What the Dodd-Frank Wall Street Reform and Consumer Protection Act Means for Public Companies

16 July 2010 Publication
Authors: John K. Wilson

Legal News Alert: Transactional & Securities

On July 15, 2010, the U.S. Senate approved the Dodd-Frank Wall Street Reform and Consumer Protection Act (Act), which the U.S. House of Representatives also approved on June 30, 2010. President Obama is expected to sign the Act into law within days.

The Act primarily addresses the overhaul of the national financial regulatory regime, but also contains corporate governance, executive compensation, disclosure, and other provisions that apply to public companies generally. This alert addresses only these provisions that are generally applicable to public companies, which include providing the SEC with authority to implement proxy access, mandating shareholder advisory votes on executive compensation and “golden parachutes,” enhancing compensation committee and adviser independence requirements, mandating executive compensation clawbacks, and increasing disclosure in proxy statements. Importantly, the Act does not require public companies to implement a majority voting standard in uncontested elections for directors as had been included in some prior versions of the legislation.

Proxy Access

The Act provides express authority for the SEC to promulgate rules requiring inclusion of shareholder nominees for director in the issuer's proxy solicitation materials and establishing the procedures to be followed by the issuer in relation to that solicitation. House and Senate conference members discussed, but did not include in the Act, minimum share ownership thresholds or holding periods for shareholders seeking to nominate directors, leaving the SEC to address these issues through rulemaking.

While the Act does not require the SEC to take action with respect to proxy access rules, we expect the SEC to do so in the near future. The SEC proposed rules in June 2009 that would establish proxy access, and SEC Chairman Mary Schapiro stated in a June 2010 speech that she was committed to bring a proposal for final proxy access rules to the SEC so that they would be in effect for the 2011 proxy season.

Shareholder Advisory Votes on Compensation Matters

“Say-on-Pay” Vote on Executive Compensation
Issuers must include in their proxy statements at least every three years a separate resolution subject to shareholder vote to approve the compensation of their named executive officers. This so-called say-on-pay vote will not be binding and expressly may not be construed as overruling any of the board's decisions, creating or implying any change or addition to any fiduciary duties, or limiting the ability of shareholders to make proposals for inclusion in proxy statements related to executive compensation. This provision will be applicable for the issuer’s first annual or other meeting of shareholders occurring more than six months after the enactment of the Act and does not require SEC rulemaking to become effective, although it is possible that the SEC may adopt rules relating to certain procedural matters with respect to holding such a vote. In addition, at such meeting of shareholders, issuers must include in their proxy statements an additional separate resolution subject to shareholder vote to determine whether the say-on-pay vote will occur every one, two, or three years. Thereafter, issuers must provide shareholders with the opportunity to vote on the frequency of the say-on-pay vote at least once every six years.

Vote on "Golden Parachutes"
Any proxy solicitation material for a meeting of shareholders occurring more than six months after the enactment of the Act at which shareholders are requested to approve an acquisition, merger, consolidation, or proposed disposition of all or substantially all the assets of the issuer must:

  • Disclose in a clear and simple form in accordance with rules to be adopted by the SEC any agreements or understandings that the entity soliciting proxies has with any named executive officers of the issuer (or of the acquirer) concerning any compensation (whether present, deferred, or contingent) that is based on or otherwise relates to the business combination being voted on as well as the aggregate total of all such compensation that may be paid or become payable to or on behalf of such executive officer and the conditions under which it may be paid or become payable; and
  • Include a separate resolution subject to shareholder vote to approve such agreements or understandings and compensation as disclosed, unless such agreements or understanding have been subject to a say-on-pay shareholder vote. This vote on so-called golden parachutes will not be binding and expressly may not be construed as overruling any of the board's decisions, or creating or implying any change or addition to any fiduciary duties.

Institutional Investment Manager Disclosure
Institutional investment managers exercising investment discretion over $100 million or more of U.S. public company equity and certain other securities must report at least annually how they voted on shareholder advisory votes on executive compensation and golden parachutes.

