The purpose of this Post is remind publicly-traded companies to revisit their stock ownership policies to determine whether a temporary waiver of the policy requirements is advisable.  This Post is Part 5 of a 7-Part series addressing compensation adjustments that Compensation Committees could consider in order to continue to incent and retain their executive officers in today’s economy.

Stock Ownership Policies Typically Denominated in Dollars

Equity ownership goals within stock ownership policies are typically denominated in shares or dollars (the latter being a fixed dollar amount or a percentage of compensation).  Dollar-denominated guidelines are the most common among publicly traded companies, and many of these guidelines are based upon a percentage of base salary.  For those companies where compliance with their stock ownership guidelines is denominated in dollars, any significant drop in stock price is likely to cause the executive to fail the policy’s requirements.

Consider a Temporary Waiver of the Policy Requirements

Compensation Committees could consider a temporary waiver of the stock ownership requirements, with the idea that the issue will be revisited in the Fall of 2020.  But in exchange for such waiver, the executive should be required to hold (i.e., not be able to sell) all shares currently subject to the policy.  Such hold requirement should continue until the issue is revisited in the Fall of 2020.

Related Posts

Blog posts that are part of this 7-part series include:

The purpose of this Post is to highlight whether Compensation Committees should be offering retention packages to their executive officers to discourage their being poached by another company.  This Post is Part 4 of a 7-Part series addressing compensation adjustments that Compensation Committees could consider in order to continue to incent and retain their executive officers in today’s economy.

Background

Many executives are suffering from depressed realizable pay levels.  This makes sense because a performance-driven compensation model would weight most of an executive’s “total compensation” towards performance-based annual awards and long-term performance-based awards, and generally speaking these performance goals are no longer achievable.  And since long-term awards typically cover three or more years, many executives are likely worried that depressed pay levels will continue to be an issue in 2021 and 2022.  Such executives are susceptible to being poached by other companies since their taking new employment could “refresh” their pay levels.

Retention Packages

Many companies are offering retention packages or specially formulated performance bonuses to their executive officers.  For those Compensation Committees considering the issue, related thoughts include:

  • Consider the time horizon for the retention bonus (current calendar year, two years or more).
  • Consider whether any payout should be in the form of a lump sum or installments.
  • With respect to the use of performance measures, consider using a more broader range of measures than would otherwise be typical, including the use of more qualitative and individual criteria.   And since it will likely be difficult to establish meaningful performance goals due to today’s economic environment, consider structuring any performance goals to be relative to the company’s peer group.

Related Posts

Blog posts that are part of this 7-part series include:

This post is part of a 7-part series addressing compensation adjustments that Compensation Committees could consider in order to continue to incent and retain their executive officers in today’s economy.  The titles of each of the 7-parts in this series are listed at the bottom of this post.   This Part 3 is entitled “Address Outstanding Performance-Based Equity Awards,” and provides some alternatives that Compensation Committees could consider with respect to outstanding performance-based equity awards that have currently unachievable performance goals.  Such alternatives include (listed in no particular order, and not an exhaustive list): Continue Reading Current Compensation Issues (Part 3 of 7): Address Outstanding Performance-Based Equity Awards

This post is part of a 7-part series addressing compensation adjustments that Compensation Committees could consider in order to continue to incent and retain their executive officers in today’s economy.  The titles of each of the 7-parts in this series are listed at the bottom of this post.   This Part 2 is entitled “Consider Changes to Increase Cash Flow,” and provides some ideas that a Compensation Committee could implement that could work to increase the company’s cash flow and produce positive proxy disclosure.  Such ideas are (listed in no particular order, and not an exhaustive list): Continue Reading Current Compensation Issues (Part 2 of 7): Consider Changes to Increase Cash Flow

