On January 25, the SEC adopted final proxy and disclosure rules to implement provisions of Section 14A of the Exchange Act that require shareholder advisory votes on executive compensation known as "say on pay," "say on frequency" and "say on golden parachutes." Section 14A was added to the Exchange Act by Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Among the noteworthy changes to the SEC's rule proposals, the final rules require companies to report on Form 8-K their determinations regarding the frequency of say-on-pay votes, and modify the standard for excluding shareholder proposals under Exchange Act Rule 14a-8 that seek subsequent say-on-pay and say-on-frequency votes. The SEC discusses the new rules in Release Nos. 33-9178 and 34-63768.

Effective and compliance dates

The new proxy and disclosure rules will be effective on April 4, 2011. The Dodd-Frank Act, however, imposes an earlier effective date for say-on-pay and say-on-frequency votes.

  • Say-on-pay and say-on-frequency votes – Companies that are not "smaller reporting companies" under the SEC's rules must propose say-on-pay and say-on-frequency votes in proxy statements relating to the first annual or special shareholders meeting involving the election of directors held on or after January 21, 2011.

For smaller reporting companies, the SEC has deferred the initial compliance date for two years until the first shareholders meeting held on or after January 21, 2013 at which directors are elected. The SEC will not object if smaller reporting companies do not propose advisory votes on executive compensation in reliance on this exemption before the new rules become effective. (A "smaller reporting company" is generally defined for the purposes of its initial testing as an issuer that has a public float of less than $75 million or, in the case of an issuer that has no public float, has annual revenues of less than $50 million.)

  • Votes on golden parachute compensation – Companies must propose advisory votes on golden parachute compensation and provide related disclosures in merger proxy statements and other specified SEC documents relating to mergers and similar transactions filed on or after April 25, 2011.

The SEC's release contains additional transition provisions, discussed below, on which companies may rely pending effectiveness of the new rules.

Say on pay

Dodd-Frank requirement. Section 14A(a)(1) of the Exchange Act requires companies to present to their shareholders, not less frequently than once every three years, an advisory resolution to approve executive compensation as disclosed in the proxy statement for an annual or other shareholders meeting for which the SEC's proxy rules require compensation disclosure pursuant to Item 402 of Regulation S-K. The rule implementing this provision reflects the SEC's view that a say-on-pay vote is required only with respect to a shareholders meeting for which proxies will be solicited for the election of directors.

SEC rules. A new Rule 14a-21(a) under the Exchange Act will implement the say-on-pay vote requirement. The final rule modifies the SEC's proposal to clarify that a say-on-pay vote will be required not less frequently than once every three calendar years, rather than within three years after the date of the most recent prior say-on-pay vote.

Under Rule 14a-21(a), the say-on-pay proposal must indicate that the shareholders are asked to approve the compensation of the company's named executive officers required to be disclosed by Item 402 of Regulation S-K. Accordingly, the say-on-pay vote must cover executive compensation as disclosed in the Compensation Discussion and Analysis (CD&A) and the compensation tables and other narrative executive compensation disclosures. (Smaller reporting companies, which are not otherwise required to provide a CD&A, will not have to include a CD&A in their proxy statements to comply with Rule 14a-21(a).) Rule 14a-21(a) does not specify a required form for the say-on-pay resolution referred to in the rule. In response to comments on the rule proposal, the SEC added to the final rule the following "non-exclusive example" of a resolution that will satisfy the rule's requirements:

RESOLVED, that the compensation paid to the company's named executive officers, as disclosed pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis, compensation tables and narrative discussion, is hereby APPROVED.

The say-on-pay vote will not extend to director compensation. In addition, the vote will not cover the company's compensation policies and practices as they relate to risk management and risk-taking incentives unless (and then only to the extent) that the company addresses those risks in the CD&A as a material aspect of its compensation policies and practices for its named executive officers.

