Proxy Season Recap – Trends and Lessons from 2014

© 2014 Winston & Strawn LLP

The Real Deal Webinar Series: Proxy Season Recap –

Trends and Lessons from 2014

June 24, 2014

©2014 Winston & Strawn LLP 2

Today’s Speakers

Erik Lundgren Partner

Chicago

+1 (312) 558-8012 [email protected]

Erin Stone Partner

Chicago


mailto:[email protected]



Overview – Proxy Season Recap – Trends and Lessons from 2014 • 2014 Proxy Disclosure and Other Trends • Say on Pay Results and Surprises • Trends in Shareholder Proposals • Executive Compensation Litigation Update • Important Post-Annual Meeting Housekeeping Items • Early Forecast and Strategies for 2015

2014 Proxy Disclosure and Other Trends


Status of Dodd-Frank Rulemaking

– Pay Ratio Disclosure (Final rules pending – SEC anticipates adoption in 2014)

– Policy on Recovery of Erroneously Awarded Compensation (Clawbacks) (Proposed SEC rules pending – anticipated in 2014)

– Disclosure of Hedging by Employees and Directors (Proposed SEC rules pending – anticipated in 2014)

– Disclosure of Pay Versus Performance (Proposed SEC rules pending – anticipated in 2014)

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Proxy Disclosure Trends • Proxy Summaries • Highlight “Good Governance” and Compensation Best Practices • User Friendly Format

– Pictures – Graphics and charts – Headings and color

• Expanded Audit Committee Report • Telling Your Story

– Go beyond the minimum disclosure requirements – Address shareholder questions – Disclosure targeted to impact QuickScore and proxy advisory firm reports – Pay for performance disclosure


Trends in Equity Plan Proposals • Notable shareholder opposition

– Coca-Cola • Vote “no” campaign by mutual fund activist claiming that plan was excessive (costing

stockholders $24 billion) • Abstention by Warren Buffett • ISS recommended a vote FOR the plan • Proposal ultimately approved by stockholders (83% support) • Say on Pay proposal received 91% support

– Cheniere Energy • Proposal to add 30 million shares to plans • Annual meeting delayed due to lawsuit over prior equity plan • Grants under prior plan alleged to be invalid because plan was not approved by

stockholders (due to vote-counting error)

– Chipotle • Equity plan proposal rejected by stockholders (45% support) • Vote “no” campaign by CtW (Change to Win) Investment Group • Pay for performance disconnect cited by ISS (though SVT and Burn Rate were

reasonable)

• Increased use of fungible share ratios in plans


– Shareholder activism increased in 2013 due, in part, to financial conditions, legal developments and growth of hedge fund activism.

– Activist shareholders experienced a number of “successes” in 2013.

– Trend continues in 2014 with a number of high profile contests.

– Traditional activist shareholders, such as hedge funds, continue to be joined by traditional investment funds as well as passive investors in shareholder activism.

– Hedge funds increasingly active in the M&A context.

– ISS continues to be influential in contests.

• Recommendation frequently outcome determinative

• Depends on composition of stockholder base

Current Shareholder Activist Landscape


• Typical Targets – Companies with any of the following characteristics, among others, may be at risk for shareholder activism:

– Underperforming their peers, including underperforming equity returns or business segments

– Stock price declining

– Decreased earnings, outlook or other perceived performance weaknesses

– Multiple business segments

– Corporate governance issues

– Inefficient capital structure / excess cash

– However, a company does not necessarily have to perform poorly or have major financial or operational issues to be a target. Large-cap companies have recently become targets of shareholder activism (e.g., Apple and Microsoft).

Activist Shareholders


Activist Shareholders • Trends in Activist Strategies

– Hedge Funds Teaming with Partners: Activist hedge fund investors have recently begun pairing with more traditional investment funds and passive investors.

– Seeking Majority Slates: Activist campaigns to obtain a majority of seats on a board received significant support from shareholders in 2013. 37.7% of proxy fights in 2013 sought majority representation on board and, of those, 60.9% resulted in one or more board seats for the dissident shareholders.

– Non-Binding Proposals: Non-binding economic referendum proposals by activist shareholders, which generally propose that the company’s board hire bankers to consider strategic alternatives or sell the company or its assets, received shareholder support in 2013.

