DEF 14A Proxy Guide
Navigating through the SEC documents can be confusing and intimidating, especially when you encounter a document that is 100 pages long and is full of text.
Hopefully this tutorial will be your ultimate and practical guide to help you glide through the Proxy document in no time.
Before getting started, see below for a previous tutorial on how to read the SEC Form 3, 4 and 5.
What is the DEF 14a Proxy Document?
The official term for the proxy document is Form DEF 14A.
DEF stands for “definitive”, and is required under Section 14(a) of the Securities Exchange Act of 1934. So it makes sense to be called “DEF 14A”.
This purpose of filing this form helps the SEC ensure that shareholders’ rights are upheld as well as when shareholder votes are required. It is required that the company files its annual proxy statement no later than the date the proxy materials are first sent or given to shareholders.
It includes a whole bunch of information related to shareholder meeting, rights, insiders, compensation, stock options and more. It is through the proxy where you will find out whether the CEO of your company receives special perks such as a private jet costing the company hundreds of thousands of dollars, or whether the compensation is being fairly reviewed by an independent committee.
What is the purpose of reading the Proxy?
The proxy is one of the three main documents you should always try to read. The other two include the annual and quarterly reports which I will get to next time.
Where the annual and quarterly reports help you gain an understanding of the business and how the company is doing financially, the proxy gives you an insider look at the company structure, its executives and other bits and pieces of information including items that the company may not want you to know about.
To put your money into any investment requires conviction in the analysis, and part of that process involves reading the proxy document.
It’s all there buried in the pages of small text, so let’s get started.
How to Find a Proxy from the SEC
Go to the company search on the SEC website (http://www.sec.gov/edgar/searchedgar/companysearch.html)
Enter a ticker symbol, and then type “DEF” in the box labeled “Filing Type”. This will filter the results to only show the proxy documents.
(As you go through various types of companies, you may come across different types of DEF forms such as DEFA, DEFC, DEFM, DEFN, DEFR and DEFS. The only ones I have come across are DEFA, where additional information is added to the proxy, DEFR, which is a revised proxy, and DEFM, which is filed when the company intends to perform a merger or acquisition.)
Click on the “Documents” button next for the document you wish to read and then on the next page, select the document where the filename has a “.htm” extension to load the proxy.
Best Method to Read Any Two Proxies Simultaneously
Rather than just reading one document at a time, you can read any two proxies at the same time and see the differences between the two by performing this simple neat trick using Microsoft Word or Open Office.
View the tutorial on how to read two documents simultaneously.
Two Methods to Read the DEF 14A
There are two ways to read the proxy document.
1. Go through it from beginning to end
2. or search the document based on what you are trying to find
Both have advantages and disadvantages.
1. Going Through the Proxy from Beginning to End
If you are fairly new or unaccustomed to reading proxy statements, you will want to at least go through the document from start to end. That doesn’t mean you have to read every word.
Simply scanning the document from top to bottom will help you recognize and get used to the format of the proxy. All forms submitted to the SEC must follow certain guidelines so you will start to see a pattern quite quickly.
Advantages
- You get all the details
- You learn more about the company
Disadvantages
- Possible information overload
- Time consuming
As you read the document you want to keep questioning statements made.
E.g. in the Diamond Foods (DMND) DEF 14A, there is a section under “Compensation Decisions for the 2010 Fiscal Year” where it says the following
Base Salary: In June 2009, the Committee recommended, and the Board approved, a 6% increase in base salary for Mr. Mendes from $610,000 to $646,600, effective in mid-August 2009. Prior to the adjustment, Mr. Mendes’ salary was 14% below the median of the benchmark data for our peer group companies (after adjusting for size), and the increase better aligned his salary with the median competitive range and recognized his individual performance during the 2009 fiscal year.
As you read this, you may question how the company recognized that Mr Mendes’ pay was 14%, what is the median benchmark, and who are the peer group companies?
You would then try to answer this question as you continue reading.
If by the time you reach the end of the proxy there is no information that answers your questions, you have already uncovered information that the company may be trying to gloss over, hoping that shareholders do not question or search for answers.
Thorton O’Glove mentioned in his book Quality of Earnings, that a good idea is to read SEC filings backwards because the important information the company wants to hide are usually at the end. Companies know that not many people will read the entire document and so they squeeze all of their hidden notes to the footnotes at the bottom of the document.
