On January 25, 2011, the Securities and Exchange Commission (the “SEC”), by a 3-2 vote, approved final rules (the “Rules”)1 requiring shareholder votes on executive compensation, the frequency of such votes and Golden Parachute compensation. Informally known as “Say on Pay,” “Say on Frequency” and “Say on Golden Parachutes,” the Rules implement Sections 951(a) and (b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Financial Reform Act”). The Rules require a non-binding “advisory” shareholder vote on the following matters:

  • Executive compensation paid to named executive officers as disclosed in the issuer’s proxy.
  • The frequency of the vote on executive compensation.
  • Compensation paid to named executive officers in connection with merger transactions.

Issuers must comply with the Say on Pay and Say on Frequency rules for all annual or other meetings at which directors will be elected that are held on or after January 21, 2011, with the exception of smaller reporting companies with a public float of less than $75 million. Smaller reporting companies have a temporary exemption from the Say on Pay and Say on Frequency rules for two years and will not be subject to such rules until the first annual or other meeting of shareholders at which directors will be elected that are held on or after January 21, 2013.2 All issuers, including smaller reporting companies, must comply with Say on Golden Parachutes disclosure and voting requirements beginning on or after April 25, 2011.

Also on January 25, 2011, the SEC proposed rules to limit the eligibility of natural persons to participate in private and other unregistered offerings of securities and other investments. Implementing Section 413 of the Financial Reform Act, the SEC proposed amendments to the definition of “accredited investor” to exclude the value of a person’s residence from counting towards the required net worth of $1 million.

Say on Pay—New Rule 14a-21(a)

The centerpiece of Say on Pay is new Exchange Act Rule 14a-21(a) that requires issuers to hold a separate, non-binding shareholder vote at least once every three calendar years to approve the compensation of named executive officers.3 The Say on Pay vote will only be required for an annual or other meeting of shareholders for which proxies will be solicited for the election of directors or a special meeting in lieu of such meeting. Shareholders will be asked to approve or disapprove the compensation as described in the proxy, including the Summary Compensation Table, and related disclosure in the Compensation Discussion and Analysis (“CD&A”). The compensation of directors is not subject to the Say on Pay vote.

Form of Disclosure and Vote

The SEC did not prescribe any particular language or form of resolution to be voted on, except that the Say on Pay resolution must contain the language from the Financial Reform Act--namely, that the vote is “to approve the compensation of the [issuer’s] named executive officers, as disclosed pursuant to [Item 402 of Regulation S-K].” The SEC noted that crafting other language, for example, to approve only compensation policies and procedures, would not satisfy the Rules.

In addition to the Say on Pay vote itself, the SEC adopted new Item 24 to Schedule 14A. This new Item requires disclosure in the proxy statement of the general effect of the vote, such as whether the vote is non-binding. In addition, the issuer must disclose the current frequency of Say on Pay votes and when the next Say on Pay vote will occur.

Changes to Mandatory CD&A Disclosure

The SEC amended the disclosure required in the issuer’s CD&A to require a discussion, to the extent material, of whether and how the issuer considered the results of the most recent Say on Pay vote in determining compensation policies and decisions and how that consideration affected the issuer’s compensation policies and decisions. Consistent with the principles-based nature of CD&A, only the most recent Say on Pay vote needs to be considered for purposes of the disclosure, unless previous Say on Pay votes are material, in which case they would need to be disclosed as well. In particular, should an issuer receive more votes “against” than “for” the executive compensation in any previous Say on Pay vote, and the issuer makes significant changes to its compensation policies as a result, such a vote would likely be material and subject to narrative disclosure under the new CD&A rules. Because smaller reporting companies are not required to include a CD&A, they are not subject to this requirement unless it is material to an understanding of the compensation as disclosed in the Summary Compensation Table.

Say on Frequency—New Rule 14a-21(b)

New Exchange Act Rule 14a-21(b) requires issuers to conduct a Say on Frequency vote at least once every six calendar years to determine the frequency of Say on Pay votes. Shareholders must be given the option to hold a Say on Pay vote annually, once every two years, once every three years or abstain from voting. The SEC did not adopt a form of resolution required by the Say on Frequency vote. Like the Say on Pay vote, the Say on Frequency vote will be only be required at an annual or other meeting of shareholders at which directors will be elected. Newly-public companies will need to conduct a Say on Pay and Say on Frequency vote in the proxy statement for such issuer’s first annual meeting after its initial public offering.

