Sunday, December 5, 2010
Staggered Board General Background for the Erudite Director: Staggered Boards have been permitted by Delaware since 1899. They are intended to provide continuity of board oversight and to enhance the bargaining power of a target's board by making in more difficult for a would be predator to gain control of the target without the board's permission. The "dark side" of staggered boards is that they may be used or perceived as tools of entrenchment, and expose their directors and management to criticism from proxy advisor firms and from gadflies and government/union pension fund shareholders. Staggered board are normally created under the terms of the Certificate and of the By-Laws. Typically, both instruments also require a super-majority vote (e.g. 2/3) to amend the staggered board. Reinforcement may also be furthered by including appropriate notice and/or written consent standards.
The Air Products Staggered Board was created by Certificate and By-Law language that proved to be vague when tested in actual circumstances. Although considered "standard" when created, the language was sufficiently lacking in clarity that the Delaware Chancery Court interpreted it to mean that the 3 year terms for the directors were only 3 terms (which could be less than a year in length so long as the began and ended at any time during a calendar year). This vagueness was exploited by Airgas, which had been engaged in a hostile takeover of Air Products and had launched a proxy contest when the Air Products Board declined the Airgas offers -- all of which had been at prices less than the market price. In the proxy contest, Airgas successfully ousted all Air Products directors in the class standing for re-election, and the Air Products stockholders also passed an Airgas sponsored by-law amendment accelerating the date for the next Air Products annual meeting by 8 months -- to January 2011 -- for the purpose of ousting the next class as soon as possible. The Chancery Court validated these actions, but the Delaware Supreme Court reversed.
The Dilemma & the Answer: Typically some flexibility for the annual meeting date is built into the by-laws, but having too much flexibility can undermine the protection intended to have been created by staggering the board. The solution is for the board to discuss, with counsel, where that unique board wants to come out on the matter and then be sure the language is drafted with more precision to achieve that outcome. For example, the Delaware Supreme Court noted that litigation could have been avoided if the language had stated that the annual meeting be held "as closely as practicable in the same month of each year."
Tuesday, October 19, 2010
- Director compensation is not subject to stockholder approval under Dodd-Frank.
- There must be a shareholder advisory say on pay vote at the 2011 annual meeting (or other meeting, whichever is first, held after January 21) and no less frequently than once every three years thereafter. The non-binding shareholder vote is required to cover the compensation of the named executive officers as disclosed under Item 402 of Reg SK, which means the tables, the narrative and the CD&A -- including the golden parachute compensation. And, of course, the CD&A must now discuss the impact of any shareholder votes on the comp committee's subsequent compensation determinations.
- At least once every 6 years, starting in 2011, stockholders must be given a separate non-binding (under the proposed rules) vote on how frequently to hold the say on pay votes. With limited exceptions, a non-binding frequency vote presented to the stockholders must be in a form that allows them to select from 4 choices: ONE, TWO or THREE years or ABSTAIN. This is NEW. Most proxy cards are structured FOR, AGAINST or ABSTAIN, and some service providers may not be able to reprogram their systems for a 4 choice vote (In that case, the SEC has provided a limited exception). Of course, management can make a recommendation regarding that frequency and is not bound by the vote, in any event. All other things being equal, we think an annual say on pay vote is preferable, even if the shareholders elect a different cycle. An annual vote makes it a routine matter and gives more immediate feedback to the Board and Management rather than delaying the conversation, building shareholder frustration and making the vote a major crisis when it finally arrives.
