Congress has approved the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and President Obama has signed it into law.  While the Financial Reform Act primarily addresses financial regulation, it also contains significant new corporate governance, executive compensation and proxy voting provisions that affect all U.S. public companies.

This Update summarizes those provisions, and includes practical advice on steps companies can take in anticipation of the 2011 proxy season as well as a table with information on how and when each provision will become applicable.  Key provisions summarized in this Update include:

    • shareholder votes on executive compensation and golden parachutes;
    • new executive compensation disclosure—pay-versus-performance and internal pay ratio;
    • mandatory clawback of some incentive compensation;
    • disclosure of company policies on hedging of company securities by directors or employees;
    • elimination of discretionary voting by brokers on executive compensation and other matters;
    • new independence requirements and considerations for compensation committees and their advisors; and
    • shareholder access to proxy materials to nominate directors.

Executive Compensation

Say-on-Pay Shareholder Vote Effective in 2011.  Companies must conduct a nonbinding "say-on-pay" shareholder vote on compensation for named executive officers at least once every three years.  "Named executive officers" are those whose pay is required to be disclosed in the company's annual proxy statement, and typically include the CEO and CFO, as well as the three other most highly compensated executive officers.  In addition, at least once every six years, companies are required to conduct a nonbinding shareholder vote on whether the say-on-pay vote should be held every one, two or three years.  Companies must hold the initial vote on both say-on-pay and the frequency of say-on-pay votes at the first meeting of shareholders that occurs more than six months after the Financial Reform Act's enactment.

Practical Tip

Start Preparing Now for 2011 Proxy Season Say-on-Pay—and Stay Tuned.  Companies should gear up to include the say-on-pay and frequency of the vote resolutions in their next annual meeting proxy statements.  While no further rulemaking is required for this provision, the SEC may issue guidance on the required content of the say-on-pay resolutions, whether a preliminary proxy statement will be required and other technical issues.  Companies should stay tuned.

Golden Parachute Disclosure and Shareholder Vote.
  Beginning with shareholder meetings held more than six months after the Financial Reform Act's enactment, any proxy materials for which SEC rules already require compensation disclosure and that solicit shareholder approval for change-in-control transactions (such as an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all assets) must disclose:

    • any compensation arrangements with named executive officers that relate to the transaction; and
    • the aggregate total of this compensation for each executive, and the conditions upon which the compensation may be paid.

In addition to disclosing the golden parachute arrangements, the proxy materials must also include a separate nonbinding shareholder vote to approve the golden parachute arrangements, unless the arrangements have already been subject to a say-on-pay vote.

The SEC is authorized to exempt certain issuers, such as smaller reporting companies, from both the say-on-pay and golden parachute provisions of the Financial Reform Act.  Institutional investment managers must report annually on how they voted on say-on-pay and golden parachute resolutions.

Executive Pay-Versus-Performance.  Companies must provide in their annual meeting proxy statements a clear description of executive compensation, including the relationship between executive compensation actually paid and the financial performance of the company, taking into account any change in the value of the company's stock and dividends and any distributions.  Companies may present the information in graphical form.

Practical Tip

Watch for SEC Guidance on Pay-Versus-Performance.  The SEC will have to clarify the details of this disclosure, such as the time period it should cover and how this new graphical information will relate to the performance graph currently required in the annual report to shareholders.  Depending on the SEC rules, companies may want to present the new pay-versus-performance disclosure in an enhanced version of the performance graph.

Ratio of Employee Pay to CEO Pay.
  Annual meeting proxy statements must also provide:

    • the median of annual total compensation of all employees, except the CEO (or equivalent executive), as calculated for purposes of the proxy statement Summary Compensation Table;
    • the annual total compensation of the CEO (or equivalent executive); and
    • the ratio of the two amounts.

Practical Tip

Watch for SEC Guidance on Ratio of Employee Pay to CEO Pay Disclosure.  This provision may prove one of the most onerous in the Financial Reform Act, potentially requiring companies to track detailed compensation information for hundreds or thousands of employees.  Companies should wait to implement procedures for tracking employee compensation data until the SEC clarifies the disclosure required.

