The Securities and Exchange Commission has issued new rules to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act designed to give shareholders the chance to voice their approval or disapproval of public company executive compensation. Dodd-Frank and the new rules require public companies to conduct a separate shareholder advisory vote on the compensation of certain of their executive officers (a so-called “say on pay” vote). Companies must also give shareholders the option, at least once every six years, to vote on the frequency of the say on pay vote (a “say on frequency vote”) – that is, whether they want a say on pay vote every one, two or three years. Finally, companies soliciting votes to approve a merger, acquisition, going private, or other similar transaction have to provide disclosure of certain “golden parachute” compensation arrangements; and in certain circumstances, conduct a separate shareholder vote regarding such golden parachute compensation arrangements.


Say on Pay

The new rules require public companies to offer shareholders the opportunity to vote on the compensation of “named executive officers” disclosed in the proxy statement for each annual shareholders meeting. Named executive officers are generally the CEO, CFO and next three most highly paid executive officers (or the CEO and next two most highly paid executive officers for smaller reporting companies). The vote will cover the disclosure required by Regulation S-K, Item 402, namely the Compensation Discussion and Analysis (CD&A) (though not for smaller reporting companies since they are not required to provide a CD&A section), compensation tables and related narrative disclosures required in proxy statements. Disclosure about director compensation or risk involved with general employee compensation programs is not subject to the say on pay vote. The rules do not require specific language for the vote itself. Though the SEC has provided an illustrative example, the SEC allows for “plain English” wording as long as the vote covers the required compensation items. Following the first year of compliance, future CD&A sections will need to also indicate how a company considered the results of the most recent say on pay vote in determining compensation policies and decisions and, if so, how that consideration affected the company’s policies and decisions.

Say on Frequency

The say on frequency vote will give shareholders the opportunity to vote, at least once every six calendar years, on whether they desire the frequency of the say on pay vote to be every one, two, or three calendar years. Shareholders must also be given the alternative to abstain from the say on frequency vote. Boards of directors may recommend a particular frequency and make supporting statements, but all of the choices must be presented to shareholders on the proxy card. As with say on pay, the SEC has not required specific language for the frequency vote. In fact, the SEC has clarified that the say on frequency vote does not need to be in the form of a resolution.

What are Companies Required to Do?

The votes are nonbinding – that is, companies do not necessarily need to take action if the shareholders vote “Against” the company’s compensation disclosures or pick a frequency that differs from what the company adopts. For both say on pay and say on frequency, companies will need to briefly explain in their annual proxy statements the effect of these votes, including their nonbinding nature and, following the first year of compliance, indicate when the next say on pay vote will occur and the current frequency the company has adopted.

Under Dodd-Frank, companies are required to hold say on pay and say on frequency votes at their first annual meeting of shareholders occurring after January 21, 2011. Though the SEC’s more detailed rules don’t take effect until April 4, 2011, most companies will now start following them. The rules exempt smaller reporting companies (generally those with a public float of less than $75 million) from the requirements to conduct say on pay and say on frequency votes until their annual meeting occurring on or after January 21, 2013.

Should Companies Recommend an Annual, Biennial, or Triennial Vote?

Public companies’ Boards will need to consider whether to recommend that their shareholders vote on executive compensation every one, two, or three years, or to make no recommendation. If a Board makes a recommendation, it must also make clear that the shareholders are voting among all of the choices (1, 2, 3 years or abstain), not whether or not to approve the Board’s specific recommendation. If a Board declines to make a recommendation, the company will lose discretionary authority to vote shares represented by proxies that are returned without indicating a frequency.

In making a recommendation to their shareholders regarding the say on frequency vote, public companies should consider the design of their current pay practices and policies, the frequencies adopted by peer group companies, the preferences of their shareholders, particularly large or institutional investors, and the influence of proxy advisory firms on the votes of shareholders.

An annual vote might be appropriate when executive compensation determinations are made on an annual basis. In addition, some investor groups and proxy advisory firms, including Institutional Shareholder Services (ISS), prefer annual votes because they expect the high frequency to improve communications between shareholders and management and provide the highest level of accountability. If a less frequent vote is adopted, proponents of annual votes fear that companies may create different executive compensation policies for voting years versus nonvoting years. Further, annual votes may help “shield” Board or compensation committee members from negative votes by shareholders – if shareholders are upset with some aspect of executive compensation, they can express their view in the say on pay vote; with a non-annual vote, that avenue will not be available in years between the say on pay votes and shareholder unrest may be directed at Board members up for reelection. However, preparing for an annual vote means time and resources must be devoted each year to the relevant portions of the proxy statement and shareholder outreach.

