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

As I said in my previous post, to paraphrase Bob Dylan, large shareholders are closer than ever to “knock-knock-knockin’ on the boardroom’s door.” And now, we know more about who gets to knock, and when they might be let in.

On August 25, 2010, the SEC adopted Rule 14a-11 (451-page PDF), the shareholder access rule that was originally proposed on June 10, 2009. The SEC approved a revised version of the rule by a 3-2 vote, with the Republican Commissioners voting against approval. The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF) on July 21, 2010 clarified the SEC’s authority to order proxy access and thus removed a major legal concern about enforcement of the rule (Act Section 972).

Rule 14a-11 grants to large shareholders of public companies the right to nominate directors and have the nominees included in management’s proxy statement. The SEC’s press release provides some useful information about the new rule. However, the best capsule summary I have seen so far is contained in today’s post by Broc Romanek on thecorporatecounsel.net Blog, “The SEC Adopts Proxy Access,” including the following practical points:

- What are the thresholds for a Rule 14a-11 access right? - Shareholders (or groups) must have 3% of the voting power (so it doesn't vary by company size as proposed) and have have held their shares for three years (up from one year as proposed) when they give notice of the nomination on Schedule 14N. When calculating the 3%, shareholders will be able to pool assets and include securities loaned to a third party as long as they can be called back - but securities sold, shorted or not held through the company's annual meeting will need to be deducted.

- Who can be nominated as a shareholder candidate? - Shareholder nominees must satisfy the applicable stock exchange's independence standards - and the shareholder exercising the right must not have the intent of changing control of the company. If a company wants to challenge a nominee's qualification, it can use the Staff's no-action process.

- How many nominees can be placed on the ballot by shareholders? - Greater of one director or 25% of the entire board. If the number of shareholder nominees exceeds the number permitted under Rule 14a-11, then preference will be given to the larger holder - not the first to nominate as the SEC had proposed.

- Is there any "opt-out" of the process rules? - Nope, it's mandatory and neither companies nor shareholders are not permitted to opt out or select a more restrictive mechanism. Rule 14a-8 was amended so that companies may not exclude shareholder proposals that seek to establish less restrictive proxy access procedures.

- When do the new rules take effect? - 60 days after their publication in the Federal Register, which is expected to happen next week. However, the deadline for submitting a nominee is 120 days before the anniversary of this year's proxy mailing. So access essentially applies for an annual meeting next year only if the first anniversary of the mailing of this year's proxy materials occurs 120 days or more after effectiveness. The example given during the open meeting: if the rules are effective on November 1st, then shareholders have a proxy access right if the company mailed their proxy materials on or after March 1st during 2010.

- How are smaller companies treated? - They get a three-year delay in effectiveness if the company has a public float of less than $75 million.

- How are foreign private issuers treated? - They aren't subject to the new access rules, just like the other proxy rules.

Image: flikr
 

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To paraphrase Bob Dylan, large shareholders are closer than ever to “knock-knock-knockin’ on the boardroom’s door.”

In a Wall Street Journal report today, “SEC Set to Open Up Proxy Process”, Kara Scannell reports that the SEC has scheduled a meeting on August 25, 2010 for approval of proposed Rule 14a-11 (PDF), the shareholder access rule that was originally proposed on June 10, 2009. Scannell reports that the Commission is expected to approve a revised version of the rule by a 3-2 vote, with the Republican Commissioners voting against approval. The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF) on July 21, 2010 clarified the SEC’s authority to order proxy access and thus removed a major legal concern about enforcement of the rule (Act Section 972).

Rule 14a-11 will grant to large shareholders of public companies the right to nominate directors and have the nominees included in management’s proxy statement. Scannell reports that under the language currently being negotiated (still subject to change), shareholders would be required to beneficially own at least 3% of the outstanding stock for at least two years before having the right to nominate directors. Under the original proposal, the threshold was 1%, 3% or 5% depending upon the size of the company, with a one year ownership requirement. The company would be required to include shareholder nominees for up to 25% of the board positions. If nominees are received above the 25% limit, access is granted on a first-come-first-served basis.

In an interesting post on the Altman Group’s Governance & Proxy Review, “Dog Days of Pre-Proxy Access Summer”, Francis H. Byrd discusses the stated intention of the CalSTRS pension fund and hedge fund Relational Investors to team up to seek four boards seats at the Occidental Petroleum 2011 annual meeting. The funds stated that the issues driving their intended contest are executive compensation and succession planning, not financial performance. Byrd points out that the joint 1% holdings of the funds will not be sufficient under the rumored 3% standard in the final proxy access rule, so it’s not clear that the funds will ultimately seek the board seats.

Byrd describes these lessons from the Occidental situation:

First, don’t let corporate governance issues – especially on compensation – fester. . . . The goal should be to limit surprise issues, and be proactive with both your largest holders and the governance influencers like CalSTRS or the NYS Common Fund.

Second, companies . . . . that have [received a majority vote or large vote in favor of non-binding shareholder proposals but] ignored such votes in the past – especially if their stock performance has struggled – will be prime targets for short slate campaigns. This also holds true for companies whose directors have been targeted in Vote No campaigns. Substantial withhold votes from directors could also serve as a beacon for activists seeking to run a potential short slate.

Lastly, your Say on Pay vote matters on more than compensation. Many investors, especially the activist institutions, view compensation as a window for judging the quality of board oversight and determining whether a CEO is ‘imperial’. . . . In that context, a failed Say on Pay vote could be viewed as a signal to an activist that there is at least some lack of confidence in the board and management.

As the proxy access rules quickly approach reality, public companies should plan accordingly – and listen for the knockin' on the boardroom’s door.
 

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Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF) requires that any public company, at its first shareholders meeting on or after January 21, 2011, hold two shareholder votes:

• a shareholder advisory (non-binding) vote on the executive compensation disclosed in the proxy statement (Say-on-Pay), which must be held no less frequently than once every three years, and
• a separate resolution “to determine whether Say-on-Pay votes will occur every 1, 2 or 3 years”.

The latter resolution has been called the Say-on-Pay frequency vote, or “Say When on Pay”. The Say When on Pay vote must be held no less frequently than once every 6 years. The SEC may adopt rules to exempt certain companies (including smaller companies) from these requirements.

