In this issue of our Dodd-Frank Survival Guide, we discuss the most significant executive compensation and corporate governance reforms instituted by the Dodd-Frank Wall Street Reform and Consumer Protection Act. These reforms impact most publicly-traded companies and certain financial institutions (whether or not they are publicly-traded). Most of these changes require rulemaking efforts by the Securities and Exchange Commission (SEC), other federal regulators and/or the national securities exchanges before they can become effective, but some are effective now.
1. Change to the Definition of Accredited Investor – Effective Immediately
Dodd-Frank changes, until July 21, 2014, the net worth threshold for a natural person to qualify as an “accredited investor” for purposes of the SEC’s rules under the Securities Act of 1933, including Regulation D. The dollar amount remains at $1 million, but a natural person must now exclude the value of a primary residence when determining qualification. Dodd-Frank allows the SEC to review the other accredited investor standards that apply to natural persons at any time and to make any changes that the SEC deems necessary or appropriate to protect investors.
Action Item: Companies who are currently conducting or considering a private placement of securities to accredited investors must ensure that their subscription materials reflect this new net worth threshold.
2. Financial Reporting – Effective Immediately
On a positive note, Dodd-Frank amends Section 404 of the Sarbanes-Oxley Act to exempt non-accelerated filers from the requirement to provide an auditor attestation of management’s report on internal control over financial reporting. Dodd-Frank did not, however, exempt non-accelerated filers from the requirement that management include its assessment of the effectiveness of the company’s internal control over financial reporting.
3. Stockholder Advisory Vote Requirements –After January 21, 2011
Dodd-Frank creates two new stockholder advisory vote requirements that will apply to public companies beginning with annual meetings of stockholders held after January 21, 2011.
First, every public company is required to seek an advisory stockholder vote on executive compensation, as disclosed in the proxy statement. The vote must be held no less frequently than once every three years. Stockholders determine the frequency of this “Say on Pay” vote, and public companies must seek a stockholder vote on the frequency at least once every six years. The SEC has the authority to exempt a company after considering the burdens that the advisory vote requirement would impose on the company.
Second, for every meeting at which stockholders will be asked to approve a change in control or similar transaction, the proxy statement must disclose all “golden parachute” arrangements between the public company and/or the acquiring company and any named executive officer that relate to that transaction, and the public company must seek an advisory stockholder vote on those arrangements.
Both of these advisory votes are non-binding on the company, so they will not overrule a decision of the company or its board of directors. Moreover, Dodd-Frank specifically provides that an advisory vote does not create or imply any change to a board of director’s fiduciary duties.
On October 18, 2010, the SEC published proposed rules regarding these new voting requirements. Companies are required to include the “Say on Pay” vote regardless of when the SEC rules are effective, but the vote on golden parachute arrangements will not be effective until the SEC rules are effective.
Action Item: Public companies should review and discuss these new requirements with counsel and the persons responsible for preparing the proxy statement.
4. Compensation Committee Reforms – Effectiveness Subject to Mandated Rulemaking
No later than July 16, 2011, the SEC is required to issue regulations that will require national securities exchanges and associations to prohibit the listing of the equity securities of most companies that do not comply with four new requirements relating to compensation committees. First, each public company must have a compensation committee that is made up entirely of independent directors, and the exchanges and associations will have to consider relevant factors in defining independence, such as how and why the committee member is paid by the company and whether the committee member is affiliated with the company and its subsidiaries. Second, the compensation committee, before retaining a compensation consultant, including legal counsel, must consider various factors that could affect the consultant’s independence. These factors will include: other services provided to the company by the consultant, the amount of fees paid to the consultant for compensation work (as a percentage of total revenues of the company), the committee’s policies and procedures that are designed to prevent conflicts of interest, any business or personal relationship of the consultant with a member of the compensation committee, and whether the consultant owns any stock of the company. Third, the compensation committee must be solely responsible for the hiring, payment, oversight and firing of compensation consultants. Fourth, proxy statements with respect to annual meetings of stockholders occurring after July 21, 2011 must disclose whether the compensation committee retained a compensation consultant and whether the consultant’s work raised any conflict of interest and, if so, the nature of that conflict and how it was or is being addressed.
Action Items: Listed companies should monitor the rulemaking efforts of the national securities exchanges and associations. Compensation committees of listed companies should consider the impact that these new rules may have on their independence and compensation policies and procedures and plan accordingly.
