Pay versus Performance – A Comment Letter to the SEC

Following is a letter that was forwarded to the Securities and Exchange Commission, in response to a request for comment, regarding the Pay vs. Performance proposal.

June 24, 2015

 

Mr. Brent J. Fields

Secretary

U.S. Securities and Exchange Commission

100 F. Street, N.E.

Washington, D.C. 20549-1090

RE: File No. S7-07-15

Release No. 34-74835- Pay for Performance (the “Proposing Release”)

Dear Mr. Fields:

Thank you for allowing me to comment on this proposal.  Overall I agree with the desire for greater transparency into the compensation vs. performance relationship.  The values identified to be used to demonstrate the relationship, would serve this purpose.  However, I am not in favor of the reporting flexibility for registrants, being considered.  I do not believe the flexibility will improve the data.  Instead the flexibility may create confusion and make it very difficult to compare registrant-to-registrant information by interested parties.  The flexibility also leaves room for the potential to unintentionally mislead.

When reviewing data (financial and statistical) there are several key elements that are required to provide confidence in the conclusions.  This situation is even more pronounced when you are comparing and contrasting the results across registrants – Is the definition of the data being reviewed consistent, for every registrant?  If I chose not to act today, when I review the information in a year or two, will the original definitions I used, be valid?  Is the data disclosed by the registrants trended over a consistent time period?

My overall recommendation is that every registrant should be asked to provide the same base information, in the same format, for the same time period.  Flexibility will be limited to a page or two of explanatory notes, subsequent to the tables.  I do not believe that these requirements create a burden in any way, as I would guess/hope that organizations perform a similar analysis currently when determining compensation levels.

Disclosure (Request for Comment #1 and #3) – Executive compensation and Financial Performance information should be included in all materials/filings that discuss compensation, including information to be distributed prior to an annual meeting or special meeting or written consent in lieu of a meeting.  There are multiple filings that a company may make to the Securities and Exchange Commission.  While an analyst may read several filing types, a shareholder or potential shareholder will most likely only read materials assembled for the purpose of the annual meeting.

Compensation Disclosure (#5, #22 and #24) – Executive compensation [as defined in (Item 402(c) of Regulation S-K [17 CFR 229.402(c)] assumes the completion of a Summary Compensation Table.  The table considers the multiple forms of compensation and should be required, with the values for each compensation component provided.  Interested parties can then see for example, what part of compensation is salary vs. bonus vs. equity….  Compensation information should be provided on an accrual basis, i.e. bonus paid in January for the prior year should be attributed to the proper year, to ensure executive compensation more closely tracks Total Shareholder Return.

Tabular Presentation (#6 and #12) – Reporting components should be defined and required, for both the Summary Compensation Table; and the Pay versus Performance table (page 19 of proposal).  The actual value of the components should be provided, not just summary or ratio information.

Graphic Presentation (#7) – A Line Graph should be included which shows for the five years under review the level of Total Shareholder Return (TSR).  Underneath the TSR line (broken vertical axis), would be a line to show the executive compensation, as a group.  You should expect to see the executive compensation line track closely with the Financial Performance.  The vertical axis can be broken again to show the median of annual total compensation (as defined by Section 953(b) of the Dodd-Frank Act), trended over five years, in relation to the annual total compensation of the CEO. In a perfect world, inclines, declines, and slopes will be similar.

Additional Information (#9) – Executives by nature will debate a financial calculation/statistic they feel does not positively represent their efforts, i.e. “But you can’t look at it that way.”  The difficult part is distinguishing the validity of that statement, i.e. perceived difference vs. actual difference.  As such, registrants must be allowed to append qualitative information to the quantitative data.  In a subsequent page, management can give an explanation of the information presented, i.e. why it is an accurate portrayal or not.  However, the goal is to have every registrant start from the same perspective, i.e. a level playing field.

Financial Performance (#34, #35 and #38) – Many ratios/statistics can be used to validate performance, which may include Total Shareholder Return, Free Cash Flow, Return on Investment, Shareholder Value Added…  Each statistic has its strengths and its weaknesses.  A claim that the statistic increases short-term approaches can be made for any measure that is used to gauge success.  Based on human nature, when a statistic is reported, managers will attempt to maximize the value.

Peer Group (#40 and #41) – The same peer group used for purposes of Item 201(e) or the Compensation Discussion and Analysis should be used.  A note should be included by the registrant that advises the interested party as to the components of the peer group.  If the registrant desires to make a change, the change must be made for both uses to ensure consistency.  However, if a decision is made to change the peer group, the data must be changed for all five years displayed.  This provision will avoid multiple peer groups in one filing.

Reporting Period (#42, #44 and #46) – All information should be provided for the most recent completed five fiscal years, without aggregation, consistently required by all registrants.  The time period is sufficient.  Additional years should not be allowed in the data page or in the subsequent notes.

In summary, there is a very real danger that the flexibility provided to registrants, which is being considered, will make the implementation of the Pay vs. Performance provisions confusing to investors.   In essence, if the rule was developed to assist investors, consistency, transparency and the ability to evaluate registrants is critical.

My recommendation is that every registrant should be asked to provide the same base information, in the same format, for the same period.  Flexibility will be limited to a page or two of explanatory footnotes.  I do not believe that these requirements create a burden in any way.

Please feel free to contact me if there are any questions with my recommendations.

 

Sincerely,

Regis Quirin

 

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

2014 Concerns to the CFO

The concern of all senior finance professionals in 2014 will continue to be the proper management of cash flow in an environment of shrinking margins and soft demand.  To foster revenues, companies will need to improve responsiveness and meet customer expectations through innovation.   Productivity advancements will come from the implementation of new technology.  To contain costs, the focus will include overall spending; technology spending; and the efficient use of marketing.   All of these actions are internal in nature, i.e. the CFO will be able to exert some amount of control.

