On January 25, 2011, the SEC issued final rules to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) mandating advisory shareholder votes on executive compensation (the so-called “say-on-pay” and “say-when-on-pay” votes) and golden parachute arrangements. The SEC had issued proposed rules on October 18, 2010. The final rules are generally similar to the proposed rules, with a few exceptions. Most notably, the final rules:

  • Provide a two-year exemption for smaller reporting companies (generally those issuers with a public float of less than $75 million) so that such companies will not be required to hold a say-on-pay or say-when-on-pay vote until their first meeting held on or after January 21, 2013
  • Do not prescribe required language for the say-on-pay shareholder resolution, but provide a non-exclusive example of a form that complies with applicable requirements
  • Restrict the ability to exclude future Rule 14a-8 shareholder proposals relating to say-on-pay or say-when-on-pay to those issuers who have adopted a policy on say-when-on-pay that is consistent with the choice of the majority of votes cast, rather than, as in the proposed rules, the choice of a plurality of votes cast
  • Move the requirement to disclose the issuer's decision on say-when-on-pay from the Form 10-Q or Form 10-K relating to the period in which the vote took place to an amendment to a Form 8-K to be filed by the earlier of 150 calendar days after the meeting at which the vote took place and 60 days before the deadline for submission of shareholder proposals for the next annual meeting
  • Establish April 25, 2011 as the date by which merger proxy statements must include the shareholder vote on golden parachute compensation arrangements
  • Clarify that bidders in third-party tender offers will not be required to provide golden parachute compensation information

The final rules will become effective 60 days after they are published in the Federal Register, but the requirements to hold the say-on-pay and say-when-on-pay votes are effective now, and companies generally may rely on the final rules until the effective date. A summary of the rules is below.

Say-on-Pay

Dodd-Frank requires publicly traded companies to include in their proxy statements for shareholder meetings, at least once every three years, a separate resolution subject to an advisory shareholder vote to approve the compensation of their named executive officers as disclosed under Item 402 of the SEC's Regulation S-K. This requirement applies to shareholder meetings held on or after January 21, 2011.

The SEC's final rules implement the Dodd-Frank say-on-pay provisions through a new rule (Rule 14a-21) that requires the say-on-pay advisory vote to be included in the first proxy statement relating to a meeting of shareholders at which directors are to be elected on or after January 21, 2011 for which Item 402 disclosure of executive compensation is required and thereafter not later than the meeting held in the third calendar year after the last say-on-pay vote. The rule does not specify a required form for the shareholder resolution, although the rule provides the following non-exclusive example of a resolution that complies with applicable requirements:

RESOLVED, that the compensation paid to the company's named executive officers, as disclosed pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis, compensation tables and narrative discussion[,] is hereby APPROVED.

The vote will not address the issuer's disclosure concerning director compensation or the issuer's assessment of compensation-related risks that is not part of the CD&A. The rules will not preclude issuers from seeking additional shareholder advisory votes on specific aspects of their pay programs.

The rules do not specify a voting standard to be used for determining whether a say-on-pay resolution has been approved. Some companies have used or indicated that they will use a state corporate law voting standard as is common for advisory votes on auditors. However, shareholder approval of a say-on-pay resolution for purposes of a state law standard will likely not preempt pressure on the issuer to modify its pay practices if the vote in opposition falls short of the standard but is nonetheless significant. Some commentators have suggested that a 20-percent to 30-percent vote against a say-on-pay resolution could be viewed as significant. Dodd-Frank's requirement that stock exchanges amend their rules to prohibit broker discretionary voting of uninstructed shares in matters relating to executive compensation, including say-on-pay, may make it more difficult to obtain passage of a say-on-pay vote by a satisfactory margin. Accordingly, companies will need to focus their proxy solicitation efforts to obtain favorable votes on this subject as well as other matters relating to executive compensation.

The rules also require an issuer to address, in the CD&A section of its proxy statement, how the issuer considered the results of the most recent shareholder advisory vote on executive compensation (rather than, as in the proposed rules, all previous votes) and the effect of such consideration on the issuer's executive compensation decisions and policies.