Voting by Brokers
National securities exchanges must prohibit brokers from granting proxies to vote shares on the election of directors, executive compensation, or other significant matters (as determined by SEC rule) unless the beneficial owner of the shares has instructed the broker how to vote on the proposal. Because amendments in 2009 to New York Stock Exchange Rule 452 eliminated discretionary voting for director elections, the practical implication of this change would be to eliminate discretionary voting on executive compensation matters, including for shareholder advisory votes on executive compensation and golden parachutes.

Compensation Committee and Adviser Independence

The SEC must issue rules within 360 days after the enactment of the Act directing national securities exchanges to prohibit the listing of issuers that do not comply with the enhanced independence requirements for compensation committee members and advisers and related provisions of the Act discussed below. These provisions of the Act will not apply to a “controlled company,” which is defined as an issuer in which 50 percent of the voting power for the election of directors is held by an individual, a group, or another issuer.

Compensation Committee Independence
Each member of an issuer’s compensation committee must be independent. The SEC rules must require that independence be determined considering relevant factors, including the source of the director's compensation (including any consulting, advisory, or other compensatory fee paid by the issuer) and whether the director is affiliated with the issuer or its subsidiaries.

Compensation Consultant and Other Adviser Independence
Although the Act does not require compensation consultants, legal counsel, or other advisers to be independent, a compensation committee will only be able to select a compensation consultant, legal counsel, or other adviser after taking into consideration factors identified by the SEC that effect independence and must include:

  • The provision of other services to the issuer by the adviser's firm;
  • The amount of fees received from the issuer by the adviser’s firm as a percentage of the adviser firm's total revenue;
  • The policies and procedures of the adviser's firm that are designed to prevent conflicts of interest;
  • Any business or personal relationship of the adviser with a member of the compensation committee; and
  • Any stock of the issuer owned by the adviser.

The factors must be competitively neutral among the categories of consultants, legal counsel, or other advisers and preserve the ability of compensation committees to retain the services of members of any such category.

Authority to Engage Compensation Consultants and Other Advisers
The compensation committee must have the authority to retain and obtain advice from independent compensation consultants, legal counsel, and other advisers and be directly responsible for their appointment, compensation, and oversight. Issuers must provide for appropriate funding as determined by the compensation committee for payment of reasonable compensation to the independent compensation consultants, legal counsel, and other advisers.

Proxy Statement Disclosure
Pursuant to rules to be adopted by the SEC, issuers must disclose in their proxy statements for meetings of shareholders occurring more than one year after enactment of the Act whether the compensation committee retained or obtained the advice of a compensation consultant and whether the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed. SEC rules adopted in late 2009 already require issuers to disclose the role of compensation consultants and work done by the consultants for the issuer as well as certain conflicts of interest.

Compensation Clawbacks

The SEC must issue rules directing national securities exchanges to prohibit the listing of issuers that do not develop and implement policies providing:

  • For disclosure of the issuer’s policy regarding any incentive-based compensation that is based on financial information required to be reported under the securities laws; and
  • That, if the issuer is required to prepare an accounting restatement due to its material noncompliance with any financial reporting requirement under the securities laws, the issuer will recover from any current or former executive officer who received incentive-based compensation (including stock options awarded as compensation) during the three-year period preceding the date on which the issuer is required to prepare an accounting restatement, based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement.

Section 304 of the Sarbanes-Oxley Act of 2002 (SOX) already contains a clawback provision, although the standard under the Act is stricter than the SOX standard because SOX requires that the restatement occur “as a result of misconduct,” only applies to a company’s CEO and CFO, and is limited to a 12-month period preceding the restatement.

Other Disclosure Matters

Pay Versus Performance and Pay Disparity
The SEC must issue rules requiring issuers to disclose in their proxy statements:

  • Information showing the relationship between executive compensation and the financial performance of the issuer, taking into account any change in the value of the issuer's shares, which may include a graphic representation of the information required to be disclosed; and
  • The median of the annual total compensation of all employees of the issuer, except the CEO; the annual total compensation of the CEO; and the ratio of those two amounts, with total compensation determined in accordance with Item 402 of Regulation S-K.

