Following the enhanced disclosures required in the 2010 proxy season by the Securities and Exchange Commission ("SEC"), additional disclosures for the 2011 proxy season relating to corporate governance and executive compensation have been mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act") (see Day Pitney alert titled "Financial Regulatory Reform: Corporate Governance and Executive Compensation" dated July 2, 2010 [click here]).
In preparation for the 2011 proxy season, public companies should review their existing disclosure and update the disclosure for compliance with the Dodd-Frank Act provisions that are currently in effect. Companies also may want to consider additions in anticipation of future Dodd-Frank Act rule-making.
This alert is intended to help you prepare for the 2011 proxy season.
New Developments with Implications for the 2011 Proxy Season
Say-on-Pay and Say-When-on-Pay
Section 14A(a) of the Exchange Act, added under the Dodd-Frank Act, requires public companies holding annual meetings after January 21, 2011, to provide shareholders with an advisory vote on executive compensation in their proxy statements. At the first meeting after January 21, 2011, companies need to provide shareholders with:
(i) a nonbinding vote on executive compensation ("say-on-pay vote"); and
(ii) a vote on whether the vote required above should take place every one, two or three years ("say-when-on-pay vote")
The SEC has released proposed rules on the advisory shareholder vote (see Day Pitney alert titled "SEC Proposes 'Say on Pay' and 'Say When on Pay' Rules" dated October 22, 2010 [click here]). The comment period on the proposed rules closed on November 18, 2010, and final rules will be adopted soon. However, the timing of the final rules will not delay the effective date mandated by the Dodd-Frank Act.
As part of the vote, companies may wish to reassess their current compensation practices by taking into account guidelines issued by voting advisory firms such as Institutional Shareholder Services ("ISS") and review more controversial pay practices, such as excessive perks, tax gross-ups and executive bonuses not tied to the company's operating performance.
The say-on-pay rules require two new proposals, so it is advisable to begin drafting the relevant sections early to allow time for input and review by management, the board of directors, the compensation committee and compensation consultants. Public companies receiving Troubled Asset Relief Program ("TARP") funds in 2009 and 2010 were required to include the advisory say-on-pay vote pursuant to the Emergency Economic Stabilization Act of 2008. Those companies often continued the vote after repaying the Treasury. It will be helpful to review some of these filings for guidance (see, for example, filings of (i) JPMorgan Chase & Co., when subject to TARP [click here] and when not subject to TARP [click here] and (ii) The Goldman Sachs Group, Inc., when subject to TARP [click here] and when not subject to TARP [click here]).
Companies are required to briefly explain the general effect of the vote and the fact that it is nonbinding in nature. The proposed rules make it clear that no specific language or form of resolutions is required; however, the resolutions must be limited to the compensation of the company's named executive officers. It may also be useful to place the say-on-pay proposal in close proximity to the compensation disclosures included in the compensation discussion and analysis ("CD&A").
The proposed rules require companies to discuss in their CD&A whether and, if so, how, compensation policies take into account prior advisory votes required under the Dodd-Frank Act or TARP. Public companies who received TARP funds will have to include this disclosure in their 2011 CD&A. It may be prudent for other companies to address this question as well, stating generally what they intend to do with the outcome of the advisory vote.
In addition to the say-on-pay vote, shareholders must indicate whether they wish to have a say-on-pay vote on an annual, biennial or triennial basis or whether they abstain from voting on the matter. The say-when-on-pay vote must be repeated at least every six years. Under the proposed SEC rules, after tallying the results of the 2011 say-when-on-pay vote, companies must disclose in their next Form 10-Q or 10-K how frequently they will conduct the say-on-pay vote.
The board of directors is permitted to recommend to shareholders how they should vote; however, it must be made clear in the proxy statement that shareholders are being asked to select one of the four voting choices provided on the proxy card: annual, every two years, every three years or abstain. The board of directors should adopt a recommendation on the frequency of the vote and then state a policy. Companies that choose to adopt a frequency that is consistent with the prior plurality vote are permitted to exclude future shareholder proposals seeking a say-when-on-pay vote on the basis that the proposal has already been "substantially implemented." TARP recipients, already required to hold a similar annual say-on-pay vote, will not be required to hold an additional say-on-pay or say-when-on-pay vote until the first annual meeting after repayment of all outstanding indebtedness under the TARP.
