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Changing Landscapes:Evolving SEC Rules on Risk-Related Compensation

and Governance Disclosure

ModeratorJustin W. Chairman, Morgan Lewis

PanelJames J. Bowes, Liberty Property Trust

Alan Singer, Morgan LewisAmy P. Kelly, Morgan Lewis

November 10, 2009

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Agenda

• July 2009 SEC Rule Proposal

• Overview of Executive Compensation Developments -- RISK

• Changing Role of Compensation Committee

• Say on Pay

• Proxy Advisory Firm Considerations

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July 2009

SEC Rule Proposal

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Overview of Rule Proposal

• Expansion of CD&A to address risk-related issues

• Board structure (CEO/CoB) and its relation to risk

• Board member qualifications

• Compensation consultant conflicts

• Reporting of stock and option award values

• Acceleration of shareholder vote reporting

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Status

• “Risk Rules” still expected for 2010 proxy season• No final rules yet - comment period ended mid-September• Other proposals (shareholder nominations) delayed• Legislative initiatives on governance unlikely to be effective

for 2010 proxy season• In its current form, proposed Investor Protection Act of 2009 would

repeal Sarbanes-Oxley auditor attestation for issuers with market cap under $75mm

• “We're not interested in lots of information; we're interested in meaningful information.” (Mary Schapiro, November 4, 2009)

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Overview of Executive

Compensation Developments

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Overview of Current Regulatory and Legislative Developments

• Obama Administration principles

• Say on Pay legislation

• SEC proxy disclosure and corporate governance proposals

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Obama Administration Statement on Executive Compensation

June 10, 2009 statement by Timothy Geithner• Compensation plans should properly measure and reward

performance.

• Compensation should be structured to account for the time horizon of risks.

• Compensation practices should be aligned with sound risk management.

• Reexamine whether golden parachutes and supplemental retirement packages align the interests of executives and shareholders.

• Promote transparency and accountability in the process of setting compensation.

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Proposed Legislation

• H.R. 3269: Corporate and Financial Institution Compensation Fairness Act of 2009

• Say on Pay

• Public companies will be required to obtain a non-binding shareholder vote on executive compensation at each annual meeting.

• A separate non-binding shareholder vote with respect to executive officer parachute payments will be required in connection with any merger or acquisition proposal submitted to shareholder approval.

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Proposed Legislation

• Compensation Committee Standards

• Enhanced independence standards will be imposed on compensation committee members.

• Any compensation consultants or legal counsel retained by the compensation committee must be independent of management.

• The company must provide the compensation committee with sufficient funding to retain independent compensation consultants, legal counsel, and other advisors.

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SEC Executive Compensation Disclosure and Corporate Governance Proposals

• SEC issued proposed guidance with respect to proxy disclosure and corporate governance on July 10, 2009.

• Executive Compensation

• Compensation Discussion and Analysis must address the risks created by the company’s compensation policies and practices for employees (including non-executive officers), if those risks may have a material adverse effect on the company.

• The key issue is whether any of the company’s compensation programs encourage excessive or inappropriate risk-taking by executive officers or other employees that would jeopardize the economic viability of the company.

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SEC Executive Compensation Disclosure Proposals

• Grant-date fair value will replace FAS 123(R) compensation expense in reporting equity awards in Summary Compensation Table and Director Compensation Table. The FAS 123(R) compensation expense recognized for financial reporting purposes for the fiscal year will no longer be reported.

• Additional disclosure will be required with respect to the fees and services of compensation consultants who perform additional services for the company.

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SEC Corporate Governance Proposals

• Corporate Governance

• Enhanced disclosure will be required with respect to the experience and qualifications of board members and nominees.

• There will be new disclosure requirements for the company’s leadership structure and the board’s role in risk management.

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Changing Role of

Compensation Committee

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SEC Proposed Proxy Disclosure Rules

• Expanded disclosures for compensation committee

• New compensation risk analysis

• Expanded disclosures for leadership structure

• Expanded disclosures for compensation consultants

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New Disclosure: Risk Analysis

• Require new CD&A section:

• Explain how company’s overall compensation policies and practices create incentives that can affect company’s risk

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New Disclosure: Risk Analysis

• To the extent material, the disclosure would need to address:

• how the design of the company’s compensation policies affects risk-taking by employees;

• the company’s risk assessment or incentive considerations in structuring the policies and paying the compensation;

• the extent to which the policies address long-term risks (e.g., by imposing clawbacks or holding periods);

• the extent and nature of changes to the policies to address changes in the company’s risk profile; and

• the extent to which the company monitors its compensation policies to determine whether its risk management objectives are being met.

