The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act), which was signed into law on July 21, 2010, significantly reforms the US financial services industry. In addition to its sweeping financial regulatory reforms, the Act includes important executive compensation and corporate governance provisions that will affect all US public companies.
In general, the Act authorizes the SEC and national securities exchanges to adopt rules that will, within one year after the date of its enactment (and six months after enactment in the case of say on pay), prohibit the listing of any US public company that fails to adopt the new standards. These new requirements are likely to increase shareholder influence on executive compensation and corporate governance matters in upcoming proxy seasons. The SEC recently announced its tentative rulemaking schedule under the Act and although subject to change, it suggests that the only governance and compensation rules described in this article that will be in effect for 2011 proxy season, will be the “say on pay” provisions. Below is a brief summary of the key corporate governance and executive compensation provisions contained in the Act.
Shareholder Voting and Access
Advisory Vote of Executive Compensation: “Say on Pay.” Every public company must include, in its proxy materials for its first shareholder meeting held after January 21, 2011, a separate non-binding shareholder advisory vote on named executive officers’ compensation. In addition, beginning with the first shareholder meeting after January 21, 2011, and at least every six years thereafter, companies are required to seek a shareholder vote on whether its “say on pay” vote should be held annually, biennially, or triennially. These requirements do not apply to US-traded foreign private issuers.
Say on Pay: Golden Parachute Vote. Public companies must include a separate non-binding shareholder advisory vote on executive change in control payments in proxy statements or consent solicitation materials where shareholders are voting on an acquisition, merger, consolidation or proposed sale or disposition of all or substantially all of the company’s assets. The company is required to clearly and simply describe the change in control compensation arrangement and disclose the aggregate amount of such compensation for each named executive officer. The rules apply to any proxy or consent solicitation for meetings occurring after January 21, 2011. The separate advisory vote to approve the golden parachute payments is not required if such payments have already been subject to a general “say on pay” vote.
Voting by Brokers. Effective as of January 2010, NYSE Rule 452 eliminated broker discretionary voting without instruction from the beneficial owners of the shares. The Act expands this prohibition by proscribing broker discretionary voting with respect to elections of directors as well as with respect to executive compensation matters and any other matters deemed significant by the SEC.
Proxy Access. The Act authorizes, but does not require, the SEC to adopt proxy access rules which allow shareholders to use the company’s proxy materials to nominate a slate of directors in opposition to the company’s candidates for election. On August 25, 2010, the SEC adopted final rules that generally provide proxy access to shareholders who have held at least three percent of the voting power of the company’s securities continuously for at least three years. For a more detailed discussion of the SEC’s new proxy access rules, see our Client Alert co-authored with Georgeson.
Other Executive Compensation Provisions
Independence of Compensation Committees and Authority over Compensation Consultants. The Act directs the SEC to adopt, no later than July 16, 2011, rules requiring compensation committee members to be “independent.” In defining independence, securities exchanges must consider both the sources of any compensation paid to committee members (including any consulting, advisory or other compensatory fees) and whether the committee members are affiliated with the company, its subsidiaries or affiliates. The independence requirements will not apply to controlled companies, foreign private issuers that disclose why they do not maintain an independent compensation committee and certain other specified entities.
In addition, effective for shareholder meetings held after July 21, 2011, public companies must disclose:
- Whether the compensation committee retained or obtained advice from a compensation consultant
- Whether that work caused a conflict of interest, and if so, the nature of the conflict and how it was addressed
It is unclear whether the additional requirements related to the disclosure of compensation consultants and other advisors will also apply to foreign private issuers.
Clawbacks. The Act requires that US listed public companies adopt and implement clawback policies pursuant to which incentive based compensation (including stock options) will be recovered from current and former executives in the event of an accounting restatement as a result of material noncompliance with financial reporting requirements. Such amounts will be recoverable for the three-year period preceding the date the company is required to prepare the restatement, and the amount subject to clawback will equal the excess of what would have been paid as a result of the restatement. Unless addressed in future rulemaking, it is unclear whether foreign private issuers will be subject to the clawback policies required by the Act.
Enhanced Proxy Disclosure Requirements
Executive Compensation Disclosures: Pay for Performance and Internal Pay Equity. Public companies will be required to disclose information detailing the relationship between executive compensation actually paid and the company’s financial performance, taking into account any change in stock value, dividends and any other distributions. In addition, public companies must disclose:
- The median annual total compensation for all employees (except the CEO)
- The annual total compensation of the CEO
- The ratio of the CEO’s compensation to the median
Disclosure of Employee and Director Hedging. The Act requires the SEC to issue rules requiring public companies to disclose whether employees or directors are allowed to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars and exchange funds) to hedge against a decrease in the value of the company’s equity securities.
Disclosures Regarding Chairman and CEO Positions. The Act directs the SEC to adopt rules requiring public companies to disclose the reasons why the same person has been chosen to serve as board chairman and CEO or why different individuals have been chosen to fill each position. Such SEC rules must be adopted within 180 days following the enactment of the Act. Current proxy rules already require similar disclosure, and it is therefore not clear whether the Act will mandate any additional disclosure.
How Foreign Private Issuers are Affected
In general, foreign private issuers are exempt from the provisions of the Act that are effected through the US proxy rules or the Regulation S-K, Item 402 rules regarding executive compensation. Accordingly, foreign private issuers are not subject to the “say on pay” and golden parachute advisory vote requirements or the new disclosure requirements with respect to executive compensation, hedging, and Chairman/CEO structure. As stated above, it is unclear whether the required clawback provisions set forth in the Act will apply to foreign private issuers.
The Act endeavors to increase the transparency of the reporting of compensation paid and payable to senior executives, and to enhance stockholders’ ability to challenge executive compensation packages that are not sufficiently aligned with stockholder priorities. It remains to be seen whether stockholder activism will increase as a result of the new rules and whether the Act will have a notable impact on the level and design of executive compensation of US public companies and foreign public companies trading in the US.