- The SEC has proposed a new table and disclosure regime for proxy statements on mergers, sales, asset sales, other changes in control etc. ( "CICc") and the related say on pay votes. The CICs format includes, among other things, a table breaking out in columnar form the golden parachute components for each NEO: cash, equity, pension/nqdc, perquisites/benefits, tax reimbursement, other and total. For their routine proxy statements companies can (but are not required to) choose to use the CICs format, in which event that disclosure and shareholder advisory vote will count when it comes time for a deal. If companies do not use the CICs format when seeking the regular say on pay vote, then another separate golden parachute vote is required in that Change in Control proxy statement. As expected, even if the CICs regime is used for routine meetings, additional disclosure and a separate vote would be required if the information in the table changes. The practice point, however, is that activist shareholders are expected to press companies (and send in comments to the SEC during the comment period) to utilize the more extensive tabular disclosure mandated by the CICs regime in its annual disclosure even where a merger or other change in control is not involved.
- Shareholder say on pay proposals may be excluded from the proxy statement to the extent they duplicate the votes presented to the meeting under Dodd-Frank.
- Broker discretionary voting of uninstructed shares, of course, is not permitted on these say on pay votes.
- These are just the highlights of most interest to directors. There are provisions for smaller companies and TARP companies and other changes and forms affected by the proposed rule. The rule can change. Comments are due by November 18, 2010, some time after which we should have a final rule.
Tuesday, October 5, 2010
Wednesday, September 8, 2010
This is not to suggest that money and effort will not be required. Corporate Governance is BIG BUSINESS with strong special interest groups and shareholders vested in the need for ongoing controversy to attract media attention and maintain full employment. Issuers do not get a "pass" by compromising or settling because controversy must continue or the corporate governance business dies. Now, as a result of Dodd Frank and the SEC, the business of corporate governance has gone viral, spreading to companies of all sizes (other than the micro caps for now). This is not about justice but about power. Management and boards who do not thoughtfully exercise their power will watch it transfer to special interest shareholders at the expense of shareholders as a group.
The dynamics of this evolving equity politics require boards to refocus on board basics:
- TSR -- Maintain and increase long term shareholder value
- Through OR -- Operating Results -- and IR -- enhanced Investor Relations and
- BICS -- Best Interests of the Corporation and Shareholders as a group.
And on three shareholder relations principles:
- KISS -- Keep It Simple Stupid,
- CAT -- Compensation Aligned with TSR and
- C2C -- Close to the Constituents.
The biggest challenge is to titrate just the right amount of additional funds, time, energy and effort to pro-actively deal with the new challenges and requirements. Visit our website HERE for our latest slide show on Questions Directors Should Ask Themselves and Management to be Prepared for 2011 as well as other materials forming a complete board primer on Dodd Frank and Winning the 2011 Proxy Season.
Tuesday, July 27, 2010
This post is a director’s summary of the key corporate governance provisions applicable to most public companies of the July 21, 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). See a Special Director's Primer on Dodd-Frank on my website (here), including a Director's Slide Show and a Management-Board Timetable to deal with the provisions discussed below.
Governance Changes with Potentially Large Impact
1. Proxy Access. The Act authorizes the SEC to require companies to include nominees submitted by shareholders and to follow certain procedures in relation to proxy solicitation materials. Stockholders who have held 3% of the company's stock for 3 years can nominate on the company's proxy statement the 25% (rounded down) of the current full board size (and at least one director in any event). On October 4, the SEC put its newly promulgated rules ON HOLD, pending the outcome of a lawsuit by The Business Roundtable and Chamber of Commerce. Most pundits do not expect the new rules to be in effect for the 2011 proxy season, but.... The legislation has increased the power of the more well organized and special agenda stockholders. While the rules are not likely to make hedge funds any more or less effective in their campaigns, the rules should lower hedge fund costs. Public employee, union and social activist funds will be the primary beneficiaries of proxy access, and many have director candidates at the ready. As a practical matter, however, rather than actually nominating competing candidates, these shareholders are more likely to use their new power in negotiations with management.