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New Disclosure: Risk Analysis

• Potential situations that may require disclosure are policies or practices:

• At a business unit of the company that carries a significant portion of company’s risk profile or is structured significantly differently from other units within the company

• At a business unit that is significantly more profitable than others within the company or involves greater risk than others

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New Disclosure: Leadership Structure

• Proposed rules would require disclosure of:

• the company’s leadership structure, including whether the positions of chairman and CEO are held by one or two individuals. If both positions are held by a single individual, must disclose whether the company has a lead independent director and the specific role played by the lead director.

• why the company believes its leadership structure is appropriate given the company’s specific characteristics or circumstances.

• the board’s role in the company’s risk management process and the effect it has on the company’s leadership structure.

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New Disclosure: Leadership Structure

• Examples include:

• the relationship between the board and senior management in managing the material risks facing the company,

• whether the board’s risk management function is performed by the board as a whole or by a committee, and

• whether, and how, the board or committee monitors risk.

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New Disclosure: Committee Qualifications

• Require disclosure of specific qualifications and attributes of directors and nominees that qualify them to serve on board committees

• Must include more detailed disclosure of directorships held in last five years, not just current board memberships

• More information regarding skills, experience, attributes, and qualifications

• Disclosure of any legal proceedings from the last 10 years, compared to five years

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New Disclosure: Compensation Consultants

• Proposed amendment to Item 407 of Regulation S-K to require additional disclosure on compensation consultants.

• A description of the nature and extent of additional services provided to the company by the compensation consultant and any affiliates

• The aggregate fees paid for all additional services and for work related to executive and director compensation consulting

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New Disclosure: Compensation Consultants

• Additional disclosure:

• Whether the decision to engage the compensation consultant for any other services was recommended or made by management

• Whether the board of directors or the compensation committee approved the other services

• Does not apply in situations where the only role is recommending compensation in connection with broad-based plans like 401(k) and health plans

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Pending Legislation and Impact on Compensation Committee

• Legislation proposed by Treasury would amend the Securities Exchange Act of 1934 to add provisions applicable to compensation committees similar to the provisions applicable to audit committees added by Sarbanes-Oxley.

• Compensation committee members would be required to meet the same independence standards as applicable to the audit committee.

• Could not accept any consulting, advisory, or other compensatory fee from the issuer, or be an “affiliated person” of the issuer or its subsidiaries.

• Any compensation consultant, legal counsel, or other adviser to the compensation committee must meet independence standards set by the SEC.

• SEC would be required to act within 270 days of enactment to direct the stock exchanges to implement these requirements as listing standards.

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Pending Legislation and Impact on Compensation Committee

• Pending legislation would require that compensation committees be given authority to retain independent advisors, including compensation consultants and legal counsel.

• Compensation committee must be directly responsible for the appointment, compensation, and oversight of independent advisors.

• Company must provide adequate funding for independent advisors.• For proxy statements filed for annual meetings occurring more than one

year after enactment, company must disclose whether the compensation committee retained an independent compensation consultant and, if not, an explanation as to why.

• SEC would be required to study the use of independent compensation consultants and report to Congress within two years.

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Items to Consider

• Compensation committee should review all compensation programs for risk arising from the programs

• Establish appropriate risk review process

• Consider reviewing board members to ensure the right mix of qualifications on board committees

• Have the compensation committee retain a compensation consultant directly instead of through management

• Review compensation consultant’s role and fee arrangements

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Say on Pay

Facing the Inevitable?

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Say on Pay, What is it?

• An annual advisory vote on executive compensation policies and procedures and/or actual compensation paid to executives.

• As an advisory vote, it is non-binding.

• Nevertheless, the theory behind the vote is that it can influence the decision-making process of compensation committees.