Recent updates to ISS' U.S. Corporate Governance Policy include a recommendation for shareholders to vote for annual advisory votes on compensation. In addition, if ISS determines a problem with the current executive compensation practices in companies with less frequent say-on-pay votes, ISS may recommend that shareholders withhold votes for director nominees, particularly compensation committee members. If a company decides to recommend a say-when-on-pay vote less frequently than annually, it is recommended that the company include persuasive justification for such a recommendation in its disclosures.
Also under the Dodd-Frank Act and included in the say-on-pay proposed rules are requirements for a say on acquisition pay. In any proxy statement relating to a merger or acquisition involving a company, the company will be required to provide:
(i) tabular disclosure regarding compensation triggered by or related to the merger or acquisition; and
(ii) a nonbinding shareholder vote on such compensation arrangements unless already voted upon at an annual meeting.
Under the proposed rules, a company would be permitted to include this golden parachute compensation disclosure and approval as part of its say-on-pay vote at an annual meeting. If this is done, then the vote is not necessary in the acquisition scenario. But most companies are not likely to take such votes at the annual meeting because the disclosure is likely to change and, as a result, an earlier annual meeting vote may be ineffective for purposes of avoiding the vote in the merger context. Companies will not have to comply with the golden parachute advisory vote provisions until the effective date of the SEC's final rules, which is expected sometime early next year and then only for proxy statements relating to change in control transactions after the effective date. The proposed disclosure applies to acquirers as well as targets.
The SEC adopted new rules in August of this year, in response to the express authority granted to it under the Dodd-Frank Act, allowing shareholders to include alternative director nominees in a company's proxy solicitation materials using a company's proxy card. In certain circumstances, shareholders who have owned at least three percent of the company's voting power for the last three years and who meet other requirements may select nominees to be included in the company's proxy materials.
These rules were to become effective on November 15, 2010, but the SEC delayed implementation of the rules pending resolution by the U.S. Court of Appeals of the petition filed by the Business Roundtable and the U.S. Chamber of Commerce on September 29, 2010, challenging the legality of the rule. It is not expected that these rules will be effective in time for the 2011 proxy season in the case of calendar year companies.
Despite the delay, companies should begin to review their shareholder base and nomination procedures and criteria. In addition, companies should review their governing documents and should consider updating advance notice requirements for director nominations and director qualification provisions in their by-laws. Corporate governance guidelines and nominating committee charters should also be reviewed.
Broker Discretionary Voting
The Dodd-Frank Act mandates that the SEC issue new rules that will prevent brokers from voting their clients' securities in connection with the election of directors, executive compensation or any other significant matter as determined by SEC rule, when their clients have not specified how they want to vote. This requirement generally applied indirectly to public company proxy voting through NYSE Rule 452. A change to Rule 452 was approved by the SEC on September 9, 2010, expanding the rule to provide that brokers do not have discretionary voting rights if the matter to be voted on relates to executive compensation. This will include say-on-pay, say-when-on-pay and golden parachute votes and any other matter that relates to executive compensation. The SEC may prohibit brokers from voting uninstructed shares with respect to other matters in proposed rules expected to be released between April 2011 and July 2011. Companies should evaluate their shareholder base to determine if this prohibition will adversely affect the say-on-pay vote.
Filers of Schedules 13D and 13G Are No Longer Required to Deliver Forms to Issuers
Under the Dodd-Frank Act, filers of Schedules 13D and 13G will no longer have to deliver a copy of such forms or any amendments thereto to the relevant issuer or to the SEC. Companies will need to take the initiative to remain timely informed of changes in beneficial ownership and the emergence of new large shareholders, especially in light of certain Dodd-Frank Act provisions such as proxy access, as they will no longer have the benefit of the notice provided by the direct delivery of Schedules 13D and 13G.
