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

The SEC has issued a proposed rule to require companies to disclose the relationship between executive compensation and the financial performance of a company.  The details of the proposed rule have been well publicized, and a summary is included to provide context for the discussion which follows.  In the discussion I intend is to highlight potential aberrations in the proposal.

Summary

The proposed rules would require companies to disclose in a new table the following information:

  • Executive compensation actually paid for the principal executive officer, which would be the total compensation as disclosed in the summary compensation table already required in the proxy statement with adjustments to the amounts included for pensions and equity awards.  The amount disclosed for the remaining named executive officers identified in the summary compensation table would be the average compensation actually paid to those executives.
  • The total executive compensation reported in the summary compensation table for the principal executive officer and an average of the reported amounts for the remaining named executive officers.
  • The company’s total shareholder return on an annual basis, using the definition of total shareholder return, or TSR, included in Item 201(e) of Regulation S-K, which sets forth an existing requirement for a stock performance graph.
  • The TSR on an annual basis of the companies in a peer group, using the peer group identified by the company in its stock performance graph or in its compensation discussion and analysis.

Using the information presented in the table, companies would be required to describe the relationship between the executive compensation actually paid and the company’s TSR, and the relationship between the company’s TSR and the TSR of its selected peer group.  This disclosure could be described as a narrative, graphically, or a combination of the two.

TSR Metric

What aberrations may exist?  First, there may be no link at all between executive pay and TSR.  This isn’t necessarily a governance faux pas.  Executive pay may well have increased because of improved financial metrics the compensation committee chose wisely to reward while the stock price declined because of general market conditions beyond the executives’ control.  Sure, the SEC invites the company to explain the reasons and to submit alternative measures of performance, but that will be hard to do without making it look like an apology.  Perhaps this will engender a trend to tie incentives to TSR to make the discussion easy and that may not universally by the best thing for companies to do.

Turnover

Turnover in the executive ranks will likely penalize the company in the pay versus performance table, even if it is for the benefit of the company.  The proposed rules are pretty clear that where more than one person served as CEO for the year you have to disclose the total compensation “for the persons who served as CEO.”  This isn’t just an aggregation of amounts paid during the period of the year during which the person served as CEO or an average of the two amounts paid to the two CEOs.  For the departing CEO, it will include all amounts earned during the fiscal year (S-K 402(a)(4)), including retirement earnings and any severance (S-K Item 402(c)(ix)(D)(1)).  For the incoming CEO, it will include any signing incentives or earnings while serving in another capacity at the registrant.  For the other named executive officers, similar principles apply, particularly where there is turnover in the CFO position (because both would be named executive officers, but here at least you get to effectively divide by two) or for those swept in by the two “additional individuals” who would have had NEO status if still employed at the end of the year (S-K 402(a)(3)(iv)).

Peer Groups

When disclosing the TSR of a peer group, registrants are permitted to choose between issuers and indexes used for the company’s stock performance graph required by S-K Item 201(e)(1)(ii) or the “peer group” for purposes of the CD&A set forth in S-K Item 402(b).   The CD&A rules do not technically refer to a “peer group” and it is most likely a reference to companies disclosed for purposes of benchmarking.  Further the peer group must be capitalization weighted.  To my knowledge, most companies do not weight for capitalization when engaging in benchmarking, which could lead to some departure in the index from decisions of the compensation committee.  If the peer group for the stock performance graph is used, that also must be capitalization weighted, apparently in all circumstances according to Instruction 7 of the proposed rule.  The stock price performance graph does not require capitalization weighting for published industry or line-of-business indexing, although those published indexes may be capitalization weighted.

The proposed rules require a “clear description” of a comparison between the company’s cumulative total shareholder return and cumulative total shareholder return of the company’s peer group.  This seems to call for a good deal of speculation, as issuers cannot have an in depth knowledge of what drove stock price returns for any number of companies that will ultimately span a five year period.

Adjustments for Equity Awards

The proposed rules require the grant date fair value of the equity awards in the summary compensation table be deducted from total compensation, and the fair value on the vesting date for all stock and option rewards in any given year be added back when calculating “compensation actually paid.”  For many, this will be a welcome adjustment given what is perceived to be unrealistically high values assigned to such awards in the summary compensation table. It will also lead to some surprises.  For instance, I surmise that even an underwater option which vests has a fair value, given the value can rise during the remaining term of the option, even though realization of that amount is uncertain at best.  In-the-money options which vest will probably have a higher fair value than the spread between the exercise price and stock price, as an option on the shares for the remaining term itself has value.