– Appraisal Rights Litigation: Under Delaware law (and the laws of other states), shareholders who object to a cash offer for their shares have the right to dissent and seek a higher price for such shares through litigation. 2013 saw an increase in appraisal rights actions.


• Potential Responses to Activist Shareholders (cont’d)

– Review charter, bylaws and other governance documents regularly in light of changing circumstances for the company:

• Action by written consent

• Ability to call special meeting

• Ability to nominate directors or create vacancies

• Require shareholder proposals for meetings to be updated at various points in proxy process in order to be deemed timely

• Designate Delaware as exclusive jurisdiction for shareholder and intra-company disputes



– Review charter, bylaws and other governance documents regularly in light of changing circumstances for the company (cont’d):

• Evaluate implementation of shareholder rights plan

– New form of poison pill: “13D Pills,” which allow shareholders filing a Schedule 13G to own up to 20% of the company’s shares but limits shareholders filing a Schedule 13D to 10% of the company’s shares

• Include certain director criteria or requirements in the charter or bylaws:

– Submission of a director questionnaire or other information about potential nominees

– Not party to voting or compensation agreements

– Agree to abide by company policies

– Requiring board members (in particular, representatives of activist shareholders) to sign confidentiality agreements



• Potential Responses to Activist Shareholders, (cont’d)

– Consider corporate messaging regarding potential issues and concerns

– Communicate with stockholders

– Know your stockholder base:

• Hedge funds, institutional investors, retail investors, etc.

• Identify parties most likely to organize a stockholder campaign/proxy contest

– When engaging in M&A transactions:

• Plan for activist efforts to potentially disrupt transactions

• Monitor significant stock purchases and consider the identity and goal of the purchasers (Form 13F, Schedules 13G/D)



• Potential Responses to Activist Shareholders, (cont’d)

– Chief Justice Leo Strine of the Delaware Supreme Court, recently wrote an article calling for a rollback of shareholder powers to prevent a “deluge” of corporate governance votes that he says are distracting management and resulting in significant costs to companies. He suggested, among other things:

• Limiting the frequency of say-on-pay votes

• Charging investors to submit matters to the annual meeting

• Prohibiting the submission of losing proposals year after year

• Requiring hedge funds to reveal more information regarding their positions and intent


Say on Pay Results and Surprises


Say on Pay Results* and Strategies • Overall passage rate for Say on Pay remains high • So far in 2014, 47 companies have failed to obtain majority approval

of their Say on Pay proposals – Institutional Shareholder Services (ISS) cited Pay for Performance

Disconnect, Problematic Pay Practices or Rigor of Performance Goals at most of these companies

– Special Awards or Mega-Grants also noted at 45% of failures • 76% of companies have passed with over 90% approval • ISS recommended a vote AGAINST Say on Pay at approximately

13% of companies it reviewed – AGAINST at 20% of Triennial companies – AGAINST at 12% of all other companies

• ISS effect? – Average approval with ISS “for”: 95% – Average approval with ISS “against”: 67%

* Semler Brossy June 18, 2014 Say on Pay Results Summary


Say on Pay Results and Strategies (cont’d) • Usual reasons for failed Say on Pay votes:

– Subpar Company stock performance – Pay and performance disconnect – Rigor of performance goals – Special awards or mega-grants – Non-performance-based equity – Problematic pay practices

• Company changes in response to Say on Pay challenges*: – Improving proxy disclosure – Ensuring incentive plan goals are sufficiently challenging – Shifting pay mix to performance based – Changing severance plan – Increasing weight of performance shares

*NYSE Governance Services / Corporate Board Member / Pay Governance Fall 2013 Survey


Say on Pay Results and Strategies (cont’d)

• Ensure that required and “best practices” disclosure and procedures are included/followed

– Supporting Statement for Say on Pay Proposal (include current frequency and when next vote will occur)

– Proxy Statement and Proxy Card Language – SEC Guidance – CD&A disclosure re: consideration of Say on Pay result – Executive Summary in CD&A – Pay for Performance Emphasis in Disclosure – Proxy Summaries – “Good Governance” Highlights – User-Friendly Format – Telling Your Story


