The SEC has proposed amendments (Release No. 33-9153) to its rules to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to shareholder approval of executive compensation arrangements. Section 951 of the Dodd-Frank Act amends the Securities Exchange Act of 1934 by adding Section 14A, which requires companies to conduct a separate shareholder advisory vote to approve the compensation of executives, as disclosed pursuant to Item 402 of Regulation S-K or any successor to Item 402. Section 14A also requires companies to conduct a separate shareholder advisory vote to determine how often an issuer will conduct a shareholder advisory vote on executive compensation.

Some of the bigger picture items were resolved by the SEC as follows:

  • Generally the say-on-pay requirement would approve compensation disclosed in the CD&A. It would not pick up director compensation and there is certain relief for smaller reporting companies to account for scaled disclosure requirements.
  • The SEC’s proposed rule would not require issuers to use any specific language or form of resolution to be voted on by shareholders.
  • The SEC proposals would amend Item 402(b) to require issuers to address in the CD&A whether and, if so, how their compensation policies and decisions have taken into account the results of shareholder advisory votes on executive compensation.
  • The separate resolution “to determine” the frequency of the shareholder vote on executive compensation is intended to be non-binding on the issuer or the issuer’s board of directors.
  • A preliminary proxy filing would not be required under proposed amendments to Rule 14a-6(a).
  • Generally TARP recipients would only be subject to one say-on-pay vote.  

General Requirements

The SEC has proposed Rule 14a-21(a), pursuant to which issuers would be required, not less frequently than once every three years, to provide a separate shareholder advisory vote in proxy statements to approve the compensation of executives. Proposed Rule 14a-21(a) would specify that the separate shareholder vote on executive compensation is required only when proxies are solicited for an annual or other meeting of security holders for which SEC rules require the disclosure of executive compensation pursuant to Item 402 of Regulation SK.

Proposed Rule 14a-21(a) would require a separate shareholder vote to approve the compensation of executives for the first annual or other such meeting of shareholders occurring on or after January 21, 2011, the first day after the end of the 6-month period beginning on the date of enactment of the Dodd-Frank Act.

Proposed Rule 14a-21(a) would specify how an issuer must provide a separate shareholder advisory vote to approve the compensation of its named executive officers, as defined in Item 402(a)(3) of Regulation S-K. In accordance with Section 14A(a)(1), shareholders would vote to approve the compensation of the issuer’s named executive officers, as such compensation is disclosed in Item 402 of Regulation S-K, including the Compensation Discussion and Analysis (“CD&A”), the compensation tables and other narrative executive compensation disclosures required by Item 402.

Smaller reporting companies are subject to scaled executive compensation disclosure requirements and are not required to include a CD&A. Therefore, for smaller reporting companies, the shareholders would vote to approve the compensation of the named executive officers, as disclosed under Items 402(m) through 402(q) of Regulation S-K. The SEC is also proposing an instruction to new Rule 14a-21 to specify that Rule 14a-21 does not change the scaled disclosure requirements for smaller reporting companies and that smaller reporting companies would not be required to provide a CD&A in order to comply with Rule 14a-21.

Consistent with Section 14A, the compensation of directors, as disclosed pursuant to Item 402(k) and by Item 402(r) is not subject to the shareholder advisory vote. In addition, if an issuer includes disclosure pursuant to Item 402(s) of Regulation S-K about the issuer’s compensation policies and practices as they relate to risk management and risk-taking incentives, these policies and practices would not be subject to the shareholder advisory vote required by Section 14A(a)(1) as they relate to the issuer’s compensation for employees generally. The SEC notes, however, that to the extent that risk considerations are a material aspect of the issuer’s compensation policies or decisions for named executive officers, the issuer is required to discuss them as part of its CD&A, and therefore such disclosure would be considered by shareholders when voting on executive compensation.

