The Financial Reform Act: SEC Issues Proposed Say-on-Pay Rules
The SEC recently issued proposed rules to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that mandate shareholder advisory votes on executive compensation (the say-on-pay vote), on the frequency of the say-on-pay vote, and on golden parachute compensation arrangements, as well as related disclosure requirements.
The comment period for the proposed rules ends on November 18, 2010. Because the Financial Reform Act requires companies to comply with the say-on-pay and say-on-frequency provisions for meetings of shareholders occurring on or after January 21, 2011, whether or not the SEC issues final rules by that date, the SEC is expected to push for adoption of final rules as soon as possible after the comment period expires. Because SEC rulemaking is required with respect to the requirements for golden parachute arrangements, the say-on-golden parachute vote and related disclosure will not be required for merger proxy statements until the implementing rules become effective.
This Update summarizes the key aspects of the proposed rules and provides practical advice on steps companies can take in anticipation of the upcoming proxy season.
Summary of the Proposed Rules
Say-on-Pay. The SEC's proposal would require companies to provide shareholders a nonbinding say-on-pay vote to approve the compensation of executives, as disclosed pursuant to Item 402 of Regulation S-K, and to disclose in the compensation discussion and analysis (CD&A) section of future proxy statements whether, and if so, how, their compensation policies and decisions have taken into account the results of previous say-on-pay votes on executive compensation.
Say-on-Frequency. The SEC's proposal would require companies to provide shareholders a nonbinding say-on-frequency vote as to the frequency of the say-on-pay vote, providing shareholders with four options on the proxy card (whether to hold a say-on-pay vote every one, two, or three years, or to abstain from voting on the proposal). Companies would then need to disclose in the quarterly report on Form 10-Q covering the period in which the advisory vote occurs (or the annual report on Form 10‑K if the vote occurs during the fourth quarter) their decisions as to how frequently they will conduct the say-on-pay vote in light of the voting results on the say-on-frequency vote.
Say-on-Golden Parachute Arrangements. The SEC's proposal would require companies to include disclosure regarding certain golden parachute arrangements in a proxy or consent solicitation seeking shareholder approval of a merger or similar significant corporate transaction. Additionally, companies would be required to provide a shareholder advisory vote on certain golden parachute arrangements unless those arrangements were previously subject to a say-on-pay vote.
Who Needs Final Rules? The Financial Reform Act requires separate resolutions for say-on-pay votes and say-on-frequency votes for proxy statements relating to a company's first annual or other meeting of shareholders occurring on or after January 21, 2011, whether or not the SEC has adopted final rules. Companies should therefore plan to rely on the proposed rules to draft the proposals and related disclosures, and stay tuned for final SEC rules or additional guidance. However, the SEC did provide some relief for companies that are required to comply with say-on-pay and say-on-frequency before the SEC's rules are final:
- No Preliminary Proxy Required. The SEC will not object if preliminary proxy materials are not filed, as would be required under current rules, so long as the only matters that would require such a filing are the say-on-pay and say-on-frequency votes.
- Flexibility on Proxy Card for Say-on-Frequency Vote. The proxy card, which under the proposed rules must provide for four alternatives (to hold a say-on-pay vote every one, two, or three years, or abstain from voting on the say-on-frequency proposal), may instead provide for only three alternatives (to hold a say-on-pay vote every one, two or three years) if a proxy service provider has difficulty programming its system to provide four alternatives, and in the event no choice is selected from the three alternatives, the proxies would be considered to have abstained from voting on the proposal.
Under the proposed rules and in accordance with the Financial Reform Act, companies would be required to provide shareholders a non-binding say-on-pay vote to approve the compensation of the named executive officers as such compensation is disclosed in Item 402 of Regulation S-K, including:
- The CD&A;
- The compensation tables; and
- The other narrative disclosures required by Item 402.
A more limited scope for this vote, such as a vote on compensation policies and procedures only, would not satisfy the requirements under the proposed rules.
Look to Voluntary and TARP Say-on-Pay Disclosures for Examples. Much like the final say-on-pay rules for recipients under the Troubled Asset Relief Program (TARP), the SEC's proposed rules do not require any specific language for the say-on-pay vote so long as the approval covers the compensation disclosures required by Item 402. Therefore, before final rules are issued (and even after that if the final rules do not provide further guidance), the proxy statements of TARP recipients and certain of the voluntary say-on-pay filers may provide useful precedents for drafting the say-on-pay proposal.
What Is Not Subject to the Say-on-Pay Vote? Disclosures relating to director compensation or disclosures under Item 402(s) of Regulation S-K relating to risk considerations as part of a company's general compensation policies for employees generally are not subject to the shareholder advisory vote. However, to the extent risk considerations are a material aspect of the company's compensation policies for named executive officers, the company is required to discuss them in its CD&A, and this disclosure would be included in the say-on-pay vote. For smaller reporting companies, the advisory vote would only need to cover the compensation of the named executive officers as disclosed under Items 402(m) through 402(q) of Regulation S-K (and smaller reporting companies are still not required to include a CD&A in their proxy statements).
