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

Maslon Law Firm has just released our memorandum (PDF) on the three new shareholder advisory votes required under the Dodd-Frank Act and the SEC’s recently proposed regulations (PDF): the Say-on-Pay vote, the frequency vote and the Say-on-Parachutes vote. We took it as a challenge to make the memo as user-friendly as possible for public companies and their advisors. The memo starts with an executive summary about the requirements, and the remainder consists of Frequently Asked Questions about each of the required shareholder votes. Here’s the executive summary:

Key provisions in the Act’s advisory vote requirements, as interpreted by the proposed SEC rules:

Say-on-Pay Vote: Public companies must hold a non-binding shareholder vote on executive compensation (the “Say-on-Pay vote”) at the first annual meeting on or after January 21, 2011. Pursuant to this vote, shareholders will be asked to approve the executive pay described in the proxy statement (including CD&A and the compensation tables). This vote must be held no less frequently than once every three years.

Frequency Vote: Also, at the first annual meeting on or after January 21, 2011, public companies must hold a separate non-binding vote (the “frequency vote”) in which shareholders will express their opinion on whether the Say-on-Pay vote should be held annually, biennially, or triennially. The frequency vote must be held at least once every six years. After their annual meetings, companies must disclose on Form 10-Q whether they will abide by the shareholders’ preference on frequency.

Requirements Not Subject to Adoption of Final SEC Rules: The above requirements to hold the Say-on-Pay vote and frequency vote at the first annual meeting on or after January 21, 2011 are effective regardless of whether the final SEC rules have been adopted.

Parachutes Disclosure and Say-on-Parachutes Vote: The proxy materials to approve any merger, sale of assets or similar transaction must include enhanced disclosure of the golden parachutes compensation to executives related to the transaction, including a table and narrative disclosure. The proxy materials must also include a separate shareholder advisory vote on the parachute compensation (the “Say-on-Parachutes vote”), unless the enhanced disclosure was part of a prior Say-on-Pay vote and there are no new arrangements. The parachutes disclosure and Say-on-Parachutes vote requirements are not effective until the final SEC rules go into effect.

Cheat Sheet Updated

The ON Securities Cheat Sheet (PDF) has now been updated to include a shorter summary of the advisory vote requirements. The Cheat Sheet also features a summary of all of the Dodd-Frank compensation and governance provisions, and a description of the proxy access rule, Rule 14a-11, the effectiveness of which has been stayed as a result of a legal challenge. True to form, the Cheat Sheet is still only two pages long!

Useful Resource on Risk Assessment

As stated in this previous post, it is important for public companies to focus this year on their assessment of risks related to their compensation programs. The proxy disclosure requirement in Item 402(s) of Regulation S-K is not limited to executive compensation programs, but the assessment need only cover compensation programs that might create a material risk for the company. One of the challenges for compensation committees and compliance officers is the creation of a reasonable process to select the compensation programs to examine and to assess the relationship of the compensation programs to risks that might face the enterprise.

Mike Melbinger, in his Executive Compensation Blog, has posted his comprehensive chart that outlines a very detailed process a public company can use for assessing risk. The chart contains many good ideas, so it is a helpful resource, even if you don’t intend to follow the entire 20-step action plan (for some companies, maybe a “12-step program” will do!).
 

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The SEC this afternoon issued its proposed rules on Say-on-Pay, Say When on Pay, Say-on-Parachutes and related matters under Section 951 of the Dodd-Frank Act. Here is the proposing release (PDF).

