The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), signed into law by President Obama on July 21, 2010, contains several provisions that will affect public companies’ future proxy statements, policies and relationships concerning executive compensation. Although many of the rules relating to how these provisions will be implemented have yet to be written, public companies and their advisors should become familiar with the changes that will take effect in 2011 and beyond.
Mandatory Say-On-Pay Voting
Beginning in 2011, public companies will be required to conduct non-binding advisory votes seeking shareholder approval of executive compensation. Three separate types of these so-called “say-on-pay” votes are mandated by the Act. First, at the first shareholder meeting that occurs on or after January 21, 2011, a company must seek shareholder approval of the prior year’s compensation of its CEO, CFO and three other most highly compensated executive officers (“Named Executive Officers”). Second, at this same meeting and at least once every six years thereafter, a company must allow shareholders to decide whether the vote approving Named Executive Officers will be held every one, two or three years. Third, if shareholders are asked to approve a merger, acquisition, consolidation or other significant corporate transaction that would trigger “golden parachute” payments to the Named Executive Officers compensation, the company must submit such golden parachute payments to a separate non-binding vote, and must include in its proxy statement clear and simple disclosures of the golden parachute arrangements and the amounts payable.
The SEC has not yet issued proposed or final rules detailing how these votes are to be conducted. For example, with respect to the vote regarding the frequency of the say-on-pay vote, it is unclear whether a company will be permitted to recommend a frequency or whether shareholders will be permitted to choose from among all three options. Until such rules are issued, public companies may wish to review the results of shareholder votes of prior years, particularly with respect to executive compensation plans that required shareholder approval, to anticipate the likely outcome of the say-on-pay vote. To the extent that a company is aware of shareholder dissatisfaction with its compensation practices, it may wish to evaluate and revise the particular elements of compensation that are problematic. In addition, companies may wish to reevaluate the description of their compensation philosophies and policies in their most recent proxy statements, and ensure that the Compensation Discussion and Analysis tells a clear, consistent story on how the compensation of the Named Executive Officers was determined.
The Act also requires national securities exchanges and national securities associations to amend their listing standards (in accordance with rules that will be written by the SEC) to require listed companies to develop and implement clawback policies. Under such policies, if a listed company is required to prepare an accounting restatement due to material noncompliance with the securities laws, the company must recover certain incentive-based compensation received by current or former executives within the three-year period preceding the date of the accounting restatement. The amount to be recovered is the excess incentive-based compensation that was paid as a result of the material noncompliance – that is, the amount that would not have been paid had the initial financial statements been correct. The new listing rules will also require listed companies to disclose their clawback policies in filings with the SEC.
COMPENSATION COMMITTEE INDEPENDENCE
The Act also requires national securities exchanges and national securities associations to develop listing standards aimed at enhancing the independence of a listed company’s compensation committee, as well as the independence of the compensation consultants, legal counsel or other advisors engaged by the compensation committee.
With respect to compensation committee members, the Act mandates that each such member be a member of the board of directors. The Act also provides that the listing standards “shall consider relevant factors” in defining the member’s independence, such as the source of the member’s compensation and whether the member is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company. Compensation committees must also have the authority to engage and pay independent legal counsel.
With respect to compensation consultants, legal counsel and other advisors, the Act provides that a company’s compensation committee may only select a consultant, counsel or advisor that is independent under the listing standards applicable to the company. In defining “independence” for this purpose, the Act lists several relevant factors that must be considered in the listing standards of national securities exchanges and associations, including:
• the provision of other services to the company by the person that employs the compensation consultant, legal counsel, or other adviser;
• the amount of fees received from the company by the person that employs the compensation consultant, legal counsel, or other adviser, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel, or other adviser;
• the policies and procedures of the person that employs the compensation consultant, legal counsel, or other adviser that are designed to prevent conflicts of interest;
• any business or personal relationship of the compensation consultant, legal counsel, or other adviser with a member of the compensation committee; and
• any stock of the company owned by the compensation consultant, legal counsel, or other adviser.
The Act gives the SEC 360 days to issue rules regarding these independence requirements, which the national securities exchanges and national securities associations must then follow in amending their listing standards. At this point, it is unclear whether these independence requirements will be effective at any point in 2011.
NEW COMPENSATION DISCLOSURES
The Act will also require public companies to include new information in their proxy statements relating to executive compensation. The Act directs the SEC to adopt rules mandating disclosure of the ratio of the total annual compensation of a company’s CEO to the median annual compensation of all employees of the company except the CEO, and to disclose the total annual compensation numbers used in such ratio. The Act also directs the SEC to adopt rules requiring public companies to disclose the relationship of compensation actually received by their Named Executive Officers to the company’s financial performance. In addition, the SEC must develop rules mandating disclosure of whether any employees or directors are permitted to trade in any financial instruments that are designed to hedge against the market value of equity securities granted as compensation to, or held directly by, the employee or director.
BREAKING NEWS - SEC DELAYS SHAREHOLDER PROXY ACCESS IMPLEMENTATION
On October 4, 2010, the Securities and Exchange Commission (“SEC”) issued a formal stay delaying the effectiveness of the controversial, recently adopted Rule 14a-11 and related amendments, commonly known as the proxy access rules. The SEC issued the stay in response to a lawsuit filed in the U.S. Court of Appeals for the District of Columbia by the Business Roundtable and the U.S. Chamber of Commerce challenging the final proxy access rules. The rules were to become effective on November 15, 2010 and would have applied to the 2011 annual meetings of public companies if the companies mailed their 2010 proxy materials on or after March 15, 2010.
The proxy access rules, adopted by the SEC on August 25, 2010, require public companies to permit a shareholder (or a group of shareholders) to include the shareholder’s own director nominees in the company’s proxy materials if the nominees meet certain eligibility requirements. The shareholder or group must hold more than a 3% stake in the company and must have held such shares continuously for at least 3 years. Any securities that have been borrowed or sold short do not count toward the 3% requirement. A shareholder or group meeting the eligibility requirements is allowed to nominate up to 25% of the number of directors on the company’s board.
Although the legal challenge relates solely to the new Rule 14a-11, the SEC also stayed the related amendment to Rule 14a-8, also adopted by the SEC on August 25, 2010, which would require public companies to include certain shareholder proposals relating to an election and its procedures (such as allowing more liberal proxy access procedures) in the companies’ proxy statements. Prior to the Rule 14a-8 amendment, public companies were allowed to exclude such proposals from their proxy materials.
Although the parties to the lawsuit challenging the proxy access rules are seeking expedited review by the Court of Appeals, it is difficult to predict the effect the stay will have on the upcoming 2011 proxy season. However, it appears highly unlikely the proxy access rules will be in effect for 2011 for calendar-year filers.