Say-When-on-Pay

Dodd-Frank also requires issuers to include in their proxy statements for shareholder meetings an additional separate resolution subject to shareholder vote to determine whether the say-on-pay vote will occur every one, two, or three years. This say-when-on-pay vote must occur at the first shareholder meeting held after January 20, 2011 and thereafter not later than the meeting held in the sixth calendar year after the last say-when-on-pay vote.

In the release setting forth its final rules, the SEC reiterates its view that the say-when-on-pay vote, like say-on-pay, will be non-binding despite Dodd-Frank's description of the vote as “determin[ing]” frequency of say-on-pay. The rules require that shareholders be given four choices as part of say-when-on-pay: to vote that say-on-pay occur every one, two, or three years, or to abstain. The issuer's board of directors may recommend one of the first three alternatives to shareholders, but all four alternatives must be clearly presented to shareholders. The SEC expects that, if the board of directors makes a recommendation with respect to say-when-on-pay, the proxy statement will include disclosure that the shareholders are not voting to approve or disapprove the board's recommendation.

The SEC has not prescribed a voting standard for determining which alternative shareholders have approved, stating that it does not believe it is necessary to do so since the vote is advisory. Under the final rules, issuers that implement the say-when-on-pay alternative receiving a majority of votes cast (not, as in the proposed rules, a plurality) will be able to exclude certain shareholder proposals under Rule 14a-8, as described below.

Disclosure and Vote on Golden Parachute Compensation Arrangements

Dodd-Frank requires that any proxy solicitation material (whether of a target or of an acquiring company) for a meeting of shareholders at which shareholders are requested to approve an acquisition, merger, consolidation, or proposed disposition of all or substantially all the assets of an issuer include specified disclosures relating to compensatory agreements or understandings with named executive officers that are based on or relate to the business combination being voted on (i.e., golden parachute compensation arrangements), as well as the amounts payable under such agreements or understandings. The proxy solicitation material also must include a separate resolution subject to shareholder vote to approve such agreements or understandings and compensation as disclosed, unless such agreements or understandings have been subject to a say-on-pay shareholder vote. This vote on so-called golden parachutes, like say-on-pay and say-when-on-pay, is advisory and non-binding.

The SEC's rules create a new Item 402(t) of Regulation S-K that requires disclosure with respect to golden parachute compensation arrangements between the target company or the acquiring company, on one hand, and the named executive officers of either the target or the acquirer, on the other hand. This disclosure is broader than that required by Dodd-Frank in that it requires the target to disclose compensation arrangements between the acquirer and the named executive officers of the target even if only the target, and not the acquirer, is the entity soliciting proxies. In circumstances where such disclosure is required even though the acquirer is not soliciting proxies, however, the rule exempts such arrangements from the scope of the resolution that the target is presenting to its shareholders.

Consistent with the proposed rules, the required disclosure under Item 402(t) consists primarily of a table disclosing amounts payable under golden parachute compensation arrangements. Footnote disclosure is required to indicate which amounts are attributable to “single-trigger” arrangements and which are attributable to “double-trigger” arrangements.

The Item 402(t) disclosure will be required not only in proxy statements for special meetings relating to mergers and other extraordinary transactions, but also in SEC forms related to business combination transactions, such as tender offers, going-private transactions, or transactions involving an information statement not subject to Regulation 14A. The SEC exempted bidders in third-party tender offers from these disclosure requirements, but a target filing a Schedule 14D-9 in connection with a third-party tender offer will be obligated to provide Item 402(t) disclosure.

As noted above, a separate shareholder vote on golden parachute compensation arrangements is not required in connection with a transaction to the extent the arrangements have already been subject to a say-on-pay vote (regardless of the outcome of that vote). To secure this exemption, however, the disclosure associated with the say-on-pay vote must meet the Item 402(t) standards described above, and the arrangements cannot have been modified in a manner that increases the compensation payable between the say-on-pay vote and the time at which shareholder approval of the transaction is sought. To the extent the arrangements have been modified to increase the compensation payable, the new arrangements or modified provisions must be subject to the separate vote in connection with the transaction. Changes in compensation due to a change in the named executive officer group, additional grants of equity compensation in the ordinary course, and increases in salary are deemed significant changes that would require another vote. Given the likelihood of such changes, we believe that most issuers will choose not to include the Item 402(t) disclosure in their proxy statements for their annual shareholder meetings.

