Developments in Securities Law - February 2011

Final Rules

Say-on-Pay Voting Rules

On January 25, 2011, the SEC adopted final rules requiring public companies to conduct separate shareholder advisory votes on executive compensation and "golden parachute" compensation arrangements.  These rules were adopted substantially as proposed on October 18, 2010.  One notable difference from the proposed rules is a temporary exemption for smaller reporting companies so that these issuers will not be required to conduct either a say-on-pay or say-on-frequency vote until the first annual or other meeting of shareholders occurring on or after January 21, 2013.  This temporary exemption does not apply to shareholder advisory votes regarding golden parachute compensation of smaller reporting companies.  Because companies that have received TARP funds are required by U.S. Treasury regulations to have an annual say-on-pay vote, which is effectively the same as the say-on-pay vote under these rules, TARP recipients are exempt from the requirement to include an additional say-on-pay vote and a say-on-frequency proposal until their first meeting at which directors are elected after the company is no longer subject to the TARP restrictions.

The Dodd-Frank Act requires public companies to conduct say-on-pay and say-on-frequency votes for their first annual or other such meeting of shareholders occurring on or after January 21, 2011, regardless of whether final rules had been adopted by the SEC.  The final rules do not become effective until 60 days following publication in the Federal Register.  Companies must comply with the new rules concerning the golden parachute vote and disclosure with respect to any merger proxy statement (and certain other similar filings) filed on or after April 25, 2011.

Michael Best Comments

Say on Pay Could Make for a Rocky 2011 Proxy Season

While the say-on-pay rules just went into effect and the 2011 proxy season has just begun, we are seeing some interesting results that may signal a rocky season.  Two of the first 55 say-on-pay votes failed to gain majority approval.  While these votes are only advisory, companies whose annual meetings are later this year should take note that proxy advisory firms are playing a significant role in the process, especially for those companies whose say-on-pay proposals failed.  Also, given the prohibition on counting broker discretionary votes in say-on-pay and say-on-pay frequency proposals, a major source of votes upon which companies have historically relied, management recommendations on voting have less significance than in the past.

Companies are also required to put to a shareholder vote the frequency with which the say-on-pay vote should occur.  Shareholders must be given the choice of annual, biennial or triennial.  Shareholders are showing a distinct preference for more frequent review of executive compensation, with the early yet distinct trend towards annual referendums, rather than a biennial or triennial schedule that is favored by most companies.  Annual say on pay votes will likely require additional time and cost for companies to design and disclose executive pay programs.  There is a discrepancy between management’s recommendation and shareholder’s response to this item.  Nearly 60% of companies recommended a triennial vote, while a majority of shareholders at nearly 70% of companies have supported an annual vote.  This divergence was more significant for the largest U.S. companies.  Most of those companies that were successful in a biennial or triennial vote were controlled by insiders.

Proposed Rules & Final Rules

Net Worth Standard for Accredited Investors

On January 25, 2011, the SEC proposed amendments to its rules to conform the definition of "accredited investor" to the requirements of the Dodd-Frank Act.  Section 413(a) of the Dodd-Frank Act requires the definitions of "accredited investor" in the SEC's rules to exclude the value of a person's primary residence for purposes of determining whether the person qualifies as an "accredited investor" on the basis of having a net worth in excess of $1.0 million.  This change to the net worth standard was effective upon enactment by operation of the Dodd-Frank Act on July 21, 2010, but Section 413(a) also requires the SEC to revise its rules under the Securities Act of 1933 to reflect the new standard.

The change to the accredited investor definition is of significant importance for securities issuers as various exemptions for private or other limited offerings of securities under the Securities Act of 1933 and state "blue sky" laws depend on whether participants are "accredited investors."  One of the bases on which individuals may qualify as accredited is having a net worth of at least $1.0 million, either alone or together with their spouse. Non-accredited investors who participate in private offerings under Rule 505 or Rule 506 of Regulation D must receive financial and other information that is not required to be given to accredited investors, and in offerings relying on Rule 506 there is a limit of 35 non-accredited investors.

Removal of Credit Rating References

On February 9, 2011, the SEC, pursuant to Section 939A of the Dodd-Frank Act, proposed rule amendments that would remove references to credit ratings in rules and forms promulgated under the Securities Act of 1933 and the Securities Exchange Act of 1934.  The focus of the proposal is to eliminate the use of credit ratings as a condition of "short-form" eligibility, which enables issuers to register securities "on the shelf" on a Form S-3 or F-3.  Currently, an issuer can use a Form S-3 or F-3 if it meets certain registrant requirements, including a requirement that, for at least one year, it has been a reporting company and has been filing its periodic reports in a timely manner, in addition to at least one of the applicable form's transaction requirements.  One such transaction requirement allows an issuer to use a short-form registration statement for an offering of non-convertible securities, such as debt securities, provided that such securities be rated "investment grade" by at least one credit rating agency that is a nationally recognized statistical rating organization.  Under the proposed rules, the transaction eligibility requirement relating to the offering of non-convertible securities would be replaced with a new requirement, which would permit use of a short-form registration statement for primary offerings of non-convertible securities if the issuer has issued (as of a date within 60 days prior to the filing of the registration statement), for cash, more than $1 billion in non-convertible securities, other than common equity, through registered primary offerings over the last three years and otherwise meets the registrant requirements.  The proposed standard is modeled on the standard for determining whether an issuer is a "well-known seasoned issuer" based on its debt issuances, where it does not meet the public equity float requirement.

New Compliance & Disclosure Interpretations

Smaller Reporting Companies – On February 11, 2011, the SEC released new Q&A interpretations addressing how to determine whether an issuer is a smaller reporting company as of January 21, 2011.  If an issuer is a smaller reporting company as of that date, the issuer will be entitled to rely on the delayed phase-in period for holding say-on-pay and say-on-frequency votes.  An issuer’s status as a smaller reporting company is based on such issuer’s public float or annual revenues at the end of the second fiscal quarter of 2010. A change in status, if any, based on the issuer’s second fiscal quarter of 2010 results is effective on the first day of such issuer’s first quarter of 2011, regardless of whether such issuer has filed a report with the SEC indicating its new status.

Sec Releases & Policy Statements 

No relevant Releases or Policy Statements.