February 1, 2010
The current economic and regulatory landscape poses unprecedented challenges for public companies and their boards of directors. They are facing scrutiny from shareholders, Congress, regulators and the public, and new proposals to address the causes of the financial crisis have been emerging on almost a daily basis for over a year now.
Some of these proposals have been adopted and some remain under consideration at a time when calendar-year companies are preparing for the 2010 proxy season, complicating the planning process. Of particular note, in December, the Securities and Exchange Commission ("SEC") adopted new proxy disclosure rules that likely will be a focal point for public company directors, as the new rules relate to disclosures regarding the composition and operation of boards of directors. This memorandum is an update of our client alert covering considerations for public company directors in the current environment issued on October 15, 2009.
1. Executive Summary
As we discuss in more detail below, among the key areas for boards to consider now are:
a. Director Elections. Boards and companies should take a holistic approach to the director election process, considering the potential impact that the loss of broker discretionary votes will have on director elections at the upcoming annual meeting, as well as the effect of majority voting, "notice and access" (also known as "e-proxy") and expected voting recommendations of the major proxy advisory firms. In addition, directors should know how their companies will respond to the new disclosures required by the SEC relating to director qualifications and experience and board diversity.
b. Executive Compensation Practices and Disclosures. Boards and compensation committees should evaluate their companies’ compensation practices and policies in light of the current environment, including the strong possibility of federal legislation requiring an advisory vote on executive compensation, or "say on pay." Beginning with the 2010 proxy season, the new SEC rules require disclosures relating to the risks created by employee compensation plans and information about the use of compensation consultants. In addition, boards and compensation committees should be aware of executive compensation practices that institutional investors and proxy advisory firms frown upon (such as tax gross-ups and "golden coffins" providing post-death benefits) and those that they advocate, such as "hold-through-retirement" provisions and "clawback" policies.
c. Board Leadership. Boards and companies should expect a continued spotlight on the issue of board leadership in the coming months. In light of the new required proxy disclosures about board leadership structure, boards should consider why their current leadership structure is appropriate. At companies that combine the positions of chair and CEO, consideration should be given to what, if any, steps should be taken to enhance the independent leadership of the board, such as by appointing or enhancing the role of a lead director. In addition, as part of the succession planning process, the board should consider what leadership structure may be appropriate in the future.
d. Risk Oversight. Boards should consider whether they have the appropriate structure and processes in place for overseeing the major risks facing their companies and how board oversight relates to management’s role in assessing and managing risk. The board should be comfortable that it understands key risks and how the risks relate to the company’s business and strategy. Boards, and those who advise them, should think carefully about how the board is spending its time and see that the board has adequate time to address critical issues such as strategy and risk. In addition, boards should review their companies’ new required disclosures about the board’s role in risk oversight.
e. Shareholder Engagement. Boards should know what their companies are doing to engage shareholders, recognizing that, more than in the past, directors may play a greater role in reaching out to shareholders. Initiating dialogue before a major issue arises helps build a relationship so that the company is not approaching a major shareholder for the first time to discuss a critical subject.
f. Shareholder Proposals for the 2010 Proxy Season. For the 2010 proxy season, shareholder proposals seeking the appointment of an independent chair and proposals seeking an advisory vote on executive compensation continue to be popular. In addition, executive compensation in general is a frequent subject of shareholder proposals. Also, under recent SEC staff guidance, proponents will have an easier time getting proposals on management succession and risk oversight in the company’s proxy. Finally, shareholders’ ability to call special meetings, shareholders’ ability to act by written consent and supermajority voting provisions also are frequent subjects of shareholder proponents.
2. Director Elections
Boards and companies should consider the impact that the loss of broker discretionary votes, and other relevant developments, may have on the election of directors at their annual meetings.
A. Loss of Broker Discretionary Votes
The 2010 proxy season is the first without broker discretionary votes in uncontested director elections. As a result of changes to NYSE Rule 452 (the "broker vote rule") that took effect January 1, brokers that do not receive specific voting instructions from customers that hold shares in "street name" will not be able to vote those shares in director elections at a company’s annual meeting. The rule in effect in past years gave brokers discretion to vote uninstructed customer shares in uncontested elections; historically, brokers have cast these votes largely in favor of company nominees.
