The Dodd-Frank Wall Street Reform and Consumer Protection Act (Act) was enacted by Congress on July 15, 2010, and was signed into law by President Obama on July 21, 2010.1While the Act primarily relates to reform of business practices of financial institutions, it also contains extensive provisions on executive compensation along with corporate governance matters. Many of these provisions will apply, in whole or in part, to almost all publicly traded companies (i.e., they are not limited to just financial institutions). The executive compensation and corporate governance provisions in the Act address the following issues:
• Shareholder Vote on Executive Compensation (Say-on-Pay)
• Recovery of Erroneously Awarded Compensation (Clawbacks)
• Additional Compensation Disclosures (Pay Versus Performance)
• Disclosure Regarding Employee and Director Hedging
• Independence of Compensation Committee Members
• Selection and Requirements of Compensation Committee Advisors
• Inclusion of Shareholder Nominees in Issuer's Proxy Statement (Proxy Access)
• Broker Discretionary Voting
• SOX 404 Exemption for Non-Accelerated Filers
Set forth below is a summary of key provisions of the Act that will apply to most publicly held companies.2
Executive Compensation Provisions
Shareholder Vote on Executive Compensation (Say-on-Pay)
Section 951 of the Act creates a new Section 14A of the Securities Exchange Act of 1934, as amended (Exchange Act). This Section will add the following three new requirements relating to shareholder approval of executive compensation:
1. that at least once every six years, a resolution be presented at a meeting of shareholders to determine whether the company will be required to put executive compensation to a non-binding shareholder vote once every year, once every two years, or once every three years;
2. that at least once every three years (frequency depending on the determination of shareholders discussed in item 1 above), a resolution be presented at a meeting of shareholders requesting their approval of executive compensation as disclosed in the proxy statement for such meeting pursuant to Rule 402 of Regulation S-K; and
3. in the event of a proxy or consent solicitation where shareholders are asked to approve an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all of the company's assets (collectively, Acquisition or Disposition), companies will be required to (i) disclose any agreements or understandings relating to compensation (whether present, deferred or contingent) to be paid to a named executive officer of the company (or of the acquiring company) that is based on or otherwise relates to the Acquisition or Disposition (e.g. golden parachute payments), and (ii) present a resolution requesting shareholders to approve such agreements or understandings and the underlying compensation as disclosed.
The results of these shareholder votes will not be binding on the company or its board of directors. Companies must comply with these requirements beginning with meetings of shareholders occurring after Jan. 21, 2011. Therefore, almost all public reporting companies will need to include resolutions relating to the aforementioned items 1 and 2 in their 2011 proxy statements. However, the SEC is authorized to exempt an issuer or class of issuers from the shareholder vote requirement, and in making this determination will take into account whether these requirements disproportionately burden small issuers.
Under Section 954 of the Act, the SEC shall direct each national securities exchange to require each listed company to develop, implement and disclose information about a "clawback" policy to recover incentive-based compensation received by executive officers in connection with an accounting restatement. This clawback policy must provide that if a listed company is required to restate its financial statements due to material noncompliance with applicable financial reporting requirements, the company must recover from any current or former executive officer any excess incentive compensation based on the erroneous data received during the previous three years. This will be broader than the clawback provision under the Sarbanes-Oxley Act, which permits the SEC to recover monies for the company only from the CEO and CFO extending back 12 months if there is misconduct leading to the restatement.
Disclosure of Pay Versus Performance
Section 953 of the Act directs the SEC to adopt rules requiring disclosure in any proxy or consent solicitation of information that shows the relationship between executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of the shares of stock and dividends of the issuer and any distributions. This will also require disclosure of the median of the annual total compensation of all of the issuer's employees except the CEO, and the ratio of this median employee annual total compensation to that of the CEO.
Disclosure Regarding Employee and Director Hedging
Pursuant to Section 955 of the Act, the SEC must adopt rules requiring each issuer to disclose in any proxy or consent solicitation for a shareholder meeting, whether employees or directors of the issuer, or their designees, are allowed to purchase financial instruments that are intended to hedge or offset a decrease in the market value of any equity security that was granted by the issuer as part of the compensation of the employee or director, or that is otherwise held by the employee or director. The requirements of this Section became effective upon enactment of the Act, subject to the adoption of implementing rules by the SEC.
Independence of Compensation Committee Members
Pursuant to Section 952 of the Act, the SEC must adopt rules directing each national securities exchange and association to require listed issuers to maintain a compensation committee that is comprised entirely of independent directors. The independence standards established must take into account all sources of compensation from the issuer to the director, including consulting, advisory or other fees, any affiliate status of the director with the issuer or any subsidiary or affiliate thereof, and any other factors established by the SEC. It is likely that the new independence standards will be stricter than the current standards maintained by the national securities exchanges and associations. The SEC must adopt such rules within 360 days following the enactment of the Act.