The mechanics of implementing of the Say-on-Pay requirement are pretty clear. The shareholders get a yes-or-no advisory vote on all executive compensation disclosed in the proxy statement, which includes the compensation discussion and analysis section and the compensation tables.

The Say When on Pay vote raises a lot more mechanical issues and has created fierce debate among corporate lawyers. For example:

• The language of the statute requires that all three choices (i.e., one, two or three years) be presented to shareholders. Can a vote with three choices (as opposed to a vote for or against a resolution) be accomplished consistent with state corporate law and the bylaws of particular companies?
• If all three choices are presented, no one choice may get a majority. Can the bylaws specify  a plurality vote, just as director elections are decided?
• Rule 14a-4(b) under the Securities Exchange Act of 1934 requires that a public company proxy card allow shareholders to specify approval, disapproval or an abstention with respect to each matter being voted on, other than elections to office. Does this rule prohibit a single vote on all three choices and if so, will the SEC amend the rule to allow for such a vote?
• Can a company consistent with the Act adopt a “default” frequency for Say-on-Pay in its bylaws (e.g., every three years) and provide that this frequency can only be overridden by a majority vote for one of the other alternatives?

The SEC may clarify the situation, but public companies should start reviewing their bylaws and state corporate law and think about how to deal with the Say When on Pay vote. As the SEC weighs in or there are further developments, I will report them here. Companies should also consider what frequency they are going to recommend for Say-on-Pay votes – annual, biennial or triennial. This issue needs to be considered carefully, as I will discuss in a future post.

Of course, there could be more interesting ways to decide among choices of “1, 2 or 3” than to have a shareholder vote. If only annual meetings could be held on the old “Let’s Make a Deal” set, with costumed shareholders being given the chance to select Door Number 1, 2 or 3 to decide Say When on Pay:

You don’t need to watch the whole seven minute video to get the idea – but if you don’t, you’ll miss some great 1970s-era prizes, like a refrigerator with a built-in tape player!
 

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On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (final text of the Act, 848-page PDF). As previously reported, the Act includes numerous governance and compensation provisions that will affect all public companies, as well as comprehensive reform of the nation’s financial system.

I have updated the ON Securities Cheat Sheet (PDF) to reflect the final provisions of the Dodd-Frank Act. The front page of the Cheat Sheet now includes a complete summary of the governance and compensation provisions of the Act. For each provision summarized, the Cheat Sheet provides the section number for reference to the full section.

The back page of the Cheat Sheet includes a summary of some other provisions of the Dodd-Frank Act that affect many public companies or otherwise have an impact on the securities laws, including a whistleblower “bounty” program and an exemption, effective immediately, for smaller issuers from the attestation report requirements under Section 404(b) of the Sarbanes-Oxley Act. The back page also summarizes the SEC’s previously proposed proxy access rules, as well as some of the important changes in the SEC compensation and corporate governance rules adopted in 2009.

An up-to-date version of the Cheat Sheet will always be available by clicking on the box at the right side of the ON Securities Blog home page. I’ll continue to update the document to reflect the waves of SEC rulemaking that we can expect over the next few months. If you have any suggestions for ways to make the Cheat Sheet more useful or for other resources that might be helpful, please post a comment below or send me an e-mail.

Over the next few weeks, I will be posting on the various new requirements of the Act and the steps public companies should be taking to prepare for the new requirements. 

Note: If you want to print out the pages of the Act that contain the governance and compensation provisions, print out pages 466-496 and 524-540 in the PDF file.

 

 

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The Senate passed the Dodd-Frank Wall Street Reform and Consumer Protection Act today and sent it to President Obama for his signature, expected next week. The Act includes numerous governance and compensation provisions that will affect all public companies, as well as comprehensive reform of the nation’s financial system.

In the Wall Street Journal, Kara Scannell reported this week that the SEC is gearing up for a heavy dose of rulemaking. In a story titled “SEC Enters Overdrive to Prepare for Overhaul” (subscription required for entire article), Scannell reported that the SEC is “on a tight deadline to write more than 90 new rules and complete nearly 20 studies.”

The story reports that the rulemaking process will be “burdensome” and will delay other initiatives the SEC considers important. For example, the SEC staff was engaged in a comprehensive review of public companies’ disclosure requirements, a process that will likely have to be put on hold. However, SEC officials say that they “remain committed” to adopt the proposed proxy access rules, as well as dozens of rules for which the timing is mandated by the Act. To prepare for the rulemaking, “ . . . the SEC’s divisions have assembled teams to tackle the various issues, and 50 to 100 staffers are involved in the preparations.”

The situation reminds me of the time after passage of the Sarbanes-Oxley Act of 2002, when we were waiting for new SEC rules issued every few weeks. The next several months promise to be very interesting.

What’s on a Page? Right Now, Not Much . . .

I’m getting a little tired of dealing with the Dodd-Frank Act (currently available as a 2,323 page PDF file) and various alternative Congressional bills that have been more than 1,000 pages each. Of course, it’s easy to run up a lot of pages when each page has huge margins and one narrow column of text down the middle of the page. Who came up with that system anyway – do people really write lots of margin notes on each of 2,323 pages? Hopefully, after the Act is finally passed, there will be a version with more text on each page. Who knows – maybe it will only take up 800 or 900 pages.

Image: flikr
 

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In this post, I report on the final financial reform bill from the Conference Committee in Washington. And then I start to sing (see video link below)!

After an all-night session last week, the Conference Committee passed the final version of what is now called the “Dodd-Frank Wall Street Reform and Consumer Protection Act”. Title IX of the Act (362-page PDF) includes the corporate governance and executive compensation provisions (contained in Subtitle E, starting on page 207). The Act still needs to be passed by both houses and signed into law. In the coming days, I'll be blogging about specific provisions, including mandatory Say-on-Pay and granting authority to the SEC to adopt proxy access rules. The final version of the Act gives the SEC the authority to exempt certain companies (possibly including smaller companies) from these requirements, and the SEC will be “filling in the blanks” in these and other provisions. It promises to be an interesting year of rulemaking.

I Sing “My Attorney Bernie”

Last week, I performed as part of the “Lawyers With (More Than Legal) Talent” competition, which capped off the Minnesota State Bar Association Convention. I didn’t win (the winners were two Minnesota District Court judges). But I had a great time, and so did everyone else. My song was the hilarious “My Attorney Bernie”, written by Dave Frishberg. In my introduction, I said that this song is about the greatest “client testimonial” ever received by an attorney:

Tax attorney David Haynes of the Leonard Street firm provided the piano accompaniment. And speaking of great Frishberg songs, see this previous post for an animated video of “I’m Just a Bill”, which educates listeners about how a bill becomes law.

