Legislative Update: Dodd-Frank Wall Street Reform & Consumer Protection Act

Legislative Update: Dodd-Frank Wall Street Reform & Consumer Protection Act

February 14 2012

PDF of Legislative Update

Background

  • Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “Act”)
    • Covers a wide-range of financial and regulatory reform initiatives
    • Includes significant corporate governance and executive compensation provisions applicable to all US public companies
  • Signed by President Obama July 21, 2010

Shareholder Votes

  • “Say on Pay” Vote
    • Shareholder approval of executive compensation
      • Resolution for shareholder to approve the compensation of executives disclosed in the proxy statement (vote does not include approval of Director compensation)
    • Not necessarily an annual vote
      • Shareholder vote required at least every three years
        • Permits companies time to respond to concerns and implement changes between votes
      • Every six years, shareholders to vote separately on desired frequency of Say on Pay Votes
        • Every one, two or three years or abstention from vote
      • Votes are non-binding
        • Negative votes will not change or overrule any decisions made by the Company or the Board of Directors
        • Meaning of a non-binding negative vote of any magnitude unclear
      • Votes are retrospective
      • Votes for both Say on Pay and vote frequency required for the first applicable shareholder meeting occurring six months after enactment (votes for smaller reporting companies required at first annual meeting on or after January 21, 2013)
  • “Say on Severance” Vote – Shareholder Approval of Golden Parachutes
    • Shareholder approval of transaction-related compensation
      • Shareholder approval of an acquisition, merger, sale, etc. must include a description of transaction-related compensation agreement or arrangement between the named executive officers and any party to the transaction
    • Detailed description of the golden parachute compensation
      • Description must include the total of all golden parachute compensation that may be paid or become payable to the named executive officer
      • Description must disclose individual elements of golden parachute compensation based on the proposed transaction in a table similar to the summary compensation table
      • Description must detail any conditions to payment, what triggers the payments, how the payments will be made and by which party
    • To be included in proxy or other consent solicitation materials for meetings at which shareholders are asked to approve proposed transaction
      • Vote need not be included if such agreements and understandings were previously subject to shareholder vote under a prior “Say on Pay” vote
    • Votes are non-binding
  • Institutional investment managers to disclose votes on such matters at least annually
    • Disclose votes on say-on-pay, frequency and say-on-severance
    • Timing of disclosure in proposed rules would be no later than August 31 of each year for the preceding 12-month period ending June 30
    • Proposed rules released October 2010, timing of adoption and implementation of final rules not specified
  • Implications of advisory votes
    • More engagement with shareholders
      • SEC interpretive guidance on Regulation FD helpful
        • Explicitly permits private discussions between directors and shareholders, provided that material non-public information is not disclosed, or shareholders expressly agree to maintain any such information in confidence (SEC C&DI 101.11)
    • Power of voting advisory services significantly increased
      • Particularly in light of the fact that brokers unable to vote un-instructed shares on executive compensation issues
    • Clear, transparent and proactive disclosure required about compensation programs
      • CD&A dominant vehicle for such communication, but not the sole voice

New Pay Disclosure in Proxy

  • Pay versus Performance
    • Each company to provide information regarding the relationship between executive compensation actually paid and the financial performance of the Company, taking into account any change in the value of the shares of stock and dividends of the Company and any distributions
    • Disclosure may be in graphic or narrative form
    • Questions still remain regarding implementation
      • Definition of corporate performance and compensation pay elements
      • Disclosure on an aggregate, average or per executive basis
      • Time period
    • May be finalized in time to apply to the 2013 proxy season
      • The proposed rules are scheduled to be released prior to July 2012 and finalized prior to December 2012
  • CEO Pay Ratio
    • Companies must disclose the ratio of (i) the median total compensation of all employees of the issuer (except the CEO) and (ii) the annual total compensation of the CEO
      • Total compensation to be determined in same manner as for the summary compensation table
    • Questions still remain regarding implementation
      • Inclusion of overseas and/or part-time workforce
    • May be finalized in time to apply to the 2013 proxy season
      • The proposed rules are scheduled to be released prior to July 2012 and finalized prior to December 2012
  • Clawback of incentive-based compensation
    • Each company to develop, implement and disclose a clawback policy providing for
      • Recovery of any incentive-based compensation (including stock options awarded as compensation) if an accounting restatement is required due to material noncompliance with any financial reporting requirements
      • Recovery from current and former executives any incentive compensation paid in the three-year period before the accounting restatement that is in excess of what would have been paid based upon restated financials
      • There is currently no “bad actor” requirement for the clawback to be triggered
    • Questions still remain regarding implementation
      • Application where incentive compensation is not clearly tied to a specific performance requirement and/or incorporates formulaic and discretionary components
    • May be finalized in time to apply to the 2013 proxy season
      • The proposed rules are scheduled to be released prior to July 2012 and finalized prior to December 2012
  • Hedging
    • Must disclose whether any employee or Director is permitted to purchase financial instruments that are designed to hedge or offset any decrease in the market value of securities
      • Applies to securities
        • Granted as compensation, or
        • Held, either directly or indirectly
    • May be finalized in time to apply to the 2013 proxy season
      • The proposed rules are scheduled to be released prior to July 2012 and finalized prior to December 2012
  • Disclosure regarding Chairman and CEO structures
    • Companies must disclose reasons why they have chosen
      • The same person to serve as Chairman of the Board and CEO, or
      • Different individuals to serve as Chairman of the Board and CEO
    • Similar to existing proxy disclosure requirement adopted in 2010; unlikely the SEC will take further action