Other Matters Relating to Say-on-Pay and Say-When-on-Pay

No Preliminary Proxy Statement Required

The final rules, like the proposed rules, do not require a preliminary proxy statement to be filed solely due to the proxy statement including the say-on-pay or say-when-on-pay vote required by Dodd Frank and SEC rules or similar voluntary votes. Accordingly, if a proxy statement includes only matters that are exempt from the preliminary proxy statement filing requirements under current rules and say-on-pay and say-when-on-pay votes, then a preliminary proxy statement filing is not required.

Transition Period for Form of Proxy Presentation of Four Alternatives for Say-When-on-Pay

With respect to the requirement to present four voting alternatives on say-when-on-pay, the SEC has indicated that, if an issuer's proxy service provider is not able to reprogram its systems to enable four alternatives in time for a shareholder vote, the SEC will not object if the form of proxy provides a means whereby the person solicited is afforded an opportunity to specify by boxes a choice among one, two, or three years, and a failure to select any of these three is treated as an abstention. The adopting release for the final rules extends this relief to meetings held at any time prior to December 31, 2011.

Exclusion for Shareholder Proposals on Say-on-Pay and Say-When-on-Pay

The SEC has amended Rule 14a-8 on shareholder proposals to permit issuers to exclude as “substantially implemented” shareholder proposals seeking say-on-pay or relating to the frequency of say-on-pay if the issuer has adopted a policy on the frequency of say-on-pay votes that is consistent with the frequency selected by a majority of votes cast in the most recent say-when-on-pay vote. For these purposes, abstentions do not count as votes cast. If none of the frequency alternatives receives a majority of votes cast, this exclusion will not be available.

Disclosure of Response to Say-When-on-Pay

After a say-when-on-pay vote, the rules require an issuer to disclose how frequently it will conduct say-on-pay in light of the results of the say-when-on-pay vote. That disclosure will need to be made by means of an amendment to an Item 5.07 Form 8-K filed to report the outcome of the shareholders meeting. This amendment will need to be filed by the earlier of 150 calendar days after the meeting at which shareholders voted on say-when-on-pay or 60 calendar days prior to the deadline for the submission of shareholder proposals for the next annual meeting. The requirement to disclose the issuer's decision in a Form 8-K replaces the SEC's original proposal to require such disclosure in a Form 10-K or Form 10-Q for a quarter in which a say-when-on-pay vote occurred.

Disclosure of Non-Binding Nature of Vote

The rules will require an issuer to briefly explain the general effect of the votes on these matters, including, for example, the non-binding nature of each vote. The final rules add a requirement, applicable only to shareholder meetings occurring after the initial say-on-pay and say-when-on-pay votes, to disclose the then-current frequency of say-on-pay votes and when the next scheduled say-on-pay vote will occur.

Temporary Exemption for TARP Companies

Consistent with the proposed rules, the final rules will generally exempt from say-on-pay and say-when-on-pay issuers that are already required to conduct a shareholder vote on executive compensation because they have received financial assistance under the Troubled Asset Relief Program (TARP) until they are no longer required to conduct such a vote under TARP.

Smaller Reporting Companies

Smaller reporting companies (generally those with a public float of less than $75 million) will not be required to hold a say-on-pay or say-when-on-pay vote until their first meeting held on or after January 21, 2013. This relief does not apply to the vote on golden parachute compensation arrangements required in connection with mergers or other extraordinary transactions. Smaller reporting companies will not be subject to the requirement to discuss in CD&A how prior votes have been considered in determining executive compensation policies and decisions because such companies are not required to provide CD&A disclosure. Smaller reporting companies that do not hold a say-when-on-pay vote under the relief provided will not be able to take advantage of the Rule 14a-8 amendment permitting issuers to exclude as “substantially implemented” shareholder proposals seeking say-on-pay or relating to the frequency of say-on-pay if the issuer has adopted a policy on the frequency of say-on-pay votes that is consistent with the frequency selected by a majority of votes cast in the most recent say-when-on-pay vote.