How equity based multi-year performance awards which vest in any given year will play out is an open question.  The underlying metrics for vesting may not be tied to TSR, leading to a departure.  Multi-year equity based performance awards which vest in the earliest of the reported period will be based on success metrics for prior years not reflected in TSR for the earliest period, perhaps skewing results.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The CFTC issued a no-action letter to Ford Motor Credit to clarify that a securitization special purpose vehicle, or SPV, that is wholly-owned by, and consolidated with, a captive finance company (as described in Section 2(h)(7)(C)(iii) of the Commodity Exchange Act, or CEA) qualifies as a captive finance company and, therefore, is eligible to elect the end-user exception from a clearing requirement determination issued by the CFTC under Section 2(h) of the CEA.

In order to qualify as a captive finance company an entity must, amongst other requirements, be in the primary business of providing financing.  SPVs often are not in the business of providing financing but most often just facilitate a financing activity.  The CFTC found it is appropriate to consider the business of an SPV to be part of the business of Ford Motor Credit because:

  • Ford Motor Credit’s securitization SPVs are wholly-owned by Ford Motor Credit, which is a captive finance company;
  • the SPVs’ financial statements are consolidated with Ford Motor Credit’s; and
  • the SPVs’ sole activity is facilitating financing undertaken by Ford Motor Credit.

The CFTC interpreted Section 2(h)(7)(C)(iii) of the CEA to cover not only Ford Motor Credit’s securitization SPVs, but also any similarly situated securitization SPV that is wholly-owned by, and consolidated with, a captive finance company. Consequently, such an SPV may elect the end-user exception like its captive finance company parent.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

During the week of April 26, 2015, 8-Ks were filed that disclosed two shareholder sponsored proxy access proposals passed and two failed.  All required three percent ownership for three years and all were opposed by the company.  Details are as follows (percentages are based on the total of votes cast for and against):

Coca Cola Company – 59% voted against (failed)

Exelon Corporation – 56% voted against (failed)

Marathon Oil Corporation – 63% voted for (passed)

TCF Financial Corporation – 60% voted for (passed)

It should be noted that Exelon had a company sponsored proposal on its ballot which passed with 53% voting in favor.  It looks like most everyone who voted for the company sponsored proposal voted against the shareholder proposal. I wonder if this seeming lack of confusion will weigh into the SEC’s review of the “directly conflicts” exclusion of Rule 14a-8.

Since April 19, four shareholder proxy access proposals have passed and six have failed.

This week United Therapeutics Corporation also adopted a proxy access by-law which permits shareholders owning 3% of the stock for three years to nominate up to 20% of the total directors, or 25%  if fewer than ten directors are then serving on the board.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

In Valma v. Templeton et al, the Delaware Court of Chancery held that grants of restricted stock units, or RSUs, to directors of Citrix Systems, Inc. were subject to an entire fairness standard of review.  The court found that the grants were a conflicted decision because all three members of the compensation committee that approved the grants also received the RSU awards.  Citing Delaware Supreme Court precedent, the court noted director self-compensation decisions are conflicted transactions that “lie outside the business judgment rule’s presumptive protection, so that, where properly challenged, the receipt of self-determined benefits is subject to an affirmative showing that the compensation arrangements are fair to the corporation.”

The court rejected the defendants position that prior stockholder approval of the plan ratified the grants at issue.  The court found that Citrix did not seek or obtain stockholder approval of any action bearing specifically on the magnitude of compensation paid to non-employee directors.

The case was before the court on a motion to dismiss.  Accordingly, the court found the defendants’ motion must be denied unless, accepting as true all well-pled allegations of the complaint and drawing all reasonable inferences from those allegations in plaintiff’s favor, there is no “reasonably conceivable set of circumstances susceptible of proof” in which plaintiff could establish that defendants breached their fiduciary duties.

The defendants contended the grants were entirely fair because the grants were in line with 14 companies identified in Citrix’ proxy as its peer group.  The plaintiff claimed that the appropriate peer group should be limited to only five of those companies based on comparable market capitalization, revenue and net income metrics.

In the court’s view the plaintiff raised meaningful questions as to whether certain companies with considerably higher capitalization, such as Amazon.com, Google and Microsoft, should be included in the peer group used to determine fair value of compensation for Citrix’s non-employee directors. The court therefore refused to grant the motion to dismiss.

