The landscape of corporate governance could change drastically in the 2010 proxy season. The NYSE has already made changes to its broker discretionary voting rules.[1] The SEC has proposed rules addressing proxy access, executive compensation and corporate governance disclosures.[2] Congress also has one bill that was introduced in the Senate[3] and two bills in the U.S. House,[4] one of which has already passed and been sent to the Senate that deals with corporate governance topics.
In the next few months, companies should start thinking about how they will respond to these various proposals if they become law. Below is our top 10 list of what you can do now to begin preparing for the 2010 proxy season.
1. Assess Your Current Corporate Governance Profile
The proposed legislation is seeking to mandate a so-called “best practices” governance profile by making changes (1) to make majority voting mandatory in uncontested director elections; (2) to separate the positions of CEO and chairman of the board; and (3) to require companies to declassify their boards.
Companies should assess to what extent their profile measures up to the best practices profile, and consider what changes would need to be made in these areas if the legislation passes as proposed. Companies should also determine if they would like to make changes even if these practices do not become mandatory. All of them are favored by the institutional shareholder advisory firms, such as RiskMetrics.
2. Evaluate Your Current Leadership Structure
The SEC proposals seek to require proxy statement disclosures relating to the leadership structure of companies. In particular, each company would be required to explain why the leadership structure in place at the time of filing is best for the company, including why the principal executive officer and board chair positions are combined or separate. In addition, each company would be required to disclose whether it has a lead independent director and the role the lead independent director plays in the company’s leadership.
While no particular leadership structure is mandated by the SEC’s proposed disclosure rules, the simplest way to avoid making disclosures that may be negatively perceived is to adopt the implicitly recommended structure. Governance committees should begin discussing now what disclosures would be made in the 2010 proxy statement and whether any changes may be appropriate before the disclosures are required.
3. Review the Qualifications of Your Directors
The SEC proposals would also require expanded disclosure about incumbent directors and director nominees. The new disclosure would focus on the specific experience, skills and qualifications that qualify an individual to serve as a director for the company and on any committee. In addition, there would be longer look-back periods for disclosure of other directorships and legal proceedings.
Companies need to update and expand their diligence files on each director’s (and nominee’s) qualifications and experience. Companies should determine how this information should be gathered, i.e., expanded director and officer questionnaires, separate questionnaires, etc. Nominating committees should also start reviewing directors’ qualifications to serve on the board and on their committees, and consider whether it may be appropriate to make reassignments or provide additional training in areas of focus for committee members.
4. Examine the Independence of Your Compensation Committee Members
Under the proposed congressional legislation, all compensation committee members would need to meet independence requirements similar to those that apply to audit committee members. This means that compensation committee members would not be able to – other than in their capacity as a board member or committee member – accept any consulting, advisory or other compensatory fee from the company.
As applied to audit committees, the rule prohibits both direct and indirect payments, meaning that payments made by the company to the director’s firm, rather than to the director individually, may also be a disqualifier. If current members of a company’s compensation committee do not currently meet audit committee independence tests, the company should think about whether to make changes in the composition of the compensation committee, without regard to whether the bill ultimately becomes law.
5. Survey Services Provided by Compensation Advisers
The proposed SEC rules would require additional disclosures, if the compensation committee’s compensation consultants provide services to the company in addition to the compensation-related services provided to the committee. In addition, proposed legislation would direct the SEC to establish independence standards for compensation consultants or other similar advisers to the committee.
Compensation committees should review with management the full range of any services that the compensation committee’s consultants otherwise perform for the company. Management should provide a report describing those services and the fees for each service. The compensation committee should consider the appropriateness of using a consultant that performs other work for the company, and if so, what processes should be in place to approve and monitor those services to guard against conflicts of interest.
6. Develop Compensation-Related Risk Assessment Procedures
The proposed SEC rules would broaden the proxy statement Compensation Discussion and Analysis to require a risk management discussion, if the risks from compensation policies and practices have a “material effect” on the company. Compensation committees will have to undertake a review of compensation risk to determine the scope of the company’s disclosure obligations under these proposed rules. Compensation committees should plan now for a comprehensive risk analysis by the end of the year.