Employee and Director Hedging
The SEC must promulgate rules to require issuers to disclose in their proxy statements whether any employees or directors are allowed to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds) designed to hedge or offset a decline in value of equity securities granted to them as part of their compensation or otherwise held by them directly or indirectly. Although the Act only requires disclosure of an issuer’s policy with respect to purchasing those hedging instruments and does not require disclosure of whether or not such individuals have actually purchased those hedging instruments, current SEC proxy rules require specific hedging transactions by executive officers or directors to be disclosed in an issuer’s proxy statement.

Chairman and CEO Structure
The SEC must establish rules requiring issuers to disclose in their proxy statements the reasons why the issuer has chosen either the same person or different individuals to serve as chairman of the board and CEO. SEC rules adopted in late 2009 already require issuers to disclose in their proxy statements whether and why they have combined or separated the board chair and CEO positions. It is not clear that the provisions of the Act will require any disclosure in addition to that already required under current SEC rules.

Smaller Companies

Exemption From SOX Internal Control Attestation Requirements
The Act permanently exempts issuers that are neither “large accelerated filers” nor “accelerated files” from the SOX Section 404(b) requirement to have the external auditor attest to internal control over financial reporting. The Act also requires the SEC to conduct a study to determine how the SEC could reduce the burden of complying with SOX Section 404(b) for issuers whose market capitalization is between $75 million and $250 million.

Potential Exemptions Under the Act
The provisions of the Act with respect to proxy access authority, shareholder advisory votes on executive compensation and golden parachutes, and the compensation committee and adviser independence requirements permit the SEC or the national securities exchanges to exempt classes of issuers from such requirements of the Act and direct the SEC or the national securities exchanges to take into account whether the requirements of the Act would disproportionately burden small issuers in making such a determination. Accordingly, it is possible that the SEC may exempt certain smaller issuers from having to comply with these requirements through rulemaking.

Timing and Actions to Take Now

Most of the provisions in the Act relating to corporate governance, executive compensation, and disclosure require rulemaking by the SEC or national securities exchanges. We believe it is likely the SEC will adopt rules implementing these provisions so that they are applicable for the 2011 proxy season. In addition, the say-on-pay vote on executive compensation requirement will become effective six months after the enactment of the Act without SEC rulemaking and thus will be applicable to most annual meetings in 2011. While public companies may not be able to make final decisions regarding matters subject to SEC rulemaking until final rules are available, public companies and their boards of directors should begin now to review and consider the matters discussed in this alert, as there may be only a short time period between the SEC adopting final rules and the 2011 proxy season:

  • Proxy Access. Companies will need to revise advance notice provisions in their bylaws to comply with the provisions of SEC final rules on proxy access, when and if adopted, and may want to use this opportunity to otherwise confirm such provisions are up to date.
  • Say-on-Pay Vote on Executive Compensation. Companies should begin now to be proactive with shareholders in justifying executive compensation, to consider that shareholders will have a vote when making compensation decisions, and to think about what they will say in their say-on-pay disclosure in their proxy statements. While the shareholder vote on compensation is only advisory, the results of that vote may impact whether shareholders withhold votes for compensation committee members in director elections, which is of particular note for companies that have adopted majority voting. In addition, the say-on-pay vote would require a company to file a preliminary proxy statement with the SEC at least 10 days in advance of mailing the definitive proxy statement, which would impact a company’s annual meeting timetable, unless the SEC adopts rules to exempt companies from having to file a preliminary proxy statement for such a vote (which the SEC did for companies receiving Troubled Asset Relief Program funds).
  • Compensation Committee and Adviser Independence. Companies will need to update their compensation committee charters once final rules become available. In the meantime, companies also should be considering the independence of their compensation committee members and compensation consultants and other advisers to determine if changes will need to be made.
  • Compensation Clawbacks. Companies will need to adopt new policies or update existing policies once final rules on compensation clawback provisions become available. Companies should be considering now what changes will need to be made in light of the provisions in the Act. 


Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues.

If you have any questions about this alert or would like to discuss the topic further, please contact your Foley attorney or the following individuals:

Peter C. Underwood
Milwaukee, Wisconsin
414.297.5630
punderwood@foley.com

John K. Wilson
Milwaukee, Wisconsin
414.297.5642
jkwilson@foley.com

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