Video: YouTube

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The new version of the ON Securities Cheat Sheet gives more detail on the Dodd Bill, the Restoring American Financial Stability Act of 2010 (1,600 page PDF). The Dodd Bill includes more extensive governance and compensation reforms than the Frank Bill, also described in the Cheat Sheet. The differences will need to be worked out in conference committee.

One interesting feature of the Dodd Bill is a requirement for majority voting for directors in uncontested elections (Section 971 of the Dodd Bill, at page 1103). The requirement applies to companies listed on securities exchanges (including Nasdaq). If the director does not receive a majority of votes cast in the election, the director must tender his or her resignation. The Board can choose to accept the resignation or can reject it by a unanimous vote. Within 30 days after the vote, the Board must disclose the specific reasons that the Board did not accept the resignation, and that this decision was in the best interests of shareholders, along with a discussion of the analysis used in reaching the conclusion.

The majority voting provision is not included in the Frank Bill, so the conference committee must decide whether it will be included in the final bill. As reported in a Reuters article, “Wall Street Critic Frank to Shepherd Final Reform Bill”, the committee could have a final bill ready for signature by the President by July 4. In a post in the RiskMetrics Blog, “Majority Voting May Not Appear in Final Reform Bill”, Ted Allen reports that Representative Frank is “unsure” whether the majority voting provision will appear in the final bill. One way or another, by July 4 there could be "fireworks" on Capitol Hill for public companies.
 

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I am very pleased to announce the return of the ON Securities Blog. The blog is now part of the LexBlog network of legal blogs, and it features improved design as well as better functionality and support. I hope you will notice the difference.

As always, I will do my best to provide topical, useful and, if possible, entertaining commentary on securities compliance, corporate governance and executive compensation. The second part of this post, below, discusses the latest reform legislation being proposed by Senator Dodd, and places it in context with other proposed reforms in governance and compensation.

Occasionally, this blog will also cover other aspects of the world of private practioners and in-house counsel, or the new world of social networking – such as these previous posts:

• “I Am Not a Crook” described useful lessons learned from a legal ethics program taught by Bud Krogh, a former assistant counsel in the Nixon White House who served jail time for his role in the break-in of Daniel Ellsberg’s psychiatrist’s office.

• “Preview of Coming Attractions, and a Movie Review” included a review of the movie Julie and Julia, the first major film about blogging. The blog included a commentary about the relationship between bloggers and their readers.

• "The Color of Blogging", which described the "very important" choice of a color scheme for the first version of this blog (and told the story of the picture of me above).

I appreciate the support of the readers who made the blog a success the first time around. I will try to find new ways to reach out to readers in the near future. Let me know if you have any suggestions or other comments. 

The New Dodd Bill: A Preview of Possible Governance and Compensation Reforms

On March 15, Senator Christopher Dodd released a new 1,300+ page discussion draft of his proposed comprehensive financial reform legislation, the Restoring American Financial Stability Act of 2010 (PDF). In addition to the provisions designed to reform the banking industry, the draft bill includes a variety of corporate governance and executive compensation reforms. For all public companies, the bill would

• require Say-on-Pay, a non-binding annual stockholder vote on executive compensation;

• authorize the SEC to require proxy access, which would enable major stockholders to nominate director candidates and have the nominees included in management’s proxy statement;

• authorize compensation committees to hire consultants and counsel, and establish standards for independent advisors to compensation committees;

• require proxy disclosure of executive pay vs. performance (including a chart); and

• require disclosure of whether the company permits hedging by directors and employees, and why the company chose to (or not to) separate the positions of chair and CEO.

For all listed companies, the draft bill would

• require majority voting for directors (with standards for accepting or rejecting the resignation of directors);

• establish independence standards for compensation committees; and

• require a clawback policy for all executive officers in the event of financial restatements.

I have reflected these features of the Dodd bill in a newly updated version of the ON Securities Cheat Sheet (PDF). The Cheat Sheet is a two-page summary of recent and proposed reforms affecting corporate governance and executive compensation, including SEC rules and proposed legislation. It’s meant to be an antidote for the dizziness and disorientation caused by diving into 1,300 page documents. To make it an even more handy reference, you can always find a link to the most up-to-date version on the home page of this blog, in the orange box at the right side cleverly captioned “ON Securities Cheat Sheet”.

The Dodd bill includes many of the same governance reforms as the Shareholder Bill of Rights Act of 2009 (PDF), introduced by Senator Charles Schumer in May 2009 and also described in the Cheat Sheet. Like the Schumer bill, the draft Dodd bill includes corporate governance reforms, with some variations. For example, the Dodd bill authorizes, but does not require, the SEC to provide proxy access to facilitate stockholder nomination of director candidates. Also, both bills require majority voting for directors for uncontested elections of listed companies. However under the Dodd bill, if a director does not receive a majority of affirmative votes, the board of directors may elect to accept that directors resignation or, by a unanimous vote, reject the resignation. This is different from the Schumer bill, under which the board is required to accept the director’s resignation.

Over the next several months, the provisions of the various bills in Congress will continue to be reconciled, and the SEC will continue to consider its proposed rules. The pace of reform has slowed somewhat, but as I have said before, the various reforms are still jockeying for position like horses in an arcade game making their way around a race track, with the lead constantly shifting – similar to the game in this video:

 

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On December 16, 2009, the SEC adopted its amendments to the proxy disclosure rules - see the press release and the full 129-page release that includes the text of the rules. The release has led to some confusion about when the new rules are effective - the release mentions an effective date of February 28, 2010, but it does not specify exactly what that means. I agree with Mark Borges in the Proxy Disclosure Blog (subscription site), who assumes that the amendments apply to proxy statements and other applicable filings on or after that date.

Part of the confusion about the effective date resulted from a comment during the open meeting/webcast, to the effect that the rules apply to companies with fiscal years ending on or after December 20, 2009. That's not the correct test. The December 20 date does appear in the final release, but only as a separate effective date for new calculation of the dollar amount of equity compensation reported in the Summary Compensation Table. Let's hope someone provides some clarification soon about effective dates.

