Proxy Season 2011: Impact of the
By: RYAN C. BRAUER & SEAN M. NAGLE
February 23, 2011
As a new proxy season gets underway, public companies and their advisors should be aware that the Dodd-Frank Act includes a number of provisions that will impact executive compensation and corporate governance practices at all public companies and require additional shareholder proposals and revisions to the proxy statement this year for most public companies. This article summarizes the key issues for the upcoming proxy season, as well as other executive compensation and corporate governance matters to consider in the year ahead in anticipation of future Dodd-Frank Act rulemaking.
Say-On-Pay and Say-When-On-Pay
On January 25, 2011, the SEC adopted final rules implementing Section 951 of the Dodd-Frank Act, which requires a public company to provide for non-binding, advisory votes of the company’s shareholders on executive compensation, known as “say-on-pay,” “say-when-on-pay,” and “say on golden parachutes” votes. All public companies other than “smaller reporting companies” (those with less than $75 million in public float) must include say-on-pay and say-when-on-pay votes in proxy statements relating to the first annual shareholder meeting being held on or after January 21, 2011. In a notable change from the SEC’s proposed rules, smaller reporting companies are exempt from holding say-on-pay and say-when-on-pay votes until the first annual shareholder meeting being held on or after January 21, 2013. The say on golden parachutes vote will only need to be included in proxy statements filed on or after April 25, 2011, relating to shareholder meetings at which shareholders are asked to approve a business combination such as a merger or sale of substantially all assets.
Beginning with the first annual shareholder meeting held on or after January 21, 2011, (or January 21, 2013, for smaller reporting companies), and at least once every three years thereafter, proxy statements must include a non-binding, advisory resolution for shareholders to approve the compensation of executives as disclosed in the proxy statement under Item 402 of Regulation S-K. The SEC’s final rules do not prescribe specific language for the say-on-pay resolution; however, the rules do require that companies explain why the vote is being conducted and the general effect of the vote, including the fact that it is non-binding. In future proxy statements, companies must address in their Compensation Discussion and Analysis (CD&A) whether and, if so, how their compensation policies and decisions have taken into account the results of past say-on-pay votes.
Drafting Tips for 2011 Proxy Statement (for non-smaller reporting companies):
- Explain that the say-on-pay vote is not intended to address any specific item of compensation, but rather the overall compensation of your named executive officers and your compensation philosophy, policies and practices, as disclosed under the “Executive Compensation” section of the proxy statement.
- Be clear that, while you value the opinions of shareholders and intend to carefully consider the results of the say-on-pay vote, the final vote is advisory in nature and therefore not binding on your company, board of directors, or compensation committee.
- Where possible, use the CD&A or other narrative description of executive compensation to illustrate your use of “good” pay practices, such as those that link pay to performance.
Beginning with the first shareholder meeting held on or after January 21, 2011, (or January 21, 2013, for smaller reporting companies), and at least once every six years thereafter, proxy statements must include a non-binding, advisory resolution for shareholders to vote on whether the say-on-pay vote will occur every one, two, or three years. As with the say-on-pay vote, the SEC’s final rules do not prescribe specific language for the say-when-on-pay resolution, but the rules do require that companies explain why the vote is being conducted and the general effect of the vote, including the fact that it is non-binding. While it is expected that most companies will include a recommendation as to how shareholders should vote, it must be made clear in the proxy statement that the proxy card provides for four choices (every one, two, or three years, or abstain) and that shareholders are not voting to approve or disapprove the Board’s recommendation. Because proxy cards have historically provided for only three choices (for, against, or abstain), companies are encouraged to contact their proxy service providers to ensure that they can accommodate four choices. As with all shareholder votes, companies will be required to disclose the results of the say-when-on-pay vote on Form 8-K within four business days after the shareholder meeting. The final rules also require companies, within 150 calendar days after the shareholder meeting, to file an amended Form 8-K disclosing their decision regarding how frequently to conduct say-on-pay votes in light of the results of the say-when-on-pay vote.
