Regulators Are Back: What to Watch in Compensation Plans

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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.

New Index Tracks Fintech Stock Performance

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Nasdaq and investment bank Keefe, Bruyette & Woods recently announced the formation of the KBW Nasdaq Financial Technology Index to track fintech companies. KBW describes it as an equal weighted index designed to track the stock performance of U.S. companies that leverage technology to deliver financial products and services, and earn most of their income from fee-based sources instead of interest payments. This is an index, not an exchange traded fund (EFT), so for now it is useful only for tacking the performance of fintech stocks, and investors cannot yet buy the index as an ETF. I won’t be shocked if that changes before too much time passes. For now, the index can be tracked under the symbol KFTX.

I find the development of the index significant for two reasons. First, fintech is one of the more investable concepts that I have run across in the past few years. In 1972, Thomas Phelps wrote a book titled “100 to 1 in the Stock Market” in which he talked about the powerful returns that can be earned by identifying companies that would benefit from a changing world and hanging onto them for a very long time. One of my favorite intellectual exercises is to sit and think of those industries that offer the potential for decades-long periods of growth that could deliver 100-to-1 returns. Fintech is pretty high on the list.

While my primary focus as an investor is and always will be on community bank stocks, I find with increasing frequency that while in the process of researching banks and talking to bankers I run across companies that focus on product areas like cybersecurity, payment processing, loan underwriting algorithms and other technology areas that help bankers make more money with greater efficiently as well as increase their safety and security factors. A few of them have made their way into my portfolio and a bunch more have made it onto my watch list in hopes that I can buy them at more favorable valuations at some point in the future.

When the new index was announced, Fred Cannon, KBW’s global director of research, highlighted something about the fintech sector that’s not widely understood. “Some people see fintech as disrupters who are going to kill the big bad banks, but we feel it’s not quite that,” he said. “We feel that there are some big companies that are already providing financial services [companies with] technology.” There is a perception of many fintech entrepreneurs as Steve Jobs-type garage cowboys who are running around disrupting the banking industry. The real story is that many of the leading edge fintech products are being developed or sold by old line companies like First Data, Fiserv, Alliance Data Systems, VeriFone Systems and Fair Isaac. All of these are included in the KFTX.

There are some new cutting edge fintech companies in the index as well, including Green Dot, Global Payments and Square. Most of the newer companies in the index appear to be those involved in payments, and they deal directly with un-banked or under-banked consumers. They are not really a threat to traditional banks.

Those fintech companies that sell directly to banks tend to be older, more established players. There a key lesson here for younger fintech companies hoping to sell technology services directly to banks. Most banks are not going to be willing to take on the early adopter risk of doing business with new and untested technology companies no matter how exciting their products might be. Younger fintech firms are going to need to partner with older, more established companies that have been doing business for decades and have a large installed user base. The makeup of the new index acknowledges the reality that very few bankers will be willing to take on the reputation and career risk needed to deal with start up vendors.

FAST Act Extends Popular JOBS Act Registration Threshold to S&Ls

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JOBS-Act-2-1-16.pngOn December 4, President Obama signed the Fixing America’s Surface Transportation Act, or the FAST Act, which included several amendments to federal securities laws. Among the changes, the law amended Section 12(g) of the Securities Exchange Act of 1934 so that savings and loan (S&L) holding companies will be treated in the same manner to banks and bank holding companies for the purposes of registration or suspension of their Exchange Act reporting obligations. Not too long ago, the Jumpstart Our Business Startups (JOBS) Act raised the threshold under which a bank or bank holding company may terminate its Securities and Exchange Commission (SEC) registration and reporting requirements to 1,200 shareholders of record from 300.

One thrift, Alpena, Michigan-based First Federal of Northern Michigan Bancorp, which has $338 million in assets, has already taken advantage of the new ruling and voluntarily deregistered and de-listed its stock from the NASDAQ stock market on December 18. The company’s stock now trades on the OTCQX market, the top tier of the over-the-counter markets operated by OTC Markets Group Inc.

In its press release about the rule change, the bank said that “the continuing increased costs and administrative burdens of public company status, including our reporting obligations with the SEC, outweigh the benefits of public reporting.”

The bank said it will continue to file quarterly interim financial statements and provide its shareholders with an annual report with audited financials, among other items, all of which are requirements on the OTCQX market.

The JOBS Act Deregistration and De-Listing Wave
Twenty banks and bank holding companies have deregistered and de-listed from a national stock exchange since the passage of the JOBS Act. Approximately half have moved to the OTCQX market.

Most banks have cited the high costs and regulatory compliance of being an SEC reporting company as the reason for their decision, as well as the ability to focus more of management’s time and resources on growing the business.

In a letter to shareholders following its de-listing, First Federal of Northern Michigan Bancorp said that deregistering and de-listing it shares would allow its management team to “spend more of its time focused on the core operations of the bank, including strategic planning and market expansion, thereby helping to create shareholder value.”

Wheeling, VA-based First West Virginia Bancorp, Inc., with $347 million in assets, said in an October 26 press release that deregistering and de-listing its securities from the New York Stock Exchange’s NYSE MKT market would allow its senior management “to devote more time and resources to focus on customers and profitable growth of the [c]ompany as opposed to the considerable time and effort necessary to manage compliance with SEC reporting requirements.”  The company’s stock now trades on the OTCQX market under its same symbol, FWVB.

Attorney’s fees, printing costs and exchange listing fees aren’t the only expenses banks stand to save from by de-listing from an exchange. Directors and officers (D&O) liability insurance is also higher for SEC-registered companies than for non-SEC reporting companies and can provide a significant cost savings to smaller banks.

Trading on the OTC Market Versus on a National Stock Exchange
The unique structure of the OTC market, which is based on a network of broker-dealers rather than a centralized matching engine, can also help reduce volatility in the trading of small bank stocks and provide better visibility into trading activity.

“For a very thinly traded bank on NASDAQ, a trader may not want to commit capital to inventory 20,000 shares of stock when those shares may represent six weeks’ worth of volume, and computers are changing the bid and ask every few minutes. Maybe that capital is better committed someplace else. Don’t get me wrong, NASDAQ is a fantastic place to be but maybe not for some of the more illiquid banks,” says Tom Dooley, senior vice president of Institutional Sales at Boenning & Scattergood.

On OTCQX, banks are required to appoint a FINRA-member broker-dealer who can provide guidance on the trading of their stock, as well as help facilitate relationships with institutional investors, investment bankers and other key market participants. OTCQX bank advisors can also help their clients handle changes in their shareholder base and correct imbalances between the number of buyers and sellers of their stock.

Small S&L companies that are interested in taking advantage of the new law should examine the various costs and benefits to their business and their shareholders. There is much to be gained from deregistering and de-listing your securities if you do it the right way.