The Securities and Exchange Commission (the “Commission”) has proposed rules implementing the provisions of the Dodd- Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) relating to non-binding shareholder advisory votes on the compensation of a company’s named executive officers (“NEOs”) disclosed in a company’s annual proxy statement and so-called “golden parachute” severance packages disclosed in a proxy or information statement in connection with a business combination transaction. This management alert provides a brief summary of the proposed rules and a summary of the steps that companies will have to take to comply with the new rules.
Say on Pay Votes
A company will be required to have its first say on pay vote at its first annual meeting taking place on or after January 21, 2011, the six-month anniversary of the effective date of the Dodd-Frank Act, regardless of whether the Commission has adopted final say on pay rules by then. Thereafter, a company must seek a say on pay vote at least once every one, two or three years as presumably determined by a separate shareholder advisory vote. The proposed rules include say on pay votes in the list of items that do not require the filing of preliminary proxy materials with the Commission. If final rules are not in effect prior to the date that a company mails and files its proxy materials, the Commission has stated that it will not object if the company does not file its materials in preliminary for so long as the only matters that would have required a preliminary filing under current rules are the say on pay votes.
The proposed say on pay rules require a non-binding advisory vote with respect to all compensation of a company’s NEOs under Item 402 of Regulation S-K, which includes a company’s compensation policies and procedures with respect to NEOs described in the CD&A as well as the tabular and narrative disclosure of compensation, contractual rights and severance benefits of NEOs elsewhere in the proxy. The proposed rules require the proxy to include disclosure explaining the vote is being sought pursuant to provisions of the Dodd-Frank Act, its general effect, and that it is non-binding. In addition, the proposed rules require a company, commencing in 2012, to update its CD&A to address whether and, if so, how its compensation policies and procedures take into account the results of say on pay votes.
However, the proposed rules do not require the specific use of any specific language or form of shareholders’ resolution, so companies will have to consider how to present the information in a proxy statement. The rules permit a company to seek a single advisory vote on all compensation of all of its NEOs as a group. A company also may elect to seek separate votes with respect to separate elements of compensation for all of the NEOs, such as separate votes for base salary, bonus, and equity compensation awards, or for individual NEOs, but we do not expect most companies to elect either of these options.
The proposed rules also provide that these matters are ones as to which brokers are prohibited from exercising discretionary voting without instructions from the beneficial owner pursuant to Section 957 of the Dodd-Frank Act.
In addition to the first say on pay vote that occurs at a company’s first annual meeting taking place on or after January 21, 2011, a company also must seek a separate shareholder advisory vote on whether the say on pay vote should be held every one, two or three years. A company must seek this frequency vote at least once every six years.
As is the case with say on pay votes, the proposed rules require the proxy to include disclosure explaining the vote is being sought pursuant to provisions of the Dodd-Frank Act, its general effect and that it is non-binding. The filing of preliminary proxy materials is not required for these votes.
The proposed rules require that proxy cards give shareholders four options with respect to a frequency vote: one, two or three years or to abstain from voting. However, the Commission notes in the proposing release that if proxy service providers such as Broadridge are unable to reprogram their systems in time to enable shareholders to have four choices (instead of the three choices of “for,” “against” or “abstain” mandated by current rules), the Commission will not object if a form of proxy provides a choice of one, two or three years and proxy cards without a choice marked on the frequency vote are treated as abstentions. However, if this option is chosen, management cannot vote the shares on this proposal with respect to proxies that are signed but where no option is selected.
A board of directors may, but is not required to, include its recommendation. The proxy disclosure, however, must clearly state that shareholders have four choices and are not voting to approve or disapprove the board’s recommendation. In addition, because the frequency vote is advisory, the proposed rules do not mandate a standard for determining which frequency is deemed to have been recommended by shareholders. However, if a company has adopted a policy on the frequency of say on pay votes that is consistent with the choice selected by the plurality of votes cast in the most recent frequency vote, then the proposed rules would permit a company to exclude from its proxy materials subsequent shareholder proposals recommending a standard inconsistent with that elected by a plurality or a majority of its shareholders.