Companies that compensate executives based on long-term performance or under plans with a multi-year measurement period should consider a triennial vote, as it could allow shareholders to more thoughtfully evaluate executive compensation policies with respect to the overall performance of the company during the full period. The administrative burden of a triennial vote would be significantly lowered compared to an annual or biennial vote, though the administrative costs and time burdens associated with an annual or biennial vote may diminish over time.

A biennial vote might be a good compromise for companies that cannot decide between an annual and triennial vote. However, if similar companies in a company’s industry adopt annual or triennial voting, the company may not wish to stand out by having a different frequency from the norm.

Although the results of the say on frequency vote are nonbinding, a company may exclude a future shareholder proposal that seeks an advisory say on pay vote or that relates to a say on frequency vote, if the company has adopted the frequency that is consistent with the majority of votes cast in the company’s most recent say on frequency vote. After each annual shareholders meeting, companies must disclose their decision on frequency in an amendment to their Current Report on Form 8-K that reports the meeting results. The amendment may be filed any time up to 150 days after the meeting, but no later than 60 days prior to the deadline for submitting proposals for the next annual shareholders meeting.

What Else Should Companies Be Thinking About?

With respect to say on pay, Boards should be analyzing the compensation packages of executive officers and revisiting the overall compensation disclosures contained in their company’s proxy statements, anticipating components that could potentially be controversial to their shareholder bases. Companies will want to make their case in support of their compensation programs in clear, concise language, including if appropriate an executive summary in CD&A. Shareholders will undoubtedly be looking for disclosure about the relationships between executive pay and company performance and strategy. Additional graphs and tables may be helpful, even if not mandated. Management or compensation committees may also want to communicate with key shareholders in advance of shareholders meetings to help identify and address any compensation concerns. Further, compensation committees should review their charters to determine if they want to add any provisions related to say on pay or say on frequency (such as committee responsibility for recommending to the Board the frequency to recommend to shareholders).

What are Say on Golden Parachutes Votes and What Related New Disclosures are Required?

The new rules also require an advisory say on “golden parachutes” vote at any shareholder meeting relating to a merger, acquisition, or other similar transaction. Like the say on pay and say on frequency votes, the say on golden parachute vote is nonbinding.

The new vote will be with respect to disclosures contained in a new table to appear in the proxy statement related to the subject transaction being voted upon. The enhanced disclosure - regarding all compensation based upon or otherwise related to the subject transaction - will be in both narrative and tabular formats and the details required go beyond existing annual disclosure requirements with respect to severance and other benefits. The disclosure will need to include descriptions of any material conditions regarding the relevant arrangements, including noncompete, or non-solicitation undertakings. This disclosure must also appear in company tender offer documents and going private documents, even if those transactions are not subject to a shareholder vote. However, third party tender offer documents do not need to include the new disclosure, nor do most filings involving foreign private issuers. The arrangements to be voted upon will cover all compensation arrangements between the soliciting company (typically the target of the merger or acquisition) and any named executive officer of either the target or the acquiring company that are based upon or otherwise relate to the subject transaction. The disclosures to be provided will further need to include any arrangements between the acquiring company and the target’s or acquiring company’s named executive officers, though these additional arrangements will not be subject to the say on golden parachutes vote.

Companies are required to comply with the say on golden parachute vote and the disclosure requirements in proxy statements and other schedules and forms initially filed on or after April 25, 2011. In contrast to the say on pay and say on frequency votes, smaller reporting companies are subject to the say on golden parachute vote and disclosure requirements.

The say on golden parachute vote is not required in an M&A-related proxy statement if disclosure regarding such golden parachute arrangements was previously the subject of a regular say on pay vote at an annual meeting of shareholders. However, for this “pre-approval” to work, no changes may subsequently be made to the applicable arrangements or else additional approval will be required. Further, including the more extensive golden parachutes disclosures in an annual proxy statement may create a more negative impression of compensation that adversely impacts say on pay voting. This could, for example, reduce support for say on pay if shareholders or advisory services perceive a company’s golden parachute arrangements to be problematic.