We have been contacted over the past 6 months by a number of large employers across the southeast, who have recently experienced a compensation audit by the U.S. Department of Labor. Key parts of these audits have been requests for documentation on the Company’s compensation policies and information to support how the Company’s practices match policy. Key areas reviewed included overall compensation policy, base compensation, distribution of salary adjustments, incentive plan structures, and FLSA compliance (interestingly these audits do not seem to have targeted ERISA or other key DOL areas).
As with any audit, preparation is always a “best practice”. If you have questions about what being compliant means, if we can assist you with an audit of your current pay practices, and/or if you need help developing policies and processes that match Company intent and are legally compliant, please contact us at 919-644-6962, or complete a contact request at http://matthewsyoung.com/contact.htm.
All of the prognosticators (including us…see The Future Community Bank Model – Greater Diversity of Revenues and Reduced Risk) are talking about the need for community banks to diversify their product mix, rely less on concentrations of commercial real estate loans and develop new fee-based services. The problem is that the current staff of most community banks has a set of knowledge, skills and abilities that do not apply in this new world community banking environment.
Commercial and Industrial Lending (aka C&I Lending) is a very different process than Real Estate lending. Will the banks retrain real estate lenders or recruit C&I lenders from other banks? Where can they find trained lenders? Large banks have relatively few credit trained C&I lenders because these banks shifted years ago to a “hunter/gatherer” strategy that deployed many relationship developers (hunters), with limited credit training, who would bring the loan request to a few credit underwriters who made the deal work for the bank. When this shift occurred, the large banks no longer developed the trained staff that community bank recruiters needed.
Banking gurus are also pushing the point that fee-based businesses need to be developed in the community banks to offset some of the continuing pressure on traditional net interest margins upon which community banks have historically depended. There has been much written about understanding your local communities’ needs and the share of wallet your bank is getting. This is how you determine what additional services are needed in your communities. All true, but where do you get the talent to develop and then manage these new businesses? Banks have not traditionally had strong sales teams, so once the new businesses are developed, will banks be able to build the businesses.
It has been estimated that half or more of the staff currently in most community banks will need to be replaced with people with new knowledge, skills and abilities needed in the new model of community banking. In some cases, the change needs to begin at the top of the organization. We hear from capital market players that investors often want a new team to deploy the new capital. CEOs would be well advised to aggressively rethink their strategies for their banks and include strategies for attracting and retaining the new talent that will be needed in the new world of community banking.
For an assessment of your community bank’s strategic plan, click here:
The Dodd-Frank Act, signed into law in July 2010 by President Obama, shines a bright light on many issues related to Executive Compensation and Corporate Governance. Specifically, one section (952) requires the SEC to adopt rules regarding Compensation Committee members’ independence and suggests a specific list of factors to be identified that will govern the Committee’s advisors. To quote chapter and verse, Section 952 – The Commission is directed to establish competitively neutral independence factors for all who are retained to advise compensation committees
First, a couple of definitions according to Webster’s dictionary:
Independent – not subject to control by others, not requiring or relying on something else, not looking to others for one’s opinions or for guidance in conduct
Neutral – having no personal preference, not supporting or favoring either side…
Personally, I don’t know how “independence” can be anything other than “neutral”…this seems a little redundant, but I digress.
The SEC is required to adopt the new rules by July of 2011 (within one year of the law being signed). The rules will require that public companies disclose in their proxy when they hire an outside compensation consultant, whether potential conflicts of interest exist (in other words – if the consultant has a personal preference or is potentially subject to control by others) and what the Committee has done to address the potential conflict. This will obviously influence Committee behavior in hiring such advisors by encouraging them to avoid any potential conflicts or breaches of neutrality and independence. In only the most extreme cases, could a Committee justify hiring an advisor that violates the independence test without public scrutiny and shareholder unrest.
Much like Sarbanes-Oxley’s requirements of independence and neutrality with regard to Audit Committee advisors, these new rules on corporate governance seem to fall into the category of “doing the right thing”. Some consulting activities that seem to contradict this characteristic would be selling products to companies whom you advise, simultaneously working for management on other projects without full disclosure and prior approval of the Committee or an engagement advising companies for fees where the consulting principals have a significant ownership position (i.e. shareholder).
At Matthews-Young, we have always subscribed to the higher ideal of “doing the right thing”. We require that we be hired and report directly to the Compensation Committee when we are engaged for Executive Compensation work. We have no sources of revenue other than being paid for our time and knowledgeable, expert advice without “supporting or favoring either side”.
If we can assist you with improving your company’s governance and committee effectiveness please give us a call at 919-644-6962 or ask us to contact you at http://matthewsyoung.com/contact.htm.
The SEC issued Final Rules regarding public company requirements to disclosure and ask shareholders for a non-binding vote on executive compensation practices, known as “Say-On-Pay.”