Say on Pay Trends and Surprises

• Low Say on Pay support at Chipotle – Failed Say on Pay Vote (only 23% support) – Opposed by Change to Win, a group of union pension funds – Large equity grants to executives – Short equity retention period – immediately selling upon vesting of awards – Chipotle’s TSR was good; 2013 revenue and net income both increased 18% from prior

year – ISS Proxy Report Excerpt: “A vote AGAINST this proposal is warranted. The company

continues to grant large annual awards of stock appreciation rights to executives, who have continued to dispose of their shares. The co-CEOS were granted additional equity in FY2013, on top of the already significant option grants, but required performance goals are not disclosed. Recently completed performance cycles, where goals are retrospectively disclosed, provide indications that previous goals have been set at levels that were not particularly challenging for the company to achieve. The company’s grant practices continue to yield escalating levels of overall pay to its co-CEOs amidst rising shareholder opposition.”

• Focus on rigor of performance goals • Low shareholder support for Say on Pay leads to increased

shareholder activism in other areas

Trends in Shareholder Proposals


Shareholder Proposal/Engagement Trends • Corporate Governance/Board

– Declassify board – Independent chair – Majority voting – Proxy access

• Environmental/Social – Political spending/lobbying – Sustainability reporting

• Executive Compensation – Stock retention – Limitations on accelerated vesting – Overall support remains relatively low (approx. 29%), but six

compensation-related proposals received majority support in 2014 • Focus on shareholder engagement continues

Executive Compensation Litigation Update


Executive Compensation Litigation

• Annual Meeting Disclosure Litigation • Say on Pay Litigation • Sec. 162(m) Litigation • Just Plain Too Much Pay Litigation • “Oops” Litigation

Important Post-Annual Meeting Housekeeping Items


Housekeeping Items

• Compensation Committee Charter • Independence Review of Committee and Advisors • NASDAQ Compensation Committee Certification (due within 30

days after annual meeting) • NYSE Annual Written Affirmation (due within 30 days after

annual meeting) • Approved Equity Plans – Prepare and File Form S-8 • 162(m) Review

Early Forecast and Strategies for 2015


CEO Pay Ratio Disclosure • The Dodd-Frank Act requires the SEC to adopt rules requiring companies to

disclose: – (A) the median of the annual total compensation of all employees of the Company,

excluding the CEO, – (B) the annual total compensation of the CEO of the Company, and – (C) the ratio of (A) to (B)

• On September 18, 2013, the SEC proposed rules that would require the disclosure of these amounts and the pay ratio in the annual proxy statement

• Comment period for proposed rule ran through December 2, 2013 • Rule to be effective for the first full fiscal year beginning on or after the

effective date of the final rule – For calendar year-end companies, final rules likely not applicable until 2016 proxy

statement (reporting 2015 compensation) • Proposed rule would not apply to emerging growth companies, smaller

reporting companies, or foreign private issuers • Ratio would need to be disclosed in all filings requiring Item 402 executive

compensation disclosure (proxy or 10-K, S-1)


CEO Pay Ratio Disclosure (cont’d) • How to Calculate the Ratio

– Include all full-time, part-time, temporary, seasonal and non-U.S. employees who are employed as of the fiscal year-end

– May (but are not required to) annualize compensation for full-time employees who served part of the year

– May choose a method of identifying the median employee that best fits the Company’s particular circumstances • May use any consistently applied compensation measure (such as payroll or

tax records) to determine the median employee • May use self-determined statistical sampling or other reasonable method to

reduce the number of employees for whom annual compensation must be calculated

• What to Disclose – Total compensation of the median employee (using the Summary

Compensation Table Rules), CEO total compensation, and the ratio between the two

– The methodology and any material assumptions, adjustments or estimates used to identify the median employee


Strategies for 2015 • Monitor SEC rulemaking • Shareholder engagement if Say on Pay results were below

expectations or other issues raised during proxy season • Review and address issues noted in proxy advisor reports • Identify shareholder “irritants” that can be removed with relatively low

cost to company • Consider early adoption of clawback and/or hedging/pledging policy • Assess share availability under equity plans • Review litigation risk mitigation strategies for equity plans • Identify possible proxy presentation enhancements


Questions?

Erik Lundgren Partner

Chicago


Erin Stone Partner

Chicago




Thank You

Proxy Season Recap – Trends and Lessons from 2014

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Transcript of Proxy Season Recap – Trends and Lessons from 2014