On October 18, 2010, the U.S. Securities and Exchange Commission (SEC) issued proposed rules regarding shareholder advisory votes on executive compensation and golden parachute arrangements under Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The proposed rules are available at www.sec.gov/rules/proposed/2010/33-9153.pdf. Set forth in this White Paper are several important features of the proposed rules that are worthy of immediate consideration in preparing for the 2011 proxy season.
The Dodd-Frank Mandate
There are three separate shareholder advisory votes under Section 951 that are covered by the proposed rules:
- “Say-on-Pay Vote” – voting on whether to approve the compensation of named executive officers as disclosed under federal securities law
- “Say-on-Frequency Vote” – voting at least once every six years on whether the say-on-pay vote should occur every one, two or three years
- “Say-on-Parachutes Vote” – voting on whether to approve so-called golden parachute compensation in connection with a business combination
None of these shareholder votes is binding on the board of directors or the issuer. A negative say-on-pay vote or say-onparachutes vote does not overrule prior decisions and does not increase or change the fiduciary duties of the board of directors.
Dodd-Frank also requires that certain institutional investment managers report their votes under Section 951. The SEC has also proposed rules relating to disclosure by these managers of their votes on executive compensation. These proposed rules are available at www.sec.gov/rules/proposed/2010/34-63123.pdf.
Issuers Required to Include Say-on-Pay Vote and Say-on-Frequency Vote for Shareholder Meetings on or after January 21, 2011
Shareholders must be provided a say-on-pay vote and say-on-frequency vote at the first annual or other meeting of shareholders occurring on or after January 21, 2011. This effective date is set forth in Section 951 and applies regardless of whether the SEC has issued final rules regarding these votes before that date. The say-on-parachutes vote and enhanced disclosure of golden parachute compensation will not be required to be included in proxy statements seeking shareholder approval of a covered corporate transaction until the effective date of the final SEC rules. As a result of being subject to similar requirements, issuers subject to TARP are exempt from providing a say-on-pay vote and say-on-frequency vote until the first shareholders meeting at which directors are elected that occurs after the issuer has repaid all TARP obligations.
No Requirement to File a Preliminary Proxy Statement Due to Including Say-on-Pay Vote and Say-on-Frequency Vote
As expected, the proposed rules exempt issuers from filing a preliminary proxy statement with the SEC due to including a say-onpay vote or say-on-frequency vote. Issuers will be entitled to rely on this provision of the proposed rules unless and until a change is made to it in the final rules.
No Specific Language Is Required for the Say-on-Pay Vote
The proposed rules do not provide any specific language or form of resolution for the say-on-pay vote. Instead, the say-on-pay vote must relate to the entirety of the named executive officer compensation disclosure under Regulation S-K Item 402–i.e., the Compensation Discussion & Analysis (CD&A), if applicable; the compensation tables; and other narrative executive compensation disclosure required by Item 402, except with respect to risk disclosure under Item 402(s) unless those risks are discussed in the CD&A. It is not sufficient for the vote to only cover the overall philosophy, policies and procedures of the compensation committee, or just its decisions during the most recent fiscal year. However, nothing in the proposed rules prohibits an issuer from including additional resolutions regarding executive compensation for a shareholder advisory vote. Unless additional requirements are added in the final rules, many issuers will likely follow the statutory language in Section 951 of Dodd-Frank when drafting say-on-pay resolutions. The proposed rules also clarify that director compensation is not part of the say-on-pay vote.
Proposed Rules Specify the Number of Choices for Say-on-Frequency Vote
The proposed rules provide for shareholders to be given four choices—namely, to vote on whether the say-on-pay vote will occur every one, two or three years, or to abstain from voting on the matter. If adopted in current form, the proposed rules would not allow an issuer to structure the say-on-frequency vote to provide shareholders with fewer choices. In response to concern that firms will not be able to change their processing systems to accommodate four choices in time for the 2011 proxy season, until the final rules are adopted, the SEC will not object if the form of proxy for the say-on-frequency vote only provides a choice among one, two or three years, and if no choice is selected on the proxy card, the proxy is disregarded for purposes of this vote. If management sets forth its views on which alternative is appropriate for the issuer, the proxy statement must make clear that shareholders are not voting to approve or disapprove the issuer’s recommendation.
Required Disclosure Regarding the Nature of Say-on-Pay Vote and Say-on-Frequency Vote
The proposed rules would require issuers to disclose the “effect” of say-on-pay votes and say-on-frequency votes. The proposed rules do not address what this means other than noting that voting will not invalidate prior corporate acts, or change or add to directors’ fiduciary duties. The advisory nature of these votes is similar to the non-binding nature of votes to ratify an issuer’s selection of auditors. A significant difference, however, is that the proposed say-on-pay rules do not require the issuer to discuss how it might respond to a negative vote. Issuers may voluntarily include a statement in their proxy statements committing to determine and evaluate the reasons for any negative say-on-pay vote.
