Compensation Committee Corner : Executive Compensation Lawyer & Attorney : Winstead Law Firm : Director Liability, Employee Benefit Arrangements

Addressing the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Act"), I previously discussed clawbacks (Post 1 of 8), say-on-pay voting requirements and a new prohibition on certain votes from brokers (Post 2 of 8), and new disclosure and shareholder vote requirements for golden parachute payments (Post 3 of 8).  As stated in those prior posts, the Act contains significant executive compensation and corporate governance rules that apply to most public companies.  This Post 4 of 8 discusses a new rule under the Act to disclose internal pay equity of the CEO against all employees.

New Internal Pay Equity Disclosure

The Act requires a comparison of the CEO's annual total compensation (as disclosed in the Summary Compensation Table) to the median total annual compensation of all employees (other than the CEO), disclosed in the form of a ratio.  In developing data for the comparison, the median compensation of all employees must be calculated in accordance with the rules governing Total Compensation under the Summary Compensation Table.

Effective Date

No effective date was specified in the Act.  As we wait for guidance from the SEC, companies should consider the comment from SEC Chairwoman Mary Schapiro that rules will not likely be in place for the 2011 proxy season. 

Issues to Consider

Some of the issues a company should consider when implementing the above include:

• Consider that it may take time to implement an internal system to track "total compensation" of non-CEO employees (using rules comparable to Total Compensation as disclosed in the Summary Compensation Table).
• It is not yet known whether temporary, part-time and/or union employees would be included in the disclosure.
• Consider that time may be needed to develop and compile compensation statistics for international employees residing in foreign jurisdictions (if such is required by the SEC to be part of the disclosure).
• It is not yet known how pay for U.S. citizens on foreign assignments would be calculated.
• To highlight the fairness of internal pay equity, consider whether to expand the above disclosure to discuss the CEO's Total Compensation against the Total Compensation of other executive officers within the company.  Consider whether to reflect such disclosure over one or more years.
• In relation to the previous bullet point, consider whether the disclosure should include an analysis of an executive's wealth accumulation and/or internal buildup of cash, deferred compensation and equity (a.k.a., walkaway pay).

Hopefully the SEC will soon provide guidance on the above disclosure rules since companies will need time to implement an internal mechanism to track Total Compensation of all non-CEO employees.  Until then, stay tune for more posts on the Act (Posts 5 through 8)! 

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A few days ago I discussed clawbacks (Post 1 of 8) under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Act"), signed into law by President Obama on July 21, 2010.  As stated in that prior post, the Act contains significant executive compensation and corporate governance rules that apply to most public companies.  This Post 2 of 8 discusses a say-on-pay requirement under the Act (the other say-on-pay requirement applies to golden parachute payments and will be addressed in Post 3 of 8) and a new prohibition on the ability of brokers to vote on compensation-related matters.

New Say-on-Pay Requirement

Under the Act, shareholders of most public companies must be provided with a non-binding advisory vote on executive compensation as disclosed under SEC rules.  Specifically: 

• A vote is required at least once every three years, beginning with the first shareholder meeting that occurs after January 21, 2011.  In other words, say-on-pay will be required for many public companies this upcoming proxy season.
• At this first annual meeting, the shareholders must also decide on whether the vote should be held every one, two or three years (thereafter a vote on frequency must be held by a separate resolution no less often than every six years). 

New Prohibition on Certain Votes from Brokers

The Act requires national securities exchanges to prohibit brokers from voting on executive compensation matters (including say-on-pay), director elections and any other significant matter (as determined by the SEC). 

Effective Date

Say-on-pay votes apply to shareholder meetings that occur after January 21, 2011.  The rule prohibiting certain discretionary voting by brokers is effective July 21, 2010.