Mandatory Clawbacks.
  Companies listed on national securities exchanges must disclose their policies on incentive compensation that is based on the company's publicly reported financial information.  Listed companies must also adopt a policy requiring current or former executives to repay certain "erroneously awarded" incentive compensation if there is an accounting restatement triggered by material noncompliance with any financial reporting requirement under the securities laws.  Current or former executives who received incentive compensation during the three-year period preceding the date on which the company is required to prepare the restatement must pay back any incentive compensation in excess of what they would have been entitled to receive based on the restated financial information.

Clawback under the Financial Reform Act is different from the clawback required under Section 304 of the Sarbanes-Oxley Act in a number of ways.  For example, clawback under the Financial Reform Act applies to all current and former executive officers (not just the CEO and CFO), applies whether or not there is misconduct, and looks back three years rather than 12 months. 

Employee and Director Hedging Disclosure.  Companies must disclose in annual meeting proxy statements whether any employee or director (or such person's designees) is permitted to hedge against declines in the market value of company securities.  The disclosure includes securities granted as compensation and securities otherwise held by the director or employee.  Companies are currently required to disclose their policies on hedging by named executive officers (if material to the compensation of those officers), and this provision effectively expands the disclosure requirement to apply to directors and employees. 

Practical Tip

Consider Updating Insider Trading Policy Regarding Hedging.  Although not required, companies may want to clarify in their insider trading policies whether hedging is permitted by employees or directors.  As with most of the provisions of the Financial Reform Act, however, companies should wait until the SEC issues rules clarifying the hedging disclosure requirements before amending their policies.

Elimination of Discretionary Voting by Brokers on Executive Compensation Proposals. 
National securities exchanges must prohibit brokers from voting shares they do not beneficially own in connection with the election of directors, executive compensation proposals, and any other significant matter (as determined by the SEC) unless they receive specific voting instructions from the beneficial owners.  In addition, the Financial Reform Act authorizes securities exchanges to prohibit brokers from voting uninstructed shares with respect to other matters as well.  The current NYSE rules, as amended in 2009, prohibit discretionary broker voting in the election of directors and on equity-based compensation plans and certain other compensatory plans.  For more information, see our July 27, 2009 Update.  The Financial Reform Act expands this prohibition to all executive compensation matters, including say-on-pay proposals.

Practical Tip

Take Two Steps Now to Encourage Favorable Shareholder Votes on Say-on-Pay.  The elimination of discretionary broker voting on executive compensation matters will likely make it harder for companies to receive the votes necessary to pass their say-on-pay.  In light of these new provisions, companies should:

    1. Take a Fresh Look at CD&A.  The Compensation Discussion & Analysis needs to "make the case" to voters that these compensation practices are the right ones to enhance shareholder value.  Preparing plain-English, transparent disclosure that clearly describes compensation programs that reward executives for corporate performance will be crucial to avoiding an unfavorable say-on-pay shareholder vote.
    2. Do More Shareholder Outreach.  Companies should devote additional resources to shareholder outreach and proxy solicitation efforts to educate shareholders about their compensation programs. 

The Compensation Committee and Its Advisors

Compensation Committee Independence.  Compensation committees of listed companies must be comprised of only independent directors.  The national securities exchanges will need to issue rules defining the "independence" of compensation committee members, and will have the authority to exempt certain relationships from affecting a director's independence.  The Financial Reform Act requires that "independence" be based on multiple factors, including:

    • the source of a director's compensation, including any consulting, advisory or other compensatory fee paid by the company to the director; and
    • whether a director is affiliated with the company, the company's subsidiaries or the company's affiliates.

While the Financial Reform Act mandates that members of a compensation committee be independent, it does not appear to require listed companies to have a compensation committee.

Practical Tip

Monitor Impact of New Independence Definitions on Compensation Committee Membership.  The new independence requirement is not expected to significantly change the compensation committee landscape.  NYSE, NASDAQ and various tax and insider trading compliance rules already have independence standards applicable to compensation committee members (although NASDAQ, like the Financial Reform Act, does not require companies to create a compensation committee).  But companies should stay tuned to rulemaking by the SEC and the national securities exchanges to make sure that the members of their compensation committees meet the definitions of "independence" that are ultimately promulgated by the exchanges.

