The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) introduced a number of regulatory provisions directly impacting executive compensation:

  • Say-on-pay – a non-binding shareholder vote on the company's executive compensation and policies
  • Say-on-golden parachutes – a non-binding shareholder vote upon a merger or acquisition that clearly outlines agreements or other arrangements that would be impacted by the event
  • Compensation committee independence – all compensation committee members are required to be independent according to the standards for listing on an exchange
  • Compensation consultant independence – compensation committees must consider independence when choosing compensation consultants and other advisers
  • Pay-for-performance disclosure – disclosure comparing executive compensation levels and stock price performance over a five-year period
  • Internal pay ratio disclosure – disclosure of the ratio of the median total compensation for all employees compared to the total compensation of the CEO
  • Clawback/compensation recovery policies – companies must implement a policy that allows for recovery of incentive-based compensation in the event of a restatement (three-year look-back period)
  • Proxy access rules – companies must include a shareholder nominee to serve on the board and follow certain procedures with respect to solicitation of proxies

The SEC has issued final rules (effective March 26, 2011) on the shareholder say-on-pay provision of Dodd-Frank. The SOP will be required for most proxy statements issued in 2011, but virtually all companies are seeking to comply. In addition, the say-on-golden parachutes provision is required at shareholder meetings held for purposes of approving a merger, acquisition or similar transaction; the vote on golden parachutes only applies to compensation arrangements that have not already been subject to the regular say-on-pay vote. The rules related to most other provisions are likely to be adopted for the 2012 proxy season. 

Shareholder say-on-pay

The shareholder say-on-pay (SSOP) vote requires periodic nonbinding shareholder votes on compensation of executives of companies subject to the SEC's proxy solicitation rules. Section 951(a) of Dodd-Frank provides that, not less frequently than once every three years, a company's proxy statement for a shareholder meeting that includes required executive compensation disclosure must also provide for a nonbinding shareholder vote on executive pay.

The say-on-pay vote is a single "yes" or "no" vote on the total compensation package provided to the named executive officers (NEOs), as described in the Compensation, Discussion and Analysis (CD&A) and compensation tables. As a result, one questionable action, payment or practice could cause shareholders to vote "no," regardless of the reasonableness of the overall packages. Therefore, compensation committees should consider literally each compensation decision, payment or policy. If the total compensation program for the NEOs is reasonable but there is one issue, such as a gross-up on perquisites or golden parachute payments, shareholders may vote "no" on the total program. There is no other way for shareholders to register disapproval; they cannot object to one provision or practice only.

The SEC's proposed rules provide that companies must give shareholders four choices regarding the frequency of the SSOP vote:

  1. The shareholder vote on executive compensation will occur every year
  2. The shareholder vote on executive compensation will occur every 2 years
  3. The shareholder vote on executive compensation will occur every 3 years
  4. Abstain

The board can recommend how shareholders should vote on the frequency of SSOP votes (as it can with other proposals put to shareholders for a vote). What should the company or board recommend to shareholders regarding the frequency of SSOP votes? In general, initial reaction has been that the vote should occur no more often than once every other year, as it:

  • gives the company more time to understand the vote and respond to the voting results,
  • aligns more closely with multiyear performance cycles,
  • allows proxy advisers to make more informed decisions and recommendations, and

Conversely, an annual vote would allow a company to address and remedy a particular practice that may have caused a negative vote in order to receive a positive vote on a timelier basis. The SEC's final rules also require that companies address in the CD&A, whether and how they took into account the results of the SSOP vote.

Companies should be mindful of the guidelines and recommendations set forth by proxy advisory firms, such as Institutional Shareholder Services (ISS, formerly RiskMetrics Group), and the influence they can have on voting outcomes.

For 2011, ISS has adopted a policy supporting but not requiring an annual vote (other shareholder advisory firms may seek an annual vote).  The advantage of an annual vote is that if the company offers (i.e., proxy statement contains) the SSOP vote every year, then ISS and other shareholder advisers will focus on it as a potential means of expressing dissatisfaction of executive compensation or other matters. However, if ISS and others cannot express their dissatisfaction through SSOP, they may be more likely to focus on and recommend a vote against directors running for re-election. And that vote is legally binding (unlike SSOP, which is merely advisory).

Shareholder say-on-golden parachutes

DFA defines, 'golden parachute compensation' as any type and amount of compensation that relates to a change in control transaction. As a result, 'golden parachute compensation' does not refer only to payments in excess of three times a covered executive's base annual compensation (i.e., the threshold that triggers adverse tax consequences under the Internal Revenue Code). Companies must conduct a separate shareholder advisory vote regarding golden parachute compensation arrangements in proxy statements for meetings to approve an acquisition, merger, consolidation or proposed sale or other disposition of all or substantially all of the assets of the company.

The shareholder say-on-golden parachutes requirement includes an exception, which provides that a separate resolution seeking shareholder approval of golden parachute compensation would not be required if shareholders already have approved such agreements or understandings in a say-on-pay vote. To take advantage of this exception, a company must follow the disclosure requirements of new, proposed rules rather than the more general, current requirements (which would continue to apply to payments arising from other severance arrangements). 

The merits of including parachute payments in the 2011 SSOP are being debated at this time. Many companies are not including the golden parachute vote in their 2011 annual meeting proxy statements because of the attention that vote may draw from ISS, as noted in their position provided in a recent frequently asked questions policy release:

  • FAQ #1: Under what circumstances would a say-on-pay vote be combined with a golden parachute proposal on a proxy? If the company's shareholder meeting proxy includes a prescribed golden parachute table in the CD&A ... the information provided in the golden parachute table would carry more weight in our overall MSOP recommendation.
  • FAQ #2: How will ISS treat say-on-pay votes if say-on-parachute votes are deferred? Will ISS fault companies for not bringing a separate parachute vote in 2011? The Dodd-Frank Act requires an advisory vote on golden parachutes when a CIC transaction is on the ballot, unless previously approved by shareholders as part of the advisory vote on say-on-pay. ISS has no policy on the timing of the golden parachute vote.

In addition, there is the concern that including parachute payments in the SSOP may raise questions from the SEC.

Recommended action steps

The Dodd Frank Act impacts 2011 SEC proxy disclosure requirements on executive compensation. Immediate action is necessary with respect to the shareholder say-on-pay vote. The SSOP may also impact the company's executive compensation programs and practices; therefore, an assessment of the company's various executive compensation policies and programs with respect to Dodd-Frank provisions may also be important and timely. One way to determine if the executive officer compensation program will receive a negative shareholder vote would be to review the company's current practices as compared to ISS "Problematic Pay Practices," which if present likely would cause the ISS to recommend a vote against a SSOP proposal. A company might also discuss their executive compensation programs with investors (particularly large or institutional investors) in advance, to help identify and address concerns prior to the formal vote.

Compensation committees will need to more carefully consider compensation policies and practices and CD&A disclosure of those policies and practices. The net effect is that the CD&A and tabular disclosures have a new target audience — retail shareholders (and employees if a company has broad-based stock ownership). To date, most of the focus has been on drafting CD&As to meet the SEC's disclosure requirements. 

As always, we recommend that companies and boards be diligent in understanding regulatory changes, assess the potential impact on compensation policies and decisions, and take action as required to maintain programs that attract and retain leadership talent.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.