As required under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), the U.S. Securities and Exchange Commission (SEC) adopted rules regarding shareholder approval of executive compensation and “golden parachute” arrangements on January 25, 2011. See Release Nos. 33-9178 and 34-63768.

Summary of New Rules

  • Companies must provide a separate shareholder advisory vote to approve the compensation of their named executive officers (a say-on-pay vote), not less frequently than once every three calendar years.
  • The SEC’s compensation discussion and analysis (CD&A) requirements are amended to require issuers to address whether and, if so, how their compensation policies and decisions have taken into account the results of the most recent say-on-pay vote.
  • Companies must provide a separate shareholder advisory vote to determine whether the say-on-pay vote will occur every one, two or three years (a say-on-frequency vote). This say-on-frequency vote is required not less frequently than once every six calendar years.
  • Schedule 14A (which sets forth the SEC’s proxy statement requirements) is amended to require companies to disclose that they are providing a say-on-pay, say-on-frequency or say-on-golden parachutes vote, if applicable, to briefly explain the general effect of each vote, such as whether each such vote is non-binding, and, when applicable, to disclose the current frequency of say-on-pay votes and state when the next such vote will occur.
  • Say-on-pay and say-on-frequency votes are added to the list of items that do not require the filing of proxy materials in preliminary form.
  • Amended Rule 14a-8 permits exclusion of a shareholder proposal that would provide a say-on-pay vote or that relates to the frequency of say-on-pay votes, if, in the most recent shareholder say-on-frequency vote, a single frequency (i.e., one, two or three years) received the support of a majority of the votes cast and the issuer has adopted a policy on the frequency of say-on-pay votes that is consistent with that choice.
  • Companies are required to disclose on Form 8-K their decision regarding how frequently to conduct say-on-pay votes following each say-on-frequency vote.
  • Companies are required to include tabular and narrative disclosure of named executive officers’ golden parachute arrangements in proxy statements filed in connection with a merger or acquisition transaction or other filings in which shareholders are effectively giving a consent with respect to their investment decision.
  • Companies must provide a separate shareholder advisory vote on golden parachute arrangements in proxy statements filed in connection with a merger or acquisition transaction.

Effective Dates

The first say-on-pay and say-on-frequency votes are required for companies’ first shareholder meeting occurring on or after January 21, 2011 at which directors will be elected and for which disclosure of executive compensation is required under Item 402 of Regulation S-K, except that smaller reporting companies will not be required to conduct a say-on-pay or say-on-frequency vote until meetings on or after January 21, 2013. All public companies, including smaller reporting companies, must comply with the say-on-golden parachutes rules with respect to any merger proxy statement or other covered transactional document filed on or after April 25, 2011.

Say-On-Pay

The SEC has adopted Rule 14a-21(a) under the Securities Exchange Act of 1934, as amended (Exchange Act), which requires companies to provide a separate shareholder advisory vote to approve the compensation of their named executive officers not less frequently than once every three calendar years. This say-on-pay vote is required only in a proxy statement in which proxies are solicited for an annual or other meeting of shareholders at which directors will be elected and for which disclosure of executive compensation is required under Item 402 of Regulation S-K. The adopting release states that the shareholder advisory vote required under Rule 14a-20 for recipients of funds under the Emergency Economic Stabilization Act, also known as the Troubled Asset Relief Program or TARP, would satisfy the requirement for a shareholder advisory vote under Rule 14a-21(a).

Shareholders will vote to approve the compensation of the named executive officers as disclosed under Item 402 of Regulation S-K, which encompasses the compensation discussion and analysis (CD&A), compensation tables and other narrative disclosure related to compensation.

Companies are not required to use specific language or a form of resolution in their say-on-pay vote, but Rule 14a-21 provides the following resolution as a non-exclusive example of a resolution that would satisfy the rules 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.”

Rule 14a-21 does not change the scaled disclosure requirements for smaller reporting companies or the fact that smaller reporting companies are not required to provide CD&A. However, the SEC notes in its adopting release that smaller reporting companies may decide to include supplemental disclosure to facilitate shareholders’ understanding of their compensation arrangements in connection with say-on-pay votes.

In connection with the adoption of say-on-pay, the SEC has adopted amendments to Schedule 14A, Item 402(b) of Regulation S-K and Rule 14a-6 under the Exchange Act. Schedule 14A is amended to require companies to disclose that they are providing a say-on-pay, say-on-frequency or say-on-golden parachutes vote, if applicable, to briefly explain the general effect of each vote, such as whether each such vote is non-binding, and, when applicable, to disclose the current frequency of say-on-pay votes and state when the next such vote will occur.

Item 402(b) of Regulation S-K contains the SEC’s CD&A requirements. The adopting release amends Item 402(b)(1) to require issuers to address in CD&A whether and, if so, how their compensation policies and decisions have taken into account the results of the most recent say-on-pay vote.