Independence Issues

  • Compensation Committee
    • Exchange listing standards to require Compensation Committee member independence
    • Minimum level of independence of Compensation Committee member to be specified by each exchange, to include
      • Source of the Director’s compensation (including consulting, advisory and other fees), and
      • Whether the Director is affiliated with the Company, a subsidiary or an affiliate of the Company
    • Independence standards will not apply to controlled companies, limited partnerships, foreign private issuers, companies in bankruptcy and open-end management investment companies
    • Companies will need to ensure that the Compensation Committee members meet the independence requirements established by their respective exchange
    • Unlikely be finalized in time to apply to the 2012 proxy season
      • The proposed rules were released March 30, 2011 with final rules expected between January and June 2012.  Exchange listing standards to be submitted for SEC approval within 90 days after SEC rules finalized
  • Advisors
    • Compensation Committee must have the sole authority to retain or obtain advice of compensation consultants, independent legal counsel and other advisers
    • Exchange listing standards to require disclosure relating to the use of, and conflicts of interests of, compensation consultants
    • Consultants need not be independent.  However, selection may only be completed after the Committee considers factors that may affect the advisor’s independence, including
      • Provision of other services to the Company
      • The amount of fees received by the advisor as a percentage of advisory firm total revenues
      • Policies and procedures of the advisor that are designed to prevent conflicts of interest
      • Business or personal relationships of advisor with members of the Compensation Committee
      • Any Company stock owned by the advisor
    • Unlikely be finalized in time to apply to the 2012 proxy season
      • The proposed rules were released March 30, 2011 with final rules expected between January and June 2012.  Exchange listing standards to be submitted for SEC approval within 90 days after SEC rules finalized
  • Compensation Committee authority relating to compensation consultants
    • Committee may, in its sole discretion, retain or obtain the advice of a compensation consultant
    • Committee shall be directly responsible for the appointment, compensation and oversight of the work of a compensation consultant
    • Company must disclose whether
      • The Committee retained or obtained the advice of a compensation consultant
      • Whether or not the work raised any conflict of interest and if so, the nature of the conflict and how the conflict was addressed
    • Company must provide adequate funding as determined by the Compensation Committee for the payment of reasonable compensation to a compensation consultant
    • Similar provisions apply to other independent advisors, including independent legal counsel
    • Unlikely be finalized in time to apply to the 2012 proxy season
      • The proposed rules were released March 30, 2011 with final rules expected between January and June 2012.  Exchange listing standards to be submitted for SEC approval within 90 days after SEC rules finalized

Other Governance Provisions

  • Proxy access
    • Companies must permit shareholder proposals that either request that the board implement proxy access of that bypass the board and directly amend the Company’s bylaws to implement proxy access
      • SEC attempted to require companies to grant proxy access, however, this rule was vacated by the U.S. Court of Appeals for the D.C. circuit
    • Proxy access increases the potential for contested Director elections
    • Considerations regarding implementation
      • Companies may want to consider proactively adopting their own proxy access standards rather than waiting for an activist shareholder proposal.  If the Company’s proposal is subject to shareholder approval, then the Company is permitted to exclude any conflicting shareholder proposals from the proxy statement
    • Applicable to the 2012 proxy season
  • Broker voting
    • Brokers may no longer vote un-instructed shares on matters related to
      • Director elections
      • Executive compensation
    • NYSE and NASDAQ amended rules to prohibit brokers from voting uninstructed shares on executive compensation matters

Enhanced Compensation Structure Reporting for Covered Financial Institutions

  • SEC-regulated financial institutions (including broker-dealers and investment advisers with $1 billion or more in assets) required to disclose to appropriate Federal regulator the structures of all incentive-based compensation arrangements offered by the institution to determine whether the structure
    • Provides an executive officer, employee, director, or principal shareholder of the covered financial institution with excessive compensation, fees or benefits
    • Could encourage excessive risk-taking and lead to material financial loss to the covered financial institution
  • Proposed rules would
    • Require annual filings with the SEC related to incentive-based compensation
    • Prohibit incentive-based compensation which encourages excessive risk taking or could lead to material loss to the financial institution
    • Provide additional requirements for financial institution with $50 billion or more in assets, including deferral of incentive-based compensation
    • Require financial institutions to develop policies and procedures that ensure and monitor compliance with requirements related to incentive-based compensation
  • Appropriate Federal regulators jointly proposed rules March 2, 2011 with final rules expected between January and June 2012