Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

ISS previously issued its 2012 policy update.  ISS has now delivered the promised additional guidance on the 2012 Pay-for-Performance (P4P) methodology in a technical document.

By way of back ground, ISS ‘ revised analysis will consider the following factors:

  • Peer group alignment.
    • The degree of alignment between the company ‘s Total Shareholder Return, or TSR, rank and the CEO ‘s total pay rank within a peer group, as measured over one-year and three-year periods (weighted 40 percent/60 percent) (“relative degree of alignment”);
    • The multiple of the CEO’s total pay relative to the peer group median (“multiple of median”).
  • Absolute alignment. The absolute alignment between the trend in CEO pay and company TSR over the prior five fiscal years – i.e., the difference between the trend in annual pay changes and the trend in annualized TSR during the period (“pay-TSR alignment”).

In cases where alignment appears to be weak, further in-depth analysis will determine causal or mitigating factors, such as the mix of performance- and non-performance-based pay, grant practices, the impact of a newly hired CEO, and the rigor of performance programs.

The new guidance has some utility in further understanding the ISS methodology but to many the ISS methodology will still be a black box.  Some highlights from the ISS guidance are set forth below.

What Does ISS Measure?

 ISS stresses it measures total compensation as set forth in the summary compensation table.  ISS feels this is a better measure than “realized” compensation for a number of reasons.  One reason is that is how companies benchmark their pay practices.  ISS focuses on the CEO’s pay because that package sets the “compensation pace” at most companies; also the compensation committee and board are most directly involved in and accountable for the decisions that generate the CEO’s pay.  ISS utilizes a standard set of assumptions to value equity-based grants, but the guidance does not suggest what those standard assumptions might be.

As for performance, ISS uses the TSR benchmark.  While there might be many ways to do this, ISS believes this is what shareholders want and it is objective and transparent.

Peer Group Alignment

Two measures are used, the “relative degree of alignment” and the “multiple of median.”

Relative Degree of Alignment (RDA)

The relative degree of alignment measure addresses the question: Is the pay opportunity delivered to the CEO commensurate with the performance achieved by shareholders, relative to a comparable group of companies? The measure compares the percentile ranks of a company’s CEO pay and TSR performance, relative to a comparison group of 14-24 companies.

Peer groups are generally constructed with reference to the company’s industry (based on GICS classification), revenue (or assets with respect to financial companies), and market value.  The comparison companies selected by ISS are not intended to serve the function that a “peer group” does for a board of directors when it benchmarks executive pay. Boards use peer groups to help determine an appropriate pay package for attracting and retaining executive talent.  The ISS comparison groups are intended, rather, to help evaluate the alignment of executive pay and company performance that results from a board of directors’ pay decisions over time.  Further details on the construction of peer groups are set forth in the appendix to the guidance.

To determine relative degree of alignment, the subject company’s percentile ranks for pay and performance are calculated for one- and three-year periods.  Because of the sensitivity of TSR to overall market performance, annualized TSR performance for all companies (subject company and comparison companies) will be measured for the same period: that is, the one- and three-year periods ending on the last day of the month closest to the fiscal-year end of the subject company. To illustrate: if a company’s fiscal year ends on November 29, 2011, then all TSRs will be measured over the periods December 1, 2010-November 30, 2011 (for one-year) and December 1, 2008-November 30, 2011 (for three-year).

Combined percentile ranks for pay and for performance are calculated, based on a 40% weighting for the one-year and a 60% weighting for the three-year ranks. The relative degree of alignment is equal to the difference between the ranks: the combined performance rank minus the combined pay rank.  If three years of data are not available for the subject company, the combined measure will reflect only the one-year rankings.

Values for the relative degree of alignment measure range between -100 and +100, with -100 representing the high pay for low performance (i.e., 100th percentile pay combined with 0th percentile performance), zero representing a high degree of alignment (the pay rank is equal to the performance rank), and positive values representing high performance for low pay.

Multiple of Median (MOM)

This multiple of median measure addresses the question: Is the overall level of CEO pay significantly higher than amounts typical for its comparison group? Is the company significantly more than comparable companies, even for strong performance?