Chairman and CEO Positions
The Dodd-Frank Act requires that the SEC issue rules requiring companies to disclose the reasons why they have chosen to combine or separate the positions of chief executive officer and chairman of the board in their annual proxy statements. This provision reflects a view that a separation of the roles is favored as a "best practice," a debatable issue at best. The SEC is required to issue rules by January 17, 2011. The SEC's 2009 amendments to its proxy rules (discussed below) already required companies to provide similar disclosure. Companies should review the disclosure once the final rules are issued to ensure that no changes to the disclosure are necessary.
Lessons Learned from the 2010 Proxy Season
The 2010 proxy season presented its own set of challenges respecting new disclosure in light of the amendments to the proxy disclosure rules adopted in December 2009 (see Day Pitney alert titled "SEC Adopts Significant Proxy Disclosure Enhancements" dated December 21, 2009 [click here]). There are lessons to be learned from the SEC Staff comments to the disclosures in the 2010 proxy statements. Below are some highlights from SEC Staff comments that should be considered when drafting 2011 proxy statement disclosure.
Qualification of Directors
Item 401(e) of Regulation S-K requires disclosure in a proxy statement of information related to the board's composition, including the specific experience, qualifications, attributes and skills that led to the board's conclusion that each nominee, including incumbent directors, should serve or continue to serve on the board. In commenting on the 2010 proxy statements, the SEC Staff indicated that it did not seek a narrative disclosure of a director's resume, but rather a specific enumeration of the aspects of the individual's experience, qualifications, attributes or skills that led to the conclusion that the person should serve on the board, in light of the company's business and structure, at the time that a filing containing the disclosure is made. For example, it would not be sufficient to disclose simply that a person should serve as a director because he or she is an audit committee financial expert. Instead, a company should describe the specific experience, qualifications, attributes or skills that led the board to conclude that this particular person should serve as a director at the time that a filing containing the disclosure is made. The SEC has commented on a few egregious examples of inadequate disclosure, mentioning a company that cited the "integrity" of each director as the sole qualification.
Item 407(c)(2)(vi) of Regulation S-K requires proxy statement disclosure of whether and, if so, how, the nominating committee or the board (if there is no nominating committee) considers diversity in identifying director nominees. The SEC did not provide any definition of diversity and did not limit diversity to simply racial, gender, ethnic or nationality criteria. Comments on 2010 proxy statements emphasized that the SEC Staff is not satisfied with a mere statement that diversity is considered by the nominating committee or the board when recommending director nominees. The SEC Staff expects to see more detailed disclosure with respect to how diversity is considered when identifying nominees for director. Additionally, there should be disclosure regarding whether the nominating committee or the board has a policy with regard to the consideration of diversity in identifying director nominees, and a description of how the policy is implemented and how the effectiveness of the policy is assessed.
Board Leadership Structure
Item 407(h) of Regulation S-K requires proxy statement disclosure about the company's board leadership structure, such as whether the company has chosen to combine or separate the chairman of the board and chief executive officer positions and why the company believes the leadership structure of its board is the most appropriate for the company at the time of the filing. The SEC Staff comments on board leadership structure disclosure consistently requested that companies explain why the leadership structure it espouses is in the best interest of stockholders, given the company's specific characteristics or circumstances.
Item 407(h) of Regulation S-K requires proxy statement disclosure describing the board's role in risk oversight, including how the board administers its oversight function and how such administration operates in the context of the board leadership structure. This disclosure is intended to illuminate how the company perceives the role of the board and the relationship between the board and senior management in managing the material risks facing the company. Many SEC Staff comments concerned a deficiency in disclosure regarding the effect that the board's role in the risk oversight of the company has on the board's leadership structure.
Compensation Policies and Risk
Item 402(s) of Regulation S-K requires disclosure of compensation policies and practices for all employees generally, not just executive officers, to the extent that risks arising from such compensation policies and practices are reasonably likely to have a material adverse effect on the company. No disclosure is required if the company does not believe its compensation policies are reasonably likely to have a material adverse effect on the company. The SEC Staff frequently requested information from companies regarding the process undertaken to reach their conclusion, especially when there was no disclosure.