The new rules specify that say-on-pay votes required under the Dodd-Frank Act must occur at least once every three years beginning with the first annual shareholders’ meeting taking place on or after Jan. 21, 2011.
Companies also are required to hold a “frequency” vote at least once every six years in order to allow shareholders to decide how often they would like to be presented with the say-on-pay vote. Following the frequency vote, a company must disclose on an SEC Form 8-K how often it will hold the say-on-pay vote.
Under the SEC’s new rules, companies also are required to provide additional disclosure regarding “golden parachute” compensation arrangements with certain executive officers in connection with merger transactions.
The Commission also adopted a temporary exemption for smaller reporting companies (public float of less than $75 million). These smaller companies are not required to conduct say-on-pay and frequency votes until annual meetings occurring on or after Jan. 21, 2013. “Public Float” is typically defined as the portion of a company’s outstanding shares that is in the hands of public investors, as opposed to company officers, directors, or controlling-interest investors.
Margins in the financial services business “stink” right now. (Stink is a technical term meaning “what margins?”.) Rates are so low, and liquidity needs are so great, community banks and credit unions have little to no margins to help rebuild capital following serious loan losses over the last three years. Margins are likely to improve in the short run, but in the long run competitive pressures will continue to keep margins tight. Community financial institutions need to be more efficient in the future, but increasing regulation will require new staff and management time. Cooperating in cost sharing pools or merging to get bigger will be needed in order to compete.
Cooperating to Win
Cost sharing makes a lot of sense. Compliance and certain Audit functions could be outsourced. Many Human Resources and some Marketing functions can be outsourced as well. With the right sources, financial institutions can get access to more senior talent at lower costs because they share the resources. The keys to making this work have to do with reliable service providers working with peer groups of financial institutions that are not competitors. I expect the remaining bankers’ banks to offer such services and consultants will provide services as well. We have been approached by small institutions looking for such services and asking us to organize peer groups for sharing costs.
There is little doubt that small community banks and little credit unions are under a great deal of pressure. Will the growing weight of new regulations and other requirements do them in or will new technologies and cooperative efforts save them? Let us hear your ideas with comments below, and if you want to know more about our offerings, call me at 919-644-6962 or ask us to contact you at http://matthewsyoung.com/contact.htm.
The SEC, US Treasury and jointly for banks the Federal Reserve, OCC and FDIC in a joint agency statement have made risks in compensation plans a high priority and point of emphasis. Furthermore, SEC proxy disclosure requirements for 2010 require an explanation of the relation between compensation plans (primarily incentive compensation) and risks that may be more encouraged due to motivations caused by such compensation plans. Specifically, these regulatory agencies want to identify and eliminate compensation plans that “create risks that are reasonably likely to have a material adverse effect on the company.”
Matthews, Young – Management Consulting has worked with several clients assisting them with the necessary process and review of Compensation Policy and Plans, including a number of community banks participating in the TARP program who must comply with similar regulatory requirements. Randy McGraw, a Senior Consultant with our Firm, collaborated with me to layout the specifics of Compensation Plan Risk reviews.
Scope and Timing of our Review
Our assessment of compensation programs requires a review of all compensation plans and practices (with emphasis on incentive compensation) to ensure that they do not encourage participants:
To take unnecessary and excessive risks which threaten the value of the company.
To manipulate reported earnings to enhance compensation.
To focus attention exclusively on short-term results at the expense of longer term performance that adds value to the institution.
For organizations taking TARP funds from the Treasury, at least every six months, the Committee and Senior Risk Officer (SRO) review all employee compensation plans related to excessive risk, manipulation of earnings, and short-term over long-term results. The Committee is required to limit and/or eliminate any plan features that encourage such behavior.
For TARP recipients, SEC reporting companies, and all financial institutions, at least once every fiscal year, the Committee and SRO, in addition to review, discuss results and prepare a narrative description of findings and actions taken on any adverse findings in review.
For TARP recipients, within the first 120 days of the end of the fiscal year, the Committee prepares a narrative report describing Committee meetings, discussions, and actions. The report must be submitted to both U.S. Treasury and primary regulator For SEC reporting companies, results of review are reported in the proxy statement.
Key Elements of our Analysis
We will look at an overview of total compensation to ensure that:
There is a balanced mix of pay elements (base salary, annual cash incentives, long-term equity award incentives)
Base salaries are sufficiently competitive to avoid undue emphasis on earning incentives in order to earn reasonable cash compensation.
Potential incentive levels achieved from short-term and long-term plans are balanced to ensure sufficient focus on long-term results.
For short term incentive compensation, our review will be focused to ensure:
Reasonable number of participants.
Maximum incentives are capped and potential incentives are reasonable.
Performance measures require a balance between earnings, return, revenue or asset growth, operating efficiency, and asset quality or other risks.
