On May 20, 2010, the U.S. Senate passed the Restoring American Financial Stability Act of 2010,1 or RAFSA, sponsored by Senator Christopher Dodd (D-CT) (the Senate Bill). The Senate Bill must now be reconciled with Rep. Barney Frank’s Wall Street Reform and Consumer Protection Act of 2009 introduced last December.2 RAFSA represents an evolution of various bills introduced in the Senate last year to reform the financial services industry following the 2008 market meltdown and the passage of TARP.
As widely reported, the Senate Bill is sweeping in its reform of the financial services industry generally. Less publicized, however, are certain sections that, if enacted into law, would require the Securities and Exchange Commission (SEC) to adopt further rules under the Securities Exchange Act of 1934 (the Exchange Act) addressing key aspects of public companies’ corporate governance processes, particularly executive compensation and stockholder voting. In addition, the Senate Bill would provide a mechanism for ensuring “accredited investor” thresholds (as defined under the Securities Act of 1933 (the Securities Act)) remain current and relevant, as well as certain other changes. This GT Alert summarizes these key proposals.
Key Corporate Governance Provisions
The Senate Bill adds new Section 14B to the Exchange Act, which would subject companies with securities listed on a national securities exchange to a majority voting standard for uncontested elections. A plurality standard would be allowed for contested elections. A director receiving less than a majority of votes cast would be required to tender his or her resignation. If the board accepts the resignation, it must then determine and publicly disclose a reasonable effective date for such resignation. The board can reject the resignation by unanimous vote and, thereafter, must disclose its decision within 30 days, including an analysis of why such rejection is in the best interests of the company and its stockholders. In adopting these rules, the SEC will have the ability to provide exemptions for certain companies
The SEC will be authorized, but not required, to adopt rules allowing stockholders to nominate directors through the company’s proxy solicitation materials. In June 2009, the SEC proposed rules allowing stockholder nominations of directors using a company’s proxy solicitation materials, which were reissued in December 2009 for further comment. It is widely expected that final rules will be issued prior to September 2010.
Broker Discretionary Voting
Broker discretionary voting in director elections, executive compensation or any other significant matter would be prohibited in accordance with new rules to be adopted by the SEC. In 2009, the New York Stock Exchange, Inc. adopted revised Rule 452, which prohibited broker discretionary voting in director elections.3 The Senate Bill would expand the action taken by the NYSE in an apparent effort to promote direct stockholder participation.
Stockholder ‘Say on Pay’
Consistent with recent reform movements in the U.K. and elsewhere, the Senate Bill requires companies to include an annual non-binding stockholder vote on executive compensation of named executive officers. The measure, which would be embodied in new Section 14A to the Exchange Act, would apply to any stockholder meeting held six months after RAFSA’s enactment. We note that an increasing number of U.S. corporations have voluntarily adopted such measures in the past few years and, like their overseas counterparts, generally receive the desired confirmatory vote.
Compensation Committee Independence and Advisors
Under new Section 10C of the Exchange Act, compensation committee members of listed companies would be required to meet heightened independence standards, taking into consideration any consulting, advisory or other compensatory fees paid to such person, as well as any affiliations with the company, its subsidiaries or an affiliate of a subsidiary. The independence and relationships of consultants, legal counsel and other advisors must be considered and approved by the committee prior to engagement. Compensation committees will also be directly responsible for the appointment, compensation and oversight of such consultants. Certain companies may be exempt from these requirements and related disclosure requirements.
Under new Section 10D of the Exchange Act, all listed companies would be required to adopt a clawback policy providing for a three-year lookback from the date the company is required to restate its financial statements as a result of material non-compliance with financial reporting requirements. Essentially, the clawback is designed to recapture excess cash or incentive-based compensation (including stock options) paid to any current or former executive. Excess compensation would be defined to include compensation in excess of that which would have been paid under the financial results, as restated.
Proxy Disclosure Requirements
The SEC would be required to adopt additional rules pursuant to Sections 10C and 14 of the Exchange Act to provide greater transparency of executive compensation. In addition to recent SEC rule changes to enhance disclosure of executive compensation policies and board structure in Exchange Act reports, the following disclosures are included in RAFSA4:
- The reasons why the positions of Chairman and CEO have been combined or separated;
- Whether the compensation committee engaged a compensation consultant, whether such work raised a conflict of interest and how such conflict is being addressed;
- The relationship between compensation of the company’s named executive officers and the company’s financial performance (which may be done graphically);
- The (A) annual total compensation of the CEO and (B) median of the annual total compensation of all employees other than the CEO, and the ratio of (A) to (B); and
- Whether employees and directors are allowed to hedge any equity securities granted to or otherwise held, directly or indirectly, by them.
Amendments to Securities Act Rules
The Senate Bill includes amendments to rules adopted under the Securities Act, including:
Update to the Accredited Investor Standards
The Senate Bill would provide a mechanism designed to ensure that the standards for “accredited investor,” as defined in Rules 215 and 501(a) under the Securities Act, are current and relevant over time. The definition is significant to the availability of certain exemptions from the registration requirements of Section 5 of the Securities Act and, in particular, the safe harbor provided by Regulation D for certain private offerings of securities. Specifically, the Senate Bill changes the calculation of net worth used to determine whether a natural person will be deemed an “accredited investor” under the Securities Act. For at least the first four years following enactment of RAFSA, a natural person must have an individual net worth, or joint net worth with that person’s spouse, of at least $1,000,000, determined excluding the value of the person’s primary residence. Not less than every four years thereafter, the SEC would be required to review the definition as it applies to natural persons and determine if further adjustment or modification is appropriate for the protection of investors, in the public interest, and in light of the economy.
Disqualifying Felons and Other Bad Actors from Regulation D Offerings
The Senate Bill would require the SEC to issue rules, not later than one year after the date of enactment of RAFSA, that disqualify offerings made under Rule 506 by “bad actors.” The disqualification rules are to be substantially similar to those under Section 262 of Regulation A (the conditional small issues exemption) under the Securities Act and would disqualify any offering or sale of securities by a person that:
- is subject to a final order of a state securities, banking or insurance authority, an appropriate federal banking agency, or the National Credit Union Administration, that:
- bars the person from (1) association with an entity regulated by such authority; (2) engaging in the business of securities, insurance, or banking; or (3) engaging in savings association or credit union activities; or
- constitutes a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct within the 10-year period ending on the date of the filing of the offer or sale; or
- has been convicted of any felony or misdemeanor in connection with the purchase or sale of any security or involving the making of any false filing with the SEC.
Additional changes are included in the Senate Bill that would impact broker-dealers, investment advisors and other industry participants, including new disclosure requirements to retail investors prior to purchase, mandatory arbitration clauses, and extension of SEC authority for industry bars relating to violations of the Exchange Act or the Investment Advisors Act of 1940.