On October 18, 2010, the SEC issued its proposed rules implementing certain portions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), including the shareholder advisory voting requirements on severance arrangements in the context of change in control transactions. Comments on the rules are due November 18, 2010. In addition to requiring certain non-binding shareholder advisory votes on change in control severance arrangements (so called “say-on-golden-parachute” votes), the proposed rules would also require both a narrative and tabular disclosure of change in control compensation and would require companies to distinguish among the sources or form of the compensation, for example cash versus acceleration of options. This heightened focus on change in control compensation arrives in a market increasingly eager to temper such arrangements.
The say-on-golden-parachute votes were one of the three new categories of non-binding shareholder votes required under the Dodd-Frank Act and addressed by the SEC’s proposed rules. The two other non-binding shareholder votes are (i) the so-called “say-on-pay” votes, which require a non-binding vote on the compensation of named executive officers disclosed per Item 402 of Regulation S-K, must occur at least once every three years, and (ii) the so-called “say-on-frequency” votes, to occur at least once every six years, regarding the frequency of the say-on-pay votes, i.e., annually, biennially or triennially.
Unless the subject of a previous say-on-pay vote, say-on-golden-parachute votes would be required whenever shareholder consent is sought to approve the underlying transaction triggering the compensation. Unlike the say-on-pay and say-on-frequency votes, which will be required by the Dodd-Frank Act of companies filing proxies for annual meetings occurring after January 21, 2011, the Dodd-Frank Act required SEC rules for implementation of the say-on-golden-parachute votes and, therefore, the separate say-on-golden-parachute votes will not be required until the SEC issues its final rules.
These new advisory shareholder votes do not bind the company nor do they change any fiduciary duties, but the votes will send a message and place heightened scrutiny on compensation packages for named executive officers. Further, the proposed SEC rules would require companies to disclose in their Compensation, Discussion & Analysis how the say-on-pay votes have affected compensation policies. Further, with respect to change in control compensation, the SEC’s proposed rules would require both a narrative and tabular description of the triggered compensation with distinct categories for the different types of compensation, including, among others, cash, the value of accelerated equity compensation (including proceeds paid for the cancellation of stock and options) and any tax reimbursement. Companies would also have to disclose whether the applicable compensation is single-trigger (i.e., triggered by the change in control alone) or double-trigger (i.e., triggered by the change in control coupled with termination of employment under specified circumstances).
The heightened scrutiny of change in control arrangements demonstrated in the Dodd-Frank Act voting requirements and echoed by the SEC’s proposed rules arrives in a market increasingly reluctant to grant executive-friendly change in control packages. For example, Frederic W. Cook & Co., Inc. conducted a study of compensation packages for the period 2006 to 2009 for named executive officers at the 125 largest publicly traded companies. The study found that, of the companies with change in control severance arrangements with named executive officers, 11% had eliminated Internal Revenue Code Section 4999 excise-tax gross-ups, while an additional 8% had moved from a full gross-up to a modified gross-up. The Frederic W. Cook & Co., Inc. study also found that 7% of the companies with change in control severance arrangements had decreased the amount of such severance. Similarly, a study conducted by the consulting firm Alvarez & Marsal indicated that the average value of change in control payments at America’s twenty largest publicly traded companies fell by nearly 40% (declining from approximately $38 million to approximately $23 million from 2007 to 2009).
Note that the new shareholder advisory votes and disclosures are part of a broader group of executive compensation-related requirements established by the Dodd-Frank Act and the SEC’s proposed rules and that the Dodd-Frank Act, which was signed into law by President Obama on July 21, 2010, impacts several other areas of corporate law as well, including establishing a Financial Stability Oversight Council, imposing additional restrictions on financial institutions and private equity funds and requiring changes affecting corporate governance.