The proposed rules require a company to disclose in its quarterly report on Form 10-Q for the period during which a frequency vote occurs (or in its annual reports on Form 10-K if the vote was held during the fourth quarter) the results of the frequency vote and its decisions regarding how frequently it will hold say on pay votes in light of such results. A company may elect to provide this disclosure on a voluntary basis when it reports the results of director elections under Item 5.07 of Form 8-K within four business days of the shareholder meeting.
The proposed rules would create a new paragraph (t) of Item 402 of Regulation S-K that requires enhanced disclosure relating to all golden parachute compensation arrangements in connection with certain transactions relating to an acquisition, merger, consolidation, proposed sale, or disposition of all or substantially all of a company’s assets. The disclosure would be required in proxy statements seeking approval of the issuance of shares in a merger, third party tender offers on Schedule TO and Schedule 14D-9 solicitation/recommendation statements to ensure that the disclosure is required regardless of the form of the transaction. The proposed rules would require a target company to disclose all written or unwritten agreements that it has with its NEOs or the NEOs of the acquiring company with respect to compensation that is based on or otherwise relates to such transaction. In addition, if the acquiring company is making the solicitation, then it must provide the same disclosure with respect to any agreements or understandings with its NEOs or the NEOs of the target. The proposed rules mandate tabular disclosure of the compensation arrangements covered by the new rules that is somewhat different from (and is more extensive than) the narrative disclosure of change-in-control and post-termination arrangements currently required under paragraph (j) Item 402 of Regulation S-K. The new tabular disclosure would have to quantify for each NEO:
- cash severance payments;
- accelerated stock awards, accelerated vesting option awards, and payments made in cancellation of stock and option awards;
- pension and nonqualified deferred compensation benefit enhancements;
- tax gross-ups;
- any other benefits; and
- the aggregate of all such compensation.
The proposed rules require footnote disclosure of which amounts in the table are triggered by the transaction (i.e., single trigger) and which amounts are contingent upon additional conditions, such as termination of employment (i.e., double trigger). The proposed rules would not require disclosure or quantification of amounts of previously vested awards, compensation from bona fide post-transaction employment agreements executed in connection with the merger or acquisition transaction, or compensation disclosed in the Pension Benefits Table and Nonqualified Deferred Compensation tables.
The proposed rules also would require additional narrative disclosure of:
- any material conditions or obligations applicable to the receipt of payment (including non-compete and non-solicitation agreements, their duration, and provisions regarding waiver or breach);
- a description of the specific circumstances that would trigger payment (whether lump sum or annual, their duration, and who would provide the payments);and
- any material factors regarding each agreement.
Under the proposed rules, as noted above, any proxy or information statement relating to an acquisition, merger, consolidation, proposed sale, or disposition of all or substantially all of a company’s assets must include a separate shareholder advisory vote on these compensation arrangements unless all of the transaction-related compensation agreements and understandings were the subject of a prior say on pay vote. As noted, a say on pay vote that includes only the narrative disclosure of changein- control and post-termination arrangements currently required under paragraph (j) Item 402 of Regulation S-K would not be sufficient for this purpose.
Unlike the say on pay and frequency votes, which are mandated by the Dodd-Frank Act in connection with any annual meeting on or after January 21, 2011 irrespective of any Commission rulemaking, effectiveness of the Dodd-Frank Act provisions on golden parachutes is conditioned upon the Commission adopting final rules implementing its provisions. Accordingly, the golden parachute rules will not be effective until the effective date of the Commission’s final rules, which are expected to be adopted in January 2011, although the Commission has noted that such rules may not be adopted until as late as March 2011.
Treatment of Smaller Reporting Companies
All of the proposed rules will apply to smaller reporting companies with a public float of less than $75 million, except that smaller reporting companies will continue to be exempt from the CD&A requirements. Although the Dodd-Frank Act grants the Commission the authority to exempt classes of companies from the say on pay and golden parachute rules, the Commission noted in its proposing release that shareholder rights with respect to executive compensation matters are important for shareholders in all public companies. Accordingly, the Commission has elected to not exempt any class of issuers from the proposed rules, though it has requested comment on whether such an exemption should be granted for smaller reporting companies in whole or in part.