2. Majority Voting. The Act does not require majority voting for uncontested director elections. We expect public pension funds and union funds to continue to press issuers to voluntarily adopt majority voting because it is a relatively inexpensive, reasonably effective tool of intimidation. To use the majority voting weapon virtually requires no holding periods, minimum ownership requirements, responsible alternative candidates, alternative visions or business plans. We predict that issuers will successfully counter arguments for majority voting with the argument that proxy access obviates the need for – and is a more responsible approach than -- majority voting. Nonetheless, the proxy access power may be so significant in particular cases that the shareholder is able to negotiate a majority voting concession from management and the board.
3. Say-on-Pay. At least once every three years, a proxy statement must include a separate non-binding shareholder vote to approve the company’s executive compensation as disclosed in the proxy statement. At least once every six years, the shareholders must vote by separate resolution on the how frequently to have the say-on-pay vote ( every year, every two years or every three years). More frequent voting should keep the company in better touch with investors, reduce the likelihood of pent up shareholder anger and make the compensation issue “routine,” but issuers may be subject to other circumstances (e.g. cost constraints, labor union -such as the Carpenters Union -negotiations, etc.) that press for less frequent voting.
4. Pay Ratio Disclosure. Companies will be required to disclose the median annual total compensation of all employees other than the CEO, the annual total compensation of the CEO and the ratio of the two. These three data points, standing only in relation to each other and without context, are meaningless, will be misinterpreted and are potential flash points. It will be important for companies to provide that context – such as depth, scope and complexity of the business, number of employees, revenue, earnings, assets, geographic expanse and so forth to support the compensation level of the CEO. The compensation discussion and analysis portion of, and the new executive summaries in, proxy statements should be revised accordingly.
5. Responding to these Changes: Close to the Constituents. Briefly stated, Management and the Board, in a well-coordinated effort, must engage and listen to shareholders more than ever and make a concerted, continuous effort to provide meaningful shareholder education in a straightforward, understandable manner on every occasion, including the proxy statement. More on this in a separate update.
Lower Impact Governance Changes
6. Board Leadership and CEO Disclosures. The Act redundantly orders the SEC to require issuers to disclose in their annual proxy statements the reasons why the company has chosen to combine or separate the board chairman and CEO positions. This provision is substantially similar to current SEC regulation.
7. Broker Discretionary Voting. Stock exchanges must prohibit broker discretionary voting in connection with the election of directors, executive compensation or any other significant matter, as determined by the SEC. NYSE requirements already prohibit such voting in connection with the election of directors and equity pay plans. Adding additional areas of prohibition is not expected to make a difference in the outcome of these votes.
8. Say-on-Golden Parachutes. Proxy statements seeking shareholder approval of an acquisition, merger, consolidation or proposed sale of all or substantially all of a company’s assets must disclose “golden parachute” payments and, in the unlikely event this compensation was not previously voted upon under the regular say-on-pay votes, must include a separate nonbinding shareholder resolution to approve such agreements. This provision, like many of the corporate governance provisions of the Act, is redundant. Companies already discuss these agreements on an annual basis in the proxy statements, and the golden parachutes will be part of the mandated regular say-on-pay voting. Furthermore, in the unlikely event that a precatory vote on the parachute is required, what is the impact if the stockholders were to vote in favor of the deal but against the parachute?
9. Compensation Committee Composition. Stock Exchanges are to require compensation committees to meet new “independence” standards that include consideration of the source of compensation for the director (such as consulting, advisory or other compensatory fees paid by the company) and whether the director is affiliated with the company. The vast majority of committees already meet these standards.
10. Compensation Committee Consultant Standards. Compensation committees will be required to consider certain independence factors (to be determined by the SEC) with respect to their consultants, legal counsel and other advisers. Companies are required to disclose the performance and possible conflicts of interest of compensation consultants. These provisions have some procedural implications, none of which is material. Many companies already have these policies in place.
11. Compensation Committee Authority. The Act redundantly grants compensation committees the power of hiring and overseeing compensation consultants, legal counsel and other committee advisers and requires companies to provide appropriate funding for these advisers. These practices are already in place for the vast majority of committees.