Today’s economic environment has resulted in substantial loss of value to many shareholders and executives of publicly traded companies (i.e., the latter losing substantial value in their stock holdings, and too, losing prospective realizable pay as a result of unattainable performance goals within their outstanding performance-based awards).  In most situations, the shareholders and the executives are aligned in such loss.  But a problem is that substantial loss at the executive level could increase undesired poaching and turnover of key executives at a time when executives should be focused on navigating the company through a reopening of the United States economy.  To overcome this problem, compensation committees of publicly traded companies (“Compensation Committees“) will likely need to consider adjustments to the company’s compensation framework in order to continue to incent and retain executives.  To that end, this Part 1 (of a 7-part series) provides thoughts that the Compensation Committee should consider with respect to upcoming equity grants. Continue Reading Current Compensation Issues (Part 1 of 7): Considerations with Respect to Upcoming Equity Grants

Just a quick update that on April 8, 2020, Institutional Shareholder Services (“ISS“) published policy guidance reflecting certain adjustments due to the impact of the COVID-19 pandemic.  The guidance addresses how ISS’s benchmark and voting policies may be applied in this new area of uncertainty.  In many cases, the guidance merely reiterates that ISS will respond to corporate actions on a case-by-case basis.  To address the topic, we published a client alert entitled “ISS Issues COVID-19 Guidance on Benchmark and Voting Policies.”

On a separate note, two of my partners (Steven Haas and Allen Goolsby) authored a client alert entitled “Should the Board Create a Special Committee to Oversee the Response to the Pandemic.”  I found it interesting from a compensation perspective, and I am sharing for that reason.

Join us on April 9, 2020 from 10:00 am to 11:00 am Central for our FREE monthly webinar on “Executive Compensation Considerations in Light of Market Volatility, Stock Prices and the Unknown,” where we will discuss compensatory issues to consider as a result of failed (or failing) performance-based compensation metrics and lost value to the issuer’s long-term shareholders, including:

  • Considerations with respect to annual incentives for 2020;
  • Thoughts with respect to outstanding performance-based equity awards where the performance conditions are not likely to be attained, including a discussion of what to do with long-term equity awards that were granted in 2018 and 2019;
  • Action items with respect to upcoming 2020 equity incentive grants;
  • How to deal with large stock awards resulting from value-based grants of equity (e.g., a grant equal to 40% of the executive’s base salary);
  • Design and governance considerations when an executive desires to reduce his or her base salary in exchange for equity grants;
  • Using a stock-price forfeiture as a design to avoid future underwater stock options;
  • Re-thinking equity plan share pool constraints and individual per grant limitations; and
  • How to structure the cancellation of Rule 10b5-1 trading plans so as to avoid negative shareholder optics.

Many publicly-traded issuers in today’s environment have outstanding equity awards with performance goals that are unlikely to be achieved.  In response, Compensation Committees of such issuers will need to strike a balance between incentivizing/retaining executives and dealing with the stark reality that shareholders have lost substantial value.  To that end, Compensation Committees are likely to discuss whether it makes sense to revise performance metrics for outstanding equity awards.  The purpose of this Post is to highlight that revising performance metrics of outstanding equity awards can trigger the SEC’s tender offer rules if not done correctly.

EXECUTIVE SUMMARY

With respect to outstanding performance-based equity awards, and from a contractual perspective within the award agreement, participant consent may be required in order for a Compensation Committee to replace ill-performing performance criteria with new performance criteria (e.g., swap out EPS with relative TSR).  Seeking such consent may inadvertently trigger the SEC’s tender offer rules.  However, if the Compensation Committee can effectuate such amendment in a unilateral manner without participant consent, then the issuer could avoid the tender offer rules on the basis that the participant had no choice and made no investment decision.  Alternatives 1, 2 and 3 in the far below portions of this e-mail are just three of the many viable alternatives that could be used by Compensation Committees to operationally revise ill-performing performance metrics without triggering the SEC’s tender offer rules.