The amendments make the following related changes to the SEC's proxy and disclosure rules:

  • Proxy disclosure of effect of vote – A new Item 24 of Schedule 14A, which sets forth required proxy disclosures, will require companies to explain in the proxy statement the general effect of the say-on-pay vote, such as whether the vote is non-binding. (Section 14A(c) of the Exchange Act expressly provides that the say-on-pay vote will not be binding on the company or its board of directors.) Companies will not have to disclose in the proxy statement the results of prior say-on-pay votes or any action they intend to take in response to the current vote.
  • CD&A disclosure of the effect of most recent say-on-pay vote – An amendment to Item 402(b) of Regulation S-K will require companies (other than smaller reporting companies) to disclose in the CD&A whether and, if so, how they have considered the results of the most recent say-on-pay vote in administering their compensation policies and decisions. The new disclosure will have to address how that consideration has "affected" the company's compensation policies and decisions. Although the rule will require this disclosure only with respect to the most recent say-on-pay vote, the SEC noted that, under the principles-based approach to the CD&A, companies should discuss any material consideration they have given to the results of earlier say-on-pay votes.
  • No requirement to file preliminary proxy statement – An amendment to Exchange Act Rule 14a-6(a) will exclude the say-on-pay vote from the types of proposals that require the filing of a preliminary proxy statement. The SEC stated that it will not object to reliance on this exclusion before the amendment becomes effective. The SEC has extended the filing exclusion to proposals for shareholder advisory votes on executive compensation that are not required by Exchange Act Section 14A.
  • Non-routine matter for broker votes – The say-on-pay vote will be an executive compensation matter on which brokers will not be permitted to vote uninstructed shares of exchange-listed companies.

Say on frequency

Dodd-Frank requirement. Section 14A(a)(2) of the Exchange Act requires companies to conduct, not less frequently than once every six years, a separate shareholder advisory vote on a resolution to determine whether the company will hold a say-on-pay vote every year, every two years or every three years. A frequency proposal must be included in a proxy statement for an annual or other shareholders meeting for which the SEC's proxy rules require compensation disclosure and for which proxies will be solicited for the election of directors.

SEC rules. A new Rule 14a-21(b) under the Exchange Act will implement the requirement for say-on-frequency votes. A frequency proposal under Rule 14a-21(b) must offer shareholders the choice to vote for holding a say-on-pay vote every year, every two years or every three years, or to abstain from voting on the proposal. The final rule modifies the proposal to clarify that a say-on-frequency vote will be required at least once during the six calendar years following the prior frequency vote, rather than within the six-year period after the date of the most recent frequency vote.

The Rule 14a-21(b) provisions, which state that companies "shall" include a "separate resolution" subject to the frequency vote, raise the issue of whether the frequency proposal must be presented as a formal resolution. Various commenters on the rule proposal observed that a frequency-vote resolution will be awkward to frame in light of the fact that shareholders will have a choice among three frequencies or abstaining from the frequency vote. Commenters asked the SEC to clarify whether the say-on-frequency proposal would have to be presented in the form of a resolution and to add to the rule non-exclusive examples of resolutions that would satisfy the rule's requirements. In adopting the rule substantially as proposed, the SEC stated that it did not consider it necessary to provide a form of resolution in the final rule, but did not expressly address whether the frequency proposal must be presented with a "Resolved" clause. After announcement of the new rules, a member of the SEC staff informally advised us that a frequency proposal is not required to be presented as a formal resolution so long as the proposal is clearly stated. Many companies have chosen not to formulate the say-on-frequency proposal in the form of a resolution.

Although the Rule 14a-21(b) does not require boards of directors to make a recommendation on the frequency vote, the SEC indicated that it expects many boards to provide a recommendation. The SEC noted that, if its board makes a recommendation, the company must disclose to shareholders that they are not voting to approve or disapprove the board's recommendation, but rather are voting on the three frequency alternatives or abstention.

Other changes to the SEC's proxy and disclosure rules relating to say-on-frequency votes include the following:

  • Disclosures in proxy statement – The new Item 24 of Schedule 14A will require companies to explain the general effect of the say-on-frequency vote, such as whether the vote is non-binding. (Section 14A(c) of the Exchange Act expressly provides that the say-on-frequency vote will not be binding on the company or its board of directors.) After the initial say-on-frequency vote, companies will be required to disclose in their proxy statements the current frequency of their say-on-pay votes and when the next say-on-pay vote will occur.
  • Amendments to form of proxy – Rule 14a-4 under the Exchange Act, which governs the form of proxy, will be amended to facilitate the presentation of the frequency vote in the proxy card. The rule currently provides that, on proposals other than the election of directors, shareholders must be given the choice to cast "for," "against" or "abstain" votes. The amendment will add an exception to this requirement and allow shareholders to vote for a frequency of one, two or three years, or to abstain from voting on the proposal. The SEC will not object if, before the amendment becomes effective, the form of proxy for a frequency proposal provides shareholders with a means to specify a choice among the four alternatives.