As a result of this decision, many advisors will now likely recommend that concrete, realistic limitations on grants to directors be built into a plan so that directors can rely on a stockholder approval defense.  If the decision becomes a prelude to the next wave of compensation litigation, many companies may submit their grant practice for stockholder approval even if they do not need a new plan approved.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

 

Six federal financial regulatory issued a final rule that implements minimum requirements for state registration and supervision of appraisal management companies, or AMCs. An AMC is an entity that provides appraisal management services to lenders or underwriters or other principals in the secondary mortgage markets. These appraisal management services include contracting with licensed and certified appraisers to perform appraisal assignments.

The final rule implements amendments to Title XI of the Financial Institution Reform, Recovery, and Enforcement Act of 1989 made by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Under the rule, states may elect to register and supervise AMCs. The AMC minimum requirements in the final rule apply to states that elect to register and supervise AMCs, as AMCs are defined in the rule. The final rule does not compel a state to establish an AMC registration and supervision program, and no penalty is imposed on a state that does not establish a regulatory structure for AMCs. However, in states that have not established a regulatory structure after 36 months from the effective date of this final rule, any non-federally regulated AMC is barred by section 1124 of Title XI from providing appraisal management services for federally related transactions. A state may adopt a regulatory structure for AMCs after this 36-month period, which would lift this restriction.

Under the final rule, participating states must apply certain minimum requirements in the registration and supervision of appraisal management companies. An AMC that is a subsidiary of an insured depository institution and is regulated by a federal financial institution regulatory agency (a federally regulated AMC) must meet the same minimum requirements as state-regulated AMCs except for the requirement to register with a state.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

The SEC announced a maximum whistleblower award payment of 30 percent of amounts collected in connection with In the Matter of Paradigm Capital Management, Inc. and Candace King Weir, File No. 3-15930 (June 16, 2014), the SEC’s first retaliation case.  The whistleblower will receive over $600,000 for providing key original information that led to the successful SEC enforcement action.  According to the SEC, the whistleblower in this matter suffered unique hardships, including retaliation, as a result of reporting to the Commission.

The SEC charged Paradigm with retaliating against the whistleblower after the firm learned that the whistleblower reported potential misconduct to the Commission.  According to the SEC, Paradigm immediately engaged in a series of retaliatory actions against the whistleblower including removing the whistleblower from the whistleblower’s then-current position, tasking the whistleblower with investigating the very conduct the whistleblower reported to the SEC, changing the whistleblower’s job function, stripping the whistleblower of supervisory responsibilities, and otherwise marginalizing the whistleblower. Those charged did not admit or deny the SEC’s findings in the settlement.

You can find further information in our prior blog.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The stockholders of Cyveillance, Inc., sold their company for $40 million up-front and a $40 million earn-out if the company’s revenues reached a certain level. Section 5.4 of the merger agreement prohibited the buyer from “tak[ing] any action to divert or defer [revenue] with the intent of reducing or limiting the Earn-Out Payment.” When the earn-out period ended, the revenues had not reached the level required to generate an earn-out.

The seller representatives sued for breach of the merger agreement. The Court of Chancery found that the merger agreement meant what it said, which is that in order for the buyer to breach Section 5.4, it had to have acted with the “intent of reducing or limiting the Earn-out Payment.” The Court of Chancery found that the seller had not proven that any business decision of the buyer was motivated by a desire to avoid an earn-out payment.

The Court of Chancery also rejected the seller’s implied covenant claim. The Court of Chancery held that the merger agreement was complex and required a number of actions, including actions that would occur post-closing. It thus found that the merger agreement’s express terms were supplemented by an implied covenant. But as to whether conduct not prohibited under the contract was precluded because it might result in a reduced or no earn-out payment, the Court of Chancery held that, consistent with the language of Section 5.4, the buyer had a duty to refrain from that conduct only if it was taken with the intent to reduce or avoid an earn-out altogether.

The Delaware Supreme Court upheld the Chancery Court decision. By its unambiguous terms, that merger agreement term only limited the buyer from taking action intended to reduce or limit an earn-out payment. Intent is a well-understood concept that the Court of Chancery properly applied. The Supreme Court noted that the seller was seeking to avoid its own contractual bargain by claiming that Section 5.4 used a knowledge standard, preventing the buyer from taking actions simply because it knew those actions would reduce the likelihood that an earn-out would be due. As Section 5.4 is written, it only barred the buyer from taking action specifically motivated by a desire to avoid the earn-out.

