Regulators Are Back: What to Watch in Compensation Plans

Written by

After taking more than a decade to finalize pay-for-performance compensation rules, the U.S. Securities and Exchange Commission now expects companies to take about six months to comply with them. 

“There will be a lot of computers blowing up in the next several months,” says Todd Leone, a partner at the compensation consulting firm McLagan, an Aon company. “There’s a lot of eye-rolling that we didn’t have much time to do this.” 

Leone was speaking to a group of more than 250 human resources professionals, directors and industry leaders attending Bank Director’s Bank Compensation and Talent Conference, taking place November 8 through 9 in Dallas. The new SEC disclosure rule is one of a host coming down the pipeline for publicly traded companies. Leone says the agency introduced 26 new proposals so far in 2022, the highest it has been in five years. 

“It’s turned into quite a big to-do,” says Susan O’Donnell, a partner at Meridian Compensation Partners, who also spoke about the pay-for-performance regulation on stage. 

After years of little activity finalizing what languished in the Dodd-Frank Act of 2010, regulators under President Joe Biden have taken renewed interest in adopting rules that will impact a broad swath of mostly public companies. In 2015, the SEC first proposed rules to require companies to disclose more about the relationship between executive pay and performance. In August, the SEC adopted the rules, which go into effect for fiscal years ending on or after December 16, 2022. In other words, most public banks will be required to provide the new disclosures starting in the 2023 proxy season. Smaller reporting companies are subject to scaled disclosure requirements. 

“I think that this rule will help investors receive the consistent, comparable, and decision-useful information they need to evaluate executive compensation policies,” SEC Chair Gary Gensler said in a statement at the time. O’Donnell says companies will have to report executive compensation alongside financial performance metrics, including total shareholder return, as well as TSR of a peer group, net income and a financial performance metric chosen by the company. In all, the company will be required to report three to seven financial performance metrics. 

This could cause problems for banks that complete M&A deals, Leone says. Typically, net income falls after an acquisition because of one-time expenses. At the same time, compensation increases, sometimes to motivate the executive team to make the deal a success. He recommends banks include a description in the disclosure that describes why pay and performance may not appear to align.

“Institutional investors aren’t looking at this to tell them anything they don’t already know,” Leone says. “The one area where we’re scratching our heads is what are the plaintiffs’ lawyers going to do. You have to make sure there’s a story behind this and a narrative that you’re telling.” The first year, Leone says companies will have to disclose three fiscal years of compensation metrics, so he advises companies to get started now on 2020 and 2021 calculations. Each year, another year will be added, until companies report five years’ worth of data. 

Companies will have more time to comply with the other recently finalized disclosure rule required by the Dodd-Frank Act, this one having to do with clawing back incentive compensation that was granted in error. Leone referred to the rule as “lovely bedtime reading for those of you with insomnia,” because it encompasses more than 200 pages. 

In October, the SEC finalized the rule that had first been proposed in 2015 requiring companies to disclose their policies regarding clawing back compensation from named executives. Usually, those clawbacks occur due to restatements of earnings or misconduct. Although the rule doesn’t say that clawbacks must occur for misconduct, the rule does require companies to claw back compensation that was based on erroneous calculations, regardless of whether the executive was at fault for the error. Leone expects the rule to go into effect later in 2023. Smaller reporting companies do have to comply with this one. 

And the third disclosure rule coming down the pike for public companies is Nasdaq’s new board diversity rule. Laura Hay, lead consultant for Meridian Compensation Partners, says the exchange will require companies to have at least one diverse director starting in 2023 and two starting in 2025, or explain why they don’t have them. Diversity may include gender or underrepresented minorities, as well as LGBTQ individuals.

The exchange also requires that companies include a diversity matrix in their disclosures, which went into effect in August for the next proxy season.

5 Compensation Approaches That Support Greater Board Diversity

Written by

Boards are cultivating a more diverse slate of directors that includes different backgrounds, experiences and skills. In 2021, over 45% of new directors in the Russell 3000 were women. Directors of different ethnic groups also made steady gains. Moreover, bank boards are seeking specific skill sets such as risk, cyber and financial markets expertise to supplement traditional CEO and CFO disciplines.