Form of Proxy Card

The SEC amended Exchange Act Rule 14a-4 to allow shareholders four Say on Frequency choices on the proxy card: 1, 2, 3 years or abstain. In the event that a shareholder submits an uninstructed proxy card, management may vote that proxy card only if it follows the existing requirements of Rule 14a-4, which require:

  • The issuer to include a recommendation as to the Say on Frequency vote in the proxy statement;
  • Permit abstention on the proxy card; and
  • Include language in bold regarding how uninstructed shares will be voted.

Shareholder Proposals

To prevent redundant shareholder proposals regarding Say on Pay and Say on Frequency, the SEC added a note to Exchange Act Rule 14a-8 to allow for exclusion of certain shareholder proposals related to those topics. Specifically, an issuer may exclude a shareholder proposal: (1) that seeks advisory votes to approve executive compensation as disclosed in Item 402 of Regulation S-K, or (2) that relates to the frequency of Say on Pay votes, provided that in the most recent Say on Frequency vote, a single frequency received a majority of the votes cast and the issuer adopted a policy on the frequency that is consistent with the choice of the majority of votes cast. The SEC noted that abstentions would not count as votes cast. Consequently, issuers may not exclude shareholder proposals on frequency even when there is one clear frequency choice, such as receipt of 40 percent of the votes for holding a Say on Pay vote every three years, and even when the issuer adopted such choice.

New Form 8-K Disclosure of Say on Pay and Say on Frequency Votes

The SEC amended Item 5.07 of Form 8-K to require disclosure of the preliminary results of shareholder votes for Say on Pay and Say on Frequency within four business days following the day the shareholder meeting ends and final voting results are known. However, the revised Item 5.07 provides a longer window for the consideration of Say on Frequency votes. Specifically, the issuer must disclose, in light of the Say on Frequency vote, how frequently the issuer will conduct Say on Pay votes within 150 calendar days after the end of the annual meeting but at least 60 calendar days prior to the deadline for submitting shareholder proposals under Exchange Act Rule 14a-8 for the next annual meeting. This disclosure will be through an amendment to Form 8-K. Importantly, if the issuer fails to make timely disclosure of either the votes cast or the consideration of the vote, it may lose the ability to utilize shelf registration as provided in Form S-3.

Preliminary Proxy Filing and Broker Voting

Say on Pay and Say on Frequency votes alone will not trigger the filing of a preliminary proxy. The SEC amended Exchange Act Rule 14a-6 to clarify, for example, that if the only matters that are to be considered at annual meeting are the election of directors, Say on Pay and Say on Frequency, the issuer will not be required to file a preliminary proxy.

The SEC also clarified that for issuers with a class of securities listed on a national securities exchange, broker discretionary voting of uninstructed shares is not permitted for the Say on Pay or Say on Frequency vote.

New Say on Golden Parachutes Voting and Disclosure

Known as “Say on Golden Parachutes,” any person that solicits shareholder approval of an acquisition, merger, consolidation or proposed sale of all or substantially all of an issuer’s assets must provide a shareholder vote and disclosure of any agreements or understandings concerning compensation of named executive officers that is based on or otherwise relates to the transaction. Smaller reporting companies are not exempt from Say on Golden Parachute votes.

To implement Say on Golden Parachutes, the SEC adopted new Item 402(t) of Regulation S-K. This Item requires disclosure, in a tabular and narrative format, of the individual elements of compensation that an executive would receive that are related to the transaction and the total for each named executive officer. Specifically, this requires disclosure, in a tabular format, the dollar value of: (1) cash severance payments, (2) equity awards, (3) pension and non-qualified deferred compensation benefit enhancements, (4) perquisites and other personal health and welfare benefits, (5) tax reimbursements and gross-ups, (6) any other award not fitting within the previous five categories and (7) the total of categories (1)-(6) above. Footnotes will be required of each separate form of compensation required and further footnote disclosure is required for any amounts that are attributable to “single-trigger” vs. “double trigger” amounts. All of the foregoing elements must be quantified and an estimated range of payments is not permitted. Disclosure is not required of any amounts which would not be paid or payable in connection with the transaction subject to shareholder approval, such as previously vested stock awards.

New Item 402(t) also requires narrative disclosure of certain compensation elements. In particular, issuers must describe any material conditions or obligations applicable to the receipt of payment, such as non-compete, non-disparage or non-solicit arrangements, their duration, and whether there are conditions regarding waiver or breach. Furthermore, disclosure must be provided as to the specific circumstances that would trigger payment, whether the payments are lump sum or annual, their duration and by whom the payments would be provided and any other material factors to each agreement.

