On July 15, 2010, the Senate passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank bill") by a vote of 60 to 39. The final text of the Dodd-Frank bill is the product of the House-Senate Conference Committee’s reconciliation of the financial reform legislation passed by the Senate in May 2010 and the House in December 2009. The Senate vote was the last remaining hurdle for the reconciled bill. The President is expected to sign the Dodd-Frank bill into law this week.
Despite the primary goal of overhauling the regulation of financial institutions at the center of the financial crisis, it was evident early in the legislative process that the reach of the final Dodd-Frank bill was never going to be limited to banks. All public companies will be affected by the executive compensation and corporate governance provisions. Other significant provisions of the Dodd-Frank bill will govern derivatives transactions, regulate companies offering consumer financial products and require the registration of many investment advisers to hedge funds and private equity funds. This Alert does not address certain significant parts of the Dodd-Frank bill, including those relating to systemic risk to the financial system and bank regulatory reform.
EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE
- Say-on-Pay. The Dodd-Frank bill requires public companies to hold non-binding shareholder votes to approve or disapprove the compensation to be paid to executives at the first annual or other meeting (requiring compensation disclosure) occurring six months after the date of the bill’s enactment. A separate vote must also be held to determine the frequency of future advisory votes, which must be held every one, two or three years. Thereafter, a re-vote on the frequency of the say-on-pay votes must be held at least once every six years.
In addition, the final Dodd-Frank bill requires public companies to hold advisory votes on golden parachutes when shareholders are asked to approve an acquisition, merger, consolidation, or sale or other disposition of all or substantially all the assets of the company. Broker discretionary voting will be prohibited on executive compensation proposals such as say-on-pay or "any other significant matter." Currently, uninstructed shares may be voted by brokers in advisory say-on-pay votes. Institutional investment managers will be required to report at least annually on how they voted on any advisory vote. The bill also authorizes the SEC to exempt a company or class of companies from advisory votes, taking into consideration whether the advisory vote "disproportionately burdens small" companies.
- Shareholder Proxy Access. The Dodd-Frank bill gives the SEC specific authority to adopt rules permitting shareholders to nominate directors for inclusion in a public company’s own proxy solicitation materials. In what became one of the most contentious issues for the Conference Committee, the final proxy access provision was stripped of any mandated ownership thresholds or holding period restrictions, pushing the details and outcome of proxy access back to the SEC. With rulemaking authority no longer in doubt, investor advocates are expecting the SEC to release proxy access rules with significantly lower thresholds than those considered by the Conference Committee. However, the bill also authorizes the SEC to exempt a class of companies, taking into consideration whether the rule "disproportionately burdens small" companies.
- Independence of the Compensation Committee. The Dodd-Frank bill requires members of compensation committees to fulfill standards of independence set by each company’s stock exchange and would permit compensation committees, without the need for approval from the full board, to hire compensation consultants and legal counsel if those advisors are independent. Controlled companies and limited partnerships are among the companies exempt from this provision.
- Increased Proxy Disclosure. The Dodd-Frank bill requires proxy statement disclosure on a number of matters, including (i) any employee or director that is permitted to hedge against equity securities held or granted by the company as compensation, (ii) reasons why the company has chosen to combine or separate the positions of chairman of the board and chief executive officer, (iii) the relationship between executive compensation and the financial performance of the company, and (iv) the ratio of median annual total compensation of employees to the compensation of the chief executive officer.
- Clawbacks of Executive Compensation. Public companies will be required to implement policies that recover incentive-based compensation from any current or former executive officer when the company restates its financial statements because of material noncompliance with any financial reporting requirement. Any compensation in excess of the amount that would have been paid using the restated accounting during a three-year period preceding the restatement must be recovered.
- Sarbanes-Oxley 404(b) Exemption for Small Issuers. Non-accelerated filers (companies with market capitalizations under $75 million) will be exempt from the SOX 404(b) requirement regarding a report by the filer’s registered independent public accountant addressing management’s assessment of internal control over financial reporting.
