Shareholder 'say on pay' voting
Independence of members of compensation committees
Compensation committee advisers
Additional executive compensation disclosures
Clawbacks of incentive-based compensation
Board structure disclosure
Enacted on July 21 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act contains significant executive compensation and corporate governance provisions applicable to public companies. This update summarises the key provisions that address executive compensation and corporate governance issues.
Each public company must provide its shareholders with a separate non-binding vote to approve or reject the compensation of its officers as 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. A non-binding vote for compensation is also required in connection with a change of control transaction. When a company seeks its shareholders' approval for such a change, 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 non-binding vote of the shareholders. While 'say on pay' votes are non-binding, directors will likely make significant efforts to avoid a negative vote through both shareholder outreach and proactive use of the compensation disclosure and analysis section of proxy materials.
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.
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 advisers. If the compensation committee retains the services of any such advisers, it may do so only after considering their independence, based on factors to be identified 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.
The act does not require compensation committees to hire outside consultants or that any outside consultants hired be independent.
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 that 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:
- the median of the annual total compensation of all of its employees other than the chief executive officer;
- the annual total compensation of the chief executive officer; and
- 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.
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 non-compliance 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 on which 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 regardless of whether the material non-compliance that caused the restatement was the result of wrongdoing.
This clawback provision applies to all executive officers, including former executive officers, even where there was no bad behaviour, and applies to the excess incentive-based compensation received during the three-year period preceding the date on which 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 being entered into.
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, reagrdless of whether the equity securities were received as compensation.
The commission is additionally required 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 chief executive officer 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 make adjustments needed to comply with the provisions. Public companies should consider:
- how the act will affect their compensation and governance structures;
- whether a broader than normal review of their compensation structure and programmes is appropriate; and
- what employee compensation information is needed to comply with the new disclosure rules.
Most significantly, public companies need to focus on the 'say on pay' rules and whether (and to what extent) incentive structures should be adjusted.
For further information on this topic please contact Kevin B Leblang or Robert N Holtzman at Kramer Levin Naftalis & Frankel LLP by telephone (+1 212 715 9100), fax (+1 212 715 8000) or email (firstname.lastname@example.org or email@example.com).
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