Dodd-Frank Ushers in New Requirements for Public Companies and Their Boards

On July 21, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama. The vast majority of the 2,300-page Dodd-Frank Act relates to the banking and financial services industry. However, the Act also contains several provisions that are specific to public companies, the more significant of which are discussed below.

Compensation

'Say on Pay' and 'Say on Severance'

Say on Pay. At least once every three years, issuers that are subject to the proxy rules will be required to include in their annual meeting proxy materials a shareholder resolution seeking a non-binding advisory vote on named executive officer compensation. In addition, at least every six years, the annual meeting proxy materials must include a separate resolution seeking a non-binding advisory vote to determine whether the say on pay vote will occur every one, two or three years. The proxy statement pertaining to the first annual meeting occurring after the end of the six-month period following the enactment of Section 14A must include both of the foregoing resolutions.

Say on Severance. The proxy statement for a special meeting being held in connection with the approval of a change in control transaction of an issuer must include a resolution seeking a non-binding advisory vote on any agreements or understandings that the soliciting person has with any named executive officer concerning compensation (whether present, deferred or contingent) that is based on or otherwise relates to the transaction unless the arrangements previously were voted on by the shareholders at an annual meeting.

The proxy statement also must disclose in a “clear and simple” form in accordance with rules to be promulgated by the SEC any golden-parachute payments for any named executive officer and the aggregate amount of the payments.

The say on severance requirements will apply beginning with shareholder meetings occurring after the end of the six-month period beginning on the date of enactment of Section 14A.

Compensation Committees And Related Matters

Heightened Compensation Committee Independence Standards

New Section 10C(a) of the Exchange Act requires the SEC to adopt rules directing the national securities exchanges to prohibit the listing of any equity security of an issuer that does not have a fully independent compensation committee. In determining independence of a committee member, the exchanges will be required to consider among other relevant factors: 1) other compensation paid to the member, including any consulting, advisory or other compensatory fee; and 2) whether the member is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer. The independence standard is similar to that applicable to audit committee members.

Independence of Compensation Consultants and Other Advisers

To the extent that the compensation committee decides to hire a compensation consultant, legal counsel or other adviser, it will be required under Section 10C(b) to first consider certain independence factors to be identified by the SEC, including: 1) the provision of other services to the issuer by the advisory firm; 2) the amount of fees received from the issuer by the advisory firm as a percentage of that firm's total revenue; 3) the policies and procedures of the advisory firm that are designed to prevent conflicts of interest; 4) any business or personal relationship between the advisor and members of the compensation committee; and 5) any stock of the issuer owned by the adviser.

The compensation committee will have the sole discretion to retain or obtain the advice of a compensation consultant or other adviser, and will be directly responsible for the appointment, compensation and oversight of the adviser's work. However, the compensation committee will not be required to implement or act consistently with the advice or recommendations of the adviser, and Section 10C will not affect the obligation of the compensation committee to exercise its own judgment in the fulfillment of its duties.

Implementation Timetable; Excluded Issuers

Not later than 360 days after the enactment of Section 10C, the SEC is required to adopt rules directing the national securities exchanges to prohibit the listing of any security of an issuer that is not in compliance with the requirements of Section 10C. The latter will not apply to controlled companies, in addition to certain other enumerated categories of issuers, and the rules adopted by the SEC pursuant to Section 10C are required to permit an exchange to exempt other categories of issuers from the requirements of Section 10C, including smaller reporting issuers.

Enhanced Executive Compensation Disclosure

The SEC is required to adopt rules requiring issuers to disclose “pay versus performance” in their annual meeting proxy statements. Specifically, issuers will be required to disclose information that shows the relationship between the executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of shares of its stock and dividends and any distributions. Issuers will be permitted to present the information in the form of a graph.

Section 953 of Dodd-Frank also requires the SEC to amend Item 402 of Regulation S-K, which requires detailed executive compensation disclosure. Following the amendment, issuers will be required to disclose: 1) the median annual total compensation of all employees excluding the chief executive officer; 2) the annual total compensation of the chief executive officer; and 3) the ratio of the former to the latter.

Compensation Clawbacks

Section 10D requires the SEC to by rule direct the national securities exchanges to adopt listing standards that require each listed issuer to develop and implement a policy providing: 1) for disclosure of the issuer's policy on incentive-based compensation that is based on financial information required to be reported under the securities laws; and 2) that, in the event that the issuer is required to prepare an accounting restatement due to its material noncompliance with any financial reporting requirement under the securities laws, the issuer will recover from any current or former executive officer who received incentive-based compensation (including stock options) during the preceding three-year period based on the erroneous data, the amount that is in excess of what would have been paid to the executive officer under the restated financial information.