The release answers some questions we have been pondering since the adoption of the Dodd-Frank Act (and in some cases raise more questions):

• The SEC confirmed that it will not object if companies do not file a preliminary proxy statement for Say-on-Pay or Say When on Pay resolutions – the same treatment it gave to TARP recipients who were required to hold Say-on-Pay votes starting in 2008.
• Regarding Say-on-Pay, no specific language is required, but the resolution has to cover all compensation required to be disclosed in the proxy statement.
• Companies will be required to address in CD&A how their compensation policies and decisions have taken into account the results of past Say-on-Pay votes.
• Regarding the frequency vote (Say When on Pay), the SEC will definitely require four choices on the ballot: one year, two years, three years or abstain. The proxy card has to have the four boxes, but there are some transition rules if the transfer agent can’t tabulate four choices.
• The SEC is affirming that the Say When on Pay vote is advisory, but the issuer must disclose in its filings whether it will follow the results of the advisory vote. If it does not, the rules will permit shareholder proposals in future years to change the frequency.
• The SEC is requiring additional tabular information on change in control payments in merger proxies with respect to the Say on Parachutes vote. An issuer may voluntarily include that information in its annual meeting proxy statements, and in that case the Say on Parachutes vote will not be required in a future merger transaction if there are no changes.
• Under the proposal, smaller reporting companies will be required to hold Say-on-Pay and Say When on Pay votes, even though the SEC had the statutory authority to exempt them from the rules.

Comment. Here is an updated list of Say-on-Pay action items in response to the proposed rules:

1. Make sure compensation disclosures clearly describe the link between pay and performance, describe how the arrangements mitigate risk-taking behaviors, avoid misunderstandings on compensation design and prepare to explain any compensation structures or levels that may be unique to the company. Consider adding a summary section to CD&A.
2. The board should review any executive compensation arrangements that may be classified by investors and governance rating agencies as "poor" practices. If any feedback has been received from investors on executive compensation, the board should decide the appropriate level of proactive shareholder engagement in this area.
3. The board should think about the preferred frequency of periodic say-on-pay votes and determine how the board will recommend shareholders vote on this matter.
4. The company should work with its advisors to determine whether a bylaws amendment will be required to accommodate a frequency vote with four possible choices (albeit a non-binding advisory vote).
5. The company should work with its advisors to determine whether to include supplemental disclosures about golden parachutes in its annual meeting proxy statement, which may eliminate the need for a separate Say-on-Parachutes vote in connection with a future merger.

More questions will arise as we have more time to digest the 122 page release and as the SEC receives public comments on the rules. But this is a start.
 

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This year, for the first time, public companies have been required to include a disclosure in their proxy statement to the extent that “. . . risks arising from the registrant’s compensation policies and practices for its employees are reasonably likely to have a material adverse effect on the registrant.” In a blog post today on compensationstandards.com (subscription site), Andy Mandel and Larry Schumer of Buck Consultants described a study they completed (PDF) about the voluntary risk disclosures (or lack thereof) in the proxy statements of 200 large public companies.

They report some interesting findings:

• Predictably, no companies reported that they found a reasonable likelihood that the compensation risk will have a material adverse effect. However, a majority of companies (67%) did include some voluntary risk assessment disclosure. Of these companies, a majority (63%) made an affirmative statement that there were no risks that created a material adverse effect.
• Few companies described the process they used in their risk assessment. Instead, most of the disclosures focused on factors in their compensation programs that mitigate risk. The study lists the risk mitigation factors cited, including 58% of companies mentioning the balance of short-term and long-term incentives.
• The SEC has started issuing comment letters asking for more detail on the assessment process. The authors reported that the SEC has issued such comments, not only to companies whose proxy statements were silent, but also to companies that stated their conclusion but did not include a discussion of the process.

Why is the risk assessment discussion an important consideration for the upcoming proxy season, when most companies will be dealing with the issue for the second time? Because this time, compensation disclosures will be the subject of a Say-on-Pay vote, and the risk assessment is an important factor that will be considered by many shareholders in casting their vote. At the recent Proxy Disclosure Conference sponsored by thecorporatecounsel.net, Patrick McGurn of ISS reported that risk mitigation is the third greatest compensation-related concern reported by investors (behind pay for performance and problematic pay practices). Investors want a robust explanation of what the risk assessment examined, and how the company ensures that pay practices don’t incentivize the wrong behavior. At the same conference, Mark Borges of Compensia suggested that the summary section of Compensation Discussion and Analysis highlight the risk discussion and refer to the place where it is discussed more fully.

