The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), enacted on July 21, 2010, contains significant executive compensation and corporate governance provisions applicable to public companies. The following is a brief summary of the key provisions that address executive compensation and corporate governance issues.
- Shareholder “Say on Pay” Voting. Each public company must provide its shareholders with a separate nonbinding vote to approve or reject the compensation of its officers disclosed in the company’s proxy statements. The vote must be provided at least once every three years, with the frequency also subject to a shareholder vote. There is also a required non-binding vote with respect to compensation in connection with a change of control transaction. When a company seeks its shareholders’ approval in connection with a change in control transaction, the company must disclose the terms, conditions and amounts of its officers’ compensation that are based on or otherwise related to the transaction. If not previously subject to a “say on pay” vote, the compensation related to the transaction must be subject to a separate nonbinding vote of the shareholders. While say on pay votes are not binding, directors will likely make significant efforts to avoid a negative vote through shareholder outreach and proactive use of the compensation disclosure and analysis section of proxy materials.
- Independence of Members of Compensation Committees. While both the New York Stock Exchange and the NASDAQ Stock Market generally require members of a board’s compensation committee to be independent and provide definitions of independence for this purpose, the Act requires the national securities exchanges and associations to draft new rules that base independence on factors such as the source of each compensation committee member’s compensation (including any consulting, advisory or other fees paid to the compensation committee member by the company) and whether the director is affiliated with the company, a subsidiary of the company or an affiliate of the company.
- Compensation Committee Advisors. The compensation committee of public companies must be given the authority and necessary funding to hire, fire and pay compensation consultants, independent legal counsel and other advisors. If the compensation committee retains the services of any such advisors, it may do so only after considering the independence of such advisor based on factors to be indentified by the Securities and Exchange Commission (“SEC”). In addition, each company must disclose in its proxy materials whether a compensation consultant’s services were retained, whether the compensation consultant’s work raised any conflicts of interest, and, if so, the nature of the conflict and how the company addressed it. Note that the Act does not require compensation committees to hire outside consultants or that outside consultants hired be independent.
- Additional Executive Compensation Disclosures. The SEC is required to adopt rules requiring each public company to disclose (graphically or otherwise) in the company’s proxy materials the relationship between the executive compensation the company “actually paid” and the company’s financial performance (taking into account changes in stock value, dividends and other distributions).
The SEC is also required to adopt rules requiring each public company to disclose in its proxy materials (i) the median of the annual “total compensation” of all of its employees other than the CEO, (ii) the annual “total compensation” of the CEO and (iii) the ratio of such two amounts. “Total compensation” for this purpose is to be determined based on the rules applicable to the summary compensation table included in proxy materials as in effect on July 20, 2010. Obtaining the compensation data related to the company’s employees will be a significant undertaking for many companies.
- Clawbacks of Incentive-Based Compensation. The SEC is required to adopt rules requiring each public company to develop and implement a policy for the recovery of incentive-based compensation paid to its executive officers if the company is required to restate its accounting statements as a result of material noncompliance with financial reporting requirements. The clawback is applicable to incentive-based compensation received by current and former executive officers within the three-year period preceding the date the company is required to restate its statements. The amount required to be clawed back is the difference between the amount awarded to the executive officer and the amount that would have been awarded based on the restated data. This clawback will apply whether or not the material noncompliance that caused the restatement was the result of wrongdoing. Note that this clawback provision applies to all executive officers, including former executive officers, and even where there was no bad behavior, and applies to the excess incentive-based compensation received during the three-year period preceding the date the restatement is required. As enacted, the clawback is mandatory and not subject to a board’s discretion. Companies may want to immediately consider the implications of this clawback provision on severance arrangements and release agreements now being entered into.
- Hedging Disclosure. The SEC is required by the Act to adopt rules requiring each public company to disclose whether it permits its employees or directors to purchase financial instruments that are designed to hedge or offset any decrease in the market value of the company’s equity securities held by the employees or directors. The disclosure must be made with respect to all equity securities held by employees and directors, whether or not the equity securities were received as compensation.
- Chairman and CEO Structure Disclosure. The SEC is required by the Act to adopt rules requiring each public company to disclose in its annual proxy statement the reason why the company has either chosen to have the same individual or different individuals serve as the CEO and chairman of the company’s board.
There are many unanswered questions as to how the foregoing provisions will be implemented. Accordingly, it is difficult for a public company to currently make adjustments needed to comply with the provisions. However, public companies should consider how the Act will impact their compensation and governance structures, whether a broader than normal review of their compensation structure and programs is appropriate and the employee compensation information needed to comply with the new disclosure rules. Most significantly, public companies need to focus on the “say on pay” rules, which will be in effect in 2011, and whether and to what extent incentive structures should be adjusted for the upcoming year.
Each public company must provide its shareholders with a separate nonbinding vote to approve or reject the compensation of its officers disclosed in the company’s proxy statements.
The SEC is required to adopt rules requiring each public company to disclose in its proxy materials (i) the median of the annual “total compensation” of all of its employees other than the CEO, (ii) the annual “total compensation” of the CEO and (iii) the ratio of such two amounts.
The SEC also is required to adopt rules requiring each public company to develop and implement a policy for the recovery of incentive-based compensation paid to its executive officers if the company is required to restate its accounting statements as a result of material noncompliance with financial reporting requirements.