On October 18, 2010, the Securities and Exchange Commission (SEC) issued proposed rules changes to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to shareholder approval of executive compensation and “golden parachute” compensation arrangements. The Dodd-Frank Act amended the Securities Exchange Act of 1934 (Exchange Act) by adding Section 14A, which requires reporting companies to conduct a separate shareholder advisory vote on the compensation of executives (frequently referred to as “say-on-pay”). Section 14A also requires companies to conduct a separate shareholder advisory vote to determine how often the company will conduct a shareholder vote on executive compensation. Finally, Section 14A requires companies soliciting votes to approve a merger or acquisition transaction to provide disclosure of golden parachute compensation and, in certain circumstances, to conduct a separate shareholder advisory vote to approve the golden parachute arrangements.
Because the Dodd-Frank Act requires that the say-on-pay vote occur for meetings held after January 21, 2011, whether or not the SEC has adopted rules to implement the requirement, it is expected that the SEC will act quickly to finalize these new rules.
“Say-on-Pay”—Advisory Vote on Executive Compensation
Section 14A of the Exchange Act provides that at least once every three years public companies must give shareholders a non-binding, advisory vote on whether to approve the compensation of named executive officers. To implement this “say-on-pay” vote, the SEC has proposed Rule 14a-21(a). Under the proposed rule, shareholders would be given a vote on all executive compensation disclosed under Item 402 of Regulation S-K, such as disclosures in the Compensation Discussion and Analysis (CD&A), the Summary Compensation Table, and the related tables and narratives. The vote is limited to executive compensation and does not cover non-employee director compensation. The proposed rule would not require any specific language or form of resolution to be voted on by shareholders.
While the shareholder say-on-pay vote is advisory only, companies (but not smaller reporting companies) would be required to address in the CD&A in subsequent years how the shareholder say-on-pay votes have impacted compensation policies and decisions. Additionally, companies would have to disclose in its next quarterly report on Form 10-Q (or annual report on Form 10-K if the vote occurs in the fourth quarter) whether they will follow the advisory vote in determining compensation. The SEC has clarified that a company’s compensation policies as they relate to risk-management and risk-taking incentives would not be subject to a say-on-pay vote.
“Say-on-Frequency”—Advisory Vote on the Frequency of Say-on-Pay Votes
Section 14A of the Exchange Act provides that at least once every six years public companies must give shareholders a non-binding, advisory vote in their annual proxy statement on whether to hold the say-on-pay vote every one, two, or three years. To implement this “say-on-frequency” vote, the SEC has proposed Rule 14a-21(b). Under the proposed rule, companies must include a separate resolution in their annual proxy statements that gives shareholders four choices—whether the vote will occur every one, two, or three years, or to abstain from voting. Further, under proposed amendments to Form 10-K and 10-Q, companies would be required to disclose its “say-on-frequency” decision; that is, how often the company will hold the say-on-pay vote in light of the results of the shareholder vote on frequency.
The SEC expects that the board of directors will include a recommendation as to how shareholders should vote on the frequency of say-on-pay votes. However, the company must make clear that the proxy card provides for four choices and that shareholders are not voting to approve or disapprove the company’s recommendation.
The SEC’s proxy rules generally require companies to file proxy statements in preliminary form at least ten calendar days before definitive proxy materials are first sent to shareholders, unless the items included for a shareholder vote are limited to the election of directors and other specified matters. The proposed rule amendments would add the say-on-pay and say-on-frequency votes to the list of items that do not require a preliminary filing.
Companies that are participating in the Troubled Asset Relief Program are required to conduct a separate annual shareholder vote to approve executive compensation during the period during which any obligation arising from participation under TARP remains outstanding. Because the say-on-pay vote required under TARP is effectively the same as would be required under the proposed SEC rules, a shareholder vote to approve executive compensation under the requirement for TARP participants would satisfy the say-on-pay requirement under the Dodd-Frank Act. Because TARP participants must have an annual say-on-pay vote, they would not be required to have a say-on-frequency vote until the first annual meeting after the company has repaid all outstanding indebtedness under TARP.
“Say-on-Golden Parachutes”—Disclosure and Advisory Vote in Connection with M&A Transactions
In connection with certain merger or acquisition transactions, Section 14A of the Exchange Act requires companies to disclose to shareholders in a merger proxy any “golden parachute” compensation arrangements with its named executive officers (or, if the company soliciting the proxy is not the acquiring company, the compensation arrangements between the acquiring company and its named executive officers). Additionally, where any golden parachute compensation arrangement has not been subject to a shareholder say-on-pay vote, shareholders must be given a non-binding, advisory vote on such arrangement.
In order to implement the golden parachute disclosure requirements of Section 14A in connection with merger or acquisition transactions, the SEC has proposed new Item 402(t) to Regulation S-K, which requires disclosure of named executive officers’ golden parachute arrangements in both tabular and narrative form. Such tabular and narrative disclosure must be provided in any proxy or consent solicitation to approve an acquisition, merger, consolidation or proposed sale or disposition of all or substantially all of the company’s assets.
Click here to see the SEC's proposed tabular form for disclosure under new Item 402(t):
Elements of compensation that would be separately quantified and included in the total would be any cash severance payment (column b); the dollar value of accelerated stock awards, in-the-money option awards for which vesting is accelerated, and payment in cancellation of stock and option awards (column c); pension and nonqualified deferred compensation benefit enhancements (column d); perquisites and other personal benefits and health and welfare benefits (column e); tax reimbursements, such as Internal Revenue Code Section 280G gross-ups (column f). Any item that does not come within the other columns would go in the “other” column. Only compensation that is based on or otherwise relates to the transaction would have to be disclosed. As a result, previously vested equity awards and bona-fide post-transaction employment agreements would not be included in the table. Narrative disclosure of any conditions or obligations applicable to the receipt of payment, such as non-compete agreements, must accompany the table.
Although not required by the Dodd-Frank Act, the SEC has proposed amendments to other rules and forms so that golden parachute disclosure would be provided in registration statements on Form S-4 that contain disclosure relating to mergers and similar transactions and in disclosure documents for going private transactions and third-party tender offers.
The SEC is not amending the requirements for golden parachute disclosure in annual meeting proxy statements, although under the proposed rules companies would be permitted to provide the new disclosure in annual meeting proxies. If the new golden parachute disclosure is provided in an annual meeting proxy statement – and voted on as part of a say-on-pay vote – a separate vote on the golden parachute payments would not be required at the time of the acquisition transaction. New golden parachute arrangements and any revisions to golden parachute arrangements made subsequent to the shareholder vote would be subject to the separate merger proxy shareholder vote requirement.
Effective Date and Transition Provisions
The say-on-pay and say-on-frequency votes will be required in any proxy statement for annual or other shareholder meetings held on or after January 21, 2011 that includes disclosure of executive compensation pursuant to Item 402 of Regulation S-K, whether or not the SEC has adopted final rules. Until the SEC adopts final rules, the SEC will not object if companies 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 the say-on-frequency vote. Also, because some proxy service providers may be unable to permit shareholders to vote among four choices (rather than the usual three – for, against or abstain), until the final rules are adopted the SEC will not object if the form of proxy for the say-on-frequency vote offers only the choice of 1, 2 or 3 years and proxies are not voted if the shareholder does not select a choice.
The golden parachute disclosures and say-on-golden parachute advisory vote will be required on or after the later of January 21, 2011 or the date on which the SEC’s proposed rule changes become effective.