In their earnest perusal of information regarding executive pay, proxy lovers may overlook an illuminating portion of the report where transactions with related parties are disclosed.
There, companies reveal what relatives of officers, directors and shareholders are on the payroll and what business they conduct with entities owned by officers, directors or major shareholders as well as their relatives.
The Securities and Exchange Commission requires companies to disclose related-party transactions involving an annual sum of $120,000 or more in their proxy statements.
The Financial Accounting Standards Board, which makes the rules governing corporate accounting, also requires disclosure of these transactions but does not set a dollar amount. Instead, it requires companies to report transactions that are “material.” The less onerous mandate means more related-party transactions are disclosed in proxies than in 10-Ks, the annual financial reports public companies file with the SEC.
While generally accepted accounting standards assume a business conducts its affairs at arm’s length, “When you’re talking about related-party transactions, you just can’t make that assumption,” says Peter Kern, partner in the McCandless office of accounting firm BKD.
“There is specific guidance both not to assume they are done at arm’s length and not to state that they are done at arm’s length,” he says.
Companies that assert a related-party transaction was done at arm’s length must provide evidence that terms of the deal are comparable to what they could have obtained on the open market.
Doing business with relatives raises a red flag because it presents the possibility of insiders enriching themselves at the expense of shareholders.
“The more related-party transactions you see in a proxy, the more concern you should have,” says Charles Elson, head of the University of Delaware’s Center for Corporate Governance.
“Typically, there is no good reason, in my view, for most of these transactions,” he says. “The company, in my view, usually ends up the loser.”
There also is evidence that related-party transactions can lead to lower stock prices and shareholders returns, according to Florida Atlantic University’s Mark Kohlbeck and Brian Mayhew of the University of Wisconsin-Madison. Their latest research found companies that did business with entities related to a director, officer or major shareholder were 15 percent more likely to restate their financial results.
While they found no direct relationship between related-party transactions and restatements, Mr. Mayhew says the willingness to engage in such transactions signals that a company’s corporate governance is weaker and that a company is “more willing to cut corners to do other things.” The potential hazards posed by these transactions can be avoided, he adds.
“You can hire a lawyer who is not on your board. You can hire a compensation consultant who is not your brother,” he says.
Here’s a look at some transactions with related parties disclosed by Western Pennsylvania companies:
■ FNB Corp. paid $123,526 for a Heinz Field suite license to an affiliate of Pittsburgh Steelers Sports, whose president, Arthur J. Rooney II, is a director of the Hermitage bank. The arrangement dates back to 2001, about five years before Mr. Rooney became a director, the company said. Mr. Rooney is a lawyer with Buchanan, Ingersoll & Rooney, to which the bank paid $23,369 in legal fees last year.
■ American Eagle Outfitters paid a total of $320,000 in cash and stock last year to two employees related to executive vice president Dennis R. Parodi: his son and sister-in-law, who was promoted in March. The troubled teen retailer also paid $777,000 for in-store music provided by a company that is majority-owned by trusts that benefit the descendants of Jay Schottenstein, chairman and interim CEO. It also made $180,000 in purchases from a company owned by Mr. Schottenstein’s sons. In September, the company signed a lease with an affiliate of Mr. Schottenstein for the site of a store. The company expects to pay $270,000 annually under the terms of the lease, subject to annual adjustments, through January 2024.
■ Mylan said two firms controlled by brothers of executive chairman Robert J. Coury received about $575,000 from insurance carriers in 2013 for serving as brokers for the Cecil generic drugmaker’s employee benefit plans. The firms have provided the service since 1995. Mr. Coury’s brothers are also principals of a firm hired in October to advise the company on compensation, benefit and health care plans. Under the 15-month contract, they will receive $30,000 monthly and are eligible for a bonus “at the company’s sole discretion,” according to the proxy.
■ Education Management paid $5.3 million in its most recently completed fiscal year to companies owned by Leeds Equity Partners, whose president is on the board of the Pittsburgh for-profit educator. It paid another $1.9 million to affiliates of Providence Equity Partners, which has two representatives on the company’s board. According to the latest proxy statement, Providence owns 33 percent of Education Management’s stock and Leeds owns another 8 percent.
■ A consulting firm owned by the brother of Consol Energy director David C. Hardesty Jr. was paid $1.5 million for helping to arrange Consol’s purchase of 90,000 Marcellus Shale acres in West Virginia from Dominion Transmission. The company also paid $4.1 million in legal fees last year to Bowles Rice, a law firm whose partners include the daughter of Mr. Hardesty. Another director, James E. Altmeyer Sr., has a brother at a law firm that received $523,370 from Consol last year. Consol said it had done business with the two firms for “many years” before Mr. Hardesty and Mr. Altmeyer joined the board.
Len Boselovic: 412-263-1941 or email@example.com