The SEC’s proposed rule would not require issuers to use any specific language or form of resolution to be voted on by shareholders. However, the shareholder vote must relate to all executive compensation disclosure set forth pursuant to Item 402 of Regulation S-K. New Section 14A(a)(1) of the Exchange Act requires that the shareholder vote must be “to approve the compensation of executives, as disclosed pursuant to [Item 402 of Regulation SK] or any successor thereto.” In the SEC’s view, a vote to approve a proposal on a different subject matter, such as a vote to approve only compensation policies and procedures, would not satisfy the requirement of Section 14A(a)(1) or proposed Rule 14a-21(a).

Compensation Discussion and Analysis

The SEC proposals would amend Item 402(b) 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 shareholder advisory votes on executive compensation. This proposed new disclosure is not mandated by Section 951 of the Dodd-Frank Act, but the SEC believes that a requirement to provide that information would facilitate better investor understanding of issuers’ compensation decisions. The SEC notes that the shareholder advisory vote on executive compensation will apply to all issuers, and as a result, the SEC will view information about how issuers have responded to such votes as more in the nature of a mandatory principles-based topic than an example. The manner in which individual issuers may respond to such votes in determining executive compensation policies and decisions will likely vary depending upon facts and circumstances. Accordingly, the proposal would amend Item 402(b)(1) to require issuers to address in CD&A whether, and if so, how they have considered the results of previous shareholder votes on executive compensation required by Section 14A and Rule 14a-20 in determining compensation policies and decisions and, if so, how that consideration has affected their compensation policies and decisions.

Frequency of Shareholder Votes

Under proposed Rule 14a-21(b), issuers would be required, not less frequently than once every six years, to provide a separate shareholder advisory vote in proxy statements for annual meetings to determine whether the shareholder vote on the compensation of executives required by Section 14A(a)(1) “will occur every 1, 2, or 3 years.” Proposed Rule 14a-21(b) would also clarify that the separate shareholder vote on the frequency of shareholder votes on executive compensation would be required only in a proxy statement solicited for an annual or other meeting of shareholders for which SEC rules require compensation disclosure. Under proposed Rule 14a-21(b), issuers would be required to provide the separate shareholder vote on the frequency of the say-on-pay vote for the first annual or other such meeting of shareholders occurring on or after January 21, 2011.

Section 14A(a)(2) requires a shareholder advisory vote on whether say-on-pay votes will occur every 1, 2, or 3 years. Thus, shareholders must be given four choices: whether the shareholder vote on executive compensation will occur every 1, 2, or 3 years, or to abstain from voting on the matter. In the SEC’s view, Section 14A(a)(2) does not allow for alternative formulations of the shareholder vote, such as proposals that would provide shareholders with two substantive choices (e.g., to hold a separate shareholder vote on executive compensation every year or less frequently), or only one choice (e.g., a company proposal to hold shareholder votes every two years). The SEC expects that the board of directors will include a recommendation as to how shareholders should vote on the frequency of shareholder votes on executive compensation. However, the issuer must make clear in these circumstances that the proxy card provides for four choices (every 1, 2, or 3 years, or abstain) and that shareholders are not voting to approve or disapprove the issuer’s recommendation. Accordingly, the SEC is proposing amendments to its proxy rules to reflect the statutory requirement that shareholders must be provided the opportunity to cast an advisory vote on whether the shareholder vote on executive compensation required by Section 14A(a)(1) of the Exchange Act will occur every 1, 2, or 3 years, or to abstain from voting on the matter.

Proxy Cards

The SEC is proposing amendments to Rule 14a-4 under the Exchange Act, which provides requirements as to the form of proxy that issuers are required to include with their proxy materials, to require that issuers present four choices to their shareholders. Under existing Rule 14a-4, the form of proxy is required to provide means whereby the person solicited is afforded an opportunity to specify by boxes a choice between approval or disapproval of, or abstention with respect to each separate matter to be acted upon, other than elections to office. The proposed amendments would revise this standard to permit proxy cards to reflect the choice of 1, 2, or 3 years, or abstain, for these votes.

Is the Frequency Vote Binding?