BACKGROUND – APPLICATION OF THE SEC’s TENDER OFFER RULES

  • GENERALLY.  Generally, the SEC’s tender offer rules under Rule 13e-4 of the Securities Exchange Act of 1934 should be analyzed whenever a holder of a security is required to make an investment decision with respect to the purchase, modification or exchange of that security.  These tender offer rules were front and center during previous financial downturns (e.g., beginning around 2001 and again around 2008) when issuers were making offers (or thinking of making offers) to employees to reprice their underwater stock options.  During those times the SEC’s tender offer rules had to be analyzed and were often triggered because the proposed amendment to the terms of the outstanding stock option created an investment decision by the employee (i.e., an investment decision is triggered due to the employee having a choice between two alternatives, even if the alternatives are only slightly different).  To be clear, unilateral repricings without optionee consent do not trigger the SEC’s tender offer rules, but such a repricing creates incremental compensation expense from an accounting perspective (measured by the difference between the fair value of the option immediately prior and after the repricing).  As a result, issuers sought to neutralize incremental compensation cost by effectuating the repricing pursuant to a value-for-value exchange.  The value-for-value exchange would replace the underwater stock options with securities of an equal fair value (typically determined pursuant to a Black-Scholes formula) pursuant to either: (i) a lesser number of shares being subject to the repriced stock option or (ii) a grant of restricted stock or restricted stock units.  The result of a value-for-value exchange is that the issuer has to solicit consent from the optionee and the optionee has to make an investment decision.  Thus, the SEC’s tender offer rules were triggered.
  • RAMIFICATIONS OF TRIGGERING THE SEC’s TENDER OFFER RULES.  On March 21, 2001, the Division of Corporation Finance issued an exemptive order (the “Exemptive Order”) under the Exchange Act for exchange offers conducted solely for a compensatory purpose.  See SEC Exemptive Order.  The purpose of the Exemptive Order was to relax the tender offer rules under Rule 13e-4 of the Exchange Act when triggered solely for compensatory purposes, and to grant an exemption from Rule 13e-4(f)(8)(i) (the “all holders” rule) and Rule 13e-4(f)(8)(ii) (the “best price” rule) for repricings that meet certain criteria.  Assuming such criteria were satisfied, compliance with the relaxed tender offer rules under the Exemptive Order would still require the issuer to (among other requirements):
    • Announce the offer by issuing a press release describing the terms of the transaction;
    • File with the SEC a Schedule TO and mail an offer to purchase (along with ancillary documents) to security holders;
    • Keep the offer open for at least 20 business days;
    • Upon expiration of the offer, issue a press release announcing the preliminary results; and
    • Provide employees with withdrawal rights that do not expire until the expiration of the offer and at any time within 40 business days from the commencement date.
  • HISTORICAL METHODS TO AVOID THE SEC’s TENDER OFFER RULES.   There were only two ways to avoid the SEC’s tender offer rules with respect to repricing underwater stock options, such being: (i) implement only a unilateral repricing without optionee consent (thus no investment decision), or (ii) reprice on an individually negotiated basis but only with respect to a small number of key executives.  As to (i), such would trigger incremental compensation cost and was often avoided.  As to (ii), the Exemptive Order provided that an exchange to a limited number of executives or senior officers of the issuer would not trigger the SEC’s tender offer rules, though the Exemptive Order did not provide guidance on what would be the appropriate maximum number of executives or senior officers.
  • APPLICATION OF THE SEC TENDER OFFER RULES TO RSAs, RSUs, PSAs AND PSUs.  Relaxation of the SEC’s tender offer rules pursuant to the Exemptive Order was specific to stock options, however, we think the Exemptive Order could also apply to resetting/amending performance criteria of outstanding restricted stock awards, stock-settled restricted stock units, performance-based stock awards and stock-settled performance-based stock units so long as there is ONLY a compensatory purpose.  That said, this issue is not settled in the law and advice from one law firm to another may vary.

ALTERNATIVES TO AVOID THE SEC’s TENDER OFFER RULES

The following Alternatives 1, 2 and 3 are just three of the many viable alternatives that could be used by Compensation Committees to operationally revise ill-performing performance metrics without triggering the SEC’s tender offer rules.

