option awards

Pension – Pension and non qualified deferred compensation benefit enhancements

Perquisites -- Perquisites and other personal benefits and health and welfare (No
de-minimus exceptions; no exception for non discriminatory health and welfare plans)

Tax Reimbursements - 280G tax Gross Ups

Other – Any other arrangements not called for above

Total – All elements listed above
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Say-on-Golden Parachute


New Tabular Footnote disclosure

Each separate form of compensation to be quantified

Individual perquisites and personal benefits to be identified and quantified

Separate footnote identifying

Amounts attribute to “single trigger” and “double trigger” arrangements

Time frames for “double trigger” events
Narrative Disclosure

Succinct narrative disclosure of any material facts necessary to understanding Golden
Parachute Compensation

Specific circumstances that would trigger payments

Payments to be made in lump sum or over time

Who is to make payments

Material conditions to receipt of payments or benefits

Non compete, non solicitations, non disparagement

Duration of such agreements and provisions on waiver or breach
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Proxy Access

Company’s proxy materials to provide shareholders with information about, and ability
to vote for, a shareholder or shareholder group’s nominee

Proxy Access included in Dodd Frank, although SEC had previously issued proposed
rules in 2009

Effective Date was to be November 15, 2010

Legal Challenge: SEC has stayed Effective Date until resolution of Business
Roundtable and Chamber of Commerce suit challenging new rule

Some states including Delaware have amended their state corporate law to allow
companies to adopt proxy access procedures
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Proxy Access

Ownership Requirements: significant, long-term stake required

Shareholder (or group) must own 3% of total voting power

Shareholder must have investment AND voting power over shares



Borrowed shares NOT included

Short shares NOT included;

Shares on loan MAY BE included if:

Shareholder has right to recall shares

Shareholder recalls shares if nominee included in proxy
Three year prior holding period, with intent to hold shares through date of election
Eligibility

Not available for shareholder seeking “change of control”

Not available for nominee or shareholder that has agreement with Company regarding the nomination

Nominee, if elected, must not violate federal or state law or rules of national securities exchange

Nominee must satisfy objective standards of independence

Subjective Board determination required by national exchanges does not apply
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Proxy Access

Number and Priority of Nominees


Greater of:

1 or

25% of Board, rounded down

Shareholder (or Group) with largest holdings given priority (regardless of timing of notice
filing (Schedule 14N)

Shareholder Nominee will count against limit even if Company allows nominee to be
unopposed
New Schedule 14N to be filed by Shareholder

To be filed with SEC between 150 and 120 days before anniversary of mailing date of
Company’s definitive proxy statement for previous year:

Up to 500 word statement of support

Certification that nomination is not intended to result in change of control

Information on share ownership, shareholder, and nominee
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Proxy Access


Deadlines

Company to notify shareholder within 14 days after deadline for Schedule 14N if NOT
including nominee

Shareholder has 14 days to correct any eligibility or procedures deficiencies

Company to notify SEC if excluding shareholder nominee at least 80 days before filing of
definitive proxy statement

Shareholder to be notified no later than 30 days before Company files definitive proxy
statement that shareholder nominee included
Other Points

Shareholder (or Group) may use Schedule 13G, unless they are conducting other
activities that trigger Schedule 13D

Shareholder proposals on proxy access procedures permitted under proxy rules
© 2010 Hay Group. All Rights Reserved
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Key Executive Pay and Governance
Provisions
Compensation Committee / Expansion of Comp Disclosure / Clawbacks



Independence of Compensation Committee and Advisors

Compensation committee members must meet new independence standards to be
established by the national securities exchanges.

Committee must have authority to retain its own compensation consultants, legal counsel,
and other advisors, but only after the committee has considered whether they are
“independent” based on factors identified by the SEC.
Expansion of Executive Compensation Disclosure

The relationship between “executive compensation actually paid” and corporate financial
performance;

The ratio between CEO total compensation and the median total compensation of all
employees; and

Policies on employee and director equity hedging.
Clawbacks

Companies will be required to implement a “clawback” policy requiring current and former
executive officers to return erroneously-paid incentive compensation (including equity)
received during the three-year period preceding an accounting restatement due to
material noncompliance with any accounting requirement.
© 2010 Hay Group. All Rights Reserved
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What to expect going forward
What to expect going forward
More conservative practices

“Cleaner” pay practices across the board

Perquisites to continue their decline

Gross-ups on change-in-control payments

Single-trigger on equity will rapidly move to a double-trigger

Severance multiples

Less targeting of the 75th percentile – more targeting of the median
© 2010 Hay Group. All Rights Reserved
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What to expect going forward
Greater pressure on share pools

Share usage and dilution are critical issues for your company’s institutional shareholders, and
their advisory groups



Harder to get shares in 2011

Linkage between vote on shares and “say on pay”

Used to get five years’ worth – now we’re lucky to get three
Eligibility to be restricted in some companies



This issue has never been more acute after a 2009 in which share consumption jumped in
most companies
Average salary levels for equity-eligible employees continue to increase
Greater use of cash-based LTI and phantom stock in others

David Ellis’ CNN Money, July 12 - Phantom stock may be the next big thing in employee pay

Liability accounting, tracking and administering cash-based performance plans = fun for stock
plan administrators
How do you retain your “next level” when you lose the perfect retention vehicle?
© 2010 Hay Group. All Rights Reserved
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What to expect going forward
Greater use of relative performance measurement


Two events driving this:

