2010 Fall Meeting Washington, DC November 19-20, Practical Guidance on Executive Compensation in the Dodd-Frank Era

Transcription

1 2010 Fall Meeting Washington, DC November 19-20, 2010 Practical Guidance on Executive Compensation in the Dodd-Frank Era

2 Preparing for the 2011 Proxy Season ABA Subcommittee on Executive Benefits, Executive Compensation, and Section 16 ABA Fall Meetings November 20, :30 a.m. 11:00 a.m. I. Introduction A. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act II. B. Although the new law is primarily devoted to reforming the financial services sector, it also contains a number of significant provisions related to executive compensation and corporate governance matters Effective Dates A. Basically, the Dodd-Frank Act executive compensation provisions become effective in three waves 1. Section 951 (the shareholder advisory vote provisions) is effective for annual shareholder meetings occurring after January 21, 2011 a) Except for the shareholder advisory vote on golden parachutes (see below) 2. Compensation committee independence and committee adviser independence provisions are effective upon completion of SEC rulemaking (which must take place by July 16, 2011) and subsequent rulemaking by the national securities exchanges 3. Other provisions are effective upon completion of SEC and/or national securities exchange rulemaking, for which there is no stipulated deadline a) The SEC has indicated that it will be proposing rules for these provisions during the April July 2011 time frame III. Shareholder Advisory Votes on Executive Compensation (Section 951 of the Dodd-Frank Act) A. On October 18, 2010, the SEC proposed rules (the "Proposed Rules") to implement Section 951 of the Dodd-Frank Act 1

3 1. The SEC has provided for a short 30-day comment period (ending November 18, 2010), indicating that it may adopt final rules as soon as possible following the conclusion of the comment period 2. The text of the proposed rules is at B. New Section 14A(a) of the Exchange Act requires non-binding shareholder advisory vote on executive compensation programs (see new Section 14A(a)(1)) 1. Effective for annual shareholder meetings occurring after January 21, Vote is whether to approve the compensation of the named executive officers as disclosed in the proxy statement pursuant to Item 402 of Regulation S-K 3. The vote is non-binding and may not be construed as: a) Overruling a decision by the board of directors b) Creating or implying any change in or additional fiduciary duty for the board of directors c) Limiting the shareholders right to make executive compensation proposals 4. In light of the prohibition of broker discretionary voting in executive compensation matters (as contained in Section 957 of the Dodd-Frank Act), companies need to take this vote seriously a) Note that this advisory vote also does not restrict or limit shareholders ability to submit other executive compensation-related proposals under Exchange Act Rule 14a-8 5. With every company subject to the SEC s proxy rules required to conduct a Say on Pay vote during the 2011 proxy season, one question was whether the advisory vote would necessitate the filing of a preliminary proxy statement a) Currently, Exchange Act Rule 14a-6 does not require the filing of a preliminary proxy statement in connection with a shareholder advisory vote on executive compensation, but 2

4 only in the case of a company subject to Section 111(e)(1) of the Emergency Economic Stabilization Act of 2008 (essentially, TARP participants) (see Exchange Act Rule 14a-6(a)(7)) b) The SEC has proposed n amendment to Exchange Act Rule 14a-6 that would make clear that a Say on Pay vote compensation would not trigger the requirement to file a preliminary proxy statement c) For companies whose annual meetings occur before the proposed rules are finalized, the SEC has said it will not object if preliminary proxy materials are not filed 6. The Dodd-Frank Act authorizes the SEC to exempt an issuer or class of issuers (for example, smaller reporting companies) from the requirement to hold a Say on Pay vote C. Content of Resolution a) This exemptive authority was inserted into the provision during the House-Senate Conference Committee; presumably to appease legislators concerned about the impact of the reforms on small businesses b) The proposed rules do not exempt smaller reporting companies from the Say on Pay vote requirement c) As expected, however, the proposed rules do not require such companies that opt to use the scaled reporting system to provide a Compensation Discussion and Analysis (see Section II.A.3 of Release No. 9153) 1. The required resolution must seek shareholder approval of the compensation of a company s executives, as disclosed pursuant to Item 402 of Regulation S-K a) While the language of the provision suggests that it covers all of a company s executives, the reference to Item 402 disclosure makes it clear that it only covers the named executive officer group (as identified pursuant to Item 402(a)(3)) 2. Proposed Rule 14a-21(a) would set for the general requirement for the Say on Pay vote, which would be based on a company's executive compensation disclosure as presented in the proxy 3

