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© 2013 Winston & Strawn LLP 1
Forum for Financial Institution Directors Second Session: 2014 Proxy Season Preparations
December 16, 2013
© 2013 Winston & Strawn LLP 2
Today’s Presenters
Christine A. Edwards Financial Services Regulatory &
Corporate Governance Chicago
Jerry Loeser Financial Services
Regulatory/Compliance Chicago
Erik Lundgren Executive Compensation
Chicago
Mike Melbinger Executive Compensation
Chicago
Oscar David Corporate Governance
Chicago
© 2013 Winston & Strawn LLP 3
Today’s Guest Presenter
Patrick McGurn Special Counsel
Institutional Shareholder Services, Inc.
© 2013 Winston & Strawn LLP 4
Winston & Strawn LLP Forum for Financial Institution Directors • Three Part Series
– What Do Regulators Expect from Directors? • November 22, 2013-available @ Winston.com
• Speaker: James W. Nelson, Federal Reserve Bank of Chicago
– 2014 Proxy Season Preparations 12/16/13
– How Do Directors Prepare for the Worst? • January 15, 2014
• Securities Derivative Litigation, Criminal enforcement, D&O Liability Insurance issues.
• Mark your calendar now for the January 15, 2014 Webinar
© 2013 Winston & Strawn LLP 5
Overview
• Second in a series of Webinars directed to Financial Institution Directors • Focus: to inform Directors what you need to know when expectations for
Boards and Committees are increasing • Today's Topic: Preparing for the 2014 Proxy Season with implications for Board
Governance
© 2013 Winston & Strawn LLP 6
Agenda: Preparing for 2014 Proxy Season
I. Introductory Comments: C. Edwards II. Introductory Comments: P. McGurn III. Roundtable Discussion of Issues: All
– Board Composition, Independence and Tenure
– Executive Compensation and Committee Oversight
– Proxy Results 2013 and decision making for 2014
– Shareholder rights; M&A transactions
– Governance Issues
© 2013 Winston & Strawn LLP 7
Introductory Comments: Chris Edwards • Overview of Governance Changes as perspective for 2014 Proxy Season
© 2013 Winston & Strawn LLP 8
Are Director Responsibilities Changing from Oversight to Management?
• Increasing regulatory expectations appear to move Directors from an oversight role to actual management.
• Trend began as traditional state corporate law dominance (Delaware) was supplemented by Federal corporate governance laws – Sarbanes-Oxley Audit Committee requirements
– Dodd-Frank Compensation Committee and Board requirements
© 2013 Winston & Strawn LLP 9
Regulatory Expectations of Directors
• Prudential regulators have substantially increased requirements for Financial Institutions Boards and then examine Board performance of, and management reporting to the Board regarding those responsibilities.
• Examples: – review and approve incentive compensation plans for risk incentives
– review and approve information security programs
– approve resolution plan
– proposed liquidity coverage approval
• "Directors must exercise their independent judgment when managing the bank's affairs…A board that is excessively influenced by management, a single director, or a shareholder, or any combination thereof, may not be fulfilling its responsibilities…" – Source: FRB Commercial Bank Examination Manual
© 2013 Winston & Strawn LLP 10
Example: Regulation O
• Limits on the amount a bank may lend Directors of bank and bank holding company – Subjects Directors and their related interests to special restrictions on loans,
overdrafts and different treatment on bank services.
• Additional Layer: Hedging and Derivative Prohibition in Dodd-Frank
© 2013 Winston & Strawn LLP 11
Introductory Comments: Patrick McGurn • Overview of ISS Priorities as they relate to Financial Institutions
© 2013 Winston & Strawn LLP 12
Evolving Governance Practices at Banks and Diversified Financials (2007-2013)
Pat McGurn Special Counsel
Institutional Shareholder Services
Data Source: ISS’ QuickScore Database
© 2013 Winston & Strawn LLP 13
Directors More Accountable
2007 2010 2013Banks 44.4 53.3 86.7Diversified Financials 57.1 65.4 75
0102030405060708090
100
% S
&P
500
Prevalence of Annual Elections
© 2013 Winston & Strawn LLP 14
Elections More Meaningful
2007 2010 2013Banks 5.6 73.3 86.7Diversified Financials 28.6 76.9 89.3
0102030405060708090
100
% S
&P
500
Prevalence of Majority Voting in Uncontested Elections
© 2013 Winston & Strawn LLP 15
Board Leadership Changes
2007 2010 2013Banks 5.6 13.3 13.3Diversified Financials 4.8 23.1 28.6
0
5
10
15
20
25
30
35
% S
&P
500
Prevalence of Independent Board Chairs
© 2013 Winston & Strawn LLP 16
Takeover Defenses Fall
2007 2010 2013Banks 16.7 0 0Diversified Financials 28.6 0 0
0
5
10
15
20
25
30
35
% S
&P
500
Prevalence of Poison Pills
© 2013 Winston & Strawn LLP 17
Rising Support for Pay Practices
2009 2010 2011 2012 2013Banks 85.9 84.3 93.5 91.7 92.4Diversified Financials 88.9 86.9 87.2 88.1 91.3
78808284868890929496
% V
otes
Cas
t For
and
Aga
inst
S&
P 5
00
Vote Support on Say on Pay
© 2013 Winston & Strawn LLP 18
Background: Board Governance Issues
• Governance Environment and Director Qualifications • Director Tenure Issues
© 2013 Winston & Strawn LLP 19
Governance Environment and Director Qualifications
• Governance Environment Observations: – Greater frequency of Board and Committee meetings
– Increasing detail and size of Board and Committee materials
– Increasing regulatory mandated reviews and approvals
– Level of sophistication to understand requirements increasing
– Number of Director/Regulator meetings is increasing (many in Executive Session)
– Holding Company: across line of business oversight requirements increasing
• Implications of Environment on Director Qualifications – Director knowledge and experience in the industry critical
– Director candidates who are in Executive Positions availability decreasing
– Board size is shrinking
– Greater responsibility for each director on smaller boards
– Complexity of issues reviewed in Committees (particularly Risk Committees) requires substantial time for preparation.