Performance measures support achievement of operating as well as strategic goals.
Performance measures strengthen teamwork as well as match a participant’s areas of accountability.
Incentives do not create a conflict of interest for officers with compliance and audit responsibility.
Whether plans contain a claw-back provision which has been communicated to participants.
For long term incentive compensation (as applicable), our review will be focused to ensure:
Reasonable number and category of participants.
Stock overhang and run rate are in line with prevailing market practice.
There is balance between appreciation-oriented (options) and full-value (restricted stock) grants; as well as balance in full-value grants between time-vested and performance-based grants.
Option grant exercise price is at or above fair market value; and re-pricing is prohibited.
Vesting and performance periods are sufficient to emphasize multi-year service and performance.
Bank regulations require that the Compensation Committee meet with the Bank’s designated Senior Risk Officer (SRO) to discuss relevant issues; and suggest using an outside compensation advisor to facilitate the compensation review. This approach is also recommended for other types of organizations. Our recommended methodology is as follows:
Matthews, Young – Management Consulting will assess compensation plans and practices based on information provided by client.
Matthews, Young – Management Consulting will draft a letter that describes our review and findings along with any recommendations for change and provide this letter to the SRO. With client’s input, we prepare a table summarizing key terms of all incentive compensation plans specifically Plan Name, Plan Purpose, Participant List, Administrative Responsibility, Performance Measures and Incentive Payout Potentials.
SRO reviews our letter; assesses the potential risk created by compensation in the following risk areas: Credit, Market, Liquidity, Operational, Legal, Compliance, and Reputation.
SRO then prepares their own letter to the Committee summarizing the review process and findings.
Compensation Committee meets with outside consultant and SRO, reviews both letter and reports, identifies any actions required to modify plans, and documents meeting activities.
We are currently offering a free telephone consultation to further discuss the regulatory requirements and risk review process. Please contact us if you would like to discuss your compensation plans and an assessment of the risks they may pose to your company. Call 919-644-6962 and ask for David Jones, Randy McGraw or Tim O’Rourke. You can also complete the request form at http://matthewsyoung.com/risk_review_contact_landing.htm.
With the “Boomers” reaching retirement age, executives are beginning to retire in large numbers, but will the new CEOs walk into empty Boardrooms? Let’s face it, becoming a Board Member is not as glorious as it once was. The liability one takes on in the current litigious environment and the work necessary to do the job well is rarely offset by the rewards, financial or otherwise.
We worry about attracting and retaining qualified directors to represent shareholder interests in the future. Recruiting and grooming future directors needs to be an ongoing process of a Nominating Committee. We have been on the lookout for practical solutions to this dilemma, and recently found a case study in the “ABA Banking Journal.” A number of years ago, First United eliminated its three Advisory Boards. In their place, an Advisory Council was created. Care was used in terming it a “council” and not a “board.” This made it clear that the role was advisory, and it did not bear the legal responsibilities of the Board.
According to William Grant, chairman and CEO, the Council meets six times per year, in a dinner meeting following our Board meetings. This affords our Board members the opportunity of attending and observing. The Council’s agenda is to kept abreast of the bank’s activities, and to solicit their input on a number of market‐related issues. The majority of the Council members are community oriented businesspeople, and able to bring this perspective to the meeting.
This arrangement provides the following advantages to the Bank:
It serves as a valued “blue sky” advisory group to help the bank establish and execute strategies
It provides a “farm system” for future directors by affording members the opportunity of learning about the bank, its mission, and its culture. The bank gets to know them. If there is a fit, then that person may eventually become a director. In fact, the last several directors at First United have come to the board by this route. If there is not a fit, then that becomes known before a member is placed on the board, and one side or the other comes to this realization.
It facilitates an environment where the Council member and various directors come to know each other, making the selection and nomination of future directors an easier chore.
This approach seems to address the issue nicely. We would love to hear other ways that have worked for you. Please comment below. Thank you. To discuss your Board’s succession planning process, call me at 919-644-6962 or complete a contact request at http://matthewsyoung.com/contact.htm.
Since September of 2008, we have been in the most challenging economic environment since the great depression. During this period, we have seen unprecedented government intervention with programs like TARP, and with the most recent passage of the Dodd-Frank Act, the regulatory burden is going to dominate the time of each management team and their board of directors. Risk Management practices have continued to improve, but it is the unforeseen risk, whether it is a double dip recession, continued declines in real estate values, deflation or a host of other things, that has to challenge the critical thinking of each bank’s leadership.
In this challenging environment, strong leadership is a must. Each CEO must be proactive and not reactive. Communication with regulators, the board of directors and the management team, as well as with all employees in the organization, is vital in order to maintain a healthy and well run financial institution. It also goes without saying that keeping shareholders informed of the strategy, vision and health of the bank is a must in order to build confidence in the marketplace. Capital is king, and investor confidence is vital especially in this economic environment and the access to new capital is paramount.
