￭ Change in balance of state vs. federal regulation of governance
￭ Internal affairs of corporation -- including corporate governance matters – traditionally governed by state law : law of state of incorporation
￭ The Dodd-Frank Act mandates governance structures / practices in areas traditionally regulated only by state law (substantive role of shareholders in nomination process, shareholder voting powers)
 Change in balance of board and shareholder power
 But Dodd-Frank Act does not alter or eliminate the protections traditionally provided to directors by the business judgment rule
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￭ Post-crisis environment highly distrustful of corporate boards and executives
￭ Ripe for mandated governance reforms, not private ordering
￭ Some proposed reform mandates rejected by Congress
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Mandatory majority voting for directors
(N.B. – 71% of S&P 500 already have it)
Limits on executive compensation
Mandatory board risk committees for non-financial companies
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￭ Focus: Restructuring regulatory framework for U.S. financial system
￭ Also includes provisions that will affect governance of all U.S. public companies, regardless of industry, including:
￭ SEC authority for proxy access
￭ Mandated shareholder advisory votes on certain compensation matters
￭ New limits on broker discretionary voting
￭ New compensation disclosures and compensation committee and adviser independence requirements
￭ Most require further rulemaking by SEC / securities exchanges
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￭ SOX (and related SEC and stock exchange listing rules) adopted in wake of accounting scandals
￭ Reflects view that empowered independent directors – particularly independent audit committees – are solution to problem of management accountability
￭ Dodd-Frank (and related SEC and stock exchange listing rules) adopted in wake of financial crisis
￭ Reflects view that empowered shareholders are solution to problem of board accountability
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￭ Increase in shareholder power to influence board composition and executive pay
￭ Increase in power of proxy advisers who advise institutional shareholders on how to vote – or to whom such shareholders delegate vote decisions
￭ More pressure on boards to accede to wishes of most vocal shareholders – including pressure to conform to rigid ideas about governance and compensation practices
￭ Expect the 2011 proxy season to be unprecedented in range of matters on which boards will need to elicit shareholder support
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￭ In new environment, critical need for boards to engage with key shareholders
￭ Board & management need to assess how new Dodd-Frank requirements will likely impact shareholder relations
-- Keep current on implementation rules as they develop
-- Consider whether to comment on proposed rules
￭ Consider How to Position for Increased Engagement
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￭ Culture, Attitude & Information
￭ Key Shareholders
￭ Capacity for Shareholder Outreach
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￭ Board Involvement
￭ Governance Community Involvement
￭ Proxy Advisers
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￭ Review director nomination process (including advance notice bylaws)
￭ Review compensation programs and disclosures, and adjust where necessary
￭ Determine whether to recommend say-on-pay on 1, 2 or 3 year basis, but only as permitted under the SEC’s proposed implementing rules
￭ Review independence of Compensation Committee members and advisers
￭ Review / revise Compensation Committee charter (as to independence of members, authority over advisers and independence of advisers)
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￭ Dodd-Frank gave SEC express discretionary authority to adopt proxy access rules.
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On August 25, SEC adopted rule giving mandatory proxy access to shareholders/ group meeting 3%, 3-year holding period criteria for nominations up to 25% of board; no control purpose or effect (Rule 14a-11)
SEC also amended Rule 14a-8(i)(8) to enable shareholders to bring proposals to amend by-laws re procedures for including shareholder nominees in company proxy statement
￭ Would have become effective in mid-November, but on October 4, SEC stayed effectiveness of both until resolution of court challenge (petition of
BRT/U.S. Chamber of Commerce filed in U.S. Court of Appeals for the
D.C. Circuit)
￭ Resolution unlikely until late spring, despite expedited briefing schedule
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SEC issued proposed implementing rules on October 18, 2010 (SEC Rel. No.
33-9153); public comment period ends November 18, 2010. Statutory obligations go into effect on January 21, 2011, even if SEC rules haven’t been adopted (but expect adoption before the end of 2010).
Say-on-Pay
￭ Companies must seek non-binding shareholder vote on compensation package of their named executive officers (“NEOs”) beginning at first meeting held on/after January 21,
2011, as disclosed in company proxy statements for election of directors (where such disclosure generally appears). No exceptions proposed for smaller companies
Say-When-on-Pay
￭ In year one, companies must seek nonbinding shareholder vote on whether “say-onpay” votes should occur every one, two or three years – shareholders have four choices – 1, 2 or 3 years, or abstain.
￭ Additional votes must occur no less than every six years
Puts even greater pressure on boards to consider shareholder views in compensation
￭ Greater potential for campaigns against Compensation Committee members
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Votes would be non-binding, but the company would have to disclose in next year’s CD&A whether and, if so, how, it has “considered” the prior year’s say-onpay and say-when-on-pay votes. Disclosure also required, in the periodic report for the period in which the vote is taken (e.g., Form 10-Q or 10-K, for 4 th quarter votes), what the company intends to do in light of the frequency vote. There are benefits to adopting a policy that is consistent with shareholders’ vote on frequency.
If a company adopts shareholders’ frequency vote as policy – for example, if shareholders approve an annual say-on-pay vote by a plurality, and the company thereafter adopts a policy that advisory say-on-pay votes will be conducted every year -- the SEC staff will permit the company to exclude shareholder proposals relating both/either to “say-on-pay” and/or “say-when-on-pay” under the Rule
14a8(i)(10) exclusion (i.e., the company has “substantially implemented” what the shareholder has proposed) – even if his or her proposal is binding rather than advisory.
