Compensation Governance
Presentation for:
Presented by:
NASPP, Austin Chapter
February 10, 2015
Anthony J. Eppert, Winstead PC
AEppert@Winstead.com
713.650.2721
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© 2013 Winstead PC
About Anthony ("Tony") Eppert

Tony is a Shareholder in Winstead's Compensation & Benefits
practice group. His legal practice focuses on executive compensation
and employee benefit arrangements in the United States and abroad

Before entering private practice, Tony:
– Served as a judicial clerk to the Honorable Richard F. Suhrheinrich of the
United States Court of Appeals for the Sixth Circuit
– Obtained his LL.M. (Taxation) from New York University
– Obtained his J.D., cum laude (Tax Concentration) from Michigan State
University College of Law
 Editor-in-Chief, Journal of Medicine and Law
 President, Tax and Estate Planning Society
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Upcoming Monthly Webinars
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2015 webinars:
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Forms 3, 4 and 5: The Intermediate Training Course (3/11)
Taxation of Equity Awards: The 101 Training Course (4/8)
Insider Trading Policies, Blackouts Periods and 10b5-1 Plans (5/13)
Effective Designs: Severance Plans/Change-in-Control Agreements (6/10)
Section 409A and Executive Contracts: The Intermediate Course (7/8)
How to Identify and Build a Compensation Peer Group (8/12)
Preparing for Proxy Season: The “To Do” List (Annual Program) (9/9)
Understanding Employment Taxes: The 101 Training Course (10/14)
Benefits: A Legislative & Regulatory Review (Annual Program) (11/11)
Update: A Report on Changing Compensation Designs & Trends (12/9)
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Purpose of this Seminar
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The purpose of this webinar is to discuss compensation governance
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Authority of the Compensation Committee

The governance process associated with director compensation is
generally as follows:
– The nominating and corporate governance committee makes
recommendations to the full board
– Compensation decisions are made by the full Board

In contrast, typically it is the compensation committee that has the
authority to make compensation decisions for the NEOs and other
employees of the Company
– This means that pursuant to the Compensation Committee Charter, the
Board of Directors delegated such responsibility to the Compensation
Committee
– Alternatively, the Board could have only delegated the ability to make
recommendations; thus, the Compensation Committee can only make
recommendations and decisions must be had at the full Board level
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Compensation Committee Action Items
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At least annually, the Charter should be reviewed and reassessed by
the Committee
– Any proposed changes to the Charter must be submitted to the full Board
for their approval

At least annually (or more frequently), the Committee should review
and approve the compensation goals and objectives that cover the
management team, to include:
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Balance between short-term and long-term compensation,
The performance of each member of the management team, and
The compensation levels of each member of the management team
NOTE: Provide the committee with tally sheets and wealth accumulation
tables so they are informed in accomplishing the above, thus bolstering
their use of the business judgment rule defense if there is ever, for
example, a shareholder derivative lawsuit
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Compensation Committee Action Items (cont.)
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With the help of HR, legal and possibly finance, the committee should
oversee the process of determining whether any of its compensation
policies and practices (for any group of employees, not just NEOs)
create material risk
– If a compensation policy is “reasonably likely to have a material adverse
effect” on the Company, then a stand-alone discussion of this risk must be
present in the proxy
– This discussion, if present, should be outside of the CD&A because it
covers more than just the NEOs
– Many companies provide affirmative disclosure
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HR/legal must develop a process to determine the above by:
– Identifying all plans,
– Assessing risk, and
– Making a determination
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Important to the foregoing is the “process”
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Tally Sheets
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If the business judgment rule is applied:
– Then the decisions of a director will be presumed to have been informed,
made in good faith, and accomplished with the belief that such was in the
best interests of the company; the presumption makes it more difficult for a
plaintiff to prove such director breached his/her fiduciary duties