As described above, smaller reporting companies are not required to provide CD&A disclosure. However, the SEC states that Item 402(o) of Regulation S-K, which requires a narrative description of any material factors necessary to an understanding of the information disclosed in the company’s summary compensation table, would require disclosure of prior say-on-pay votes if consideration of such votes is a material factor.

The amendments to Rule 14a-6 add say-on-pay and say-on-frequency votes (whether included by a company or by shareholder proposal) to the list of items that do not require the filing of proxy materials in preliminary form. This means that the inclusion of a say-on-pay or say-on-frequency vote will not subject the filing to a ten-day preliminary filing period prior to mailing.

Finally, the SEC notes in its adopting release that Section 957 of Dodd-Frank directs the national securities exchanges (e.g., the New York Stock Exchange) to change their rules to prohibit broker discretionary voting of uninstructed shares in certain matters, including say-on-pay and say-on-frequency votes.

Say-on-Frequency

The SEC has adopted Rule 14a-21(b) under the Exchange Act, which requires companies to provide a separate shareholder advisory vote to determine whether the say-on-pay vote will occur every one, two or three years. This say-on-frequency vote is required not less frequently than once every six calendar years, only in a proxy statement in which proxies are solicited for an annual or other meeting of security holders at which directors will be elected and for which disclosure of executive compensation is required under Item 402 of Regulation S-K. Like say-on-pay, the first say-on-frequency vote will be required for companies’ first such shareholder meeting occurring on or after January 21, 2011, except that smaller reporting companies will not be required to conduct a say-on-frequency vote until meetings on or after January 21, 2013. Rule 14a-21(b) exempts TARP recipients who are required to provide annual say-on-pay votes from the say-on-frequency requirements. Like say-on-pay, companies are not required to use specific language in the say-on-frequency vote.

In connection with the adoption of say-on-frequency, the SEC has adopted amendments to Schedule 14A, Rules 14a-4, 14a-6 and 14a-8 under the Exchange Act and Form 8-K. The amendments to Schedule 14A and Rule 14a-6 are discussed under “Say-On-Pay” above. The discussion of broker discretionary voting provided under “Say-On-Pay” also applies to say-on-frequency votes.

Rule 14a-4 provides the requirements as to the form of proxy that issuers are required to include with their proxy materials. Rule 14a-4, as amended, permits proxy cards to reflect the choice of one, two, or three years, or abstain, on the say-on-frequency proposal. In addition, companies are permitted to vote uninstructed proxy cards in accordance with management’s recommendation for the say-on-frequency vote 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.

Rule 14a-8 allows eligible shareholders to include a proposal in a company’s proxy materials for a vote at an annual or special meeting unless the shareholder has not complied with the rule’s procedural requirements or the proposal falls within one of the rule’s 13 substantive bases for exclusion. One such basis for exclusion, Rule 14a-8(i)(10), provides that an issuer may exclude a shareholder proposal that has already been substantially implemented. The SEC has adopted a note to Rule 14a-8(i)(10) to permit exclusion of a shareholder proposal that would provide a say-on-pay vote or that relates to the frequency of say-on-pay votes, if, in the most recent shareholder say-on-frequency vote, a single frequency (i.e., one, two or three years) received the support of a majority of the votes cast and the company has adopted a policy on the frequency of say-on-pay votes that is consistent with that choice.

Under Item 5.07 of Form 8-K, companies will be required to disclose their decision regarding how frequently to conduct say-on-pay votes following each say-on-frequency vote. To comply, a company will file an amendment to its Form 8-K filing that discloses the results of the say-on-frequency vote no later than 150 calendar days after the date of the end of the meeting in which the vote took place, and no later than 60 calendar days prior to the deadline for submission of shareholder proposals for the subsequent annual meeting.

Golden Parachute Disclosure

The SEC has added Item 402(t) to Regulation S-K, which requires public companies, in connection with an acquisition, merger, consolidation, sale or other disposition of all or substantially all assets, to provide disclosure (in both narrative and tabular formats) of named executive officers’ golden parachute arrangements. Item 402(t) applies to named executive officers of the target and the acquirer. Companies may voluntarily include disclosure pursuant to Item 402(t) in an annual meeting proxy statement if they believe it would permit shareholders to gain a better understanding of the company’s compensation programs. Furthermore, companies may be able to avoid a future say-on-golden parachutes vote (see “Say-on-Golden Parachutes” below) in connection with a later transaction if such disclosure has been included in an annual meeting proxy statement and was part of a prior say-on-pay vote.

Tabular disclosure is required of all cash compensation, equity compensation, pension and nonqualified deferred compensation benefit enhancements, perquisites and benefits, tax reimbursements and other compensation that an executive officer would receive based on or otherwise related to the transaction. Separate footnote identification is required identifying amounts attributable to “single-trigger” and “double-trigger” arrangements. The tabular disclosure requires quantification with respect to any agreements or understandings between (i) each named executive officer of the target company and the acquiring company and (ii) 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 transaction.

