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

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

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

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

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

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

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

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As public companies prepare for their first proxy season under the Dodd Frank Wall Street Reform and Consumer Protection Act (848-page PDF), I’m fielding many questions about implementation of the compensation and governance provisions of the Act. Unfortunately, given the broad language of the Act and the current absence of SEC regulations, there are not a lot of definitive answers.

However, the Society of Corporate Secretaries and Governance Professionals has provided a very thoughtful and helpful analysis. Darla C. Stuckey, Senior Vice President of the Society, in her testimony before the House Finance Committee last week, discussed the possible impact of various compensation-related provisions of the Act, as well as the Society’s “wish list” of possible regulatory clarifications. Ms. Stuckey’s testimony (PDF) makes interesting reading for anyone wrestling with preparation for the 2011 proxy season:

Say-on-Pay and Related Votes. The Society observes that the SEC is targeting January through March of 2011 for adoption of rules on Say-on-Pay and Say When on Pay. Since these votes are required at the first shareholders meeting on or after January 21, 2011, even January is too late to provide guidance for many affected companies. The Society requests that the SEC propose the rules in early October so the final rules can at least be adopted before January 21.

Advisory Firms. The Society also commented that the SEC should consider the power of proxy advisory firms (which would include ISS) in the Say-on-Pay process. A recent survey indicated that almost half of Society members reported 30% or more of the companies’ shares being voted in line with the advisory firms’ recommendations. Over 60% of respondents indicated at least one experience with an advisory firm’s recommendations being based on materially inaccurate or incomplete information, and of those recommendations, 60% were not corrected.

Comment. I have listened to several public company representatives complain about advisory firm recommendations based on inaccurate or incomplete information. Unfortunately, with the increased workload of the advisory firms in the coming year, this problem is not likely to get better.

Say When on Pay. The Society recommends that the SEC rulemaking should give weight to board recommendations on the frequency of Say-on-Pay votes. They suggest providing boards “a choice whether to offer a resolution with a single recommended choice (e.g., every two years), or a resolution that would give the board’s preference but ask for a vote on a one, two or three year frequency in a multiple-choice fashion.” The latter type of vote would involve a plurality vote of the shareholders.

Comment. The Society is asking the SEC to allow companies the discretion to offer When on Pay as a yes-or-no vote on a single recommended choice (e.g., an up or down vote on a triennial Say-on-Pay vote). I don’t believe it is clear that such a vote would be consistent with Section 951(a)(2) of the Act, which requires a separate resolution “to determine whether votes on the . . . [Say-on-Pay resolutions] will occur every 1, 2 or 3 years.” Ms. Stuckey included with her testimony a comment letter (PDF) on the Act to the SEC from the Center on Executive Compensation. That letter does make a cogent argument that the vote with a single recommended choice is consistent with the Act, but certainly doesn’t answer all questions about the SEC’s authority in this area. Ultimately, the SEC has to make a determination about its authority to permit a “single recommended choice” vote – and quickly, if it is to propose rules by early October, as requested by the Society.

If the SEC rules do allow an up or down vote on a single recommended choice, the rules will have to answer other questions. For example, if the shareholders vote against a triennial Say-on-Pay vote, what action will the board of a company be required to take in subsequent years – would the company then be required to hold annual Say-on-Pay votes, or could the board elect to hold biennial votes?

Internal Pay Ratio. The Act will require companies to present the median annual total compensation of all employees of the company (other than the CEO) and the annual total compensation of the CEO, then provide the ratio of these figures. These rules are expected to be in effect for the 2012 proxy season. Ms. Stuckey’s testimony makes it clear just how difficult and complex a task will be presented by the calculations. The Society recommends that the Act be clarified, either through a technical amendment or rulemaking, to provide that “all employees” be limited to full time U.S. employees, and that the total compensation amount exclude pension accruals, benefits and other non-cash items. According to an Alert from the Society dated September 28, 2010, Congressman Frank indicated his agreement with Ms. Stuckey on this issue.

The Society also commented on the Act’s clawback requirement, a subject I will address in a future post.

Legal Challenge Seeks to Invalidate the Proxy Access Rule

The U.S. Chamber of Commerce yesterday announced that the Chamber and the Business Roundtable filed a petition with the U.S. Court of Appeals challenging the SEC’s adoption of Rule 14a-11, the proxy access rule. This rule grants large shareholders the right to nominate directors in certain circumstances and have these nominees included in the company’s proxy statement. The petition claims, among other things, that the Rule is arbitrary and capricious and that the SEC failed to follow appropriate procedures. It’s not clear whether the petition will affect the Rule’s scheduled effective date of November 15, 2010.
 

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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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