- Notable Omissions. The final Dodd-Frank bill did not include a mandate for majority voting in uncontested director elections. Director election voting standards for public companies will continue to be governed by state corporate law.
REGULATION OF DERIVATIVES
The Dodd-Frank bill gives the CFTC and the SEC authority to regulate over-the-counter derivatives. Swap dealers and major swap participants will be required to meet capital and margin requirements as well as conduct and disclosure standards established by the CFTC and SEC. Without an exemption, such as if a commercial end user is a party, the bill requires most derivatives to be cleared and traded on exchanges. A compromise was included in the final bill regarding Senator Blanche Lincoln’s proposal to force banks to spin off their derivatives operations to nonbank affiliates in order to continue to receive Federal assistance. The Dodd-Frank bill permits insured depository institutions to continue derivatives activities that hedge their own risk or relate to interest rates, foreign exchange rates, gold, silver and investment-grade debt securities.Banks will be required to move only uncleared and non-standardized derivatives operations to a separately capitalized affiliate.
BUREAU OF CONSUMER FINANCIAL PROTECTION
The Dodd-Frank bill establishes the Bureau of Consumer Financial Protection. Although housed within the Federal Reserve, the Bureau will have autonomous authority to issue and enforce rules governing all entities that offer consumer financial services and products. The Bureau will also have broad supervisory powers to detect risks to consumers and assess compliance with federal consumer financial laws. A number of entities are exempted from the Bureau’s authority, including retailers of nonfinancial goods or services, realtors, accountants, tax preparers, attorneys and persons regulated by the SEC, CFTC, or state insurance or securities regulators. The much debated exemption for auto dealers was also included in the final bill.
REGULATION OF INVESTMENT ADVISERS AND OFFERINGS
- SEC Registration for Advisers to Hedge Funds and Private Equity Funds. The Dodd-Frank bill eliminates the exemption in Section 203(b)(3) of the Investment Advisers Act of 1940 for advisers to fewer than fifteen clients. The asset threshold for federal registration of investment advisers will be increased to $100 million. The SEC is required to exempt from federal registration advisers solely to private funds with assets less than $150 million and advisers to venture capital funds. However, recordkeeping and annual reporting requirements may be imposed as the SEC finds necessary. The definition of a venture capital fund is left for determination by the SEC. The SEC is also directed to define "family office" in a manner consistent with current no-action positions.
- Fiduciary Duty. The Dodd-Frank bill provides the SEC with authority to impose, after completion of a six month study, a fiduciary duty on brokers and dealers to act in the best interest of their customers when providing personalized investment advice about securities to retail customers.
- Notable Omissions. The changes initially proposed to private placement offerings under Regulation D were removed in the Senate and replaced with a prohibition of offerings by certain convicted offenders of securities laws. The Dodd-Frank bill will maintain the current eligibility threshold for accredited investor status for four years but will exclude the value of the investor’s primary residence in the net worth calculation.
CREDIT RATING AGENCIES
- Oversight. The Dodd-Frank bill creates a new Office of Credit Rating Agencies within the SEC, with authority to improve independence and increase accountability of credit rating agencies.
- Liability. Investors could bring a private right of action against rating agencies for knowingly or recklessly failing to conduct a reasonable investigation or to obtain reasonable verification of information from an independent source.
- Rating Shopping. The Dodd-Frank bill directs the SEC to study the current system of issuer selection of a credit rating agency for its structured financial products, such as asset-backed securities. After the study, the SEC must create a new system based on random assignment of qualified credit rating agencies for structured financial products.
The Dodd-Frank bill limits interchange transaction fees charged by issuers of debit cards (with assets over $10 billion) for electronic debit transactions to an amount that is reasonable and proportional to the cost of processing the transactions. Retailers are also given more flexibility regarding form-of-payment discounts and policies.