Attracting and retaining a new breed of diverse directors, many of which are younger than traditional directors and may still be working, requires forward thinking. Boards with compensation programs that are unclear, overly restrictive or developed as a “one size fits all” program may encounter recruiting and retention issues. Just as director experience needs to be more diverse to oversee modern banking, director compensation practices must adapt and change to address varied perceptions and needs. Banks can take five actions to position themselves for greater success.

1. Ensure Compensation Programs are Up-to-Date.
Director pay has continued its upward trend after a brief hold during the pandemic. Furthermore, banks are adopting practices more consistent with general industry practices:

  • Consider a retainer-only approach. Eliminating meeting fees creates greater clarity around the total compensation a director receives while streamlining administration.
  • Grant restricted stock. Governance advocates and regulators alike consider full-value shares to be more appropriate for director pay, compared to stock options, since shares provide ownership without the potential for leveraged gains. The most common vesting period for equity retainers range from immediate up to one year after grant.
  • Eliminate “old school” practices. Certain practices may carry the perception that a bank board is out of touch with market practice and governance norms. These include director retirement and benefit programs, meeting fee reductions for committee meetings held on the same day as the board meeting or for meetings held “telephonically,” reimbursement of spousal travel and paying executives board fees.

2. Consider Pay Mix and Timing.

  • Coordinate cash and equity vesting. Governance advocates encourage companies to pay a minimum of 50% of board fees in the form of equity. In most cases, equity compensation is welcomed by directors but taxes can be an issue. Timing cash, such as board and committee retainers, alongside equity award vesting is helpful; this is especially true if open window periods to sell equity are limited throughout the year.
  • Consider immediate vesting. Even a one-year vesting can create unexpected tax consequences with share price movement. If a bank’s share price increases substantially over the vesting period, the tax liability at vest may be substantially higher than planned. This tax liability can create a burden on directors, especially when combined with ownership requirements and sales restrictions.
  • Rethink long holds and other restrictive policies. Stock retention and ownership guidelines are the market norm. And while welcomed by shareholders, less prevalent practices such as mandatory deferral policies and other stock retention provisions that defer stock vesting until director retirement may receive pushback from candidates and reduce the potential pool of directors.

3. Review Equity Grant Levels, Stock Ownership Guidelines.
Banks should model stock ownership requirements to ensure that directors can reach the guidelines through the compensation program within the prescribed timeframe and on an after-tax basis. Rarely are directors expected to pay out-of-pocket to serve on a public company board. If the annual equity retainer alone is deficient, banks can grant sign-on awards to give new directors a head start in achieving the ownership guideline and to support recruiting efforts.

4. Provide Programs That Let Directors Manage Cash Flow.
Board diversity may lead to varying financial objectives, which banks can address by implementing choice programs that are flexible in form of payment and tax timing.

a. Stock programs that allow directors to receive cash retainers in stock. These programs typically allow a bank to pay cash board retainers as shares. Some provide a “kicker” incentive of 10% to 20% to directors that opt for stock over cash.

b. Voluntary deferral programs. These programs may include voluntary deferrals of cash retainers and/or equity awards that may be held in company stock, an interest bearing account or in diversified investments.

5. Employ More Mindful Recruiting Efforts.
Executive recruiters and board-directed searches often resort to drawing from the same limited pool of sitting board members to fill new seats rather than broadening to other sources of talent, such as women executive groups, ethnic chambers of commerce and affinity groups. A larger recruiting pool places less pressure on the board compensation program.

Board compensation programs can act as an enticement or deterrent when banks are recruiting diverse candidates. Banks put themselves in the best position when compensation programs are clear, market-based and provide flexibility for varying life stages and financial positions.

Aligning Strategy and the Board

Written by

The board plays an important role in guiding the bank’s strategy and supporting the strategic plan. That requires a varied mix of skills, backgrounds and expertise in the boardroom. In this video, Scott Petty of Chartwell Partners shares the gaps that some boards may need to fill, and provides tips on how to expand your board’s network to attract candidates.

