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How financial reform will change the corporate landscape Print E-mail
Thursday, 29 July 2010

By Jason Harmon and Christopher Edwards

President Barack Obama recently signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law. Among other requirements, the new legislation includes provisions related to mandatory "say on pay" requirements, clawback policies and matters regarding shareholder access to a company's proxy statement. These significant changes are expected to be applicable to the 2011 proxy season.

The act requires companies subject to the proxy solicitation rules to submit for stockholder vote a separate non-binding advisory resolution to "approve the compensation of executives," not less frequently than once every three years. Over the past several years, stockholder groups and governance activists have increasingly sought stockholder votes on executive compensation as a means to influence senior executive pay. The proposals have generally taken the form of a non-binding resolution requesting that the company seek approval of some or all of a company's executive compensation disclosed in its proxy statement. Such proposals are known as Say on Pay (SOP) and have become common in the United Kingdom and Europe and have gained popularity here in the United States.

Because the SOP proposal will be non-binding and advisory in nature, a company will not be required to take any specific action based solely on the outcome of the vote. In considering these SOP proposals, stockholders will be reviewing both the information about executive compensation, and perhaps more importantly, the company's explanation as to the compensation paid to the executives. Consequently, compensation committees should focus on good governance principles in making compensation decisions for executives, and companies should be transparent regarding the process undertaken and reasons for all executive compensation decisions. Stockholder rejection of a SOP proposal may be viewed as a vote of no-confidence in the company's executive compensation program, and will likely have repercussions with respect to the company's governance posture and stockholder relations.

Companies also must provide a non-binding advisory vote on compensation paid to named executive officers in connection with an acquisition, merger, consolidation, or disposition of all or substantially all of the company's assets in a business combination transaction (generally referred to as "golden parachutes"). The vote would occur at the time the transaction is approved by the stockholders, and is required unless the golden parachutes were previously subject to a stockholder vote pursuant to the SOP proposal described above.

It remains to be seen what effect the advisory vote on golden parachute payments will have on the stockholder vote for the business combination transaction itself. Separating the issues of compensation from the business combination transaction may be beneficial to the goal of obtaining votes on the transaction itself, because it allows a separate vote on the compensation, or it may further highlight the executive compensation paid or payable as a result of the deal, potentially making it more difficult to obtain approval of the transaction itself.

Another compensation related aspect of the Act is that national securities exchanges (like the NYSE and Nasdaq) will be prohibited from listing companies that do not implement a compensation clawback policy allowing the company to recoup incentive-based compensation if the company is required to restate its financials due to material noncompliance with any financial reporting requirement under the securities laws. The clawback policy must apply to any current or former executive officer of the company who received incentive-based compensation (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. This means that the clawback policy must have a three-year "look-back" from the date of the restatement and require repayment of incentive compensation in excess of what would have been paid after giving effect to the accounting restatement. The clawback policy must require recovery without regard to whether there was any misconduct.

The act also provides the SEC with express authority to issue rules requiring that a solicitation of proxy, consent, or authorization by or on behalf of a company include a nominee submitted by a stockholder to serve on the board of directors of the company (also known as "proxy access").

In recent years, stockholder groups and corporate activists have championed proxy access as a means to remove impediments under the federal proxy laws to a stockholder's ability to exercise their rights under state corporate law to nominate and elect directors. The SEC has previously proposed changes to the federal proxy rules to address proxy access, but has met considerable opposition from the business community. Much of the controversy surrounding the adoption by the SEC of these rules revolves around the ownership requirements a stockholder must meet before being entitle to submit a proposal.

The act authorizes, but does not require, the SEC to issue rules permitting the use by a stockholder of proxy solicitation materials supplied by a company for the purpose of nominating individuals to membership on the board of directors of the company. SEC Chair Mary Schapiro has indicated that she expects proxy access to be adopted in time for the 2011 proxy season. The SEC's rules are expected to resemble the SEC's most recent proposal on proxy access in June 2009.

Taken together, these provisions represent the most significant changes to the federal proxy rules in recent memory. Companies should continue to monitor developments in this area, but should not wait until 2011 to start thinking about compliance.

Jason Harmon is a partner and Christopher Edwards is an associate in the law firm DLA Piper. Sanjay Shirodkar of DLA Piper also contributed to this article.

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