5. Executive Compensation Disclosures – Effectiveness Subject to Mandated Rulemaking
Dodd-Frank requires the SEC to amend the proxy rules to require new disclosures by publicly-traded companies about executive compensation. First, the proxy statement for any annual meeting of stockholders must disclose the relationship between executive compensation and the financial performance of the company. Second, these proxy statements also must disclose the median of the annual total compensation of all employees of the company other than the chief executive officer, the annual total compensation of the company’s chief executive officer and the ratio of these two amounts.
6. Claw-Back of Executive Compensation – Effectiveness Subject to Mandated Rulemaking
The national securities exchanges must adopt rules that prohibit the listing of any security of a company that does not adopt a policy with respect to the “claw-back” of executive compensation. The policy must provide for disclosure of the company’s policy on incentive-based compensation that is based on financial information required to be reported under the securities laws. In the event of an accounting restatement due to the company’s material noncompliance with any financial reporting requirement, the policy must require the company to recover any excess compensation above that which would have been paid, after giving effect to the restatement, from any current or former executive officer who received incentive-based compensation (including stock options) during the three-year period preceding the restatement date.
7. Compensation Reports to Federal Regulators – Effectiveness Subject to Mandated Rulemaking
On or before April 21, 2011, Dodd-Frank requires the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the National Credit Union Administration, the SEC and the Federal Housing Finance Agency to jointly promulgate regulations requiring each “covered financial institution” with assets of $1 billion or more to disclose to its federal regulator the structure of its incentive-based compensation arrangements and prohibiting a covered financial institution from entering into any incentive-based compensation arrangement that encourages (as determined by the federal regulators) the institution to take inappropriate risk. A “covered financial institution” includes a depository institution, a depository institution holding company, a registered broker or dealer, a credit union, an investment adviser, FannieMae, FreddieMac, and any other financial institution designated by the federal regulators.
8. New Limits on Voting by Broker-Dealers – Effectiveness Subject to Mandated Rulemaking
The national securities exchanges must amend their rules to prohibit a member broker-dealer from granting a proxy with respect to director elections (except in uncontested elections of board members of registered investment companies), executive compensation or any other significant matter (as determined by the SEC) unless the broker-dealer has received voting instructions from its customer.
9. Corporate Governance –Subject to Discretionary and Mandated Rulemaking
Dodd-Frank gives the SEC express authority to adopt rules that would require a publicly-traded company to include in its proxy statement a director nominee submitted by a stockholder. The SEC's existing proxy access rule was made final in August 2010, but the SEC stayed the rule's effectiveness pending the resolution of litigation challenging its enforceability. It is uncertain how Dodd-Frank will impact this litigation and the SEC's rulemaking efforts, but it is clear from the existing rule that the SEC is eager to facilitate the effective exercise of stockholders' traditional state law rights to nominate and elect directors.
No later than January 17, 2011, the SEC must adopt rules that require publicly-traded companies to include in their annual proxy statements an explanation of why the positions of chief executive officer and chairman of the board of directors are separate or combined.
Finally, the Federal Reserve Board must promulgate rules by July 21, 2011 to require publicly-traded "Systemically Significant Nonbank Financial Companies" and publicly-traded bank holding companies with total consolidated assets of at least $10 billion to have risk committees that are responsible for oversight of enterprise-wide risk management practices. These risk committees must include a number of independent directors determined by the Federal Reserve Board and at least one risk management expert who has experience in risk management at large, complex companies. The Federal Reserve Board is authorized to require risk committees for smaller publicly-traded bank holding companies if it determines that such committees are necessary or appropriate to promote sound risk management practices. The Federal Reserve Board must adopt rules to implement these requirements no later than July 21, 2011 (subject to a six-month extension).
Please contact our Dodd-Frank Survival Guide Team to discuss any of the above topics in greater detail.
Copyright 2010 Gordon Feinblatt, LLC. DODD-FRANK SURVIVAL GUIDE is intended for informational purposes only and is not legal advice to any person, entity, or firm. The material included in DODD-FRANK SURVIVAL GUIDE is obtained from a variety of public sources. Portions of the content of this email may contain Attorney Advertising under the rules of some states. Prior results do not guarantee a similar outcome.