I'll blog further about the rules themselves, and I'll post a new version of the ON Securities Cheat Sheet soon that reflects the new rules. In my last post, I mentioned one of the "sleepers" in the rules. But I think there may be another one. The Commission added a requirement to discuss the nominating committee's policy on diversity of Board nominees and, if there is a policy, to assess its effectiveness. The Commission declined to define "diversity" for this purpose. This is another area where some companies will be scrambling to figure out what to disclose, and may find it difficult to come up with a consensus on this sensitive topic with virtually no lead time.

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Just In Time For Thanksgiving - The Compensation Turkeys of the Year!

At Thanksgiving, our thoughts naturally turn to gluttony of all sorts. So it seems like a fitting time to recognize a few companies for granting awards to their executives that look so ridiculous they practically beg Congress to speed up compensation reform. A great place to look for these examples is the footnoted.org blog, which prides itself on posting the interesting stories "found in the footnotes" of SEC filings.

So pass the cranberry sauce and gravy, here are my nominees for the "Compensation Turkeys of the Year", all reported by footnoted.org in the past few weeks:

Of course, Goldman Sachs makes the list for its announcement that it is setting aside around $17 billion for compensation and bonuses, calculated to be more than $700,000 on average for each of the company's 31,700 employees. I blogged about this last month. The bonuses are based on Goldman's financial results for the current year, and commentators disagree on how much the results were enhanced by the government bailout of AIG and other financial companies.

Allis-Chalmers reported recently that healthcare benefit premiums and expenses for its CEO exceeded $72,000 last year. (That buys a lot of aspirin.)

Microsoft announced that, for one new executive, they paid a relocation allowance of $4.1 million, and a related tax gross-up of $1.2 million.

These aren't the only examples of compensation that grab your attention, but they are just the most recent obvious ones. As Mark Borges pointed out at the NASPP Annual Conference and other presentations, when companies eventually are required to have advisory votes on executive pay (Say-on-Pay), most companies' compensation will be approved. However, to prevent a "no" vote, they will need to think about the compensation practices that appear the most excessive - personal use of corporate jets, tax gross-ups, etc. It will be interesting to see whether, in a couple of years, after compensation reform, the Compensation Turkeys of the Year will be extinct birds. Don't count on it.

If you have any other Compensation Turkeys of the Year you would like to report, send me an e-mail. (As with any other good whistleblower policy, I won't use your name unless you give permission.)

By the way, the picture above shows the family of wild turkeys that hung out in our back yard for the past few months. Leading up to Thanksgiving, though, I haven't seen them lately. Times are tough.

Anyway, have a fantastic Thanksgiving!

RiskMetrics Update

Last week I reported that RiskMetrics Group came out with its 2010 updates to its proxy voting guidelines, summarized here. The compensation policy has changed more in form than in substance from last year, integrating separate policies into a single policy. RiskMetrics also clarified its methodology when it has compensation-related recommendations for a company based on its analysis. If that company has a Say-on-Pay proposal on the ballot, RiskMetrics will generally apply its recommendations to that resolution. However, if egregious practices are identified, or if a company previously received a negative recommendation on a Say-on-Pay resolution and the issue is not resolved, RiskMetrics may recommend a withhold vote with respect to compensation committee members.

The new governance policy also changes RiskMetrics' standards when making recommendations with respect to shareholder rights plans and revises its director independence standards.

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Several new reports have been published that provide valuable information about what's going on in the public company world. Here are two that just came out:

Pearl Meyer & Partners released a survey report covering companies' attitudes toward Say-on-Pay, which is currently required for TARP recipients but will not be required for other public companies until at least 2011. The survey found that most respondents were not very concerned about Say-on-Pay and are not yet taking specific steps to plan for shareholders advisory votes. The Pearl Meyer firm reports that virtually all advisory votes have passed, mostly by a sizeable majority. However, the firm cautions that institutional shareholders may get tougher on Say-on-Pay votes in the future. The survey report recommends some specific steps companies can take over the next several months to plan for Say-on-Pay.

Frederick W. Cook & Co. released a report of its study of non-employee director compensation at the 100 largest New York Stock Exchange companies and the 100 largest Nasdaq companies. The study found that compensation levels generally stabilized in 2009 after several years of increases, which had tracked increased director responsibilities under the Sarbanes-Oxley Act of 2002. The study also found that the compensation mix changed, with more companies moving director equity awards out of stock options and into stock awards. Also, the declines in the equity markets had a significant impact on equity award values, especially at Nasdaq companies. The study outlines median compensation levels at these companies and examines a number of compensation practices.

One more update - hot off the presses: I noticed that RiskMetrics today published some of its 2010 policy information, which applies to all shareholder meetings occurring on or after February 1, 2010. The more comprehensive proxy voting guidelines will be published in December. However, the just-released documents shed some light on RiskMetrics' evaluation of compensation and governance practices for the 2010 season. It appears that RiskMetrics will make some changes to its approach in making recommendations on Say-on-Pay votes and other compensation-related votes. I will report further on this next week.

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I've just finished three and a half very interesting days at the NASPP Annual Conference and the Proxy Disclosure Conference sponsored by CompensationStandards.com in San Francisco. Aside from an unexpectedly big crowd and some great food, attendees encountered some interesting updates:

Proxy Disclosure Rules. Shelley Parratt, Director of Corporation Finance of the SEC, addressed the group, and there were two main news items. First, she previewed the currently proposed amendments to the proxy disclosure rules. She didn't address when the amendments would be considered, but stated that the new rules "may well" be in place for the 2010 proxy season. The SEC staff still clearly wants to accomplish this goal. Since the rules probably won't be considered until early December, this will likely put proxy drafters and compensation committees in a bind.

Second, apart from the new rules, Parratt discussed compliance with the proxy disclosure rules adopted in 2007 and indicated that the SEC staff will take a more assertive (aggressive?) posture in its comment process. The staff has observed that companies that have already responded to comments on these rules are doing a pretty good job of compliance, although they can always do better. On the other hand, companies that have not yet received the comments seem to be waiting to receive comments before complying with the staff's guidance. She indicated that companies should be more proactive in changing their practices before they get comments, because the SEC will be taking a "no more Mr. Nice Guy" approach. Instead of "futures comments" (amend your filings in the future to comply), the staff will now be requiring many companies to go back and amend their prior filings. The main areas to focus on: (1) make sure your CD&A contains real analysis of "how" and "why" compensation decisions were made, and (2) disclose the performance targets underlying incentive compensation, unless there is a really compelling case to support competitive harm.

