Tips for compensation committees & HR teams in 2024 

The December 1, 2023 deadline for stock exchange listed companies (NYSE and Nasdaq) to adopt a compliant clawback policy is looming. The policy must require companies to recover excess incentive-based compensation received by current or former Section 16 executive officers on or after October 2, 2023, if payments were based on financial statements that were later restated and executives received amounts that otherwise would have been lower. Compensation is deemed “received” when the performance goals are satisfied, regardless of when the award is granted, vested or paid.

Many companies that adopted a policy before the SEC finalized rule will have to expand the types of restatements covered, move to a “no fault” standard and eliminate board enforcement discretion. Companies may decide to meet only the minimum requirements or to include additional individuals, types of compensation (such as service-based awards) or types of triggers (such as misconduct). If they adopt a broader policy, they need to decide where the “extras” should be housed — in the compliant policy or a separate policy, or in incentive plans, award agreements or employment agreements. Of note, proxy advisor Institutional Shareholder Services (ISS) gives credit for a policy only if it covers all equity awards.

Key action steps

• Adopt a compliant policy or review current policies for compliance, and if there are multiple policies (including an SEC compliant one), ensure they are complementary and not conflicting.
• File policy as an exhibit to Form 10-K and describe it in the 2024 proxy statement.
• Communicate the policy to covered executives and consider whether to have them sign an acknowledgment.
• Update committee charter to add responsibility for overseeing adoption, implementation and enforcement of a clawback policy.
• Review corporate bylaws, compensation plans, and employment agreements to ensure they don’t prohibit compensation recovery or indemnify or insure executives from losses.
• Establish processes for tracking former executive officers, calculating excess compensation (including how to estimate a restatement’s effect on stock price or total shareholder return), and determining how the company will recover the required amounts.
• Back test to determine if recent financial misstatements would have resulted in a clawback under the new rule.

Mercer resources

• Deadline to adopt clawback policy postponed to December 1
• Final SEC clawback rule requires significant changes to policies

New SEC rules will put a spotlight on “spring-loaded awards” by requiring disclosures on equity grant timing. Spring-loading is where companies grant stock options and other awards shortly before announcing material nonpublic information (MNPI) that can significantly affect stock prices, such as an earnings release with better-than-expected results or a significant transaction.

A 2021 SEC staff accounting bulletin already requires companies to consider the impact of the release of MNPI on the value of spring-loaded awards and reflect any estimated additional value in both compensation cost and the Summary Compensation Table and Grants of Plan-based Awards Table.

Under disclosure requirements embedded in amended Rule 10b5-1, companies will have to describe in proxy statements their policies on the timing of option grants in relation to the release of MNPI. Disclosures should discuss how the board determines when to grant awards (e.g., on a predetermined schedule), whether and how the board or compensation committee considers MNPI when determining the timing and terms of awards, and whether the company timed the disclosure of MNPI to affect the value of executive compensation. And, if the company granted options in the last completed fiscal year to named executive officers within four business days before or one business day after the filing of a Form 8-K with MNPI or the filing of any Form 10-Q or 10-K, the proxy must also include a table showing those grants. While the disclosures generally aren’t required until 2025, the table will cover 2024 grants.

Key action steps

• Review and refresh equity grant timing practices to minimize the risk of spring-loaded disclosures; consider prohibiting grants during blackout periods or limiting them to open window periods. Under either approach: 
  
  • Prohibit granting options within four days before or one day after filing a Form 8-K with MNPI or any Form 10-Q or 10-K.
  • Require preclearance by legal and finance of off-cycle grants to confirm there’s no planned release of market moving information that could impact an award’s grant date value.
• Document the practices in a formal policy (or update any existing policy).
• Ensure the policy is consistent with omnibus plan, applicable law (e.g., state corporate law, state and federal securities laws, etc.), compensation committee charter, and company charter and bylaws.
• Draft pro forma disclosures describing the policy in preparation for inclusion in SEC filings.
• Ensure actual practices are consistent with disclosures — non-routine grants can be a trap!

