On September 21, 2017 the US Securities and Exchange Commission (SEC) issued interpretive guidance on the CEO pay ratio calculation and disclosure.  The pay ratio rule was adopted by the SEC on August 5, 2015 under the Dodd-Frank Wall Street Reform and Consumer Protection Act. It requires companies to disclose their CEO’s annual total compensation as a multiple of the annual total compensation of the median employee for the first fiscal year beginning in 2017.

The guidance came in the following three areas:

SEC Guidance

  • As long as the company uses reasonable estimates, assumptions, or methodologies (to identify the median employee or calculating any elements of annual total compensation for employees), the pay ratio itself and related disclosure would not provide the basis for an enforcement action from the SEC
  • A company may use internal records (such as tax or payroll records) to identify its median employee
  • For determining whether independent contractors are “employees”, companies may apply a widely recognized test under another area of law (e.g., tax or employment laws) that they would otherwise use to determine whether their workers are employees

Staff Guidance

  • Provides guidance and detailed examples on the use of statistical sampling

Revised Compliance and Disclosure Interpretations (C&DIs)

  • Adds a new C&DI that issuers can state the ratio is an “estimate”
  • Withdraws C&DI that primarily addressed the treatment of independent contractors and leased workers

The latest guidance now provides more flexibility for companies in determining the median employee, specifically as it relates to the use of statistical sampling and clarification of independent contractors. We will track pay ratio disclosure over the coming year and keep you informed of new developments as they occur.

CAP reviews proxy disclosures of S&P 500 companies on a weekly basis as part of an on-going Say on Pay study. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”) mandates that public companies provide shareholders with a non-binding vote on executive compensation every one, two or three years. This study tracks all Say on Pay and Say on Frequency related proposals and the corresponding vote results. (Updated September 12, 2017)

On February 6, 2017 the Acting Chairman of the US Securities and Exchange Commission (SEC) issued a Public Statement on Reconsideration of Pay Ratio Rule Implementation. The pay ratio rule was adopted by the SEC on August 5, 2015 under the Dodd-Frank Wall Street Reform and Consumer Protection Act. It requires companies to disclose their CEO’s annual total compensation as a multiple of the annual total compensation of the median employee for the first fiscal year beginning in 2017.

The statement indicated that “some issuers have begun to encounter unanticipated compliance difficulties that may hinder them in meeting the reporting deadline.” The SEC began a 45-day comment period for issuers to submit detailed comments on challenges they have experienced in preparing for compliance with the rule. Additionally, the staff was directed to determine whether additional guidance or relief is necessary.

Click on this link to see the full text of the Public Statement.

We believe pay ratio disclosure is an example of regulation that will be costly to implement and serves no clear purpose to benefit investors or American companies. We expect that a number of issuers will provide their comments on the challenges, cost and effort related to the preparation of compliance with the rule. This may be a first step in a major overhaul, delay or reversal of the rule.

In addition to the SEC’s Public Statement, it was reported by Bloomberg BNA that House Republicans “plan to introduce legislation to roll back the Dodd-Frank Act in mid-February”. Depending on the timing of any changes to the Dodd-Frank Act or the results of the comment review process, issuers may not have definitive direction before the summer.

We will track these issues over the coming year and keep you informed of new developments as they occur.

 

 

On February 3, 2017 President Trump issued an Executive Order entitled “Core Principles for Regulating the United States Financial System. “ While the Executive Order does not specifically mention the Dodd-Frank Act, it is widely viewed as the first step in a roll back of Dodd-Frank.

The Executive Order lays out Core Principles that are to be used by the Trump Administration to regulate the US financial system. The Core Principles talk about:

  • empowering the American consumer;
  • making American financial markets supportive of growth;
  • preventing tax-payer funded bailouts;
  • better enabling American companies to compete in global markets; and
  • making regulation efficient and subject to public accountability.

Click on https://www.whitehouse.gov/the-press-office/2017/02/03/presidential-executive-order-core-principles-regulating-united-states to see the full text of the Executive Order.

The Order directs the Secretary of the Treasury to consult the member agencies of the Financial Stability Oversight Council and report back to the President within 120 days, and periodically after that. The agencies are charged with reporting on the ability of existing regulations to promote the Core Principles, reporting on actions taken to promote the Core Principles and identifying any laws and regulations that are inconsistent with the Core Principles.

