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117 th Annual Illinois Banker’s Conference June 25-27, 2008 Corporate Governance Best Practices Presented By: Dave Muchnikoff Silver, Freedman & Taff, L.L.P. 3299 K Street, N.W., Suite 100 Washington, D.C. 20007 (202) 295-4513 dmm@sftlaw.com. Corporate Governance. USA Today, 2-18-08.
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117th Annual Illinois Banker’s Conference June 25-27, 2008 Corporate Governance Best Practices Presented By: Dave Muchnikoff Silver, Freedman & Taff, L.L.P. 3299 K Street, N.W., Suite 100 Washington, D.C. 20007 (202) 295-4513 dmm@sftlaw.com Silver, Freedman & Taff, L.L.P.
Corporate Governance USA Today, 2-18-08 Silver, Freedman & Taff, L.L.P.
Corporate Governance Why Corporate Governance – other than because banking and securities laws and regulations says you must? Silver, Freedman & Taff, L.L.P.
Corporate Governance • What is your bank’s legal status? The rules on corporate governance are different depending on that legal status: • Non-publicly reporting bank or bank holding company • Publicly-reporting bank or bank holding company • Stock listed on NASDAQ or NYSE or AmEx • Assets of less than $500 million • Assets of $500 million or more • Assets of $3 billion or more Silver, Freedman & Taff, L.L.P.
Corporate Governance Fiduciary Obligations Directors have “a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists…failure to do so…may…render a director liable for losses causes by non-compliance with legal standards.” In re Caremark Int’l. Inc. Deriv. Litig., 698 A. 2d 959, 970(Del. Ch. 1996) Board liability exists if, after “having implemented [a reporting or information system or controls, the Board] consciously fail[s] to monitor or oversee its operation, thus disabling themselves from being informed of risks or problems requiring their attention” Stone v. Ritter, 911 A.2d 362, 370 (Del 2006) Silver, Freedman & Taff, L.L.P.
Corporate Governance Federal Sentencing Guidelines – Overview Culture of Compliance – §8B2.1(a): company must exercise due diligence to prevent and detect criminal conduct and otherwise promote a culture that encourages ethical conduct and a commitment to compliance with law • Director/senior management visible commitment to clearly articulated values is vital • Companies/executive penalized when corporate culture found to be unethical Board Leadership/Oversight – §8B2.1(b)(2): directors must take an active leadership role, be knowledgeable about the content and operation of the ethics and compliance program and exercise reasonable oversight over it implementation and effectiveness Train Everyone – §8B2.1(b)(4): compliance and ethics training includes the board and senior management Silver, Freedman & Taff, L.L.P.
Corporate Governance What Did Sarbanes-Oxley Give Us? • Greater transparency • Increased scrutiny • More vocal shareholder activists • Unprecedented media visibility • Shareholder frustration and anger. • Majority voting and proxy access • Executive Compensation and Option Backdating • Section 404 refinement Silver, Freedman & Taff, L.L.P.
Corporate Governance What Did Sarbanes-Oxley Give Us? • Rise of shareholder activism • Acceptance, proliferation of governance ratings • CEO compensation and succession • Ratcheting up involvement in director succession • Classified vs. annual elections • Majority voting vs. plurality • Targeting of individual director nominees for withhold/no votes • Say on Pay Silver, Freedman & Taff, L.L.P.
Danco & Jonovic 1990 Silver, Freedman & Taff, L.L.P.
Corporate Governance Corporate Governance Best Practices Topics: • Board Self-Evaluations • Majority Voting and Other Director Election Developments • Tally Sheets and Other Compensation Committee Best Practices • Equity Grant Procedures • CEO Succession Planning • Reminders Silver, Freedman & Taff, L.L.P.
Board Self-Evaluations Silver, Freedman & Taff, L.L.P.
General Process by which a board or board committee assesses its own performance with the goal of enhancing future effectiveness by identifying strengths and weaknesses in the primary areas of the board’s or committee’s responsibilities. Required for NYSE-listed companies, optional for all others. As with most things, there are pros and cons. Board Self-Evaluations Silver, Freedman & Taff, L.L.P.