Mercer resources

• Pending disclosures prompt companies to refresh equity grant and insider trading policies
• Executive and director trading under new Rule 10b5-1

Companies should also refresh their insider trading policies in light of new SEC disclosure requirements embedded in amended Rule 10b5-1 and a new share buyback rule. The focus of the Rule 10b5-1 amendments is to add conditions to the affirmative defense to insider trading for transactions under pre-established trading plans (e.g., a cooling off period between plan adoption or modification and the first trade) to prevent opportunistic trading. The focus of the share buyback rule is to give shareholders additional information about company share repurchase programs and their intended purpose. But the new insider trading policy disclosures are mandated whether or not the individuals enter into trading plans and, in some cases, whether or not a company buys back shares.

Proxy statements must describe the company’s insider trading policies, procedures and rationale and the policy must be filed as a Form 10-K exhibit. Forms 10-Q and 10-K must describe the company’s policies relating to purchases and sales by officers and directors during a repurchase program (such as a prohibition or preclearance requirement). And a new share repurchase table in quarterly filings must include a checkbox indicating if officers or directors purchased or sold shares within four business days before or after the announcement of a buyback program. The disclosures regarding trading in company shares during a buyback program are first required in the 2024 Form 10-K. The description (and filing) of the insider trading policy isn’t required until 2025.

Note: An appeals court is reviewing the buyback rule and, unless the SEC can address concerns raised, it may not go into effect.

Key action steps

• Document, communicate to insiders, and enforce the enhanced conditions for using Rule 10b5-1 trading plans.
• Consider whether to continue to require (if applicable) that insiders trade only through Rule 10b5-1 plans if the new conditions are too inflexible and the company has preclearance procedures or other controls sufficient to prevent opportunistic trading.
• Assess the adequacy of the company’s controls and procedures for tracking the use of Rule 10b5-1 trading plans and insider transactions.
• Update the company’s insider trading policy for alignment with best practices and, if the share buyback rule takes effect, consider whether to prohibit purchases and sales of company stock within four business days before or after the announcement of a repurchase program (which would likely include “sell to cover” transactions, where officers and directors sell shares to pay taxes and exercise prices on equity awards, but not share withholding by the company).
• Draft pro forma disclosures describing the policy in preparation for inclusion in SEC filings.
• Ensure actual practices are consistent with disclosures.

Mercer resources

• Pending disclosures prompt companies to refresh equity grant and insider trading policies
• Executive and director trading under new Rule 10b5-1

In 2023, companies first disclosed the relationship between executive “compensation actually paid” (CAP) and company performance under the SEC’s pay-versus-performance (PVP) rule. The second year of disclosure should go more smoothly since companies are familiar with the pay and performance calculation methodologies, and the 2024 PVP table will require only adding one year. However, new SEC Staff guidance in the form of Compliance & Disclosure Interpretations (CDIs) may require companies to change some of the methodologies they used to calculate CAP. The CDIs cover, among other things: when awards are deemed to have vested if vesting accelerates on retirement eligibility or if awards have goals that must be certified by the compensation committee; whether alternative valuations and simplifying assumptions can be used to calculate stock option values; and the treatment of awards granted prior to an IPO or spinoff. In the first year, the SEC Staff gave deference to good faith compliance efforts, and proxy advisors ISS and Glass Lewis didn’t incorporate CAP in their pay-for-performance analyses — but this could change in 2024.

Key action steps

• Determine whether the SEC Staff guidance requires changes to how CAP was calculated in 2023 and how equity award valuation assumptions and reconciliations to non-GAAP company selected measures are described.
• Review SEC Staff comment letters sent to individual companies to see what the staff identified as inadequate disclosure or an incorrect interpretation of the rule and be on the lookout for additional staff guidance.
• Review peer company approaches to PVP narratives and graphs.
• Monitor proxy advisor and shareholder policy updates to determine whether or how they will consider the PVP disclosures in their pay-for-performance assessments.
• Ensure disclosures are clear, accurate and complete.

