Banks soon will have more explaining to do about the extra pay executives gain from mergers.
Dodd-Frank Act rules that take effect in April will force banks to clarify who is earning what from a deal, something that has been tough to determine. Merger-related pay is complicated, and lenders have a lot of leeway in disclosing it.
Though the changes may end some of the head-scratching prompted by traditional disclosures, they aren't likely to eliminate so-called golden parachutes. Hefty payouts for top executives who lose or change jobs — however maligned by shareholder activists and others — will only become more common as merger activity picks up, experts say.
If anything, the rules may compel banks to make the case for parachutes, which investment bankers and lawyers say remain necessary.
"Typically, whenever a bank sells, the buyer wants the existing CEO to remain in place for a period of time to make the transitions go smoothly," said Curtis Carpenter, an investment banker with Sheshunoff & Co. in Austin, Texas. "The idea of the executives getting kind of a good, juicy contract as part of the sale is still in the industry, and it's still appropriate."
Parachutes — a common feature of pre-recession mergers — are coming back as more nonfailed banks change hands. An $18 million payout is due Mark Furlong, the chief executive of Marshall & Ilsley Corp., whose deal to be sold to Bank of Montreal was announced in December. J. Downey Bridgwater, the CEO of Sterling Bancshares Inc. of Houston, would get at least $1.83 million in connection with its deal announced in January to be sold to Comerica Inc.
The Securities and Exchange Commission in January issued a rule aimed at making these types of payments more transparent. Banks and other public companies will have to file a standard form that tells investors all the compensation due to top people from a deal, including parachutes and other pay, such as restricted shares that vest early. Banks also have to explain in easy-to-understand language what triggers these payments.
Right now, all of that information tends to be disclosed in brief, jargon-laden sections of deal filings with the SEC. The difference between hypothetical payments and actual payments isn't always clear, and readers often have to do their own math to figure out how much in total someone will receive.
"The form of the disclosure will be mandated — you'll really have to cover everything," said Kyoko Takahashi Lin, a partner with Davis Polk & Wardwell LLP. "Right now, we lawyers in the business call the existing disclosure the 'interest of certain persons' section. They don't mandate a form."
Shareholders will get nonbinding votes on deal pay in some cases, such as a previously undisclosed retention bonus a bank promises its CEO. Arrangements are exempt from additional votes if they haven't changed. Companies with fewer than $75 million of shares outstanding are exempt too. Shareholders also don't get a vote on any compensation an executive of a selling bank may get from the buyer, though it must be disclosed.
Aside from making things easier to understand, the rules are not expected to have an immediate impact on pay or merger structures. For one thing, most of the annual shareholder meetings that set compensation for the year are in March, a month before the rule takes effect.
Executive pay has already been changing under heavier scrutiny emanating from the financial crisis. Banks that haven't repaid federal aid can't pay parachutes. Others have had to modify parachutes after push-back from investors: NewAlliance Bancshares Inc. of New Haven, Conn., made changes to outgoing CEO Peyton Patterson's parachute that freed the bank from paying the extra taxes on her severance, a once-common practice that's becoming taboo. Banker salaries have gotten smaller, which could mean smaller parachutes because the two are intertwined.
But it would take more than symbolic shareholder votes and extra disclosures to kill parachutes, experts say. It might look bad when a CEO gets a big paycheck after selling a troubled franchise, but that pay is usually the result of an ironclad contract signed years ago.
"In healthier bank deals, there are change-in-control contracts, and they have to be paid as part of the deal," Carpenter said. "In a way that comes out of the purchase price of the deal, because the buyer knows the bank is going to pay that money, so they adjust the price accordingly. Shareholder activists don't like that."
Extra disclosures could help eliminate some confusion about what a parachute actually is, experts say. The phrase is commonly used to describe everything due to a banker upon termination, including vesting stock to liquidating retirement accounts. But those two things are not technically parachute money. They are essentially delayed salary, or money already earned.
In the minds of regulators and compensation experts, parachutes are an extra bonus due upon a sale, job change or termination. A typical parachute is at least three years' pay for a CEO, and a year's or two years' worth for other high-ranking players. They're often a lump sum of cash, which is what Furlong is getting. Bridgwater's payment is being placed into a nonrefundable deferred account at Comerica, where the executive has a post-merger job.
Ralph "Chip" MacDonald, a partner with the law firm Jones Day, said those types of payments are actually designed to benefit shareholders, something that is often lost in the negative headlines and confusion they generate. The rule changes offer banks an opportunity to explain that better, he said.
"Having that disclosure as part of the merger transaction probably gives you a better means to articulate" what they are, he said. "It could be less misunderstood by shareholders. It's important to see what people are going to get in a transaction."
Parachutes, when done right, are like an insurance policy that boards take out on perhaps their biggest asset — and biggest risk: People that run the bank. There's no job security for a selling-bank CEO. That means they might be less open to entertaining deals if they're worried about losing their livelihood, MacDonald said. What's the incentive to stick around through a sale? What's to stop them from joining a direct competitor? Lots of money.
"That's not all bad if the shareholders come out ahead," MacDonald said.
The counterargument, of course, is that working for the benefit of shareholders is the central part of the CEO job, which pays well to begin with. CEOs are paid with stock, so their interests are the interests of shareholders. And some critics say it is just unfair when a CEO gets a big severance and little goes to the rank-and-file workers cut in a merger. It becomes a particularly sore point when a once-renowned local institution loses its independence after poor management decisions, a description that could apply to many takeover targets these days.
Still, MacDonald said, extra disclosures could help lessen the stigma of parachutes. They could put more pressure on boards to structure them appropriately, he said, which could make for smoother mergers.
"The main thing is it's a very serious area. It needs careful and thoughtful attention to the details," MacDonald said. "Boards, generally, they ought to consider these change-in-control payments before there's a deal."