– Professional boards?
© 2013 Winston & Strawn LLP 20
Governance Environment and Director Qualifications
• Director Qualifications and Tenure – Question: with this level of time, knowledge and sophistication required of directors, is
a shorter tenure for directors a good thing?
– Said another way, how long does it take for directors of financial institutions know their institution and be capable of doing their job well?
© 2013 Winston & Strawn LLP 21
© 2013 Winston & Strawn LLP 22
Executive Compensation and Compensation Committee Responsibilities
Erik Lundgren Executive Compensation
Chicago
Mike Melbinger Executive Compensation
Chicago
© 2013 Winston & Strawn LLP 23
Executive Compensation and Compensation Committee Issues • Independence of Compensation Committee and Advisors • Say on Pay Strategies - Shareholder Proposals • Hedging, Pledging and Rule 10b5-1 Trading Plan Policies • CEO Pay Ratio Disclosure • Limits on Awards to Directors
© 2013 Winston & Strawn LLP 24
Dodd-Frank Report: SEC Rulemaking
• Effective Now – Shareholder Say on Pay and Say on Pay Frequency
– Shareholder Approval of Golden Parachute Compensation
– Disclosure Regarding Chairman and CEO Structures
– Elimination of Discretionary Voting by Brokers on Executive Compensation Proposals
– Whistleblower Bounties
– Independence of Compensation Consultant, Legal Counsel, and Other Advisers
– Compensation Committee Member Independence
• Effective 2015/2016? – Pay Ratio Disclosure
• Still Waiting – Policy on Recovery of Erroneously Awarded Compensation
– Disclosure of Hedging by Employees and Directors
– Disclosure of Pay Versus Performance
– Incentive Compensation for Financial Institutions
© 2013 Winston & Strawn LLP 25
Independence of Compensation Committee Advisors
• Action Items for Compensation Committees and Companies – Confirm the independence of the compensation committee members under new
standards - annually
– Update D&O questionnaire
– Complete certification re: compensation committee matters (NASDAQ)
– Verify that Compensation Committee Charter prior to compliance deadline has been amended
© 2013 Winston & Strawn LLP 26
Say On Pay Results
• Overall passage rate for Say on Pay remains high • So far in 2013, 69 companies failed to obtain majority approval of their Say on
Pay proposals – Institutional Shareholder Services (“ISS”) cited Pay for Performance Disconnect or
Problematic Pay Practices at most of these companies
• 72% of companies have passed with over 90% approval • ISS recommended a vote AGAINST Say on Pay at approximately 13% of
companies it reviewed • ISS effect?