We expect the regulatory agencies to focus on regulatory oversight of the financial markets. Discussion to date in the business press has focused on issues such as bank capital requirements, the Volcker Rule and the designation of “systemically important financial institutions.” However, implementation of the Core Principles may impact executive compensation. As you know, the Dodd-Frank Act contains a number of regulations related to executive compensation, including Say-on-Pay and pay ratio disclosure, among others.

What do we expect to see? How will the Trump Administration impact executive compensation from a regulatory perspective?

Since the first report by the regulators is due by early May, we don’t expect the roll back to have a direct impact on the 2017 proxy season. By early May, most calendar year companies will have filed proxies and, in many cases, conducted their annual shareholder meetings. We expect that the regulations that have already been implemented, including Say-on-Pay, hedging disclosure, and Compensation Committee independence, will continue in effect for the foreseeable future. Not least because companies have already implemented these regulations and they are relatively benign. One could even argue that Say-on-Pay aligns with a populist agenda.

We do believe that a number of changes will occur over the course of the year. More than likely, we think pay ratio disclosure will be rolled back. It is a good example of regulation that will be costly to implement and serves no clear purpose to benefit investors or American companies. Certainly the business community does not support it. We expect the Trump Administration to roll it back and that would likely occur before the 2018 proxy season, when the new rules are scheduled to go into effect.

Regarding the regulations that have not been finalized, including clawbacks and pay and performance disclosure, we think it is more likely than not that neither will be implemented. Both of these issues are complex. One can argue that they duplicate existing policies and practices at many companies and that it is not necessary to give these rules the weight of law. As an example, shareholders have voted affirmatively to conduct Say-on-Pay votes on a regular basis, generally annually. In addition, our research indicates that most major companies have a clawback policy in effect. Even if these are no longer required under the Act, we expect most companies to continue current practices that support good governance.

We will track these issues over the coming year and keep you informed of new developments as they occur. It will certainly be interesting to watch as the Trump Administration makes its mark on our country’s regulatory framework.

In today’s post Dodd-Frank executive compensation market, most companies are familiar with, and many have implemented, “shareholder-friendly policies” such as clawbacks, hedging/pledging, and stock ownership guidelines. Further, companies have grown increasingly savvy on the executive compensation policies of shareholder advisory firms such as Institutional Shareholder Services (ISS) and Glass-Lewis—specifically as they relate to Say on Pay resolutions (SoP). Most executive compensation professionals—ourselves included—do not deny the influence on voting results when a company receives the dreaded Against recommendation from one or more of the proxy advisory firms. Our research shows that when ISS and Glass-Lewis recommend Against an SoP resolution, there is an approximate 20-30% and 5-15% reduction in the voting results, respectively.

Is this causation or simply correlation? Perhaps that question cannot be answered so easily, but it is possible to study how large institutional shareholders vote on SoP in order to try and understand what factors influence their voting. Companies are already aware of who their largest shareholders are, but an understanding of their voting policies and practices can provide insights on potential shareholder reaction to executive compensation program design, program modifications, and company performance.

To gain a deeper understanding of how large institutional shareholders tend to vote on SoP, CAP compiled a list of the top 25 institutional shareholders (in terms of assets under management) that were invested in at least 250 of the companies in the S&P 500 (“Institutional Shareholders”). CAP collected voting data from Proxy Insight, a leading provider of global shareholder voting analytics.

Among these Institutional Shareholders, 92% (23 out of 25) have their own “in-house” voting policies. What that means, is that even if ISS or Glass-Lewis makes a recommendation, the Institutional Shareholder will make the final determination on its voting decision. Based on 2016 voting results, Institutional Shareholders voted Against SoP 6.6% of the time, at median, for S&P 500 companies. When we expanded the scope of our review to all U.S. public companies, we found that Institutional Shareholders voted Against SoP 8.2% of the time, at median.