Although the language in Section 951 of the Dodd-Frank Act indicates that the separate resolution subject to shareholder vote is “to determine” the frequency of the shareholder vote on executive compensation, in light of new Section 14A(c) of the Exchange Act, the SEC believes this shareholder vote, and all shareholder votes required by Section 951 of the Dodd-Frank Act, are intended to be non-binding on the issuer or the issuer’s board of directors. Under new Section 14A(c), the shareholder votes referred to in Section 14A(a) and Section 14A(b) (which includes all votes under Section 951 of the Dodd-Frank Act) “shall not be binding on the issuer or the board of directors of an issuer.” As proposed, new Item 24 of Schedule 14A would include language to require disclosure regarding the general effect of the shareholder advisory votes, such as whether the vote is non-binding.

Shareholder Proposals

The SEC believes that additional shareholder proposals on frequency generally would unnecessarily burden the company and its shareholders given the company’s substantial implementation of a plurality shareholder vote regarding the frequency of say-on-pay votes. For the same reasons, a shareholder proposal that would provide an advisory vote or seek future advisory votes on executive compensation with substantially the same scope as the vote required by Rule 14a-21(a) would be subject to exclusion under Rule 14a-8(i)(10). Section 14A(c)(4) provides that the shareholder advisory votes required by Sections 14A(a) and (b) may not be construed “to restrict or limit the ability of shareholders to make proposals for inclusion in proxy materials related to executive compensation.” As proposed to be amended, Rule 14a-8(i)(10) would only provide a basis for exclusion of a say-on-pay proposal if the company has adopted a policy on the frequency of say-on-pay votes that is consistent with the plurality of votes cast in the most recent shareholder vote. Otherwise, simply having the required vote on frequency would not restrict or limit the ability of a shareholder to have a say-on-pay proposal included in the company’s proxy materials.

Preliminary Proxy Statement

The SEC is proposing to amend Rule 14a-6(a) to add the shareholder votes on executive compensation and the frequency of shareholder votes on executive compensation required by Section 14A(a) to the list of items that do not trigger a preliminary filing. Under the proposed amendments, a proxy statement that includes a solicitation with respect to either of these shareholder votes would not trigger a requirement that the issuer file the proxy statement in preliminary form, so long as any other matters to which the solicitation relates include only the other matters specified by Rule 14a-6(a).

TARP Recipients

Issuers that have received financial assistance under the Troubled Asset Relief Program, or TARP, are required to conduct a separate annual shareholder vote to approve executive compensation during the period in which any obligation arising from the financial assistance provided under the TARP remains outstanding. Because the vote required to approve executive compensation pursuant to the Emergency Economic Stabilization Act of 2008, or EESA, is effectively the same vote that would be required under Section 14A(a)(1), the SEC believes that a shareholder vote to approve executive compensation under Rule 14a-20 for issuers with outstanding indebtedness under the TARP would satisfy Rule 14a-21(a). Consequently, the SEC would not require issuers who conduct an annual shareholder vote to approve executive compensation pursuant to EESA to conduct a separate shareholder vote on executive compensation under Section 14A(a)(1) until such issuers have repaid all indebtedness under the TARP. These issuers would be required to include a separate shareholder advisory vote on executive compensation pursuant to Section 14A(a)(1) and proposed Rule 14a-21(a) for the first annual meeting of shareholders after the issuer has repaid all outstanding indebtedness under the TARP.