New Governance Reform Bill. There was some discussion of the financial reform bill released this week by Senator Christopher Dodd - the "Restoring American Financial Stability Act of 2009". Buried in the 1,136 page bill, which would reform the financial regulatory system, are numerous governance reforms that would apply to all public companies. These are very similar to the provisions of the Schumer bill, described in the ON Securities Cheat Sheet. See this description of the Dodd bill provisions in the Corporate Counsel Blog. The Dodd bill is significant to governance reform, because it may give momentum to the provisions of the other reform bills, which can now be reconciled and carried forward as part of financial institution reform.

A New Ball Game. I bumped into well known compensation attorney and blogger Mike Melbinger, but he was rushing out to the Fox News affiliate to give an interview. It's very entertaining - he talked about AIG CEO Robert Benmosche's statement that he may leave the company because of the government's limitations on executive pay. Melbinger likened the Treasury to a baseball owner. He said that if you want your team to be successful (i.e., if you want AIG to pay back the $180 billion in government aid), you pay whatever it takes to hire C.C. Sabathia, rather than hiring a journeyman pitcher for a low price and hoping for the best. Even Melbinger, however, admitted that if everyone at AIG is driving around in Lamborghinis, you might have a PR problem.

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I attended a compelling legal education program this week, taught by Egil "Bud" Krogh. Political junkies know that Krogh was a young assistant White House counsel in the Nixon years. As a leader of the "Plumbers" unit, he authorized the 1971 break-in of the offices of Daniel Ellsberg's psychiatrist after the leak of the Pentagon Papers. After the break-in came to light in the Watergate hearings, Krogh pleaded guilty, served time in prison, was disbarred and later reinstated.

Bud now lectures on the topic of legal ethics, based on his recent book, Integrity: Good People, Bad Choices, and Life Lessons from the White House. His premise: in a pressure-filled environment such as the White House, intense loyalty to individuals can blind you to your higher principles. This is compounded by fear, inexperience, pride and other factors.

Krogh's description of an environment that can put pressure on decision-making is familiar to anyone called on to say yes or no to any proposal by a corporate officer. Whether the proponent is the client of an outside attorney or the boss of an in-house attorney, there is a lot of pressure just to nod approval, as Bud Krogh nodded to Howard Hunt when the Plumbers break-in was discussed. I think the situation is especially acute for in-house attorneys. Of course, most proposed actions are legal, and the advice is often about the level of risk involved in two alternatives. And most in-house attorneys do a great job of balancing the competing pressures of giving sound advice while also being part of the team. But how do some decisions, even decisions by good people, go astray?

A great example can be found in the options backdating scandals. An article in the Financial Times in November 2006 reported that the backdating scandals had resulted in at least twelve major US companies replacing their general counsel, and a March 2008 speech by the SEC's Director of Enforcement reported that at least seven former general counsel had been charged by the SEC in connection with the scandals. Backdating, even though not necessarily illegal in itself, in these cases represented falsification of documents and involved misleading accounting and tax fraud. I know many attorneys said "no" to the practice, but these counsel simply nodded as backdating was pushed by other corporate officers. It might not have seemed like such a big deal at the time.

I asked Krogh how to advise an attorney (maybe a younger in-house attorney) how to avoid the pitfalls of losing perspective in a pressure-filled situation. He steered me toward a Top Ten List provided by Hank Shea, a former Assistant U.S. Attorney in Minnesota who teaches ethical leadership at the University of St. Thomas Law School, including the following two lessons learned from the misconduct of others:

When faced with a right versus a wrong decision, guard against that first intentional misstep.

When faced with an ethical dilemma, seek advice and counsel from others.

After an interesting program, Bud entertained us with a great Nixon impression, including, at the request of one of my colleagues, the famous phrase "I am not a crook". Bud proved that we can all learn lessons about how to be able to make that statement, and mean it.

It's Just An IP Thriller - One More Comment

Bud Krogh also told a great story about Elvis, the King of Rock and Roll, who came to visit President Nixon in a meeting engineered by Bud. I just saw a great film about another King - the King of Pop. "This Is It" chronicles the rehearsals for Michael Jackson's planned comeback concert tour. I recommend it to anyone who wants to see the combination of pure genius and meticulous attention to detail shown by MJ. If you didn't see it before, it's worth reading my previous post, reporting that Jackson was actually one of the named inventors in an issued patent.

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Mark Borges, the well known compensation consultant with Compensia, gave a very interesting talk this week at a joint meeting of the Society of Corporate Secretaries and Governance Professionals and the Twin Cities Compensation Network. Mark was gracious enough to give me permission to post his presentation, which is full of useful updates on governance and compensation reform and tips on how to get ready. One of the interesting features is a time line showing the dates of adoption and introduction of various legislative and regulatory initiatives, as well as a preview of what's to come. As I've said before, watching the progress of these initiatives through Congress and the SEC reminds me of the arcade game where you can watch the little mechanical horses race around and around the track, with the lead constantly changing - as in this great video.

Mark made these points, among many others:

Given the amount of attention Congress is giving to health care reform, it is very possible that governance and compensation reform will be pushed to 2010 - unless there is some unforeseen crisis before then, which is always possible.

Mark, like me, had thought the Shareholder Bill of Rights Act (the Schumer Bill) introduced in the Senate had probably been swept aside or at least delayed by the passage by the House of the Corporate and Financial Institution Compensation Fairness Act (the Frank Bill). Now, he believes that the Schumer Bill may be getting new traction. The Schumer Bill is heavier on governance reform than the Frank Bill, and some of these provisions may be grafted onto a financial institutions reform bill.

Even though a shareholder advisory vote (Say-on-Pay) requirement likely will be part of any reform bill, it almost certainly will not be effective for the 2010 proxy season. Meanwhile, some major companies have voluntarily adopted other advisory vote models - in September, Microsoft adopted a triennial advisory vote, and in October, Prudential adopted a biennial advisory vote. If one of these approaches gains support, Congress may mandate one of these approaches rather than an annual vote on compensation.

I will mention some of Mark's other observations in a future post.

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"Psst - Wanna Buy Some (D&O) Insurance?" This Survey Will Help.