Source: Proxy Insight

Why do Against votes occur more frequently among all U.S. public companies compared to S&P 500 companies? This outcome could reflect that S&P 500 companies, in the aggregate, are larger and tend to have the resources to develop and maintain more balanced compensation programs. For example, a long-term incentive (LTI) program that is composed of a portfolio of time- and performance-based awards is viewed positively by institutional shareholders and is more common among S&P 500 companies versus all U.S. Companies. S&P 500 companies also have the capacity to lead more extensive shareholder outreach campaigns, which allows them to explain the rationale for their programs.

Although most Institutional Shareholders vote For SoP in most cases, there are some that will vote Against SoP 10% of the time or more. When voting on S&P 500 Companies, 5 out of 25 of the Institutional Shareholders vote Against 10% of the time or more. When voting on all US companies, 11 out of 25 vote Against 10% of the time or more.

Institutional Shareholder

Percent of Time Voting Against SoP

Institutional Shareholders Voting Against S&P 500 Companies 10% of the Time or Greater

Robeco/RobecoSAM

30%

BNY Mellon

27%

Dimensional Fund Advisors, Inc.

18%

California Public Employees’ Retirement System (CalPERS)

16%

Schroders

10%

Institutional Shareholders Voting Against U.S. Companies 10% of the Time or Greater

BNY Mellon

44%

Robeco/RobecoSAM

28%

Dimensional Fund Advisors, Inc.

23%

California Public Employees’ Retirement System (CalPERS)

20%

Canada Pension Plan Investment Board (CPPIB)

13%

Schroders

13%

AllianceBernstein LP

12%

T. Rowe Price Associates, Inc.

10%

AXA Investment Managers

10%

Principal Global Investors LLC

10%

RBC Global Asset Management, Inc.

10%

Source: Proxy Insight

CAP suggests that companies should track the voting tendencies of their major institutional shareholders, particularly if they vote Against more frequently. Companies may want to look at historical voting on SoP and should review their institutional shareholders’ proxy voting guidelines—particularly as it relates to compensation. For example, BNY Mellon voted Against SoP at 27% of S&P 500 companies and Against SoP at 44% of all U.S. companies. A review of BNY Mellon’s proxy voting guidelines states that they “consider proposals on a case-by-case basis in situations where:”

  • There are tax gross-ups or make-whole provisions in CIC/severance agreements
  • The company has poor relative stock performance, especially when compensation is deemed excessive compared to peers
  • The company fails to address compensation issues identified in prior meetings
  • There appears to be an imbalance between performance-based and time-based long-term incentive awards

Therefore, if one of your company’s major shareholders is an institutional investor that supports SoP less frequently, it is important to understand their voting guidelines, especially if your executive compensation program has practices or includes features that are viewed negatively (i.e. tax gross ups, 100% time-based LTI program, etc.).

Although most Institutional Shareholders have in-house voting policies, they do still subscribe to proxy advisory research from ISS and Glass-Lewis. Among Institutional Shareholders, 88% (22 out of 25) subscribe to ISS and 48% (12 out of 25) subscribe to Glass-Lewis. While there is only one out of these 25 Institutional Shareholders that generally automatically-votes with ISS (Principal Global Investors LLC), CAP determined that there is a correlation between an ISS or Glass-Lewis Against recommendation and voting results. When subscribing to ISS or Glass-Lewis, we found that Institutional Shareholders’ voting aligns with an Against recommendation, at median, 62% of the time for ISS subscribers and 31% of the time for Glass-Lewis subscribers. The data exhibits a greater correlation (approximately double) of vote alignment with an Against recommendation from ISS than Glass-Lewis. This may occur because Glass-Lewis recommends Against about twice as often as ISS does (16% of companies receive an Against recommendation from Glass-Lewis vs. 8% from ISS).

Source: Proxy Insight

As mentioned above, it is not easy to confirm whether the alignment of an Against recommendation from ISS or Glass-Lewis and voting outcomes is the result of causation or simple correlation—perhaps it is a bit of both. However, when companies are trying to understand the voting practices of their institutional shareholders, knowledge of how their institutional shareholders vote in relation to an ISS or Glass-Lewis Against recommendation is a valuable input, particularly in cases where the alignment is very consistent. Since the recommendation from ISS and Glass-Lewis precedes voting, companies can predict potential outcomes based on shareholder tendencies—particularly in cases where the institutional shareholders voting tendencies are correlated with an Against recommendation a high percentage of the time.