Calculating this measure is straightforward: the company’s one-year CEO pay is divided by the median pay for the comparison group.  Values can therefore range from zero (if the subject company paid its CEO nothing) to infinity. In ISS’ back-testing analysis, the highest observed value was just over 25 times peer median.

Pay-TSR Alignment (PTA)

ISS’ new measure of long-term absolute alignment is intended address the question: have shareholders’ and executives’ experiences followed the same long-term trend? It is important to note that PTA is not designed to measure the sensitivity of CEO pay to performance – whether pay and performance go up and down together on a year-over-year basis. It is a long-term measure of directional alignment.

If you have managed to follow the calculations so far, this is where it gets really mind numbing:  At a high level, the measure is calculated as the difference between the slopes of weighted linear regressions for pay and for shareholder returns over a five-year period. This difference indicates the degree to which CEO pay has changed more or less rapidly than shareholder returns over that period.

The trend lines calculated by these regressions are analogous to a 5-year “trend rate” for pay and performance, weighted to reflect recent history. The final pay-TSR alignment measure is simply equal to the difference: performance slope minus the pay slope. Potential values for PTA are theoretically unbounded, but in practice they range from just over -100% to just over 100%,

Qualitative Evaluation

If misalignment in pay-for-performance quantitative measures is detected, ISS will perform an in-depth qualitative assessment to determine either the likely cause or mitigating factors.  The ISS guidance indicates a number of factors that ISS may consider.

For example, if a company exhibits long-term disconnect between pay and performance, ISS closely examines its disclosed benchmarking approach to determine whether that may be a contributing factor. For example, a preponderance of self-selected peers that are larger than the subject company may drive up compensation without regard to performance. Above-median targeting may have the same effect.

Special circumstances are also considered.  The qualitative analysis may also consider exceptional situations, such as recruitment of a new CEO in the prior fiscal year or unusual equity grant practices (e.g., bi- or triennial awards) that may distort a quantitative analysis.  Recruiting a new CEO is not a free pass however.  While shareholders may welcome a new CEO in light of lagging performance, they may nevertheless be concerned about a board that has been forced to pay dearly for outside talent but fails to appropriately link the new CEO’s pay to performance improvement.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Consumer Financial Protection Bureau, or CFPB announced several ways that whistleblowers can alert the Bureau to potential violations of federal consumer financial laws.  But they are not offering huge rewards, like the SEC and CFTC whistleblower programs.

The whistleblower channels announced include an email address, and a toll free “tips hotline.”   Early next year, the Bureau plans to introduce an online tips portal accessible through its website. People who submit tips through any of these channels may request confidentiality or even remain anonymous to the extent permitted by law, although providing contact information may assist the Bureau in investigating and remediating potential violations of federal consumer financial laws.

The Dodd-Frank Wall Street Reform and Consumer Financial Protection Act provides certain anti-retaliation protections for employees of providers of consumer financial products and services who share information regarding potential violations. Employees protected by the statute may not be terminated or discriminated against for:

  • providing information to the employer, the Bureau, or any other state, local, or federal government authority or law enforcement agency relating to a violation of federal consumer financial law;
  • testifying about a potential violation;
  • filing any lawsuit or other proceeding under any federal consumer financial law; or
  • objecting to or refusing to participate in violations of federal consumer financial laws.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

 

The Dodd-Frank Act created the  Office of Fair Lending & Equal Opportunity, part of  the Consumer Financial Protection Bureau, or CFPB, to address credit discrimination.  Congress also gave the CFPB authority over two key federal fair lending statutes. The CFPB has authority over the Equal Credit Opportunity Act, which prohibits discrimination against applicants in any type of credit transaction. This includes mortgages, car loans, student loans, and credit cards. The CFPB also has authority over the Home Mortgage Disclosure Act, which requires lenders to report mortgage data to allow for better fair lending enforcement.