Tally sheets
– Tally sheets can be a key for a director to preserve the defense of the
business judgment rule because tally sheets act as proof that the director
made an “informed” decision, even if the wrong decision
– A tally sheet lists each component of an executive’s compensation and
tallies it up (i.e., a placemat)
– Compensation committees should require a tally sheet showing range of
potential payments in alternative scenarios
– It should be prepared and explained by a compensation expert
– It should be attached to minutes
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Amounts to tally
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Income for the year
Projected values under different performance and termination scenarios
Realized option and stock gains (last 5 years)
Total wealth accumulation
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Wealth Accumulation Tables
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Wealth accumulation analyses focus on how much wealth the
executive will accumulate at various career points
– Includes realized and unrealized equity value, plus deferred income (e.g.,
retirement plans)
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Used to determine “how much is enough”
– Determine wealth accumulation targets
– Determine a reasonable minimum guaranteed wealth and from what
sources
– Determine how performance metrics figure into the analyses
– Determine whether accumulation is appropriate in context of overall
compensation
– Determine whether shareholders should fund this level of accumulation
– Determine whether improved long-term incentive plans could improve
alignment with shareholders
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Delegations: Authority to Grant Equity
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The following is an overview of the rules that companies should
consider when granting equity
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Absent a delegation, only the Board has the authority to grant equity
– Unless a delegation exists from the Board to the compensation committee,
this means that the compensation committee can only make
“recommendations” to the Board
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The following slides on this topic assume a valid delegation exists
from the Board to the compensation committee
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Delegations: Authority to Grant Equity (cont.)
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Typically, the compensation committee has the authority to implement
a further delegation of its authority to grant equity to an inside director
or non-director officer
– If such exists, it is typically contained in the compensation committee’s
charter and/or in the equity plan document

