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

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

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

The presentation included the following interesting points:

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

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

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

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

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

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

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The SEC has a new weapon in its enforcement proceedings, thanks to a provision in the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF). In an interesting article in DealBook, “Can the S.E.C. Avoid Scrutiny of its Settlements?” Professor Peter J. Henning points out that Section 929P of the Act “now allows the S.E.C. to impose a civil monetary penalty in an administrative proceeding ‘against any person’ who violates a provision of the federal securities laws.” Prior to enactment of the Act, the S.E.C. had to go to court to impose penalties against companies other than broker-dealers or investment advisors.

Professor Henning points out that this authority might have made a big difference in the SEC’s recently announced settlement of an enforcement proceeding against Citigroup over its disclosure of its exposure to subprime mortgages. Like the settlement in the Goldman Sachs proceeding, the Citigroup settlement is being delayed, as a federal district judge scrutinizes the settlement.

Under the new Dodd-Frank Act provision, Professor Henning says the SEC enforcement staff will be able to bypass the courts altogether on some types of proceedings by filing settled cases as administrative proceedings. This may allow the staff to act more quickly and impose sanctions on a greater number of companies more quickly. It’s hard to predict the impact of such a trend, however. The scrutiny of the judge in cases such as the Goldman Sachs settlement forced the SEC to get tougher in the final settlement, so the availability of administrative proceedings may make it easier for the SEC and its corporate targets to negotiate deals that are less tough than a federal judge would require. One way or another, however, the flurry of activity from the newly empowered SEC enforcement staff is sure to continue.

Show Me the Logo

Speaking of the empowered enforcement staff, the SEC obviously wants to showcase their toughness – I noticed the brand new logo that’s now prominently displayed at the upper right corner of the home page of the SEC’s website, just above a set of links to its latest high profile enforcement cases:

I’m not going to try to take any credit for the logo, but it does remind me a bit of the graphic I have used in this blog a few times:

I first used the "Busted" graphic in my post in September 2009, “’Busted’ - Don't Be Blindsided by the SEC's New Enforcement Posture,” in which I provided some tips for public companies to avoid problems with enforcement proceedings. I’ll provide an updated list of tips in an upcoming post.

Actually, one of my partners said the SEC’s new enforcement logo reminds him of another one – maybe the SEC is trying to show that its new “cops on the beat” are just as tough as the cops represented by this logo:

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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 a separate vote “to determine whether Say-on-Pay votes will occur every 1, 2 or 3 years”. This vote has been called the frequency vote or “Say When on Pay.” The Say When on Pay vote must be held no less frequently than once every six years. In a previous post, I described some mechanical issues with offering all three choices of frequency (i.e., an annual, biennial or triennial Say-on-Pay vote). 

But what frequency should companies recommend for Say-on-Pay votes – annual, biennial or triennial? Most public company officials will quickly react that they prefer a triennial vote. The advantages are obvious – Say-on-Pay votes create some additional drafting, solicitation and shareholder relations issues, and a triennial vote allows the company to avoid these issues in two out of every three years.

Are there any advantages to annual or biennial votes? In a webcast (subscription only) sponsored by CompensationStandards.com, compensation consultants Mark Borges of Compensia and Mike Kesner of Deloitte brought up a few factors that should at least be considered before settling on a triennial vote recommendation:

• Some companies are coming to the conclusion that an annual vote is preferable, on the theory that an annual non-binding vote will seem routine after the first year – somewhat like the annual vote to approve the company’s auditors.
• Also, biennial or triennial votes may present a disadvantage because there will be “off years” with no vote. If ISS or other shareholder advisory services want to send a signal to the board about compensation in an off year, their only choice is to recommend a withhold vote against compensation committee members.
• It’s not clear whether the shareholder advisory services such as ISS will recommend annual votes or some other cycle. Companies should also be mindful of any stated preferences of their large shareholders.

On the last point, companies should not assume that institutional investors will all prefer an annual vote. In a post on Altman Group’s Governance and Proxy Review, “Open Questions on Dodd-Frank: Say-on-Pay Implementation (SOP) and Proxy Access,” Francis H. Byrd reports that many institutional investors have feared the prospect of being flooded by annual advisory votes for all of their portfolio companies. Such investors may be happy to vote for biennial or triennial advisory votes. Byrd also points out a common justification by companies for triennial votes – that many companies’ pay plans are crafted around three-year periods, and triennial votes allow investors to better judge the value of these plans.

In any event, the Say When on Pay vote presents a variety of strategic considerations, and public companies should start thinking about these considerations now.

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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