Wachtell Lipton Discusses Compensation Season 2024

In contrast to the volatility that vexed the economy in 2022, markets rose in 2023 as inflation fell and the labor market remained strong.  Entering 2024, ongoing international instability, rapidly changing technology and the United States presidential campaign are certain to impact the corporate landscape.  Those companies with strong leadership will be best positioned to face the challenges that arise in the coming year.  We identify below some of the fundamental themes that may shape company compensation decisions in the year ahead.

Non-Competes Live to Fight Another Day.  Courts and legislatures have historically regarded non-compete agreements with skepticism and have approved or construed any such limitations narrowly.  Last year featured several existential challenges to non-compete agreements:  At the national level, the Federal Trade Commission proposed a prohibition on non-competes that is expected to come to a vote in April.  A New York state non-compete ban would have become law but for a last minute veto by the governor just prior to the year-end deadline; however, the governor has indicated that she would be supportive of a more narrowly tailored ban that excludes highly compensated employees.

Many other states have recently adopted, or are considering, rules that would narrow the permissibility of non-competes.  We urge policy makers to exercise restraint in this sensitive area. Recognizing the importance of a free market for individual services, there are circumstances in which reasonably tailored agreements not to compete advance vital business interests, including research and development, investment in human capital and protection of intellectual property.  At the same time, companies are advised to track developments on a state and national level as rapid shifts in this area may impact the ability to enforce, or necessitate modifications to, existing restrictive covenants.

Pay versus Performance (PvP).  Last year, the SEC issued guidance with respect to PvP disclosure requirements in the form of Compensation and Disclosure Interpretations and staff comment letters, including the following key items:

  • Average compensation paid does not include unvested equity awards that vest upon retirement, even if the award holder is retirement-eligible.
  • The value of dividends or dividend equivalents paid prior to vesting of a stock award need not be taken into account if the value of the dividends or the dividend equivalents is reflected in the fair value of the stock award or otherwise included in total compensation.
  • Registrants should provide a reconciliation of non-GAAP measures to GAAP financial statements, where applicable.

Given its complexity, registrants should begin preparing PvP disclosure for their 2024 proxy statements as soon as possible and should involve all relevant functional experts, including legal and accounting personnel.

Compensation Clawbacks.  With the final listing standards now in effect, a listed U.S. issuer must file its recovery policy as an exhibit to its Form 10-K (or, in the case of foreign private issuers, Form 20-F or Form 40-F).  In addition, the final rules require disclosure in an issuer’s annual proxy statement of the following items, among others, if, during the prior fiscal year, either a triggering restatement occurred or any balance of excess incentive-based compensation was outstanding:  (a) the name of, and the amount due from, each individual from whom excess incentive-based compensation had been outstanding for 180 days or longer, and (b) the names of individuals from whom the issuer declined to seek recovery, and the reasons for declining to do so.

Disclosure Regarding Option Grant Timing.  New Item 402(x) of Regulation S-K requires a registrant to discuss its policies and practices on the timing of option awards in relation to the disclosure of material nonpublic information, including how the board determines when to grant such awards; whether (and, if so, how) the board takes material nonpublic information into account when determining the timing and terms of such an award; and whether the registrant has timed the disclosure of material nonpublic information for the purpose of affecting the value of executive compensation.

If, during the last completed fiscal year, a registrant awarded options to a named executive officer in the period beginning four business days before the filing of a periodic report on Form 10-Q or Form 10-K, or the filing of a current report on Form 8-K that discloses material nonpublic information (MNPI), and ending one business day after the filing of such report, Item 402(x) requires the registrant to disclose the grant date, number of shares covered, per share exercise price, and grant date fair value of the award, as well as the percentage change in the closing price of the shares covered by the award between the trading day ending immediately prior to disclosure of the MNPI and the trading day beginning immediately following disclosure of the MNPI.

A registrant with a calendar year fiscal year must include these new disclosures in its Form 10-K or annual proxy statement filed in 2025.  In order to avoid potentially difficult disclosures in the future, companies should evaluate their grant practices now.

A Deliberate, Principles-Based Approach to ESG.  ESG-related goals can have an appropriate place in the design of executive compensation programs.  Determining the nature of those goals and their relative impact on compensation outcomes is within the purview of the compensation committee.  Given the ever-shifting landscape, we recommend that compensation committees annually review all performance goals, including those linked to ESG objectives.  A well-designed ESG goal should reward the achievement of meaningful, objective metrics that drive better company outcomes.

Proxy Advisors.  The ISS 2024 compensation policy updates include a roadmap for companies seeking to change an ISS say-on-pay voting recommendation.  At least five business days before its annual meeting date, a company must disclose in a public filing any remedial actions that it has taken in order for ISS to consider a change in its recommendation.  Based on this public disclosure, ISS may issue a “proxy alert” to update its analysis and, if it so determines, change its vote recommendation.  Disclosure of a detailed commitment to change existing practices that ISS has identified as problematic is more likely to prompt an ISS response than general commitments regarding future compensation.

In another 2024 policy update, ISS addresses the impact of adjustments to non-GAAP performance goals:  If a company adjusts non-GAAP performance goals in a manner that materially increases incentive payouts, the company should explain in its proxy statement the nature of the adjustment, its impact on payouts, and the board’s rationale for the adjustment.  The absence of these disclosures would be viewed negatively by ISS, as would adjustments “that appear to insulate executives from performance failures.”

The Glass Lewis 2024 policy update urges companies to extend the reach of compensation clawbacks to empower listed companies to recover incentive compensation from an executive when there is evidence of “problematic decisions or actions, such as material misconduct, a material reputational failure, material risk management failure, or a material operational failure….”  If a company declines to implement and enforce recovery under the expanded Glass Lewis framework, the Glass Lewis policy provides that the company should disclose its rationale and any alternative measures that it takes to address the problematic decisions or actions.  The Glass Lewis clawback is much broader than is mandated by the stock exchange listing standards and may have unintended negative consequences.

Expanded 162(m) in 2027.  Section 162(m) of the Internal Revenue Code disallows a federal income tax deduction to public companies for certain compensation in excess of $1 million during a company’s taxable year to “covered employees” which is generally defined to include the company’s named executive officers.  The American Rescue Plan Act amended the definition of “covered employees” for tax years beginning after December 31, 2026 to include an additional five highest compensated employees.  While the expanded definition does not become effective for several years, companies might consider structuring long-term incentive awards to individuals who might be covered by the expanded definition to vest and be paid in 2026 in order to avoid a lost tax deduction.

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The rules and regulations governing executive compensation have dramatically expanded over the last two decades.  The extensive compliance and disclosure requirements impose a heavy burden on company boards and management teams, with compensation-related disclosure commanding a disproportionate amount of proxy statement real estate, relative to areas of comparable import.  Over-regulation of matters historically left to the discretion of directors restricts the flexibility and creative energy that directors bring to a board. Heavy-handed policies from the proxy advisory firms exacerbate these conditions.  Effective boards overcome these challenges and continue to develop and implement compensation plans and programs that attract and retain key talent and advance the long-term interests of company stockholders.

This post comes to us from Wachtell, Lipton, Rosen & Katz. It is based on the firm’s memorandum, “Compensation Season 2024,” date January 22, 2024.