Because this rule change addresses the conduct of brokers, it affects voting at both NYSE- and NASDAQ-listed companies. The loss of broker votes may affect the outcome of director elections, particularly at companies with majority voting, and at mid- and small-cap companies which tend to have more retail shareholders. With the assistance of their proxy solicitors, companies should do modeling, using 2009 voting results, to assess the anticipated impact of not having broker votes. In evaluating the extent of this impact, companies should consider the cumulative effect of no broker votes in the election of directors, majority voting, "notice and access" (also known as "e-proxy"), and expected voting recommendations of the major proxy advisory firms. Companies also should evaluate whether any of their directors are potentially vulnerable to "vote no" campaigns.
At companies with majority voting, the loss of broker votes will not result in increased votes "against" director nominees, but could lower the percentage of votes cast "for" director nominees. A similar result could occur at companies that still have plurality voting with a director resignation policy requiring that their director nominees tender a resignation if they do not receive a majority of "for" votes. The impact of no broker votes will depend on the composition of a company’s shareholder base and the percentage of institutional versus retail ownership. Companies, particularly those with larger retail ownership, should consider enhancing investor communication strategies to encourage retail shareholders to instruct their brokers. At a minimum, companies should use the proxy statement to highlight this change and emphasize the importance of voting at the annual meeting.
This is particularly true for companies that opt to use e-proxy to distribute their annual meeting materials because e-proxy has reduced retail shareholder voting levels. Companies may want to consider using e-proxy only for non-retail shareholders or subsets of retail shareholders. In addition, companies that are considering whether to adopt majority voting, or use e-proxy, may wish to defer doing so until after the 2010 proxy season so they have an opportunity to assess what, if any, impact the loss of broker votes has on director elections.
B. Disclosures about Director Qualifications and Diversity
Boards should expect that the backgrounds of their director nominees will receive greater scrutiny due to new rules the SEC adopted in December that require companies to provide proxy disclosure, for each director and nominee, about the particular experience, qualifications, attributes and skills that qualify the director to serve on the board. Companies should expect to devote additional time to gathering information, and preparing disclosures, about their directors’ qualifications and backgrounds. These disclosures also may become a focal point for proxy advisory firms in formulating recommendations about how shareholders should vote on particular nominees. In addition, companies now also must disclose whether, and if so how, the nominating/governance committee or board considers diversity in identifying director nominees. If the nominating/governance committee or the board has a policy with regard to the consideration of diversity, companies also must disclose how that policy is implemented and how the board or committee assesses the effectiveness of the policy.
The new director qualification and diversity disclosures are just one component of an increasing focus on board composition and the director nominations process that has emerged in recent years. During this time, boards and their nominating/governance committees have become increasingly deliberate in assessing board composition and seeking director candidates who possess relevant expertise. At the same time, institutional investors increasingly are looking for evidence that a board is evaluating its evolving needs, assessing the effectiveness and contributions of existing directors and making changes when appropriate. Boards and nominating/governance committee now routinely engage in a process of considering the background and expertise of existing directors and the specific needs of the board when seeking new board members. They also are conducting targeted efforts to identify and recruit individuals who have specific qualifications identified through this process. In deciding whether to recommend incumbent directors for renomination, nominating/governance committees are taking a critical look at the skills and contributions that individual directors bring to the board. In addition, some boards are conducting more formal individual director evaluations outside of the annual renomination process. Boards and nominating/governance committees should periodically evaluate their board membership criteria, as well as their processes for identifying and evaluating director candidates and for evaluating incumbent directors, whether in connection with the renomination process or otherwise. In addition, as part of the new director qualification and diversity disclosures, we expect that many companies will discuss their processes for assessing the skills and qualifications currently on the board and the skills and qualifications the board may need in the future.
C. Impact of Proxy Advisory Firm Recommendations
Companies also need to look carefully at whether the major proxy advisory firms, RiskMetrics Group, Inc. and Glass Lewis & Co., are likely to recommend "against" or "withhold" votes with respect to their director nominees. RiskMetrics Group and Glass Lewis typically recommend "against" or "withhold" votes with respect to directors who do not meet the firms’ own independence standards—which are stricter in some cases than those of the major stock exchanges—if these directors serve on any of the three "key" committees (audit, compensation and nominating/governance). Both firms also generally issue "against" or "withhold" recommendations on compensation committee members where a company has certain pay practices that the firms view negatively (see section 3 below on "Executive Compensation"). For the 2010 proxy season, RiskMetrics Group has updated its voting policy on director elections to clarify that it will consider issuing a negative voting recommendation if, with respect to service on a different board, a director has had significant involvement with a failed company and/or has appeared, in RiskMetrics Group’s view, not to have acted in the best interests of all shareholders.