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The Say on Pay Revolution

2003

• The Directors' Remuneration Report Regulations 2002 require all UK companies that are listed in the UK or any other EEA country, or on the New York Stock Exchange or NASDAQ, to:

• include a detailed report on directors' remuneration in the annual report; and

• submit for shareholder vote at each annual general meeting a resolution to approve the report.

2006-2009

• AFSCME (in 2006) and, subsequently, a coalition of institutional and retail investors sponsor proposals seeking an advisory vote on executive compensation:

• In 2009, over 100 shareholder proposals seeking say on pay votes.

• Many received majority support.

• In the most recent proxy season, a number of companies that are not TARP recipients (approximately 15) conducted say on pay votes – including Verizon, Intel and Motorola.

• The financial crisis has led to legislatively mandated say on pay for TARP recipients, as well as legislation approved by the House of Representatives that would mandate say on pay for most public companies.

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The Say on Pay VoteWhat are Shareholders Voting On?

• Say on pay votes have focused either on policies and procedures used in formulating executive compensation or on the actual compensation paid.

• Policies and procedures approach:• Aflac (2008) – “Resolved, that the shareholders approve the overall

executive pay-for-performance compensation policies and procedures employed by the Company, as described in the Compensation Discussion and Analysis and the tabular disclosure regarding named executive officer compensation (together with the accompanying narrative disclosure) in this Proxy Statement.”

• Intel – Sought approval of the compensation committee’s philosophy, policies and procedures as described in the CD&A.

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The Say on Pay VoteWhat Are Shareholders Voting On?

• Actual compensation approach:

• Alaska Air – Proposal that shareholders ratify the compensation of the named executive officers set forth in the Summary Compensation Table and accompanying footnotes (but not including the CD&A).

• Tech Data – Proposal that shareholders vote, on an advisory basis, for the compensation awarded to the named executive officers for FYE 1/31/09, as shown in the Summary Compensation Table.

• MBIA – two proposals:

• Support compensation paid to the CEO for 2008 and the 2009 salary, as shown in a table appended to the resolution.

• Support for compensation paid to Senior Executive Officers as a whole (excluding the CEO) for 2008 and the 2009 salaries, as shown in a table appended to the resolution.

• Littlefield Corporation – Shareholder vote on whether the CEO’s total compensation is "within 20 percent of an acceptable amount.”

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The Say on Pay VoteConsequences of the Vote?

• “Because your vote is advisory, it will not be binding upon the Board. However, the Compensation Committee will take into account the outcome of the vote when considering future executive compensation arrangements.” – Aflac

• Virtually identical statement used by several other companies.

• Reference to discussions with shareholders:• Blockbuster – The Compensation Committee, in addition to considering the shareholder

vote, intends to take into account discussions between stockholders and a committee to be established by the Board to address stockholders’ concerns (the committee would be formed if shareholders do not approve the say on pay proposal).

• Intel – “Voting results provide little detail by themselves, and [in the event there is a ‘significant negative voting result’], the company would consult directly with stockholders to better understand issues and concerns not previously presented.”

• Forest Laboratories – “The Board and Management are committed to our stockholders and understand that it is useful and appropriate to obtain the views of our stockholders when considering the design and initiation of executive compensation programs.”

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The Say on Pay VoteOther Disclosure and Voting Matters

• Limited or no supporting statements.

• Verizon and H&R Block - disclosures contained bullet point recitations of improvements to compensation practices.

• MBIA - Describes Say on Pay Policy.

• Broker Non-Votes – NYSE Rule 452

• Say on pay proposals are company proposals supported by the company’s board.

• Therefore, they generally are considered “routine.”

• Brokers can vote in their discretion if they do not receive instructions from shareholders.

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Say on Pay for TARP InstitutionsLegislative Action

• American Recovery and Reinvestment Act of 2009:

• Amended Section 111(e) of the Emergency Economic Stabilization Act (EESA) to require financial institutions whose TARP funding obligation remains outstanding (over 300 companies), in connection with proxy solicitations, to “permit a separate shareholder vote to approve the compensation of executives,” as disclosed pursuant to the compensation disclosure rules of the Commission, which “shall include” the CD&A, the compensation tables, and “any related material.”

• The say on pay vote requirement does not apply if the Federal Government “only holds warrants to purchase common stock of the TARP recipient.”