Institutional Shareholder

Percent of Time Voting with Rec.

Institutional Shareholders Voting with ISS Against Rec. Greater than 85% of the Time

Deutsche Asset & Wealth Management

99%

Principal Global Investors LLC

98%

Canada Pension Plan Investment Board (CPPIB)

97%

RBC Global Asset Management, Inc.

97%

Dimensional Fund Advisors, Inc.

96%

AllianceBernstein LP

91%

BNY Mellon

87%

Institutional Shareholders Voting with Glass-Lewis Against Rec. Greater than 50% of the Time

California Public Employees’ Retirement System (CalPERS)

75%

Dimensional Fund Advisors, Inc.

60%

BNY Mellon

57%

Source: Proxy Insight

In examples where Institutional Shareholders do not have a high correlation of voting with an ISS or Glass-Lewis Against recommendation, this can generally be attributed to those Institutional Shareholders that vote For SoP a high percentage of the time in line with their own voting policies.

In our view, it is important for companies to develop a compensation program that aligns with the business strategy, promotes shareholder growth while minimizing risk, and attracts and retains key talent. Once a framework is established, companies can then overlay an understanding of the voting practices of their institutional shareholders, including specific proxy voting guidelines, voting history, as well as the alignment of voting results with ISS or Glass-Lewis recommendations. This becomes more important in cases where the institutional shareholder votes Against SoP more frequently than the norm or follows ISS and Glass-Lewis recommendations a very high percentage of the time. While some companies may engage in comprehensive shareholder outreach programs, other companies do not have the resources for large-scale shareholder engagement. For these companies, an understanding of their institutional shareholder voting policies and practices becomes an important consideration when it comes to compensation program plan design.

Appendix

Institutional Shareholders Used in this Analysis

AllianceBernstein LP

Legg Mason Partners Fund Advisor, LLC.

AXA Investment Managers

MFS Investment Management, Inc.

BlackRock

Morgan Stanley Investment Management, Inc.

BNY Mellon

Norges Bank Investment Management

California Public Employees’ Retirement System (CalPERS)

Northern Trust Investments

Canada Pension Plan Investment Board (CPPIB)

Principal Global Investors LLC

Deutsche Asset & Wealth Management

RBC Global Asset Management, Inc.

Dimensional Fund Advisors, Inc.

Robeco/RobecoSAM

Federated Investment Management Co.

Schroders

Fidelity Management & Research Co.

SSgA Funds Management, Inc. (State Street)

Fidelity SelectCo

T. Rowe Price Associates, Inc.

Franklin Templeton Investments

Vanguard Group, Inc.

Goldman Sachs Asset Management LP

CAP is a leading independent consulting firm specializing in executive and director compensation and related corporate governance matters. Our consultants have served as independent adviser to Boards and senior management at many leading companies in the areas of compensation strategy, program design and in promoting sound corporate governance principles.

Highlights

Requirements of the SEC’s Final Rules:

Disclosure of

  1. the median of the annual total compensation of all employees, excluding the Principal Executive Officer (“PEO”), defined as A;
  2. the annual total compensation of the PEO, defined as B;
  3. the ratio of the amount in B to the amount in A, where A equals one, or alternatively, expressed narratively as a multiple

Example:

If A equals $50,000 and B equals $2,500,000, the pay ratio may be described as either “50 to 1” or “50:1” or the company may disclose that “the PEO’s annual total compensation is 50 times that of the median annual total compensation of all employees.”

Timing:

  • Reporting required for the first full fiscal year beginning on or after January 1 2017.
  • For calendar year companies, this means the proxy statement for the 2018 Annual Meeting

Exclusions: Smaller reporting companies, foreign private issuers, MJDS filers, and emerging growth companies

For the full report, download our PDF above.

Compensation Advisory Partners LLC (“CAP”) appreciates the opportunity to comment on Section 956(e) of the Dodd-Frank Act. CAP is a leading independent consulting firm specializing in executive and director compensation program design and related corporate governance matters. Our consultants serve as advisors to Boards and/or senior management at many leading companies, and have an interest in advancing sound corporate governance. A significant portion of our clients are financial institutions, including covered institutions.