The Office will play a lead role in the Bureau’s efforts to ensure fair, equitable, and nondiscriminatory access to credit for both individuals and communities.  According to the CFPB, the Office has the following tools to enforce relevant statutes:

  • Review lenders’ policies, procedures, and lending activity to detect and address potential discriminatory practices.
  • Bring enforcement actions to stop discriminatory practices and remedy harm to consumers.
  • Develop new policies, including rules about loan data collection required by Congress. These data will help ensure that lenders make credit available in a fair and non-discriminatory manner.
  • Partner with private industry and fair lending, civil rights, consumer, and community advocates to promote fair lending compliance and education.
  • Help ensure that consumers have the tools they need to make sound financial decisions and protect themselves from discriminatory practices.
  • Assist in reviewing consumer complaints of unlawful discrimination. We can also review complaint patterns for early warnings about troubling lending practices. This data will help us in our supervision, enforcement, rule writing, and education efforts.
  • Conduct research and analysis on equitable access to credit. This will include analyzing data collected under Federal regulations.
  • Work with the Department of Justice, Department of Housing and Urban Development, Federal Trade Commission, and other federal and state agencies to make sure that our fair lending enforcement efforts are consistent, efficient, and effective.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

 

The FDIC is proposing a rule that provides for the treatment of a mutual insurance holding company as an insurance company for the purpose of Section 203(e) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The proposed rule clarifies that the liquidation and rehabilitation of a covered financial company that is a mutual insurance holding company will be conducted in the same manner as an insurance company. The proposed rule is intended to harmonize the treatment of mutual insurance holding companies under Section 203(e) of the Dodd-Frank Act with the treatment of such companies under state insolvency regimes.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The MSRB has announced that the SEC is seeking additional time to consider its proposal regarding the duties of underwriters to state and local government issuers under the MSRB’s “fair dealing” rule. The proposal would for the first time establish detailed obligations of underwriters of municipal securities to their state and local government clients regarding clear disclosure of risks and conflicts of interest, among other things.

The proposal is a key piece of the MSRB’s rulemaking initiatives to protect issuers in the municipal market, which is required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Our analysis on the original proposal and related amendments  can be found here.

The proposal was published in the Federal Register on September 9, 2011, and an amendment to the proposal was published on November 21, 2011. Under federal law, the SEC had 90 days from September 9 to approve or disapprove the proposed rule change, or institute proceedings to determine whether to approve or disapprove the proposed rule change. The 90-day period ended December 8, 2011.

On December 9, 2011, the SEC published a notice and order to institute proceedings pursuant to Section 19(b)(2)(B) of the Securities Exchange Act to determine whether to approve or disapprove the MSRB’s proposed rule change. In its notice, the SEC said that the institution of the proceedings does not indicate it has reached any conclusions with respect to the proposed rule change, or that it will ultimately disapprove the proposed rule change. The SEC is however seeking additional input from interested parties on the issues presented by the proposed MSRB rule change.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

Neil Wolin, Deputy Treasury Secretary, recently addressed the status of the Federal Insurance Office, or FIO, at a recent conference sponsored by the FIO.

Mr. Wolin noted that before the Dodd-Frank Act was passed, the Federal government had no central repository for comprehensive insurance expertise. He also added that “Dodd-Frank fixed this glaring omission so that, through FIO, we will have the institutional capability to develop and coordinate insurance policy at the federal level more effectively than in the past.”

Mr. Wolin said the office is responsible for, among other things:

• Monitoring the insurance industry, identifying gaps in regulation, and participating in the Financial Stability Oversight Council – all to help ensure stability in the insurance industry and the broader financial system;

• Developing and coordinating federal policy on prudential aspects of international insurance matters;

• Evaluating the accessibility and affordability of insurance products for low- and middle-income Americans; and

• Advising the Secretary of the Treasury on insurance issues.

Mr. Wolin made clear that regulating the insurance industry is not one of FIO’s responsibilities. Nothing in the Dodd-Frank Act alters the fact that insurance is fundamentally regulated by the states.