Even though issuers with outstanding indebtedness under the TARP have a separate statutory requirement to provide an annual shareholder vote on executive compensation so long as they are indebted under the TARP, these issuers would be required, pursuant to Section 14A(a)(2) of the Exchange Act, to provide a separate shareholder advisory vote on the frequency of shareholder votes on executive compensation for the first annual or other such meeting of shareholders on or after January 21, 2011. In the SEC’s view, however, because such issuers have a requirement to conduct an annual shareholder advisory vote on executive compensation so long as they are indebted under the TARP, a shareholder advisory vote on the frequency of such votes while the issuer remains subject to a requirement to conduct such votes on an annual basis would not serve a useful purpose. The SEC has considered, therefore, whether issuers with outstanding indebtedness under the TARP should be subject to the requirements of Section 14A(a)(2) of the Exchange Act. The SEC does not believe it is necessary or appropriate in the public interest or consistent with the protection of investors to require an issuer to conduct a shareholder advisory vote on the frequency of the shareholder advisory vote on executive compensation when the issuer already is required to conduct advisory votes on executive compensation annually regardless of the outcome of such frequency vote. Because Section 14A(a)(2) would burden TARP issuers and their shareholders with an additional vote while providing little benefit to either the issuer or its shareholders, the SEC believes an exemption by rule is appropriate, pursuant to both the exemptive authority granted by Section 14A(e) of the Exchange Act and the SEC’s general exemptive authority pursuant to Section 36(a)(1) of the Exchange Act. As a result, Rule 14a-21(b), as proposed, would exempt issuers with outstanding indebtedness under the TARP from the requirements of Rule 14a-21(b) and Section 14A(a)(2) until the issuer has repaid all outstanding indebtedness under the TARP. Similar to the approach for shareholder advisory votes under Rule 14a-21(a), these issuers would be required to include a separate shareholder advisory vote on the frequency of shareholder advisory votes on executive compensation pursuant to Section 14A(a)(2) and proposed Rule 14a-21(b) for the first annual meeting of shareholders after the issuer has repaid all outstanding indebtedness under the TARP.

Transition

Because the mandates of the Dodd-Frank Act apply to shareholder meetings taking place on or after January 21, 2011, any proxy statements, whether in preliminary or definitive form, even if filed prior to this date, for meetings taking place on or after January 21, 2011, must include the separate resolutions for shareholders to approve executive compensation and the frequency of say-on-pay votes required by Section 14A(a) without regard to whether the SEC has adopted rules to implement Section 14A(a) by that time.

Rule 14a-6 currently requires the filing of a preliminary proxy statement at least ten days before the proxy is sent or mailed to shareholders unless the meeting relates only to the matters specified by Rule 14a-6(a). Until the SEC takes final action to implement Exchange Act Section 14A, the SEC will not object if issuers do not file proxy material in preliminary form if the only matters that would require a filing in preliminary form are the say-on-pay vote and frequency of say-on-pay vote required by Section 14A(a).

Rule 14a-4 under the Exchange Act currently provides that persons solicited are to be afforded the choice between approval or disapproval of, or abstention with respect to, each matter to be voted on, other than elections of directors. Exchange Act Section 14A(a)(2) requires a “separate resolution subject to shareholder vote to determine whether [the say-on pay] votes … will occur every 1, 2, or 3 years.” Until the SEC takes final action to implement Exchange Act Section 14A, the SEC will not object if the form of proxy for a shareholder vote on the frequency of say-on-pay votes provides means whereby the person solicited is afforded an opportunity to specify by boxes a choice among 1, 2 or 3 years, or abstain. In addition, the SEC understands that some proxy service providers may have difficulty in the short term in programming their systems to enable shareholders to vote among four choices and that their systems are currently set up to register at most three votes – for, against, abstain. If proxy service providers are not able to reprogram their systems to enable shareholders to vote among four choices in time for the shareholder votes required by Section 14A(a)(2), until the SEC takes final action to implement Exchange Act Section 14A, the SEC will not object if the form of proxy for a shareholder vote on the frequency of say-on-pay votes provides means whereby the person solicited is afforded an opportunity to specify by boxes a choice among 1, 2 or 3 years, and proxies are not voted on the frequency of say-on-pay votes matter in the event the person solicited does not select a choice among 1, 2 or 3 years.

Finally, issuers with outstanding indebtedness under the TARP are already required to conduct an annual shareholder advisory vote on executive compensation until the issuer has repaid all outstanding indebtedness under the TARP. Because such issuers are subject to an annual requirement to provide a say-on-pay vote, a requirement to provide a vote on the frequency of such votes would impose unnecessary burdens on issuers and shareholders. Until the SEC takes final action to implement Exchange Act Section 14A, the SEC will not object if an issuer with outstanding indebtedness under the TARP does not include a resolution for a shareholder advisory vote on the frequency of say-on-pay votes in its proxy statement for its annual meeting, provided it fully complies with its say-on-pay voting obligations under EESA Section 111(e).