Corporate Governance

Stock Buybacks: Trouble in Paradise?

This week, the new Democrat SEC Commissioner, Robert J. Jackson, Jr., gave a speech in which he presented the findings of his staff’s research into how “buybacks  affect how much skin executives keep in the game.” Commissioner Jackson was a law professor who liked to conduct research before joining the SEC. Commissioner Jackson said that he often asked his students two questions when thinking about how to give corporate managers incentives to create sustainable long-term value:

  • Are we making sure that executive pay gives managers reason to invest in the long-term development of their workforce and their communities?
  • Or are we paying executives to pursue short-term stock-price spikes rather than long-term growth?

Commissioner Jackson noted that the theory behind paying executives in stock is to give them incentives to create long-term sustainable value. But, as he also pointed out, that only works when executives are required to hold the stock over the long term.

So when the Tax Cuts and Job Act was signed into law, Commissioner Jackson worried that we would see a repeat of what corporations did when the last corporate tax holiday was enacted in 2004–use the cash influx for stock buybacks and not necessarily  invest in long-term value creation. The first quarter of 2018 saw corporations buyback $178 billion in stock. So Commissioner Jackson and his staff studied 385 buybacks over the last 15 months and matched them to information on executive stock sales. They found:

  • A buyback announcement leads to a big jump in stock price–typically more than 2.5% during the 30-days after the announcement;
  • In half the buybacks studied, at least one executive sold shares in the month following the buyback announcement.
  • In the days before a buyback announcement, executives trade in relatively small amounts (less than $100,000 worth daily), but during the 8 days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day.

Commissioner Jackson did acknowledge that this stock trading by executives is not necessarily illegal. However, he finds it troubling as he see it as more evidence that executives are spending more time on short-term stock trading than long-term value creation.

Commissioner Jackson pointed out that, “Executives often claim that a buyback is the right long-term strategy for the company, and they’re not always wrong. But if that’s the case, they should want to hold the stock over the long run, not cash out once a buyback is announced. If corporate managers believe that buybacks are best for the company, its workers, and its community, they should put their money where their mouth is.”

Commissioner Jackson then called for the SEC to update its rules to limit executives from using stock buybacks to cash out from America’s companies. He also called for an open comment period to reexamine the SEC’s rules in this area to make sure they protect employees, investors, and communities given today’s unprecedented volume of buybacks.

Implications

At the very least, any company that has undertaken a stock buyback during the past 1 to 2 years, should know how their executives traded stock shortly after the announcement of their buyback. Companies should know which executives made these stock sales and the rationale for the sales. Companies should be prepared to answer questions about such transactions from their investors and the media. It also might be a good idea to review whether peers undertook stock buybacks during the past 1-2 years and how much stock was sold by their executives shortly after their buybacks were announced. Companies should review this data and know how they compare to their peers, and, if relevant, larger market players. Companies contemplating adopting a stock buyback should consider this emerging view as an additional point in their deliberations.

Executives should ensure that they are utilizing a Rule 10b5-1 stock trading plan, and have established such a plan when they do not have any material non-public information (such as the fact that the company is considering adopting a stock buyback plan). While a Rule 10b5-1 plan does not offer full protection to executives, it is the best currently available to protect them from allegations of illegal stock trading, assuming the plan is set up as required by the rule. If stock sales were made after a buyback announcement that did not utilize a Rule 10b5-1 plan, executives should ensure that all preclearance procedures were followed. To the extent that stock sales increased after a buyback announcement, executives should review the reason for such action and be prepared to discuss with their Boards or internal compliance officer.

Link to SEC Commissioner Jackson’s Speech

https://www.sec.gov/news/speech/speech-jackson-061118

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ISS Opens Its QualityScore Data Verification Window Through November 28

On November 13, 2017, ISS opened the data verification window for its QualityScore.  The data submission window will remain open until 8 pm Eastern on November 28. The data submission for both QualityScore and peer groups is doen through ISS’s Governance Analytics database, so a working user login is required for companies to make these submissions.

ISS at the same time released an updated technical document on QualityScore that details the factors that go into it, available at:

http://images.info.isscorporatesolutions.com/Web/ISSCorporate/%7Bec72720c-4c60-4f81-a5e6-ddf60de12b0c%7D_qualityscore-techdoc-13112017.pdf 

 

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ISS to Introduce QuickScore 3.0

ISS recently announced that it will be revising its corporate governance scoring system again this year.  The new system will be referred to as QuickScore 3.0 (when will ISS come up with some snappier titles for its sequels?). There will be a data verification period for companies from 9 am Eastern on November 3rd through 8 pm Eastern November 14th. QuickScore 3.o will then be released (into the wild?) at 9 am Eastern on November 24th.