The administrative burdens associated with the compensation
committee acting through written consent are not likely sufficient
enough to warrant the additional delegation cited above
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However, if such a delegation is warranted/desired, then it could be
made appropriate in instances where:
– The company routinely grants equity to new hires who are NOT executive
officers, and
– The equity is granted within a limited period of time from the date of hire
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Delegations: Authority to Grant Equity (cont.)
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Assuming it is determined that a delegation from the compensation
committee is appropriate, then the following points should be
considered:
– Delegations must comply with applicable state law (e.g., DGCL 157(c))
– Delegations should be governed by a written equity grant policy (the
“Policy”) that was approved by the compensation committee and/or the
Board
– The Policy should include a reporting mechanism to the compensation
committee of all equity grants. To avoid “date of grant” issues, the Policy
should clearly state that only a “reporting” to the compensation committee
is required (i.e., no ratification or approval is required)
– Attached as exhibits, the Policy should contain award agreements that
were pre-approved by the Board or the compensation committee. This will
help avoid successful arguments that delegated awards contained terms
not previously approved by the Board or the compensation committee
– The Policy should specify the total number of awards (individually and
collectively) that may be made pursuant to the delegation
– [See next slide for continued list]
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Delegations: Authority to Grant Equity (cont.)
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[Continued from prior slide]
– Delegations should exclude the ability to make grants to those who are
Section 16 insiders as of the date of grant (e.g., compliance with Rule 16b3 requires the full board of directors or a committee of 2 or more nonemployee directors to approve in advance of all grants to Section 16
insiders)
– Delegations should exclude grants to those who would be “covered
employees” as of the exercise date (if a stock option) or vesting date (if a
stock grant)
 Compliance with the performance-based exemption under Section 162(m)
requires such grants to be approved in advance solely by two or more outside
directors
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Equity Grant Practices: Date of Grant
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An accurate date of grant is important to support accurate accounting
charges and to avoid adverse tax consequences under Section 409A
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The date of grant is generally the date the Board or the compensation
committee (or delegates) “approves” a grant containing “definitive
terms”
– If the Board or the compensation committee acts prior to knowing the
definitive terms, then the date of grant would typically be the date all
definitive terms become known
– Generally, “definitive terms” means the identity of the recipient, the number
of shares subject to the award, the vesting schedule and the exercise price
(if applicable)
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Keep in mind that the grant is “approved” on the date the board or
compensation committee acts pursuant to written minutes (though
such could contain a later effective date for the grant)
– Thus, AND DO NOT FORGET, if the action is pursuant to unanimous
written consent resolutions, then the grant is deemed approved on the
date of the last signature
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Equity Grant Practices: Amount of Grant
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Try to avoid providing “mega grants” every three or four years, and
instead provide annual grants with a vesting schedule that straddles
and overlaps with other annual grants over a 3 or 4 year period
– Remember that the grant date fair value of the award is included in the
summary compensation table, and therefore, a mega grant could impact
the identity of the NEOs
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Stock Ownership Guidelines
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Consider whether to implement a stock ownership policy in
conjunction with grants of equity to NEOs
– A stock ownership policy sets the parameters on the level of stock that
must be owned
– Such a policy increases the message to the company’s shareholders that
the latter can rely on the commitment of the NEOs to the company’s longterm success (i.e., there is a direct alignment of interest with the
company’s long-term shareholders)
– Helps bolster performance pay
– Could act as a mitigating factor to negate risk assessment disclosure.
Remember that companies must disclose the relationship between their
compensation practices (for all employees) and their risk management
philosophy, BUT ONLY IF such compensation programs are “reasonably
likely to have a material adverse effect”
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Though a multiple of salary (i.e., a fixed value) is a most common
stock ownership policy, consider using a fixed percentage/number of
shares because the former is difficult to satisfy if the underlying stock
price is volatile
– A specific dollar value of shares could also be used (more common among
director ownership guidelines)
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Stock Ownership Guidelines (cont.)
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The Board must determine the length of the accumulation period
within which executives must attain their ownership levels
– A five year accumulation period is a most common time frame
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Or instead of the above, the Board might consider whether to also
implement a holding requirement, which is another share retention
tool:
– For an indefinite period of time, require the NEOs to retain a certain
percentage of his/her net profit shares until the required ownership levels
are attained (in contrast to a term of years requirement within which the
ownership percentage must be satisfied)
 Net profit shares refers to the shares remaining after payment of any exercise
price and/or taxes owed
 Holding period could be indefinite; OR
– Require the CEO to hold a percentage of net profit shares for a certain
period of time (i.e., a one-year holding period is common)
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Additionally, stock ownership guidelines are viewed favorably by
shareholders
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Stock Ownership Guidelines (cont.)
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The following is a sample stock ownership policy that was adopted by
a publicly-traded company:
“[Company] has adopted a common stock ownership policy for
members of the board and our executive officers. This policy
requires our executive officers to own shares of common stock
having a value equal to five times base salary in the case of our
CEO, four times base salary in the case of our President and
three times base salary for all other executive officers.
In addition, executive officers are required to retain ownership of
at least 50% of any stock acquired by them through our stock
compensation plans, after taxes and transaction costs, until retirement
or other termination of employment.
These ownership levels will be calculated annually. Executive
officers have five years to meet the minimum level with certain
ownership thresholds that must be met in the interim period.
Our Board believes this stock ownership policy substantially enhances
stockholder value by materially aligning management’s interest with
those of our stockholders.”
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Stock Ownership Guidelines (cont.)
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The “stick” or penalty for failing to satisfy a given stock ownership
policy is not typically disclosed in a proxy statement. Such penalties
can include:
– Increased holding requirements,
– Prohibiting sales of equity, and
– Paying annual incentives in equity and not cash
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And where satisfying a stock ownership policy would otherwise create
undue hardship on an executive, a company could modify the stock