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Proposal included in SEC Rel. No. 33-9153. In connection with any shareholder vote to approve an acquisition, merger or other extraordinary transaction at a meeting on or after
January 21, 2011, each person soliciting votes on such a transaction must: (1) disclose any agreements or understandings with senior executive officers (NEOs) regarding any compensation relating to the transaction, along with the total amount; and (2) hold a separate, non-binding shareholder vote on any such agreement or understanding.
SEC has proposed expansive new disclosure requirements relating to understandings/arrangements, written or unwritten, between target NEOS and either/both the target company and/or the acquiring company. Proposed disclosure would apply to documents filed in connection with mergers, as well as tender offers and going-private transactions that do not involve a shareholder vote.
Shareholder vote on such disclosure where proxy rules are triggered would be non-binding
– vote can be taken annually or via deal document, but latter seems more likely, at least with respect to deal-specific acquiror arrangements with target NEOs.
Obligations imposed by statute and implementing rules would not become effective until the SEC’s final rules become effective (unlike say-on-pay and say-when-on-pay).
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￭ Dodd-Frank requires that certain investment managers report at least annually on how their votes are cast on the statute’s new executive compensation provisions. SEC proposal issued on October 18, 2010; comment period ends November 18, 2010, in SEC Rel. No. 34-63123.
￭ Applies to money managers (“13F filers”) exercising investment discretion over U.S. public company equity securities and certain other securities with an aggregate fair market value of at least $100 million.
￭ Will transparency affect voting decisions? Note that registered investment companies have been making annual vote disclosures since
2004
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￭ Last proxy season (2010), broker discretionary voting was barred for the election of directors
￭ New bar on broker discretionary voting on say-on-pay and other executive compensation proposals applicable to the 2011 proxy season
￭ Possible additional bars on other matters as SEC deems “significant”
￭ To be proposed April - July 2011
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Bounty Payments: Payments (of between 10% and 30% of amount recovered) to an employee who voluntarily supplies “original information” leading to successful SEC/DOJ enforcement actions
Availability of bounty may reduce incentives to report in-house using internal whistleblower complaint mechanisms
Employee Cause of Action for Retaliation: Dodd-Frank provides that employees subject to retaliation for whistleblowing may sue directly in federal court
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Listing rules must require that Compensation Committee:
￭ Satisfy heightened independence standard under SEC rules that must consider receipt of consulting/advisory fees & “affiliate” status (similar to
SOX Audit Committee model)
￭ Has authority to appoint, compensate and oversee consultants, independent legal counsel and other committee advisers (and access to funding)
￭ Considers independence factors in hiring consultants/advisers
￭ SEC proposing rules expected November – December 2010
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￭ Pay vs. Performance: Clear description of relationship between executive compensation paid and the company’s financial performance, taking into account changes in stock price and dividends.
Pay Equity Disclosure
A) The median of the annual total compensation of all the company’s employees except the CEO
B) The annual total compensation of the CEO, and
C) The ratio of (A) to (B)
Proposals on each of the foregoing expected April – July 2011
Whether Compensation Committee has retained consultant (for meetings on or after July 21, 2010), whether any conflicts of interest and if so, how addressed
￭ Tied to new independence standards; proposal expected in November –
December 2010
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￭ Listing rules must require company to have & disclose clawback policy
￭ Broader than Sarbanes-Oxley clawback provision (Section 304)
￭ If financial statements restated due to material noncompliance with financial reporting requirements, company must recover from current & former executive officers (not just CEO & CFO) any incentive compensation
￭ Based on the erroneous data
￭ Received during three-year period preceding date on which company becomes required to prepare restatement and
￭ In excess of what would have been paid if calculated under the restatement
SEC implementing proposal expected in April – July 2011
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￭ Disclosure of Permissibility of Hedging by Directors and Employees
(SEC proposal expected April – July 2011)
￭ Board Committee Approval of Security-Based Swap Transactions as
Condition to Reliance on “End-User” Exception from Mandatory
Clearance (SEC proposal expected November – December 2010)
￭ Watch CFTC rulemaking schedule for end-user exception available for swaps regulated by that agency
￭ Disclosure of Board Leadership Structures (required by SEC rule since
2/28/10)
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￭ Some governance provisions limited to financial institutions could inform
“best practices” for non-financial companies; has already happened under TARP (link between compensation and excessive risk)
￭ SEC may enhance transparency of securities ownership (i.e., close the
13(d) “10-day window”), short sales and share-lending activities often used to facilitate short-selling and other types of hedging
￭ SEC Proxy “Plumbing” Project – covers a broad array of issues relating to proxy voting by “street-name” holders. Could lead to tighter SEC regulation of proxy advisory firms, given concerns raised by potential ability to sway voting outcomes in era of majority voting and “vote no” campaigns, proxy access (?), say-on-pay, virtual demise of broker discretionary voting, etc.
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￭ Separate chair / CEO
￭ Majority voting for directors
￭ Board declassification
￭ Shareholder right to call special meeting
￭ CEO succession
￭ Risk management
￭ Corporate social responsibility:
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￭ disclosure re environmental risk political contributions
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