During the 2009 proxy season, there was a significant increase in the number of directors who failed to win majority support (up from 32 directors in 2008 to 93 in 2009), as well as an increase in the number of "against" or "withhold" votes that directors received, according to RiskMetrics Group. The most common situations where directors faced opposition in 2009 involved: (a) non-independent directors serving on key committees; (b) directors being "overboarded"—that is, serving on outside boards in excess of limits set by RiskMetrics Group; (c) companies taking "unilateral" actions without shareholder approval, such as adopting poison pills or conducting option exchanges; and (d) companies not implementing shareholder proposals that received majority votes in prior years.
Without the broker vote, votes from institutional shareholders may have a greater impact than in prior years, increasing the influence of proxy voting recommendations, particularly where a company’s institutional shareholders adhere closely to these recommendations. In addition, the voting recommendations of the proxy advisory firms are likely to have a greater impact at companies with a significant institutional shareholder base. Companies should analyze their institutional shareholder base to assess how closely different institutions follow these voting recommendations and reach out to these institutions as appropriate (see section 6 below on "Shareholder Engagement").
D. Proxy Access
Boards and companies should continue to monitor developments with respect to the SEC’s proxy access proposed rules. The SEC re-opened the comment period for its proxy access proposals to allow interested persons to comment on additional data and analyses that were submitted on or after the close of the original comment period. The reopened comment period has now closed, and the SEC likely will act on the proposals later this winter. Although it is widely expected that the SEC ultimately will adopt some form of proxy access, it is unclear whether that will include a mandatory federal proxy access right, a regime that allows proxy access proposals under the SEC’s shareholder proposal rules, or some combination of the two, such as a mandatory federal regime that companies can opt out of based on a shareholder vote. Depending on the rules ultimately adopted by the SEC, companies may need to amend their bylaw provisions regarding director nominations in preparation for the 2011 proxy season or, for companies with annual meetings later in the year, the 2010 proxy season.
3. Executive Compensation
Boards and compensation committees should evaluate their companies’ compensation practices and policies in light of the current environment, where executive pay practices continue to face heightened scrutiny and public anger. In addition, there are new disclosure requirements beginning with the 2010 proxy season, and Congress is widely expected to enact some form of "say on pay" legislation in the coming months. In evaluating their policies and practices, boards and compensation committees should assess not only the amount and form of compensation paid to the company’s executives, the risks created by compensation policies and practices, and other substantive aspects of the company’s compensation programs, but also matters relevant to the compensation decision making process, such as the role of compensation consultants.
A. New Disclosures for the 2010 Proxy Season
In December, the SEC adopted rules that require companies to discuss and analyze their overall compensation policies and practices for employees generally, including non-executive officers, if the risks arising from the incentives created by these policies and practices are reasonably likely to have a material adverse effect on the company as a whole. The SEC has stated that its prior rules already required disclosure in the compensation discussion and analysis ("CD&A") section of the proxy statement to the extent that these risk considerations are a material aspect of the company’s compensation policies or decisions for named executive officers. The new rules include examples of the types of situations that potentially could trigger disclosure as well as the types of information to be disclosed if disclosure is required. It will be necessary to brief the compensation committee about whether any non-executive compensation policies may incentivize conduct that is reasonably likely to contribute materially to a company’s business risks, and management will need to review the policies in order to make that assessment. In addition, the compensation committee should be comfortable that it understands any significant risks that may result from incentives created by compensation policies and decisions applicable to named executive officers and other senior executives.
