On January 25, 2011, the Securities and Exchange Commission issued a final rule to implement Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rule was passed by a 3-to-2 vote of the Commissioners. Section 951 of the Dodd-Frank Act requires public reporting companies to provide nonbinding shareholder advisory votes on executive compensation (say-on-pay and say-on-frequency votes) and on golden parachute compensation arrangements in a merger or similar transaction. The say-on-pay and say-on-pay frequency votes described in this legal alert will be required for all public reporting companies, other than smaller reporting companies, for any annual or special meeting at which directors are to be elected, occurring after January 21, 2011. The golden parachute advisory vote described below will be required in all initial filings of a “merger proxy” or similar transaction filing made on or after April 25, 2011.

The Final Rule as Compared to the Proposed Rule

The SEC considered comments received on the proposed rule and made a number of modifications and amendments in the final rule, including:

  • providing a two-year deferral for smaller reporting companies1 for say-on-pay and say-on-pay frequency votes, but no deferral from the requirements to provide golden parachute advisory votes
  • changing the disclosure requirement to Form 8-K disclosure under Item 5.07 regarding the company’s decision as to the frequency of say-on-pay votes on executive compensation following each shareholder say-on-frequency vote
  • clarifying that say-on-pay and say-on-frequency votes will be required only at an annual meeting, or a special meeting, in lieu of an annual meeting, at which directors are to be elected
  • permitting a company to exclude a shareholder proposal that would provide for a say-on-pay vote at that or at future meetings, or that relates to the frequency of say-on-pay votes, as long as the company has adopted a policy on the frequency of say-on-pay votes that commits the company to select a say-on-pay vote frequency that is consistent with the majority shareholder vote (rather than a plurality vote, as in the proposed rule) at the most recent meeting
  • requiring companies to include disclosure, for purposes of the golden parachute vote,regarding compensation arrangements that are based on or otherwise relate to the acquisition transaction for named executive officers of both the target company and the acquiring company  

Say-on-Pay Votes

Rule 14a-21(a) specifies the procedures for providing the separate nonbinding, advisory say-on-pay vote, at least once every three years, to approve the compensation paid to named executive officers (NEOs), as such compensation is disclosed in accordance with the requirements of Item 402(a)(3) of Regulation S-K, including Compensation Discussion & Analysis (CD&A), the compensation tables, and other narrative executive compensation disclosures. The final rule does clarify that this say-on-pay vote must be included in the proxy statement only if directors are to be elected at the meeting. Like the proposed rule, the final rule does not specify the language or form of resolution that is required to be used for such shareholder vote. However, the final rule states that a vote to approve a proposal on different terms, such as a vote that seeks approval only of compensation policies and procedures, is not sufficient.

As noted above, smaller reporting companies have a two-year deferral on complying with this say-on-pay vote requirement. In addition, as in the proposed rule, smaller reporting companies are not required to provide CD&A disclosure in order to comply with Rule 14a-21.

Only executive compensation for NEOs is covered—no shareholder approval is required for director compensation, or for any disclosure regarding compensation policies and practices as they relate to risk management and risk-taking incentive compensation for employees generally.

The proxy statement disclosure will need to include a brief explanation of the general effect of the say-on-pay vote, such as whether the vote is non-binding.

The final rule did not alter the disclosure requirement regarding say-on-pay votes. Companies will need to include mandatory disclosure, under Item 402(b) of Regulation S-K, of whether and, if so, how, a company’s compensation policies and decisions considered the results of the most recent (and earlier, if material) say-on-pay vote.

Say-on-Frequency Votes

Public reporting companies are also required, beginning with the first annual or special meeting held after January 21, 2011, to elect directors, and then at least once every six years following the prior frequency vote, to conduct a separate shareholder advisory vote on the frequency of presenting say-on-pay votes. Under the final rule (new Rule 14a-21(b) and amended Rule 14a-4), shareholders must be given four choices on the company’s proxy card: whether the say-on-pay vote should occur every one, two, or three years, or to abstain from voting on the matter. A company may vote uninstructed proxy cards in accordance with management’s recommendation for the frequency vote only if the company follows the existing requirements of 14a-4.

Smaller reporting companies are provided a two-year deferral from this say-on-frequency vote requirement.

Future proxy statements will need to include disclosure about the company’s current frequency of say-on-pay votes and when the next scheduled say-on-pay vote will occur. In addition, after each say-on-frequency vote is held, the company will need to disclose, on Form 8-K, the company’s decision as to the frequency of say-on-pay votes following each say-on-frequency vote. The company must file this Item 5.07 Form 8-K no later than 150 calendar days after the date of the annual or special meeting at which the vote took place. Such 150-day period may need to be accelerated so that the disclosure is provided at least 60 calendar days prior to the deadline for submission of Rule 14a-8 shareholder proposals for the subsequent annual meeting. This represents a change from the proposed rule, which would have required disclosure on Form 10 Q or Form 10-K filed for the period in which the annual or special meeting occurred, and provides companies with more time to evaluate the say-on-frequency vote.