Specifically exempted from these requirements are controlled companies, limited partnerships, companies in bankruptcy proceedings, certain open-ended management investment companies, and certain foreign private issuers. In addition, the national securities exchanges and associations will be permitted to exempt specific categories of issuers or particular relationships from the requirements of the SEC rules adopted pursuant to Section 952, taking into account the size of an issuer and any other relevant factors.
Selection and Requirements of Compensation Committee Advisors
Section 952 of the Act also requires that compensation committees have the authority to hire compensation consultants, legal counsel and other advisors to the compensation committee and shall be directly responsible for any such advisor's appointment, compensation and oversight. In selecting any such advisor, a compensation committee must first consider the independence of such advisor based upon factors to be determined by the SEC. Such factors are to be competitively neutral among the categories of advisors and preserve the ability of the compensation committee to retain the services of advisors in any category. In each proxy or consent solicitation for a shareholder meeting occurring on or after one year from the date of enactment of the Act, issuers must disclose, in accordance with rules to be adopted by the SEC, whether the issuer hired a compensation consultant, and, if such consultant's work raised a conflict of interest, the nature of the conflict and how such conflict is being addressed. The SEC must adopt rules implementing these requirements within 360 days following the enactment of the Act.
Corporate Governance And Internal Control Provisions
Section 971 of the Act amends Section 14(a) of the Exchange Act to explicitly authorize the SEC to adopt rules requiring a company's proxy solicitation materials to include a nominee to the board of directors submitted by a shareholder. This provides the SEC with the authority to mandate that shareholders be provided "proxy access," which is expected to significantly lower the cost of nominating a director candidate to run against a nominee recommended by the company's board of directors. Many commentators believe the SEC will move quickly on this to enable proxy access to be in effect for the 2011 proxy season. However, the SEC is authorized to exempt an issuer or class of issuers from any proxy access rules, and in making this determination the SEC will take into account whether these rules would disproportionately burden small issuers.
Broker Discretionary Voting
Under Section 957 of the Act, the SEC must direct each national securities exchange to prohibit member brokers from voting customer shares on certain matters without receiving voting instructions from the beneficial owner. These matters include director elections, executive compensation and any other "significant matter" as determined by the SEC. Given that the New York Stock Exchange (NYSE) already prohibits discretionary voting on some of the matters covered by Section 957 (e.g., equity-based compensation plans and uncontested director elections), the most prominent change under this provision is to prevent discretionary voting on a Say-on-Pay proposal, which is currently permitted under NYSE rules.
SOX 404 Exemption for Non-Accelerated Filers
Section 989G of the Act provides that Section 404(b) of the Sarbanes-Oxley Act (auditor report on internal control over financial reporting) shall not apply to a company that is neither a "large accelerated filer" nor an "accelerated filer" (i.e., a company with a public float less than $75 million). This provision takes effect immediately. The SEC is also required to conduct a study and present its findings to Congress within nine months regarding how the SEC could reduce the burden of complying with Section 404(b) on companies with a market capitalization between $75 million and $250 million, while maintaining investor protection. Note that Section 989G does not make Section 404(a) inapplicable and, therefore, non-accelerated filers will still need to provide management's assessment of the effectiveness of internal control over financial reporting as of the end of the most recent fiscal year.
The Act imposes new disclosure and corporate governance requirements and significant new substantive and procedural executive compensation requirements, some of which will be applicable for the upcoming proxy season. However, many of the requirements imposed by the Act will be developed by final rules to be adopted by the SEC and the national securities exchanges. In the interim, companies should begin considering changes to their executive compensation and corporate governance practices that may be required or advisable, such as adoption of a clawback policy and employee hedging policy and consideration of the independence of compensation committee members and compensation consultants. In addition, companies should consider their current executive compensation policies in light of pending Say-on-Pay proposals and shareholder relations. Lastly, companies should plan on leaving additional time on their agenda for upcoming board and committee meetings to consider and implement the new SEC rules as they are adopted.
The information in this article is not intended to - and does not - create an attorney-client relationship. This article is not intended to provide legal advice, and readers should refrain from acting on information herein stated without seeking specific legal advice from individually qualified counsel. 1 See http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h4173enr.txt.pdf to access the final provisions of the Act.
2Note that this article is not meant to provide legal advice, a complete overview of the Act in general, or as it may apply to publicly held financial institutions.
Eric Schoenborn is a Partner and Chair of the firm's Publicly Held Companies Practice Group. He represents a broad range of companies in connection with capital raising transactions, mergers and acquisitions, securities law compliance and corporate governance matters. Lori Buchanan Goldman is an attorney in the firm's Publicly Held Companies Practice Group. She advises a broad range of clients with respect to securities regulatory compliance, public and private offerings of securities, public and private mergers and acquisitions, public financing and corporate organization and compliance.