I was interested to read the most recent Towers Perrin survey of D&O insurance practices of around 2,600 public and private companies and non-profits. One of the purposes of the survey is to provide companies with information about the structure and cost of D&O insurance practices of a broad cross-section of companies. Towers Perrin emphasizes that the companies surveyed do not represent a scientific sampling. However, it is helpful to have a reference point for the range of coverage amounts and retention amounts for companies of various sizes.

This survey also reports on various insurance trends, including an increasing number of public companies purchasing only "Side A" coverage, which covers directors and officers only in situations where indemnification from the company is not available. This trend was especially apparent in very large organizations.

More From the Deloitte Executive Compensation Trends Presentation

Last week I mentioned the excellent materials prepared by Deloitte Tax for a presentation on trends in executive compensation, for the Twin Cities Chapter of the National Association of Stock Plan Professionals. A few other compensation trend observations worth noting:

Around 40% of the largest companies changed their long-term incentive (LTI) plans or granting practices for 2009, including modifying performance measures, reducing LTI grant values, introducing intermediate goals, etc.

The authors predict a significant decline in LTI grant values for 2009 - in light of lower stock prices, some companies had to reduce grant values in order to manage equity dilution.

Surveys noted significant increases in executive compensation "clawback" arrangements for large companies.

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I just went through some of the hundreds of comment letters on the SEC's controversial proposal to adopt Rule 14a-11 on proxy access. The rule would grant large shareholders the ability to include director nominees in management's proxy statement - see the description at the end of the ON Securities Cheat Sheet. A companion rule, a proposed amendment to Rule 14a-8, would explicitly allow shareholders to include proposals in the proxy statement to approve various forms of proxy access.

Several comment letters, including the letter from the U.S. Chamber of Commerce, describe explicit theories about why the proposed rule should be struck down by the courts if adopted. Generally, these letters claim that the rule exceeds the SEC's authority or preempts state law. One of the most interesting letters is from Stanford Professor Joseph Grundfest, a former SEC Commissioner. Grundfest focuses on the major contradictions he perceives between the SEC's stated goals in its proposing release and the provisions of the rule itself:

. . . Like Charles Barkley's claim that he was misquoted in his autobiography, contradictions spawn skepticism as to the credibility of an entire enterprise.

Professor Grundfest then describes how these inconsistencies could be the basis of a legal challenge to the rule.

It seems apparent that, if the SEC adopts Rule 14a-11, the enforcement of the rule will be tied up in court, and the rule could eventually be struck down. This leads to a couple of likely scenarios involving Rule 14a-8:

The SEC could adopt both Rule 14a-11 (with the same 3-2 vote as for the proposal) and the amended Rule 14a-8, risking a legal challenge. The amended Rule 14a-8 will serve as a backup that will almost certainly not be subject to a legal challenge. As described in this post, Delaware law was recently amended to specifically permit such bylaw amendments.

On the other hand, the SEC could back down and just adopt the proposed amendment to Rule 14a-8 (possibly with a 5-0 vote). This is the compromise suggested by the National Association of Corporate Directors, which opposes Rule 14a-11 but supports the amendment to Rule 14a-8.

Either way, the amendment to 14a-8 is likely to be effective long before Rule 14a-11. This will give activist shareholders an avenue to start the process of demanding shareholder access through shareholder proposals at annual meetings to amend company bylaws. One way or another, it won't be long before we hear the big shareholders "knock-knock-knockin' on the boardroom door".

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Preview of Coming (Regulatory) Attractions

The past few weeks have been fairly slow in terms of new developments in securities law, corporate governance and executive compensation. However, summer's over, and I'm expecting a flurry in the next few weeks. Take a look back at the ON Securities Cheat Sheet - a lot of these developments are likely to change as we head into the fall:

Congress is back in session, and we are likely to see action on the Corporate and Financial Institution Compensation Fairness Act of 2009, passed by the House in July. Congress will likely try to reconcile that bill with the other legislation described in the Cheat Sheet, and I would expect that something will be enacted by the end of the year. Virtually every bill would require Say-on-Pay for public companies, but we don't know when the requirement will go into effect.

Comment periods are ending for the SEC's proposed proxy disclosure and solicitation rules and the proposed shareholder access rules. The SEC will almost certainly adopt the disclosure and solicitation rules this fall. As described in this post, action on the shareholder access rules is more uncertain.

The SEC and Treasury Department may further clarify compensation standards for financial institutions that received TARP funds - including the SEC's proposed rules to clarify Say-on-Pay standards for TARP recipients (maybe a preview of what Say-on-Pay will look like for other public companies).

Companies preparing their proxy statements for annual meetings held starting on January 1, 2010 will be dealing with the reality of the elimination of broker discretionary voting, described in this post.

We'll be watching carefully - as Siskel and Ebert used to say, "The Balcony Is Open".

Mastering the Art of American Blogging - and Begging

Last weekend I saw my all-time favorite film about blogging - okay, maybe the only film I have seen about blogging. "Julie & Julia" follows two parallel true stories - Julia Child's authorship of "Mastering the Art of French Cooking", and Julie Powell's creation of a blog that chronicles her quest to prepare all 524 recipes in the Julia Child book in one year.

I agree with the critics who said that the Julia Child story is much more compelling, and Meryl Streep is wonderful as Julia. But I watched Julie's story with my "blogger hat" on, and I tried to figure out what made her blog successful. Aside from a good concept and great writing, she found a way to create a community among readers with a common interest, and she fed off their support and feedback.

Which leads me to the begging - I am gratified by the number of subscribers to the ON Securities blog, but I'd like to hear from you a little more often. I know it's not always easy - as expressed in an e-mail I received from one subscriber who provided a great comment but then said:

I need a trip to the Wizard of Oz before summoning up enough courage to post a response.

I've paraphrased his/her comment anonymously in the "Comments" section of my last post.

So my request is that you not hesitate to give me feedback - let me know when I'm right or wrong or off base, or if there's any information you would like me to provide in this space. My promise: reading my blog won't leave you as hungry as watching "Julie & Julia" or reading Julie's blog.

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There have been several recent articles on the SEC's proposed proxy access rule, Rule 14a-11. If adopted, this rule would allow large shareholders to nominate director candidates and have the candidates included in management's proxy statement for the company's annual meeting.

