Ed Hauder's Equity Compensation Blog

RMG Issues FAQs on New SEC Proxy Disclosure Rules

RiskMetrics Group (RMG) recently issued several FAQs related to the new SEC proxy disclosure rules.  Previously, I blogged about the RMG FAQ regarding Compensation Risk Disclosures, and today I will address the two other FAQs, one on compensation consultant conflicts and the other on the enhanced disclosure about directors – qualifications, diversity policies, and board leadership and risk oversight of risk management.

Compensation Consultant Conflicts

RMG was asked whether it would do with compensation consultant fee disclosures.  RMG indicated that since this disclosure is new, it is waiting to gather and analyze the data after the proxy season and develop any new policies in consultation with its clients.  So stay tuned, this one has the feel of the director overboarding issue and the tax gross-up issues which RMG first took some time to study and then came out with policies that directly dealt with the issues.

Directors Enhanced Disclosures

RMG was asked what its views and the prospects for related voting recommendations were given the new director qualifications, diversity policies, and board leadership and oversight of risk management disclosures. Again RMG deferred a bit indicating that it was waiting to gather information and analyze the disclosures made this proxy season, but would not implement any policy changes as a result of these disclosures for 2010.  My guess is that RMG will study the disclosures made, discuss the issues internally and with its clients and develop a set of new policies for 2011 that will seek to encourage a minimum level of disclosure on these issues and some minimum level of corporate governance as to this items.

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RiskMetrics Weighs In on Compensation Risk Disclosures

The new proxy disclosure rules (Item 402(s) to be precise) require public companies to include a narrative disclosure discussing the company’s compensation policies and practices as they relate to the company’s risk management if risks arising from the company’s compensation policies and practices for its employees are “reasonably likely to have a material adverse effect on the company.” The new rule does not require a company to provide a negative disclosure, e.g., “We reviewed our compensation policies and practices and found no material adverse risks.”

Speculation is that the SEC Staff likely will focus on this Item 402(s) disclosure as part of its review of proxies filed during the 2010 proxy season. However, it is unclear whether these comments will be primarily filed this proxy season as it is the first in which this disclosure will be in place, and will then be somewhat dropped going forward.

Companies considering how and where to address this disclosure item in their proxies need to also consider a FAQ issued yesterday by RiskMetrics Group (along with 2 others I’ll deal with in another post):

What will RiskMetrics be looking for in the new disclosure requirement on risks raised by compensation programs? In particular, how will RMG react to non-disclosure?

RMG understands that issuers typically do not like to provide negative disclosures (e.g., “we found no material adverse risks caused by compensation”) due to concerns over liability, and the SEC generally does not require them to make such statements. As a result, some companies may choose to say nothing in their proxy statement this season with regard to searches for material adverse effects from pay which conclude there are no such risks. While RMG does not have a policy regarding non-disclosure, we advise issuers to, at a minimum, talk about their process and any mitigating features (such as claw-backs or bonus banks) that they have adopted. We view this disclosure as an opportunity for communication, not simply compliance, and we expect that shareholders will be looking for a reasonably substantive discussion of the board’s process to determine whether the company’s incentive pay programs might motivate inappropriate risk-taking, and what they are doing to mitigate that.

RMG’s view may spur a few companies to address the risks associated with their compensation policies and practices and any risk assessment that was conducted.  However, note that this is not an RMG policy. As such, it is not required that companies follow this guidance from RMG or risk a negative vote recommendation against directors or an equity compensation plan proposal. That being said, companies may be better off coming up with a paragraph of disclosure that walks through the steps they have in place that mitigate any risks that exist, i.e. clawback provisions, stock ownership guidelines, stock retention guidelines, a particular balance of compensation, the performance goals utilized, mechanisms like bonus banks to keep a portion of previously “earned” compensation at risk, etc.  Doing so would be far more instructive to shareholders about what is currently in place to help mitigate risks than any statement that says, we found no risks to exist.  As such, this type of statement is likely to be well received by RMG and would not necessarily require a company to include a dreaded negative disclosure (“We determined after a careful review and assessment that Company does not have any risks  from its compensation policies and practices for its employees that are reasonably likely to have a material adverse effect on the Company”).

Of course, the next question is where to place this disclosure? I think most folks realize that it does not have to (and in the vast majority of cases should not) be included in the Compensation Discussion & Analysis (CD&A) section. However, the SEC Staff has issued guidance (C&DIs, Regulation S-K, Q. 128A.01) to the effect that it expects the Item 402(s) disclosure to be with the other Item 402 disclosures on compensation and would not expect it to be hidden, obscured, or difficult to locate. So, perhaps this should go somewhere in the narrative section following the Summary Compensation and the Grants of Plan-Based Awards Tables.

