Holly J. Gregory is a partner in Sidley’s New York office, and is co-head of the firm’s global Corporate Governance and Executive Compensation practice. Gregory counsels clients on the full range of governance issues, including fiduciary duties, risk oversight, conflicts of interest, board and committee structure, board leadership structures, special committee investigations, board audits and self-evaluation processes, shareholder initiatives, proxy contests, relationships with shareholders and proxy advisory firms, compliance with legislative, regulatory and listing rule requirements, and governance “best practice.”
Gregory played a key role in drafting the OECD Principles of Corporate Governance and has advised the Internal Market Directorate of the European Commission on corporate governance regulation, and the joint OECD/World Bank Global Corporate Governance Forum on governance policy for developing and emerging markets. She also drafted the NACD Key Agreed Principles of Corporate Governance. In addition to her legal practice and policy efforts, she has lectured extensively on governance topics and was recently appointed to a three-year term as Chair of the Corporate Governance Committee of the ABA’s Business Law Section.
In addition to her legal practice and policy efforts, she has lectured extensively on governance topics, including at events in Europe and Asia sponsored by the U.S. State Department, International Corporate Governance Network (ICGN), The Conference Board, National Association of Corporate Directors (NACD), Association of Corporate Counsel, Society of Corporate Secretaries & Governance Professionals, and Institutional Shareholder Services (ISS). The author of numerous articles on governance topics, she writes the governance column for Practical Law: The Journal.
CSI: As co-head of a corporate governance group at a top law firm, you’ve counseled clients on issues relating to compliance and governance practices. You have also seen first-hand the changes brought forth by Dodd-Frank. What has been the most impactful rule change?
Holly: For rank-and-file public companies outside the financial services industry, the shareholders’ advisory vote on executive compensation has had the most significant impact on governance. That non-binding vote has resulted in much more attention to shareholder engagement and to aspects of compensation plans as companies seek to understand what drives shareholder decisions and strive to construct pay to avoid a growing list of red flags with the proxy advisors who influence institutional shareholder voting.
In turn, company engagement with shareholders has proven to be an effective device for releasing tensions with shareholders in certain situations. Much has been written about shareholder engagement since Say on Pay went into effect in 2011. Engagement efforts are driven by a host of factors including concerns about shareholder votes on say on pay and other proposals, and activist efforts. A recent study by the Investor Responsibility Research Center Institute and Institutional Shareholder Services Inc. determined that since Say on Pay was instituted, shareholder engagement efforts have increased by more 50 percent. More than two third of Russell 3000 companies disclosed some form of engagement with their investors.
CSI: What other issues do your clients face from this regulation?
Holly: Another key provision that has had a significant impact on public companies is the Securities and Exchange Commission’s (SEC) whistleblower bounty program. Under this program, a whistleblower can receive significant payment from the SEC for reporting concerns of wrongdoing. The Dodd-Frank Act gave the SEC authority to pay large cash bounties to whistleblowers who provide original information leading to a successful SEC enforcement action. The SEC is required to award such persons between 10 and 30 percent of monetary sanctions, exceeding $1 million received by the SEC, the Department of Justice, or other regulatory agencies in related enforcement actions.
Concerns about increased whistleblower activity as well as the need to avoid any retaliation for such activity has caused greater attention to compliance and reporting systems within companies, including enhanced attention to employee education regarding compliance and ethics, increased focus on professional development and reporting lines of compliance personnel, and more active board oversight of compliance, ethics, and internal reporting systems.
CSI: In general, how has the response to corporate governance changed since the introduction of Dodd-Frank?
Holly: The Dodd-Frank Act, signed into law in 2010 in reaction to the financial crisis, required rule making by a number of federal agencies including the Securities and Exchange Commission. While many of the provisions targeted the financial services industry, the SEC was instructed to adopt a number of regulations that broadly impact publicly traded companies outside that industry as well. These include shareholder advisory votes on executive compensation (Say on Pay), compensation committee and adviser independence, development and disclosure of incentive a compensation clawback policy, and enhanced whistleblower incentives and protections. Moreover it has impacted the disclosure of board leadership, relationships between pay and performance, and the ration of median compensation to CEO compensation.
Some rules have yet to be fully adopted, including those on disclosure of pay ratios, pay-for-performance, clawback policies, and hedging by employees and director.
CSI: Relating to Dodd-Frank, an issue on the minds of many is the disclosure of CEO pay ratios. The SEC put off proposing rules for several years, and delayed finalizing the rule for over a year. Could you clarify what this rule would entail for the SEC?
Holly: The Dodd-Frank Act (§ 953(b)) requires the SEC issue rules mandating companies to disclose the ration of the median of the annual total compensation of all the company’s employees except the CEO to the annual total compensation of the CEO. The SEC has proposed — but not yet adopted — these rules.
CSI: As there is no “standard” for this type of disclosure, what sort of hurdles does the SEC face in setting guidelines for corporate issuers to disclose this information?
Holly: The challenge for the SEC is to provide workable rules from both a company and investor perspective that can withstand legal challenge. The potential burden on companies and the value of this information to investors must be considered and there are legitimate concerns about both. The SEC is faced with the particular challenge of providing clarity around how a company is to determine the median — or midpoint — for compensation in the range of its employees and to determine who must be included as an “employee,” for example, whether to require inclusion of part-time, leased and foreign employees, and at what point in time.