Section 10D expands upon the clawback already contained in SOX 304. In contrast, the SOX 304 clawback only applies to chief executive officers and chief financial officers, has a 12-month look-back and requires misconduct.

Disclosure Regarding Hedging Policies

New Section 14(j) of the Exchange Act requires the SEC to adopt rules requiring issuers to disclose in their annual meeting proxy statements whether any of their employees or directors or their designees are permitted to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars and exchange funds) that are designed to hedge or offset a decrease in the market value of equity securities granted to the employees or directors as part of their compensation or held directly or indirectly by them.

Governance

Proxy Access Rules Authorized

Section 14(a) of the Exchange Act has been amended to explicitly provide the SEC with the authority to adopt rules and regulations requiring that a proxy solicitation by an issuer include a director nominee submitted by a shareholder, as well as the authority to adopt related procedural requirements. The SEC is expected to vote on final proxy access rules as early as sometime later in August.

As part of its focus on the proxy process, on July 14, the SEC also issued a concept release seeking public comment on various aspects of the proxy voting infrastructure. The concept release focuses on several topics relating to the accuracy and transparency of the voting process, the manner in which shareholders and corporations communicate and the relationship between voting power and economic interest.

Broker Discretionary Voting Further Limited

Section 6(b) of the Exchange Act has been amended to add a new subsection (10)(A) that requires that the rules of the national securities exchanges prohibit any member that is not the beneficial owner of a security registered under Section 12 of the Exchange Act from granting a proxy to vote the security in connection with the election of directors, executive compensation or any other significant matter as determined by the SEC pursuant to its rule-making authority, unless the beneficial owner of the security has instructed the member as to how to vote.

In 2010, amendments to NYSE Rule 452, which allows broker discretionary voting on certain routine matters, eliminated discretionary voting in uncontested director elections. Therefore, the principal change that will be brought about by the amendment to Section 6(b) is that broker discretionary voting will no longer be permitted on executive compensation matters, including in connection with the new say on pay and say on severance advisory votes.

Preparing for Compliance With Dodd-Frank

Many of the public company provisions of Dodd-Frank will be the subject of further rulemaking, either by the SEC or the exchanges. However, there are several action items that issuers and their boards should consider now in furtherance of Dodd-Frank.

Review NEO Compensation Levels and Structures

In anticipation of say on pay, say on severance and enhanced pay for performance disclosure, many issuers will want to review their executive compensation and severance against that of peer firms, as well as against corporate and individual performance. With a view to obtaining the desired outcome on the first say on pay vote, issuers also should consider whether next year's CD&A should be beefed up relative to last year's to more adequately explain the “why” behind executive compensation decisions.

Determine Recommended Frequency of Say on Pay Vote

Dodd-Frank provides for a say on pay vote every one, two or three years, with an advisory vote on the frequency of the say on pay vote at least every six years. Issuers should consider the recommended frequency of their say on pay vote and the reasons supporting that determination.

Examine the Composition of the Compensation Committee

Although the exchanges have not yet promulgated the new mandated compensation committee independence standards, Dodd-Frank lays out their framework. Issuers should determine which compensation committee members are expected to qualify as independent under the new rules and whether changes to the board and/or compensation committee will be necessary. To the extent that a change in board membership, rather than just a reshuffling of committees, is expected to be required, the issuer should consider whether to begin a director search now. Due to the heightened focus on the role of the compensation committee, both due to Dodd-Frank and generally over the last few years, the search may require significant lead time.

Determine Independence of Compensation Committee
Consultants

The compensation committee should determine whether any existing or contemplated consultants and advisers are likely to meet the independence criteria of Dodd-Frank.

Review and Revise Existing Compensation Committee
Charter, Company Policies and D&O Questionnaire

Issuers will need to review their compensation committee charter and other corporate policies implicated by Dodd-Frank. The new rules relating to compensation committee independence and the retention of advisors by the compensation committee will in many cases require changes to the compensation committee charter. Changes to other policies also may be implicated by the new rules relating to compensation clawbacks and disclosure of hedging policies. Dodd-Frank also will require changes to the form of annual D&O questionnaire.

Assess the Overall Effectiveness of the IR Program

In light of say on pay, say on severance, proxy access and changes to broker-discretionary voting, issuers should consider the overall effectiveness of their investor relations function and whether additional resources need to be allocated to investor relations, or any aspects of the IR program or shareholder outreach or communications generally should be enhanced or modified.

Michael R. Littenberg is a partner in the New York office of Schulte Roth & Zabel LLP. He represents both public companies and their boards in ongoing securities law compliance matters. He has spoken, written and been quoted extensively in the press on the Dodd-Frank Act. He can be reached at [email protected].

