It’s been a long time since I’ve heard much buzz about the Sarbanes-Oxley Act of 2002 (affectionately known as “SOX”). Yet in the past week, I think I’ve heard more about it than in the past several years combined. That’s probably because SOX has been around for over a decade and nothing has changed, leaving not too much to discuss. Last week, in what I think is my first blog ever about a SOX related matter, I covered the SEC’s pursuit of a clawback under Section 304 of SOX. As more firms have taken notice of the SEC’s action, it’s becoming clear that there are some emerging signals from the SEC on clawbacks that should be of note to companies.
To learn about the background of SOX 304 and the impact on clawbacks, see A CFO’s (Non) Misconduct Brings Clawback Under SOX. Last week’s blog centered on the former CFO of Marrone Bio, who was required to pay back 11k in bonuses he received after financial disclosures that later required restatement. The interesting nugget in the SEC’s action is that the CFO was not accused of any wrongdoing, but was deemed to be in violation of SOX 304 since he did not repay his bonuses to the company. This is a significant example of how the SEC views misconduct under SOX 304, because often companies seem to think that clawbacks under SOX are only necessary if the CFO or CEO engaged in misconduct themselves, which is not the case.
As more discussion around this topic has ensued over the past week, details of another case came to light. In a settlement action involving Monsanto Company of St. Louis, the company was found to have materially misstated earnings over a three-year period. The company’s former COO was charged with wrongdoing. In announcing that they had settled the case with the company for an $80 million penalty (among other requirements), the SEC clarified that the CEO and CFO were not charged with misconduct and no clawback would be sought because the executives had already voluntarily reimbursed the company for certain bonuses and stock awards paid during the period in question. However, the SEC was clear that the reimbursement was necessary under SOX 304.
A recent Davis Polk & Wardwell memo on the topic opined that:
“Although the Monsanto and Marrone Bio actions are interesting in that they illustrate the SEC’s focus on financial reporting and disclosure and the SEC’s willingness to charge individuals believed to be engaged in wrongdoing, what is most noteworthy about these cases is whom the SEC did not pursue in its actions against the companies. These actions appear to signal the SEC’s evolving approach to Section 304 enforcement, including an expectation of reimbursement of some forms of compensation, a willingness to forego an enforcement action if reimbursement is made, and a willingness to pursue an enforcement action to compel what the SEC considers appropriate (indeed required) reimbursement.”
Companies involved in restatements should take careful note of the SEC’s recent 304 actions in considering whether reimbursement of compensation (including stock compensation) is necessary. The Commission seems to be sending a fairly clear message that reimbursement is expected in restatements born from misconduct, even if not on the part of the CEO or CFO. In both of the recent cases, the CEO and CFO were not found to have engaged in misconduct, yet still were obligated to comply with the clawback of their incentive compensation. The difference between the two is that the SEC had to bring a clawback action in the the case where the CFO did not voluntarily reimburse the company. In the other case, voluntary reimbursement had already occurred and no further action was needed. The difference between the two resolutions can be a lot of time and expense, so voluntary reimbursement seems much more practical than waiting for the SEC to bring a clawback option.
Tip #4 to Submit a Success Speaking Proposal: Be Timely
My last tip for submitting a winning speaking proposal is to submit your proposal on time. I’ll be honest; we look at this as a test. If you can’t submit your speaking proposal on time, it indicates to us that you probably aren’t going to meet any of the other speaker deadlines either. We have close to 200 speakers at the Conference, so it’s critical that our speakers be responsible about meeting their deadlines with minimal prompting from us. Don’t bother asking for an extension; if you can’t get your speaking proposal in on time, this probably isn’t the year for you to speak.
Speaking proposals for the 24th Annual NASPP Conference can be submitted online and will be accepted through Friday, February 26. Check out my podcast of other tips for submitting a successful proposal.
Don’t Miss Your Chance to Save on the Online Fundamentals
Taught by the industry’s leading experts, the NASPP’s acclaimed online program, “Stock Plan Fundamentals,” is the definitive training program for stock plan professionals, covering both the regulatory framework and day-to-day administrative procedures key to overseeing stock plans. Don’t wait to register—the early-bird rate is only available through this Friday, February 26.
NASPP To Do List
Here’s your NASPP To Do List for the week:
Does your company issue grants to outside directors out of the same plan that you issue grants to executives and other employees? If do you, does the plan expressly limit the number of shares that can be granted to directors over a specified period of time?
If it doesn’t, you aren’t alone. According to the NASPP/Deloitte Consulting 2014 Domestic Stock Plan Administration Survey, 77% of respondents’ plans don’t include a limit on grants to outside directors. But a recent spate of litigation, including a lawsuit that Facebook recently agreed to settle, suggest that maybe companies should rethink this practice.