Mercer resources

• SEC Staff issues guidance on pay-versus-performance rule
• Pay-versus-performance disclosure: First year learnings
• New SEC pay-versus-performance guidance addresses some questions raised by the complex rule
• A deep dive into the long awaited pay-versus-performance disclosures

Shareholders, proxy advisors and the public have been pushing for more information on how companies manage their human capital and address diversity, equity and inclusion (DEI) initiatives, and how boards oversee the process. Some companies have responded by using environmental, social and governance (ESG) metrics in their incentive plans to demonstrate a commitment to supporting their workforce and the broader public good. ESG metrics in incentive plans became a majority practice (53%) in 2022 among S&P 500 companies, up from 49% in 2021 and 34% in 2020, according to a Mercer review of proxy disclosures. DEI metrics were the most prevalent, with a split between qualitative (44%) and quantitative goals (52%). Except for environmental stewardship metrics, over 90% of ESG metrics appear in short-term (not long-term) incentive plans. While the prevalence of ESG metrics in incentive plans is rising, the recent Supreme Court decision on affirmative action in college admissions and the rise of anti-ESG shareholder proposals may cause companies to reconsider using goals with specific DEI targets and in some cases opt for a more qualitative approach.

In this challenging environment, the SEC is expected to update its 2020 human capital management (HCM) “principles-based” disclosure mandate as early as this fall to require prescribed, objective measures that all companies must disclose. Expected enhancements are likely to require specific information on HCM, such as workforce turnover, skills and development training, pay and benefits, workforce demographics (e.g., use of independent contractors), and health and safety. If the proposal requires diversity data, it may be challenged in court.

Key action steps

• Monitor SEC rulemaking activities.
• Review peer company HCM disclosures.
• Keep up to date on shareholder and proxy advisor policies on HCM.
• Assess the company’s HCM policies and practices, track HCM metrics that support the company’s values and business objectives and assess risks and progress toward HCM goals.
• Monitor challenges to company race-based initiatives and the use of DEI metrics in incentive plans.

Mercer resources

• Human capital management: Tips for boards and human resource & compensation committees

In 2023, say-on-pay (SOP) vote results significantly improved from 2022, with fewer failures and fewer ISS against recommendations at both all-size companies and S&P 500 companies. Despite these generally positive results, companies that received low levels of support should respond to proxy advisor and shareholder concerns by enhancing shareholder outreach and engagement disclosure in their proxy statement and, if applicable, making changes to their pay programs and disclosing them in their proxy statement. ISS and Glass Lewis expect companies to respond to a low SOP vote (less than 70% for ISS and less than 80% for GL) or they may recommend against not only the SOP on next year’s proxy, but also directors — particularly those on the compensation committee.

At companies that received low support for their SOP proposals, typical concerns raised by shareholders and proxy advisors included a pay-for-performance disconnect and significant one-time or special awards. Of note, ISS continues to target companies that characterize executive terminations as retirements but pay severance. And in its 2024 policy benchmark survey, ISS asks whether companies should disclose line-item reconciliations of non-GAAP adjustments to incentive pay metrics — signaling its 2024 voting policy guidelines may flag adjustments that significantly affect performance results and payouts when identifying pay-for-performance disconnects. Proxy advisor voting policy updates are typically finalized in the fall and take effect early the following year.

Separately, in August 2024, companies will be able to access annual SOP vote results of institutional investment managers (including investment advisers, banks, insurance companies, broker-dealers, pension funds, and corporations) on Form N-PX. Mutual funds already make these disclosures. The new requirement will make it easier for companies to understand which of their institutional investors have concerns about their pay program so they can better target their shareholder engagement activities.

Key action steps

• Review the company’s 2023 ISS and Glass Lewis reports to identify and address concerns.
• Conduct market analyses of executive pay programs, levels, and incentive plan designs to understand how current programs — and any potential changes — compare to market practice.
• Engage with top investors, particularly if the 2023 SOP proposal didn’t receive strong support.
• Disclose the details of engagement efforts and actions taken to address the issues that contributed to the low level of support (e.g., “what we heard/what we did” table).
• Track proxy advisor policy updates to prepare for changes that may impact 2024 voting recommendations on the company’s pay and governance proposals.

