Hot-Button Issues for the 2017 Proxy Season

This post is based on an Equilar publication by Troy A. Paredes, founder of Paredes Strategies LLC and former SEC Commissioner; Jonathan Salzberger, Director at Innisfree M&A, Inc.; Jennifer Cooney, Advisory Director at Argyle; Paula Loop, Leader of the Governance Insights Center at PricewaterhouseCoopers LLP; and John H. Stout, Partner at Fredrikson & Byron, P.A. This publication is based on the Winter 2017 issue of C-Suite magazine, available here.

Engaging Regulatory Change

Troy A. Paredes, Founder, Paredes Strategies LLC

People matter. Or as it is put in Washington circles, “personnel is policy.” With the transition of the White House from President Obama to President Trump, there will be new people throughout the federal government. This includes a Republican majority at the Securities and Exchange Commission (SEC)—a new chairman along with two Republican commissioners. (The SEC is bipartisan with no more than three of the five commissioners allowed to be from the same political party.)

Although it is too early to say for sure how this will change securities regulation, consider the many rules that were adopted 3­2 recently with the SEC Republican commissioners, including myself, dissenting. When it comes to proxy season, two rules that Republicans objected to stand out: proxy access and CEO pay ratio disclosures.

Equally important is what Republican SEC commissioners have been “for” lately, such as:

  1. Making it easier for companies to go public;
  2. Reconsidering the SEC’s regulation and oversight of proxy advisory firms;
  3. Enhancing the effectiveness of the SEC’s disclosure regime by remedying the information overload problem; and
  4. Reforming the shareholder proposal process under Rule 14a­-8.

While the past positions of Republican commissioners don’t necessarily predict the future of securities regulation, we nonetheless can expect new leadership at the SEC to usher in new policies and priorities. Since regulatory change—whatever its exact details—will soon be front-­and­-center, companies have a choice to make: whether and how to engage. To help with this, I’ll offer two thoughts.

First, as the SEC’s agenda takes shape, companies should ask themselves, “How will our shareholders view this?” Even if companies welcome the shifts in securities regulation, some shareholders may not. Accordingly, it may prove to be more useful than ever to discuss regulatory developments—including those impacting corporate governance and executive compensation—with shareholders. Indeed, effective shareholder engagement may require anticipating SEC rule changes that may unsettle shareholders and engaging sooner rather than later.

Second, companies should consider engaging the SEC. I benefitted immensely as a commissioner from the input public companies provided us. Through comment letters and in-­person meetings, companies can share a unique take on the potential real­-world impacts—both for better and for worse—of a rule change the SEC is

considering. I recognize that a lot goes into deciding whether or not to participate in a rulemaking or otherwise weigh in with a regulator. But I also know that without the right input, the SEC might miss something when evaluating costs and benefits, possibly setting the stage for an ill­-advised decision that does more harm and good.

Shareholders Want to Be in the (Board) Room Where It Happens

Jonathan Salzberger, Director, Innisfree M&A Incorporated

While the real Aaron Burr may not have actually sung “The Room Where It Happens,” the disappointment at being left out of the room where “the game is played… [and] the sausage gets made” so cogently expressed in the musical Hamilton may inspire certain investors concerned about corporate board processes to burst into song.

Several investors have increasingly registered their discontent with settlement agreements made between issuers and activists without consulting the rest of the shareholder base. If recent commentary is any indication, there could be an increased focus on such concerns leading into, and after, the 2017 proxy season.

State Street Global Advisors (SSGA) alerted corporate boards in October 2016 to its concerns around rapid settlements with, and board representation provided to, activists. SSGA argues that this process often occurs without the input of other shareholders around the company’s strategic direction and results in agreements it believes fail adequately to protect long­-term shareholder interests. Although SSGA acknowledges that proxy contests are costly, it asserts that contests at least offer all investors the opportunity to provide their views on capital allocation, strategy and board composition. SSGA further states that boards should focus on obtaining agreements that include longer standstills, minimum holding periods and ownership thresholds for the activist, and prohibit or mitigate an activist’s pledging of company stock.

Reflecting the broader tension between long and short­-term perspectives raised by investors, BlackRock and Vanguard have likewise sent letters to companies emphasizing the importance of focusing on a sustainable, value­-creating strategy and effectively communicating that strategy to long­term institutional holders. More specifically attacking short­-termism, SSGA said it will engage with companies that pursue “unplanned financial engineering strategies” within a year of settling with an activist to better understand the strategy’s rationale.

While it may be very difficult for boards, without violating Regulation FD, to obtain meaningful input from their long­term shareholders before settling with activists, 2017 could be the year when institutional investors push back against specific issuers and their directors who have tried to avoid protracted proxy contests. At the very least, they will continue trying to get in “the room where it happens.”