Benefits Compels directors to identify strengths and weaknesses and assess how the board or committee has actually been functioning compared to how it should be functioning. Can identify potential problem areas before they become real problems. Fosters better communication among directors. Helps re-focus directors on long-term goals and strategies. Assists with director nomination process. Improves directors’ sense of personal accountability. Board Self-Evaluations Silver, Freedman & Taff, L.L.P.
Board Self-Evaluations Risks • Information gathered discoverable in litigation. Ways to mitigate: • Limit retention of written materials. • Follow-up and take corrective action. • Can negatively affect board collegiality and discourage board service. Silver, Freedman & Taff, L.L.P.
Board Self-Evaluations Oversight of Process • For NYSE-listed companies, must be nominating/corporate governance committee. • Audit, compensation and nominating/corporate governance committees of NYSE-listed companies must conduct their own self-evaluations. • For non-NYSE-listed companies, should be committee charged with corporate governance matters or some other independent body of the board. • Use of outside parties (e.g., counsel, consultants). Silver, Freedman & Taff, L.L.P.
Board Self-Evaluations How to Conduct • No requirements – board/committee needs to decide what’s right for it. • Questionnaires • Interviews • Board discussion • Summary report • Follow up!! Silver, Freedman & Taff, L.L.P.
Board Self-Evaluations Performance Objectives • Again, no “one size fits all.” Typical areas of coverage include: • Role of the board. • Board organization and composition. • Board meetings. • Board compensation. • Committee evaluations should cover same areas plus check how well committees are performing their obligations outlined in committee charters. Silver, Freedman & Taff, L.L.P.
Board Self-Evaluations Individual Director Evaluations • Controversial. • Benefits include: • More direct feedback to directors. • Early warning system for problem directors; opportunity to turn things around. • Instills stronger sense of personal accountability. • Risks include: • Negative effect on board collegiality. • Reluctance of directors to criticize peers. • Discourage new directors from joining board and may lead existing directors to leave board. • Encourage counterproductive participation. • Liability risk. Silver, Freedman & Taff, L.L.P.
Board Self-Evaluations Methods of Conducting Individual Director Evaluations • Chairman or lead director evaluates each director. • Self-assessment questionnaires. • Peer evaluations. Silver, Freedman & Taff, L.L.P.
Board Self-Evaluations Public Disclosure of Evaluations • Only the fact that they’re performed, but not the results. • Can be communicated in proxy statement or in corporate governance guidelines, if company has them. Silver, Freedman & Taff, L.L.P.
Board Self-Evaluations Director Nominations • Ongoing board evaluation is the key • Selection and replacement of directors • Should reflect the strategic direction of the company • Are competencies continuously aligned with strategic challenges? • Do directors spend the necessary time? • Do directors feel they automatically stay until retirement? • Do you have a formalized selection process? • Do directors have first-hand experience with characteristics of high-performing companies? • Are board members engaged? Silver, Freedman & Taff, L.L.P.
Majority Voting and Other Director Election Developments Silver, Freedman & Taff, L.L.P.
Majority Voting and Other Director Election Developments Overview • Historically, most companies used a plurality standard – whoever gets the most votes for the position wins. • Critics say not meaningful where election uncontested, as it only takes one vote to get elected. • Under majority voting, number of votes cast for must exceed number withheld (or cast against, if applicable). • Majority of companies in S&P 500 have adopted majority voting. • Companies without significant institutional shareholder bases less likely to feel pressure to follow suit. Silver, Freedman & Taff, L.L.P.
Majority Voting and Other Director Election Developments Implementation Options • Policy • Bylaw amendment • Charter amendment Silver, Freedman & Taff, L.L.P.
Majority Voting and Other Director Election Developments Legal/Practical Issues • Resignation of directors who don’t receive requisite majority vote. • Board can find itself in Catch-22 situation. • Contested elections. Silver, Freedman & Taff, L.L.P.
Majority Voting and Other Director Election Developments Other Important Considerations • Proposed elimination of broker voting discretion for uncontested elections. • E-proxy (notice and access model) now available for companies and dissident stockholders starting. Can make it easier for dissidents to wage proxy contests. • Movement for shareholder access to management’s proxy materials. Silver, Freedman & Taff, L.L.P.
