US disclosure changes may be useful for remuneration committees and Australian Productivity Commission
24/07/2009
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On July 17, 2009 the USA’s SEC published proposed new requirements for compensation disclosure (see HERE).  Many of the suggestions will meet various stakeholder concerns if adopted in Australia and, coincidentally, reflect several aspects of Guerdon Associates’ submission to the Australian Productivity Commission (see HERE).  Others go beyond what we think may be appropriate for Australia’s shallow market.

In addition, some aspects may provide useful guidelines for remuneration committee consideration, even if they are not adpoted? In particular, guidelines for ascertaining if remuneration practices are aligned with the company’s risk appetite.

While still open to public comment, the SEC prospective changes to executive compensation disclosure include:

  • Additional discussion of how compensation practices affect risk 
  • Use of grant date fair value for reporting of annual equity grants in the Summary Compensation Table (SCT)
  • Additional disclosure of the compensation consultant relationship

Coincident with changed SEC regulations is draft legislation likely to be passed by the US congress that tries to reduce the potential conflicts of interest involving compensation consultants. Many of those consultants also provide other services to the companies, putting them in a conflicting role for issuing fairness opinions about pay.

The measure also gives regulators the authority to prohibit inappropriate or risky compensation practices for banks and other regulated financial institutions, although this has a long way to go before APRA style regulation is developed (if at all).

An interesting measure, to try and deal with institutional investor conflicts of interest, requires large institutional investors to reveal how they vote the shares that they own on pay proposals.

Expectations are that this legislation should pass through both houses of Congress with only minor concessions, because to oppose action on executive pay in current US politics is akin to opposing motherhood.  However, despite the politics, the measures appear to be reasonable and workable.

We trust that reasonableness will prevail when it comes to act on the Australian Productivity Commission’s report in an election year.

Compensation programs and risk
 
Only a few Productivity Commission submissions specifically addressed the issue of remuneration and risk.  This is unfortunate, particularly as it is a significant feature of APRA’s draft prudential standards, which are likely to trickle over into general market practice.  

The proposed rules would require a discussion and analysis of situations in which any employee compensation programs may “create incentives that can affect the company’s risk and management of that risk.”  (Interestingly, this is a current feature of US proxy discussion, but is generally limited to compensation programs and policies for key management personnel.) 
 
The new disclosure would be limited to risks arising from programs that could have a material effect on the company.  While the SEC indicates that materiality requires a facts and circumstances analysis, it provided the following useful examples of policies and situations that would trigger such disclosure, and coincidentally a useful guide for board remuneration and risk committee attention:       

  • A business unit of the company that carries a significant portion of the company’s risk profile;  
  • A business unit with a significantly different compensation structure from the rest of the company;  
  • Business units that are significantly more profitable than others;  
  • Business units in which compensation represents a significant percentage of revenues; or  
  • Programs that vary significantly from the company’s overall risk and reward structure, such as bonuses that are paid upon accomplishment of an objective for which the revenue and associated risk to the company extend over a significantly longer period. 

If risk disclosure is triggered, the proposed rules offer some useful examples of issues that may need to be addressed:   

  • The general design philosophy of compensation policies for employees whose behaviour would be most affected;  
  • The risk assessment or incentive considerations used, if any, in structuring, awarding and paying out compensation; 
  • Policies that address short-term and long-term compensation risks, such as requirements for claw backs or holding periods;  
  • How compensation policies are adjusted to address changes in the company’s risk profile; and 
  • Any material adjustments made to compensation policies or practices due to changes in the company’s risk profile.

Reporting of the fair value of equity award grants

The US adopted a similar reporting requirement to Australia’s, in that the expense value of equity grants was reported as remuneration.  The proposed rules would revert to calculating aggregate grant date fair value (but still in accordance with the relevant accounting standard). This approach is already in use in Canada, and so far appears to work well.

The SEC mentions that returning to the use of grant date fair value will permit investors to better evaluate the value of equity compensation awarded for that year.

This also reflects comments in submissions made to the Australian Productivity Commission by Guerdon Associates. This will also eliminate the anomaly arising from having the income recognised on an annual basis, and reporting a figure that (against common sense) may be negative in the years following the original grant.

However, the proposed changes do not reflect changes requested by many more submissions (as well as by Guerdon Associates) for equity remuneration to be shown also as the realised value on vesting.

Enhanced compensation consultant disclosure

The proposed rules cite shareholders’ concern about potential conflicts of interest when executive compensation consultants perform additional services for the company, particularly if the fees earned for such additional services are exponentially bigger than those for executive compensation consulting.  These concerns reflect those of many submissions to the Productivity Commission, although do not appear to feature in APRA draft prudential standards, beyond advice that the remuneration committee independently employs external advisers.

However, unlike Australia but like the UK, the US already has consultant disclosure requirements.  In an effort to shed more light on such potential conflicts, the SEC would require additional disclosure of any “other services” provided to the company or its affiliates by its compensation consultants.  Currently, the disclosure of the use of a compensation consultant is limited to:

  • Identification of the consultant; 
  • Any role in determining or recommending the amount or form of executive and Director compensation; 
  • The nature and scope of the assignment; 
  • Whether the consultant is engaged directly by the Compensation Committee or another person; and 
  • The material elements of the instructions or directions given to the consultant with respect to the performance of duties.

The proposed rules would require that where “other services” are provided, companies additionally disclose:

  • The nature and extent of any and all other services provided by the compensation consultant; 
  • The consultant’s aggregate fees related to advising on executive and director compensation;  
  • The consultant’s aggregate fees related to other services; 
  • Whether management directly engaged, or otherwise participated in, the decision to engage the consultant for other services; and 
  • Whether the board or compensation committee approved the other services 

This level of disclosure may raise issues of commercial sensitivity.  Guerdon Associates’ submission to the Productivity Commission suggested instead that there be a narrative disclosure on the remuneration committee’s opinion of consultant independence.  This recognises issues of commercial sensitivity, as well as the practical reality that the Australian market is too shallow to support a plethora of board only advisers in law, tax, recruitment and remuneration matters, and that there are sometimes good reasons to employ a more broadly based firm.

© Guerdon Associates 2021
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