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Coming Attractions

Dodd-Frank Act – Compensation Items

The financial reform bill, titled the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” will impact all public companies beginning in 2011. Informally known as the Dodd-Frank Act, certain items contained in the Act require companies to describe, defend and seek shareholder votes on specific compensation-related areas. The compensation items are to be regulated by the Securities and Exchange Commission. The following are initial highlights of the compensation-related areas. More details, including effective dates, will appear as the SEC issues final rules.

Say on Pay

Public companies are required to provide shareholders with a non-binding advisory vote on executive compensation as disclosed in their proxy, a so-called “say on pay” provision. However, the law makes clear that the say on pay vote does not create a fiduciary duty on the company or its Board. The company must also ask shareholders how frequently they would like to vote on executive pay, the so-called “say on frequency” provision. The choices are annually; every two, three or six years; or the shareholder may abstain.

Golden Parachutes

Eventually, shareholders must also be given the right to a non-binding vote on executive compensation agreements that include severance packages (written or verbal). In other words, shareholders will vote on golden parachutes. Any form of compensation, such as accelerated payments or vesting of options, must be included in this vote if it results from a merger or acquisition. Like “say on pay” and “say on frequency,” this vote is non-binding on the company and its Board.

Enhanced Compensation/Proxy Disclosures

The Act supplements existing requirements to now include a proxy discussion of the relationship between executive compensation actually paid and the financial performance of the company. The SEC seeks a discussion on how effectively executive pay relates to performance. This disclosure may include a graphic representation of the amount of executive compensation compared to a financial performance measure of the company, or the return to investors, during the period. The Act also requires companies to report the median annual total compensation of all employees (excluding the CEO) and the ratio of the median annual employee total compensation to that of the CEO. There are also expanded disclosures on payment to officers due to a change of control, specifically indicating payments that result both due to “single trigger” and “double trigger” events.

Chair/CEO Structure Disclosure

Companies must disclose in their annual proxy whether they have a separate CEO and chair of the Board of Directors, and if those roles are filled by the same individual or by separate individuals. Companies must explain their strategic reasons for adopting the leadership structure they have chosen. If these roles are combined, and a lead independent director is also designated, the disclosure must indicate the role the lead independent director plays in the leadership of the Board. The proxy must then discuss the reasons why this Board leadership structure is most appropriate for the company.

Clawbacks

The SEC will direct all companies to adopt clawback provisions that would recover incentive-based compensation, including stock options awarded as compensation, when a company is required to make significant financial adjustments such as restating its financial statements. The clawback period is the three-year period preceding the adjustment or restatement, and the clawback policy would apply to both present and former executive officers. The amount to be recovered, even if there is no misconduct by the executive (e.g., the financial adjustment is due to human error), would be any incentive-based compensation in excess of the amount that would have been payable after taking into consideration the financial adjustment.

Employee Hedging Disclosure

All public companies are to disclose in their proxies if employees or directors are eligible to purchase financial instruments that are designed to hedge or offset any decrease in the market value of equity that is part of their compensation package. This item is usually addressed in a company’s code of ethics policy.

Compensation Committee Independence

All public companies must have Compensation Committees that consist only of independent directors, and the committees must be authorized to hire independent consultants. The Act spells out that the committee is directly responsible for the appointment, compensation, and oversight of the work of the compensation consultant.

Compensation Consultant and Other Advisor Independence

The Compensation Committee must now consider the independence of any compensation consultant or advisor before engagement. The Act specifically states that, in developing independence factors to be considered, the Compensation Committee must make sure that the factors are competitively neutral among categories of consultants, legal counsel and other advisors. The Act lists some factors such as (a) policies and procedures that are designed to prevent conflicts of interest, (b) business relationships of the compensation consultant with members of the Compensation Committee and (c) stock of the company owned by the compensation consultant. The Act affirms the right of the Compensation Committee to use its sole discretion to retain compensation consultants. Any such compensation consultant retained must be disclosed in the company’s proxy along with a statement acknowledging any conflict of interest, the nature of the conflict, and how it is being addressed.

 

Immediate Actions from Dodd-Frank – Say on Pay

Say on Pay

The SEC published their proposed “Say on Pay” rules in October 2010, with final rules scheduled for release no later than March 2011. These rules require a non-binding vote regarding say on pay, say on frequency and change of control agreements (golden parachutes). All companies, regardless of size, will be required to seek at least two non-binding votes from shareholders in their 2011 proxy. The first proxy vote, say on pay, seeks approval on the executive compensation programs as described in the company’s proxy. This vote will need to be conducted in 2011 via the company’s proxy, and then potentially conducted once every one, two, three or six years thereafter (see below).

The second proxy vote, also in 2011, gives shareholders a “say” on how often they wish to vote on the company’s executive pay programs (i.e., annually, or every two, three or six years). This is the “say on frequency” vote.

 

Other Actions from Dodd-Frank Act Compensation Items

What should we be doing now?

With the exception of say on pay, little activity should be taken in early 2011 regarding the compensation items in the Dodd-Frank Act. The mantra should be: go slow. The SEC may change their schedule (timeline) for rulemaking (see below) and certain sections of the Dodd-Frank Act may be rewritten or abandoned in 2011. Finally, the congressional political climate may significantly alter the rulemaking process of the SEC.

For planning purposes, however, companies could develop specific compliance requirements, and then further detail the work steps and timeline for compliance (i.e., what we should be doing). For example, a functional department (e.g., Legal or Finance) could help define the overall requirements, then these requirements could be assigned to individuals or a department head for appropriate detailed action plans and follow-up. Some of the requirements include:

  • Chair/CEO disclosure requirement
  • Compensation Committee independence
  • Compensation Committee advisor independence
  • Compensation recovery policies (“clawback”)
  • Pay versus performance disclosure
  • Internal pay equity disclosure
  • Employee-director hedging policy disclosure
  • Broker voting of uninstructed shares

 

Appendix: SEC Rule Dates of Dodd-Frank Act

On September 20, 2010, the SEC posted a tentative schedule for its Dodd-Frank Act rulemaking on compensation items. Note that most of the executive compensation-related rules will not be finalized until mid-2011.

  1. Section 951 – Shareholder approval of executive compensation (including say on pay vote, say on frequency vote and golden parachutes vote)
    • Proposed rules: October – December 2010 – PUBLISHED
    • Final rules: January – March 2011
     
  2. Section 952 – Compensation Committee independence (including the requirement that the committee assess the independence of advisors)
    • Proposed rules: October – December 2010 – PUBLISHED
    • Final rules: April – July 2011
     
  3. Section 953 – Executive compensation disclosure (including the pay versus performance and internal pay equity disclosures)
    • Proposed rules: April – July 2011
     
  4. Section 954 – Recovery of erroneously awarded compensation (the “clawback” policy requirement)
    • Proposed rules: April – July 2011
     
  5. Section 955 – Disclosure regarding employee and director hedging
    • Proposed rules: April – July 2011
     
  6. Section 957 – Voting by brokers
    • Proposed rules: April – July 2011

As it stands, companies will need to comply with each rule if their proxy date follows the published rule dates.

 

Syzygy consultants are a valuable guide to ensure for regulatory compliance and best practices for compensating executives.

Founded in 1995, Syzygy’s principals have more than 50 years of collective experience and ask you to consider Syzygy when seeking truly independent executive compensation expertise. For example, Syzygy provides:

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