Majority Voting and Other Director Election Developments Related Initiatives by Corporate Governance Reform Activists • Board declassification. • Elimination of “shark repellants” and other supermajority vote charter provisions. Silver, Freedman & Taff, L.L.P.
Tally Sheets and Other Compensation Committee Best Practices Silver, Freedman & Taff, L.L.P.
Tally Sheets and Other Compensation Committee Best Practices Wall Street Journal, 4-14-08 Silver, Freedman & Taff, L.L.P.
Tally Sheets and Other Compensation Committee Best Practices What is a tally sheet? • Centerpiece of best compensation committee practices. • Identification and quantification of all elements of the executive’s pay, including compensation that would be owed to him or her upon retirement or other termination of employment. • Shouldn’t just be an annual exercise – tally sheet should be reviewed and discussed before making any decision on the executive’s pay. Silver, Freedman & Taff, L.L.P.
Tally Sheets and Other Compensation Committee Best Practices What should go into the tally sheet? • Tailored to fit each executive’s compensation package. • Should capture all elements. • Can generally track SEC compensation disclosure rules, but not a perfect fit. • Numerical components of tally sheet will be reflected in various areas of compensation disclosures. • Disclosure of compensation committee practices should include discussion of tally sheet exercise. Silver, Freedman & Taff, L.L.P.
Tally Sheets and Other Compensation Committee Best Practices Other Things Compensation Committees Should Be Doing • Reevaluate compensation philosophies and components of existing program. • Accumulated wealth analysis • Survey use – don’t cherry pick. • Internal pay equity. • Employment agreement provisions: • Evergreen Provisions • Definition of “termination for cause” • Change in Control payouts • Gross Ups • Compensation consultants should be engaged by and report directly to the compensation committee. • Annually review compensation committee charter. • Director Compensation: • Trend away from meeting fees in favor of annual retainers • Increased proportion of pay in equity • General disdain for director “retirement” plans • Reduction or discontinuation of perquisites Silver, Freedman & Taff, L.L.P.
(New Math) (SEC Rules) +Proxy=Confusion* * *Firms Disclose FormulasBehind Executive Pay,Leaving Many Baffled Wall Street Journal, 3-21-08 Silver, Freedman & Taff, L.L.P.
Washington Post, 5-5-08 Silver, Freedman & Taff, L.L.P.
Equity Grant Procedures Silver, Freedman & Taff, L.L.P.
Washington Post, 5-14-08 Silver, Freedman & Taff, L.L.P.
Equity Grant Procedures General • Still a white hot area – numerous SEC investigations ongoing and shareholder lawsuits filed, and guilty pleas continuing to roll-in for backdating. Recent Broadcom enforcement action shows SEC’s interest has not waned. • Restatements. Silver, Freedman & Taff, L.L.P.
Equity Grant Procedures Practices Being Scrutinized • Backdating - choosing a grant date with the benefit of hindsight so that the date selected is earlier than the date on which the grant was actually approved, with the selected grant date usually being a date on which the market price is lower than the date on which the grant is actually approved. • Spring-Loading - the granting of equity awards in anticipation of the issuer’s disclosure of material information that is likely to have a positive effect on the issuer’s stock price. • BulletDodging - purposefully waiting until material negative information is publicly disclosed before granting an equity award. Silver, Freedman & Taff, L.L.P.
Equity Grant Procedures Why are these practices problematic? • Effectively results in discounted options; most shareholder-approved plans require options to be granted “at the market” or at a premium. • Potentially a breach of directors’ fiduciary duties. • Potential restatements. • Big potential tax problems if options purporting to be granted “at the market” are later determined to be below market: • Lose ISO treatment, if intended. • Won’t qualify as “performance-based compensation” under Internal Revenue Code Section 162(m). • Constitutes deferred compensation under Internal Revenue Code Section 409A, potentially resulting in excise tax on executive. Silver, Freedman & Taff, L.L.P.