On July 21, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama. The vast majority of the 2,300-page Dodd-Frank Act relates to the banking and financial services industry. However, the Act also contains several provisions that are specific to public companies, the more significant of which are discussed below.

Compensation

'Say on Pay' and 'Say on Severance'

Say on Pay. At least once every three years, issuers that are subject to the proxy rules will be required to include in their annual meeting proxy materials a shareholder resolution seeking a non-binding advisory vote on named executive officer compensation. In addition, at least every six years, the annual meeting proxy materials must include a separate resolution seeking a non-binding advisory vote to determine whether the say on pay vote will occur every one, two or three years. The proxy statement pertaining to the first annual meeting occurring after the end of the six-month period following the enactment of Section 14A must include both of the foregoing resolutions.

Say on Severance. The proxy statement for a special meeting being held in connection with the approval of a change in control transaction of an issuer must include a resolution seeking a non-binding advisory vote on any agreements or understandings that the soliciting person has with any named executive officer concerning compensation (whether present, deferred or contingent) that is based on or otherwise relates to the transaction unless the arrangements previously were voted on by the shareholders at an annual meeting.

The proxy statement also must disclose in a “clear and simple” form in accordance with rules to be promulgated by the SEC any golden-parachute payments for any named executive officer and the aggregate amount of the payments.

The say on severance requirements will apply beginning with shareholder meetings occurring after the end of the six-month period beginning on the date of enactment of Section 14A.

Compensation Committees And Related Matters

Heightened Compensation Committee Independence Standards

New Section 10C(a) of the Exchange Act requires the SEC to adopt rules directing the national securities exchanges to prohibit the listing of any equity security of an issuer that does not have a fully independent compensation committee. In determining independence of a committee member, the exchanges will be required to consider among other relevant factors: 1) other compensation paid to the member, including any consulting, advisory or other compensatory fee; and 2) whether the member is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer. The independence standard is similar to that applicable to audit committee members.

Independence of Compensation Consultants and Other Advisers

To the extent that the compensation committee decides to hire a compensation consultant, legal counsel or other adviser, it will be required under Section 10C(b) to first consider certain independence factors to be identified by the SEC, including: 1) the provision of other services to the issuer by the advisory firm; 2) the amount of fees received from the issuer by the advisory firm as a percentage of that firm's total revenue; 3) the policies and procedures of the advisory firm that are designed to prevent conflicts of interest; 4) any business or personal relationship between the advisor and members of the compensation committee; and 5) any stock of the issuer owned by the adviser.

The compensation committee will have the sole discretion to retain or obtain the advice of a compensation consultant or other adviser, and will be directly responsible for the appointment, compensation and oversight of the adviser's work. However, the compensation committee will not be required to implement or act consistently with the advice or recommendations of the adviser, and Section 10C will not affect the obligation of the compensation committee to exercise its own judgment in the fulfillment of its duties.

Implementation Timetable; Excluded Issuers

Not later than 360 days after the enactment of Section 10C, the SEC is required to adopt rules directing the national securities exchanges to prohibit the listing of any security of an issuer that is not in compliance with the requirements of Section 10C. The latter will not apply to controlled companies, in addition to certain other enumerated categories of issuers, and the rules adopted by the SEC pursuant to Section 10C are required to permit an exchange to exempt other categories of issuers from the requirements of Section 10C, including smaller reporting issuers.

Enhanced Executive Compensation Disclosure

The SEC is required to adopt rules requiring issuers to disclose “pay versus performance” in their annual meeting proxy statements. Specifically, issuers will be required to disclose information that shows the relationship between the executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of shares of its stock and dividends and any distributions. Issuers will be permitted to present the information in the form of a graph.

Section 953 of Dodd-Frank also requires the SEC to amend Item 402 of Regulation S-K, which requires detailed executive compensation disclosure. Following the amendment, issuers will be required to disclose: 1) the median annual total compensation of all employees excluding the chief executive officer; 2) the annual total compensation of the chief executive officer; and 3) the ratio of the former to the latter.

Compensation Clawbacks

Section 10D requires the SEC to by rule direct the national securities exchanges to adopt listing standards that require each listed issuer to develop and implement a policy providing: 1) for disclosure of the issuer's policy on incentive-based compensation that is based on financial information required to be reported under the securities laws; and 2) that, in the event that the issuer is required to prepare an accounting restatement due to its material noncompliance with any financial reporting requirement under the securities laws, the issuer will recover from any current or former executive officer who received incentive-based compensation (including stock options) during the preceding three-year period based on the erroneous data, the amount that is in excess of what would have been paid to the executive officer under the restated financial information.