The SEC cautioned that Item 402(t) does not allow for the exclusion of de minimus amounts, but does allow for exclusion of any bona fide future employment agreements because such agreements are not related to the transaction. In addition, disclosure need not be provided for persons who are named executives because they would have been the most highly compensated executive officers but for the fact that they were not serving as a named executive officer at the end of the last fiscal year.

Golden Parachute Exemption—Preliminary Filing

Issuers may exclude a Golden Parachute vote and disclosure in connection with a transaction if they had included Item 402(t) disclosure in their annual proxy statement and subjected it to a non-binding, advisory vote. To implement this option, the SEC issued new Exchange Act Rule 14a-21(c). In order to rely on this exemption, the Golden Parachute arrangements previously subjected to a vote at an annual meeting must remain in effect and the terms must not have been modified, except as noted below. Changes in the price of the issuer’s securities do not constitute a modification, but any new Golden Parachute arrangements, and any revisions to Golden Parachute arrangements will require a new separate proxy vote on such changes. Changes in Golden Parachute arrangements that result only in a decrease of the value of the total compensation payable do not require a new shareholder vote. Any changes in compensation due to a newly-named executive officer, additional equity compensation grants and increases in salary would be the type of changes that would be subject to a new Golden Parachute shareholder vote for the transaction in question.

Issuers that have revised arrangements requiring a new Golden Parachute shareholder vote will need to provide two tables under Item 402(t). One table would disclose all previously-disclosed amounts that were subject to a shareholder vote and the other table would contain the revised terms that are subject to the instant vote.

Application to Going Private Transactions, Tender Offers and Share Issuances or Reverse Stock Splits—Amendments to SEC Schedules In addition to transactions requiring a vote of shareholders, the SEC amended several schedules to require Item 402(t) disclosure in situations where there is no shareholder advisory vote. Schedules 14A, Schedule 14C, Schedule 14D-9 and Schedule 13E-3 have all been amended to require Item 402(t) disclosure. The SEC amended Schedule TO to provide that bidders in certain third-party tender offers are not required to provide Item 402(t) disclosure given the difficulty bidders may face in obtaining accurate information regarding a target company’s golden parachute arrangements.

Practice Pointers:

  • Consider increasing transparency in the CD&An in order to explain why the issuer’s compensation policies and procedures are in the best interests of shareholders.
  • Because management can vote uninstructed shares in conformity with its recommendations consider recommending a particular Say on Frequency vote.
  • Update planning calendars to provide for a consideration and deliberation of the Say on Frequency vote within the window for 8-K disclosure.
  • With a view to obtaining a majority vote, engage shareholders on the Say on Frequency vote to allowexclusion of shareholder proposals not in conformity with the vote.
  • Take care to fully document how the compensation committee considers the results of, and any changes it makes to, executive compensation as a result of the Say on Pay shareholder vote for inclusion in the CD&A, especially for issuers conducting triennial votes. Include a special item for consideration by the compensation committee to ensure robust and topical disclosure.
  • Consider whether probable changes to compensation arrangements at the time of a merger transaction, would make submission of Golden Parachutes to a vote at an annual meeting moot.
  • Issuers who have adopted voluntary Say on Pay in the past should review and revise their disclosures as necessary.

Proposed Rules Regarding the Definition of “Accredited Investor”

Also on January 25, 2011, the SEC proposed revisions to the definition of “accredited investor” to exclude the value of the person’s primary residence in determining accredited investor status.4 The accredited investor rules limit the eligibility of natural persons to participate in private and other unregistered offerings of securities and other investments. To be considered an “accredited investor”, a natural person, either individually or with his or her spouse, must have a net worth of $1 million. These revisions were mandated by Section 413(a) of the Financial Reform Act. Although Section 413(a) of the Financial Reform Act was effective upon passage, the proposed rules clarify how to make the net worth calculations. Specifically, the amendments would set the same standard for both Securities Act Rules 501 and 215 and add the language “excluding the value of the primary residence of the natural person, calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property.” Although the term “net worth” is not specifically set out by the Securities Act, it is generally understood to be the excess of assets over liabilities (or debt).

In effect, this removes a person’s net equity in a primary residence from the definition of net worth by removing from the “assets” side of the net worth calculation the value of the person’s primary residence, and removing the debt on such residence from the “liabilities” side of the ledger. Of course, other residences may be used to calculate the net worth standard of the investor, since the language of the Financial Reform Act did not address any other assets other than the person’s “primary residence.” For mortgages that are “underwater” (indebtedness exceeds the fair market value of the property), the excess debt would be subtracted in determining net worth. The SEC is seeking comment on certain portions of these provisions by March 11, 2011.