Additional Say-on-Pay Proxy Statement Disclosures. The SEC's proposal would also require the following disclosures relating to the separate shareholder advisory say-on-pay vote:
- The Say-on-Pay Vote. Companies must disclose in their proxy statements that they are providing a separate say-on-pay shareholder vote and briefly explain the general effect of the vote (i.e., the nonbinding nature of the vote).
- Future CD&A Disclosure. Companies must disclose in the CD&A how their compensation policies and decisions have taken into account the results of previous say-on-pay votes on executive compensation, including whether they have considered the results of previous say-on-pay votes in determining compensation policies and decisions and, if so, how it has affected these policies and decisions. This would not be required for smaller reporting companies that are not currently required to include a CD&A in their proxy statements.
Under the proposed rules and in accordance with the Financial Reform Act, companies would be required to provide a separate shareholder advisory vote in their proxy statements for annual meetings (or other meetings of shareholders for which the rules require compensation disclosure), beginning with meetings occurring on or after January 21, 2011, to determine whether the say-on-pay vote will occur every one, two or three years. Companies would be required to provide this separate shareholder advisory vote not less frequently than once every six years. The SEC views the say-on-frequency vote as nonbinding.
The SEC did not propose specific language for the proposal but would require the following:
- Companies must disclose in their proxy statements that they are providing a separate say-on-frequency shareholder vote and briefly explain the general effect of the vote (i.e., the nonbinding nature of the vote).
- The proxy card must provide shareholders with four alternatives: to choose one of the alternatives for the frequency of the say-on-pay vote (every one, two or three years), or to abstain from voting on the say-on-frequency proposal.
- Although the SEC notes that it would expect that boards of directors will include a recommendation as to how shareholders should vote on the say-on-frequency proposal, it says that companies must make clear that the proxy card will provide for four choices (to choose a frequency of every one, two or three years, or to abstain), and that shareholders are not voting to approve or disapprove the recommendation of the board of directors.
Voting Standard for Say-on-Frequency Vote. The SEC notes in its proposing release that it believes that it is not necessary for companies to prescribe a voting standard for determining which option has been "adopted" or "approved" by shareholders as a matter of state corporate law since the say-on-frequency vote is advisory and therefore not binding on the company or its board of directors.
Mind Your Qs and Ks—Reporting on Say-on-Pay and Say-on-Frequency Votes. Currently, companies are required to disclose vote results on a current report on Form 8-K following the shareholder meeting. The SEC's proposal would require companies to make an additional disclosure in their quarterly reports on Form 10-Q covering the period during which the shareholder advisory vote occurs, or their annual reports on Form 10-K if the advisory vote occurs during the fourth quarter, stating their decision on how frequently they will conduct shareholder say-on-pay votes in light of the results of their shareholder say-on-frequency votes.
Plan, Plan, Plan. Companies should have an action plan in place, since they will need to act quickly and disclose, in their next periodic report following the annual meeting, their decision on how frequently they will conduct say-on-pay votes going forward. Issues to consider include:
- How will the company make a decision and implement it? Will the company need board approval, or will the board delegate authority?
- Will the company need to reach out to advisors on the decision and its implementation?
- Will the company's disclosure controls and procedures need to be revised to account for the company's required action and disclosure under these proposed rules?
- Will disclosure schedules need to be adjusted to comply with the timing of this disclosure?
May Companies Exclude Related Shareholder Proposals? The SEC proposes to add a note to Rule 14a-8 clarifying that shareholder proposals on executive compensation and the frequency of votes on executive compensation could be excludable from a company's proxy statement as "substantially implemented" if the company has adopted a policy on the frequency of say-on-pay votes that is consistent with the result from the plurality of votes cast in the most recent say-on-frequency vote.
Preliminary Proxy Statements
The SEC proposes to amend Rule 14a-6(a) to add shareholder say-on-pay and say-on-frequency votes to the list of matters that would not trigger a preliminary proxy statement filing requirement. In the SEC's view, since the votes are required of all issuers, a preliminary filing requirement would impose unnecessary burdens and costs related to proxy materials that would be unlikely to be selected for review.
Until the SEC issues final rules, issuers would normally be required under the current proxy rules to file preliminary proxy materials that include say-on-pay and say-on-frequency proposals. To relieve issuers from this requirement, the SEC has stated in its proposal that it will not object if companies do not file proxy materials in preliminary form if the only matters that would require such a preliminary filing are the say-on-pay vote and the say-on-frequency vote.
TARP Recipients Excluded
The SEC's proposal would exempt companies with outstanding indebtedness under the Troubled Asset Relief Program, or TARP, from the proposed rules on shareholder say-on-pay and say-on-frequency votes until the company has repaid all outstanding indebtedness under TARP. Currently, TARP recipients are required to submit votes on executive compensation to shareholders on an annual basis, and therefore the SEC believes the additional say-on-pay and say-on-frequency votes would be overly burdensome and have little benefit to the TARP recipient or its shareholders.