With respect to lending, there is an old saying that “you can fix bad loan underwriting but you cannot fix a bad market.” In light of the economic issues and the increased regulatory burden, Management needs to constantly monitor asset quality, ensure a diverse loan portfolio and be acutely aware of trends in the markets that the bank serves. Constant independent loan review in order to maintain a strong performing loan portfolio is now a best practice.
On the funding side, deposit composition is critical, as Jumbo CD’s and Brokered Deposits are not considered as part of a strong core deposit base. The true value of a bank is based on its loyal core deposit base. At the same time, management must make the tough calls and close branches where the economic risks are too great in a market that has been challenged by this prolonged economic downturn.
The banking business is still a people-driven business. Long-term, the key to success is having strong leadership that continually adds talented people to the organization.
To close, I’ll leave you with the idea that tough times do not last but tough-minded people and organizations do!
Time after time, personal development plans have all the staying power of a new year’s resolution. What goes wrong? Why is a good plan so hard to build, and even harder to execute?
Too Ambitious ….
Too trivial ….
Too vague ….
Too far away ….
Correct on all counts, but mere symptoms of the real problem – Creating and executing effective executive development plans is hard work, and planning efforts most often fail because someone forgot that people are unique, and that the change we are talking about may be real change. More often than not those attempting development planning processes (participants and practioners), don’t take time to understand how the “person they are working on” learns and grows, and/or don’t have a solid process for “testing” to see if the plans they have made have a high probability for generating change (i.e. provides the motivations needed for effective follow-through).
The Dodd-Frank Act, signed into law in July 2010 by President Obama, requires publicly traded companies to disclose the following additional information in their proxy.
Pay for Performance
A disclosure regarding the relationship between a company’s financial performance, including changes in shareholder return and the executive compensation actually paid.
Comparison of Compensation
A comparison of the dollar amount of the median of annual total compensation of all employees (excluding the CEO) and the total annual compensation of the CEO, with a ratio of CEO total compensation to the median total of all employees. Total Compensation is expected to be defined according to the SEC rules for calculating total compensation for named executive officers in the Summary Compensation Table in the current proxy disclosure rules, but we will have to wait for the SEC rules to be certain.
The final rules regarding these disclosures is the responsibility of the SEC but the Agency has no deadline for publishing the new rules. A recent comment from SEC Chairwoman Mary Schapiro indicated that the final rules would not likely be in place for the 2011 proxy season.
One challenge (and burden) for all companies will be the requirement to calculate the total compensation of each employee under the same rules as named executives in the proxy to then be able to calculate the median value. This will require computing the value of equity awards, bonuses, perquisites, changes in the value of pension plans for all employees (full and part-time) and a conversion to US dollars of foreign subsidiaries employees’ compensation. The Act does not limit these disclosures to the proxy statement but includes disclosure in a number of SEC filings (i.e. registration statements and quarterly and annual financial statements).
It’s obvious that this new disclosure provision of the Act will require an inordinate amount of time and effort to comply. Furthermore, it will also likely require a good bit of narrative for companies to explain their methodology and computation of all employees total compensation, especially when the ratio comparing CEO’s pay to the median of all employees is seen to be excessive or out of line with peers.
What will this new disclosure reveal about a company’s compensation strategy and philosophy? Will companies change their compensation strategy as a result of this disclosure? Will it influence the type of compensation offered in order to reduce or minimize the total compensation value calculation? What does the proposed ratio really tell us about the value of a CEO’s compensation? These are but a few of the questions that come to mind in light of the “unintended consequences” of the new Act.
We are working with clients on methods for collecting necessary data for disclosure and preparing draft proxy statements for Committee review. We recommend companies begin to prepare early for these new disclosure rules that will become required once the SEC publishes the final rules.
There is a clear trend among companies to strengthen the linkage between shareholder and executive interests. Many companies are responding to this trend by evaluating the effectiveness of having stock ownership and/or stock retention guidelines for their executive officers.
We observe that implementing such guidelines in the current economic environment can be challenging for these executives. Since executive cash compensation is flat or increasing only slightly, achieving stock ownership requirements can represent a greater burden than in the past.
However, these difficult times also present a partial solution. Many companies decided not to give salary increases to key executives for 2009 and, some cases, 2010 as well. Hopefully, those companies are having better financial results this year, are concerned that executive salaries may trail the market, and are considering giving an additional salary increase beginning in 2011 – say five percent on top of whatever a regular raise might be. Herein lies the opportunity to address some of the challenge of increasing executive stock ownership.