However there are three very specific issues in 2014, which will consume the thoughts of CFO’s as they potentially have a direct impact on the cost structure of the business model.  All of these activities are external in nature.  The CFO will have little control, but will be responsible for integrating change within the organization.

Data Security – Gregg Steinhafel Chairman, President and CEO, Target announced on December 19, 2013 – “We wanted to make you aware of unauthorized access to Target payment card data. The unauthorized access may impact guests who made credit or debit card purchases in our U.S. stores from Nov. 27 to Dec. 15, 2013.”  As a result of the breach, up to 40 million credit- and debit-card accounts may be compromised.  The true impact of the theft to consumers will not be known for some time; but the impact to Target will be immediate and may include a loss of confidence by its consumers with a corresponding decline in business.  It will be important to watch this situation unfold to understand what Target does correctly vs. what Target does incorrectly.  What regulatory actions will evolve out of this issue?

Tax – On January 1, 2014, the IRS’s new requirements regarding when taxpayers capitalize vs. expense for acquiring, maintaining, repairing and replacing tangible property becomes effective (T.D. 9636).  The exact impact to your organization is based on your business model.  The regulation is complex and should be reviewed early on to maximize the benefit to your organization.

With respect to state tax, twenty-three states have either expanded or proposed sales tax nexus expansion laws, i.e. click-through nexus for internet sales.  A firm without physical presence within a state, but sells goods and services, may be required to pay sales tax to the state.  This trend is expected to continue to evolve.  Check with the tax body in the states where you operate to understand if you will be newly impacted.

Compensation – Various unrelated actions are occurring in the compensation space, which will result in this area as a main focal point in 2014 –

  • CEO Compensation Ratio – On October 1, 2013, the SEC Pay Ratio Disclosure proposal was published in the Federal Register for a 60 day comment period.  “As required by the Dodd-Frank Act, the proposal would amend existing executive compensation disclosure rules to require companies to disclose: the median of the annual total compensation of all its employees except the CEO; the annual total compensation of its CEO; and the ratio of the two amounts.  [SEC Proposes Rules for Pay Ratio Disclosure, Press Release 2013-186] From October 1 through December 2nd – 493 comments were received.  Expect the SEC to publish its analysis during 1Q2014 with a final rule published soon after.
  •  Minimum Wage Changes – Thirteen states will have minimum wage increases effective January 1, 2014 – Arizona;  Colorado; Connecticut; Florida; Missouri; Montana; New Jersey; New York; Ohio; Oregon; Rhode Island; Vermont; and Washington.  The smallest increase is $0.10/hour; with the largest increase $1.00/hour.
  • Cost of Healthcare Benefits – The cost of health insurance is evolving and should be closely watched.

The success of your business is directly related to your ability to execute on your plans, i.e. internal factors where you have some control.  However, it is important to understand external actions that may impact your business in the future, to allow for their future integration, if required.

What issues are of concern to you?

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

What do you do with a whistleblower that is not satisfied?

As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Whistleblower program within the Securities and Exchange Commission was launched August 2011. Since that time, 3,335 complaints were received, from which four rewards have been granted, i.e. one Aug 21, 2012 and three June 12, 2013.

But the SEC is not the only program – In March 1867 the Treasury began a form of a Whistleblower Tax program.  The IRS program was modified in December 2006 as a result of the Tax Relief and Health Care Act. From 2006 through 2012, 40,110 cases were received, with 1,077 awards paid.

What is of concern is that even though people are reporting issues to the respective regulatory bodies, the conversion from claim to outcome is very low, i.e. 0.1% for SEC and 3% for IRS.  The low SEC rate is most likely attributed to the newness of the program.  So when the SEC program reaches the seven year mark of the IRS program under review, will the claim rate reach 3%?

Now as more and more companies launch whistleblower programs internally they should tread lightly and consider how they will address issues raised.  If a process is established to address a legal or ethical issue raised by an employee, and the process fails, dis-satisfaction will be created. As such, creating an internal program where companies can identify issues and resolve them, prior to them becoming public brand blemishes, may backfire.  When a company does not act on information provided, the whistleblower may become unhappy and seek resolution outside the organization in a public forum.

“Markopolos began contacting the SEC at the beginning of the decade to warn that Madoff was a fraud. He sent detailed memos, listing dozens of red flags, laying out a road map of instructions for SEC investigators to follow, even listing contacts and phone numbers of Wall Street experts whom he said would confirm his findings. But, Markopolos’ whistle-blowing effort got nowhere.” (Madoff whistleblower blasts SEC by By Allan Chernoff, Sr. Correspondent, CNN 02.04.2009 CNN Money)

“Interviews with university officials, former players and members of the board, as well as reviews of internal documents and legal records, show that when the most senior Rutgers officials were confronted with explicit details about Mr. Rice’s behavior toward his players and his staff, they ignored them or issued relatively light penalties.” (Rutgers Officials Long Knew of Coach’s Actions by Steve Eder 04.16.2013 New York Times)

The SEC and Rutgers will be attempting to repair their respective images for some time.

While not every report of unethical or illegal activity will be valid, every claim should be treated the same way, until the results of a qualified investigation are finalized.  When training employees on the existence of a program, where they may freely lodge complaints without fear of retaliation, let them know that there is an established process that will be followed to investigate each and every claim.

Prior to embarking on establishing an internal Whistleblower Program, engage a Labor Attorney.  Understand the Federal Laws, as well as the laws within the states you operate.  Note – the Department of Labor has their own Whistleblower program.

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.