Issues to Consider

There are many issues a company should consider when implementing say-on-pay, and even more if the company has a large percentage of retail shareholders.  These include:

• How should a company revise its proxy statement to incorporate the mechanics of the say-on-pay mandate?  How should it frame the resolution?  Should the board of directors make a recommendation on the frequency of the vote? 
• Consider whether a company should make changes to its CD&A and tabular disclosure since shareholders will now be voting on its overall disclosure.
• Assuming retail shareholders typically vote with management, it would follow that the influence of institutional shareholder advisory services (e.g., RiskMetrics Group, Glass Lewis) could be disproportionately increased if the beneficial owners of the shares do not provide voting instructions to the retail shareholders.  This means a company may want to revisit its ability to comply with mandates set by shareholder advisory services (e.g., review change in control policies, employment agreements, separation pay arrangements, etc.).
• For those companies with a large percentage of retail shareholders, consider implementing ongoing educational campaigns with shareholders and beneficial owners to explain the company's compensation programs and educate beneficial owners that a failure to provide the broker with specific instructions would be the equivalent of a "no vote."
• Though say-on-pay is "nonbinding," keep in mind that compensation committee members would need to react to a failed say-on-pay proposal or risk receiving withhold votes during their reelection.  Last proxy season the shareholders of three companies voted against management say-on-pay proposals (KeyCorp, Occidental Petroleum and Motorola).  It could happen.

Given the number of action items a public company will need to consider or implement, the best advice is to prepare early, especially if shareholder educational campaigns need to be conducted.  Until then, stay tune for more posts on the Act (Posts 3 through 8)!

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The legislation I have been following (Prior Post 1, Prior Post 2) is no longer a bill sitting on the steps of Capitol Hill.  On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Act").  The Act represents significant legislation containing executive compensation and corporate governenance rules that apply to most public companies.  Due to the significance of the Act and the fact blog entries are not intended to be lengthy, I will address the Act in 8 separate entries, beginning with clawbacks.

New Clawback Requirement More Expansive than Section 304 of SOX

As a listing requirement, national securities exchanges will require companies to implement clawback policies (a.k.a. recoupment policies) that are more expansive than current requirements under Section 304 of the Sarbanes-Oxley Act (“Section 304”).  Under the Act:

• The clawback policy must be triggered any time the company prepares an accounting restatement resulting from material noncompliance with any financial reporting requirement (in contrast, Section 304 applies only when a restatement of financial statements is “required” and is the result of “misconduct”).
• Once the clawback policy is triggered, it would apply to all incentive-based compensation paid to current and former executive officers (in contrast, Section 304 applies only to the CEO and CFO).
• The look back period for which incentive-based compensation is subject to clawback is the three-year period preceding the date on which the restatement is required (in contrast, the look back period under Section 304 is twelve months).
• The amount subject to the clawback is the difference between the amount paid and the amount that should have been paid under the accounting restatement.

Effective Date

No deadline was provided within which national securities exchanges must implement this rule.

Issues to Consider

Previously (Prior Post) I set forth issues that should be considered in designing clawback policies.  Due to the Act's requirements, I am updating that Post with the following:

• Clawback policies should be revisited to determine what changes would be required under the Act.
• Determine “who” should be responsible for clawback enforcement (e.g., a risk assessment officer, the compensation committee, the full board of directors) and what repayment procedure should be used once a clawback is triggered.
• Determine whether the clawback policy should be more expansive than required under the Act.  For example, consider adding more events that would trigger the clawback than currently required under the Act, such as poor performance, violation of noncompetes, negligence, etc.  As I previously addressed (Prior Post), one reason for a strong clawback policy is that it can act as a mitigating factor to negate risk assessment disclosure under recent SEC rules (which require narrative disclosure of compensation policies and practices that are “reasonably likely” to have a “material adverse effect” on the company). Plus, a strong clawback policy acts as positive CD&A disclosure.
• The above should involve a current analysis and review of all compensation arrangements between a company and its executive officers (e.g., employment agreements, bonus arrangements, equity awards) to ensure proper integration between such arrangements and a company's new clawback policy.

 We will likely see more activity in this area as the national securities exchanges begin to implement this rule.  Until then, stay tune for more posts on the Act (Posts 2 through 8)!

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 It looks like Senator Dodd's bill entitled "Restoring American Financial Stability Act of 2010" (PDF, pages 1056-1090) finally got its legs in that it was approved by the Senate on May 20, 2010 (though a copy of the bill did not become available to us until last week).  The purpose of this Post is to highlight some of the compensation and corporate governance changes within the Senate bill that would affect public companies. 

