On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) into law. Designed primarily to reform the financial regulatory system, the Act also contains a number of provisions that will affect corporate governance and capital raising by foreign private issuers.
This overview briefly summarizes those provisions of the Act which:
- amend Sarbanes-Oxley,
- impose additional requirements for companies listed on U.S. stock exchanges,
- change broker discretionary voting,
- impact capital raising in the United States,
- extend the extraterritorial jurisdiction of certain provisions of the federal securities laws, and
- amend the proxy statement rules.
SOX 404 Amendments. In a tacit acknowledgement of the burdens excessive rulemaking can impose, Section 989G of the Act expressly exempts issuers that are neither “large accelerated filers” nor “accelerated filers” from the requirement contained in Section 404(b) of The Sarbanes Oxley Act of 2002 to provide an auditor attestation of internal control over financial reporting. This effectively exempts issuers with a market capitalization of less than US$75 million from this requirement.
In the next nine months, the SEC is also required to conduct a study to determine how to reduce the burden of complying with Section 404(b) for companies whose market capitalization is between US$75 million and US$250 million while maintaining investor protections. The study is also to consider whether the reduction or elimination of this compliance burden would encourage companies to list on U.S. stock exchanges for their IPOs.
Audit Information to be provided by foreign accounting firms. The SEC and the Public Company Accounting Oversight Board (the “PCAOB”) may request the audit work papers of any non-U.S. public accounting firm that performs material services upon which a PCAOB-registered public accounting firm relies in the conduct of an audit or interim review. Further, any registered public accounting firm that relies on the work of a non-U.S. public accounting firm must produce the audit work papers of the non-U.S. public accounting firm and all other documents related to the work in response to a request for production by the SEC or the PCAOB and, prior to reliance upon the work of a non-U.S. accounting firm, secure the agreement of the non-U.S. public accounting firm to the required production.
PCAOB May Share Information with Foreign Oversight Agencies. The Act amends provisions of the Sarbanes-Oxley Act to permit the PCAOB to share information with foreign auditor oversight authorities without loss of the information’s status as confidential and privileged if:
- the PCAOB finds that sharing the information is necessary to protect investors, and
- the foreign auditor oversight authority agrees to keep the information confidential and provides a description of the applicable information systems and controls of the foreign auditor oversight authority and the applicable laws and regulations relevant to information access.
Additional Requirements for Listed Companies
The Act requires the SEC to adopt regulations that will prohibit national securities exchanges or associations, such as the NYSE, Nasdaq and NYSE Amex, from listing companies that do not have independent compensation committees or that have not adopted clawback policies.
Pursuant to the Act, the requirements relating to compensation committees do not apply to “foreign private issuers” so long as the issuer annually discloses to its shareholders the reasons that its compensation committee does not meet the independence requirements of the exchange. Listed foreign private issuers are currently required to provide a summary of any significant ways in which its corporate governance practices differ from those followed by domestic companies. The exemption in the Act relating to foreign private issuers expands this disclosure slightly to include the reasons the issuer’s compensation committee does not meet the independence requirements of the exchange.
Unlike the provisions relating to the independence of compensation committees, there is no explicit exemption for foreign private issuers with respect to the new clawback provisions. However, as foreign private issuers are not currently subject to many of the corporate governance provisions of the exchanges, the rules promulgated by the SEC may exempt foreign private issuers from these provisions as well. These provisions, as well as the provisions relating to the independence of compensation committees, as discussed in more detail below.
- Compensation Committee Independence. Section 952 of the Act requires the SEC to adopt, on or before July 16, 2011, a rule that will prohibit the listing of issuers that do not have independent compensation committees. Given the existing requirements of the NYSE, Nasdaq, and NYSE Amex for independence of compensation committee members, or for decision making on executive compensation by disinterested members of the board, and the exemptive authority of the SEC provided by Section 952, particularly as it relates to smaller issuers, these rules are likely to have very little impact on currently listed companies.
- Independence of Compensation Committee Advisers. As part of the new compensation committee independence rules, Section 952 also requires the compensation committee of a listed issuer to have authority to retain independent compensation consultants, legal counsel and other advisors, each of whom will report directly to, and be compensated by, the compensation committee. Although many listed issuers have already adopted provisions permitting compensation committees to engage outside advisors, few issuers have adopted policies that require the independent compensation of such advisors, including legal counsel. It is unclear whether the requirement for direct compensation by the compensation committee will require separate engagement of legal counsel.
For companies subject to the SEC’s proxy rules, in the proxy statement for any meeting occurring after July 21, 2011, the issuer must disclose whether the compensation committee has retained a compensation consultant and whether any conflicts of interest exist with respect to the compensation consultant. The same requirement does not apply as to legal counsel or other advisers.
The SEC is also directed to study the use of compensation consultants and to submit a report to Congress about such use within two years.
- Clawback of Executive Compensation. Section 954 of the Act creates new Section 10D of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which requires the SEC to adopt rules (without an explicit rulemaking deadline) prohibiting the listing on a national securities exchange of any issuer that has not adopted a clawback policy consistent with the section. The policy required under the section will require the issuer to recover from any current or former executive officer any incentive compensation that was paid during the three years preceding any accounting restatement due to material noncompliance with reporting requirements, to the extent in excess of the compensation that would have been paid based on the restatement. For issuers listed on a national securities exchange, this provision expands the existing clawback provisions of Sarbanes-Oxley. The new clawback policies will apply:
- whether or not the officer receiving incentive compensation or the issuer engaged in misconduct,
- to all incentive compensation paid during the three-year period preceding the restatement, and
- to all executive officers.
It is not clear whether the SEC’s rules will exempt foreign private issuers from this requirement.