  • ALTERNATIVE 1 – LEAVE OUTSTANDING AWARD AND GRANT NEW PERFORMANCE-BASED EQUITY AWARD.  This Alternative 1 would not trigger the SEC’s tender offer rules, however, it could substantially increase the strain on the available shares that remain for grant under the issuer’s equity incentive plan.  This is a fact specific analysis, but many issuers have substantially constrained share pools under their equity plan.  These issuers need to conserve shares because they typically are not in a position to seek shareholder approval to increase the share pool size.
  • ALTERNATIVE 2 – DO NOTHING NOW, AND LATER APPLY POSITIVE DISCRETION TO WAIVE THE PERFORMANCE CONDITION.  The optics of this Alternative 2 can be shaped if the issuer implements a robust shareholder outreach program prior to the next proxy meeting.  As background, with the elimination of the performance-based exception to the $1mm deduction limit under Section 162(m), many issuers now allow for positive discretion within their performance-based equity incentive program, and as a result, the Compensation Committee could have the authority to later waive any portion or all of the pre-existing performance conditions.  The ability to execute this Alternative 2 is based on facts and circumstances, that is, the equity plan and award agreement will have to be reviewed to determine whether the Compensation Committee has the authority to exercise positive discretion.  And the SEC’s tender offer rules would not be triggered in this Alternative 2 because such positive discretion can be implemented unilaterally without participant consent (thus, no investment decision by the participant).  That said, this Alternative 2 might not be enough to incent and retain the participant since he or she would have no contractual rights that positive discretion will be used in the future.
  • ALTERNATIVE 3 – LAYER THE NEW PERFORMANCE SCHEDULE ON THE EXISTING AWARD, AND REQUIRE THAT THE EXECUTIVE RECEIVES THE “GREATER OF”.  The optics of this Alternative 3 can be shaped if the issuer implements a robust shareholder outreach program prior to the next proxy meeting.  The idea of this Alternative 3 is that the executive would receive the greater of the number of shares that would vest based on either the pre-existing performance schedule or the new performance schedule.  Since the participant’s rights would not be impaired in implementing this Alternative 3, participant consent would generally not be required.  As a result the SEC’s tender offer rules would not be triggered and the outstanding performance award continues to have performance metrics.

To close, the above is not legal advice and intentionally does not address the accounting or institutional shareholder implications of revising performance metrics of outstanding equity awards.

To help issuers prepare for the upcoming proxy season, and as a follow-up to our prior post entitled “Compensation Considerations for the 2020 Proxy Season,” we are hosting a FREE webinar entitled “Upcoming Proxy Season: Compensatory Thoughts from ISS (an Annual Program)” on Thursday, January 16, 2020 from 10:00 am to 11:00 am Central [Register here].  The purpose of this webinar is to discuss compensatory thoughts and trends of institutional shareholder advisory services such as ISS, including:

  • New compensation pronouncements and positions of ISS since the 2019 proxy season;
  • Compensatory thoughts where issuers should focus their attention due to continued focus by ISS;
  • The impact the foregoing is likely to have (or could have) on current compensation designs; and
  • Our overall thoughts and suggestions.

See you soon!

This is a just a quick note that proposed Treasury regulations were issued under Section 162(m) that reverses a series of private letter rulings previously granted to UPREITs.  Under the proposed Treasury regulations, the $1mm deduction limitation under Section 162(m) would apply with respect to compensation that a publicly-traded REIT’s covered employee receives from an operating partnership for services he or she provided on behalf of such operating partnership.  The proposed Treasury regulation is applied by potentially disallowing a REIT’s distributive share of any compensation deduction arising from compensation the covered employee received from the REIT’s operating partnership.  As a result, at least from a Section 162(m) perspective, compensation paid to a covered employee by an operating partnership should now be vetted and analyzed at the REIT level.

A more detailed analysis of the proposed Treasury regulations was drafted over the holidays by my partners Kendal A. Sibley and George C. Howell, III in the attached Client Alert entitled “Unexpected Provision in Proposed Section 162(m) Regulations May Affect Compensation Deductibility for UPREITs.”

Other aspects of the proposed Treasury regulations will be set forth in upcoming posts!