Item 407(e)(3) of Regulation S-K requires disclosure in certain circumstances if the compensation committee of the board, the board or management engaged a consultant to provide executive or director compensation consulting services, and the consultant also provided additional services to the company in excess of $120,000 during the company's last completed fiscal year. SEC Staff comments requested information concerning the decision to engage the compensation consultant and whether the decision was made or recommended by management.
Other Disclosure Considerations
Liquidity and Capital Resources
On September 17, 2010, the SEC issued interpretive guidance about disclosure of liquidity and capital resources in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"). The interpretive guidance addressed liquidity and funding risk in three types of disclosure within the MD&A: (1) liquidity disclosure, (2) leverage ratio disclosure and (3) contractual obligations tabular disclosure.
With respect to the liquidity disclosure, the SEC reemphasized the following principles. Companies should:
Respecting the disclosure of certain repurchase agreements that are accounted for as sales, as well as other types of short-term financings that are not otherwise fully captured in period-end balance sheets, noting that legal opinions regarding "true sale" issues do not obviate the need for companies to consider whether disclosure is required, the SEC clarified that disclosure is required in the MD&A where a known commitment, event or uncertainty will result in (or is reasonably likely to result in) the use of a material amount of cash or other liquid assets.
With respect to leverage ratio disclosures, the SEC reminded companies of its approach to disclosure of financial measures and nonfinancial measures in the MD&A.
In either event, any ratio or measure should be accompanied by a clear explanation of the calculation methodology. Additionally, a company would need to consider its reasons for presenting the particular financial measure and should include disclosure clearly stating why the measure is useful to understanding its financial condition.
Finally, with respect to the contractual obligations tabular disclosure, such disclosure should be prepared with the goal of presenting a meaningful snapshot of cash requirements arising from contractual payment obligations. Companies should develop a presentation method that is clear, understandable and appropriately reflects the categories of obligations that are meaningful in light of their capital structure and business, and should prepare the contractual obligations table with the goal of:
Footnotes should be used to provide information necessary for an understanding of the timing and amount of the specified contractual obligations or, where necessary to promote understanding of the tabular data, additional narrative discussion outside the table should be considered.
Proposed Rules on Short-Term Indebtedness
The SEC has also proposed new short-term indebtedness disclosure rules, with the comment period expiring at the end of November. The proposed rules would require all public companies to disclose more details about their short-term borrowings in their MD&A. Although "financial companies" will have the most requirements to meet, any public company that uses commercial paper, repurchase agreements, letters of credit, promissory notes or factoring arrangements to meet its liquidity needs will be required to disclose additional information in its filings. The final rules may not be available for the upcoming annual report season, but companies should be watchful concerning this possible disclosure area.
On February 8, 2010, the SEC issued interpretive guidance regarding climate change with the aim of clarifying the scope of, and promoting consistency in, disclosures by public companies of material risks related to climate change. While many public companies have been voluntarily reporting climate change-related risks, all public companies will need to reexamine the disclosures they have (or have not) been providing regarding climate change in light of this interpretive guidance.
The SEC highlights the following four areas where climate change may trigger disclosure obligations:
For more information on this topic, see Day Pitney alert titled "SEC Issues Guidance on Climate Change Risk Disclosures" dated February 8, 2010 [click here].
In October 2010, the SEC's Division of Corporation Finance sent an illustrative letter to certain public companies as a reminder of the disclosure obligations they should consider in light of continued concerns about potential risks and costs associated with mortgage and foreclosure-related activities or exposures. Such disclosure obligations are not limited to financial institutions that sold or securitized mortgages or mortgage-backed securities. Companies that engage in mortgage servicing, title insurance, mortgage insurance and other activities relating to residential mortgages should also consider the disclosure obligations. A copy of the illustrative letter can be found here [click here].
In November 2010, the SEC's Division of Risk, Strategy, and Financial Innovation posted observations from its review of filings with eXtensible Business Reporting Language ("XBRL") exhibits submitted from June through August of 2010. Starting in June 2010, large accelerated filers were required to use XBRL, and by June 2011, all public companies will need to report financial statement information to the SEC using XBRL. Companies should note the issues identified by the SEC Staff in its report and should seek to address such issues in their filings. Issues noted by the SEC Staff include incorrectly entering negative values; extending an element where an existing U.S. GAAP Taxonomy element is appropriate; extending because of relatively minor additions to or deletions from the U.S. GAAP taxonomy standard definition; extending because of the context of an element; and extending elements, axis, domains or members to ensure that the XBRL renders in a particular fashion.
