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

Bloomberg reported on Wednesday that General Electric Company received a positive Say-on-Pay vote at its annual shareholders meeting. As disclosed in GE’s proxy statement filings, the company achieved this result, or at least increased the likelihood of an affirmative vote, through its recent restructuring of an existing equity award originally granted to the CEO in 2010. This may be a preview of things to come in the shifting balance of power between boards and shareholders, facilitated by the reforms under the Dodd-Frank Act of 2010. Here’s the time line:

• On March 14, 2011, GE filed its annual meeting proxy statement. As required under the Dodd-Frank Act, the proxy statement included a non-binding shareholder advisory vote on executive compensation (Say-on-Pay).
• On April 7, GE filed additional soliciting materials. The company disclosed that ISS, the shareholder advisory service, had issued a report recommending a “no” vote in GE’s Say-on-Pay vote. GE challenged ISS’s conclusions, including ISS’s valuation of the grant of 2 million stock options to CEO Jeffrey Immelt in March 2010. GE had valued the options at $7.4 million, while ISS valued the same options at $14.5 million. GE also challenged other aspects of ISS’s negative report.
• On April 18, GE made an additional proxy filing reporting that the compensation committee, “with Mr. Immelt’s full support,” had modified the 2010 options to add performance-based vesting. Half of the options will now vest based on GE’s industrial cash flow, and the other half will vest based on the company’s total shareholder return compared to that of the S&P 500. GE reported that the change in the option award was based on “a number of constructive conversations with our shareowners.” In her Bloomberg article, “GE Ties CEO Options to Performance as Investor Meeting Nears,” Rachel Layne reported that, after the change in the options, ISS changed its negative recommendation and advised shareholders to support a positive Say-on-Pay vote.
• On April 27, GE’s shareholders voted to approve the Say-on-Pay resolution, with 85 percent of the shares voted in favor of the resolution.

GE joined a number of companies this year that filed supplemental proxy materials challenging a negative recommendation by shareholder advisory services, as reported by Broc Romanek in TheCorporateCounsel.net Blog. At least one other company has made changes to its compensation programs in response to a negative recommendation. The Walt Disney Company eliminated tax gross-ups for golden parachute payments, which caused ISS to change its recommendation, as reported by Janine Sagar in Business Insider, and enabled a positive Say-on-Pay vote.

However, the GE saga marks a new era in direct communications about specific compensation terms that may be acceptable or unacceptable. It’s one thing for Disney to eliminate gross-ups, which are high on shareholders’ lists of unacceptable pay practices. It is another thing for GE to adjust, as part of a dialogue with shareholders, specific terms of a past award to base the payout on different performance metrics (i.e., industrial cash flow and relative shareholder return, rather than simple stock appreciation inherent in a stock option). This negotiation appeared to tip the balance in favor of a positive Say-on-Pay vote.

This back-and-forth dialog is the most obvious example yet of the increased power of shareholders, and shareholder advisory services, to limit or even define executive compensation under the Dodd-Frank Act regime.
 

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In the next few weeks, more public companies will hold their annual meetings, which will include the shareholder advisory votes on compensation required under the Dodd-Frank Act. One of these votes allows the shareholders to select the desired frequency of Say-on-Pay votes. Under this frequency vote, sometimes called “Say When on Pay,” shareholders may express a non-binding preference for whether Say-on-Pay votes should be held on an annual, biennial or triennial basis. After the annual meeting, the company will be required to report on the frequency with which it will actually hold Say-on-Pay votes, in light of the results of the shareholder vote – see new Item 5.07(d) of Form 8-K (PDF).

Therefore, once the annual meeting is held, the board of directors will need to report their response to the non-binding shareholder vote. So, what steps should the board of directors take following the Say When on Pay vote? Of course, if the shareholders chose the alternative that the board had recommended in the proxy statement, the determination is pretty easy. If the shareholders chose a different alternative, it’s a little more complicated. The process will be different for every company, but here is a checklist of governance steps and tips to consider:

• The rule gives you five months – take it. Item 5.07(d) gives the company 150 days to file the 8-K that includes the response (but no longer than 60 days before the deadline for submission of shareholder proposals for the next year’s annual meeting under Rule 14a-8). The consideration of this determination should be put on the agenda for a future board meeting in advance of the deadline for reporting.
• Consider the factors listed in the proxy statement. Many companies included in their proxy statement a list of factors they considered that caused them to conclude that the recommended frequency was in the best interests of the company and it shareholders. At the meeting, the board should discuss these factors once again, and balance them against the will of the shareholders expressed in the vote.
• Consider the strength of the views expressed in the shareholder vote. Presumably, a strong majority vote in favor of one of the alternatives should be given more weight than a close vote where none of the three alternatives received a majority. In either case, it is perfectly appropriate for the board to follow the preference of the shareholders despite the board’s prior recommendation of a different alternative.
• Consider having the compensation committee make a recommendation. Especially if the compensation committee initially recommended to the board the frequency expressed in the proxy statement, it may be appropriate to have the committee recommend the ultimate frequency of the Say-on-Pay vote to the board for its approval.
• Document the deliberations carefully. Make sure the minutes reflect the matters considered by the board and/or the compensation committee in making its determination.