• The shareholder vote required under amended Section 111(e) of the EESA: • is not binding on the board of directors;

• may not be construed as overruling a decision of the board of directors;

• does not imply any additional fiduciary duty of the board; and

• does not limit the ability of shareholders to make proposals related to executive compensation for inclusion in proxy materials.

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Say on Pay for TARP Institutions SEC Activity: Staff Compliance & Disclosure Interpretations

• Triggered by a February 20, 2009 letter from Sen. Christopher Dodd (Chairman of the Senate Committee on Banking, Housing and Urban Affairs) to Mary Schapiro (SEC Chairman):

• The legislation applies to preliminary or definitive proxy statements filed after February 17, 2009 (except for definitive proxy statements relating to preliminary proxy statements filed on or before February 17, 2009).

• The Compliance and Disclosure Interpretations::

• A say on pay proposal applies only to (i) an annual meeting at which proxies will be solicited for the election of the board of directors or (ii) a special meeting in lieu of such an annual meeting.

• Smaller reporting companies need not provide a CD&A.

• Companies including a say on pay proposal will have to file a preliminary proxy statement.

• Section 111(e)(1) of the EESA does not condition the requirement for a shareholder vote on the receipt of a shareholder proposal on approving executive compensation.

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Say on Pay for TARP InstitutionsSEC Activity – Proposed Rules

• Proposed Rule 14a-20:• During the period in which any obligation arising from TARP financial assistance is

outstanding, as required by Section 111(e)(1) of the EESA, a TARP recipient subject to the proxy rules “shall provide a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to Item 402 of Regulation S-K, including the compensation discussion and analysis, the compensation tables, and any related material.”

• Language describing the nature of the vote basically tracks the statute.

• The SEC did not propose any specific language or form of resolution.

– However, the vote must be to approve “the compensation of executives” as described in the manner set forth in the statute.

– A vote to approve only compensation policies and procedures would not satisfy the requirements.

• Generally incorporates the Compliance and Disclosure Interpretations.

• Schedule 14a, Item 20:• Companies subject to Rule 14a-20 must disclose that they are providing the vote as

required pursuant to Section 111(e)(1) of the EESA, and briefly explain the general effect of the vote.

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Say on Pay for TARP Institutions2009 Activity

• In 2009, the TARP recipients generally followed the statutory language in Section 111(e)(1) of the EESA:

• Bank of America:

• “RESOLVED, that the stockholders approve the compensation of executive officers, as disclosed pursuant to the compensation disclosure rules of the Commission (which disclosure shall include the Compensation Discussion and Analysis, the compensation tables, and any related material).”

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Say on Pay for TARP Recipients2009 Activity

• Supporting statements:

• Generally brief.

• Generally reference the CD&A.

• Some address, usually in bullet-point fashion, several compensation policies and practices (pay for performance, clawbacks, stock ownership requirements, etc.).

• A number address the fact that no bonuses were paid in 2008 due to failure to meet performance criteria or other factors (e.g., bonuses withheld at the request of senior executives “because, in light of the circumstances, it was the right thing to do.” – Goldman Sachs).

• Some did not provide a substantive supporting statement.

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Proxy Advisory Firms Voting Guidelines

• Risk Metrics’ 2009 Proxy Voting Guidelines For Say on Pay Proposals – factors used for U.S. Companies:

• Relative Considerations:

• Assessment of performance metrics relative to business strategy, as discussed and explained in the CD&A;

– The CD&A should explain why the company is using specific performance metrics and goals.

• Evaluation of peer groups used to set target pay or award opportunities;

– Is the company’s peer group and benchmarking process reasonable in light of the company’s industry and size?

• Alignment of company performance and executive pay trends over time (e.g., performance down: pay down); and

• Assessment of disparity between total pay of the CEO and other named executive officers.

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Proxy Advisory Firms Voting Guidelines

• Design Considerations:• Balance of fixed-pay vs. performance-driven pay.

• Assessment of excessive practices with respect to perks, severance packages, supplemental executive pension plans and burn rates.

– These elements, as well as tax gross-ups, excessive supplemental payment arrangements and resetting of performance goals, are deemed to undermine links between pay and performance.

