On May 20, 2010, the U.S. Senate passed its version of the much-debated financial regulatory reform bill, the Restoring American Financial Stability Act of 2010. The legislation follows on the heels of a similar bill, the Wall Street Reform and Consumer Protection Act of 2009, passed by the U.S. House of Representatives in December 2009. The Senate and the House will now move to conference in an effort to reconcile the remaining differences between the two bills.
The legislation primarily addresses the overhaul of the national financial regulatory regime, but also contains corporate governance provisions that apply to all public companies, including shareholder voting matters such as proxy access and majority voting, executive compensation matters such as say-on-pay, compensation committee and adviser independence and clawbacks, and other disclosure matters. This alert addresses only the corporate governance provisions of the financial regulatory reform legislation.
Both the Senate bill and the House bill provide express authority for the SEC to promulgate rules requiring inclusion of shareholder nominees for director in the issuer's proxy solicitation materials and outlining the procedures to be followed by the issuer in relation to that solicitation. While neither bill requires the SEC to take action in this regard, the SEC proposed rules in June 2009 that would establish proxy access, and we understand it is currently considering final rules.
The Senate bill requires the SEC to issue rules directing national securities exchanges to implement a majority voting standard in uncontested elections for directors of listed companies. The bill provides that directors in uncontested elections would need to receive a majority of the votes cast to be elected. If a director receives less than a majority of the votes cast, the director must tender his or her resignation, after which the board would be required to either accept the resignation and determine (and disclose) a date on which the resignation will take effect, or unanimously decline to accept the resignation and disclose the specific reasons for that decision and why that decision was in the best interests of the issuer and its shareholders. With respect to contested elections, directors would be elected by a plurality vote. The House bill does not address majority voting.
The Senate bill requires that the rules of national securities exchanges prohibit brokers from granting proxies to vote shares on the election of directors, executive compensation or other significant matters (as determined by SEC rule) unless the beneficial owner of the shares has instructed the broker how to vote on the proposal. The House bill does not address broker discretionary voting. Because amendments in 2009 to New York Stock Exchange Rule 452 eliminated discretionary voting for director elections, the practical implication of this change would be to eliminate discretionary voting on executive compensation matters, including for say-on-pay resolutions discussed below.
The Senate bill requires issuers to include in their proxy statements a separate resolution subject to shareholder vote to approve the compensation of their named executive officers. The vote would not be binding and expressly could not be construed as overruling any of the board's decisions, creating any new or different fiduciary duties, or limiting the ability of shareholders to make proposals for inclusion in proxy statements related to executive compensation. The House bill addresses say-on-pay in essentially the same manner, except that the House bill requires the SEC to issue final rules before the say-on-pay requirement becomes effective, whereas the Senate bill requirement applies to shareholder meetings beginning six months after the enactment of the legislation regardless of SEC rulemaking.
Compensation Committee Independence
Both bills require the SEC to issue rules directing national securities exchanges to mandate that listed companies have an entirely independent compensation committee. The Senate bill provides that independence would be determined considering certain factors, including the source of the director's compensation (including any consulting, advisory, or other compensatory fee paid by the issuer) and whether the director is affiliated with the issuer or its subsidiaries. The House bill specifically provides that, to be considered independent, a member of a compensation committee may not, other than in his or her capacity as a member of the board or a board committee, accept any consulting, advisory, or other compensatory fee from the issuer (a standard akin to the current standard for audit committee member independence).
Compensation Consultants and Other Advisers
Both bills require the SEC to issue rules directing national securities exchanges to mandate that listed companies address the independence of compensation consultants and other advisers to the compensation committee, but do so in different ways. The House bill requires compensation consultants and “other similar advisors” to the compensation committee to meet standards of independence, which the SEC will determine in rules. The Senate bill, on the other hand, does not actually mandate the use of only independent compensation consultants or other advisors. Rather, it only requires compensation committees to take into consideration certain independence factors, which the SEC is to identify in rules, prior to selecting a compensation consultant, legal counsel, or other adviser. These factors include:
- The provision by the adviser's firm of other services to the issuer
- The amount of fees received from the issuer as a percentage of the adviser firm's total revenue
- The policies and procedures of the adviser's firm that are designed to prevent conflicts of interest
- With respect to the adviser himself or herself (as opposed to the advisor's firm), any business or personal relationship of the adviser with a member of the compensation committee and any stock of the issuer owned by the adviser
Under both bills, the compensation committee would have the authority to retain independent compensation consultants, legal counsel, or other advisers and be responsible for their compensation and oversight.