The lawsuits cover a range of issues related to stock and executive compensation. Some suits allege excessive compensation and some allege deficiencies over stock plan disclosures or proxy disclosures. In addition to Facebook, companies that have been targeted in these suits include Republic Services, Citrix Systems, Goldman Sachs, Cheniere Energy, and Unilife. One common denominator in all of these suits, however, is that the plaintiffs allege that because the company’s outside directors can receive unlimited awards under the plans, they aren’t disinterested administrators of the plan.
Why Is Disinterested Administration Important to these Lawsuits?
These lawsuits are all “derivative” actions (which are lawsuits brought by a shareholder on behalf of the corporation, usually alleging that management is doing something that is to the detriment of the corporation). In a derivative lawsuit, the plaintiff has to meet a “demand” requirement for the suit to proceed. Demand means that the plaintiff asked the company to investigate the matter and the company either refused to investigate or the shareholder doesn’t agree with the outcome of the investigation. In a lot of cases, these suits never get past the demand stage.
But, there is an exception to the demand requirement in lawsuits over stock compensation plans. Can you guess what it is? Yep, that’s right, the demand requirement is excused if a majority of the directors administering the plan lack independence. Plaintiffs are claiming that directors who can receive unlimited awards under a plan aren’t disinterested.
What Happened with Facebook?
Well, first of all, once a suit gets past the demand stage, it gets expensive. So the first thing is that Facebook had to spend a bunch of money on their own lawyers. That, in and of itself, is reason enough to want to keep any of these suits from getting past the demand stage.
The settlement Facebook agreed to includes the following provisions:
Corporate governance reforms, including (A) an annual review of all compensation (cash and equity) paid to outside directors, (B) engage a compensation consultant to advise the company on this review and on future compensation to be paid to outside directors, and (C) use the results of the review to make recommendations to the board on future compensation to outside directors.
Submit the 2013 grants to outside directors to shareholder vote (these grants were the subject of the lawsuit). Hopefully the shareholders approve them–I’m not sure what happens if they don’t (but I’m pretty sure it would make a good blog entry).
Submit an annual compensation program for directors to shareholders for approval. The program has to include specific amounts for equity grants and has to delineate annual retainer fees. As far as I can tell, this is a one-time requirement, for Facebook’s 2016 meeting; if I understand the settlement correctly, the board is allowed to make changes to the program in the future, commensurate with the results of the annual review required under #1 above.
Pay an award of attorneys’ fees and expenses to plaintiff’s counsel not to exceed $525,000 (this is, of course, in addition to whatever Facebook has paid to its own counsel).
A Simple Fix
The simple fix to avoid all of this is to have a limit on the awards that can be issued to outside directors in your plan. If your company is submitting a stock plan to shareholder vote this year, it is worth considering adding a limit like this to your plan.
Thanks to Mike Melbinger of Winston & Strawn for providing a handy summary of the Facebook settlement, as well as a number of the other lawsuits, in his blog on CompensationStandards.com (see “Follow-Up on Facebook Litigation Settlement,” January 29, 2016).
Here’s what’s happening at your local NASPP chapter this week:
Sacramento: Marlene Zobayan of Rutlen Associates presents “International Developments and Trends.” (Tuesday, February 23, 11:00 AM)
Chicago: Andrew Schwartz of Computershare presents “Taxation of Equity Awards: Myths and Facts.” (Wednesday, February 24, 7:30 AM)
Silicon Valley: Takis Makridis of Equity Methods and Ingrid Friere of HP present “Innovative Compensation Next Practices for 2017.” (Wednesday, February 24, 11:30 AM)
Connecticut and Orange County: Emily Cervino of Fidelity and I host a webinar presentation of “Living on Easy Street: Innovative Ideas to Make Your Life in Equity Comp Easier.” (Thursday, February 25, 2:00 PM)
Los Angeles: Nathan O’Connor and Kevin Zhao of Equity Methods present “What’s on Tap in 2016 at the SEC and the FASB in Equity Compensation.” (Thursday, February 25, 11:30 AM)
San Francisco: Raenelle James of Equity Methods presents “Performance Awards – More than the Basics” and Kevin Liu of Glass Lewis presents “Glass Lewis Equity Compensation Analysis.” (Thursday, February 25, 11:30 AM)
I’ll be at the Silicon Valley chapter meeting; I hope to see you there!
This week the SEC announced a settled enforcement action against the former CFO of Marrone Bio Innovations, Inc. At issue were bonuses the former CFO received within 12 months of various financial filings containing results that the company was later required to restate. Using Section 304 of the Sarbanes-Oxlely Act of 2002 (SOX 304), the SEC pursued the clawback of $11,789 in bonuses from the former CFO.