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Sample RMG Burn Rate Commitment Language

Last week I blogged about the new burn rate commitments that RiskMetrics Group’s (RMG’s) Research Group was accepting.  Thanks to a reader, I’m now able to share sample burn rate commitment language that was supported by RMG:

The Company commits to a three-year average burn rate for the years 2010, 2011 and 2012 not to exceed the higher of two percent of the Company’s weighted average common shares outstanding or the blended mean plus one standard deviation of the Company’s GICS group for 2009 and 2010.  The blended mean plus one standard deviation for 2009 and 2010 is equal to X% (GICS cap of Y% in 2009 and Z% in 2010).  For purposes of this burn rate calculation, each stock option award granted will count as 1.0 shares while each Full Value Award granted will count as 2.5 shares.

Notes:

1. The blended mean plus one standard deviation (X) is the average of the 2009 (Y) and 2010 (Z) brun rate means plus one standard deviation for the Company’s GICS industry group per RMG’s Burn Rate Tables for 2009 and 2010.

2. The count for Full Value Awards (2.5) was established based on RMG’s currently-calculated volatility for the company (i.e., the volatility calculated by RMG for purposes of analyzing the company’s 2010 proxy proposals)  and RMG’s 2010 Burn Rate multiplier table.

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Another Burn Rate Commitment RiskMetrics Should Consider

Well, as expected, RiskMetrics Research Group is being a little flexible when it comes to companies’ burn rate commitments for 2010 (for the full details, read this blog entry). But, as I indicated, given the speculative nature of two of the new allowable options, I don’t think many companies will easily undertake such commitments.

After giving this some thought, it seems to me that what RiskMetrics needs to do is provide an interim commitment equal to their current 3-year average burn rate or the applicable cap for their GICS under the 2010 caps, which would apply until either (1) the 2011 Burn Rate caps are typically produced and released, or (2) the 2011 Burn Rates and caps are produced on an accelerated basis, say by June 30, 2010, or September 1, 2010. This would allow companies to commit to maintaining the burn rate at a reasonable level for a short period of time (no more than 1 year) until such time that RiskMetrics can pull, clean and assemble the 2011 Burn Rate Data.  At that point, companies could then commit to either (1) maintaining their Burn Rate for the remaining portion of the 3 year period to the new 2011 Burn Rate cap, or (2) one of the other alternatives already set forth. This would enable companies to be in a better position to evaluate what they were committing to before obligating themselves.  If not, and companies need RiskMetrics approval, I foresee a greater number of companies utilizing cash-settled equity vehicles such as cash-settled SARs and cash-settled RSUs, which don’t count towards burn rate as calculated by RiskMetrics.

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Changes to RiskMetrics Group’s Burn Rate Commitment Policy

RiskMetrics Group just announced that its Research Group is allowing companies some flexibility in their burn rate commitments for 2010. Companies that have a 3-year average burn rate that exceeds their GICS industry group cap must either publicly commit to maintaining their burn rate for the next three years at the burn rate cap for their GICS industry group as determined by RiskMetrics for that year or face a negative vote recommendation on their equity compensation plan proposals from RiskMetrics.

Some of the approaches that RiskMetrics’ Research Group has found acceptable include:

1. Committing to the average between the 2009 and the 2010 RiskMetrics burn rate caps,
2. Committing to the average between the 2010 and the 2011 RiskMetrics burn rate caps, and
3. Committing to the 2010 cap for one year, the 2011 cap for one year, and the 2012 cap for the last year.

As a result of the significant declines in the RiskMetrics Burn Rate Caps for 2010 (discussed here), RiskMetrics had little choice other than to work with companies on this issue.  I’ve spoken to companies that were willing to let RiskMetrics recommend against their plans as a result of this policy and would then discuss with their shareholders how inflexible RiskMetrics was being on this issue given the dramatic shift in burn rate caps. It sounds like RiskMetrics’ Research Group heard this message and decided that some flexibility was warranted.

I think this will make the commitment a little easier for companies to swallow, but the last two options do present their own concerns. Yes, equity grants (# of awards granted) probably increased on average for 2009.  Yes, that data was not included in the burn rate caps that RiskMetrics came out with for 2010. Yes, when those 2009 grants get factored into the 2011 burn rate caps, the caps will likely rise from where they sit for 2010.  But by how much and to where exactly?  Good questions, with not very good answers at this time. Hence, the last two options are a little less certain for companies but offer an opportunity for an increase in the rate a company commits to, but the exact extent of it will be unknown until subsequent years, but they should be better than simply committing to the 2010 burn rate caps.

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