In response to comments on the Rule 14a-4 amendments, the SEC indicated that a company may vote signed proxies with no voting instructions in accordance with management's recommendation if the company follows the existing requirements of Rule 14a-4 to (1) include a recommendation for the frequency of say-on-pay votes in the proxy statement, (2) permit abstention on the proxy card and (3) include language regarding how uninstructed shares will be voted in bold on the proxy card.

  • Report of frequency determination in Form 8-K – Under the rules as originally proposed, companies would have had to disclose, in the Form 10-Q or Form 10-K report covering the period in which the say-on-frequency vote occurred, their decision regarding how frequently they will conduct say-on-pay votes in light of the results of the frequency vote. In the final rules, the SEC moved this disclosure requirement to Form 8-K in a new paragraph (d) to Item 5.07. Companies presently are required to disclose under Item 5.07 the preliminary results of shareholder votes within four business days after the day on which the shareholder meeting ends and the final voting results within four business days after the date on which the final results are known. Under the amended Form 8-K, if the company does not report its position on say-on-pay frequency in its initial Item 5.07 filing following the frequency vote, it will have to disclose its frequency determination in an amendment to that filing no later than 150 calendar days after the date of the end of the meeting in which the vote took place, but in no event later than 60 calendar days before the deadline for the submission of shareholder proposals under Rule 14a-8 for the next annual meeting.

To facilitate the reporting of say-on-frequency votes, the SEC adopted a technical amendment to Item 5.07(b) of Form 8-K to clarify that, with respect to the frequency proposal, the company will be required to disclose the number of votes cast for each of one year, two years and three years, as well as the number of abstentions.

  • No requirement to file preliminary proxy statement – An amendment to Exchange Act Rule 14a-6(a) will exclude the say-on-frequency vote from the types of proposals that require the filing of a preliminary proxy statement. The SEC will not object to reliance on this exclusion before the amendment becomes effective.
  • Non-routine matter for broker votes – The say-on-frequency vote will be an executive compensation matter on which brokers will not be permitted to vote uninstructed shares of exchange-listed companies.

Exclusion of Rule 14a-8 shareholder proposals

An amendment to Rule 14a-8 under the Exchange Act will permit companies to exclude certain shareholder proposals that seek a vote on the same matters as the advisory votes on executive compensation conducted under the new proxy rules. The amendment will add a note to Rule 14a-8(i)(10), which provides that an issuer may exclude a shareholder proposal that has already been "substantially implemented." The note will clarify that a company may rely on Rule 14a-8(i)(10) to exclude a shareholder proposal from its proxy materials seeking a say-on-pay vote or a say-on-frequency vote if (1) the company has adopted a policy on the frequency of say-on-pay votes (one, two or three years) that is consistent with the choice selected by the majority vote of shareholders in the most recent frequency vote and (2) the company conducts a frequency vote at least once every six years as required by Section 14A(a)(2) of the Exchange Act.

The final amendment imposes a more stringent exclusion standard than the proposal, which would have permitted exclusion of the shareholder proposal if the frequency adopted by the company had received a plurality of the votes cast. The SEC acknowledged that, because Rule 14a-21(b) requires that shareholders be allowed to vote on three different frequencies, it is possible that no single frequency will receive a majority of the votes cast. In that case, a company would not be able to rely on the Rule 14a-8 amendment to exclude subsequent shareholder proposals regarding say-on-pay matters even if it adopts a policy on frequency that is consistent with a plurality of the votes cast. The SEC said that it was persuaded by comments that use of a plurality rather than a majority standard would unduly restrict the right of shareholders to make proposals related to executive compensation.