By now, I hope you are motivated to read the proxy statements, but what if you are already know this but just want a better way to to go through the proxy filings?
2. Searching based on your Objective
If you have a good grasp of how the proxy document is laid out and comfortable with navigating through the entire document, this method is for you.
When you are performing any type of research, you have a clear objective in mind.
Just the other day, I concluded I needed to organize my papers in my room. Currently I have it in all sorts of folders lying around everywhere. My objective was to organize it all.
If I break it down into steps it would look like this.
- Objective: Organize my papers
- Process: Find something to organize the papers
- Steps: Purchase a filing cabinet, hanging folders and labels
How is this relevant to reading proxy documents?
Unlike reading a document from beginning to end where you are essentially diving into a black box and looking for answers, by clearly stating your objectives first and then breaking that process down into manageable pieces, navigating through the proxy will be much quicker. Note that you may have more than one objective. Here are examples of what I mean.
The process for searching the proxy would be as follows.
- Objective: Learn about company organization
- Process: Go to management section of the document
- Steps: Read about the executives, board of directors, who controls the company, who established the company, what the company culture is like.
- Objective: Find management compensation
- Process: Go to compensation table
- Steps: Look up how much executives are getting paid, how compensation is calculated, what the performance threshold for bonuses are.
- Objective: Find “hidden” or off the book compensation
- Process: Go to footnotes of compensation table
- Steps: Look for additional compensation perks such as limos, expensive personal services that the company is paying such as $10,000 golf club fees
As you can see, breaking it down like this makes it much easier to process and navigate.
The “process” and “steps” section seem obvious and redundant, but that is only because you are already doing it subconsciously.
Over time, you will only be thinking about the objective and the process and steps will come automatically.
Advantages
- Quickest method
- Creates good habit and process
Disadvantages
- Possible to skip information
- Could end up looking for the same information all the time
7 Questions I want to Answer with the DEF 14A
Here is a list of questions/objectives that I like to search for in the DEF 14A.
- What is the background of each of the executive team?
- Is the board independent or are there lots of executives on the board?
- How much of the stock do insiders own?
- What are the compensation levels?
- What perks do the insiders receive?
- Are there any related party transactions?
- Are there any unpaid pensions?
Which Sections Do I Read? LULU Example.
Whether you follow method one of reading the entire filing, or navigate to the desired sections, the table of contents is your friend.
Here is the table of contents for lululemon athletica’s (LULU) from the 2010 DEF 14A. (Click on the image to enlarge)
I have split up the table of contents into two sections. The red section comprised of the information related to what the company wants you to vote on and the purple section which contains the meat of the document.
I’ll go through each item in the table of contents and discuss whether it is an important section to read or not.
Topics to Read in the Proxy Voting Section
The following sections may be overkill for the majority. Feel free to skip it to the end.
However, this will be a good starting base if you are completely new to reading these filings and don’t know what is important and what isn’t.
As you read from here on, remember that each DEF 14A may differ slightly. LULU just came to mind and it turns out their proxy was short yet detailed enough to be used as a good example.
The following are contents from the proxy voting section (highlighted in red) for LULU with a brief comment of each one.
>>NOTICE OF 2011 ANNUAL MEETING OF STOCKHOLDERS
- Recommend to Read
What it is: A summary of the proposals the shareholders will be voting for, instructions on how to vote, rights of shareholders and other general information.
>>PROPOSAL NO. 1 – ELECTION OF DIRECTORS
- OK to Skip
What it is: A table with the director names up for election.
>>CORPORATE GOVERNANCE
- OK to Skip
What it is: Short biography of each director up for election.
The bio of the executive team is more important.
>>PROPOSAL NO. 2 – RATIFICATION OF APPOINTMENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
- OK to Skip
What it is: vote to keep the current independent accounting firm.
>>PROPOSAL NO. 3 – ADVISORY VOTE ON EXECUTIVE COMPENSATION
- OK to Skip
What it is: a brief summary explaining a vote is required for executive compensation.