7. Prepare for Advisory Shareholder Votes on Compensation Structure
The pending legislation would require all publicly traded companies to hold an annual shareholders’ “say-on-pay” vote. The vote would be advisory only, and would not be binding on the company. The subject matter of the vote would be the compensation of the named executives as disclosed in the company’s proxy statement. Compensation committees may want to reach out now to some of the company’s largest shareholders to find out what their concerns are and what sort of response the shareholders are likely to give if presented with an advisory say-on-pay vote.
The company and the compensation committee should begin considering what should be included in the proxy and how the vote proposal should be phrased for inclusion in the proxy statement. The company should think about whether to submit an advisory say-on-pay resolution to shareholders in 2010, without regard to whether the bill ultimately becomes law.
8. Anticipate Other Governance-Related Shareholder Proposals
Even if the proposed SEC rules are not adopted, and the proposed federal legislation is not passed for the 2010 proxy season, companies may receive shareholder proposals on various aspects of corporate governance. Key corporate governance shareholder proposals from the 2009 proxy season include advisory vote on executive compensation, majority voting for uncontested director elections, requiring an independent board chairman and the repeal of classified boards. With the heightened focus of these areas, companies should think about how they would respond if they receive one of these shareholder proposals.
9. Know Your Shareholders
Companies should identify their largest and most active shareholders, and survey the nature of the shareholder base generally. Is it primarily institutions? Are there numerous holders of positions exceeding 1% of the outstanding shares? How many shares are held in individual accounts? What is the voting history of the company’s shareholders? Companies may want to reach out now to some of these shareholders to find out what their concerns are with respect to governance issues, and what sort of actions shareholders are likely to take in 2010 with respect to these issues.
Under the newly revised NYSE Rule 452, brokers no longer have the discretion to vote on the election of directors without instructions from their clients. Brokers still have the discretion to vote on “routine matters” such as the ratification of auditors. However, if a routine matter is not included in the proxy, brokers will not be considered present for quorum if they have not received voting instructions from their clients. If a quorum were not present, the annual meeting would have to be adjourned. Companies should survey whether their shareholders who hold in street name generally give voting instructions to their brokers. In addition, companies should include at least one routine matter in the proxy so that brokers will count toward quorum.
Companies should also reevaluate whether, or to what extent to use, the notice and access rules for proxy delivery. Would the number of shareholders who vote decrease if hard copy proxy materials were not mailed to them other than by special request? If decreased voting is likely to result, will it matter for items expected to be on the meeting agenda?
10. Start Early!
Revised NYSE Rule 452 applies to shareholder meetings held on or after Jan. 1, 2010, and it is anticipated that the proposed SEC rules and federal legislation will be in effect for the 2010 proxy season. New disclosures could require companies to discuss the manner in which governance topics were addressed in 2009. Such circumstances may make early action on the topics discussed above desirable.
McGuireWoods LLP assists clients in complying with their corporate governance and public reporting obligations, and we actively monitor developments relating to the issues discussed above. We are ready to assist you to comment on the proposed rules, and to assist you in preparing to respond to any changes in the area of corporate governance.
NOTES:
1. 34-60215 — SEC Order Approving Amended NYSE Rule 452.
2. 33-9046 — Facilitating Shareholder Director Nominations; 33-9052 — Proxy Disclosure and Solicitation Enhancements.
3. Shareholder Bill of Rights Act of 2009 introduced by Senator Schumer on May 19, 2009.
4. Shareholder Empowerment Act of 2009 introduced by Representative Peters on June 12, 2009; Corporate and Financial Institution Compensation Fairness Act of 2009 introduced by Representative Frank on July 21, 2009, passed by the U.S. House on July 31, 2009 and sent to the Senate on August 3, 2009 for approval.