A Wall Street Journal article last week (subscription required for full article) reported that ". . . the measure looks like it will be passed by the Securities and Exchange Commission in November." The article describes efforts by the U.S. Chamber of Commerce and others to block the measure, but reports that ". . . most opponents expect the measure to pass." The article states that many corporate comment letters are suggesting a weakened version of the measure rather than opposing it altogether.

However, this post by Dave Lynn in the Corporate Counsel blog last Friday puts the proposal's status in perspective and raises doubts that shareholder access is a "done deal". Lynn refers to several interesting comment letters, including this comment letter from several prominent former SEC staff members, urging the Commission to focus on other, more pressing regulatory matters. The Corporate Counsel post points out that "this is a road that we have all been down before", basically stating that it's too soon to know where this will end up. We all need to stay tuned.

As always, you can refer to the ON Securities Cheat Sheet for information on this and other proposals before the SEC, as well as pending legislation.

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On Friday, the House of Representatives passed the Corporate and Financial Institution Fairness Act of 2009. The Senate still needs to consider similar legislation, and any differences will need to be resolved.

For most public companies, the bill will (1) require an annual advisory vote on executive compensation ("Say-on-Pay") and (2) for exchange-traded companies, increase the independence requirements for compensation committee members. The bill also would, if enacted, regulate pay at the largest financial institutions. TheCorporateCounsel.net Blog in its August 3, 2009 post contains an excellent summary of the bill. As that blog points out, Say-on-Pay almost certainly will not be a reality during the 2010 proxy season.

The bill allows the SEC to exempt certain companies from both the Say-on-Pay requirement and the compensation committee requirements. Therefore, the SEC might exempt smaller companies from either or both provisions.

We have updated the ON Securities Cheat Sheet to include the revised status and content of this bill. As you can see, there are still several other bills making their way through the Senate and the House, as well as several proposed regulations that would impact governance and compensation. These bills and rules continue to jockey for position, like the toy arcade horses in the video that amuses me so much.

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How to Play Say-on-Pay

It's a pretty good bet that non-binding shareholder advisory votes on executive compensation ("Say-on-Pay") will be adopted this year and will become mandatory for public companies, probably starting with the 2010 proxy season. There are several different pieces of proposed governance reform legislation in Congress, and virtually every one of them would, if adopted, require Say-on-Pay. See the ON Securities Cheat Sheet for details. If Say-on-Pay becomes a reality, this would be in line with the prediction I made in my StarTribune Business Forum commentary last April.

So, what does Say-on-Pay look like in practice, and what is the likely outcome of the shareholder vote? A recent alert by Compensia, a compensation consulting firm, gives a good summary of the proxy statement language used by various companies and the reported results to date. So far, very few companies have reported the results of advisory votes, but in most cases the resolutions approving compensation have passed by wide margins. We should see the reported results of many more votes soon - hundreds of financial institutions that received TARP funds were required to conduct advisory votes in the past few months. The results of most of these votes will be reported in 10-Qs over the next few weeks, and we should get a clearer picture of the atmosphere for these proposals, especially within the financial services industry.

Assuming Say-on-Pay is required to be on the ballot in 2010, what should companies do now? At the very least, companies should start planning early to review their proxy statement disclosures, including CD&A, to address concerns that institutional investors are likely to raise. I recommend reading the RiskMetrics 2009 report, "Evaluating U.S. Management Say On Pay Proposals" (note: you will need to create a free RiskMetrics account if you don't already have one). This report outlines a set of factors that RiskMetrics advises investors to consider in evaluating an advisory vote. Expect RiskMetrics to come out with a more specific set of guidelines in preparation for the 2010 proxy season. Compensia, in its alert, also recommends planning a program of shareholder communications regarding compensation matters.

Another resource is the Say-on-Pay web forum, sponsored by Corporate Secretary magazine, which looks like it will be providing ongoing analysis of Say-on-Pay votes.

What is your company doing to get ready for Say-on-Pay? How much of a pain will it be? Post a comment below or send me a confidential e-mail.

Updated Cheat Sheet Posted

We have just posted an updated version of the ON Securities Cheat Sheet under the Resources listing on the home page of this Blog. The updated document describes the Corporate Governance Reform Act of 2009 introduced by Minnesota's own Rep. Keith Ellison. The Cheat Sheet also reflects the actual introduction of the bill previously proposed by Treasury Secretary Geithner and now introduced by Rep. Barney Frank.

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As described previously, on July 1, 2009, the SEC approved by a 3-2 vote an amendment to New York Stock Exchange Rule 452 to eliminate broker discretionary voting in uncontested elections of directors. Of all the recent proposals (see the ON Securities Cheat Sheet), this was the first to be adopted, and this change may have the biggest practical impact on corporate governance for most companies. The rule change is effective for shareholder meetings held on or after January 1, 2010, and it is likely to make it more difficult to get affirmative votes in favor of management's slate of directors.

So for management of a public company, is this your worst nightmare? Maybe it's a little early to start screaming. But at the very least, it's not too early to do some advance planning to avoid surprises for the board. And for the in-house attorneys I work with, it's always a good idea to avoid surprises for the board. Or you WILL have something to scream about.

So what should a company do to prepare? Georgeson, a leading proxy solicitation firm, recently did a good explanation of the possible impact of the amendment, including three main tips:

Analyze - run some numbers to determine the possible impact of the amendment on your next election, including the possible impact of factors that might lead proxy advisory firms like ISS/RiskMetrics to recommend a vote against the incumbents.

Communicate - develop a communication plan to educate retail investors on the importance of voting and a last-minute "get out the vote" campaign, just in case.

Prepare - develop a damage control plan in case of a large percentage of negative votes (or a failed election, in the case of a company that has adopted majority voting for directors).

I talked to one in-house attorney who has started to run analyses of historical vote patterns to predict how the next election will come out. What is your company doing? And how much impact do you think the amendment to the broker voting rules will have? Post a comment below or send me an e-mail.

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Is your head spinning from the number of new developments in corporate governance and compensation reform? Are you dizzy from trying to remember whether "say-on-severance" is part of the Schumer Bill or the Treasury Department's white paper? Is your heart racing from trying to keep track of the progress of shareholder access proposals?

We have just the answer - the ON Securities Cheat Sheet will cure what ails you. The Cheat Sheet is a one stop shop for "capsule summaries" of each bill and regulatory proposal being considered. These capsules are sure to make you feel better - and in the spirit of health care reform, this remedy is ABSOLUTELY FREE!