For listed companies, new Section 10D requires the SEC to also adopt rules that require the issuer to develop a policy relating to disclosure of the clawback policy—presumably in the annual proxy statement, or if foreign private issuers are subject to this requirement, in the annual report on Form 20-F or 40-F.
Broker Discretionary Votes.
Although separate from the corporate governance provisions, Section 957 of the Act might have more impact on corporate governance than Section 951. Mirroring the changes of last summer caused by the passage of New York Stock Exchange Rule 452, and effective immediately, Section 957 prohibits brokers who are members of U.S. national securities exchanges from voting on matters related to the election of directors, executive compensation or other significant matters as determined by the SEC, unless the broker has received voting instructions from the beneficial owner.
Provisions Impacting Capital Raising
Accredited Investor Standards under Regulation D. Effective immediately and for four years following the enactment of the Act, the $1,000,000 net worth category of accredited investor for natural persons has been changed to US$1,000,000, excluding the net value of the primary residence of the investor. The SEC has informally expressed the view that the amount of any mortgage or other indebtedness secured by an investor's primary residence should be netted against the value of the residence; thus, so long as the amount of the indebtedness is less than the fair market value of the residence, it need not be considered as a liability deducted from an investor's net worth. If, however, the amount of the debt exceeds the fair market value of the residence and the mortgagee or other lender has recourse to the investor personally for any deficiency, that excess liability will have to be deducted from the investor's net worth. Please be aware that this change will impact outstanding offers to purchase securities, such as common share purchase warrants.
Not earlier than four years from the date of enactment and not less frequently than every four years thereafter, the SEC is directed to review the definition of accredited investor as applied to natural persons, to determine if the definition requires modification.
“Bad Actor” Disqualification from use of Regulation D. Within one year from enactment of the Act, the SEC has been directed to issue rules to disqualify felons and other “bad actors” from Regulation D offerings. The rules would disqualify any offering or sale under Regulation D by any person:
- that has been prohibited from associating with certain types of federal or state regulated entities or engaging in the business of securities, insurance, banking or savings association or credit union activities based on fraudulent or deceptive conduct, or
- has been convicted of any felony or misdemeanor in connection with the purchase or sale of securities or involving the making of any false filing with the SEC.
Credit Rating Agency Consent Requirement. The Act repeals Rule 436(g) under the Securities Act of 1933, as amended (the “Securities Act”). Rule 436(g) provided an exemption for credit ratings contained in registration statements so that registrants were not required to obtain the consent of credit rating agencies to include the credit rating in the registration statement. With the repeal of this exemption, registrants will be required to seek the consent of the credit rating agencies, and those rating agencies that provide a consent would be exposed to liability as experts under Section 11 of the Securities Act for material misstatements or omissions with respect to such included ratings. Credit rating agencies have indicated that they do not intend to provide the required consents. However, certain types of credit rating disclosure should not trigger the consent requirement, such as when discussing changes to an issuers credit rating or the impact of a credit rating on an issuer’s cost of capital. Further, there may be ways to use credit ratings in public offerings without triggering the consent requirements. We are engaged in working on this issue in a number of different contexts and will be able to provide further advice as developments occur.
Extraterritorial Jurisdiction of the Antifraud Provisions of the Federal Securities Laws.
In Morrison v. National Australia Bank Ltd., U.S., No. 08-1191 (decided June 24, 2010) the U.S. Supreme Court held that the principal antifraud provisions of the US securities laws, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, apply only to transactions in securities that take place in the United States or transactions in securities listed on a US securities exchange. The Court stated that these key provisions do not have extraterritorial application since Section 10(b) lacks an explicit statement of extraterritorial effect. In response to this ruling, the Act explicitly extends the reach of the jurisdiction of the antifraud provisions of the securities laws with respect to actions brought by the SEC or the United States in connection with “conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” The SEC was directed to study whether this right should be extended to private rights of action.
Proxy Statement Amendments.
Foreign private issuers are not currently subject to Section 14(a) and 14(c) of the Exchange Act and the SEC’s rules thereunder relating to the procedures for soliciting proxies and the content of the proxy statement. While the Act amended the proxy rules to add new requirements, we expect that in the SEC rulemaking process foreign private issuers will be exempt from the new requirements as well. The amendments to the proxy disclosure rules include the following:
- Executive Compensation Disclosure—Pay versus Performance. Section 953 of the Act also amends Section 14 of the Exchange Act to require that the SEC adopt regulations (without a specific rulemaking deadline) requiring companies to disclose in their proxy statements the relationship between the amount of executive compensation actually paid to executive officers and the financial performance of the company. Section 953 also effectively invites the SEC to require that this information be presented graphically.
- Shareholder Approval of Executive Compensation. Section 951 of the Act adds a new Section 14A to the Exchange Act that will require companies that provide executive compensation disclosure under the SEC’s proxy rules to include nonbinding “say-on-pay” proposals in their proxy statements at least once every three years, and non-binding proposals to approve any “golden parachute” arrangement in all proxy statements relating to business combinations.
- Leadership Structure. Section 972 of the Act adds a new Section 14B to the Exchange Act that requires the SEC to issue rules on or before January 17, 2011 requiring disclosure in proxy statements about why the issuer has chosen to have the same person or different persons serving as the Chairman of the Board and the Chief Executive Officer.
- Disclosure of Hedging Policies. Section 955 of the Act adds a new subsection (j) to Section 14 of the Exchange Act that requires the SEC to issue rules (without any explicit rulemaking deadline) requiring public companies to disclose in their proxy statements whether directors and employees are permitted to hedge the value of equity securities held directly or indirectly by the director or employee.