Equity Grant Procedures What should be done to minimize risk of problems? • Review existing equity grant practices. • Tighten internal controls. • Adopt formal written grant policy. Silver, Freedman & Taff, L.L.P.
Equity Grant Procedures Adopting an Equity Grant Policy • No “one size fits all” approach. • Determine role played by equity grants in overall compensation programs. • Key components: • Frequency and timing of grants – consider limiting to fixed dates or during open trading windows. • Designate equity grants compliance person(s). • Delegation of grant authority to officers – critical to ensure permissibility of delegation under state law and plan documents. Delegation should not cover grants to Section 16 reporting persons (i.e., Form 4 filers). • Limit grant approvals to in-person or telephonic meetings of board or compensation committee and avoid written consents if possible. If written consents must be utilized, do not use “as of” dating. • Forms of equity award agreements. Should be approved by compensation committee before grants are made and executed as soon as possible after grants are made. If multiple forms of agreements are used depending on level of employee, critical to have controls in place to ensure right form of agreement used. Silver, Freedman & Taff, L.L.P.
Equity Grant Procedures SEC Compensation Disclosure Implications • CD&A should include disclosure of any practices of timing equity grants in coordination with public release of material information. • Disclosure required in “Grants of Plan-Based Awards” table if date on which compensation committee approves award differs from grant date or if exercise price of a stock option differs from closing price on grant date. Silver, Freedman & Taff, L.L.P.
CEO Succession Planning Silver, Freedman & Taff, L.L.P.
CEO Succession Planning Why Is It Important? • CEO plays critical role in implementation and development of strategic policy. • Company always needs to be prepared for a change in top executive position, regardless of CEO’s age. • CEO’s departure could be sudden and unexpected or known well in advance – company needs to prepare for either contingency. • Delays in replacing CEO may raise investor and employee angst. • Important to plan for succession of other key senior executive positions for many of the same reasons. Silver, Freedman & Taff, L.L.P.
CEO Succession Planning What Should a Succession Plan Entail? • Prepare early: 3-5 years out • No “one size fits all.” • Determine who will lead process. Usually an independent committee, such as compensation or nominating/corporate governance. • Communicate/partner with CEO. • Should cover CEO and other senior executive positions. • Reflect board’s understanding of critical factors to company’s future success, direction and culture. • Identify and periodically update qualities and characteristics for effective CEO. • Should cover sudden and unexpected departures as well as planned successions. • Tie succession planning to the strategic business plan. • Stockholder preferences • Consider insiders before going outside. Silver, Freedman & Taff, L.L.P.
Succession Planning at Community Banks • Hiring leaders from the outside is risky • Lack of continuity • Less loyalty • Can be disruptive, hurt morale and change the culture – sometimes for the better but often for the worse • Outside candidates are far more likely to fail than internally developed candidates • Easier for the board to make the wrong choice with an outside candidate, particularly if selection criteria are not defined • Promoting leaders from the inside can have its issues • Reward longevity or loyalty, not talent • Lack of development program or process • Lose opportunity for “cross-pollination” from other institutions • But still generally better to grow and develop leaders Silver, Freedman & Taff, L.L.P.
Succession Planning at Community Banks Silver, Freedman & Taff, L.L.P.
Reminder Areas Silver, Freedman & Taff, L.L.P.
Reminder Areas Reminders • Executive Sessions of Directors • Approval of Related Party Transactions • Insider Trading Matters • Regular Review of Committee Charters and Other Corporate Governance Documents and Additional Considerations Silver, Freedman & Taff, L.L.P.
Reminder Areas Executive Sessions • Under NYSE rules, non-management directors must meet at regularly scheduled executive sessions outside management’s presence, and if any non-management director is not independent, independent directors must meet in executive session at least annually. • Under NASDAQ and AMEX rules, independent directors must meet in regularly scheduled executive sessions. • “Regularly” not defined in NYSE or NASDAQ rules, but should be at least twice a year. AMEX requires at least one executive session annually. • No limit on potential topics of discussion, but can’t act in lieu of full board. • Who should lead sessions? • Minutes of executive sessions and feedback given to management. Silver, Freedman & Taff, L.L.P.