5 statement the Compensation Discussion and Analysis (if required), the compensation tables, and any related narrative disclosure a) Following the same formulation that it applied last year to TARP participants, the SEC in the proposed rules does not dictate a specific form of resolution or specific language to be used in structuring the Say on Pay vote, except the vote must relate to all of the executive compensation disclosure required by Item 402 of Regulation S-K b) The SEC notes in the Proposing Release that a vote on a different matter, such as to approve only compensation policies and procedures, would not satisfy the Say on Pay vote requirement D. Proxy Statement Disclosures 1. Proposed new Item 24 to Schedule 14A would require companies to disclose in their proxy statements that they are conducting a Say on Pay vote and briefly explain the effects of the vote, such as whether it is non-binding 2 As for the Say on Pay vote, the SEC has proposed an amendment to Exchange Act Rule 14a-6 that would make clear that the Frequency vote (as described below) would not trigger the requirement to file a preliminary proxy statement 3. An amendment to Item 402(b) of Regulation S-K would add a new mandatory discussion topic for the Compensation Discussion and Analysis whether and, if so, how a company has considered the results of previous shareholder advisory votes on executive compensation in determining its compensation policies and decisions E. Action Items 1. There are four action items to prepare for the initial Say on Pay vote: a) Address any lingering concerns about executive compensation program Has ISS identified any problematic pay practices that should be reconsidered? 4

6 (ii) Has the Board of Directors identified any problematic pay practices, or been on the fence about adopting generally-accepted best practices (such as stockownership guidelines or ant-hedging policies)? b) Review current executive compensation disclosure to see whether it should be improved (ii) (iii) (iv) Consider simplifying the Compensation Discussion and Analysis Consider use of an executive summary or overview or resolution supporting statement to highlight key compensation actions and decisions Consider reducing length and complexity, replacing narrative disclosure with crisp use of graphics Look at last year s ISS report on proxy statement to see where it believes disclosure can be improved c) Become familiar with the executive compensation policies to key shareholders and proxy advisory firms to identify red flags that may influence a no vote Decide whether to reach out to these shareholders to address their possible concerns or make changes to program to avoid a negative vote recommendation from ISS d) Analyze shareholder base to determine whether absence of broker voting will have any impact on vote If so, determine how to ensure an adequate vote F. New Section 14A of the Exchange Act also requires that proxy materials for first annual shareholder meeting occurring after January 21, 2011 include (and going forward, not less frequently than once every six years) a separate proposal for an advisory vote to determine whether the Say on Pay vote should occur every one, two, or three years (see new Section 14A(a)(2)) 1. Proposed Rule 14a-21(b) would set for the general requirement for this Frequency vote in 2011 and thereafter at least once every six years 5