Instead of granting the additional raise, consider an equivalent value in Restricted Stock Units (RSU’s) with a reasonably short restriction period (e.g., two years). Since the salary increase is an annuity as long as the executive is employed, then the company would grant the same dollar value in RSU’s every year. RSU’s also offer an interesting feature that is not available with Restricted Stock grants – RSU’s can be voluntarily deferred beyond the restriction period as long as the executive complies with IRS Code Section 409A requirements related to the deferral.
This approach offers several benefits both to the company and to the recipient:
The executive defers income taxes until actual shares are finally received at the end of the restriction period, including the voluntary deferral period. Thus, the executive accrues more shares than if the additional salary were used, on an after-tax basis, to buy stock.
The company’s stock ownership guidelines would give credit for RSU’s that have been granted and not yet converted into actual shares. By using the voluntary deferral procedure, the executive can count all RSU’s towards meeting stock ownership guidelines as well as postpone income tax.
There is also the option to take cash in lieu of shares (or a portion in cash to pay income tax and the remainder in shares) at the end of the deferral period, or to defer the cash payout as long as the executive complies with IRS Code Section 409A rules.
The company does not have to issue actual shares until the end of the voluntary deferral period.
Since this will be an ongoing program of annual grants and increasing stock ownership among executives, there is also a pretty nice story to tell shareholders.
These are challenging times for addressing executive compensation issues. But maybe this is one of those instances of being handed “lots of lemons”, but using the opportunity to “make some lemonade”.
We wonder about the future of community banking. Times are tough right now in community banking, but we are thinking about the business model for the long-term future of community banks. Does anybody care? We think so.
It seems every time there is a major wave of consolidation in banking, there follows a wave of new local bank charter applications. There is always a strong desire among local business owners, developers and city fathers to have a locally owned bank that understands the local market and its needs for financing. When the dust settles on the current banking crisis, and the coming wave of consolidation begins to wane, it is predictable that there will be another wave of interest in starting new local banks. The necessary capital should be available as long as a business model can be found that will produce a reasonable return on what is sure to be a higher capital requirement. We will take up the question of how much capital is needed in a future blog.
So, if you were starting a new bank, what business model would you want to use? One lesson we relearn every 15 or so years is that concentration of loans in any one industry or type of lending is always risky. There is just not enough margin in many types of lending to warrant risking more than a relatively safe level of concentration. Some community banks have found some success in the insurance business or the investment brokerage business. One thing seems clear, diversity of assets and revenue sources will be a key part of the future model.
It has also become clear that most, not all but most, of the small banks that got into trouble after the 2008 credit and liquidity crunch had little to no local franchise. A local franchise is a brand that your local community understands and sees as a valuable part of the community. While money was cheap and plentiful during the nineties and the beginning of the current decade, many banks started and leveraged their capital with brokered and wholesale deposits instead of local consumer and business deposits. The demand for loans, especially for funding local real estate projects was strong during those boom days and a small marginal spread could be made with that model. As we know though, when the easy money dried up, that model of banking did too.
The new community banking model will require more capital and greater control of risk. We may not know everything about a new model for community banking but we can be sure it will require a strategy of building a local franchise for deposit growth and loan diversity. I would love to hear your thoughts, so please comment below. Also, to discuss your bank’s future, call me at 919-644-6962 or complete a contact request at http://matthewsyoung.com/contact.htm.
Parenting, teaching and counseling are leadership activities. Unfortunately, today’s parents, teachers and team leaders are all too likely to be operating as if their primary goal is to establish wonderful relationships with their children and/or students. Leaders, however, must guard against letting the desire for relationships undermine their leadership responsibilities. An attempt on the part of a person in a leadership position to establish “wonderful relationships” reflects insecurity, which can open the door to challenges within or surrounding the relationship. They don’t have to like you for you to be respected and seen as an effective professional, and seeking that fully appreciated “high” can be draining and disillusioning.
Effective leaders command by establishing an energizing vision of the future. They usually guide by establishing the “outer boundaries” and can delegate the known, while managing the unknown themselves. People in leadership positions who are overly demanding do not know how to command. Effective leaders are relaxed, not uptight. They realize that perfection is not necessarily a “best” goal. They are open to changing their minds (albeit they have to take care not to appear to be wishy-washy), and are not defensive when questioned, etc. They communicate clearly and concisely, which is essential to a projection of decisiveness, but are not prone to over control or feeling that they must know answers or be right. They understand the power of “discovery”, and while they may protect their charges from disaster, they also let people make mistakes and learn from them. Above all, the effective leader is focused on helping the people s/he leads become better at what they are doing. As a consequence, working for or with a good leader is intrinsically rewarding.
In a recent blog, we talked about taking a broader perspective when planning salary increases for 2011. We were also waiting for better forecasts for 2011. More comprehensive reports are now available and suggest the following:
We are seeing a clear increase in the percent of employers and banks granting pay raises. While two-thirds of employers gave increases in 2009, nearly 85% gave increases in 2010. And we expect this percentage to increase for 2011.