Selection and Funding of Compensation Committee Advisors.
  The Financial Reform Act explicitly empowers compensation committees to retain, appoint, compensate (at listed companies' expense) and oversee advisors, including compensation consultants and legal counsel.  In selecting their advisors, compensation committees must consider factors that may affect the advisors' independence, such as:

    • whether the advisor provides other services to the company;
    • the percentage of the advisor's total revenue received from the company;
    • the conflict-of-interest policies implemented by the advisor;
    • the existence of a business or personal relationship between the advisor and a member of the compensation committee; and
    • any company stock the advisor owns.
Practical Tip

Plan to Revisit Compensation Consultant Selection Procedures. Compensation committees will need to revisit their procedures for selecting advisors once the SEC and the national securities exchanges issue final rules to implement this provision.  Compensation committees are required to consider an advisor's independence, but may choose to engage nonindependent advisors.

Independence Information Regarding Compensation Consultants.
  In connection with annual meetings (or special meetings in lieu of annual meetings), companies will be required to disclose the following information in their proxy materials:

    • whether the compensation committee received advice from a compensation consultant;
    • whether the work of the compensation consultant raised any conflict of interest; and
    • if so, the nature of the conflict and how it was addressed.

This information supplements the substantial disclosure regarding compensation consultants that is already required in proxy statements.  For more information on these requirements, see our December 29, 2009 Update.

    • Exemptions.  The requirements described above regarding the independence of compensation committees do not apply to certain issuers, including
      • controlled companies—that is, listed companies where over 50% of the voting power to elect directors is held by a person, group or another company;
      • foreign private issuers that provide annual disclosure to shareholders of reasons why they do not have an independent compensation committee; and
      • companies that list only debt securities and not equity securities.

Controlled companies are also exempt from the provisions regarding the selection, funding and independence considerations of compensation committee advisors and the new disclosure regarding compensation consultants.  In addition, the exchanges are permitted to issue exemptions from these provisions for other categories of companies, such as smaller reporting companies, as the exchanges deem appropriate.

Disclosure of Chairman and CEO Structures

Annual meeting proxy statements must disclose why a company has chosen to have the same individual, or different individuals, serve as the company's CEO and Chairman of the Board.  Under existing proxy rules, companies are already required to disclose their reasons for adopting their board leadership structure, including whether to separate or combine the CEO and Chairman roles, so it is not clear if this directive will result in significant additional disclosure.

Shareholder Proxy Access

The Financial Reform Act gives the SEC authority to adopt rules providing shareholder access to companies' proxy statements to nominate directors.  It also directs the SEC to consider whether proxy access rules would disproportionately burden smaller companies and authorizes the SEC to exempt issuers or classes of issuers from any access rules the SEC ultimately adopts.  The SEC has the discretion to set thresholds for minimum shareholdings and holding periods.  The Senate version of the Financial Reform Act contained a five-percent minimum shareholding requirement and a minimum holding period of two years—thresholds rejected by the House.  The Financial Reform Act does not mandate proxy access, but addresses the concern raised by some that the SEC did not have authority to mandate proxy access.

Other Corporate Compliance Provisions

Removal of Auditor Attestation Regarding Internal Controls for Non-Accelerated Filers.  Section 404(b) of the Sarbanes-Oxley Act requires auditors of public companies to attest to the companies' assessment of internal control over financial reporting.  The SEC had delayed imposing this requirement on public companies with market capitalizations of less than $75 million (non-accelerated filers).  The Financial Reform Act now eliminates the auditor's attestation report for non-accelerated filers.  In addition, the SEC is tasked with studying ways to reduce the burden of Section 404(b) compliance on companies with market capitalizations between $75 million and $250 million.

Credit Rating Agency Exemption Eliminated From Regulation FD.  The SEC must revise the Regulation FD fair disclosure rules to remove the exemption for disclosures to credit rating agencies.  The revision does not require companies to publicly disclose information given to credit rating agencies—it merely seems to require that a credit rating agency agree to keep in confidence any material nonpublic information disclosed by a company.