Soaring inflation, labor shortages, fears of a recession, interest rate policy decisions, supply chain issues, and international political instability and conflicts continue to change the economic outlook and affect company performance. As a result of these economic challenges, many stock options granted to employees are once again underwater and some performance-based awards are unlikely to payout, reducing or eliminating the incentive originally intended. And compensation committees continue to grapple with whether to address the impact of these factors on outstanding and future incentive awards.

For future awards, companies can consider changing the mix of long-term incentive awards, using different performance metrics and/or widening performance goal ranges with corresponding changes to payout levels.

For companies facing a retention risk, an option repricing or exchange for another type of award, or adjusting performance share metrics, can restore the holding power of outstanding awards. And granting special retention awards is another solution. But companies should consider how all stakeholders will view these actions and whether they’re premature given market volatility and the competitiveness of the company’s compensation program overall. Although shareholder support for executive pay generally remains strong, proxy advisors and investors may not support SOP proposals if companies modify in-flight awards or grant special awards absent very compelling circumstances.

Key action steps

• Review the value of outstanding equity grants and how performance is tracking to assess the holding power of these awards, particularly for key talent.
• Consider design changes for 2024 grants given anticipated continued volatility and uncertainty.
• Evaluate goal rigor of new awards in light of assumptions in company’s budget as well as upside and downside risks to the budget’s targets.
• Review the business case, proxy advisor policies, messaging to stakeholders and regulatory implications of changes to inflight awards, including tax, accounting and disclosure especially if an option exchange or performance award modification is undertaken.

Mercer resources

• Addressing in-flight incentive awards a holistic approach for comp committees

Efforts to increase board diversity have been a priority among regulators, investors and proxy advisors for several years but progress has been elusive despite increased disclosure mandates aimed at drawing attention to companies that lack diverse directors. Companies can demonstrate their commitment to board diversity with detailed proxy statement disclosures.

Nasdaq-listed companies are already required to disclose a board diversity matrix annually on their website or in their proxy statement. Several states have enacted director diversity disclosure laws, including California, Colorado, Illinois, Massachusetts, New York, Pennsylvania, and Washington. Proxy advisors highlight nondiverse boards in governance ratings and recommend voting against directors where boards lack diversity. And several investors are pushing for greater diversity, including BlackRock, State Street Global Advisors (SSGA) and Goldman Sachs Asset Management. Finally, the SEC is working on a rule to require directors to self-identify (and companies to disclose) gender, race and ethnicity details of their directors.

Key action steps

• Encourage the recruitment of more diverse board nominees to be prepared for new requirements and pressure from proxy advisors and investors.
• Add a board diversity matrix (if not already required to have one) to proxy disclosure highlighting gender and underrepresented minority representation.
• Track federal and state diversity laws, stock exchange initiatives, and proxy advisor and investor policies.
• Follow lawsuits and campaigns against efforts to enhance diversity following the US Supreme Court decision on affirmative action in college admissions.

States typically regulate non-compete agreements and some ban them altogether. For example, non-compete agreements are prohibited in California, Minnesota, North Dakota and Oklahoma, and New York is considering a ban. Now federal agencies are joining in, with the Federal Trade Commission (FTC) proposing a federal ban that would prohibit future non-competes and require recission of existing non-competes. The proposal may be revised before it’s finalized, including to potentially exclude “highly paid or highly skilled” workers, and any final rule is expected to face significant legal challenges. At the same time, recent National Labor Relations Board (NLRB) memos take aim at non-competes and other restrictive covenants. Although the future of the FTC rule is uncertain, both the FTC and NLRB can bring enforcement actions now.

Key action steps

• Follow federal and state law developments and review non-compete agreements to ensure they are narrowly tailored and comply with federal and state laws that may limit or prohibit non-compete provisions.
• Review confidentiality/non-solicitation provisions and other restrictive covenants to ensure they are not so broad they could be considered de facto non-competes.

Mercer resources

• Roundup: US employer resources on recent noncompete restrictions

Key action steps

• Develop comprehensive disclosure controls and procedures to track perquisites to ensure proper disclosures.
• Review the SEC’s perquisite analysis to determine which payments and benefits would not be considered “integrally and directly related” to an executive’s job.
• To potentially avoid significant penalties if there’s a disclosure failure, inform the SEC and shareholders immediately and cooperate with the investigation.