>>PROPOSAL NO. 4 – ADVISORY VOTE ON THE FREQUENCY OF HOLDING A STOCKHOLDER VOTE ON EXECUTIVE COMPENSATION
- Recommend to Read
What it is: a proposal to see how often executive compensation should be voted upon.
>>PROPOSAL NO. 5 – APPROVAL OF THE PERFORMANCE-BASED COMPENSATION MEASURES USED UNDER THE 2007 EQUITY INCENTIVE PLAN, AS REQUIRED BY SECTION 162(M) OF THE INTERNAL REVENUE CODE
- Recommend to Read
What it is: a brief summary of any option or compensation plans.
>>PROPOSAL NO. 6 – APPROVAL OF THE MATERIAL TERMS OF THE EXECUTIVE BONUS PLAN, AS REQUIRED BY SECTION 162(M) OF THE INTERNAL REVENUE CODE
- OK to skip
What it is: general information stating eligibility and objectives that must be met for bonuses.
>>PROPOSAL NO. 7 – APPROVAL TO AMEND OUR CERTIFICATE OF INCORPORATION TO EFFECT A TWO-FOR-ONE FORWARD STOCK SPLIT, WITH A PROPORTIONATE INCREASE THE NUMBER OF AUTHORIZED SHARES OF COMMON STOCK AND SPECIAL VOTING STOCK AND A PROPORTIONATE REDUCTION IN THE PAR VALUE OF SUCH STOCK
- Recommend to Read
What it is: details of a two for one stock split the company intends to move forward with and how it will work.
Most of these proposals are generic and are repeated in the main body of the document.
Topics to Read in the Body of the DEF 14A
>>REPORT OF THE AUDIT COMMITTEE
- OK to skip
What it is: details of a two for one stock split the company intends to move forward with and how it will work.
The audit committee is always going to say they did approve the financial reporting responsibilities. Same goes for independent auditors. Don’t make my mistake of blindly trusting auditors. Look at how the Diamond Foods audit committee was late to the party with their audit.
>>EXECUTIVE COMPENSATION
- Must Read
What it is: Get the details on the elements of compensation.
Anything, compensation related, you should read.
>>SUMMARY COMPENSATION TABLE
- Must Read
What it is: Compensation of executives over the past two or three years.
You must read the footnotes for this table to find additional “hidden” compensation information.
>>2010 GRANTS OF PLAN-BASED AWARDS & 2010 OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
- Recommended to Read
What it is: Table of stock options awarded to executives.
>>2010 OPTION EXERCISES
- Must Read
What it is: Table showing stock options exercised and the value realized.
The more important section is the employment agreement included in the option exercises where detailed agreements with each executive is included such as severance packages, benefits and reimbursements.
>>DIRECTOR COMPENSATION
- Must Read
What it is: Compensation table for the board of directors.
Best to do a Google search on the board to see what their previous track record is.
>>CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
- Must Read
What it is: Information on any transactions with company insiders.
>>PRINCIPAL STOCKHOLDERS AND STOCK OWNERSHIP BY MANAGEMENT
- Must Read
What it is: Table listing the ownership as a percentage.
Make sure to read the footnotes.
E.g. the CEO may own 1% under his name, but his trust could be a 30% holder, which makes the CEO a 31% owner.
>>SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
- OK to Skip
What it is: Compliance requirements for 10% or more owners in reporting to the SEC.
>>TRANSACTION OF OTHER BUSINESS
- Recommended to Read
What it is: If the company performs any other business, it will be noted here.
Rarely do you see anything. A quick glance is all you need.
>>STOCKHOLDER PROPOSALS TO BE PRESENTED AT THE 2012 ANNUAL MEETING OF STOCKHOLDERS
- OK to Skip
What it is: General information about attending the annual meeting of stockholders.
>>APPENDIX
- Recommended to Read
What it is: Not required but good idea to go through. There could be additional information that hasn’t been clearly explained in the body of the document.
Additional Resource
Check out footnoted. It is a site that goes through filings and brings to light unusual footnotes found within. It will help you tune your thinking and interpretation of notes from the documents.
Closing Summary
Hopefully this truly is a complete guide for anyone new to proxy documents.
I admit that every piece of this article is not required reading, but I hope that it covers all grounds. If there are additional thoughts I have missed, please leave a comment below so that I can update it. After all, I’m trying to create the ultimate guide.