The SEC’s new rules also include enhanced disclosure requirements relating to compensation consultants. Motivated by concerns that consultants’ relationships with management may compromise the independence of the advice they provide compensation committees, several institutional investors have called for the elimination of these potential conflicts while others have called for increased disclosure of consultants’ services. The new rules require companies to provide enhanced disclosure about compensation consultants that provide advice to the board, compensation committee or management regarding executive or director compensation if the consultants also provide other services to the company. Specifically, if a compensation consultant that provided advice or recommendations to the board or compensation committee on the amount or form of executive and director compensation provided additional services to a company in excess of $120,000 during the fiscal year, the company would have to disclose: (1) the aggregate fees paid for work related to determining or recommending executive and director compensation; (2) the aggregate fees paid for all additional services; (3) whether management had a role in the decision to engage the consultant for the additional services; and (4) whether the board or compensation committee approved all of the additional services. Also, if the board or compensation committee did not engage a compensation consultant, but management engaged a compensation consultant to provide advice or recommendations on the amount or form of executive and director compensation and the compensation consultant provided additional services to a company in excess of $120,000 during the fiscal year, the company would have to disclose the aggregate fees paid for work related to determining or recommending executive and director compensation and the aggregate fees paid for all additional services. Disclosure would not be required if the compensation consultant’s services were limited to: (1) consulting on a broad-based plan that does not discriminate in scope, terms or operation, in favor of executive officers or directors and that is available generally to all salaried employees; and (2) providing information that either is not customized for the company or that is customized based on parameters that are not developed by the compensation consultant and about which the compensation consultant did not provide advice.
In addition, there is legislation pending in Congress on this subject. In July, the House of Representatives approved the "Corporate and Financial Institution Compensation Fairness Act of 2009," which would require that any compensation consultants or other similar advisors to the compensation committees of listed companies meet independence standards to be developed by the SEC. Moreover, on an annual basis, companies would have to disclose in their proxy statements whether or not they retained an independent compensation consultant. The Senate Committee on Banking, Housing & Urban Affairs began considering a bill sponsored by Senator Christopher Dodd (D-CT) in November called the "Restoring American Financial Stability Act of 2009" that contains a similar provision.
B. Say on Pay
Boards and compensation committees should prepare for the strong possibility that federal law will soon require public companies to give their shareholders an advisory vote on executive compensation, also known as "say on pay." The "Corporate and Financial Institution Compensation Fairness Act" (discussed above) and the "Restoring American Financial Stability Act of 2009" (discussed above) each contain a provision mandating say on pay votes at public companies but with an implementation schedule that would delay its effectiveness until after the main 2010 proxy season.
In the meantime, companies that have received majority or high votes on say on pay shareholder proposals in 2009 should be preparing to address say on pay now, as they are likely to face pressure from institutional investors to act voluntarily. Whether or not they already have received a say on pay shareholder proposal, companies should assess their compensation practices and compensation disclosures, with a particular focus on the CD&A. Revisions that may be appropriate due to the prospect of say on pay include reorganization of the CD&A to highlight the connection between performance and specific pay decisions, enhanced disclosure of performance measures and "total compensation" calculations, and more informative explanations of benchmarking standards and of the bases for significant compensation decisions.
Since 2007, shareholder proposals requesting that companies provide for an annual advisory vote on executive compensation have become increasingly popular and have received high votes. According to RiskMetrics Group, say on pay shareholder proposals received approximately 46% support at 76 meetings in 2009, including 24 proposals that received majority support. Shareholders have submitted 40 say on pay proposals for 2010 as of January 29. Moreover, in the past several years, at least 41 companies, including Intel Corp., Motorola Inc., Verizon Communications Inc. and Goldman Sachs Group Inc., have agreed to hold an advisory vote on executive compensation, either voluntarily undertaking to provide for these votes or doing so in response to shareholder proposals. In addition, approximately 400 companies that received funds under the Troubled Asset Relief Program ("TARP") were required by law to hold a say on pay vote at shareholder meetings held in 2009. In 2009, company-sponsored say on pay votes garnered high support for the companies’ executive compensation programs, with approximately 88% of votes cast at 139 meetings for which results are available, according to data from RiskMetrics Group. Notably, although RiskMetrics Group recommended votes "against" the company say on pay proposals in a number of instances, there has yet to be a majority vote against a company’s say on pay proposal.
