US proxy season looks set to be dominated by pay & diversity

Anticipation that the US Securities and Exchange Commission is due to finalise three remaining Dodd-Frank Wall Street Reform and Consumer Protection Act compensation rules as well as recent rulings from Delaware Courts will keep executive pay in the spotlight during 2016, according to Vivien Coates of law firm, Womble Carlyle Sandridge & Rice.

Coates said that due to increased scrutiny of board decisions involving director or executive remuneration, directors should consider whether their corporate governance practices could be enhanced by stepped-up periodic review of compensation practices and enhanced board and committee action documentation.

US investors have shown themselves willing to use the Delaware courts to question the compensation schemes of major companies and to make them more open to scrutiny, according to Coates. In a case brought last October an investor criticised the compensation that Facebook paid to its non-employee directors, which was approximately 46% higher than the director compensation paid by its peer group. Last month, as part of the settlement to resolve the dispute, Facebook agreed to improve its corporate governance practices by providing for an annual review of non-employee director compensation with the assistance of an independent compensation consultant; submit for shareholder approval the 2013 non-employee director award grants and Facebook’s annual director compensation program pay plaintiff’s attorneys’ fees to settle the lawsuit.

In another dispute a shareholder used Delaware’s Chancery Court to question the independence of Yahoo’s compensation committee. The Court ruled  that the shareholder could inspect Yahoo’s books and records—including, potentially, any relevant emails from Chief Executive (CEO) Marissa Mayer and Yahoo’s compensation committee members if such individuals chose to use a personal email account to conduct Yahoo business, in addition to any emails from their Yahoo corporate accounts—to investigate alleged excessive compensation to Yahoo’s former Chief Operating Officer, Henrique de Castro, assess the independence of the compensation committee and investigate the circumstances surrounding de Castro’s departure.

Additionally recent actions by the SEC enforcing Section 304 of the Sarbanes-Oxley has meant that chief financial officers could find themselves having to pay money back to companies – that may have been paid by way of bonuses – if they have forced to issues financial restatements as a result of misconduct even if they were not to have been found to have participated in the wrongdoing. The SEC forced the former CFO at Marrone Bio Innovations to repay money in this way. Coates said that this showed that companies needed to consider their policies or implement their one to ensure they can clawback money from executives if required.

US accounting firm BDO also highlighted new SEC requirements being implemented as part of the Dodd-Frank reforms as issues companies needed to be aware of during 2016. Most prominent of these is the requirement for public companies to disclose the ratio of the CEO’s compensation to that of the median employee in all annual reports or proxies beginning on 1st January, 2017.  Media reports of high ratios are likelty to attract attention, BDO notes, so companies neeeded to mitigate any negative press by proactively communicating the benefits of their performance focused executive compensation models to shareholders ahead of time.

The SEC also has a pending proposal that will require U.S. public companies to disclose the relationship between executive compensation paid and the company’s financial performance. The proposal will require a new proxy table that shows (over a multi-year period) compensation “actually paid” to the CEO and the average compensation “actually paid” to other named executive officers compared to the company’s total shareholder return (“TSR”) during that time.  An additional table will require a comparison of the business’s overall TSR relative to the TSR of its peer group.  Although an effective date for this new disclosure has yet to be determined, BDO reports, management should be monitoring TSR relative to those of its peers and be prepared to respond to any shareholder inquiries on the topic.

Shareholders are also encouraging companies to address the pay gap between men and women this year. Amazon had sought to prevent a shareholder resolution being put forward at its AGM this year by Arjuna Capital on behalf of Margherita Baldwin and Michael Baldwin, and Pax World Mutual Funds requesting the company to report on its policies and goals to reduce the gender pay gap. Amazon had argued to the SEC that the resolution could be rejected on the grounds that it was so inherently vague or indefinite that neither the shareholders voting on the proposal, nor the company in implementing the proposal, would be able to determine with any reasonable certainty exactly what actions or measures the proposal requires. However, the SEC has rejected Amazon’s arguments and does not believe the shareholder proposal can be omitted from its proxy papers. The activist shareholders are targeting technology companies on this issue with Facebook, Microsoft, Google, Expedia, Adobe and eBay facing similar resolutions.

Beyond pay issues BDO suggests that shareholders may also increasingly question whether audit committees have the appropriate experience to address increased responsibilities such as dealing with  with issues ranging from cybersecurity to foreign corrupt practices to whistleblower claims. It may be that shareholders will call on companies to appoint a separate risk committee composed of the proper expertise to provide oversight of these areas.

There has also been increased scrutiny of board diversity. The SEC has begun to look into existing company disclosures on board diversity and may consider a mandatory requirement for businesses to provide more specific information about the racial and gender composition of their boards and BDO said investors may push management to be proactive in addressing this issue before it becomes a requirement.

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