ownership policy to incorporate hardship provisions
– Question is whether to incorporate the terms into the stock ownership
policy, or instead to simply provide the Board or compensation committee
with the discretion to deviate from the requirement if a hardship is present
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Recent FASB Announcements
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On October 8, 2014, the Financial Accounting Standards Board
(“FASB”) made tentative decisions to improve and simplify accounting
for stock-based compensation
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Minimum statutory withholding requirement
– Generally, current rules require that companies limit “net withholding”
transactions to the minimum statutory withholding rates, otherwise, liability
accounting could apply to the entire award
– FASB decided to relax such limitation by allowing for net withholding at the
highest applicable marginal tax rate
– FASB also decided that a net withholding is really a form of financing and
should be reflected on the statement of cash flows as a financing activity
(i.e., its substance is a repurchase of shares)
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Review equity incentive plan
– Is a plan amendment required to implement the above
– Would shareholder approval be required
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Clawbacks: Generally
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The purpose of a well-defined clawback provision is to prospectively
and contractually thwart bad behavior
– Additionally, a well-drafted clawback provision can be used to punish bad
behavior
– Typical bad behavior covered by a clawback provision includes:
 Breach of non-compete clauses, non-solicitation clauses, and confidentiality
 Unethical conduct or disloyalty
 Acts that are injurious to the company's financial health or reputation
– More recently, clawbacks are being used in no-fault situations (e.g.,
Section 304 of SOX litigation, Dodd-Frank)
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Compensation that is typically covered by a clawback policy can
include:
– Equity
– Bonuses
– Severance
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Clawbacks: Dodd-Frank
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As background, the clawback requirements under Dodd-Frank are not
effective until final rules are issued
– Such rules will require companies to implement clawback policies that are
more expansive than the current requirements under Section 304 of the
Sarbanes-Oxley Act (“Section 304”)
– The Dodd-Frank clawback requirements are an issue between a company
and the applicable listing agency. Therefore, a current goal of a company
should be to avoid a future tug-a-war between the company’s duty to
comply with the rule on the one hand, and creating a contractual breach
with an executive on the other hand
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To date companies have been applying a variety of approaches while
they await final rules, such being:
– Do nothing and wait,
– Adopt a “loose” policy that is expected to be amended in a more robust
way once final rules are issued,
– Have executive officers sign a contractual arrangement whereby each
such executive agrees to comply with the Dodd-Frank clawback
requirements (when effective) and any clawback policy adopted by the
company as such is amended from time to time, and
– Adopt a very formal and robust clawback policy
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Clawbacks: Dodd-Frank (cont.)
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As review, the current requirements of the Dodd-Frank clawback
include:
– The clawback policy must be triggered any time the company is required to
prepare an accounting restatement resulting from “material”
noncompliance with any financial reporting requirement under the
securities laws
 In contrast, Section 304 applies only when a restatement of financial statements
is “required” and is the result of “misconduct”
– Once the clawback is triggered, it would apply to all “incentive-based”
compensation paid to current and former executive officers
 In contrast, Section 304 applies only to the CEO and CFO
– The look back period for which incentive-based compensation is subject to
clawback is the 3-year period preceding the date on which the restatement
is required
 In contrast, the look back period under Section 304 is 12 months
– The amount subject to the clawback is the difference between the amount
paid and the amount that should have been paid under the accounting
statement
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Clawbacks: Issues to Consider
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Consider revisiting the current clawback policy (if any) to determine
what changes would be required under Dodd-Frank
– One reason for a strong clawback policy is that it can act as a mitigating
factor to negate risk assessment disclosure under recent SEC rules (which
require narrative disclosure within the proxy statement of compensation
policies and practices that are “reasonably likely” to have a “material
adverse effect” on the company)
– Additionally, an expansive clawback policy acts as positive CD&A
disclosure
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Determine “who” should be responsible for clawback enforcement
(e.g., the risk assessment officer, the compensation committee, the
full board of directors) and what repayment procedure should be used
once a clawback is triggered
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Determine whether the clawback policy should be expansive
– Should it be limited to Dodd-Frank and SOX?
– Should “poor” performance, violation of restrictive covenants (e.g.,
noncompetes), negligence, etc. be covered?
– Should fault be a requisite element?
– Should there be a clause that if the non-compete provision is ever judicially
or administratively ruled to be unenforceable, that the executive must
forfeit certain portions of his/her severance pay (including a return of any
gains on equity awards that the executive sold after his/her termination of
employment)?
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Clawbacks: Issues to Consider (cont.)
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Analyze and review all compensation arrangements between the
company and its executive officers
– Such would include employment agreements, bonus arrangements, equity
awards, change in control agreements, form severance agreements,
corporate policies, etc.
– Goal is to ensure proper integration between such arrangements and the
company’s new clawback policy
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Verify whether form severance agreements (or clauses within other
agreements) contain mutual releases that will need to be amended so
as to carve out Dodd-Frank clawbacks
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Verify whether indemnification policies/procedures will need to be
amended to carve out Dodd-Frank clawbacks
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Verify whether applicable state wage and hour laws would prohibit the
forfeiture of compensation that is otherwise considered to be earned
wages
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Consider whether enforceable contractual rights need to be entered
into with the executive officers
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Risk Assessments
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Disclosure continues to be required to the extent the Company’s
compensation policies or practices (for both executive and nonexecutives) are reasonably likely to have a material adverse effect on
the Company
– Disclosure is only required if risk is present
– However, consideration should be given to whether positive disclosure
should be implemented even if such risk is not present
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Thus, every year the Company must perform a risk assessment
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This issue is more about “process”
– Assemble the team
– Review existing compensation policies, programs and arrangements
– Look for arrangements that could incentivize individuals to take great risks
that could threaten the value of the Company
– Analyze the results
– Change any policies, programs or arrangements that create such risk
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