Section 10D expands upon the clawback already contained in SOX 304. In contrast, the SOX 304 clawback only applies to chief executive officers and chief financial officers, has a 12-month look-back and requires misconduct.

Disclosure Regarding Hedging Policies

New Section 14(j) of the Exchange Act requires the SEC to adopt rules requiring issuers to disclose in their annual meeting proxy statements whether any of their employees or directors or their designees are permitted to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars and exchange funds) that are designed to hedge or offset a decrease in the market value of equity securities granted to the employees or directors as part of their compensation or held directly or indirectly by them.

Governance

Proxy Access Rules Authorized

Section 14(a) of the Exchange Act has been amended to explicitly provide the SEC with the authority to adopt rules and regulations requiring that a proxy solicitation by an issuer include a director nominee submitted by a shareholder, as well as the authority to adopt related procedural requirements. The SEC is expected to vote on final proxy access rules as early as sometime later in August.

As part of its focus on the proxy process, on July 14, the SEC also issued a concept release seeking public comment on various aspects of the proxy voting infrastructure. The concept release focuses on several topics relating to the accuracy and transparency of the voting process, the manner in which shareholders and corporations communicate and the relationship between voting power and economic interest.

Broker Discretionary Voting Further Limited

Section 6(b) of the Exchange Act has been amended to add a new subsection (10)(A) that requires that the rules of the national securities exchanges prohibit any member that is not the beneficial owner of a security registered under Section 12 of the Exchange Act from granting a proxy to vote the security in connection with the election of directors, executive compensation or any other significant matter as determined by the SEC pursuant to its rule-making authority, unless the beneficial owner of the security has instructed the member as to how to vote.

In 2010, amendments to NYSE Rule 452, which allows broker discretionary voting on certain routine matters, eliminated discretionary voting in uncontested director elections. Therefore, the principal change that will be brought about by the amendment to Section 6(b) is that broker discretionary voting will no longer be permitted on executive compensation matters, including in connection with the new say on pay and say on severance advisory votes.

Preparing for Compliance With Dodd-Frank

Many of the public company provisions of Dodd-Frank will be the subject of further rulemaking, either by the SEC or the exchanges. However, there are several action items that issuers and their boards should consider now in furtherance of Dodd-Frank.

Review NEO Compensation Levels and Structures

In anticipation of say on pay, say on severance and enhanced pay for performance disclosure, many issuers will want to review their executive compensation and severance against that of peer firms, as well as against corporate and individual performance. With a view to obtaining the desired outcome on the first say on pay vote, issuers also should consider whether next year's CD&A should be beefed up relative to last year's to more adequately explain the “why” behind executive compensation decisions.

Determine Recommended Frequency of Say on Pay Vote

Dodd-Frank provides for a say on pay vote every one, two or three years, with an advisory vote on the frequency of the say on pay vote at least every six years. Issuers should consider the recommended frequency of their say on pay vote and the reasons supporting that determination.

Examine the Composition of the Compensation Committee

Although the exchanges have not yet promulgated the new mandated compensation committee independence standards, Dodd-Frank lays out their framework. Issuers should determine which compensation committee members are expected to qualify as independent under the new rules and whether changes to the board and/or compensation committee will be necessary. To the extent that a change in board membership, rather than just a reshuffling of committees, is expected to be required, the issuer should consider whether to begin a director search now. Due to the heightened focus on the role of the compensation committee, both due to Dodd-Frank and generally over the last few years, the search may require significant lead time.

Determine Independence of Compensation Committee
Consultants

The compensation committee should determine whether any existing or contemplated consultants and advisers are likely to meet the independence criteria of Dodd-Frank.

Review and Revise Existing Compensation Committee
Charter, Company Policies and D&O Questionnaire

Issuers will need to review their compensation committee charter and other corporate policies implicated by Dodd-Frank. The new rules relating to compensation committee independence and the retention of advisors by the compensation committee will in many cases require changes to the compensation committee charter. Changes to other policies also may be implicated by the new rules relating to compensation clawbacks and disclosure of hedging policies. Dodd-Frank also will require changes to the form of annual D&O questionnaire.

Assess the Overall Effectiveness of the IR Program

In light of say on pay, say on severance, proxy access and changes to broker-discretionary voting, issuers should consider the overall effectiveness of their investor relations function and whether additional resources need to be allocated to investor relations, or any aspects of the IR program or shareholder outreach or communications generally should be enhanced or modified.

Michael R. Littenberg is a partner in the New York office of Schulte Roth & Zabel LLP. He represents both public companies and their boards in ongoing securities law compliance matters. He has spoken, written and been quoted extensively in the press on the Dodd-Frank Act. He can be reached at [email protected].