U.S. employers report they are budgeting average raises of 3.0% in 2011, as are banks and other financial institutions.
The middle 50% of employers report 2011 salary increase budgets between 2.6% and 3.5%.
Again, financial institutions are very similar – ranging from 2.5% to 3.2%.
History shows some fluctuation between forecast and actual increases among general industry as well as financial institutions:
If this fluctuation between projected and actual continues, banks may give less than 3% in actual raises in 2011.
In addition to the broader questions we raised in our previous blog, budgeting for pay raises eventually comes down to practical questions:
What’s your best estimate of what the competitive market will do?
How long has it been since your last round of raises?
What can you afford to do, considering your expected financial performance?
And as we pointed out in an earlier blog, how do your overall salary levels stack up against current market salaries? If you haven’t checked the market lately (perhaps because you didn’t grant raises), then you lack important information on competitiveness and whether (a) you are still paying competitive rates or (b) a gap has opened between your organization’s salary levels and the market.
We have also seen a couple of other techniques to mitigate the cost of salary raises:
Postpone the effective date of raises until later in the year. Granting raises on July 1 rather than December 1 saves half the expense for the calendar year.
Grant merit pay in a lump-sum to employees high in their salary ranges but performing at a superior level. While the lump-sum payment is a current expense, it does not increase the employee’s future pay rate.
These are challenging times for compensation planning. If we can be of help, please don’t hesitate to contact the firm at (919) 644-6962 or me direct at (404) 435-6993.
Say on Pay is not a new concept to executive compensation but since it’s now law (Dodd-Frank Act), a quick look at history might be useful.
Shareholder votes on executive compensation practices initially surfaced in the UK as early as 1999.
The first negative vote on executive compensation occurred in 2003, when GlaxoSmithKline shareholders voted against the report of compensation paid to executives.
In 2007, in the U.S. there were about 50 companies that had shareholder resolutions calling for an advisory vote on executive compensation.
In the 2007 – 2009 proxy seasons combined, there have been about 200 companies with shareholders voting on compensation practices.
In 2009, under the American Recovery and Reinvestment Act, all companies receiving funds from the US Treasury (TARP) were required to include a non-binding advisory vote on compensation to the highest paid group of executives. This resulted in approximately 400 companies required to hold such vote, mostly banks.
On July 21, 2010 the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”), was signed into law by President Obama and includes a provision requiring public companies to allow shareholders a non-binding advisory vote on executive compensation.
Specifically, the Act requires:
A vote at least once every three years, beginning with the first shareholder meeting that occurs after January 21, 2011. Therefore, say-on-pay will be required for many public companies this upcoming proxy season.
Also at this first annual meeting, the shareholders must decide on whether the vote should be held every one, two or three years (thereafter a vote on frequency must be held by a separate resolution no less often than every six years).
What are Shareholders actually voting on?
With the non-binding advisory vote, what are shareholders actually going to be voting on? Are they voting on the amount of compensation paid? Are they voting on the compensation philosophy of the company? Are they voting on the types and delivery of compensation? Ultimately, you would think the vote would be on all of the above but the compensation philosophy seems to be the most important issue. Poor compensation philosophy can lead to many other problems, specifically overpayment for poor performance.
Issues to Consider
As with many of the provisions in the Act, there will unintended consequences of the new legislation. Here are a few issues to consider when asking shareholders to vote on executive compensation:
Companies will need to revise proxy statements to include the mechanics of voting on compensation. Will the Board make a recommendation on the vote?
Institutional shareholder advisory services will have a greater influence on compensation practices as a result of the vote and therefore companies will more likely want to comply with mandates from such advisory firms (i.e. employment agreements, change in control provisions, severance arrangements).
Ongoing educational efforts of a company’s compensation plans and philosophy will be necessary to inform shareholders required to vote, especially since retail shareholders/brokers will need instructions from beneficial owners in order to vote the shares in favor of compensation plans (no instructions = a no vote).
While the vote is “non-binding”, Directors will be forced to react to such votes or risk a “withhold” vote on their re-election as board members. In the 2010 proxy season, there were three companies that received a no vote (KeyCorp, Occidental Petroleum and Motorola)…so it can happen.
A more subtle influence of the Say on Pay shareholder vote of confidence will be the risk of focusing senior management on shorter term performance results so that a company’s annual performance will justify higher compensation when a longer-term, strategic investment focus would result in greater shareholder value in the long run.
With the many issues to consider and the potential of getting a negative vote from shareholders on compensation practices, companies would be wise to get an early start on reviewing current practices and seek advice on their proxy draft now.
Why do community banks fail? We are being called by a growing number of community banks that have serious credit problems, usually related to commercial real estate loans. These banks desperately need capital, as losses from loan write-offs have eroded the capital base. Why have so many community banks found themselves in this situation?