– Positive elements include clawbacks, stock ownership requirements and long-term shareholding requirements.

• Communication Considerations:• Evaluation of information and board rationale provided in CD&A about how compensation is

determined (e.g., why certain elements and pay targets are used, and specific incentive plan goals, especially retrospective goals)

• Assessment of board’s responsiveness to investor input and engagement on compensation issues (e.g., in responding to majority-supported shareholder proposals on executive pay topics)

• Glass Lewis: “The CD&A will . . . be integral to the evaluation of compensation proposals at companies . . .”

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Shareholder Communication Efforts

• Several companies have pursued, initially as an alternative to an advisory vote, different measures to enable shareholder input regarding compensation, including:• Surveys (e.g., Schering Plough) – seeking shareholder feedback on various aspects

of compensation programs and disclosure – more comprehensive in addressing specific compensatory policies and practices than a say on pay proposal.

• Meetings with large shareholders (e.g., Intel, Pfizer).

• While these communications efforts likely will not slow down the momentum toward adoption of say on pay, they could provide a channel for communications in the event that a significant negative vote is obtained and they may influence future voting decisions.

• They also may address a key criticism of say on pay – namely, that a broadly worded say on pay proposal does not provide useful information to a compensation committee.

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Say on Pay Voting Results

• Voting results generally have been favorable for companies:

Company Percentage of Vote for Say on Pay Proposal

Aflac (May 2009) 97.0

Jackson Hewitt Tax Service (August 2008) 53.6

H&R Block (September 2008) 89.6

Intel (May 2009) 93.8

Motorola (May 2009) 63.5

Par Pharmaceuticals (June 2009) 93.0

Verizon (May 2009) 87.4

Bank of America (April 2009) 69.6

Citigroup (April 2009) 82.6

Goldman Sachs (May 2009) 97.3

JPMorgan Chase (May 2009) 96.5

KeyCorp (May 2009) 87.2

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Say on Pay For All?

• The Corporate and Financial Institution Compensation Fairness Act of 2009 (adopted by the House of Representatives): • Applies to any annual meeting of shareholders to elect directors (or a special

meeting in lieu of such annual meeting) where proxy solicitations are subject to the proxy rules under the Securities Exchange Act.

• Requires that such proxy “shall provide for a separate shareholder vote to approve the compensation of executives as disclosed pursuant to the Commission’s compensation disclosure rules for named executive officers (which disclosure shall include the compensation committee report, the compensation discussion and analysis, the compensation tables, and any related materials, to the extent required by [rules to be adopted by the SEC]).”

• Contains provisions underscoring the advisory nature of the vote, that no additional fiduciary duty of the board is created and that the statute does not limit the ability of shareholders to make proposals related to executive compensation for inclusion in the proxy statement.

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Say on Pay For All?

• The SEC must adopt final rules within six months after enactment of the legislation. • The SEC may exempt certain categories of issuers from the say on pay

vote requirement “where appropriate in view of the purpose of this subsection.” The SEC “must take into account, among other considerations, the potential impact on smaller reporting companies.”

• The legislation would apply to proxy solicitations made on or following six months after the date the SEC adopts final rules to implement the legislation. • Unlikely for 2010 proxy season.

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Considerations for the 2010 Proxy Season

• CD&As should be revised to more effectively address, among other things, the reasons for components and amounts of compensation, and the relationship of pay to performance.

• Although the legislative trend appears to be favoring say on pay votes on actual compensation, an effective discussion of policies and practices designed to address pay for performance, risk considerations (including clawbacks) and compensatory “hot buttons” (perquisites, tax gross-ups, etc.) can influence meaningfully the evaluation of say on pay proposals by proxy advisory services and some institutional shareholders.

• In light of factors addressed by the proxy advisory firms in considering say on pay votes, the nature of the shareholder vote (i.e., whether the vote is on actual compensation or on policies and practices) likely will not make much of a difference in most situations.

• Consider alternative modes of shareholder communications – meetings with large shareholders, “town hall” meetings, surveys, shareholder forums, etc.