  • Three Questions to Consider
  • Attributes Every Board Needs
  • Building Diversity in the Boardroom
  • Expanding Your Network

The Secrets Behind Diverse Boards

Written by

Four women currently serve on the board at Eagle Bancorp Montana, the $1.3 billion asset holding company for Opportunity Bank of Montana. That’s by design, says Chairman Rick Hays.

“[We] decided that we needed to have a larger board,” Hays says, after a 2012 branch acquisition doubled its footprint in Montana and prompted a later increase from seven to nine members. The Helena, Montana-based commercial bank wanted to add directors representing its expanded geography, along with younger board members and women. Maureen Rude, who joined the board in 2010, was the sole female director at that time.

“We had all the board members, all the executive officers, the local market presidents in those communities, all looking for people with the characteristics we were looking for,” says Hays. Expanding its networks worked: Two women joined in 2015, and the fourth, public accountant Cynthia Utterback, in 2019. During that time, the bank also replaced a male director with another man with a technology background.

“We’re looking for the best possible candidates,” Hays says. “If you decide what you want and commit to getting it, you can get it done.” Adding new perspectives and backgrounds benefits the board and the bank, he adds. “I firmly believe that diversity is about the best possible business decision we can make; I’ve experienced it over and over in a variety of organizations.”

Almost 60% of the directors  and CEOs responding to Bank Director’s 2021 Governance Best Practices Survey believe that diversity in the boardroom improves corporate performance. However, fewer than half — 39% — have three or more board members who they’d consider to be diverse, based on gender, race or ethnicity.

The benefits of diversity in the boardroom are frequently touted by corporate governance experts, and many of the survey participants shared their experience. Here are a few of the comments we received:

“[D]iversity has helped shape everything from policies to product positioning.” — Lead director of a public bank between $1 billion and $10 billion in assets

“We have diversity in age, gender, geography, ethnicity and career experience. Creates more robust questioning when discussing products, trends, issues to ensure full vetting, understanding and ramifications of decisions.” — Independent director, public bank above $10 billion in assets

“[Due to diversity] [w]e have re-visited agendas, meeting logistics, and historical approaches to initiatives with a fresh lens.” — Independent chair at a private bank between $1 billion to $10 billion in assets

Sixty-five percent of respondents want to add more directors with diverse backgrounds, but almost as many (61%) believe it’s difficult to identify and recruit them to serve on the board. These candidates may be in high demand, but the survey finds that respondents representing more diverse boards report that it’s easier to recruit diverse candidates with the skills and expertise their organization needs.

 

As Rick Hays at Eagle Bancorp Montana illustrates, diverse boards broaden their networks to recruit diverse, qualified candidates. But an analysis of the habits of diverse boards yields further clues about their practices. They tend to have mechanisms in place to create space on the board, and to identify the skills and attributes they’re seeking.

Board evaluations can be valuable tools to evaluate governance practices and identify disengaged members. The survey finds that diverse boards more frequently use and also make deeper use of performance assessments, from assessing the effectiveness of the entire board, to identifying underperforming directors and conducting one-on-one conversations with directors.

Bank Director offers a board evaluation and peer assessment through its membership program. Mascoma Bank, a Lebanon, New Hampshire-based mutual, uses this evaluation annually. Clay Adams, the $2.4 billion bank’s CEO, says the tool provides a framework for the board to assess its practices, such as ensuring that the board is receiving an appropriate level of detail about the bank’s operations.

“We’re always thinking about how to do things better,” says Adams. “We use the board effectiveness survey to make sure that we’re on the right path.”

Peer evaluations are less commonly used by bank boards — 24% say their board uses one. Respondents representing boards with three or more diverse members (36%) are more likely to use this tool.

Mascoma’s board conducts a peer assessment every other year, under the purview of the governance committee. Adams has served on other boards that used similar assessments, which he believes provide tremendous value in driving conversations with underperforming directors. “Diverse board member or not,” he adds, “if a person is not fulfilling the duties — duty of trust, duty of care, duty of loyalty — then they shouldn’t be on the board.”

Bank Director included Mascoma Bank in its analysis of the Top 25 Bank Boards for Women earlier this year; the mutual has since added two more women to its board, so its composition is now evenly split between men and women. Adams emphasizes the importance of intention in building a diverse, skilled board. “We’re constantly talking about it [and encouraging] board members to think about people they come across in their lives or reaching out to communities where we may not — as a board, as individuals — interact,” he says.