Say on golden parachutes

Dodd-Frank requirement. Section 14A(b)(1) of the Exchange Act requires persons soliciting proxies or consents for shareholder approval of an acquisition, merger, consolidation or proposed sale or disposition of all or substantially all of an issuer's assets to provide disclosure of any agreements or understandings that the soliciting person has with its named executive officers (or that it has with the named executive officers of the acquiring issuer) concerning compensation that is based on or otherwise relates to the transaction. In addition, Section 14A(b)(1) requires disclosure of any such "golden parachute" agreements or understandings that an acquiring issuer has with its named executive officers and that it has with the named executive officers of the target company in any such transaction for which the acquiring issuer seeks shareholder approval through a proxy or consent solicitation. Under Section 14A(b)(2) of the Exchange Act, a separate shareholder advisory vote to approve these golden parachute agreements or understandings will be required unless they previously have been the subject of an advisory say-on-pay vote pursuant to Section 14A(a)(1).

SEC rules. A new Rule 14a-21(c) under the Exchange Act will implement Exchange Act Section 14A(b)(2) by requiring a registrant that solicits proxies or consents for shareholder approval of a merger or other specified transaction to conduct a separate shareholder advisory vote on golden parachute agreements or understandings disclosed in a new Item 402(t) of Regulation S-K adopted in accordance with Section 14A(b)(1). The SEC extended the Item 402(t) disclosures to golden parachute agreements and understandings between a soliciting target company's named executive officers and the acquiring issuer, even though the disclosures are not required by Section 14A(b)(1). Accordingly, Rule 14a-21(c) expressly exempts those agreements and understandings from the requirement for a separate shareholder advisory vote.

As provided in Exchange Act Section 14A(c), the shareholder vote to approve golden parachute agreements or understandings will not be binding on the company or its board of directors. Rule 14a-21(c) does not prescribe a form of resolution for presentation of the proposal.

The new Item 402(t) will require disclosure of all golden parachute compensation (whether written or unwritten) that a named executive officer would receive based on or otherwise related to the triggering transaction. The disclosure will have to be presented in both tabular and narrative form. The Item 402(t) table will present, in separate columns, quantitative disclosure of the following categories of compensation payable to each named executive officer, as well as the total of all such compensation in a final column:

  • Cash severance payments (such as base salary, bonus, and pro-rata non-equity incentive plan compensation payments);
  • Dollar value of accelerated stock awards, in-the-money option awards for which vesting would be accelerated, and payments in cancellation of stock and option awards;
  • Pension and nonqualified deferred compensation benefit enhancements;
  • Perquisites and other personal benefits and health and welfare benefits;
  • Tax reimbursements (such as Internal Revenue Code Section 280G tax gross-ups); and
  • Additional elements of compensation not specifically includible in the other columns of the table.

Footnotes to the table will have to identify separately the amounts attributable to "single trigger" payment arrangements and those attributable to "double trigger" payment arrangements.

If a compensation agreement or understanding relating to a transaction previously has been the subject of a periodic say-on-pay vote under Rule 14a-21(a), a say-on-golden parachute vote will not have to be duplicated when the company seeks shareholder approval of the transaction. For the agreement or understanding to have been subject to a previous say-on-pay vote, it must have been presented in a manner that satisfied the requirements of new Item 402(t), rather than existing Item 402(j) of Regulation S-K, which generally requires disclosure in annual meeting proxy statements of amounts payable in connection with employment terminations and a change in control of the company. Among the differences from Item 402(t), Item 402(j) does not require tabular presentation of this information, permits exclusion of some items that do not discriminate in scope in favor of executives or that involve de minimis amounts, and does not require presentation of a total of all golden parachute amounts payable to the named executive officers.

The SEC's final rules extend the Item 402(t) disclosure requirements beyond merger proxy statements to specified types of information statements, registration statements, tender offer documents and other SEC filings for mergers and similar transactions of the type identified in Exchange Act Section 14A(b)(1) which do not require the solicitation of shareholder votes or consents. Although the Dodd-Frank Act does not require such disclosure in these types of filings, the SEC justified the broader reach of its rules as appropriate to minimize the disparity in disclosure of golden parachute compensation that otherwise could result based solely on the form of the transaction.