7 2. The SEC in the proposed rules does not dictate a specific form of resolution or specific language to be used in structuring the Frequency vote 3. Proposed new Item 24 to Schedule 14A would require companies to disclose in their proxy statements that they are conducting a shareholder advisory vote on the frequency of the "Say on Pay" vote and briefly explain the effects of the vote, such as whether it is non-binding a) Although some language differences in the Dodd-Frank Act have led to questions about the non-binding nature of the frequency vote, the SEC confirms in the Proposing Release that it views the Frequency vote to be non-binding 4. The decision of the House-Senate Conference Committee to let shareholders determine the frequency of the vote annually, biannually, or tri-annually presents a host of questions that will play out over the next several months a) Content of resolution It is not clear under the statute how the resolution is to be drafted (ii) One alternative that was identified was for a company to structure the vote to be a choice between an annual vote and a periodic vote (that is, either every two or three years, in the company s discretion) However, the plain language of Section 14A(a)(2) appears to require that companies permit shareholders to choose between holding the vote every one, two, or three years b) The SEC has addressed these issues in a proposed amendment to Exchange Act Rule 14a-4, which would require companies to provide shareholders with four choices whether the Frequency vote will be held every one, two, or three years or to abstain from voting While that appears to be consistent with Congressional intent, it raises the possibility that the decision will be made by a plurality of shareholders (meaning that a majority of shareholders may not favor the choice that ultimately prevails) 6

8 c) The SEC stated in the Proposing Release that, while it expects that the board of directors will include a recommendation as to how shareholders should vote on the Frequency vote, the company must make clear that the proxy card provides for four choices (every one, two, or three years, or abstain) and that shareholders are not voting to approve or disapprove the company's recommendation d) Frequency of the vote - While Section 14A(a)(2) requires that the frequency of the Say on Pay vote be submitted to shareholders at least every six years, there doesn t appear to be anything in the provision preventing this vote from being held more frequently (ii) (iii)` So, for example, if, in 2011, shareholders decide that the Say on Pay vote should be held annually, the company can hold a Section 14A(a)(2) vote again in 2012 to seek a different result Similarly, if, in 2011, shareholders decide that the Say on Pay vote should be held once every three years, a shareholder could submit a shareholder proposal for 2012 seeking that a Say on Pay vote be held annually (see Section 14A(c)(4) stating that the Say on Pay vote is not to be construed to restrict or limit the ability of shareholders to make proposals relating to executive compensation in a company s proxy materials) But see the SEC s proposed amendment to Exchange Act Rule 14a-8(10), which would permit a company to exclude a shareholder proposal dealing with the Say on Pay vote and the Frequency vote where the company has adopted a policy on the Frequency vote that is consistent with the plurality of votes cast in the most recent Frequency vote d) While it s a bit early to know exactly how this new requirement will play out, the various permutations that could arise suggest that a company will want to carefully consider it strategy for submitting executive compensation matters to its shareholders over an extended period of time - the Say on Pay resolution itself, the Frequency vote, and any employee stock plans 7

9 With the ever-changing composition of many companies shareholder bases, this is an area that, going forward, will have to be evaluated holistically 5. In some states, the decision with respect to shareholder proposals requires majority approval of the shareholders a) For example, under Delaware law, it appears that a majority vote of the shares present and entitled to vote is required for all matters other than the election of directors (unless provided otherwise in the company s charter or bylaws) (see Delaware General Corporation Law Section 216) b) Where a clear majority of the votes cast indicate a preference as to the frequency of the vote, there s no problem. But what happens if none of the three choices receive a majority? Section 14A(a)(2) doesn t provide a default resolution. c) The SEC has addressed this issue in the Proposing Release that, because the Frequency vote is advisory only, it does not believe that it is necessary to prescribe a standard for determining which frequency has been adopted by shareholders 6. Currently, companies must disclose their annual meeting vote results in the current reports on Form 8-K following a shareholder meeting. The SEC is proposing amendments to Forms 10-Q and 10-K to require companies to make an additional disclosure of how frequently they will conduct a "Say on Pay" vote in light of the results of the most recent Frequency vote IV. a) This disclosure must be in the Form 10-Q for the fiscal quarter in which the Frequency vote occurred or the Form 10-K if the vote occurs in the fourth fiscal quarter Advisory Vote on Golden Parachutes (Section 951 of the Act) A. The other shareholder advisory vote contemplated by Section 951 of the Dodd-Frank Act is the vote on golden parachute compensation (see new Section 14A(b) of the Exchange Act). B. Disclosure requirement 1. While most of the attention has been focused on the shareholder advisory vote itself, Section 14A(b) actually imposes a new mandatory disclosure requirement for all proxy or consent 8

10 solicitation materials pursuant to which shareholders are being asked to approve a merger or other corporate transaction a) Under this requirement, the person making the solicitation must disclose: (ii) any agreements or understandings that such person has with any named executive officer of the company that is the subject of the transaction concerning any type of compensation (whether present, deferred, or contingent) that is based on or otherwise relates to the transaction; and the aggregate total of all such compensation that may (and the conditions upon which it may) be paid or become payable to or on behalf of such executive officer. b) This requirement is not linked to the required shareholder advisory vote In other words, although the requirement for a shareholder advisory vote does not arise where the agreement or understanding has been previously subject to a Say on Pay vote as required by Section 14A(a)(1), the disclosure requirement applies to all change-in-control-related compensation arrangements, regardless of whether (or when) they have been subject to a shareholder advisory vote 2. Section 14A(b)(1) states that the disclosure is to be in a clear and simple form in accordance with regulations to be promulgated by the Commission. a) The SEC has proposed a new Item 402(t) to Regulation S- K to set forth the disclosure requirements that a company must follow in proxy or consent solicitations in connection with a merger or other extraordinary corporate transaction The disclosure would cover all golden parachute compensation relating to the transaction among the target and acquiring corporations and the named executive officers of each entity 9

11 (ii) (iii) (iv) The disclosure would be presented in both narrative and tabular form, with tabular disclosure made in a new table captioned Golden Parachute Compensation that would include columns for cash, equity, pension and nonqualified deferred compensation, perquisites and other personal benefits, tax reimbursements, other items, and then total compensation The SEC states in the Proposing Release that the current information required by Item 402(j) of Regulation S-K (the Potential Payments Upon Termination of Change-in-Control disclosure) does not conform to the dictates of the Dodd-Frank Act, because Item 402(j) does not require tabular disclosure, and permits omission of certain items such as perquisites in amounts less than $10,000 in the aggregate for an individual named executive officer A company seeking to take advantage of the exception to the shareholder advisory vote on golden parachutes requirement would have to provide disclosure in its annual meeting proxy statement using Item 402(t) disclosure rather than Item 402(j) (which would continue to apply to termination of employment and other severance arrangements) C. Shareholder advisory vote 1. Any proxy, consent, or authorization relating to materials that contain the disclosure described above must include a separate resolution permitting shareholders to vote on the disclosed agreements or understandings and the related compensation, unless such agreements or understandings have previously been subject to the general Say on Pay vote required under Section 14A(a)(1) (see Section 14A(b)(2)) 2. Proposed Rule 14a-21(c) would set forth the general requirement for the shareholder advisory vote on golden parachutes a) As with the Say on Pay vote, the proposed rules do not dictate a specific form of resolution or specific language to be used in structuring this shareholder advisory vote 10

12 3. As with the Say on Pay vote, this merger-related vote is nonbinding and will not compel companies (or their boards of directors) to reverse these compensation arrangements (see Section 14A(c)) a) In addition, the presence of this vote will not preclude shareholders from continuing to submit proposals concerning golden parachute arrangements to the company (see Section 14A(c)(4)) 4. As a tactical matter, this shareholder advisory vote requirement may place a greater premium on companies having their golden parachute arrangements in place well before a proposed transaction and, presumably, subject to the Say on Pay vote a) This may be more difficult where the company s shareholders have approved a Say on Pay vote to take place every two or three years. (It s not clear whether a company that has approved new golden parachute arrangements in an off year (a year in which no Say on Pay vote is scheduled) could hold an additional Say on Pay vote to take advantage of the exception to the golden parachute advisory vote Section 14A appears to give shareholders but not the company the ability to determine when the Say on Pay vote will be held. However, since it s not a binding vote (see below), it appears that the company can just schedule an additional Say on Pay vote of its own accord) D. Effective date 5. It s likely that more attention will be paid to golden parachute arrangements going forward once shareholders realize that the Say on Pay" vote may present their only opportunity to provide feedback on these arrangements 1. The SEC has deferred the effective date of the shareholder advisory vote on golden parachutes (as well as the accompanying disclosure) until the proposed rules are finalized (which should take place before the end of March 2011) 2. It s not clear whether pre-existing golden parachute arrangements will be exempt from Section 14A(b)(2) 11