On July 14, 2010, the SEC issued a concept release on the proxy voting system, seeking public comment on the proxy system and proxy mechanics. The comment period for the concept release officially ended on October 20, 2010.
The release focuses on three primary topics:
With over 200 comment letters received in response to the concept release, the SEC Staff is looking through comments received with a view to moving forward with proposals on discrete issues. Although it is unclear whether any changes will affect the 2011 proxy season, it is important to be aware of the potential changes in this area.
Dodd-Frank Provisions Awaiting SEC Rule-Making
The SEC has provided a timetable [click here] for implementing the Dodd-Frank Act. There are a number of corporate governance and executive compensation items that the SEC will be addressing in the near future.
Compensation Committees, Consultants and Advisors
Compensation Committee Independence:
The Dodd-Frank Act requires the SEC to issue rules directing the national security exchanges to mandate fully independent compensation committees based on new heightened standards that exceed current requirements under both NYSE and NASDAQ rules. Such rules are expected to be similar to the current standards of independence required of audit committee members. Relevant factors in determining a member's independence include:
(i) each board member's compensation, including any consulting or advisory fees or other fees; and
(ii) whether the member is affiliated with the issuer, its subsidiaries or an affiliate of a subsidiary of the issuer.
Compensation Consultants and Other Advisors:
Additionally, the Dodd-Frank Act requires that compensation committees have the authority and funding to retain independent compensation consultants, counsel and other advisors. Compensation committee members would be responsible for the selection and oversight of these advisors. Compensation committees must consider the independence of the compensation consultants, counsel and other advisors in rules to be promulgated by the SEC, which will include:
(i) the provision of other services to the company;
(ii) the amount of fees as a percentage of the compensation consultant's, legal counsel's or advisor's total revenues;
(iii) the compensation consultant's, legal counsel's or advisor's policies and procedures regarding conflicts of interest;
(iv) the compensation consultant's, legal counsel's or advisor's business and personal relationships with the compensation committee; and
(v) any stock ownership by the compensation consultant, legal counsel or advisor.
In addition, companies will be required to disclose in their annual proxy statement:
(i) whether the compensation committee retained a compensation consultant; and
(ii) if any conflicts of interests were raised, how those conflicts were addressed.
The SEC must issue rules in this area within 360 days of enactment of the Dodd-Frank Act. The SEC has indicated that proposed rules will be issued in 2010 with final rules to be adopted between April and July 2011, the deadline being July 16, 2011. Although the final rules will not affect 2011 proxy disclosure, companies may want to revise their D&O questionnaires and compensation committee charters to address the new standard; review current compensation committee members to determine whether they meet the heightened standard; assess the engagement of consultants, counsel and advisors; and draft disclosure for their proxy statement to address any conflicts of interest with respect to consultants and advisors.
Additional Executive Compensation Disclosures
Three additional compensation disclosures will be required by public companies once the SEC issues rules pursuant to its directives under the Dodd-Frank Act (see Day Pitney alert titled "New Executive Compensation Disclosures Under Dodd-Frank" dated August 2, 2010 [click here]).
Pay versus Performance:
In future proxy statements, public companies will be required to disclose the relationship between compensation actually paid and a company's financial performance, taking into account any change in the value of shares of stock and dividends of the issuer and any distributions (a graphical representation may be included).
In addition, public companies will be required to disclose the following in their annual report or proxy statement (total compensation is to be determined in same manner as the Summary Compensation Table):
(i) the median of the annual total compensation of all employees (except the chief executive officer);
(ii) the chief executive officer's annual compensation; and
(iii) the ratio between the two.
The Dodd-Frank Act does not specify a deadline as to when the SEC is required to issue these rules relating to compensation; however, the SEC plans to propose rules between April and July 2011. Companies should assess how executive compensation will measure up to performance and decide on the method to be used to calculate the pay of all employees.