Counting and Reporting Say-on-Pay Votes and Say-on-Frequency Votes
The proposed rules do not address how to count say-on-pay votes under Section 951, which is not surprising given that this matter is subject to state law requirements. One issue to consider is how an abstention would be counted for purposes of the say-on-pay vote. Unless bylaws or charter documents provide otherwise, at meetings of Delaware corporations, abstentions will effectively be counted as de facto “against” votes because approval of the matter would require the vote of a majority of the shares present and entitled to vote. Under this method of counting, the treatment of abstentions could result in a negative say-on-pay vote that might otherwise be avoided if the approval is based on a majority of the votes cast. Votes with respect to say-on-frequency are determined based on a plurality of the votes (i.e., the option with the most votes regardless of whether it is an absolute majority of the votes). An issuer will be required to report the numerical results of voting on a say-on-pay and say-on-frequency resolution on Form 8-K within four business days of the shareholders meeting.
Reporting the Issuer’s Response to Say-on-Pay Voting Results
An issuer is not required to take any action in response to a say-on-pay vote. However, the proposed rules would require an issuer to address in the next CD&A (a) whether, and if so, how, the compensation committee has considered the results of a say-on-pay vote, and (b) how has consideration of a prior say-on-pay vote actually affected compensation policies and decisions. As a practical matter, imposing this disclosure obligation as part of the CD&A requirements puts pressure on the compensation committee to carefully consider how to respond to say-on-pay votes.
Reporting the Issuer’s Response to Say-on-Frequency Voting Results
There is no requirement that an issuer adopt a policy consistent with the results of a say-on-pay vote as this vote is advisory in nature. Instead, the proposed rules would require an issuer to report in its next 10-Q (or 10-K if the shareholder meeting is in the last quarter of the fiscal year) what policy it has adopted regarding the frequency of say-on-pay voting. If the issuer’s policy is consistent with the plurality of votes, the issuer will be able to exclude subsequent shareholder proposals related to the frequency of the say-on-pay vote on the basis that any such proposal has been “substantially implemented.” For example, if the say-onfrequency voting option that gained the most votes was two years, and the issuer adopted a policy consistent with those votes that included a future say-on-frequency vote in six years, a shareholder proposal requesting a say-on-pay vote in the proxy for the following year could be excluded. However, this shareholder proposal would be included in that proxy statement if the issuer adopted a policy of having the say-on-pay vote every three years despite the two-year voting option receiving the most shareholder votes.
New Disclosure Requirement Proposed for “Golden Parachute” Compensation
The proposed rules provide for a new standardized form of disclosure for golden parachute compensation to be included in proxy and consent solicitations in connection with an acquisition, merger, consolidation, or sale of all or substantially all assets (a “business combination”). Golden parachute compensation is defined to include any type of compensation (whether present, deferred or contingent) that is based on or related to a business combination. New Item 402(t) differs from the existing rules for disclosing estimated payments upon termination or change in control as follows:
- Issuers would be required to use a standardized form of table.
- A total amount of compensation would be reported in this new table.
- The table would include all compensation to a named executive officer that is “based on or otherwise relate[s]” to the transaction, including cash severance, the dollar value of accelerated stock awards, pension and non-qualified deferred compensation enhancements, perquisites and tax reimbursements.
- There would be no exclusion of de minimis perquisites and other personal benefits, and the issuer would be required to disclose benefits under arrangements that do not discriminate in favor of executive officers.
Avoiding a Say-on-Parachutes Vote
Section 951 provides that a say-on-parachutes vote is not required at the time of a business combination if golden parachute compensation agreements or understandings have been subject to a prior say-on-pay vote (regardless of the outcome of that vote). It appears that the SEC will not allow an issuer to take advantage of this exemption unless shareholders were provided the enhanced form of golden parachute disclosure under new Item 402(t). In addition, if there are changes to the golden parachute arrangements after the say-on-pay vote, a new vote, with two tables (to show the previously approved arrangement and the effects of the changes) would be required at the time of the transaction. Issuers should carefully evaluate the potential risks and benefits of voluntarily including the enhanced form of golden parachute compensation under Item 402(t) when soliciting a say-on-pay vote.
Brokers Can No Longer Vote Uninstructed Shares on Matters Relating to “Executive Compensation”
Brokers are no longer able to vote on any matter involving “executive compensation,” including shareholder advisory votes under Section 951. This change may make it significantly more difficult to obtain a favorable say-on-pay vote depending upon the issuer’s shareholder demographics.
Potential Impact of New Institutional Investor Voting Disclosure Requirement
The proposed rules would require institutional investment managers that are subject to reporting on Schedule 13F to disclose, by August 31 of each year, how they voted with respect to the advisory votes on executive compensation at each company. It is possible that some of these managers could decide to abstain from voting on say-on-pay resolutions in light of this new disclosure requirement. As noted above, issuers should carefully consider how abstentions will be counted for purposes of the say-on-pay vote.
The proposed rules leave open many questions, and the SEC has solicited comments on 56 separate matters, which are listed in the appendix of this White Paper. The deadline for submitting comments is November 18, 2010. The SEC has indicated its intention to issue final rules prior to the time when calendar year issuers file their 2011 proxy statements.
Please click here to view the Appendices.