New Canadian compensation rules make work for issuers in coming proxy season

By Guest Contributor
August 17, 2011

By John Mackie

Aug. 16  (Business Law Currents) With the recent announcement by the Canadian Securities Administrators (CSA) that changes in executive disclosure requirements will apply for financial years ending on or after October 31, Canadian issuers may want to do some advance planning in order to avoid last minute scrambling in the New Year.

The proposed amendments to Form 51-102F6 – Statement of Executive Compensation range from simple drafting changes and clarifications to new substantive requirements, and reflect both the proposal issued last November and the comments received in response.

Perhaps the biggest changes contemplated by the new form are the obligation to disclose an issuer’s risk management practices vis-à-vis compensation policies and practices, and the emphasis placed on discussions of performance targets. For issuers, the former may require stepping onto unfamiliar ground, and the latter may test their willingness to share financial planning data with the street at large.

As regards risk management practices, the new form will require each issuer to disclose whether or not its board of directors, or a committee of the board, considered the risks associated with the company’s compensation policies and practices. If so, the issuer is required to provide additional disclosures regarding mitigation practices and risks considered “reasonably likely to have a material adverse effect on the company.”

The current practice on disclosing risk management practices in this area is mixed, with many issuers providing no information, or little information – quite possibly because many boards may not have formally turned their minds to the matter. Many companies continue to focus on the central purpose of compensation plans – to attract and retain qualified individuals at a competitive cost, and to ensure that they are motivated to create shareholder value. Other issuers, such as Toronto’s Just Energy, which sells natural gas and electricity to residential and commercial customers, have at least begun the process of assessing compensation-related risk.

In Just Energy’s most recent proxy circular, the company notes that, in the previous year, the Compensation Committee of the Board implemented formal processes for ensuring that risk is appropriately considered in the company’s compensation plans. On the issue of mitigation, the company comments that:

…we believe we have practices in place, such as significant common share ownership requirements for both directors and executive officers, trading restrictions, requirements to receive a significant percentage of annual cash bonuses in securities which vest over three years subject to continuing employment on each applicable vesting date and long term hold requirements for NEO’s to whom long term retention restricted share grants…to mitigate the risks associated with our compensation policies and programs…

BCE Inc., Canada’s largest communications company, frames risk assessment as an exercise intended to ensure compensation policies and practices do not encourage undue risk-taking on the part of its executives. On the issue of mitigation tools, it references clawback provisions, share ownership guidelines, trading restrictions and a deferred share unit plan.

One of the things issuers will need to remember as they examine compensation-related risk is that risks can take several forms, such as plans that: encourage excessive risk as compared to the organizational return; lack a cap, thus exposing a company to massive expenses; or focus on short-term return rather than long-term value. Indeed, issuers must also balance risk in this area with other organization risks, as illustrated by Lone Pine Resources, which spun-out of U.S. parent Forest Oil by way of an IPO in May, raising net proceeds of $178 million.

In Lone Pine’s prospectus, its disclosures on compensation speak to the experience at Forest, and are addressed in the form of a Q&A.

Referring to Forest’s practices, Lone Pine states that the company’s compensation programs “have been reviewed in terms of the long-term best interests of shareholders,” and the Compensation Committee of Forest believes that “executive pay practices comprise adequate financial security and incentives for executive officers to achieve the optimal short-term and long-term objectives of Forest.” For Forest, the compensation-related risk is to be examined in the context of the organizational risk of having officers lacking security or incentives sufficient to motivate them appropriately.

The other major topic addressed by the new disclosure requirements concerns performance goals or targets. The form already requires issuers to disclose performance goals based on objective, identifiable measures, or, where the goals are subjective, to describe them. In the past, however, an “out” was available where “a reasonable person would consider that disclosing them would seriously prejudice the company’s interests.” In addition, there was no obligation for an issuer to disclose when they were relying on the exemption.