Some companies have taken different approaches to soliciting shareholder input on executive compensation. A number of companies, including Ingersoll Rand Co. Ltd. and Pfizer Inc., have held meetings with their large shareholders to discuss governance issues, including executive compensation. In April 2009, Schering-Plough Corp. submitted a survey to its shareholders to obtain their views on a variety of compensation issues, and Amgen Inc., Lockheed Martin Corp., and Northrop Grumman Corp. have posted web-based surveys for their shareholders to provide feedback on their executive compensation practices. In addition, some shareholders have advocated an alternative to annual advisory votes on executive compensation, with the Carpenters Union Pension Trust submitting shareholder proposals calling for an advisory vote on executive compensation once every three years and additional steps designed to provide greater meaning to and feedback from the process. Microsoft Corporation announced that it would hold an advisory vote on executive compensation once every three years, beginning with its annual meeting this past November, while Pfizer Inc. and Prudential Financial, Inc. have indicated that they will provide shareholders with a say on pay every other year starting this year.
In addition to reviewing their compensation practices and disclosures, companies that have not done so already should be prepared to engage with shareholders that raise concerns about executive compensation issues. That way, a dialogue will already be underway in the event that say on pay legislation becomes a reality, facilitating the process of seeking shareholder support for a favorable vote. Depending on the circumstances, it may be appropriate to involve the chair and/or other members of the compensation committee in these discussions (see section 6 below on "Shareholder Engagement").
C. Scrutiny of Specific Pay Practices
Companies and boards also need to be cognizant of the policies that the major proxy advisory firms apply in assessing companies’ executive compensation practices. In particular, RiskMetrics Group annually updates its list of "poor compensation practices," which it uses in recommending whether shareholders should vote "for" or "against" company-sponsored say on pay proposals or vote "against" or "withhold" voting authority from directors. According to its 2010 proxy voting guidelines updates, RiskMetrics Group will review compensation practices in deciding how to recommend on a company-sponsored say on pay proposal. If a company does not have this type of proposal on the ballot (or the board has failed to respond to RiskMetrics Group’s concerns raised with respect to prior company-sponsored say on pay proposals), RiskMetrics Group will review compensation practices in deciding how to recommend on compensation committee members and, in some cases, the entire board. RiskMetrics Group considers certain pay practices to be "most problematic," which could result in a negative voting recommendation regardless of other factors. These practices include: (1) employment contracts with multi-year compensation guarantees; (2) overly generous new hire packages for CEOs; (3) abnormally large bonus payouts without justifiable performance linkage or proper disclosure; (4) pension plan or supplemental executive retirement plan payouts that include in the benefit calculation additional years of unearned service or performance-based equity awards; (5) certain perquisites for former executives (including lifetime benefits, car allowances and personal use of corporate aircraft) and current executives (including extraordinary relocation benefits); (6) certain severance or change in control provisions (including payments exceeding three times base salary plus bonus, single-triggered change in control payments and new or materially amended contracts providing for modified single-triggered change in control payments or excise tax gross-ups); (7) tax reimbursements on executive perquisites; (8) dividends or dividend equivalents paid on unvested performance-based equity awards; (9) executives using company stock in hedging activities; and (10) repricing or replacing underwater stock options without prior shareholder approval.
Other practices that, depending on the circumstances, may draw negative voting recommendations from RiskMetrics Group include severance or change in control provisions providing for payment upon termination for "cause" or upon announcement of a tender offer or shareholder approval of certain transactions, certain perquisites for current executives (including personal use of corporate aircraft, personal security systems, car allowances and executive life insurance), internal pay disparity and executives’ voluntary surrender of underwater options. For 2010, RiskMetrics Group also will assess compensation policies and practices that could incentivize excessive risk-taking.
In addition, we anticipate that shareholders will focus on whether compensation committees take into account gains accrued on equity awards that were granted during the down market, and that union pension funds and others will closely scrutinize whether large bonuses are awarded at companies that implemented broad layoffs. Boards and compensation committees should evaluate whether their companies have any of the practices that RiskMetrics Group has identified and determine if the practices remain appropriate.
D. "Hold-‘Til/Through-Retirement" Provisions and "Clawback" Policies
Boards and companies also should be aware of compensation "reforms" that are a particular focus for shareholders and activists, including "hold-through-retirement" provisions and "clawback" policies.
1. "Hold-‘Til/Through-Retirement" Provisions
Initially, shareholder activists sought to require senior executive officers to retain substantial amounts of their equity in a company until they left the company—so-called "hold-’til-retirement" requirements. More recently, the focus has shifted to "hold-through-retirement" requirements, which would require stock ownership for one or two years following an executive’s separation. These requirements are designed to align the interests of executives with those of shareholders, to discourage executives from taking unnecessary or excessive risks shortly before their retirement in order to maximize short-term stock returns to the detriment of long-term value, and to promote long-term succession planning. While "hold-through-retirement" requirements reflect some of the same policies underlying traditional stock ownership guidelines/requirements, their advocates do not view stock ownership requirements as an acceptable substitute.