Frequency Vote Update

Mark Borges just published his updated tally (as of April 15) of 1,976 companies’ proxy statements in his Proxy Disclosure Blog on compensationstandards.com (subscription site). According to Borges’ tally, these companies recommended as follows in their “Say When on Pay” shareholder advisory votes on frequency:

Triennial Say-on-Pay vote recommendation: 839 companies (includes 36 smaller reporting companies)
Biennial Say-on-Pay vote recommendation: 66 companies (includes two smaller reporting companies)
Annual Say-on-Pay vote recommendation: 1,009 companies (includes 11 smaller reporting companies)
No recommendation: 62 companies (includes six smaller reporting companies)

As for the results of the votes to date, Borges provided a good summary:

. . . . 252 companies [have] reported the voting results from their annual meeting of shareholders.
Here are the shareholder preferences for the frequency of future "Say on Pay" votes:

- Of the 15 companies that have recommended a biennial vote, 11 have seen their shareholders express a preference for annual votes.

- Of the 145 companies where the Board of Directors has recommended that future "Say on Pay" votes be held every three years, 63 (or 43%) have seen their shareholders indicate a preference for annual "Say on Pay" votes. That number decreases to 42% - 52 of 125 companies) when you exclude smaller reporting companies.

- Of the nine companies where the Board of Directors has made no recommendation at all with respect to the frequency vote (excluding smaller reporting companies), eight have seen their shareholders state a preference for annual "Say on Pay" votes.

And, at one company, Qualstar Corporation, where the Board of Directors had recommended annual "Say on Pay" votes, shareholders expressed a preference for a triennial vote.

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On March 30, 2011, the SEC issued proposed rules (PDF) under Section 952 of the Dodd-Frank Act, which added Section 10C under the Securities Exchange Act of 1934. The proposed rules will direct the national securities exchanges to adopt independence and other listing standards relating to compensation committees and compensation advisors. The proposed rules don’t contain any big surprises and probably won’t have a big impact on most companies’ practices, but there are still some provisions of interest.

Independence of Committee Members. Under new Rule 10C-1, the exchanges must adopt independence standards for members of compensation committees, considering factors such as the sources of compensation of the individual by the company, and the individual’s affiliations with the company. Note that exchanges such as the New York Stock Exchange and Nasdaq already require committee members to meet the exchanges’ general independence standards, and that at most companies the committee members also must meet additional independence standards such as the requirements for “non-employee directors” under Rule 16b-3.

Comment: Interestingly, the SEC did not specify the parameters of the independence standards. This is very different from Rule 10A-3, adopted under the Sarbanes-Oxley Act (SOX) to apply to audit committees. Rule 10A-3 specified the heightened independence standards for audit committees, rather than leaving the details up to the exchanges. In its new proposing release for Rule 10C-1, the SEC pointed out that the authorizing statutes had different language. Unlike the SOX provision, Section 952 of the Dodd-Frank Act did not require the SEC to establish the standards. However, there was speculation that the new rule would define standards for compensation committee members similar to the provisions of Rule 10A-3 for audit committee members. Instead, it’s possible that the exchanges will each adopt differing sets of standards under the rule. Once the SEC adopts its final rules, the exchanges will have up to a year to adopt their final standards.

Standards for Selection of Advisors. Under proposed Rule 10C-1, listed companies’ compensation committees will also be required to consider five independence factors when selecting advisors such as consultants or counsel. Note that these advisors will not be required to be independent, but the committee will have to consider the factors, which include whether the advisor provides other services to the company, whether the advisor has business or personal relationships with members of the committee, and whether the advisor’s firm has adopted policies to prevent conflicts of interest.

Comment: Some commentators have speculated that, in practice, these standards will lead lots of compensation committees to engage independent counsel, because they won’t want to document that they chose non-independent counsel. We’ll see – I’m not convinced that this will happen in practice. After the adoption of SOX in 2002, there was widespread speculation that many audit committees would hire independent counsel. After the storm blew over, very few committees adopted this practice.

New Disclosure Standard. Under the proposed rules, Item 407(e)(iii) of Regulation S-K would be modified to add some additional disclosures in the proxy statement about the role of compensation consultants to the committee and payments to the consultants for other services to the issuer.

Comment: The proposed revised disclosures will not be dramatically different from the Item 407(e)(iii) disclosures added by the SEC for the 2010 proxy season.
 

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