I could argue that the nation’s policies and regulations pushed community banks into their current situation. If the problem today is too much concentration in real estate loans, I’m sorry, but this was the only lending niche left for community banks after interstate banking allowed large-scale mega-banks to form and compete on price for Commercial and Industrial loans and the consumer loan business was handed to the credit unions with their non-taxable status and the auto companies with their ability to finance their cars at giveaway rates. Where else could community banks turn but local businesses and their real estate needs.
Now, having argued that they couldn’t help it, I would also argue that the real problem was a lack of leadership. Lack of leadership started in Washington, where Congress allowed unfair competition. Regulators tried to bring attention to the concentration of real estate loans being built-in community banks, but they were obviously not very convincing in so doing. Boards of Directors allowed concentration risk to build because they assumed that real estate value would always appreciate. Finally, too many CEOs and other senior officers of community banks took the easy way out and grew their banks down the path of least resistance. People ALWAYS make the difference; on the way up and on the way down.
Armchair quarterbacking is easy, and I can’t claim that I saw the enormity of the impact of the real estate bubble or the liquidity crisis, but these things worried me and I tried to warn clients that diversity of assets, funded by a strong local deposit franchise was a worthy goal. Alas, wholesale funds were too cheap and real estate was booming, so that approach seemed pretty boring. Perhaps next time, we will all risk being stronger leaders.
In 2002, as a result of a few high profile cases of corporate wrongdoing and scandalous financial behavior, Congress passed The Sarbanes-Oxley Act of 2002 that required clawback of incentive compensation from the CEO and CFO. According to Equilar’s 2009 Fortune 100 Clawback Policy Report, between 2006 and 2009 the percentage of companies reporting Clawback Policies jumped from 17% to 72%. Furthermore, as a requirement of all banks participating in the Troubled Asset Relief Program (TARP), all incentive compensation paid to the top 20 highest paid executives must be subject to clawback policies in the case of materially inaccurate financial data or performance metrics. So, the public company arena has an increasingly heightened awareness of such a risk reduction policy. And now most recently, The Dodd-Frank Wall Street Reform and Protection Act of 2010 includes a provision requiring Clawback Policies.
Dodd-Frank Wall Street Reform and Consumer Protection Act 2010
The new law signed by President Obama on July 21, 2010 requires all companies listed on national security exchanges to develop and adopt a policy to recoup incentive-based compensation upon the discovery of misreported or erroneous financial information. The requirements under the new law are more far reaching than those under Section 304 of the Sarbanes-Oxley Act (SOX 304).
Provisions of the Dodd-Frank Act
Any time a company is required to prepare an accounting restatement as a result of material noncompliance with any financial reporting requirement the clawback policy will be triggered. This expands the requirement under SOX 304 which applied only when a restatement of financial statements is “required” and is the result of “misconduct”.
The clawback policy would apply to all incentive-based compensation (cash or equity) paid to any former or current executive. SOX 304 applied only to the CEO and CFO.
The look-back period is for the thirty-six (36) months preceding the date on which the restatement is required. The look-back period under SOX 304 is only twelve months.
The amount to be recovered would be the difference in the amount actually paid based on the erroneous data and the amount that would have been paid based on the corrected data.
Policy Design/Review Considerations
Review any existing policies to determine any possible changes required by new law.
Identify the specific party required to enforce the policy (i.e. senior risk assessment officer, Compensation Committee, full Board of Directors)
Determine what method of recoupment will be necessary for recovery of any incorrect payments (i.e. deduction from future payments/awards, enforcement of re-payment by executive or potential litigation against former executives)
Determine whether policy should be more expansive than required by Dodd-Frank Act to include poor performance, violation of non-competes, negligence, etc.
Determine if policy is strong enough to be a mitigating factor to deter excessive risk under SEC rules which requires narrative disclosure in the CD&A in proxy.
Conduct a review of all compensation arrangements (i.e. incentive plan documents, employment agreements, equity award agreements) to insure proper integration with a new clawback policy.
So, while there may be many “unintended consequences” of the Dodd- Frank Act and there is much final government regulation yet to be published, it appears that Clawback Policies contribute to risk mitigation in compensation and are likely here to stay.
Increasingly, Compensation Committees are asking if Supplemental Executive Retirement Plans should be eliminated from executive pay packages along with Change in Control Parachute payments and country club dues. SERPs are misunderstood as unnecessary expenditures of shareholders’ hard earned capital, but in a 2009 survey of executive benefits, conducted by Clark Consulting, Inc., 67% of responding companies reported having supplemental executive retirement plans (SERPs), similar to the prevalence in 2007. Let’s look at the history of SERPs to see why they are so prevalent.