In 2009, shareholders submitted 17 hold-through-retirement shareholder proposals, and 14 of these proposals were voted on by shareholders. The majority of these proposals were submitted by the American Federation of State, County and Municipal Employees ("AFSCME") Employees Pension Plan and requested that the compensation committee adopt a policy requiring senior executive officers to retain a "significant percentage" of shares acquired through equity compensation programs until two years after their departure from the company. The shareholder proposals further recommended that the compensation committee adopt a percentage not lower than 75% of net after-tax shares, and that the policy address the permissibility of hedging and other transactions that are not sales but reduce the risk of loss to executives. Hold-through-retirement shareholder proposals received average support of 26.1% of votes cast in 2009, with RiskMetrics Group taking a case-by-case approach when formulating voting recommendations on the proposals. According to data from RiskMetrics Group, shareholders have submitted 11 hold-through-retirement shareholder proposals for 2010 as of January 29.
2. "Clawback" Policies
"Clawback" policies are policies providing for the recoupment of bonuses and other incentive compensation payments made to individuals (usually senior executives) based on financial results that are later found to be inaccurate or based on individuals’ failure to comply with certain aspects of their employment agreements, such as non-compete and no-solicitation clauses. Since 2004, shareholders have submitted a total of 39 shareholder proposals requesting that companies adopt clawback policies. More than half of the companies that received these proposals previously had restated their financial results. The popularity of clawback shareholder proposals peaked in 2006 and 2007, and since then, there has been a decrease in both the number of and the average support for these proposals. This decrease is likely due to the increase in the number of companies that voluntarily have adopted clawback policies. A Fall 2009 survey by Equilar, Inc. indicates that among Fortune 100 companies, the prevalence of disclosed clawback policies increased from 17.6% in 2006 to 42.1% in 2007, 64.2% in 2008 and 73% in 2009. A June 2008 survey of approximately 2,100 companies from The Corporate Library found that approximately 300 companies had clawback provisions, compared to only 14 companies that had disclosed the existence of these provisions in the four years prior to the survey. The "Shareholder Empowerment Act of 2009," introduced in June in the House of Representatives, would require public companies to adopt clawback policies to recoup performance-based compensation paid based on inaccurate financial results. The "Restoring American Financial Stability Act of 2009" (discussed above) would require public companies to adopt clawback policies to recoup performance-based compensation paid to executive officers in the event the company is required to restate its financial results and the compensation was paid during the three-year period preceding the date of the restatement. This provision would not require any misconduct on the part of the executive officer.
RiskMetrics Group takes a case-by-case approach when formulating voting recommendations on clawback shareholder proposals, considering whether a company has a clawback policy, whether the policy substantially addresses the concerns in the proposal and whether the company has a history of restatements or other financial problems. According to its 2009 proxy voting guidelines updates, RiskMetrics Group has determined that the clawback provisions applicable to companies that received funds under TARP represent the new "best practice" in the area. Recipients of these funds must seek recovery from certain senior executives of any bonus or incentive compensation paid to them that was based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria, even when there is no misconduct. Thus, RiskMetrics Group likely will support a clawback shareholder proposal if the provisions of a company’s current policy do not align with those applicable to TARP recipients.
4. Board Leadership
Boards and companies should expect a continued spotlight on the issue of board leadership in the months ahead.
It is now common practice for larger companies to have a lead/presiding director in order to provide independent leadership for the board, but shareholder activists and some governance experts increasingly are calling for the appointment of an independent chair. For example, in March, the Chairman’s Forum, organized by Yale University’s Millstein Center for Corporate Governance and Performance, issued a policy briefing arguing in favor of independent chairs and specifically calling on all North American companies to adopt an independent chair, effective upon the succession of an existing combined chair/CEO. Although the number of companies with independent chairs has gone up in the past several years, the majority practice among U.S. companies remains a combined chair/CEO. According to RiskMetrics Group data, as of August 1, 2009, 53.6% of S&P 1500 companies had a combined chair/CEO, while 21.1% had a fully independent chair, and 22.7% had a separate chair who was not independent due to current or past employment by or other affiliation with the company. Larger companies are more likely than smaller or mid-cap companies to combine the positions.