The Dodd-Frank Act requires the SEC and the stock exchanges to issue rules requiring listed companies to implement a clawback policy providing for:
(i) disclosure of the company's policy on incentive-based compensation that is based on financial information required to be reported under the securities laws; and
(ii) reimbursement to the company from a current or former executive for any excess incentive-based compensation (including stock options) paid during a three-year period preceding a restatement of the company's financials. This applies regardless of whether or not the error was a result of the officer's misconduct.
The Dodd-Frank Act does not specify a deadline as to when the SEC is required to issue these rules relating to clawback of compensation; however, the SEC plans to propose rules between April and July 2011. These provisions extend the Sarbanes-Oxley clawback provision, which applies only to a company's chief executive and chief financial officers. Companies should revise current policies or adopt new policies in light of these proposed rules and should evaluate the effect of the clawback provisions on any existing agreements or company policies.
The Dodd-Frank Act also requires the SEC to adopt rules to mandate proxy disclosure regarding whether any employees or directors of the company or their designees are permitted to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars and exchange funds) designed to hedge or offset any decrease in the market value of equity securities granted as compensation or held directly or indirectly by the employee or director (see Day Pitney alert- titled "Disclosure of Employee and Director Hedging" dated July 28, 2010 [click here]). Companies should revise current policies or adopt new policies to prohibit hedging transactions for directors and employees.
Investment Manager Vote Reporting
In October 2010, the SEC proposed rules regarding the requirement for investment managers to disclose how they voted regarding executive compensation and golden parachute compensation in a report made by August 31 of each year covering the twelve-month period ending June 30. Final rules are expected to be released in the first quarter of 2011.
In November 2010, the SEC issued proposed rules with respect to the Dodd-Frank Act whistleblower program. The program is designed to provide incentives for whistleblowers to report securities law violations to the SEC. The SEC plans to release final rules in the first quarter of 2011. Companies should review current policies and procedures and confirm that they have sufficient anti-retaliation provisions. Companies may also want to provide internal incentives to encourage employees to follow existing internal reporting programs.
The SEC has started to run advertisements to encourage whistleblowers. Plaintiff's lawyers also have begun to run advertisements in several cities to encourage whistleblowers to come to them.
The SEC is expected to issue rules in 2011 pursuant to the Dodd-Frank Act requiring annual disclosure relating to the use of "conflict minerals" in the new year. "Conflict minerals" include minerals such as gold, columbite-tantalite or anything else the U.S. Secretary of State determines to be financing conflict in the Democratic Republic of Congo or adjoining countries. As a wide range of products contain derivatives of such minerals, companies must carefully review their supply chain to assess the source and chain of custody of the conflict minerals.
Payments Made by Resource Extraction Issuers
The SEC is also expected to issue final rules in 2011 requiring disclosure by resource extraction issuers of any payments made to foreign governments or the U.S. federal government for the purpose of the commercial development of oil, natural gas or minerals.
 SEC Release Nos. 33-9153; 34-63124, "Shareholder Approval of Executive Compensation and Golden Parachute Compensation." [click here]
 SEC Release Nos. 33-9136; 34-62764; IC-29384, "Facilitating Shareholder Director Nominations." [click here]
 SEC Release Nos. 33-9144; 34-62934, "Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management's Discussion and Analysis." [click here]
 SEC Release Nos. 33-9143; 34-62932, "Short-Term Borrowings Disclosure." [click here]
 SEC Release Nos. 33-9106; 34-61469, "Commission Guidance Regarding Disclosure Related to Climate Change." [click here]
 Staff Observations From Review of Interactive Data Financial Statements (from November 1, 2010). [click here]
 SEC Release Nos.34-62495; IA-3052; IC-29340 "Concept Release on the U.S. Proxy System." [click here]
 SEC Release Nos. 34-63123; IC-29463, "Reporting of Proxy Votes on Executive Compensation and Other Matters." [click here]
 SEC Release No. 34-63237, "Proposed Rules for Implementing the Whistleblower Provisions of Section 21F of the Securities and Exchange Act of 1934." [click here]