Obama Administration Delivers Draft Legislation on Independent Compensation Committees and Say-On-Pay

The Securities and Exchange Commission has proposed rule amendments that enhance compensation and corporate governance disclosures and require shareholder voting results to be reported on Form 8-K. The Commission also proposed amendments intended to clarify rules relating to non-management proxy solicitations. The amendments are intended to be effective for the 2010 proxy season.

In addition, the Treasury has delivered to Congress draft legislation that will require publicly traded companies to give shareholders a non-binding, advisory vote on executive compensation packages each year and in the context of change in control transactions. The proposals also include mandates for SEC rulemaking to ensure the independence of compensation committees and their consultants.

Enhanced Compensation Disclosure

CD&A. The proposed amendments would broaden the scope of Compensation Disclosure and Analysis by requiring companies to disclose compensation policies that can affect risk and the management of risk. If risks arising from certain general compensation policies and practices may have a material effect on a company, the company would be required to discuss and analyze those policies and practices. The proposed amendment is designed to help investors identify companies that have established a system of incentives that can lead to excessive or inappropriate risk-taking by employees. Although the new disclosures undoubtedly arise out of the view that incentive programs for financial institutions led to inappropriate risk taking, the new disclosures will apply to all reporting companies, subject to a materiality standard.

The Commission cited compensation policies and practices regarding the following, among others, as those that would give rise to disclosure:

  • a business unit that carries a significant portion of the Company's risk profile;
  • a business unit with compensation structured significantly differently from other units;
  • a business unit that is significantly more profitable than other units;
  • a business unit whose revenues make up a significant proportion of the Company's total revenues; and
  • a business unit that differs significantly from the Company's overall risk/reward profile, such as when incentive compensation is paid upon achievement of a task whose benefit and risk will accrue to the company over an extended period of time.

The proposed rules provide a non-exclusive list of issues that a company may need to address in its disclosures if it identifies a material risk arising from compensation policies. These issues include the general design of compensation policies for employees as they relate to or affect risk taking by employees, the company's risk assessment or incentive considerations in structuring compensation policies, how the company's policies relate to short-term and long-term realization of risks resulting from employees' actions, including policies relating to claw backs or holding periods, policies regarding adjustments to compensation policies to address changes in risk profiles, material adjustments the company has made to its compensation policies or practices as a result of changes in its risk profile, and the extent to which the company monitors its compensation policies to determine whether its risk management objectives are being met with respect to incentivizing its employees.

Reporting of Equity Awards. Proposed amendments to Item 402 of Regulation S-K, dealing with executive compensation disclosure, would require disclosure in the Summary Compensation Table of the aggregate grant date fair value of stock option awards (computed in accordance with FAS 123R) when those awards are disclosed in the Summary Compensation Table and Director Compensation Table. Currently, only the amount recognized in the applicable fiscal year for financial reporting purposes is required to be included. The Commission feels that disclosing the amount of equity compensation the company decides to award during a fiscal year is more informative to voting and investment decisions than the dollar amount recorded its financial statements. Additionally, because total compensation is also the basis for determining which executives are the named officers whose compensation is reported, the full grant date fair value measure will better align the identification of named executive officers with company compensation decisions. The proposed amendment would also rescind the requirement to report the full grant date fair value of each individual equity award in the Grants of Plan-Based Awards Table and corresponding footnote disclosure to the Director Compensation Table.

Enhanced Director and Nominee Disclosure

The Commission has proposed to amend Item 401 of Regulation S-K to specifically require companies to disclose for each director and nominee for director the particular experience, qualifications, attributes or skills that qualify that person to serve as a director of the company and as a member of any committee that the person serves on or is chosen to serve on. The expanded disclosure would apply to incumbent directors and nominees for director whether or not they are part of a management slate of directors. Currently, only factual, historical information about directors is specifically required. The amendments would also require companies to disclose public company board memberships held by each director and director nominee during the past five years (as opposed to existing rules which only require disclosure of current board memberships) and would extend from five to ten years the look-back period from which disclosure of specified legal proceedings relating to a director or nominee is required.

New Disclosure about Company Leadership Structure and Risk Management

The Commission has proposed to amend Item 407 of Regulation S-K and Item 7 of Schedule 14A to require disclosure of the company's leadership structure and why the company believes it is the best structure for it at the time of filing. This amendment would require a company to disclose whether and why it has separated or combined the principal executive officer and board chair roles, as well as whether and why the company has a lead independent director, describing that director's role, if applicable. Additionally, this amendment would require disclosure concerning the board's role in the company's risk management process, such as implementation of the board's risk management function, reporting requirements within the company, and risk monitoring procedures.

Compensation Consultant Disclosure

The Commission has also proposed to amend Item 407 of Regulation S-K to require disclosure of the fees paid to compensation consultants that played any role in determining or recommending the amount or form of executive and director compensation, if the consultants also provide other services to the company. If additional services are performed by the consultants, an enhanced list of disclosures is required.

Reporting of Voting Results on Form 8-K

The Commission has proposed transferring the requirement to disclose shareholder voting results from Forms 10-Q and 10-K to Form 8-K, which would require that information to be made public within four business days after the end of the applicable shareholder meeting. If definitive results are not available within four days and the matter relates to election of directors, companies will be required to disclose on Form 8-K the preliminary voting results within four business days, and file an amended Form 8-K as soon as the final voting results are confirmed.

Proxy Solicitation Process Clarification

The Commission has proposed amendments to the rules governing the proxy solicitation process that will facilitate "withhold vote" campaigns and permit a non-management party with a short slate of nominees to round out its slate by soliciting authority to vote for nominees of another non-management party or management's nominees. This amendment the proxy rules is consistent with the staff's informal advice. The Commission has also proposed a change to Exchange Act Rule 14a-2(b)(1). That rule generally provides that shareholders or other non-management parties who are not seeking proxy authority and do not have a substantial interest in the subject matter of the solicitation are not required to file proxy materials except that the exemption is not available to, among others, a person who furnishes or requests a form of revocation. When a dissident shareholder requests other shareholders to send in an unmarked copy of management proxy directly to management, that request will not be deemed a request for a form of revocation even if a solicited shareholder's use of that proxy card will result in the revocation of a prior vote.

Potential Corporate Governance Legislation

On July 16, 2009, the Obama Administration, acting through the Treasury Department, delivered draft legislation to Congress requiring an advisory vote on compensation and addressing the independence of Compensation Committees

U.S. Treasury Proposal: Shareholder Say-On-Pay

The "say-on-pay" proposal would require all publicly-traded companies to give shareholders a non-binding vote on executive compensation packages. This vote would be required for any annual meeting taking place after December 15, 2009. The vote would apply to all elements of total compensation for senior executives, including salary, bonus, stock and option awards, golden parachutes, and pension compensation. Also, in connection with any shareholder meeting which concerns an acquisition, merger, consolidation or proposed sale of all or substantially all of the assets of the company there must also be a separate vote on any compensation that is based on or relates to the transaction, together with tabular disclosure of that compensation.

U.S. Treasury Proposal: New Independence for Compensation Committees

The legislation would require the Commission to promulgate rules that would prohibit the exchanges from listing any company that does not (i) have a compensation committee that meets the more stringent independent standards set forth in the legislation, which generally track the standards for audit committee independence (the director cannot be an affiliate of the issuer or accept any advisory or consulting fees, both other than in the capacity as a board or committee member), (ii) requiring any compensation consultant, legal counsel or other advisor to the committee to meet standards of independence promulgated by the Commission, and (iii) requiring the compensation committee to have the authority in its sole discretion to retain the advice of a compensation consultant meeting the independence standards mentioned above.