CSI: Corporations have sighted numerous issues with the rule. What have you seen as the most common or biggest problem posed by the pay ratio rule?
Holly: A number of legitimate concerns have been expressed about the burden that this disclosure will place on companies and whether this information is likely to provide meaningful information to investors. Some investors have argued that the pay ratio data will provide the ability to compare practices among companies, and to look at how a particular company’s practices change over time. However, concerns have been voiced about the potential for pay ratio information to provide incomplete and therefore misleading information. The pay ratio will not provide information about the unique conditions that impact the ratio. These include aspects such as business structure, mix of employee skill sets (for example the proportion of highly skilled versus lower skilled workers), geographic mix, reliance on outsourcing, and other industry practices and market and industry conditions.
CSI: In response to calls from the SEC and investors, disclosure in proxies and other SEC documents has seen a change over the last several years from legal, and sometimes opaque language, to clearer and more “plain English” descriptions. What other changes are you seeing in proxy disclosures?
Holly: As a key disclosure document that must strictly comply with an ever-expanding array of SEC rules, the typical proxy statement can be a dense read even in plain English. In the last several years, companies have explored ways to improve their proxy statements. These include letters from the board and CEO summarizing key highlights, summaries at the outset of important information related to voting issues, and summaries throughout particularly lengthy sections. They may incorporate the CD&A, user-friendly graphics and charts, director skill matrices, and electronic navigation tools for online readers.
From a content perspective, companies are taking greater efforts to place their governance and compensation decisions in context, and to describe the rationales of decisions that may draw shareholder concern. For example, there is more effort in discussing how a company has engaged with shareholders and responded to a low say on pay vote or a high vote on a shareholder proposal that the board opposed.
While anything to improve readability of proxy statements has value, the sheer amount of information that must be covered may itself be the central problem in the usability of the information.
CSI: You follow events in the international arena, and advise clients on these trends. What do you see as the major governance developments in foreign markets that may have implications in the United States?
Holly: Governance practices and rules that develop in Europe and elsewhere can migrate to the US through investor expectations and regulatory approaches. The advisory vote on executive compensation is a good example. Currently in Europe, there are several developments to watch that could migrate to the US in the next decade.
In the UK and other parts of Europe, shareholders have been granted binding say on pay. Shareholders have a binding vote on the compensation policy of the company, and if the company does not receive support for the compensation approach, the company must change the approach.
Last year in Switzerland, there was an effort to impose through a constitutional amendment to a cap executive compensation at no more than 12 times worker pay. The electorate rejected the effort, but concerns about pay disparity continue to be voiced in parts of Europe as a potential topic of regulation.
Many parts of Europe have adopted gender quotas for their corporate boards.
CSI: What governance issues do you foresee making their way to the forefront this upcoming year? What do you think will be most important in 2015?
Holly: Changes in investor power and expectations regarding governance over the past 15 years have influenced, and will continue to influence, governance reform through SEC regulations, listing rules, and voluntary corporate action. As companies begin to prepare for the 2015 proxy season, they should be mindful of the priority items on the wish list of key institutional investors for further governance reform. Efforts to improve the link between executive compensation and performance, eliminate staggered boards and poison pills, and expand shareholder ability to call meetings and act by written consent, are likely to continue. However, the priorities for regulatory and voluntary governance reforms now focus on investor rights in director elections, and the quality of board composition.
Expect public pension funds to continue to press for more meaningful ability to nominate and elect directors. Examples include the imposition of listing rules to require majority voting in director elections, renewed calls for the SEC to adopt proxy access rules through listing rules to prohibit dual class registration (one share/one vote), and through SEC allowance of universal proxy cards that list all director nominees in contested elections.
Board succession and refreshment are on the priority list of institutional investors as areas for voluntary corporate action. This is due to rising concerns about whether board composition is adequately addressing industry sector knowledge needs, low board turnover rates, and slow improvement on board gender diversity.
In terms of shareholder proposals for 2015, the emphasis on expanding shareholder rights will likely continue to focus on eliminating supermajority provisions to amend by-laws, annual election of directors (board declassification), and majority voting in the election of directors. Other expansions may include the ability of shareholders to call special meetings, ability of shareholders to act by written consent, and proxy access.
In the governance area, companies should expect shareholder proposals on the separation of chair and CEO and limiting the tenure of directors.
In the social and environmental areas, companies should expect shareholder proposals on political contributions and lobbying, environmental sustainability and risks, human rights policies and impacts, and board diversity.
On the shareholder activist front, 2015 is likely to continue to be a year of active efforts by hedge fund activists to influence, and at times, take control of companies through efforts to seat directors on the board. The number of actual proxy fights is unlikely to reach the high levels seen in 2008 and 2009, but largely because companies are now more likely to engage in negotiations that result in concessions.
Overall, boards will continue to feel the pressures of expanding shareholder expectations, and will be challenged in considering the range of viewpoints and interests while applying their own objective fiduciary judgment to the issues at hand.