Drafting Tips for 2011 Proxy Statement (for non-smaller reporting companies):
- Consider whether to recommend that the say-on-pay vote be held every one, two, or three years. To date, approximately 50% of companies filing proxy statements for 2011 annual meetings have recommended a triennial vote, 25% have recommended an annual vote, and the rest have been evenly split between recommending a biennial vote and making no recommendation. Note that ISS is recommending that shareholders vote for annual say-on-pay votes.
- Explain that the say-when-on-pay vote is not intended to approve or disapprove the Board’s recommendation, if any, but that you will consider the shareholders to have expressed a preference for the option that receives the most votes.
Additional Dodd-Frank Highlights
- Say On Golden Parachutes. Effective April 25, 2011, companies seeking shareholder approval of an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all assets must include in their proxy statements disclosure of any compensation arrangements between any of their named executive officers and any party to the transaction being voted on that are based on or otherwise related to the transaction. In addition, unless previously subjected to a say-on-pay vote, companies must include non-binding, advisory resolutions for shareholders to approve such golden parachute arrangements.
- Compensation Committees. The Dodd-Frank Act imposes additional requirements regarding compensation committee independence, independence of compensation committee advisors, and the retention and funding of compensation committee advisors. While the SEC has not yet issued proposed rules implementing these new requirements, companies are encouraged to review the independence of their current compensation committee members and advisors and to evaluate the independence of any potential compensation committee members and advisors. Once final rules have been adopted by the SEC, it is likely that companies will need to update their compensation committee charters to reflect the new requirements.
- Pay Versus Performance; Internal Pay Equity. The Dodd-Frank Act will require proxy statements for annual meetings to include new disclosure regarding (i) the relationship between executive compensation and the company’s financial performance; (ii) the median of total annual compensation of all employees, excluding the CEO; and (iii) the ratio of the median employee annual total compensation to the CEO’s annual total compensation. The SEC has not yet issued proposed rules implementing these new requirements so no new disclosure is required in this year’s proxy statement, but companies should now assess their ability to collect the data required to provide these internal pay equity disclosures. In particular, calculating the median of total annual compensation of all employees, excluding the CEO, may be extremely time consuming and companies should work with their human resources departments now to ensure appropriate systems are in place to collect and report this data.
- Insider Hedging. The Dodd-Frank Act requires the SEC to issue rules requiring public companies to disclose in their proxy statements whether directors and employees are permitted to purchase financial instruments designed to hedge against losses on their company equity securities, including any such equity securities granted as compensation. While proposed rules have not yet been issued by the SEC, companies should consider adding disclosure to their proxy statements regarding insider hedging.
- Clawbacks. The Dodd-Frank Act requires the SEC to issue rules directing the national securities exchanges to prohibit listing any company that fails to adopt a policy that provides for the recovery from any current or former executive officer of any incentive compensation that was paid during the three years preceding any accounting restatement due to material noncompliance with reporting requirements, to the extent it exceeds the compensation that would have been paid based on the restated financials. The SEC has not yet issued proposed rules regarding compensation clawbacks, but companies with existing clawback policies should review them for compliance with the Dodd-Frank Act requirements and those without policies should consider adopting one this year.
The Dodd-Frank Act imposes several new executive compensation and corporate governance requirements on all public companies. The items of immediate importance for the 2011 proxy season are the “say-on-pay” and “say-when-on-pay” votes (not applicable to smaller reporting companies until the 2013 proxy season). For more information on the impact of the Dodd-Frank Act, or to have us review language or provide further assistance with drafting the relevant sections of your 2011 proxy statement, please contact Fredrikson & Byron’s Securities Department.
In addition, we will continue to monitor SEC rulemaking under the Dodd-Frank Act and will keep you informed regarding future developments in areas such as compensation committee independence, pay for performance, internal pay equity, insider hedging and compensation clawbacks.