Under Rule 14a-21(b), the proxy statement will need to include a brief explanation of the general effect of the say-on-frequency vote, such as whether the vote is nonbinding.

Amendment to Shareholder Proposal Rule

Rule 14a-8 (covering shareholder proposals) is amended to add a note to Rule 14a-8(i)(10) to permit a company to exclude a shareholder proposal that provides for a say-on-pay vote at that or at a future meeting, or that relates to a say-on-frequency vote, as long as the company has adopted a policy on the frequency of say-on-pay votes that commits the company to select a say-on-pay vote frequency that is consistent with the majority vote of the shareholders on the say-on-frequency resolution provided at the most recent meeting. This portion of the final rule is not likely to provide clarity to companies presented with shareholder proposals on this topic; for example it is possible that a majority decision of shareholders will not be achieved on the say-on-frequency vote, so it appears that a company in that situation may find itself needing to include a shareholder proposal in a subsequent proxy statement promoting a different frequency vote, or a different type of say-on-pay vote.

Golden Parachute Arrangements

The Dodd-Frank Act requires a company soliciting votes to approve a merger, acquisition, consolidation, or proposed sale or other disposition of all or substantially all of its assets, or a similar transaction, to seek an advisory say-on-pay shareholder vote on any agreements or understandings that the target company or the acquiring company has with the NEOs of the target or the acquirer. This vote relates to compensation that is based on or otherwise relates to the subject transaction. Such vote must include the aggregate total of all such compensation that may (and the conditions upon which it may) be paid or become payable to or on behalf of such NEOs.

This Dodd-Frank requirement is implemented through new Item 402(t) of Regulation S-K, which sets forth these disclosure requirements. Proposed Item 402(t) disclosures must be presented in a clear and simple form in both tabular and narrative format. The tabular disclosure would require quantification with respect to any agreements or understandings, whether written or unwritten, between each NEO and the acquiring company or the target company, concerning any type of compensation, whether present, deferred, or contingent, that is based on or otherwise relates to the subject acquisition, merger, consolidation, or other similar transaction. The table must quantify cash severance, equity awards that are accelerated or cashed out, pension and nonqualified deferred compensation enhancements, perquisites, tax reimbursements, and any other compensation related to the transaction. This would not include bona fide post-transaction employment agreements to be entered into in connection with the transaction. The final rule provides companies with the ability to add additional NEOs or additional columns or rows to the tabular disclosure to provide additional information about such change in control payments. However the final rule also retains the prohibition on any exclusions for items such as de minimis perquisites and other personal benefits that are permitted under other Item 402 disclosure requirements.

The final rule does not require companies to use any specific language or form of resolution in seeking such golden parachute vote. The results of the shareholder vote will not be binding on the company or its board of directors.

These non-binding shareholder votes will also need to be included in solicitation material seeking shareholder approval of an acquisition, merger, consolidation, or sale of all or substantially all assets in a going-private transaction or third party tender offer. However, a bidder in a third party tender offer would not need to provide information about a target’s golden parachute arrangements, rather the company must provide that information in its Schedule 14D-9.

A company would not be required to include this golden parachute vote in a merger proxy statement if disclosure of such compensation had been included in the Item 402 disclosure that was subject to a prior say-on-pay shareholder vote. This exception would be available only if the golden parachute arrangements remained in effect and had not been modified. Modified or new portions of such an arrangement are subject to the separate golden parachute shareholder vote. The company would need to provide two separate tables—disclosing all golden parachute compensation in one table and only the new or modified arrangements in the second table. Item 402(t) disclosure is not required in annual or special meeting proxy statements, so a company wanting to take advantage of this exception would need to include Item 402(t) disclosure voluntarily.

As noted above, smaller reporting companies will be required to comply with this golden parachute vote requirement at the same time as other public reporting companies. These requirements will apply to the applicable initial filings made on or after April 25, 2011.

Other Issues to Consider

The final rule also confirms the following:

  • Shareholder advisory votes on executive compensation, including say-on-pay and say-on-frequency votes, do not trigger the requirement to file a preliminary proxy statement. The transition rules included in the final rule release provide comfort on this topic until the final rule becomes effective.
  • Broker discretionary voting of uninstructed shares is not permitted for these say-on-pay votes.  
  • A company that has received financial assistance under the Troubled Asset Relief Program (TARP), which itself mandates annual say-on-pay shareholder votes, is not required to comply with the say-on-frequency vote mandate until the company has repaid all indebtedness under TARP.