Perhaps concerned that the open-ended exemption invited abuse by issuers, the revised form requires issuers to specifically indicate when they are relying on the exemption, and explain why disclosure would seriously prejudice the company’s interests. On that point, the CSA has also indicated in the new form that:

For the purposes of this exemption, a company’s interest’s are not considered to be seriously prejudiced solely by disclosing performance goals or similar conditions if those goals or conditions are based on broad corporate-level financial performance metrics which include earnings per share, revenue growth, and earnings before interest, taxes, depreciation and amortization. This exemption does not apply if it has publicly disclosed the performance goals or similar conditions.

As in the case of compensation-related risk, many issuers presently provide little in the way of meaningful disclosure on the issue of performance goals. This is notwithstanding the fact that the obligation to disclose such goals was already contained in the form. There are, however, a number of issuers which do provide details regarding the targets against which executive performance is measured. Sporting goods retailer The Forzani Group, for example, which Canadian Tire is in the midst of acquiring, addresses the performance goals of each of its named executive officers in the company’s recent annual meeting proxy circular.

In discussing the compensation of Forzani’s chief financial officer, the company discloses that his objective vis-à-vis financial results was to deliver earnings per share of $1.17 and improve return on equity (ROE) by at least 100 basis points over Fiscal 2010. Both objectives were apparently met. On a less objective front, he was also responsible for implementing a “meaningful share buyback” – another goal that was achieved in fiscal 2011. Forzani similarly reviews the objectives of each individual officer, summarizing the various objectives and briefly indicating whether the objective was satisfied or not.

Aviation simulator company CAE goes another step in its discussion of the financial performance metrics used to calculate bonuses under the company’s short-term incentive plan (STIP). Indeed, the company notes that these “financial metrics are easily measured and the performance thereof can be tracked in our Management Discussion and Analysis (MD&A).” It’s an investor-friendly approach to disclosure that provides significant transparency on the compensation front.

CAE also provides a table specifying each of the company’s financial performance targets, such as book to sales ratio and free cash flow. For each, the threshold at which bonuses will be paid, performance target and maximum cap are identified, as are the actual achievement and actual payout. Several performance indicators which are somewhat subjective – such as implementing a “global talent management process” – comprise 25 percent of the STIP payout. For each, the company provides a brief description.

One aspect of the revised form that may prove a challenge for some issuers is the fact that the CSA has made it clear that they do not consider serious prejudice to result solely from the disclosure of performance goals based on broad corporate-level financial performance metrics. As a case in point, consider Empire Company of Stellarton, Nova Scotia, which owns food retailer Sobeys and the Empire Theatres movie chain, and is the largest shareholder in Crombie REIT.

Empire Company notes that the company’s executives participate in an Annual Management Incentive Plan (AMIP), pursuant to which awards are based on the attainment of a board approved budget for earnings before capital gains and other items (“operating earnings” which is calculated as net earnings before capital gains and other items, net of tax). The AMIP target for executives responsible for regional and divisional business unit operations is dependent upon the achievement of sales and profitability targets specific to their business unit.

The company does not provide additional detail, apparently because of the belief that “more detailed disclosure of executives’ or Company goals would assist in providing earnings guidance to the market, which Empire does not do.”

Empire raises an interesting point, and one that issuers will have to face as they develop the proxy circulars for the next AGM season – disclosure of performance goals that have a prospective aspect, for example, multi-year improvements in ROE – could indeed be seen as a form of earnings guidance.

There is another concern which issuers may wish to take note of, as illustrated by the comments published in connection with the original CSA proposal. Even where goals are disclosed on a purely historical basis (i.e. the issuer targeted $X in revenue, and achieved $Y), investors and competitors will gain insight into the issuer’s planning processes. As an example, should a revenue target be substantially higher than that actually achieved, investors may question whether the board or management truly understand their markets. In the event the numbers suggest a revenue boost from a new product line which fails to crystallize, that might also benefit a competitor.

These questions regarding risk and disclosure are ones issuers will need to examine as they develop their proxy disclosures for the 2012 annual meeting season, and will require some advance planning, in order to ensure boards have sufficient time to consider them appropriately.

(This article was first published by ThomsonReuters’ Business Law Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Business Law Currents online at




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