12. Pay-for-Performance Disclosure. The Act requires companies to disclose in their annual proxy statements the relationship between executive compensation and the company’s financial performance, basically as measured by total shareholder return. Many issuers are already following this practice.
13. Compensation Clawbacks. Companies must develop, implement and disclose policies with respect to the clawback of incentive-based compensation paid to current or former executive officers following a restatement. For all but a handful of companies, complying with this requirement will be an academic exercise.
14. Hedging disclosure. Issuers must disclose in their annual proxy statements whether employees or directors of the company are permitted to hedge any company equity securities granted as compensation or otherwise held. Issuers and Boards who have not yet adopted anti-hedging policies should do so, but we expect the impact of the legislation in this area to be negligible.
Changes Affecting Certain Classes of Companies
15. Financial Institution Compensation Restrictions. Bank holding companies and certain other financial institutions will be prohibited from providing executive officers, employees, directors or principal shareholders with compensation that is excessive or that could lead to material financial loss to the financial institution. The SEC already requires disclosure of such compensation, and we have come across no proxy statement of any financial or other institution acknowledging that compensation of this nature is being paid to employees.
16. Disclosure of Say-on-Pay and Say-on-Golden Parachute Votes by Institutional Investors. Institutional investment managers subject to Section 13(f) of the Securities Exchange Act of 1934 must disclose their say-on-pay and say-on-golden-parachute voting records annually. Mutual funds already make these disclosures. The Act has broadened the list to include other institutional investors (e.g. banks), but if the previous experience with mutual fund disclosure is any guide, this requirement is another non-event.
17. Board of Director Requirements for Nationally Recognized Statistical Rating Organizations. The Act substantially increases the oversight, liability, disclosure obligations and procedural requirements for credit rating agencies. In addition, at least one half of the Board (and no fewer than two) directors must be “independent” as described in the Act, and some of them must be users of the ratings. Director compensation must not be linked to corporate performance and must otherwise be structure to “ensure” independence of judgment. The maximum term of board service is a non-renewal 5 years. Among their duties, directors are required to oversee policies and procedures for determining credit ratings, conflicts of interest and the effectiveness of internal controls for credit rating. Compliance with this requirement is not expected to be burdensome.
18. Smaller Public Companies Permanently Exempt from Sarbanes-Oxley Internal Control Requirements. The Act exempts smaller public companies from compliance with the internal control auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act. This is good news for these companies, who had previously been relying on the SEC’s discretion (which had run out) in postponing the effective date.
Sunday, June 20, 2010
This post is about using the hunt for asymmetric risks, primarily "black swans" and "ugly ducklings" as one tactic or tool in risk oversight and governance.
1. There is no shortage of advice, literature, regulations and consulting services concerning the board's role in risk oversight. See, for example, this recent excellent post from Marty Lipton, the NACD's publication and KPMG Advisory's risk methodology, not to mention current SEC proxy statement requirements.
2. Asymmetric risk, however, is under appreciated. The current regulation and advice on risk management would probably only identify asymmetric risk if it already happened to be associated with excessive compensatory inducement or coincidentally to be among the top business risks identified at the company for the CEO and Board through such methods as red, yellow and green color coding.
3. Asymmetric risk is risk that is catastrophically and collaterally disproportionate to its catalyst. 911 was caused by a handful of militant extremists; the current economic collapse, initiated by handfuls of non-C-suite individuals; the Putnam meltdown, by one employee broker; and the BP disaster, apparently by operational level decisions (e.g. reportedly deploying only one blind shear ram in the blowout preventer rather than two, under-designing the well, omitting a cement quality test, and not installing appropriate capping devices at the top of the well).
4. The "black swan" type of asymmetric risk gets its name from the pre-Darwin era in Europe, where the only swans known were white. Black swans were not known until Australia was explored. Black swan asymmetric risks are driven by inadequate information or poor data quality.
