By Laura J. Finn
Executive compensation remains a top focus of the regulatory issues facing executives and board members.
Executives and directors need to keep abreast and informed of current regulatory issues their companies face and the potential impacts on their organizations. For proxy season 2019 that means paying attention to the following five top issues.
1. Pay Ratio Disclosure
For most companies, last year’s disclosure was a non-event. Companies learned three important lessons, according to Todd Sirras, managing director of executive compensation consulting firm Semler Brossy. First, this disclosure adds no insight into executive pay practices. Second, the true driver of pay ray ratios is scale and labor intensity. And third, median employee pay is not related to scale. With companies choosing for themselves the metrics to use in creating this ratio, there wasn’t a consistent way to compare ratios between companies and industries.
Shareholders have so far responded to the new rule with more concern over median employee pay and the perception that employees are being paid less than their colleagues, rather than the ratio itself. But don’t discount this new disclosure yet.
“Simplicity makes the CEO pay ratio likely to become more prominent as time passes,” Sirras wrote.
2. Final Rules on Smaller Reporting Companies
Last summer, the U.S. Securities and Exchange Commission voted to broaden the definition of a smaller reporting company to increase eligibility and provide relief from some of the reporting requirements enacted under the Sarbanes-Oxley Act.
Skadden cautions that while companies who are now eligible to file as a small reporting company “may benefit from cost savings in the form of reduced compliance costs, it is not clear at this point whether the markets will counter some of these savings in the form of higher capital costs tied to less fulsome disclosures, particularly as it relates to financial statements.”
3. Hedging Practices
Section 955 of the Dodd-Frank Act requires companies to disclose the hedging practices and policies by employees and board directors. The rule goes into effect for most firms in July, with a delay for smaller reporting companies. Although this isn’t in effect for the current proxy season, compensation committees need to be aware that these disclosures will be required next year.
“It’s a pretty simple disclosure compared to all the many others and it isn’t controversial,” says Donald Kalfen, a partner at Meridian Compensation Partners. But companies will need to figure out how to handle such a broad disclosure. “Generally disclosures are for [named executive offices], but this more broad than what is in the [compensation discussion and analysis],” Kalfen says.
That is because the hedging policy applies to all employees, even rank and file employees that may or may not own stock.
In the SEC’s publishing of the final rule on hedging by employees, officers, and directors, it noted that out of 100 S&P 500 companies, 97 have hedging disclosure policies for named executive officers. Seventy-seven of those companies have policies for boards of directors, and about 50 do for non-executive employees, with smaller percentages for smaller reporting companies. The SEC noted a lack of uniformity on reporting this matter.
Proxy advisory firms Institutional Shareholder Services and Glass Lewis both view hedging by employees and board members as an unfavorable practice. Kalfen notes that the hedging policy “is not as dicey as pledging policies. But no hedging is good for boards, because you’re betting against your company’s success.”
4. Say-on-Pay and Say-When-on-Pay Votes
In 2008, Aflac scored positive press for being the first American company to give its shareholders a say-on-pay vote, before it was required. Eleven years later, say-on-pay remains a top regulatory consideration for companies, along with its sister regulation, say-when-on-pay (annually, biennially or triennially. Warning: companies choosing triennially have an uphill battle with investors.)
Last year, “a record number of companies (72) failed to receive majority support, the most failures in any years since 2011 when SOP was first effective,” according to consulting firm Mercer. This year, to ensure a majority on this advisory vote, “companies should tell a good story on why their compensation programs benefit shareholders and disclose performance goals and results in a manner that is succinct and easy to follow,” advises law firm Pillsbury Winthrop Shaw Pittman.
5. Political Spending Disclosure
Political activity, spendings and disclosures are the most popular shareholder proposal ahead of the 2020 elections, according to Proxy Preview 2019, a report from As You Sow, Sustainable Investments Institute, and Proxy Impact.
For the first time ever, asset manager BlackRock discussed political spending in its proxy voting guidelines, stating “we believe that companies which choose to engage in political activities should develop and maintain robust processes to guide these activities and to mitigate risks, including a level of board oversight.”
This topic falls into the top five regulatory concerns because the U.S. House of Representatives is considering a bill that would require public companies to disclose political expenditures in their annual reports. With a divided government, this may be a long shot, but a topic worth reading up on, nonetheless.
Also in the early stages is the SEC’s draft recommendation regarding human capital management. For now, the draft recommendation is under review and SEC Commissioner Jay Clayton has stated that he doesn’t believe in imposing “rigid standards or metrics for human capital on all public companies.”