The financial reform bill, formally known as the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” was passed by the House of Representatives on June 30, 2010, and is expected to be voted on by the Senate shortly. The act contains a number of new requirements that will significantly modify corporate governance and disclosure practices relating to executive compensation, and affect the design of compensation arrangements at public companies of all sizes (private companies are generally unaffected by these provisions). The following is a brief summary of those provisions.
Shareholder Resolution on Executive Compensation (Say-on-Pay)
The act requires a non-binding shareholder vote on executive compensation at least once every three years. Shareholders will vote on whether to approve the compensation of the company’s executives, as that compensation is disclosed in the proxy statement. In addition, shareholders will determine every six years, in a separate non-binding vote, whether the vote on whether to approve executive compensation should be held every one, two or three years. The shareholder vote will not be deemed to overrule any decision of the board or the company, to create or imply any additional fiduciary duties for the board, or to preclude shareholder proposals on compensation matters.
Effective Date: Applies beginning with the first annual meeting that occurs six months after the act is enacted. At that meeting, shareholders will be permitted to vote on executive compensation and vote on how frequently the say-on-pay vote should occur (i.e., every one, two or three years).
Shareholder Resolution on Golden Parachutes
The act requires disclosure of any compensation payments that are triggered by an acquisition, merger, or other extraordinary transaction (“golden parachute” payments). This disclosure must be included in the proxy statement for shareholder approval of the transaction. The vote on the golden parachute compensation must be separate from the vote on approval of the transaction. No vote is required for golden parachute arrangements that had been subject to a prior shareholder say-on-pay vote (as discussed above). As with say-on-pay, the vote on golden parachute payments will not be deemed to overrule any decision of the board or the company, to create or imply any additional fiduciary duties for the board, or to preclude shareholder proposals on compensation matters.
Effective Date: Applies beginning with shareholder meetings that occur six months after the act is enacted.
Independence of Compensation Committees and Compensation Committee Advisors
The act requires (through stock exchange listing standards) that the compensation committee of each listed company consist entirely of independent directors. Independence will be determined by considering factors such as the source of all compensation paid to a director, and any affiliation the director may have with the company.
The act also requires that the compensation committee have the authority to hire independent advisors (compensation consultants, legal counsel and other advisors). The compensation committee must consider the independence of any such outside advisor, applying independence factors to be identified by the SEC, which must be competitively neutral among categories of advisors. The compensation committee must be directly responsible for the appointment, compensation and oversight of any advisor that it retains under its discretionary authority to hire advisors, and the committee must be provided with access to funding to pay compensation for such advisors.
Effective for proxies filed for shareholder meetings held on or after the first anniversary of enactment, proxy statements must disclose whether the compensation committee retained a compensation consultant, and if the consultant’s work raised a conflict of interest issue, the nature of the conflict and how such conflict is being addressed.
The act directs the SEC to provide companies with an opportunity to cure any failure to comply with these rules that would result in delisting, and allows exemptions from independence requirements for certain categories of companies (such as smaller reporting companies) as the SEC determines appropriate.
Effective Date: The SEC must develop rules implementing these requirements within 360 days following enactment of the act.
New Compensation Disclosures in Proxy Statements (Pay vs. Performance and Internal Pay Equity)
Companies are required to disclose pay versus performance information in proxy statements for annual meetings, including the relationship between executive compensation actually paid and the financial performance of the company. This disclosure may be provided graphically. In addition, companies must disclose: (a) the median annual total compensation of all employees of the company, excluding the chief executive officer; (b) the annual total compensation of the chief executive officer; and (c) the ratio of the amounts in (a) and (b). For purposes of performing these calculations, “total compensation” is determined under the same rules as for determining total compensation shown in the Summary Compensation Table of the proxy statement.
Effective Date: These rules take effect upon enactment of the act, subject to the SEC adoption of implementing rules.
Clawback Policies Required
The act requires listed companies to develop and implement policies providing for: (a) disclosure of the company’s policy on incentive compensation based on reported financial information; and (b) recovery (“clawback”) from current or former executive officers of “erroneously awarded” incentive compensation in the event of an accounting restatement required due to material noncompliance with financial reporting requirements under the securities laws. For purposes of the clawback requirement, “erroneously awarded” compensation is the incentive compensation paid to an executive officer of the company during the three years preceding the restatement in excess of what would have been paid to the executive under the accounting restatement. The clawback applies to all executive officers, whether or not the officer engaged in misconduct. Companies that do not comply with these clawback requirements could be delisted.
Effective Date: These rules take effect upon enactment of the act, subject to the SEC adoption of implementing rules.
Disclosure of Hedging Arrangements
Companies are required to disclose in proxy statements for annual meetings whether any employee, director or designee may hedge ownership of the issuer’s equity securities through the purchase of financial instruments, such as prepaid variable formal contracts, equity swaps, collars and exchange funds. The disclosure applies to hedging by executives or directors with respect to company stock received as compensation or stock they otherwise hold directly or indirectly.
Effective Date: These rules take effect upon enactment of the act, subject to the SEC adoption of implementing rules.
Special Compensation Restrictions for Financial Institutions
Federal regulators are required to prescribe regulations to: (a) require enhanced disclosure of incentive-based compensation offered by covered financial institutions; and (b) prohibit incentive-based compensation that encourages inappropriate risks by providing compensation to employees, directors or principal shareholders that is excessive or could lead to material financial loss. “Covered financial institution” is broadly defined, includes public and private companies, and may be expanded by the federal regulators. Covered financial institutions with assets of less than $1 billion are exempt from these requirements.
Effective Date: The regulators must issue rules implementing these requirements within nine months following enactment of the act.
Broker Voting Restrictions and Disclosure by Institutional Investment Managers of Voting Actions
The act prohibits brokers from voting on proposals relating to election of directors, executive compensation (including the shareholder advisory votes described above), or any other “significant matter” (as determined by the SEC), unless they receive specific voting instructions from the beneficial owners of the securities to be voted. Institutional investment managers must report annually how they voted on say-on-pay and golden parachute resolutions.
Effective Date: The broker voting rule is effective on the date the act is enacted, subject to the national securities exchanges adopting implementing rules. The vote disclosure requirement for institutional investment managers is effective beginning with the first shareholder meeting of a company that occurs six months after the act is enacted.
Disclosure of Company’s Leadership Structure
The act requires that the annual proxy statement include a discussion of why the company has one individual serving as both CEO and chairman, or has separated those roles. Existing SEC proxy disclosure rules already contain a similar requirement.
Effective Date: The SEC must develop rules implementing this requirement within 180 days following enactment of the act.
More to Come
McGuireWoods will be hosting a teleconference within the next few weeks on other securities and corporate law aspects of new act, including the new executive compensation requirements. Please visit our events section for more information about the teleconference and for instructions as to how to register.