Reconciliation

In July 2009 the House of Representatives passed the Corporate and Financial Institution Compensation Fairness Act of 2009, which was introduced by Representative Frank (the "Frank Bill").  In December 2009 the House passed the Wall Street Reform and Consumer Protection Act of 2009, which incorporated a variety of bills, including the Frank Bill.  The Senate bill will have to be reconciled with the House bill.  It may be a few months before legislation is enacted. 

Overview of the Senate Bill

As discussed in a prior post (Prior Post), the compensation and corporate governance provisions of the Senate bill and House bill are similar in many respects.  Thus, the following is intended to highlight the more significant provisions under the Senate bill: 

• Say-on-Pay.  Say-on-pay provides shareholders of public companies with a non-binding vote on the compensation of named executive officers.  This is not a new development in terms of proposed legislation and is similar to the House bill. 
• Discretionary Voting by Brokers.  Discretionary voting by brokers in connection with executive compensation matters (including say-on-pay) and other "significant matters" would be eliminated absent specific instructions from the beneficial owner.  This provision is not present in the House bill.  If this provision survives reconciliation, it is likely to result in fewer shares of retail shareholders being voted absent a specific effort by issuers to educate their shareholders that voting is necessary.
• Majority Voting.  This provision would generally require a board member to tender his resignation if his election was uncontested and he failed to receive a majority of the votes cast. 
• Pay v. Performance.  The annual proxy statement would have to describe the relationship between compensation actually paid and the financial performance of the company.  This could be disclosed in a graph or pictorial.
• Clawbacks.  Continued listing on a national securities exchange would require the issuer to develop a clawback policy more robust than currently required under Section 304 of Sarbanes-Oxley.  The more robust clawback policy would (i) include all executive officers (not just the CEO and CFO), (ii) eliminate the requirement that a clawback be triggered due to "misconduct," and (iii) expand the period covered from 12 months to 3 years. 

More posts will follow as this legislation develops.  Till then, if you would like to learn more about the differences between the House and Senate bills, you can sign up for our free webinar entitled "Hot Topics in Executive Pay," to be held at 10:00 am (CST) on June 9, 2010.  Sign up can be found at http://www.winstead.com/AboutWinstead/ContinuingEducationWebinarSeries/CompensationBenefits.

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Yesterday Senator Dodd (Chairman of the Senate Banking Committee) introduced the "Restoring American Financial Stability Act of 2010" (PDF), yet another piece of legislation to address perceived abuses in executive compensation.  As I read all 1,336 pages of the bill (just kidding, the executive compensation provisions are contained in pages 868 through 900), I noticed that many of the issues addressed are substantially similar to prior bills introduced over the last 12 months.  I thought readers might benefit from a summary of the most repeated issues.

Background on Recent Legislation

The following are the more significant items of legislation that was introduced or passed within the last 10 months or so.

• On May 19, 2009, Senator Schumer introduced the "Shareholder Bill of Rights Act of 2009."
• On July 22, 2009, Senators Levin and McCain introduced "Ending Excessive Corporate Deductions for Stock Options Act."
• On July 31, 2009, the House of Representatives passed the "Corporate and Financial Institution Compensation Fairness Act of 2009," which was introduced by Congressman Frank.
• On November 10, 2009, Senator Dodd (with 8 other Senators, including Senator Schumer) introduced the "Restoring American Financial Stability Act of 2009," which was referred to the Senate Banking Committee.
• On February 26, 2010, Senator Menendez introduced the "Corporate Executive Accountability Act of 2010."
• On March 15, 2010, Senator Dodd introduced the "Restoring American Financial Stability Act of 2010."