As we await final clawback rules from the SEC (which originate from Dodd-Frank and would apply to national securities exchanges), it’s important to remember that the SEC already has the present ability to enforce clawbacks in certain situations under SOX 304. The SOX provisions apply only to CEOs and CFOs and the courts have determined that only the SEC has the power to enforce clawbacks under SOX. One common misunderstanding about SOX 304 centers on “misconduct.” A Latham & Watkins memo once described SOX 304 as follows: “The statute states that, in the event an issuer is required to prepare an accounting restatement caused by “misconduct,” the CEO and the CFO “shall” reimburse the company for any bonus or other incentive-based or equity-based compensation, and any profits from the sale of the issuer’s securities, received during the year following the issuance of the misstated financial statements.” The memo later explained that the misconduct does not necessarily need to be on the part of the CEO or CFO who is subject to the clawback, a fact sometimes overlooked in our view of the type of misconduct that would trigger a clawback.
The recent SEC enforcement in the case of the former MBI CFO is a prime example that the SEC appears to have determined the misconduct by someone or something other than the person subject to the clawback (the CFO) as a legitimate grounds to demand the repayment of the CFO’s compensation. In this case, the former CFO had to return $11,789 in bonuses, but the SEC did not allege misconduct on his part. They did, however, allege that by not voluntarily returning his incentive compensation once the restatements occurred, he had violated SOX 304. It’s important to understand that in order for the circumstances for a clawback to be ripe, misconduct specifically by the CEO or CFO does not need to be present. Misconduct by someone or something else leading to a restatement can be enough to require the clawback of incentive compensation under SOX 304.
It’s important for companies to evaluate the circumstances regarding any restatement to ensure that appropriate measures have been taken to clawback the appropriate compensation from the CEO and CFO under SOX 304.
The SEC’s proposed clawback rulemaking resulting from Dodd-Frank will require national securities exchanges to adopt standards that, among other things, expand the scope of clawbacks – making them applicable to more individuals and for a longer period of time. The types of compensation subject to the clawback will be more limited under the proposed rules. These rules will not replace SOX 304; the SEC can still continue to rely on SOX 304 as means to enforce clawbacks. For full details on the proposed rules, visit the NASPP Alert on this topic.
Tip #3 to Submit a Success Speaking Proposal: Don’t Wait Until the Last Minute
Things always go wrong at the worst possible moment—like when you are rushing to submit your speaking proposal at the last possible minute before heading out for your Friday evening plans. Give yourself a little extra time; submit your proposals before the last day, so that you have time to address any unexpected hiccups before the deadline.
Don’t Miss Your Chance to Save on the Online Fundamentals
Taught by the industry’s leading experts, the NASPP’s acclaimed online program, “Stock Plan Fundamentals,” is the definitive training program for stock plan professionals, covering both the regulatory framework and day-to-day administrative procedures key to overseeing stock plans. Don’t wait to register—the early-bird rate is only available until February 26.
NASPP To Do List
Here’s your NASPP To Do List for the week:
Register for the NASPP’s acclaimed online course, “Stock Plan Fundamentals”—early-bird rate available until February 26.
One area of ISS’s voting policy that you can count on changing every year are the burn rate benchmarks. ISS updates these benchmarks based on historical data. In theory, if granting practices haven’t changed, the burn rate benchmarks won’t change either. But, inevitably, practices change (in response to changes in the economic environment, the marketplace, and compensation practices, not too mention pressure to adhere to ISS’s burn rate benchmarks) and the burn rate benchmarks change as well.
Surprise, Surprise (Not!)—Burn Rate Benchmarks Lower in 2016
It seems like a self-fulfilling prophecy to me that if ISS sets a cap that burn rates can’t exceed and companies are forced to manage their grants to come in under that cap, burn rates are going to keep decreasing. This year, by my calculations, burn rate benchmarks dropped for 40% of industries in the S&P 500, 59% of industries in the Russell 3000, and 68% of industries in the Non-Russell 3000. ISS indicates that the median change across all industries/indices is a decline of .07%.
It’s a “Benchmark” Not a “Cap”
ISS calls the standard a “benchmark” not “cap.” When they made this change last year, I thought maybe this was because they thought the word “benchmark” sounded friendlier. This isn’t the case at all, however. It’s a “benchmark” because the cap is actually lower than the benchmark. To get full credit for the burn rate test in ISS’s Equity Plan Scorecard (EPSC), a company’s burn rate has to be less than 50% of the benchmark. In other words, the cap is 50% of the benchmark.
Burn Rate Scores Can Go Negative
Laura Wanlass of Aon Hewitt tells me that, just like the score for the SVT test (see “Update on the ISS Scorecard,” July 21, 2015), the burn rate score can also be negative.