Adams hopes to further diversify the boardroom. “We’d like to have a [person of color] on our board,” he says. “We live in a predominantly white region, northern New England. Therefore, we need to work a little harder to network with people who are members of that community.”

Mascoma also incorporates term limits for directors — 15 consecutive years — and a mandatory retirement age, at 72, as mechanisms to regularly open seats on the board. These policies were last examined by Bank Director in 2020; our survey found that boards with “several” diverse directors were slightly more likely to use a mandatory retirement age or term limits.

Getting the right mix of skill sets, backgrounds and experiences results from a gradual, deliberate process, says Hays. “When we’ve filled any of our board slots, we’ve probably had discussions for a year and a half to two years to get there,” he says, due to the value Hays and the board place on its composition. “It takes time to find the people we were so fortunate to find [and] bring onto the board. We could not have done it any sooner.”

2021 Governance Best Practices Survey Results: Who’s Driving Bank Strategy?

Written by

The best banks balance short-term thinking with long-term strategy.

“Long-term performance is always our paramount objective,” Bank OZK Chair and CEO George Gleason told Bank Director at its recent Inspired by Acquire or Be Acquired virtual event. The $27 billion bank topped Bank Director’s 2021 RankingBanking study. “If short-term results suffer because of our focus on long-term objectives, then that’s just part of it.”

Strategic discipline starts with a bank’s leadership team — and the board should play an important role in developing the strategy and monitoring its execution. But that’s not always the case, according to the results of the 2021 Governance Best Practices Survey, sponsored by Bryan Cave Leighton Paisner LLP.

The survey explores the board’s approach to strategic planning, as well as governance practices, board composition and the relationship between executives and the board. The results find that most boards don’t drive strategic planning at their institutions: Just 20% say the board drives this process and collaborates with management to develop the strategic plan. Most — 56% — say their board establishes the risk appetite but relies on management to develop the strategy.

The vast majority believe their strategic planning process is effective. But of the 11% who believe their process to be ineffective, some express regret over the lack of input from their board. One respondent believes their bank’s strategic plan to be “too in the weeds,” while another holds the opposite concern. “It flies at 30,000 feet for [the] most part,” says one independent chair. “[We] need to get a little closer to the ground with metrics and clear paths for management to build.”

Most — 84% — reviewed their strategic plan during the pandemic, but few shortened the time horizon of their strategy. This may seem surprising, given previous indicators that Covid-19 accelerated bank strategy in some areas, particularly around the implementation of digital technology. Perhaps this indicates that, for most bank leadership teams, balancing short-term results and long-term strategy remains top of mind.

Key Findings

Strategic Review
Three-quarters of respondents say their board reviews the strategic plan annually. Roughly two-thirds bring in an outside advisor or consultant to assist in developing the strategic plan — but not generally every year.

Board Responsibilities
When asked to identify the board’s most important functions, the majority of respondents point to holding management accountable for achieving goals in a safe and sound manner (61%) and meeting its fiduciary responsibilities to shareholders (60%). Just 34% say that setting strategy is a key board responsibility.

Competitive Pressures
Respondents say that pressure on net interest margins (52%), the ability to grow organically in their markets (44%) and meeting customer demands for digital options (37%) threaten the long-term viability of their bank.

Interacting With Management
The vast majority of independent directors, chairs and lead directors believe they’re getting the right level of information from bank executives. Almost all interact at least quarterly with the bank’s CEO (98%), CFO (94%) and chief risk officer (85%).

Credible Challenge
Three-quarters say their board has several directors willing to ask tough questions when warranted; 92% find their management team receptive to feedback.

Needle Moving on Board Diversity
Almost 60% believe that fostering diversity in the boardroom improves corporate performance. Thirty-nine percent have three or more board members who bring diverse characteristics to the board, based on gender, race or ethnicity.

Assessing Performance
Less than half conduct an annual evaluation of their board’s performance, which most use to assess the effectiveness of the board as a whole (84%), improve governance processes (60%), identify training needs for the board (59%) or assess committee performance (58%).

To view the full results of the survey, click here.