On July 21, 2010, the President signed into law the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (“Dodd-Frank”). While the bulk of Dodd-Frank regulates financial institutions and their products, it also includes several corporate governance and executive compensation provisions that apply to public companies generally. Many of the provisions require the SEC or the exchanges to adopt implementing rules. However, the say on pay rules will be effective for the 2011 proxy season, and the SEC is quickly moving forward on the remaining rules and studies required under Dodd-Frank. The following is a summary of the corporate governance and executive compensation provisions included in Dodd-Frank.
Corporate Governance Provisions
Mandatory Proxy Access
Dodd-Frank authorizes, but does not require, the SEC to adopt rules requiring companies to include shareholder nominees for the board in their proxy materials on terms determined by the SEC. The SEC proposed proxy access rules in 2009, but received over 500 comment letters questioning the SEC’s authority to adopt the rules and the advisability of the rules. Now that questions regarding the SEC’s authority to adopt proxy access rules have been eliminated, it is likely that the SEC will move forward to adopt final rules. SEC Chairman Mary Schapiro has stated that she expects to adopt final rules that would be effective for the 2011 proxy season. The SEC has the authority to exempt small issuers from the proxy access requirements.
Compensation Committee Independence
The SEC must issue rules requiring exchanges to prohibit the listing of a company’s securities if its board does not have a compensation committee composed entirely of independent directors. For purposes of determining whether a particular director is independent, the exchanges must consider:
- the source of the director’s compensation, including any consulting, advisory or compensatory fees paid to the director
- whether the director is affiliated with the company, a subsidiary or an affiliate of a subsidiary
While the current exchange rules contain independence requirements for compensation committee members, under Dodd-Frank, consideration must also be given to the source and nature of compensation, rather than just the amount. In addition, similar to the audit committee independence requirements, the director’s status as an affiliate of the company, such as through share ownership, must be considered. As a result, director representatives of significant shareholders may no longer be deemed independent since they may be deemed to be affiliated with the company.
Dodd-Frank permits exchanges to exempt certain relationships from the independence requirements based on the company’s size and other relevant factors. Furthermore, controlled companies, limited partnerships, companies in bankruptcy proceedings and foreign private issuers that disclose to shareholders why they do not have an independent compensation committee are exempt from these requirements. The SEC must adopt these rules no later than July 16, 2011.
Compensation Consultants, Legal Counsel and Other Advisors
Dodd-Frank specifies that compensation committees may engage compensation consultants, legal counsel or other advisors, although they are not required to do so. However, when selecting these advisors, Dodd-Frank requires that the compensation committee consider factors to be identified by the SEC as affecting the independence of the advisors, including:
- the provision of other services to the company by the consultant or advisor
- the amount of fees received from the company by the consultant or advisor, as a percentage of the total revenue of the consultant or advisor
- the policies and procedures of the consultant or advisor that are designed to prevent conflicts of interest
- any business or personal relationship of the consultant or advisor with a member of the compensation committee
- any stock of the company owned by the consultant or advisor
Additional factors identified by the SEC must be competitively neutral among the categories of compensation consultant, legal counsel or other advisors and must preserve the ability of compensation committees to retain the services of members of any such category.
The compensation committee will be directly responsible for the appointment, compensation and oversight of the work of these advisors. Dodd-Frank requires companies to provide appropriate funding for payment of reasonable compensation to its advisors.
In its proxy materials for an annual meeting of shareholders that occurs on or after July 21, 2011, a company must provide additional disclosure regarding its compensation consultants (but not legal counsel and other advisors) as to whether:
- the compensation committee retained or obtained the advice of a compensation consultant
- the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed
The SEC is required to issue rules by July 16, 2011, prohibiting the exchanges from listing any security of a company that is not in compliance with these requirements. The SEC rules would, however, provide a company a reasonable opportunity to cure any defects that would lead to a violation of these rules. The exchanges may exempt controlled companies and other companies, such as small issuers, from these rules.
Disclosure of Separation of Chairman and CEO
By January 17, 2011, the SEC must issue rules mandating that companies disclose in their annual proxy statements the reasons they have chosen to either have a single CEO and chairman, or why they have separated the CEO and chairman positions. The proxy enhancement rules issued by the SEC in December 2009 currently address this type of disclosure and, consequently, it is unclear what additional rules the SEC may issue to address this provision.