Under both bills, the SEC must issue rules directing national securities exchanges to require issuers to disclose in their proxy statements whether the compensation committee retained or obtained the advice of a compensation consultant. The Senate bill adds to this mandate by requiring issuers to disclose whether the work of the compensation committee has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed. SEC rules adopted in late 2009 already require issuers to disclose the role of compensation consultants and work done by the consultants for the issuer as well as certain conflicts of interest.
Disclosure of Pay Versus Performance
The Senate bill requires the SEC to promulgate rules requiring issuers to disclose in their proxy statements information showing the relationship between executive compensation and the financial performance of the issuer. The bill provides that such information should take into account any change in the value of the issuer's shares and may include a graphic representation of the information required to be disclosed. The Senate bill also requires disclosure of (a) the median of the annual total compensation of all employees of the issuer, except the CEO, (b) the annual total compensation of the CEO, and (c) the ratio of those two amounts. The House bill does not address additional executive compensation disclosures.
Under the Senate bill, the SEC must issue rules directing national securities exchanges to require listed companies to develop and implement policies providing:
- For disclosure of its policies regarding any incentive-based compensation that is based on financial information required to be reported under the securities laws
- That, if the listed company is required to prepare an accounting restatement due to its material noncompliance with any financial reporting requirement, it will recover from any current or former executive officer who received incentive-based compensation (including stock options awarded as compensation) during the three-year period preceding the restatement, based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement
The House bill does not contain a clawback requirement. Section 304 of the Sarbanes-Oxley Act of 2002 (SOX) already contains a clawback provision, although the standard proposed under the Senate bill is stricter than the SOX standard because SOX requires that the restatement occur “as a result of misconduct” before it mandates clawing back executive compensation and only applies to a 12-month period preceding the restatement.
Advisory Vote on "Golden Parachutes"
Under the House bill, the SEC must issue rules to require, in connection with any proxy solicitation material requesting approval of a business combination, issuers to disclose, and provide a separate non-binding vote on, any agreements or understandings with any named executive officers of the issuer (or of the acquirer) concerning any type of golden parachute compensation that is based on or otherwise relates to the business combination as well as the aggregate total of all such compensation that may be paid to or on behalf of such executive officer. The Senate bill does not contain a provision relating to an advisory vote by shareholders on golden parachute arrangements.
Other Disclosure Matters
Employee and Director Hedging
Under the Senate bill, the SEC must promulgate rules to require issuers to disclose in their proxy statements whether any employees or directors are allowed to purchase financial instruments to hedge a decline in value of equity securities granted to them as part of their compensation or otherwise held by them directly or indirectly. The bill does not require disclosure of whether or not such individuals have actually purchased those hedging instruments. The House bill contains no similar provision.
Chairman and CEO Structure
Under the Senate bill, the SEC must establish rules requiring issuers to disclose in their proxy statements the reasons why the issuer has chosen either to combine or separate the positions of chairman of the board and CEO. The House bill contains no similar provision. SEC rules adopted in late 2009 already require issuers to disclose whether and why they have combined or separated the board chair and CEO positions.
Congressional leaders have indicated that they would like to see a final bill on the president's desk by July 4, 2010. In the interim, the debate will move on to conference, and both the House and the Senate will need to vote again on a final reconciled bill. Nevertheless, the likely impacts of this latest legislative effort on corporate governance are beginning to crystallize. It seems likely that many, if not most, of the provisions contained in the Senate bill relating to the corporate governance matters described in this alert will survive conference and be part of the final law. While many of the provisions require SEC rulemaking, it is likely the SEC will have sufficient time to promulgate rules such that the provisions would be applicable for 2011 annual meetings and proxy statements. Accordingly, public companies and their boards of directors should begin now to prepare for these changes.