Burn Rate Is Important
Burn rate is not quite as important as a plan’s SVT score, but it’s still significant—a negative score could be impossible to come back from in the EPSC. Laura tells me that it is the largest percentage of points in the Grant Practices pillar, which is worth less than Plan Cost (i.e., the SVT test) but more than the Plan Features pillar.
Before the EPSC, burn rates didn’t matter as much. If a company didn’t pass the burn rate test, they simply made a three-year commitment to stay under ISS’s cap in the future—no harm, no foul. But those three-year commitments are just a distant fond memory under the EPSC.
The Burn Rate Test Is Getting Harder
While the standard to earn full points for burn rate remains 50% of the benchmark, overall, the benchmarks have been lowered for most industries/indices. In addition, Laura tells me that ISS is recalibrating the test so that burn rates above 50% of the benchmark will earn fewer points and will go negative sooner than last year.
Divorce is almost never pretty, and sometimes the more there is at stake, the more complicated the process becomes. In today’s blog I’ll explore how a couple of states are taking a more definitive stance on how stock compensation is handled in divorce proceedings.
In Illinois (an equitable distribution state for purposes of dividing marital assets in a divorce), recent changes to the divorce laws included that stock options and restricted stock acquired during the marriage and prior to a divorce are presumed to be marital property unless the holder can prove they were acquired by way of a gift, legacy, or in exchange for other non-marital property. As a result, Illinois divorce courts will allocate and divide the applicable stock options or restricted stock (or something else representative of their value) in awarding each spouse property from their marital estate. This appears to streamline many of the “are they or aren’t they?” property of the marriage questions. According to a blog by Illinois divorce attorney Mark Schondorf,
“Courts understand that stock option’s values may not be realized until years after a divorce is finalized. The new divorce laws instruct the courts to consider 1) the vesting schedule of an option; 2) the time between the granting of the option and the exercise date and 3) whether the option was granted as a reward for past performance, or whether it was designed to promote future performance or employment. It would be unfair for the court to award the husband a large portion of a stock option’s value if the wife would have to work for a number years after being divorced to realize the options value.”
On another divorce related note, a Massachusetts court of appeals ruling confirmed that the vesting of RSUs counts as income for child support purposes. In the trial court case of Hoegen v. Hoegen, the father claimed that he retained his RSUs as property division under the parties’ divorce judgment, and that the wife waived all rights, title and interests in the RSUs. Accordingly, he argued that income from the RSUs should be excluded when the parties periodically recalculated child support after the divorce by agreement. The trial court agreed with him. The mother appealed the case and the appellate court reversed the trial court’s decision, on the grounds (in part) that “just because you receive the value of an asset at the time of divorce, it does not mean that the income you derive from that asset should not be included in the definition of gross income for purposes of a subsequent child support calculation.” (Source: “Restricted Stock Units: Income for Child Support Purposes” by Jeffrey A. Soilson, Fitch Law Partners LLP, Divorce & Family Law Blog, January 29, 2016.)
It’s not surprising that stock compensation can be a significant issue at the core of many divorce and post-divorce cases. In years past it seemed that many states took a reactive approach to handling this type of compensation in divorce litigation, and the results were mixed. It appears more states are now recognizing the “loophole” arguments that are made in these cases and are attempting to take a firmer and clearer stance on how stock compensation should be handled.
It’s important to keep an eye on the changes emerging at the state levels in divorce cases, because as we all know, sometimes new legislation or court rulings emerge that conflict with language in the plan, grant agreement or company practices in handling these situations. While stock plan administrators are not usually involved in the process of negotiating divorce settlements or child support agreements, they do have a role in administering the after-effects of those arrangements. As more states and courts aim to settle some of the arguments over this type of property, we should we watchful to ensure our practices, policies and plan terms can be administered efficiently and effectively as more and more non-employee spouses retain what can be long-term rights to stock compensation.
Submit a Speaking Proposal for the 24th Annual NASPP Conference
The NASPP is now accepting speaking proposals for the 24th Annual NASPP Conference. Proposals can be submitted online and will be accepted through Friday, February 26.
Tip #2 to Submit a Success Speaking Proposal: Many Egg and Many Baskets
Don’t underestimate your competition. We get around 150 proposals for about 40 sessions—the odds are against you. They are especially against you if you leave it to the last minute and submit a half-completed idea. The submitters of winning proposals have already started thinking about speaking topics, are asking their colleagues to help refine their ideas and join their panel, and are looking for clients to serve as case studies. Make sure you submit a well thought out proposal that succinctly but clearly describes (and sells) your idea, that includes a well-rounded panel of speakers, and that stands out from the competition. Look for topics that are unique—that haven’t been presented before or that provide a new perspective.