Broker Discretionary Voting
Dodd-Frank requires exchanges to amend their rules to prohibit brokers from exercising discretionary authority to vote in connection with the election of directors, executive compensation (including say on pay), or any other significant matter as determined by the SEC. Dodd-Frank does not specify a timeframe for the exchanges to adopt these rules.
Effective for the 2010 proxy season, the NYSE had already amended its rules to eliminate broker discretionary voting for the election of directors, whether or not the election was contested. The prohibition affects not only the NYSE but also companies listed on other exchanges, such as NASDAQ, because most large brokerage firms are NYSE member organizations. Dodd-Frank extends the prohibition to other matters such as say on pay.
Executive Compensation Provisions
Say on Pay
At least once every three years, companies are required to provide shareholders with an advisory vote on executive compensation. In addition, at least once every six years, shareholders must be provided a separate advisory vote on whether the say-on-pay vote should occur every one, two or three years. Companies must comply with these requirements beginning with their first shareholder meeting occurring more than six months after the enactment of Dodd-Frank. As a result, the proxy materials for companies with annual meetings on or after January 21, 2011, must contain both the non-binding resolution on compensation and the non-binding resolution regarding the frequency of the say-on-pay vote. The SEC has authority to exempt small issuers from these votes. No SEC rulemaking is required to implement this say-on-pay provision.
Vote on Golden Parachutes
In proxy materials where shareholders are asked to approve a merger, acquisition, consolidation, or proposed sale or other disposition of all or substantially all the assets of a company, the proxy must include a non-binding shareholder vote regarding golden parachute payments. In connection with this non-binding vote, the proxy statement must disclose, in clear and simple form:
- any agreements or understandings with any named executive officer of the company concerning any type of compensation (whether present, deferred or contingent) that is based on or otherwise relates to the transaction
- the aggregate total of all such compensation that may be paid or become payable to or on behalf of such executive officer
The SEC is required to adopt rules regarding these disclosures, although Dodd-Frank does not specify a timeframe for adoption of these rules. Companies must comply with this requirement beginning with their first annual shareholders meeting or any other meeting of shareholders occurring after January 21, 2011.
Disclosure of Institutional Voting Records
Dodd-Frank requires that institutional managers subject to Section 13(f) of the Exchange Act annually disclose how they voted on say-on-pay and say-on-golden-parachutes proposals. However, it is unclear what the format of this disclosure will be since the SEC is not required to adopt implementing rules and Dodd-Frank does not specify the disclosure requirements.
Enhanced Executive Compensation Proxy Disclosure
Dodd-Frank requires the SEC to adopt rules requiring disclosure in a company’s annual proxy statement of the relationship between executive compensation actually paid and the financial performance of the company, taking into account any change in the value of the shares of stock and dividends of the company and any distributions. The rules may require a graphic representation of the information. In addition, the company must disclose:
- the median of the annual total compensation of all employees of the company, excluding the CEO
- the annual total compensation of the company’s CEO
- the ratio of the median employee total compensation, excluding the CEO, to the CEO’s total compensation
For purposes of these calculations, total compensation includes all components of compensation disclosed in the summary compensation table of a company’s proxy statement. Dodd-Frank does not specify a timeframe for the SEC to adopt these rules.
The SEC is required to issue rules mandating that companies disclose in any annual proxy statement whether any employee or member of the board of directors or their designee is permitted to engage in hedging activities that are designed to hedge or offset market declines affecting compensatory equity awards. Dodd-Frank does not specify a timeframe for this provision.
Dodd-Frank mandates exchanges to adopt listing standards requiring that listed companies develop and implement a clawback policy for accounting restatements. The policy must provide that in the case of an accounting restatement due to the material noncompliance with any financial reporting requirement, whether intentional or not, the company will recover from all present and former “executive officers” any incentive-based compensation (including stock options) received in excess of what would have been paid based on the company’s results after giving effect to the accounting restatement during the three-year period preceding the date on which the company is required to prepare the restatement. This provision is broader than a similar provision contained in Section 304 of the Sarbanes-Oxley Act in that it covers all current and former executive officers and not only the CEO and CFO, does not require that the restatement results from misconduct and the look-back period is three years instead of one year. Further, under Dodd-Frank companies will be required to disclose and adopt a specific clawback policy.
For a discussion of the implications of Dodd-Frank on foreign private issuers, please see our August 3, 2010 alert, Foreign Private Issuers and the Dodd-Frank Act.