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

On November 19, the shareholder advisory group Institutional Shareholder Services (ISS) released its 2011 Corporate Governance Policy Updates (PDF). This is ISS’s annual list of policies indicating how it will recommend that shareholders vote on various matters. The 2011 policies shed light on ISS’s likely recommendations regarding the new Say-on-Pay vote and frequency vote (“Say When on Pay”) required at 2011 annual shareholders meetings under the Dodd-Frank Act. Among the important policies are the following:

• As expected, in connection with frequency votes, ISS indicated that it will recommend a vote for annual Say-on-Pay votes (rather than biennial or triennial votes). ISS believes Say-on-Pay is most effective as a communication vehicle if the vote occurs every year.
• If ISS concludes that a company has “problematic” compensation practices, ISS will generally recommend a vote against the Say-on-Pay proposal, but won't necessarily recommend a “withhold” vote relating to compensation committee members. However, ISS will recommend withhold votes on compensation committee members when there is no Say-on-Pay vote. For example, if a company adopts triennial Say-on-Pay vote frequency, in the “off years” between votes, ISS would react to problematic practices by recommending withhold votes on committee members.
• If ISS concludes that a company has some pay practices that are “egregious” (i.e., worse than problematic), it may recommend withhold votes on compensation committee members, regardless of whether there is a Say-on-Pay vote that year. ISS includes on this list (i) extraordinary relocation benefits (including home buyouts), (ii) change in control payments in excess of three times base salary and target bonus, (iii) new or materially amended agreements that provide for excise tax gross-ups and (iv) repricing or replacement of underwater options without shareholder approval.

The Say-on-Pay era definitely increases the clout of ISS and other shareholder advisory groups. In fact, I heard an unsubstantiated rumor that “ISS” actually stands for “Influence Surpassing Senators”.

Proposed SEC Rules Become More Portable

I noticed that two sets of lengthy SEC proposed rules have now been published in the Federal Register. These versions have smaller type and fewer pages, making them much easier to carry around with me everywhere. The proposed SEC rules on shareholder advisory votes (including Say-on-Pay) (PDF) print out on 31 pages (compared to 122 for the original SEC version). The proposed whistleblower rules (PDF) print out on 69 pages (compared to the original 181).

This is great news! Now I can easily bring the proposals to the family Thanksgiving dinner – and if I spill gravy on them, it’s easy to print out new copies.

Happy Thanksgiving, everyone!
 

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In a post in the ISS Insights Blog, “After Election Day, Governance Observers Expect Status Quo,” Ted Allen reports that the recent Congressional elections are unlikely to have a major impact on corporate governance reform under the Dodd-Frank Act. However, Republican control of the House of Representatives may mean that the SEC has fewer resources and a brighter spotlight on its activities:

Professor James Cox, a securities law professor at Duke University, said the SEC likely will receive substantially less funds than were authorized in Dodd-Frank Act. "This will likely starve the SEC's efforts to step up the size and experience of its staff to carry out inspections, which is frightening, considering the addition of thousands of investment advisers to the inspection mission of the SEC," Cox said.

While the prospects for any investor-friendly or pro-regulatory legislation are now "dead," Cox said, "It is unlikely that the House can push through reversals of any major legislation, including approval for proxy access." However, he said Congress may try to pass legislation to make "technical corrections" to the Dodd-Frank Act, and there may be some provisions that concern investors. Cox said House Republicans may await the outcome of the lawsuit filed by the U.S. Chamber of Commerce and the Business Roundtable before addressing proxy access.

There may be some uncertainty about the impact of the federal elections, but at least we know the results. Unlike the governor’s race in Minnesota, where we seem destined for an eternity of recounts. . . .

Useful Resource Analyzes Shareholder Preferences In the Frequency Vote

Nothing in the Dodd-Frank Act is currently raising more questions than the frequency vote, or “Say When on Pay.” Under the Act, at the first annual meeting on or after January 21, 2011, public companies must hold a separate non-binding 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. Many public companies have asked me about the optimal frequency to recommend, as I addressed in this prior post.

One factor that companies should consider is the preferences expressed by their major shareholders. Phoenix Advisory Partners, a proxy solicitation firm, recently released a report entitled “Say on Pay Frequency: Annual, Biennial or Triennial – Considerations in Making Your Recommendation (PDF).” The most interesting thing about the report is that it is based on conversations with large institutional investors. For example, the report lists the names of a number of institutional investors who support annual Say-on-Pay: Walden Asset Management, AFCSME, etc. Phoenix also reports that the Council of Institutional Investors supports annual Say-on-Pay votes. On the other hand, T. Rowe Price has indicated that it may not take a blanket approach, but may tailor its recommendations based on the compensation practices of individual companies.

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The SEC yesterday issued proposed rules (PDF) under Section 21F of the Securities Exchange Act of 1934 (Section 922 of the Dodd-Frank Act), which provides a bounty to whistleblowers who disclose securities law violations leading to large monetary sanctions. This press release issued by the SEC summarizes the new rules. In order to qualify for a bounty under Section 21F, the whistleblower must “voluntarily” provide the SEC with “original information” that “leads to” successful enforcement in which the SEC obtains monetary sanctions totaling more than $1 million. The proposed rules clarify these concepts. The rules also define a number of types of individuals who are not entitled to the bounty, including the wrongdoers, persons with a pre-existing duty to report the information or attorneys or accountants in certain cases.

My main concern about Section 21F is that the bounty program will encourage employees and other potential whistleblowers to bypass the internal reporting systems public companies have carefully set up in the past decade to comply with the provisions of the Sarbanes-Oxley Act of 2002. The SEC has tried to address this concern in the proposed rules, which would facilitate and encourage internal reporting in the following ways:

• The rules allow an employee to report information internally as a whistleblower and still get credit for original reporting to the SEC as of the same date – as long as the employee provides that same information to the SEC within 90 days of that date. According to the SEC, “ . . . employees will be able to report their information internally first while preserving their ‘place in line’ for a possible award from the SEC.”
• The rules provide that the SEC may consider higher percentage awards for whistleblowers who report internally first, as long as the company has an effective compliance program.

Comment. The proposed SEC rules are an improvement over the provisions of the Dodd-Frank Act. However, there are still concerns that the bounty program will encourage whistleblowers to “take no chances” and report any questionable information to the SEC. The potential financial rewards for a whistleblower are huge.

Also, there are numerous reports that plaintiffs’ employment attorneys are actively encouraging whistleblowers to file reports. Broc Romanek in a post in thecorporatecounsel.net Blog referred to this recent article, “Get Snitch Quick,” by Kaja Whitehouse in the New York Post about a lawyer who is playing a commercial in New York movie theaters before showings of “Wall Street: Money Never Sleeps.” The commercial directs viewers to go to his website, SECSnitch.com, to get information about whistleblower reporting. In the words of Gordon Gekko, “Greed is good. . . .”

In light of the bounty program, public companies will need to refine their whistleblower policies and training programs. This is only one of the aspects of Dodd-Frank in which we corporate lawyers will need to partner with our colleagues who specialize in employment law. Just wait until listed companies need to draft new clawback policies, under SEC and stock exchange rules expected in 2011, which will require companies to recover incentive compensation from former as well as current officers. . . .

ISS Recommends Annual Say-on-Pay Vote

In this draft policy recommendation, the shareholder advisory service ISS recommends that Say-on-Pay votes be taken annually as a way of providing the most meaningful communications between shareholders and public companies. Assuming the final ISS policy is to recommend an annual vote, this is one more consideration for boards of directors in deciding whether to recommend an annual, biennial or triennial vote, as described in this prior post.

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