The Delaware Supreme Court found the Court of Chancery was very generous in assuming that the implied covenant of good faith and fair dealing operated at all as to decisions affecting the earn-out, given the specificity of the merger agreement on that subject, and the negotiating history that showed that the seller had sought objective standards for limiting the buyer’s conduct but lost at the bargaining table. Therefore, the Court of Chancery correctly concluded that the implied covenant did not inhibit the buyer’s conduct unless the buyer acted with the intent to deprive the seller of an earn-out payment.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

During the week of April 19, 2015, 8-Ks were filed that disclosed two proxy access proposals passed and four failed.  All required three percent ownership for three years and all were opposed by the company.  Details are as follows (percentages are based on the total of votes cast for and against):

AES Corp.—66% voted for (passed).

American Electric Power—67% voted for (passed).

Arch Coal—64% voted against (failed).

Cabot Oil & Gas–55% voted against (failed).

Domino’s Pizza—54% voted against (failed).

PACCAR Inc.—58% voted against (failed).

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

Assistant Attorney General Leslie R. Caldwell recently gave her views on the proper scope of internal investigations regarding FCPA matters.  In her views she noted:

Although we expect internal investigations to be thorough, we do not expect companies to aimlessly boil the ocean.  Indeed, there have been some instances in which companies have, in our view, conducted overly broad and needlessly costly investigations, in some cases delaying our ability to resolve matters in a timely fashion.

For example, if a company discovers an FCPA violation in one country, and has no basis to suspect that violations are occurring elsewhere, we would not necessarily expect it to extend its investigation beyond the conduct in that country.  On the other hand, if the same people involved in the violation also operated in other countries, we likely would expect the investigation to be broader.

She also noted:

To assist cooperating companies in appropriately targeting their investigations, to the extent possible, we will make clear to those companies our areas of interest.  I tell my prosecutors that where possible, if it would not compromise our own investigation, we should share information about our investigation with a cooperating company to help focus the company’s internal inquiry.  I encourage an open dialogue between company counsel and our prosecutors about the progress of the internal investigation.  Companies that truly demonstrate a commitment to cooperation will find that this dialogue comes easily.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

In United States v. Coscia, the District Court for the Northern District of Illinois Eastern Division declined to dismiss an indictment for “spoofing” against a high frequency trader under 7 U.S.C. §§ 6c(a)(5)(C) and 13(a)(2) based on the defendants allegations that the statute was void for vagueness. It is important to note that since this was a motion to dismiss the Court was required to assume the allegations in the complaint are true.

The “anti-spoofing” provision of the Commodity Exchange Act prohibits “any trading, practice, or conduct [that] . . . is of the character of, or is commonly known to the trade as, ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).” 7 U.S.C. § 6c(a)(5)(C). Knowing violation of the anti-spoofing provision is a felony. Id. § 13(a)(2).  Coscia argued that the anti-spoofing provision is unconstitutionally vague because it fails to offer any ascertainable standard that separates spoofing from legitimate trade practices such as partial-fill orders (larger-than-necessary orders entered to ensure a sufficient quantity is obtained) and stop-loss orders.

The Government argued that there was never any serious debate as to whether the conduct alleged in the indictment — intentionally entering bids and offers with the intent to cancel them — falls within the meaning of the statute.  For instance, in January 2011, before the CFTC had issued any interpretive guidance, CME’s CEO Craig Donohue opined that: “The distinguishing characteristic between ‘spoofing’ . . . and the legitimate cancellation of other unfilled or partially filled orders is that ‘spoofing’ involves the intent to offer non bona fide orders for the purpose of misleading market participants and exploiting that deception for the spoofing entity’s benefit.

The court found the statute’s “intent to cancel” requirement was significant.  It cited precedent which stated “When the government must prove intent and knowledge, these requirements do much to destroy any force in the argument that application of the statute would be so unfair that it must be held invalid.”

The court found Coscia’s alleged “intent to cancel” sets his conduct apart from the legitimate trading practices described in his memorandum. The alleged conduct in the indictment involves the entry of large-volume orders with the intent to “immediately cancel.”  Because the alleged conduct clearly involves “bidding or offering with the intent to cancel” the Court did not find § 6c(a)(5)(C) impermissibly vague as applied to Coscia.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.