Corporate Governance and Executive Compensation Changes in Financial Reform Legislation
On July 15, 2010, the U.S. Congress approved the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act"). President Obama is now expected to sign the Act into law. The 2,300-page Act sets forth a variety of measures designed to stimulate job growth, enhance consumer protection, prevent another financial crisis, and end "too big to fail." The Act also includes a number of corporate governance and executive compensation provisions that apply to public companies generally, regardless of industry.
Below is a summary of the key corporate governance and executive compensation provisions:
Corporate Governance Provisions
- Independence Standards for Compensation Committees, Consultants, and Other Advisors.
- Committee Membership Independence — Section 952 directs the Securities Exchange Commission ("SEC") to issue rules requiring national securities exchanges and national securities associations to prohibit the listing of any security of a company that does not have an independent compensation committee. Similar to SEC audit committee requirements, companies will need to consider, for purposes of determining independence: (1) sources of compensation of a member, including any consulting, advisory, or other compensatory fees paid by the company to the member, and (2) whether the committee member is affiliated with the company and its subsidiaries. The SEC's rules must provide reasonable opportunity for a company to cure noncompliance with this requirement.
- Independence of Consultants/Advisors — This provision also grants compensation committees the authority to hire their own compensation consultants, legal counsel, or other advisors. The committee would be responsible for hiring, paying, and overseeing any consultants or advisors it retains. Before hiring an advisor, the committee must consider certain independence factors identified by the SEC, including: (1) the provision of other services to the company by the advisor, (2) the amount of fees paid by the company as a percentage of the advisor's total revenue, (3) the conflict-of-interest policies and procedures of the advisor, (4) any business or personal relationship of the advisor with a committee member, and (5) any company stock owned by the advisor.
- Consultant Disclosure — In any proxy or consent solicitation for an annual meeting, or special meeting in lieu thereof, a company must disclose whether its compensation committee retained a compensation consultant and whether the work raised any conflict of interest and, if so, the nature of the conflict and how it was addressed.
- Controlled Company Exemption — These provisions do not apply to controlled companies, which are companies listed on a national securities exchange or national securities association in which more than 50 percent of the voting power is held by an individual, a group, or another issuer.
The SEC must require national securities exchanges and national securities associations to adopt these standards within one year of enactment of the Act. The consultant disclosure requirements apply to shareholder meetings occurring on or after one year from enactment.
- Proxy Access to Nominate Directors. Section 971 enables, but does not require, the SEC to give shareholders an opportunity to include a shareholder director nominee in a company's proxy statement. It also gives the SEC authority to require companies to follow a certain procedure in relation to such a proxy solicitation. The provision does not set forth any specific ownership threshold requirements or holding periods.
This provision is effective immediately.
- Enhanced Disclosures of Chairman and CEO Structures. Section 972 requires the SEC to issue rules mandating companies to disclose in their annual proxy statements the reason(s) why the company has chosen either the same person, or different individuals, as applicable, to serve as the Chairman of the Board and Chief Executive Officer (CEO).
The SEC must issue rules within six months from the enactment of the Act. Notably, the SEC recently amended its proxy rules in December 2009 to require similar disclosure.
Executive Compensation Provisions
- Say on Pay. Section 951 gives shareholders a say on pay with the right to a non-binding vote on executive compensation. The say on pay vote shall occur at least once every three years. Shareholders must also be allowed to vote at least once every six years on whether the say on pay vote should occur every one, two, or three years.
This provision goes into effect six months after the enactment of the bill, and requires the proxy, consent, or authorization for the first annual or other shareholder meeting after the six month period to include the following two separate resolutions subject to shareholder vote: (1) whether executive compensation should be approved, and (2) whether future votes on pay will take place every one, two, or three years.
- Say on Golden Parachutes. Section 951 extends shareholders' right to say on pay by requiring a non-binding vote to approve payments, or "golden parachutes," to any named executive officers as a result of an acquisition, merger, consolidation, or other disposition of all or substantially all of the company's assets, unless previously approved by a say on pay vote. The provision also provides that whenever a company seeks shareholder approval of an acquisition, merger, consolidation, or sale of all or substantially all of the company's assets, the company must disclose in its proxy statement all compensation arrangements with named executive officers that relate to the transaction and the amount of compensation that may be paid to them.
As with the say on pay provision, this provision becomes effective for the first shareholders' meeting occurring six months after enactment of the Act.
- Enhanced Clawbacks. Section 954 directs the SEC to require national securities exchanges and national securities associations to prohibit the listing of any security of a company that does not develop and implement a policy providing (1) for disclosure of the company's clawback policy for incentive-based compensation, and (2) that, in the event the company is required to prepare an accounting restatement due to material noncompliance with financial reporting requirements, the company will recover executive incentive-based compensation paid to any current or former executive officer (including stock options awarded as compensation) during the three-year period preceding the date on which the company is required to prepare an accounting restatement in excess of what would have been paid to the officer under the accounting restatement. No misconduct is required to clawback pay.
No time frame is specified under this provision.
- Executive Compensation Disclosures. Section 953 directs the SEC to issue disclosure rules that require companies to show the relationship between executive compensation actually paid and the financial performance of the company. Companies must also disclose: (1) the median total annual compensation of all employees, except the CEO, (2) the annual total compensation of the CEO, and (3) the ratio comparing those two amounts.
No time frame is specified under this provision.
- Hedging Disclosure. Section 955 requires the SEC to adopt rules to require companies to disclose in their annual proxy statements or consent solicitation materials whether any employee or director is permitted to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds) designed to hedge or offset any decrease in market value of the company's equity securities granted as compensation or otherwise held directly or indirectly by such employee or director.
No time frame is specified under this provision.
- Broker Discretionary Voting. Section 957 requires national securities exchanges to prohibit broker discretionary voting in connection with the election of directors, executive compensation, or any other significant matter, as determined by the SEC, unless the beneficial owner provides voting instructions to the broker. NYSE already precludes brokers from voting on a discretionary basis on the election of directors and other non-routine matters, including the approval of equity-based compensation plans. This provision expands the prohibition to apply to executive compensation generally, including say on pay and cash plans.
The broker voting rule is effective immediately.
Additional Securities-Related Provisions
- Whistleblower Incentives and Protections. Section 922 provides substantial monetary awards for whistleblowers in any SEC enforcement action resulting in a sanction of more than $1 million with award amounts determined as a percentage of the SEC's recovery. It also grants whistleblowers a private right of action against employers that retaliate. The right of action enables whistleblowers to claim reinstatement, double back pay, and litigation costs and attorney’s fees.
The SEC must issue final regulations implementing these provisions within nine months after the date of enactment. Whistleblowers, however, can get bounties for information provided even before the SEC issues its regulations.
Over the coming months, many of the details and rules relating to these new corporate governance and executive compensation requirements will be promulgated by the SEC, securities exchanges, and other regulators. Companies will need to monitor these developments closely.
If you would like additional information about the matters covered in this publication, please contact our Securities/SEC Practice Group attorneys.