Summary of Certain Issues Repeatedly Addressed

It is not certain which legislation or issues will become law, however, it is safe to assume any such law would include some or all of the following issues (not intended as an exhaustive list):

• Say-on-Pay.  This is an obvious one.  It would require a public company to provide its shareholders with an annual non-binding vote on all compensation disclosed in the proxy statement.  In some cases a separate non-binding vote would apply to change-in-control payments and any related gross-ups.
• Independence of Compensation Committee Members.  It would require the SEC to bolster its rules relating to independence of compensation committee members.  Additionally, it would require independence of those hired by the compensation committee (as opposed to the new SEC proxy disclosure rules which attempt to influence such behavior through disclosure). 
• Clawbacks.  It would amend Section 304 of SOX to (i) include all executive officers (not just the CEO and CFO), (ii) eliminate the requirement that a clawback be triggered due to "misconduct," and (iii) expand the period covered from 12 months to 3 years.  As indicated in a previous post (Prior Post), there are a few deficiencies within Section 304 of SOX that could be bolstered either through enacted legislation or by proactive efforts of compensation committees, preferably the latter. 

The following are not repeated among the various bills, but listed because they are somewhat interesting (not intended as an exhaustive list):

• CD&A Pay Comparisons.  Senator Dodd's bill would require a graph or pictorial showing the relationship between executive compensation actually paid and the financial performance of the company.  Senator Menendez's  bill would require a comparison of the CEO's pay to the median pay of all employees, disclosed in the form of a ratio.     
• Stock Options.  Senators Levin/McCain's bill would limit tax deductions for stock options to the amount expensed under ASC Topic 718 (formerly FAS 123R).  Additionally, it would eliminate stock options from qualifying as "performance-based" compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended.  

It is likely there will be some form of enacted legislation this year.  So stay tuned!   

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Recently the SEC issued interpretative guidance (PDF) on how the effective date of the new proxy disclosure rules (Previous Post) would apply in various factual scenarios.  Though the new proxy disclosure rules are effective February 28, 2010, the interpretative guidance provides the following transition rules:

• An issuer must comply with the new rules if its fiscal year ends on or after December 20, 2009, and its definitive proxy statement is filed on or after February 28, 2010. Under such facts any preliminary proxy statement required to be filed would have to comply with the new rules even if it is filed prior to February 28, 2010.
  
• Under the above facts an issuer's proxy statement must comply with the new rules even if its 2009 Form 10-K is filed prior to February 28, 2010.
  
• An issuer is NOT required to comply with the new rules if its fiscal year ends prior to December 20, 2009. This rule applies even if the proxy is filed on or after February 28, 2010.
  

Addressing voluntary compliance, the interpretative guidance provides that an issuer may voluntarily comply with some or all of the new rules; however, if an issuer desires to comply with amendments to the Summary Compensation Table and Director Compensation Table, then it must comply with all of the new rules relating to the form filed.

Addressing Form 8-Ks, the interpretative guidance provides that new item 5.07 to Form 8-K (generally requiring issuers to disclose the results of a shareholder vote and to have that information filed within four business days after the end of the meeting at which the vote was held) will apply if the annual meeting of shareholders takes place on or after February 28, 2010, even if the proxy was mailed prior to that date.  Annual meetings taking place prior to February 28, 2010 would not have to comply with new item 5.07.

The interpretative guidance may be good news for those issuers with a fiscal year ending prior to December 20, 2009, but who file their proxy (or have their annual meeting) on or after February 28, 2010.

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On December 16, 2009, the SEC adopted final rules (PDF) that broaden executive compensation disclosures within proxy statements and annual reports. The new rules are effective on February 28, 2010, just in time for the 2010 proxy season.

As a summary, the final rules generally:

• expand director qualification disclosures,
• require a description of the board's role in risk oversight and an explanation of its leadership structure (e.g., whether it combines the CEO and Chairman positions),
• require disclosure of certain fees paid to compensation consultants,
• require a discussion of compensation risk management policies that are "reasonably likely to have a material adverse effect on the company", and 
• change the valuation of equity awards reported in the Summary Compensation Table and Director Compensation Table (from the accounting expense recognized during the year to the grant date fair value).

Though the final rules are straight forward and for the most part consistent with the proposed rules, companies should review these rules to determine whether immediate action is required. For example, director and officer questionnaires will likely need to be revised, the company may need to gather information on engagements with its compensation consultants, and it is possible that using the grant date fair value of equity awards may change the identity of a company's named executive officers for 2009.

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