Care is in Order in HR

In the corporate world, human resources is often the ugly stepsister. It's a department that spends money rather than making it, always has someone annoyed at it and is rarely viewed as an asset to the company. You may choose to disagree with those assertions, but that's not what this piece is about.

Just the other day, I wrote about being clear in your documents. Today, I move along the spectrum from clarity to care.

My motivation for writing this is a Supreme Court case fashioned as Yates v United States. It's not a case that relates to human resources. It's not a case that relates to anything that most HR departments ever even think about.

It's about fishing. Yes, you read that right. Mr. Yates is a commercial fisherman. And, in that role, Mr. Yates has some people who work for him. Mr. Yates and his workers were caught with undersized grouper and were ordered to leave them in the boat as evidence. Mr. Yates ordered his men to throw the grouper back in the water and they did. Mr. Yates was charged with a crime.

Of course he was, you might think. He and his workers were violating federal law by catching undersized grouper.

Hold on. That's not what he was charged with violating. Mr. Yates was charged with violating the Sarbanes-Oxley Act (SOX or SarbOx). You remember SOX. It was passed in 2002 to help the federal government to combat underhanded business practices such as those that were found at Enron. But, in this case, Mr. Yates was accused of the destruction of "any record, document, or tangible object" for the purpose of obstructing a federal investigation. Had he been found guilty and lost his appeal(s), he could have had to serve 20 years in a federal penitentiary.

Okay, so you just know that I am going to tell you that SCOTUS voted 9-0 to throw this case out. Wrong. The vote was 5-4 with Justice Kagan joining the utlra-conservative wing of the Court on the side that felt that Mr. Yates should, in fact, suffer the consequences of SarbOx). (By the way, you should all consider reading Kagan's dissent as it is the first one that I have seen that references Dr. Seuss.)

So, what's my point?

We all need to take care. Congress especially should take care, It is often their loose wording of the bills that they pass that causes this sort of unintended consequence.

But, perhaps more than other corporate functions, HR needs to take care. HR and its programs tends to be subject to lots of laws that either were never intended for HR or had a small component that was that was embedded in a much larger law. When the latter occurs, that benefits or compensation or workplace practice component tends to be drafted very quickly by people who may not have particular experience in that area.

Nobody can keep up with all of this stuff. But, plaintiff's bar seems to look for unusual wording in statute that can be applied in ways that would appear to have never been intended by the drafters.

So, I give a word (several actually) to the wise. No matter how sound your practices appear to be, it may wise to consider how they could be twisted and misconstrued to violate something. Can someone argue discrimination on the basis of age, gender, race, ethnicity, religion, sexual orientation, or anything else because of your well-intentioned policies? As strange as it seems, the prudent approach may be to work backwards. Start by assuming that your policies violate everything possible and work backwards to prove that they don't.

And don't forget to read about the application of One Fish, Two Fish, Red Fish, Blue Fish to Sarbanes-Oxley.

PCAOB Expands Purview of Accounting Profession to Review Compensation Arrangements

Unless you are in a field related to accounting or review of public companies, you may never have heard of the PCAOB, or more formally, the Public Company Accounting Oversight Board. It is actually a private-sector, non-profit company that was created by the Sarbanes-Oxley Act (SarbOx or SOx) in 2002. According to SOx, the PCAOB is to, among other things, oversee the audits of public companies. In part, to do so, the PCAOB creates a set of auditing standards that must be approved by the Securities and Exchange Commission (SEC).

Got that?

So, why am I writing about this? Earlier this year, the PCAOB issued Auditing Standard 18. In late October, the SEC approved it. And, so it is.

Auditing Standard 18 (AS18) is a lovely document. It's 223 pages of, and I can't think of a better word for it, stuff carrying the clearly far too brief title, "Related Parties and Amendments on Significant Unusual Transactions and a Company's Financial Relationships and Transactions with its Executive Officers."

Got that as well?

Among other things, AS18 asks that auditors, among other things:

1. Read the employment and compensation contracts between the company and its executive officers
2. Read the proxy statements and other relevant company filings with the SEC and other relevant regulatory agencies that relate to the company's financial relationships and transactions with its executive officers
3. Obtain an understanding of compensation arrangements with senior management other than executive officers including incentive compensation arrangements, changes or adjustments to those arrangements, and special bonuses
4. Inquire of the Chair of the Compensation Committee as well as outside compensation consultants
5. Obtain an understanding of expense reimbursement policies with respect to executive officers

All of this is to be done to identify risks of material misstatement.

I understand why all of this is being done. Early in this century, there were a number of corporate scandals resulting from apparently fraudulent misstatement of financials. Many of you remember Enron, WorldCom, and Tyco. This is intended to be one more step to lessen the likelihood of such abuses and to restore faith that corporate America, as a whole, are being good citizens.

We place lots of faith in auditors in this regard. Now, I have friends and acquaintances who are auditors. Some of them are very good and knowledgable. And, this is not intended to say that the rest (the complement of some of them) are not good, but in any profession, some practitioners will always be better than others.

Here, however, the PCAOB and the SEC are either assuming that auditors have sufficient expertise in compensation arrangements to handle this undertaking or that the firms of which they are a part have this expertise internally to which the auditors may refer. At the Big 4, this is probably the case. They have massive staffs and are able to engage specialists to handle such complex questions. How about the next tier of auditing firms? Do they have this expertise? I don't know, but I suspect the answer is sometimes. Let's take it down one more tier. Do those firms have that expertise? Again, I'm guessing, but I suspect that the answer is not very often. And, if we move to the smallest of the auditing firms, I would be inclined to move the needle to rarely, if at all.