In December, the SEC adopted rules that require companies to provide disclosure about whether the company separates or combines the roles of the chair and CEO, whether the company has a lead director and the specific role the lead director plays in board leadership and why the company believes that its leadership structure is appropriate for it. Notably, in adopting the rules, the SEC stated that different leadership structures may be suitable for different companies and that the disclosure is not intended to influence a company’s decision about its board leadership structure.
Congress also has taken an interest in the issue of board leadership. The "Shareholder Bill of Rights Act of 2009," introduced in May in the Senate, and the "Shareholder Empowerment Act" (discussed above), would direct the SEC to adopt rules mandating that all public companies have an independent chair. The "Restoring American Financial Stability Act of 2009" (discussed above) only would require public companies to disclose the reasons for choosing their board leadership structure and would not mandate companies adopt a particular structure.
Independent board leadership has been a popular topic for shareholder proposals in recent years. Given the success of these proposals in 2009, we expect that the number of shareholder proposals seeking an independent board chair will increase during the 2010 proxy season. According to data from RiskMetrics Group, shareholders have submitted 34 independent chair proposals for 2010 as of January 29, including two binding proposals that would amend the company’s bylaws and thus mandate an independent chair structure. In 2009, both Exxon Mobil Corporation and Bank of America Corporation received binding bylaw proposals, and Bank of America appointed an independent chair after the proposal passed by a narrow margin. RiskMetrics Group generally recommends a vote "for" independent chair shareholder proposals unless a company meets a number of criteria, including having a lead/presiding director with duties specified by RiskMetrics Group, not exhibiting sustained "poor total shareholder return performance," and not having experienced other governance issues.
In light of the SEC’s new disclosure requirements for the 2010 proxy season, boards should consider the reasons why their current leadership structure is appropriate. At companies that combine the positions of chair and CEO, consideration should be given to what, if any, steps should be taken to enhance the independent leadership of the board. In addition, as part of the succession planning process, the board or responsible committee should look ahead and consider what leadership structure may be appropriate in the future.
5. Risk Oversight
In the wake of the financial crisis, there has been increasing focus on how companies address risk assessment and management. Many boards have been considering how to address their risk management oversight responsibilities most effectively, including whether to allocate risk oversight responsibilities to the audit committee, a separate risk committee and/or the board as a whole. In this regard, boards and companies should consider whether the board has the appropriate structure and processes in place for overseeing the major risks facing the company. Boards should be comfortable that they understand these risks, as well as the company’s business and strategy and how these relate to risk.
In December, the SEC adopted rules that require companies to provide proxy disclosure about the extent of the board’s role in the risk oversight of the company and the effect, if any, this has on the board’s leadership structure. Companies may want to discuss: (a) how the board administers its oversight function, whether through the whole board or through a committee, such as the audit committee; (b) whether the persons who oversee day-to-day risk management report directly to the board as a whole, to a committee such as the audit committee, or to one of the board’s other standing committees; and (c) whether and how the board, or board committee, monitors risk. In addition, the "Shareholder Bill of Rights Act" (discussed above) would direct the SEC to adopt rules requiring the establishment of a separate risk committee. However, the "Restoring American Financial Stability Act of 2009" (discussed above) limits this requirement to large financial institutions.
The vast majority of companies address risk through their audit committees, presumably because NYSE rules require audit committees to discuss risk assessment and risk management policies, although the rules also clarify that the audit committee need not be the sole body responsible for risk oversight. Some companies address risk through one or more other committees—including, in a minority of cases, through a separate risk committee. Delegation to other committees can avoid overburdening the audit committee in light of the significant responsibilities audit committees face in the post-Sarbanes-Oxley environment. It also enables the board to draw on the input of other board committees that may be relevant to the company’s particular risks and can elevate the visibility of the board’s oversight of risk to management and shareholders. Finally, risk issues are inherently tied to corporate strategy and the company’s business plan, which most companies deal with at the full board, not committee, level. For this reason, some companies address risk oversight only at the full board level, while others see that there are frequent reports to the full board on the issue by management and the responsible board committee(s).