As to activities of the FIO, Mr. Wolin spoke about:

  •  FIO recently became a full member of the International Association of Insurance Supervisors (IAIS), which is currently working to designate globally significant insurers and develop a framework for supervising of internationally active insurance groups.
  •  FIO’s advisory body, the Federal Advisory Committee on Insurance, has also been established. Last month, FIO announced the appointment of 15 insurance experts.
  •  FIO will report to Congress in January 2012 on how to improve and modernize the United States’ system of insurance regulation.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Bureau of Consumer Financial Protection, or CFPB, is requesting comment on a proposed Policy Statement  that addresses the CFPB’s proactive disclosure of credit card complaint data. The CFPB receives credit card complaints from consumers under the terms of the Consumer Financial Protection Act of 2010. The proposed Policy Statement sets forth the CFPB’s proposed initial disclosure of credit card complaint data. It also identifies additional ways that the CFPB may disclose credit card complaint data but as to which the CFPB will conduct further study before finalizing its position. The proposed Policy Statement does not address complaint data about any other consumer financial product or service.

The proposed Policy Statement does not contemplate the disclosure of confidential consumer complaint information. Under the proposed Policy Statement, the CFPB would not disclose information contained in consumer credit card complaints (and responses to such complaints) that is exempt from disclosure under the FOIA. The CFPB will not publish the name, full address, or credit card account number associated with any given credit card complaint. In addition, the CFPB’s policy will be not to publish credit card complaint information that could enable the consumer to be identified by any party other than the issuer of the credit card in question. Further, the CFPB will not disclose confidential and proprietary business information that issuers provide in response to complaints. Because of these limitations, the CFPB’s proposed publication of consumer complaint information pursuant to the Policy Statement does not rely upon any of the exceptions to the general prohibition on disclosure of confidential consumer complaint information.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Fed, the FDIC and the OCC have announced they are seeking comment on a notice of proposed rulemaking, or NPR, that would amend an earlier NPR announced in December 2010. The initial NPR proposed modifications to the agencies’ market risk capital rules for banking organizations with significant trading activities.

The amended NPR includes alternative standards of creditworthiness to be used in place of credit ratings to determine the capital requirements for certain debt and securitization positions covered by the market risk capital rules. The proposed creditworthiness standards include the use of country risk classifications published by the Organization for Economic Cooperation and Development for sovereign positions, company-specific financial information and stock market volatility for corporate debt positions, and a supervisory formula for securitization positions.

The earlier NPR was based largely on the revisions to the market risk framework published by the Basel Committee on Banking Supervision since 2005. However, it did not include aspects of the Basel Committee revisions that rely on credit ratings. Under the Dodd-Frank Act, all federal agencies must remove references to, and requirements of, reliance on credit ratings from their regulations and replace them with appropriate alternatives for evaluating creditworthiness. The agencies believe that the capital requirements resulting from the implementation of these alternative standards would be generally consistent with the standards in the Basel Committee’s revisions.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Consumer Financial Protection Bureau, or CFPB, has published a prototype credit card agreement. It is important to note that it is not a model form, and use is not mandatory. The CFPB believes its approach will help consumers better understand their credit card agreements.

The prototype credit card agreement separates important information about prices, risks, and terms from the legalese by taking much of the legal language and moving it into standard definitions. In the prototype, the definitions have been formulated by the CFPB based on standard industry usage and practices. To ensure that consumers can easily find these definitions, they will be housed online in a place where consumers can readily access them. For consumers who do not have Internet access, the definitions will be available from their issuer in printed form. Doing this allows for a plain language document that clearly explains to consumers how the credit card works.

The CFPB’s simplified agreement is intended to serve as a thought starter. The Bureau is testing the prototype with the Pentagon Federal Credit Union, which has more than one million member customers – including roughly 350,000 cardholders. The CFPB plans to continue to work with the Pentagon Federal Credit Union and other card issuers interested in making simplified credit card agreements an industry reality. The consumer agency is also inviting the public to weigh in on the prototype on its website.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Financial Stability Oversight Council, established pursuant to the Dodd-Frank Act, has recently held executive sessions to discuss a couple of high profile topics:

  • On October 31, 2011, FSOC convened by teleconference to discuss developments regarding MF Global. Members of the Council provided oral reports. No votes were taken during the meeting.  The meeting lasted approximately ½ hour.  Ben Bernanke was absent.
  • On November 11, 2011, FSOC convened by teleconference to discuss European market developments. No votes were taken during the meeting.  The meeting lasted approximately ½ hour.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.