We can't promise that the Cheat Sheet contains the most in-depth analysis available of each bill and regulatory proposal. But it's helpful just to be able to scan the different proposals. For example, it's helpful to see that Say-on-Pay for all public companies is proposed as part of the Schumer bill, the Peters bill, and the Treasury Department's legislative proposal. At the same time, the SEC's proposals issued on July 1 included proposed Say-on-Pay standards for TARP recipients, which have previously been subject to Say-on-Pay requirements under the recovery bill.

We will continue to include the Cheat Sheet in the "Resources" section featured on the home page of this blog, and we will do our best to keep the document up to date. Since you'll be able to put the developments in context, your head should stop spinning. However, I can't make any promises about dizziness. Watching progress of the various proposals making their way through Congress and the regulatory agencies reminds me of the arcade game where you can watch the little mechanical horses race around and around the track, with the lead constantly changing. Here's a great video that shows you what I mean.

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ABA Releases Exposure Draft of Model Bylaw for Shareholder Access

TheCorporateCounsel.net Blog reports that the ABA's Task Force on Shareholder Proposals has released an exposure draft of a model bylaw for Delaware corporations to grant shareholder access - giving significant shareholders the ability to nominate one or more director candidates and have the candidates included in management's proxy statement. The model bylaw provides a company with flexibility in its provisions, including the percentage of the company's outstanding stock the stockholder must hold, and the length of time the stockholder must have owned the shares. The Task Force has asked for comments on the model bylaw.

It's not clear how many companies will voluntarily adopt the Task Force's model bylaw without being required to do so. The Delaware General Corporation Law was amended in April 2009 to add a new Section 112 to facilitate bylaws such as the model bylaw. Before 2007, numerous companies faced shareholder proposals supporting shareholder access. The SEC in 2007 determined that management could refuse to include these shareholder proposals in their annual meeting proxy statements. However, there may still be pressure on public company boards to allow shareholder access.

The SEC's proposed rules on shareholder access, if adopted, will make shareholder access mandatory and will eliminate much of the flexibility incorporated into the model bylaw. The Task Force clarified that the model bylaw does not take the SEC's proposed rules into account. However, assuming the SEC's rules become effective, public companies will move to adopt bylaws to clarify the procedures and standards for shareholder access, and the Task Force's draft will be a useful starting point.

The King of Pop - and IP

Working with companies and entrepreneurs gives you an appreciation for innovative business leaders. And whatever you think about Michael Jackson, the guy was a genius within the entertainment business. Some of his business ventures are well known - like his purchase of most of the Beatles' music catalog in the mid-1980s. But until I read his Wikipedia profile, I didn't realize that he was the named inventor on an issued patent. Michael developed an illusion for dancers performing "Smooth Criminal" to lean far forward, as if defying gravity. The trick was originally done with wires, but the Gloved One helped develop special shoes for the trick, and in 1992 he and two co-inventors were granted U.S. Patent 5,255,452: "Method and Means For Creating Anti-Gravity Illusion". Unbelievable - see the video in this article.

If only he had survived long enough to develop "Method and Means for Creating an Economic Comeback."

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The SEC takes action on July 1, but that's not the whole story.

On July 1, 2009, the SEC voted to take several actions:

The Commission proposed rules that would clarify the statutory requirement that TARP recipients hold annual stockholder votes on compensation ("Say-on-Pay").

The Commission proposed revisions to the compensation disclosure rules that, among other things, would (1) disclose the relationship to risk of a company's overall compensation policies (not just policies covering top executives) and (2) disclose potential conflicts of interest of compensation consultants.

In probably the most important move, the Commission approved the New York Stock Exchange's proposal to eliminate discretionary voting in elections of directors. Therefore, brokers must receive instructions from the beneficial owner before voting. The conventional wisdom is that brokers acting without instructions generally vote in favor of management's slate, and that this change will reduce the percentage of shares voting for the director candidates in routine elections. The Wachtell Lipton law firm presented an interesting analysis of this issue in March, taking the position that the current broker votes in favor of management are a pretty good proxy for the votes of retail stockholders, who generally support management's candidates.

However, to understand the impact of the July 1 actions, it is necessary to understand other current developments, some of which would have an even greater impact on a broader segment of companies:

The Commission's Say-on-Pay proposals covered only TARP recipient companies. However, the Shareholder Bill of Rights Act introduced in the Senate by Senator Schumer, if adopted, would mandate Say-on-Pay for all public companies, as would two other bills currently being considered by Congress.

The Commission did not require that public companies adopt a specific structure to assess risk and ensure that compensation practices are consistent with the company's risk profile. However, the ARRA and the Treasury's interim final rules currently require the compensation committees of TARP recipients to perform specific risk management functions. Also, the Schumer bill would require that the board of directors of all public companies form a risk committee of independent directors to report to the board about the company's risk profile and the appropriateness of its compensation practices.

The elimination of discretionary voting by brokers takes on added importance because it could alter the balance of power between management and activist stockholders, especially for companies that have adopted majority vote standards in director elections. This shift would compound the potential increase in power by institutional investors that would result from the Commission's controversial proxy access proposal, reported here, which would allow large stockholders to nominate director candidates who would be included in management's proxy statements.

The bottom line: you need a scorecard to keep everything in context. The ON Securities Blog is working on a scorecard that will cover the SEC proposals, the Schumer bill, other pending bills and the Treasury regulations under TARP and the stimulus bill. What would you like to see covered? Send me an e-mail and let me know.

Maslon Small Public Company Forum's Inaugural Event is a success (singing fish and all).

On June 24, 2009, I participated in the inaugural event of the Maslon Small Public Company Forum, which included presenters from Maslon, Baker Tilly Virchow Krause, Carver Moquist & O'Connor, Feltl and Company and Internal Control & Anti-Fraud Experts, LLC. Course materials and podcasts of the presentations are available at the Small Public Company Forum website, which we hope will be a great resource for small public companies across the region.

For my presentation on underwater options entitled "Underwaterworld", I presented the "world's leading expert on underwater options": Big Mouth Billy Bass, the famous singing fish. You can watch Billy's full performance here. In his immortal words, once you solve your company's underwater options problem, you can take his advice: "Don't Worry, Be Happy!"

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