Whatever oversight structure a board adopts, it should be one that enables the board to remain informed about, and understand, all of the major risks facing the company and the steps the company is taking to manage those risks. In this regard, some companies have appointed a chief risk officer or another individual to oversee the risk management process, coordinate risk assessment and mitigation and report to the board or committee of the board as appropriate. In addition, the board should be aware of the risk oversight structure it has implemented—specifically, who, among the full board and various committees, is responsible for overseeing what risks—and be comfortable that the oversight system provides appropriate coverage of all major risks. Directors also should be comfortable that they understand how the company’s risks fit within the "big picture"—specifically, that they understand how these risks relate to the company’s business and strategy, and more fundamentally, that they understand the business and strategy itself. Boards, and those who advise them, should think carefully about how the board is spending its time and see that the board has adequate time to address critical issues such as strategy and risk. To the extent that directors would benefit from "deeper dives" into particular areas, boards should consider devoting a portion of the time allocated for ongoing director education to helping directors obtain a greater understanding of the company’s business and strategy, as well as associated risks.
6. Shareholder Engagement
A critical component of addressing many of the issues discussed above is effective shareholder engagement. This means that companies should make good investor relations and "good listening" a priority, so that engagement with shareholders happens on ongoing basis. Boards should be attentive to what their companies are doing in this area and recognize that, more than in the past, directors may need to play a greater role in reaching out to shareholders. Board-level involvement in shareholder engagement can generate goodwill and avoid a situation where shareholder exposure to the board and its work is limited to the annual meeting context.
Effective shareholder engagement can help companies educate shareholders and other stakeholders about what the board does and the nature of the board’s oversight role. The board should consider what the company is doing to communicate effectively and regularly with shareholders, the business press and analysts about the company’s business and strategy, including the role that the board plays in overseeing these critical areas. The current environment also presents an opportunity for companies to be proactive in discussing the steps being taken to manage risk and the board’s role in overseeing this process.
Looking ahead to the upcoming annual meeting, the board should be comfortable that the company knows its shareholder base and that the company is anticipating areas of potential shareholder concern and how to address them. The company should have an understanding of what proportion of its shareholders are institutional as opposed to retail, who the largest shareholders are and how long they have held the company’s stock. In the case of institutional shareholders, it is important to know how closely these shareholders follow the recommendations of the major proxy advisory firms. For those holders that take these recommendations into account but do a case-by-case analysis in making voting decisions, outreach may be helpful in order to avoid a negative vote on a director or a shareholder proposal. In addition, some institutional shareholders may have their own proxy voting guidelines that are publicly available, which the company should be familiar with.
In addition, the board should consider the company’s strategies for engaging, or enhancing engagement, with its largest shareholders. Shareholder outreach can be important to convey the company’s views and may be helpful in preventing shareholder proposals or obtaining withdrawal of a proposal that has already been submitted. In this regard, it is important to recognize that proxy voting decisions at institutional shareholders often are not handled or influenced by the portfolio managers and analysts with whom management engages at industry conferences and during earning calls, but instead are often handled by separate personnel at the institution. Initiating a dialogue before a major issue arises helps build a relationship so that the company is not approaching a major shareholder for the first time to broach a critical subject. Where shareholders express concerns about particular issues, such as board leadership or executive compensation, it may be appropriate for board members—such as the relevant committee chair or committee members—to participate in the dialogue with shareholders. This sends a message that individuals at the highest levels within the company take shareholder concerns seriously and helps to reinforce shareholder confidence in the directors.
In communicating with shareholders, directors and companies should strive for transparency while at the same time being sensitive to confidentiality concerns. At a meeting of the SEC’s Investor Advisory Committee in July 2009, there was some consensus that the SEC should issue guidance clarifying that dialogue between boards and shareholders on corporate governance matters is acceptable under Regulation Fair Disclosure, which prohibits the selective disclosure of material nonpublic information. In addition, directors should take care to maintain the confidentiality of board deliberations and keep in mind that any written communications between themselves, and with management, may be discoverable in litigation.
7. Shareholder Proposals for 2010
For the 2010 proxy season, as discussed above, shareholder proposals seeking the appointment of an independent chair and proposals seeking an advisory vote on executive compensation have continued to be popular. Executive compensation in general has been a frequent subject of shareholder proposals, which address a range of compensation issues including hold-through-retirement requirements (discussed above) and internal pay disparity. Other focal points for shareholder proposals in 2010 include: