ON Securities : Securities Lawyer & Attorney for Corporate Governance & Executive Compensation Matters

As public companies prepare for their first proxy season under the Dodd Frank Wall Street Reform and Consumer Protection Act (848-page PDF), I’m fielding many questions about implementation of the compensation and governance provisions of the Act. Unfortunately, given the broad language of the Act and the current absence of SEC regulations, there are not a lot of definitive answers.

However, the Society of Corporate Secretaries and Governance Professionals has provided a very thoughtful and helpful analysis. Darla C. Stuckey, Senior Vice President of the Society, in her testimony before the House Finance Committee last week, discussed the possible impact of various compensation-related provisions of the Act, as well as the Society’s “wish list” of possible regulatory clarifications. Ms. Stuckey’s testimony (PDF) makes interesting reading for anyone wrestling with preparation for the 2011 proxy season:

Say-on-Pay and Related Votes. The Society observes that the SEC is targeting January through March of 2011 for adoption of rules on Say-on-Pay and Say When on Pay. Since these votes are required at the first shareholders meeting on or after January 21, 2011, even January is too late to provide guidance for many affected companies. The Society requests that the SEC propose the rules in early October so the final rules can at least be adopted before January 21.

Advisory Firms. The Society also commented that the SEC should consider the power of proxy advisory firms (which would include ISS) in the Say-on-Pay process. A recent survey indicated that almost half of Society members reported 30% or more of the companies’ shares being voted in line with the advisory firms’ recommendations. Over 60% of respondents indicated at least one experience with an advisory firm’s recommendations being based on materially inaccurate or incomplete information, and of those recommendations, 60% were not corrected.

Comment. I have listened to several public company representatives complain about advisory firm recommendations based on inaccurate or incomplete information. Unfortunately, with the increased workload of the advisory firms in the coming year, this problem is not likely to get better.

Say When on Pay. The Society recommends that the SEC rulemaking should give weight to board recommendations on the frequency of Say-on-Pay votes. They suggest providing boards “a choice whether to offer a resolution with a single recommended choice (e.g., every two years), or a resolution that would give the board’s preference but ask for a vote on a one, two or three year frequency in a multiple-choice fashion.” The latter type of vote would involve a plurality vote of the shareholders.

Comment. The Society is asking the SEC to allow companies the discretion to offer When on Pay as a yes-or-no vote on a single recommended choice (e.g., an up or down vote on a triennial Say-on-Pay vote). I don’t believe it is clear that such a vote would be consistent with Section 951(a)(2) of the Act, which requires a separate resolution “to determine whether votes on the . . . [Say-on-Pay resolutions] will occur every 1, 2 or 3 years.” Ms. Stuckey included with her testimony a comment letter (PDF) on the Act to the SEC from the Center on Executive Compensation. That letter does make a cogent argument that the vote with a single recommended choice is consistent with the Act, but certainly doesn’t answer all questions about the SEC’s authority in this area. Ultimately, the SEC has to make a determination about its authority to permit a “single recommended choice” vote – and quickly, if it is to propose rules by early October, as requested by the Society.

If the SEC rules do allow an up or down vote on a single recommended choice, the rules will have to answer other questions. For example, if the shareholders vote against a triennial Say-on-Pay vote, what action will the board of a company be required to take in subsequent years – would the company then be required to hold annual Say-on-Pay votes, or could the board elect to hold biennial votes?

Internal Pay Ratio. The Act will require companies to present the median annual total compensation of all employees of the company (other than the CEO) and the annual total compensation of the CEO, then provide the ratio of these figures. These rules are expected to be in effect for the 2012 proxy season. Ms. Stuckey’s testimony makes it clear just how difficult and complex a task will be presented by the calculations. The Society recommends that the Act be clarified, either through a technical amendment or rulemaking, to provide that “all employees” be limited to full time U.S. employees, and that the total compensation amount exclude pension accruals, benefits and other non-cash items. According to an Alert from the Society dated September 28, 2010, Congressman Frank indicated his agreement with Ms. Stuckey on this issue.

The Society also commented on the Act’s clawback requirement, a subject I will address in a future post.

Legal Challenge Seeks to Invalidate the Proxy Access Rule

The U.S. Chamber of Commerce yesterday announced that the Chamber and the Business Roundtable filed a petition with the U.S. Court of Appeals challenging the SEC’s adoption of Rule 14a-11, the proxy access rule. This rule grants large shareholders the right to nominate directors in certain circumstances and have these nominees included in the company’s proxy statement. The petition claims, among other things, that the Rule is arbitrary and capricious and that the SEC failed to follow appropriate procedures. It’s not clear whether the petition will affect the Rule’s scheduled effective date of November 15, 2010.
 

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I just returned from the Annual Conference of the National Association of Stock Plan Professionals (NASPP) in Chicago, and I came home with a briefcase full of notes and materials on best practices in executive compensation, compensation disclosures and corporate governance. I’ll share thoughts from individual sessions over the next few weeks, but I came away with these general thoughts:

• “Pay for Performance” was the mantra repeated by many of the speakers. The single most important factor in “getting to yes” in Say-on-Pay votes will be demonstrating the link between pay and performance. This must be done in the Compensation Discussion and Analysis (CD&A) disclosure in the proxy statement.
• It will be important to craft the summary section of CD&A carefully. The section should summarize the pay for performance link and should highlight best practices explained in more detail elsewhere. In this first proxy season involving mandatory Say-on-Pay, advisory services such as ISS, as well as institutional investors, will be scrambling to sort out the practices of many companies in a short time. Issuers will want to make it easy for investors to determine quickly that the company has sound pay practices.
• The Dodd-Frank Act will require a “Pay for Performance” proxy statement table. However, the enabling regulations won’t be adopted until April to July 2011, and the table will likely not be in effect until the 2012 proxy statement for most companies. The panelists speculated that the table will be based on a total shareholder return (TSR) measure. They recommended that companies consider whether other measures provide a better method for evaluating their performance relative to compensation (other metrics, peer group comparisons, etc.). If so, consider providing that data in the 2011 proxy statement as a “preemptive strike.”
• Clawbacks will be tricky for many companies, particularly companies listed on exchanges who will need to adopt a clawback policy next year under expected new rules. Companies that previously adopted clawbacks should highlight this fact in their next proxy statement, as it is considered a best practice by institutional investors. All public companies will have some choices to make about the scope and structure of the clawback policies, as I will cover in an upcoming post.

SEC Publishes Rulemaking Timetable

The SEC recently posted this rulemaking timetable for its regulations under the Dodd-Frank Act. Only the rules for Say-on-Pay (shareholder advisory vote on executive compensation) and Say on Parachutes (shareholder advisory vote on severance in connection with changes in control) are scheduled to be adopted in time for the 2011 proxy season. Those regulations are scheduled to be proposed in October to December 2010 and adopted in January to March 2011.

The ON Securities Cheat Sheet has been updated to include the anticipated proposal dates for other regulations implementing provisions of the Dodd-Frank Act.

Watch Out For Those Claws!

Speaking of clawbacks, Mike Melbinger, in his presentation on clawbacks at the Conference, used the video below in his presentation to illustrate a true “clawback” (i.e., one involving actual claws!). Mike is the author of the Executive Compensation Blog.
 

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Today I attended a terrific presentation by Don Nemerov and Eric Gonzaga, compensation consultants with Grant Thornton, LLP, to a meeting of the Twin Cities Chapter of the National Association of Stock Plan Professionals (NASPP). The program materials are available here. The presentation covered the new executive compensation and corporate governance requirements under the Dodd Frank Wall Street Reform and Consumer Protection Act (848-page PDF), and what public companies should be doing to prepare.

Don and Eric spent much of their presentation talking about mandatory Say-on-Pay, the requirement under Section 951 of the Act that public companies submit their compensation to an advisory vote of the shareholders starting with the 2011 annual meeting. Slides 12 through 14 of the presentation contain charts that outline “potential drivers of ‘no’ votes" under the guidelines of the two most influential proxy advisory firms – RiskMetrics/ISS and Glass Lewis. Interestingly, the speakers described RiskMetrics as having policies that are more quantitative, while Glass Lewis takes a more principle-based qualitative approach.