Golden Parachute Compensation Arrangements
In accordance with the Financial Reform Act, the SEC proposes to add a new Item 402(t) to Regulation S-K pursuant to which companies would provide, in a proxy or consent solicitation seeking shareholder approval of a merger or similar transaction, disclosure of any agreement or understanding (written or unwritten) that the soliciting target company has with its own named executive officers (or with the named executive officers of the acquiring company) concerning any type of compensation (current, deferred or contingent) that is based on or otherwise relates to the transaction. Item 402(t) would also require disclosure of golden parachute arrangements between the named executive officers of the soliciting target company and the acquiring company (although these arrangements would not be subject to the advisory vote discussed below). The proposed rules also would require companies to provide a shareholder advisory vote on certain golden parachute arrangements, unless those arrangements were subject to a prior say-on-pay vote.
Golden Parachute Disclosure. The SEC explained that current Item 402(j) of Regulation S-K, which requires disclosure regarding potential payments upon termination of employment or in connection with a change in control, does not sufficiently comply with the requirements of the Financial Reform Act with respect to its mandated golden parachute disclosure, including because the Item 402(j) disclosure is not required to be in tabular format and because it permits certain exclusions. Therefore, the SEC proposes that companies be required to include both tabular and narrative disclosures in a proxy or consent solicitation seeking shareholder approval of a merger or similar transaction with respect to any golden parachute arrangements.
- Tabular Disclosure. In order to provide disclosure "in a clear and simple form," the SEC proposes that the golden parachute compensation be in a tabular format, utilizing the following categories for its columns (with the aggregate dollar amount for each category):
- Cash severance;
- Equity awards that are accelerated or cashed out;
- Pension and nonqualified deferred compensation benefit enhancements;
- Perquisites and other personal benefits and health and welfare benefits;
- Tax reimbursements, such as 280G tax gross-ups;
- Other items not covered in the other columns; and
- The total of all compensation reported in the table for each named executive officer.
Each separate form of compensation reported in any column would be required to be identified in a footnote. Additionally, amounts attributable to "single-trigger" and "double-trigger" arrangements would be required to be separately identified by footnote.
- Narrative Disclosure. Proposed new Item 402(t) of Regulation S-K would require a description of any material conditions applicable to the receipt of golden parachute payments, including non-compete and non-solicitation agreements. Companies would also have to describe the particular triggers for the payments, whether the payments would be lump sum payments, or annual payments, the duration of the payments, and by whom the payments would be provided.
- Golden Parachute Disclosure in Other SEC Filings. The proposed rules would amend the disclosure requirements for other SEC filings that do not involve a proxy or consent solicitation so that comparable golden parachute disclosure would be included for other, similar transactions, including in registration statements on Forms S-4 and F-4 containing disclosure relating to mergers and similar transactions, Schedule 13E-3 filings for going-private transactions, and Schedule TO filings for third party tender offers.
Advisory Vote on Golden Parachutes. Under the proposed rules and in accordance with the Financial Reform Act, companies would be required to provide a nonbinding shareholder vote on golden parachute compensation arrangements in connection with mergers and similar transactions (except where the arrangement is between the acquiring issuer and the named executive officers of the target issuer, unless the acquiring issuer is soliciting proxies to approve the transaction). Like the say-on-pay and say-on-frequency votes, the proposed rules do not require any specific language or form of resolution to be voted on by shareholders.
Include Golden Parachute Arrangement Disclosure With Annual Say-on-Pay Vote. Under the SEC's proposal, the advisory vote on golden parachute arrangements would not be required if the compensation in question had been included in compensation disclosure that was subject to a prior say-on-pay vote. This exception would only be available if the compensation disclosure subject to the prior say-on-pay vote included the Item 402(t) disclosure of these golden parachute arrangements. As a result, companies may consider voluntarily including the Item 402(t) golden parachute arrangement disclosure with their other executive compensation disclosure in annual meeting proxy statements and including that disclosure in the annual say-on-pay vote described above so that this exception would be available for potential mergers or similar transactions that might occur during the year.
What About New Golden Parachute Arrangements? With respect to new golden parachute arrangements, or revisions to arrangements that were subject to a previous say-on-pay vote, only the new arrangements or revisions would be subject to a new advisory vote. Item 402(t) would then require companies to include two tables (one for the original golden parachute arrangements and one for the new or amended golden parachute arrangements) to allow for a comparison of the new or revised arrangements against the arrangements that were previously subject to a say-on-pay vote.
This Update is intended to provide only a summary of the proposed rules. You can find a copy of the full text of the SEC's proposed rules release at: http://www.sec.gov/rules/proposed/2010/33-9153.pdf. You can find discussions of other recent cases, laws, regulations and rule proposals of interest to public companies on our website
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