In addition to the tabular disclosure, narrative disclosure of certain conditions upon which the compensation may be paid is also required. Item 402(t) requires issuers to describe any material conditions or obligations applicable to the receipt of payment, including, without limitation, non-compete, non-solicitation, non-disparagement and confidentiality agreements, their duration, and provisions regarding waiver or breach. Narrative descriptions are also required for the specific circumstances that would trigger payment, whether the payments would or could be lump sum or annual, their duration, by whom they would be provided and any material factors regarding each agreement.

Where Item 402(t) disclosure is included in an annual meeting proxy statement, tabular quantification of dollar amounts based on the company’s stock price will be calculated based on the closing market price per share of the company’s securities on the last business day of the last completed fiscal year. In a proxy statement soliciting shareholder approval of a merger or similar transaction or a filing made with respect to a similar transaction, the tabular quantification of dollar amounts based on the company’s stock price will be based on the consideration per share, if such value is a fixed dollar amount, or otherwise on the average closing price per share over the first five business days following the first public announcement of the transaction.

In connection with new Item 402(t), the SEC has adopted amendments to Schedule 14A, Schedule 14C, Schedule 14D-9, Schedule 13E-3, Item 1011 of Regulation M-A, and Schedule TO. These amendments are intended to implement the disclosure requirements in Section 14A(b)(1) and to ensure that such disclosure is provided in all circumstances in which shareholders are effectively giving a consent with respect to their investment decision.

Say-On-Golden Parachutes

The SEC has adopted Rule 14a-21(c) under the Exchange Act, which requires companies to provide a separate shareholder advisory vote in proxy statements for meetings at which shareholders are asked to approve an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all assets. Like say-on-pay and say-on-frequency, companies are not required to use specific language in the say-on-golden parachutes vote.

When a target issuer conducts a proxy solicitation to approve a merger or similar transaction, golden parachute compensation agreements or understandings between the acquiring issuer and the named executive officers of the target issuer are within the scope of disclosure required under Item 402(t), but a say-on-golden parachutes vote is not required.

Companies are exempted from the requirements under Rule 14a-21(c) if all of the compensation arrangements and agreements were included within a prior say-on-pay vote. This exemption applies even if the arrangements included within the prior say-on-pay vote were not approved by the shareholders. To take advantage of this exemption, companies would have to include disclosure that satisfies Item 402(t) (rather than the currently existing and similar Item 402(j)) in their annual meeting proxy statements. New golden parachute arrangements and golden parachute arrangements that have been revised subsequent to the say-on-pay vote are ineligible for this exemption unless such revisions were to reflect movements in the company’s stock price or to reflect a reduction in the value of the total compensation payable.

Though smaller reporting companies are given a phase-in period with respect to say-on-pay disclosure and say-on-frequency shareholder votes, no such period is allowed for smaller reporting companies with respect to Item 402(t) disclosure and say-on-golden parachutes votes.

Actions to Consider

  • Companies should begin to determine what recommendation to make to their shareholders with respect to the say-on-frequency vote. Institutional Shareholder Services (ISS), the counsel to many institutional investors, has stated that they will support annual say-on-pay votes. Annual votes have the following benefits:
    • They provide a high level of accountability and direct communication.
    • They allow management to better measure how they have responded to the prior year’s vote.
    • By making say-on-pay votes more perfunctory and less intrusive, they potentially reduce shareholder scrutiny.
    • They forestall the likelihood of shareholder proposals for more frequent voting.
    • Annual say-on-pay voting coincides with annual election of the board of directors for companies without staggered boards.

However, biennial and triennial votes are appealing for the following reasons:

  • Less frequent voting eases the administrative and paperwork burden on companies.
  • They allow compensation plans and practices to be evaluated over the longer term against the longer-term corporate financial performance of the company and its peers.
  • They give companies more time to carefully evaluate shareholder input and review and revise their plans.
  • There is less of an opportunity for reactionary voting by the shareholders in response to short-term price drops or unusual events.
  • Companies should begin to draft or revise the CD&A and narrative portions of their compensation disclosure as appropriate to support the say-on-pay vote.
  • Companies should begin to draft the say-on-pay and say-on-frequency portions of their annual proxy statements.
  • Companies should consider whether to include Item 402(t) disclosure in their say-on-pay vote so that no further advisory vote will be required in connection with a potential subsequent merger or acquisition transaction. At this point, it seems unlikely that companies will take advantage of this exception to the say-on-golden parachutes vote for several reasons:
  • Golden parachute disclosure in the annual proxy statement will add complexity to the annual proxy statement in an area that is already lengthy and confusing to many shareholders.
  • Inclusion of the Item 402(t) information in the annual proxy statement will most likely not avoid a later say-on-golden parachutes vote because the exception only applies if the golden parachute arrangements are virtually identical to what has already been disclosed, and companies may want to revise these arrangements in light of a change in control.
  • If a company does end up holding a separate say-on-golden parachutes vote in a change-of-control proxy statement, it will have been made more complex due to the addition of multiple tables distinguishing between previously voted-on and new golden parachute arrangements.