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Proxy Advisory Firm Considerations

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Institutional Governance Entities:What They Do

• Provide Advice to Institutional Investors on Corporate Governance Issues

• Examples:

• Risk Metrics

• Fidelity

• Glass, Lewis

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Who Is RMG

• Preeminence of RMG Franchise

• Consulting/Advisory Function

• Increase in Use of RMG “Pre-review”

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Equity Plan Review

• RMG primarily known for recommendations relating to votes on equity plan issues

• How much will the plan cost?• Shareholder Value Transfer (SVT): Binomial (proprietary) model that

measures the amount of wealth flowing out of the company to plan participants as awards exercise and vest

• SVT is expressed as a dollar value and as a percent of a company’s market cap

• Considers proposed new shares, unvested full value shares and all outstanding options (even out of the money)

• Unless restricted to use as options, counts all new shares as full value

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Equity Plan Review

• Compare SVT to allowable cap

• The allowable cap is industry-specific, market-cap-based, and pegged to the average amount paid by companies performing in the top quartile of their peer groupings

• If SVT cost is above the allowable cap, RMG will recommend a vote against the plan

• Mechanical test – business rationales (e.g., reduction in use of cash compensation) do not help

• Option overhang a killer

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Equity Plan Review

• RMG will recommend a vote against plans if burn rate exceeds one standard deviation from industry mean and 2%

• Full-value awards (restricted stock, performance awards, etc.) will count as more than one in burn rate depending on company’s stock price volatility

• Companies that fail the RMG burn rate test may make public commitment to future burn and RMG will not apply the burn rate test

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Pay for Performance

• RMG is becoming more involved in executive compensation through “pay for performance” positions

• Looks at whether “the Board lacks accountability and oversight, coupled with sustained poor performance relative to peers”

• Companies on list do not necessarily receive adverse vote, but list helps RMG identify poor performing companies for purposes of:• Evaluating director performance in uncontested elections

• CEO pay relative to company performance

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Pay for Performance

• Measure of total shareholder return (TSR) versus CEO total direct compensation for companies in lower half of TSR performance

• Based on peer group that RMG designates based on one-year and three-year TSR

• RMG will recommend a withhold/against vote on the compensation committee members if there is a pay for performance disconnect (increase in CEO compensation and the company’s one-year and three-year TSR are in the bottom half)

• Also, RMG could recommend a vote against an equity plan if increase in total direct compensation is at least 50% based on equity and CEO in the equity plan proposal

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Pay for Performance

• RMG considers whether a company evidenced commitment to pay for performance principles; CD&A should provide meaningful disclosure; boilerplate disclosure is discouraged

• Company may make a public commitment and RMG may override the pay for performance test

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Poor Pay Practices

• Poor pay practices may result in a “withhold” or “against” vote for directors

• Excessive severance or change in control arrangements:• Payments for termination on account of performance failures

• Excessive change in control or severance payments (over 3x)

• Single trigger change in control termination (walk right)

• Perquisites continued for former executives

• Any new or materially amended arrangements that include:• Excise tax gross-up provisions

• Modified single triggers (walk right on change in control)

• Liberal change in control definitions (without actual change in control)

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Poor Pay Practices

• Tax reimbursements of perquisites

• Excessive perks

• Dividends or dividend equivalents on unearned performance awards

• Contracts containing multi-year guarantees for salary increases, bonuses and equity compensation

• Large bonus without performance condition• Pension/SERP (additional years of service; inclusion of equity

awards in calculation)• New CEO overly generous hire package• Limited use of employment contracts; short term• Double trigger equity acceleration

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Repricing

• RMG will recommend a vote against any plan that permits repricing

• Specific language requested (overly broad)

• No reduction of exercise price or cancellation of options/SARs in exchange for cash, other awards or options/SARs with exercise price less than exercise price of original options/SARs without stockholder approval

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Repricing

• Shareholder friendly programs include

• Value for value exchange

• Exclusion of NEOs and directors

• Exercise price of surrendered options must be above the 52-week high in stock price

• Reset the vesting schedule

• Explanation of rationale

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Contact Information

• James J. Bowes, Liberty Property Trust - jbowes@libertyproperty.com

• Justin W. Chairman, Morgan Lewis - jchairman@morganlewis.com

• Alan Singer, Morgan Lewis - asinger@morganlewis.com

• Amy P. Kelly, Morgan Lewis - akelly@morganlewis.com