During the last quartile of the Twentieth Century, the capitalist world moved away from offering defined benefit retirement plans. Shifting mortality rates and increasing volatility of investment markets rendered Plans that promise certain retirement benefits much riskier and companies found it increasingly difficult to forecast their future costs. Most of those old defined benefit retirement plans provided for a retirement at roughly 75% of a career employee’s final five-year average base salary. There were variations, but that was about the average Plan’s promised benefit. Along came ERISA (Employee Retirement Income Security Act) which established by statute that highly compensated folks could not benefit at the same percentage as the average worker in these IRS qualified plans. The limits that ERISA imposed on participation in qualified retirement plans, like defined benefit and defined contribution 401(k) Plans, meant that executives can only provide for about 40% of their final five-year average base salaries during their retirement years. This is still true.
So, Companies realized that the folks who were having the greatest impact on the organization, were being discriminated against on their ability to participate in the retirement plans. Supplemental Executive Retirement Plans were then created to plug the gap. Over time, some have forgotten what SERPs were designed to do and some of the benefits got out of hand. Those high benefit SERPs were criticized, and rightfully so, by stakeholders. One old argument was that executives make so much on stock-based long-term incentive plans that they should not need to save supplements for retirement savings. Recent trends in stock markets and other forces have pushed previously granted stock options “under water,” meaning the cost to the executive to exercise the option is now greater than the value of the underlying stock. Who wants that? Some would say, “well, to bad for the executives. It is their fault that the stock price has declined.” Maybe the executives should be replaced, but if a Board decides that they want to retain their executives, or recruit new executives, the SERP issue will need to be resolved.
Retirement funds are like “bread, butter and mortgage money.” People do not want to risk it too much, especially now that traditional sources of savings, like Social Security, are shaky. Congress, long ago, in all its wisdom, decided that highly compensated folks did not need help saving for retirement. So, what happened? SERPs were born…..and my guess is that they will be around for the foreseeable future.
We recently surveyed a group of financial institution clients about the status of their digital marketing programs. Twenty one community financial institutions were emailed invitations to participate in this survey during May and early June. Nineteen participated and fifteen of those who completed the survey identified themselves as the person responsible for overall retail marketing in their organization. 50% of the respondents are financial institutions with assets of $500 Million to $999 Million. Most are community commercial banks.
This Chart summarizes their use of various digital marketing tools:
The scores shown above are combined weighted average scores for “plan to use” and “currently use.” If every respondent was currently using a tool, the score would be “2.”
While almost everybody has a website, significantly smaller numbers of these financial institutions are using digital media and social websites to direct traffic to the primary sites, and delivery of services through mobile devises is still rare for community institutions. While the survey sample is not large enough to be statistically representative of the industry, the findings beg some questions. Will smaller banks and credit unions be able to compete for the customers of the future; the folks who never come into your office and do everything on-line or via mobile technology? How do you cross sell services in this new environment, when you never see your prospect?
We believe that there is still time to “get in the game,” but the new generation of customers/members is forming banking habits now that will be “sticky” for a long time. It is imperative that community institutions figure out how to communicate with young customers, what they want and how to deliver those services in a safe and convenient fashion.
We have talked to lots of banks, credit unions and other organizations that chose to forgo or greatly reduce salary increases in 2009 and 2010 due to significantly lower company earnings. While it’s only common sense that you can’t raise salaries if there isn’t the money to pay for them, the risk of your best talent seeking other jobs grows as time passes without seeing a raise.
To add to the challenge, data on actual raises in 2010 and early forecasts for 2011 paint a blurred picture at best. So what do you do when there isn’t much useful market or competitor data to guide you? The best approach in these trying times isn’t really different from what it’s always been – only more challenging. Instead of thinking of your salary increase budget in a vacuum, think in terms of broad salary planning for your anticipated workforce. For example, ask yourself the following questions:
Are you experiencing turnover in positions that you can afford not to fill? Lower headcount could free up some salary expense that could fund raises for others.
If you are filling vacant positions, will you be able to recruit qualified candidates at salary levels below those paid to employees that left? This may be especially true in cases where turnover was due to retirement of long service employees.
Do you expect revenue growth that can be generated without headcount increases? Will this revenue growth be profitable growth evidenced by increased earnings?
Are there underperforming employees that should have raises postponed while you work with them to improve performance?
Are there employees already paid well above market rates that might not qualify for a raise or might have their raise postponed?
And perhaps most importantly, how do your overall salary levels stack up against current market salaries? If you haven’t checked the market lately (perhaps because you didn’t grant raises), then you lack important information on competitiveness that can tell you whether you are still paying competitive rates or that a gap has opened between your organization’s salary levels and the market.
Truly effective salary planning takes into account all relevant factors – only one component of which is the amount budgeted for raises. And knowing how your salaries stack up against the market is a critical step which Matthews, Young can help with.
So, it’s not too early to start this review. And as we gather more intelligence on projected raises for 2011, we will get back to you.
David Jones, Principal and Executive Compensation Practice Leader