Performance in the Context of Say on Pay

Jennifer Cooney, Advisory Director, Argyle

For years, reasonable minds have disagreed—and continue to disagree—over the appropriate definition and calculation of “pay” in the context of Say on Pay and the evaluation of pay for performance alignment. In addition, there has been growing dissatisfaction among both the corporate and investor communities with the use of TSR (total shareholder return) as the sole metric for evaluating performance, which adopts a one­-size­-fits-­all definition of “performance.”

As part its 2017 updates to its pay for performance methodology, ISS indicated that 79% of investor respondents to its global benchmark policy survey supported using metrics beyond TSR. For 2017, ISS will include, as part of its report, CEO pay and financial performance rankings relative to peers using a weighted average of six additional financial metrics. Although these metrics will only supplement the TSR based quantitative screening (the metrics may be referenced as part of ISS’s qualitative analysis), consideration of additional data marks a shift towards a more dynamic approach to evaluating corporate performance.

Over the past six months, my Argyle colleagues and I have conducted investor focus groups and engaged in detailed benchmarking of current disclosure practices. Investors shared with us that they are looking for better disclosure about how companies’ strategies are responsive to market and industry conditions, how strategy is designed to create long­-term value, and how performance against such strategies are reflected in executive rewards.

Our benchmarking revealed that 78% of the S&P 500, 53% of S&P 400 mid-­cap and 53% of S&P 600 small-­cap companies included in our study provide disclosure that effectively and explicitly links executive compensation to corporate strategy. The best examples (in our humble opinion) presented strategy in a manner that is consistent with other disclosures, and then clearly linked elements of compensation and outcomes to performance against that strategy. Moreover, we think these “best in class” disclosures are responsive to what our focus groups suggest that investors want to see.

Despite the still unresolved TSR­-based pay for performance disclosures rules proposed by the SEC in April 2015, there is renewed support to broaden the lens with respect to how performance is viewed. Companies should embrace the opportunity to define performance on their own terms.

Addressing What’s on the Minds of Investors

Paula Loop, Leader, Governance Insights Center, PricewaterhouseCoopers LLP

There are a number of important issues for the 2017 proxy season. If I had to pick one, it would be shareholder engagement. While this is a broad topic and goes beyond the proxy season, it is fundamental to addressing what’s on the minds of investors. Today, the topics getting greater scrutiny by investors are: board composition and diversity, proxy access proposals, and sustainability. Of course, the efficacy of the company’s strategy and its capital allocation plan and how executive compensation is linked to strategy are important topics too.

We have seen an upward trend in the level of direct communications with investors, and I expect this trend will likely continue. But the key is ensuring that engagement efforts are successful. This means that there is interaction—a two­-way dialogue between the company and its investors—to ask questions, address concerns, and even debate topics. Ultimately, both parties should leave with a better understanding of each other’s perspectives about the company.

Forward­-looking companies are looking to build important relationships before crises hit. This is particularly important considering the increased level of hedge fund activism that we are witnessing in the market. Companies are also enhancing their proxy disclosures to include more detail and be more meaningful for investors.

The Board’s Responsibility for Corporate Integrity

John H. Stout, Partner, Fredrikson & Byron, P.A.

From Enron to Volkswagen, and recently Wells Fargo, corporate shareholders and other stakeholders have too often faced severe financial and non-financial consequences resulting from corporate integrity failures. A critical challenge for boards in 2017, as the body ultimately responsible for a company’s integrity, is to accept assurance of their companies’ integrity as Job No. 1. Specifically, that means assuring that:

  1. The company’s values and culture emphasize the critical importance of integrity, ethical conduct and compliance with laws, regulations and company conduct policies;
  2. Directors and CEOs, in addition to other needed skills and qualities, are chosen and evaluated for their integrity and ethical conduct, and assuring that CEOs apply similar standards in selecting, evaluating, promoting and compensating their management teams;
  3. The company’s financial statements and other disclosures to regulators, shareholders, and all others who rely on the company’s business and financial information are truthful and accurate, and that those within the company who speak for or about the company do so truthfully and accurately;
  4. Management is held accountable for conducting the business of the company, including the establishment of compensation and incentive programs, in a manner that serves rather than detracts from the company’s integrity;
  5. Directors and management avoid actual or perceived conflicts of interest that would detract from the integrity of the company and its governance;
  6. Management has in place compliance systems and processes that will provide early warnings of activities which would threaten the integrity of the organization, and when warnings come, that they will be investigated independently and without restrictions that might adversely impact the company’s integrity; and
  7. The board periodically assesses the integrity of the organization, using the various tools at its disposal to assess the company’s compliance with its values, and confirm that management is conducting the company’s business with integrity in all respects.The bottom line of governance is that the board is responsible for the company’s integrity. In many of the failures that have occurred, the board ultimately failed because it did not take responsibility to see the company’s integrity as intertwined with their own, and ultimately that is the critical point.

The complete publication is available here.

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