ISS indicates that the changes embodied in QuickScore 3.0 include:

  • Enhanced methodology  which for US companies will include the disclosure of annual performance evaluations for the board, the presence of a controlling shareholder, a material degradation to the rights of shareholders, the existence of a sunset provision for companies with unequal voting rights, and the weighting of board gender diversity.
  • Closer examination of investigations to include review of the type of regulatory investigation and the materiality of penalties.
  • Enhancements to the company report to include historical scores, a log of data changes and trending analysis.
  • Exapaned coverage of 4,500 companies in 30 markets with deeper coverage of Europeans companies in the STOXX 600 and emerging market coverage for Brazil, Russia, South Africa, and the introduction of India, China, and South Korea in Q1 2015.

ISS has released a technical document for QuickScore 3.0 that lists the factors considered by QuickScore 3.0 for each region.  The document can be found at: http://www.issgovernance.com/file/products/qs3-appendix-final.pdf

The factors that will be considered under the Compensation subscore of QuickScore 3.0 for US companies include:

  • What is the degree of alignment between the company’s cumulative 3-year pay percentile rank, relative to peers, and its 3-year cumulative TSR rank, relative to peers?
  • What is the degree of alignment between the company’s 1-year pay percentile rank, relative to peers, and its 1-year TSR rank, relative to peers?
  • What is the size of the CEO’s 1-year pay pay, as a multiple of median pay for company peers?
  • What is the degree of alignment between the company’s TSR and change in CEO pay over the past five years?
  • What is the ratio of the CEO’s total compensation to the next highest paid executive?
  • What is the degree of alignment between the company’s annualized 3-year pay percentile rank, relative to peers, and its 3-year annualized TSR rank, relative to peers?
  • Are any NEOs eligible for multi-year guaranteed bonuses?
  • What is the ratio of the CEO’s non-performance-based compensation (All Other Compensation) to Base Salary?
  • Do the company’s active equity plans prohibit share recycling for options/SARS?
  • Do the company’s active equity plans prohibit option/SAR repricing?
  • Does [sic.] the company’s active equity plans prohibit option/SAR cash buyouts?
  • Do the company’s active equity plans have an evergreen provision?
  • Do the company’s active equity plans have a liberal CIC definition?
  • Has the company repriced options or exchanged them for shares, options or cash without shareholder approval in the last three years?
  • Does the company’s average 3-year equity grant rate exceed the greater of 2 percent and the average of its industry/index peers?
  • Did the company disclose a claw back or malus provision?
  • What are the vesting periods mandated in te plan documents for executives’ stock options or SARS in the equity plans adopted/amended in the last 3 years?
  • What are the vesting periods mandated in the plan documents, adopted/amended in the last three [sic.] years, for executives’ restricted stock/stock awards?
  • What is the holding/retention period for stock options (for executives)?
  • What is the holding/retention period for restricted shares/stock awards (for executives)?
  • What proportion of the salary is subject to stock ownership requirements/guidelines for the CEO?
  • Does the company disclose a performance measure for the short term incentive plan (for executives)?
  • What is the level of disclosure on performance measures fr the latest active or proposed long term incentive plan?
  • Did the most recent Say on Pay proposal receive shareholders’ support below 70%?
  • What’s the trigger under the change-in-control agreements?
  • Do equity based plans or other long term awards vest completely upon a change in control?
  • What is the multiple of pay in the severance agreements for the CEO (upon a change-in-control)?
  • What is the basis for the change-in-control or severance payment for the CEO?
  • Does the company provide excise tax gross-ups for change-in-control payments?
  • What is the length of employment agreement with the CEO?
  • Has ISS’ qualitative review identified a pay-for-performance misalignment?
  • Has ISS identified a problematic pay practice or policy that raise concerns?

We’ll have to see what impact this has on the QuickScores for US companies. However, base dont eh above, I do not think the changes will be too significant in the vast majority of cases.

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SEC Finishes Investigation of Big Lots’ Executives’ Trading

On May 21, 2013, Big Lots released this Form 8-K indicating that the SEC had concluded its investigation into executive trading and determined that no further action will be taken. Where’s the front page story in the Wall Street Journal announcing that? Where’s the infographic showing that the SEC decided not to take any further action?

Here’s the link to Big Lots’ Form 8-K announcing that the investigation was completed and no further action would be taken by the SEC:

http://www.sec.gov/Archives/edgar/data/768835/000076883513000040/big-8xkxotherevents.htm?goback=.gmp_2311483.gde_2311483_member_243466994

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