For more information on risk assessments, see this previous post for a description of how a compensation committee might select which non-executive pay programs to include in its evaluation. And, for a comprehensive description of risk elements examined by one company, see the 2010 proxy statement of Brown-Furman Corporation under “Compensation Risk Assessment” starting on page 36.
 

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In the hope that it will bring the Minnesota Twins better luck in their upcoming trip to Yankee Stadium, I am providing this link to my post from March 29, 2010, entitled: “Talkin' Baseball, Joe Mauer and Proxy Statements: Hypothetical Disclosures of Compensation Risk and Qualifications.” In the post, I included “hypothetical” proxy statement language, as if Joe Mauer were the CEO of a public company. The language was meant to illustrate the following disclosures, which were required this year for the first time for public companies in their proxy statements:

• A discussion of compensation-related risk under Item 402(s) of Regulation S-K, required if compensation is determined to create material risks. Of course, the “hypothetical” disclosure focused on the merits and risks of Joe’s then-newly signed $184 million contract.
• A discussion of the qualifications of each member of the board of directors, including their special qualifications and skills. Of course, the “hypothetical” set of reasons read, in full, as follows: “HE’S JOE MAUER.”

Comment: In preparing for the upcoming proxy season, companies should focus anew on these sections of the proxy statement, even though they will generally be included for the second time:

• Whether or not the Item 402(s) risk disclosure is technically required, many companies have chosen to discuss the process used by the Board or the Compensation Committee to analyze compensation–related risks. These discussions often include an analysis of features of the compensation program that mitigate risks. Such a discussion of risk mitigation factors will likely be one factor considered by shareholders in evaluating whether to vote in favor of the Say-on-Pay resolution on the ballot at the 2011 annual shareholders meeting. Therefore, the risk mitigation factors should be emphasized in the Compensation Discussion and Analysis section of the proxy statement.
• The discussion of the qualifications of board members will take on added importance in future years (probably starting in 2012), when proxy access will likely give large long-term investors the ability to nominate director candidates and have them included in management’s proxy statement. It’s not too early to consider whether the reasons stated in the coming year’s proxy statement wlll provide shareholders a compelling reason to vote for management’s candidates in future years.

Image: Wikimedia Commons
 

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It looks like it will be another year, at least, before large shareholders will be “knock knock knockin’ on the boardroom’s door.” Today, the SEC issued an order (PDF) delaying the effective date of the rule pending the results of a legal challenge.

As reported in this previous post, last week the U.S. Chamber of Commerce 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 Chamber and the Roundtable requested that the effectiveness of the rule be delayed until the court had a chance to rule. In today’s order, the SEC agreed to the delayed effective date and joined the two groups in requesting expedited review by the court.

Ted Allen, in the RiskMetrics blog published by ISS, posted “The SEC Puts Proxy Access Rule on Hold,” discussing the anticipated impact of the SEC’s order:

. . . . Even if the appeals court acts quickly and upholds the controversial rule [14a-11], it’s not likely that proxy access would take effect until at least the 2012 proxy season.

The SEC also said it would delay an amendment to Rule 14a-8, which would have allowed investors to file bylaw proposals that seek more permissive access procedures. That rule change was not challenged by the corporate groups, which have argued that companies and investors should be able to adopt issuer-specific provisions instead of being subject to uniform federal standards. The SEC said it decided to delay the implementation of this rule change, ‘because the amendment to Rule 14a-8 was designed to complement Rule 14a-11 and is intertwined, and there is a potential for confusion if the amendment to Rule 14a-8 were to become effective while Rule 14a-11 is stayed.’

The SEC's decision, especially its move to also delay the Rule 14a-8 amendment, surprised both investors and corporate advisers. The Dodd-Frank Act, which was enacted in July, included authorization for the SEC to adopt a proxy access rule, so many SEC observers expected that the commission would move forward to implement the rule after obtaining that legal support.

Image: Picasa Web

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