13 a) This question may quickly become moot, however, once companies begin conducting Say on Pay votes, as long as they provide the new disclosure as contemplated under Item 402(t) of Regulation S-K E. In light of the prohibition of broker discretionary voting in executive compensation matters (as discussed more fully below), companies need to take this vote seriously 1. Note that this shareholder advisory vote also does not restrict or limit shareholders ability to submit other executive compensationrelated proposals under Exchange Act Rule 14a-8 F. Although the Dodd-Frank Act authorizes the SEC to exempt an issuer or class of issuers (for example, smaller reporting companies) from the requirement to hold an advisory votes on golden parachutes, the SEC in the proposed rules has determined not to exempt small issuers from this requirement V. Voting by Brokers (Section 957 of the Dodd-Frank Act) A. Last year the New York Stock Exchange amended its Rule 452 to eliminate broker voting of uninstructed shares in uncontested director elections (Rule 452 permits brokers to exercise discretionary authority to vote on certain routine matters where they have not received instructions from the beneficial owners of the shares B. Section 957 of the Dodd-Frank Act codifies this change and extends it to executive compensation matters and any other significance matter, as determined by the [SEC] C. Technically, Section 957 of the Act amends Section 6(b) of the Securities Exchange Act of 1934, which sets forth the requirements for registration of a national securities exchanges, to prohibit the registration of any exchange which permits any of its members (brokers and others) to vote securities that the member does not beneficially own on certain specified matters unless the member has received voting instructions from the beneficial owner of the securities. As noted above, the specified matters on which the voting of uninstructed shares is prohibited are: 1. the election of a member of a company s board of directors; 2. executive compensation; and 3. any other significant matter, as determined by the SEC D. Companies affected 12

14 1. Since this is a provision that affects the members (such as brokerage firms) of the national securities exchanges, rather than the companies listed on the exchanges, it will affect all public companies, since every public company has some portion of its outstanding equity securities held in street name on behalf of their beneficial owners. 2. The actual impact of the provision will vary among companies, depending on the composition of their shareholder base (institutional versus retail investors) E. Votes covered 1. The elimination of broker voting of uninstructed shares in uncontested director elections has already gone into effect, so this aspect of new Section 957 should have no additional impact on companies 2. The immediate effect of the provision is the elimination of broker voting of uninstructed shares on executive compensation matters a) Clearly, this change will apply to the shareholder votes under new Section 951 of the Dodd-Frank Act: the shareholder advisory vote on executive compensation (Section 14A(a)(1) of the Exchange Act), the shareholder advisory vote on the frequency of the shareholder advisory vote on executive compensation (Section 14A(a)(2) of the Exchange Act), and the shareholder advisory vote on golden parachute compensation (Section 14A(b)(2) of the Exchange Act). b) These items will join the approval of equity plans as nonroutine matters upon which brokers are not permitted to vote uninstructed shares 3. The real question is what additional executive compensation matters (for example, the approval of cash-based incentive compensation plans (for purposes of Section 162(m) of the Internal Revenue Code) and, possibly, any employment agreements or post-employment compensation arrangements that are submitted for shareholder approval) this prohibition will cover 4. The SEC has indicated that it will propose rules on the other significant matters that are covered by this provision in the April July 2011 time frame 13

15 F. Effective date 1. New Section 957 became effective as of July 21, 2010, when the Act was signed into law a) Since them, the national securities exchanges have modified their rules to conform them to this new requirement VI. Questions 14