In some sectors, uncertainty is making absolute goal-setting difficult

Disclosure of relationship between financial performance and pay
The new disclosure requirement provides shareholders with all the information they need to conduct
a relative pay-for-performance analysis fairly easily


No Board will want to explain why they underperformed their three largest competitors but also
increased the CEO’s TDC
Could have substantial implications for HR, accounting teams and stock plan administrators

Greater use of relative TSR programs  valuation complexity

Puts a premium on ability to track “performance condition” plans to handle quarterly true-ups

Puts a premium on the communications to employees about how the plan is tracking, as relative
performance makes it much harder for the average employee to predict payouts

May require use of third party benchmarking resources, depending on the performance measure
© 2010 Hay Group. All Rights Reserved
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What to expect going forward
More companies will consider premium-priced or performance-vested option plans



The “pay ratio” requirement is the silliest of all provisions within Dodd-Frank

A meaningless statistic without accounting for organizational structure, job size, etc.

Was a top focus of business lobby

Nonetheless, Boards will start looking at it too, and what gets watched, gets addressed
CEO TDC is driven primary by the LTI, which will prompt Boards to look for ways to lower the grant
value of LTI while still giving the CEO significant upside opportunity

Hence, premium-priced or performance-vested options

Both plans will have lower valuations than plain vanilla stock options
Alternatively, some Boards will explore raising pay levels throughout the organization…


Which will not be a tenable solution long-term
However, this runs counter to the concern about dilution – the lower the value, the more you have to
grant (theoretically)

Regardless, expect some companies with large ratios to dust these plans off
© 2010 Hay Group. All Rights Reserved
29
What to expect going forward
The other things to watch for

Never underestimate the power of director embarrassment

Board consultants to stop doing any other work - period


Less use of traditional HR firms, more use of the boutiques

Has implications for other areas of HR where the same consultant is used for various services
Tracking of previously-exercised stock options may become more detailed

Clawback provision to apply to stock option gains, not just bonuses

Assessing how much to claw back will become quite an exercise
© 2010 Hay Group. All Rights Reserved
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What to expect going forward
Preparing for 2011

These provisions will cause most compensation committees to reexamine their programs in light
of the new requirements and required disclosures as they determine what programs should look
like in 2011

Some companies will naturally react to look for comfort in replicating what peers are doing –
seeking out the “middle ground”. We are cautioning our clients that there is no safety in this
“middle ground”, and that changing programs to look the same as that of peers may very well be
an adverse outcome

The one area where we expect companies to find defensibility in their programs – regardless of
the actual features of those programs – is in linkage to strategy

Companies need to explore every element of their pay program and redouble their efforts to
ensure their program maintains a strong link to business strategy, and that this gets clearly
communicated to shareholders

Not just disclosure, but active and targeted communication
© 2010 Hay Group. All Rights Reserved
31
What to expect going forward
The questions to ask – and answer – before next year

Does the mix of pay – or emphasis on fixed vs. variable pay, on annual vs. long-term
performance – link to the time horizons of the company’s key challenges?

Does the use of long-term incentive vehicles – or emphasis on stock performance vs. strategic
performance vs. ownership – map to the way in which the company intends to create value?

Does the make-up of top executives’ vested and unvested share holdings provide sufficient
sensitivity to changes in the stock price to make a significant – but not excessive – difference
in the value of those shares?

Are the performance measures chosen for the incentive plans linked to the strategic plan, and
adequately controllable by executive behavior?

Are the performance levels selected for the incentive plans calibrated to the strategic plan,
representative of true incremental value creation, and set at levels that are reachable?

If there are “other” components of the program – perquisites, severance or change-in-control
provisions, and the like – can their link to strategy be identified and rationalized?

Taken together, the answers to these questions should provide a read on the degree to
which the current program is linked to strategy, and provide a platform for shareholder
communication
© 2010 Hay Group. All Rights Reserved
32
What to expect going forward
Key discussion areas
Area
What makes business sense?
What do shareholders
want?
Where’s the breaking
point?
Pay philosophy
Pay positioning that maps to competitive
positioning
Pay positioning that maps to
competitive positioning
Targeting P75 without P75
performance
Pay mix
Mapping pay mix to key time horizons for the
business
>50% in LTI for CEOs
>50% in STI
Performance
measures
A balance that rewards something when
returns are low but the team outperforms
High absolute returns AND relative
outperformance
Big payouts when shareholders
lose
STI / bonuses
Allowing some discretion when warranted
Balancing financial and strategic measures
Formula-driven financial
performance
Overriding the formula with big
discretionary payouts
LTI
Performance-vesting when linked to the “right”
measures and key milestones
Less dilution
Performance-vesting
Lack of a performance-vested
vehicle
Perquisites
Some of these, some of the time
None of them
Gross-ups
Change in
control
Incentive for executives to be thinking in the
best interest of shareholders
Double-triggers
2x payouts (from 3x)
Single triggers – even on equity.
And gross-ups
Managing risk
in pay
Some balance – but not too much
Pay profile that maps to the risk profile
Balance, but with a focus on
shareholder value
One measurement that drives
most of the pay
© 2010 Hay Group. All Rights Reserved
33
Questions?
Speaker contact information
Michael Andresino
Posternak Blankstein & Lund LLP
Boston
617-973-6113
[email protected]
David Wise
Hay Group
Metro New York
201-557-8406
[email protected]
© 2010 Hay Group. All Rights Reserved
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