The presentation included the following interesting points:

• Starting with slide 36, the presentation includes a list of action items for each compensation-related provision of the Dodd-Frank Act.
• Management and the board should do due diligence right away to determine whether the company’s pay will be considered reasonable relative to its performance. Performance will likely be evaluated by reference to total shareholder return (TSR), particularly by ISS/RiskMetrics.
• Communication will be absolutely critical, and companies should start now in determining how to communicate the reasons for the company’s pay policies and why pay is reasonable relative to performance. If shareholders should be considering performance factors other than TSR, including performance relative to peers, the company should be thinking about how best to communicate this.
• The company’s investor relations personnel are critical in this process and should be consulted early, including on ways to make the CD&A more effective in telling the pay-for-performance story.

I’m attending the NASPP Annual Conference in Chicago next week, where national speakers will be providing input on the latest developments in SEC rulemaking under Dodd-Frank. I should be able to pass along further tips on how public companies should prepare.

The SEC’s Proxy Access Rules Will Be Effective November 15, 2010

As reported in this previous post, on August 25, 2010, the SEC adopted Rule 14a-11, the shareholder access rule that was originally proposed on June 10, 2009. The Rule was finally published today (September 16, 2010). Here is the convenient Federal Register version of the Rule (127 page PDF). Therefore, we finally know the effective date of the Rule, November 15, 2010 (60 days after today's publication).

The critical date, however, is March 15, 2010. If a company mailed its proxy materials this year before March 15, then it will not be subject to proxy access rule for the 2011 proxy statement. This is because on November 15, 2010, a shareholder of the company would not be able to provide notice that is 120 days before the first anniversary of the 2010 proxy mailing. On the other hand, any company that mailed its proxy materials on or after March 15, 2010 will be subject to proxy access for the 2011 proxy statement. As Broc Romanek said in today’s post in thecorporatecounsel.net Blog, beware “the Ides of March”.

In her blog, “The Filing Cabinet,” in Compliance Week today, Melissa Aguilar posted “Proxy Access Rules Effective Nov. 15 — Who’s Affected?”, in which I provided commentary on which companies will be affected by the rule in 2011, and on other aspects of the new rule.

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Under Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF), public companies must hold a shareholder advisory vote on executive compensation, starting with the first shareholders meeting on or after January 21, 2011. In June, in anticipation of the adoption of the Dodd-Frank Act, the compensation consulting firm Towers Watson surveyed 251 midsized and large public companies on their preparations for Say-on-Pay and other compensation practices. In July, the firm published its report, titled “With Say on Pay Looming, Companies Move to Further Tighten the Link Between Executive Pay and Performance” (PDF).

The Towers Watson survey of these companies found that only 12% of the respondents said they were very well prepared for Say-on-Pay, with 46% saying they were somewhat prepared. When asked what steps they are taking to prepare, 69% of the respondents said they were identifying potential executive pay issues and concerns in advance, with 60% reporting that they are improving their CD&A disclosures to better explain the rationale and appropriateness of their pay programs.

The survey included a question about specific pay practices the respondents had recently changed or are considering changing (Figure 5). The two most commonly mentioned changes were

• requiring double triggers before acceleration of unvested long-term incentive awards (including stock options) upon a change in control (20% recently changed, with another 8% expecting or considering a change), and
• eliminating tax gross-ups for golden parachutes (18% recently changed, with another 15% expecting or considering a change).

However, the respondents reported concerns about taking away existing benefits due to concerns about retaining executives.

Must the Say-on-Pay Vote Necessarily Include Severance Programs?

Several in-house attorneys have recently asked me whether the Say-on-Pay vote must include an evaluation of the company’s executive severance agreements and programs, including change-in-control policies. The answer is yes. Section 951(a)(1) of the Dodd-Frank Act requires that the vote cover “the compensation of executives, as disclosed pursuant to [Item 402 of Regulation S-K].” Since severance and change-in-control arrangements are disclosed in the proxy statement pursuant to Item 402(j), they are necessarily included in the Say-on-Pay vote.

The “Say on Golden Parachutes” advisory vote required under Section 951(a)(2) of the Dodd-Frank Act is a separate requirement, and is not an alternative to covering severance arrangements in a company’s regular Say-on-Pay vote. A Say-on-Parachutes vote only occurs in the context of a special shareholders meeting to approve an M&A transaction. The vote need not be conducted on any change-in-control compensation arrangements previously covered in a Say-on-Pay vote. Therefore, the Say-on-Parachutes vote will only apply to arrangements entered into relatively recently before the M&A deal (i.e., parachute payments negotiated since the last annual meeting).

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