5. The "ugly duckling" type of asymmetric risk derives from the famous childhood story of seeing what appears to be an ugly baby duck only to have it develop into a gorgeous swan. Ugly duckling asymmetric risks are driven by bad judgment. It is a cygnet misjudged as an ugly duckling.
6. Asymmetric risks are particularly difficult to identify because (1) they are caused by people or events beyond the board's (and often management's) visibility, (2) detection requires time for attention and reflection from employees, management and directors -- all of whom are pressed for time and for whom issue prioritization is an ongoing challenge, (3) comprehending the threat's import requires a shift in the frame of reference to a "stop, look, listen and visualize-outside-the-norm" mentality and (4) the employees most likely to know the most about these risks are typically beyond management and the board's normal visibility.
7. There are two reasons for the Board and CEO to pay special attention to asymmetric risks. The potential for massive company, constituent and collateral damage is life threatening to the company and its many publics. Secondly, asymmetric risk hunting should result in a good indication of the quality of the company's risk management program.
8. Here are five areas of questions the CEO-Board team could explore to contribute to minimizing asymmetric risks and to testing the quality of the risk management program:
A. Highlight the Risk Class. Ask that all asymmetric risks be separately identified and added as items to be covered in the risk management program, including giving them line item treatment in management's risk reports and by adding them to the list of the Board's topics overseen, about which specific questions will be asked.
B. Seek the Overlooked Data. Seek and ask for the outliers, dissenting reports and "contrary" information in connection with these reports and presentations. For example, a report last year to Transocean indicated that single blind shear rams on blowout preventers were 99% reliable and that having two increased reliability only to 99.3%, there have been only 62 failures out of almost 90,000 government-designed tests and two thirds of the rigs in the Gulf today only have one shear ram in their blowout preventers. On the other hand, numerous reports have called out the "single-point failure vulnerability of the ram's hydraulic shuttle valves, another study reported that of 11 real-life cases where crews had lost control of their wells, the blowout preventers failed 45% of the time, in 2003 a BP crew faced a situation where they decided to activate both blind shear rams in the blowout preventer to prevent a disaster such as the Deepwater Horizon's loss of control over the Macondo well, and (last, but not least) some one or more employees at BP have been sufficiently concerned about this issue to equip the blowout preventers on 11 of BP's 14 Gulf rigs with two shear rams. Instead, the Board's SEC filings show that the Safety Committee was focused on refinery safety rather than drilling safety (and - in another PR misstep - that the Board obtained "Deeds of Indemnity" shortly after the explosion occurred).
C. Insist on Responsible Judgment. Ask that the risk reports and presentations include a discussion of risks, issues and areas where poor judgment calls at all levels of the company might be made and the nature of what those potential poor judgment calls might be. Ask whether the tone at the top and the company's culture supports responsible judgment.
D. Stand in the Field of 600 Dead. Ask yourselves and the members of the company's risk management team to form a "fresh" frame of mind to understand the significance of what is being detected and communicated in those efforts, reports and presentations. The late Rick Rescorla (the hero of Morgan Stanley who, as its head of security, saved 2700 employees on September 11 because of his individual foresight and persistence in training them for emergency evacuation) warned the Port Authority officials BEFORE THE FIRST GARAGE BOMBING of the Twin Towers and again LONG BEFORE THE PLANES STRUCK. He also tried, to no avail, to persuade Morgan Stanley to move out of the World Trade Center because he had thought about and understood the asymmetric risk. No one at the top listened. No one created that special attentiveness or had the life experience or took the time to "scenario think" to understand and give proper weight to what Rick was saying. Rick (who fought in some of the bloodiest battles in Viet Nam) has often been quoted as having said "They never stood in a field of 600 dead people and thought about what men could do to each other."
E. Find the "One." Identify the key employees who truly "know" -- who are the company's Rick Rescorla -- and discuss the advisability of having a presentation from, or conversation with, them.
I wish you "good hunting."