– Average approval with ISS “for” - 95%
– Average approval with ISS “against” - 65%
© 2013 Winston & Strawn LLP 27
Say On Pay Results
• Companies that adopted a triennial frequency in 2011 must again include a Say on Pay proposal in the 2014 proxy statement
• Not less frequently than once every three years, Company's annual proxy statement must include a separate non-binding resolution asking shareholders to vote to approve the compensation of executives, as disclosed under Item 402 of Regulation S-K
• For smaller reporting companies, confirm whether Say on Pay proposal is to be included again in 2014 (dependent on frequency decision)
© 2013 Winston & Strawn LLP 28
Shareholder Resolutions
• Shareholder proposals regarding executive compensation decreased in 2011, as shareholders and their advisors gained Shareholder Say on Pay right – 39 shareholder proposals on executive compensation in 2011
– 61 shareholder proposals in 2012
– More than 100 in 2013
– Many more withdrawn – but often only after the targeted company agreed to make changes
• Extremely high success rate of companies’ SSOP resolutions and the lack of response by some companies that failed to achieve a majority vote in favor of their SSOP resolutions seem to have led shareholders and their advisors back to shareholder proposals
© 2013 Winston & Strawn LLP 29
Shareholder Resolutions
• The most common shareholder proposals in 2013 were requests for – Adoption of a stock retention policy
– Adoption (or improvement) of a compensation clawback policy
– Pro-rata vesting of equity awards, rather than acceleration, upon a change in control
• The strategy for avoiding a shareholder proposal is much like the strategy of achieving a majority vote in favor of Say on Pay. The Compensation Committee should review the areas where its compensation policies and practices differ substantially from those demanded by shareholders and their advisors (i.e., ISS)
© 2013 Winston & Strawn LLP 30
Hedging and Pledging Policy
• Dodd-Frank Act Section 955 requires disclosure in annual Proxy Statement whether the Company permits any employees or directors to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds) that are designed to hedge or offset any decrease in the market value of equity securities that are/were: – Granted to the employee or director as compensation; or
– Held, directly or indirectly, by the employee or director
© 2013 Winston & Strawn LLP 31
Hedging and Pledging Policy
• ISS Final Policies for 2013 • Key Change: hedging of company stock and significant pledging of company
stock by directors and/or executives are considered failures of risk oversight • Examples of failure of risk oversight include, but are not limited to: bribery; large
or serial fines or sanctions from regulatory bodies; significant adverse legal judgments or settlements; hedging of company stock; or significant pledging of company stock
© 2013 Winston & Strawn LLP 32
CEO Pay Ratio Disclosure
• Dodd-Frank Act Section 953(b) requires every public company to disclose: – A.) The median of the annual total compensation of all employees, except the CEO
(including employees outside the U.S.)
– B.) The annual total compensation of the CEO (or any equivalent position) of the company
– C.) The ratio of the amount described in subparagraph (A) to the amount described in subparagraph (B)
© 2013 Winston & Strawn LLP 33
CEO Pay Ratio Disclosure
• SEC proposed rules on September 18, 2013 • Likely to be first effective for the 2016 proxy statement, for calendar year-end
companies • However, some shareholder activists have announced their intention to
pressure targeted corporations to make this disclosure in 2014
© 2013 Winston & Strawn LLP 34
CEO Pay Ratio Disclosure
• Will this disclosure become a magnet for new litigation? – The calculation will inevitably involve assumptions and discretion
– This disclosure is easier to understand (for judges) than stock plan approval
– It will be easy to find an “expert” who will testify that any given formula for calculating the ratio is misleading
– Resolution sponsors are likely to push litigation and may even initiate litigation
– Advisers are certain to create innovative formulas for calculating the ratio – some of which are likely to be on the aggressive side
© 2013 Winston & Strawn LLP 35
Limiting Shares Available: Director Awards
• A condition precedent to filing a shareholder derivative suit is to file a demand with the company’s board of directors that it investigate and/or bring legal action to remedy the alleged wrong against the company
• However, this “demand” is excused if (a) a majority of the board was “interested” in the allegedly wrong decision or lacked independence, or (b) decision was not the result of valid business judgment
• Since the SEC changed the “disinterested director” requirements, conventional wisdom has been to provide for stock awards to non-employee directors from the same stock incentive plan that the company uses to provide awards to everyone else.
• Seinfeld v. Slager, Delaware Chancery Court declined to dismiss plaintiffs’ stock incentive plan related claims alleging that the company’s directors had breached their fiduciary duty to shareholders by paying themselves excessive compensation.
© 2013 Winston & Strawn LLP 36
Limiting Shares Available: Director Awards
• Four risk based alternatives for company/board action (see following chart)
• Board Action: weigh the costs of seeking shareholder approval under the first two alternatives, versus the potential litigation risk during the time before the company can adopt more comprehensive protection
• Recent Towers Watson survey found that 22% of the Fortune 500 companies that adopted or amended stock plans this past year added a director-specific annual grant limit to their plans.
© 2013 Winston & Strawn LLP 37
Risk of Shareholder Derivative Litigation Compared to the Cost of Reducing the Risk
Cost/ Effort
Risk
Higher
Higher
Lower
Lower
Adopt a New, Separate Stock Plan for Non-Employee Directors Amend Stock
Plan to Impose Limits on Awards to Non-Employee Directors and Seek Shareholder Approval
Amend Stock Plan to Impose Limits on Awards to Non-Employee Directors No Action
© 2013 Winston & Strawn LLP 38
Roundtable Discussion
• OTHER TOPICS: – M&A
– Resolutions seemingly remote from financial services business
– International initiatives
© 2013 Winston & Strawn LLP 39
© 2013 Winston & Strawn LLP 40
Questions?
© 2013 Winston & Strawn LLP 41
Winston & Strawn LLP Forum for Financial Institution Directors • Three Part Series
– What Do Regulators Expect from Directors? • November 22, 2013-available @ Winston.com
• Speaker: James W. Nelson, Federal Reserve Bank of Chicago
– 2014 Proxy Season Preparations 12/16/13
– How Do Directors Prepare for the Worst? • January 15, 2014
• Securities Derivative Litigation, Criminal enforcement, D&O Liability Insurance issues.
• Mark your calendar now for the January 15, 2014 Webinar
© 2013 Winston & Strawn LLP 42
Thank You