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Senate Financial Reform Bill Includes Corporate Governance And Compensation Provisions

The Senate on May 20 passed the Restoring American Financial Stability Act of 2010.  The legislation includes a number of significant corporate governance and executive compensation-related provisions that would apply to all public companies, although the SEC would have the authority to exempt companies from any of the requirements based on size, market capitalization or other criteria.

Corporate Governance Provisions

Majority Voting.  The NYSE and NASDAQ would be required to impose a majority vote standard in uncontested director elections.  A plurality standard would apply in contested elections.

  • Any director who receives less than a majority of the votes cast must offer to resign.  The board could determine not to accept the resignation and must publicly disclose its decision and rationale within 30 days.
  • The corresponding House bill does not require majority voting.

Proxy Access.  The SEC would be authorized to establish rules permitting stockholders to include their own director nominations in issuer proxy solicitation materials.  The House bill requires the SEC to establish proxy access.

  • The SEC last May proposed rules expanding stockholder proxy access rights.  The SEC has not taken action on the rules in part due to questions concerning the SEC’s authority to adopt such rules.  The new legislation removes the doubt.
  • Under the current SEC proposal, stockholders (or groups of stockholders) owning a specified percentage of the company’s shares for one year could use the company’s proxy card and its proxy statement to nominate directors.  The percentages are 1% for large accelerated filers ($700 million market cap), 3% for accelerated filings ($75 million market cap), and 5% for non-accelerated filers (market cap less than $75 million).
  • Under the current SEC proposal, stockholders could nominate the greater of one nominee or up to 25% of the board.  For example, if a company has a classified board of nine members, the stockholder could nominate up to two persons at an annual election of three directors.

Broker Discretionary Voting.  The NYSE and NASDAQ would be required to prohibit broker discretionary voting in connection with the election of directors, executive compensation, or any other significant matter.

  • The NYSE and NASDAQ currently prohibit brokers from voting without specific client instructions on election of directors, the adoption of equity plans, and shareholder proposals.
  • The new legislation would extend the prohibition on broker discretionary voting to other types of management proposals, including management say-on-pay proposals.

CEO / Chairman Position.  The SEC would be required to issue rules within 180 days after enactment requiring disclosure in the proxy statement of the rationale for the combination or separation of the positions of Chairman and CEO.  The SEC adopted similar disclosure requirements in 2009 and consequently most companies made these disclosures in the 2010 proxies.

Executive Compensation Provisions

Annual “Say-On-Pay” Vote.  Proxy statements must include an annual nonbinding vote to approve executive compensation as reported in the proxy statement.  The requirement would be applicable to any stockholder meeting occurring more than six months after the legislation is enacted.

  • The combination of say-on-pay and majority voting may mean that boards that do not respond to stockholder disapproval of compensation programs will face activist stockholder pressure on their own tenure at the following year stockholder meeting.
  • Say-on-pay was voluntarily adopted by about 70 companies during the 2010 proxy season.  Motorola and Occidental Petroleum failed to receive stockholder approval of their executive compensation programs.

Clawbacks.  The NYSE and NASDAQ would be required to implement policies relating to compensation clawbacks.  The trigger must be based on material noncompliance with any financial reporting requirements that led to a restatement during the three-year period preceding the date on which a company is required to prepare the restatement.  The amount to be clawed back is the amount paid in excess of what would have been paid under the restated results as incentive-based compensation (including stock options).
Compensation Committee Independence Matters.  The NYSE and NASDAQ would be required to impose specific independence requirements on compensation committees, taking into account consulting, advisory and other compensatory fees and affiliate status.  The compensation committee must be given the authority to select consultants, counsel and other advisors; such consultants, counsel and advisors would not be required to be independent, but the compensation committee would be required to take into consideration factors that effect their independence.  The listing exchanges must adopt the compensation committee rules within one year after enactment of the legislation.
Compensation Disclosure.  The SEC would be required to revise compensation reporting in proxy statements to include two new provisions:

  • A disclosure of the relationship between executive compensation and financial performance.  The compensation discussion and analysis of most companies currently includes such a discussion.
  • Disclosure of (1) the median annual total compensation of all employees except the CEO, (2) the annual total compensation of the CEO, and (3) the ratio of the median employee annual total compensation to that of the CEO.

Director and Employee Hedging Transactions.  The SEC must adopt rules for proxy statements requiring disclosure of whether any director or employee is permitted to purchase financial instruments (any type of derivatives) that are designed to hedge or offset any decrease in the market value of the company’s equity securities. The legislation does not require disclosure of actual hedging transactions, but only of the company’s policies with respect to such transactions.

Legislation Process

The Senate legislation must be reconciled with the House legislation, and the final bill must be signed by the President.  Most provisions in the legislation will become effective following adoption of rules by the SEC, NYSE and/or NASDAQ, with time periods for adoption generally ranging from six months to one year following enactment of the legislation.