Effectiveness and Timeline

As noted above, many of the Financial Reform Act's provisions require rulemaking either by the SEC, the national securities exchanges or both, and some provisions include deadlines for the promulgation of SEC rules.  The table below summarizes the actions needed to effect each of the provisions highlighted above, the deadline (if any) for those actions to be taken and any available exemptions.

Provision  Action Required  Deadline/Effectiveness  Exemptions 
Say-on-Pay Votes  No SEC rulemaking required for say-on-pay vote.  SEC rulemaking expected to enable voting on frequency of say-on-pay votes. Votes on say-on-pay and frequency of the say-on-pay vote required at the first shareholder meeting held six months following enactment. SEC may exempt an issuer or class of issuers, taking into account whether small issuers are disproportionately burdened.
Golden Parachute Disclosure & Vote SEC rulemaking required.

Disclosure and shareholder vote required at the first applicable shareholder meeting held six months following enactment (vote not required if already subject to a say-on-pay vote).

No deadline for SEC rulemaking.

SEC may exempt an issuer or class of issuers, taking into account whether small issuers are disproportionately burdened.
Disclosure of Pay-versus-Performance & Internal Pay Ratio SEC rulemaking required. No deadline for SEC rulemaking. None stated.
Clawback Policy SEC to direct national securities exchanges and national securities associations to issue listing rules. No deadline for rulemaking. None stated.
Hedging Disclosure SEC rulemaking required. No deadline for SEC rulemaking. None stated.
Limits on Discretionary Broker Voting National securities exchanges to issue implementing rules. None specified. Does not apply to uncontested elections of directors of registered investment companies.
Compensation Committee Independence SEC to direct national securities exchanges and national securities associations to issue rules for listing of equity securities.

SEC to direct exchanges and associations no later than 360 days following enactment.  (But see "Compensation Committee Advisors/Compensation Consultants Disclosure" below.) 

Listing rules must provide companies a reasonable opportunity to cure defects before delisting.

Controlled companies, limited partnerships, companies that only list debt securities, companies in bankruptcy proceedings, open-ended management investment companies registered under the Investment Company Act, and certain foreign private issuers are exempted.

Exchanges/associations may exempt certain relationships from affecting a director's independence, taking into consideration an issuer's size and other relevant factors.

Exchanges/associations may also exempt a category of issuers, taking into account the potential impact on smaller reporting issuers.
Compensation Committee Advisors/ Compensation Consultants Disclosure SEC to direct national securities exchanges and national securities associations to issue listing rules.

SEC to direct exchanges and associations no later than 360 days following enactment.  However, disclosure regarding compensation consultants must be included in proxy statements for meetings occurring one year following enactment.  Therefore, presumably the SEC must act in time for these disclosures to be made one year after enactment.

Listing rules must provide companies a reasonable opportunity to cure defects before delisting.

Controlled companies are exempted.

Exchanges/associations may exempt a category of issuers, taking into account the potential impact on smaller reporting issuers.

Enhanced disclosure of CEO/Chairman structures SEC rulemaking required. SEC to issue rules no later than 180 days following enactment. None stated.
Shareholder proxy access SEC rulemaking is required to implement proxy access.  The SEC is not required to act on proxy access, but is expected to do so. None specified. SEC may exempt an issuer or class of issuers, taking into account whether small issuers are disproportionately burdened.
Removal of auditor attestation requirement for internal control over financial reporting/reduction of SOX Section 404(b) compliance burdens

No SEC rulemaking required.

SEC directed to study ways of reducing burden of SOX Section 404(b) compliance for companies with market capitalizations between $75 million and $250 million.

SEC to provide SOX Section 404(b) compliance burden reduction study within nine months of enactment. Exemption for auditor attestation requirements applies only to non-accelerated filers.
Elimination of Regulation FD exemption for disclosures to credit rating agencies SEC rulemaking required. SEC to revise Regulation FD within 90 days of enactment. None stated.

Additional Information

This Update is only intended to provide a summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act.


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