Most auditors that I know are nice people. Most auditors that I know are pretty smart. Most auditors that I know are pretty honest. That said, most auditors that I know are being asked here to weigh in on matters in which they have no training and are frankly not likely to have it anytime soon.

What is the answer? I'm not sure. I'm not a fan of more regulation or more government control generally, but perhaps people who engage in review of compensation arrangements of public companies need some sort of licensure. Actuaries need it for many functions that we perform and we are also, as a group, pretty nice, smart, and honest.

I think that the PCAOB and SEC have used their unencumbered power to stretch too far. Perhaps, it's time to rein them in?

Plaintiff's Bar -- The Good, The Bad, and The Ugly

Collectively, they are known as plaintiff's bar. These are the attorneys who gear their practices toward representing plaintiffs in civil litigation. As I see it, they fall into three categories:

• The group who represent plaintiffs in litigation where the plaintiffs in question have clearly been wronged. While it's not where I am going to focus here, consider, for example, the made-up case where plaintiff goes to a restaurant (think Japanese steak house) where the chefs put on a show for their diners. They toss food. They flip spatulas. I have never seen a diner get hurt in one of these situations. But, in this fictional situation, one chef decides to fling diners' food to them on razor sharp knives. One diner gets up to leave because he is frightened and just as he does, a knife flies astray and hits him blade first in the back, seriously injuring him. The restaurant's insurer says that the diner assumed a risk when he sat down at the hibachi grill. I don't have legal training, but the lay person in me thinks he needed an attorney to right this wrong.
• The group who represent plaintiffs who have probably not been wronged, but where there might be a court that will find for plaintiffs and award massive damages. As an example, consider the spate of cash balance plan lawsuits that were filed. Typically, the issue was age discrimination. Whether or not there actually was age discrimination in designs was a matter of opinion. As a group, actuaries are well-trained to opine on this issue. Being one of these actuaries and being one who knows many others, I've not personally found one yet who thinks that cash balance plans are inherently age discriminatory. But, the attorneys filing the suits know that all they need is one big win and the payoff for them will be huge. I disagree with these attorneys, but it is possible that they are right and I am wrong.
• Finally, there is the group who seek out plaintiffs to file lawsuits where there is never any thought of wrongdoing. All they are doing is hoping that defendants will think it is less expensive to settle the lawsuits than to defend them. Since the attorneys in such situations don't, in my opinion, even care if there is any wrongdoing, I view this as the worst of all situations.

Yes, I have an example for you. As regular readers of this blog know, Dodd-Frank and its older brother Sarbanes-Oxley have imposed significant requirements on issuers of proxies to disclose executive compensation. Most companies have worked hard to ensure that their disclosures are, at a minimum, adequate. A meaningful percentage of them have gone above and beyond in their disclosures providing information to shareholders beyond that which is required and providing excellent supporting rationale for their compensation decisions.

So, what's the litigation here?

A group of attorneys made the startling (well not really) discovery that if you could find a way to stop a company from holding its annual shareholder's meeting that all proverbial hell would break loose. I wrote about this here. What they claim is that disclosure of executive compensation in the proxy is inadequate for the shareholder to make an informed decision regarding say-on-pay or some other vote on which their client could weigh in.

We apologize for this brief commercial interruption before returning you to your regular program. In my profession, I work with a lot of people who do understand compensation. Many of them are also shareholders in companies so that they get to cast their votes on these matters. As part of the small group who could actually make sense of these disclosures, how many of them actually take the time to review the executive compensation disclosures in proxies? A very unscientific review of data that I did on this group (this means that I observed, asked a few people and took a guess) suggests that fewer than 10% of this group actually reviews the executive compensation disclosures carefully enough to opine on its reasonableness. Most institutional shareholders outsource the review and even the firms to whom they outsource such review are working far more from checklists than they are from hard analysis of the data.

So, there's no case, right?

That's not the point. A well-timed lawsuit can cause a company problems. Put yourself in the position of a company and decide how you would react when you learn that plaintiffs have gone to court seeking an injunction to prevent you from holding your annual shareholder's meeting (for those even less legally informed than me, this means that a court would prohibit that meeting from taking place). You are probably left with just a few options, all costly and none foolproof:

• Fight the injunction and hope you win
• Settle to make plaintiffs and their attorneys go away, so to speak
• File significantly enhanced disclosures with the SEC and provide them to shareholders on a timely enough basis

The attorneys for plaintiffs are betting that most companies will choose what's behind door number two. That is, they are betting that companies will opt to settle for an amount of money whereby those attorneys will recover their expenses plus perhaps 35%-40% of the remaining settlement. That makes it profitable litigation for those attorneys.

What should companies do?

There is no great answer, but it seems a good tact to prepare for this sort of litigation.

• Enhance your disclosures proactively. That is, make yourself a less vulnerable target. 
• Have a team internally that understands the issues and that can be mobilized to combat the opposition. This should probably be composed of internal people and have outside counsel in the loop.
• Make your disclosures convincing. Describe how you developed your practices and why they are appropriate for your company in your industry and your geography.

And, yes, there is a fourth thing that you can do that some may think is as useful as the first three: hope you don't get sued.